Interesting Readings May 14 2018 - Development Finance Institutions.

Financing reindustrialization: bring back development banks

Deepak Nayyer talks about capabilities created in Development Financial institutions (DFIs) for longterm lending. 

These DFIs are very important in creating a capability for lending to special investments. India, till 2000, had developed the capabilities to lend to infrastructure, sector-wise capacity creation etc. We need the concentration of skills in one place. This way, special knowledge reduced the risk for lending.

The commercial banks decided to reduce the lending risks by consortium lending. That is a statistical approach to risk mitigation.

Now Deepak Nayyar wants to create a National Development Bank. That I think is a bad idea. Though there may be some merit in creating a network of professionals who can lend to industry and towards infrastructure. These professionals can be monitored using DIN-like number (Director identification number) and their investments performance tracked. These people may be employed with commercial banks but without sign-off from these persons, such loans will not be approved.

Note:

What we are creating is attribution chain. I have discussed the importance of attribution in both of my books - Subverting Capitalism and Democracy and Understanding Firms. Please use the links below to check out the books. 

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My two favourite HR people!

I was listening to Masters in Business and discovered Patty McCord. Patty is former HR head of Netflix. She doesn't speak HR she speaks innovation. Listen to the MiB episode with Patty Mccord here. It is worth it. THIS is what HR should be.

My suggestion:

1. Ask your HR manager if he/she knows what is your job like day-to-day. ( analyse financial statement, work on new toothpaste launch, etc.) it has to be specific.
2. Does he/she know who are your clients? 
3. How do you make money for the firm? How much?

And the next one is of course EvilHRLady.

Knowledge improves Risk Mitigation

Improved knowledge of business domain: A person who has better knowledge of the nature of risk is better placed than person without any knowledge.  What you want to know is - where are the bargaining power centres, do you understand them and who owns them and whether you can change those. Given my knowledge of pharma and allied sectors, I do not invest in pharma.

Improved knowledge of parties involved: If you know the founders well, you may be able to take higher risks than otherwise. You may also "know" competitive landscape - what they think, how they act.

Mechanisms to hedge risks are available and known: Hedging mechanisms are not always obvious. Not always "options" will solve your problem. Your knowledge must be comprehensive enough to determine what are the hedging mechanisms involved. Sometimes you can create an alternate product line to improve your bargaining power. 

With knowledge, you can better understand the risks. For you, the risks will be lower than others.

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Should banks create money?

Bloomberg has a post about centralizing money supply - whole money, as they call it. It is not a very good idea. This is not the first time such suggestions have come up. As mentioned in the article, Irving Fisher first proposed a similar plan in the wake of the great depression. Since then many have proposed this idea but not many understand money creation.

Taxonomy of centralized money creation idea

The money creation ideas are varied:

