Hollowness in banking

News coverage of Dr. Y.V. Reddy’s (former Governor of the Reserve Bank of India – India’s central bank) second book launch was extensive. He has friends in the media. MINT and Business Standard did their interviews with him. You can find them here and here. His comments on the hollowness in our banking in his interview to MINT caught many eyes predictably since they put it up in the header. This is what he said:

The major area of concern is the hollowness in banking. And, especially when there are huge uncertainties and volatilities in global markets, the importance of stimulating productive activity within the economy is important.

I think it is time for some countries—and I am not restricting to India, it may even be United States—to consider selective credit controls and the credit allocation to sectors. It may appear to be too retrograde, but these are extraordinary times when you have to stimulate (productive sectors).

Alarm bells would go off in many heads and for good reason. Government allocation of credit is not what he is after, though. Think of how private equity, venture capital funds and even hedge funds try to limit their exposure to any one stock or sector or company, etc. Ultra-lowshort-term interest rates together with free international capital flows mean that many investments go for investments with short horizons. Invariably, they are to be found in the financial markets with liquidity. Real estate comes next because it is much more profitable than patient investing into businesses and new ventures. So, how to ensure that the so-called and alleged positive impact of low interest rates is felt in real investments and not in speculative and/or financial investments? (for the most part, both mean the same thing).

That is the question that Yours Truly tried to grapple with (or, ended up merely posing) in one of his recent MINT columns:

…central banks in the region must think of internal capital controls before they think of holding back hot money inflows from abroad.

Naturally, this might bring howls of protests of capital rationing, etc. Central banks and governments have been intervening in financial markets for dubious ends in the last several years. For a change, they could do so for a good cause. It is invariably the case that loose monetary policy and low interest rates encourage speculative investments rather than good investment that officials seek. That they are determined to inflict low interest rates on the economy with the fond hope of boosting the right investment spending in the economy in disregard of empirical evidence raises doubts about their intent or intellect or both.

Hence, for a change, they and their governments must consider either signalling or directing capital to inflation-unfriendly investments (those that lift potential GDP growth rate) than to inflation-friendly investments (stock markets and property). [More here]

It is hard to quarrel with Dr. Reddy when Sanjaya Baru writes, after his interview with Dr. Reddy for Business Standard,

He is not too enthused by the global response to the crisis. Neither the International monetary Fund (IMF) nor the G20 has yet grasped the fundamentals. Globalisation of finance without global governance is a recipe for disaster. Recent events in Europe are a reminder that all is still not well, so India’s policy makers have to be on constant alert.

Bernanke’s counterattack

Mr. Bernanke tried hard and succeeded partially in deflecting criticism from the Federal Reserve’s Quantitative easing programme. But, he was conveniently ignoring some issues which were not that easy to defend. He is right about capital flows into emerging markets being a consequence of better growth over there and inferior growth prospects in the developed world. In other words, with or without QE, capital flows to developing nations would have happened. QE might have been an incremental factor.

But, what is harder to defend is the impact of the expected and actual QE programme on commodities prices that are denominated in US dollars. They have risen a lot more than they would have. Well, I do not have to waste my breath on this. He can read James Hamilton’s blog post. Nor has Mr. Bernanke provided a good response to Mr. Richard Fisher’s speech.

Eric Kraus at his best

I first listened to Eric Kraus, Russia based fund manager cum investment advisor, at the CLSA Investment Conference in Hong Kong in Oct. 2007. I was impressed by his humour, provocative views and his language. I had made it a point to read his ‘Truth & Beauty (… and Russian Finance)’ newsletters from time to time, even as it went through many sponsors. I am glad that he has finally set up his own website, www.truthandbeauty.ru. It is worth bookmarking. His latest missive, ‘Swimming with sharks’ is easily one of his best. There is a personal note at the beginning as to how he found himself ‘laid off’ through a journalist.

