It happened!

The Federal Reserve lifted the federal funds rate by 25 basis points today - the first in almost a decade. Congratulations. Good job. Right decision. 

Zigzag Fed!

I am really starting to doubt the credibility of the members of the Federal Reserve. Every serious policy maker should have known and did know that China was overheating this year, especially their stock markets. And predictably, the Chinese stock markets took a severe hit this year. And everyone should have known that such a hit in the Chinese stock markets would expose the excesses and balance sheet weaknesses in their state-owned enterprises. But all along, the heads at the Federal Reserve kept saying that any slowdown in China will not impact the United States’ economy in a significant way – and thereby, given their “reasonable confidence” in inflation and growth projections are met, they would start the normalization of interest rates starting from this year.

China took a hit. Emerging markets started showing signs of slowdown as a result. But this shouldn’t impact the US economy in any significant way, right – as per the Fed? But no! It does suddenly. Now the slowdown in China is dragging global growth down. And now that weakness in global growth has started to impact the inflation and growth projections for the US economy – and this is as per the Fed. Wow! I would have expected such a sudden shift in fundamentals from an under-grad student, but not from the world’s most powerful central bankers.

To make matters worse, different FOMC (Federal Open Market Committee) members come on different TV channels on different days and espouse different policy proposals for the near term monetary policy. Such a confusion and non-alignment in what should have rather been a consensus by now begs one to wonder if the world’s economy is safe with these experts. And by the world’s economy, I literally mean each and every world citizen who has any form of monetary wealth - as the decision by these monetary policy makers has a potential to impact everyone.

The Fed says that they are data dependent, but no amount of data seems to be enough for them to come to a conclusion or a consensus. If they need the data until a day before they make a decision to increase the fed funds rate by 25 basis points (0.25%) to be in sync with their “reasonably confident” projections, then there is something terribly wrong here. Either the data that they are looking at it is not accurate or their communication skills are terrible.

The point is – the Fed doesn’t know where the full employment is. They cannot understand why the core inflation hasn’t picked up even after the unemployment has fallen significantly. To an extent, they correctly blame the lack of fiscal policy support from the US Congress, but beyond that, their mystifying zigzag communication (and probably understanding) is very much disconcerting for a participant in the economy like me, who is just an ordinary person looking forward for a stable global financial growth. 

Infrastructure, not interest rates!

In the US, currently, inflation is very low (atleast as per the official data) and has remained and is expected to remain low for a considerable amount of time. And so some, like the Federal Reserve Bank of Minneapolis president Narayana Kocherlakota, have called for further easing of monetary stimulus. They even argue for a negative interest rate in the US, meaning, pushing the federal funds rate below the 0% bound (check this link). And with all due respect, I have to disagree with this proposal.

First of all, let’s take a look at the global economy today. The United States’ economy, in all parameters, has considerably rebounded from the recession era lows (not just the stock market – which has had a massive bull run for the past 6 years - but the real mainstream economy itself, has rebounded nicely).  In the last two years especially, the job market has been relatively healthy and quite resilient. Consumer spending has grown. Consumer confidence in the economy has grown. Services industry has grown. Manufacturing rebounded nicely last year, but has been quite badly hit this year (due to a stronger dollar and weak global growth – and I will get to it in a minute). All this happened at a zero bound interest rate setting. But was that the only factor that spurred growth? Absolutely not!  

As much as the monetary stimulus was effective, an equally important factor for the growth in the last 6 years was China. China’s fiscal stimulus was a boon to a large part of the world. Countries from Australia to Brazil, Thailand to South Africa, Japan to Russia, Indonesia to Switzerland and many more profited from the immense investments that took place in China. These investments not only contributed to higher commodity prices – which made nations like Saudi Arabia immensely rich in forex reserves – but also increased the sheer number of Chinese middle class consumers – whose purchasing power was a boon to many - like the Swiss watch makers and German car makers. So the global economy itself largely benefited from these investments in China, and that had a positive effect on the United States as well. Along with all these positives, a lot of mistakes were done (in terms of quality, size and credit) in these investments in China – for which China is paying a price now. And not just China, the world itself is paying a price now – not because China overdid things, but rather because the world under-did things. In other words, the major factor that is holding back global growth today is a lack of capital investments globally. What China overdid, was underdone by the rest of the nations.

Now this gets us back to the negative interest rate. Do we need it? In my opinion, no! – because the root of this problem goes back to a sudden slowdown in the Chinese economy. Naturally, the Chinese economy overheated and is going through a cooling phase. And along with it, all the nations that benefited from the Chinese super-growth story are going through the slowdown as well. During this phase, China is also, rightly, going through a transformation to shift its economy’s over-reliance on manufacturing, export and investment-led model to a decent reliance on consumer-driven, more services and innovation-based model. But this will take time. As a close observer of global finance, I have no doubt in my mind that China will ultimately be successful in this transition. But I have also no doubt in my mind that China will make a lot of mistakes during this transition phase – mainly due to their inexperience, and not necessarily inability, in managing such a heavy transition in such a massive economy.

A negative interest rate in US will do nothing more than provide a cushion, to a certain extent only, for currency instability in China and other emerging markets. But barring that small advantage, the negative interest rate will only lift up asset prices globally – which again goes to this thinking of monetary strategists that – if asset prices go up, consumers will feel more confident to spend and this in itself will provide a boost to the economy. But what kind of boost is that? A boost given by artificial demand! I call it “artificial” because the consumers will be forced to make use of their money even when they would have preferred to save. Such a strategy severely distorts the global supply & demand, investments, free markets and asset prices. We followed such a strategy at the depth of the global recession – as a temporary and a priority measure to reboot the economy and create sufficient demand. But we are well past that phase now. Repeating that again and again will only set us up for a long term pain through distorted capital flows and more recessions or setbacks.

