Global Rebalancing-wont exchange rate achieve it?

Yves Smith has another excellent post on problems with Keynesian response to the crisis. She quotes Tom Ferguson on how Keynes would have chose global rebalancing as a key solution. There is merit in old Keynesian approach when there is increase debt repayment capability in the future. Currently, US needs jobs and work, but thanks to weird gloabal policies it has neither. So it is dependant on "investor-like" income generation - i.e. through capital appreciation and investment. This, to me, is pushing the ignorant risk-averse citizens along a high-risk cutting edge finance path. This is unfair to US citizens who are not aware how long it will take to repay the stimulus. And dont even think you can print your way out of it! Thus the global rebalancing solution seems only way out. But, as Yves Smith points out, there are hurdles.

I dont see any reason why exchange rate realignment + concerted international financial regulation cannot solve this problem.

Global banking regulation needs reform and Shiller has also highlighted this his new book (I just saw the interview - waiting for the book). There is something fundamentally wrong with accounting policies that let banks lower capital requirements based on "perceived" asset price increases. The same regulation also creates holes in balance sheets as asset prices falls. This regulation needs to be suspended for sometime - (upside suspension), banks be forced to take all the write-downs marking the assets to agreed upon prices (lets call them steady state prices) - and then made to raise capital enough to sustain them.

Secondly exchange rate realignment is absolutely must. I have been harping about this on this blog comments for long now. US must become producer and China and surplus countries must become consumers. Without this there is no resolution of this crisis.

Finally, there is likely to be a diplomatic war to protect and isolate the consumers an keep the consumer to itself. Such a trading barrier game will be detrimental to global prospects and will decrease the total pie. If a big ship(US and EU) is sinking - one way is to protect your resuce boat - or save the ship. Former saves you comfortably but leaves the world with just a boat! and latter is difficult but the Ship stays so we are better off.

What a week! *sigh*

What a week we had.

Mumbai Terror attacks started last Wednesday and it was Friday before it ended with 190+ dead and scores injured. Twitter covered the best news on the Mumbai Terror with real time rumour-destroying coverage from fellow Mumbaikars.

Tanta or Doris Dungey passed away at very young age of 47. James Hamilton has a good post on So long Tanta with a few must-read links.

It is time to sweat the grey -cells to make my country better. The current political system is wreaking havoc with the world's largest democracy. It is time to take action. Welcome to a new revolution!

Great Depression, China, US, War, defaults and other comments

Yves Smith, my favourite financial commentator, has one great post titled China's Smoot Hawley- a reaction to Micheal Pettis (another of my favourites) article. Its an awesome post and worth read - including the comments. I was naturally late to this friday party - so here are my comments on the post!

Hunger of deprived and hunger of developed is different

So pre-Mao chinese hunger and post-Den Chinese hunger are two different animals. If a developed country goes hungry, violence is also a fallout. Sale of guns has risen in US for a good reason. We have to realise that people on ground know best.

China wants to run this game for a wee-bit longer

China has nearly 1.5-2 trillion dollars in USD assets. Now China wants just a little bit of time to save some of it. China believes that this is their sweat money. The way around as they see it is to
let CNY depreciate against the dollar. But this relation is difficult to hold if USD depreciates and commodities rise.

With 2 trillion at stake - War is not yet a possibility

The cost of Iraq war was about a trillion (vague recollection). And it was a trillion dollar
"stimulus". As one part of the world's "skin in the US game" increases the probability of war will
increase. War has many benefits for regimes. It aggregates the population, it creates employment, creates a stimulus, creates an enemy outside of the regime. In this matter India is lethargic and will never have enough "mind in this game". But war is on the horizon - and I am scared.

China and India must become consumers - US must become producer

I have been making this point for like ages now (even in comments to your posts). A recovery without demand from China and India will not happen. US is not going to be a consumer - it has to be a producer. The best way to get these 3 billion people into consumption fold is by letting exchange rates correct. SE Asia and other surplus countries will need to do the same.

