The Rise of Finance

The article is an extract from a forthcoming book. It is thoughtful and thought-provoking.

Some paragraphs are exactly in line with the sentiments expressed in ‘The Rise of Finance: Causes, Consequences and Cures’ and those were the sentiments that motivated our book:

Jensen and his co-author, William Meckling, proposed a series of measures to correct then-prevailing ideas about corporate governance. They argued that the owners of stocks and bonds should push corporate management to attend very closely to the price of their company’s shares and less closely, if at all, to the needs of society.

It’s always tempting to think about the way things turned out as having been inevitable—as the only possible response to vast, irresistible forces—but history is always contingent.

But there was a problem. The shareholder revolution and the rise of finance made the kind of social vision that Berle, Drucker and others were promoting for post-World War II America impossible to sustain.

Just as political systems a century ago had to adjust in response to the social dislocations produced by industrial capitalism, today they are adjusting to the social consequences of the financial revolution of the late 20th century.  

This became the theoretical accompaniment to a great remaking of the relationship between corporations and finance, which put finance in a much more empowered position.

We are at an inflection point in the world. The Conservative movement in the UK is in disarray. The Labour Party has radical (but unviable) ideas. In the USA, the Democratic Party’s balance of power has shifted decisively to the Left.

To a large extent, the rise of finance and the corporate greed that rose along with it are to be blamed for this.

Postscript: it appears that Binyamin Applebaum’s book also mentions ‘financial liberalisation’ as one of the bad ideas to have emerged from ‘free market’ economists. I have not read the book but here is a review of the book (ht: Rajeev Mantri).

STCMA – 5th September 2019

Who is to blame for the Indian auto industry’s funk? Look in the mirror? [Link]

Low interest rates and world’s biggest banks – too much of a good thing? Or, was it ever a good thing? [Link]

The historic asset boom passed by half the families in the USA. Hardly surprising. QE favoured the asset-rich to become more asset-rich. [Link]

Seth Godin’s blog post on Google’s hoarding and monopoly [Link]. Check out this tweet and these two stories too. Google is pushing secretly pushing user data to advertisers and then the American State Attorneys are planning to launch anti-trust investigations into Google. About time, one would say.

Wall Street Journal’s Small Business Survey says that small businesses are feeling the blues but the NFIB survey (latest: July 2019) is still showing optimism. What gives?

Charles Goodhart has contributed to this article on why low interest rates might hurt. It is a bit late and a bit too mild too. Must have come out years ago.

Informative piece by Amol Agrawal in BloombergQuint on the recent merger of Public Sector banks in India.

Who provides traction for populism?

Daron Acemoglu and James Robinson have an interesting piece in ‘Project Syndicate’ on the forces that contribute to the victory of populists.

They cite Jean-Claude Juncker and that is rather dangerous elitist thinking, totally self-absorbed:

In Europe, Jean-Claude Juncker, while serving as prime minister of Luxembourg, once described the European Council’s decision-making as follows: “We decree something, then float it and wait some time to see what happens. If no clamor occurs … because most people do not grasp what had been decided, we continue – step by step, until the point of no return is reached.” Such elitist logic is intrinsically vulnerable to populism.

Their conclusions appear very reasonable:

To defeat populism, then, one must address all the factors that make it a viable strategy. That starts with recognizing that populism can emerge only when there are real social and economic problems to give it electoral traction. It also means being honest about the fact that there are competing and contested visions of citizenship, which should be debated, not ignored.

Somewhat connected to this but not very directly is the blog post by Chris Dillow on the adverse impact of neo-liberalism on productivity. It might take a few days to go through all the links in that post!

Any case, fat chance that elites will heed their (Acemoglu and Robinson’s) message. Check out my previous post on the so-called open letter of China experts in America.

Public Private Partnership or Patronage

My friends cum coauthors – Gulzar Natarajan and T.V. Somanathan have a joint piece – based on many of Gulzar’s readings on the situation in the UK – has many layers and nuances: from a very broad picture, ideological debate about capitalism, market economy vs. state-led growth to micro level skills in negotiating PPPs (assuming public interest is the goal or objective) and all the layers in between, it can be a good case study in economics class-rooms, public policy schools and in business schools too.

