Talking about Economics, Science and Religion. And then adding humans to the equation.
So what do we know about science, economics and religion ? Well! for starters, science existed since the day Universe came into being, and therefore science has been around long before humans or human civilisation came into existence. Science is as old as the universe itself. There is science on Mars, but no economy. Also there is science all across the cosmos, but till date, the size of the space economy is limited to human activity closer to earth or our solar system, although this may change as humans venture into space on a larger scale. There are vast amount of natural resources spread across various parts of the Universe as well as continents like Antarctic here on Earth, which has resources worth tens of trillions of dollars. But it still has no economy or in other words GDP, and that is down to the fact that, there is no permanent human civilisation based there.
The idea of economics and economy started along side religion, nation state, and culture etc. And therefore, like other human ideas, it was conceived as a subject by humans. So humans will continue to influence it. Human behaviour, human perception and psychology, and their overall sentiment will continue to influence the subject of economics and the idea of economy. The data created by a human society, categorised as economic activity related data, tends to be the metrics widely used, to understand or gauge the overall wellbeing of an economy. And as the human society becomes more complex, so has the economy. It has no doubt continuously evolved and changed reflecting the changes in the human society. But like religion or culture, it has design flaws, and therefore fails to serve the entire human civilisation. The prime example is, the aftermath of the financial crisis. While we can measure the financial cost to an economy, what we cannot accurately measure is, the human costs that is directly and indirectly related to the financial crisis of 07/08. And the same does apply to religion. Although some of may of us continue to argue the case for religion, none of us have tried to accurately assess or measure the human costs of religion on humans, in terms of holding back human’s overall progress etc while the various religious franchise aka religions have gone richer and wealthier over time.
In the US alone, based on various estimates, the society known as the American society tends to give away around $ 82.5 billion a year to religion. And then, there are direct and indirect human costs. Having said that, wars have killed more humans than religion, and they also cost a lot more money than religion. But in historical context, some of the wars were religiously motivated, and humans still tend to fight over their religious and cultural ideology.
The question then is, do we need religion or economy for that matter ? And the answer isn’t that difficult. For many of us religion is still the answer to questions like, why do we exist and what’s our purpose ? And to a very large extent economics and economy has played a very vital role in the evolution of the human society as well as its overall progress. So to take away economics or religion from humans may not work out well. While science has always existed, sometimes, it is the economics that has justified scientific progress. And it is the economics of space that will most likely drive humans exploration of space.
According to space foundation, the space economy is already worth over $ 329 billion, and in the next 50 to 100 years, space industry will become the most dominant among all the sectors of the economy. It will not only create new jobs, but also help take humans as a civilisation to the next frontier. At least that’s what I feel. Imagine an economy that is not only going to measure the economic activities here on Earth, but also from across the Universe. But can it create enough wealth, to help fund the living of the entire human race ? Now this is a rather difficult question to answer, because unless and until, we keep finding ways to make the entire design of the economic system more efficient, it will continue to fall short.
My own assessment is that, economics and economy as an idea and subject is not a complete science, but unlike a religion, it isn’t stagnant, or requires the human society to completely surrender itself, and be at its mercy. It has flaws, but it also does have the capacity to continuously evolve, and so it should. Humans are the key input to the entire equation, and without adding humans, one could say, nothing is relevant. And the human element will continue to add a level of unpredictability and uncertainty to the field of economics and economy.
The Changing GAME, and the Global economy
The recent movements in the markets and its overall behaviour is starting to indicate that the game is changing and has already changed somewhat, and the market participants are having to adapt to these changes rather quickly. And here is an example, so when my GrandMa suggested that never mind the good old correlation theory, the markets overall behaviour today has changed so we could very well see the stock going higher while the crude oil could go as low as 70 or even lower,some folks in the market thought, it hasn’t happened before, and probably won’t now because crude and stock pricing have had historical correlation. And that’s a very understandable observation. But in the past month, the stocks have clearly been on an upward trajectory while the crude has continued to be on a downward trend. And by relying on the old economic theory as a reference, some may argue that one of these stories might be not be true, but I would disagree with that old economic assumption that one of these stories must be lying. Not at all, it’s just that people have evolved, and some of the old rules don’t work that well in the markets today. And here is an attempt to explain both the stories.
The stocks have been supported by a number of factors. For example, the European Central Bank ( ECB ) has just started its quantitative easing ( QE ) program, and the Bank of Japan ( BOJ ) as well as the Bank of England (BOE) are still maintaining the level of their QE program, also there are no real indication that the FED or any another central bank for that matter in the developed world is going to start raising rates around Q1 of 2015, it’s simply too risky. And although at some point, the FED and BOE might have to raise rates in 2015 , the central banks in China and India will most likely be lowering their rates, and PBOC ( the Chinese Central bank ) has already started the process so clearly the game is being played differently around different parts of the world today.