Import restriction response is a threat

I hope there is enough sense to not impose import restrictions. Yet, I fear India and China will impose them eventually. There will be a race to corner the "able" consumers for domestic industries. China has a difficult decision to make then. The domestic consumer will be a loser and their money will be looted by domestic corporation. Though it will be done sophisticatedly as a economic process.The best way to get domestic consumption going is to first get the latent demand for best brands going. For that you need to keep imports open.

USD and Gold - Printing currency does not matter

There is a lot of talk that Us can print its way out of the crisis. It is surely doing that. However,
real value is able to discount this printing phenomenon. The only way this might work is - if US has some means where it can aggregate this printed money and destroy it as write-down or something. Printing will set the new money in motion and it has to be collected and destroyed else there will be devaluation.
Currently"US denominate" (in terms of thoughts) people are asking this question hence possibility of US dollar depreciating does not seem feasible - it never does to local as it does not matter so long as other things remain equal. But "other things" like commodities do not remain equal - hence the effect is actually measured as rise in commodity prices. (Or conversely - commodity tries to retain value - whereas USD depreciates).
Further one must understand that equity is open to risks whereas debt has the habit of correcting / adjusting for currency changes. (Particularly cross currency debt).

In sum

Welcome to eye of the storm!!

Links:

Yves Smith, Naked Capitalism, China's Smoot Hawleys

Micheal Pettis, China Financial Markets, Rising unemploymentt and trade policies

Soverign Wealth accumulation and wealth dispersion process efficiency

The last decade was characterised by excessive accumulation of wealth by soverign entities. Central Banks accumulated large surplus - that was parked in US treasuries and later in riskier asset classes (through SWFs). This is one of the primary drivers of the current crisis. VoxEu examines the reason for soverign wealth accumulation and suggests that this was primarily done to avoid exchange rate appreciation.

Economy as a Wealth managing engine
Any domestic economy serves as wealth creating and wealth distributing engine. We can imagine an economy as equivalent to two different motors linked in tandem (feeding into each other). Entreprenuership is common name given to the wealth creation motor. Governments add inefficieny into this motor by interfearing with it. What governments are really concerned about is the woking of the other motor - the wealth distribution motor.

In case of economies creating wealth using labour arbitrage, it is the wealth distribution motor that matters more. If this motor is working perfectly then the national income is able to percolate to the lowest rungs of the society. Unfortunately this is not so in developing Asia. The local governments role is of creating, improving and efficiently running this engine. But the measures taken by developing Asian governments had, intentionally or otherwise, no such effect. Indian government is talking of inclusive development - but its only lip-service. Only China built infrastructure but followed policy of enforced migration (to and from) and managed this to certain extent. These indicate a weakness of this critical motor in developing Asia.

The policy of accumulating further wealth while leaving the wealth distribution mechanism broken has lead to rise of very-high income population in developing Asia while low end remains poor. It is interesting that this is a good policy so long as reserve build-up is within a certain limit. Beyond this limit, a policy of allowing exchange rate appreciation may have achieved better wealth dispersion (at least globally) - than what we have achieved. This policy would have raised inflation, and consequently incomes across the income pyramid.

In Sum
There is a need to put this VoxEu research under further scrutiny. There is definitely a lot of merit in the argument. We need to understand the wealth distribution/dispersion process in more detail. Obviously the theory I suggested above has holes and needs thorough examination.

Links:
Asian Exchange Rate asymmetry - Voxeu.org

Financial Crisis - Moving Towards a solution

Finally the quest for solution, both long term and short term, has began. It was going on in hapazard manner across blogs and opinions in newspapers but the most intelligent response comes from Voxeu.org.

They have published and edited version of essays suggesting action plan for G20 leaders to stabilise the economy and fix the financial system. Its 76 pages all worth reading!! Enjoy!

The Core of the organisation - the Honda story

I have read a lot of talk about Core-competency in the past decade. I have seen companies make a mockery of the core-competency issue. I often look at the top management and check how many of the top management team came from "core-competency team". In most - hardly any. Many in fact absued it so much that management gurus like Tom Peters were left screming on their blogs!

