US economy

(1) Real Final sales  (RFS) – a better measure of aggregate demand since it strips out inventory fluctuations – grew at an annual rate of 3.6% between 1953 and 1971, double the rate of 1.8% recorded between 2000 and 2014.

(2) RFS actually declined 0.5% in Q1.

(3) RFS has recorded an annual average growth rate of 1.1% since the pre-crisis peak in the winter of 2007-08 (perhaps, December 2007 quarter).

[Of course, the average annualized growth rate of RFS will be higher, if measured from the bottom of the cycle in 2Q2009]

(4) The balance sheet of the Federal Reserve expanded USD42.0bn between 1953 and 1971 – that is annual nominal growth rate of 5.7%. In real terms, it amounted to 3.0% per annum. That is only 0.8 times the annual growth rate of RFS of 3.6% during that period.

(5) Between 2000 and 2014, the Federal Reserve Balance sheet has expanded by nearly USD4.0trn. That is almost 100 times its expansion of the Fed balance sheet in the period between 1953 and 1971. That is a 17% CAGR and a 15% CAGR in real terms, adjusting for the 1.9% rise in the GDP deflator.

(6) That (15% CAGR in real terms) represents 8.3X times the growth rate of RFS of 1.8%. Contrast that with the 0.8X between 1953 and 1971.

(7) Defence spending component of RFS recorded zero real growth between 1953 and 1971. Hence, the 3.6% annual growth in RFS during that period is ‘superior’ to the more recent 1.8% annual growth in RFS between 2000 and 2014 because, during this period, real defence spending grew 37% cumulatively during this period.

I culled out these factual (verifiable) statistics from David Stockman’s blog post after the US Q1 GDP data was released last night. I had not done the verification myself, yet. He has more to say on the ‘Owners’ Equivalent Rent’ vs. Index of Median Rent. The latter would have added 30 basis points to the annual CPI inflation in the new millennium. That is what he says. How much would it have added to GDP deflator? We do not know. Second, he also talks about the index of car prices which has gone up by 1% in the last two decades, according to him. This is due to hedonic adjustments. He calls it ‘hedonic adjustment gone haywire’. Fair enough. But, now all countries have begun doing that. His blog post is here.

Ambrose Evans-Pritchard thinks that the US economy is not on the cusp of a recession. But, the length of the US ‘expansion’ is against him. Certainly, the US economy is not about to embark on a major upswing. My sympathies are neither with him nor with the US economy.

Probably, central banks know that their official indices understate inflation and that true inflation was higher and that the higher actual inflation rate is helping reduce the real value of debt in the economy. Hence, screaming deflation is actually a decoy, to mute the real secret of higher inflation and the real erosion of debt.

He is also implying – well, stating openly – that the Federal Reserve is getting far less bang or nothing for its balance sheet. He wants the Federal Bank to go back to being simply the lender of last resort, in a crisis. Lending freely at penal rates to provide liquidity, in a crisis. That is all that they need to do. This blogger (Yours truly) has a lot of sympathy for both views. In fact, the world and technology have come a long way that a fiat money or paper money may not be needed at all and people can preserve their purchasing power by themselves. Central banks are clearly not helping at all. Time for some radical thinking, before it is too late.

Jeremy Warner in ‘The Telegraph’ thinks that the world is approaching the end-game for both Keynesianism and monetary economics. I think he is right.

Take a bow

The Federal Reserve Bank of Atlanta had done a very good job with its ‘Nowcast’ model for GDP growth in the first quarter in the US which came in at 0.2% (QoQ, annualised). This is what FRB, Atlanta wrote:

Latest forecast

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2015 was 0.1 percent on April 24, unchanged from April 16. The real GDP growth nowcast ticked up to 0.2 percent on April 22 when that morning’s existing home sales release from the National Association of Realtors boosted the model’s nowcast of residential investment growth. The GDP growth nowcast fell back to 0.1 percent this morning as the durable goods manufacturing report from the U.S. Census Bureau reduced the nowcasts of both equipment and inventory investment.

(This was as of 24.4.2015) [Link]

Relative returns anyone?