If so much debt had been built up and the monies paid out as dividends with very little real asset investment whereas the still-public Scottish Water has had a far stellar record of public service, then the question of whether the saving in terms of public deficit and deficit is really worth it, arises.

How do we even evaluate the efficacy? From the standpoint of the economy, what should be the yardstick to look at? Public debt or overall debt? Or, should one also take into account assets created with the debt?

Therefore, should good, old-fashioned financial ratios with respect to the balance sheets of corporations be deployed to evaluate whether the country is doing something right, but by reckoning these figures at the national level (including public and private sectors) rather than looking at them in isolation?

Is predatory capitalism – which is what many of the privatised utilities have practised – better than state-ownership?

Or, can it be tolerated if performance metrics in terms of provision of public services and public goods show ‘substantial’ improvement? How does one define them?

Should privatised services have different agreements between the Government and the new private owner than purely private-sector originating enterprises? – a bit like what the British government tried with China in respect of Hong Kong?

In other words, should the government continue to be co-owner of the delivery, hold itself jointly accountable and, consequently, incorporate the accountability parameters in the PPP agreement?

In the light of their piece, this edit should be of interest.

More broadly, I wonder, particularly in the case of the UK, whether the ‘ripping off’ of the public by the privatised utilities and railroads is part of the same phenomenon that had seen the big four audit firms in a big credibility crisis. I have not followed the story closely except to read the headlines. The FT has to be commended on their meticulous coverage of the crisis with audit firms in the UK.

But, without independent and verifiable and reliable accounts and their certification, arms-length capitalism has no future. Arms-around or crony capitalism has limitations. Socialism is tried, tested and failed. The world is staring down the barrel, in my view.

Thus, in global economic and political leadership, the world is confronting a big vacuum.

STCMA on August 1, 2019

Pakistan rolls back the increase in cooking gas tariffs for roadside roti/naan outlets. [Link]

Ruchir Sharma’s piece in Times of India on July 31 echoes what I wrote for Mint on July 26:

Japan showed that central banks can print all the money they want, but can’t dictate where it will go.

Authorities in the Chinese capital have ordered halal restaurants and food stalls to remove Arabic script and symbols associated with Islam from their signs, part of an expanding national effort to “Sinicize” its Muslim population. [Link]

OF course, none of these seem to matter for Stephen Roach who sees nothing ‘red’ in China.

His tally of assets at a broader universe of Chinese lenders in “distress” is 9.2 trillion yuan, or about 4% of the commercial banking system and nearly 10% of gross domestic product. [Link]

The UBS analyst, cited above, is being careful, to sound positive (if you read the full story) so that he avoids the fate that befell his economist-colleague

I think what Raghuram Rajan is saying here is that central bankers have become the fall guys because they set themselves up to be supermen and women. It is time for a confession.

Business Today carried an useful article on tech. applications that are considerate to our privacy concerns [Link]

A friend had flagged this. It is indeed nuts. See Ruchir’s piece above too.

The analysis by S&P Global Market Intelligence found unrated entities in China, the U.K. and the technology sector in Asia Pacific are among the most at risk of a sudden spike in defaults. [Link]

Jeffrey Frankel is not sure whether inflation targeting really works because we still do not know, after all these years, how inflation expectations are formed. At least, one interesting link to a paper in his piece. [Link]

Finally, Google gets rid of another employee who is a conservative Republican.

Why 2007-08 was only a curtain-riser

What began as a message to my faculty colleagues at IFMR Graduate School of Business was eventually abandoned and it ended up being a ‘long read’ article published in Mint. They had removed many of the hyper links to keep the piece tractable. Fair enough.

Here is the original version. Perhaps, Mint should have titled the piece, ‘Why it feels like the autumn of 2007?’ The original version, below, has more links.

