Central banks and market calmness

For Yours Truly, articles such as this are indication that we have not absorbed the lessons of 2007-08 or any central bank policy induced crises before that. Attributing the market ‘calm’ to central banks without even contemplating for a moment that markets might be complacent as they were in 2007 boggles the mind.

Of course, this reaction on my part is unsurprising because I think differently. That is the burden of my song in today’s MINT article. The answer to the NYT piece linked above is specifically in this paragraph:

The stock market in the US is ignoring these developments as it has in the past. This is both complacent and myopic. Strong corporate earnings were offered as a defence in 2007. That could not prevent a stock market rout in 2008. There is no reason to expect anything different this time. Markets seem to be able to look only at the numerator (and that too, earnings and not dividends) whereas rising risks must be factored into the denominator (the discount rate). Investors refuse to do so because central banks have permanently shut down the signalling function of interest rates.

By now, there is a high chance that readers have heard of and read the speeches by Jim Grant and Robert Wenzel at the Federal Reserve Bank of New York. OF course, both are preaching to the converted. While it is praiseworthy that FRBNY invited them, listened to them and offered them food, it is unlikely they would have swayed hearts and minds beyond a few seconds or minutes. But, do read the speeches for the wit, sarcasm and views stated without pulling any punches.

Jim Grant calls the Federal Reserve the ‘Office of Unintended Consequences’ while Wenzel invites them to shut down the office and walk out with him after dinner.

As a side-note, this blogger owes it to himself and to the name of this blog itself to comment on Chairman Bernanke’s comments on Gold Standard. Murray Rothbard had done so eloquently some twenty years ago. But, that is another topic for another occasion.

In this regard, it came as a surprise (to this blogger, of course) that Hugh Hendry is massively bearish on China and is on the cusp of being bullish in the US. Well, his negativity on China is old news. For the most part, I can accept the former with some qualifications and I can understand that one can get bullish about the US at some stage. For example, given US demographics, long-term attractiveness as a dynamic place for entrepreneurship and creativity, one can lock in some value in US real estate now. But, US stocks on the cusp of a bull market as in 1982?!

On the plus side we also believe that we are much closer than before to the beginning of a bull market of perhaps 1982, if not 1932, proportions. We just need the last shoe to drop.

Of course, there is the last shoe to drop. We do not know how big the shoe is and how steep is the drop going to be. He has hedged himself, alright.

Frankly, it is not much of a contrarian stance NOW to be bullish on the US and bearish on China.

Some of the comments to this above post in ‘ZeroHedge’ are rather interesting.

Drama of the outlook downgrade

Here is the S&P announcement on downgrading the outlook on India’s lowest investment grade credit rating. By and large, I think it is a reasonable decision. I am not ‘shocked‘. It is interesting that the linked BS article talks of Indian FinMin officials expecting an upgrade. That shows how far they are out of touch with market perception of India and how far their government has contributed to it in the last twelve months.

S&P had laid down markers for the credit rating to stabilise:

the ratings could stabilize again if the government implements initiatives to reduce structural fiscal deficits and to improve its investment climate. Fiscal measures could include an increase in domestic prices and a more efficient use of fuel and fertilizer subsidies, or an early implementation of the goods and service tax.

The government has given an inkling of its ‘in-principle’ decision to decontrol prices. The reactions of Prakash Singh Badal and that of BJP are both typical and disappointing. One hopes they are merely political. The government is testing the waters and others are putting down markers. Somebody has to rise above short-term political goals. Easier to write in a blog than to do it. When the government is ‘keen‘ on putting Bangaru Lakshman in jail while it stoutly defends all its ministers in the 2G scam, it is hard (but not impossible) for the BJP to appear and act magnanimous.

That is why the political climate is so important in a country to undertake crucial reforms that impinge on several vested interests. When there are no divergent political ideologies but only divergent personal agendas which, of necessity are ‘either-or’, meeting points are usually quickly lost and there is stalemate. Of course, it is not peculiar to India now.


