This could be very big and important

The Commerce Minister of India said that the government is actually not setting great store by a weak currency for driving exports. Wow! That is a big policy shift and a mindset shift.

I welcome it, in principle and cautiously.

I hope the move is borne out of conscious confidence and not complacent confidence.

Conscious confidence would address the underlying economic fundamentals that would justify, support and vindicate a strong currency.

Further, global capital flows tend to punish overvalued currencies too much. That is why Dani Rodrik advocates mildly undervalued currencies. Of course, it is not costless. Accumulating foreign exchange reserves is not costless. But, he reckons that it is less costly than being subject to the vicissitudes of global capital flows.

If one had stopped looking up to the exchange rate to bail exports out of inefficiency, then all the more reason to keep inflation under check and that means supply-side reforms and productivity improvement.

Fragmented production – in farms and factories – militate against efficient production. If anything, India’s land is getting more fragmented. That is what a report by the Ministry of Agriculture said. See this:

1.33 Increasing fragmentation of land holdings is a continuing cause for concern. Around 85 percent of the operational holdings in the country are small and marginal, i.e., that is holdings of less than 2 hectares each. Between 2000-01 and 2010-11, the number of marginal holdings increased from 75.41 million to 92.83 million, a rise of 23 per cent and number of small holdings increased from 22.70 million to 24.78 million (9 per cent rise).

By contrast, the medium holdings dropped by 3 per cent and large holdings by almost 11 per cent.

Semi-medium holdings increased by 0.7 per cent, while the number of medium holdings dropped by 3 per cent and the number of large holdings declined by almost 11 per cent.

In terms of the proportion of area under different sized holdings, small and marginal holdings in 2010-11 accounted for 44.6 per cent of the area, while semi-medium and medium holdings accounted for 44.8 per cent of the area and the remaining 10.6 per cent by the large holdings. This is indicative of the significant fragmentation of operational holdings in India.

Medium holdings are getting converted frequently into small and marginal holdings, and no signs of reversal can be seen in the foreseeable future.

It is estimated that the average size of land holding, which at present is 1.15 hectare, is likely to reduce further by 2020-21. [Link – pages 14-15]

The same is true of industries. In general, unregistered micro enterprises dominate the overall factory landscape. Registered enterprises are very small. Of that, medium to large enterprises are a tiny fraction.

Further, the government’s policy priorities in recent months is about distribution than about growing the pie.

Rupee strength induced by an ultra-careful central bank that is perhaps out to prove a point on its independence (in other words, keeping real rate high) and foreign hot money inflows should not be confused with fundamental strength of the economy.

So, I am not sure if the symphony on the strong currency is in sync. really.

Therefore, an in-principle and a cautious welcome.

Rebalancing the colour of the sky – China links

The 16 percent decline in hot-rolled coil prices over the past month, compared with a 7 percent decline in rebar, suggests that a reversal of that value proposition is underway. Instead of a robust private sector outspending the state, it looks like government cash is protecting the steel industry from a brutal slowdown in demand.

The stimulus from Beijing, however, is evidence that the country’s almost-forgotten ambition to rebalance away from investment and toward consumption is still a pipe dream. [Link]

Caixin notes that there were fewer days of blue skies in Beijing in the first quarter. that fits in with the story above and the story below. That means that smokestacks China is doing well and that rebalancing away from rebalancing.

FT reports:

Water-guzzling coal-conversion projects are springing to life in arid western China, setting the stage for the large-scale deployment of what was previously a niche industry. A three-year downturn in coal prices has revived projects that convert coal to motor fuel, petrochemical feedstock or gas, after many were shelved in 2008 because of concerns about water supply and pollution.

Projects that work in China’s state-dominated economy may not be practical elsewhere. Coal conversion has become profitable in China because of an unusual combination of low coal prices relative to state-set gas or petrol prices. Coal-to-liquids projects normally make economic sense only when oil prices are high or supply is limited. The technology was first developed in Nazi Germany, and commercialised in apartheid-era South Africa. [Link]

Natixis report on China’s first quarter trade data and GDP growth forecast for the first quarter also confirms that ‘old industries’ did well in the first quarter. No wonder, Beijing had few ‘blue sky’ days. That is a good barometer of China rebalancing or its absence.

