Recent thoughts, readings and links

Been at the Indian Institute of Management at Bangalore for the last five days and will be here for another five days – teaching a second-year PGP elective course titled, ‘Concepts and Current Issues in International Finance’. Student participation in the class is slowly picking up. The campus is great with its tall trees, shades and sounds of nature. Bangalore weather is fabulous – especially inside the campus – an island without vehicular pollution. Mornings are fresh and days are warm. No sweat.

Was fortunate to listen to some great artists at the Yamini dusk-to-dawn concert organised by the SPIC-MACAY at the Institute. This was their 10th edition. Malavika Sarukkai spoke beautifully. She said that dance was her sadhana, a meditation to align her body and mind. She clarified, pointedly, that sadhana is not the same as practice. It is much more than that. I was reminded of Rajiv Malhotra’s ‘Being Different’ – I have not read it yet. But, the point is that certain Sanskrit words have no English equivalent. She then dedicated the last piece – Vande Mataram – to the nation, as a note of thanks to the nation for the depth of her civilisation! Touching.

Apparently, this takes place on Jan. 25th night from 7:00 PM up to 6:30 AM on 26th morning, every year. May it continue.

On the 26th January, attended a Takshashila panel discussion on how the Republic will be, in certain aspects, by 2030. I heard of the unfortunate remarks made by Professor Joseph Stiglitz while in India, extolling ‘Right to Food’, cautioning on FDI and on India having a big internal market to concentrate on. Even if his remarks were nuanced, that is what the headliners picked up. I wish he had read Ashok Gulati’s papers on the costs of ‘Right to food’ before making his remarks to please his hosts. I have made this the theme of my article in MINT tomorrow.

It was also nice to go back to the colourful and useful slanging match between him and Ken Rogoff in 2002. The Economist too had weighed in.  I could not recall seeing this response of Stiglitz in FT in 2002.

The debate between stimulus and austerity is a relevant one now and in many places: US, Europe and India. Policy prescriptions must be relevant to the context and political and economic history specific to that country. Others should not wade in loosely just to be courteous to their hosts.

I wish Stiglitz had read Dr. Pratap Bhanu Mehta in IE. His piece (‘Liberal DNA’) published on the Republic Day was a gem. I liked this sentence, in particular:

unlike the left and the right, liberals, in many matters of economic policy, do not presume to give the same answer to every question even before the question is asked.

Forget about left or right, this is the hallmark of evolved intelligence in any human being.

To his credit, Rogoff has tried to move beyond the sterile left vs. right postures on this issue. In this note, he recognises that, even if government spending has to be curbed, the public continues to expect the same level of service and services. Therefore, he has tried to go beyond the headline level analysis of how governments should respond.

Elsewhere on the issue of the sudden rush of unbridled optimism in world financial markets, John Hussman has a characteristically good piece (a long one this time since it has also a full speech of Martin Luther King, Jr.) on the state of euphoria in financial markets. This was written on January 22, 2013. There is one more after that and I am yet to read it. In his January 22nd piece, he has a particularly good explanation for the drastic fall in initial jobless claims. I think seasonal adjustment factors have played havoc with data considering the exceptionally warm December weather.

David Rosenberg, on his part, pointed out that the University of Michigan consumer sentiment – both current conditions and expectations – have dropped for two months in a row. I did not realise that. Also, the National Association of Home Builders’ Index for Single family detached homes – next six months ahead – has dropped for two months in a row in December 2012 and January 2013. I had not noticed that either.

Of course, I had noticed that all the regional manufacturing indices in the US are contracting. Also, while I was on the flight to Bangalore, it suddenly struck me that the United States’ CPI (and that of many countries now) is subject to hedonic quality adjustments. That is, even if absolute prices rise, if the good has a better quality, its price may be deemed to have declined on a quality-adjusted basis. When investment in software and technology was all the rage in the 1990s, this hedonic adjustment played no small part in boosting US real GDP figures in the 1990s as price changes were understated. Hence, real growth gets to be overstated.

This issue has been forgotten. I did an internet search on ‘US CPI without hedonic adjustments’ – I could not find the time-series that I was hoping to find.

I found this interesting comment in a blog post at on this topic:

using a hedonic adjustment to tell me the price is unchanged is like relieving yourself on my head and telling me it’s raining.