Then, his comments on the US political system and society are devastating. You must read the whole stuff. But, here is a sample:

The manipulation of mainstream American political thought is extraordinary. Large segments of the populace vote against their own interests – laid-off workers are convinced that the corporations are their friends, the government their enemy. The illusion of shared prosperity was maintained for several decades thanks to a series of asset bubbles and by the ever-increasing use of leverage. Both have now run out of rope. Rising popular discontent is being channelled into Wizard-of-Oz political movements, convenient safety valves which pose no real threat to the dominant economic interests.

 As a result of an obviously paralyzed and dysfunctional US political system, there is a craving for a Man on Horseback – someone to lead his people out of the desert into the Promised Land. Such men do, at times, arise – but to confide one’s future to the expectation of a Messiah is giving hostages to fate. Considering the succession of US presidents over recent decades suggests that the options are, at best, an alternation between disappointment and disaster… Mr. Obama may be something of a disappointment – but he is the product of a dysfunctional political system he sees as the natural order of things, and his margin of action was always very limited – to have expected radical change suggests the triumph of hope over experience.

 That said, the Bush legacy gives a whole new flavour to the term “disastrous,” and for Obama to now be blamed for the failed wars in Afghanistan and Iraq, rising inequalities, regulatory failures, a hollowed out industrial structure, rising and persistent unemployment, and a financial system living on the public teat seems a bitter irony.

 Freed of any further requirement for political correctness, T&B would suggest that any country in which Sarah Palin could be taken at all seriously as a national political figure is not ready for self-governance.

 It is utterly terrifying that a nuclear-armed state could conceivably elect someone as vapid, as assertively uneducated, as profoundly ignorant of politics, history, economics and international relations. Her appeal is, at best, sociological – at worst, pure show-business. Ignorance and blind faith are perhaps appropriate for religion, certainly not for the hard business of governance. While we realize that she will never be president, this is beside the point – the fact that the matter is discussed at all is truly chilling…

 The political system has become ossified, increasingly dysfunctional and unable to embark on desperately-needed reform, and is totally beholden to financial interests. The electorate is deeply in denial, a substantial minority clinging to a world view not much more sophisticated than that of your average aborigine (who, on the other hand, is not called upon to express electoral judgements on complex geopolitical issues). The thirty-year process of dumbing down the US media – culminating in the utterly vapid USA-Today and the video-game Fox News – does not come without a price. That price was George Bush. The next price may be higher still.

 Yes, the reader may argue that we are painting caricatures, throwing back at us the example of some thoughtful, high-brow East coast monthly, but which one determines the outcome of elections? There is ample reason for concern. [The full stuff is here]

I used to find his enthusiasm for China a trifle too strong. Not that that was wrong. It is just that my views were more restrained. But, I am glad to find him more open-minded about his enthusiasm for China. Nothing like seeing intellectual openness to have one’s faith in some one’s thought-process and conclusions restored or enhanced (as it is, in this case).

Considering just how little China is actually threatened, their pathological hypersensitivity suggests that Chinese policy is a matter for psychoanalysis rather than for ordinary diplomacy. While the West must understand that its erstwhile hegemony is now totally archaic, equally, the Chinese should realize that the 15th-century system of tribute is not about to be reconstituted, and (hopefully), that divide-and-conquer is not an effective strategy for dealing with Europe.

If the world is condemned to have a hegemon, one would rather said hegemon be both benevolent and reasonably tolerant – Beijing clearly fails to meet at least the second criterion. There is much reason for concern that the rise of China, with the reciprocal decline of the old powers of the West, may be something other than a smooth, beneficent process.

This is the final coup de grace:

The smartest of our peers are now focused not on the developing bubble, but upon what is to come after – the inevitable unwind, as well as the possible cataclysmic changes in the global financial architecture and in asset values following upon the collapse of the dollar system.

Season for open letters in America

I read in Wall Street Journal (Europe) this afternoon in Zurich that some eminent economists, close to the Republicans, would issue a signed letter opposing the Federal Reserve’s new 600 billion of Treasury Securities purchase programme. I was surprised to find, via Zerohedge, that such a letter has already been published by the Wall Street Journal (America?).

