Amusing and priceless

This is the amusing stuff:

“Juncker vows to turn euro into reserve currency to rival US dollar”

He must pay close attention at least the topline results of the PEW Survey I had blogged on earlier.

A quick recap:

Underneath Mr. Macron’s pro-European rhetoric, the French people are only closely behind Italy in their distaste for the European project. Politicians do not command much trust. The public is confused and worried on immigration. Distrust of media is rather high as it is the case with financial institutions.

(2) This is priceless stuff:

“Aung San Suu Kyi defends verdict against Reuters journalists”

This underscores the ‘free lunch’ of being a ‘Liberal’ outside the government and how difficult it is to govern as a ‘Liberal’. Indeed, there is an inherent contradiction being in government and being Liberal.

Two years of Patel, the RBI Governor

My friend Gulzar Natarajan drew my attention to an article by Andy Mukherjee and an Edit in MINT on the second anniversary of Dr. Urjit Patel as the Governor of the Reserve Bank of India. I had read the Mint Edit myself.

Andy’s piece is an interesting one. I do not recall readily if he had been critical of the RBI Governor’s role in demonetisation and in the ‘Reverse Bank of India’ moniker that was slapped on the institution in the initial weeks and months of the demonetisation exercise. My vague recollection is that he was. But, in any case, this amounts to a retraction of such criticisms, if he had made them earlier.

More substantively, the Governor has breathed some credibility into the Monetary Policy Committee (MPC) and the Non-Performing Asset (NPA) resolution mechanism. Arguably, he had to take tougher decisions on these than his predecessor. During RR’s period, the NPA problem was beginning to come to light. Very few had a clear idea of either the dimensions or the complexity of the problem. Of course, RR took the bold call to order Asset Quality Reviews (AQR) which allowed both of the above to be revealed. That was very important at that time. Now, Dr. Patel has to navigate the political economy of resolution which is perhaps a stiffer challenge than the political economy of disclosure. May be, I am just splitting hairs, here.

Also, the other challenge that Dr. Patel is facing is the Fed tightening and an ‘election-mode’ government both of which, collectively, bring pressure on the fiscal, current account balances and consequently on the Rupee. Popular commentary on the Rupee weakness is unhelpful to the Governor.  It bleats about the Rupee weakness as though it is a problem in and of itself. It is not. The problem is with the underlying low productivity of the economy – especially in its farm and factory sectors. On top of them, fiscal policy has quietly but steadily slipped at a general government level.

Collectively, the farm loan waivers announced by State governments – BJP and Congress-Ruled – have been more than two and half times the farm loan waiver that the UPA-1 government had announced in 2007-08. The general government fiscal deficit for 2017-18 is 7.0% as per IMF estimates. The two rate increases in June and August announced by the RBI are very important and may prove to be very important and useful in ensuring monetary and exchange rate stability.

As for macroeconomic stability, it is in the hands of the Government and not the RBI. Raghuram Rajan was right to stress its importance going into an election, in his Bloomberg interview at Jackson Hole recently.

In short, yes, the Governor has quietly re-established his personal credibility and that of the institution he heads and that can only be good news for the country.

[Post-script: Tamal Bandyopadhyay adds his two cents worth of tribute to Urjit Patel while Amol Agrawal provides the much-needed alternative perspective]

EM Currency Crises

As the currency crises in Argentina and in Turkey resume, readers should read this paper by BIS, especially Section 5 (pages 24-29). Raghuram Rajan says, in this interview, that Indian rupee weakness is not yet a serious concern. I agree there. BTW, he also notes, somewhat mildly, that globally, leverage and higher asset prices caused the 2008 crisis and that they are both high now. Again, I agree.

Two weeks ago, I had written on the fundamentals behind Indian rupee weakness. They do point to a weaker and not a stronger currency. As long as the weakness is gradual and orderly, that is what the fundamentals dictate. No point in complaining about the mirror for the quality of its reflection. Get the reality right.

It is good to see MINT encouraging a student of economics from the Madras Christian College to write, by publishing his article. It is reasonably well written. The last paragraph stumped me, however. Also, the blurb chosen for the article is not the right one. That contradicts the message of the article as did the last paragraph.

