Wonder why

If all the administrative measures that China has taken so far still result in this kind of a news story (ht: Kedrosky) – ‘Beijing Cancels Land Auction After Bids Exceed Price Ceiling’ (more here), the questions are as follows: why are the signals not being taken or received by the other side? Or, how big is the bubble? What are we missing here? More worryingly for the Chinese government, what are they missing?

This piece by Gerard Lyons on China beating back the U.S. dollar via backdoor must have been written at least couple of weeks ago, if not longer. Times have changed. That is what my recent MINT column tried to convey.

There is some useful advice here from Geoff Dyer for nations trying to influence, contain China. It should help the US too.

[Posting all of these from the Seoul Airport on the way back to Singapore after speaking at a conference on the topic of ‘New Decade’ for world markets and economies. I said that the ‘New Normal’ had not arrived for the world. More on that later. Well, managed to actually complete the post 24-hours later in Singapore!]

SKS – a MFI IPO in India

Vijay Mahajan lends a neat touch of sobriety and cool reason to the hot issue of the forthcoming IPO of SKS Microfinance in India. It would help to cool temperatures and manufactured rage on IPO profits, etc. He has lucidly shown how scale and reach make IPOs inevitable for efficient, successful and ambitious Micro Finance Institutions (MFI).

The hope is that the success makes them focus on the livelihood solutions apart from lending and second, that the industry engages in  ‘moral self-policing’ on super-normal profits for investors – issues that have become relevant to Micro Finance surprisingly quickly while it took several decades to become ones for ‘mega finance’.

Two good commentators

Swaminathan Aiyar is a shrewed, perceptive and intelligent observer of the world and Indian economic scene. His recent piece on the ‘intellectual superiority and casteist superiority’ that socialists assigned themselves is marvellous. More than that, with few empirical observations, he nails the Leftist naysayers to the cross. Must-read piece.  Some choice paragraphs, reproduced here:

Anand Chandavarkar’s recent book Unexplored Keynes and Other Essays has a lovely anecdote about Nehru’s unwillingness to see beyond Fabian socialism. Nehru asked B P Adarkar, Trade Commissioner to West Germany,” What is the secret of Germany’s phenomenal economic recovery?” Adarkar forthrightly responded: “Mr Prime Minister, I know the answer but you will not like it. It is free enterprise.” An impassive Nehru merely looked out of the plane window!

Rajni Kothari and several other contributors to Economic and Political Weekly forecast in 1991 that economic reforms would make Indian industry collapse or become indentured labour to MNCs. They also claimed that accepting patents in the Uruguay Round would destroy India’s pharma industry. Events soon proved them economically illiterate and intellectually bankrupt. Kothari moaned in 1989 that India had moved from self-reliance to Reliance. He could not even conceive that it would be a change for the better!

Another commentator that readers should follow regularly is Prof. Arvind Subramanian. The concluding paragraphs in his latest piece in VoxEU are unassailable:

The policy lesson is clear. Coordination is needed among emerging economies on managing capital flows and exchange rates. Key to facilitating this coordination is China’s exchange-rate policy. It is a welcome development that China has signalled that the renminbi will be more flexible going forward. But its likely policy of gradualism risks being overtaken by events. Given the tidal wave of capital flows, a small move by China will probably only elicit a small move by other countries especially in Asia. Given the widely held belief about the magnitude of eventual appreciation, the one-way bet will remain largely intact, with not much dampening effect on flows.

Rectifying the new imbalance will, in this environment, require a more ambitious move by China. With that in place other emerging economies can follow suit and allow more flexibility in their own currencies. De facto policy coordination is possible and China moving soon and substantially can help bring that about.

I do not agree with him on this, however:

… emerging economies have started to tighten monetary policies either to head off incipient inflationary pressures (China, India and Indonesia) or simply to unwind the earlier monetary accommodation as growth returns to normal.