This morning, FT has a news-item on Poland issuing a SFr. denominated bond with negative coupon rate. The first Emerging Market economy to do so. Poland is rated six notches below German AAA. One of my friends who works for a money manager said that in a world of relative returns, it might make sense for some investors to say that if I owned the bonds in the benchmark, I pay the issuers 1.0% but for the bonds I hold, I pay only 0.5% to my issuers! So, I am beating the benchmark!!

If it made sense to you, then you are the man for the leadership of any of the Western central banks.

In the meantime, the policymakers who are now taking interest rates negative are simply not grasping the basic truth of human existence: there is a lot that we do not know and we cannot anticipate. Here is the proof.

Strikes by unelected policymakers

Central government employees have given a strike notice from November 3 and, among the things, they want to decide on the following:

They also demand redressal of pending anomalies in the Sixth Central Pay Commission, interim relief, scrapping foreign direct investment and public private partnership schemes, filling of vacancies, and amendments in labour laws, among others, according to a release. [Link]

Basically, they, the unelected salaried employees, want to make Government policy! So, should India feel concerned that they are going to strike work or be grateful that they won’t get paid for those days that they do not work, unlike other days when they do get paid?

In the meantime, transport unions have called for a nation-wide strike on April 30. Wonder if Mr. Madhav Nalapat was on to something here.

Government removes the cockroach

In this interview with Reuters, Jayant Sinha, India’s Minister for State for Finance, says that regulation of the government bond market would stay with the Reserve Bank of India. Good stuff. In my piece on the Indian Federal Budget for Pragati, published on 9 March 2015, I had accused the government of being guilty of not applying its mind in its dealings with the Central Bank and called it a ‘cockroach in a bowl of cherries’ (borrowing a phrase from Daniel Kahneman’s book, ‘Thinking Fast and Slow’). The government is in the process of removing the cockroach. We need to see what happens with the composition of the Monetary Policy Committee and how it goes about capital account convertibility, an idea that has come back into the mainstream now.

If India pursues capital account convertibility, then the question of who regulates capital flows (either in line with the hair-splitting recommendations of the Financial Sector Legislative Reforms Commission or otherwise) becomes irrelevant. So, the thought does arise as to whether the unchanged stance on regulation of government bonds is linked to the revived discussion of capital account convertibility.

Regardless of the answer to that question in my head, I am clear that one of the most important pre-conditions – besides domestic fiscal policy, its stability and elevated potential GDP growth – is the ‘return to normal’ of monetary policy settings worldwide. That is not in India’s hands. Further, right now, the world is moving in the opposite direction.

These remarks – attributed to Mr. H.R. Khan, deputy Governor of the Reserve Bank of India – are bang on target:

I must point out that BCD nexus is neither absolutely necessary nor a sufficient condition for mobilising resources for investment to support economic growth. I will just have to point out the growth story of post-war Japan, that of China of last two decades and even of India before the crisis to support this point… [Link]

So, India had better attend to many other urgent issues/risks – monsoon, drought, inflation, fiscal deficit, productivity, potential growth – before it takes up capital account convertibility.

QE comes to China (almost)

How does one say ‘Quantitative Easing’ in Mandarin? We better learn quickly. It is coming. Well, almost. China has not reached the zero-bound in interest rates. It has room to do so, before printing money to buy bonds. It is doing something similar to what the European Central Bank did in 2011 (or, 2012?). Wall Street Journal has a breaking story on it. I had flagged it (sort of) in my MINT column last week. A detailed piece will be up in Pragati soon.

PBoC is giving Long-Term Repo loans to banks. Purpose is to bail out local governments. At least, on paper. Ambrose Evans-Pritchard is right to call it QE-lite. There could be other considerations. The fact that the People’s Bank of China (PBoC) is resorting to this could also be due to the fact that the economic picture, beneath the 7% officially reported GDP growth rate, could be rather worse. Apparently, Lombard Street thinks that the QoQ GDP growth rate in 1Q2015 was negative! [Link]. There is even a nice chart of that, in the above link.

