The right prayer and other links

Stephen King of HSBC writes in ‘The Guardian’ that some of the drivers of growth have reached their maturity and the prayer ought not to be for a strong recovery but for the ability to live within one’s means. This has been the burden of my song in recent times – in presentations, articles, blog posts, etc. since July/August 2012 last year when I came across these two blog posts in ‘The Economist’.

The Standing Committee of the Politburo (Political Affairs Bureau in English) dealing with the economy met unscheduled in April.  Journalists excitedly tried to divine the underlying message. It is hard to figure out if their concern was growth or financial system stability. They talked about both. Mind you, what we read is in English. The true intonations and the subtexts might be clearer in the original Mandarin version. So, that they met at all to discuss the economy is the most important thing. If things were going along rather well, why would they have had an unscheduled meeting? Here is the Xinhua news release.

Recently, in a blog post, I had labelled the the combine – regulators, banks and the rest of the financial industry – as one giant criminal enterprise. Little did I realise that Jeffrey Sachs had aired similar thoughts in a conference organised by the Global Interdependence Centre at the Federal Reserve Bank of Philadelphia. No transcripts or presentations are available.

Some one has recorded his extempore remarks and it is available here. Sachs pulls no punches. The real stuff is there from minute 12. This is the NY Post article that set me searching for Sachs’ speech. Sachs has been consistent. I unearthed a ‘Project Syndicate’ article that he had written in April 2011 on the global corporate crime wave.

Good FT article on how riskier lending practices are back and this particular paragraph is a revelation:

Moody’s, the ratings agency, has been raising the alarm. On its calculations, the loan-to-value ratio of commercial mortgages has hit a “tipping point” of 100 per cent. It took 10 years to reach that point after the widespread adoption of CMBS in the 1990s, Moody’s says; it has taken just two years since the resumption of CMBS buying after the crisis to get back there.

I print; you borrow; I lend; you spend

Western nations demanded that developing nations/emerging nations re-balance towards domestic demand. Four years after the so-called recovery began in 2009, emerging nations have done that remarkably well. What have western nations done to rein in leverage, to reduce the financial sector to a manageable size? Zilch. I deal with the first aspect in my today’s MINT columns. What the regulators in the West have not done on financialisation should form the subject of the next column.

The non-sense that is spewing out from American publications and on TV as to how the bond market has not brought the curtains down on deficit spending and debt has to be read/seen/heard to be believed. This is Orwellian propaganda. Where is the bond market? Is there a market for any financial assets? It is a cartel between the Federal Reserve, other central banks, Wall Street firms and Sovereign Wealth Funds. When the bond market was ‘free’, we saw what happened to bond yields in 1994 and later in Sweden and Canada in 1995-96.

‘I print; you borrow; I lend; you spend’ – where has the market been allowed to have a say in this cosy little insider game of immiserising savers and piling debt on debt?

Free marketer supports central planning

‘The Economist’ must be embarrassed about its support for Central Bank loose-money policies which amount to manipulation of prices of all types of financial assets.

‘Free Exchange’ (a pro-stimulus, Keynesian blog) in ‘The Economist’ group site discusses a new paper that, yet again, holds up a mirror to the fallacies of the assumptions and theories that economists rely on. Judging by the hot air surrounding the critique of Rogoff-Reinhart by UMASS professors, it is unlikely to happen.

Reinhart and Rogoff penned a dignified response in NYT on the controversy. Some interesting links available in that Op.-Ed. Their Op.-Ed pointed to this interesting blog. They had done a very good analysis of the controversy and evaluated both the UMASS and R&R positions.

Amol Agrawal sent me this link to an interesting article on the Political Economy Research Institute (PERI) at the Univ. of Massachusetts. Good to see these closing remarks from the founder of PERI:

But the department’s radical openness to alternate perspectives still sets it apart. “Learn from Marx, learn from Keynes, learn from Hayek,” Pollin says. “One of the biggest influences on me personally was Milton Friedman. He was very engaged with real world questions, and he made no bones about his ideological predilections.” Have not read the Herndon-Ash-Pollin paper yet. Downloaded it.

