Macron bubble and protest vote in Spain

Recent French protests at the Fuel tax has multiple dimensions:

France is a high-tax country; but the question is whom does government provide relief – Macron reduced wealth tax earlier; fuel tax affects all; it is also a climate change issue; the vandalism that the protesters engaged in, targeted affluent communities, cafes and boutiques. Macron’s approval rating is one-fifth. 

Gideon Rachman on the Macron bubble that has burst. A rare piece of candour and correct opinion.

Much to reflect on the global angst and anger, manifested in the protests in France and protest vote in Spain.

Recently, Wall Street Journal has gloated that Thomas Piketty’s work on inequality has been discredited by recent research from the American Institute of Economic Research. May be, they are right. I have not seen their work. But, that makes the global angst and anger an even bigger puzzle. What is the motivation?
Wolfgang Muenchau on how the broken plane that led Merkel to catch an Iberian Air flight to go to Buenos Aires for the G-20 summit meeting is an apt metaphor for Europe. I agree with him. [Link]

A lumpy error by Tim Harford

By lumping Fed, BoE and RBI in one article, Tim Harford missed out the nuances. Trump’s sniping at the Federal Reserve is unfortunate. America needs a return to normal monetary policy because ultra-accommodative policies have created a lot of imbalances – social and economic. Asset price bubbles are back in many asset classes if not in real estate. Excessive leverage caused the problems in 2008 and leverage ratios are higher now. Eight years of near-zero interest rates and bond buying might have hidden risks in places that would be revealed only later. Therefore, normalisation of monetary policy in America is long overdue. Trump is wrong.

The Bank of England (BoE) inserting itself into the debate on Brexit has been ‘condemned‘ by Mervyn King himself, a long-standing former BoE Governor. Well, he was ‘saddened’. BoE eased pre-emptively in 2016 but the worst macro-economic consequences of Brexit have not materialised.

In India, the story is different. The Reserve Bank of India (RBI) is a creation of Parliament. It is not an independent organ of governance established by the Constitution of India. In the Westminster system of governance India has adopted, institutions created by Acts of Parliament are answerable to the Parliament through the Executive. The Ministry of Finance is answerable and accountable to the Parliament for RBI’s performance. Therefore, the MoF must have authority too, over RBI.

It had ceded the monetary policy function to a committee constituted by RBI and the Government together. The Government has signed an agreement with RBI for inflation targeting and hence the committee is responsible for setting the interest rate. The Government is not commanding the RBI to cut interest rates or intervening in this function. The previous Finance Minister in the previous government did so. He once directed the government-owned banks not to raise their interest rates when the central bank raised rates. That is blatant interference with the transmission mechanism of monetary policy.

The present Government had not acted to curb any institution that has been set up independent of the Executive, by the Constitution. Hence, the question of eorsion of institutional independence does not arise. Nor has it interfered with the monetary policy mandate of RBI which it has ceded to the central bank. One can argue on whether the central bank has excessive capital and whether there is a macroeconomic need for additional liquidity support by the central bank, etc. but the charge of ‘sniping’ is weakly founded.

Further, those who bat for central bank autonomy (independence is illusory except in the case of the Bundesbank and now the European Central Bank) should also bat for central bank accountability. In the West, central banks must be held accountable for their role in the rise of political and economic polarisation (wealth and income inequality and concentration of market power). Arguably, the former is the consequence of the latter.

In India, RBI must be held accountable for its failure to detect and take timely action on the rise of bad debts, on its monitoring of banks’ risk and compliance management systems with respect to frauds and on its regulation of non-banking finance corporations. With respect to monetary policy too, there is a reasonable case that it has been guilty of a doctrinaire approach to inflation-targeting. So, there is really no need to shed too much tears for the exit of the previous RBI Governor.

John Authers

I used to read Jason Zweig regularly. I have slipped now. Have not kept up with him lately. But, I do read John Authers. He is probably the most thoughtful market commentator writing currently. He was with Financial Times and he has moved to Bloomberg.

Without exception, his columns make you think. In more recent times, I will single out two pieces:

(1) ‘Don’t discount China’s role in the stock sell-off’. He is arguing that China’s economic weakness could be one underlying factor. Perhaps, he might have contradicted himself in the following piece where he writes about investors looking for ‘excuses’. He too might be looking for ‘excuses’ when he attributes a market move of a single day to a larger issue. There is a difference between catalysts and reasons. The reason for market crash: they are too expensive. They just cannot levitate at these levels. Expectations have gotten far ahead of reality. Period. No other reason needed. Everything else is a catalyst for this cause to create the effects.

In any case, I was more impressed with his analysis of Brexit.  He is absolutely right that ‘remainers’ cannot put the genie back into the bottle. He does not say it in so many words but things can never go back to being the same, even if a second referendum were held and it results in ‘Remain’ vote winning this time:

A second referendum seems more likely than it did. A lot has happened in the last two years, and much has been learnt. It seems reasonable to put the question again. But there is a real risk that this would result in a deeper nightmare scenario.