Good story on why Australia banned Huawei from its 5G networks.

Ashok Gulati rightly takes the Commission on Agricultural Costs and Prices to task for tailoring its recommendations to suit the governing political party’s political priorities.

What to do to avoid a rupee ‘crash’?

A friend to whom I had sent this piece of mine on Rupee risks asked me as to what steps might help avoid a ‘crash’ in the Rupee. Such questions make us think if there is anything at all that governments and central banks can do to avoid such an outcome or it might be that the train had left the station? The truth could be a bit of both. The bulk of the conditions that presage a fairly large depreciation might already be in place but policymakers should, nonetheless, do a few things (if they are still possible) to mitigate the effect; to cushion the effects or to even moderate the depreciation. So, here goes:

(1) Very important to project confidence and calmness and avoid looking panicked. I am starting with this because, in these situations, that is arguably the most important aspect.

(2) Also, panic will force the government to take measures that would aggravate the situation. RBI’s decisions to increase the limits on foreign portfolio investors for government and corporate bonds and the relaxation on eligible external debt borrowers from India are examples of measaures that could be considered ‘panicky’.

(3) Avoid measures that would aggravate the fiscal deficit. For example, these would be reducing excise duties on petrol and diesel and not allowing oil companies to pass on prices. Both are wrong. One, the Government of India (GoI) needs the revenues badly. Two, if GoI has to keep the import bill under check, it has to pass on the higher prices and curtail demand growth.

(4) RBI should neither cut rates nor raise rates unless its inflation mandate is materially threatened. It must see through the oil price related inflation impact. Unless second round effects are important, it should ignore first order effects

(5) The Government should refrain from public advice or instruction to RBI on interest rates. It is lose-lose-lose. Loss for the Government – meddling image; loss for RBI – even its independent decision would be labelled ‘capitulation’ if it coincides with Government’s wishes; Loss for the economy because these two would drive rupee down.

(6) If the GoI can come up with some schemes to consolidate or reform PSU banks’ governance – even if they cannot privatise now – it would be a positive

(7) Any forward movement (or, a successful bidder announcement) on AIR INDIA privatisation will be a positive

(8) I do not know the details of the NSE law suit against SGX (Singapore Stock Exchange) but it is bad optics

(9) Similarly, SEBI diktat banning all Foreign Portfolio Investors (FPI) from participating in Indian capital markets if they were managed by people of Indian origin from buying into Indian market seems rather too drastic and excessive. It will curtail inflows when these are the ones who will have more patience, tolerance given their better understanding of India’s ground reality. If their goal is to avoid round-tripping of Indian money, they can impose more KYC requirements (even though they may be already quite comprehensive and tight) but banning FPI that are even remotely connected to Indians or people of Indian origin (even if they are now foreign nationals) for this reason is too drastic. They aggravate the situation with respect to capital inflows and increases pressure on the Rupee.

(10) I do not know the current situation but if they can completely remove or lift all restrictions on agricultural exports, it will be a good signal. But, may be, very few restrictions remain but they should let farmers cash in on export markets or domestic markets – wherever they get better prices. It is farmer-friendly and also rupee-friendly. If domestic urban consumers have to adjust their consumption, that is the price that has to be paid or a cost incurred.

Import(ant) angle to rupee weakness

When I was doing some research for my recent weekly column in MINT on whether a rupee depreciation would help India, I came across some important statistics on India’s imports. Indirectly, they once again reaffirm the limitations of India’s growth numbers ever since the new methodology and the new base year came into effect.

There are five categories of imports:

22. Machine tools
23. Machinery, electrical & non-electrical
24. Transport equipment
25. Project goods
26. Professional instrument, Optical goods, etc.

These are taken from Table 130 of the Handbook of Statistics of the Indian Economy from the website of the Reserve Bank of India.

The sum total of value of imports (USD million) under these five heads in each of the last five years have been

2011-12 2012-13 2013-14 2014-15 2015-16 2016-17
68204.9 66083.9 57606.2 56889.5 56873.4 58877.9

Of course, there has been a big fluctuation in the value of the Rupee versus the US dollar in this period. So, we may be spending more in rupee terms but the dollar price may not have changed much. In other words, the dollar value does reflect the fact that we may be importing less of them either because they are now more expensive in rupee terms or because the economy might not be doing well or both. In some sense, the recovery in economic growth rates since 2012-13 as per CSO figures is not borne out by these numbers.

