Occupy Economics- Alternative to Capitalism

Nancy Folbre has a post on NY Times blog asking what is alternative to capitalism. My immediate thoughts went to "nothing is wrong with capitalism per se, it is simply today's capitalism that is the problem". However, I thought let me expand on that idea a bit and explain it in detail. So here goes.

We must look at economic systems in broader range. At one end we have law-of-jungle style systems with basic legal structure and not much else - lets call it North side*. (I don't want to use left and right as it may cause confusion). On the other we have an equitable society with perfect equality - this becomes the south side. Within such a spectrum, let us imagine a center. Usual capitalistic systems (the most perfect we had), I venture, lie to the north of such center but never to the extreme. Socialist systems lie to the south of this center and still never to the extreme.

One can debate how far North the capitalist systems are currently, or how far south are the proposed socialistic alternatives are. But best option, I believe, is to create a balance that is possible at the center. It means we need a capitalistic society that is more south than what we like or we need a socialistic society that is more north than we assume.

The point is further complicated because capitalist systems tend to move Northwards easily. Conversely, Socialistic systems tend to move southwards easily. "More of what works" seems to be driving force. It means when we adopt a capitalistic system, we must focus on adding clear, precise, boundary regulations to let markets function effectively. Conversely, if we adopt socialistic system, we must focus on deregulating regulation in spheres that can stand on its own. As a metaphor, capitalism is like an open field game (soccer) and referee must move along with the ball. Socialism is like lawn tennis, you play where referees sit. Thus, moderation is best solution.

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

Systemic faults in Capitalism & Democracy

Brief synopsis of my book "Subverting Capitalism & Democracy"

A consensus is emerging that the crisis of 2007-09 was primarily caused by following seven factors: the property bubble; explosion in debt; fragility and dominance of financial sector; weak risk assessment; monetary policy errors; saving glut in developing countries like China; and complacency and incompetence of regulators including rating agencies. The scale of the damage has been attributed to a perfect storm – a concurrent failure of all the above factors. However, we should ask why these factors emerged in the first place and why did all of them fail simultaneously. These are symptoms of a structural decay of the democracy-capitalism system. 

Finance sits at the top of the bargaining power hierarchy. Through a multi-tiered incentive structure, financiers influence virtually every aspect of corporate decision-making. The financial innovations, riding atop asset bubbles, pushed expected returns higher. It pushed the corporates to take even more risks on their balance sheets as Wall Street cheered on. High leverage, currency exposure, cross-country acquisitions, unrelated diversifications, exposure to exotic products, reduced R&D spending, experimenting with buyouts and share buybacks, etc left corporate balance sheets vulnerable. These dynamics fanned the property bubble and led to an explosion of debt. 

The concentration of power is not a design feature of the capitalist system. Our transaction-based economic system is fractal in nature and the concentration of power was simply an emergent property, an unintended result, of this fractal system. Over time, as countless transactions aggregated, the bargaining power concentrated with the financiers. Occasionally when bargaining power does aggregate with certain economic agents, the democratic set-up is supposed to provide the counter-balancing force. Governments or regulators step in to level the playing field. 

But, government waited for markets to self-regulate. To understand government behaviour, we have to view government and markets as competing systems addressing citizens’ needs. Governments create services for few and charge everyone through taxes. Markets are efficient, they charge as per usage. Hence, in good times, there is pressure on government to step back. At times, governments even abandon areas where markets are ill developed. Only in a crisis do we realise the distinction between the two. Markets are exclusive, accessible to only those who have measurable value to offer. Conversely, governments, by definition, are inclusive. Government is the right of the citizen while market is just a privilege. Naturally powers of the government supersede those gained by markets. The question therefore arises, why didn’t government use its powers? 

The root of government problems lies in the broken political system. The political system had the incentive to be silent. The cost of politics has increased. It is kept high artificially to restrict the access to political office. Naturally, the politician is now very attentive to her campaign financers. In the process voters are being denied their right. Voters choose their candidate from amongst those pre-selected by influential contributors. The voters don’t have a real choice. 

Governments, globally, have a strong election focus. The lack of genuine upper house in parliaments may have caused this short-termism. In a bicameral legislature, the role of upper house was to bring strategic focus and act as a check on the lower-house populism. Sadly, many nations have actually abolished the upper house. Where it exists, the upper house has become an instrument to repay political debts. 

The surrender of politics compromised the government and the regulatory machinery. The laws have become vague allowing room for interpretation and, consequently, rent-seeking. Laws can be compromised using, what is called, the necessary and sufficient condition problem. No matter how elaborately necessary conditions are written, there will always be a loophole. For example, imagine a case where mugging is defined as stealing at gunpoint. Gun is the necessary condition for mugging. Now if a victim is mugged at knifepoint, can the thief get away just because he used a knife instead of a gun? This is exactly what is happening in financial crimes. That mugging happened is sufficient condition. Laws must be based on sufficient conditions. We are about to make similar mistakes when developing a regulatory framework for too-big-to-fail institutions. 

