Keynes returning?

Yves Smith has guest post by Paul Davidson author of The Keynes Solution. I generally liked the post and recommend you read it too. Here are some points I would like to make:

1. Republicans abhor government but still want to get elected. Sounds like wanting the job you hate doing.
2. It is never about taxes it is always about demand, if demand exists taxes are affordable. Don't eliminate taxes make them affordable by getting demand.
3. Prudent regulation is good idea. Else it is like a football match without referees and ground markings.
4. At 2008, either solution Keynes or otherwise would have worked. Today only alternative is Keynes.

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms".

Combining managerial and economic theory of firm

Understanding Firm - A Manager's model of the Firm presents a new model combining managerial and economic theory of the firm.

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Buy my book "Understanding Firms - A Manager's Model of the firm".

Combining Managerial and Economic theory of the Firm

Understanding Firm - A Manager's model of the Firm presents a new model combining managerial and economic theory of the firm.

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Buy my book "Understanding Firms - A Manager's Model of the firm".

Understand Firms - A Manager's Model of the Firm

My book "Understanding Firms - A Manager's Model of the Firm has been launched.

Generations ago, the firm was conceived in the image of the army. Since then the army has moved on, but the firm hasn’t. Naturally, we experience severe difficulty while working with firms. Employees are dissatisfied, mergers fail, innovation is impossible, cost cutting is never enough and growth is not always profitable. May be we don’t understand the firm so well. 

The book presents a unique model at intersection of economic and managerial theory. The model uses five elements - the concept of transaction chains, Coase transaction cost hypothesis, Porter’s bargaining power theory, a new way of profiling transaction and new types of roles undertaken by employees. 

This model provides insights into which mergers will work, how to make them work, how to promote disruptive innovation, how to manage knowledge oriented teams etc. It explains why sometimes our strategy fails, why we are blind to competition and inefficiency. This model provides a new framework for thinking about firms. This framework will help us make firms better.

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Buy my book "Understanding Firms - A Manager's Model of the firm".

My book: Understanding Firms

My book Understanding Firms - A Manager's Model of the firm is now available. 

The book presents a unique model at intersection of economic and managerial theory. The model uses five elements - the concept of transaction chains, Coase transaction cost hypothesis, Porter’s bargaining power theory, a new way of profiling transaction and new types of roles undertaken by employees. 

This model provides insights into which mergers will work, how to make them work, how to promote disruptive innovation, how to manage knowledge oriented teams etc. It explains why sometimes our strategy fails, why we are blind to competition and inefficiency. This model provides a new framework for thinking about firms. This framework will help us make firms better.

I say the book is essential read for managers, investors and everyone who works in organizations. The kindle version is available at $5 (£ 3.50 and € 4.00) and print at $8 (£ 5.50 and € 6.50)

Let me know what do you think about ideas presented in the book.

LIBOR and US Dollar

The ongoing Libor scandal is interesting to watch for other reasons as well.

First, Libor is benchmark against all the debt-risk is priced. Ok, Us treasury yields are the main benchmark, but Libor performs quite similar function. What the scandal tells us is than since last so many years this benchmark was flawed. Therefore, real Libor must be something different and hence the risk linked to it must be adequately readjusted.

Second, how will you readjust the risk without knowing what the benchmark should be. In geometry a similar problem occurs when there is a change of origin. When axes or origin are/is changed the coordinates make no sense unless you know the coordinates of new origin as per the old axis. It creates a hell lot of confusion in the geometry class when this concept is taught. Same confusion can be caused in debt markets as well. Bankers will need to reprice the debt.

Same is true with US Dollar

We really don't know what is the real value of dollar but we know value of all other currencies relative to the dollar. So watch the Libor scandal unravel will point us to important lessons for dollar. So watch carefully!

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

DJIA 1920-1940

A lot of people are drawing parallels between 1930-31 and today. I thought let me post a chart of  DJIA over that period to understand what it means for us.

Courtesy: Stockcharts

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Elinor Ostrom

Elinor Ostrom is no more and economics is poorer today. Her work on management of commons and economics in general was path-breaking. She was the only woman Nobel Laureate in Economics. RIP Ms. Ostrom we will never find someone as capable to carry forward your work.