Organisations have to evolve an ethic of honouring its core-competency. Forbes highlights how Honda promotes in engineers to top ranks - and not marketers or accountants - engineers! This is the truest way to honour your commitment to "core competency".

Hat tip - Paul Buchheit

Are the store-shelves empty?

We are precariously placed in the recession। Sadly my reading of political and economic news tells me that the top honchos have just messed up pretty big. I am looking for validation.

Just want to know if the store shelves in major super markets are full or empty। At this time, they should start stacking up for Christmas sale - so it should be full।

Can you help me with feedback over next few days? If possible can you post pictures? or email them to rahuldeodhar (-a-t-) yahoo (d-o-t) com! Do include brief store details - name, area, city etc.

The Chinese Dilemma!

There is an interesting post at Marginal Revolution on Chinese model. Tyler Cowen smartly collects lot of pros and cons on the matter. Yet, this is very critical at this stage.

World economy had predominantly two engines of growth - the US consumer and Chinese producer. Both had second and third order effects that accelerated the economy. Now US consumer is dysfunctional - at least for some time to come. So the world looks at China!

China is also aware of the issue. It wants the huge savings rate to translate into consumption and therefore demand. The only way to get the saving population to start spending and kick-start consumption is to let them buy brands that have build up aspirations in their minds. This will be possible with letting CNY appreciate and letting the products be available freely.

The trouble is this will make non-china manufacturing cheaper - leading to job loss from manufacturing sector. However if China really wants to move to a consumption driven economy then there will be job shift to services and out of manufacturing.

This is more critical now। If China misses a step then we are all goner! The question is will china bite the bullet!

Links:

Marginal Revolution - Tyler cowen - This is another premium blog on finance and economics.

We were warned!!

I was really surprised when I realised that entire credit crunch and related problems were highlighted and we were warned back in 16th century itself.

"How to avoid the credit crunch?"

For Rating Agencies
See thou character. Give thy thoughts no tongue,
Nor any unproportioned thought his act.

For investors - particularly those who misguide people on CNBC
Give every man thy ear, but few thy voice;
Take each man's censure, but reserve thy judgment.

For US / UK and European Consumers
Costly thy habit as thy purse can buy,

For Mortgage dealers (they heeded but CDS borrowers didnt)
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,

For all market operators
This above all: to thine ownself be true,
And it must follow, as the night the day,
Thou canst not then be false to any man

By now you must have recognised this is Shakespeare's Hamlet! Edited snippets from Lord Polonius' advice to son Lartes.

-Full advice-
Yet here, Laertes! aboard, aboard, for shame!
The wind sits in the shoulder of your sail,
And you are stay'd for. There; my blessing with thee!
And these few precepts in thy memory

See thou character. Give thy thoughts no tongue,
Nor any unproportioned thought his act.

Be thou familiar, but by no means vulgar.
Those friends thou hast, and their adoption tried,
Grapple them to thy soul with hoops of steel;
But do not dull thy palm with entertainment
Of each new-hatch'd, unfledged comrade. Beware
Of entrance to a quarrel, but being in,
Bear't that the opposed may beware of thee.

Give every man thy ear, but few thy voice;
Take each man's censure, but reserve thy judgment.

Costly thy habit as thy purse can buy,
But not express'd in fancy; rich, not gaudy;
For the apparel oft proclaims the man,
And they in France of the best rank and station
Are of a most select and generous chief in that.

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.

This above all: to thine ownself be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.
Farewell: my blessing season this in thee!

- Shakespeare in Hamlet (Lord Polonius advice to son Lartes)

Hat tip - to Free exchange blog from The Economist (for inspiration!)

Interesting reading about China

All roads lead to China -by Richard Burbaker has a post with interesting link to China Dilemma - a collection of 18 chapters though he mentions 19.


Link:
The Big Picture | All Roads Lead To China

"Commodities as Anti-Dollar"?