To the extent that some flows are unavoidable and even desirable, emerging economies have to be ultra-vigilant in preventing overheating of goods and asset prices domestically. Here there is reason for optimism. Especially in Asia the experience of and lessons from the late-1990s crisis and that of the recent one have been firmly etched in the collective DNA. The 1990s crisis in emerging economies taught them what not to do, while the latest financial crisis that emanated elsewhere affirmed the prudent policy choices made in the intervening years.

Lessons might have been accepted at a conceptual level. But, they are not being put to use. Both China and India are not being pre-emptive enough – nowhere near the required level. I have commented on it in detail in my forthcoming piece in ‘Pragati’.

RBI falls behind?

A central bank that has tightened the Cash Reserve Ratio by 100 basis points in just four months and raised interest rates twice in the New Year already cannot, under normal circumstances, be said to be lagging behind in its quest to bring the cost of funds in line with reality. Reserve Bank of India is that central bank. It has a stellar reputation in keeping inflation, by and large, on a tight leash, in a country that has become very firmly addicted to huge and mostly unproductive fiscal deficits. But, the problem is that RBI has made its task a lot more difficult than it already is. That is what this post is about.

From the website of the RBI, these are its main functions:

Main Functions

Monetary Authority:

Formulates, implements and monitors the monetary policy.
Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.

Regulator and supervisor of the financial system:

Prescribes broad parameters of banking operations within which the country’s banking and financial system functions.
Objective: maintain public confidence in the system, protect depositors’ interest and provide cost-effective banking services to the public.

Manager of Foreign Exchange

Manages the Foreign Exchange Management Act, 1999.
Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.

Issuer of currency:

Issues and exchanges or destroys currency and coins not fit for circulation.
Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.

Developmental role

Performs a wide range of promotional functions to support national objectives.

Related Functions

Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker.
Banker to banks: maintains banking accounts of all scheduled banks.

As a monetary authority, it is only responsible for ensuring adequate supply of credit to productive sectors. Government is not one of them!

Now, let us fast forward to April 2010. From the third sub-paragraph of the paragraph no. 40 of the recently released Annual Policy Statement 2010-11,

Third, notwithstanding lower budgeted government borrowings in 2010-11 than in the year before, fresh issuance of securities will be 36.3 per cent higher than in the previous year. This presents a dilemma for the Reserve Bank. While monetary policy considerations demand that surplus liquidity should be absorbed, debt management considerations warrant supportive liquidity conditions. The Reserve Bank, therefore, has to do a fine balancing act and ensure that while absorbing excess liquidity, the government borrowing programme is not hampered. [Link]

However, I am not sure that this policy would not prevent this from happening:

Second, inflationary pressures have accentuated in the recent period. More importantly, inflation, which was earlier driven entirely by supply side factors, is now getting increasingly generalised. There is already some evidence that the pricing power of corporates has returned. With the growth expected to accelerate further in the next year, capacity constraints will re-emerge, which are expected to exert further pressure on prices. Inflation expectations also remain at an elevated level. There is, therefore, a need to ensure that demand side inflation does not become entrenched. [Second sub-paragraph of paragraph no. 40].

There is a potential for conflict of objectives here with the central bank running a monetary policy that is aligned with fiscal policy instead of counteracting it. That is what Paul Volcker did in the early 1980s. That acts as a check on the government’s spending tendencies. But, keeping interest rates low (or, lower than they should be) when the government is borrowing and keeping it high when the government is not, risks making monetary policy pro-cyclical.

But, then it is dangerous to think that they do not know what they are doing. They must have done their cost-benefit analysis of this policy versus a counter-cyclical one. We have to wish them luck and a good monsoon ahead. India needs both.

Smart work by America

Bloomberg is right to give credit to the American Treasury Secretary (or, American diplomacy) on assembling a ‘coalition of allies’ on the question of Chinese currency revaluation.  This news story appeared in Bloomberg earlier in the week. It was a surprise to see India and Brazil make this call public soon after the BRIC summit.

