‘The Gold Standard Site’ on Gold

The following is the comment I had made on John Authers’ column that included a comment on the recent decline in the price of gold.

This is not investment advice. Period.

I read your comments on Gold with a great deal of interest. As an investment advisor, I have been recommending Gold but as an insurance. How much of insurance to hold will depend on one’s risk aversion. But, the question is what does it insure?  It turns out that it is not insuring against the risk of global systemic instability or inflation, unless these risks are also reflected in U.S. dollar weakness. In other words, gold in the end responds negatively to dollar and everything else becomes secondary.

In the Eighties, when dollar soared, gold crashed. Then, gold recovered briefly from USD300 to USD500 as the US dollar crashed. Then, from late Eighties to mid-Nineties, both of them were range-bound. From the mid-Nineties, the dollar strengthened.  From 2002 onwards, until about September 2011, gold rallied, except for the second half of 2008, when the two ‘assets’ that performed well was US dollar and U.S. Treasuries. After that, the US dollar stopped falling.  Almost until end-2015 or early 2016. Then, as the dollar declined again for two years, gold attempted a recovery. Now, since February or March of this year, the US dollar has arrested its two-year decline and in recent weeks, its strength has gathered momentum. Hence, the decline in gold too has accelerated and it broke below USD1300 per ounce.

Of course, we should note here that it is only in the new millennium that the world had glimpsed unconvetional monetary policies. The Federal Reserve sent the Federal Funds rate to 1.0% and the Bank of Japan attempted QE for the first time.

Until the current monetary regime – exemplified by the near-polar status of the US dollar – proves itself unable to cope with the frailties it has thrown up – gold will underperform. Naturally, such a break is so cataclysmic that sovereign governments will be determined to prevent it. Further, America will not be keen to lose the US dollar’s pre-eminence status.

Those who believe that the world is sufficiently and durably repaired will probably see no insurance value in gold. Those who believe that the policy experiments since 2008 have not even remotely addressed the underlying issues, that the world, if anything, has become more fragile since then and that a final donouement still awaits, should hang on to their gold. It is quite likely that such a denouement will also result in or be used as an opportunity to end the hegemony of the US dollar in global trade, capital markets and much else.


‘Deep state’ paranoia

Gideon Rachman of the FT has an article on Team Trump’s Deep State Paranoia. Pl. find below a slightly modified version of the comment I had left on the article. The text below includes a reference to the latest WSJ Edit which is not there in the comment I had left in the FT pages.

In a way, calling it a ‘Deep State’ makes it easy to paint it as paranoia and two, to evade responsibility for specific actions that specific individuals or their departments took or have been taken, specifically with respect to the 2016 Presidential campaign and beyond.

The Wall Street Journal did not endorse Trump, has called some of his policy agendas as mistaken (reducing capital adequacy requirements on banks, for example) and yet, it has been consistently calling attention to instances of egregious interference by government agencies in a democratic political process. Here is its latest ‘no-nonsense’ Edit on the matter.

I do not need to list them here. Anyone with a modicum of curiosity in knowing the truth will have little difficulty in finding them. They cannot be wished away or dismissed as ‘deep state’ paranoia.  That is an exercise in evasion of journalistic responsibility and also a masterclass in self-destruction of credibility on the part of the writer of this article.

Casual cynicism

Alan Blinder has a book out called, ‘Advice and Dissent’.  The title is the same as the book by Dr. Y.V. Reddy, former Governor of the Reserve Bank of India. Wonder why no one told Blinder about it. Dr. Reddy’s book came out in 2017 itself.

The FT had a review of his book and under the ‘comments’ section, I found two very interesting links.

The casual cynicism that underlies the ventures that Blinder was part of (or, co-promoted) boggles the mind.

Two vs. 1157

Reproducing the article that I co-wrote with Dr. Srinivas Thiruvadanthai for MINT. He blogs here.

Economists write letter to the wrong address

Economists have deservedly earned a reputation for being out of touch with reality. They are cementing it with their latest letter to Donald Trump

As of last count, 1,157 economists had sent a letter to US President Donald Trump warning him not to repeat the mistake of the Smoot-Hawley Tariff Act of the 1930s. The one-page letter was a copy-and-paste job from the letter that economists sent to the then president in 1930 because the fundamental principle, according to them, has remained unchanged since then.

No honest economist would generalize theory across space and over time, without considering the context. In the 1930s, the Great Depression had many parents. When it suits them, economists point to the gold standard as the culprit. With considerable justification, some of us would like to point to the asset bubbles, excessive bank lending and the “Great Gatsby” decade of the 1920s as more important causative factors for the Great Depression. At best, the Smoot-Hawley tariff might have been a complementary factor. The tariffs were enacted in June 1930. By that time, the US and the global economies were already in a vicious downward spiral. Industrial production was down almost 20% by June and the Dow Jones Index down close to 40%. More importantly, as Barry Eichengreen and Kevin O’Rourke have shown, world trade fell more in 2008-09 than in the Great Depression, though there was no trade war in 2008-09!

