Finance and inequality

The latest Buttonwood column in ´Economist´dated March 26th, 2011 hits the nail on the head. It highlights the role of Finance and the American monetary policy in fostering huge income inequality in the country:

One factor that should perhaps get more emphasis is the role of the financial sector. Central banks have repeatedly cut or held down interest rates over the past 25 years in an attempt to boost bank profits and prop up asset prices. With this subsidy in place, is it surprising that earnings in finance have outpaced wages for other technologically skilled jobs?

Attempts to remove that subsidy are met by threats from international banks to move elsewhere. This is a little reminiscent of the protection rackets run by the gangsters in Mario Puzo’s “The Godfather”. It is as if the finance sector is saying: “Nice economy you got there. Shame if anything should happen to it.”

Backing him up is Neil Barofsky, the special inspector-general of the Troubled Asset Relief Programme (TARP) in the US.  His column (ht: Dr. Vidyasagar) is both simple and effective. Read it here.

At first glance

Been on the road – well, precisely, more in the air than on the ground in the last several days flying to the world´s end, as the Chileans call their country. I flew from Singapore to Chile for a conference and after that, I am taking a break. Hence, posts have been light lately and would be light for some more time.

In the flight to Sao Paulo from Santiago, I caught up with David Brooks´s column in NYT on `Emergent thinking´.  The symposium organised by Edge.Org sounds like a worthwhile initiative. I think what he means by emergent thinking is the ability to connect dots, to think holistically and to think of problems in their multiple dimensions and not just rely on the past as the basis to analyse the present or predict the future. I agree with him on that.

The latest example of the folly of relying on the past to guide our analysis was on display when many analysts immediately leapt to conclude that the 1995 earthquake of Kobe was the best basis to analyse the consequences of the quake-tsunami of March 2011. I wrote about it in my MINT column on March 15th. I was naturally pleased to see my arguments validated in this FT piece on March 24th. Past is, at best, a point of departure for analysis and seldom, it is the point of arrival too.

Going back to David Brooks´s column, he quotes Daniel Kahneman:

Daniel Kahneman of Princeton University writes about the Focusing Illusion, which holds that “nothing in life is as important as you think it is while you are thinking about it.”

An illustration – not necessarily fully related to this quote of Mr. Kahneman – is the book review I read in ´Economist´dated March 26th. The book analyses the role of trade protectionism in the Great Depression of the 1930s. No doubt, it played a role in triggering ´beggar thy neighbour´retaliatory trade protection measures by other nations. But, read the last paragraph:

In the longer run, however, the fiasco of Smoot-Hawley may have helped remove American trade policy from Congress’s control. The act’s bad reputation may also have spurred the United States to try and negotiate bilateral reductions in trade barriers after the second world war.

That does not mean that you do the opposite of what you intend to achieve. That is harder than it seems, precisely because it is counterintuitive. But, the message is that one does not have to despair over developments that, at first glance, seem wholly destructive. They may be so at that point in time but that might prove to be the very basis of lasting and welcome change in future.

Think of the Republican party´s antics in several states in the US on labour unions, on budget policies, on minority-bashing, etc or bankers´bonuses.

Three cheers for two edits

Close on the heels of my column in MINT, I was gratified to find Business Standard back me up with an editorial, advising the Congress Party to wind up the National Advisory Council. The newspaper’s proximate provocation was an interview that noted agriculture scientist Dr. M. S. Swaminathan had given the newspaper. The edit, his interview, his weak denial can all be seen here, here and here.

On March 17th, the Indian Express wrote an editorial criticsing the Income-Tax department going after the investors who committed to invest in Gujarat in the Vibrant Gujarat Investors’ Summits. It was said well and said without equivocation.

Why we should buy stocks now

In Hong Kong, I bumped into good friend Jim Walker and he listed four reasons to buy equities: US is dysfunctional, Europe is broke, Japan is bankrupt and the Middle East is in flames. Lest there be any misunderstanding, he was being sarcastic.

One of my colleagues wrote back that he could re-arrange the countries and the causes in any combination and that it would still make sense! Good one.