My long piece in ‘Pragati’ on the controversy raked up by the UMASS trio is published. There is no need for ideology in economics. It is about people’s welfare. What works in one place might not work in another place. What worked in the past in the same place might not work later. Therefore, theory based rules must be few, general can only be broad guideposts. Fiscal intervention in the event of an externally induced (or, crisis induced) slowdown may be desirable, provided it does not impede real private sector adjustment that is needed to purge the prior excesses. Further, it must be targeted, minimal, time-bound and must have due consideration of long-term fiscal sustainability.

Jahangir Aziz in MINT poses a valid question:

Why did expectations come unhinged? Because RBI, too, till mid-2011, nearly 15 months after the inflation spike in early 2010, believed that supply constraints were the drivers of inflation and insisted on tightening policy at a glacial pace, showing none of the urgency that the 22 months of double-digit inflation over 2010-11 demanded. Add to that the government’s fiscal profligacy—it refused to withdraw the massive stimulus provided in 2008-09 despite growth flying at 8.6% and 9.3% in FY10 and FY11. With that kind of excess demand persisting for more than two years, households and firms rationally changed their beliefs, doubling their expectations about where inflation could and did reach.

The government,  in my view, is to blame, for it leant on the RBI not to kill the growth recovery. Indian government, to be rather generous to it, allowed itself to be seduced by double-digit growth rates. It was a demand surge and did not reflect a sustainable rise in the economy’s potential to deliver higher growth consistently. We are still paying the price for it and will continue to pay a price for it, for some more time to come.

T. N. Ninan’s column this Saturday in Business Standard and Jitendra Bhargava’s piece yesterday on the Jet – Etihaad deal are MUST-READS for they provide the clues as to we will be paying heavily and for quite some time to come.

Harsh Gupta pointed me to this development. After ‘hedonic’ adjustments that made the Consumer Price Index understate inflation, the United States is embarked on revisions to the computation of GDP with an intent to overstate it, perhaps. See the FT article on this.  Perhaps, to be fair ,I must go through this before commenting on it.

Yesterday’s U.S. first quarter GDP growth numbers disappointed market expectations. The second quarter must be even softer, going by recent economic real-time data and this. Rail traffic growth has clearly slowed to a crawl.

Hounding R&R

I wrote up  a lengthy blog post on the enormous outpouring of schadenfreude in the media (esp. led by FT and the incorrigible academic Paul Krugman) on the so-called errors of the paper on growth and public debt published by Ken Rogoff and Carmen Reinhart (R & R)in 2010. Then,  I decided to convert it into an article for Pragati. Perhaps, it will be uploaded on the internet today.

The errors were ‘discovered’ by economists at the University of Massachusetts, Amherst. (I am an alumnus of the School of Business at UMASS, Amherst)

In the meantime, I came across another sensible piece (the first one I noticed came from Gavyn Davies, a blogger for FT) by Robert Samuelson in Washington Post. He points to a 2012 paper (link is available in Robert Samuelson article) by the same R&R duo in which they do not suggest that growth in advanced countries fall off the cliff once public deb crosses 90% of GDP. They also addressed the issue of causality running from low growth to high debt than the other way around. Their big support comes from a IMF working paper. You can find it in the list of references in R&R paper.

The one weakness in their paper is that they do not discuss even at a hypothetical level the factors that produce lower growth once debt levels reach a certain threshold.