1. Gold money: This is natural money creation. No one has any control over the money creation. Previously, gold, silver, diamonds, precious stones and other valuables (and sometimes sea shells too) were used. Many serendipitous discoveries of valuables created havoc with the money supply. Discovery of Potosi in South America and thereafter further discoveries of gold and silver had the effect of expanding Spanish money supply. 
1. Not under any control: Neither governments nor banks, no one has any control over the money creation process.
2. But Non-Arbitrary: It depends on the amount of gold you have. If you want more gold, you better import more gold by giving some valuable service to the other countries  who have gold. Over time as the total amount of gold available starts reducing you need to offer more and more to the countries that have gold.
3. Though subject to Nature: If by chance you discover a gold mine, you will be filthy rich, though if you discover too much then it may unleash inflation. Spain is believed to have faced such inflation on the discovery of silver mines in the South American colonies.
4. Deflationary and restrictive: As economic activity grows it becomes too high compared to the total amount of gold available to back it. Thus it tends to slow the economic growth pace. (Don't know if that is good or bad).
5. Favours status quo, old money and advantageous to miserly: Since total value of gold you have increases with time, people tend to postpone purchases and hold on to gold. Spending happens when absolutely necessary.
6. Exploitation and Theft prone: A doctor can charge atrocious fees from a rich person because of bargaining power equations. Gold can also be stolen. Stealing credit cards is less useful.
2. Gold-backed money: Introduced to circumvent the deflationary gold currency, countries peg the value of their currency to the gold they can back it with. When people talk of gold standard they are referring to this type of money creation. 
1. Partly Government controlled: Government issues currency and states the total amount of gold they back it with. So a gold-to-dollar exchange rate is established. The government can improve its reserves and thus improve money creation. 
2. Non-arbitrary: In its pure form it is non-arbitrary and similar to gold-money.
3. Not purely nature driven but subject to shocks: Since the government has control over the amount of money and amount of gold, the money creation is not as whimsical as simply discovering a gold mountain. Governments can reset the exchange rate to compensate for some changes. But arbitrary government intervention results in shocks and disruptions.
4. Mostly deflationary: Governments cannot measure economic activity easily (yes GDP calculations are guess-work and there is no Santa Claus just in case you were wondering). That leaves money creation open to political whims and fancies and invites tampering of measurement of the economic health. Mostly governments are slow to acknowledge the real growth in economy since it is always backward looking. It realises the growth till the growth results in deflationary pressures then increases money supply and causes a spike.
5. Perception of money losing value as government reset gold rate: As total amount of product and services of value in the economy rise more than amount of gold to back it up, the government is forced to alter the gold-dollar exchange rate downward leading to people feeling that each dollar is worth lesser in terms of gold though purchasing power may be higher.
3. Government-created money: This is non-gold standard money. Simply speaking the government issues money and backs it with a promise. This is what people wrongly believe is the current regime. 
1. Full government control: The government has effective control over the process. This is a mixed bag. It depends on the government. 
2. Some central bank control: The exact control depends on how money is created, is it by using government bonds then bought to a certain extent by central banks or some other way (simply printing).
3. Depends on confidence in Government: Prudent governments enjoy advantages but if you are Zimbabwe then you will end up in trouble.
4. Inflation/deflation depends on policy: If a government print too much then it stokes inflation and too little results in deflation. Prudently executed (Milton Friedman's about 3% money supply growth) works fine.
5. Value of money depends on inflation: If the government is able to deal with money creation effectively then a mild inflation - say 2% may result. There is not too much loss in value and it can be notices only over long time frames when quality of life changes are also noticeable.
4. Money created by banks: Mostly commercial banks create money by giving loans. These loans do not exist as money. This is the most misunderstood money creation mechanism. It is distributed money creation, without extreme control. Bankers and regulators forget that its success depends on devising proper incentives. 
1. Less government control:No country uses this method exclusively. Both Government-created and bank-created money is deployed. Thus there is always government control of some sort. Also since government is also a borrower (a big one at that), it has control.
2. Part central bank control: Central bank exercises additional kind of controls in this mechanism. First, it can partner with government in its money creation process by buying government bonds etc. Second, it controls the lending to the banks and thus influences at what levels of risk do banks create money. The key word is influences and not dictates. Thus this process is often likened to "pushing at a string" (which is difficult, you can pull at a string pushing does nothing unless there is pulling at other end by the banks).
3. Control to banks: In this scenario, Banks can ALSO determine whether to create money or not. That decision is based on whether the person demanding the money will be able to repay it or not. If he can, it means he is creating value with this money and thus able to repay it. 
4. Decision at the point of demand of debt: The decision to create money is forward looking. It is made at the point the person makes a demand for the debt. That borrower is expecting to create future value. If by banks assessment that value can be generated ONLY then money is created.
5. Depends on incentives: After reading this if you wonder why banks lend for consumption goods or lend to uncreditworthy borrowers - it is because of incentives. The power to create money is substantial power and with bad incentives, it can cause systemic harm as seen in 2008 crisis.
6. Central bank oversight: Central banks have oversight duty to watch what kind of money is created by the banks. The nature of lending is supposed to be value-focussed. Some consumer lending at the time economy is entering a pro-longed boom phase can be advantageous. But in an economy which cannot sustain a prolonged growth phase, these are risky loans and their proportion needs to be limited.

My suggestion

Out of the options, I prefer the last one - a combination of bank created and government created money. It is quite forward looking and takes place at the point of demand. It needs a lot of oversight and decentralisation. I have argued that IT systems have in fact centralized the loan decision making than allow the front-line managers to make them. This has resulted in an inaccurate assessment of borrowers and partly responsible for the 2008 crises. Amar Bhide also makes a case for intelligent decision making in his book "A call for judgement".

