Yeah, right

Take cash away, however, or make the cost of hoarding high enough, and central banks would be free to drive rates as deep into negative territory as they needed in a severe recession. People could still hoard small bills, but the costs would likely be prohibitive for any realistic negative interest rate. If necessary, central banks could also slap temporary fees on any large withdrawals and deposits of paper currency.

Yes, of course. People will take it meekly and not protest. Or, Ken Rogoff will send in the troops.

Others worry that negative rates will push banks, if not the entire financial sector, to engage in reckless risk-taking, which is threat enough with interest rates at zero. But if a strong dose of negative rates can power an economy out of a downturn, it could bring inflation and interest rates back to positive levels relatively quickly, arguably reducing vulnerability to bubbles rather than increasing it.

Yes, that is easy. Negative rates suggest that all is well and the only thing that stands in the way of negative rates spurring more investment, employment and output is this sinister little thing called cash.

Stupid and sinister arguments about ‘sinister’ cash by Kenneth Rogoff of Harvard University, here.

There was a colourful answer to him some fifteen years ago by Charles Goodhart and his co-authors (ht: Izabella Kaminska – source)

goodhart on cash and ecash has written a lovely PUT-DOWN of Ken Rogoff. It is worth a read.

As Rogoff put it, “In principle, cutting interest rates below zero ought to stimulate consumption and investment in the same way as normal monetary policy by encouraging borrowing.” Rogoff is apparently unfamiliar with Japan’s failure to stimulate consumption and investment through the Bank of Japan’s various stabs at price control at the zero rate. Also apparently lost on Rogoff is that for every borrower there must be a saver first. Wouldn’t zero rates cause fewer people to save? If rent controls below the market rate lead to apartment scarcity, wouldn’t interest rates at zero lead to credit scarcity?…

… To Rogoff, seemingly any infringement on our individual rights is ok so long as it empowers government.

Rogoff’s latest commentary brings to mind the old ad against drunk driving: “friends don’t let friends drive drunk.” So true. Rogoff’s friends and colleagues would reveal grand compassion if they applied this to Rogoff. Friends, and most certainly economists, don’t let Kenneth Rogoff go public with his “observations.” It’s not fair to Rogoff’s good reputation (his book with Carmen Reinhart was pretty informative at times), and certainly not fair to the reputation of his profession.

Yes, I too am ‘worried’ about the damage to Rogoff’ reputation. More worryingly, his brain could be infected by the ‘hubris’ virus.

NITI Aayog Inaugural lecture

India’s NITI Aayog, as directed by the Prime Minister, launched its ‘Transform India’ lecture series. The first talk was delivered by Tharman Shanmugarathnam, Deputy Prime Minister (DPM) of Singapore on August 26.
(1) First of all, it is an important and highly laudable initiative. The value of such initiatives is hard to quantify but the multiplier effect could be tremendous. The Indian PM deserves plenty of praise for initiating this. To tell the speaker to be frank was also the right thing to do.
(2) It is a fact that DPM Tharman is one of the leading public intellectuals of the world.
(3) He clearly told India to make in India for the world.
(4) Of course, he used PM’s words from his welcome remarks that India needs ‘rapid transformation and not gradual evolution’ but he did lay out a few important messages which were qualitative:

(5) India is in a race against demography and in a race against intelligent machines – a very important point. While I listened to the optimism of Nandan Nilekani in Bangalore (end-July) and also to Mr. Mohandas Pai in Singapore bilaterally on the combination of technology and services, we need to think and examine this phenomenon a lot more in depth given the scale and numbers that need to be gainfully employed in India.