Money is still cheap. That is not the problem here. It’s the application of money that is the problem. Where do we apply the cheap money available? Can we start with worker training /skill training programs? Or can we start with more affordable housing for the poor that would reduce their rent burden? Can we start with putting more money in the hands of families with children that will reduce their child care costs? Or can we resolve the immigration problem that will help lift business investments and thereby demand? Can we start with reducing the health care costs of middle-income and poor families by transferring some of the wasteful agricultural subsidies into the health care and medical research sectors? Or at the very least, can we employ the thousands of unemployed without a college degree by repairing and improving the transportation and sanitation infrastructure?

It all boils down to two words – “capital investments” or "fiscal stimulus" – not just in US, but also in countries like India, Indonesia, nations in Africa etc. (especially by commodity importing countries - now that commodity prices are so cheap). That is the right kind of stimulus needed now, not negative interest rates, to push the global economic growth to a higher and more sustainable trajectory. 

Donald Trump – the 1980’s man?

So I have been following Donald Trump a little and honestly, I liked the way he kicked back everyone who made fun of him as a clown, joker etc. Today, those same people in the media are just frightened of his rise and have toned down their commentary on him – and this was clearly fun and exciting to watch. Almost everyone who joked about him, not in the distant past, are now clearly shocked in the way he has gathered momentum.

And initially, I liked how Donald Trump was able to identify key issues that have affected the growth of the middle class in the US negatively – particularly, the trade deals with different countries. For example, no one can argue that the Chinese currency wasn’t a factor that affected the US manufacturing industry over the past decade (though I have a slightly different take and don’t blame China completely for every manufacturing job lost in the US – more importantly, I believe it was a direct consequence of the global free trade campaign that was kick-started by the US and other western powers to find and open new markets across the globe – a consequence which has been negative for many, but has been very positive for many many more people across the globe – including many in the US middle class).

But there is no question that trade over the past decade with a country like China, which pegged/manipulated and today manages the currency through heavy government intervention, has severely distorted the flow of capital across the globe. It has also resulted in sudden seismic changes for which the US middle class and frankly, many middle and lower-income groups across the world were not ready. All this created severe stress in the financial growth of the middle class in the US and many other western countries.

But all this said, is Donald Trump’s plan to charge a tariff on all products imported from China or for that matter from Mexico – a country which by the way has a cost advantage to manufacture products there purely from a standard of living standpoint (and probably less regulations) – the right way to go?

Mr. Trump says that he would charge 35% import tariff on all products manufactured in Mexico and shipped into the United States. As wonderful that this might seem, the simple fact is that the World Trade Organization, for which both the US and Mexico are party to, will simply rule this tariff as protectionist and probably as against the accepted rules – thereby opening the window for Mexico and other countries that trade with the US to slap countervailing duties and tariffs on all products shipped from the US – and for that matter, WTO, as far as I know, allows a broad range of options to impose countervailing duties and other protectionist measures that can seriously cripple American industries trying to capture a share of the market in these economically important nations.

It might be true that in any protectionist or trade war, China, Mexico and other such countries might stand to lose more than the US – but I don’t think we are on a war as to who would lose more, but instead on a co-operation as to how much would each make more. Mr. Trump’s policies are like taking the clock back to the past – when all seemed well and good. But that was also a time when China was still a very poor country, India was not open for business at all and the Euro currency did not exist. And so much more has since happened in the last few decades. Who would have expected that American companies can sell millions of phones, clothes, cars, heavy equipment, technology etc. to a country like India, or a country like China? Who would have expected the capitalist American middle class to more than double their investments within half a decade by investing in the communist China? Who would have expected that American shoes and German cars will be exported to Africans when all that was expected at some point in time in the past was an import of an African disease?

And who would now expect to reverse all this progress by starting a trade war through protectionist measures such as import tariffs? Not me and not the people who understand the basics of free market economics.

Obviously, there are heavy distortions in the world economy today – the capital controls and currency manipulation in China is a case in point (or) the delay in opening up of some sectors in India is a another example (or) the presence of a cartel that tries to control and manipulate the prices of oil globally..and I can go on and on. But how we address these issues is as important as these issues itself.

When Adam Smith, the great free-market Scot, repeatedly advised the British government in the 18^th century that trade with the East Indies (India) would be much preferable and would in fact create more wealth to Britain than the mercantilist policies followed by the Great Britain in East Indies, the British didn’t seem to listen. Ultimately, the British did create a lot of wealth by expanding their colonization and mercantilist policies, but that came at what cost is a question that should be in everyone’s minds – especially when the same (and probably more) could have been achieved through just using the principles of free market theory and trading with all these “colonies”.

Likewise, though Mr. Trump identifies the issues in hand correctly, his solutions make one ask – “at what cost?”

Devaluation of the Renminbi

On April 9^th of this year, I wrote in this blog that the Chinese stock markets were going crazy by reaching new peaks every day and that it was better to get out of Chinese stocks. In the months that followed, the stock markets in China took a hit and lost more than 50% of its value – in fact, the declining trend was put to a pause only because of the aggressive interference by the Chinese government (there are still thousands of companies whose trading is yet to resume after the Chinese regulators halted them).

Today, the Chinese government shocked (or should I say annoyed) the global financial markets by devaluing its currency, Renminbi, by 1.9% against the US dollar and other major currencies. I was not shocked. This move by the Chinese made a lot of people in the US and other parts of the world who trade with China angry complaining that this devaluation was giving an unfair advantage to Chinese exports. It did not make me angry, though I felt a little sense of “missed opportunity”.

