Germany: 100 years later

That was the headline for my MINT column published today. I pose the question of whether Germany is interested in the Eurozone any more. Thanks to my readings, thinking and more importantly, my conversations with strategic thinkers, I am increasingly convinced that the United States is engaged in ‘re-arranging’ the world. Whether it would succeed or not is an altogether different question. Perhaps, the odds are far less in its favour than they used to be (say, in the Eighties) considering how much the country is divided internally, how morally and ethically weaker it has become, how big and influential the financial sector has become and how much the State and other pillars of the Capitalist system have been prone to and subjected to various forms of capture. But, all of these are not going to stop them from trying, however. The end-game appears far less predictable than at any other point in time in the past because there are far too many variables now – variables that humans have unleashed but are no longer in their control. They are natural disasters, climate change, biological threats (pandemics like Ebola, for example).

On reading my article, a good friend wrote to me about his personal impression of Germany and the rest of Europe:

Having lived and worked in Germany I would venture to say that the economy has mastered productivity- innovation has and always will be a way of life there. I see a young workforce- mostly immigrants multi tasking as against staid old master workers whose unions objected to multiple skilling as recently as late 1990’s. I observe a thrifty nation that does not live on a credit card; I see a nation in which labour unions sit with management unions and thrash out matters; I see board governance with devolved responsibilities and accountabilities; I see a nation with an envious work life balance. I see a nation accepting of diversity ( Check recent comments on limiting immigrant workers by their Chancellor)

In contrast Italy is selling what Italians achieved 2000 years ago ( and very little once the empire rotted away amidst indulgence and excesses) ; how long can they live off what was achieved by their emperors and a boutique fashion business ? France has very little and is struggling with its ethos more than anything else. Spain is four distinct ethnicities- held together- not integrated  by its history ( The Catalans, The Basque, The Southern decedents of the Ottoman empire and the true blooded Spaniards, most of whom are trading on what Columbus achieved!

The Scandinavian countries have found an enviable macro-micro balance in the economy, in their social life and in their political ethos- albeit at a very big cost but with incomes being proportionate it does not seem to matter.

As I told Romano Prodi much to his chagrin- the Euro is more Anti US $ and less pan European in its intent!!!

Came across this article by one Mr. Philippe Legrain in ‘Project Syndicate’ – an interesting but one-sided critique of Germany.

Unbeknownst to me, Robert Zoellick had penned this Op.-Ed piece in FT. It has appeared in FT on Monday and I had missed it. It is interesting that he is calling up on the US and Germany to launch a strategic dialogue about the changing world. If one reads the article, the space between words is a lot more interesting than the words themselves. In other words, what is left unstated is tantalising.

I am quite pleased actually to note that his thinking is not dissimilar to mine.

The Blues for the Blue Chips

Following the story of IBM and Caterpillar, the Wall Street Journal has another good report on the struggling business models of many stocks in the Dow-Jones Industrial Average Index. The story could be a good point for discussion in business schools. But, at an investment level, the story re-confirms, if it were needed at all, that the last four-five years of the performance of Dow-Jones index has been mainly due to Quantitative Easing and not as much to core corporate fundamentals such as Revenue growth. The article is here (may be, subscription needed)

The CAT is out of the bag

US stock indices are surging back to their old record highs (or even higher), thanks to some deft intervention by central bankers. Yesterday, in particular, it was supposed to be stellar guidance of ‘Caterpillar’ that had lit a fire under US stock indices. I do not analyse company results much. But, I have, every once in a while, looked at Caterpillar’s results since it is an equipment company and is some sort of a leading indicator. This time, I looked at the company results for signs of financial engineering, if any. I was not disappointed.

Sales were about flat in the quarter ending 30th September 2014, compared to the quarter ending 30th September 2013. Operating profits were very slightly lower actually – by 9 million USD. Sales had been strong only in North America. Asia and Latin America trends were disappointing (cue China and Brazil and more in LatAm?). One wonders if the lower oil price is sustainned, will the Shale extraction industry in the US cut back on CapEx and how would it impact Caterpillar? Shale extraction is profitable as long as the price of crude oil is at least around USD80 per barrel.

Shareholder equity was lower, long-term (more than one year) debts were up and net fixed assets were lower on 30th September compared to December 2013. Of course, there were some 7154 fewer employees compared to a year earlier. Company’s revenue guidance for 2014 was not different from earlier ones. The company is in the middle of a USD10.0bn share buyback programme. Sales at Construction and Resources Divisions were lower and yet profits were strongly up in the Construction Division. One of the reasons mentioned is ‘currency effects’.

On China, the company expects the ‘Chinese construction machinery industry to remain challenged in the near future.’