A brilliant post by Simon Johnson with the provocative title that Vikram Pandit has no clothes referred to a letter that has been issued by a bunch of US academics on why Basel III accord fails to address systemic risk posed by banks. Simple solution is to have banks fund more of their assets via equity than via debt. The authors of the letter propose 15%. The letter makes a lot of sense.

These are welcome developments in the US.

Jeremy Grantham talks to Maria Bartiromo

I caught the link in FT Alphaville and I proceeded to read the full interview. Here is a teaser:

GRANTHAM: Our institutional clients— sell very gracefully into this rally. We’ve already started to sell. We’re not even— averagely weighted. We’re modestly underweighted. And you must remember bonds are even worse than stocks on a seven-year forecast. So, you get caught in this paradox. It’s very tempting— and this is what the Fed wants by the way.

Jeremy Grantham
Jeremy Grantham, Chief Investment Strategist of Grantham, Mayo, Van Otterloo

It wants us to go out there and buy stocks, which are overpriced because bonds they have manipulated into being even less attractive. So, we’re being forced to choose between two overpriced assets. That is not always a terrific choice to make because there is a third choice, and that is don’t play the game and hold money in cash.

Read the full transcript of his interview here.

Now, I think it is time to go to the gate to catch the flight to Zurich. Connect with you soon.

What others miss

… after all there is no such thing as Chinese “economic data”: it is whatever the central committee agrees on… [More here]

From Christopher Wood:

.. interesting point about US financials is the real quality of their stated books. An interesting anecdotal insight on this point was provided by the purchase of a regional bank, Wilmington Trust, last week when the tangible book value was written down by 51.5%, following due diligence from the acquirer, another regional bank M&T Bank. The main problem here appears to have been commercial real estate loans. …

… at last the American President finally made it to his former home of Jakarta this week at the third time of trying though his visit had to be cut short by two hours allegedly because of volcanic ash  from the erupting Mount Merapi! Given the bizarre nature of this excuse, GREED & Fear cannot but wonder if the president’s minders did not want media coverage of the American President visiting his former school in Jakarta because of paranoid conspiracy theories apparently rampant on the internet that the American president was not born in the USA!

Source: Greed & Fear, Nov. 12, 2010 (available only for clients of CLSA)

John Mauldin in his weekly missive (‘First let’s lower the bar), shares an important information:

I was sitting in London when the employment numbers came out last Friday, and I didn’t have time to really get into the data. I did send you Lacy Hunt’s quick analysis as to why it was weaker than it appeared, but something else did not seem right. I follow a few people who are pretty good at predicting the employment numbers (like Philippa Dunne of The Liscio Report). Most were expecting numbers in the 60,000 range. Most unusual for there to be such a big miss from these guys. I read the press release and saw nothing to raise my eyebrows.

And then Alan Abelson in Barron’s gave us the following, after reciting the headline number: “Happily, the always astute Stephanie Pomboy of MacroMavens provided a quickie explanation: “‘The seasonal bar which the payroll data must jump was (inexplicably and dramatically) lowered from prior Octobers. ” ‘Thus, in October 2009, the BLS set the bar at 870,000 jobs, similar to the 840,000 it anticipated in October 2008. This year, by contrast, it lowered the bar to 768,000. Mumbo, jumbo, payrolls presented “an upside surprise” of 100,000.’ “According to John Williams at Shadow Government Statistics, the BLS’ fiddling with the figures via what he calls ‘seasonal-factor games’ actually created 200,000 phantom jobs last month. John cites such finagling as the reason his prediction of an October decline and a rise in the jobless rate was wrong. It also explains why seasonally adjusted payrolls were revised upward by 110,000 in September, including 56,000 in August.”