Now, China yuan depreciation/devaluation is almost inevitable (or, a foregone conclusion). So, India will not be sweating the rupee weakness of April and might want more. Personally, willing to stick my neck out and say that China is not in control of its markets or macro much.

Patrick Chovanec has a very good tweet. Worth pondering over, in America:

The outdated narrative of China-as-unstoppable-economic-juggernaut still dominates US political discussion. Wake up, folks. [Link]

Just as an aside, read this brilliant/classic piece on how BHP/Rio Tinto got China’s steel production (and, hence the demand for iron-ore) spectacularly wrong. This should be a staple case-studiy in all management programmes around the world:

It’s a lazy number, which has taken on a life of its own.” Another insider, who asked to remain anonymous but has direct knowledge of when and why the forecast was adopted, says it was little more than a “slogan”. “It was external propaganda which became internal policy.” ….. Garnaut argues Australia suffers from a “circularity of elite communication” [Link]

In the light of the above tweet by Patrick Chovanec, perhaps, even American elites on China suffer from circularity of (or, incestuous) communication.

Let us sell, please

My MINT column (up online already) that appears in print on Tuesdays was motivated not only by my reading the book, ‘The evolutionary psychology behind politics’ but also by the incredibly deluded speech that Rahul Gandhi, the Congress Vice-President, is supposed to have made in the Parliament. They may not be the ruling party now but if this is the best bench-strength that India has in the ranks of the Opposition parties, the future is bleak, indeed. Very few dared to challenge him. Business Standard was the first to do so. It felt that Rahul Gandhi needed some elementary lessons in Congress history and in economics. Few days later,  MINT raised uncomfortable questions as to the implications for India to have the leader of a so-called centrist party hold views such as he does.

Sanjoy Chakravorty’s piece in ‘Outlook’ is a MUST-READ for all. Some key excerpts:

More than 90 per cent of the land converted after independence was used for state projects. Those who lost land and livelihood subsidised India’s development, or more accurately, its winners—that is, the populations that got water, power, roads, factories and jobs. This deeply regressive redistribution system lasted well into the 2000s. The Congress was at the helm of this. No major political party was against it. This was considered “normal”.

Almost nowhere in the country is it possible to find farmland at less than Rs 5 lakh per acre today. To see this in context, consider the price of farmland in the US state of Kansas: it’s less than $2,000 (Rs 1.2 lakh) per acre. This is what highly productive land should cost if the price were based only on productivity. Therefore, we must conclude that the price of farmland in India is five to 100 times more than can be justified by agricultural productivity. This has serious implications.

If the same Singur acquisition is attempted now, the landowners will be paid in excess of Rs 50 lakh per acre. The additional costs for landless workers and resettlement and rehabilitation will total another Rs 35 lakh per acre. Added to this Rs 85 lakh per acre (70 times the price in Kansas) will be the cost of waiting 4-5 years to complete the acquisition process. Will Singur’s landowners reject this windfall? It seems irrational and unlikely, but what if they do? What will a promoter do when a project fails to get land after 4-5 years?

Can any private project survive these prices, the waiting  and the uncertainty? Probably not. So who will gain if Singur farmers reject the project? Sanand again? Maybe, maybe not.  It could be Kuala Lumpur, or Jakarta, or Shenzhen. The competition for private capital is real and fierce, and in this period of globalisation, it is not limited to India. This is not a zero-sum game. Singur’s loss had real costs for Calcutta and Bengal, and Sanand’s gain created real benefits for Ahmedabad and Gujarat. And if in the future, both lose because of land acquisition, there will be real costs for the country. This is the truth. But who will tell our politicians?

