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.

The twilight

They also give an explanation for the rise of the National Front that goes beyond the usual imputation of stupidity or bigotry to its voters.

When France’s was a national economy, its median workers were well compensated and well protected from illness, age, and other vicissitudes. In a knowledge economy, these workers have largely been exiled from the places where the economy still functions. They have been replaced by immigrants.

Paris’s future seems visible in contemporary London. Between 2001 and 2011, the population of white Londoners fell by 600,000, even as the city grew by 1 million people: from 58 percent white British at the turn of the century, London is currently 45 percent white.

In Paris and other cities of Guilluy’s fortunate France, one often encounters an appearance of civility, even consensus, where once there was class conflict. But this is an illusion: one side has been driven from the field.

Never have conditions been more favorable for deluding a class of fortunate people into thinking that they owe their privilege to being nicer, or smarter, or more honest, than everyone else. Why would they think otherwise? They never meet anyone who disagrees with them. The immigrants with whom the creatives share the city are dazzlingly different, exotic, even frightening, but on the central question of our time—whether the global economic system is working or failing—they see eye to eye.

Three years after finishing their studies, three-quarters of French university graduates are living on their own; by contrast, three-quarters of their contemporaries without university degrees still live with their parents. And they’re dying early. In January 2016, the national statistical institute Insée announced that life expectancy had fallen for both sexes in France for the first time since World War II, and it’s the native French working class that is likely driving the decline. In fact, the French outsiders are looking a lot like the poor Americans Charles Murray described in Coming Apart, failing not just in income and longevity but also in family formation, mental health, and education. Their political alienation is striking. Fewer than 2 percent of legislators in France’s National Assembly today come from the working class, as opposed to 20 percent just after World War II.

The real divide is no longer between the “Right” and the “Left” but between the metropoles and the peripheries. The traditional parties thrive in the former. The National Front (FN) is the party of the outside.

Hollande government’s legalization of gay marriage, which in 2013 and 2014 brought millions of protesters opposing the measure onto the streets of Paris—the largest demonstrations in the country since World War II.

France’s antiracist Pleven law, which can punish speech, passed in 1972. In 1990, the Gayssot law criminalized denial or “minimization” of the Holocaust and repealed parts of France’s Law of July 29, 1881, on Freedom of the Press. Both laws are landmarks in Europe’s retreat from defending free speech. Suits against novelists, philosophers, and historians have proliferated.

Nobody wants to be thought a bigot if the membership board of the country club takes pride in its multiculturalism. But as the prospect of rising in the world is hampered or extinguished, the inducements to ideological conformism weaken. Dissent appears. Political correctness grows more draconian. Finally the ruling class reaches a dangerous stage, in which it begins to lose not only its legitimacy but also a sense of what its legitimacy rested on in the first place.

These are the extracts from the brilliant review-essay by Christopher Caldwell of the books by Christophe Guilluy written in French with the latest being Le crépuscule de la France d’en haut (roughly: “The Twilight of the French Elite”) – ht Niranjan Rajadhyaksha. The full essay – a MUST READ, in my view – is here.

Read Andrew Sullivan’s piece on what Macron means. He too refers to the Caldwell essay.

 

French Presidential elections

The combined vote share of Marine Le Pen and Jean Luc Melenchon was around 41.0% (21.4% for Le Pen and 19.6% for Melenchon). The combined vote share of Macron and Fillon was 43.7% (23.8% for Macron and 19.9% for Filon). Macron and Le Pen are through to the second round.

The Communist Melenchon also polled nearly 20% of the vote. Between Le Pen and Melenchon, 41% of those who cast their  votes were voting for some sort of redistribution policies and away from the European Union.

Macron, if he wins as he is widely expected to, will find the going tough. That is why he is talking of strengthening Europe’s collective borders. It is a safe bet that, one year from now, there would be a feeling of disillusionment and malaise in France.

Much of the current euphoria surrounding an economic recovery in Europe is due to the European Central Bank’s loose monetary policy that has vastly overstayed its welcome. Financial conditions are too loose in the Eurozone. They can only get tighter.

Slow-motion trainwreck

Greece is back in the news with disinformation and noise beginning to swirl.

Game of brinkmanship between IMF and Germany with Greece as the ball to be tossed around.

This is also a case of slow motion train-wreck. No one notices them unless the approaching noise and the headlights are too close for comfort. By then, either it is too late or that the escape action is too costly and leaves no one happier.

More importantly, a band-aid is applied as there is no time for a comprehensive solution. The problem again is then kicked down the road.

This is human nature.

The future of the Euro and the Yuan

Three days of ‘dawn to desk’ (and longer) deliberations with a company (I am on their Board of Directors) in Singapore have left me feeling like I have to scramble this weekend to catch up. Not that I have forgotten any pending deadline. But, still….

A good friend sent me this link. This is an article from October of last year. A distinguished Italian academic tears into the Eurozone and wants Italy to leave the Eurozone.

Perhaps, it makes sense to read this article, right after that. Martin Schulz is the chosen challenger by Social Democrats against Angela Merkel. The article notes that his candidature makes things interesting in the race. I believe, going by law of averages and historical precedence from other nations, Ms. Merkel will lose decisively. Not to mention how Germans feel about the immigration challenge from accepting too many refugees in too short a time. Mainstream media has not made us any wiser and better informed on that. Not that it has on other matters.

Ashley Tellis has an article on Indo-American relations in the NBR Round-Table on US-Asia relations at a time of transition. Have not read it yet.

Christine Fair has a report on Pakistan’s strategic culture (Dec. 2016) for the National Bureau of Asian Research. Yet to read it.

This piece by David Dollar on China’s currency management challenges is a good read for a superficial understanding of the problem.

Michael Pettis’ review article from Jan. 6 of a long FT article on China’s economic prospects. I have not read the original yet but have read Michael Pettis’ article. Worth a read. Whether China is getting its debt under control or not (it is not) is evident from the growth numbers of Total Social Financing for 2016. Goldman Sachs think that the official reported growth rate of total credit understates the true number. It puts the true growth number at 20% per annum.

This is an important article on the Dodd-Frank financial sector regulation being rolled back under President Trump. I was concerned about it. I have always held that regulation of the financial sector is different from the real economy. The latter requires a lighter tough than the former. The former is inherently unstable and is pro-cyclical. Hence, regulation needed. I was concerned that Trump was going to dismantle it. Not quite, says the article. I am happy.

Art Cashin finds the U.S. stock market rally discomforting. I feel more strongly than that.