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Reforming Indian Agriculture

Agriculture reform is one of the big successes of Gujarat Model the foundation of Narendra Modi's political success. Yet, national agricultural reform is still lagging. In a recent article, Ashok Gulati points this out with reference to fertiliser reform. That gave me some food for thought. So here are my set of key ideas for reforms for Agri-dependant population.

Farmers' problems can be summarised easily. Farmers are not sure of what to sow, the technology and funds to improve productivity are difficult to source and they do not have mechanism to maximise the cash flow from what they reap.

Improve Crop Selection: Use soil health card to determine effective crops for that land. Suggest crop selection every sowing season based on available stock of the crop, area already under cultivation and alternatives. Commodity demand and supply can be managed before sowing stage itself. It allows for less farmer/crop failures. 

1. Give the farmer data on national area under cultivation for current year and past 5/10 years. (say area under paddy cultivation)
2. Also give total stocks of various commodities (available stock of rice with FCI and national rice stock)
3. Give rice national price trends for past 5/10 years. (say rice prices)
4. Also give comparable import prices for that commodity. Create databank for allowing informed decision on grow v/s import for various crops at various land quality levels.
5. Give suggestions of alternate crops 
6. Using these data points let the farmer make an informed decision as to what to plant. 

Land and Asset Reforms: Clear land title implies that farmers can get easy benefits of land ownership and clear share of benefits arising from land. It allows farmers to create collateral for investing into farms. Allow clearer ownership of assets such as vehicles, animals and other agricultural implements. 

Farmer productivity support: Farm productivity improvement techniques are available at various price points. It is not necessary that most technologically advanced solutions are the best. A database of techniques and corresponding funding agencies should be made available to farmers. This is more information dissemination strategy rather than anything else.

Farmer Produce Income Maximisation:

1. Improve farmer availability by focusing on farmer health. This improve farm-labour availability and thus improves earning potential. It also prevents crops failures because of on-availability of labour.
2. A national farm produce market without middlemen should improve incomes for farmers. But it requires produce classification and grading mechanism. It can be done using kits.
3. Make food processing units investment allowing the produce to be processed for easy transportation across distance and time. Thus, pulping, pickling etc. can be one type of produce revenue maximisation. Other could be farm-side cutting and packaging into easy to consume items - say pre-packaged salads made at farm itself. The whole value-chain from consumers to influencers like dieticians and  master-chefs to food factories to farmers should be leveraged.
4. India can leap-frog the agri-produce canning/packaging style processing to directly ready to cook packaging.
5. This activity is more valuable for non-staples like vegetables, fruits etc.

Farmer Income diversification:

1. Augment agricultural income with horticulture, floriculture and other allied agricultural activities. Considering the necessity of creating seepage reservoirs to allow replenishment of land-water, fresh-water based fish, crops etc can be considered. 
2. Involve farmers in agri-support transportation services, food processing services etc. 

Farmer Savings support: Improve reach of banking to rural areas. Problem for farmers is that loan availability is at high cost and savings benefits are at low rates. Even if loans are not made available a secure savings infrastructure needs to be developed for farmers. Jan Dhan is a good first step.

With these, farming should be gaining traction and agriculture can add at least 2 percentage points to India's GDP growth.

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Banking and the Post Office

Yves Smith blogged about post office providing banking services. Here is my take on it.

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Operational vs Financial leverage

Hugh Hendry made some points at the Milken Institute conference recently, I am sure you have already seen this but this is the link anyways. 

I want to highlight one comment he made. I paraphrase here "Germany has high operational leverage and when you have high operational leverage, you want to have very little financial leverage. That is why Germany is so averse to debt."

Then he mentioned Siemens vs. P&G. Interesting comment this.

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Documenting processes at offices

Recently I was party to a discussion about understanding office processes improving them. The arguments were standard, processes are ad hoc and it is difficult to capture tacit knowledge. That reminded me of a document I had created a long time ago on How to do exactly that. I have put that up online. Have a look.

Process Documentation & Improvement Ebook