The Wikipedia entry on farmers’ suicides has a paragraph on how it is a global phenomenon:

Farmers suicide is a global phenomenon. Outside India, studies in Sri Lanka, USA, Canada, England and Australia have identified farming as a high stress profession that is associated with a higher suicide rate than the general population. This is particularly true among small scale farmers and after periods of economic distress.[32] Fraser et al., similarly, after a review of 52 scholarly publications, conclude that farming populations in the United Kingdom, Europe, Australia, Canada and the United States have the highest rates of suicide of any industry and there is growing evidence that those involved in farming are at higher risk of developing mental health problems. Their review claims a wide range of reasons behind farmers suicide globally including mental health issues, physical environment, family problems, economic stress and uncertainties.[95] Significantly higher suicide rate among farmers than general population have been reported in developed countries such as the UK and the US.[96][97][98] [Link]

Farming is tough. Period. With fickle water and power supply, small and marginal landholdings, restricted market access, exploitation and illiteracy, it is considerably tougher for the Indian farmer.

Ashok Gulati, former Chairman of the Commission for Agricultural Costs and Prices (CACP) and now with ICRIER suggests cash transfer for food and fertiliser subsidies, to farmers. Unfortunately, a substantial chunk of the farmers surveyed by the Centre for the Study of Developing Societies (CSDS) did not have a view on it. About 40% did not have a view on DBT. Of course, those who preferred it were 34% of those surveyed. Only 19% preferred to stick to the status quo (Figure 5.4, p.33 of the report). The survey was published in March 2014. CSDS had conducted the survey between December 2013 and January 2014. About 5350 farmer households were interviewed in their local language and small and landless farmers constituted 74% of the survey respondents.

That report has many other interesting and useful information. One hoped that policy-makers saw it. Clearly, Rahul Gandhi has not seen it. This is what the farmers surveyed about the Land Acquisition Law:

Only 27 per cent of the farmers have heard about the Land Acquisition law. Among those who had heard about this law, only 21 per cent said that farmers stand to benefit from the law, and 57 per cent of the respondents said that farmers stands to lose from this law. [p. 34]

On suicides, only one in seven had heard of farmers committing suicides in the area. Large chunk (41%) of respondents reported that domestic problems were the most important reason for suicides followed by credit/loans (35%). However, repayment of loan did not show up as a major ‘life worry’ at all.

On electricity, the response of the farmers is disappointing and once again highlights how difficult it is to run public policy when basic understanding of the fundamental laws of supply and demand is conspicuously absent or, it could be that they simply do not trust the government to deliver them 24-hour power. Perhaps, they want to see uninterrupted power supply before committing to pay for it:

When asked if in order to receive uninterrupted power supply they were ready to pay more for it than what they pay today, 46 per cent of farmers rejected the idea, while 31 per cent said that they are willing to pay more for uninterrupted electricity supply.

On the important issue of the Land Acquisition Bill, essentially, the survey clearly showed that landless and small farmers welcome FDI in agriculture and would prefer to migrate to cities for better jobs for themselves and for their children in future. Given that the bulk of the farm holdings are small and marginal, a generous compensation coupled with easier exchange of their land holdings for cash might be what they would prefer, rather than having to continue to toil for meagre returns in their farms. Rahul Gandhi should go through this brief 36-page report.

The Land Acquisition Bill, in its present form, is a huge millstone around the neck of India and a big stumbling block (no land has been acquired since 2013) to encouraging capital formation, employment generation and domestic manufacturing. The Indian revival story will be dead on arrival without this millstone around the neck of the Indian economy removed. Well, now we can understand why amendments to the Bill are resisted.

India’s FM on the MAT

Personally, I applaud this Op.-Ed. Some will claim that he is deflecting the blame on tax administration. That he is not taking responsibility. Well, he is. He is promising to fix it. Yes, he had been wrongly briefed and he should have asked more questions.

If the rulings of the AAR have been challenged in Courts (mind you,Castleton Investments is not a FII), then the government (Income-Tax Department) should have waited for the court rulings to come, study them, decide on the appropriate course of action and send notices, if that presented itself as the most logical and the correct thing to do. All that should have been done after the Court verdict. AARs have given conflicting verdicts. Clearly, MAT does not apply to those who do not have a permanent business establishment in the country. In fact, even if the highest Court upholds the verdict of the AAR in the Castleton, it would have to be seen if that was applicable in the case of FIIs. So, the task before the Highest Court of the land is critical. It has to decide if MAT applied to transactions undertaken by foreign entities and FIIs separately.