Yves Smith has a recent post on whether commodities, particularly oil is finding favour as anti-dollar. In the comments, you will find some arguments about oil demand and fundamentals.

I think Oil price movement were retro-fitted to fundamentals. In other words, the movement in oil was primarily as a value retainer against dollar. But two things happened that twisted the outcomes. First, dollar strengthened (for whatever reasons) and second more money rushed into oil taking it too far away from retro-fitted fundamentals.

Now we are about to witness a second flight into "value". Are we foreseeing another commodity upswing? I think we need to watch Oil, Gold and other key commodities. But one thing is sure - perishable agri-commodities will not be able to retain value for the length of time that we are looking at.

Time to watch out and hold tight!

Links

naked capitalism: Is the "Commodities as Anti-Dollar" Trade Back?

The economics of labour market intermediation | vox - Research-based policy analysis and commentary from leading economists

David Autor has a fantastic post on Vox on economics of labour market intermediation. Labour markets are imperfect and they are kept that way by interest of recruiters and employees. In the end both loose but still there is enough weight in status quo.

Let us consider an employer and a prospective employee. There is no way for the employer to know the employees performance in previous organisation. Therefore the metric is salary drawn currently.  Now if, by any chance, an employee accepts a job with lower salary then his salary growth is lower! This appears unfair - but its actually a manifestation of inefficient market at work. The only way this situation corrects is when imperfection on other side - i.e. you have a desperate employer. 

As per my experience the intermediaries actually twist this situation to the benefit of the employer. Hence most of the time employees distrust HR managers and intermediaries. That is the reason salaries are secret. Often even though companies treat everyone fairly - employees still feel distrust.

In sum, there needs to be two areas of research in this. First - does this behaviour actually benefit the employer at all. Second - does this distort the labour markets to an extent that it impacts the economy. My intuitive guess is no on first count and yes on second. 

Links:

The economics of labour market intermediation | vox - Research-based policy analysis and commentary from leading economists.

Banks need to stop hoarding money - or should they?

Mike Shedlock posts an interesting comment to a White house recommendation (directive?) to banks to stop hoarding money. Prof. David Beckworth however explains why banks are hoarding money.

Now we already knew they would happen, didn't we?

The risks arise in the next step. Here the money system goes
into self preservation mode rather than help push the bailout effects down to
individuals and small businesses. Here second bailout will be required. But this
bailout will need concurrent regulatory changes so that the money system does
not simply fatten up – but actually pushes the recovery stimulus down the chain.
The size of this stimulus will be at least twice the first bailout.

I think, these two bailouts will have to clean the system.
Beyond this will be a period of lull. This is the time individuals and small
businesses start reducing their loan outstanding. This is likely to take long
time in case of US.

To my mind this reaction is rational given the accounting requirements and state of real economy.

There is a serious need to assess accounting norms for banks in the light of Fed guarantees. Banks may be holding too much reserves, capitalising a little too much among other things*. So if indeed Fed is going to prevent the systemic collapse then banks may be able to free some money. But of course its not as simple as that - the issue needs more understanding.

Further, with real economy showing signs of slowing, banks are reluctant to lend. (Rather, banks are now being sensitive to slow-down signs that were present even before the financial crisis!) Now is the time for bailout 2 to materialise. Though this one needs to be aimed at the consumer rather than banks. Banks may be used as a transmission mechanism for this bailout.

Note:

I dont mean to say that bank's have enough capital - but what I mean is so long as Fed gurantees are in place the banks may be better off (for easing out of this crisis) in lending rather than increasing researves. Banking system may need a lot more capital later once we are out of crisis - but the time to get the capital may not be now!

Links:
Mish's Global Economic Trend Analysis: White House: "Banks Need To Stop Hoarding Money"
Second bailout - FIs into self-preservation mode

Macro and other Musings - Is there are credit crunch?

