Why the China shock may never come

Arvind Subramanian and Josh Felman think that China’s economy is in trouble; that it might sharply depreciate its currency; other Asian countries would follow suit resulting in a deflationary shock for the West. We can buy that framework because most of us have been saying it for years. No one knows when it would happen. Or, precisely because the West knows the pain of China’s economic pain would visit it eventually, it goes out of its way to prevent China’s economy from melting down. In other words, the West has lost its capacity to bear pain to score a permanent geopolitical and geoeconomic victory over its rival. Make no mistake. China will not be so magnanimous, even for selfish reasons.

For the West, China is ‘too big to fail’ or the West is ‘too timid to act’. America, on its part, is trying to impeach one man who had gone, by far, the farthest against China.

Well, even if not impeached, he might settle for less, as Greg Ip fears, because he has other things to worry about or that he is impatient for deals just as his predecessors were too hesitant to provoke a conflict with China. As Scott Kennedy says, in different words, that would be a pity. It would amount to much ado about nothing.

China would return to its old ways even as America would turn socialist. Not a great prospect for the world. That would leave the United States more vulnerable and clear the way for China.

Quick reads and thoughts

(1) India lost the second T-20 match to Australia, after scoring 190. Rishab Pant and Shikhar Dhawan scored 15 runs in 30 balls – that is 3.0 runs per over. For Australia, Stoinis and Finch scored 15 runs in 18 balls – that is 5.0 runs per over. That explains the difference. The chain is only as strong as its weakest link. The weakest links for Australia were stronger than the weakest links for India. Period.

(2) Ashley Tellis’ piece makes a lot of sense. Just brace for it and be prepared for it, is the message. But, for all the patriotic talk by Indian politicians, this should rankle:

truth be told, the Indian defense forces, including the army units manning the Line of Control (LoC) and those internal security components deployed in Jammu and Kashmir, are woefully underequipped and often lack even the most rudimentary technologies now available to combat terrorism.

The failure of Indian policymakers to invest in these capabilities is indeed unconscionable. [Link]

He is also right about the opportunity that the United States missed (from the Indian angle, that is) and the naivety of expecting China to ride to India’s support:

After 9/11, Washington blew the one opportunity it had to compel Pakistan towards genuine reform. Instead it ended up turning a Nelson’s eye towards Pakistan’s preservation of its anti-India proxies as the price of its cooperation against Al Qaeda. An opportunity of this sort has never materialized again. 

Expecting China to enjoin Pakistan to eschew terrorism against India is laughable. Whatever the Wuhan spirit may be, it does not extend to squeezing all-weather friends against strategic rivals. [Link]

(3) Dhruva Jaishankar says why India always abhors international mediation in dealing with Pakistan. See here.

(4) Aravindan Neelakantan on the significance of PM Modi washing the feet of sanitation workers.

(5) John Authers on why the bull market in stocks in China feels fake

(6) Will Michael Cohen facilitate the arrival of socialism in America? Or, in other words, will he be the man to slay the demon of financialisation and replce it with another? Read his testimony and decide for yourself.

Economists and public policy

I had the privilege of spending an hour with Dr. Y.V. Reddy on Saturday morning at the RBI Staff College Quarters in Chennai as he was on his way back from Pondicherry to Hyderabad. He is as sharp as ever.

Later in the evening, he forwarded two of his speeches for me to read – one from 1997 and one from 1996. The first one is the title of this blog post and the second one – in 196 – was on central bank communication.

The 1997 speech was a great read. Amazingly impressive that he found time to read so much and remembered to quote from them too.

The mention about Rajaji’s contribution was noteworthy. Also, economics being a science somewhat closer to astrology was a terrific observation.

This was a very good one:

If you are a good economist, a virtuous economist, he said, you are reborn as a physicist. But if you are an evil, wicked economist, you are reborn as a sociologist.

This is a great sentence:

In fact, it can be argued that there are no facts without values since one notices facts when one looks for them, and the process of looking for certain facts presupposes some predilections reflecting one’s values.

Also, he subtlely took a position on the issue of Swadeshi vs. Videshi economists:

However, the contribution of Indian universities to senior level positions in Government, as economists, is not very significant. It would be too simplistic to explain this away in terms of bias against pure Swadeshi economists. …..

There is another interesting factor in employment of economists and statisticians that we experience in the Reserve Bank. We are not bad pay masters by Indian standards. We in the Reserve Bank find that although a large number of candidates appear for the entrance examinations, the required number are not able to meet the minimum standards prescribed by us.

This is an important advice, especially to the people around the present government:

Even as interactions are increasing among other countries, we seem to become defensive. I submit that we should seek advice from all around, but keep our own counsel.

I liked these lines by Henderson:

It is my contention that Government economists perform their most effective professional work when they speak plainly and do not trim their views to suit the presumed wishes of those who consult them; in other words, when they deliver their best analysis of reasonable policy options in fair and comprehensible terms.