The Chinese authorities set a reference rate every day for the renminbi against the US dollar and other major currencies – and allow the currency to trade within a band of 2% from that reference rate (plus or minus 2%). In currency markets, they call this as “managed float” of a currency. It has to be noted that the band was much less than 2% years ago and over the course of the years, China has increased the trading band to 2% with the reference rate as the mid-point.

I, as most people, would like to see the renminbi to freely float. And I, as most people, would like to see the renminbi appreciate in value rather than depreciate in value (given China’s account surpluses, it is only natural to expect the renminbi to appreciate over the long run to a more stable and fair value). But all that said, today’s devaluation of the renminbi has caused over reaction in the markets and among policy makers, people and politicians.

In the recent past, I have advocated for a stronger renminbi through interference in the markets – a.k.a currency manipulation. The reason for that is that I am counting on China in the years and decades to come to create a global engine of consumer-driven growth. And in many respects, it is time for China to start taking up that role – given their account surpluses, forex reserves, state investments plateauing and their massive population. But what I am talking about is a significant re-structuring of the economy that would initially slow down the growth by a significant margin before picking up steam. And that requires enormous political will in a communist nation. Today’s action made it clear that the government is not ready yet to go through that tough road of re-structuring. Fine, that’s ok, but I am atleast expecting that they would take the smooth road of re-structuring – which they seem to be. In other words, if I have to wait for the renminbi to depreciate first before it starts appreciating, then I am ready to do that – provided there won’t be any artificial hindrance to its appreciation when the time comes.

Other than that, all the hue and cry about today’s action by the Chinese monetary authorities to devalue the renminbi is not warranted, in my opinion. Everyone demands China to float their currency freely (and I do too, though I am okay with a managed float during extreme volatility) and if China had indeed freely floated their currency, we would have seen the renminbi to depreciate far more in value this year than the 1.9% that the authorities devalued there. The Chinese economy has been doing terribly this year, there has been an exodus of foreign money from stock markets – and all this should have dented the renminbi to a significant extent (well above the 1.9% devalued today) even if it were left to market forces. Instead the renminbi stayed stronger than the market would have priced it because the renminbi tracked the strengthening US dollar throughout this year.

One significant change that the Chinese authorities did today is to start taking the previous day’s final value of the renminbi into their calculation rather than the previous day’s reference rate to set the next day’s reference rate. This is akin to dancing with the markets in the direction the markets take the currency’s value. In my mind, this is a significant and a positive change in the way the “managed-float” of the renminbi is carried out on a daily basis. If China had followed this methodology from the start of this year, we would have seen the renminbi depreciate by 1.9% (or even more) by now – albeit that would have been a gradual depreciation rather than today’s sudden devaluation.

What is important for the US and other trading partners of China is not to complain about their actions today, but rather to welcome it and make sure that China follows the same methodology even during times when the market forces pull the currency in the opposite direction (when the renminbi is supposed to appreciate). And the US and other trading countries should also put pressure on China to gradually increase the trading band to 3% or more instead of the 2% that they currently have (and make sure that China actually allows the value of its currency to reach the upper and lower limits of the band if the supply and demand requires it to).The pressure could also be put to eliminate other forms of capital control that China currently has in place. 

And by the way, on a different issue, as long as China maintains a trading band for its currency on a daily basis, the renminbi should NOT be added to the basket of reserve currency list by the International Monetary Fund. 

Hillary’s Capital Gains Tax

Hillary Clinton wants to increase capital gains on the top 1% income earners. And I am in full agreement with that. But I disagree with the way she wants to do it. She is currently proposing a sliding scale for capital gains tax for the top 1% (joint filers earning approximately more than $450,000) and the scale itself will be based on the number of years a person is invested in an investment. She says that she wants to discourage “short-termism” – where investments like equities are bought and sold within a shorter term (of less than a year) and would instead want to encourage long-term investments (something like a buy and hold strategy that gives more weight to value investing rather than speculative trading; and encourage CEOs and rich folks to invest in a company's long term growth rather than being worried about "quarterly" stock bounces).

Where I disagree with her is on the word “short-termism” itself. And I would prefer the sliding scale she proposes to be based on the amount of realized capital gain itself rather than the time period of investment. In today’s capital markets, we don’t want the government to direct our investment models. Say for example, I invested in a company ‘X’ in January based on my prediction that the company has a very good future potential. Then sometime in July, another great company ‘Y’ went public and from what I see and analyse, my prediction says that ‘Y’ has even higher future potential than ‘X’. So at this point, why would it be wrong for me to move my capital from ‘X’ to ‘Y’? Why should I be punished by the government for a smart decision I made? Why would the government defy and disrupt the very basics of the free market theory which tells us that capital gets allocated efficiently where needed and where there is potential.

In this case, it should be noted that my money is still in the markets. I didn’t take it and run away and my capital is still being deployed at places where I deem fit. How could the government behave like I am doing something sinister and hence I need to be taxed at a higher rate? Now before I write further, I have to note that I won’t be impacted by this capital gains tax proposal – because it is meant only to the top 1% income earners. So in reality, it is possible that this proposal might have a net positive effect, but my opinion is that this proposal is flawed and could have addressed the capital gains tax reform in a much better way.

My proposal would be to get rid of the terms “short-term” and “long-term” altogether. Today’s financial markets are more complex and more globally integrated than the 1990s and as we go into the future, the size, scope, participation and thereby the opportunities itself become wider and more diverse. At this juncture, government encouraging me to stay long on a stock when I see better opportunities elsewhere (at home or abroad) is like a grandmother advising a twenty year old on modern technologies.

