Same old, same old

From Gavyn Davies’ blog on July 9:

The main impetus for the sudden rise in the growth rate in the AEs [Advanced Economies] in the past 18 months has probably come from the demand side of the global economy. Both fiscal and monetary policy have been accommodative in 2016-17, and financial conditions have been very supportive of demand, even in the US where the Federal Reserve has been raising short term interest rates. [Link]

After six years of pulling on a string, some reaction from the demand side coming from financial conditions turning looser. This does not presage a sustained supply-side response.  It is unsustainable and unbalanced.  Needless to add, unhealthy, too. Policymakers do not appear to have absorbed the lessons of the pre-2008 boom. What about analysts and economists?

Not much to show, I am afraid. The inability of Martin Sandbu to learn from history – recent or distant – and his extraordinarily consistent record of ignoring empirical evidence, marks him out as a quintessential modern economist.

Apparently, Claudio Borio of BIS and the latest BIS annual report (released on June 25, 2017) talk of an extended financial cycle that central banks must respond to. I am yet to read the BIS Annual Report. But, not surprising, coming from BIS. This blogger is aligned with that. But, the Federal Reserve and the European Central Bank are ignoring that warning. As before. Yellen’s testimony on July 12 was inexplicable, to this blogger. My column in MINT tomorrow has a slightly more detailed take on that.

Same old, same old stuff from central banks but the next crisis may not be same old, same old.


Millennials and the hard Left

I came across this interesting article in my mailbox (ht: Vaidy).  It talks about how voters in the age group of 18-24 favour hard Left candidates. That is not quite ‘Millennials’. But, the short-hand works for expository convenience.

It was the case with Bernie Sanders in the American Presidential elections, with Jean-Luc Mélenchon in the French Presidential polls last month and with James Corbyn, now in the UK elections due on June 8. They have made the race a lot tighter than it appeared in April.

There was one sentence that I could not quite understand:

As the world is going against a concrete wall of debt, the youngsters may think accelerating one more time could work.

Was the writer being ‘tongue-in-cheek’? Perhaps. That remains a big risk with hard Left policies.

The young just do not want the Left but the hard Left. That is a bit  worrying because Theresa May’s Conservative Party is not Margaret Thatcher’s Conservative Party. Her speech at the Party Annual Conference in 2016 was a watershed moment. I wrote a column in MINT on it in October last year.

Coincidentally, only last morning, I had finished reading Kenneth Arrow’s ‘A cautious case for Socialism’, a speech delivered at Columbia University in 1978. Yes, Kenneth Arrow!

While he was not sure if democracy and socialism could co-exist, he said the following about democracy and capitalism:

In a capitalist society, economic power is very unequally distributed, and hence democratic government is inevitably something of a sham. In a sense, the maintained ideal of democracy makes matters worse, for it adds the tensions of hypocrisy to the inequality of power.”

Even more breathtakingly, he said that it was near impossible to have prices for all State-Contingent situations in future because the market for uncertainty was not developed. In other words, he was prepared to throw a big pail of water on his groundbreaking work with Debreu on the allocative efficiency of a competitive market equilibrium.

In practice, it simply did not exist. In that sense, perhaps, we had misinterpreted their work, all along!

I recall my professor in the Grad School at UMASS Amherst back in the 1990s telling us that Modigliani and Miller, they did not set out to prove that capital structure was irrelevant. By showing that it was irrelevant only under extreme assumptions that did not prevail in reality, they actually proved that capital structure mattered. It had stuck with me ever since.

In a way, Arrow and Debrew were doing the same thing. Only by knowing all future States, the state contingent claims and if a market existed that priced all State contingent claims, could the allocative efficiency achieved by a competitive market economy be superior – without scarcity or surplus – to that of a planned economy.

Since those conditions are never met, the case for the superior allocative efficiency of a competitive market economy was never established! Professor Arrow was actually admitting to that in that speech!

