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.