The twilight

They also give an explanation for the rise of the National Front that goes beyond the usual imputation of stupidity or bigotry to its voters.

When France’s was a national economy, its median workers were well compensated and well protected from illness, age, and other vicissitudes. In a knowledge economy, these workers have largely been exiled from the places where the economy still functions. They have been replaced by immigrants.

Paris’s future seems visible in contemporary London. Between 2001 and 2011, the population of white Londoners fell by 600,000, even as the city grew by 1 million people: from 58 percent white British at the turn of the century, London is currently 45 percent white.

In Paris and other cities of Guilluy’s fortunate France, one often encounters an appearance of civility, even consensus, where once there was class conflict. But this is an illusion: one side has been driven from the field.

Never have conditions been more favorable for deluding a class of fortunate people into thinking that they owe their privilege to being nicer, or smarter, or more honest, than everyone else. Why would they think otherwise? They never meet anyone who disagrees with them. The immigrants with whom the creatives share the city are dazzlingly different, exotic, even frightening, but on the central question of our time—whether the global economic system is working or failing—they see eye to eye.

Three years after finishing their studies, three-quarters of French university graduates are living on their own; by contrast, three-quarters of their contemporaries without university degrees still live with their parents. And they’re dying early. In January 2016, the national statistical institute Insée announced that life expectancy had fallen for both sexes in France for the first time since World War II, and it’s the native French working class that is likely driving the decline. In fact, the French outsiders are looking a lot like the poor Americans Charles Murray described in Coming Apart, failing not just in income and longevity but also in family formation, mental health, and education. Their political alienation is striking. Fewer than 2 percent of legislators in France’s National Assembly today come from the working class, as opposed to 20 percent just after World War II.

The real divide is no longer between the “Right” and the “Left” but between the metropoles and the peripheries. The traditional parties thrive in the former. The National Front (FN) is the party of the outside.

Hollande government’s legalization of gay marriage, which in 2013 and 2014 brought millions of protesters opposing the measure onto the streets of Paris—the largest demonstrations in the country since World War II.

France’s antiracist Pleven law, which can punish speech, passed in 1972. In 1990, the Gayssot law criminalized denial or “minimization” of the Holocaust and repealed parts of France’s Law of July 29, 1881, on Freedom of the Press. Both laws are landmarks in Europe’s retreat from defending free speech. Suits against novelists, philosophers, and historians have proliferated.

Nobody wants to be thought a bigot if the membership board of the country club takes pride in its multiculturalism. But as the prospect of rising in the world is hampered or extinguished, the inducements to ideological conformism weaken. Dissent appears. Political correctness grows more draconian. Finally the ruling class reaches a dangerous stage, in which it begins to lose not only its legitimacy but also a sense of what its legitimacy rested on in the first place.

These are the extracts from the brilliant review-essay by Christopher Caldwell of the books by Christophe Guilluy written in French with the latest being Le crépuscule de la France d’en haut (roughly: “The Twilight of the French Elite”) – ht Niranjan Rajadhyaksha. The full essay – a MUST READ, in my view – is here.

Read Andrew Sullivan’s piece on what Macron means. He too refers to the Caldwell essay.


Economists and the reality of trade

If you read this interview with Dave Donaldson, a young economist who had won the John Bates Medal given to outstanding economists-academics below 40 years of age, you might get a clue on why economists are out of touch with reality and hence, not very popular with the media. Just sample this question and the answer. Economists have a long way to go.

Q: Obviously foreign trade is an especially important topic right now in Washington and capitals around the world. Do you think there are policy lessons that your research offers leaders in the U.S. and elsewhere?

A: I’ve worked on fairly high-level issues. I certainly haven’t tried to work on some of the complex trade agreements and trade policies that we and other countries sign and negotiate. But I think there’s a number of high-level points that my work has tried to quantify and illustrate.