(6) I was also very heartened that he spoke about the need for the discipline of dynamism or, if you will, discipline and dynamism. The need for a culture that instinctively shuns mediocrity. Shekhar Gupta had written on it over the weekend in BS but it is behind paywall and my attempts to renew my subscription were unsuccessful.
(7) Indeed, he read out statistics on child mortality and stunted growth but the last data point stopped in 2009. That, in itself, is a big lacuna. It is not easy for a big country but it is also important for a big country to put a lot of emphasis on data collection and minimising lags.
(8) It was nice that he focused on the words, ‘domestic demand’ and rejected both of them separately. He said that the focus ought to be on supply – productivity and skills. I had mentioned more than once in my MINT columns that the PM must dedicate one of his Mann ki Baat to productivity and repeat it at regular intervals. Nothing else matters – not a 200-basis point cut in interest rates out of nowhere and with no regard to other economic fundamentals which will all freeze and not react to it and cheap exchange rate that hides all inefficiencies.
(9) He was absolutely right to mention that schooling being India’s biggest crisis. Our response to the PISA 2009 revelation was to stop participating in it! Anyone in this group who has not yet read James Tooley’s ‘Beautiful Tree’ should quickly address that lacuna. I wrote a blog post after reading it titled, ‘Game, Set and Match to China’. Read the book to understand that title.
(11) He was absolutely correct to point out the global phenomenon of over-educating students through a general undergraduate education. Ha-Joon Chang talks about it rather well in his lovely little book, ’23 things they don’t tell you about capitalism’.  He mentions the Swiss success story of vocational education. ’23 things….’ is well worth a read.
(12) Finally, his point on Cities being clusters of innovation and inclusiveness and the need to give them autonomy, to empower them, to hold them accountable and to make them compete with each other was well made.
In all, it is a good initiative. A good lecture by Singapore DPM. Well begun is half done.

Burying the myth of peaceful rise

Earlier this month, China’s top envoy to British Columbia challenged the 15% tax on foreign buyers of residential property that the province had imposed. This story in Bloomberg makes for delightful reading. Apparently, Chinese students complained to her about not being able to drum up the cash to pay the tax! What were students doing buying homes?!

Then, a Chinese think-tank lashed out at India warning it of retaliation if India fomented trouble in Baluchistan.

Xinhua, depending on your preference, either implored or warned the Federal Reserve not to raise interest rates.

Jamil Anderini had written how China was scapegoating the West on August 11 in FT:

Since President Xi Jinping took power in late 2012, there has been a noticeable negative shift in Chinese attitudes towards foreigners living in the country.

I was reminded of the report of the Mercator Institute of China Studies published in June – a collection of essays titled, ‘The Core Executive’. I had cited the following from that report in my recent piece for ‘Swarajya’ titled ‘Permanent interests trump permanent ideas’:

In his essay in the collection titled China’s Core Executive, published in June 2016 by the Mercator Institute for China Studies, Richard McGregor dismisses the fond but naïve belief that a prosperous and successful China would be magnanimous. This is what he wrote:

“There is nothing in the party’s DNA, nor in the public’s, as far as one can tell, that suggests China would be more accommodating if it were more powerful and better armed.”

He should know. He was the Bureau Chief for The Financial Times in Beijing and wrote a much acclaimed book, The Party, on the Chinese Communist Party.

In their concluding essay for the Mercator collection mentioned above, Sebastian Heilmann, Björn Conrad and Mikko Huotari came up with four scenarios for the evolution of China in the next five years. None of the four scenarios holds out the prospect of China co-existing peacefully and harmoniously with the rest of the world.

Indeed, in the same article in ‘Swarajya’ I had tallied some of the recent China attacks/criticism of other nations:

They threatened the United Kingdom that it would face consequences if it did not go ahead with the Hinckley nuclear plant; they warned Japan that it would face military action if its self-defence forces joined U.S. naval ships in the “Freedom of Navigation” passage in the South China Sea and they called Australia “paper cats” for daring to applaud the judgement of the International Court of Justice at the Hague for its verdict on the disputed islands in the South China Sea. For good measure, China’s Global Timeswarned Japan that its plans to place land-to-sea missiles in the Miyako islands would prompt China to limit Japan’s waterways in the South China Sea.

Now, to cap it all, China worries that the West would derail its G-20 party:

The state-run Study Times wrote in mid-August that Western countries were trying to deliberately exclude a rising China and deny it a proper voice on the world stage with schemes like the U.S.-led Trans-Pacific Partnership. [Link]

“China is angry with almost everyone at the moment,” said a second Beijing-based Western diplomat familiar with the summit.

That about sums it up right. So much for China’s peaceful rise.


What is and who is divisive?

This news may be close to a month old. For all his moral outrage against the failed monetary policies of the West and at the behaviour of banks, Mervyn King ended up as an advisor to the Citigroup and, more importantly, was embarrassed enough about it to ask his ’employer’ to keep it quiet. That is very sad. We should not be surprised that trust in people and in institutions is at an all-time low in the world.