The intent of the law can also be compromised within the details of the wording. No matter how finely you read the law, if the intent is compromised, the wording is meaningless. During the crisis, many financial firms have abided the law in letter and violated it in spirit. Some have even blatantly violated the law by paying an insignificant share of profits as fines. The legal system has not shown true appreciation for the intent of the laws. Hence the weakened legal system must also bear part of the blame for the crisis. 

Finally, blame for the crisis must also be allocated to the observer i.e. the media. It was the responsibility of media to explore and expose the possibility of this crisis. It is clear that media needs to be cleaned up. We must separate journalism from what is essential gossip reporting. The power of media, the access, the privileges, should be limited to journalists. We also need new business models to fund journalists. The current business models create harbour conflicts of interests similar to rating agencies. The democracy-capitalism system was envisaged as a self-preserving, counter-balancing structure protecting the interests of citizens or commoners. The factors we discussed above structurally weakened the system. This system is definitely not going last this decade. Now is the time to set it right.

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

Pricing EU break up using the Soviet breakup

Gillian Tett, my favourite columnist, recently drew parallels between Russian break-up in late 80s and a possible breakup of EU. The general lessons are critical when politicians consider the future of EU. But what I want to point out is a little different.

Today a lot of analysts talk about default of Greece being priced in. Some also say market understands the price of breakup of EU. I would like to see a paper that uses Soviet breakup of mid-80s and then draws up a scenario for EU breakup, in terms of costs, markets and general investment trends. That analysis will be more meaningful. One may deduce a milder process of EU breakup learning from the Russians.

Gillian Tett talks about some differences in institutional infrastructure. She believes presence of central banking, expertise on monetary policy etc. will stand EU in good stead. However, she points out, todays economies are far more integrated than the isolationist (my insertion) Soviets. It is possible we may be effectively pulling the rug from under our feet.

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

Euro Crisis - A of tragedy of Commons

European Union was evolved to create an unified market. It implied giving away some monetary policy control to reduce the transaction costs (or friction) in trade between Euro countries. It was understood that each country will maintain fiscal health. There were no rules of resolution in case someone didn't. All this reads like problems we encounter as tragedy of commons.

Elinor Ostrom has suggested a few issues with tragedy of commons that are directly applicable to Euro Crisis. There are a number of factors conducive to successful resource management but absent in current Euro-land.

1. One factor is the resource itself; resources with definable boundaries (e.g., land) can be preserved much more easily. Does it mean that the fiscal health should have had boundaries?
2. A second factor is resource dependence; there must be a perceptible threat of resource depletion, and it must be difficult to find substitutes. This was clearly missing - the peoples of Greece, Italy etc, I am assuming, did not believe things will come to this.
3. The third is the presence of a community; small and stable populations with a thick social network and social norms promoting conservation do better - trust. Trust is something that is missing.
4. A final condition is that there be appropriate community-based rules and procedures in place with built-in incentives for responsible use and punishments for overuse. None prescribed as yet.

Here is Elinor Ostrom explaining the tragedy of commons.

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

Future of Economics

Roger Martin's Post on challenges to Economics profession.  In response, Mark Thoma responds with economists as imagineers. Both posts make wonderful read.

Imagineering is still a long way away. Fundamental impediments to imagineering skill exists. For example, many have a narrow focus and abstract the system to solve their problem.

First part of Imagineering is Engineering, an ethic that transforms theoretical science into applied science. In engineering, the stability of system is more important and thereon you make micro changes and measure the systemic stability. Economics takes a reverse approach, you estimate micro changes based on some logic and then try and build a system that is hopefully stable.

Economics is, till now, emerging as a theoretical science. No doubt economic systems are complex, but so were all other systems till we understood them. The deterministic nature of other system is function of our understanding. Even economics is macro-deterministic but micro-indeterminate.

In the end, Mark Thoma is right to say that we are moving in the right direction.

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

Die Creditor Die!

Felix Salmon links upon Krugman V/s Summers debate. One of the central point about the current crisis is that how can we solve the problem of excess debt by taking on even more debt? I propose to answer this question. We can't!

To put it simply, what the Keynesian remedy is to offset short term debt with a far longer term debt -  reducing the annual payout while retaining the liability for substantially long period. The process works when you can replace the current creditor (one who is rather short-term focused) with a visionary long term creditor (or someone whose liabilities tend to stretch out for equally longer term). The new creditor bails out the previous one backstopping the losses. The new creditor needs a pretty strong liability that they propose to take to match this super-long term assets.

But we realize the folly in this option immediately. The new type of creditor is absent. The conditions are not exactly conducive for emergence of this very long term liability holder. A typical condition could be found at the beginning of the baby-boomer generation.