If you want to have a sliding scale, then fine, but in that case, my view is that it is better to have a sliding scale on the amount of realized capital gain itself. If the realized capital gains by an individual in less than $100,000 in that tax year, then tax the gains at 15%; if it is between $100,000 to $300,000, then tax at 20%; if it is between $300,000 to $500,000 then tax at 25% and for gains above $500,000, tax at 30%. These numbers are just arbitrary for now, and the relevant experts can work out these numbers, but the sliding scale in my opinion should be something like this – where it is based on the capital gain itself rather than the time period of investment. I don’t want the government to encourage or discourage me on how to invest or where to invest or how long to invest, but instead the government should just tax based on how much I made – with obviously the tax being more lenient to low income earners than to high income earners.

When it comes to labor, I don’t hear Hillary saying that she wants to encourage a worker to stay longer in a company as that would provide benefits to the business and reduce training costs, but instead she seems fine with just taxing the total labor-based income at progressive tax rates. In my opinion, investment income should be treated no differently and no “encouragement” of any sort is needed from the government to stay long or short on any investments. 

​Now, if Hillary wants to discourage extreme​ short term trading - like buying and selling in a single day, arbitrage trading across different markets, high frequency speculative trading and such, then that might be better addressed by an extremely small fee (to the order of a few cents to a dollar) on financial transactions rather than through this needlessly bureaucratic tax proposal she has put forward - and that doesn't necessarily reform the capital gains tax structure more broadly and more importantly, in a fair manner.

Restructure to Recover

I am not an expert on the Greek debt crisis and have very little knowledge on the actual Greek economy itself. But that said, one really doesn’t have to be an expert here and with even a little understanding of the Greek economy and its debt crisis, it is abundantly clear that the Greek economy cannot survive on its own feet without a massive debt restructuring. And that massive debt restructuring definitely has to involve a significant amount of debt write-off.

I know how annoyed and angry I would be if someone borrowed my money and asks me to write that loan off. So I completely understand the anger amongst many Europeans by the talk of any debt write-off. But there is simply is no other way. Anything short of a debt relief and restructuring is only going to kick the can down the road. Again, a simple look into Greece’s economic data, the reforms implemented, the unemployment numbers, the under-employment numbers, the tax codes, pension promises, exports, imports, demographics etc. will easily make it clear to anyone with an objective mind that there is simply no way here without a massive debt restructuring.

In the current crisis, I am neither a fan of the EU nor Greece. Both have horrible proposals. Both have clearly different visions of a Greek recovery and both those visions are blinded by ideologies and politics. In all this, it is the people of Greece who are suffering the most.

Let me give you a simple example of one of the horrible reforms implemented by Greece under pressure from EU: Before the crisis, anyone who earned less than 12,000 euros annually paid $0% in income taxes. After the reforms, that number was reduced to 5000 euros. In an economy that is in deep recession, I don’t know how anyone can come with a plan to increase taxes on the very low-income people, without expecting that economy to plunge into depression. And this is just one example of the austerity madness. Greece’s economy depends 80% on its services industry. Anyone with a little knowledge of economics can point out that all the reforms implemented point to one thing – demand suppression. And so there is no surprise here that from a 9% unemployment in 2011 during the recession, it has now gone up to more than 25%, with the economy plunging from a recession to a depression.

Now, I understand that to be a member of the Eurozone, there are some rules. And those rules point to a very strict limit on the budget deficit a country can run and the debt path that the country can take. And I understand that the reforms demanded by the IMF, EC and the ECB in return for the bailout money were to steer Greece towards those rules. But one has to also look at how steering towards those rules during a recession would work for an economy. I am sure everyone at the table would have known that the internal demand would be drastically suppressed by those reforms. Fine, let the demand go down internally so as to reduce the debt and deficit. But then, what does one do in this situation to propel growth in the economy? They start to look for demand elsewhere and cater to that external demand, thereby putting the economy on a growth path again. But how can Greece cater to external demand when their currency has the same purchasing power as that of the currency that the extremely efficient Germans use. In effect, to cater to that external demand, Greece has to compete with Germany, France and other top-tier European countries with the same purchasing power and production cost. And how is this even possible for Greece, given their structural situation.

If there was a way for Greece to have devalued their currency, then all the reforms asked out of them by the IMF, EC and the ECB would have worked. Without devaluation, it should have been pretty clear that Greece would lead to a path of disaster. And that’s exactly what happened.

Now, currently, on the other side, Mr.Tsipras, the Greek prime minister, has not been very impressive in his proposals too. I never understood why, in a country where pensions consume 16% of the GDP, would he want to reinstate the Christmas bonus to low-income pensioners that was eliminated as part of the reforms that were already implemented (though he later dropped this proposal). And why would he even initially resist to phase out provisions to eliminate early retirement options immediately, rather than over the course of many years, as he had wanted, is a mystery to me (he later dropped this proposal too). One could only hope that these were negotiating tactics and not serious proposals - because these proposals are doomed to fail the economy, rather than propel it to higher trajectory.

Now, what if Greece leaves the euro and adopts its old national currency, the drachma? In my opinion, it’s too late and Greece is not ready for it. Manufacturing (cement is a main example), construction, shipping and tourism are the major industries in Greece today. There was a time not long ago, in fact, just a few years ago, when China and other major countries went on a public spending binge, which would have helped Greece to cater to these demands, all the while also restructuring its economy. But that time has now passed. In fact, I am afraid that all these industries that Greece is dominant in is about to go through a period of slow growth worldwide.