And with regards to the downward trajectory of the current crude pricing, it isn’t all a reflection of a seriously deteriorating global macro economic condition. In fact the recent policy easing in China as well as the Euro 315 billion investment & growth plan announced by the European Union along with the quantitative easing (QE) plan of the European Central Bank is all aimed at creating growth so the under normal circumstances, the markets should push the crude prices up but the underlying reasons for a falling crude isn’t all based on global macro issues. There are number of other factors at play, and one of them is that the US marching on to becoming a net exporter of energy, and OPEC mainly lead by Saudis are trying their best to maintain their position in the game by making the shale gas business unsustainable. It’s hard to project, if OPEC and the Saudis will eventually succeed but the game has obviously changed, and the old rules don’t really apply.
The other interesting thing happening today is the positive momentum build up over India. And if India is able to find a way to unleash its potential then quite frankly, the global economy will be better for it. But the Indian economy has to deal with a series structural issues, and inflation being one of them.I believe, the current RBI governor needs to sit down with the government, and help device a plan to carry out wholesale structural reforms in the economy. Monetary policy has its limitations, just look across the world, the central bankers aren’t really able to get a good handle on inflation anymore because as stated before, the game has changed. And we need to look at the bigger context when talking about inflation today.
For example, the financial assets in the U.S. as well as other developed markets got highly inflated, but without a real increase in disposable income, there is simply no capacity in the real economy to drive up inflation in the developed world. And specifically in context of India, India’s inflation is hard wired into how the country’s economy is structured, and unless the economy is unclogged, taming the inflation isn’t going to work. So practically, it’s almost impossible for India to export its inflation overseas, a process through which the developed world including of the U.S. was able to to export its inflation to an economy like China while continuing to grow and keep a relatively high living standard. The RBI governor has done an extremely good job so far, and I believe , he along with other central bankers know the limitations of monetary policy tools. Also Indian economy isn’t efficient enough structurally to quickly respond to policy changes, and this is thanks to the old ways of doing things. So an incremental reform agenda aimed at unclogging the engine has to be at the forefront. Inflation will tame down going forward with the structural reforms in the economy and also the existing lower fuel prices etc, but without carrying out a thorough structural reform, any slow down in inflation can’t be sustained. I believe, the current governor of the RBI shouldn’t hesitate to use inflation as a leverage to keep the pressure on the finance minister to keep the reform agenda at forefront. And in Mr Rajan as the governor of India’s central bank, India has found a central banker who has a global reputation, also a central banker who isn’t shy of a debate. And this is why he gets respect in the market.
Overall, it looks like India is heading in the right direction. A country like India needed a strong government, and most importantly a strong leader. And on both these counts, the people of India have delivered, but India is a federal structure so if the states don’t participate in the growth and prosperity agenda of the federal government then it will be a struggle for the central leadership on their own to take the country forward. There is an overall positive sentiment around India today, and the country does have an immense potential. And the way, I would describe India’s potential is, if for example, the economic model followed by China has helped it create a Boeing 777 then India today has the chance to create Boeing a 777 X series plane, an upgraded version that will be largest and most efficient twine engine plane in the world, but for this to happen a lot has to go right for India.
Progress and reform has to be incremental, and also gradual. A steady take off requires the pilot to guide the plane making sure the climb is comfortable, and will not put the passengers as well as the plane at risk. And once the plane is flying at the desired altitude, a seasoned pilot as well as a passenger know that there will always be turbulence on the way. So the approach by the INDIAN leadership shouldn’t be based around trying to blast off the country into outer space by carrying out one time wholesale Big Bang reforms. No progress or reform is permanent so the leadership and the policymakers should factor in a period of consolidation in the economy, and be always prepared to carry out the next set of reforms.
Also any well thought policy reform will fail to deliver the desired result, if the policy delivery mechanism isn’t fit for purpose. The current economic infrastructure of the economy is old and too clogged up so the focus of the government should be to take immediate measures to unclog the system, and then the growth will start to trickle through. The road ahead won’t be a smooth ride but the focus should be on unclogging the system and changing the current administrative policy delivering mechanism set up in the country. Also, the rural India will need to be fully plugged into the overall progress agenda. This will create,and is already creating tremendous opportunities for entrepreneurs who are able to spot them. The strategy has to be tailored to make sure all parts of the economy is starting to perform efficiently, and won’t burden the ascend of the overall economy going forward.
Also most importantly a ” progress for all ” idea has to be sold to the entire nation, and by trying to make this into a national movement, the current PM of India is heading in the right direction. However, the people of the country will need to be willing participants by making their own contributions. So the leadership of the country should aim to pitch India as a potential B777 X, the latest and more powerful as well as more efficient version of the existing B777, and India can be that.
