Monstrous non-sense

Martin Sandbu, I think, outdoes himself in his latest column. He says that central banks were not loose enough in the years following the crisis as, even after the latest Trump tax cut stimulus in the US, inflation rates are not picking up and therefore, spare capacity was much higher. If only central banks had been bolder, the negative output gap would have closed much earlier!

The certitude here is indeed breathtaking. It took my breath away for a minute. I just did not know where to begin.

The simple truth is that monetary policy has been completely orthogonal to the real economy developments after the crisis. The economies of America and Europe have recovered on their own because monetary policy has been so loose for so long that such a belated recovery cannot be attributed to policy effectiveness.

It is wrong to argue that central banks had not done enough. By April 2010, the S&P 500 had nearly doubled (up 81%) from its low in February 2009. The 10-year bond yield had crashed from 4.0% to 2.0%. Everytime it threatened to rise above 4.0%, the Federal Reserve did QE2 and QE3. It did not raise rates in 2014. In 2015 and in 2016, it raised rates by 25 basis points each – 0.5% in total in two years! Mr. Sandbu thinks that they were not bold enough?!

Monetary policy operates through financial market variables. Where was the wealth effect from these reactions in bond yields and in the stock market? Nothing.

Had the Federal Reserve been more reckless, it would have sent financial assets to even greater heights but to what effect on the real economy?

It would have only widened the inequality and the angst among the middle and lower classes. Hasn’t he seen the UK Housing Affordability Index released by the Office for National Statistics for 2017?

On average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, a significant increase of 2.4% since 2016.

Workplace-based housing affordability significantly worsened in England between 2016 and 2017, but there were no significant changes in Wales.

Housing affordability has worsened significantly in 69 local authorities in England and Wales over the last five years, with over three-quarters of these being in London, the South East and the East.

All but five London boroughs had significant worsening of affordability since 2012.

House prices and earnings increased in all English regions and Wales, but the two regions with the largest increase in house prices (the East (10%) and the South East (6.9%)), were the two regions with the significant differences over the year. This suggests that house prices are driving the significant worsening in affordability.

The affordability ratio has more than doubled for every property type in England from 1997 to 2017. [Link]

Right after the Brexit vote, the Bank of England had taken out a pre-emptive monetary policy accommodation insurance on top of the ultra-loose monetary policy that prevailed. Yet, Mr. Sandbu thinks that policy wast not loose enough!

Given continuously worsening affordability caused by asset price increases which are a consequence of monetary policy, does he reckon with the social and economic costs of his implicit recommendation that central bankers should have been more reckless than they already were? May be, Brexit would have been forced on David Cameron than him calling for a referendum on the matter.

May be, Trump would have won with an even bigger margin or Bernie Sanders would have won the Democratic Primaries notwithstanding all the attempts to stop him from winning it.

The Chicago Fed Financial Conditions Index is hovering near the easiest despite the Federal Reserve hiking interest rates gradually since 2015 (data as of July 27, 2018 was available at the time of writing this blog post). It only shows that the normalisation is proceeding at such a glacial pace that it is hardly registering on the financial conditions.

Graeme Wheeler, then Governor of the Reserve Bank of New Zealand said this in October 2015:

Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy’s influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.

Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets – requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards. [Link]

A gentleman (Ben Carlson) had posted a comment under Martin Sandbu’s column implicitly supporting him by providing a link to his blog post.

My comments on that are as follows:

(1) The Fed’s remit is, officially, not the stock market index

(2) Earnings improvements were a functioning of low interest rates as top lines did not improve much for quite some time after 2009. Federal Reserve policy was powerless to influence aggregate demand and real economy. See Graeme Wheeler’s comments.

(3) Most ordinary people save through bank deposits. They were robbed of their incomes even as asset prices went up.

(4) Household debt has fallen but corporate and other debt have risen significantly. Overall leverage of the U.S. economy has only increased despite the crisis having been caused by leverage

(5) The improvement in household networth says nothing about its distribution. For that, check out the work (‘A lost generation’) by the Federal Reserve Bank of St. Louis on whose networth has improved. Mr. Ben Carlson’s stock market performance would not make a difference to them.

(6) If one taunts the Fed sceptics that their criticism was a reflection of ‘sour grapes’, it is equally possible that one’s approval of Fed policy is a reflection of their personal riches. Social and public welfare consequences be damned.