A second referendum might be as close as the first. A narrow victory for “Remain” would leave the country in the EU and almost half of the country with a lasting sense of injustice. A repeat of the first result would leave the country no further forward. Uncertainty would rise during the process. If the polls suggested that the country had now overwhelmingly turned in favor of staying in the EU, this calculation would be different, but there is no such evidence. [Link]

This reminds me of something that I tend to forget: sometimes, we cannot reverse certain decisions, even if we technically reverse them. Once the objective conditions have changed for good, it is impossible to restore them. So, some policy decisions cannot be reversed, even if we are open-minded about evidence and are prepared to swallow pride and reverse them. That puts the onus on getting it right the first time and also teaches us to be humble about unintended consequences and uncertainty in general.

While on the topic of Brexit, you should read Mervyn King’s op.-ed. too on the topic. He asks the UK Parliament not to endorse the deal (or, no-deal) that the British PM has arrived at. He says it is a ‘heads I lose; tails you win’ deal that UK has given the EU. It is a bit hard to sympathise with the plight of the Brits. I am reading ‘The Indian summer: the secret history of the end of an empire’. What one learns makes it hard to feel sympathetic for their travails now.

Apart from that, Mervyn King states publicly what we all know about the European Economic and Monetary Union:

the political nature of the EU has changed since monetary union. The EU failed to recognize that the euro would demand fiscal and political integration if it was to succeed, and that countries outside the euro area would require a different kind of EU membership. It was inevitable, therefore, that, sooner or later, Britain would decide to withdraw from a political project in which it had little interest apart from the shared desire for free trade. [Link]

(2) The second recent John Authers’ piece that I liked is the one titled, ‘Behind the Market Turmoil Lies Nothing But Excuses’. These conclusions are valid:

My best guess is that people were in need of an excuse to buy bonds Monday, catching others in a “short squeeze,” as many had been betting on higher bond yields. Plenty of others wanted to escape the stock market with gains while they could, and that carried on until prices had fallen enough to trigger the algorithms to buy stocks.

After years of central bank quantitative easing, there are lots of positions in markets that make little sense. Their holders have been awaiting for excuses to unload them. Keep tuned to see whether there really are convincing reasons to buy bonds or stocks. This week has been a litany of excuses. [Link]

Searching for fundamental reasons for market action is futile, especially for a market that has been rising for so long on the back of enormous leverage-based stock buyback aided by extraordinary global monetary accommodation. It simply had to end.

The hilarious paragraph of the year

Earlier this year, HMRC was embarrassed when it emerged that it had refused to assist a French investigation into suspected money-laundering and tax fraud by the UK telecoms giant Lycamobile, citing the fact that the company was the “biggest corporate donor to the Conservative Party”.

HMRC initially denied the Lycamobile story, saying: “This is the United Kingdom for God’s sake, not some Third World banana republic where the organs of state are in hock to some sort of kleptocracy.” It later conceded that the story was accurate. [Link]

Monstrous non-sense

Martin Sandbu, I think, outdoes himself in his latest column. He says that central banks were not loose enough in the years following the crisis as, even after the latest Trump tax cut stimulus in the US, inflation rates are not picking up and therefore, spare capacity was much higher. If only central banks had been bolder, the negative output gap would have closed much earlier!

The certitude here is indeed breathtaking. It took my breath away for a minute. I just did not know where to begin.

The simple truth is that monetary policy has been completely orthogonal to the real economy developments after the crisis. The economies of America and Europe have recovered on their own because monetary policy has been so loose for so long that such a belated recovery cannot be attributed to policy effectiveness.

It is wrong to argue that central banks had not done enough. By April 2010, the S&P 500 had nearly doubled (up 81%) from its low in February 2009. The 10-year bond yield had crashed from 4.0% to 2.0%. Everytime it threatened to rise above 4.0%, the Federal Reserve did QE2 and QE3. It did not raise rates in 2014. In 2015 and in 2016, it raised rates by 25 basis points each – 0.5% in total in two years! Mr. Sandbu thinks that they were not bold enough?!

Monetary policy operates through financial market variables. Where was the wealth effect from these reactions in bond yields and in the stock market? Nothing.

Had the Federal Reserve been more reckless, it would have sent financial assets to even greater heights but to what effect on the real economy?

It would have only widened the inequality and the angst among the middle and lower classes. Hasn’t he seen the UK Housing Affordability Index released by the Office for National Statistics for 2017?

On average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, a significant increase of 2.4% since 2016.

Workplace-based housing affordability significantly worsened in England between 2016 and 2017, but there were no significant changes in Wales.

