Fooling nobody

My column in MINT today focused on the near-term outlook for the US dollar and gold. American quantitative easing is, by no means, the end-game. We are getting there, no doubt. There could be QE 3.0 and there would be pervasive capital controls globally. I attempt to sketch out an intermediate milestone in this column. Very pleased to note that commentators, hitherto dismissive of gold as the ‘barbaric relic’ writing in all seriousness about the rising importance of Gold and about European Central banks halting gold sale, etc.

It took the Brazilian Finance Minister to say the equivalent of ‘the emperor has no clothes’ – basically, to say the truth. He says that a currency war has broken out globally. Now, go back and re-read my column and the other links on why Gold has come this far. Now, you would also see the logic of why it a lot more to go.  The fiat money end-game has drawn closer.

Mr. Gavyn Davies says pretty much the same thing in his latest blog post. It is lucid and written for the non-economists. Recommended reading to understand the situation within the Euro-bloc and the US-dollar bloc. His concluding line is diplomatic but it could have done with a lot more straight-talk as the Brazilian finance minister did. The chances are close to zero. [Accept my apologies if this post is behind a subscription wall]

In the meantime, the Federal Reserve provided some amusement via a solemn news story (planted?) in Wall Street Journal that it is considering incremental and small purchases of bonds rather than a big bang of printing of money to buy bonds (QE 2.0). They fool nobody (Title explained). This story, perhaps, reflects internal schism in the Federal Reserve and/or an attempt to appease those who are reluctant to go along with QE 2.0 for fear of losing the US dollar’s reserve status for ever (that would be a good thing, eventually, for America and the rest of the world) and/or the fear of unleashing inflationary forces (again, the operative word is ‘eventually’).

My money is on a big-bang QE 2.0 from the Federal Reserve in November – after the elections. Well, that is part of how they respond. They are skiiing down a slope and things would improve only after they hit the bottom. Until then, it is all about short-term and populist fixes. The ‘tea-party’ is firmly part of this framework.

The yuan squeeze

The US House of Representatives would vote on Wednesday to decide on allowing companies and the US government to request and to impose higher import duties and other punitive measures for exchange rate undervaluation. In other words, it aims to make exchange rate undervaluation a protectionist trade practice, fit for retaliation within the WTO framework. If the vote enjoys strong bipartisan support, the Senate would want to catch up too. David Leonhardt indirectly endorses it. He simply says that the trade deficit with Japan droppped now that the currency has strengthened (far too much?) against the US  dollar.

We have Anatole Kaletsky’s strange column (ht: Dr. Vidyasagar) in New York Times. It seems to have been written backwards  – conclusion first and supporting arguments later. France and Germany are fiscally more sustainable than the US?!

So, the US should not soak the rich but soak the middle class that has seen its real income go down since 2002?  So, what is great about Asian capitalism? The fact that the whole of Asia – including India – is in the grip of an asset price bubble is a testimony to Asian capitalism?

The US alone was not critical of Chinese exchange rate policy. Brazil, India, Korea joined them. 

The answer for the US savings – consumption imbalance or its current economic malaise may not be a forced revaluation of CNY because China does hold a few cards up its sleeve vs. the US. But, that is geopolitics and not economics and that does not mean that China’s mercantilist, command capitalism with financial repression offers an alternative model for capitalism ‘inspired by Asian values’.

What are those Asian values, if I may ask? Profits without productivity and getting rich through asset price bubbles?

To anoint a mercantilist model as an alternative to capitalism and imbuing it with a loaded term such as ‘value’ simply because Asia is now fashionable, is intellectual tragedy of immense proportions.

(postscript: A blog based in ‘Economist’ had written an insightful piece on the latest spat between China and Japan. Whether China’s overreach would be the trigger for Japan to shake off its lethargy in all aspects is an interesting possibility to look out for. The yen joins the race to the bottom)

Reading links

If we thought that American consumers are actively paying off their debts, this Wall Street Journal story puts a different colour on it. Implications, made light of in this piece, are significant. Credit access won’t be restored once cut off like this. Consumption could fall off. For a more dramatized take on this, check out this link.