Three days in Manila this week. Returned on Thursday night. The flight was full. Consistent with what I saw in Manila. The place seems to be humming, for now. Shangri-La was full. There is the upcoming ADB Board meeting from May 2nd. The memory of the deadly attack on Hong Kong tourists in 2010 is now distant.

One local businessman, when asked to name the key ingredient of President Aquino’s governance, he said that he has kept at bay all the corrupt elements that were close to his mother. The test of his integrity is going to be in the case in which the judiciary has ruled against his family.

The Manila airport is a parody of an airport. Philippines per capita GDP is twice that of India’s. But, it is arguable if, even in the Socialist era, the Indian capital had such a drab, crowded and inefficient airport. They collect the airport tax in pesos or dollars (the exchange rate is updated to reflect current market rates) and it adds to the delay. The security check stops short of a strip-search. Therefore, when one scrambles to put back the belt and shoes, the area is filled with the smell of stale odour from socks!

[Waiting for my turn at the check-in counter, it was fascinating to watch one young European banker (my guess) showing off his importance to the world to the lady assisting passengers in the check-in counter and deigning to leave his Business Card with her. He had the air of some one who has done a huge favour to a poor girl from a developing country. He was clearly the Master of (his) Universe.]

Monetary and fiscal policies score high marks. Deficit is at 2% of GDP and inflation is under control. Remittances remain the backbone and this backbone has become even more important and stronger in recent times. Of course, a country of over 100 million people with a high education attainment can and should do a lot better in providing jobs to its people onshore. I had not known before of the country’s rare earths (cobalt) and mineral endowment.

Unsurprisingly, Philippines and Indonesia are now in the forefront of the stalling of the ASEAN Services Treaty with India.

The front-page story in the local newspaper (The Star) delivered to my hotel room was the President attending the concert by a Brazilian singer with Korean TV anchor and model Grace Lee.

Of course, the big story is about China’s claims and warnings to Philippines on not to operate in a part of the South China Sea. US and Philippines have sent some ships to the disputed region. China has told Philippines not to internationalise it. But, China too has sent warships to the disputed site.

The Philippine peso and the Indian rupee used to be in lockstep against the US dollar. Since the middle of last year or around August, they diverged. The Philippine peso will now trade at 1.1-1.2 Indian rupees soon. This appears deserved. Philippine 10-year government bond is yielding 5.8% or so. It is the same as Indonesia’s. But, Philippines’ credit rating is two notches below that of Indonesia’s and India’s. Either Philippine government bond is too expensive or its credit rating deserves an upgrade. As usual, there is truth in both statements. The stock market appears fully priced. Of course, the market is shallow and free float is thin for most stocks. There are no easy ways for some foreigner to participate in the good macro story. Of course, the key is that it should last.

It is good that the Philippine Presidential term is six years. If one wants to, some useful things can be initiated and followed through. There is so much to be done and the country has numbers in its population, people of the right age, skills, drive and more. It is clear that all that is required is minimum standards of integrity and the rest of the society takes care of itself, for the most part. Hope the show continues.

Executive Compensation

When I came across this article in New York Times on how employee-shareholders might have voted on a non-binding resolution against the pay-packet of Vikram Pandit, I was reminded to search for my own letter sent to FT in 2002 on this topic. I am reproducing the letter below:


Marx and Smith needed more than ever

Financial Times; Jun 06, 2002

From Dr V. Anantha-Nageswaran.

Sir, It was a pleasure to read John Plender’s thought-provoking article on the issue of stock options (“Fuzzy lines of ownership”, May 29). The argument that technology companies depend more on internal capital (human capital) rather than external capital and hence there is a case to be made for rewarding insiders better, is insightful.

However, this argument is grounded by the audaciously disproportionate rewards that top management bestows on itself.

The public outcry would be muted if only such rewards for internal capital were more evenly spread. On the other hand, this self-congratulation often comes at the expense of employees who had helped to build up the company. The standard prescription is to lay off employees in the thousands in an attempt to shore up the value of the stock options.