Brazil’s Henrique Meirelles told a senate hearing yesterday in Brasilia it was “absolutely critical” that China should let its currency appreciate. [More here]

“If China revalues the yuan, it will have a positive impact on our external sector,” Subbarao said. “If some countries manage their exchange rate and keep them artificially low, the burden of adjustment falls on some countries that do not manage their exchange rate so actively.” [More here]

Chinese-made products such as tires and stereo speakers are the target of 26 Brazilian anti-dumping measures, more than any other country and nearly half of all 68 in place, according to Brazil’s Trade Ministry. Soy and iron ore accounted for 66 percent of $20 billion in Brazilian sales to China last year. [More here]

Writing op-eds. on the eve of summits eulogizing bilateral relations is easier for Presidents than it is for businessmen to ensure their survival.

Saran’s useful reminder

 This op-ed by Mr. Shyam Saran, the former Foreign Secretary to Government of India serves as a useful reminder of the limitations of linear projections. In an email discussion, fellow INI blogger Dhruva wondered if there was any thing better out there. His question is not rhetorical but useful. Linear projections may be simplistic but at least, there is a basis. It weights recent past more than distant past  – again not an unreasonable thing to do. More importantly, other methods might be worse than this. All that is true but it is good to be flexible with respect to projections. Most discussions of the future are starting points and, by definition, cannot be conclusive. Also, it is useful to remember the adage that one should distrust the obvious. That is what Mr. Saran’s piece reminds us, esp. his last paragraph:

But what struck me as I headed back home were the parallels in the world’s response to Japan’s dramatic rise in the 80s and to China’s even more spectacular rise today. The anxieties that China’s emergence is generating today are no different from those provoked by Japan then. Some of the complacent self-confidence, even arrogance, that afflicted Japanese attitudes then may be glimpsed in China’s touchy nationalism today. Japan’s sense of inevitable destiny as a pre-eminent power, based on its peculiar brand of social and economic development, is echoed today in China’s faith in its model of socialist statism with market characteristics. Japan’s rise came to an abrupt end and reversal. The US reinvented itself, the Cold War was over and the unilateral, unipolar moment was all over the place. The suddenness with which the Japanese moment turned sour, just as the unipolar moment appears destined to do today, brings to mind historian Niall Ferguson’s cautionary warning: “When thing go wrong in a complex system, the scale of disruption is nearly impossible to anticipate.” And so, too, the speed of collapse. One could add to this list the contrary prospect for resurgence and revitalisation of economies, as the US has demonstrated time and again. And as Indians, we are not immune to these same largely inexplicable forces of history. There is no inevitability about India’s rise in linear progression either.  [More here]

TGS is personally pleased to see this piece appearing soon after this post on President Lula’s op-ed on the eve of the BRIC summit.

Why are we like this only?

Thanks to Paul Kedrosky’s blog, I came across this blog, ‘Vancouver Real Estate Anecdote Archive’. It is incredible. Just scan through it. This one, as flagged by Paul, is a revelation:

“Can someone say the market is stupid hot? If you ever need a speculative blow off top example here it is:
This story is absolutely true (no, I do not have the MLS number). It was a friend of my mother’s house. She listed it in Richmond Thursday for $799K for a 3 bedroom rancher (small).
The open house was Sunday they had people lined up to get in. There were 12 offers and it went for $910K. One guy even offered the agent $25K “extra” in her pocket if she’d sell to him. It was pandemonium there!
I must admit, even as a long term investor in real estate, I am stunned by this. This is going to end even worse than I thought. I wonder how the person who “won” the bidding war is going to feel in a year? Do people believe this sort of behaviour is normal? I can’t wait for the days like in the late 80’s where I was the only person who had made an offer since it was put on the market 103 days ago.” [More here]

This link too comes from the Paul Kedrosky blog.

Less than two years after the GFC! So, who is responsibles for booms to turn into bubbles into busts?