Resilience of human irrationality, a I wrote in my MINT column two weeks ago, is remarkably strong.


Wrong solution for a distant problem

I was happy to read Harsh Vora’s piece and it is good that he was thinking far ahead – 10 to 20 years down the line.

I just have the following comments:

The case for freer capital flows, however, does not follow from his argument. If global economies are in a far advanced state of demographic decline – which they are – how do freer l capital flows help overcome the low natural rate of interest problem induced by the aging of the population?

Second, in India’s case, it will still be a developing nation and potential GDP growth improvements will occur through many other channels. In advanced nations, their potential growth is already exhausted. It is between 0.0% and 2.0%. The demographic transition to old age compounds the situation. It is not so in India.

Third, even if the supposed benefit of freer capital flows is that it allows the country to circumvent the domestic interest rate ceiling imposed by aging population is true, it comes with other bigger costs. Monetary policy autonomy is gone, in the presence of capital flows. It is the famous impossible trinity. In fact, it is an impossible duality. The exchange rate regime does not matter at all.

It might amount to burning down the house to get read of the bed bug.

A tragedy and a travesty if…

In today’s MINT, Ajit Ranade argues clearly and convincingly against the Government or the Parliament diluting RBI’ norms issued in February for recognition of non-performing debt. He is right and I agree with him. I had written on this right after RBI came out with its NPA recognition norms in February 2018.

This story in MINT on how the ICICI Bank had made an accounting rule change that enabled it to keep its non-performing loan ratio low and that too without disclosing the rule change to shareholders only strengthens the RBI directive issued in February.

It is all about a culture of accountability that is sorely lacking in India. It is missing almost everywhere, especially in public space.

It will be a travesty and a tragedy to dilute RBI norms issued in February.

State capacity malnutrition

A very sobering piece by Shankkar on Indian governments’ public service delivery or the lack thereof.

Niranjan analyses the economic growth constraints that have become history and leaves us to think about which constraints are binding (or enduring?):  lack of scale in production in farms and factories, human capability and state capacity – read the piece above.

Ajit Ranade on the enduring power sector woes [Link]

What these three articles tell us is that the amount of state capacity – intellectual and execution – that India needs – is of the highest order and, therefore, the ‘State Capacity malnutrition’ is probably the worst malnutrition?

Which PM will address the quality of his Cabinet, the organisational structure of his Cabinet and institute accountability mechanisms?

High external tariffs were effective once

I was preparing for a lecture I have been asked to give on Technology and Development to visiting scholars of Indian Economic Service at the Singapore Civil Services College tomorrow. I had made a mental note of referring to Professor Robert Allen’s work on the history of economic development. I had written on it in MINT in February 2015. Let me recall those words here:

According to him, North America and western continental Europe caught up with the British industrial revolution by adopting the following:

• Internal free market (elimination of internal tariffs)—national single market

• Stable domestic banking system

• High external tariff

• Universal education

• Infrastructure.

They did not catch up practising free trade and open capital markets. What a surprise! [Link]

High external tariff was needed to catch up with Britain which industrialised earlier. Now, President Trump is again resorting to high external tariffs. America has a stable banking system and an internal free market. Its infrastructure is in need of improvement, for sure. In other words, trade barriers were effective. They may well be effective again. Academics are finding it difficult to accept that possibility.

I saw an article by Professor Dani Rodrik in FT.  He was making two points of which I thought one was valid – that the WTO was more intrusive than that of GATT. His second point was that such intrusion did not allow for heterogenous economic models like that of China’s. I thought that the second point was problematic.

Countries are now holding China into account for its failure to honour the very commitments it made when it joined the WTO.  It signed up to it. It benefitted from it. Its breakneck export growth and foreign exchange reserves accumulation were due to its accession to WTO. Higher Foreign Direct Investment into China was also due to WTO accession.

Second, I was not sure if China’s economic model was that heterogenous. It followed Japan’s model  – export growth, undervalued currency and protected domestic markets. Post-2008, China copied the neo-Western model of economic growth – reliance on debt. I doubt if there was much that was or is heterogenous about China’s growth model.

But, on the intrusiveness of WTO (vs. GATT), Professors Joel Trachtman and Simon Lester have responded sharply to Dani Rodrik. You can see their posts here and here.