If one looked at the first nine months of 2014 compared to the first nine months of 2013, the sales revenues were lower (USD40.94bn vs. USD41.25bn).  Yet, it now projects a full-year sales of USD55bn. Second, its operating profits were higher than last year’s for the same nine-month period only because of the entry, ‘Other income’ amounting to USD236mn of which USD179mn came from ‘Consolidating Adjustments’. Here goes the explanation for the same:

Elimination of discount recorded by Machinery, Energy & Transportation on receivables sold to Financial Products and of interest earned between Machinery, Energy & Transportation and Financial Products.

Try figuring that out. I hope some analyst asked. Well, actually, fat chance, they did.

Hence, but for this lovely intra-company adjustment of USD179mn, the Profit for the nine months of 2014 at USD2.938bn would have been lower than the last year’s (same period) USD2.786bn. Of course, the company would have still reported higher EPS because the number of shares outstanding on Sept. 2014 compared to Sept. 2013 seems to be about 30 million shares less.

The joy of financial engineering! It is all here, if you care to look and go through the 28 pages.

The ‘Bullard’ PUT

My MINT column on Tuesday was arising out of my anger/frustration/disbelief at the comment by James Bullard, the President of the Federal Reserve Bank of St. Louis, that the Federal Reserve should reconsider ending its asset purchases in October. He made that comment in the middle of last week when the S&P 500 stock index had dropped a few percentage points from its ridiculously overvalued level. His comments were a pathetic admission of the well-known fact that the US monetary policy targets only one thing – asset prices. One thing we do not know for sure is whether Mr. Bullard was speaking on his own or if he was the voice of the Federal Reserve Board. Perhaps, the latter. See next paragraph.

A week  before Mr. Bullard spoke, Stanley Fischer, his Vice-Chairman, had said that weakness in foreign economies would influence the Federal Reserve to delay its monetary policy normalisation. Suddenly, the Federal Reserve had become sensitive to international consequences of its actions! I wrote in my column in MINT if it had anything to do with bailing out China. Unfortunately, for him, in a research piece, Goldman Sachs has noted that any slowdown in economic growth overseas should have negligible impact on US economic growth (‘Weak Global Growth Is Not a Big Threat to the US Recovery’, October 21, 2014). Not that TGS shares the optimism of the economists at Goldman Sachs with respect to the US economic growth outlook but all the same, their observation that foreign growth slowdown should not matter to the US exposes the hollowness of Mr. Fisher’s excuse to hold rates at low levels a bit longer, in the United States.

I was also disappointed to read a speech by my policy hero Andrew Haldane of the Bank of England in which he too held out the prospect of ‘lower for longer’ interest rates in the UK. When he was the Director in charge of Financial Stability, he usually said all the right things about the financial sector, financial markets, etc. Now, that he is the Chief Economist of the Bank of England and is a member of the Monetary Policy Committee, I wonder if he is constrained to or compelled to sing from  a different hymn book.

My consternation with James Bullard’s speech is shared here and here. The speech by Andrew Haldane and by Stan Fisher can be found here and here respectively.

I have a question: when commentators talk of poor quality of institutions in the developing world inhibiting sustainable economic growth, I wonder if they would apply the same logic to Western central banks and their respective countries.

Exemplifying Keynes

Keynes wrote the following in his ‘General Theory of Employment’:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done…

Does the latest warning on corporate earnings from IBM, a company that practised financial engineering enthusiastically in the last half to full decade, exemplify this?

Summers (+1) predicts a long winter

Thanks to the Sinocism newsletter, two-three days ago, I stumbled on the paper by Lant Pritchett and Lawrence Summers on the inevitability of a substantial growth slowdown in China and in India too, in the years ahead. I am curious to know the rationale for the paper and the rationale for the timing of the paper. That apart, there is nothing very profound about its conclusions. Countries that experience a long period of high growth inevitably run into a long period of slowdown. How long is that ‘long’ and when does it arrive? No one knows. But, it does, apparently. When they talk of mean reversion, no one knows what exactly is the mean and who fixes that ‘mean’ level of growth.

That said, none of the economic models would have or had predicted a 34-year period of an economic growth rate of 9.8% per annum (at constant prices) in China. This is the annual average growth rate of constant prices GDP in local currency in China from 1979 – the year, the economic transformation of China started.  In India, the annual average real economic growth rate since 1990 (until 2013) is 6.4%. So, when they make their model-based predictions of a substantial growth slowdown in these countries, they need to be humble and honest about what their models did not predict.