But, here is their key conclusion:

Consistent with a small but growing body of research, we fifi nd that the vast majority of high debt episodes—23 of the 26— coincide with  substantially slower growth. On average across individual countries, debt/GDP levels above 90 percent are associated with an average annual growth rate 1.2 percent lower than in periods with debt below 90 percent debt; the average annual levels are 2.3 percent during the periods of exceptionally high debt versus 3.5 percent otherwise. Of course, public debt overhang and slow growth are surely a simultaneous relationship:  countries experiencing a period of slower growth may be more vulnerable to ending up with very high levels of public debt, and once the public debt overhang arises, countries with slower growth are going to take longer to escape it. As we shall discuss, a number of recent studies have concluded that the relationship cannot be entirely from low growth to high debt, and that very high debt likely does weigh on growth.

They add the caveat on mechanical interpretation of their results:

This paper should not be interpreted as a manifesto for rapid public debt deleveraging exclusively via fifi scal austerity in an environment of high unemployment. Our review of historical experience also highlights that, apart from outcomes of full or selective default on public debt, there are other strategies to address public debt overhang including debt restructuring and a plethora of debt conversions (voluntary and otherwise).

Couple of interesting paragraphs from Robert Samuelson:

Still, these modest mistakes have inspired outlandish allegations. “Did an Excel coding error destroy the economies of the Western world?” asked economist Paul Krugman in his New York Times column. Well, no. The Reinhart/Rogoff paper was published in January 2010, more than a year after Lehman Brothers’ failure and the onset of the financial crisis. At that point, all the ingredients of Europe’s debt crisis (housing bubbles in Spain and Ireland, huge budget deficits in Greece, weak banks throughout the continent) were also in place.

“How much unemployment was caused by Reinhart and Rogoff’s arithmetic mistake? That’s the question millions will be asking,” suggests Dean Baker of the Center for Economic and Policy Research, a left-leaning think tank. Actually, millions won’t ask, and the answer is: probably none. History may or may not judge Europe’s austerity a mistake, but German Chancellor Angela Merkel — its chief advocate — was not taking her cues from Reinhart and Rogoff. Her policies reflect strongly held German beliefs and values.

Look at the thoroughly intellectually dishonest remark of Paul Krugman. There has been no causality from the R&R paper of 2010 to the austere stance adopted by the EU led by Germany vis-a-vis Southern Europe. I had referred to that in my article for Pragati.

Arvind Subramanian of the Peterson Institute took the opportunity to call for some humility from economists. I wish he had specifically included economists of all hues, stripes and ideologies. He made it sound like it was relevant only for R&R. Yet, the quote from Hayek, provided in AS’ article is worth repeating:

At the Nobel Banquet in 1974, Economics prize co-winner Friedrich von Hayek made a speech in which he suggested that the Nobel committee require its laureates to take “an oath of humility, a sort of Hippocratic oath, never to exceed in public pronouncements the limits of their competence.” His explanation: “the Nobel Prize confers on an individual an authority which in economics no man ought to possess. This does not matter in the natural sciences. Here the influence exercised by an individual is chiefly an influence on his fellow experts; and they will soon cut him down to size if he exceeds his competence. But the influence of the economist that mainly matters is an influence over laymen: politicians, journalists, civil servants, and the public generally. There is no reason why a man who has made a distinctive contribution to economic science should be omnicompetent on all problems of society—as the press tends to treat him till in the end he may himself be persuaded to believe.” [Link]

The Nobel Committee should have extracted this pledge at least of Paul Krugman.

I stumbled on (unfortunately) another Keynesian academic/blogger when I tried to see the three important charts for the UK economy. How, on earth, would fiscal expansion directly result in a productivity boost is beyond me. There are more compelling arguments to be made for fiscal largesse inducing sloth as it keeps alive institutions and businesses that should have closed down.

In any case, this sensible comment on that post was good to read.

Tail risk

The first quarter review of BIS ‘International Banking and Financial Market Developments’ (March 2013) has a box-item on the impact of central bank actions (mostly quantitative easing announcements and promises to keep interest rates exceptionally low for exceptionally long periods) and concluded that, based on their analysis, that central bank actions have reduced market perceptions of tail risk. In other words, it is the perception of the market, central banks have reduced the risk of extremely calamitous events occurring. A careful statement of fact, regardless of whether we agree with those market perceptions.

