Demonetisation - What if deposits in banks are greater than 15 Lac Crores?

On November 28th the Reserve Bank of India stated that

Banks have since reported that such exchange/deposits effected from November 10, 2016 upto November 27, 2016 amounted to ₹ 8,44,982 crore (exchange amounted to ₹ 33,948 crore and deposits amounted to ₹ 8,11,033 crore). They have also reported that the public have withdrawn, during this period, ₹ 2,16,617 crore from their accounts either over the counter or through ATMs.

The expectation was that thereafter the RBI will release similar data every Monday. On Dec. 5th, when RBI did not release the data for the week past, speculation was rife that most of the money may have actually returned to the RBI. And further that it amounts to a failure of the policy and that there is no black money at all. 

The amount forecasted / estimated by sources of journalists is Rs. 12.6 Trillion. has been deposited in banks till Dec 6. Total bank notes in circulation as of Nov. 8 was about Rs. 15 Trn. We still have about 3 weeks to go. 

The correct way to establish how much money has returned is to look at this 8.44 Tr figure. That is the focus. 

So weekly average is about Rs. 2.8 Trn as per RBI and as per Moneycontrol it is about  Rs. 3.15 Trn per week. Going by the same run-rate estimates we can get at least Rs. 19.64 Trn to Rs. 22.46 Tr. If you understand the "last-minute" psyche of Indians, I think last week will get at least twice the weekly deposits. Then you will get between Rs. 22.4 Tr to Rs. 25.2 Tr. 

Please note that these numbers are more than Rs. 5Tr  to Rs. 10 Tr more than what RBI has printed. 

So here are my thoughts on this:

1. It is OK if all the money comes back to the RBI and either gets changed or deposited in the banks. It means there won't be any disinflation because of loss of currency. 
2. If money is deposited in the bank that does not make it white money. It merely becomes visible black money as opposed to invisible black money. Knowledge of the quanta so revealed that itself is a benefit. Further, it is open for authorities to review and tax these proceeds accordingly. So it is ok if the deposits reach Rs. 15 Tr. 
3. The problem is what happens when the total deposits/exchanged amount exceeds Rs. 15 Trn. Once it reaches 15 Trn can RBI tell banks now don't accept any more notes? Or it accepts and asks Government to pay (reverse of dividend)? [Please refer to my previous blog-post on Black money and demonetisation before demonizing me.]
4. I would say, the fact that entire Rs. 15 Trn comes back itself means that the problem of Fake Indian Currency Notes (FICN) was more potent than was admitted previously. If our run-rate calculations turn out correctly, FICN could be between 33% and 66% of legitimate Indian Notes. That is not a joke. It is also a success of the Demonetisation drive.
5. I would say about 20-25% of the notes would have been definitely destroyed. But given the tax amnesty announced let us assume about 10-15% were destroyed. The black economy was estimated at 20-25%. Assuming some can be dissipated as white (through jan-dhan and other tricks) we can say at least 10% would be black. Still about 20% of the currency in circulation could be FICN. Compare this with estimates of about 2-5%. 

To top it all Modi did not ask for 50 days to clean up the black money he asked for 17 months. So there will be more action coming. This will be interesting, to say the least.

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Free Trade - or no free Trade - either ways it ain't free!

Econgirl commented about the latest free-trade issue.  It is a must read - continue down to the comments too! Then David Henderson commented about it on his blog and the comments where @econgirl responded to his question. All must read in the overall dialogue about free trade.

There are a few things that need consideration:

1. The losers of free-trade - how adaptable they remain after they lose: In many cases, these people are lost - this is a political price we are paying. Thus, a $10 gain per-consumer v/s say a total job loss of 10,000 people (hypothetical primary loss) usually it remains concentrated (think Detroit) and second and third order economic losses. Now in monetary terms, the gain-loss may be whatever, but when a group of people loses their livelihood without any margin or buffer to create new opportunities for themselves, then it makes for a difficult choice.
2. The initial condition is responsible for the losers being as many as they currently are: If the trade was always free, the adjustment would have taken place a long time ago, giving the population enough margin to adjust. However, the governments by their initial protectionist intervention create a bigger adjustment problem in the future. When a competency develops in a country, the government rallies behind the firms with the very policies which later accumulate into a bigger problem. The adjustment to new potential trade-based threat can be innovation or it can be defeat. The auto-industry failed to innovate - something Tesla did, Ford and GM should have done years ago. But those are victims of their own success. At present, China is funding auto-tech companies to bring out a competitor to Tesla. 
3. Free trade - v/s Fair trade: Indeed some countries do "dump" products on to other markets. At the same time, some countries do use "non-tariff barriers" for the protection of domestic industry. When is the "fire-sale" not dumping and when "non-tariff barriers" are not protectionist can only be answered on a case-by-case basis. This ambiguity is used to target Free-trade unfairly. 
4. Economic V/s moral - politics enters through morality: Can we allow some trade partner using slave labour to create losses in our country? Economics says why not, morality says no. Blood diamonds are an example. That is where politics comes in. So while overall benefits of free trade may be high - the morality over why the government should not choose one set over other is a strong political motive against change of status quo. Of course people selectively forget that it was government intervention that helped the problem to get bigger.

So in an ideal case:

• Free Trade is the default. Government has no business interfering in that unless some moral issue arises. The scope of these issues are pretty narrow - slavery etc.
• Countries should progressively move all policy towards sector neutrality - including trade policy. Thus, a government would be right to have 50% markup over all goods/services entering the country/sold in the country without discrimination.
• Then let this state continue and let governments step away from the issue altogether. (more on this in another post).

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Risk Adjusted income and certainty of employment

Mike Kimel has a post Reproduction, Income, and the Future where he quotes comments from breadth of political spectrum and cites his own experience as under:

my wife and I got married late and had one child (one and done) very late. Economic worries were a big part of the decision making process. On paper, my wife and I are doing relatively well financially, but we are extremely aware that a job loss - something that has become extremely common in recent years - or one financial mis-step could mean the difference between whether our son will have far greater opportunity in life than either my wife or I did growing up, or far less opportunity. There doesn't seem to be much in-between. In talking with my parents, they also seem to believe outcomes are more stark for families today. Many of my friends tell me the same thing. And when I talk to people ten or twenty years younger than I, in general, their costs seem to be higher than those I faced, and the potential opportunities fewer.

Yves Smith also weighs in on similar issue - in Disposable workers: Why throwaway employees are bad policy? This post covers a slightly different angle. However, the central issue remains the same.

Now we know that the incomes have grown over the generations but we fail to notice that correspondingly risks to that income have also increased. Thus in general language, while the earning has shot up, the stability of the earning or certainty of earning over long periods has declined. If we truly use risk adjusted income, we will realize new generations are worse off than previously thought. Similar line of argument is followed by Elizabeth Warren in her book Two-income Trap.

This also gives us a corresponding corollary with reference to macro-economic recovery. A recovery is sustainable when there is reasonable certainty about some level of income. That level income, which is certain, forms our debt carrying capacity - not the fluctuating actual income number. Thus, unemployment numbers by themselves do not convey anything about recovery but certainty of employment over most of working life should signal recovery.

I have written along similar lines in my book "Subverting Capitalism and Democracy - Systemic faults that caused the financial crisis."

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Agricultural income vs. Industrial income

I have often wondered why Agricultural incomes are less than industrial incomes. Following are some of the reasons:

1. Agricultural incomes are not as tradable as industrial incomes because 
1. they are tied to the land, corresponding weather and topographical externalities and therefore limited by its productive constraints. Other industries have freedom to migrate to better assets with higher productivity.
2. they have low spatial availability as compared to industrial opportunities that are clustered. Thus geographically, agriculture is at disadvantage.
2. Agriculture has been around for longer than industrialism thus it has gone through various stages of productivity development and now the labour component is stabilized. As industry will go through with similar development cycle the wages will taper off.
3. The agricultural produce forms part of inflation basket and central banks make sure the value of basket does not grow rapidly thus capping the incomes from agriculture.
4. Industrial products are more globalized and specialized as compared to agricultural products. The demand for agricultural products depends on tastes and those are more tuned with local produce. Only staple foods are truly globalized. The perishable nature of the products also prevents wider distribution of the products. No so for industrial products.

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Sticky Wages, Prices and effects of pouring money

Scott Sumner has a post about pouring of money - i.e. effects of expanding money supply. He disagrees with the metaphor that money pours into certain asset classes. While I agree with the principles behind Scott Sumner's post, I find most of times the metaphors send better signals for interpretation. But my main point is about prices and wages.

