Month-end lipstick effect

In the famous Tamil film, ‘Indian’ that was released in the 1990s, actor Kamal Hassan played the role of an aging ex-freedom fighter who kills corrupt officials and government servants.  In the movie, he chooses to kill a government doctor who would refuse to treat his daughter with third-degree burns unless he was ‘taken care of’. ‘Kamal’ would keep brandishing the knife in front of the doctor and the doctor would offer to pay him something to let him go. That would settle the issue. The ‘Indian’ would kill the doctor noting that these guys never change.

I was reminded of that scene when I saw a short message on my mobile phone that global central bankers had co-ordinated a cut in the dollar swap rates.

It is the last business day of the month. It helps to put a lipstick on the pig’s face.

Just in the evening, a good friend working for an internationally well-known global macro hedge fund was trying to convince me that even if the European Central Bank bought up all bonds of peripheral European countries printing Euros, it need not be necessarily inflationary as was the case when the Federal Reserve did that in 2009-10. He said that the crucial difference between then and now was that China had unleashed a credit boom and was buying up commodities needed for its infrastructure rollout and manufacturing sector. Now, China had no more credit bullets left and hence, ECB money printing would not have to be inflationary.

He made me pause and think but left me unconvinced. Absence of bullets does not mean that the gunmen would refrain from shooting. Witness what they did today. Further, if there is no China to stoke the commodities fire, there was no Arab spring then and nor was there a Iranian takeover of the British Embassy.

In any case, China too joined the lipstick party by cutting reserve requirements on banks with effect from December 5. The other central banks had also announced that their swap rate cut would take effect from December 5th. What a coincidence!

Financial speculation had not gone away. So, if the ECB printed, the price of crude oil might not double in price as it did from September 2008 to September 2009 but it could add at least ten dollars. Bank of Japan has published important pieces of research to that effect.

I hope my friend re-examines his logic after seeing the central banks’ brazen action aimed at month-end asset prices and the Pavlovian crazy reaction in financial markets to that lipstick measure of global central banks.

He should remember that some people never change. They are either removed from the scene or they continue to harm. They never reform.

Taxing the 1%

Just as many Congressmen have said (we do not have to take them at their face value) that they would have voted differently had they known all the facts, I wonder whether those who are opposed to taxing the 1% will also change their views or at least put primary importance on curbing rent-seeking, after reading this report. It is a long one but well worth a read.

It is one thing to lend freely in crisis (the Bagehot principle) but it is another thing to lie about it and another thing to offer that for free without any conditions or penal rates of interest. Paulson, Geithner and Bernanke, step forward and take a bow. They should erect statues for the three of them in all Wall Street banks.

The fear of the printing press

Good friend Ramana and batchmate from IIM-A days sent me the link to an interesting piece by Richard Evans on the historical background to the German aversion to inflation and their inflation phobia. Those who have read ‘Lords of Finance’ would be familiar with the contents of the piece by Richard Evans. Others would find it fascinating to read the turbulent and painful history of Germany in the 20th century that lasted nearly four decades.

[Parenthetically, I had covered this in my MINT column in July, 2010 inspired, no doubt, by Liaquat Ahamed’s ‘Lords of Finance’. Germany/ECB is setting policy for the 1920s while the Federal Reserve is setting policy today for the 1930s]

The interesting issue is that the market is validating German inflation-phobia. Last week’s German government bond auction went so poorly that the Bundesbank had to pick up nearly 40% of the debt auctioned. Far from strengthening the case for the European Central Bank buying bonds of Italy, Spain, etc. in unlimited quantities, this failed auction underscores the risk to the core countries from such an approach. It is a quicksand that would drag and drown them all in. The failed bond auction is a warning from the market that the risk of inflation is too high in the Eurozone to justify such a low yield, even from Germany.