SEC questions ‘God’s work’

Since Friday afternoon, I have been participating in a corporate off-site. On Friday night, returned home late weary and reflecting on the prospect of getting up early and returning to the off-site on Saturday morning. A cryptic email from a friend based in the US alerted me to the SEC charging Goldman Sachs. Now, it is Sunday evening in Singapore. By now, reams of analysis had been done on blogsphere. It almost feels like very old news. Such is the power and bane of a connected world. I managed to catch up with some good ones. I would refer readers to Felix Salmon’s blog over at Reuters. These two posts are recommended. I would particularly refer to the transcript of a live chat that took place as the SEC press conference unfolded. The email from Fabrice Tourre of Goldman Sachs is a gem. That captures everything that went wrong up to 2007 and is still going wrong.

I suspect that Lloyd Blankfein’s comment in an ‘interview‘ to Sunday Times claiming that bankers were doing God’s work is going to be regurgitated ad infinitum as that of Charles (Chuck) Prince who claimed that bankers had to dance as long as the music was playing. Recently, Chuck Prince and Robert Rubin were asked to testify to the Congress. They both said that they did not recognize the risks in CDOs. H..mm

One person who understood the risks actually wanted to short them. Especially Collateralized Debt Obligations created out of Residential Mortgage Backed Securities. Well, if you roll your eyes at these terms, that would be perfectly understandable. Just read the last paragraph. If they did not get it, why should you feel bad for not getting it? Of course, you should and could feel bad that you did not get paid as much as they got paid for not getting it!

This sentence from page 4 of the 22-page SEC charge-sheet is, in some ways, a good take on the rabbits that were being pulled out of hat (perhaps, it is better said as ‘pulled out of thin air) – “position Goldman to compete more aggressively in the growing market for synthetics written on structured products” [More here]. ‘Synthetics on structured product’ is clever phrasing. SEC had taken it from an internal memo in Goldman Sachs. A ‘Structured Product’ is a synthetic in itself. So, Wall Street was creating synthetics on synthetics. In other words, these financial products had taken a life of their own and were priced with no reference to the risk of the underlying securities from which they were synthesized. Those underlying securities were mortgages taken on by borrowers who had no income, no jobs and no assets.

A world of finance driven by and built on perception should not really surprise any one since the very notion of ‘fiat money’ is based on perception and nothing real. Hence, the need for ‘The Gold Standard’ 🙂

A surprising defence of Goldman Sachs comes from this blog post by Henry Blodget. I do not agree with it. I think Felix Salmon answers it well. If you read through the 22-page charge-sheet of SEC as I did, you would know why I think his defence and not the original charge of SEC is very weak.

Essentially the case is that Goldman Sachs helped John Paulson, a hedge fund manager, to structure a product that was based on the premise that defaults on sub-prime mortgages would occur on a massive scale. Hence, securities based on such mortgages (MBS) would default. Hence, it should be possible to create a CDO on such MBS that he could short by buying default insurance (Credit Default Swaps) on such a CDO. Wait. He played a role in selecting the MBS. A company called ACA Management with a decent reputation for selecting MBS was roped in, to lend credibility to the process. They were under the impression that Paulson was taking a ‘LONG’ position in the CDO. An investor with a LONG position gains if the financial asset goes up in value. The paragraph should make it clear that John Paulson was having a ‘SHORT’ position. That is, he stood to make money, if the asset (CDO) collapsed. It did. Since he had purchased insurance against those assets collapsing, he made a lot of money!

There is one missing link that astute readers would have caught. Who was on the other side? ABN-AMRO and a German State-owned bank – to name just two. They bought this CDO in good faith because, well, the credit- rating agencies had also rated them! This structure contained AAA, AA portions too!