Raghuram Rajan is thinking beyond Op-eds. for bringing about change. He thinks that the IMF should reach out to the grassroots to ensure political and public support for economic changes that are needed in key countries to bring about global rebalancing. His message applies to domestic change agents and intellectuals in every country. For a country like India, his message is relevant for him, for me and scores of others. The key is to how to construct and package the message in such a way that grassroots can identify with it as being in their interest. Right now, there are many things that prevent this from happening. The most important one is that most of us preach to the converted or to the existing constituencies.

Barry Eichengreen is not wrong here. He argues (or, hypothesizes?) that productivity growth could be the saviour for America as it was in the 1930s. Problems in identifying a pattern that resonates with the past and making it our prediction for the future, carries with it lots of risks for a discipline such as economics. Not many things are held constant. Therefore, colour me sceptical.

If one reads Bjorn Lomborg here, one feels heartened that there could be some consensus emerging on dealing with climate change rather than engaging in grandstanding. This holds out hope. Public policy solutions lie in the hard and grinding work of finding common ground (one cannot succeed unless one is able to win support from others) and not in entrenching oneself in ideology. Good to see that emerging on this, arguably, the most important topic for the future of the humanity.

In that vein, it is good to see M. K.Venu’s piece  (ht: Ram Narayan) of Financial Express come down on the side of sound analysis based on facts on the vexing question of the incidence of rural poverty in India. Of course, the icing on the cake is the conclusion based on studies undertaken in two Dalit dominated villages in one of the States still considered backward – Uttar Pradesh.

Per contra, it was diificult to digest some of the additional elements that Mr. Sainath bundles into his (otherwise) well argued and well-writtten piece on the Government of India’s food storage and distribution policies and failures. The piece offers no solutions, of course. That is no serious flaw. What is disappointing is that he makes it into an omnibus piece – critical of everything from energy pricing policies to child labour. There are many things wrong with the way they are thrown casually into the piece.  Such an attitude does not pave the way for an honest discussion on what is needed for the larger good and what needs to be done, if any, to provide relief to a specific segment of the population that might be adversely affected.

I hope the book that Bjorn Lomborg talks about in his piece (op. cit) provides an answer to the fears, predictions and estimates of Alhajji on the declining OPEC production of crude oil.

While the title of Robert Shiller’s piece leaves no one in doubt, his text is too restrained and subtle to be clear to the reader. He should express his concerns over the current policy stance more explicitly than he does, in this piece. That is, if I am right that that is what his ntentions are.

Krugman vs. Rajan – 2/2

Thought experiment for KW

Here is a thought-experiment for KW: If they are determined to recommend further fiscal stimulus, how about asking the US government to issue 30-year bonds at 5% – 6% coupon (long-term nominal growth rate of the US?), to bar foreigners from subscribing and to ask Americans to spend less and save and invest the savings in these bonds, while using the proceeds for infrastructure spending and job creation?

Are they ready to allow capital to be priced properly and naturally in the US when they are ready to condemn China and other nations for not allowing their currencies (and consequently, their cost of capital) to be priced properly in the foreign exchange market?

If KW wished to be agents of constructive change, throwing all the blame at the door of the foreign saving glut (without asking the question as to why and what made Americans not save or save far less than before) is not helpful because there is far little influence that domestic intellectuals or academics or policymakers can have on other nations’ course of policy, except through mutually damaging protectionism.

Surprisingly, both KW and RR seem to have overlooked one (very) important common thread between both of them.

This is what KW write in their piece:

In late 2005, just a few months before the US housing bubble began to pop, he declared—implicitly rejecting the arguments of a number of prominent Cassandras:—that housing prices “largely reflect strong economic fundamentals.” And like almost everyone else, Bernanke failed to realize that financial institutions and families alike were taking on risks they didn’t understand, because they took it for granted that housing prices would never fall.

This is what RR wrote in his response:

My book suggests that many – bankers, regulators, governments, households, and economists among others – share the blame for the crisis.