The government will need to discover an economic growth model that is sustainable over a long term period and also inclusive. Adopting and following an existing growth model will not work for a country like India, and this is why I always struggle to understand the idea proposed by some in the market that all emerging economies should follow the economic growth model of China as an example for their country without really understanding if that specific economic model is going to be sustainable for their respective economies.
China’s heavy reliance on investments to drive it’s GDP has created a massive over supply, and there are large amount of infrastructure assets that are simply sitting idle without creating any return for the tax payers so if we were to look in terms of return on investment basis then the picture is quite murky. In short they would fall under inefficient investments category, and we are talking about trillions of dollars worth of such investments here. And this is one of the reason why the leadership of China based companies are looking to invest overseas, and it makes good business sense because the companies in China do have tremendous experience in building substantial infrastructure assets.
So going forward, the state owned enterprise in China will look to invest overseas as there isn’t much to do at home, and in a way, this strategy works out well because the emerging economies that have massive infrastructure deficit might find that China based companies are more willing and flexible to help them develop and finance those projects than others. And as Europe and the U.S. gets more competitive, the foreign players currently operating in China will start to move their production facility closer to home, and it’s already happening as the cost of production is starting to get lower than that in China. The economic engine of China is going through a gear change, and the leadership will need to make sure the transition is well managed. And as the game continues to change, companies operating in the real economy will face different type of challenges but at the same time there will be many opportunities, and that’s just a natural process, the powerhouse of yesteryears will become irrelevant as the economy evolves.
Read Full Post | Make a Comment ( None so far )Taking measures to manage the future financial crises better – KNOWING the UNKNOWNS.
A well thought out financial regulatory framework, economic system, and policy decisions that can stand the test of time needs to be evolutionary, and requires a certain level of debate, discussion of ideas and possibilities. A strategy and approach that has gone through an evolutionary process, and is proactive, tend to have a greater chance of success than a policy decision or measure that is more or less reactive. And that’s just common sense. But during the financial crisis of 07/08, and in its immediate aftermath, we were hit by a barrage of half baked ideas and measures that came out of a reactive decision making process, and although the aim of the exercise were well intended, and in some case temporary in nature, they haven’t made the markets or the global economy any more safer than they were before.
Also the existing reactive measures put in place to deal with the financial crisis can only be defined as an experiment. And even in a post crisis world, we continue to operate in the experiment mode, be it, the ultra loose monetary policy experiment to support the markets and the economy or the hard core regulatory environment aimed at avoiding future financial crises. Making it a hot topic of debate, and the possible outcome or outcomes of this ongoing experiment are being discussed around various quarters. But the end result still remains somewhat unknown because quite simply there are no precedent, so all we have is, best guess estimates, and theories to help us navigate through the unknown terrain.
Having said that, we are at a better place today than during the financial crisis of 07/08, but even after being 5/6 years on the road to recovery, the global economy is still not firing on all cylinders, and there are obviously a number of reasons for that. In my own view, we will only be able to get a better assessment of the strength of the economy after the unconventional monetary policies are taken offline (exit), as there are still many UNKNOWNS out there. The record high stock markets is not fully reflective of the real economy, and although the global economy is in a much better shape than during the financial crisis, parts of the economy are still not firing on all cylinders. A large percentage of the people on the main street are still stretched as evident from the lack of wage growth. And the ongoing geopolitical instability will most likely have an impact on the markets and the economy especially the EU states. The Euro area is still in a very precarious situation, and it is quite likely that the year 2014 will turn out to be a lost opportunity for Euro Zone nations especially if the leadership in the EU fail to get their priorities right. And going forward, we may see significant monetary policy divergence among developed nations especially between the EU, UK and the United States because the respective economies are already in different speed gears. Also major economies like China are going through a transition period, in other words, a gear shift which needs to be managed well through policy changes as we all know that running a car in a wrong gear for a long period of time can pretty much ruin the car’s engine. So the Central bank in China as well as major world economies including of the US and UK will need to manage the gear change efficiently. And this is why, it is important to create a mechanism that allows greater policy coordination in the global financial system going forward.
And though, there are still many unknowns, but what we do know, and have learnt so far especially in the immediate aftermath of the financial crisis of 07/08 is that, the financial markets and the economy are anything but efficient, and this may be contrary to what some may believe. The fear of the unknown will always trouble the market participants, and as a way to better understand the road ahead, people will make their own projections, which at times could raise more questions than answers.
So while taking a stock of the overall situation, may be its time, we look ahead , and find a way to revisit some of these experiments to help us better understand, and improve the existing structure of the economy and the markets going forward. And with this in mind, I thought, I will take the liberty, and share my own two cents worth on the subject.
