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Tuesday, November 30, 2010

Behaviour of Indian Equity Markets

In the recent time Indian equity market are showing four distinct behaviour clusters. These zones are independent in the sense that their behavior does not seem to correlate with news or other stimuli. If that were the case, it would not be worth commenting on. However, this behaviour  is important to note this as it affects the trading strategy.

The trading happens in four peculiar disjoint zones. 

First zone represents the newly started pre-market operations. The price movements in this segment are very difficult to predict and the pre-market prices do not reflect in any way the likely direction markets may take post open. I avoid using the prices set in this phase totally.

The second zone represents the market open to about mid-day wherein European markets open. However, the timing match with European markets is not exact. The second zone lasts till about 1.30 -2 pm India time. 

Post this till close at 2.30 -3 pm represents the third zone. The performance in this zone is drastically different from performance in the second zone. Note, it is not necessarily opposite, just different. The markets may expand on second zone performance or simply reverse it.

The final zone is the last 30mins to 1 hour of trade. This zone appears occasionally. But can make or break your day trades.

Monday, November 22, 2010

QE2 polarizing Haves and Have-nots

The policy of supporting asset prices at artificially high levels through easy money policy is popularly referred to as QE2. This policy is widening the difference between Haves and Have-nots. 

Preventing new net Asset ownership
Asset Price support helps those who owns assets, while denying those who do not own assets an opportunity to ever own any asset. If you own some asset, you can convert it into others. If you do it skillfully by selling your asset at its peak price and buying other assets at their lowest prices, then you get richer. In other words, we are all asset managers.

What happens if we do not own any asset to start with? Well, earlier, your hard work, your labour value was an asset. But today that won't get you far. You need to start with an asset if you want to get close to median income. And that is where credits or loans come in. At a very basic level, you can get a students loan and improve your labour value and convert it into a labour category that markets value. This is the central utility of credit to our economy.

The Income-asset price connection
Usually asset price - income cycle works other way around. Higher median incomes drive asset prices up. The converse is not always true. In other words, higher asset prices need not drive median incomes. Note the use of word "median"income.

Here it is important to explain that at a gross level the asset price-income cycle is reversible. It means if we use total national income and asset prices across all assets in our cycle then we get a reversible cycle.

However, the moment we consider median incomes the reversibility breaks down. With each iteration, the income of the rich increases while those of the poor reduces. The median income reduces as we push through with these cycle.

Ben Bernanke is operating at a gross level but real economy will recover only when median incomes start stabilizing. Thus the Fed's policies of QE-X won't achieve anything unless Fed starts looking at median income levels. I hope they get it sooner than later.

Friday, November 19, 2010

Higher Food Prices and Poverty

Dani Rodrik asks if higher food prices mean higher poverty or does it mean higher income for the poor. He points to several articles and essays on this topic (refer notes below).

The issue is complicated. Just as we have expense basket we also have income basket. Agriculture appears in income basket of low-income HH. An increase in food prices, at least those forming part of income basket, should ideally help these low-income HH. However, the reality is different for most countries.

Often, most of price rise is effected at middleman levels (know for sure about India). The reason is typically inadequate market infrastructure for farm goods. Thus in countries where agri-product markets are well evolved, higher food prices tend to seep to the low income HH whereas in other areas they don't. (Some logical assumptions included).

Further, if a certain section of the low-income population is suffering drastically because of food price increases then it is difficult to justify the increase. Urban poor almost always suffer because of any food price increase. However, if urban poor can return to rural areas then it is possible to tweak their income basket to their advantage. This obviously depends on how volatile the price rise is.

The point is, whether the net impact of increasing food prices is beneficial depends on various factors. First, it depends on the profile of income basket and how much of income basket is increasing. Second, it also depends on how effective are agri product markets. Thirdly, it also depends on polarization of income baskets within lower income class.


Dani Rodrick 2007 post - Food prices and poverty
Dani Rodrick 2008 post - Food prices and poverty confusion or obfuscation
Johan F.M. Swinnen - The right price of food
Maggie McMillan - Does OECD support for agriculture increase poverty in developing countries?
World Bank Implications of higher global food prices for poverty in low-income countries
World Bank Distributional effects of WTO agricultural reforms in rich and poor countries

Monday, November 15, 2010

The idea of taxes

Scott Sumer discusses taxes TheMoneyIllusion » Income: A meaningless, misleading, and pernicious concept. There have been responses by Bob Murphy, Richard Thaler and others all linked in his recent post titled Comment on Murphy and Thaler. I wish to draw attention to a more fundamental issues.