It appears that José Manuel Barroso is not so fortunate as Mr. King has been. His hiring by Goldman Sachs has evoked furious protest.The French President called it morally unacceptable. Mr. Juncker was disappointed that he chose Goldman Sachs of all institutions.

In contrast, none of the last four governors of the Reserve Bank of India have gone to work for the private sector on retirement – C. Rangarajan, Bimal Jalan, Y.V. Reddy and Subbarao. Nor have the Deputy Governors, as far as I can tell.

The revolving door (it is a two-way street, actually) between power elites and moneyed elites is confirmation that they are as indifferent as they ever have been, to the real plight of the marginalised and left-behind. No wonder the world is sorely divided. What is the point in blaming a particular Presidential candidate for being divisive?

These are more egregious examples of divisive behaviour.


De-personalising policy

This sort of coverage and reporting gets the goat of anyone. On August 18, RBI published the working group report on the development of a corporate bond market in the country. Some of the areas in which actions were due from RBI were announced a week later.

These decisions are announced by RBI but they are not taken by RBI alone and, even more importantly, they are not taken by the Governor alone. Hence, to announce these decisions as ‘Raghuram Rajan’s last hurrah’ does a disservice to others who were involved in the exercise from the Government of India, from SEBI and from within RBI and it also does a disservice to Dr. Rajan. It creates and breeds hostility, disappointment and anger in those whose contribution is ignored. Those in the government would be especially peeved. Dr. Rajan does not need their undeserved enmity either.

De-personalising and institutionalising policy changes are desirable and healthy. Newspapers and their journalists must play their due roles in that.

As the H.R. Khan Working Group Report states upfront, some of these things have been in the making for years, if not decades. The government made it already clear that these changes would be coming, when the Finance Minister delivered the Budget in February. In fact, the Working Group Report mentions the government announcements in the last page. Hence, what is happening is a Government of India policy initiative – long overdue – but which has been announced by the RBI. Most certainly not by Dr. Rajan in his personal capacity.

Now, as to whether these changes would herald the arrival of a corporate bond market with healthy liquidity is anybody’s guess. But, most certainly, they are desirable and they constitute the necessary conditions. Ultimately, the ball is in the court of companies that wish to borrow. In the developed world, financial markets’ are disappearing thanks to central banks. They have become the market. When companies place bonds privately with the central bank, the notion of a financial market place is risible.

This can, in theory, lead to better corporate governance and transparency in reporting. India’s accounting standards must keep pace with international standards even if they are more often breached rather than observed in the developed world itself. Who said that the developing world cannot set an example?  This document, released in June this year, says that Indian Accounting Standards have substantially converged with International Financial Reporting Standards but where there are ‘forbearances’ granted corporations, they can be removed and/or phased out soon.

To push and prod corporations to access the market, on the same day that RBI announced measures on the development of fixed income and currency markets, it also released the draft framework for banks’ large exposures to corporations and corporate groups. Once made into a policy, it becomes effective from March 2019. Since banks have to set aside more capital for exposure to a particular company or a corporate group, it dissuades banks from lending more, pushing corporations into the capital market to borrow. In principle, this is a welcome step.

Most of these developments would be greatly enhanced, as stated earlier, if corporations embrace the market as opposed to them continuing to hug friendly managers of majority government-owned banks. Further and equally importantly, if not more, the Statutory Liquidity Ratio of the government too must come down so that banks can direct their credit to medium and small enterprises instead of replacing loans to their corporate customers with Treasury bonds. Perhaps, RBI should come up with disincentives for excess investment in government paper. Another ‘large exposure framework’ document might be needed!

Andy Mukherjee had written that the new RBI Governor might act to discourage this tendency on the part of public-sector banks to seek the safety of government bonds whenever their non-performing assets begin to rise, choking credit flow into the private sector even further. It would be nice if the government co-operated. After all, SLR was needed at a time when the Government of India needed captive buyers for its bonds. A market might not have been available then. But, times have changed and how!

Today, with zero and negative rates of interest in the developed world, there would be ready takers for Indian government bonds that would carry a nominal coupon of 6% to 8%, depending on the Indian inflation rate. This situation will be with us for quite some time and even for quite a long time to come. Indeed, the problem may not be inadequate demand but too much demand, encouraging profligacy for a while only to ruthlessly punish much later and disproportionately. Financial markets are anything but linear. Otherwise, even as public debt in advanced economies leapt higher over the last four decades, investors would not have lent them at diminishing coupon rates!