This is similar to the views expressed by Isher Judge Ahluwali and I.M.D. Little:

In fact, it is a civil servant s dharma to advise an elected Government freely and at the same time defend the policies that finally emerge.

I would say that this is how an economic advisor to the Government, working inside the government, must behave.

His caution against public grandstanding by economists working for the government is much needed, even now:

There are issues of packaging some economic measures for effect , and canvassing public support for a proposal (as distinct from explaining or elaborating a proposal) – especially in the media or industry associations. There may be some merit in such actions but soon they can spill over into an alien territory viz., that of politicians.

Overall, it was indeed amazing to note that Dr. Reddy had managed to draw from so many rich references and, as always, he had succeeded in weaving together a rather thoughtful speech. I had not come across this one before.

Invisible hand of morality

I enjoyed writing my MINT column for Tuesday on the rise of socialism among millennials and how capitalism – both ‘arms-length’ and ‘arms-around’ varieties – brought about this love for socialism. The MINT column was triggered by ‘The Economist’ cover (16th February 2019) and the ‘leader’ on the topic. While researching for the topic, I came across a paper by Amar Bhide titled, ‘An accident waiting to happen’ written in 2009. It is a well-written paper – both cogently and passinately argued.

In my MINT column, I argue that both arms-length capitalism and relationship capitalism (citing an example from India) had failed and the common reason for that failure is that morality has disappeared from both forms of capitalism. The common belief stemming from a faulty reading of Adam Smith’s ‘Wealth of Nations’ was that morality was not required. Self-interest was both necessary and sufficient to drive collectively beneficial outcomes. It is quite possible that Adam Smith never meant it that way. I had covered that in an earlier blog post. The visible hand of morality was the foundation or pillar of capitalism. My argument and Amar Bhide’s arguments are not mutually exclusive.

In his paper, Amar Bhide argues that the crisis of 2008 was a case of humans lacking in humility (excessive belief in mathematically determined probabilities) and failing to factor in the law of unintended consequences. He argues that tight securities market regulations (investor protection laws; insider trading rules, etc.,) created arms-length capital markets in which nobody had a stake and hence, managers looked after themselves. No single shareholder was powerful enough or interested enough to stop excesses of managements.

Similarly banking or financial deregulation, he says, enabled banks to take on risks that they otherwise would not have. He cites abolition of inter-state banking, repeal of Glass-Steagall, proprietary trading, etc. Federal Deposit Insurance encouraged banks’ excessive risk-taking: moral hazard. Ho brw come economists ignored moral hazard in this matter? With deposit insurance, depositors were not interested in monitoring risk-taking by banks.

He writes:

In the narrative offered by Rajan and several other economists, exogenous technologies played a deterministic role, inexorably forcing changes in regulation and financing arrangements. But technology might, instead, have facilitated relationship banking…. The outcome was not predetermined. In fact, in the story that I have told here, the increased share of securitized financial assets was driven mainly by the beliefs of financial economists and regulators. [Link]

His conclusion is pithy, sharp and correct:

Economics has underpinned securitization through its embrace of mathematical models to the exclusion of other perspectives, and through a complementary tendency to ignore the downside of liquidity and arms-length relationships. Regulation has brought this way of thinking into the world of practice in two paradoxically related streams: by increasing the scope and effectiveness of the New Deal securities acts and subsequent rules that fostered the growth of arms-length transactions in corporate control; and the progressive dilution of New Deal banking acts, which nurtured and protected long term relationships. This is the complicated story that may explain why developments in mortgage banking, of all things—traditionally the plodding, conservative bread-and-butter of depository banking—should have led to the implosion of the world economy.

I also chanced upon two of his op.-eds. One calls for the end of the Federal Reserve (as we know it) and the other faults the IMF for encouraging reckless lending by banks in foreign currencies to emerging sovereigns. Who, in their senses, could disagree with his (and his co-author’s) arguments?

Notwithstanding all of these, I could not resist pointing out in my column that the love of socialism is misguided and that humans were once again falling back on lazy answers. In this regard, the article I had cited in my MINT column on the case for wearing fur and leather was very thoughtful. The costs imposed on societies by misguided and/or uninformed do-gooders are substantial. I encourage you to read it.

I would also like to recommend reading a blog post I had written little less than six months ago.

Whose sufferance?

This is not a long article but makes some important points. It is about technology taking over our lives. AS always, it is an outcome of ‘means’ becoming the ‘end’. Technology was the means to a comfortable life. But, because we chased it too hard, technology has become the ‘end’ in itself and it is now dominating our lives.