Greece also imports a lot more than it exports. 100% of its oil demands are met through imports. By some estimates, 40% of the food Greeks consume is imported. And a lot of medical supplies are imported.  Furthermore, barring the shipping industry, Greek exports are mainly to other European countries – from which I wouldn’t expect a lot of demand growth in the coming years. And remember, from a productivity standpoint, Greece is in many respects an aging population - more than 20% of the Greek citizens are 65 years or older and many younger, educated Greeks have already left the country. If Greece returns to drachma, we can be assured that it will be shut out of the global financial system for years to come, with inflation running sky high and capital controls sucking the economic blood out of the most vulnerable people. And in many respects, Greece will still have to depend on European money - this time only classified as a "humanitarian aid".  

So the bottom line is that – irrespective of which road is taken – more austerity by staying in the Eurozone or returning to drachma, Greece has a tough road ahead with unimaginable economic pain. Given this painful situation, and considering the larger political and economic benefits of a unified Europe, the best that can be done now is a massive debt restructuring with a significant debt write-off. I hope Europe’s leaders will find the political will to do the right thing. And if Greece gets such a deal, I hope they don’t mess it up again! 

Rand Paul's Flat Tax

Recently, the republican presidential candidate, Rand Paul, put forward a flat-tax proposal for the American economy. Now, I have nothing against Rand Paul and infact I have liked Rand Paul and his ideas on various topics. But when it comes to his tax policies, I remain skeptical.

He recently introduced a proposal to tax everyone at 14.5%. His proposal was also to eliminate the payroll tax (that currently funds Social Security, Medicare and Medicaid). There will not be a separate capital gains tax and everything – individual income tax and business tax – will be taxed at 14.5%.

Now, this looks like a lot of savings for everyone participating in the economy. This is going to put thousands of more dollars each year in the pockets of everyone. I am a big fan of less taxes (who isn’t?), but I am also a big fan of reducing gross inequality in the economy. More importantly, I want to make sure that there is sustainable demand in the economy for decades to come – because if you lose the consumer market, then you lose the economy.

At first, this tax proposal looks very attractive – leaving a lot of money with the individuals rather than with the government. And I would be willing to spend my money myself rather than allowing the government to spend my money. And above all, this is deemed as a “fair tax” as every individual will contribute the same percentage of their taxable income rather than the government re-distributing it from the rich to the poor through various tax structures. So it does seem fair.  But if you take a step back from all these attractions and concentrate on the larger picture – where in the coming years, you will have to sustain demand from the middle-income people - this plan looks a little less attractive to me.

Today, one of the biggest economic malaise in the world is gross income inequality. And the U.S. is not exempted from that.  Setting aside for a minute the $15,000 individual exemption (or $50,000 exemption for a family of four) and mortgage-interest deduction that Rand's plan envisages, let’s concentrate on a simple case – a case of two individuals – named John and Mark - (and let’s start from year one), where John earns $100,000 the first year and Mark earns $1,000,000 the first year. To keep things simple, let’s say that both individuals increase their yearly income by 2% and let us also put aside any state and local taxes. 

So at the end of the first year, after paying 14.5% in taxes, John would have a disposable income of $85,500 whereas Mark would have a disposable income of $855,000. So that states that Mark has 10 times more cash left in hand than John at the end of the first year. If you continue this for the next ten years, where every year John and Mark get a 2% increment to their salary/income, at the end of the 10^th year, John would have had a disposable income of $100,890 for the 10^th year, whereas Mark would have had a disposable income of $2,394,000 during his 10^th year. Now that translates into Mark having 23.73 times more cash in hand than John at the end of the 10^th year.

Now, let’s not kid ourselves in saying that a person with millions of dollars in income would grow his net-worth at the same rate as that of a person who earns in the low hundreds of thousands. He, for sure, will grow at a faster rate. And let’s not kid ourselves by not taking inflation into account – which would eat up a large part of the additional disposable income obtained by the massive cut in taxes across the board. And when inflation occurs, Mark, who is guaranteed to own assets at that point, will see his assets’ worth going up in value, whereas John would increasingly find it difficult to buy those assets – thereby once again creating a gross inequality in the standard of living.

Moreover, to balance the budget (which Rand says he will), massive cuts in public services will have to take place. Though I am not much of a fan myself these days on government provided services and the debt they incur, it is no doubt that these massive cuts in the public services will cause a considerable re-structuring in the economy and I am afraid that that re-structuring will occur on the backs of the middle-income and low-income people – thereby once again, giving a smooth ride to the high-income people and a bumpy ride to the middle and low-income people. Now tell me how is that fair?

Even in today’s tax structure (setting aside all deductions, state and local taxes for simplicity), at the end of the 10^th year, Mark, who would have paid a federal tax rate of 39.6% vs John’s 28%, would have had 17.66 times more cash in hand than John. And Rand Paul’s flat tax would have increased that 17.66 number to 23.73. So the bottom line is – I am skeptical about Rand’s tax plans being able to address effectively the economic ills in the society – both now and in the decades to come.

If Rand or someone comes up with a multi-tiered flat tax system, I would be willing to consider and study its effects. But this one-tiered flat tax system proposed by Rand doesn’t impress me. Sorry Rand Paul!

My advice to a presidential candidate: Social Security

When I followed the U.S presidential elections in 2012, I had a bad feeling when some candidates spoke about reforming Social Security. I understand that the Social Security fund is in dire danger of becoming insolvent within the next 20 years if the program itself is not reformed. But you don’t speak about reforming – and in this case, “reforming” meant cutting Social Security payments in the future in one form or another – when the country is still reeling from the effects of the Great Recession. In fact, you don’t speak about cutting any major social program that the middle class depends on when the economy is fully not out of a recession – not the least a recession that obliterated the savings of millions of people, depleted a large portion of any equity that they had in real estate or other financial assets, caused massive disruptions in the jobs, pension and health care sectors.

When millions of people have lost their jobs and are scared and unsure about their future, the talk of reforming such a major social program adds to that uncertainty of their future. You don’t want to make people psychologically suffer and get alienated by talking about things that add to the fear that they already have about their future and their children’s future.