But, as Dr. Y.V. Reddy, former Governor of the Reserve Bank of India noted in his book in 2010, financial markets do treat emerging economies differently. Therefore, it is important not to get carried away. Endorsement by Goldman Sachs is not the ultimate stamp of approval of sound public policies. These institutions lost their credibility long ago and have ceased to be benchmarks of excellence in their own spheres let alone be fair arbiters of public policy. The state of public disaffection for the central bank and financial institutions in the United States is proof of that.

All that being said, there is a case for substantial lowering of the Statutory Liquidity Ratio for Indian banks and even its total elimination within a reasonable time-frame. After that, it should become a normal credit decision for the banks to decide how much of their assets is held in the form of government debt – for trading and for maturity.

The private sector too and not just the government should be on guard against getting carried away by the demand for Indian paper. Again, there can be no doubt that ‘Masala’ bonds are a welcome development. It familiarises overseas investors with the Indian economy, Indian borrowers and with the Indian currency. India is internationalising quietly without much fanfare. That is to be applauded especially when offshore Renminbi deposits are dwindling and internationalisation of the Renminbi has slowed, if not reversed.

RBI in its circular has indicated that banks would be permitted to issue ‘Masala’ bonds (Perpetual Bonds or Perpetual Debt instruments) for meeting Additional Tier 1 and Tier II capital requirements. In theory, the exchange rate risk under ‘Masala’ bonds is borne by the investor and not by the issuer. In that sense, they are not ‘External debt’ strictly speaking. The currency of denomination of the debt is the Indian rupee. However, the currency risk is not fully eliminated. That should not be lost sight of. To the extent that the base currency of investors is not the Indian rupee, the exchange rate risk at a macro level for the country remains. If they take fright or if they decide to seek the safety of their own currencies for any reason, there will be pressure on the Rupee. So, ‘Masala’ bonds eliminate currency risk at the micro level but not at the macro level.

All told, there has been a quiet and steady onward march of right policy measures that slowly seek to enhance India’s potential economic growth rate and eliminate barriers to financing the enhancement of potential growth. From Bankruptcy code to GST Bill to Elimination of capital gains tax advantage to Mauritius-domiciled investors to reviving the corporate bond market, a lot is being done. Even as they deserve our unreserved praise, cautious counsel to stay grounded and focused on the tasks ahead would not be out of place.

(A modified version of this piece appeared in MINT on August 30).

An extraordinary confession

Soon after the speech (needs to be commented upon separately) of Ms. Janet Yellen, the Chairperson of the Federal Reserve Board, concluded at Jackson Hole, Wyoming, China’s official news agency Xinhua wrote an Edit imploring/beseeching/begging the Federal Reserve not to hike interest rates. Yes, from 0.25% to 0.50% will be too much for the world economy to bear. Well, it seems like it will be too much for the Chinese economy to bear.

The Editorial is actually an extraordinary confession of the extreme fragility of the Chinese economy. The emperor has really no clothes.

A friend wrote to me that China was extracting its pound of flesh for not selling US Treasury bonds from its reserves at the height of the global crisis in 2007-08, at the request of the Americans. May be, it is true and may be, it is not. If it is true and if America requested China not to sell any of its US Treasury holdings, it betrayed a profound lack of understanding of the extreme dependence of Asian economies, principally China, on the American consumer. China could not have sold US Treasury bonds without hurting itself very badly. America should have known that.

America’s lack of confidence is baffling. Joe Biden, American Vice-President apologised to the Turkish government last week. He has done so before -two years ago. His comments from two years ago were actually backed up by German Interior Ministry in its letter in response to queries raised by a political party in Germany.

In my archives, I found this letter that I had written to the ‘Financial Times’ in April 2005. I do not recall if it was published. Well, I do not recall if I even sent it to FT.

Here goes:

If the American Treasury Secretary goes down on his knees in gratefulness to his Asian financiers (Martin Wolf, FT April 20, 2005), he might well make eye contact with his Asian counterparts kneeling to thank the American consumer.

While the entire world finds it easy to castigate the US – there is plenty of merit in that – what is not easily appreciated is that Asian countries have no other source of growth except the American economy. In the last eight years, OECD growth was negative in just two years. Take America out and it becomes five.

