Tuesday, February 25, 2020

Storm over Trump nominee for Fed Governor, Judy Shelton

Shelton the charlatan, wrote economist Bradford de Long. Shel-no, commented the Economist. This is no way to run a central bank, pontificated the New York Times.

When the establishment gangs up against somebody as solidly as it has done in the case of Judy Shelton, one of two individuals nominated for Fed Governor by President Trump, you begin to suspect there must be something faintly right about her.

Shelton is not an economist. She has a doctorate in business administration. She was appointed Executive Director to the EBRD by President Trump. She was written extensively on economic matters- and quite well, I might add.

What do Shelton's critics have against her? They say she has in the past favoured a return to the gold standard- this makes her seem archaic. They argue that she has changed her views on the Fed's policies several times. She was against monetary loosening a few years ago. Today she favours loosening. She was opposed to the Fed supporting stock prices a few years ago. Now she wants the Fed to do just that.

Well, it's been pointed out that Ben Bernanke himself has spoken favourably about the gold standard at one point. Policy prescriptions can change as economic conditions change. It's not clear that these are sufficiently strong arguments against a nominee for the Fed.

No, the reason that many in the establishment are up in arms against Shelton is that she has challenged a key tenet of the establishment, namely, central bank independence. Shelton has said:
How can a dozen, slightly less than a dozen, people meeting eight times a year, decide what the cost of capital should be versus some kind of organically, market supply determined rate?. We might as well resurrect Gosplan ( the agency of the Soviet government that ran its economy.). 
You can see what gets the goat of the technocratic elite that runs our financial system.

Central bank independence, at the very least, means that monetary policy is set by technocrats insulated from political interference. The idea is that politicians are driven by short-term considerations, such as winning elections, whereas technocrats can afford to take the long view.

Well, maybe, maybe not. Technocrats do have political leanings and loyalties and may want to tailor monetary policy to favour a particular party at election time. Leaving aside voting preferences, central bankers do have views that are politically important. They may favour low interest rates and how stock prices because they have had links with financial firms (or want to hop on to cushy posts in financial firms after they retire). There is nothing apolitical about decisions on money supply.

Money is a public good. And banks, because they enjoy the public safety net, have a public dimension to themselves. The supply of money and the stability of banking are matters that involve the larger public good. Is there any reason why these matters should not be subject to political direction when most other matters in the public realm are? In other words, has the time not come to democratize central banking especially when the track record of central bankers before and after the global financial crisis has not exactly been exemplary?

Many are asking these questions. Shelton's problem is that she asks these questions and wants to get on to the board of Fed.

Wednesday, February 19, 2020

World Bank chief economist departure

I guess I picked this up a little late... the World Bank's chief economist Penny Goldberg, who's from Yale, is quitting.

While the departure was reported to be over the Bank's decision not to publish a paper produced by its research department, the precise details were not know. The FT today  enlightens us on the subject.

The paper, authored by a World Bank staffer and two academics, was about how aid given by the Bank to countries was creamed off by the elite. This is hardly a secret. But for the Bank to substantiate the point with research is clearly to too hot for the Bank's top brass and its principal shareholders.

The link I have provided gives the details of the research paper. The authors looked at aid flows to 22 most aid-dependent countries, flows from those countries to tax havens and also flows from those countries to non-tax havens. They found that periods of large aid flows to a country also saw large flows from the country to a tax haven. At the same time, there was no such surge in flows to non-tax havens.

This is not conclusive proof of the aid being creamed off but it's also not evidence that you can shrug off. The study estimates that 7.5 per cent of the aid leaks out. That may not take away the case for aid to the country- there's still a large portion that could benefit the people there. But it's clearly embarrassing for the Bank to accept that it is abetting corruption in aid-receiving countries. Also, there could be political reasons for the Bank's principal donors to keep the dominant elites in some countries happy.

Goldberg's departure follows the departure in2018 of David Romer following a quarrel over the use of some statistical methods. One should not be surprised if this causes top economists to think twice about spending time at the Bank.