Rahul

Parallels and differences Germany vs. EU and US vs. China

I would like to draw attention of policy watchers to this interesting parallel - What Germany is to EU, China is to US. I have raised this point earlier as well.

1. Germany is the manufacturing powerhouse primed by debt-accumulation across EU just like China is manufacturing powerhouse primed by US debt. 
2. Both Germany and China hold government bonds in quantities that may break the bond markets and trigger concurrent run on currencies and banks. 
3. Both want others to follow austerity while trying to keep interest rates low and economy primed at low unemployment.
4. In effect, both will have to be architects of bailouts at substantial costs to their respective tax payers. It seems unfair but it is only reasonable way out of the current problem. 

Let us watch what experts recommend to both economies in these scenarios.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

George Soros - remarks on the Euro

Rocking Jude pointed towards a recent George Soros Speech about EU crisis (among other things) via Business Insider, which I believe is a must read. Here are some diverse but important issues:

1. Soros highlights "you cannot reduce the debt burden by shrinking the economy, only by growing your way out of it." which I agree with. However, those forcing the governments to austerity may do well to remember that in the end, government enjoy a kind of legitimacy that they don't. So if push comes to shove, the politicians will roast them alive and announce a victory parade while they are at it. One of the  solution to a debt crisis is to eliminate the creditor. History bears witness to many such "eliminations" (a few of them quite physical).
2. The objective of the economic studies should not be search for Newtonian-like laws but rather seeking engineering objectives of "fail safe" and "factor of safety" into regulation, policy and economic system as a whole. The current risk management system is falling woefully short.
3. Two-level currency system: An ideal currency system, I think, may be a two level currency system. A currency at the national level should signal the relative prices of goods and services in the economy. An international currency should signal the confidence in the judgement exercised in national currency. The international currency therefore decides the relative prices of currencies and thus of everything.
4. The problem of EU is that at current position it is unsustainable. It has either to go forth (towards complete integration) or go back (break-up). Mustering the political will to forth in such climate is challenging as Soros highlights.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Importance of Emerging markets in portfolio

Barry Ritholz has linked to a very important WSJ chart:

Here are my comments:

1. Growth is in EMs: If you use GDP growth in addition to GDP, emerging markets will come out still higher.
2. Currency story: The undervalued currencies of EM economies make it good opportunity from currency gains aspect as well.
3. Known trajectory: EM economies require product and services, regulations, infrastructure along well established and well understood lines. We have done such things in developed markets before and thus it is less risky.
4. Less consumer leverage: One significant difference between other economies and EMs is consumer is not leveraged. In fact there is substantial class of people with good amount of savings and latent demand. Thus, once government policies are on track, you can have growth and not face deleveraging.
5. Political risks: Government or political risks, to my mind are same as developed countries. All politicians are jack-asses and we have seen how politicians from any country, developed or emerging, can turn it into a banana republic. Further, some entrenched vested interest may work against developed economies in this case.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Explaining Indian Policy Paralysis

A lot of recent comments, including mine, have pointed out the lack of policy commitment from the government. I believe there is a reason to this policy logjam and it may reverse quite quickly, to surprise of many, making the current time most critical time to invest in the country. To warn this is a conjecture.