And in my opinion, 2016 is no different. The effects of the Great Recession of 2008 are still felt well across millions of households in the country. So a talk about reforming Social Security is a strict NO, NO, NO! – if you want to win the presidency.

If the media asks you about what you would do to make the Social Security program solvent in the longer term – say what would lessen the fear of the future for the people – which is that you would grow the economy at a faster rate, creating more high-paying jobs, eliminating waste in government, sounder immigration policies and in the process through a better and stronger economy keep the Social Security program solvent. I know that this sounds just like a rhetoric, but this is better than any “reform” talk because of one reason – The country is simply not ready for a Social Security reform…yet!

I for one believe that a leader is supposed to change people’s minds for the better, help them understand the need and effects, and lead the nation towards long term glory and prosperity, but these days I don’t see leaders but rather I only see politicians who want to win elections. And my advice is to these politicians and not necessarily leaders. I would dare not blame these politicians as the system itself has become more election-oriented rather than a long-term vision. And that system includes the very people who vote these politicians into office.

Maybe in future elections, when there isn’t this severe a slack in the labor market, and the income-inequality is reduced to a certain extent, a Social Security reform talk might be apt to win the election. But now is not the time!

Minimum Wage

These days there is a lot of discussion in the United States as to whether there should be a nation-wide increase on the federally mandated minimum wage. Currently, the federal minimum wage stands at $7.25. There are proposals currently from various quarters to increase that amount to $10.10. There are also proposals from some to take that amount up to $15.50 within the next five to ten years.

The minimum wage concept is something that I am still trying to get my head around and understand its effects better. I might be willing to change my opinion as I learn more but for now, I don’t believe there should be a minimum wage concept at all. Yes, companies like Walmart who earn billions in dollars annually should increase the pay to their employees well above the minimum wage. But what about a working family who hires a nanny at the minimum wage to care for their babies when the family is out working to earn bread and butter? An increase in the minimum wage of Walmart employees may at best reduce their corporate profits. But an increase in the minimum wage of the nanny in my example would probably result in reduced working hours for the nanny or an outright prevention of using any nannies to care for their babies or at the least, an increased financial stress for the working family. So the situation of individual businesses and families differ greatly and in my view, the wages of the employees is best handled through the markets (supply and demand).

I understand the side of the argument where some experts say that putting more cash at the hands of the people who are at the lower end of the economic spectrum will generate more economic activity in the region. And I also understand and strongly believe in the argument that anyone who works 40 hours a week should not live in poverty. But increasing the minimum wage, in my view, is a flawed way to eliminate poverty. If you look closely, most of the businesses that depend largely on minimum wage employees are businesses that cater to the middle class. An outright increase in the minimum wage to all employees will undoubtedly tempt the businesses to transfer some of that cost to the consumers – who, as I said, are mostly middle income earners. The business itself would only transfer a partial amount of that cost from its profits. In essence, those calling for an increase in the minimum wage fail to see that this increase would result in a transfer of a large part of the financial wealth from the middle income earners to low income earners and not necessarily from the high-income earners to the low-income earners.

A large part of today’s economic perils could easily be ascribed to the lack of sufficient demand.  And demand itself is best created when both the middle-income earners and low-income earners have more disposable income. An increase in the minimum wage, in my view, greatly reduces the disposable income of the middle-income earners.

The best way to increase the wages of low-income earners (or minimum wage earners) is to move people out of those minimum wage jobs and into semi-skilled and higher-skilled jobs. When the supply dwindles, businesses will raise the wages to match with their demand much more efficiently than the government passing an arbitrary number by decree.

How to move people from minimum wage jobs to semi-skilled and higher-skilled jobs? – this is altogether a different analysis which I will try to cover in my later posts (or let the experts work it out).

Is the bull market over?

Is the bull market over? The simple answer is no. There are many analysts out there who warn that the market is about to enter a bear phase. But I disagree. In my view, the bull market will continue to run for the remainder of 2015 and well into 2016. Yes, from a sector wise, there are some stocks or sectors that appear to be overpriced. But there are still many individual stocks that are fairly priced or even under-priced.

The US economy – though remains sluggish – is about to enter a period where we will witness a private spending splurge and a modest wage growth. The European economy will continue to grow, albeit the growth rate might not be as fast as some might predict. China will surprise us with better economic results in various fronts, though Chinese public investments will be far less than what we have seen in recent years. Japanese investors will look outside of Japan for better yield, while Japanese companies grow modestly in the near future. India and other south/east Asian economies will continue to create demand, although the pace might be slower than the hype. Demand from African markets is a question mark. And the same could be said of the Latin American markets (though I could be wrong here).

In essence, private demand across the world is set to increase in the remainder of 2015 and 2016, while public investments take a significant dip. That combined with a relatively stronger dollar will put a lid over many commodity prices. Australia is a market that I would advise to stay away from until we see clearer directions for the future of the commodity prices.

All the above said views of mine do not mean that there is no structural risk involved in many of the economies that I mentioned. But those risks are far from derailing the bull market for now. Barring any unforeseen geopolitical events (like ‘Grexit’ for example), I don’t see a bear market in formation. Yes, there could be tantrums in the market in the second half of 2015 – but those tantrums will be short lived and the bull market would continue to run as we enter into 2016.

Thus in my view, the bull might run a little slower from this point with occasional stops and retreats, but the bear is still well into his sleep.

U.K vs U.S election questions

In following the United Kingdom’s general election this year, I noticed some interesting differences in the policies and priorities of the people of the U.K vs. the policies and priorities that are very commonly discussed during an election cycle in the United States.