In reality the visionary long term creditor is same as one has super-long term liabilities. Invisible hand forces them into heroism we attribute to altruist nature. Americans (and recently Europeans) love to imagine China in all its altruist glory donning this role. Folly again my friends. 

But there is another way to reduce this debt. Let the creditor die. It sounds horrible but it is one way that is still available. When the creditor dies so do the obligations and then we have a clean slate.

That is precisely why banks or creditors should not become too concentrated. History is rife with example of creditors impaled by the mob or forced to surrender their rights. It is in the interest of creditors that there are many of them, at least more than 1%. Alas, we have not heeded history. Creditors beware!

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

War between Democracy and Capitalism

A few days ago Greek PM decided to take a referendum about EU bailout package. It represented an opportunity for democracy to validate capitalism. Alas pseudo-capitalists arm-twisted Greece into backing out of a momentous occasion. Today, markets are cheering, if you believe the talking heads on TV, resignation of Italian PM. I find that alarming. 

Frankly, today's EU is the theater of war between capitalism and democracy. Well, the capitalism here is pseudo-capitalism. I cannot believe why capitalism should be at logger heads with democracy. In any case, I must warn that this is all taking turn for the worse.

Any significant victory of capitalism against democracy should be, will be short-lived. The rights that create and nurture capitalism sprout from fertile bed of democracy. The problem is once capitalism tries to thwart democracy, it may have to deal with a horrible backlash - a move towards socialism. It is a situation I hate.

The world needs someone with the vision of John Pierpont Morgan who can confine some of the big-wigs in a room and talk some sense into them. Sadly, none comes to mind - the whole pack is short of ideas and, more importantly, morals.

 Apologetic plug - I discuss a possible win-win outcome in my book link below.

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

Explaining Currency Valuation

My attempts to explain currency value continue. I was thinking how we tend get caught up with mechanical determinants of currency value. One way of thinking about currency is to think about two different things. First being capability of the nation and second being a mechanism to measure it.

Capability

Capability refers to ability of the country to produce surplus benefit. I am deliberately using vague terms because what one nation construes as benefit may not be the same for others. But key term is surplus. Surplus implies the nation must produce more than it needs for subsistence. So benefit must be discretionary.

The Mechanism

The mechanism to measure it is simply numerical denominator of that value into discrete quanta. If the denominator is high, we can split the value into smaller parts - more numerous shares within the pie but size of the total pie remains the same.

Understanding the complexity of currency valuation

Imagine there are 100 units of currency and 100 widgets (all exactly the same). The equivalence is 1unit of currency for 1 widget. This is a stable version of ideal.

Let us introduce a slight complexity. Imagine, suddenly we have 200 units of currency instead of 100, the equivalence will be 2 units of currency for 1 widget. This is called inflation.

Let us bring add a little more complexity. In this, the number of widgets also keeps growing as does the currency. Now there are three scenarios. 

1. Widgets grow to 200 and currency also grows to 200. Here we have continuity in ideal situation.
2. Widgets grow to 200 currency grows only to 150. Here we have deflation.
3. Widgets only grow to 200 but currency grows to 400. This amounts to inflation.

Now imagine instead of just one type of widget we have two types of widgets. First one is food widget which is highly in demand and other is fun widget which comes after food. Now imagine if an economy produces only fun widgets and there are not enough food widgets for the population. In such case, food inflation will spike up - i.e. currency value of food widgets will grow higher and that of fun widget, naturally, will grow lower.

Now reality is far more complex. Instead of few types of widgets, we have vastly innumerable and ever expanding universe of products and services. Further, each product does not have same relative position to the universe, they keep changing. In other words its chaotic.

The question, therefore, is how to ascertain how much increase in currency is ideal. Clearly, there is no easy answer.

Cannot decipher if currency is correctly valued 

Never, and I am going out on a limb here, is a currency correctly valued as per its fundamentals. Rather, the value of currency is the opinion of select few stating that value is within ball-park. It is relatively easier to know when a currency is not in ballpark of its fundamental value.  In other words, while we cannot determine what the value of currency should be, we can be reasonably certain what it should NOT be. Any analysis beyond this is self-justification or retrofitting explanation to suit analysis.

Borrowing from Physics, currency values seem to obey something similar to the Heisenberg's Uncertainty principle. We can predict the value of any currency generally, but never exactly. And just like the Heisenberg's principle, the very act of determining the value upsets the value.

What should NOT be the value of the currency?

The key lies in looking at the "benefit" we stated earlier. "Benefit" is net of two things. On one hand, lets call it the income side, it includes the ability to produce larger number of widgets (productivity), the ability to produce wider variety of widget (innovation) and the ability to produce unique widgets (strategic advantage). On the expense side, we have committed expenditure including non-discretionary spending and part of income committed to taxes and debt repayment. Benefit, to reiterate, is net of these two things.