As both of them acknowledge, why did so many – central bankers, financial institutions, other intermediaries, borrowers and lenders – get it wrong?

The answer lies in the evolution of hubris which was encouraged by policymakers and thought-leaders in the financial industry that, through their efforts and risk management, they had conquered business cycles, achieved ‘great moderation’ and diffused risk to an insignificant minimum by diversification across many participants.

Unfortunately, this line of argumentation is unappealing because it is not gossip or innuendo, it does not throw wild allegations at some one or the other and hence makes for boring reading.

But ,the truth is that it persists and nothing has been done to dispel this false belief in human infallibility.  Reading of history would help. William Bernstein’s ‘Four Pillars of Investing’ would be a good place to start, for policymakers, investors and financial industry practitioners. But, their narrow, short-horizon focus blinds them to the truths out there.

The perpetuation of a greedy gambling machine that narrow banking and the broader financial industries have become continues sadly. It is again in evidence today in asset prices globally.

To the extent that they are completely ignoring these consequences of their recommendations, KW’s prescriptions are dangerous and harmful.

To the extent that the diagnosis and the prescriptions of people like RR do not focus on this aspect, their analysis and conclusions are incomplete.

To the extent that policymakers are willing to repeat their erroneous practices, they are both being dishonest and doing a disservice to the nation and the people they profess to serve.

To the extent that we are willing to remain ignorant and uninformed, we not only fail to evolve into better human beings but are also causing harm to our own financial wealth.

Krugman vs. Rajan – 1/2

(A condensed version of this post appeared as my MINT column today)

The acknowledgement starts with the email from friend Hemant Takalkar on a Saturday morning. That email took me to the CafeHayek link, to Clive Crook’s blog at The Atlantic, to Marginal Revolution’s blog post, to Paul Krugman and Robin Wells’ critique of Raghuram Rajan’s ‘Faultlines’ and to Raghuram Rajan’s response to their critique here.

Now, I have not read the book, ‘Fautlines’  yet, though I have a copy of it. After a point, I felt saturated reading and discussing the financial crisis of 2008. Wanted to avoid indigestion and hence kept the book in reserve for reading, by the bedside. But, I keep reading Raghuram Rajan’s articles and have blogged on them almost always.

On balance, I tend to side with Raghuram Rajan (RR) in this exchange with Krugman and Wells (KW). In their critique, KW had politicized the matter by stating that RR has been critical of democrats. Economists can find common ground or at least zero in precisely on where they differ only if they stick to facts, interpretations rather than on motivations. It should be possible to verify whether Freddie Mac and Fannie Mae contributed to the sub-prime bubble. There is no need to argue on facts.

Global factors can co-exist with local causes

KW are on a strong wicket when they point to the global nature of the bubble. Hence, there is some merit in seeking to find a common ground for the global bubble rather than on the US causation alone. But, bubbles could have both common and idiosyncratic grounds. Idiosyncratic reasons might have aggravated the global causes. Further, in their absence, they could have muted the global causes. Hence, focusing on the global cause does not preclude and cannot preclude finding local causes.

It is somewhat disappointing to note that KW find the only global cause to be the global savings glut. That is too easy and absolves several others of responsibilities for the crisis.

Yes, one can always trace the 2008 crisis to the decision of China to devalue the renminbi by 45% on December 27, 1993. From there, (among other things) flowed Asian trade and current account deficits, the Asian crisis, the exchange rate devaluation, the Reserve Accumulation, the investment of those reserves in US Treasuries and Agency debt by foreign central banks, the impact of that on US interest rates (it caused them to drop), the US lending boom and borrowing binge, and bingo the crisis.

In fact, this line of reasoning can be immediately faulted. It does not explain the housing boom and bust in some European countries and elsewhere. Global savings glut seems to have played a role only in the US!

