Demonetisation update 19 – MMS writes for THE HINDU

Dr. Manmohan Singh has written a op.-ed. for THE HINDU today. A reader of this blog brought it to my attention. I consider this op.-ed. a far more effective intervention than his speech in the Rajya Sabha. He has used two of my favourite expressions that I attach to economic policy-making. Or, rather the perils of policymaking: the law of unintended consequences operates and that the road to hell is paved with good intentions. I agree with both.

We can ignore his last sentence. It is theatre. We can even condemn these sentences as being grossly hypocritical:

It may be tempting and self-fulfilling to believe that one has all the solutions and previous governments were merely lackadaisical in their attempts to curb black money. It is not so. Leaders and governments have to care for their weak and at no point can they abdicate this responsibility. [Link]

His government not only did not try but worsened all the problems – corruption, black money and lack of governance – considerably. India is still paying a price for it and will continue to pay a price for it, for quite some time to come.

The share of High Denomination Notes in ‘Currency in Circulation’ was 26.7% in March 2001 and it jumped to 47.0% in March 2004. By the time, UPA demitted office it had gone up to 84.0%. In March 2016, it stood at 86.4%. The rise in the share of HDN was partly a response to the high inflation that the Indian economy suffered and endured under UPA and it was also a facilitator for storing ill-gotten wealth. So, one should dismiss the previous sentences highlighted above, with the contempt they deserve.

However, this framework of his is correct:

Black money is a menace to our society that we need to eliminate. In doing so, we have to be mindful of the potential impact on hundreds of millions of other honest citizens…It is important to deftly balance these risks with the potential benefits of such decisions.

The ‘withdrawal of specified bank notes’ is a move that can benefit a society for a long time to come. Whether it does so or not is not possible to evaluate today nor even well into the future because, by then, the benefits may not be correctly traceable to this move which happened in November 2016. But, the costs are real, immediate and palpable.

So far, the public has been prepared to pay that price. However, it is a risk – and there is no other way to put it – that this tolerance for pain and inconvenience can fade, wane and disappear. Their assessment of the net balance of benefits and costs might shift. That is the risk that the Prime Minister has taken. That risk could turn out to be a wrong one or a right one. We would not know. A risk, by definition, is one because it can result in gains or losses.

If he underestimated or misjudged the execution challenge, then the risks to him are personal (reputation, standing and image), are to his party’s election prospects and to the economy (short-term growth loss and deterioration in living standards for several (thousands or millions?).

That is why, on occasions, policymaking is entrepreneurship. Just as a gross error by an entrepreneur would be ‘punished’ by the market, a policy error would be punished by the electorate. When the market punishes the entrepreneur, the investors lose.

Of course, the big difference between commercial entrepreneurship and policy entrepreneurship is that the consequences are borne more by the society and the economy than by the policy entrepreneur. So, the care involved in exercising judgement and taking risks must be much higher. There is no way for outsiders to prove that it has not been done so. That can only be inferred in hindsight and after lapse of reasonable period.

As of now, these are still early days and too soon to conclude if events have delivered a judgement or that the developments are such that a judgement can be delivered or that it should be delivered today. No. Not yet.

Demonetisation update 18 – the Chakravarty fest

There was Manas Chakravarty, Praveen Chakravarty and Chakravarty Rangarajan. Not to mention Sudeep Chakravarti who held a mirror to Modi.

Manas Chakravarty wrote:

For what Prime Minister Narendra Modi is trying to do, through the demonetisation exercise, through the Benami Property law and by pushing through the Goods and Services Tax (GST), is nothing short of a revolution….Why call it a revolution? Simply put, if the reforms being forced through now are successful, they would change the face of the Indian economy. I am not talking here of mere GDP growth, but of a fundamental structural change. It is Modi’s Great Leap Forward. [Link]

After expanding on how these would (or, could) pave the way for the transformation of an economy dominated by informal activity (mostly illegal too) into one where economic activity is conducted in the formal sector (note that economic output is already largely contributed by the formal sector), he concludes on an ominous note:

Even so, the endeavour is fraught with great risks, exacerbated by the unsettled global environment. The original Great Leap Forward, after all, was an unmitigated disaster.