When we compare currencies of two nations, if the difference in benefit is largely or appreciably in favour of one, then the currency of that nation should be strong and other should be weak. Again, we cannot exactly determine the difference as discussed earlier but only generally.

About US dollar
My contention is that US Dollar is artificially high considering US economy offers no particularly differentiated benefit as compared to other economies. This is also generally true of all developed nations. That is why I am skeptical of developed economy currencies.

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

Can China become a Consumer-economy quickly?

In its latest issue The Economist says

It would hasten the reorientation of China’s economy from exports to consumer spending, give its central bank more freedom to fight inflation, and divert demand to depressed Europe and America, catalysing an essential rebalancing of the global economy.

I contend that it is not easy to create a domestic-demand focussed economy or consumer economy as we call it. In my June 2009 post titled "China domestic demand and other notes", I explained:

Creating domestic markets is not easy and does not simply happen by throwing capital. Domestic tastes and preferences, as we see in India, are lot different than we anticipated. Same logic should hold for China. It is easier to customize goods (and services like restaurant services) are easy to manage – but inflexible goods (capital goods e.g.) take long time. The changes cascade from consumer side till they reach the top end. Examples:

1. A large part of textile industry may be geared to service cotton clothes – whereas Chinese might prefer silk. (OK I simplified it a bit too much)  
2. You take milk, some producers added some hormones to aid milk production. Resulting milk was not safe for children. Now we need institutions, legal, regulatory etc that create a feedback system to discover and curb such practices. These complex frameworks anchors in democratic setup – leading us to political minefield.

If someone clarified the entrepreneurial scene – we may actually get better clues about domestic demand. Large entrepreneurial pool backed by venture funds experimenting with products and distribution is the best way to create (and an indicator for thriving or potentially thriving) domestic market.

The easiest part of domestic demand stimulus is to allow top brands to enter the domestic market and give them some price leeway through currency appreciation. Louis Vitton bags, Chanel perfumes etc will kick start domestic consumption faster.

What is a consumer economy?
I must reiterate that consumer-economy is not a simple concept. It represents a system with various parts    many contradicting the political climate in China.

Principle of Choice: Consumer economy is under-pinned by a principle of choice. The consumers get choice and their choosing creates a feedback loop that allows such preferences to be incorporated into national manufacturing and service capacities. Let me give and example.

Imagine a population that fancies, say, sour cream flavoured potato chips, but without any chips manufacturing capacity it does not yet know of it. Manufacturers must experiment with various flavours and then, by trial and error, or through research, arrive at this conclusion. This implies a cycle of investment in various flavours which gets wasted, stock outs of preferred flavours and large inventories of less preferred ones etc.

Principle of Consumer orientation: A consumer economy must necessarily be consumer oriented. I am sure you have noted the pun but people often forget this. Existence of choice necessitates competition and, hopefully, benefit of the consumer rises to the top of priority list. This seemingly simple mechanism is very difficult to implement. Milk producers can collude in using hormones or additives that may be detrimental to consumers and rival producers should feel free to expose such practices rather than cower and join forces with them.

Institutions of dispute resolution: A mechanism of choice and consumer orientation, as discussed above, leads to disputes and conflicts. A system of institution is required for resolution. Independent courts and free press are part of such institutions.

Political implications

Thus we observe the congruence between democratic principles in political systems and consumer orientation in economic systems. Both these systems feed off each other and reinforce each other. In the democratic world, we almost take this congruence for granted. It is this congruence that is critical problem for Chinese authorities. Therefore I don't believe the process of reorienting China into a consumer economy is going to be easy without corresponding political reform. But we can always wait and watch, I will be happy to be proven wrong.

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

  

Understanding the behaviour of the US Dollar

I have often written about mainstream media missing the bigger picture about the US Dollar. I always wondered how some of the astute commentators, some I respect highly, would miss the bigger picture. I have been asked why, despite my talk about US macro weakness, does the USD appreciate in times of risk aversion. I think I should take one more shot at explaining one aspect of the US Dollar issue.

Dollar behavior is aggregate of multiple forces

The US dollar is influenced by following forces:

1. Adjustment of US economic activity in terms of skill, ability and productivity of the population. 
• With rising capital intensity the minimum qualification requirements are changing. This change is not in sync with the US population in terms of availability of skill, ability and productivity. 
• I know some people will react to inclusion of productivity in the list, but careful assessment will indicate its aptness. 
• This adjustment is rather complex and will take years to play out. Thus the effect of this force, my guess is, will be rather small at the moment. However, once the realization is complete, there may be a drastic impact on the US Dollar.
• This force will augment a devaluation of US dollar.
• In geek-speak, since force is a vector, both the magnitude and direction of this force are not  manifesting itself effectively as yet. The magnitude is small and direction may be opposite to what can be expected.
2. Forces creating adjustment of prices. 
• The term price has two elements to it. First one represents the information about how relative value of goods and services stack up against each other, or simply inter-goods comparison. The Second and more relevant for us is the information about how the value of goods stack up in relation to those in other countries, or simply, price comparison between countries for similar goods. 
• My sense is that relative prices of non-food goods and services are far cheaper in developed economies than in emerging market economies (though not for all products and services). 
• As we establish clarity in this, we will see inflation in USD terms while deflation in other currencies if they let their currencies float to their natural level. However many countries have pegged currencies, particularly those with large dollar reserves. The pegging process will create inflationary forces in these countries as well. Their central banks thereafter will be forced to choose between inflation and losses on external account. It appears they will prefer losses than inflation. 
• This will be devaluing force for the US dollar.
3. Risk Aversion forcing the US Dollar denominated money to return home. 
• One of the tenets of risk aversion is that during such times investor feels safer at home, keeping money in her own currency. It is a fact that US has been biggest investor for some time now and hence risk aversion creates a demand for dollars. 
• The fact to be noted is that this is mostly private investment and hence more fickle.
• This force is supporting the US dollar.
• At the moment, this force has the right magnitude and direction to support US Dollar appreciation.
4. Subdued Capital withdrawal by those with US Dollar reserves - particularly China and Japan. 
• For reasons best known to them China and Japan have continued to pledge their support to the USD. China with nearly 3.2 trillion USD and Japan with 1.1 trillion hold considerable sway in the market. 
• Here the investments are initiated by the respective governments and thus more stable but changes can be abrupt. It is sort of a dormant volcano, if it erupts, there will be tremendous loss. Similarly, if, for any reason, any tiny bit of doubt crops up in these governments, we will see tremendous meltdown.

Interpreting US Dollar movement

It is important to know the forces above and what impact they have on the US Dollar movements. We realize that most of the devaluation forces are diffused and their magnitude is small. However, a keen investor will realize that the alignment between these forces is increasing and we may soon reach a tipping point in favor of devaluation. Further, the forces supporting the US Dollar are fickle and may reverse quite quickly.

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

A World Central Bank

An esteemed group of economists' has recommended:

the creation of an International Monetary Policy Committee composed of representatives of major central banks that will report regularly to world leaders on the aggregate consequences of individual central bank policies.

While this is still recommendatory in nature, it has pricked a few ears already. The implied loss of sovereignty is the usual contentious issue. However there are a few issues.

The global nature of banking and finance implies that regulatory and policy mechanisms be equally global. Such realities compel a kind of global cooperation that may not work without appropriate legal support. The financial system, in this regard, has become similar to international navigation, global climate or such other global systems.

The legal support, possibly in the form of treaties accepting the global policy direction, may indeed reduce the sovereign freedom a nation enjoys.

A solution, I believe, will be to create a global monetary policy with a new two-level global currency system. This system should allow the national central bankers to create a monetary policy based on  specific national requirements.

The global currency to signal confidence in national monetary policies. Each national currencies will be valued in terms of a global currency based on various factors. One of the factors will be their alignment with global monetary policy. Thus a country that has a relatively expansionary policy will see a currency devaluation. 

Such system incorporates, to my mind, the benefits of a gold based currency system while limiting (or possibly eliminating) its deflationary effects.

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

Limits to total capital in the system

One of the implication of the crisis is that there is a limit to total capital in the system. While the statement is simplistic, it has more sophisticated underpinnings. In a sense, we collectively found that there is too much capital in the system and too little stock of assets, goods, services etc (hereafter simply referred as assets and goods) to show for it.

Clearly at some point we realized that our stock of assets and goods contains too many derivatives  and too few real assets and goods. At such point the capital locked in or residing in some of these derivatives (the bad ones specifically) was under risk. Economists would call this misallocated capital. This capital should have evaporated in a true capitalist system so as to keep the Darwinian selection mechanism healthy.

Yet, what happened was transfer of this mal-investment to government and hence to public shoulders. By virtue of the fact that governments cannot be obliterated, the capital must also continue to burden us till the government sees light of the day.

Whatever the reality, the crisis does indicate a threshold for level of capital in the global economy where things are at equilibrium. The questions are many. 

How can decipher the exact amount of capital stock existing in some secular value terms? How can the world estimate the collective stock of assets and goods to correspond to this stock of capital?

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

Importance of Jobs and certainty

The recent US job report had zero new additions. In that context, I would like to discuss a briefly about importance of jobs and certainty.

Time and again I have emphasized that it is the certainty rather than specific level of income that is important objective of stimulus. Any stimulus directed elsewhere is of little significance. Thus, tax breaks, cash-for-clunkers kind of programs have little meaning as tools of stimulus. Both, as the population is aware of their limits, create an incentive to save the gains rather than kick start the consumption engine.

Jobs, specifically long term permanent jobs, are indicators of certainty of income available to the population. 

It is also possible for the economy to add transient jobs in large numbers. In other words, there would be a high turnover. Such a situation will have high uncertainty and high job creation at the same time. Thus, I presume, the impact would be similar to tax-breaks or cash-for-clunkers type of program. 