Very significant domestic factors at work in the US

To come back to the culpability of several others – was it correct on the part of President Bush to have urged Americans to go and shop in the wake of 9/11? Was it correct on the part of Chairman Greenspan to have sided with Republican tax-cuts, relying on unreliable estimates of future fiscal surpluses? Was it correct on the part of Summers and Rubin to have blocked regulation of derivatives trading and to have brushed aside Ms. Brooksley Born? Was it correct on the part of Greenspan and Bernanke’s Federal Reserve to have kept rates so low for so long and to flag their increases well in advance, for two years? What did it do risk attitudes on Wall Street and elsewhere?

To acquit the Federal Reserve is astounding

The free pass that KW give to the monetary policy behaviour of the US then and now is a hard one to swallow. RR is correct that the European Central Bank was only marginally different from the Federal Reserve in policy easing. I have shown a slide in numerous speeches in the last several years that showed how real short rates were well below long-term average for the US, Europe, Switzerland and Japan (not to mention UK, Australia, etc.) in 2001-04.

Now, the question to ask is why did all of them engage in exceptional policy loosening? Clearly, the chief reason is that they were reacting to the Federal Reserve stance. Had they not done so, their currencies would have appreciated even more than they did, vs. the US dollar. The Federal Reserve thus not only engineered a very loose monetary policy for the US but also for the world, given the role of the US dollar as the global reserve currency.

The world was and still is on a de facto dollar standard. That is what enables America to export its bubbles to others (Japan in the 1990s is an obvious example). Failure to recognize and admit that is a significant and deliberate omission.

Further, in calling for loose fiscal policy focused on job creation for a short-term fix might be acceptable if there is also a willingness to accept the need for long-term solution such as increase in savings and investment. That is not there. Certainly, negative real rates do not encourage de-leveraging and saving. If the American public is still trying to save and pay down their debt, then it shows their wisdom but it does no credit to US policymakers who only pay lip service (Mr. Geithner’s latest testimony to the US Congress on China’s currency policy is an example of such lip-service) to encouraging savings. Cash for clunkers was certainly not an inducement to save.

One only has to look at the global bubbles building up in 2010 to understand the evils of the current interest rate regime in the West and exchange rate regimes in the East. It is amazing that we are writing about acknowledging, accepting and understanding the consequences of ultra-loose monetary policy, barely two years after the crisis of 2008 caused by such policies practiced from 2003-07.

To blame one without acknowledging the other as both the East and the West are doing might be fair game in geo or local politics but is not recommended practice for academics.

Is India ‘safe’?

A blog post of significance on a matter of enormous consequence has been written by Mr. Bibek Debroy. It is a pity that this morning the link does not seem to be functioning.  I saw it yesterday and I think it is worth reproducing in full:

Driving backwards

Bibek Debroy Posted online: Thu Sep 16 2010, 14:00 hrs

New Delhi : A proposition used to float around, at least so far as
Central government is concerned, since 1991, regardless of political
party (barring the Left), that there is a consensus on reforms, even
though there may be differences on the nitty-gritty. Reforms are good.
Competition and efficiency are good. Growth is good, because it leads
to trickle-down, though this doesn’t negate the need for direct
government intervention through anti-poverty programmes.

The efficiency of public expenditure, however, must improve. Despite
Left parties and NCMP (National Common Minimum Programme) and
complaints about non-reform, this consensus existed during UPA-I too.

For the first time since 1991, we see this consensus breaking down.
Beyond a point, one can’t differentiate between the Congress Party and
UPA-II government. Congress has turned increasingly left, has
incorporated the Left through NAC and NGOs and since government is
unable to resist this swing, the distinction between party and
government is irrelevant.

Whether Congress is attempting to do this for narrow political
dividends is also beside the point. We have major state elections
coming up this year and in 2011. And perhaps Central elections will
also be brought forward to before 2014. But the point is this. Once
Congress accepts itself as a party of government and government moves
beyond the present state of complete non-action, is there an economic
blueprint one has in mind?

In discussions of the history of reforms, it is often mentioned that
Congress, when it was out of power, under Rajiv Gandhi’s leadership,
drafted a forward-looking reforms blueprint in 1989-90. While this
never became a public document, it was invoked by P.V. Narasimha Rao
when there was resistance to reforms, especially around 1993.

