Jagdish Bhagwati

Whoever decided to invite Prof. Jagdish Bhagwati to speak at the Hiren Mukherjee Memorial Lecture at the Indian Parliament (Lok Sabha) deserves to be congratulated. Thanks to a friend, I saw the edited excerpts of his speech. It was a good speech delivered with trademark sarcasm and wit. It was good to note that he spoke of the importance of second generation reforms. 

From the available version, it appears that he could only give a light treatment to the issue of governance in the country. That is not to say that the proposal he made is anything less serious. One must agree that both the fountain head and the largest source of corruption is contesting elections. Hence, his call for finding legal ways to raise campaign finance is right on the money.

Overall, I hope there is a follow-up discussion and debate on his speech in the Parliament. Or, others should find ways to bring reforms back to the centrestage of the Indian public policy discourse.

I visited his faculty home page at the Colombia University. That led me to find out that he now blogs at ‘The American Interest’. See his latest blog post here. It appears to be a more concise version of his speech at the Indian lower house of the Parliament.

One of the links to his short comment, first written in March 2010 and later modified in July 2010, refers to the IMF revising its stance on the usefulness of capital controls. He mentions that he had never been invited to Jackson Hole conference of the Federal Reserve. That comes across as a striking omission on the part of the Federal Reserve.  Professor Bhagwati is a free-market economics but he did not toe the official Washington line on capital flows. If that was the reason for his exclusion, it does not redound to the credit of the Federal Reserve.  Check out his comment here.

Prof. Bhagwati’s comment in Project Syndicate on the non-importance of manufacturing drew fairly critical responses and my sympathies lie with those critics. In an interesting coincidence, Gurcharan Das sides with the critics on the importance of manufacturing in his latest blog post dated Nov. 14, 2010 titled, ‘In search of America’s liberty and India’s dharma’.

Finally, Bhagwati’s piece on ‘India or China?’ predictably drew a lot of readership when the English magazine Caijing posted it on their website. The blurb they had given it was a good one:

China’s authoritarian politics means that it cannot profit from the innovations that depend on software, as that is an instrument through which dissent can flourish and become subversive of total control.

The full article is available here.

FT Christmas reading list

It is interesting to see, in the reading recommendations of FT journalists, that Raghuram Rajan’s ‘Faultlines’ is picked by Lionel Barber while Raghuram Rajan himself picks ‘The difficulty of being good’ by Gurcharan Das. I have not read both. Michael Lewis’ ‘Big Short’ finds favourable mention from many. I love his writing. But, I have not gotten around to reading this work of his (or, for that matter, that of Andrew Ross-Sorkin either) due to fatigue of reading too much on crisis.

Tom Friedman makes sense

Several people that I know of think that Tom Friedman writes mostly obvious stuff. But what is so obvious still proves elusive for global policymakers. Let us take the so-called ’60-minute’ interview by the chairman of the Federal Reserve. While no full transcript is available yet and I have not seen the interview either, based on what is circulating in cyberspace, it is baffling that there were no searching questions on banking regulation, Fed loans to banks at subsidised rates, compensation in the sector, the failure to rein in credit growth and the reliance on the same mechanisms that brought us to the brink of financial extinction, so on. These are obvious questions to me but perhaps, the interviewer did not think so.

Hence, it is good to see Tom Friedman makes the point about America’s oil dependence and low savings as the fountainsprings of its lack of influence, evident in the Wikileaks. Read his article here.

National average price of regular unleaded gasoline is up 14% in the US in the last one year. Some commentators gloat over the recovery in auto sales while the unemployment rate (the augmented unemployment rate) stands transfixed at 17.0% and the average hourly earnings of non-supervisory workers raises a princely 2.1% annually.

House prices in China

From 2001 to present, real interest rate on 5-year Chinese government bond has averaged at 0.8 percent, while comparable real interest rates in other economies range from 1.4 percent in the Euro area to 3.9 percent in New Zealand. Even these figures are considered by some to be too low to contain a significant asset price buildup shown in the previous sections, and indeed may have amplified the asset price cycle.

The Chinese government’s policy measures to cool down the markets unveiled in April 2010 appear to have had some impact on price growth. §It is too early to say, however, whether the impact of such policies will turn out to be long lasting. Nevertheless, even if they are relatively effective against the recent surge in prices, such measures at best only treat the symptoms of high residential real estate inflation and not the underlying structural causes. To do that will require an increase in real interest rates, a higher carrying cost of homeownership (such as can be achieved by a broad-based property tax), and, in the case of China, broad financial market development to alternative investment vehicles to housing.

