The Charge of the Light Brigade

When I see the world’s central banks misdiagnosing the root causes of the anemic global growth today and treat the problem with a heavy dose of poisonous zero interest rate policy (ZIRP) and negative interest rate policy (NIRP), with a heavy bias toward increasing the dosage at all costs if the not-so-sick patient (global economy) doesn’t recover as they expect it to, I just couldn’t help myself from remembering the narrative poem written by Lord Alfred Tennyson in 1854, which I had to memorize and write in my English class exam when I was in the middle school –

From Wikipedia: Lord Alfred “Tennyson's poem written on December 2, 1854, published December 9, 1854 in The Examiner, praises the Brigade, "When can their glory fade? O the wild charge they made!", while mourning the appalling futility of the charge: "Not tho' the soldier knew / Some one had blunder'd.”

Half a league, half a league, Half a league onward, (anemic global growth)
All in the valley of Death (global deflation)
    Rode the six hundred. (global middle class)
"Forward, the Light Brigade!
"Charge for the guns!" he said: (global central banks)
Into the valley of Death
    Rode the six hundred.

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When can their glory fade?
O the wild charge they made!
    All the world wondered.
Honour the charge they made,
Honour the Light Brigade,
    Noble six hundred.

To my friends in Britain...

My dear British friends,

I am writing this blog post sitting thousands of miles away from your beautiful island at a time of increased uncertainty concerning your decision on whether or not you would like to stay in the European Union. I am not a European. And I am not British. But that doesn’t matter – in the sense that the world is so interconnected today that everything has a ripple effect. And those ripples go back and forth. It affects us all. Positively or negatively. We are living in a world of increased financial uncertainty. We all fell together in 2008 during the onset of the recession. And nothing should stop us from getting up and marching together as we build a financially secure world for every good human being on this planet. 

Over the weekend, I met an elderly couple from Scotland. I asked them how they would vote in the upcoming referendum. They said that they will vote to leave the EU. And when I asked them why, they gave me two reasons – 1. Homelessness is on the rise in Aberdeen and other places in Scotland. 2. They want to use this opportunity to send a message to the elites, bankers and financial markets about how angry and disappointed they are with the status quo. I felt their genuine frustration. And there was validity in the concerns that they expressed. The National Health Services (NHS) is under stress; the housing markets are over-priced due to the influx of foreign money; public services are under stress due to a surge in immigrants. 

And here I am telling you the same thing that I tried to tell them - that leaving the EU will not really solve any of these problems. Voting to leave will not affect the elites or the bankers. The elites and the bankers make money when the world is great; they also make money when the world is not great. But you leaving the EU will affect the rest of us all. I respect that it is your sovereignty. And it is your decision. But undoubtedly, a Brexit will cause ripple effects that will be far reaching - ripples that will only be exacerbated and intensified by the very financial markets that have let you down in the past…and that will let us down again.   

There is too much uncertainty here. No one really knows how the day after the Brexit will look like. But I cannot imagine that some of you think that you would be able to get full benefits of the single EU market even without being in the EU and by not allowing the free movement of people. Though your argument that EU will need the British market as much as the British need the EU market might be true, think for a second why would the EU members accept any proposal that will benefit the U.K more by staying out of the EU than in the EU?  Why would the EU volunteer itself for its disintegration? - because that is what will happen if the U.K. gets sweet deals after deciding to opt out of the EU. Every other member of the EU would then be tempted to ask for such sweet deals. So however economically punishing it might be, EU countries, especially Germany and France will have every motive to bear their economic pain in order to stop that temptation by causing economic pain to the U.K. Doesn’t matter how severe that pain is, but it will undoubtedly hurt. And when it hurts, who do you think it will hurt more? I am afraid it is not the elites. Nor is it the bankers. But the very working people of your country. That will have economic consequences that will send ripples across your shores – the ripples that will tear into the heart of the global financial system and can jeopardize any progress we have made since the financial crisis caused by the bankers and the financial engineers.   

In my humble opinion, considering how the world’s future is shaping out to be, the U.K. would be stronger in the EU than outside the EU. In a world where China is five times the size of your economy and India’s total output is almost the same as yours, size matters - the size of the nation; and the size of the market. For all its flaws, EU is still a formidable single market. It is the world’s largest free trade zone. It is a market which everyone wants a share of – China, India, the US and all other nations. It is a market which produces some of the best and brightest talent and technology. 