In effect, what we saw in the 1990s was neither capitalism nor socialism but elitism – top managers rewarding themselves and getting governments to work in their favour. Maybe we need an alliance of Karl Marx and Adam Smith to restore a semblance of parity between labour and capital on the one hand and top managers on the other.

V. Anantha-Nageswaran, Singapore 039393

© Copyright The Financial Times Ltd

I am  glad that the alliance of Karl Marx and Adam Smith is now becoming a reality.

I am also linking here to an article I wrote on American capitalism in 2003. At that time, I had a fortnightly column in ‘Business Line’ (a publication of THE HINDU group).

RTE and elites

My cousin brought to my attention the piece that Ms. Shoba Narayan had written in MINT on the 25% reservation for poor students in private schools, mandated by the Right To Education (RTE) bill. His views were:

Any affirmative program will feel like it won’t work when forced and we all can talk about reservation being not really effective etc., However, unless some mass movement that can ignite and sustain social change as it has done for India in end of 19th century and pre-independence 20th century happens, legislation is the only way. I do know that it will not achieve all that it purports to but it will start and start for sure.

Ironically, besides this aspect, there are so many other aspects to Education in India as well as RTE but the fact that all elites and elites of Mint focus on this aspect typifies typical resistance. We need to be as honest about that too…..

Personally, I liked Shoba’s piece. It was politically incorrect and hence, in my view, courageous. She did not motivate her piece on macro arguments against reservations. She dealt with the psychological and social dangers (attitudes) that might limit or even nullify the effectiveness of the 25% reservation. Her piece is here.

I am prepared to add my two cents worth:

(a) 25% reservation might end up alienating both sides as the Australian programme of planting aboriginal children in white homes achieved.

(b) At another level, it makes sense to start reservations early so that the periphery-centre gap is plugged early in life. If so, should it be extended all the way up to jobs and promotions?

As long as reservations are seen as pure entitlement and not empowerment, resentment and bitterness in ‘others’ are inevitable. One cannot criticise the latter without blaming the former for it. Political parties want to make the poor feel as though they are being done favours rather than make them feel that they have rightfully deserved it and thus feel less inferior or equal to their more affluent contemporaries.

Political interests continue to focus on entitlement approach for three reasons: (1) Entitlements are favours granted by ‘royalty’ and that makes them feel powerful (2) Keep ‘them’ poor and dependent and (3) keep divisions within society brewing and rising.

In the final analysis, with any public policy-making, we can debate them to death. But, experimentation is in order and the only way to improve policy. Nothing better than empirical verification to validate policy goals. If reality falls short of goals, there should be no hesitation in admitting failure in design (if not in goals) and in re-designing. We often fail to do that.

However, as my cousin writes, there are, perhaps, more important issues with the RTE bill. After reading James Tooley’s book (I have blogged on it here), I have been concerned about the impact of the RTE bill on small private schools, run in poor neighbourhoods. The Act threatens (or, proposes that they be) to  shut them down if they did not meet infrastructure requirements.

So, Parth Shah of the Centre for Civil Society (CCS) is happy that the rules framed by the Government of Gujarat under the RTE have been far more pragmatic:

Appendix 1 of the Gujarat Rules is the one which has a path breaking formulation for recognition of a school: this will be a weighted average of four measures:

Student learning outcomes (absolute levels): weight 30%
Using standardised tests, student learning levels focussing on learning (not just rote) will be measured through an independent assessment.
Student learning outcomes (improvement compared to the school’s past performance): weight 40%
This component is introduced to ensure that schools do not show a better result in (1) simply by not admitting weak students. The effect of school performance looking good simply because of students coming from well-to-do backgrounds is also automatically addressed by this measure. Only in the first year, this measure will not be available and the weightage should be distributed among the other parameters.
Inputs (including facilities, teacher qualifications): weight 15%
Student non-academic outcomes (co-curricular and sports, personality and values) and parent feedback: weight 15%
Student outcomes in non-academic areas as well as feedback from a random sample of parents should be used to determine this parameter. Standardised survey tools giving weightage to cultural activities, sports, art should be developed. The parent feedback should cover a random sample of at least 20 parents across classes and be compiled.