Housing affordability has worsened significantly in 69 local authorities in England and Wales over the last five years, with over three-quarters of these being in London, the South East and the East.

All but five London boroughs had significant worsening of affordability since 2012.

House prices and earnings increased in all English regions and Wales, but the two regions with the largest increase in house prices (the East (10%) and the South East (6.9%)), were the two regions with the significant differences over the year. This suggests that house prices are driving the significant worsening in affordability.

The affordability ratio has more than doubled for every property type in England from 1997 to 2017. [Link]

Right after the Brexit vote, the Bank of England had taken out a pre-emptive monetary policy accommodation insurance on top of the ultra-loose monetary policy that prevailed. Yet, Mr. Sandbu thinks that policy wast not loose enough!

Given continuously worsening affordability caused by asset price increases which are a consequence of monetary policy, does he reckon with the social and economic costs of his implicit recommendation that central bankers should have been more reckless than they already were? May be, Brexit would have been forced on David Cameron than him calling for a referendum on the matter.

May be, Trump would have won with an even bigger margin or Bernie Sanders would have won the Democratic Primaries notwithstanding all the attempts to stop him from winning it.

The Chicago Fed Financial Conditions Index is hovering near the easiest despite the Federal Reserve hiking interest rates gradually since 2015 (data as of July 27, 2018 was available at the time of writing this blog post). It only shows that the normalisation is proceeding at such a glacial pace that it is hardly registering on the financial conditions.

Graeme Wheeler, then Governor of the Reserve Bank of New Zealand said this in October 2015:

Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy’s influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.

Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets – requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards. [Link]

A gentleman (Ben Carlson) had posted a comment under Martin Sandbu’s column implicitly supporting him by providing a link to his blog post.

My comments on that are as follows:

(1) The Fed’s remit is, officially, not the stock market index

(2) Earnings improvements were a functioning of low interest rates as top lines did not improve much for quite some time after 2009. Federal Reserve policy was powerless to influence aggregate demand and real economy. See Graeme Wheeler’s comments.

(3) Most ordinary people save through bank deposits. They were robbed of their incomes even as asset prices went up.

(4) Household debt has fallen but corporate and other debt have risen significantly. Overall leverage of the U.S. economy has only increased despite the crisis having been caused by leverage

(5) The improvement in household networth says nothing about its distribution. For that, check out the work (‘A lost generation’) by the Federal Reserve Bank of St. Louis on whose networth has improved. Mr. Ben Carlson’s stock market performance would not make a difference to them.

(6) If one taunts the Fed sceptics that their criticism was a reflection of ‘sour grapes’, it is equally possible that one’s approval of Fed policy is a reflection of their personal riches. Social and public welfare consequences be damned.

Resilience of human irrationality, a I wrote in my MINT column two weeks ago, is remarkably strong.

High external tariffs were effective once

I was preparing for a lecture I have been asked to give on Technology and Development to visiting scholars of Indian Economic Service at the Singapore Civil Services College tomorrow. I had made a mental note of referring to Professor Robert Allen’s work on the history of economic development. I had written on it in MINT in February 2015. Let me recall those words here:

According to him, North America and western continental Europe caught up with the British industrial revolution by adopting the following:

• Internal free market (elimination of internal tariffs)—national single market

• Stable domestic banking system

• High external tariff

• Universal education

• Infrastructure.

They did not catch up practising free trade and open capital markets. What a surprise! [Link]

High external tariff was needed to catch up with Britain which industrialised earlier. Now, President Trump is again resorting to high external tariffs. America has a stable banking system and an internal free market. Its infrastructure is in need of improvement, for sure. In other words, trade barriers were effective. They may well be effective again. Academics are finding it difficult to accept that possibility.

I saw an article by Professor Dani Rodrik in FT.  He was making two points of which I thought one was valid – that the WTO was more intrusive than that of GATT. His second point was that such intrusion did not allow for heterogenous economic models like that of China’s. I thought that the second point was problematic.

Countries are now holding China into account for its failure to honour the very commitments it made when it joined the WTO.  It signed up to it. It benefitted from it. Its breakneck export growth and foreign exchange reserves accumulation were due to its accession to WTO. Higher Foreign Direct Investment into China was also due to WTO accession.

Second, I was not sure if China’s economic model was that heterogenous. It followed Japan’s model  – export growth, undervalued currency and protected domestic markets. Post-2008, China copied the neo-Western model of economic growth – reliance on debt. I doubt if there was much that was or is heterogenous about China’s growth model.

But, on the intrusiveness of WTO (vs. GATT), Professors Joel Trachtman and Simon Lester have responded sharply to Dani Rodrik. You can see their posts here and here.

For what it is worth, Professor Rodrik should also read this Merics brief on what certain things mean in China.