Wall Street Journal recently issued an oxymoron alert. The oxymoron was that high yield bonds had gone negative. “There are about 14 companies with junk bonds worth more than €3 billion ($3.38 billion) that are trading with negative yields, according to Bank of America Merrill Lynch. They include telecom giant Altice Europe NV and tech-equipment company Nokia Corp.” It would have been unthinkable even a few years ago to have high-yield/speculative/junk bonds being sold for negative yields. They were meant to be high-yielding bonds because they carried with a high probability of default. But, to compensate the borrower to buy them means that the logic of higher expected return for higher risk has been upended. This makes investing impossible.

A pension fund manager in a European country was told by his regulator not to hold too much cash because it is risky and was told to invest them in negative yielding bonds, instead! This cannot and will not end well. It is time for investors to baton down their hatches and settle for safety rather than returns because it is a recipe for the elevation of socialist policies in America to a historically unprecedented level, after the next Presidential elections in 2020.

Globally, about USD 13.0 trillion of debt is trading at negative yields. Two US companies that issued leveraged loans have quickly seen their bonds lose value. Obviously, lenders chasing yields have ignored risks. The companies recycle printer ink cartridges and another one is a beauty company! – Clover Technologies and Anastasia Beverly Hills! See here.

Amidst all this, what is funny or tragic (depending on your lens) is that investors, according to Schroders, have upped their return expectations for 2019 to 10.7% from 9.9%. This is based on a survey of 25,000 people across 32 countries. In other words, the survey respondents plan to make riskier investments (some of which now yield negative returns!) and that they expect central banks to underwrite their risks with ultra-low interest rates or negative rates or nominal GDP targeting into eternity.

Who is responsible for this upside-down world of investing?

Let us start with the Federal Reserve. Its monetary policy committee is meeting on July 30-31. Donald Trump is putting tremendous pressure on the Federal Reserve to ease monetary policy aggressively. Check out his four tweets on the Federal Reserve including and starting from this one. Although the Federal Reserve strenuously denies complying, it is behaving as though it is complying. The Federal Reserve is ready to cut interest rates by 25 basis points at the minimum in its meeting in July. One should not be surprised if the pre-emptive ‘vaccination’ is 50 basis points. The American economy does not need it. William Dunkelberg of the National Federation of Independent Businesses marshalled data to show that no real business – including small ones – is being starved of credit.

All else being equal, a besieged Federal Reserve would have made the US dollar a sitting duck for speculators and for the world, in general, to fall out of love with the greenback. But, it won’t happen in a hurry because others are far worse off. So, the story of the world finally getting out of the dollar standard has to wait. That is because other central banks are again talking of cutting rates aggressively. European Central Bank is fully prepared to outdo the Federal Reserve. Eurozone countries have selected a ‘tainted’ politician to replace Mario Draghi as the President of the European Central Bank. She will be more populist and ‘bolder’ than him with monetary policy experiments. That will be music to financial markets, hedge funds, PE investors who place bets with a high degree of leverage.

The crisis of 2008 was supposedly due to excessive debt carried by different financial institutions – some visible and some hidden. But, the answer from central banks has been to incentivise even higher gearing of balance sheets. In America, the number of companies with increased risk of becoming financially distressed  – companies that either generated negative EBITDA or have net debt to EBITDA over 3x – has grown noticeably this cycle (53% as 6/30/19) versus last cycle (32% as of 6/30/2007). It gets worse.

Central banks deliberately avoid thinking about why their decade-long policy of ultra-low interest rates have failed to mend economies. In less than a year after proclaiming the return to normalcy, central banks are priming themselves to become even more adventurous with their monetary policies. All that their policies have engendered is reckless risk-taking in financial markets, more leverage, greater inequality and tremendous stress on savers, bank deposit-holders and pensioners. Think of the clients of the pension fund mentioned earlier.