 This is one of the first times in India’s history that public policy has focused on children and parents, instead of focusing on the public sector producers of education services.

Specifically, on this issue of infrastructure, this is what the Gujarat Government has proposed:

The Gujarat Rules allow for the State to takeover the school, or transfer management to a third party, and create a genuine possibility for the school to continue and meet the norms. This, once again, shows the focus of the Gujarat Rules upon the interests of students and parents.

On the physical infrastructure issue, I have been harping on, in private conversations, on a solution that is identical to the one proposed by Abhijit Banerjee and Raghuram Rajan in a piece published more than two years ago:

The problems of private schools with inadequate facilities and government schools with inadequate motivation need to be dealt with jointly so that the poor can benefit from the resulting competition. Is there some way that schools with high verifiable performance that charge fees that are low enough to be generally affordable could be rewarded with better government-supported facilities regardless of whether they are private or government? And in reverse, could poorly performing government schools be starved of promotions, salary increments, and capital funds until they shape up — and shut down if they fail to do so? Could well-performing private schools be allowed to avail of the facilities of government schools that do not attract students? [Link]

I was in the first batch of the 10+2+3 system in Tamil Nadu. Many schools were not ready with laboratories. Intermediate students (11+1) went to colleges for their pre-University education and colleges had laboratories (or, supposed to). So, schools were allowed to form clusters and each cluster was assigned to a college. Students went there and performed their experiments, etc. In essence, that is what AB and RR propose.

Shoba gets it right here:

What the government seems to be saying is that they have failed the 90% of children who go to government schools and, therefore, want the private schools to step in and do their work.

Of course, she does not have an answer to the problem. But, India has not found an answer so far, for educating its poor (most likely because politicians did not really want them to be educated) and hence, why blame her alone?

Government education was the solution and it has failed miserably so far. India’s gross tertiary education enrolment is still very low. Same old motivation issues with teachers and staff as with other government workers.

They – politicians – do not have the courage to hand the schools over to local communities to run the schools themselves. They will do a far better job of it, I am sure. Just read the 11th chapter (‘The Men who uprooted the Beautiful Tree’) of James Tooley’s book on how India used to educate her children before the British arrived.


In the April 2012 investment newsletter that I wrote for one of my clients, I wrote the following on the bond market:

The reaction of government bonds will be interesting to watch. Will they respond to ample liquidity and promise of record-low short rates by rallying or will they begin to price in an appropriate risk premium for inflation and for fiscal debt and deficit burdens? (This was in the context of my earlier remarks in the letter that QE3 in the US was on the cards in the second half)

In a world where risk mispricing is more the norm than the exception and where bond markets are dominated by global central banks and sovereign wealth funds, it is hard to see bonds signalling risks appropriately as they once did. Therefore, on balance, government bond yields would remain depressed. Premature obituaries will continue to be written for the bond bull markets. Central banks must be chuckling quietly. The day bonds begin to sell off and yields begin to rise will be the beginning of the return to normalcy in the world of finance. It is hard to predict its arrival.

I was pleased to find Tim Price echoing my thoughts in this newsletter. It is a MUST READ for its sheer wit. J.K. Galbraith’s views on the usefulness of  economics and Tim Price’s comments on Paul Krugman are priceless.

Here are his comments on what goes for ‘MARKETS’ today:

Unfortunately for those of us with a purist‟s approach to the business of investing, “the market” is rapidly becoming something of an endangered species. Your mission, should you choose to accept it, is to try and identify any asset of significance that isn’t experiencing huge and artificial distortion to its price by forces that we might term “the monetary authorities” and their huge and daunting printing presses. Inasmuch as participating in “the market” is a game, it is a game of water polo with a blue whale as referee.

But there‟s the “nice-to-have” market, and then there’s the “market-as-currently-exists”, with all its attendant monetary debauchery and artificial, bad bank-perpetuating stimulus. We may not want to be starting the investment journey from here, but we do not have the choice. Amid all the stimulus and the QE and the LTRO, the bubbles denoting investment insanity are more than usually visible. They are, more to the point, wearing high visibility jackets, sounding klaxons, and wearing garishly coloured T-shirts and party hats announcing  “We are a giant bubble !”