I want a German car; a French designer clothing; and may be a Nobel prize in Sweden :). But to even dream of success, I still would want to be able to access the London financial services. So please Britain, stay in the EU. As an English speaking country, we want you as the gateway into Europe and all that excellent opportunities that Europe provides. In this small planet, we are all in this together…and let us continue to be in this together. Let our theme be better integration and not disintegration. 

Sincerely,

A common citizen, a Commonwealth citizen, a global citizen. 

The Fed is making a grave mistake! ... again!

For the last two years, the Federal Reserve officials are all over the place. Now their jumps across the walls have suddenly become very intense starting from this year. One month, there are some officials of the central bank talking in one direction. Within a matter of weeks, they do an about-turn and speak in the other direction (i.e. hawkish vs. dovish).

And with regard to the fed funds rates, the Fed should have raised them by 25 basis points in March. But they missed it. Not only did they miss it, but they started speaking in extreme dovish voice. And they claimed that none of their fundamental analysis of the economy has changed and that they were merely being cautious. That is baloney. Last September, when they should have raised the rates, they feared the stock market crash in China and held back, only to move further in December to raise rates. And then in January, a devaluation of renminbi along with Japan going into negative interest rate territory caused financial market volatility. They again got scared. This is getting tiresome. If they are going to expect a smooth financial market without any volatility before they can raise rates, then they are never going to get that. 

Then one might ask – why the hurry in raising rates? We don’t even have enough inflation, right? Well, because the global economy is no more about just maintaining price stability in goods and services. It is also about maintaining price stability in assets. And more importantly, it is also about preventing misallocation of capital across assets. And when you keep interest rates at zero for so long, it seriously messes up with the loan-to-savings ratio and savings-to-investments ratio. The deposits in banks are going down globally. And productive loans (where a loan is used to create a good or service) has been going down as well and instead is used in share buy-backs and refinancing/servicing debt.

It’s not even just about all the above. We have actually come to a point where monetary policy is becoming ineffective by the day. In the US, for example, cheaper interest rates have already made many Americans to buy houses and cars. Beyond that, however cheap the interest rate on a loan is, what do you expect them to buy with a loan? Furniture? Well they won’t!  Why would they? Their incomes haven’t gone up; they don’t get any interest on any form of savings anymore. So without that additional income, why would they take a loan and buy something that will not appreciate in value in the future? This is scaring the heck out of them regarding their future financial stability (a.k.a future financial obligations). This in turn makes people want to save for their future rather than spend. And they are saving it in the form of hard cash. And the experts wonder why people aren’t spending? And they wonder why we have a deflation scenario? And they try to fight this deflation by further lowering rates (even negative in some countries). 

Folks – there is a floor to how low you can take the interest rates? Up to a point in the downward direction, a lower interest rate is inflationary/reflationary. Beyond that point, it triggers disinflation/deflation. 

The other argument that lower interest rates will help corporations to borrow and invest is another baloney. Corporations have a lot of cash.  The only reason that they aren’t spending is because they don’t see enough demand – or more importantly, they don’t see a reason to invest when there is such a skewed monetary and fiscal policy that is deflationary rather than inflationary (especially when the demand is looked from the consumer side).

Sorry to say, but the current Federal Reserve members seem so weak to me with regards to taking the tough decision. They are following the financial markets in whatever direction they take them. This is totally skewed. An interest rate increase at this point when the US economy is doing relatively well will bring back many sections of the economy that has been built over decades and that are totally out of whack now. For example: the insurance and pension sectors are suffering from the low interest rates; seniors are suffering from the low interest rates; savers are suffering from the low interest rates; banks are suffering from the low interest rates. Misallocation in search of higher yields is becoming a common phenomenon all across the globe. And with every misallocation, the risk of a bubble burst or crash in the future increases. 

In my view, an equilibrium fed funds rate in not one common point, but rather a range. And few 25 basis point increases this year should not impede the mortgage loan growth or vehicle loan growth or corporate debt servicing. The effects on this front should be minimal and manageable. Instead, majority of the poor and middle-income consumers who aren’t in the financial markets but are instead dependent on fixed income with an anticipated reward for savings will be benefited directly through additional income through their fixed income investments, including any savings. And these are the people we depend upon for demand growth. Once we have more demand, then we should see more corporate spending in the form of capital investments – which is what is lacking today and is the main reason for the weak growth worldwide.