The real point of improvement of the economy will be when permanent job addition bottoms out and starts rising. At such point the consumption engine will restart sustainably. This process will happen eventually if economy is left to its own devices. The objective of stimulus is to hasten the process.

A debt-ridden economy take a little longer to reach the bottom after permanent job addition has bottomed. The time lag is explained by the debt repayment that takes place subsequent to job addition. A debt restructuring program can hasten this process. HAMP and other programs can be classified in this family.

Now intelligent readers will note that unless BOTH things happen we won't see noticeable recovery in the economy. I hope the political intelligence catches on this reality.

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

India view: Brace for flood of money

I must be sounding ridiculous but that is exactly what I expect to happen in near future. If the developed world investors are keen to retain their wealth, which they are, they will want to move to economies where conventional growth is still possible.

Conventional and unconventional growth

Conventional growth refers to well understood process of growth. In the emerging economies, we know what needs to be done. We need to build infrastructure, power plants etc. That investment will trigger efficiencies which will push EM economies on to a growth path. The history of development of the western world provides the understanding of this process and there is ample evidence as to what works and strategies for growth. This is the opportunities wealth retaining funds will eventually seek as compared to unconventional growth in developed markets.

I have argued previously that growth in developed markets will depend on two forces. The first is renewal and maintenance of infrastructure that already exists and second refers to the new kind of infrastructure and development that is essential. The new kind is uncharted territory and requires patient capital the likes we deploy in R&D. Possible candidates are Water-related infrastructure and forestation related investments. I call them Green and blue options. These investments are more of the Private equity variety than what normal funds would like.

The coming money flood in EM
The money eventually has to move to EMs before EM economies adjust their currency regimes reacting to resultant imported inflation. That implies funds will compete to reach EM shores, in all probability, creating a sharp uptick in EM equity markets.

My strategy
I am going all in as the markets decline. My focus is domestically driven revenues. It means I am avoiding Indian IT companies for strategic reasons. I find Indian consumer goods firms a bit over-valued, though I own telecom stocks as proxy for consumption story for short term. My focus is on infrastructure stocks (GVK, L&T) and banks. I am not very sure about Indian asset valuation story so I am staying away from real estate (except for occasional  short term high risk investments in Unitech which appears to be below its liquidation value). I expect the sector to start turning around when housing deals start happening on ground. I believe that should take 3-5 years at least. However, I do like Indian Hotels which, I believe to be a well managed company with sensible management. I do expect domestic auto firms (Tata Motors, Ashok Leyland and Maruti) to become big players in the coming decades and their current valuation provides a good entry point. In all above cases I am betting on liquid names and large volume stocks only.

It is possible that I am early and will need to hang on to the strategy for a little while. Let us see how things go from here.

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

Realignment: Ratings and relative risk stack

Investors think of risk associated various assets (across classes) in relative terms. We have a notional relative assessment - A is riskier than B but C is more risky than A etc. This applies to asset classes and specific assets within them. So Manhattan land parcel may be riskier than NY state debt etc.

Thus, we have a stack of assets. We can imagine this as a deck of cards that the investor carefully aligns according to their risk profiles. On one side, lets say the bottom of the deck of cards, we have less risky and they get progressively more risky as we reach the other end, i.e. the top.

The S&P ratings change signals a change in the order of this stack - sort of shuffling of the cards. Some investors believe that shuffling happened a long time ago and S&P is just highlighting it. Others believe there has been no shuffling of the deck and previous order remains valid.

In essence, each investor is making his or her own assessment. We are all on our own.

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

Answers to Barry Ritholtz's 10 questions about S&P downgrade

Barry Ritholtz asks 10 questions about S&P downgrade and I answer most of them below:

Here it goes:

1. The change in trajectory of US debt was in service of Banks: It began with TARP, and continued with every other bailout/stimulus/economic plan. What was S&P’s role in creating that crisis?

 S&P is centrally responsible. So are US regulators, banks and those crying hoarse. Let us remember there is plenty of blame to go around for GFC. 

2. How will non-US investors (Private and Central Banks) view the downgrade?

Most non-US investors already discount the news. However, investment strategies will compel some to act if another agency downgrades.  

4. What does the downgrade do to US currency — is that the true impact of the credit downgrade?

Over 5 year horizon I think USD will begin to decline. A declining dollar is in the interest of US. It will reinforce US manufacturing. Immediately, though, flight to cash and commodities seem to be possible options.  

5. Will borrowing costs likely increase for the US? What about consumers?

Borrowing costs for US entities will increase. I suspect the ability to pass on these cost to consumers will remain under pressure. Consumer rates, after accounting for all adjustments, a quite high. It will impact borrowing cost of investors, leverage will be difficult to come by.   