Prices and wages are embodiment of information - historical, present and future. If they change too quickly then the historical aspect is lost. For better or worse, our scale of value are anchored to the past. It does get influenced by present and to a less degree by expectations of future. But if we lose our anchor point or the reference scale then our mental models collapse and we lose our sense of reality. Thus, if we get paid $30,000 in year 1, $3,000 in year 2 and $3million in the next year, we will develop a sense of confusion.

Then comes the question of pouring. What pouring refers to is change in the relative value of asset classes. Imagine a spread of assets along a value spectrum, sort of a hierarchy (with sometimes assets jointly occupying a hierarchal position). 

If money increase does not modify the hierarchy then it does not impact much. If it does then it creates gainers and losers just because money is created. For example, if a really thirsty person would rather be just under the tap than away where water will eventually get to him. 

The argument therefore is whether the government or central bankers be allowed to create such distortion that has no grounding of productivity or real value creation.

One can argue that over long term the asset hierarchy goes back to a certain mean. But during the time a distortion is set in motion and the time we get back to time-tested mean we can extract advantage. Finance is prepping to do just that.

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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.

Notes:

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

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My book "Subverting Capitalism & Democracy" is available on Amazon

Who is Rich?

The philosophical answer to the question "those who have more than they need" was always disconcerting. I never related with it. But looking at the situation of developed markets today, I have rediscovered the wisdom in the words. 

An indebted rich nation is not rich

By all counts, average American household is indebted. Those with high income but still indebted to the hilt cannot be considered rich. These households need to scale down their spending. To add to their woes, these households are facing an increasing tax burden.

Tax burden on households is based on incomes not profits
And this is a critical difference between corporates and individuals. When corporates face higher taxes, they increase their costs by investing in assets, paying higher salaries, etc. Thus, in my view taxing corporates is a better alternative than taxing individuals.

Taxing rich is better than taxing poor
Though this is obvious, rich often use corporations to park their earnings and thus get taxed lower. There should be differential rates for different income slabs - particularly at high income levels. Here the size of population is small but the value of tax collect is large.

Reference
New Yorker on Tax reform

The crisis of middle-class America

FT, more often than not, does a better job of reporting than many other newspapers. Here is FT talking about middle class America - FT.com / Reportage - The crisis of middle-class America. The examples are well chosen. People with income twice the national median, working four jobs (between two adults) are not able to reliably meet their obligations. Some are stretched by healthcare expenses others while others are fighting through job losses. One can only imagine what happens at lower-than-median incomes.

Welcome to the new normal

One of the harsh realities economists talk about is the "new normal". It includes a lifestyle with smaller cost footprint. It means scaling back on purchases. It means no new clothes, no new cars, no computers and cameras. The middle class is not saving, it is simply adjusting to new levels and risks associated with their income. At least a third of American households are in this situation. So we can only imagine what it will do for a consumption-led GDP. The future does not look bright. 

The question of jobs

The government needs to look at the profile of population and profile of jobs available for the population. I mentioned in an earlier post that every economy has an ideal job profile based on education and skill levels of the population. America is losing those jobs that its people are qualified to do. They are losing these jobs thanks to uncompetitive currency, higher wages and benefits and possibly inflexible workforce (in education). This will cause further pain in the coming years.

Declining Wage profile

Just as economy has a job profile, similarly every job profile has an associated income profile based on global wages adjusting for productivity. The wages in US are higher, I believe, than global wages AFTER adjusting for productivity.  So the incomes for those jobs that americans have will not rise much or may even fall. It will stretch middle class households beyond redemption.

Volcker-Warren conundrum

At such times, America should call Volcker-Warren combine to lead the entire financial reform process.   The Warren appointment is being fought at the CFPA level itself so that it is easier to control the Warren-influence over the general Financial reforms process. I hope, rather pray, that Warren ultimately triumphs. She is the only hope in otherwise hopeless economic and political landscape. Same goes for Volcker, the ultimate Volcker rule is so watered down, I doubt Paul Volcker is really satisfied with it. It is time for leaders of America to stand up and be counted. Alas, there aren't any.

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My book "Subverting Capitalism & Democracy" is available on Amazon