Sunday, February 16, 2020

Goldman Sachs woes

Goldman Sachs, prima donna among investment banks and once the darling of investors, is today a laggard in stock performance, the Economist says.  A dollar invested in Goldman in 2010 would today be worth just $1.60; the same dollar invested in the S& 500 would be worth $3.60.

Investment banks produced higher returns in the past than commercial banks. Today, J P Morgan Chase earns a return on equity of 19 per cent whereas Goldman earns only 11 per cent.

Well, one should not get carried away by the example of J P Morgan; banks in Europe and many in the US produce a return on equity of less than 10 per cent. Goldman's performance is still good but it's not the star it used to be.

One reason, as the Economist points out, is that trading, which typically produced the lion's share of profit for investment banks, today requires far more capital than before, thanks to tighter regulations. It isn't just that. One imagines Goldman would be subject to restrictions on proprietary trading under the Dodd Frank Act. Proprietary trading is where Goldman used to make enormous profit. Moreover, a bank with a strong retail franchise, such as JP Morgan Chase, would have greater access to lower cost funding the form of retail deposits than Goldman.

Goldman is trying to boost returns by trying to expand its consumer finance arm with the help of technology. This is useful but it has its limits: you need a solid branch network to reach out to retail customers, digital alone won't be enough. Another response could be to reduce dependence on trading profit and to try to boost fee income through more debt and equity placements, advisory services, etc.

A fundamental problem for firms such as Goldman is the culture of high pay and bonuses. Despite falling returns, investment banks have been loath to cut back on pay. Until this changes, it may be difficult for them to boost shareholder returns significantly.

Saturday, February 15, 2020

LIC disinvestment is not a great idea

The FM's announcement in the budget about LIC going in for an IPO was roundly cheered by market analysts. Apart from the fact that it is intended to fetch Rs 90,000 crore in revenues to a cash-strapped government, analysts lauded the move saying it would lead to greater transparency and improved governance.

Now, 'transparency' and 'better governance' are things it's hard to argue with. However, it's worth remembering that these are not ends in themselves. In the context of a commercial institution, they are meant to result in better performance and outcomes.

The case for an IPO at LIC must, therefore, be that it's under-performing at the moment and that an IPO would result in better performance. This is simply not true. LIC is an outstanding performer, judged by any criteria one would like to apply to an insurance company. The entry of private companies into insurance, far from undermining LIC, has led to a surge in sales volumes. LIC still commands 70 per cent of the market for insurance premiums. It offers returns on annuities that hardly anybody in the market can match. And it is financially sound.

LIC has achieved these outcomes while performing a larger social role. It intervenes to support the markets where required. It is a big investor in public sector banks and is now the majority shareholder in IDBI Bank. It has a terrific reach in the yet under-served rural areas. LIC's social role has not   come in the way of commercial performance.

There's no case, therefore, for LIC being listed on the exchanges at this point- you can't seriously say that listing is necessary in order to improve outcomes. What listing would do is call into question the larger social role that LIC performs. We still need an institution that can support the market given the fickleness of foreign investors. Until a measure of stability returns to the banking system, it would not be wise to list LIC as retail and institutional shareholders could challenge its socially-driven actions as inimical to shareholder interest.

The only reason for listing LIC is that it will fetch enormous revenues for the government. That's not a good enough reason for an institution as vital and vibrant as LIC.

The good news is that listing LIC would require parliament to amend the LIC Act. LIC unions are opposing the move. Valuation of LIC and other steps required for listing would take a couple of years, so it's unlikely that the listing will happen in FY 2020-21.

Frontline carries a good article on the subject.

Friday, February 14, 2020

The bombing of Dresden

On February 13, 1945, as war against Germany was nearing its end, 800 Allied bombers mounted a raid on the Germany city of Dresden at around 10 pm.The next wave came at mid-night. The third one came the next morning. Three raids in the space of fourteen hours. The city was reduced to rubble. A firestorm swept through the city.