Those who advocate/suggest that Germany should shed its fear of inflation and allow ECB to print and buy European debt in unlimited quantities  – Richard Evans is one of them – are guilty of one thing. Sure, they are not guilty of making a wrong suggestion. They are guilty of not admitting that the consequences could be global and are unforeseen in their magnitude. Surely, there will be a inflationary impact on the Rest of the World as it would breathe fresh life into commodities. How would the emerging world respond? Trade barriers? Capital Controls? Renminbi devaluation?

What would be America’s response to that remains to be seen? At one level, America would be happy at the complete transformation of the ECB into a clone of the Federal Reserve. That eliminates the threat of Euro emerging as a dominant international reserve currency. At another level, the resulting strengthening of the US dollar would be viewed with mixed emotions at best or negatively, at worst. America would not be able to engage in a stealth default of its public debt. Its stated goal of doubling exports would also be jeopardised.

This suggestion has been made not just by Mr. Richard Evans but by several others like George Soros, Martin Wolf, et al.

As is the case with the American Keynesians (think Paul Krugman), their vanity lends an exaggerated sense of certitude to their policy recommendations.

This blog has no shame in putting up his suggestion as a starting point for discussion among Eurocrats!


Gavyn Davies, formerly of Goldman Sachs, has this new blog post on the various scenarios for the Euro. Check it out here. Subscription may be required. Look at the graphic embedded in the post. The way option (3) is presented is disingenuous. It is not easy at all. Will peripheral countries be prepared to lose fiscal sovereignty? If so, under what conditions? What is the quid pro quo? If the quid pro quo is that the Euro strengthens, that is no compensation at all. It is doubling the pain of surrendering fiscal sovereignty and accepting fiscal austerity. How will the ECB know where and when to stop with its bond purchases of the indebted European issuers?.

The truth is that, at this stage, all the easy answers are over. Either the pain is taken by the peripheral countries fully (unlikely), the pain is kept within Europe as far as possible or it is spread globally by the printing of the Euros. Actually, scratch that. All options would result in global pain. The duration and the intensity of the pain would differ depending on the option chosen. That is the only that remains to be established.

Felix Salmon thinks that the Federal Reserve has a lot to teach the ECB. Quite.

The cover ‘curse’

‘Economist’ is at it again. In its latest issue dated November 26, 2011 it has displayed the Euro like a shooting star (or a meteor) that is crashing fast towards the earth. Is it time to close the Euro shorts?

I quickly browsed through a PowePoint file that I had put together in December 2007 for my class at the SP Jain Centre for Management in Singapore that month where I had referred to the ‘magazine cover’ indicator for developing short-term forecasts!

Here are the interesting results. These were sourced from I think the blog still exists but it is not the same ‘macroman’ that is blogging.

(1) Dec. 2, 2006: Economist cover: ‘The falling dollar’

Next five weeks: EURUSD down 3.8%

(2) December 2004 (date not clearly visible) Economist Cover: ‘The disappearing dollar’

Next two months: EURUSD down by 5%

(3) Feb. 2004 (again, date not clearly visible) Economist Cover:  ‘Let the dollar drop’

Next three months: EURUSD drops by 6.5%

To be fair to them, the long-term trend was correct. The dollar slipped a long way by 2007. It is just that, in the short-term, the magazine cover simply confirms that all news must be in the price.

So, should one go long EURUSD now?

Back to Indonesia – guest post

I was reading this Bloomberg News story on Indonesia today:

Under the old regime, corruption was highly organized and predictable, and now it’s highly disorganized and unpredictable,” said Hill. “You knew who to pay, how much and what the payoff would be. Now, none of those are clear.

Of course, this should be a lot familiar to Indian readers.  The full story is worth reading.

In this context, this blog had a discussion on Indonesia some time ago. My good friend Manu Bhaskaran of the Centennial Group who has followed the Southeast Asia region and its economies closely for more than two decades, kindly agreed to send his comments below to be posted as a guest-post.  In fact, he had sent me this almost two weeks ago. My travels (I am now at Madurai in Tamil Nadu as I am posting this) have caused a delay in posting this.