That is not entirely unfair. There is many a slip betwixt the cup and the lip.

Chakravarty Rangarajan and Usha Thorat – former RBI Governor and Deputy Governor respectively – focused on the transfer of cancelled monetary liability to the Government. They came up with a suggestion that splits the gains down the middle – transfer a portion of it to the Reserves and for the remainder, cancel government debt. This precludes creation of fresh reserves to transfer profits to the government. But, this might be academic for two reasons. One, RBI is not in any hurry to cancel its ‘promise to pay’ on the specified bank notes withdrawn. Two, if almost all of the specified bank notes withdrawn come back into the banking system, there is no question of transferring any benefit to the government or cancelling government debt owed to RBI.

As it puts it – it is not demonetisation; it may be more precisely called currency swap – but I cannot now change all the headers of my blog posts!

Praveen Chakravarty says that the Prime Minister has been shifting the objectives of his announcement on November 8. As per the original speech, it was corruption, black money and terrorism. But, he has now begun to emphasise digital/cashless. That could be for various reasons. Praveen wonders if the objectives were clear and well thought-through, before the exercise commenced.

Of course, we had devoted a separate blog post to what Sudeep Chakravarti wrote.



Trump, Taiwan and China – 2

I was looking for some articles by Philip Bowring, veteran journalist, on China when, coincidentally, an email from FT landed in my mail box.China is going to help Malaysia’s Sovereign Wealth Fund – 1MdB – to pay its loans. It has adverse implications for regional stability. In that context, Trump’s phone conversation with Taiwan President assumes more salience and legitimacy.

Philip Bowring has been in Asia for nearly four decades. He currently writes for the South China Morning Post. He has written some very good pieces on China’s claims in the South China Sea. In fact, his piece questioning the very name provides a great deal of historical context. South China Sea’ is of  very recent vintage.

This piece makes a strong case for rebutting China’s claims to ‘South China Sea’.

His article for ‘Yale Global Online’ on Malaysia leaning on China was hard hitting. The header says it all: ‘Desperate to Survive, Malaysia’s PM Sells His Country to China’.

But, came this piece and I found it hard to understand. Even if one were not happy with Trump, how can China be expected to step into his place and do the right thing, in the light of all that he had written above? His judgement on the voter choice in the U.S. fell into the stale and disappointing pattern of the mainstream analysts. Oh, well.

In other news, China tightening and imposing more stringent exchange controls hardly befits that of a country that has foreign exchange reserves of over USD3.0trn and a country that aspires for international reserve currency status for its currency. It is hurting European companies operating in China, says this story in FT.

FT has a longish discussion on the pros and cons of a Renminbi devaluation, on the back of a supposedly ‘rogue’ currency move that saw a Renminbi fix that was 8% lower than the previous day. It was dismissed as an error. May be, something is cooking.

Just about two hours ago, FT informed us that China’s foreign exchange reserves had declined by around USD70.0bn in November. USD3.0trn is within a whisker of being breached on the downside.

In this context, the Reserve Bank of India’s decision today not to withdraw interest rate support to its currency seems all the more appropriate.

Demonetisation update 17 – good show by the Reserve Bank of India

The Monetary Policy Committee (MPC) of the Reserve Bank of India had defied consensus and slightly extreme expectations of a 50-bp. rate cut. The latter would have been quite negative, in my view, negating the purpose of drawing more money into the banking system.

They have avoided a knee-jerk reaction. They did not wish to fuel panic. That is a good thing. Most of the expectations coming from many analysts are not based on data. I do not blame them because there is no hard data yet. So, most downside expectations are possible. But, they have to pass three more stages: plausible, probable and then reality. So, there is time.

So, RBI did the right thing by waiting for data rather than go by hearsay and expectations that are as much influenced by noise and anecdotal evidence as they contribute to such noise.