1. Indian politics has undergone a change of mechanism in financing. A significant (non-trivial) percentage of money deployed in politics comes from stock markets where it remains invested in distributed accounts. 
2. This implies that the stock markets must have a good peak about a year before the election. Year being the approximate time required to oil the election machinery of the political parties.
3. This also implies that there should be a good opportunity to invest around 2 years before the election without which the peak referred above will have no meaning. 
4. Political money is gained from rent-seeking and corruption and not invested in first three years as it is being collected at that time. It is usually available around 2 years after new government takes office, the bulk being available around 3 years time. (term of government = 5 years in India)
5. Insiders inform me that Late Mr. Pramod Mahajan (parliamentarian of BJP) was amongst the pioneers of such strategy around 2002-03. Subsequently ruling party Congress, inducted relevant talent into this strategy. Some say, former finance minister P. Chidambaram, known for his investment sense, may have used this means earlier. Though I have heard conflicting reports that state branches of parties in South using similar means since 1998-99.
6. While earlier efforts benefitted from a global bull market, current efforts require ingenuity to create returns in an adverse global macro environment. 
7. I hear that ruling party has taken an ingenious approach to current problem. The first phase of the strategy is to create policy misdirection, increase rhetoric and in general cause panic and injure investor sentiment (only enough to create a equity market). The second phase is to establish policy direction and build credible reform base that should lead to uptick in equity markets.
8. The magnitude of money involved is not small. Even small district magistrates have wealth in excess of INR 50 million. Politicians have access to money in excess of INR 200 million each. There are tons of them. However, substantial amount of this money is in black (cash not accounted or declared) and thus cannot be funneled into the equity markets. However, the numbers are mind-boggling.

Thus, I expect:

1. Reform process to gather steam from current levels.
2. Increasingly positive policy news of reform and clarity coming from governments.
3. In general improving investment climate.
4. Proactive and improved response from government to cushion or even counter negative news coming from global economies.
5. Government may talk the market up.

Implication for Equities:

1. I believe this current level is a bottom for next year or more.
2. From this point we will move up is a sustained manner till beyond March of next year (around).
3. At that point we may see a sharp correction as money starts being pulled out of the markets.
4. So, this is time to be long India and get out by March next year.
5. Risk is that if all start working on the same strategy exit needs to be critically examined.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Problem of Indian Economy

The problem of Indian Economy needs to be explained better.

Imagine the economy as a car (favourite of economists). The car has an engine of 4 cylinders (say). Then process of policy development adds cylinders to the engine. Thus, with prudent reform and policies the 4-cylinder engine economy can grow to become 6-cylinder engine economy. This is achieved while the 4-cylinder engine is still working and therefore is a complicated process.

First set of problems

Indian Economy is a car with 4 cylinder engine (as against US economy which could be 16 cylinder or China could be 12-cylinder etc). This engine is capable of growing at ~7% steadily. But to grow at 9-10% we need a bigger engine. Sadly, the Indian politician has no inclination to undertake these reforms.

Second set of problems

To add to our woes, the 4-cylinder engine itself is not running to its capacity. Not all cylinders are firing, brakes are engaged slowing the economy and there isn't enough lubrication to transmit all the engine power to the wheels. As a result we are finding it difficult to hold on to 6% GDP growth. Here again the problems are created by political class.

Solutions

In times of global macro-economic distress, one expects politicians to at the very least avoid second set of problems. In corporate lingo, these can be solved by "de-bottlenecking". In other words just simplify the procedure and keep policy clear and simple and you will have solved second set of problems.

Tackling first set of problems is going to be difficult and will need decisive political leadership that sadly is not even available on the far horizon.

 

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Austerity isn't a choice!

If you are already in debt, then you cannot get out of this mess (or hole) by borrowing more. Or can you?

This is oft repeated argument you will hear in current crisis. Well, here is my clarification.

Who is the "you" in that statement?

If you includes everyone then austerity won't help. If, on the other hand, "you" only refers to government then austerity may help.

What do you do when you find yourself in a deep hole?

Frankly, tell me what would you do? Would you say starve yourself that you may become lighter and thus be easy to pull out by some onlooker or, for that matter, rise to top? Or would you gain strength and carve out steps on the side of the hole and try to climb up? I would definitely do the latter. But it involves digging. But I cannot be expected to dig to make the hole deeper.

In other words, we need to dig, just not deeper. We need stimulus. But one that can create competence and help build a path out of this mess. Thus it becomes very critical for government to choose the projects rightly - something not many governments are good at. 

Big government vs small governments

Just remember, governments must get bigger when everyone else is getting smaller and vice versa.

There! I said it all better than Paul Krugman.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Indian Economy: Difference between 2001 and 2012

The difference between Indian Economy of 2001 and 2012 relates to how demand and policy are inter-related.