We don’t have a blueprint now, not as far as one knows. But if we did,
it would be pre-1991
. Indeed, it would be the economic model of the
late-1960s to mid-1970s, which did enormous damage to India in terms
of lost growth opportunities. If one ignores nitty-gritty, as a broad
brush proposition, young India, especially urban India, supported the
reforms. It is because this young segment tacitly supported reforms,
with income and employment growth, that reforms have been relatively
less controversial.

Does this aspiration of young India mesh with what Congress now
increasingly projects? The problem is that this projection is not
being done by what is perceived to be the old guard, but the new
generation within Congress. While this is primarily a dilemma for
Congress, it has major consequences for the country

Emphasis and colour are mine. Together with the column by C. Raja Mohan on India’s defence preparedness (or the lack of it), this piece poses questions that the leadership of the Congress party and the UPA have an obligation to answer. That is of lesser importance to us than what they mean for the nation’s future.

(Postscript: The message of today’s column by Mr. Swaminathan Anklesaria Aiyar is not clear to me. What is clear to me is that it would be useful to have a debate between him and Mr. Bibek Debroy on the political and economic philosophy of Shri. Rahul Gandhi)

No liquidity trap?

Prof. Deepak Lal has  a slightly ‘wonkish’ (to borrow a Krugman phrase) column in Business Standard. He argues that there is no liquidity trap at zero interest rates if broad money growth can be engineered in conjunction with fiscal authorities. As he points out, that is what has been done by the Federal Reserve, the Bank of England and the European Central Bank. So, he says that the ‘Fisherian’ deflationary consequence of the financial crisis that follows a ‘Hayekian boom’ has been avoided.

Therefore, between deflation and inflation, his fear is that failure to exit Quantitative easing would be inflationary. He does not fear deflation.

Key to his conclusion is this:

It is only if the increase in broad money has no effect on the non-banks’ normal desire to substitute excess cash for bonds or equities (or general spending) — i.e. the non-banks’ demand to hold money is infinitely elastic — that there will be a “broad” liquidity trap. There is no evidence that this has, in fact, occurred. [More here]

He might be prematurely concluding this way. Non-bank entities (individuals and corporations) seem to have shown a reasonably ‘infinitely elastic’ tendency to accumulate money rather than acquire financial (investment in stocks and bonds) or durable assets (investment in capital goods by corporations).

According to the International Company Institute website, funds continue to flow out of domestic equities in the US for the 20th consecutive week. In fact, it is 11 out of the last 13 months that have seen outflows from equity funds. Check out the data here. Bond funds are seeing inflows steadily and perhaps, they see bonds as cash-substitutes because they pay coupons and they might be more liquid with easier redemptions.

If so, there might be still a liquidity trap threat and that, in turn, calls for another round of quantitative easing (QE 2.0) in the US.  That might be the line of thinking right now in the Federal Reserve Open Market Committee.

A minor quibble. In the sentences below, I wonder whether Prof. Deepak Lal meant to say ‘assets’ instead of ‘liabilities’:

Normally, the commercial banks would respond to their higher-than-desired cash reserves by expanding their liabilities, i.e. loans to the non-banking sector. The resulting increase in bank deposits would expand the broad money supply (M2/M4). However, in a banking crisis, the commercial banks may be unwilling to increase their liabilities (loans). In this case though the monetary base has increased, broad money will not. The economy is in a “narrow” liquidity trap.

Ninan wants a weaker rupee

BS Editor- Emeritus (my own title for him) T. N. Ninan has pitched for some good-old mercantilism in Indian exchange rate policy because export numbers are not as good as they appear. They are flattered by the low base year figures of 2009. Fair enough. Even the call for some realism in exchange rate policies is fine by me. But, the figures he cites in support of his argument are not borne out by statistics.

Indian real effective exchange rate (nominal, trade-weighted exchange rate adjusted for inflation differentials with the trading partners) stands at 104.5% – statistically insignificantly different from the base year (2005) value of 100. China’s stands at 119. There has been a greater real exchange rate appreciation in China (loss of export competitiveness based on exchange rate considerations) than in China, according to Bank for International Settlements effective exchange rate series.  One can look at IMF or JP Morgan numbers and they would point in the same direction. The problem is not in the exchange rate.