The Monetary Policy Committee has evidently taken into consideration the recent volatility in financial markets, the strength of the U.S. dollar, the impending monetary policy decisions from the US (next week) and ECB (tomorrow) and the OPEC production cut agreement.

The communication mentions, at least in three places, the stickiness of core inflation: headline inflation less food and fuel. They are concerned about its persistence and rightly so.

There are cynics and sceptics who question whether monetary policy has any influence on the evolution of actual inflation and inflation expectations. But, in a world that is dominated by financial and international capital flows, monetary policy matters. For the inhabitants of that world, monetary policy credibility matters. That, in turn, affects portfolio flows and the currency.

The RBI monetary policy decision has done no disservice to the credibility of the newly formed Committee and has thus underpinned the Indian rupee.

After their somewhat thinly-supported rate cut in their very first meeting and their relative silence since the ‘withdrawal of Specified Bank Notes’ (as the Bank puts it), questions were beginning to be asked of their credibility and even competence and with some justification.

I think this decision goes a long way in addressing those questions and allaying those concerns.

Some would call their rate cut in October and this ‘no-change’ decision as a case of compensating errors. May be. That is a point of view that Yours Truly does not share.

When the government appears to be conducting policy by the seat of the pants and changing goal posts, it was necessary for RBI to show that it has not lost its head. It has an inflation mandate and it is sticking to it. Good for them.

The Reserve Bank of India has also withdrawn the temporary Cash Reserve Ratio (CRR) of 100% that they had imposed on incremental bank deposits. Good decision.

Overall, it has been a good day in office for the RBI Governor and the MPC.

Trump,Taiwan and China

It is not quite clear as to who initiated the phone call – Taiwan or Trump. But, it has set off apocalyptic reactions in media. Unsurprisingly, there is frenzy. No time for reflection and thoughtfulness. Trump has committed a huge blunder, apparently. Offending Beijing, it seems, is worse than offending God. The United States had to ‘reassure‘ Beijing.

Even reasonably intelligent people think that Trump had made a mistake out of inexperience and that he would ‘learn’. What if it was calculated and deliberate? Some may retort that there are better ways for him to deal with China. Really? Something as harmless as taking a congratulatory phone call was not done?

This may lead to unexpected consequences. But, ‘I told you so’ response, in this situation, would be hindsight wisdom. Most policy decisions are entrepreneurial shots. One takes chances. They may backfire or hit the target. But, those decisions have to be taken. What better way to signal the end of ‘business as usual’ than doing something like this?

In the United States, the ‘fear’ of the consequences of offending China is real, even if wholly inexplicable. The relationship is two-way street and, if anything, it can be argued that the United States has more chips than China has. This blogger has said so. See here and here.

See these observations by Francis Fukuyama:

China has a lot of sources of leverage over us, beginning with how much of their currency they’ve been willing to buy, and they’ve been buying airplanes from Boeing and turbines from GE, and there’re all sorts of ways that economic relationship could go south very quickly. [Link]

A similar but not-so-disappointing piece by Yanis Varoufakis appeared in ‘Project Syndicate’ recently:

The US was also saved by the Dragon: the Chinese government cranked up domestic investment to unprecedented levels to pick up the slack created by the contraction in spending in the US and Europe…. China’s leaders knew what they were doing. They were creating a bubble of unsustainable investment to give Europe and the US a chance to get their act together. Alas, both failed to do so….

… if he plays hardball with China, pushing the Chinese to revalue the renminbi and employing threats of tariffs and the like, he may well end up pricking the bubble of China’s private debt – unleashing a deluge of nasty consequences that would overwhelm any domestic stimulus he introduces.

Prof. Varoufakis is usually savvy and sensible. It is hard to treat his observation that China was giving the US and Europe a chance to get their act together as anything more than a hypothesis. Equally, China was desperate and panicky for it feared the collapse of its own export-led growth model and hence, tried to replace it with a massive and desperate stimulus. It was nothing to do with substituting for US and Europe. If anything, US had already undertaken massive monetary and fiscal stimulus.