In 2001, policy certainty (directional certainty) helped drive investments when demand was yet not established. In 2012, demand is well established but it is the lack of policy certainty (again directional) that is preventing investments.

Thus, if India can sort out its politics it can gain quite a bit in a short time. Meaningless ambivalence about policy has condemned India to low growth seen recently. Hopefully the 5.3% quarterly GDP growth may wake the government from its slumber.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Rant: Read the Annual Reports for God's sake!

I find it unbelievable to a point of dejection how many people only look at the statements (balance sheet, P&L and cash flow) and discard the rest of Annual Report. I sincerely wish these people read the Annual report in detail (that leaves just a few) with concentration, eyes peeled (Hah! that leaves no one except for John Hempton). I am not demanding a Philip Fisher-type depth, just a bare reading will suffice!

Remember that 

1. The Annual report is a detailed communication that company makes with you. No meeting can cover these many issues in that depth.
2. Most often, there is lot left unsaid in the report. But what is said is no less important. Please read it at least. I can forgive you if you don't understand what is written, but not reading is not an excuse.
3. Many times we don't get picture of how divisions are performing, which products are losing money etc. But use what is given construct a picture of that what you cannot see. Remember Annual report  has legal weight. 
4. Further, quite a few companies are open about information sharing if you just care to read.

To me, the analyst who does not have capacity to read is no analyst. The investor who does not want to read is far more dangerous and bunch of investors who don't read are simply today's market participants.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Investors are at the gates - When will India open them?

One of the big problems driving Indian inflation is lack of investments. The investors are here; the question is where is the government. 

How to get investments?

First rule of investments is that higher uncertainty should be compensated by higher return potential of investment. If the return available from the Indian market is given then government can increase investment by reducing uncertainty. 

Indian government is doing exactly opposite.

In general government is failing on many levels and the Indian courts are able to stem the erosion in some areas but in critical policy areas the constitutional arm of government, the RBI, is not empowered to do much. And it has done all it can. Sadly RBI cannot undo what 8 years of inaction has borne to bear. 

Policy nuisance 

The current UPA government came after 5 years of NDA rule. The NDA government had good alignment of strategic direction and policy follow-up. In the first term,  the UPA government was befuddled with coalition issues thereby creating policy ambivalence. However the developmental inertia of previous NDA terms proved beneficial in hiding the policy ambivalence. However the second term is characterized by lack of strategic direction in policy. The policy, rather strangely, is moving in the opposite direction in general. The haphazard manner of conducting policy has confused investors, both domestic and foreign. If the government just stops this policy nuisance we can hope to hobble along a reasonably correct path.

Knowing Congress - future is bleak

The most reasonable forecast is bleak. The only possibility is that a looming crisis may kick the government into action. Just like Churchill's America, at the very last, India will do the right thing. So here is waiting for the crisis, hoping for the dark clouds to see some silver lining... 

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Follow up to S&P rating negative outlook

After the post some people wanted to know if my forecast has changed. Quite the contrary, I think S&P rating outlook downgrade may signal the upcoming improvement in equity performance.

So I think: 

1. A revival of sorts may happen by July this year, peaking around December.
2. Analysts will start upgrading around October by which time I expect the move would be reasonably underway.
3. I think a good strategy should be to invest in any weakness.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

S&P putting India rating outlook to negative - comments

Everyone knew that India's situation is precarious. Lack of reforms, rising fiscal deficit and lack of focus from a dream-team that brought in first wave of reforms. So it is hardly a surprise that India's rating outlook is changed to negative. It is made big news, was shrugged off by the markets. But it deserves a few comments.

It ratifies that India's policy direction has reversed signifying the third phase of reform process - reversal. Between 2001-2004 the direction of policy reform was positive. Between 2004-08 there was a policy logjam, primarily attributed to stifling policy of the Left parties. However, post-2008 the policy environment has turned adverse despite no participation by Left in present government.

