All you need to know is in four pages

IF you wanted to get a deeper understanding of why we are in the mess that we are in and why we are unlikely to come out of it (since we are solving the problems with the same mindset that created them), you need not read tomes. You just need to read four pages of the Federal Reserve Bank of Chicago Fed letter for October 2012 blandly titled, ‘How to keep markets safe in the era of high-speed trading’.

‘Speed’, ‘Instantaneous’ – the great instant gratification trip of the human race in the last three decades (esp.) is going to be its ultimate destruction weapon.

It is a very profound piece of research on not just high-speed/algorithmic trading but on every aspect of how we conduct our lives and businesses and how society/economies have come to organise themselves.

Each sentence (or, sentences) is pregnant with meaning and possibilities.

High-frequency trading is a made-to-order systemic disaster, all for few extra bucks. The reason why risk controls are overlooked is that the greater the volume of orders, the greater the gains since the per share gain is miniscule.

Amazing chutzpah on the part of market participants to suggest that regulators are responsible for setting risk control parameters and to ensure compliance with those parameters! Then, they will call for free-market, self-regulation and engage in regulatory capture.

Some of the Broker-dealers and Futures traders have equity stake in the Exchanges. How will exchanges impose risk controls on its members? So much for arms-length and Chinese walls.

This is the best piece of research you can read in 2012.

It documents why we have become our own Frankenstein monsters.

Doffing the hat to Bair and Fisher

TGS had failed to blog on this article by Ms. Sheila Bair written in April 2012 dripping with sarcasm. It exposes the intellectual vacuum in policy and academic circles (many exceptions, of course). Sad part is that QE3 still happened.  Now, her book is about to be released on Tuesday. This link cites her remarks on some personalities on Wall Street and the Treasury. Enjoyable. More highlights of the book here, here, here and here.

I must also acknowledge the extraordinarily honest speech delivered by Richard Fisher at the Federal Reserve Bank of Dallas to the Harvard Club of the New York City on September 19th. I had referred to it quite liberally in my MINT column on Tuesday. But, one particular paragraph deserves to be repeated here:

…nobody on the committee, nor on our staffs at the board of governors and the 12 banks, really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. And nobody—in fact, no central bank anywhere on the planet—has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank—not, at least, the Federal Reserve —has ever been on this cruise before [Link to the full speech]

America still has the people with which to re-generate itself, if it sets its heart and mind to it.


Home coming, QE Infinity and other links

Well, well, well. In the face of economic hardship, young Americans are coming back home to live with parents. In the name of independence and self-interest, they secularized the joint family culture. Now, they are forced to return to it. Can they fit in, again?

This is wonderful news for cancer patients.

This is not, for Spain. Catalonia wants to ‘secede’. The province gives 20% of Spain’s GDP

Dead in five years – a Baosteel project in China.

A very insightful (and long) article on Robert Rubin by William Cohan. He comes across neither as a saint nor as a sinner. That is how most of us are. Most cases, there are no outright villains or heroes. This is one more fascinating reminder of that.

“The Fed officials are some of the smartest economists around,” he wrote in his most recent note to clients. The trouble is, said Mr Jen, “they know everything except their own limitations”. [Link]

While you read the linked FT article on how hedge fund managers look at the Federal Reserve QE 3 (correctly re-labelled QE Infinity), do not forget to read Andrew Garthwaite’s remarks. After that, if you look for the nearest wall to bang your head on, I won’t blame you. The mechanical interpretation of the impact of previous episodes of QE on stocks is frustratingly dumb. Stocks had different starting points – in terms of valuation – then compared to now. Now, markets need one QE announcement a day to keep rallying. This is classic addiction at a very advanced stage.

One should not waste much time on a report like this: ‘Consumer confidence in the U.S. raises to a 7-month high’ because how consumers feel about their lives and the economy is simply a function of the amount of ‘gold in their pocket’. A rising stock market correlates neatly, highly and always with consumers feeling confident.

CNN shortlists ten heroes for 2012. Most of them have converted personal tragedies into opportunities to serve others.  Of course, lest I be misunderstood, the first is no pre-condition is for the second.

Indians and Asians do not need to apply. H….mmm. Well, at least they are being honest about their intentions. Not much point in hiring them first and treating them badly next, right?