These are some interesting observations from the IMF Working paper titled, ‘Are house prices rising too fast in China’ and released early in December. The paper has a very useful analysis of China’s house price developments and some rather interesting charts. As the authors observe somewhat plainly, real interest rates this low and which have no bearing to the real cost of capital in an economy that has grown at a rate of 10% over the last decade cannot but have adverse consequences for bank balance sheets.

The full paper is available for download here.

Canonical bailouts

Amy Kazmin has written a good piece in FT on the ongoing saga of Indian microfinance. Read it here. Accept my apologies if it is behind a subscription wall. She concludes as follows:

if a competitive market is starting to deliver credit to people who have never had access to it, that also places a greater emphasis on the sector’s social role.

It is not that difficult to establish that, in finance, there is no competitive industry. It is oligopolistic. Competition, if any, induces them to take more risks at the expense of all other stakeholders except the executives concerned. We have more proof of it, in Europe and, of course, in the US.

Barry Eichengreen usually does not get angry. He is mild-mannered. He and I were co-speakers at a conference in Singapore organised by ‘Business Times’ newspaper, in November. He is also self-deprecating. Asked if he was bearish or bullish, his laconic reply was that Nouriel Roubini was his student!

His article published in a German newspaper, well translated by another famous economist Kevin O’ Rourke, is available here. He is angry. You should read it yourself and draw your own conclusions. In the past, IMF bailouts used to go to repay the lenders to sovereign nations while the borrowing nations imposed budget cuts and austerity on their population. The poor were hurt the most. Of course, if the borrowing governments did not mend their ways, they would be shut out from international capital markets. While there is a grain of truth to that, borrowers and lenders both make mistakes. But, usually, the punishment falls on the borrowers. The lenders get away scotfree. They repeat their mistakes all over again because they know that they would be bailed out. The game is rigged in their favour from day one.

(You may like to read Kevin O’ Rourke himself here and Wolfgang Muenchau in FT on thinking the unthinkable in Europe)

It is now being re-enacted in Europe. It is sickening. It is not as though there is no other way. Iceland did it. I do not agree with Paul Krugman all the time. But, this piece made sense. Iceland guaranteed bank deposits but not other creditors, depreciated its currency and is now on its way to recovery. Why is this not possible for Ireland or Portugal or Spain or Greece?

Answers are to be found in political economy, the identity of the lenders (think German, French, American and UK banks), their clout and their ability to take losses and remain afloat, etc. Now, you must be getting the picture.

Look at this article from the FT today. The Federal Reserve has released data on their USD3.3 trillion dollar support to the global financial system or, shall we say, the Western financial system. I have not gone through the spreadsheet yet. This article says that Goldman Sachs approached the Fed 84 times for funds and Morgan Stanley did some 212 times!

One would think that, given this massive debt (literally and otherwise) that Wall Street owes the taxpayers, the governments would be able to walk all over them. We have seen the opposite of it in the last two years. What is going on?

If one does not wish to attribute criminality or venality to policymakers, the only explanation that seems to make sense is this:

These institutions are still far too fragile to take any form of tighter regulation. They need to be protected from harming themselves and the rest of the economic system (but why does that extend to a ‘wink and nod’ approach to compensation in the banking system still eludes me) for a long period. In other words, policymakers know more than we do and what they know is not pretty at all.

Can they succeed in ‘muddling through’ to good health? They are hoping. But, I am not keeping hopes up. They are not omnipotent. Well, banish that thought. What they do will have and is having unintended consequences. That could come in their way of kicking the can down the road and hoping for the best. Once the game is up, either because commodities prices or any other shock occurs, the unravelling would be swift and big. There would be no backstop then.

Given that the stakes are this high, one should not be surprised that asset prices are staging completely counter-intuitive and big rallies on flimsy news. Propping up asset prices and making them rise at all costs is the only light at the end of the current ‘muddle through’ tunnel. But, the costs are not going to be small and they pack a punch. Think commodities, think oil and think inflation.

If the costs do not arrive sooner, then what Sebastian Mallaby says in his article in FT would happen, perhaps a little later:

The message from this data dump is that, two years ago, these too-big-to-fail behemoths drove the world to the brink of a 1930s-style disaster – and that, if regulators don’t break them up or otherwise restrain them, they may do worse next time.

We would not have believed it even if some one had fictionalised such brazen behaviour on the part of financial institutions and such craven behaviour on the part of the public sector. It is now canonical that public sector would orchestrate bailouts of private sector risk-taking and losses at the expense of the public. Welcome to 21st century capitalism!