The current policy environment is typically familiar territory of Congress party - it is a poisoned policy environment. There are arbitrary decisions (Spectrum allocation), abnormal legislations (retrospective tax liabilities), populist measures (NREGA, reversal of first fare hike in 8 years in Railways), arbitrary intervention in infrastructure sectors (under the heading of environmental clearances - POSCO deal), gross corruption aimed at filling the party coffers (commonwealth games scandal), disregard for law and order particularly by government, etc.

To top it all, no change of policy-scene is likely in future despite the promises of finance minister and Prime minister. These people were not waiting for S&P to turn negative before bringing in the main reforms. They do not want reform.

For everyone, investors, general public, firms, foreign investors etc, consistent long-term strategic direction about policy is more important that precise current policy regime. It is immaterial if you have high fiscal deficit, but it matters if you have no plan to come out of such deficit. It is immaterial if there are high taxes so long as there is a progressive clarity in tax laws and consistency in application.

In all, the only change possible is that this government is defeated and subsequent government will bring in a clear long-term strategic view to policy making.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Deploying Public Assets (spectrum, coal blocks, etc.)

One of the important functions of the government is to deploy public assets for public gain. However, selling these assets or renting them has landed many a government in a soup. Be it the mill-land fiasco in Mumbai, spectrum auctions for 2G or coal block allotment, governments seem to fumble at every step. And this is not the only problem with deployment of public assets. Let us look at problems and solutions to selling or deploying public assets in the interest of public.

The problem with deploying public assets
The process of deploying public assets is difficult. Inappropriate deployment usually turns into allegations of scams and threatens the political order.

1. An infant nation is compelled to deploy the assets it owns in a legal environment that is not yet sophisticated and evolved. Thus, such a nation is faced with immediate prospects of inappropriate deployment and therefore political disorder.
2. Asset deployment theories themselves are still evolving. Thus, the jury is still out on whether renting is better than sale of assets in conditions of uncertainty, how long should lease durations be,etc.
3. The asset pricing mechanism is ill-developed for untested or new technology. Here, it is difficult to estimate the present value of the asset. These new technologies are sensitive to choices and, in scientific parlance, to initial conditions. thus, what may be a good technology elsewhere,and therefore priced at premium, may become a failed idea at high costs. In such cases it is nearly impossible to estimate in advance and accordingly price such assets.
4. The question of opportunity cost is of prime importance. If I sell an asset to a firm and the firm does not develop it but simply sits on it. That may be advantageous for that firm but it defeats the purpose of sale of assets by the state.
5. The risk being taken in new development must be paid for. In other words, when the entrepreneurs bid for a technology that has not established itself, they are taking risk. If the government starts demanding higher initial payments, the entrepreneurs' risk is amplified resulting in under-developed sector. A better way is to let the initial payment be lower while gain from profit sharing or revenue sharing mechanism.

Two types of asset sale problems or mistakes
Even when there is no corruption, there are two types of problems or mistakes government can face or make with asset deployment. 

1. The government sells the asset at lower than market value thus resulting in loss for the exchequer. This is usually because the government cannot value the asset correctly. Alternatively, government is advised to "leave some value on the table". In all these circumstances, the exchequer is the loser. 
2. The second type involves selling the asset at market price but to someone less qualified or simply, preferring one buyer over the other. Here the problem is not for exchequer directly. Here the shareholders of the company denied the asset end up losers while those of winning company gain windfall profits. It is possible that the preferred buyer may not have technical capabilities to effectively deploy the investment thus resulting in second order loss for exchequer. 

Out of the two types of problems with asset deployment, first is detrimental to the exchequer but the second is indifferent (at least directly). It follows that the level of tolerance for first type of mistake should be lower than the second one.

Types of Asset pricing
Asset pricing depends on various mechanism for cash flows and availability of asset itself. 