Another important consequence of such remarkable persistence with such ill-advised policies is the diversion of capital for unproductive ends and personal aggrandisement. Loss-making start-ups are carrying on without a concern for profits because cheap money means private equity investors blanket them with funds. ‘Wework’ is a technology unicorn in the office rental space. The company has filed for an IPO but it had the temerity to issue USD 4.0 billion debt before that and its co-founder has cashed out USD 700.0 million in the last year! It is valued at USD 47.0 billion. Softbank wanted to invest USD 16.0 billion in that company with USD 6.0 billion in new money. Its partners protested and the investment was pared back. IWG, the owner of Regus, another office space rental company, is valued at USD 4.0 billion and it is making profits. I had blogged on it here.

We heard of price-eyeball ratio in the dotcom bubble era of the Nineties. Now, ‘Wework’ presents ‘community adjusted’ EBITDA which strips out “not only interest, taxes, depreciation and amortization, but also basic expenses like marketing, general and administrative, and development and design costs.” No one has heard of this EBITDA before because it is effectively gross revenue and without accounting for costs, it turns into profits, of course.

Not only have promoters benefited immensely from loose monetary policies and funds available on liberal terms from capital markets but they have also profited from the tendency of governments to compete away their tax dollars from companies.

The corporate tax rates in developed world have come down steadily from 38% in 1990 down to 22% in 2018. This has forced low-income countries to lower their tax rates as well as, otherwise, companies will shift their tax bases to havens that still remain in high-income countries. Corporate tax rates in low-income countries have come down from 46% to around 28% in the same period. This data comes from the International Monetary Fund which, officially, has been the cheer-leader for unconventional monetary policies that have played a leading role in precipitating the next biggest crisis after 2008. That will not be just an economic crisis but a socio-political one too.

Capitalism does not need enemies or competing ideologies. Capitalists are doing a great job of destroying it with multilateral institutions like the IMF egging on central banks to stick to policies that would ultimately cause capitalism to implode.

There has been much schadenfreude in Asia at the self-destruction of capitalist western societies. But, if only such sentiment were justified. Asia, if anything, is more vulnerable. The crisis of 2008 has damaged their growth models irreparably. Let us start with China. Beijing is presiding over a shaky economy in China as official growth rate is again overstating true economic growth and global manufacturing supply chains are moving out of China, exactly as intended by the American administration, even if they are not returning to the United States.

In the meantime, China’s Minsheng Investment Trust Corp. is defaulting on its dollar debt. Its parent, Minsheng Banking Corporation is China’s largest private sector bank by assets. In 2015, it did warn of ‘systemic, concentrated financial risk happening in China’ but it has become a victim of it, itself. In Hong Kong, protests against the pro-Beijing government are intensifying.

Smaller Asian nations are faring no better. Japan’s exports have had seven straight months of decline up to June 2019. So has the performance of Korea’s exports been except that its export slump appears to be worse than that of Japan. No wonder South Korean auto industry is in a slump. Singapore’s non-oil domestic exports is a bell-weather for international trade and global economy. It is declining  precipitously and Singapore economy itself appears headed for harder times. Singapore’s overall GDP contracted 3.4% in the second quarter (QoQ, annualised). Of course, this is an advance estimate based on two months’ of data. Preliminary estimates based on three months of data will be released in August. Indonesian exports have declined for eight straight months up to June and Malaysia’s exports have fared slightly better than Singapore’s and Indonesia’s.

In Europe, German investor and economic sentiment (ZEW) is going deeper into negative territory. The same ZEW survey also pointed out that “the indicator for the current economic situation in the eurozone fell 6.9 points to a level of minus 10.6 points in July.”

A survey of the global political landscape confirms our worst fears. Leaders are ill-equipped to face the oncoming economic storm. Worse, they are seeding and nourishing it. Japan and South Korea are back to feuding in which the trade disputes playing a small but significant role in it. The wounds are historical and they were re-opened by a Seoul court ruling last October. Malaysian Prime Minister looks all set to walk back on his word to hand over power to Anwar, again! Such political conspiracies and power-grab have rendered ASEAN irrelevant both politically and economically. It was laid low by the crisis of 1998 and it has not recovered since then.