Trade is rarely bad on the aggregate. … Those gains are important, at least according to the estimates I and others have come across and tried to develop. Railroads have enabled trade and railroads had a big impact on living standards. At some level, that doesn’t surprise a lot of people. But again, there’s no difference between building railroads to enable trade with other members of our country and lowering tariffs to enable trade with other members of the world. They’re the same basic principle. You’re trading with others and reducing barriers to enable more trade.

Joan Robinson was a famous economist between the wars and she talked about how, I’m paraphrasing, but how it was ludicrous to fill up our harbors with rocks. We don’t do that and if our trading partners start filling up their harbors with rocks, that’s not a good reason to start filling our harbors up with rocks, too. This idea that … the nation wins at trade or the nation succeeds by imposing tariffs – there are special circumstances where that possibly helps. But by and large, we on the whole are better off when we trade more. That basic instinct, I don’t think is controversial, because we don’t stand in the way of trade with California and Colorado. …

I’ve stressed the aggregate benefits. Of course, within those aggregate benefits, there are winners as well as losers within the same country. Obviously things would be better if that weren’t true, but unfortunately that sad truth is also the same sad truth about all of economic life. When Amazon entered the retail sector and made it harder for Wal-Mart and Kmart to do business and that led Wal-Mart and Kmart to close down some establishments, that of course is not good for the workers of those establishments. But it is good for other workers elsewhere, and it’s good for consumers on the aggregate.

That kind of churn and evolution of a market economy of course generates winners and losers all the time. We all wish that wasn’t the case. But because the gains on aggregate are large, those kinds of things are by and large worth permitting, allowing, and that’s why we allow them when they happen within the country. And as I tried to stress, I don’t think there’s anything fundamentally different about the kinds of shocks that create the aggregate benefits but nevertheless, unfortunately, have some domestic winners and losers. The fact that there are domestic losers does not per se mean that we should prevent those kinds of trades.

We should do what we can to help mitigate the losses. But the essence of economic growth involves, as [Joseph] Schumpeter called it, creative destruction. The act of creating growth, the act of making living standards better on aggregate, does just inevitably involve some people losing. And we need to find ways to mitigate that, but standing in the way of progress is unlikely to be the best way to do that mitigation.

In contrast, read the comment below by one Graham Lovell from Australia on the article by Gillian Tett on financial markets and political risks.

In a well-reasoned article, Jillian Tett has failed to mentioned one very likely possibility. That is the possibility that “protectionism” will not hurt growth, but will encourage it. It was nice to get a recognition that monetary policy is now taking a lower place and structural reform is beginning to happen.

Yet what is this structural reform to which she refers? Perhaps she meant spending on infrastructure. If so, one has to protest that that is not really reform, just a replaying of well-established Keynesian economics. The real reform, which has to come if the world is to really recover from 2008, is one that means that investment in ordinary businesses can recommence in the West. That cannot happen at the levels that are required while the West has to compete with wages in the rest of the world at a simple fraction of Western wages.

A trade re-alignment, called here “protectionism,” is required. This is a long way from “mercantilism,” a fact that is missed by many commentators. (I say that, not because Jillian Tett has confounded the two things, but because others do.) The fact is that there is little investment activity happening in the West because there is a shortage of investment opportunities. This could be why the US stock market is showing signs of exuberance – maybe investor hope that there will be things in the US in which US companies can invest, instead of trying to find the currently partly exhausted opportunities in the “emerging world.”

If this is happening, it can be put at Donald Trump’s feet, and for which he can, quite rightly, take the credit, at least when he puts his policies into place. Even in Australia, now there are limited opportunities to invest. I am a small investor In Australia, which remains “free trade heaven.” My residual investments are in the mining industry. I am hoping for a recovery there. However, much of my new investment $s are in the medical industry, in companies like CSL and Resmed, who happen to be the best in the world in their fields.