I may have blogged on this earlier. But, it is worth repeating. The article ‘Alienation 101’ is about the life of Chinese students in the University of Iowa. American Universities, in search of incomes, had aggressively wooed overseas students, particularly Chinese. It has not gone down well. Indeed, try searching with the key words, ‘Iowa, China Students’ and you get some very interesting stories. This long article in the 1843 magazine of The Economist has a fascinating and yet chilling account of how China controls its students coming to study in the Universities in America and how it prepares to be the extended propaganda arms of the Communist Party and the Chinese government:

The Chinese students aren’t really disengaged, however. They are just immersed in a world that is largely invisible to the rest of the university. At its centre is the Chinese Students and Scholars Association (CSSA), funded and monitored by the consulate in Chicago. Its structure even mimics the Communist hierarchy, with a “propaganda department” and a tight circle of leaders tacitly approved by the consulate. It puts on four big events each year aimed almost exclusively at Chinese students, including a Lunar New Year gala marking the biggest holiday in China. Last November, Mingjian attended a CSSA “speed dating” show in which male students in tuxes declared their love for female students in flouncy dresses, with nearly 300 students egging them on. It was conducted entirely in Mandarin.

One of CSSA’s main purposes is to make students aware that Beijing is watching over them. A Communist Party directive last year exhorted members to “assemble the broad numbers of students abroad as a positive patriotic energy”. At Iowa, the effort starts even before the students leave China: at the university’s pre-orientation session in Shanghai last summer, student-information packets included a dvd produced by the Chinese consulate in Chicago called “Rules for Studying Abroad”. And in January, the CSSA posted on social media a Lunar New Year’s greeting from the Chinese students’ official minder, Chicago consul-general Hong Lei. “He is the idol of students in the United States!” the message went. “He is the pride of the Chinese people!”

The CSSA also stands ready to protest against any campus speaker deemed harmful to China’s interests. In February, the CSSA at the University of California, San Diego, blasted the university’s choice of commencement speaker, the Dalai Lama, whom Beijing considers a traitorous monk, saying in a letter that it was “awaiting the advice of the Consulate General.” Over the past few years, the Chinese government’s direct involvement in CSSAs has prompted two other universities, Columbia and Cambridge, to ban them temporarily.

While helping newcomers in from the airport, CSSA representatives welcome them with advice about settling in – and a reminder that their behaviour reflects on the entire Chinese nation. The students do not really need reminding, for their education at home has inculcated in them the virtues of, and importance of loyalty to, the Communist Party. Their own encounters with American students – whose views on China can be condescending, even hostile – tend to intensify their reflexive patriotism, even if, like Sophie, they choose to keep their opinions to themselves.

Outspoken patriotic fury tends to be reserved for fellow Chinese. Last October, after Professor Tang gave a talk about Beijing’s sensitivity to public opinion, he received an angry email from a Chinese student: “I’m so ashamed of you. You just bought into American propaganda against China. Where is your moral limit as a Chinese citizen?” Tang, who is now an American citizen, shakes his head. “This generation has been indoctrinated since day one.” [Link]

While I was searching for the above article, I ran into a five-part Reuters story on the tactics and methods that foreign students, particularly Chinese, employ to gain admission into American Universities. I just saw and read the third part. Links to other parts are available in the article. The ‘competition’ that hard working and sincere students are up against is frightening. The obsession to succeed at all costs and against all norms is not normal. It is a pathological obsession – a mental condition.

Benn Steil has some good charts on the Renminbi strength or the lack thereof. He says that RMB internationalisation has stopped. He is right. Chris Balding thinks that the analysis is flawed. I am not sure. Renminbi has stopped internationalising because the Chinese government is simultaneously exerting controls on exchange rate outflows and has also placed restrictions on foreigners’ repatriation! Benn Steil acknowledges that.

Brad Setser’s ‘Follow the Money’ blog is worth following. He is tracking China macro data and external data with clinical efficiency as he used to do before. He is a great resource. He has shown why it might be difficult to label China a currency manipulator now. He shows the periods in which it would have been appropriate to do so. That was mostly between 2005 and 2012. Both Bush and Obama were asleep at the wheel, then.

This sarcasm of his in the end, is well deserved (by China). Well, they had earned it!:

I also have great confidence in the ability of China’s authorities to engineer official outflows that would substitute (he means, ‘compensate’) for reserve growth should China start buying foreign exchange in the market. I consequently doubt that China will ever trigger the 2% of GDP in reserve growth threshold. But that is a topic for another time.