In the United Kingdom, Boris Johnson looks set to become Prime Minister and Brexit – deal or no deal – looks likely. Its consequences will be unpredictable because the country has now fraught relations with the United States, with European Union, with China and with Iran. But, the English team’s Pyrrhic victory in the Cricket World Cup 2019 is a small boost to national sentiment. In continental Europe, Angela Merkel’s physical health is deteriorating. Turkey, the pivotal Eurasian nation at the frontier of the Western alliance against Russia, is no longer a part of it, de facto, if not de jure. This is historic and has enormous implications.

Elsewhere, Iran has seized a British oil tanker and America has shot down an Iranian drone. Of course, the current expectations are that things won’t spiral out of control. But, a President seeking re-election is increasingly focusing on cementing and consolidating his base. Belligerence towards his domestic and international opponents will be consistent with those political goals.

Finally, let us examine if India is anywhere close to being a safe haven from the turbulent world. After all, in the elections held in May, its government won a strong mandate with a better majority Alas, its economy is getting deeper into trouble. The slump in the Indian auto sector mirrors that of South Korea and its overall economy has not stopped slowing. The Reserve Bank of India Governor has taken to chiding public sector banks on their non-transmission of his rate cuts. Just as it is the case in the West, monetary policy has no answers to structural ills. Resolving them starts with admitting to them and then being patient without too much anxiety about short-term growth pains. Window dressing only complicates the problem and delays eventual resolution, recovery and strong growth. The budget was incoherent at best and dangerous at worst, for it privileged financial liberalisation and trade illiberalisation. It socked the rich again and that was needless, both politically and economically.

The government announced that it would go for sovereign foreign currency borrowing at a time when India’s export performance is poor and the global growth environment is becoming worse. Dr. Y.V. Reddy, former Governor of the Reserve Bank of India, wrote that a decision on India’s capital account convertibility must precede the decision to issue sovereign dollar bond. But, this is not the best time to liberalise capital account when India’s fiscal health is not at its best and when export performance is sluggish at best and has deteriorated, at worst.

What appeared to be a cleverly disguised (positive) move to divest government stake in public sector enterprises below 51% has been denied, as well. Monsoon is erratic once again and anecdotal evidence points to India being more vulnerable to global climate change than most other nations. India may be sleepwalking into a major and prolonged economic slowdown. Narayanaswamy Jayakumar may have been prophetic here.

As we head into 2020 – the year of American Presidential elections –present trends in financial markets and economies around the world would coalesce into a major storm, convulsing most of them in the process. The Presidential election campaign in America could yet be the most fractious in history searing the nation apart, at a time when the economy may be pushed into a recession by a crash in the stock market or the other way around. That may set off a dollar crisis. The rest of the world, with political and economic problems of their own, will be unable to fill the leadership vacuum left by a politically fractious and economically floundering America.

Once the storm subsides, a new world economic and political order might emerge. To end on a positive note, the destruction wreaked by the storm might mark a true and a lasting bottom for the world economy on which its durable recovery could be built with more sensible policies than the snake oil that central banks have applied.

G-2 to G minus 2

My friend Rohit Rajendran forwarded the ‘Project Syndicate’ piece written by Arvind Subramanian and Josh Felman. The article is, in short, about global leadership vacuum. Calling it ‘G minus 2’ is smart.

The points made about China’s lack of soft power, it not being a benevolent hegemon are well made. I would be blunter: I would call it a predatory hegemon.

US, wrongly, for the most part, thinks that it has been too benevolent a hegemon. That is convenient excuse to deflect problems which defy easy answers.

Taking a step back or rising above these, we should expect these kinds of long cycles to keep coming in a 30-year rhythm. 

We have just begun the long journey of turbulence. 2008 was a decent-enough warning. Our central banks applied monetary balm and politicians were happy to go along with it.

The truth – which most humans do not accept – is that some problems do not have answers. Or put differently, the problems will have to solve themselves, through sheer passage of time and through participants realising the folly of their ways. 

In the current global context, it is going to take rather long, I am afraid.