So you want to fight weak inflation or deflation? – increase the fed funds rate. On the fiscal front – address the excessive debt with a long term strategy and reform taxes to put more money in the hands of the poor and middle income people. Without these two changes, we will just keep chugging along with a very weak growth worldwide and wondering why people aren’t spending. Extreme low interest rates = deflation (beyond a point). Negative interest rates = Deflation (immediately). 

In Brexit, a diamond for India

No, I don’t mean the Koh-i-Noor diamond that was siphoned away from India by the British during the colonial era. Or as some recent commentators have pointed out, it was not taken but rather given to the British under the Treaty of Lahore after the end of the second Anglo-Sikh war. For the record, I personally don’t see much of a difference between the words “taken” and “given” given the colonial history of those times. And I personally think that this diamond in some ways represents the ugly truths of the European colonialism of the mercantilist era – and therefore it is better left to stay in the crown of the British queen where it currently resides. 

The diamond I am instead talking about is – is the opportunity that would fall at the doorstep of India if Britain decides to leave the European Union (EU). From the 1990s onwards, globalization has drastically changed the global economic landscape. The size of a market matters more today than at any other point in time in history. And sadly, if Britain decides to leave the EU and thereby pull itself out from the larger EU market, then there will be a need for Britain to find larger markets for its goods and services. Britain will undoubtedly try to maintain the same market share in its exports to the EU. But my opinion is that the EU countries will give it a tough time before agreeing to any sort of trade agreement – especially given the fact that Britain wants to limit immigration from the EU countries – which is one of the main reasons why a Brexit referendum is being held in the first place.

In that case, a U.K-India trade agreement of some sort will definitely start to interest policy makers on both sides. From the U.K standpoint, the British will be under pressure to show that even after a Brexit, they can seal important bilateral trade agreements – agreements that will provide British goods and services access to bigger markets like that of India. From the Indian standpoint, it is much easier to seal a deal with a single country in Europe than with the EU bloc as a whole. For example, a free trade agreement is already in the discussion phase between EU and India for almost ten years now. And they are still not able to seal the deal  because of various regulations and restrictions – mainly coming from the EU side. Traditionally, EU governments have stricter regulations and stringent requirements and when one has to negotiate with all those EU countries as a bloc, then the negotiations are tougher for a developing country like India – which desperately needs both the EU market and the EU capital. 

But when it comes to U.K, what India would require more is the U.K capital than the market itself. Not to get me wrong, the British market will still be important for India, but given the size of just 60 million people, India’s immediate preference will be to the British capital and technology more so than their market. And given this fact, India will have an upper hand when it comes to trade negotiations with the British. The whole world is currently desperate for access to the Indian market given its enormous size. U.K. would just be one among them. But for the U.K. itself, a concluded trade agreement with a country like India would be absolutely necessary to keep its economy shining – even after leaving the EU. With this being the case, India would be well suited to pull more British capital into India, along with obtaining guarantees for more high-skilled immigration of Indians into Britain in any trade agreement. And in my opinion, the British will come along for such a deal. 

One of the problems that is currently a hot issue in Britain is the flow of low-skilled immigrants from the EU countries (mainly eastern European countries) into Britain – and the benefits and welfare that is given to them. But in India’s case, India will be looking to boost high-skilled immigration of Indians into Britain and not low-skilled. And these immigrants are generally not welfare recipients. Initially, Britain will try to resist any kind of immigration. But I believe, if a Brexit happens, and if Britain initiates a trade agreement dialogue with India, India should use that opportunity to hold steady in asking for more high skilled immigration from India to Britain. India has the upper hand here and it shouldn’t miss if such an opportunity presents.

Similarly, Britain might resist some flow of capital into India – especially if the trade agreements involve domestic sourcing or setting up of local manufacturing units. But here too, I believe India has the upper hand. While simultaneously negotiating agreements with EU and the U.K., India can successfully leverage the size of the market it has with the priority to U.K vs EU or vice versa by successfully getting a good end of the deal.

And that is why I say that there is a diamond for India in the event of a Brexit scenario. Though from a global economic standpoint, I still would like to see Britain in the EU, if in case the British voters decide to leave the EU, then there could be one country that might benefit immensely from such a scenario if played right. And that country could very well be India.