The casualties are a matter of dispute. The controversial British historian David Irving  claimed that as many as 200,000 could have died. Official estimates are closer to 25,000. It was hard to estimate casualties because the city had had an enormous influx of refugees who were fleeing the Soviet  army advance to the East.

Dresden was thought to have little importance as a military or industrial centre. Its claim to fame was more as a cultural centre. Many writers have contended that the intention was to terrorise the German population and force a surrender on the Hitler regime that was still putting up a tenacious fight. Some have called it a war crime. Others say that there was military objective, which was to disrupt communications in the region and prevent the flow of troops to the Eastern front.

Dresden was not unique in the savage treatment it had received. Berlin, Hamburg, Tokyo and other cities were severely bombed.  Then, we have the nuclear bombs dropped on Hiroshima and Nagasaki. Nevertheless, the bombing of Dresden will be forever remembered as a symbol of the savagery of World War II. Here is one appraisal of the event and here is another.

Fiscal deficit target is now a mirage

The fiscal deficit target of 3 per cent of gdp was supposed to be met by March 2008. It won't be met by March 2023!

Several amendments and an 'escape clause' built into the FRBM Act in recent years has made it possible for successive governments to avoid meeting the target.

Is there an answer? I'm afraid not. We will keep muddling along until a global recovery helps improve the chances of meeting the target.

More in my BS article, Missing fiscal deficit target is in Budget DNA.

Monday, February 10, 2020

Clayton Christensen

Clayton Christensen, the Harvard professor who popularised the idea of 'disruptive innovation', passed away recently. Schumpeter pays him a in tribute in the Economist.

Schumpeter explains Christensen's contribution:

In a nutshell, Mr Christensen’s insight was that it is not stupidity that prevents great firms from foreseeing disruption but rather their supreme rationality. They do “the right thing”, focusing on better products for their best and most profitable clients, often to the point of over-engineering (how many Mach and Fusion blades does a chin need?). But that is “the wrong thing” if it blinds them to the threat from poorly capitalised upstarts offering cheaper stuff in markets too obscure to worry about. Such threats can swiftly turn existential if the rivals move upmarket and go for the jugular.

I am not sure that great firms focus merely on "better products for their best and most profitable clients". They are also trying to grab market share by reducing costs and the prices of their products. Take banks, for instance. When they manage to increase the proportion of low cost deposits in their liabilities, banks compete for the best companies and retail borrowers on price.

Secondly, the idea that companies are trying to improve their products without seeing challenges emerging from altogether new ways of satisfying the customer is not all new. Peter Drucker spoke about it long ago and Theodore Levitt elaborated on the same theme in his paper on 'Marketing Myopia'.

It may well be that, in the era of the Internet, Christensen's idea caught the imagination of large companies in a way that Drucker and Levitt had not. So, as Schumpeter points out, big firms have moved to buy up challengers as Google did with YouTube and Facebook with WhatsApp. But the idea that, in a market economy, upstarts are forever dislodging entrenched giants is an old one. As Schumpeter points out, disruptive innovation merely builds on Joseph Schumpeter's idea of 'creative destruction'.

Thursday, February 06, 2020

Budget 2020-21

The positive in the budget is that government capital expenditure will be 1.8 per cent of gdp, higher than the average of 1.6 per cent we have seen in recent years.

The fiscal deficit target of 3.5 per cent of gdp is unlikely to be met. Disinvestment and telecom revenues are likely to fall short. No provision has been made for bank recapitalisation, my guess is some amount will be required. Expect fiscal deficit to end up at around 3.7 per cent of gdp.

None of the structural reforms mentioned in the Economic Survey have been addressed. There's no overhaul of governance in public sector banks, no mention of a Temaske-like entity for PSUs. ( I happen to think the latter is unrealistic in our situation). Status quo on land acquistion, labour laws.

There's more focus on specific projects in mission modes. That's where the PM excels, a prime example being Swaccha Bharat. Better to focus on projects that can make an impact on the ground instead of expecting a miracle on the macroeconomic front.

My detailed analysis in the Hindu of Feb 2.