The central argument, which implies the efficiency of a competitive economic system, presupposes that all relevant goods are available at prices that are the same for all participants and that supplies and demands of all goods balance. Now virtually all economic decisions have implications for supplies and demands on future markets. The concept of capital, the very root of the term “capitalism,” refers to the setting-aside of resources for use in future production and sale. Hence, goods to be produced in the future are effectively economic commodities today. For efficient resource allocation, the prices of future goods should be known today. But they are not. Markets for current goods exist and enable a certain coherence between supply and demand there. But very few such markets exist for delivery of goods in the future. Hence, plans made by different agents may be based on inconsistent assumptions about the future. Investment plans may be excessive or inadequate to meet future demands or to employ the future labor force.

The nonexistence of future markets is no doubt linked to uncertainty about the future. But this points to an even more severe shortcoming of the actual capitalist system compared with an ideally efficient economic system. The uncertainties themselves are relevant commodities and should be priced in such an economy. Only a handful of insurance policies and, to a limited extent, the stock market serve to meet the need for an efficient allocation of risk-bearing.

In the ideal theory of the competitive economy, market-clearing prices serve as the communication links that bring into coherence the widely dispersed knowledge about the needs and production possibilities of the members of the economy. In the absence of suitable markets, other coordinating and communicating mechanisms are needed for efficiency. These come close to defining the socialist economy, although admittedly wide variations in the meaning of that expression are possible.

Of course, I would admit to a few caveats. He was speaking in 1978, at the height of the period of economic turbulence in the West – wars, oil shortage, stagflation, etc. The weaknesses of the Soviet economy had not been exposed yet (sub-caveat: to a large extent, the Soviet economy was undone by a combination of arms race with America in the Eighties combined with the collapse of the price of oil in the same decade).

Further, many state-contingent financial products were developed in the Eighties and Nineties. But, of course, they did zilch to the allocative efficiency of the economies nor did it prove that financial markets knew how to price uncertainty. To date, the answer is an emphatic NO. Financial markets know next to nothing about how to price risk, let alone uncertainty.

So, who is to say that the hard-Left policy agenda – Sanders, Corbyn, Mélenchon – would be worse, in economic terms? I feel certain about lesser and lesser things these days.

Where the Hard Left worries me is with their their conflation of secularism and appeasement of hardcore Islamists. They are very likely wrong on that one and that would be disastrous for the rest of the society and the country. What has been happening in Britain in the last few months is, perhaps, a culmination or lagged effects of misguided policies of the last several years or even decades. But, that is a separate topic.

[Postscript: I just read two tributes to Kenneth Arrow who passed away few months ago. I liked this one a lot better than this one. But, both do not mention the speech I mention here. Pity. He was teaching a class even at 94. Incredible.]

Trump, Disney and the weather

Walt Disney’s Robert Iger has threatened to resign from the President’s Council of Advisors after President Trump decided to walk out of the Paris Climate Change Accord. I recalled this interesting factoid about Walt Disney Co.,

This past march, Walt Disney Co. settled a claim by the Department of Labor that it had violated the law by deducting the cost of uniforms from employees’ wages—which brought the workers’ pay below the federal minimum wage. The violations, which occurred at Disney facilities in Florida over the past few years, didn’t add up to a lot of money. Disney will pay back wages of $3.8 million to 16,000 workers (about $230 per employee). What made the story galling is that the entire expense is roughly in line with what Robert Iger, Disney’s CEO, earns in a single month. Last year Iger netted $44 million. [Link]

Of course, the CEO of the company that does God’s work has also threatened to leave the Council. Quite.

BTW, did you know that

European countries that pursued aggressive reductions were engaging in economic masochism. According to a 2014 Manhattan Institute study, the average cost of residential electricity in 2012 was 12 cents per kilowatt hour in the U.S. but an average 26 cents in the European Union and 35 cents in Germany. The average price of electricity in the EU soared 55% from 2005 to 2013.

Yet Germany’s emissions have increased in the last two years as more coal is burned to compensate for reduced nuclear energy and unreliable solar and wind power. Last year coal made up 40% of Germany’s power generation compared to 30% for renewables, while state subsidies to stabilize the electric grid have grown five-fold since 2012. [Link]

STCMA – 4.6.2017

A long article analysing various scenarios as to how demand for crude oil would evolve. All of them point to the downside from the projected demand. Well written article. Easy to follow.