Although economists are virtually unanimous in their support of free trade, the theoretical justifications are much less sound than they make it appear. Comparative advantage, the cornerstone of the benefits of trade, assumes full employment and frictionless movement of factors of production across sectors. These conditions are generally not true in practice. It is not easy for a middle-aged, laid-off steel worker to be retrained as a lab technician, much less a software engineer. Indeed, recent work by David Autor shows that the entry of China into the World Trade Organization (WTO) had a strong, negative impact on the long-term prospects of US workers displaced by Chinese competition. Economists will be quick to point out that these negative effects reflect the failure to implement adequate compensatory policies, but how many times have you seen 1,000 top economists write to the president urging more aggressive policies to help workers displaced by free trade?

The signatories to the letter cite the 1930s precedence. However, there is no precedence for dealing with a nation of 1.3 billion people that makes commitments with the conscious intent of not honouring them—whether it is on trade or technology matters. William A. Galston, who served during president Bill Clinton’s first term in office, wrote for The Wall Street Journallast August (“Second Thoughts On Trade With China”) that when China joined the WTO in 2001, it had promised to sign the Government Procurement Agreement, which requires government purchases to be made on a non-discriminatory and transparent basis. Sixteen years later, at the time of his writing the article, China had not yet done so. China pledged not to militarize the islands it had created in the South China Sea. But, it proceeded to do exactly that. “They tell us what we want to hear and then do the opposite,” says an unnamed German government official, in a Reuters news report. German government officials note too, wryly, that trade with China is win-win. That is, China wins twice. More than half the members of the German chamber of commerce in China are not planning new investments in the country.

Bryan Riley, director of the National Taxpayers Union’s free trade initiative, which coordinated the letter, had said that the anti-free trade message was not being driven by public opinion and that it was top-down. This is inconsistent with facts. The monthly Harvard-Harris poll tells a different story. From the March 2018 edition:

—55% said America’s trade agreements cost jobs and only 45% said that they created jobs

—61% approved of the president leveraging the threat of tariffs to win more favourable terms for America from trade agreements

—More than two-thirds (67%) said that the US should punish China for forcing American companies to give up technology secrets

—72% were either concerned or very concerned about the US losing technological supremacy to China

—75% said that the US should take steps (including tariffs) to correct the $375 billion trade deficit with China

—58% supported the imposition of tariffs on Chinese goods

—68% said that the American government should buy America-made goods and hire Americans

Economists have deservedly earned a reputation for being out of touch with reality for their failure to anticipate the 2008 crisis and read the mood of the people correctly on either side of the Atlantic in the last three years. They are cementing their reputation with this letter to the US president. They should reflect on why even 1% of the number of signatories do not emerge from China to tell their president to honour international commitments, and on their own reluctance to address a similar letter to China, despite its documented breaches of trust.

In short, the inability and unwillingness of 1,000 learned men and women to call out a nation that plays either by its own rules or none at all, with no recourse to others against such unilateralism, do not provide good soil for the growth of world peace.

V. Anantha Nageswaran and Srinivas Thiruvadanthai are, respectively, a Mint columnist, and director of research at the Levy Forecasting Institute.

Comments are welcome at theirview@livemint.com

Debt, deleveraging and defaults in China

If not shadow banking, it is shadow lending, anyhow:

Insurers are allowed to allocate up to 55 percent of total invested assets in alternative investments. Those investments accounted for 40 percent of invested assets in 2017, but the number has risen sharply in recent years. In 2012, the proportion was 9 percent.

Of the 40 percent recorded in 2017, the largest proportion was in debt investments, where the funds mostly end up as loans to infrastructure and real estate projects, Reuters analysis of insurance asset management product data shows.

In the three years to the end of 2017, insurers’ investment in loans for infrastructure nearly tripled and nearly doubled for real estate. [Link]

Private sectore defaults:

Earlier this month a private Chinese manufacturer, DunAn Group, sent a letter begging the Chinese government to help it out with its $7 billion of debt.

“If a credit default happens, it will deliver a serious blow to many financial institutions in Zhejiang and may even cause systemic risks,” said DunAn’s letter, according to the Financial Times. The letter also blamed the company’s troubles on China’s tepid effort to tighten credit conditions and rein in corporate debt. [Link]

Private corporate defaults in general, up more than 30% in the first four months of 2018:

China’s private sector firms are facing a debt crisis amid falling profits and rising financing costs, with the value of bond defaults in the sector rising by more than a third in the first four months of the year, according to industry watchers.

More than 10 companies, several of them listed, from a variety of industries have defaulted on 15 bonds worth more than 12.8 billion yuan (US$2 billion), according to figures from China Central Depository and Clearing Company, which manages and promotes the sector.