Also, I am not sure many in America see the US-China trade dispute the way Professor Stiglitz sees it. I have cited in these pages from the Harvard-Harris poll of the last few months that those polled did not want a trade war but they also wanted China dealt with, firmly.  Stiglitz writes:

No country could have a more unqualified economic team than Trump’s, and a majority of Americans are not behind the trade war

He may be too harsh on the first part of his statement but he appears most certainly wrong with the second part of his statement. He should go through carefully pages 123-130 of the June 2018 Harvard-Harris poll.

If China was winning the trade war, a rare and risky outburst from a Chinese professor against President Xi Jinping would not have happened.

As of now, it does not appear that China is either winning the battle or the war. China has imposed unremunerated reserve requirements on forward transactions on Yuan and the People’s Bank of China demands ID proof for transfer of US dollars over USD1000.00 Professor Stiglitz has allowed his biases to cloud his judgment.

He should spend some time reading the detailed two-part article that the South China Morning Post on how China might have mishandled the US on the trade dispute. One can find them here and here.

Both he and Professor Rodrik would also find it useful to read the Merics China Monitor dated 18th July 2018 on China’s cosmological communism.

Read this comment too in the FT on strains showing in China.

Not too many people – even those who are ideologically ill-disposed towards Trump find it easy to side with China. For example, FT thinks that IMF would be wrong to bail out Pakistan which tantamounts to bailing out Chinese banks that lent to Pakistan to get China to build some infrastructure as part of its ‘One Belt One Road’ initiative.

On the Edg(e)baston

Three days and one session – that is all it took to get a result in Edgbaston – the venue of the first of the five Test match series between England and India. It was gripping but as India entered the fourth day needing 84 runs with five wickets in hand, one had to admit the odds favoured England. Seldom these days have teams performed well overseas. Probably, that distinction belonged to the West Indies team of the Seventies and Eighties and the Australian team of that period too. After that, it is not just India who are supposedly tigers at home and lambs everywhere else. It applies to all teams.

I had watched South Africa in England last summer. I watched a day’s play each at the Oval and at Old Trafford. Hashim Amla, Faf du Plessis – they all disappointed. South African bowlers did not make English batsmen play as many balls as they should have. I was disappointed by their under-par performance.

India had a good outing in England in 2002 and in 2007, not to mention 1986. In 1990 and in 1996, India lost a test each. They were three-test series. In 2002, India drew the series. It was a four-test series in 2002. In 2007, India won the three-test series. India was humilated in the Test Series in 2011 and in 2014. A 0-4 whitewash in 2011 and India lost the final three tests badly in 2014, after having drawn the first and won the second.

Indian batsmen, based on my recollection, have not done that well, with the exception of Vengsarkar in the Eighties and Dravid from 1996 up to 2011. Sachin has a good average against England but he had two good series – 1996 and 2002. The rest – 1990, 2007 and 2011 were mediocre, especially the 2011 series. In that series, he managed two fifties in ten innings.

Ganguly had only twelve tests against England and he has a better average. Laxman had not done well against them, except perhaps in 2002. I am citing all these from memory. In other words, Indian top order batsmen have not fired consistently against England. That, to the best of my recollection, happened only in 2002.

So, the failure of Rahane, Rahul, Murali Vijay and Shikhar Dhawan in both the innings are par for the course although one is disappointed at Rahane’s shot selection. I thought he was made of better stuff. Rahul had a brutish delivery in the second innings but, in the first, the dismissal was of his own making.

It is the pressure, of course, that is built up by the good deliveries that make batsmen play loose shots at poor deliveries and get out to them.

That is the achievement of Virat Kohli in this test match – he did not let the good deliveries creat the platform for the poor deliveries to swallow him!

That said, I would hold his dismissal – against the run of play – on day 2 – as an important turning point in the match. Towards the end of the innings, he was on fire, toying with Ben Stokes and other bowlers. I thought he would earn India a 20-run lead or something closer to that. But, his tame dismissal against Rashid was a bit of a surprise. It came unexpectedly.

The second important turning point of the match was the quick half century+ by Curran. At 87 for 7, India will have fancied their chances of getting England out under 150, at most. The extra thirty runs made the difference in the end.

To succeed in England or to avoid embarrassing series defeats, a team needs at least two top order batsmen to score well and consistently and bat longer. If India does not manage that, a repeat of 2011 and 2014 might be in store. One hopes not.

In English conditions, this England team has a good attack – Anderson, Broad, Stokes and Curran. One has to admire Jimmy Anderson’s resilience, fitness and longevity in Test cricket.

Engrossing game of cricket, no doubt – not very pleasant to watch, if you are a batsman or inclined towards batsmen but gritty game. One that separates the greats from the also-rans. In that sense, Kohli succeeding in this test overcoming his own mental blocks and ego was a far more satisfying outcome for him and his fans than his centuries on other occasions.

Battling the mental demons and coming on top is always very satisfying. It elevates us and maks us better and stronger human beings.