Development 2.0 is gathering steam

One of the many things Web 2.0 will help streamline is poverty alleviation and development of backward regions of the world. World bank's PSD blog earlier had a post about what this development 2.0 needs. Their recent post hints at a BBC initiative that has potential.

Links:
Development 2.0
A lesson in openness - PSD Blog - World Bank Group

USD strength is an opportunity!

Confused Capitalist JW has a post today about how to make money in the moment. I agree with him totally. The current rush to USD assets is actually an opportunity to convert USD liquidity into other currency assets, particularly CNY (Chinese Yuan). If you see the behavior of Chinese markets vis-a-vis global markets you will see some strains of this actually happening. 

Under the hood of these flows, however you will see the reason why the systemic destruction of capital will be cyclical in nature. The cycle is similar to Roger's adoption curve in marketing. Small, smart money managers are "early adopters", big money is fast follower, everyone else follows big money (and that changes the equations - validating the theory - to an extent). The individual investors are typically the laggards - if they follow this they loose money. If they stay put they might make some actually.

The entire cyclical movement of money also lends credit to rising oil and gold price theories. So I will watch these commodities closely. Further the mechanics of this wind-down will be cyclical - with different wave-length. I guess this means its time for traders to earn their money. Welcome to the rough ride roller-coaster!

Short Selling

There has been a lot of blame allocated to shorts. Ajay Shah put his arguments against banning short-selling in "Why ban short selling?". But there are ways where short-sellers can impact the market mechanism adversely.

Now fundamentally, there is nothing wrong with short-selling. Even shorts with borrowed shares are fine and so are naked shorts. Yet, I haven't read detailed analysis of mechanism of how short-selling is causing the market panic.

Generally markets operate on a play between probabilities. The buyers believes probability of gain in buying the object is high, whereas seller allocates higher probability to making a gain by selling. Short-selling pay-off, in-essence, becomes function of two variables - the probability of the bet and size of the bet. Generally these are independant variables.

However, as we deal with wealth concetration risks, the size of bet starts influencing the probability of the event. When big money moves on a bet - it coordinates the operation across futures and swaps in stocks trading in different geographies leading to coordinated move making the bet a self-fulfilling prophecy. This is precisely the pain area. In order to understand this better we need to know:

1. How the size of bet influences the probability of event.
2. Is it possible to increase the size of bet and thereby get a coordinated buy-in in favour of the bet without resorting to illegal, immoral means.
3. Has it happened in some stocks - and if so how.

In sum, the problem is plausible. But it impacts upside as well. Yet, human nature is not adept at understanding or complaining about this "surprising" good fortune. So how can we deal with it?

Country defaults lighting the Forex fuse?

There is now talk of run on countries. The countries in question are Iceland, Hungary, Pakistan, Ukraine, Belarus, South Africa, Argentina and South Korea. Have a read here:

Peston's Picks: Now there are runs on countries
Naked Capitalism: Is another Emerging markets Crisis in motion? (Note interesting comments particularly by Richard Kline)

The risk is enhanced by possible political response. The breadth of possible political response of these set of countries is wide as ever. This will no doubt exert pressure on Forex markets. So what will give first.

I have believed in dollar weakness all along. Initially I thought it will be the China RMB USD friction that will trigger it. But increasingly I suspect the wear down will happen from Euro and GBP side. In other words - a European slowdown can visibly translate into Euro weakness more easily than US slowdown reflecting in USD weakness.

Financial Crisis - Goes regional, triggers a real economy shock!

The financial crisis is not becoming real economy crisis in an explosive war-like situation. I wish to highlight the first (noticeable) explosions showing crisis moving regional and hitting the real economy. As always all links refer to Nakedcapitalism.com (one of my favourite blogs).

This was the result of financial crisis (among others)
Regional Banks post losses
Biggest US Bank Wachovia shows off a BIG loss!

And now here is the quote that ignites the real economy wick!

Ohio’s largest banks all suffered losses. National City said it planned to cut
about 4,000 jobs, or 14 per cent of its workforce, over the next three years
after the bank posted a net loss of $729m, or 85 cents a share. Fifth Third
reported a quarterly loss of $56m, or 61 cents per share, and KeyCorp lost $36m,
or 10 cents per share.