Cash grab

In response to my recent post on China macro, SPV had a rather detailed and useful comment. Must read. Towards the end, he had asked me about the Claudio Borio paper on inflation (”The financial cycle and macroeconomics: what have we learnt?, December 2012, BIS), on the JP Morgan report on the ‘Whale’ losses and on the UK Chancellor dipping into Bank of England cash balances. Somewhat embarrassed, I had to concede my ignorance of all three matters.

I had recently caught up with A. K. Ramanujan’s paper on contextual morality (‘Is there an Indian way of thinking’),  a short interview of Benjamin Friedman (he wrote ‘Moral Consequences of Economic Growth’), a long paper from the Institute of Policy Studies in Singapore on inequality in Singapore. I am making slow progress with Jeff Madrick’s ‘Age of Greed’. Not that the book is boring but that I was glued to the television (rarely happens) watching Djokovic and Wavrinka battle it on Sunday. High quality tennis.

It is easy to dismiss the move by the UK Treasury Secretary as window dressing and ‘smoke and mirror’. It indeed is because QE flatters public finances. This happened in November and I had completely missed it. If governments were to borrow in private capital markets that are unrigged, god knows what interest rates they would have had to pay. Of course, I am reminded of what Dr. Y.V. Reddy wrote in his book, ‘Global Crisis, Recession and Uneven Recovery’ that financial markets do not treat developed and developing countries symmetrically. Even so, the UK government would have had to pay more than 2.9% it is paying to the Bank of England.  In other words, the Bank of England was already providing a concessional loan facility to the government. That  interest subsidy just got bigger. If Bank of England goes into circulation via the Treasury, it does amount to loosening of monetary conditions. But, that increment is insignificant in the context of overall loose conditions that prevail in the UK and elsewhere.

Postscript: The news-story on Geithner having possibly leaked information of a discount rate cut to American banks has come out of the transcripts of the Federal Reserve monetary policy meetings held in 2007. As expected, Zerohedge has a colourful post on it and here is the Reuters story on this matter that could potentially snowball into something bigger and more embarrassing for President Obama as he just begins his second term. Here is Simon Johnson on the legacy of Geithner – written, presumably, before the story of the discount rate cut leak broke out.

Swan’s China song

I had intended the above to be the title for my column in MINT last Tuesday but somebody over at MINT thought otherwise. China’s stimulus, evidenced in iron ore price jump, in the inexplicable last fortnight rally in China stocks, etc. is unlikely to be good for global commodity consumers. China’s total social financing jumped 22% in 2012. This news about seven-fold jump in ‘Trust’ loans provides indirect confirmation of that, if one were needed. Land sales was not that low either. Beijing either has little control over local governments or acquiesces with their conduct. The jump in China exports in December was not corroborated by imports statistics of Taiwan and Korea. Even as some economists questioned China’s third quarter GDP growth estimates, its fourth quarter growth estimate was familiarly, sickeningly close to consensus growth estimates. Real GDP growth beat consensus estimates in Bloomberg by 10 basis points on a y/y basis in 2012Q4 (7.9% vs. 7.8%) and for the year as a whole (7.8% vs. 7.7%).

In the meantime, analysts working in Forensic Asia (I am a consultant economist with sister concern, ‘Asianomics’, an independent economic research firm founded by Dr. Jim Walker, former Chief Economist of CLSA) confirm that what is going on in Zoomlion Construction is only tip of the iceberg and that operating cashflows in Chinese companies are either distressingly low or even negative. No surprises that China stocks had done so badly since peaking in 2007. If China’s growth were so good and it saved the world, questions need to be asked as to why China stocks do not reflect that.

That is why Australian Treasurer Swan’s song on China could well be a swan song.

Anchoring growth expectations

Manas Chakravarty in MINT has an interesting piece on anchoring growth expectations. He raises the question of whether it should not be the mandate of the central bank as much as anchoring inflation expectations should be. I do not agree. Stabilising inflation expectations is a pre-condition for stabilising growth. But, stabilising growth expectations – regardless of underlying growth drivers – could actually unhinge inflation expectations.

Extreme links

“Brazil’s hot, dry summer may lead to energy rationing.”

“No End to Coldest China Winter in 28 Years, Forecaster Says

“Wildfires Spread Amid Catastrophic Heat wave in Australia

“Dust Bowl Wilting U.S. Wheat as Funds Turn Bearish”. While you are at it, check out this Reuters story on USDA declaring the entire wheat belt as the drought affected area and this Bloomberg story on how hot 2012 was in the United States. Note the information on the flow (or, the lack of it) in the Mississippi river.