IF you are not convinced about the conflation of ‘means’ and ‘ends’, read this paragraph by George Dyson:

The search engine is no longer a model of human knowledge, it is human knowledge. What began as a mapping of human meaning now defines human meaning, and has begun to control, rather than simply catalog or index, human thought. No one is at the controls. If enough drivers subscribe to a real-time map, traffic is controlled, with no central model except the traffic itself. The successful social network is no longer a model of the social graph, it is the social graph. This is why it is a winner-take-all game. Governments, with an allegiance to antiquated models and control systems, are being left behind. [Emphasis mine; link]

This warning by a MIT professor in 1970 was very prescient:

While Minsky believed that A.I. might solve the world’s problems, he also recognized how it could all go drastically awry. In an interview with Life magazine in November of 1970, Minsky warned: “Once the computers get control, we might never get it back. We would survive at their sufferance.” In one of his more famous premonitions, he posited, “If we’re lucky, the [machines] might decide to keep us as pets.” [Link]

The reference to the work of Arthur C. Clarke, ‘Childhood’s End’ is interesting. One should check it out.

Perhaps, this tribal community in Nagaland, in its own way, is showing us the way?

Stuff that caught my attention (STCMA) – 15th February 2019

Who would have thought that ‘The Economist’ would be forced to write a leader on the love of the millennials for socialism. I think, once again, the diagnosis is correct. But, the solutions are hackneyed. Capitalism has gone to extremes. Share buyback, financed by debt, and its brazen link to executive compensation are just an example.

Pity that an astute observer like James Mackintosh twists himself too much to exonerate or minimise share buyback. It is hard to understand how one has to be mutually exclsuive about these things. That is, one can be critical of share buybacks and one can also be critical of the other stuff that he writes. Why does it have to be EITHER/OR?

This is incredible. The story is about how some of the corporate bonds that the European Central Bank bought went bust barely a year later. Had it happened in India, all hell would have broken loose and the Reserve Bank of India would have either had to close down and then be reinvented or the entire management and the Board would have had to resign. But, there is barely an eyelid batted in Europe. They preach governance to us. Read these extracts:

Scores of banks and bond investors were freely lending to investment-grade rated companies on not particularly onerous terms back in 2016. Yet the ECB determined that jostling its way to the front of this queue would boost investment and create jobs. What it did create were immediate pricing distortions, with companies able to issue negative-yielding bonds for the first time — charging investors for the privilege of lending to them. …

This QE bezzle was sometimes dramatically revealed even while central bank bond-buying was in full swing. Months after the ECB bought Steinhoff’s bonds in 2017, it had to dump the position at half face value amid an accounting scandal at the retailer. [Link]

I do not think Indians are paying attention to what is happening in Italy although folks of Italian origin continue to make the news in Indian politics. Mateo Salvini, one of the two Italian Deputy Prime Ministers,spoke about seizing the gold reserves from the Bank of Italy. Again, had the Government in India spoken like this, the so-called elites will have concluded that India was doomed forever.

In the meantime, the other Deputy Prime Minister did meet anti-government protesters in France:

Italy’s Deputy Prime Minister Luigi Di Maio said he met leaders of France’s “yellow vest” anti-government movement on Tuesday, an encounter likely to further test already strained bilateral relations. [Link]

Interesting, isn’t it?

For economists who see ominous patterns in the world of numbers, one figure — 18 — is giving pause for thought. Last year, China, the world’s second-largest economy, accounted for 18 per cent of the global economy — just like Japan on the cusp of a decade of stagnation, and just like the Soviet Union shortly before it collapsed.

“In different ways, the USSR and Japan both stumbled when they faced the need to generate growth from more bottom-up, entrepreneurial, service- and network-oriented activities,” says Arthur Kroeber, managing director of research company Gavekal Dragonomics. “Despite a strong record of bottom-up dynamism, China is now moving in a much more statist direction.” [Link]

That leads to interesting political battles too:

Last month, the son of 1980s reformist leader Hu Yaobang warned that the USSR’s demise was due to overly centralised power and over-reliance on a planned economy, in a pointed swipe at Mr Xi. The son of reformist leader Deng Xiaoping has similarly warned that the country’s aggressive international stance could lead to danger. [Link]

The Free Exchange blog in ‘The Economist’ argues that a world without Facebook will be a better place. It might be hard to quarrel with that, even for FB users.

Michael Jensen’s legacy

(1) This link takes us to the work by Alex Edmans of London Business School, showing how CEOs release news in the month in which his share sale takes place. He and his co-authors do control for many other factors.

(2) This paper shows corporate stock buybacks and executives’ share sales are linked.

I got the link to the article by visiting his home page. Click on the Jan. 18 paper. A good summary of the paper is here.

(3)  In turn,  I was led to the HBR article from this blog post.

(4) While you are at it, do not miss this FT Alphaville post which is also linked in the above blog post by Jesse Felder.

In a way, this shows up the inadequacy of Michael Jensen’s work. Or, to put it differently, the law of unintended consequences is always operational and tha the road to hell is paved with good intentions.

Or, third, it proves my point that whatever starts as MEANS to an END becomes the END in itself. That is what Sapiens always do.

Postscript: let us not forget what makes debt-financed share buybacks feasible: ultra-low interest rates of central banks done in the name of supporting the economy