In another post, he has expressed scepticism on China’s current account balance having come down drastically in the last one year. Interestingly, current account balance is one of the parameters tracked under the IMF Exchange Rate surveillance and US Treasury’s Enhanced Enforcement Monitoring.

Lingling Wei’s long-form article in the Wall Street Journal is an important read. It shows the impossible set of foreign exchange goals that China is pursuing. Some predict – as I think – that China would let go off exchange rate stability in return for financial stability. We do not know when the tipping point arrives. China has been skilfully plugging the leaks in the dyke with band-aids, for several years now. It will be silly to venture and put a timeline on it.

China is tightening interest rates because the Federal Reserve is doing it. But, President Trump may have just gotten them out of jail on that one. See my MINT column on Tuesday (18.4) on that one.

Barrick Gold, the world’s largest producer of the precious metal, has agreed to sell a 50 per cent stake in one of its biggest mines to a state-backed Chinese company. [Link].

China tightens grip on football in Italy. A Chinese consortium has bought Berlusconi controlled football club AC Milan. Chris Balding calls it the purchase of a ‘money losing asset’ and that China is taking its economic model global!

Finally, two Martin Wolf pieces on China. One is about the impossibility of China escaping the debt trap and the second is about Chinese financial system storing up trouble for the rest of the world. Both are not new and nothing much that is not known has been said in these articles. China is ‘too big to fail’ in the eyes of the United States. North Korea is a physical security threat and China is a economic security threat.

The U.S. has no clear way – not that many have better answers – of handling both. It is buying time and appeasing and threatening alternately. The United States too has lost its ability to take them on and face the consequences. Its economy too is too weak and indebted. I guess this implosion or combined mutual assured destruction of China and American economies will happen when we least expect it to.

Market Commentary – Nov. 2016

What began as a nerve-wracking month for stock market bulls ended up as one for the bears. The U.S. election went against consensus expectation. Mr. Trump became President-elect. Again, contrary to expectations, stocks began to rally, anticipating corporate tax cuts, repatriation of corporate cash from overseas, stock buybacks, boost to Earnings Per Share (EPS), higher interest rates and a stronger dollar.  Gold was the biggest loser in the bargain. It gave up nearly 9% in the month. An agreement among OPEC countries to cut crude oil production boosted crude oil price. WTI crude was up 6% in the month. Therefore, commodities in general gained 2.8%.

Total returns from S&P 500 for the month was 4.4%. Emerging markets paid a price for the return of optimism about the United States. MSCI-EM dropped 4.3%. Among emerging markets, India fared the worst as, on the same day of U.S. elections, India decided to withdraw high denomination notes from circulation with immediate effect. MSCI India lost 7.8%. Political uncertainty returned to Brazil and it dropped nearly 7%. China lost 1.8% and Russia stood out with a gain of little under 4%.

Like EM stocks, EM bonds ended up on the losing side. JP Morgan Emerging Market Bond index lost nearly 4%. Developed country bonds were also big losers. US Treasuries (above 1 year remaining maturity) were down 3.5% and Eurozone government bonds were down 5.2%. All figures are on total return basis and in US dollars.

It will be tough to sustain the global and U.S. reflation trade too long into the New Year, if interest rates climb steadily.

[Please note that this is not an investment newsletter or advice of any sort. Usual caveats apply]

Worrisome developments

These are written more from the perspective of a financial market observer/participant.

I think that the world is becoming infinitely more complex and challenging to deal with. Almost a month after the Trump election victory, the other side has not reconciled. Recount has commenced in Michigan. Three more States could also head for recount. We do not know what is in store. This story has some update on the recount.

In the meantime, the U.S. House of Representatives has passed two resolutions: One is to control the so-called fake news outlets including Zerohedge and Naked Capitalism. The second resolution is on sanctions in Syria. The resolution on Syria seeks to impose a non-fly zone! It can lead to grave consequences, even if unintended. A lameduck House has passed these two resolutions.

‘Washington Post ‘ has pitchforked itself into the campaign to ban the so-called ‘fake news’ sites. It is both a commercial move and a move to stifle alternate voices. It is unbelievable that it is happening in America, when all the mainstream media channels lined up on one side in the Presidential elections. Yves Smith of ‘Naked Capitalism’ had sent a legal notice to ‘Washington Post’. See here, here and here.

A Republican elector had written an op.-ed. in NYT as to why he won’t be voting for Trump. Jan. 20th is  long way off. It appears that a lot can happen there. The United States is not headed in the right direction.

