The World Economy : So Where Are We Today ?

Posted on October 10, 2015. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

The QE along with the ultra low rates, as a loose monetary policy did what it had to do, during the crisis and also in the immediate aftermath, but the temporary measure also made the market somewhat irrational, and then came a time when markets got addicted to it, and kept on going higher regardless of the underlying fundamentals. And what we thought was a large Airbus 380 flying at 40,000 feet turned out to be an Airbus 318, so now, when our perception is changing, we find ourselves stuck, because, we know that an Airbus 318 is, simply not big enough to carry, and then keep the world economy flying at 40,000 feet, and also there is a realisation in some parts of the market that the Airbus 318 was never really flying at 40,000 feet. But the problem is, the central bankers, who kept the plane flying are now running out pages in the instruction manual.

So the central bankers in the developed world will need to find a way to get themselves unstuck. Low rates coupled with low inflation is not what most central banks in the developed world were expecting, and now they find themselves STUCK. In the QE era world, low interest rate environment isn’t necessarily all good and positive for the real economy, because the incentive to chase better returns leads to misallocation of capital. The asset price inflation that came about mainly from the misallocation of capital has more or less peaked, the fundamentals of the real economy were never that strong to drive the record level asset pricing. Easy money supply from QE was the main factor that created asset inflation.

Today, globally , the overall inflationary pressure in the real economy is somewhat subdued, and the central banks in the emerging economies are also lowering the rates. And this creates a very interesting problem for the central banks going forward especially in the UK and the US. The way, I see it is, the world economy is now starting to sail blind ( more or less ), and I must say, I’ve got my fingers crossed.

By waiting for an opportune time to raise rates, the central banks in the developed world have started the work of undoing all the previous good work that was done during the crisis, and in it’s immediate aftermath. Water in the ocean has to travel in a wave, and a still ocean is always a sign of something disruptive that’s probably on the way. So, we are getting stuck, by design, QE and the low rates as a part of the ultra loose monetary policy were supposed to be temporary measures, but for whatever reasons, it became the norm, and now, the markets have simply got addicted to the ” new temporary “.

The FED as well as the BOE will rightly say that there is no change in circumstances that demands a rate hike, in fact, the slowing world demands that the rates remains low for an extended period. And the markets are now starting to position themselves accordingly. But there is no guarantee that a low interest rate environment globally, will do the world any good, even when the developing world is also seeing a subdued inflationary environment. In my own view, the central banks can and should try to influence the flow of capital. It is what is required, and there is almost no real harm to the global economy if the FED was to raise rates by 25 bps, and by not doing that we run the risk of making what was supposed to be a temporary status quo, the ” new permanent “. If we continue with the existing ” status quo ” then there is a serious risk that markets will remain irrational and therefore volatile, and both will have damaging implications on the real economy. Take for example, the recent upswing in commodity prices , the price movement is not based on the assumptions that the fundamentals of the global economy is improving, or going to improve dramatically. In fact, it isn’t, and if we look at the recent growth projection of IMF, and also the overall inflation environment around the world, then it will be quite difficult to find a sound economic argument for the price movement upwards, but in my own view, I believe, the commodity market is moving up because of the realisation that rates will remain low. So the misallocation of capital as well as the distortion of market reality will therefore continue.

The benefits of QE as well as low rates was somewhat limited to the real economy, as a large part of the capital didn’t really flow into the real economy. And most data suggests that financial investors were in fact the main beneficiaries. The financial investors saw no real benefit, in terms of overall return of investing in the real economy , so a large part of the capital went into inflating the pricing of the financial assets for obvious reasons. Real economy isn’t designed to create high double digit returns in a very short period of time. So financial investors chasing quick and substantial return saw no incentive of committing capital to the large part of the real economy. But the hope was, especially from the central banks that at some point, the money will flow into the real economy. Having said that, QE and the low rates more or less served a their good purpose, but the central banks to a large extent failed in their attempt to channel the flow of capital where it could have been utilised to create growth in the real economy.

And if we are to rely on historical evidence, most available data suggests that when the financial markets starts growing bigger and faster, it is generally at the expense of hurting the real economy, and more often than not, it leads to a crisis.