Twenty years ago there was a thriving manufacturing sector, now there are only niche players. This is a product of the drive to reduce tariffs combined with a very high $A resulting from supercharged returns from mining. So now the search for industrial players on the Australian Stock Exchange returns only two significant operators. One is a toll-road operator, the other is Sydney Airport. Is that really the best we can do in Australia in the industrial space? Well, yes it is, if free trade ideology is given open charter, as it is in Australia. Yet not every company can be “best in the world,” not in Australia, and not even in the USA. However, the current dominant economic ideology expects only the “best in the world” to survive. This is a recipe for disaster. It is what the events of 2008 exposed. It led to many voters in the UK and the USA abandoning those who support the dominant economic ideology.

My case is that “protectionism,” by which I mean a trade realignment, will not hurt growth, but is more likely to encourage it. Perhaps that possibility could also be mentioned in passing in future articles.

Political risks and stocks

I just read a Gillian Tett piece (could be behind a paywall) in FT published two months ago. She felt that investors (stock markets) should heed political risks. She had referred to the probability of a Presidential impeachment suggesting that markets have not priced that in! But, to be fair to her, the article suggested other important issues and considerations.

I had posted the following comment on her article:

It is good to see some very interesting, insightful and useful comments on the article. I loved the comment by Mr. Graham Lovell from Australia. I am reading the ‘Global Economics History: A Very short Introduction’ by Professor Robert Allen. He notes that the economic model for Western nations in the 19th century and in the early part of the 20th century before the wars and the Depression intervened was: mass education, mass banking, national markets and external protection. Colonisation helped the British to source raw materials cheaply and force their finished products on colonies, decimating the colonies’ manufacturing base. De-industrialisation.

So, free trade was not the formula or route to economic growth and prosperity. It has helped many to prosper in the developing world too, no doubt, in recent decades. But, that is a very small portion of their overall population. India is an example. China benefited in the last three decades but it practiced exactly the kind of ‘free trade’ that today’s advanced nations practiced in their early development phase.

So, Trump’s model – if it can be called that – is very consistent with international empirical evidence. Now, I certainly do not think that American stock market investors had been very perceptive enough to understand this and price it in, because the stock market was not cheap by any means when he took office.

That the stock market has not been pricing in geopolitical risk is not something unexpected. One, average holding periods have shrunk to a few months. Two, stock markets (and, financial markets more broadly) have demonstrated a singular lack of ability to price in either complex or long-term risks. Since the 1980s, global debt and debt in advanced nations, in particular, has risen in absolute terms and as a percentage of GDP to today’s unsustainable levels. What did stocks and bonds do? In the last three decades or so, bond yields have been in secular decline and stocks have also move higher, in sympathy with declining yields.

So, financial markets are myopic – both with respect to the factors that they discount and their horizons.

Third, we should not forget that the Federal Reserve monetary policy is in the process of moving away from being ‘extraordinarily reckless’ to ‘somewhat extraordinarily reckless’. The European Central Bank has not stopped its ultra-loose policies nor has the Bank of Japan and nor has the Bank of England and scores of other smaller European nations. China’s liquidity splurge in the last few months that has restored economic growth to ‘respectable’ levels too must have found its way into international assets via capital outflows, at least until very recently.

So, in a sense, the stock market rise in the last few months could very much be explained by generous liquidity and ‘still irresponsible’ monetary policies in most advanced nations and not attributed to President Trump, for the most part.

There is a small role for him and his policies in the sense that investors could have ratcheted up their earnings expectations anticipating a large corporate tax cut. But, surely, they had not reduced their expectations after his failure to get health care reform through and after many of his initiatives faced legislative and judicial roadblocks.

Real economic growth indicators – notwithstanding auto sales – had perked up quite a bit in recent months. I am referring to the Chicago Fed National Activity Index (CFNAI), Durable Goods Orders and the Labour Market Conditions index of the Federal Reserve. The index of confidence among small businesses (the sentiment index published monthly by the National Federation of Independent Businesses) had shot up in November and has held there in the last few months. They are anticipating a massive de-regulation under the new administration.

Journalists and academics had paid far too little attention to the chokehold that the regulations of Obama administration had placed on the American economy. On a per day basis, the regulations passed by his administration exceeded that of Presidents Bush and Clinton before him.