In Europe, we had a very bizarre reaction to the resounding defeat of the referendum in Italy: Euro and European stocks rallied. The only rational explanation I can think of for this is that policymakers have acted to prevent the market from reacting normally to the news. It is not possible that the referendum was actually bullish for Euro assets and Eurozone stocks.

Gold sold off in the weeks after Trump election because the U.S. dollar rallied. Now, gold has been sold because the U.S. dollar is weakening! What is happening is mind-blowing and deeply worrisome.

This post at ‘Zerohedge’ with numerous charts captures the bizarre market reaction very well.

This reaction is a classic:

…[Apparently] the pattern of fading a potential crisis and then scrambling to cover and get long when everyone takes a breath and realizes that this time is not the apocalypse either still holds more than ever. I can’t justify any of this. The lesson investors and traders are getting is that everything is a buying opportunity and you need to not miss the boat. Brexit? Bullish. Trump winning the election? Bullish. Italy saying no to the referendum and the Prime Minister handing in his resignation? Bullish. Heck, all we need is a coup d’etat in India and the entire Belgian banking system to go kablooey and the S&P 500 will be at 3,000 by Christmas Eve. [Link]

The only possible explanation for the utterly bizarre reaction is massive manipulation. But, the question is what to do about it.

It is all coming unhinged. The apparent signs of extreme madness – manifesting in many areas – are precursors to the deluge that inevitably and invariably follows.

Somethings do not add up

Doug Noland writes in his weekly credit bubble bulletin as follows:

Let’s return to election late-night. I doubt traders and the more sophisticated market operators will easily forget what almost transpired. It’s worth noting that while S&P500 futures and the Mexican peso were collapsing, the Japanese yen was in melt-up. In just over two hours, the dollar/yen moved from 105.47 to 101.22 – an almost 4% move. Meanwhile, EM and higher-yielding currencies were under intense selling pressure – the Brazilian real, South African rand, Turkish lira, Colombian peso, Australian dollar and New Zealand dollar (to name a few). At the same time, gold surged from $1,270 to $1,338. Crude sank 4%. Global markets were on the brink of a serious speculative de-leveraging episode. [Link]

Gold has sunk to USD1229 in the spot market by close of Friday. Japanese yen is back at 106.685. Stocks made new highs and held on to them on Friday. But, at the same time, EM stocks, currencies and bonds are hurting. Risk aversion is partial. U.S. stocks and dollar are exempt. So, there is a portfolio reallocation from EM assets, US bonds and gold to US stocks. I am not convinced it makes sense.

A new target

Now that the FT feels sufficiently reassured that it has ensured a win for its favourite candidate in the US Presidential elections, it has chosen its next target: Theresa May.

In two forex related stories, FT journalists have decided that the crash of the pound sterling is a warning to Theresa May and that she would back down. Sample these:

The rand and sterling. One is a beaten-up, illiquid currency, bumped around daily by chaotic politics but with the potential to force national leaders to rethink tough stances. The other is the national currency of South Africa.

Sterling has fallen by about 24 per cent against the rand so far this year, despite South African debt teetering close to junk status with the key rating agencies. [Link]
Then, John Authers speculates that the UK government would back down:
The sharp sell-off in sterling in many ways represents a challenge by the forex markets to the UK government; it is possible that the government will back down.[Link]
Because the pound sterling appears to be falling into a bottomless pit, it has become the most important market judgement for FT. The stock market in the UK has been making new highs, until very recently. Even after Theresa May’s speech. It was unfazed by Brexit.
It is too early to say if Britain or EU will have the last laugh or none will. We know that markets have gotten and do get a lot of things spectacularly wrong. Many bubbles are still floating even now.

Why,the same ‘market’ until a day or two ago, pushed up UK stocks to record highs! Suddenly, the stock market is less important than the currency market! I suppose it does not fit a preconceived narrative that the newspaper wants to put out.

Politicians may and do get it wrong but markets get it wrong more often and cause more damage. Indeed, whatever is happening now is, due in large measure, to what the market did and market participants did before and after 2008.

So, to elevate the market judgement to that of a wise oracle and hoist the British government on a petard is both laughable and vacuous.
Elites and their cheerleaders are consistently failing to do the one thing that would give them the moral right to call out politicians and their populist solutions. That is to issue a mea culpa and back it up with actions that address inequality – voluntary surrender of tax and other privileges that they have coaxed out of willing politicians over the last quarter century – and other real grievances. Until that happens, neutral observers like Yours truly would be tempted to and would side with the popular and political backlash.
That may not set matters right but that would be in the fairness of things.