Since the demographic and political culture might be a little different between the U.S and the U.K, this might not be an apple-to-apple comparison, but still an interesting one. Here are a few I observed –

1.      Health Care:

·        U.K: Every major party in the U.K wanted more funding for their universal healthcare system - the National Health Service (NHS). The question was always about which party’s ideas had a better prospect to acquire more funding for their NHS and never about reducing the funding.

·        U.S: In contrast, in the U.S, many republican politicians have been talking about defunding the Affordable Care Act (Obamacare) for the last two years without actually providing a solid alternative for the current beneficiaries of the Affordable Care Act.

2.      Marriage Equality:

·        U.K: Marriage Equality was never a topic of discussion in the U.K elections. This is no surprise given the fact that sometime in 2014, legislation was passed in England, Scotland and Wales allowing gays to legally marry. The only place gay marriage is still not recognized is in Northern Ireland and I am not sure if candidates from those constituencies had to face this question.  

·        U.S: Politicians contesting for office in the U.S are repeatedly hammered on this topic. In fact, if one wants to run for office in the U.S, he better be ready to answer questions on this topic on day one (and make sure the answer satisfies his constituents).

3.      Immigration:

·        U.K: The two major parties in U.K – Conservatives and Labour – wanted to reduce net immigration from both the European Union and non-European countries.  Many smaller parties like the U.K. Independence party were also for reducing net immigration. And all these parties also wanted to cut back the benefits given to immigrants. They were in consensus that the “free movement of people” should not be misused to turn it into “free to claim” benefits. The question among these parties was only about how far one would go to reduce net immigration (and claiming of benefits).

·        U.S: In the U.S, the question on what to do with the illegal (or undocumented) immigrants has been going on for quite a while without solid answers. And same with the benefits – some wanted to give benefits to immigrants who are already in the U.S illegally for many years, and some do not.

To put it in other words, major U.K. parties seem to be in consensus that the incentives given to unskilled or low-skilled or illegal immigrants need to be cut back so as to reduce the attraction of immigrating to the U.K just to claim welfare benefits. In the U.S though, whether those incentives even need to be cut back is still a question that is debated across party lines and among the people themselves.

4.      Neck Ties:

·        U.K: During election debates, the politicians in the U.K seem to be wearing more colorful ties than the ones in the U.S J

·        U.S: Most politicians in the U.S more or less stick to blue or red…more fanciful colors are hard to see in a U.S politician’s tie than in a U.K politician’s tie J

Where are we heading?

There were two financial reports coming out of the United Kingdom today – housing prices and general inflation. These reports petrified me – just as similar data from the US these days is causing a concern to me.

The housing prices in the U.K. have been going up at a pretty pace recently. The annual housing prices went up by 9.6% in the year to the end of March. The annual house price inflation in Scotland during the same period was 14.6% – the fastest since 2007.

Now, the general inflation in U.K. (as measured by the Consumer Price Index) turned negative (-0.1%) in April (year-over-year).

The two contradicting data above points to eerily similar situation during the housing boom before 2008. For the last decade, we have been facing this constant problem of asset price inflation not in line with the inflation of the prices of general goods and services. Now, remember, the central banks base their interest rate decisions on the consumer price index and not on the housing price index. In fact, before the 2008 recession, many central bankers thought that housing price inflation was not something to worry about. They did not believe that there could be a nation-wide housing market collapse – as they thought that housing price depends of various factors, many of which are regional. But what they failed to see was how the housing market was directly linked to the very heart of the global finance and how the collapse of the housing market could cause a chain reaction across many large financial institutions.

It would be hard to believe for anyone to think that the central banks did not foresee the link between the housing market and the banking system – as even in a traditional banking model, it is the banks which lend to the home owners and so anyone would have known that there would be an impact if the housing bubble bursts. But the irrational calculation that the central banks did at that time was that a bank, run by extremely savvy individuals, would not hurt itself by sub-par lending standards (we would call this “no-regulation”, but the central banks called it “self-regulation”). But what the central banks missed to see at that time was – it was no longer necessary for the banks to worry about the creditworthiness of the borrower – as long as the banks could securitize those loans and sell it to market participants, they thought that the risks were minimized. In fact, they thought that by selling these newly innovated financial products, the risks were shifted from just the lenders to the many number of financial market participants – participants who were more in number than one lender and who were thought to have the capacity to absorb the hit if in case the borrower defaults. These securitized loans were complex financial instruments that went under the radar of the supervising agencies of the government. So when the housing market collapsed, it set up a chain reaction with these financial instruments acting as a trigger that led to an incredible worldwide turbulence in the global financial markets - a turbulence whose effects are still being felt today, and a turbulence that brought us close to the complete shutdown of the global financial system as we know it.

Today, after ‘n’ number of new regulations introduced, various bank stress tests conducted, billions in fines paid and bills like the Dodd-Frank passed, we are again looking at data that points to assets like houses and equities going up when wages and inflation of general goods remain stagnant. Where did we go wrong? More importantly, where are we heading?

A complete mug or a dodgy prime minister

Just a light-hearted post:

Today, May 7th, is the general election in U.K. I am not a British citizen and I have no facts in hand to comment (and probably no right too :)), but I am going to say this - I am rooting for David Cameron of the Conservative Party to win the election. How can one not vote for this guy? - especially after watching him obliterate the Labour Party leader Ed Miliband during many "Prime Minister's Questions" sessions in the House of Commons!

Tomorrow will be interesting to see if David Cameron who called Ed Miliband "a complete mug" or Ed Miliband who called David Cameron "a dodgy prime minister surrounded by dodgy donors" will become the next prime minister of U.K. :) 

Gotta love those British accented face-to-face funny yet intense Q&A sessions in the House of Commons!