So, anticipation and delivery of de-regulation have also had a role to play in the improvement in economic optimism notwithstanding complex political noise. Perhaps, certain sections of the society are sole producers and consumers of their own dissonance with respect to Trump with little heed for any objectivity.

In sum, the stock market ascent of the last few months has something to do with the changed executive focus on regulations but a lot to do with traditional irrational and myopic considerations.

Equally, if the stock markets crash -as they will, at some point – it cannot be pinned on President Trump.

French Presidential elections

The combined vote share of Marine Le Pen and Jean Luc Melenchon was around 41.0% (21.4% for Le Pen and 19.6% for Melenchon). The combined vote share of Macron and Fillon was 43.7% (23.8% for Macron and 19.9% for Filon). Macron and Le Pen are through to the second round.

The Communist Melenchon also polled nearly 20% of the vote. Between Le Pen and Melenchon, 41% of those who cast their  votes were voting for some sort of redistribution policies and away from the European Union.

Macron, if he wins as he is widely expected to, will find the going tough. That is why he is talking of strengthening Europe’s collective borders. It is a safe bet that, one year from now, there would be a feeling of disillusionment and malaise in France.

Much of the current euphoria surrounding an economic recovery in Europe is due to the European Central Bank’s loose monetary policy that has vastly overstayed its welcome. Financial conditions are too loose in the Eurozone. They can only get tighter.

Wrong message from Financial Conditions

Goldman Sachs has come up with its new revamped G-10 Financial Conditions Index (sorry, no link is possible). The biggest problem is that it is pro-cyclical. A bit like the Credit Rating Agencies whose ratings are the best when the asset valuations are the highest and hence the risk is at the highest.

If the strength in the bond market and in the stock market is very high  – lofty valuations and tight spreads (credit spreads) – then the risk of a correction and financial conditions becoming tighter is also the highest at these levels. Therefore, as asset prices keep rising, financial conditions going forward come under increasing risk.

Financial conditions are the most favourable for growth when they are extremely tight. In other words, they cannot get any worse. They can only keep getting better. That is why 2009 was the best to invest and was also heralding the recovery (no matter how tepid it was).

This is a bit counter-intuitive. But, it needs to be grasped. Mainstream institutions have not grasped them because their incentives are not aligned to grasping this truth. Their business models would collapse, if they did so, perhaps. I do not know.

Unjustified Indiaphoria

A friend sent me a message this morning on WhatsApp:

“Rupee at 63 handle, Sensex over 30k, nifty over 9300! Too good to last? Methinks not!”

My response:

“Sorry, Sir. I am afraid so. Economic fundamentals do not justify them. I will be happy to short them all, if I can.”

That response was given as someone who was the Chief Investment Officer of a Wealth Manager and one who is a natural contrarian (with all its attendant risks and pitfalls) when it comes to investing.

In other words and in the interests of brevity, I belong to the school that believes in buying when no one has a good word to say on the market and sell when everyone is a cheerleader for a market. India, more or less, belongs to the second category.

In fact, its fundamentals are not great too. Its economic growth rate is exaggerated. The current real GDP growth is close to 6% or slightly lower. I had a blog post on it yesterday. Corporate earnings are improving but gradually.  On that, this is what I heard from a stock broker six weeks ago:

Despite an improvement in the economy after the demonetisation shock, the earnings downgrade cycle has continued. In the past month, consensus Nifty EPS for FY18 has seen 6% downgrade and that for the wider BSE100 has seen 5% downgrade. Commodity sector companies have seen the highest upgrades whereas the large downgrades were concentrated in sectors such as banks, telecom, and consumer discretionary. Consensus estimates still imply doubling of profit growth (ex-PSU banks and metals) to 15% in FY18, which looks optimistic to us, given limited scope for margin expansion.

Leather industry hubs in Uttar Pradesh have recently come under a cloud. Someone should visit them and check out the fallout of the ‘Cow Protection’ movement. Hotels are beginning to feel the fallout of the alcohol ban. See this article in FT (could be behind a paywall).