Who wrote that insurance that John Paulson bought? ACA wrote insurance on that CDO which it had helped construct as a ‘portfolio selection agent’. They must have done so in good faith thinking that Paulson was a LONG and not a SHORT investor. The crux of the SEC complaint is that, at no stage, did Goldman Sachs communicate to ACA or to other investors who bought different tranches of that CDO that this CDO (i.e., its underlying securities) was proposed by Paulson with an interest to sell it short and not own it.

I hope I had made it clear. Now, you should be able to read the 22-pages and arrive at your own judgement as to whether SEC has a good case or not.

One thing needs to be said here. I recall reading some time ago in Baseline Scenario (a great blog on the capture of Washington, D.C. by Wall Street run by Simon Johnson and James Kwak) that the government was giving the financial industry a long rope and that it would strike at the opportune time. I could not recall that exact post but I do say that this is a good coup. It enhances the chances of passage of financial reforms in the US enormously.

[Postscript: Co-blogger Dhruva raised a legitimate question as to whether this would lead to the much-feared ‘double-dip’ in the US economy. Tangentially, it might. But, the case for that should be built on the US labour market situation. On the face of it, it is not improving. Incomes are not rising. Consumer credit data shows that consumers are not borrowing. Yet, US Commerce Department keeps reporting brisk retail sales even excluding gasoline whose price has been rising. It beats me]

BRIC triumphalism is misplaced

There are many things troubling about this article by President Lula of Brazil.  It has been written on the eve of the BRIC summit. There is far too much of chest-thumping and revisionism of the wrong kind.

I do not think that the global financial crisis (GFC) corroborated any of the stuff below:

The recent collapse of financial markets and the ensuing wave of global recession are symptoms of a failure of paradigms accepted until then as absolute truths, not to be questioned. Dogmas about market deregulation came crashing down, as did theories of the virtues of the so-called “minimal state” and the limited role to be played by the state in public policy, especially on social issues. The need to adopt more flexible labor rules have also ceased as the only answers to combat unemployment. When these orthodox theories collapsed along with global markets, it was the visible hand of the state that had to reach out to save economies from a collapse created by the so-called “invisible hand” of deregulated markets.

Nor is it true that speculative bubbles were to be found only in the developed markets:

While certain, major, developed countries allowed the speculative bubble that led to the crisis, Brazil, Russia, India and China managed to promote economic growth focused on hard work and a prudent approach to the theories that the markets tried to dictate as universal truths.

They were global. One should go back and read what Jeremy Grantham wrote in 2007 April. You can find it here. Memories are too short and that does not seem to be an afflcition of bankers in developed countries alone.

In the final analysis, it is good to see President Lula swear by multilateralism:

For that reason, the conclusion of the Doha Round of trade negotiations cannot wait any longer. By strengthening the World Trade Organization, we will be taking a huge step toward reducing asymmetries that are most costly to the poorest.

WTO is one of the few multilateral institutions in which developing countries have an equal voice: one country, one vote.

Of course, leaders of India and Russia can roll their eyes at the special treatment accorded China in the end. I doubt if they would or could do more.

Has Krugman changed since 1998?

I had taken the day off today. Originally, I was supposed to go to Bali with family. But, I chose to stay behind and blog! Kidding, of course. Chose to stay behind and work on clearing the remaining boxes in the house that I had recently moved into. In the process, I came across this interesting article  (yellowing newspaper clipping from Wall Street Journal 1998). It always gives all of us tremendous clarity on our logical faults when we read what we had written some time ago. If they sound very immature and silly now, then it is a cautionary tale on how much we should take our current views seriously. If they sound brilliant and if we do not say such things now, then it is a good case for asking ourselves as to why and how we have been intellectually corrupted. IF they sound good and makes us feel proud that we wrote something like that and IF we are saying the same thing now, then we can be proud of our intelligence and of our consistency.

It will be interesting to see which of these three feelings that Paul Krugman feels when he reads his own comments here. Incidentally, the article itself is interesting, especially for the believers in free-market. Well, I guess, for disbelievers too.