8. Why did the rating agency not wait until the special committee / debt ceiling deal was completed later this year?

I think the rating rationale was more political than financial – more related to “willingness to pay” rather than “ability to pay”. The debt committee would have done more related to “ability to pay”. The statements by politicians about “debt ceiling debates hereafter should be conducted this way”, “maybe default is a good option” etc. makes one really skeptical of US governance. You see such things in banana republics not US – definitely not a behaviour of AAA rated sovereign. 

9. The Rating Agencies were downgraded by Dodd-Frank, with all regulatory and legal references to be removed. Was S&P’s move retaliatory?

I don’t think so.  

10. How will US markets open on Monday in response to the downgrade?

Move to cash and commodities could be a good idea to bet on. Though one can never be adequately sure. 

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

Impact of the US Rating downgrade

The rumours of a downgrade had started during US trading hours, but the actual S&P announcement came post market hours, so Friday's market closing does not reflect the ratings impact.

Immediate impact - is it the last straw?

With concerns on US growth slowdown and EU debt crisis already troubling markets, this is another nail in the coffin. The immediate reaction should be negative: equities sell off, commodities fall, bond yields rally, dollar weakens, safe haven assets (gold, CHF, JPY) appreciate. However, it is not clear if this impact will persist beyond the near term.

On bond yields 

Some are arguing that since it was well known that the US would get downgraded, this is priced in and that there may not be much lasting impact. Moreover, Moody's and Fitch still have the US at AAA for now. Analysis of the impact of past rating downgrade of other countries on their long-term yields has shown that yields rose in the days before the downgrade and then either fell or were unchanged after the actual downgrade.

Over a few years, one can expect yields to trend upwards, till the US regains its AAA ratings. If the situation deteriorates further, there is likely to be sustained uptrend in the bond yields.

Money moving out of US treasuries
The US downgrade raises two medium-term issues with respect to money movement.

First, the downgrade will accelerate the already ongoing trend of reserve diversification away from the US dollar. Confidence in dollar's reserve status will be tested by the markets. This may be a slow moving process or in the worst case scenario, this can trigger panic reaction.

Second, some funds may start taking money out of US as they are mandated to invest in AAA only. However, a lot of funds rely on ratings of two agencies and not just one, so this effect may be more prominent if one other ratings agency follows S&P.

Further, the question remains, where will they invest? None of the other AAA rated countries have the size and liquidity that the US markets offer. Norway, Singapore, Australia, Sweden are some of the AAA rated countries where investors could flock and put pressure on their currencies to appreciate. 

In such a scenario, people expect this money to move in emerging markets through a diversified investment approach. Thus, post the initial risk aversion shock, they expect EM markets to show positive reaction over the medium term. I do not agree with this. There is no reason to trust Indian or other treasuries over US treasuries.

I think people may shift into commodities. Commodities will start acting like stores of value. Thus, we will see an increase in commodity prices. This will adversely impact EM inflation leading to weakness in EM. EM central banks will be forced to revalue their currencies with respect to USD, triggering the realignment process.

In sum
A lot depends on whether beyond the near-term negative reaction, there is further panic or sanity prevails at some point.

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

Who is rich?

How do we determine which nation is richer? Normally, we use metrics like GDP, GDP per capita etc. By many metrics the west and developed countries are rich. But are they really rich? I am not sure.

We evaluate wealth or richness at a point in time. As a concept, we have create this utopian set of goods and services that the richest nation must ideally consume. This rich consumption basket includes high quality healthcare, regular electricity supply, cars and automobiles etc. In other words, this basket comprises necessities and comforts. We measure how much a nation needs to spend to achieve this utopian consumption basket, how much it earns and that difference gives us how rich it is.

I disagree.

Let us imagine a nation of chronically ill people. The median income in this nation is 100 units. However, their illness implies that they require 110 units for consumption - 10 units for their needs and 100 units for medications. Now since all the other nations earn a maximum of 20 units, we can say this nation is rich. But other nations are healthy and they only need 10 units - they save 10 units of their earnings. In this case, the other nations are actually richer. Very simply, a nation of savers should be richer than nation of borrowers.

I think at all times, we should be net savers, in high investment phase, the level may be low or nearly zero with positive bias. I think a nation of savers has the option to stop consuming comfort goods while those who borrow set in motion a negative spiral that reduces jobs, hence consumption potential of both comforts and necessities. Importantly, it impairs repayment potential. It is difficult to initiate a turn around.

Asset ownership and dispersion - median asset ownership

Another aspect of debate is asset ownership dispersion as against asset ownership alone. This works just like employment intensity. The more dispersed the asset ownership within the country richer the country. Ideally, median household asset ownership makes more sense. If we look at asset ownership of household and find income generating assets then the country is definitely richer. These could be, saving deposits, equity shares (positive on MTM or yielding reasonable dividends), house that can be rented (fully paid up or rent greater than mortgage payment), vehicles for hire, etc. The consumption goods are TV, computer (used as consumption good rather than income generating asset), vehicle (personal use - not for hire), etc. These consumption goods should be expensed rather than be treated as assets.