“First Argentina Dust Bowl in 85 Years Said to Cut Wheat”

All of the above point to the importance of climate change. Whether or not humans are responsible for it and whether or not humans could do something about it, it is a fact. Climate has become volatile.  Singapore is piping hot one day and cooler the next. Or, piping hot in one hour and cooler, the next.

It is going to wreak havoc on crops, harvests and hence food prices will spiral. What hedge funds are doing – being bearish on wheat prices – is beyond me.

Chutzpah of the millennium

Dr. Vidyasagar alerted me to the news-item that the shareholders of AIG intended to sue the US Government for, er…., ‘destroying shareholder value’. Yes, you read that right. He succeeded in waking me up. As he wrote, you cannot make this stuff up. Here is a company that was on the verge of bankruptcy and that threatened to take the country with it while it went down. It was rescued by the US government to the extent that the company is alive and shareholders actually have a chance to recoup their losses over time. Yet, the shareholders are suing the US government! The person leading this extreme absurdity is the former CEO of the company, Maurice Greenberg. The company is evaluating the risks of (not) going along with shareholders and be a party to the suit lest shareholders sue the Board!

What a bizarre state of affairs?! This can happen only in the United States. Nowhere in the world will such brazen behaviour by a corporation will be tolerated by either the political system or the judiciary, except in America. European companies would dare not do that.

This is the American version of capitalism. There is nothing Darwinian about it. It is about ‘heads I win; tails you lose’. It has been the case since time immemorial. I am currently reading Jeff Madrick‘s ‘Age of Greed’. It has documented how Walter Wriston of the First National Bank (fore-runner of Citibank) rode roughshod over Regulation Q, etc. with his negotiable Certificates of deposit but when his borrower Pennrail collapsed, he appealed to the government to rescue Pennrail and then beseeched the Federal Reserve to keep the discount window open on the weekend. He succeeded.

So, commentators blasting Europe and praising America for its creative destruction are making a big mistake. They are giving a huge berth to the US and wrongly.

With consensus opinion having swung decisively in favour of the US as a safe-haven between still-troubled Europe, uncertain and politically divided Asia, it is quite likely that the United States turns out to the black swan of the year. I hope that is the case for I believe that perception of American superior fundamentals is thoroughly misplaced. It is based on partial and incomplete analysis.

What should worry Americans more than anything else is the brazenness of American ‘elite’s that has made them think that they can even contemplate getting away with a legal challenge of this nature.

Artificial, rigged and irrational

My first MINT column in the New Year addresses the stock market reaction to the ‘avoidance’ of fiscal ‘cliff’ in the US and its reaction to the discussion in the December of the Federal Reserve Open Market Committee on the costs and consequences of its asset purchase programme. This discussion came to light with the release of the Minutes of the December meeting. of the FOMC last week. Stock markets reacted positively to the ‘avoidance’ of the fiscal ‘cliff’ and negatively to the discussion in the FOMC on the costs and side-effects of the asset purchase programme of the Federal Reserve. Sensible, rational, long-duration investors (equities are long-duration assets) should have reacted the other way around.

However, as we have argued several times, equity investors the world over are anything but rational. One can blame policymakers for getting them addicted to liquidity and low interest rates. But, bubbles have been around for a long time  – well before central banks ‘spoiled’ them in the last two or one and half decades.

So, even as El-Erian sounded his warning to investors to be wary of the Central bank PUT, markets have sent a message to him that that is what they are banking on. He is right to warn them of it, of course. But, these warnings will have little effect, for two reasons. One is that the the pool of real-money private players has shrunk substantially relative to the size of the non-private or state-dominated players: sovereign wealth funds and reserve managers (central banks and those who do so on behalf of central banks). Second, the private sector actually revels in the Central Bank policy PUT. That is what my column flags.

Elsewhere, El-Erian acknowledges a fact that TGS has consistently flagged in the last two to three years:

Several asset classes now have highly manipulated prices due to experimental central bank activities, both actual and signalled.

TGS also agrees with him that the situation is reminiscent of 2006-07. We wrote about it in a MINT column in April 2012.

He is too hopeful on this one:

Also, at some point, and it is hard to tell when exactly, the private sector will increasingly refuse to engage in situations deemed excessively artificial and overly rigged.

There are not enough private players who are worried about artificial and rigged prices. Most day traders – they constitute 50% of NYSE volume in the US  – could not care less about artificial and rigged prices.