To start with, I believe, we can all agree that the financial crisis has revealed to us the vulnerabilities of our existing economic system and financial infrastructure. And, if we are to attempt to find a way to upgrade the system then we will need to explore ways to remodel, the whole financial infrastructure, in order to make sure it’s sustainable over a long run. So here is an outline of the broader idea, which is based around creating an ” emergency only use spare money supply capacity ” in the system, that could be tapped into during an exceptional situation ( a financial crisis type event ). This could be a possible solution to mitigate or address some of the underlying solvency related concern on a sovereign nation.
And here is how it could work, first and foremost, the utilisation of the newly added capacity will have to be approved by a country’s parliament, second the whole process could be monitored by a global financial stability board or a body under the IMF, and third the market should have a clarity about the rules. So the assumption is, if the markets know or knew that a country could tap into its inbuilt safety mechanism put in place or in other words utilise a back up facility under a defined set of rules in case of emergency then it is less likely to speculate about a potential bankruptcy of that country.
The overall premise is based on a common sense approach that an efficient and sustainable system should have a back up or IN CASE OF EMERGENCY provision put in place to be used under exceptional circumstances. So for example, in event of a tyre puncture, you would use the spare tyre that comes with your vehicle or in case of a power failure, you will switch on a back up generator, in same way the emergency money supply pool ( as a spare capacity ) could be tapped into or utilised during an exceptional financial crisis type event. So under the proposed framework, a country could be allowed to print emergency money equivalent to up to 10% of its GDP, and this new money supply will automatically cease to exist within a period of let’s say 5 years, and could be linked to the overall GDP growth. In others words, the money supply by design will be created with a limited shelf life, to be used under extreme and exceptional circumstances. And the assumption here is that a five year cycle should be a sufficient transition period to help the economy rehabilitate.
Also linking the temporary additional money supply to the GDP growth creates a balance. So the overall idea works more or less like the rocket booster engine system that are used to take spacecraft into space, they do a job and then cut off (burn out ). We are taking about, creating a provision that will allow a country to tap into its spare capacity, a builtin safety mechanism that could kick in, in case of emergency. And since the provision will have a defined set of rules, the debate around a possible exit, and its outcome will not have to factor in many UNKNOWNS, making the outcome somewhat certain. So we know what happens, and at what level.
And beside the concern over sovereign risk, the other big issue item are the large financial institutions considered too big to fail. Asking the institution to create a living WILL doesn’t really go far enough. So one of the idea worth exploring could be, creating a mechanism that will allow troubled large ( too big to fail ) financial institutions to temporarily come under the protection of the central bank. The limited protection will not be for a period longer than 2.5 years, and the restructuring and unwinding process could be monitored, supervised by a special committee reporting directly to the central bank.
The experimentation with unconventional monetary policies like QE created uncertainty causing extreme volatility, and the problem was not the QE but the perception of QE, and what it will do or has done to the overall economy. Unconventional monetary policy tools like QE aren’t really a complete idea, and just like any human idea they need to reach a level of maturity through evolution. Also by design, the current structure of our economic system makes it prone to crises so if you are operating in a global financial system that has inherent builtin inefficiency then there is always a good chance that any policy measure even with best intention or design may not have the desired result.
So creating a defined safety mechanism in the overall infrastructure of the financial system should hopefully go a long way in providing a level of certainty to the market. And here is an example, during the financial crisis, the uncertainty over whether a country would get bailed out or not, and on what terms sort of magnified the problem.
Also an investment or a business model can only factor what is known, and what can be seen so a decision making will always have an element of risk involved. But knowing that there are many UKNOWNs keeps us honest and wise. So going forward, what we need to admit, and fully understand is that ,the journey to creating an efficient financial system will come with failures, and we may not have all the answers so being open to all and any good ideas makes all the sense. A Market economy is nothing but a human idea, and it has to go through an evolutionary process, and one of the reasons why the financial markets go through boom and bust is simply because the undefined rules creates an environment for extreme uncertainty leading to speculation.
That said, striving to create a financial and economic system that is 100% efficient, is quite impractical ( at least for now) . Also it must be said that inefficiencies do create opportunities, which allows entrepreneurs to add value, and in the process profit from it. Money or capital has no NATIONALITY so people will chase opportunities where ever they can find, and I believe thats a fair game because it encourages economies and businesses to compete for capital.
However, as a part of the evolutionary process, and over time, we have learnt to make safer cars, planes, and made tremendous progress in making various manufacturing process safer, transformed the telecom industry. And we have also made significant progress in many other fields including of space exploration among others, but our innovation in financial markets hasn’t really made the economy or the markets any safer.
So its about time that we focus our efforts on not only making the economy and the financial markets safer, but also on making it work better by improving the overall design of the existing system, and take measures to manage the future financial crises better, in order to minimise the financial hardship on people in the Main Street as well as on the nation states during the time of an exceptionally damaging financial crisis that leads to broken people, broken families as evident from the financial crisis of 07/08. This will be a journey of knowing the unknowns.
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