Separately, the Review also documents the following regulatory relaxations that happened during the period it was reviewing:

Market participants also reacted positively to recent regulatory developments.On 7 January, the Basel Committee on Banking Supervision issued the revised liquidity coverage ratio (LCR) to be phased in more slowly with more lenient run-off assumptions and a broader definition of liquid assets (now including qualified mortgage-backed securities (MBS), corporate bonds and equity). The market reaction included equity gains and credit default swap (CDS) spread compression, particularly among banks with lower liquidity ratios. In the United Kingdom, the Financial Services Authority provided assurances of regulatory flexibility to help support bank lending. Meanwhile, the UK government proceeded with plans to ring-fence UK banking groups, while turning down some of the stricter recommendations of the Vickers Report. Similarly, a European Commissioner stated that any implementation of the Liikanen proposal to separate trading activities from deposit-taking would have to avoid penalising lenders that were supporting the economy, while two alternative proposals emerged from France and Germany. Market analysts regarded these regulatory changes as helpful in relaxing some of the near-term challenges weighing on banks’ earnings prospects. Separately, planned margin requirements for non-centrally cleared derivatives were eased to reduce the liquidity impact on market participants.

While markets/investors have perceived central bank actions as reducing tail risks now, what are the chances that their actions, coupled with regulatory forbearance such as above, actually raise the risk of tail events in future?

I suppose TGS is posing questions that the market does not want to ask or does not care about, for now.

You can find the BIS Quarterly Review here.

What chances do we have?

I slept well on Thursday night. Could have slept longer, had the early morning rains on Friday in Singapore not intervened. There should be a ban on thunders at 5 A.M. But, whatever residual sleep I carried into my waking state vanished on seeing this report in Bloomberg:

In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them. The Bank of Japan, holder of the second-biggest reserves, said April 4 it will more than double investments in equity exchange-traded funds to 3.5 trillion yen ($35.2 billion) by 2014. The Bank of Israel bought stocks for the first time last year while the Swiss National Bankand the Czech National Bank have boosted their holdings to at least 10 percent of reserves. “In the last year or so, I have spoken with 103 central banks on diversification,” Gary Smith, London-based global head of official institutions at BNP Paribas Investment Partners, which oversees about $649 billion, said in a phone interview. “If reserves are growing, so are diversification pressures. Equities are not for every bank tomorrow, but more are continuing down this path.” [Link]

Among central banks, big guys print and smaller guys buys equities. What chances do we have, watching fundamentals?

According to a Barclays Capital report that landed in my mailbox, here are the fundamentals:

1Q13 earnings season is roughly half complete, and the most striking feature is disappointing revenue growth (tracking 1.5%) despite reasonably soft expectations. International exposure once provided a considerable boost to US equities’ top-line growth, but is now in some instances a drag. Domestic growth also ended the quarter on a weak note. When we look for evidence of improvement in macroeconomic or corporate fundamentals, other than share prices in some global markets, though not those most leveraged to global growth, we generally come up empty.

Do they matter?

Let us see what Bank of England has been up to:

Enter the Bank of England (BoE), which in August 2012 launched an ambitious scheme, dubbed “Funding-for-Lending” (FFL), which is designed to improve credit conditions in the UK, particularly for small and medium-sized enterprises (SMEs).

Under the £80 billion FFL scheme, UK banks are permitted to borrow up to 5% of the value of their outstanding loans directly from the BoE at below market rates. And if banks increased their net lending, the amount they can borrow from the BoE would increase at the same rate….

To make matters worse, the spread between the price UK banks borrow money at and the rate that they lend money at has widened since the FFL scheme was introduced, suggesting that savers are being punished without borrowers receiving commensurate rewards.

So far, FFL seems to have been tentatively successful in re-inflating the UK housing market, albeit at a steep cost to savers. However, it has been next to useless in reviving the languishing business sector, which is the scheme’s intended target and the lifeblood of the UK economy.