So, a lot still remained unclear. So, sending the notices was not the right thing to do. The FM could and should have asked all these questions beforehand. But, that is now water under the bridge. Damage has been allowed to be done. So, now it is about damage limitation.

This Op.-Ed. is to be seen in that light and, as a damage limitation exercise, this Op.-Ed is well written and well done. Well drafted. Not too long. To the point and promises action, combined with some mea culpa and some sensitivity. Good show!

Coincidentally, this Op.-Ed. by India’s FM has appeared about half a day after the Vodafone Chief Executive complained of taxes and red tape in India. Five days ago, a news-report in India’s Business Standard called the FM Pranab Mukherjee 2.0. That must have hurt. The current Indian President did a lot of damage to India’s fisc. and reputation with his budgets from 2009 to 2012.

Some of the points made in this blog post are based on Arvind Datar’s column in Indian Express and this Edit in Financial Express.

A nice crisp Op.Ed in Wall Street Journal. One has to agree. The FM has undone a lot of good work of the PM’s foreign visits with this MAT demand on FIIs.

Gods of financial liberalisation

In its country report no. 15/62 [(‘India: Selected Issues (March 2015)], there is a chapter on spillover from surges in global financial market volatility. Its conclusions are worth noting and internalising:

The key findings of this chapter are as follows:

  • We confirm Rey’s (2013) view that there is a global financial cycle in capital flows and asset prices, as derived from our GVAR modeling framework.
  • We show that global financial market volatility (e.g. induced by monetary policy normalization uncertainty in advanced economies) has significant spillovers to emerging market economies (operating through trade and financial linkages, global liquidity and portfolio rebalancing channels).
  • We observe that there are heterogeneities across countries in their responses to a surge in global financial market volatility. This would reflect the scale of EMs’ trade and financial exposures to AMs, their individual cyclical positions, and their internal/external imbalances.
  • Consistent with Rajan (2014), we conclude that a prolonged term-premium compression raises financial stability concerns as the magnitude of financial spillovers has become larger over time, while asset prices and interest rates have become more correlated globally during the period of unprecedented monetary easing by advanced economies (see Figure 2).
  • We argue that strong fundamentals and sound policy frameworks per se are not enough to isolate countries from an increase in global financial market volatility. This is particularly the case where there is a sudden adjustment of expectations triggered by monetary policy normalization uncertainly in advanced economies. This argument is supported by the impulse responses in Figure 3, where no country (neither AMs nor EMs) appears immune from the impact of a surge in global financial market volatility.

There is a global cycle in capital flows; regardless of fundamentals being good, all countries are affected. There is a hetoregenity of impact on countries and therefore, differentiated policies on interest rates and capital flows are required. It is obvious that there is ‘no one size fits all’ approach.

That is why it was rather strange to note Mr. Ajay Shah, Professor at NIPFP writing as follows in his blog post on March 2:

By this time, serious people in Indian macro/finance knew where India needed to go: Inflation target + Open capital account + Floating exchange rate. All the other expert committee reports supported this. [Link]

If expert committees appointed in India have recommended these, then one must remember that they were a product of the times during which these were unquestioned. Now, all three have been proven to be wrong and dangerous, if taken to a cultish extreme. The conclusions of the IMF study cited above is but the latest example of the rethinking, induced by real world developments. We in India seem to think that the clock stopped in 2007 and that all needed to be learnt on monetary policy, capital flows and foreign exchange were learnt before that.

Open Capital Account + Inflation Targeting + Floating Exchange rates – all three are wrong at worst and, at the minimum, need to be context-specific and based on responses and policies of other countries on their capital accounts and their currencies.

Inflation targeting blinded the West to credit and financial market excesses before 2008 and they are at it, again. That is why India’s adoption of an inflation targeting regime at this stage, seems utterly misguided and unnecessary and second, taking into account India’s unique circumstances (supply rigidities caused by government intervention and high component of food in CPI basket), represents an unfair distribution of responsibility for meeting the inflation target between the Government and the Central Bank.