The Free Speech for a Rational Mind

When I hear incidents like the Charlie Hebdo shootings in Paris or the one in Garland, Texas this week, I am immediately reminded of someone called Periyar E.V. Ramasamy. Periyar, who was born in 1879 in British India to Hindu parents and went up to live until 1973 - which was by then a free India - was an atheist and was the founder of the "Self-Respect" movement and a strong figure in the Dravidian movement that took roots in the southern part of India in the 1920s, especially in the state of Tamil Nadu. 

Periyar, through his self-respect movement, fought against what he said was the oppression of "backward" caste people by the "forward" caste people. He claimed that this oppression stemmed directly from the ills of the Hindu religion and said that the northern-aryanic brahmanism, a concept that he said was foreign to the southern dravidian race, introduced countless superstitious beliefs within the Hindu religion that led to people being marginalized and oppressed across caste lines. 

Periyar, to whom freedom of speech was not at all foreign, criticized the Hindu religion, its gods and goddesses and its belief system in ways and words that were considered extremely offensive to the millions of Hindus. He called anyone who believed in God a fool and even organized rallies where he broke the statues of Hindu gods and called upon his followers to do the same. He even compared the forward caste man, who is of the priest class in the Hindu society, to a "snake" who surrounds the legs of the oppressed people - where the snake doesn't allow the oppressed people to move (up the economic ladder) and if one still tries to move, the snake bites.

In a society that was vigorously religious, Periyar gained millions of followers. They called themselves "rationalists". Even religious people saw in him a figure that questioned the very faith that they were afraid to question. They saw in him the courage to use his "God-given" intellectual capability that they themselves were afraid to use to question the gods and goddesses. 

Periyar might have been very offensive in the ways he questioned Hinduism, but he also put forward "rational" thoughts and begged people to use their "thinking" capability to question everything rather than just blindly accept them. He hated when people called him an atheist, for he believed that that term was misused against anyone who used their thinking prowess and questioned the logic behind an assertion.   

Periyar admired Buddha - for he thought that Buddha was a rationalist of his time who questioned the Hindu religion and its practices. He refused to believe that Buddha was any form of divine incarnation and he didn't believe Buddhism was a religion. But he openly advised many oppressed and backward caste people to convert to Buddhism to break out of the "evil" machinations of Hinduism. But when some asked him to convert to Buddhism as a form of solidarity, he refused. And the reason he gave was that that it was easier (and in some ways logical and even ethical) to stay within the bounds of Hinduism to criticize Hinduism. 

Out of many millions of his followers, some went out to form political parties. And these parties and its atheist members have repeatedly been elected by the vastly religious society to govern the state of Tamil Nadu in the last five decades. And so was atheism accepted by the religious people of Tamil Nadu. In fact, today people demand that these atheists stay true to their atheism as a form of trust to their rational thinking and leadership. 

Periyar's free speech to question the ills of Hinduism was very effective because he stayed within the system to question the system. No one was able to question his freedom to speak against the Hindu religion for he himself belonged to the Hindu society. No one could deny him that right even during the pre-constitutional era. And I wonder if today's free speech against a religion's ills needs people like Periyar, who will not only have the courage to beg the people to question faith, but will also be members within that faith-system to make that very free speech as not just a constitutional right, but rather an intellectual tool that leads to rational thinking and real transformation instead of just a provocation. 

Drugs, Death and Demand

I read in the news yesterday that Indonesia executed 8 men for drug trafficking. From watching movies over the years, I have also come to know that drug possession and trafficking is a serious crime that is punishable by death in countries like Indonesia, Malaysia (and maybe even Singapore, though I am not sure).

I have always been strongly against anyone who traffics or sells drugs – because the only reason I see why these people do what they do is greed and money-motive. It is just not excusable to traffic or sell drugs knowing that what they do is affecting young people and families in extremely horrible ways. It tends to destroy a society and its culture. So it is just not excusable.

All this said, I should also note that I am generally against death penalty. I just don’t believe that the state has the right to kill people. It seems barbaric and societies need to have an honest debate if these criminals should be executed even if they seem to exhibit a genuine willingness to change for the better and rehabilitate over the course of many years. Yes, some criminals don’t change and we all have to have a debate on what to do with these repeat offenders and how to punish them or put them away from society. But there could also be criminals who could be rehabilitated. Two of the eight persons executed in Indonesia are Australians and this is what the Australian prime minister had to say – These executions are “unnecessary because both of these young Australians were fully rehabilitated while in prison.” Now, we will not know for sure if they were fully rehabilitated or not. But what if they were? – especially considering that they were arrested ten years ago when they were aged 21 and 23.

Now the other reason why the criminal justice system in many countries still has the death penalty is to stop future offenders from committing the same crime – basically, these countries argue that the death penalty acts a deterrent. It may or may not be true depending on the crime. But what needs to be studied is – is the death penalty the only deterrent?

Now coming to the drug problem, I think countries are fighting it in the wrong way. As like in any product, as long as there is demand, there will be supply. We kill one supplier, then the next supplier pops up. The more we kill, the price of the product increases, as the demand remains the same and supply dwindles. It is just a matter of time before another supplier (this time well organized) fills in the gap as the risk/reward ratio would have gone up. So we will kill more and the cycle would just continue thereby creating mafias and drug gangs along the way. So I believe to address the drug problem, the demand side needs to be addressed – meaning, demand should be brought down (almost to nil would be ideal) along with the supply. How to bring down the demand is a matter to discuss and debate by the societies concerned - but I would recommend a little civilized way rather than a barbaric death sentence.

Reference:

1. http://news.yahoo.com/australia-cant-more-death-row-prisoners-indonesia-055550357.html