1. One-time sale - this transfers public asset to private ownership: This involves higher risk to government as the real value of the asset may not be correctly assessed at the time of sale. However, once sale has concluded there is not much that can be legally claimed from this type of transaction. 
2. One-time payment for right of usage for few years and renegotiated every few years: This is capitalized rent and the value of this changes as perception of risk changes. The risk involves depends on what the asset is and how long is the first lease period. E.g. Mumbai Mill lands have been leased to companies on 99 year leases. Recently 99 year period has expired but the ownership of those lands has not reverted back to government.
3. One-time license-fee payment followed by share of revenues/profits: Here the one-time component is lesser to account for untested risk that entrepreneur must take. Thus, this option is less risky for entrepreneur as well as government. There are sub-categories within this option depending on where the government takes its cut - at revenue stage or at operating profit stage or net profit stage.
4. Only share of revenues or profits: Technically Taxation achieves this effect either through general tax or specific industry based levy, either in the form of excise, cess etc.

The first three methods are used where the asset is scarce (usually resources like spectrum, mines, land etc.). The fourth method is used for everything else.


Structure of Corruption around these problems
Corruption is structured around these potential problems to aggravate the loss to exchequer. Following problems occur generally:

1. Asset is impaired and sold thereafter: Impairment can be positive act or negative acts. Positive act means the asset is deliberately impaired wherein losses increase and asset appears hopeless. A negative act means allowing the asset to degenerate without actively doing so.
2. Mechanism of Asset pricing is changed midway: Here the original intention of pricing the asset is ignored. First, the asset is priced lower to encourage investment by lowering the risk in the asset deployment. Thereafter, an argument is evoked at the deployment is only profitable at such low prices and hence the asset value is actually low. Thus, Mill lands went from following method 2 above to method 1 without commensurate payment.
3. Concessional rate for PSU buyers: In this form the government allots a public asset to a public sector undertaking (PSU) company. This seemingly benevolent act can be hideously corrupt. Unless the PSU is 100% owned by the government, it is reducing public gain and has same effect as selling the asset at throw-away prices. A PSU in receipt of such asset must not complain if the government caps the prices of the end-products it produces.
4. Concessional allocation to PSU and subsequent divestment: This is modified part of third problem in which asset is alloted to a 100% government owned PSU and thereafter the ownership is divested. This buries the asset under the PSU performance and makes it less valuable to lay-person. 
5. Asset Valuation is not proper: In this case, the sum-of-parts value of the asset is higher than the asset itself. Thus the parts must be valued appropriately. Thus the land owned by a specific PSU that is divested may be of more value for other use than for use of PSU itself.
6. Profitability Estimation is impaired: This form works with assets like airports and roads where the right to collect toll or charge for services is leased to private entities. Recent experience suggests the estimation can go wrong in both ways as has happened in toll-roads and airports privatized recently.
7. Arbitrarily choosing pricing mechanism for two similar assets (Inconsistency): For reasons unknown, without effecting a policy change, government allots one asset in one manner and other using different pricing mechanism.
8. Granting asset to unqualified buyer: When asset is granted to an unqualified buyer who sells the license to other party at substantial profit, there is ground for doubt to believe that asset is underpriced and opportunity exists for arbitrage trade.

Note: The list is not exhaustive as people are infinitely more creative than anyone can anticipate.

The solution
The real solution is not a model for asset pricing but one of transparency. 

1. Conservative approach: I believe, from the exchequer's point of view the risks associated one-time outright sale are quite high. Instead, a non-trivial license fee in addition to share of revenues forms a better alternative. It allows for future adjustments of asset value and exchequers share in the same.
2. Transparency: If the process is transparent and mechanisms are fair, there is not much corruption that can happen. 
3. Changes to reflect true assessment of changing value of asset: If it so appears that initial payments were underpriced, then subsequent revenue sharing could be raised and net effect can still be adjusted.
4. Consistent changes: Any policy driven choice must be applied consistently. Thus if government chooses auction method then auction should be followed everywhere. If First-come-first approach is used it should be used consistently and fairly.
5. Principles of natural justice and equity: Any solution accepted by government must abide with principles of justice and equity enshrined in the constitution. Thus, if all qualified parties are given equal opportunity to bid for asset, there is not much scope of corruption.

In Sum

The focus of asset deployment is to get best value for the asset being deployed for public interest. The duty of the government is to deploy public assets for public gain. So long as basic principles are adhered we can have a flexible system that can account for past mistakes in an on-going manner.

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My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.