Lastly, even though this piece by Edward Hugh is nearly a month old, it is a neat analysis of why QE2.0 in the US was inevitable (of course, he has been proven right) and of the extent of underlying and structural problems that need to be overcome in the developed countries. He is referring to an interesting work by Deutsche Bank economists in that post. Hope to check it out in the coming days:

For reasons which aren’t worth going into now, I’m reading through a recent report by Deutsche Bank Global Markets Research entitled “From The Golden To The Grey Age” this afternoon. The report (all 100 pages of it, many thanks to researchers Jim Reid and Nick Burns who produced the thing) looks at the extent to which a variety of macro indicators – like GDP growth, inflation rate, equity yields, etc – may have been influenced by demographic forces over the last 100 years or so. It is certainly one of the most systematic reports of its kind I have seen, and well worth losing a Saturday afternoon to read.

The state of the union

Prof. Barry Eichengreen, in his recent column (‘Is America catching the British disease?’) on Project Syndicate, has compared the decline of the British empire and that of the US today. It is a good column. I recommend it.

The country failed to develop a coherent policy response to the financial crisis of the 1930’s. Its political parties, rather than working together to address pressing economic problems, remained at each other’s throats. The country turned inward. Its politics grew fractious, its policies erratic, and its finances increasingly unstable.

In short, Britain’s was a political, not an economic, failure. And that history, unfortunately, is all too pertinent to America’s fate.

In case you were not convinced by Barry Eichengreen, I would recommend that you read the sovereign credit report on the US published by Dagong (China’s private credit rating agency). Translated into English from Chinese, it makes for colourful reading and most of it is reasonable, well-argued and with substance. They have downgraded the US credit rating from AA with a negative outlook to A+ with a negative outlook. Two days later, Moody’s upgraded China’s credit rating.

This is their judgement:

It would be difficult for the U.S. to find the correct path to revive the U.S. economy should the U.S. government fail to understand the source of the credit crunch and the  development law of a modern credit economy, and stick to the mindset of traditional economic management model, which indicates that the U.S. economic and social development will enter a long-term recession phase.

These are their reasons:

the credit expansion policy has changed both the economic fundamentals and the operating mechanism of the U.S. economy. It is a basic state policy of the U.S. to take credit expansion as an engine of economic development. As a result of the highly developed domestic credit policy, the credit relations between the creditors and debtors have become the basic economic relations between social members.

the economic financilization and industrial hollowing-out in the United States has broken the normal relationship between the financial system and real economy, leading to the pursuit of the virtual wealth.

the U.S. global hegemonic strategy has consumed enormous national financial resources, but its own capacity of wealth production is insufficient to support its huge strategic target.

long-term dependence on the U.S. dollar depreciation to export debt is not only harmful to the creditor’s interests, but is also unable to solve its debt dilemma. the reform of financial and rating systems has failed to fully reflect the essential

the reform of financial and rating systems has failed to fully reflect the essential requirements of the credit economy, and it is difficult to establish a basic service system of national economy that accommodates the development law of a credit economy, so as to push the U.S. economy into a path of revival.

You can read the whole thing here.

If you are still not convinced, pl. read the latest Matt Taibbi (of the ‘Vampire Squid’ fame) article in Rolling Stone on how wrongful foreclosure cases are being handled in a Florida court.

Perhaps, it takes no special intellectual effort to say that things have to get and will get a lot worse before they get better. If they do, that is.

Zoellick for Gold Standard?!

Robert Zoellick, the World Bank President seemed to argue for some role for Gold in a new monetary arrangement for the World:

the G20 should complement this growth recovery programme with a plan to build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today. [Full article here]

Reaction was swift. Those who reacted set up straw men and shot them down. He was not advocating the return of Gold Standard. In fact, one could broaden his comment even further. His call for inclusion of Gold in the calculus could be deemed to reflect a desire to impose some sort of discipline on policymakers.

According to many American economists, discipline of the Gold Standard gave us depression and World War II. But, discretion has given us bubbles and busts and might give us World War III? Clearly, we need something that incorporates more discipline on policymakers rather than less, based on their record of the last twenty-five years.