A very good story on China’ ghost collaterals. Everyone fakes sincerity and everything is normal. It is one big illusion.The IFC comment that it was an isolated case is pure delight.

Millennials and home ownership in America. A distant dream. With their savings, they can afford dogs, though.

A German law professor wants Germany not to have any association with ECB’s Quantitative Easing programme any more. It is scheduled to run up to 2018.

More robots; fewer jobs – the workers appear screwed either way, robots or no robots. Post-2008, it was supposed to be different. Or so we thought.

Yuval Harari paints it stark: ‘​​Are we about to witness the most unequal societies in history?’

Rural America is the new inner city. Poignant reading.

Shankkar Aiyar on the riveting and unending saga of 100 worst districts in India. Riveting, if depressing reading.

Father of nepotism

Raised as I was in Italy , I know a few things about nepotism . In its origins , the term is a euphemism : historically , the “ nephews ” receiving favors were in fact natural children of a pope ( Alexander VI ) , who — being a Catholic pope — was not supposed to have children.

Source: Zingales, Luigi. A Capitalism for the People: Recapturing the Lost Genius of American Prosperity (p. 40). Basic Books. Kindle Edition.

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)

Twilight – continued

The article by Christopher Caldwell (see my earlier post, ‘Twilight’) had set me thinking. I sent the following email to my friend Niranjan who had forwarded the article to me:

Made for a thoroughly scary, disturbing and engrossing reading!

I am really surprised that the world has not imploded. That is the good news. The bad news is that it is still to be played out. It is coming.

I really doubt if any of us have answers to stop the Doomsday Clock from moving towards midnight. The clock will strike 12. IT is a matter of time.

Another friend who read the piece concurred on my assessment of the article and engaged in an email discussion on some of the issues such as hostility to outsiders (identity as the market, as he put it) as a consequence of economic hardship faced by the locals.

This was my response to him:

Identity is part of the mix, no doubt. But, it is part of the capital over labour imbalance that started with the collapse of the Bretton Woods in 1973. Monetary ‘rules of the game’ were abandoned. ‘Growth at all costs’ became the policy goal. Central banks’ discretionary money and the liberal use of debt contributed to economic growth, relentless rise in asset prices. Those who have assets benefited. Those who did not, simply became more indebted. Then, this ‘growth at all costs’ meant globalisation.

That was the second leg – or the second pillar of ‘growth at all costs’ – of the 1970s regime change in both purpose and paths. Globalisation meant offshoring and outsourcing plus immigration. It helped countries like India and, in a far bigger way, China. Both are mostly the stories of the new millennium: Y2K and China’s WTO entry were signature launchpad of the western malaise.

The third leg is the Western hubris induced political regime change in the Middle East that has brought waves of immigration – especially that of Muslims. The fourth leg of this is Islam itself with its ‘they are with me or they are against me’ binary attitude towards the rest of the world and the various acts of terrorism committed by terrorists.

The fourth leg has been greatly amplified by the wave of political correctness that is sweeping through Western societies – I wonder if I can trace the genesis and the driving spirit of it – is it guilt or is it fear or both or is there something else?

My logic above takes me in the direction of fixing the ‘root cause’ – going back to the old monetary rules of the game that would, in turn, reverse the other legs – particularly economic inequality.  Company leaders and, more generally, businesses would go back to doing genuine product and process innovations rather than gaming stock prices and their compensation through labour retrenchment and squeezing out labour compensation. If they do, loyalty and motivation might return boosting productivity and employment. A virtuous circle could set in and, who knows, it could starve terrorist organisations of recruits. May be, I am being too optimistic.

There was one crucial difference about the post-World War II period that lasted up to the early Seventies. Economic growth was easier to come by, because it was catch-up growth, reconstruction and rebuilding and all of that. Demographics were favourable in the West. Climate change was not a factor that militated against the burning of coal and other hydrocarbons, etc.

So, will merely restoring the ‘monetary rules of the game’ help? Well, perhaps not. But, we can only change things that we can influence and change. What else can we do? That might work. After all, the law of unintended consequences can work in a virtuous way too.