(One last point: It has always been an exaggerated and false claim that capital markets exert discipline on policymakers. We have now chalked up one more evidence. Stock markets should have punished the fiscal cliff deal and approved of the Fed discussion on the costs of asset purchase programme. Stock markets did the opposite. So much for capital market’s restraining discipline)

Taxing the super rich

It takes a while to return to normal activities after a long break. Travel on work – CFA Middle East Conference had invited me to speak at Dubai, Abu Dhabi, Bahrain and Kuwait in December – and immediately, thereafter, on holidays had meant a long hiatus from blogging. Not that the rest of the world was any poorer for it. It is a place to register my thoughts. For whom and to what end are questions that bloggers prefer not to seek answers for.

The proposal floated by C. Rangarajan to tax the super-rich is an interesting one. It sets the cat among pigeons in India. It could be exploited for political ends. Alternatively, it could be a viable quid pro quo for paring back the Food Security Bill.

Good friend and batchmate at IIM-A (1983-85) had shared with me a letter written by one Mr. Kargenian on the investment philosophy of John Hussman of Hussman Funds. He was responding to this article. I had not read this article in full. But, I had read the latest weekly comment of John Hussman. It is here.

Since I am not sure that the letter would remain for a long time, I re-produce it here:

Habits of the Bear

To the Editor

Is John Hussman bearish (“A Real Cliff Hanger,” Up & Down Wall Street, Dec. 3)? Does a bear defecate in the woods? As Alan Abelson duly noted, Hussman has compiled quite a record over the years, staggering in both its grandness and ineptitude. From Nov. 21, 2000, to March 9, 2009, the low of the last down cycle, his flagship Hussman Strategic Growth Fund gained 92% while the Vanguard Total Stock Market Index Fund lost 37%. Since March 9, 2009, to Dec. 5, 2012, his fund lost 11% while Vanguard Total Stock gained over 130%.

I love Hussman’s discipline, research, transparency, and integrity, but his overreliance on fundamental and economic indicators, with very little weight on technicals, has led him astray. Valuation indicators are terrible for timing. Even after last year’s 20% decline in the Standard & Poor’s 500, to 1100 in October, he remained nearly fully hedged and has remained mostly that way to the present. One has to wonder how far the S&P would need to fall for him to turn constructive.

I’m rooting for him to regain his touch. John is good for our industry, and does so many things the right way. Our firm owns over $13 million of his fund on behalf of our clients, a number of whom have questioned our sanity.

In the world of Wall Street, if you’re bullish and wrong, you usually have plenty of company. But if you’re bearish and wrong, it’s almost unforgivable.

Bob Kargenian

TABR Capital Management

My response to the point made by Mr. Kargenian is this:

So, at the end of Dec. 2012, Hussman would still be at 81.9 and Vanguard at 81.9, starting at 100 on Nov. 21, 2000. All managers go through these phases. I personally, of course, approve of his philosophy. In hindsight, it is easy to say that he ignores technicals, etc.
But, his approach stood him in great stead in the decade up to 2009. No one approach is going to deliver returns at all times. I think he will be vindicated in 2013.  The madness has to and will stop.
Stocks, since the turn of the millennium, have been driven more by low interest rates and liquidity, than by fundamentals. The addiction of financial markets to liquidity was evident in the ‘shocked’ reaction to the Federal Reserve Open Market Committee (FOMC) Minutes of the Meeting held on Dec. 11-12. Some FOMC members had discussed the side-effects of asset purchases. I am not entirely sure if this was a genuine discussion or something put up for public consumption just to show that the Federal Reserve is not all that irresponsible.
Leaving that aside, it is instructive to see the market reaction to even a discussion of withdrawal of quantitative stimulus despite the Federal Reserve promising to maintain accommodative monetary policy for a considerable period, well after asset purchases cease.
It is clear that asset markets will not sustain themselves at the merest reversal of monetary policy. Seeing this, western policymakers will not reverse their policies. Bubbles will form (student loans; commercial real estate; junk bonds) and then bust. See the comments in the FOMC Minutes on the fundamentals in Commercial Real Estate:
Financial conditions in the commercial real estate (CRE) sector were still generally strained amid elevated Vacancy and delinquency rates. However, prices for CRE properties continued to increase in the third quarter, and issuance of commercial mortgage-backed securities remained at a solid pace in the current quarter.
Western policymakers will lower rates further. Can they, if they had kept rates at 0.0% or 1.0%, going into the bust? The current policy and market madness has a bad ending written all over it.