The FED as well as BOE will need to change the ” status quo ” or in other words tweak the current market dynamics, a bit. You need a positive and a negative polarity to create the flow of current. The wind flows, when you have a high and a low pressure environment. And to keep a plane flying, you need to have a strong flow of air across both the wings. An economy like most planes requires two pilots, and so far, the central bankers have taken the lead in flying the plane, and they have done a good job especially in the absence of a strong leadership from various governments, but now, it’s time for the governments to play their role. So far the governments have failed to deliver on the important reforms that was badly needed. We have had sound bites coming out from various pockets of the governments as well as the political class in general, but the real lasting reforms aren’t quite visible yet. Blaming the financial markets and making the banks, a villain, is now an old story. The fact is, without the central banks taking the lead, the governments won’t really have an economy to talk about today. But there is a limit to what can be achieved through monetary policy alone, and I have always suspected that at some point, the central bankers will run out of tricks, and the limits of monetary policy tools will be tested and exposed. And it looks like that’s where we are today.

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PERCEPTION and the Need For Greater Global Policy Coordination in a 2014 WORLD

Posted on February 4, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , |

Perception is a major factor driving volatility in the market and this is why I am of the firm opinion now that it’s the market psychology and the overall investors sentiment aka the “mood of the markets” that creates and drives the volatility. And when a perception starts getting entrenched then people generally tend to ignore the sense of reasoning and stop looking at the big picture and this is why at times markets tends to behave like headless chickens because the underlying perception creates uncertainty and CHOAS takes over. So it is important to arrest this momentum before it ends up damaging the economy, it’s like this…we create a perception and then use that perception to create a reality.

In an interconnected global economy perception can create volatility and uncertainty and this is one of the reasons why a contagion risk remains a plausible scenario especially when people tend to get overwhelmed by the sound bites coming from various quarters of the financial markets. But it must be said that there is always value in looking at each market and economy individually. For instance, if we look at Turkey and Argentina, the fundamentals of these economies didn’t really deteriorate overnight. The Turkish central bank should have raised rates over a year ago but today the stretched fiscal situation combined with the political uncertainty is hurting the economy real bad but having said that a quick political resolution will likely calm the fears around Turkey and with regards to Argentina, the central bank of the country has been running a wacko monetary policy for sometime now so what the country is facing today is an outcome of such policies.

And assuming the worst case scenario, both Argentine and Turkish economies isn’t big enough to possess a systemic or a damaging contagion risk for all the emerging market economies, at least not based on the ground realities but yes in perception there might be. And to get some perspective, it is worth remembering that both Turkish as well as Argentine economies have gone through crises in the past without causing any significant problems for the world economy and also the rest of the EM didn’t really see any damaging contagion  come through and that’s the reality. Also, it is important to note that economies both in EM as well as developed markets tend to be at a different levels of maturity and they are different in many ways. For example, China and Brazil although a part of the same block of BRICS nations are in fact two different economies in many ways. The leadership in China for instance needs to implement the planned financial reform agenda whereas Brazil clearly needs a wholesale supply side reforms. So in short they aren’t dealing with the same issues.

We live in a very interconnected 24 x 7 world where perception drives the overall investors sentiment creating volatility and the global economy of 2014 reflects that reality. Perception can have a snowball effect and is no doubt contagious. So even though the IMF has revised up its global growth projection for the year 2014, there are a number of factors that could influence the real economic growth going forward. And one of them is a possible decline in positive sentiment and confidence in general around the global economy driven by a change in overall perception. And in most likelihood a potential sluggish growth and deteriorating fundamentals across emerging markets will have an impact on the overall growth dynamics of the developed world so it will be unwise to assume that the developed markets are going to be somehow immune. This is why it will be ill-advised to conclude that the developed markets have entered a self sustaining growth in 2014 so when I hear the sound bites coming from parts of the markets suggesting that the current volatility in the market is more or less an emerging market issue and thus the policy markers in the EM should get their house in order by adjusting to the market expectations, I can’t help but wonder, are they seriously suggesting or assuming that the developed world can grow in isolation especially in a post financial crisis world and also that the turbulent cloud over the emerging markets won’t enter the developed world? The markets clearly believe that a potential turmoil in the developing world could have an effect on the developed world. And there is probably a strong reason behind  that assumption.