To be sure, one can question the quality of growth in China to a large extent and in India to some extent. Nonetheless, the economic transformation in the former is rather impressive and in the latter, somewhat less so, but equally impressive. Further, in India’s case, the political change since May 2014 heralds a new beginning and the previous government had left a lot of low-hanging fruits for the government to pluck and rejuvenate economic growth. India’s big risk is complacency and hubris something that the previous government was afflicted with, after few years of growth which had nothing to do with the then government.

No matter how pervasive and universal their evidence is, the fact remains that there is no other country in their sample that has a population of 1 billion people and some. So, there is something unique about these countries. They will go through their slowdowns and severe contractions. That does not necessarily mean that they are doomed.

The United States of America, at the beginning of the 20th century, was not considered an economic winner. It turned out to be one, despite six recessions (am I under-counting) and one economic depression. Now, it has reached a state of moral and ethical decline more than an economic decline and that is what makes its continuation at the top of the global league tables a hard act to keep up with. Whether that has anything to do with this ‘talking down’ of the prospects of China and India is anyone’s guess.

That apart, the real issue I have with them and especially with Mr. Summers is this. If India and China have to inevitably slow, what about the global economies and the economies in the West, in particular?

Take a look at the chart on this blog post that appeared in ‘The Economist’ in 2011. Much of the global growth since 1 AD has occurred in the 20th century. It is not hard that for us to further infer that much of it would have happened after 1950 and that too, after 1980. Put that together with the global rise in bank assets and indebtedness in general since the Eighties and you have the phenomenon of a surge in global growth and the big portion of the explanation behind it. Even ‘worse’ was the surge in global growth in the first decade of the 21st century. 23% of all global output since 1 AD happened just in these ten years as banks in the West created money at will.

Isn’t it logical that this would inevitably have to slow? If so, then what is the point in trying to prolong it with Quantitative Easing and Zero interest rates? Notice how Pritchett and Summers feel that they do not need to offer any explanation for their prediction of a substantial growth slowdown in both India and China, because they feel that the evidence is overwhelming and pervasive in their data. Then, what is not inevitable about the global growth slowdown (and particularly in the West) and what is the point in trying to stimulate it? Isn’t that pushing on a string with the risk that the costs of such a policy outweigh the benefits? I would like to hear what Pritchett and Summers have to say on that.

There is a paragraph in the paper towards the end:

It is impossible to argue that either China or India has the quality institutions that have been associated with the steady dynamic of growth in the currently high productivity countries. The risks of sudden stops are much higher with weak institutions and organizations for policy implementation. China and India have very different modalities of this risk, but both have tricky paths to continued prosperity.

We will concede them this point, for the sake of argument. But, institutions do evolve over time. Did America have quality institutions at the beginning of the 20th century? It did build them and now they are declining. That augurs rather poorly for future growth there. All the more reason that stimulus policies will achieve counter-productive results with declining and deteriorating institutions.

In the final analysis, if the broader point is that there is no room for complacency either in China (more so, given its too extraordinary growth spell and its extraordinarily high level of debt) or in India, that point is well heeded.

But, one has doubts over their predictions of both the inevitability of and lower growth and the duration of such low growth.

Financial Repression meets Financial Engineering

In my classes, I use the example of IBM as a company that has engaged in debt issuance to buy back shares. Even as its revenues stagnated or declined, it reported improved EPS thanks to this Financial Engineering. Then, came the inevitable warning on earnings few days ago. See the Bloomberg news-story on the warning here and some op.eds here and here. Stanley Druckenmiller warned of this outcome precisely in July. The column in Reuters is a good read.

In a private email exchange, a good friend raised the question as to why financial repression resulted in overconsumption in the US but overinvestment in China. I think there is a Ph.D on researching this question. My ‘off-the-cuff’ response to him was that the economic cycles and the state of development (level of aggregate and per-capita GDP) in both the companies are very different. I should have added that it is easy to engineer overinvestment in a corporate world that is dominated by State-owned enterprises whereas the degenerate capitalism that America practises now, when combined with financial repression, does not result in overinvestment but financial engineering, higher executive compensation and overconsumption.

Notwithstanding the earnings warning of IBM (the Reuters article linked above mentions that several other companies are in the same boat), US stock markets are in a hurry to wipe out the losses for the month. Financial Engineering and financial repression are winning.

Recent China links

Two Universities in the US close Confucius Institutes:

Queen’s grandson officially launches horse racing in China. These things have more influence on diplomatic relations than we imagine.

The nightmare story of Chinese companies listed in Germany

Party paper hits out at foreign firms, alleging widespread tax avoidance

Drought worsens China’s water crisis

China swoops in Italy’s power grids and luxury brands

(This is part of the FT Series titled, ‘Silk Road Redux’. There are other stories of Chinese inroads into Portugal, Greece and Spain).

Xi Jinping embraces old guard as Hong Kong challenges party rule. This is a good one.