If Prof. Varoufakis is arguing here that China is too big to fail for the U.S. just as the U.S. was in 2008 for China, that would be acceptable and worthy of consideration, even if there is no final acceptance of the proposition. But, quite what he is recommending to President-elect Trump here is difficult to figure out.

In a paper published in 2009, Dan Drezner argues that China has not had much success in bending America to its will, despite ‘bailing out’ the United States. But, President Obama, while campaigning in 2008, had conceded that it was hard to be tough with one’s bankers! The mindset, it appears, had been set. So, even if China may not have succeeded in influencing American policies, it has succeeded in another way:

While China’s compellence measures against the United States fell short,
Beijing used its capital surplus to deter pressure from others. Financial statecraft
allowed Beijing to reduce its risk and increase its ºexibility in its foreign
exchange portfolio. As the ªnancial crisis deepened, China allowed the renminbi
to depreciate, ignoring U.S. pressure to alter course. Prime Minister Wen
asserted, “No country can pressure us to appreciate or depreciate” the renminbi.
Continuing its quasi-mercantilist policies, the government offered tax
rebates for exporters as a way to boost economic growth and rebuffed efforts
by Coca-Cola to acquire a Chinese juice maker.

China’s financial muscle also tempered U.S. foreign policy. Secretary of State
Hillary Clinton acknowledged in her February 2009 trip to Beijing that pressuring
China on human rights would take a backseat to economic issues for
the foreseeable future. In his June 2009 trip to China, Treasury Secretary
Geithner backed away from earlier U.S. calls for China to allow the renminbi
to appreciate. Geithner explained this shift in policy by noting the absence
of U.S. leverage given China’s financial leverage. Although China could not
compel the United States, it could deter Washington from trying to apply its
own foreign policy pressure.

China also used creditor power to get its way within international institutions.
Beijing effectively vetoed any discussion within the IMF to investigate
whether China’s currency was fundamentally misaligned. China vetoed
loans to Asian Development Bank loans to India because of a territorial dispute with
New Delhi.

Clearly, the Presidential candidate Obama in 2008 had set the tone and the media had obligingly fallen in line with the official policy stance since then. That is perhaps one reason why the much touted ‘pivot to Asia’ was more sound and fury signifying nothing than anything substantive. Perhaps, that was deliberate.

So, Trump’s telephonic conversation was a good signal of a policy shift. What comes out of it is a different story altogether. But, calling it impetuous or irresponsible or inexperienced reveals more about the servile mindsets (including intellectual arrogance) of the commentators than anything else.

On the issue of Trump conversation with Taiwan President, two mild or medium antidotes here and here. This is a great comment in the FT article (second link):

The irony that some liberal western analysts fiercely denounced a call to a democratic US ally, led by a feminist, progressive president, has not been lost on the Taiwanese.

Surprising that these articles appeared in places that they did despite the official and predictable FT View here. But, by the ‘objective’ standards of the newspaper, it was a passable edit.

A bigger and more forceful antidote is here. Even more surprising is that it appeared in Washington Post. John Pomfret’s article has many good parts to it.  It is hard to pick out the paragraphs. It is worth reading in full. The historical background to the evolution of US position on the so-called principle of ‘One China’ is rather interesting.

James Taranto’s piece in Wall Street Journal is another sensible, assertive and forthright pushback. He calls out the lies of journalists who call Trump a liar.

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.

Beyond repair or reason

The referendum in Italy was lost. There won’t be reforms to the Italian Senate. The margin of defeat for the referendum was 41:59. Italian Prime Minister resigned. The Euro and European stocks rallied. It gets funnier. A Bloomberg story says, in all seriousness, that financial markets figured it all out in 3 minutes. 3 days for Brexit, 3 hours for Trump and 3 minutes for Italy.

Until last week, gold fell because the U.S. dollar was stronger. Today, the Euro strengthened against the U.S. dollar. Gold had dropped another ten dollars per ounce.

We are supposed to believe that these are normal market moves made by normal investors.

Desperate times call for desperate measures except that it will make the situation more and not less desperate! A tragedy of immense proportions awaits us.