Over to Manu:

Indonesia has many things going for it and even with few reforms, there are probably enough positives – young and cheap work force, commodities, large consumer market, less trade dependence on the US and Europe – to keep the economy on a reasonable growth track of around 5% on average for the next few years.

However, in order to match the expectations built into the valuation of its equities, bonds, currency and assets which foreigners are buying, Indonesia should be doing a lot better and its failings could well make it a lot more vulnerable to downside risks than expected:

First, the political economy is moving in an unfortunate direction. It is a weak democracy that is proving too easily captured by vested interests.

Parliament’s efforts to weaken the Constitutional Court and the anti-corruption agency are just the most recent examples of this, there are so many other outrageous examples. This produces a country that is run for the benefit of certain private interests and against those of the country and people at large.

A country known for its extraordinary religious tolerance is also increasingly seeing extremist intolerance which the current government has shown no backbone in confronting – the brutal videotaped murders of Ahmadis saw the murderers given light prison sentences while one of the Ahmadis who fought back was jailed!

Second, the financial dimension of Indonesia’s economy remains a concern – even recognising the improvements such as the strong rise in FX reserves, the sharp fall in the fiscal debt/GDP ratio and the better capitalisation of

the banking sector. Indonesia has been borrowing on a large scale from European banks in the last 2 years, as they cut back on lending, Indonesian entities will have to find other sources of loans.

Indonesia has a history of devaluations and inflationary spikes which means that inflation and exchange rate expectations of economic agents can change very quickly and destabilise. The recent financial travails of a very large Indonesian company is a reflection of how quickly the financial position of key entities can deteriorate.

Third, growth has been driven in recent years by (a) the fall in risk premium (as political and macro-economic stability improved after the dislocations in 1997-2002) driving down cost of capital and spurring investment; and (b) surging commodity prices driving incomes and demand as well as inflows of FDI. The first driver has been in operation for nearly a decade and probably does not have long to go. As for the second, if the global economy slows as will surely happen, commodity prices and volumes will be hurt. Indonesian growth is far more susceptible to global events than many assume.

In short, Indonesia is not a bad story in the long term but there are increasing vulnerabilities which investors may have under-estimated.

Too soon to tell

Too soon to tell

The decision of the Reserve Bank of India announced on November 16th to conduct Open Market Operations (OMO) to the tune of Rs. 100 billion (USD 2 billion appx.) and buy Government of India securities was not unexpected. Recent Government of India debt auctions have devolved on underwriters as the cut-off yield that the Central Bank had determined were perhaps too low for market participants to pick up the debt issuance voluntarily. This has had the effect of further squeezing liquidity in the economic system. Although the Reserve Bank of India does not directly monetise Government of India debt, OMOs amount to backdoor monetisation.

Would it be inflationary? Some reckon that it would not be since the RBI is not expanding the reserve money growth but only meeting the demand shortfall. This is semantics. At the margin, supply of liquidity is set to rise and, ceteris paribus, it is inflationary. However, there could be mitigating factors.

This might signal that someone is in charge and they are taking some action to relieve liquidity pressures. Further, the crisis of confidence that has suddenly developed on the Indian economy might have already begun to work to weaken demand impulses that this OMO need not be inflationary. This belongs to the realm of conjecture.

For now, the upward pressure on India’s inflation and on USDINR remains because the government is not signalling that it has got the market’s message. Fiscal balance remains precarious and efforts are afoot (bringing more items into the Service Tax net) to squeeze more revenue out of the slowing economy rather than cut or scale back frivolous and wasteful populist government programmes. Newspapers are full of hints and leaks on imminent economic reforms but the truth is that no tangible change has happened yet.

(Postscript: RBI announced slightly higher interest rates (+1%) for Non-Resident External Rupee Term Deposits. See here. It does not change the above comments)