In fact, the quantity index of imports under the category, ‘Machinery and Transport Equipment’ confirms the above observation:

India_Machinery and Transport Equipment Import

Source: Table 138 of the Handbook of Statisics on the Indian Economy, Reserve Bank of India.

The chart is as important as it is dramatic. Quantum of capital goods imports has dropped substantially even as their unit value has gone up substantially, presumably because of the rupee weakness.

So, the more rupee weakens, the less we import of these goods and, consequently, India adds less and less to its productive capacity and potential. So, paradoxically, we will be importing more of the goods that would be produced locally with these machinery, otherwise. So, rupee weakness will make us import less of what we need and more of what we would otherwise be producing internally!

That is why I wrote that we should be sure of what we want, lest we get it!

Some thoughts on EURUSD

In the past, when we look at the two episodes of strong U.S. dollar, it happened when the U.S. real interest rates were higher than elsewhere: 1982-85 and in 1995-2001.

Between 2003 and 2008, the dollar was weak when U.S. real rates were broadly lower than in the Eurozone.

Between 2009 and 2010, USD weakness resumed as U.S. reduced nominal rates to zero and real rates were negative, more negative than in the Eurozone.

Between 2010 and 2013, the EURUSD stayed broadly stable but the negative relationship with the USA-Euro real rates was maintained.

Between 2013 and 2016, US dollar was strong not so much because U.S. real rates went up but real rates in the Eurozone were much lower. In other words, the differential moved in favour of the U.S. and hence EURUSD weakened. Again, the negative correlation was maintained. But, the anomaly started in Dec. 2016. The two lines – red and blue are correlated positively!

See the two charts below. One is the long-term chart and the second chart is for the more recent period.

EURUSD - Chart 1

EURUSD - Chart 2

Even though Ms. Yellen has softened her interest rate increase talk, as he writes, the U.S. real rates have trended higher compared to the Eurozone. The Eurozone is nowhere near beginning to think about the matter.

Further, even Fed balance sheet reduction in the U.S. should see a tightening of rates.

So, to sum up, why is EURUSD moving higher even as the real rate differential is moving in favour of US dollar?

(1) Perception of competence, leadership and decisiveness strongly favours Eurozone political leadership than the American leadership, including the Congress.

(2) In political and policy leaderships in both the regions – America and the Eurozone  – there is no constituency that objects to the current trend in EURUSD.  Germany does not mind a stronger EURO. It has a current account surplus of 8.5% of GDP. It does not want to stimulate the economy by spending more. The economy does not need stimulus. It is growing nicely.  Germany hates to become fiscally profligate because of long-term fiscal sustainability. Any faster growth would stoke inflation concerns. Better to let the currency appreciate and it would also make the American President less critical of the exchange rate.

(3) Should the stock market crash in the U.S., and globally, there is a recession or slowdown combined with rising risk aversion, it usually makes the dollar stronger. But, we never know about the future. This time, clearly Yellen would turn around and go back to easing.  But, for the Eurozone, there will be no change in policy. So, therefore, at the margin, the policy would turn easier in the U.S. with no change in the Eurozone. That too is negative for the U.S. dollar.

[Important: this is not an investment recommendation. Just some loud thinking on the EURUSD exchange rate. Nothing more. ]

The Euro over the Gold Standard

I just chanced upon this piece two days ago. It is meant to be a provocative piece and not a defence of Gold Standard. If one could tolerate Euro and its institutional setting, why not tolerate a Gold Standard? That is the question he poses and answers and the question does not answer why Euro could be tolerated or should be tolerated. That argument is not made, looking at costs and benefits.

Telling someone to tolerate random shocks arising out of fluctuations in gold supply and production because they are tolerating random shocks or are forced to tolerate random shocks from member country situations in the Eurozone and the consequent monetary policy responses is not particularly helpful.