This is phase 2 of the crisis. The repurcussions will move east geographically towards China in coming months. Holt on tight.

Depression 2.0 dilemma - Inflation, deflation, capitalise, solvency

If at all you have just one blog to read - please read naked capitalism. Yves Smith is absolute best! Here is another song of praise - naked capitalism: It Isn't Over Until the Fat Lady Sings

The post looks a wide ranging issues including gems people will do well to remember.

oversold does not necessarily mean undervalued

the stock market increasingly seems to serve as a quick proxy for how the economy is doing, when it has a strong propensity to give false positives

Marc Faber comments -

"The governments in this world have no other option but to print money. That will lead down the road to inflation,'' Faber said. "You don't need to be an economist graduated from Harvard to know we're already in a recession. They will just put white paint on a crumbling building...."

"To rebuild economic health in the United States, you need a serious recession that will last several years,'' he said. "The patient that got drunk on credit growth needs to go into rehabilitation. To give him more alcohol, the way the Fed and the Treasury propose to do, is the wrong medicine."

Chirstopher Whalen comment - In anticipation of such heavy losses, banks are now diverting capital into loan loss reserves rather than seeking to make new loans.

And a fantastic snippet from Andrew Ross Sorkin at the New York Times:
“Our purpose is to increase confidence in our banks and increase the confidence of our banks, so that they will deploy, not hoard, their capital,” Mr. Paulson said in a statement Monday. “And we expect them to do so, as increased confidence will lead to increased lending. This increased lending will benefit the U.S. economy and the American people.”...But Mr. Paulson is making a big assumption about confidence, because until the real economy recovers — which could take more than a year — lending to Main Street is unlikely to return rapidly to normal levels.“It doesn’t matter how much Hank Paulson gives us,” said an influential senior official at a big bank that received money from the government, “no one is going to lend a nickel until the economy turns.” The official added: “Who are we going to lend money to?” before repeating an old saw about banking: “Only people who don’t need it.”

Housing has another 10-15% to fall (see here for a reminder), and that assumes no overshoot or second leg down due to a sharp increase in unemployment. And this won't happen quickly, either. Alt-A and option ARM resets continue at high levels through 2011 (in fact, 2009 is a bit of a lull, so we might have a false sense that the crisis here has passed midway through the year).

Here we need to pause and remember two main things. First is unless we know what is everyone hiding and what is it exactly worth we wont get anywhere. Second is markets have failed till now so there has to be someone willing to roll up his/her sleeves and get his/her hands dirty and really look at every single mortgage / asset. Asset backed instruments will work better if we have better information on underlying assets.

So now will someone please stand-up and help me look at this crumbling house in US that sits in balance sheet of bank in timbucktoo!

LEssons for Poverty alleviation - The economics of civil strife

Dr. Dani Rodrick points to an article by Oeindrila Dube and Juan Vargas. (Dani Rodrik's weblog: The economics of civil strife). The paper concludes that when prices of labour intensive commodity rise - strife reduces a benefits are wide spread. Whereas when prices of capital intensive commodity rises - strife increases if benefits are concentrated. This has some lessons for poverty alleviation programs.

I am tempted to go to my example of snakes-and ladder model for poverty. Here snakes are poverty creators and ladders are poverty alleviaters. Ladders are typically income related and snakes are expense related.

In the context of ladders, poverty alleviation has two-fold objectives. First is to have ladder-accessibility to all (income growth / economic growth of labour intensive activities). Second is to have more ladders (income generating activities supporting /surrounding the capital intensive sectors)

A quick view on the strife part of paper

In my view, strife actually happens when both the above conditions are negated. Or if income generating opportunities are not available to large scale population while being selectively available to few. AND whatever other income generating opportunities are available are not growing. When oil prices increase in Columbia did not translate into ancillary economic activity then strife is definite.