Index of Ghost cities in China:

There are a few more important links that I have left out. But, I have referred to them in my new Economic Briefing on China for the Takshashila Institution that should be up in a week’s time, if not earlier. That took up most of my time in the last one week or so.

A government that knows its mind

The NDA government gave more evidence of its sensible, steady and surefooted approach to governing the nation over the weekend. These reforms, coming on top of the steps taken in the previous four months, should leave no one in doubt that this government knows what it wants to do and how to do them, how to pace them, etc.

Besides the changes in the Ministry of Finance about which I had blogged earlier, the government had also announced labour reforms on Friday. They are small individually but collectively sizeable. I am a strong believer in the adage that small things add up. India has neglected many of these small measures with big payoffs. For example, self-attestation could be very important in saving time, energy and mental stress. We should not forget that, for the most of the year, India is a humid, hot and dusty country. The more trips we save for people to government offices the multiplier effects on their time, mental and physical health are tremendous. The portability of Employee Provident Fund number is no less significant.

Reading Manish Sabharwal’s piece in Financial Express on the National Skilling challenge, I was pained to note that the Congress Party was planning to block the amendments to the Apprenticeship Act – amendments that were mooted during Indira Gandhi’s time. Some commentators note that this is how the BJP behaved when the UPA was in office. Well, but for the support of the BJP, the obnoxious and the colossally damaging Food Security Bill and the Land Acquisition Bill would not have been passed.

Then, over the weekend, they decontrolled the price of diesel. Now, Indian upstream marketing companies can fix the price of diesel in line with international prices of crude oil. Well done. On this one, we must credit the UPA government for having taken a major step by authorising an automatic 50-paise increase in the price of diesel every month sometime in 2013 and sticking to it. One of those rare instances of sound public policy by the previous government. But, all credit to them for that. Good to see this government taking that to its logical conclusion.

The government has also decided to follow the same model for gas pricing by announcing a modest increase now followed by a review every six months. Reforms are as much about packaging and giving time for change as it is about intent to sweep away the old, the unnecessary and the harmful.

Sajjid Chinoy of JP Morgan notes that, amidst the excitement over the labour reforms, one more crucial decision made by the government would go unnoticed:

Finally, in a move that is likely to get buried under the more dramatic diesel and gas price announcements – but one that, we believe, is equally important in reducing subsidy leakages in the medium term –the government announced it will be linking cash transfers (“Direct Benefits Transfer”) with recent efforts to increase financial inclusion (“Jan Dhan Yojna”).

The Finance Minister indicated that, as a start, in 54 districts of the country those with bank accounts will receive the LPG subsidy in the bank-account. While the details are still to be announced, tying financial inclusion with cash transfers is unambiguously positive. A move to cash transfers will eventually ensure that distortions caused by dual-pricing of products will disappear, better targeting (to the extent that the UID is involved and results in de-duplication) will result in fiscal savings, and that households have a reason to use and service bank accounts and build up a financial history that can eventually be used to avail of credit.

On this one, we have to note that the UPA, despite having begun the Aadhaar project, had developed cold feet in the wake of electoral setbacks. The BJP, on the other hand, had moved from resistance to embrace, thanks to the personal intervention of Nandan Nilekani, the Aadhaar czar with the current Prime Minister. The Prime Minister saw the logic and did not abandon the scheme. Full marks to both of them here.

Now is the time to shake up the Cabinet and bring competent folks to important portfolios. That is the point Arvind Panagariya makes here. It is also time to take the axe to the UPA’s Land Acquisition Act in some form.

In this context, I was dumbfounded to note that some 28 ‘economists’ had written an open letter to the government not to tamper with the National Rural Employment Guarantee Programme. A programme that set its face against asset creation and productivity and that should not be tampered with? What exactly was their motivation? I am glad that Rupa Subramanya (ht. Dr. Vidyasagar) saves me the trouble of commenting on their obnoxious open letter.

The nominal GDP of India, in US dollar terms, has barely crossed the 2 trillion mark. This milestone was expected to be reached earlier. It is to UPA’s credit that the milestone got delayed by a few years. Skills and jobs are the answer to India’s poverty and demographic bulge. This government’s USP must be ESP – Education/Energy, Sanitation and Productivity and a relentless focus on these three aspects is needed. A good start has been made on the middle one (S). To a good extent, productivity in government offices is being tackled and productivity of citizens is being facilitated through many small, procedural improvements. A lot more needs to be done. The PM has to make ‘productive work force’ as much his mantra as he had made ‘Swachh Bharat’ his message. Then, of course, there is Education…..

With the distraction of the elections to Maharashtra and Haryana over, one hopes that the Government maintains its policy overdrive.