For what it is worth, Professor Rodrik should also read this Merics brief on what certain things mean in China.

Also, I am not sure many in America see the US-China trade dispute the way Professor Stiglitz sees it. I have cited in these pages from the Harvard-Harris poll of the last few months that those polled did not want a trade war but they also wanted China dealt with, firmly.  Stiglitz writes:

No country could have a more unqualified economic team than Trump’s, and a majority of Americans are not behind the trade war

He may be too harsh on the first part of his statement but he appears most certainly wrong with the second part of his statement. He should go through carefully pages 123-130 of the June 2018 Harvard-Harris poll.

If China was winning the trade war, a rare and risky outburst from a Chinese professor against President Xi Jinping would not have happened.

As of now, it does not appear that China is either winning the battle or the war. China has imposed unremunerated reserve requirements on forward transactions on Yuan and the People’s Bank of China demands ID proof for transfer of US dollars over USD1000.00 Professor Stiglitz has allowed his biases to cloud his judgment.

He should spend some time reading the detailed two-part article that the South China Morning Post on how China might have mishandled the US on the trade dispute. One can find them here and here.

Both he and Professor Rodrik would also find it useful to read the Merics China Monitor dated 18th July 2018 on China’s cosmological communism.

Read this comment too in the FT on strains showing in China.

Not too many people – even those who are ideologically ill-disposed towards Trump find it easy to side with China. For example, FT thinks that IMF would be wrong to bail out Pakistan which tantamounts to bailing out Chinese banks that lent to Pakistan to get China to build some infrastructure as part of its ‘One Belt One Road’ initiative.

On the Edg(e)baston

Three days and one session – that is all it took to get a result in Edgbaston – the venue of the first of the five Test match series between England and India. It was gripping but as India entered the fourth day needing 84 runs with five wickets in hand, one had to admit the odds favoured England. Seldom these days have teams performed well overseas. Probably, that distinction belonged to the West Indies team of the Seventies and Eighties and the Australian team of that period too. After that, it is not just India who are supposedly tigers at home and lambs everywhere else. It applies to all teams.

I had watched South Africa in England last summer. I watched a day’s play each at the Oval and at Old Trafford. Hashim Amla, Faf du Plessis – they all disappointed. South African bowlers did not make English batsmen play as many balls as they should have. I was disappointed by their under-par performance.

India had a good outing in England in 2002 and in 2007, not to mention 1986. In 1990 and in 1996, India lost a test each. They were three-test series. In 2002, India drew the series. It was a four-test series in 2002. In 2007, India won the three-test series. India was humilated in the Test Series in 2011 and in 2014. A 0-4 whitewash in 2011 and India lost the final three tests badly in 2014, after having drawn the first and won the second.

Indian batsmen, based on my recollection, have not done that well, with the exception of Vengsarkar in the Eighties and Dravid from 1996 up to 2011. Sachin has a good average against England but he had two good series – 1996 and 2002. The rest – 1990, 2007 and 2011 were mediocre, especially the 2011 series. In that series, he managed two fifties in ten innings.

Ganguly had only twelve tests against England and he has a better average. Laxman had not done well against them, except perhaps in 2002. I am citing all these from memory. In other words, Indian top order batsmen have not fired consistently against England. That, to the best of my recollection, happened only in 2002.

So, the failure of Rahane, Rahul, Murali Vijay and Shikhar Dhawan in both the innings are par for the course although one is disappointed at Rahane’s shot selection. I thought he was made of better stuff. Rahul had a brutish delivery in the second innings but, in the first, the dismissal was of his own making.

It is the pressure, of course, that is built up by the good deliveries that make batsmen play loose shots at poor deliveries and get out to them.

That is the achievement of Virat Kohli in this test match – he did not let the good deliveries creat the platform for the poor deliveries to swallow him!

That said, I would hold his dismissal – against the run of play – on day 2 – as an important turning point in the match. Towards the end of the innings, he was on fire, toying with Ben Stokes and other bowlers. I thought he would earn India a 20-run lead or something closer to that. But, his tame dismissal against Rashid was a bit of a surprise. It came unexpectedly.

The second important turning point of the match was the quick half century+ by Curran. At 87 for 7, India will have fancied their chances of getting England out under 150, at most. The extra thirty runs made the difference in the end.