For a more balanced view, you can click here. I must admit that even I was struck by the audacity of the Bloomberg headline that the linked post on ‘Free Exchange’ refers to.

Important to add that, with some caveats and some exceptions, I am in Jim’s camp.


The world has shifted its gaze from Japan. Western powers have launched air strikes on Libya. The price of oil is set to rise. India and China are still tightening policy. I do not think they are done yet even though many are predicting an end to the tightening in China soon. Some are calling the tightening (in India, for example) plain wrong. I do not agree with that, given what happened in Japan and what is happening in the Middle East and the impact both would have on the price of crude oil. India seems to be facing many challenges – domestic and global , political and economic – at the same time. At some level, it is all overwhelming.

Some good readings:

This raises perhaps the most troublesome concern of all: with a post-crisis world getting hit by one shock after another, and with central banks having no latitude to cut interest rates, it is not hard to envision a scenario of open-ended monetary expansion that ends in tears. The dreaded inflationary endgame suddenly looms as a very real possibility.

The significance of the earthquake and tsunami of 2011 is not the relatively low magnitude of Japan’s direct impact on the broader global economy. The more meaningful message is how these shocks box the rest of us into an even tighter corner.

[Stephen Roach says these in his piece over at ‘Project Syndicate. Very well said. Captures my thoughts well].

Buttonwood (‘The Economist’) gets it right on Bernanke and quantitative easing:

Note that Mr Bernanke seems to treat both lower and higher bond yields as evidence for the success of the policy. And note also how his first two references are to the recovery in the stockmarket. His big speech on QE, back in January 2009, did not mention share prices at all.

If it is vital to maintain stockmarket confidence, then equity jitters—whether caused by Japanese earthquakes, European fiscal problems or something else—are a reason to keep QE going. And the bigger the programme, the harder it is to unwind. Mr Gross is right to worry. [More here]

James Kwak has this lovely piece at Baseline Scenario on American banks raising their dividends. Readers should note Prof. Anat Admati’s relentless campaign on banking reforms. Her letter co-signed by 16 other economists on the issues of banks paying dividends can be found here.

This blog post by Emanuel Derman is a gem (ht: Dr. Vidyasagar).

The downward spiral continues

It is hard to know whether the threat of radiation from Japan’s damaged nuclear power plants is more dangerous to the world than the hubris of America’s bankers.

(1) Via Reuters BreakingViews, the New York Times carries this story on how pay for America’s bankers is beginning to creep up.

(2) Paul Krugman is dripping with sarcasm when he notes that politicians are finally showing outrage at … “those trying to hold banks accountable for these abuses.” (See his full Op-ed here).

(3) The Federal Reserve chose not to raise interest rates in the US at its meeting held on Tuesday.  Not a big surprise. America has an unemployment problem. Its measured inflation rate (whatever it measures) is still low and right now, it does not have a credit bubble onshore. But, despite writing a few sentences on inflation and inflation expectations, the Federal Reserve chose to highlight that measures of core inflation – ones that exclude food and gas – remain low.

It is not clear who told them that longer term inflation expectation remains stable. Just last Friday, the University of Michigan consumer confidence index showed that median 5-10 year ahead inflation expectations jumped 30 basis points from 2.9% in February to 3.2% in March. It was 2.7% last September.

Burying their head in the sand combined with the fixation with those prices that do not rise and indifference to those that do, landed them in trouble the last time in 2007. This time around it is landing every one else in trouble with bubbles in property and rise in cost of living. Not a combination that guarantees social stability in the world. The question is WHEN does it wash up on the shores of the US and not IF.

Reserve currency status

Michael Pettis has a long piece (as usual) on the comment by Barry Eichengreen in Wall Street Journal last week. The Gold Standard has commented on it here. Michael Pettis’ message is broadly similar to ours. This particular observation by Michael Pettis caught this blogger’s attention:

Remember that one of the reasons sterling never achieved the dominance that the dollar has today is that the French and the Germans, not to mention some other European powers, actively undermined its role in favor of their own currencies.  I don’t see why this won’t happen again.

H..mmm. Good one.