In the days of trillions of dollars of capital flows dwarfing trade flows, it makes no sense to motivate an argument based on trade considerations alone. Yes, floating exchange rates do not offer any protection against spillovers and sudden starts and stops of capital flows. But, that does not prove that fixed exchange rates are better. The logic is flawed.

Floating exchange rates may not help. But, fixed exchange rates most certainly don’t. See the difference? Gold Standard is most certainly an extreme version of fixing. To actualise it and make it work for the real economy, one needs to confront the demon of financial flows and, more generally, financialisation.

An example would help clarify things. A this very mature stage of the economic cycle and an even more advanced stage of the market cycle, the SEC has approved a passive ETF on NASDAQ leveraged four times for public distribution. Under these circumstances, no regime would work – fixed or floating or the Gold Standard.

That Matthew Klein is not serious about the Gold Standard is evident from his recourse to the ‘snake oil economics’ of Martin Sandbu. I stopped wasting time on reading that gentleman’s writings more than a year ago. One cannot resort to debt write-downs, as one would do a morning walk every day to stay fit and healthy. Nor is wage flexibility a solution these days, except in blogs. It never probably was a solution except for Britain in the Gold Standard era. That was a different period and the difference was not just about the Gold Standard.

Second, he disappoints with his standard, run-of-the-mill baseless assertion that Draghi saved the Euro and that Trichet almost buried it. Economists who know about policy lags, the impossibility of counterfactuals and the unintended consequences of policy decisions would not make such glib assertions. First, had Trichet used up all the monetary policy bullets, Draghi may not have had many bullets left to fire. Two, we do not know how history would play out and whether Draghi would be reviled or revered. It is still very early days. The lagged effects of ‘whatever it takes’ have not yet played out.

Further, Mr. Klein is surprisingly sloppy with facts. The monetary policy response to German reunification happened in the 1990s before the Euro and ECB were reality. That was the German Bundesbank. They were tight and that led to the two European Exchange Rate Mechanism (ERM) crises including the famous ejection of the pound sterling from the ERM. Indeed, only then, did the Euro project come alive from 1993 onwards.

But for the Bundesbank’s tight monetary policy battling German money supply increase and the temporarily higher inflation, the ERM fissures wold not have been exposed, speculators would not have targeted it, the European currencies would not have come out of their sub-optimal policy straitjacket and economic growth in continental Europe and the UK would not have resumed from around 1994 or 1995.

ECB in fact loosened monetary policy in 2001-02, notwithstanding that the Euro had just plumbed new lows in October 2000. European real short rates were below normal and below average up to 2004 or so. In fact, those were engineered for Germany that was hurting from the collapse of the technology bubble. Therefore, monetary conditions were too loose for Spain, Italy and Greece. Their real estate booms ensued and turned into bubbles later.

With those facts and chronology addressed, let us revert to his arguments on the Gold Standard.

My blog is named, ‘The Gold Standard’. One can appreciate my predilections here. But, even then, I would concede that the enabling conditions simply do not exist for considering the Gold Standard. What the world needs is something far less radical than that but still a very radical departure from the current central bank orthodoxy.

The world abandoned fixed exchange rates (Bretton Woods/Official Global Dollar Standard) in 1973. I has experimented with floating exchange rates and discretionary central banking. The data point in favour of ‘discretionary central banking’ (alternatively, against rule-based central banking) was one – the Great Depression. Now, forty-four years later, the costs have begun to exceed benefits vastly – in many ways – economic, political and social.

Discretionary central banking with unrestrained ability to create reserves providing the basis for unfettered money creation by commercial banks does not make for a stable system at all. Nor is it social welfare enhancing. The blind and empirically unverified faith in the transmission from asset prices to the real economy and the indifference to the distributional consequences of such a faith/belief need to be abandoned.

The onus lies with the Federal Reserve, the intellectual leader in global central banking and the Wall Street alumni who govern other central banks.

The world has walked too far down the path of discretionary monetary and financial recklessness to return to the Gold Standard. Some simple changes, as suggested above, would do for now.

(p.s: Matthew Klein has put up a brilliant post rebutting the arguments of Steve Rattner on U.S. tax cuts. Very well worth a read)