They include, but are by no means limited, to:

10 year UK Gilts yielding 2%

10 year German Bunds yielding 1.75%

10 year US Treasuries yielding 2%.

At the same time,

UK CPI stands at 3.4%. Conventional Gilt buyers are losing money in real terms.

Euro zone CPI stands at 2.3%. Bund buyers are losing money in real terms.

US CPI stands at 2.7%. Treasury bond buyers are losing money in real terms.

After reading it, those who think of me as an ‘Economist’ can conclude that I have the ability to laugh at myself. Alternatively, they can accept my explanation that I was never a formal student of economics. I did my Bachelor’s Degree in Commerce in Madurai, my MBA from IIM-A (some would legitimately like to equate both MBA and Economics as voodoo/pseudo sciences that try to sell snake-oil to the unsuspecting public and they would be right, in my view) and my Ph.D on exchange rates. My professor taught Finance at the School of Management in the University of Massachusetts.

But, let me end this trivia as I do not want to stand in your way of reading this great piece of wit, sarcasm and wisdom.

LBJ ‘paid’ more

Bloomberg came up with an interesting observation on minimum wages in the US, adjusted for inflation, being lower than they were during the time of Lyndon B. Johnson. It wrote an editorial recommending an increase. That intellectual openness has to be applauded. It is all right to harp on efficiency and how a raise in minimum wages discourages hiring, etc. Beyond certain limits, they sound hollow and merely provide cover for capitalists’ greed.  Once certain well-accepted social norms of fairness and reasonableness are crossed, capitalism becomes indistinguishable from robbery. So, Bloomberg deserves our praise for noticing an extreme deviation and writing about correcting it.

Why is that so in America? If you are able to connect the dots, here are two of them. One is by Roger Lowenstein who has penned a detailed note on how the industry is lobbying against rules to make the world safe from derivatives and their trading of it. These two paragraphs (in this long article) caught my eye:

It is hard to see why industry would attempt an end run around the rulemaking — save that it wants to protect one of the most lucrative and highly concentrated sectors on Wall Street. The House bills are so specific they are almost comical. (Emphasis mine). It is doubtful that members even understand what they are voting on.

This legislative pre-emption recalls a similar interference by Congress in 1999-2000, when Arthur Levitt, then chairman of the SEC, sought to enforce higher standards on corporate auditors. Congress threatened to strip the agency of its power to regulate audits; Levitt was forced to compromise. Less than a year later, America was hit by a wave of corporate accounting scandals, including that of Enron Corp.

The second one is by professors Thomas Cooley and Kim Schoenholtz, at New York University’s Stern School of Business. They write about ‘shape-shifting’ by financial institutions – a form of regulatory arbitrage. Deutsche Bank has de-linked its investment bank from the Bank holding company to avoid the higher capital requirements mandated by the Dodd-Frank Act.

Their last paragarphs make for sad reading:

The most straightforward solution to this problem is to regulate financial instruments and markets (say, through collateral and margin requirements), rather than just regulating institutions. Another is to promote transparency and infrastructure that empower greater market discipline. Dodd- Frank makes some progress along these lines by shifting derivatives trading to clearinghouses. And the Fed has pushed for years to reduce the systemic risks emanating from the critical market for collateralized short-term funds (repurchase agreements).

But not all systemic risks are easily amenable to this approach. History shows that increased regulation of instruments and markets also will create incentives for innovations that avoid it. Such innovations may be quite profitable, even as they undermine efforts to limit systemic risks.

Have the great financial crisis, the extraordinary policy responses, the deepest postwar recession and the dismal recovery altered these historical tendencies? Not if Deutsche Bank and other foreign banks’ version of regulatory arbitrage proves representative.

But, banks are not the only ones who have not altered their behaviour yet. There is no remorse in other quarters too.