The spike in defaults has unsettled regulators that have been keen to prevent systemic risks as they seek to reduce national debt levels. [Link]

Debt addiction has not really been kicked but bank lending somewhat rationalised:

Here’s a widely told yarn: Last year China successfully curtailed skyrocketing debt issuance without hurting growth…. For investors watching the Chinese economy and rates, the message is clear: China hasn’t somehow magically cracked the code on debt-free growth. If industrial profits and inflation keep heading sharply lower, expect another round of substantial stimulus before too long. [Link]

Therefore, this should not come as a surprise at all:

In a speech made in the Chinese capital, Xia Bin, who has been advising the State Council – China’s cabinet – on financial policy since 2009, painted a far less rosy picture of the country’s financial industry than the one presented by Beijing.

“Systemic risks are elusive and spread fast” in China, said the 67-year-old, who was a key figure in a clean-up campaign of non-banking financial institutions two decades ago, when he was a senior official at the People’s Bank of China.

Beijing must remain alert to the threat of a financial crisis, he said, adding that government indicators did not reflect the true dangers.

China’s official non-performing loan ratio, for instance, bore little resemblance to the true figure, he said.

“From a dynamic perspective, it should be beyond [the official figure of] 2 per cent.”

Similarly, banks’ exposure to the property market was far higher than official figures suggested, he said. Official numbers say that about a quarter of all outstanding bank loans are linked to real estate, but Xia said the real figure could be as high as 80 per cent if all loans that used property as collateral were taken into account.

The whole Chinese economy had been “hijacked” by property, and that had created an enormous threat to the country’s financial stability, he said. [Link]

Reinhart on EM

She makes some interesting points:

There’s a whole range of sub-Saharan African and Middle Eastern countries that have become indebted to China. It’s a very opaque area. Countries like Angola, if you factor in Chinese loans, their external debt is 20 percent higher than what official data suggest.

The point above is that as everyone scrambles to get hold of dollars to repay (creditors too – including sovereigns like China – will demand repayment, banks will refuse rollover or do so only on stiffer terms and thus aggravate the dollar shortage.

“There used to be this larger barrier between internal and external debt. That’s been blurred, as we see with Argentina. Internal debt is increasingly being held by non-residents, making for bigger spillovers.”

I am glad she made this point because many miss this or refuse to see this. When non-residents hold domestic debt, the currency of denomination of debt is as good (or, as bad) as foreign currency.

If you look at capital flows to EM, it’s also closely connected to volatility. It’s not just that interest rates were low but volatility was non-existent for a while. Volatility is on the rise and neither of those bode well for inflows to EM.

I think she too is making the mistake of association with causation. Low volatility does not cause debt flows to EM. Low volatility and debt flows to EM are parts of the same phenomenon of risk appetite. When risk appetite turns cautious, low volatility ceases and it rises. EM debt flows reverse.

These snippets are taken from the Bloomberg story.

More on Trump and ZTE

FT had an Edit on Trump’s mind-bending tweet on ZTE. I left the following comment there:

IF I were FT, I would wait to assess. It was a big shock to see that tweet alright. But, precisely because it was such an incomprehensible tweet, we should give ourselves time to figure it out.

Plus, FT’s Economics Commentator Martin Wolf had written that the United States has imposed humiliating conditions on China that it could not possibly accept.

Now, FT View says that Trump might have bargained away a serious national security threat for short-term  gimmicks from Xi and that he might have struck one of the worst deals he has ever struck.

So, which side is FT on? We know one thing for sure. There is only one consistency that FT follows: oppose what Trump does even if it means opposing what FT itself wrote on the same day in another page or another day.

I am ready to wager that Trump is secretly having a laugh at the fantastic twisted tangle that the so-called ‘elites’ and ‘intellectuals’ have gotten themselves into ever since he became a contender for the American Presidency.

Two things that they ought to be doing but have not: give some credit to the intelligence on the other side especially since they had no idea of what was coming, how or why and two, take time out and reflect on what they have gotten wrong and why.

Chris Balding’s tweet alerted me to this another mind-bending stuff – this time from Martin Wolf of FT:

China needs strong central rule

A noteworthy fact was the belief of our interlocutors that Chinese political stability is fragile. History suggests that they are right. The past two centuries have seen many man-made disasters, from the Taiping Rebellion of the 19th century to the Great Leap Forward and cultural revolution. [Link]

But, wait! The ‘Great Leap forward’ and ‘The Cultural Revolution’ were because of strong central rule. Oh, boy! What a mess!!

Chris Balding tweeted thus, in response:

I don’t even know where to start with this one. You argue that China NEEDS strong central rule and to make your case you cite the Great Leap Forward? Going to stop now before some four letter words words come out. [Link]

I can very well understand that.

He had another terrific tweet:

Progression of Twitter conversation on US China trade negotiations
1. Trump is too easy
2. Trump is too hard
3. Trump should ask for market opening
4. Trump should ask for hard targets
5. It’s all about Trump Tower
6. Return to #1 and repeat as needed