Firstly, we set the tax rates and plan expenditures accordingly. Why can't we do the reverse? I know the wording may not be clear so let me explain to the best of my abilities. Government sets tax rates, looks at collections, plans expenditure that (hopefully) results in more income and hence more taxes. This is a loop of sorts. However, I think we should go the reverse way, every year we should look at important, unavoidable, expenses and then deduce the tax rates from those. In the first case we tend to expand or contract government consumption (for the lack of better word - expenditure may not be appropriate) to fit the tax collections. In the second case we adjust the tax rates to fit with expenditure. It may lead to other issues related with fiscal deficits, productivity and development focus, and others. We will deal with them in a later post.

Second, taxes are less about being complicated right and more about being fair and easy. We have yet to discover a best first principles solution to tax calculation. Any mechanism we use ends up with unfair outcomes for certain portion of population. But if we stick to being fair, people should not have reason to complain. So I agree with you when you say that consumption is a better alternative.

Finally, taxes should not create distortions. Taxes are not means to guide the population and this, as such, should be considered as encroachment on civil liberties. Government has not business nudging people to have more babies, get more insurance, consume more, or invest in tax-havens etc. Alas, I am in a minority on this issue.

Friday, November 05, 2010

A logic against QE

Now that extra $600 billion is available to play, world markets are enjoying the party. However, there is a strong logic that suggests QE won't work without other changes. Here is my attempt to explain it:

Let us take a simplistic equation [1],
Personal Income = Expenditure = Price * Volume

In this equation, Volume represents volume of various goods we buy. Volume of goods consumed represents our quality of life. Simply put, if we are able to buy 2 computers every year, then our quality of life is better than if we can afford just one. So volume going up is a good thing in general. 

Price represents price of each of those goods. If price goes up and volume remains same or increases, then the price increase is acceptable. However, if price goes up and volume goes down, we have a problem. In economic theory, both phenomenon are defined as inflation. But effect of one is acceptable while other reduces the quality of our lives. We end up with inflation when there is too much money in the system and too few goods.

Now let us come to income. Income for the next year feeds on changes in price and volume in previous year. This is called feedback loop. So in general, if prices or volumes or both rise then incomes will follow.

However, within this generalization we have some specific differences. If volumes rise the chances that employment will increase is higher. If only prices rise and volumes don't (i.e. there is still extra inventory or idle capacity at current employment level) then employment does not rise. To take it a step further, if prices rise (because costs are higher) and volumes fall (as in bad kind of inflation) then employment may actually reduce. 

In current scenario, the income feedback loop is broken and we are pumping money by trillions. Unless we fix the income feedback loop, we are going to have inflation of bad kind. There is a tremendous risk to standard of living. It is surprising that politicians of the world do not understand this simple logic. I am beginning to smell malicious intent here. The only other alternative is incredulous stupidity.

[1]: I have made many assumption, including no savings or debt. This is to simplify the logic.
Paul Krugman's latest post on Why Inflation targets need to be high wonkish works on similar logic but assumes sufficiently high inflation will fix income loop.

Tuesday, November 02, 2010

Why Koreans still work at 75?

Tyler cowen links to an interesting post about age and employment across countries. The article suggests we rethink the early retirement norm. Here are my comments:

First, retirement should be a personal choice depending on factors such as health, financial comfort etc. It was nudged into a norm through the use of social security. Instead of the lump sum social security, we must rethink the size, frequency and conditionality of social security payouts. We may, for example, decide on step -wise increasing payouts starting at age 55. We may, as another idea, keep the size of payout restricted for those in employment, within the principles of fairness and social justice.

Second, even if we accept the principle behind retirement, the exact age itself must change. The retirement age is a leftover from a effort dominated era. In those times, productivity waned with strength and thus older you got less productive you were. But no longer. We are now a predominantly knowledge economy. And knowledge productivity increases with age. (It also vanishes with new knowledge.)

Third, in the short term, whether adding the retirees to working population helps or not depends on skill profiles. If skill profiles of older workers is different from younger workers then entrepreneurs may devise methods to deploy these skills to economic gain. However, if these skills are similar to those of younger population then demand supply equations will come into play and overall effect will either be lower wages or unemployment. 

Fourth, in the long term, younger workers will get re-skilled (hopefully fairly quickly) and create a skill difference that will help the economy.

Fifth, whatever new form social security takes, it cannot undermine the promises made earlier. Government or any party must be held accountable to the promises they make. The lives of individuals are based on these promises. Had the government not promised social security, people may have saved for themselves instead of spending everything.

In sum, the idea behind social security is laudable. The implementation leaves a lot of scope for improvement.