To succeed in England or to avoid embarrassing series defeats, a team needs at least two top order batsmen to score well and consistently and bat longer. If India does not manage that, a repeat of 2011 and 2014 might be in store. One hopes not.

In English conditions, this England team has a good attack – Anderson, Broad, Stokes and Curran. One has to admire Jimmy Anderson’s resilience, fitness and longevity in Test cricket.

Engrossing game of cricket, no doubt – not very pleasant to watch, if you are a batsman or inclined towards batsmen but gritty game. One that separates the greats from the also-rans. In that sense, Kohli succeeding in this test overcoming his own mental blocks and ego was a far more satisfying outcome for him and his fans than his centuries on other occasions.

Battling the mental demons and coming on top is always very satisfying. It elevates us and maks us better and stronger human beings.

How to become a good economist

Yesterday, I began teaching for the fifth year, the Global Macroeconomics and exchange rates course at the Singpaore Management University to graduate students of the Wealth Management programme, 2018-19. The first session is to set the stage for the course, for learning economics, the right approach to learning economic theories. Emanuel Derman says that they are models and models, to him, are approximations. A theory is an ‘explanation of everything’. Economic theories cannot be that. He calls them models.

In the process of preparing for the class, I read the first chapter of the book, ‘A brief history of economics: artful approaches to dismal science’ which I had downloaded some years ago. Ray Canterbery writes well.

Sample these lines:

As important as pure analytics, mathematics, and statistics are, if we know only the tools of the trade, we will be unable to know the place of economics within the broader community of ideas, much less be able to explain it to the uninitiated. We will be unable to engage in the rhetoric of the intellect….

…A broader approach invites readers to range across the neighboring fields of history, philosophy, mathematics, politics, natural science, and literature….

… Historical perspective puts the lie to any claim that economics always is a progressive science—operating, like nuclear physics, outside time and in pursuit of eternal verities.

….We cannot recognize truly new ideas unless we are familiar with the ideas that economists have already explored. And we cannot understand the ideas of the great economists unless we understand the times of their lives.

…..Institutions include formal systems, such as constitutions, laws, taxation, insurance, and market regulations, as well as informal norms of behavior, such as habits, morals, ethics, ideologies, and belief systems.

The highlighted portion is what Deirdre McCloskey would call ‘Bourgeois Virtues’ – courage, temperance, prudence, justice, faith/love. She says the word, ‘Bourgeois’ strictly referred to the ‘Middle Class’ before. She is using that word to refer to the ‘Middle Class’.

By the way, the interview of her by Arjun Jayadev here is very good read. There is also a link to the transcript of the interview, if you do not like to watch the videos. But, the good thing about the videos is that they are broken into small slices on specific topics. You can pick and choose. Thoughtful, in all.

See this paragraph:

The focus on a deeply felt and embedded analysis is typical of McCloskey for whom economics is better understood as social history rather than meteorological prediction. As a critique of the faux scientific economics that pretends otherwise, she went over her long-standing criticisms of the narrowness of economic methods (as she put it, the discipline as the breadth of ‘M to N’ rather than A to Z) and its delusions. …

…. To McCloskey, a criticism of the ways in which economics is currently practiced is not to deny the importance of formalization and abstraction but rather to know its place and to never stray from the serious business of understanding the world.

She makes an observation in the course of the interiew, that is rather significant:

The American Statistical Association, incidentally in the spring of 2016 issued an official report denying that tests of statistical significance are a sensible guide to the importance of a variable. [Link]

Read what she says about philosophy:

In economics, this surprises outsiders, the word philosophy is a swear word. People say, ‘That’s rather philosophical’ as though that was an exceptionally stupid thing to

Back to Ray Canterbury:

For all its concern with form, the new rhetoric about rhetoric nonetheless relies on argumentation within context. Without the villainous mercantilists, Adam Smith’s free trade arguments would have been as dull as the proverbial Scottish coastal town to which the tide, having gone out, refused to return. If David Ricardo had been championing industrialization during the Middle Ages, the more pious Malthus would have won their debate. Besides, there always was more than rhetoric. The great economists gave us entire systems for observing economic behavior.

Canterbury’s introduction ends with these lines, aptly:

Wall Street Capitalism had culminated in a Casino Capitalism characterized by making money with money through speculation.

Quite. It is also the apt note on which to end this blog post.