Then, the government’s orders on stents are backfiring. Pharma companies are fighting back. The government order on price controls and its rediscovery of the price controls as a public policy tool is rather unfortunate. My column in MINT yesterday was largely built around this. The consequences are not so much unexpected as they are unintended.

Reliance Jio has placed the financial health of many of its competitors under a question mark and the Reserve Bank of India has warned the banks of the risk of exposure to the telecom sector. Usually, public warnings mean that the situation is no longer a risk but a reality. It has asked banks to set aside higher provisioning.

E-Commerce start-ups are seeing big erosion in valuation and investors are marking them down in their portfolios. Further, there are other stories that sap investor morale and sentiment. In general, Indian PE/VC investing is a bit like Hotel California. You can check out but cannot leave.

Overall, bank credit growth to industry is contracting. Non-performing loans are holding back credit growth and the revival of capital formation in the country. This story is not an exaggeration. The extradition order on Vijay Mallya is a sideshow. Non-banking sources of finance are picking up market share, surely. But, they cannot be accessed by smaller firms. Not surprisingly, this article mentions that the International Monetary Fund, in its latest World Economic Outlook (April 2017), does not expect a big jump in India’s investment share of GDP.

Government’s tax and black money collection drives – laudable though they are as to purpose but condemnable as to process – are unlikely to help investment sentiment.

Notwithstanding (or, because of?) the Bharatiya Janata Party (BJP)’s political successes in elections including in Delhi, there is actually economic malaise in the country.

Financial markets and asset prices are largely a sideshow, supported by an equally unjustifiable and myopic global market sentiment. That is a separate story, however.

India’s GDP growth estimate and the law of unintended consequences

The more one thinks about it, the more I feel that the Central Statistical Organisation (CSO) has done a big disservice to India. Politicians will always be politicians. They have short-term compulsions. Much as we talk of rational policy making, they do undertake rational policies that suit their goals, even if they are not in the long-term interest of the nation. They are fine as long as they satisfy popular demands in the short-term. So, the only way or the only time politicians act in the long-term interest of the nation is when the nation is in crisis. Then, they take short-term unpopular decisions because there is no choice.

India’s economic growth number could have been one such crisis but by printing numbers that are above 7% with their new methodology, CSO has taken away the sense of urgency.  It is not my case that their estimation is mala fide. Nor am I holding the Government of India responsible for it. I have serious questions about their growth estimate for 2013-14 too.

For my previous blog post on the issue of GDP growth estimation, please click here. I had provided links to two of my briefing notes on this matter written for Athena Infonomics.

RBI’s potential growth estimate is around 6.8%, as per their working paper last year. The latest RBI Monetary Policy Report shows that the output gap (actual growth – potential growth) is around 1%. So, RBI estimates the actual growth at 5.8% for its analytical purposes, it seems. This is my inference only.

Similarly, for 2013-14, CSO reported that India grew at 6.5%. RBI’s output gap in that year is around 2%. It cannot be that India’s potential growth in 2013-14 was 8.5%. In fact, IMF had estimated it to be around 6.5% (working paper published in January 2014 – p.6 last paragraph). Indeed, in one estimate (published in the World Economic Outlook, October 2013 – Box 1.2), the Fund had put India’s potential growth rate at 5.7% then. Hence, whether it is 5.7% or 6.5%, the actual growth rate must have been at most 4.5%, given the output gap of around 2%, then. But, CSO now estimates India’s real GDP growth in 2013-14 at 6.5%.

If  that is true, in the last three years, India’s real GDP growth has managed to edge up to 7.1% in 2016-17 (second advance estimate). That is no big achievement. But, 4.5% and 5.8% would tell us a different story. They would have been embarrassing. The government of the day would be impelled to act. CSO has forestalled that with its new estimates. At the same time, it is two years since the revised numbers and the methodology have been published. We do not have the historical series based on the new methodology with the new base year (2011-12).

Notwithstanding all the affirmations of integrity of the CSO, it has not acquitted itself well at all. I am constrained to say that.