Perhaps because of this failure, the BoE earlier this week announced that it would expand the FFL scheme, extending it to January 2015 from January 2014 and also increasing the amount that banks can borrow from the BoE. [Link]

Re-balancing is out (why only in the UK economy?)

I don’t think I’m the only one who has noticed this. It is hard to read current Treasury policy on the housing market as anything other than an attempt to drive down down the household savings ratio by encouraging more mortgage borrowing. Rebalancing, as I noted after the budget, has been all but abandoned.

Last week’s forecasts from the Item Club confirmed this. The International Business Times noted that rebalancing is ‘on hold’ whilst the “government’s influence on the housing market could spike consumer spending and engender a faster recovery than many UK businesses are currently anticipating”. [Link]

What is the Federal Reserve up to?

Debate among Federal Reserve policy makers is shifting away from the timing of a reduction in bond buying to the need to extend record stimulus as inflation cools and 11.7 million Americans remain jobless.

At their meeting last month, several members of the Federal Open Market Committeeadvocated slowing purchases and stopping them by year-end. Since then, seven have voiced support for maintaining the current pace, including five who vote on the policy making panel: Governor Daniel TarulloNew York Fed President William C. Dudley, James Bullard of St. Louis,Chicago’s Charles Evans and Boston’s Eric Rosengren. [Link]

Just couple of days ago, I threw up my hands in a prayer. I need to borrow more hands. One of my friends wrote to me thus:

God has gifted you with the ability to analyze financial markets so well( as well as a wonderful ability to articulate what’s happening)…so if I were in your place, I would be grateful, as well as hope for a similar fate in my next birth too!!!

My reply:

The trends and behaviour are so disgusting that it is hard on me. It has ceased to be a pleasant task. I do not find what is happening agreeable. Reporting on the disagreeable is possible if it remained exception. It has gone mainstream.

After posting this in my blogsite, I came across the Matt Taibbi article on how everything that can be ‘fixed’ is being fixed by bankers. The article is here. The jaw-dropping content in that piece is how, Lanny Bruer, former Justice Department Criminal Division chief, had migrated to the private sector and his firm represented Citigroup in the case brought by cities, local governments and pension funds against banks on their fixing of LIBOR.

Central banks print money; central banks buy equities; central banks buy bonds; Banks collude on inter-bank rates and now, apparently on swap rates too. They engineered a crash in gold, out of nowhere. The Federal Reserve helped by leaking the Minutes of the FOMC Meeting that apparently hinted at rolling back quantitative easing. Read the above now to note how transient and even blatantly misleading that was. Since then, many of the voting members at the FOMC have sung a different tune. 

Financial markets have arrived at their final destination: it is one vast criminal enterprise.

What chances do the rest of us have?

A sincere prayer

On Tuesday, in Asian data, China’s Markit Purchasing Managers’ index (PMI) declined. After another credit bubble induced phony revival in the second half of last year, China’s manufacturing is heading back towards contraction. Thai imports fell big time. Australian and Singapore inflation data were better (lower) than expected, signalling weaker and weakening underlying economic vigour.

European data were far more dismal. The official unemployment rate in Finland edged up to 9.0% from 8.7% in February. German Purchasing Managers’ index data showed that both manufacturing and services sectors were contracting in that country in March. French Production Outlook indicator worsened from -42 to -49 and French business confidence indicator dropped from 90 to 88. In today’s European data, we learnt that Austrian industrial production contracted in February. Italian retail sales contracted for the 9th month in a row (ok, one of the nine months showed a flat reading). German IfO Business Confidence indicators declined for the second month in a row.

In the US, the Markit advanced PMI slowed down from March. Richmond Fed manufacturing index printed a negative reading and GE results disappointed on top of what we saw the previous day from Caterpillar.

Stocks in Europe and in the U.S. rallied big time

At least in the next birth, I hope God grants me the wish to have nothing to do with financial markets.