Thus, a nation that has higher net assets (total assets less debt) at a median level should be richer.

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

Challenges of Journalism (chapter from my book)

The recent News of the World scandal left me dejected. The rot in media has reached epidemic proportions. 

Amongst all the institutions in a democracy, media has the most powerful role. It is not a pillar of democracy without reason. It is an active observer of the world. It is, to a degree, omnipresent. Therefore, it often acts as eyes and ears of the law enforcement setup. Media is not impartial. It is partial to the public interest and public interest alone. But the foremost role of media is in its ability to view the world through the changing social lens. It has the power and knowledge to debate the changing values and, to a certain degree, influence the course of the society. It is unfortunate that media has failed us.

The revival of journalism must start with examination of its shortcomings. The very definition of journalist is no longer clear.

Who is a journalist?

Journalist clearly does not refer to employees of media institutions. It would be unfortunate to call celebrity experts as journalists. (The term celebrity expert refers to those people who specialise in affairs and the private life of celebrities. It does not refer to experts who are celebrities.) Neither should sports reporters be called journalists. In today’s context, some of the real journalists are simply bloggers. It was never more important to define journalists than today. Journalist should be defined as agent who furthers the principles of the democratic system we discussed earlier. Only journalists should be allowed the privileges embedded in the democratic setup. Thus, in my view, News of the World should not get journalistic priviledges. It should be treated differently. 

Social connectedness of journalists

The degree of separation between journalists and any individual should be as low as possible. It should be closer to one. Unfortunately, the journalists of today are no longer connected to individuals and their issues. That is why we need celebrities to further genuine causes like planting trees etc. It is imperative that journalists go closer to the individuals and communities.

Focus on speed

The other factor ailing journalism is the focus on speed. That takes away any opportunity for in-depth analysis. Top newspapers are shifting to a two-step approach, journalists usually report the facts on the ground and the section editor thereafter goes through with in-depth analysis.

This model is well developed in financial media. There, providers like Bloomberg, Reuters provide data at varying frequency while the teams of analysts from various brokerages analyze the data and provide the expert perspective.

While I understand the motivation behind this setup, I think it is inadequate. Journalists, in certain cases, operate more like detectives and there is nothing to replace real evidence. Even financial analysts regularly meet with companies and validate the information they receive from data sources.

Further, journalists are more than detectives. They have to sniff out stories where there is no report of a crime. This requires, what experts call, “nose for the job”. The depth of journalism, at least in such analytical stories, suffers to a great extent.

Journalists need an aggregator of facts

In the context of current problems, media should at least function as an aggregator of facts and data. Here we refer to media as separate from journalism. The journalists, even if external to such organisations, may be able to mine the data and evolve their analysis. These facts, once established, should be available in public domain. It should be possible to augment and improve them through subsequent fact-finding missions by other media employees.

Journalists, in such a scenario, are moving away from traditional media hierarchy. We need to create recognition for this new breed of journalists.

Problem of continuity

Journalism requires longer follow-ups, particularly for important issues like WTO negotiations, carbon emissions, financial crisis etc. As the events continue to unfold the scope, severity and depth of investigation and understanding changes. Journalists today, are not able to follow through with their stories. In a way, it is easy to follow the scandals of top sportsman or politicians. However, the important debates, related to US healthcare, foreign policies etc, are very difficult to follow.

Popular bloggers, with their subject focus, are able to do a better job at following stories with arguments as commentary. The quality of discussion is enriched. It is probably the reason why top journalists now have their own blogs.

Imperatives

It is critical to design a system where journalists are able to work for the democratic system and further its goal. The system should start by redefining what journalism is supposed to be at its core. Such a system may be actually evolving as a network of bloggers, but it needs to be nurtured and expanded. Further, the current model of subsidising journalists with revenues from corporates or entertainment will not be enough to sustain this key pillar of democracy.

From my book Subverting Capitalism and Democracy - chapter titled Challenges of Journalism

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

Global Realignment of Economic Power

Just days before I was thinking how this feels like pre-Bear Sterns days and today Yves Smith has a post titled Shades of 2007. It indeed does feel like it. In a way, there is nothing new. We know how it will end.

However, I fear there is more coming. Something more interesting that we haven't really thought about.

I believe, soon we should enter an era of realignment of economic power. We tend to believe the west is generally rich. But it may soon change. As the screws of austerity will tighten across EU and even the US, the developed world may realize that they are not so rich after all.

To say that such a realignment will be challenging will be an understatement. We will have to evaluate the correct value of each currency, rework the location of manufacturing capacities and realize that the savers of the world will be real demand drivers of global consumption. The process is likely to take 2-3 decades or more.

The question that consumes me, how should we preserve and increase our wealth?

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