The Queen asked the right question.

Mythical Indian reforms

Sections of the Indian media continue with their deliberate obfuscation of the Government of India’s actions as reforms when they are actually the very anti-thesis of reforms. Consider this news-item in Times of India and especially, the first paragraph:

The government is readying a package to boost real estate activity by easing lending and provisioning norms for banks as part of a strategy to prop up the sector that provides significant employment in the country after developers expressed their inability to cut prices to increase demand.

Any genuine reformer will jump from his chair or see his heart beat a lot faster or his eyes would pop out on reading the above. ‘Inability to cut prices’?; ‘Strategy to prop up the sector’? and this is the economy booster? Shame on us.

Similarly, the ‘bailout package’ that the Government has come up with for the restructuring of the losses of State utilities (electricity distribution companies or ‘discom’s in the Indian parlance) is another anti-reform exercise.

As a good friend put it, 50% of the losses have been ‘fiscalized’ and the other 50% is ‘loan elongation’. The quid pro quo is that the State governments will engage in periodic tariff revisions:

According to the restructuring plan, states will be part of tripartite agreements signed to implement the debt recast. SEBs will also promise to revise tariffs regularly and in correlation with their costs, besides working to reduce theft, transmission and billing losses from the present levels of 27%.

Yes, State governments will revise tariffs as frequently as the Government of India revises prices of petroleum products.

Comments made by CEOs of some of the banks exposed to Indian DISCOMs are marvellous for their ‘see no problem; speak no problem’ attitude.

A loan recast package without any effort to address the underlying causes that gave rise to the unviability of DISCOMs is not economic reform.

Arvind Subramanian begins positively on Indian reforms in FT:

The Indian government’s recent reforms to reduce government subsidies and embrace greater foreign direct investment were unexpected and bold.

But, finds it difficult to sustain it until the end of his Op.-Ed.:

This indifference to high inflation and the opportunistic, rather than serious, effort to roll back high government spending may yet come back to haunt the Indian economy in the future.

Actually, if one stepped back and thought over Government of India’s actions over the last two weeks, they have been motivated by the same mindset that had characterised their functioning over the last eight years: Short-term imperatives and let long-term consequences be damned. R. Jagannathan got it very right in his comment in ‘Firstpost’.

Algo and oil

I caught this MINT article on how fat fingers or algorithmic traders might have exacerbated the recent crash in the Brent crude oil price. This means that the recent price will reverse itself. Second, it is a reminder, if one were needed, that these algorithmic trades are a menace to the market, along with several other menaces that policymakers have created.

David Rosenberg wrote yesterday that there is now a 74% correlation between S&P 500 index returns and the Federal Reserve balance-sheet. There you go. If evidence were needed of phantom and paper gains being created by Ben Bernanke, you got it now.

But, we are digressing. In this particular instance, India might not regret the impact that algorithmic traders have caused. India would love to see global oil prices crash. But, their potential for destabilising disruption is powerful. Andrew Haldane, Executive Director of the Bank of England, has provided some wonderful research on the systemic dangers posed by algorithmic trading. His paper, ‘Race to zero’ is worth reading and reflecting upon. There is no place for it in India. It should be banned. Period.

As the CFTC Commissioner has correctly observed, it aids neither in hedging nor in price discovery. Amen.

Economic reforms

My weekly column in MINT is on the Government of India ‘reform’ measures announced last Thursday and Friday.

I had previously, in these pages, defended the decision to open up multi-brand retail to foreign investment. I still do. I just do not think that it would do much to change the growth-inflation dynamic near-term. International evidence is scanty at best. But, given the heightened sensitivities in India to foreign investment in retail, I hope the investors are more sensitive of local concerns. It is in their own self-interest. I think doomsday scenarios for India’s petty and small traders are overblown. The government has done well to leave it to the States. Of course, there is always the dnager that politicians cannot be bought out. India might turn out to be a more useful case-study for the rest of the world on the impact of hypermarts on local retail practices and players.

I like the Business Standard edit on the manner in which the reduction in subsidised cylinders was achieved ‘successfully’. I put it under quotes because there are rumours that the Government might increase the number to 10 from 6. I hope they remain and die as rumours. Nonetheless, it is important to highlight success stories in implementing reforms/change. It is as important to learn from successes as it is to learn from failures. This should be a business-school case study.