After the Asian economic crisis, which was mainly due to funding domestic long-term real estate investment with foreign currency loans, Asian governments have abandoned investment spending. Malaysia undertook public investment spending post-crisis and it has reached the limits of fiscal policy. Thailand and Korea tried to reflate the consumer and the consequence is high consumer debt. American households have plenty of company in this part of the world too.

Hence, all attempts at domestic demand-led growth have been abandoned. Ever the China-admirer, Mr. Stephen Roach of Morgan Stanley admits that China lacks any meaningful domestic demand impulse. For an economy attracting around USD 50 billions of foreign direct investment, it ought to be running a substantial trade deficit. It is not.

While the substance of the American fiscal expansion and the reliance on rising home prices to finance consumption can be legitimately questioned, the discussion would both be incomplete and unfair without an equally scathing criticism of East Asian growth formula.

It is fairer to say that America and East Asia are in a fatal embrace which would end with much pain for both of them. There is no appetite for painful choices in either place. Nor do economists recommend deliberately inflicting pain as a policy option after Japan’s lost decade of the Nineties, partly brought about by a deliberate bubble-bursting effort by the Bank of Japan.

Hence, what well-meaning suggestions do not achieve, economic crises normally do. As Brad Setser says in his blog , there is risk in acting and there is risk in not acting. Therefore, the best thing for policymakers is to wait for crises to do the job. That is what they are doing – playing the waiting game.

I just searched for this letter on the Internet. No success. But, I did come across a detailed comment I had left on Brad Setser’s blog post on ‘Asia’s Savings Glut’ in May 2005. That is still worth reading. Here is the Brad Setser post and you can locate my comment (a long one) by searching for ‘Nageswaran’.

Simply put, America has nothing much to lose by returning the gaze. Others will blink first. They are more  vulnerable.

Haldane’s stuck

My friend Gulzar Natarajan suggested that I read Andrew Haldane’s paper, ‘Stuck’ – a speech that he delivered in June of last year.

How does Mr. Haldane propose to reconcile Chart 17 and Table 2 WITH Chart 9? Chart 9 shows tear-way equity markets. Table 2 shows cash balances piled up in corporations. Chart 17 shows very modest real investment revival in the developed world. Any policy that seeks to address Table 2 (get firms to spend cash on real investments) is only ending up sending equity prices higher, creating more divergence between the real economy and financial markets.
Why are financial markets, especially in the U.S., on a tear when global real rates are negative, when liquidity/investment ratio is so high suggesting subdued path for future profitability of investments?
How does one explain the US real stock market performance in Chart 9, without recourse to the monetary easing that has been pursued since 2008? That also explains the sentence above and the ‘half-empty’ mindset among the public (economic agents, to be more formal).
Zerohedge captured it well here. What central banks have done will have real consequences for a long time to come:
 Asset prices remain primarily supported by excess monetary abundance across the world:
  1. There have been 667 interest rate cuts by global central banks since Lehman;
  2. G7 central bank governors Yellen, Kuroda, Draghi, Carney & Poloz have been in their current posts for a collective 17 years, yet only one (Yellen in Dec’15) has actually hiked interest rates during this time;
  3. Central banks own $25tn of financial assets (a sum larger than GDP of US + Japan, and up $12tn since Lehman);
  4. There are currently $12.3tn of negative yielding global bonds (28% of total);
  5. There is currently $8tn of negative yielding sovereign debt (54% of total). [Link]
The reason that monetary tightening had had to be reversed in the past (his Table 3) might probably have to do with the fact that they were kept too loose for too longer – longer than necessary – without allowing forces of creative destruction to play their role.
Indeed, his concluding paragraph could so easily be used against all the monetary policy adventurism, post-2008. The kite (economic growth in advanced economies) might well have come unstuck without monetary policy getting stuck into zero, negative territories and in the skies with helicopters.
It is very surprising – to put it mildly – that Andy Haldane is woefully insufficiently critical of the policies pursued by his institution. The surprise is all the greater since the person who led it has expressed so much scepticism in his book (Mervyn King).
Also, if one perused John Williams’ piece on the low R* world, he refers at least twice to the need for cost-benefit analysis of any new policy move – having a higher inflation target or the pursuit of nominal GDP targeting, etc.
That openness to reckoning with costs is missing from the recent perspectives of Andrew Haldane. That is sadder than surprising.