The IMF that battled for free and unrestricted capital flows in the 1990s has substantially modified its stance on capital flows. It advocates capital controls. Jonathan Kirshner’s ‘American Power after the Financial Crisis‘ has a riveting account of the efforts made by the US Treasury under Robert Rubin and Larry Summers (mostly during his period), egged on by Wall Street, to include a commitment to free capital flows in the IMF charter.

Now, it has not only dropped that but also turned around to accepting the usefulness of capital controls. In fact, the Independent Evaluation Office of IMF has noted that the Fund has been more open in advising member-countries on the usefulness of capital control measures than it had done so in its 2012 paper linked above.

This blog post has a useful summary of issues on which the Fund has now become intellectually more flexible while some folks in India have hardened their stances and are pushing the country in the wrong direction. Unfortunately, their views are being heard too seriously and not with the degree of scepticism that is both warranted and suggested by empirical developments elsewhere in the world.

India can have truly floating exchange rates if every other country has a genuinely floating exchange rate. QE is nothing but exchange rate manipulation and the RBI Governor is correct to say that emerging markets, adopting QE policies, would have been labelled currency manipulators by the US Treasury Department. The Federal Reserve Board, the European Central Bank and the Bank of Japan have been at it for quite some time now and the intent is to free ride on external demand through cheaper exchange rates. Bank of England did so too. That they have not succeeded is altogether different matter. Now, China may follow these big three with its own QE and currency devaluation down the road. I had discussed these potential moves by China in my recent column in MINT and have a detailed discussion document coming up at Takshashila Institution.

Given this backdrop of unprecedented global monetary easing and ‘beggar thy neighbour’ exchange rate policies, it was rather amusing to note the observation in this blog post that India’s foreign exchange intervention has increased under the current RBI Governor as though it was a crime!

Proponents of financial, foreign exchange and capital account liberalisation policies must wake up and smell the coffee instead of dragging a largely underinformed and uninformed country into the dangerous wild west land of finance driving the real economy. The world is trying to move forward into a saner and more stable policy setting with regard to the financial sector whereas India is being dragged backward, as usual. India should examine the efforts being contemplated by Iceland. There is no point in making India go through the horrible experiences that Western nations endured before turning to sensible and prudent oversight and regulation of the financial sector.

Finance must remain the handmaiden of the real economy and policymakers should not become the handmaidens of the financial sector.

RBI ready to lift the Federal funds rate

The headline might appear strange. But, you cannot fault me for coming up with it after this comment by Raghuram Rajan, the Governor of the Reserve Bank of India, in this interview with Wall Street Journal:

WSJ: We’re talking about slow growth. We’re talking about global disinflation. We’re talking about how hard it is to reach escape velocity. Can the rest of the world afford for the Fed to raise rates in this environment?

RAJAN: Can we afford for the Fed not to? The worry is that the longer we stay in this environment, the deeper are the distortions that we’ll have to undo eventually. At some point you’ve got to say, ‘OK, enough. We’ve got to get out.’ The longer we stay here the more the distortions pick up. There will be no perfect time. [Link]

He is right. There is no perfect time. In fact, the longer it takes to make things normal, the better if it were begun sooner. Unfortunately, many have interpreted his comments made in 2013 on spillover effects to make the case for the Federal Reserve not to embark on making monetary policy more normal again. As we had blogged, Ray Dalio of Bridgewater Associates made that case, bizarrely, before the Federal Reserve met in March.

Strangely, I saw the same sentiment expressed somewhat indirectly in ‘India: Selected Issues (March 2015)’ (IMF Country Report No. 15/62)

It is therefore very much in the source countries own interest to ascertain that financial stress is contained when tightening their monetary policy stances. [page 11 – Link].

How to ascertain that financial stress is contained and if ascertained, what to do about it? Not embark on monetary policy normalisation.

That said, the conclusions mentioned in that essay, ‘SPILLOVERS FROM SURGES IN GLOBAL FINANCIAL MARKET VOLATILITY’ are worth internalising for many advocates of financial liberalisation in India. A separate post on that is warranted.