When the western economies were on the verge of collapsing during 07/08 crisis, the politicians and the policy makers were busy calling anyone and everyone including their counterparts in emerging markets to help the global economy get out of the mess and most emerging markets did come together and a global policy coordination was worked out to keep the world economy going and from falling under. To help safe the financial sector and the economy, the central banks adopted an ultra loose monetary policy and there is very little doubt that part of the current volatility in the EM is driven by this ultra loose monetary policy adopted by the central banks in the developed world. So clearly, the EMs are dealing with the side effects of QE. The hot and easy money that flowed into various emerging markets chasing yields created asset price distortion. So the fundamentals of the emerging markets were known to the investors while they flocked into EM chasing high returns but now that the supply of hot money flow is being cut, the worry is that the real ground on which they were standing will get revealed.

Generally investors tend to invest in emerging markets attracted by the growth story but GDP numbers shouldn’t be the only indicator when considering an investment opportunity. In theory, we can measure GDP using three different approaches. 1 – overall production approach, 2- overall expenditure approach, 3- and the overall income approach but none of these 3 approaches can fully and comprehensively report or record the overall economic activities or output of a country let alone the world. High growth in a high inflationary environment creates distortion and isn’t really a sustainable growth model. And here is why, entrenched Inflation in the developing world tends to destroy disposable income and living standards and the idea that somehow high growth could fix everything in the long run doesn’t really hold water. In short, strong GDP growth numbers isn’t necessarily a one way ticket to prosperity because high growth creates various types of unforeseen problems and challenges so any growth model has to factor the exponential function rules, for example a 10% growth rate year-on-year means the economy will double in just 7 years and doubling of the economy isn’t just all positive. So any sustainable economic growth model will have to factor in a period of adjustment to allow for consolidation.

An economic journey isn’t about just about speed at which a country can reach from point A to Z quite simply because there is no Z or in other words there is no final destination but targets  to help deliver overall progress. A sustainable economy will have to keep evolving every 5 years or so to remain relevant and this is where the challenge lies for the global economy. By design, the global economic model along with the existing structure of the financial markets are less than efficient and this is why every now and then we find ourselves in a CRISIS. For example, today while the developing world is struggling with inflation, the developed world would love to have some of that inflation in the system.

And the ultra loose monetary policy has so far failed to deliver inflation in the developed world. Also though the tapering of quantitative easing (QE) by FED which I must say is inline with my own expectations ( not that is matters ) is being perceived as a start of an early tightening measure than ideally preferred by some in the market. But this perception does not accurately reflect the reality and here is why. So based on the latest (Jan 2014) data, FED’s balance sheet is now around US$ 4.1 trillion and even with tapering the balance sheet will continue to expand and also by committing to keep the rates near zero the FED continues to be in expansive mode. So by reducing the QE level ,the FED is basically trying to slowly dial down the booster engine put in place during the crisis to support the economy and switch over to traditional and conventional monetary policy tools to manage the economy going forward. And the reality is, it will be unwise to expect the FED to keep operating in crisis emergency mode so a gradual switching over makes good sense. Also it is important to note that if the FED gets its QE exit wrong then it could have substantial losses so it will have to be mindful of the market condition. A continued improvement in the economy along with the housing market will enable the central bank to book a substantial profit on the purchased securities and obviously a big chunk of the overall profit will end up at the US treasury and could very well be used to pay down the debt.

Whatever may be the perception of the market today, there is very little evidence to suggest that Quantitative Easing has in fact financed the global growth however, it has been extremely useful in supporting the financial markets and to a large extent helped create a distortion in the asset pricing across the world so a curb in QE will most likely help the global economy remove all the speculations and fear around the nature of the overall growth going forward because quite clearly the markets today aren’t sure if the world economy has entered a self sustaining growth cycle hence the extreme volatility.

And when looking at the bigger picture, in the medium to long term investment perspective, the Emerging Markets ( with the exception of some ) will most likely grow at a better rate than their counterparts in the developed world. Having said that, today when the markets are dealing with extreme volatility that is clearly creating CHAOS then talking about medium to long term investment horizon may not make much sense to most in the market. Also, a wait and watch approach and hoping that markets will look at the big picture and by applying some common sense figure things out is an extremely risky strategy because the markets are all about perception, momentum and confidence so an announcement on a global policy coordination by major central banks from around the world going forward should go a long way in providing a degree of certainty and should help arrest the current CHOAS from spreading into every corner of the market. And the thing about perception is, if you could keep a perception going for a period time irrespective of it being right or wrong then there is a good chance that perception will most likely be perceived by some as the REALITY.