Splendid isolation

One of the most important/best articles I have read this year: “Complete confusion between principal and principle”. Well said. Check out the comments. It is worth the effort.

Former Indian Finance Minister (and BJP leader) Yashwant Sinha’s piece on the media faithfuls of the government feigning short-term and long-term memory loss. Article is from August 29th but well worth a read.

For once, I agree with this edit in THE HINDU on the Indian government’s so-called economic reform measures announced over Thursday and Friday.

FT Beyondbrics blog post on the mysteriously large net FII inflows into India. It makes sense to me.

Financial Express interviews Professor Arvind Panagariya on the release of the second edition of his book – edited by him and Prof. Bhagwati. He does not buy the argument that coalition politics explains economic paralysis (or, if I may add, with wrong economic decisions) in India. I agree.

More and wrong

Please run this past me again:

Once settled in the White House, however, even Mr Romney would have to consider whether a tight monetary policy was actually in his interest, given that re-election would probably depend on delivering strong economic growth. [Link]

That was from a FT article on Romney’s objections to the Federal Reserve’ QE3. So, FT writers tell us that the Federal Reserve monetary policy was tight before September 13-14, 2012. God bless the FT and its writers.

I append below a comment that I had written immediately after the Fed announced its decision and expanded later to include more information on the number of Americans on food stamps:

Financial markets love it. The Federal Reserve Open Market Committee (FOMC) almost delivered on all that the financial markets were expecting it to do. It announced a new asset purchase programme. The Federal Reserve will buy mortgage-backed securities at the rate of 40 billion dollars per month starting this month. It has promised to buy more should the desired improvement in labour market conditions does not occur. It continues with Operation Twist. It has conceded that monetary conditions would have to remain accommodative even after economic recovery strengthened and it pledged to retain the Federal funds rate at 0% to 0.25% into mid-2015.

Financial markets would have been ecstatic with a monthly asset purchase programme of 60 billion dollars per month. Now markets are just happy. US stocks are rallying. The S&P 500 at 1465 points is within striking distance of its all-time high although now valued in a vastly depreciated US dollar. Brent Crude oil is now trading at above 116 dollars per barrel. Spot gold price is now 1770 dollars per ounce. However, the Federal Reserve is unlikely to achieve job and wage growth with this policy move.

Despite more than two trillion dollars of asset purchases, fiscal stimulus and zero interest rates, number of Americans on food stamps is more than 46 million as of June 2012. The number was little over 30 million in October 2008. Average hourly earnings are rising at a paltry 1.7% annual rate. Median household income had dropped 8.1% from 2007 to 50, 054 dollars in 2011. These figures are adjusted for inflation. Clearly, a different medicine is needed and not more of the same wrong medicine.

However, wrong medicine is what Bernanke has delivered and has force-fed into the mouths of Americans and the rest of the world. Bernanke is sure to deliver inflation for the rest of the world, particularly the developing world, if not for America. If the rate of change in the American consumer price index begins to accelerate, we should not be surprised. The 5-year, 5-year (inflation rate for five years, five years from now) has crossed above 3.0% for the first time in several years.

This comes in the wake of the announcement by the European Central Bank (ECB) that it would buy bonds of 1 to 3 years’ remaining maturity of European governments that are under a European structural reform programme. ECB will not claim any seniority on the bonds over private creditors. Further, it made a weak pledge to mop up the liquidity implication of its decision to buy unlimited (or, unspecified) quantities of government paper.

CLSA’s Christopher Wood, anticipating the FOMC decision, increased his recommended exposure to physical gold to 45% for dollar based US long-only pension funds. Asian economies are struggling. Decisions made in Frankfurt and in Washington, DC might push more money into Asia, causing further divergence between real economies and financial markets. The rise in commodity prices will test social stability through its impact on the cost of living in Asia.

China’s economic slowdown and strained political transition will be severely tested by policy moves in the West. India’s belated decision to raise the price of diesel a little will be largely offset by the renewed rise in the international price of crude oil.

If you are seduced by the euphoria and bluster that pass for economic commentary and analysis in the world, then you will be swallowed by the faultlines that will open up sooner rather than later.