It would have been more productive (pun intended) had Mr. Ninan focused on India’s worryingly low productivity. TGS had recently posted on this topic.

Three cheers to RBI

India’s Reserve Bank of India cemented its reputation in the region as one of the most competent and prudent central banks by raising the repo. rate and the reverse repo. rate today. The repo. rate went up by 25 basis points and the reverse repo. rate by 50 basis points. The latter was more than expected. The stock market has reacted negatively. That is not a surprise since it was ripe for some profit-taking (and more than that).

 The important highlights from RBI’s press-release are as follows:

(a) The monsoon of 2010 is deemed a success. RBI makes a pointed reference to the plentiful storage in reservoirs and replenishment of groundwater due to the monsoon. It expects a good winter crop now.

(b) It expects the fiscal deficit to be on track for the year ending March 2011. It has taken into consideration additional demands placed by Ministries after the budget was passed in April/May this year

(c) It reckons that the inflation rate has peaked

(d) It now thinks that it has largely re-adjusted its policy and would now be in a reactive mode on raising or holding rates steady rather than be biased towards tightening.

The RBI made a specific reference to the negative real rates in India and its damaging effect on the availabiity of credit. It omitted to say that negative real rates also encourage speculative investments. Officials at the Peopole’s Bank of China would only nod and shake their heads in sympathy since they have not been able to persuade their political bosses that China needed to do the same. Its negative real rates or abysmally low real rates in the face of near double-digit growth stores up a lot of risks for the future. But, that is a topic for a (much) later date or so we (and they) hope.

 In the final analysis, three cheers to the Reserve Bank of India.

William White and Microfinance

William White’s comments on the presentation by Reinhart & Reinhart at the Jackson Hole conference in August 2010 (ht: Naked Capitalism) are well worth the read. Yves Smith over at Naked Capitalism has highlighted the key paragraphs from White’s comments. So, I do not have to repeat them. But, what I would do is to clarify further the remarks by Mr. White on one aspect: He writes that many macro-economic slumps have not been preceded by periods of high inflation.

I would go one step further. I think that many macro-economic slumps have been preceded by periods of remarkably low or benign or quiescent inflation. In fact, that seems almost like a pre-condition. Of course, I am not saying anything original. It has been said by Harold Minsky that stablity begets instability. Low inflation lulls policymakers into maintaining low interest rates. Given their anti-inflation framework – fighting inflation is also a proxy battle between capital and labour – policymakers are on the side of capitalists. But that  could change in a few years.  That is a topic for another occasion and a bigger post or column. But, the low interest-rate policy breeds and feeds asset price bubbles. They burst eventually. The, the mop-up operations are launched and the cycle starts all over again.

Based on the above, it follows logically that countries should be, forever, in high inflation to avoid macro-economic instability later! That does not seem right. The only answer is to have policymakers lean against the wind. Most policymakers would nod their heads vigorously at this. They would have nodded more vigorously in the immediate aftermath of the crisis. As memories fade, the resolve weakens. Witness the behaviour of Asian central banks now. It is no different from their behaviour in 2007-08. So, we are doomed to experiencing booms and busts except that they might be even more frequent than before. Already, they had become frequent in the last twenty years.

But, policymakers are not alone in this respect. In fact, it is ingrained in human nature. Notwithstanding the memories (still relatively fresh) of subprime mortgage crisis in the United States, look at what has happened in the world of microfinance.  One microfinance institution in Nicaragua has collapsed and that too after converting itself into a bank (name change from Findesa to Banex as it became a bank).  Check out the blog posts here, here and here.

This is a good report to read as well. The report, commissioned by CGAP, covers the payment and default crisis in microfinance in four countries – Nicaragua, Morocco, Bosnia and Herzegovina (BiH), and Pakistan. India is mentioned as a box-item for its nascent/latent ‘potential’ to join the above list.