And this is why the global economy of today requires a greater degree of policy coordination from major economies and is essential to addressing both immediate and long term challenges facing the world economy. Also this has to be by far the biggest lesson learnt from the 07/08 financial crisis.

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Making Sense of The Policy Debate Inside The Financial Market

Posted on June 18, 2013. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , |

There is no shortage of opinion in the market today on the current state of affairs of the global economy and most of the commentary as well as analysis seem to be centred around Central banks policies and its overall current impact assessment and on how things may play out going forward. The discussions are generally focused on what the central banks especially the Federal Reserve System (aka the Federal Reserve ) did do and didn’t do during the financial crisis of 2008 and in the immediate aftermath and also what it should have been done instead among other things.

So during a conference call to discuss a deal, I managed to get myself into a what I would probably classify now as a silly debate on phone with two of my dear analyst friends in wall-street. It was quite evident from our conversation that  both of them had pretty strong opinion on one central banker in particular and I won’t say it’s shocking to learn how some folks create and form an immediate opinion on someone based on mostly what other market practitioners are saying or have said for that matter but what does surprise me is when people fail to realise that markets are run by human ideas and not all Ideas are good. It is good to have different ideas along with different perspective and we can always agree to disagree and but what we shouldn’t do is dismiss everything simply because it doesn’t fit with our own school of thoughts.

The reality is most of us do not have the essential or required foresight to accurately predict or map out the outcome of the implementation of an idea, strategy or decisions we are going to make but we do know that we can’t necessarily FIX today’s problems by applying tools of the past. And the financial crisis of 08 can’t be compared to other crises before it so fixing it will require a new approach and application of new tools. But the problem is we also live in a different era, a 24 x 7 world where any and every decision a policy maker takes will get scrutinised instantly and people pouring in with opinions expecting instant results without realising that a policy needs to go through a policy cycle in order to be fit for impact analysis. The market tends to carry out an instant autopsy right at the birth and sometimes even before an idea or a policy is fully conceived. And yes there are situations where initial debates are quintessential and do help in formulating good policies.

This crisis has been a breeding ground for learning and testing ideas. And unlike many of my friends I haven’t yet made an opinion on the decisions taken by Mr Ben Shalom Bernanke as I believe it is a bit early to carry out a full and comprehensive assessment and analysis of each and every policy decisions taken by the top central banks especially the Federal Reserve Bank of United States. Also it will be unwise to formulate a clear opinion on the type of legacy Mr Ben Shalom Bernanke as the chairman of the FED will leave behind. We will have to wait and see. And to those who are extremely eager to write their version of immediate history I would say this, where is the logic and common sense behind a person writing an auto biography at age 21 when you know you may end up looking like a complete idiot at the age of 65. As human beings we are never a finished item.

Whatever may become of Mr Ben Shalom Bernanke’s legacy, he has clearly been one of the most proactive central banker who made bold and conscious decisions to get ahead of the crisis and to add to that I would say that I have more faith in him than his house mate at Winthrop house in Harvard, Mr Lloyd Blankfein. Also his policy decisions will most likely keep many student of economics around the world busy for some time to come.

In order to make sense of a policy and policy decisions you do need to spend time on understanding the person or people behind the policies. It is important to look at the bigger picture and develop a better understanding of how that person or a group of people think and react in a given or different situations, how they make specific decisions and why, what is their thought process, what are their priorities, what is their understanding of a particular situation and what are they trying to achieve among other things. The ability to fully grasp a situation differs from people to people.

We live in a Facebook world where most of us tend to post and share our thoughts before it had a chance to fully develop or evolve and the same goes for policy making. A fully developed policy idea takes time to evolve but since most policy decisions during the crisis were made against a ticking clock they were generally half-baked ideas so there will obviously be some uncertainty around them which may cause or continue to create volatility in the market. And it is highly likely that most policy makers including of Mr Ben Bernanke are probably keeping their fingers crossed and hoping things will work out well eventually and history will be kind on them but we are not there yet.

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