Pizza on Lexus and other readings

The fact that only 20% of the 9.7 million vehicles sold this year have been small cars and the average sales price of new cars sold is now $31,000 proves Americans are still living in a delusional fantasyland of cheap gas and monthly payments for eternity.

As gas prices surpass $4 per gallon across the country, somehow 4.7 million of the 9.7 million vehicles sold in 2012 have been pickups, vans, crossovers or SUVs. Three of the top eight selling vehicles are pickups. Luxury vehicle sales are booming, with Mercedes, BMW, Porsche, Land Rover and Audi showing double digit percentage sales gains over 2011. We’ve entered a recession, gas prices are approaching all-time highs, job growth is pitiful, and Americans continue to buy luxury gas guzzlers on credit. This will surely end well.

Offers of 7 year financing at 0% interest and monthly lease offers of $150 to $200 for brand new cars now are understandable. The newer model BMWs, Cadillac Escalades, Volvos, and Jaguars I see parked in front of the low income luxury gated townhome community in West Philadelphia now makes sense. A pizza delivery guy driving a new Lexus is now explainable.

Full article (‘Subprime auto nation’) here.

Swaminathan Aiyar’s piece on ‘Better Economics’ makes interesting reading. But, there is no better economics that is out there. This is all there is to economics. All we can ask for is for humbler economists.

Two + trillion US dollars of asset purchases by the Federal Reserve has not really helped. They are going to try more. Will they? We will know shortly. The full census bureau report is here. I am yet to go through it.

You can be optimistic or pessimistic about the outcomes, but you can’t speak of the China or, by implication Asia, miracle nowadays, without considering the chances of successful political and institutional reforms. More to the point, perhaps, what would the consequences be for China if, for existential reasons, the CPC wasn’t willing or able to go down this path?

Very well put by George Magnus of UBS in his new report, ‘Asia: is the miracle over?’. A brief blog post on that is here. I think the answer to the question is YES. According to work by Angus Maddison, China and India dominated the global GDP league tables up to around 1820. The baton has been passed on. I doubt if it would return to Asia soon.

A non-executive director at ICBC (China) writes on the end of good times for China banks. Couple of interesting statistics.

A Caixin edit (I think) asks governments in China – local and federal – to learn to live with and in hard times.

If Ben Bernanke did not read Ruchir Sharma, it is even less possible that he read Rajeev Mantri and Harsh Gupta in MINT. Now, we know that he did not read any of them nor, of course, Baretalk.

We have now learnt that the Federal Reserve would buy more mortgage backed securities (40 billion dollars per month), has determined that accommodative monetary policy would be warranted well after economic recovery strengthens and that zero to 0.25% interest rates would be maintained well into 2015. Markets would have been happier with 60 billion dollars per month of asset purchases but they would take this.

More pizza delivery on Lexus now!

In an action packed Thursday night, the Government of India announced an increase in the price of diesel by 5.0 Rupees per litre and limited subsidised cooking gas to six cylinders per customer per year. These are good decisions – overdue but incomplete. Under-recovery from diesel will still remain big. We have to wait and see if Congress’ ‘allies’ will let the measures go through.

10 to 5 to 10

Niranjan Rajadhyaksha covers the decline in India’s potential growth rate from the estimated or alleged 8% to 6% or so, based on the work of economists in JP Morgan. Coincident that I had just finished reading that report when Niranjan’s piece caught my eye. Probably, even 6% is a generous estimate. It is probably closer to 5%. The actual GDP growth in 2Q (April – June) was 3.9% (y/y) based on expenditure estimates. As FT’s ‘Beyondbrics’ noted, India revises its GDP growth rates so substantially as to be wholly indistinguishable from original estimates. Recessions turn into roaring booms and vice-versa. Poor data collection and analysis are the culprits.

Gone are the days when the talk was about growing at 10%. It is still not impossible. A new beginning is needed. Many are hard at work to prevent that from happening.

My personal estimates (crude and picked from the sky) of what would take India back from 5% to 10% potential growth:

2.0% can be added through de-bottlenecking power sector and ensuring 24*7 power availability.

1.0% through right education and availability of right skills

0.5% through better mass transportation, removal of dependence on diesel

0.5% through legal reforms – removal of outdated laws and through speeding up justice

0.5% through administrative reforms; remove and simplify rules and procedures

0.5% through good health, fitness and diet