Switzerland restores sanity

http://www.livemint.com/Opinion/j00Da2NRakrh8bjqVUjQfO/Switzerland-restores-sanity.html

MINT (FIRST PUBLISHED: MON, JAN 19 2015. 02 58 PM IST)

Switzerland restores sanity

(V. Anantha Nageswaran)

As I was driving to my class on Thursday evening here in Singapore, I got two short messages from a broker about EURCHF dropping to 0.85 and then recovering to around parity. I was convinced that both were wrong messages or typos. I casually mentioned it to my students who confirmed that they were not mistakes but that the Swiss National Bank (SNB) had removed the cap it had set on the Swiss franc against the euro some three years ago.

As I write this, the EURCHF exchange rate is trading around parity. I was in Zurich for four days after four years in the week before the SNB pulled the plug on their policy of capping the Swiss franc against the euro. I was rather shocked to note that the central bank’s balance sheet was around 80% of gross domestic product (GDP) and that property prices in Zurich were outrageously high. It was regrettable that the guardians of the once mighty and “hard” Swiss franc did not hesitate to make it yet another paper currency—currencies whose managers routinely spawn asset bubbles and crashes.

I am glad that the SNB “heard” my lament and moved to “fix” the problem. Of all the breast-beating, hand wringing and waving that followed the move, unsurprisingly, the comment by Nobel Laureate Paul Krugman takes the cake: “So, let us learn from the Swiss. They’ve been careful; they have maintained sound money for generations. And now they are paying the price.”. Krugman does not mind leaving his readers with the impression that the Swiss have finally met with their comeuppance for having followed a “sound money” policy. Bizarre. Economists should not be surprised if their standing with the rest of the world continues to diminish.

The second prize for the most egregious reaction to the SNB-move came from Christine Lagarde, the managing director of the International Monetary Fund (IMF). She was not happy that the Swiss did not either consult or inform IMF of its decision. I do not know if SNB consulted with IMF before instituting a cap and, if not, whether the Fund minded it. In other words, we would like to know if consultation is insisted upon only if countries deviated from the Fund’s book of policy prescriptions. Actually, IMF should be grateful to SNB. By removing the cap on the Swiss franc against the euro, SNB has allowed the euro to depreciate. A weak euro may or may not help the sclerotic European economy. But, it is worth a try.

The fact that the euro fell significantly after the move is a clear sign that, all these years, SNB had prevented the euro from finding its natural floor with its intervention. Lagarde and euro zone leaders should be grateful to SNB for having given a higher chance for the world’s largest economic area to grow again. For Swiss exporters too, no amount of price discounting will help them sell their wares or ski slopes to Europeans, if they have no income. It is better to have a recovering Europe and a strong Swiss franc than a weak Swiss franc and a stagnant euro zone economy.

For investors, the SNB decision expands the choice of currencies to diversify into. Investors are tired of looking for a currency whose central bank is not actively debasing it. There are not many around, these days. One should not count the dollar in the list of sound currencies. The impending monetary normalization in the US will turn out to be all sound and fury, signifying nothing. Consensus opinion on the US economic expansion is as excessively optimistic as it is excessively sanguine about the economic slowdown in China.

The comment by one major Swiss wealth manager that it expected its clients to abandon the Swiss franc and diversify into dollars after the SNB decision was comical as it stood economic logic on its head. For the financial market types who are howling and growling that SNB sprang a surprise on them, this columnist has no words of consolation. Policy surprise is a legitimate tool in a central bank’s tool-kit. Policy transparency helped none but speculators and trading desks in financial institutions. It is a cleverly disguised (pun intended) subsidy for the financial sector. It is good that a central bank has asserted its independence, not just with respect to politicians but with respect to financial institutions and financial market participants. Arguably, the latter had been more successful than politicians in keeping central banking in chains.

Finally, for those who argue that Switzerland has been made worse off in every possible way by this decision, here is a question: how would SNB ever make good on its holding of euro-denominated, overpriced euro zone sovereign bonds if the euro zone broke up?

We have just learnt that India’s Raghuram Rajan has been voted the best central banker for the year 2014. The award for 2015 should go to Thomas Jordan of the Swiss National Bank for reminding central bankers around the world that their core obligation is to preserve sound money and not write Put options on stock markets.