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.
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.
Read Full Post | Make a Comment ( 1 so far )So why didn’t the quantitative easing (QE) create the inflationary fire in the developed world?
When answering the question, why the quantitative easing (QE) didn’t create an inflationary fire in the developed world as expected by many in the markets, we would probably need to go back to basic. And based on basic economics, we know that the real inflation is driven by an increase in spending from the consumer side. The worry was that easy money pumped through an unconventional monetary policy tool like quantitative easing (QE) will spill over, and the over supply of money will create runaway inflation. Now based on the evidence we have seen so far, it is probably safe to assume that while QE did in fact inflate the financial assets valuation, folks on the street didn’t real see a real term increase in their savings or disposable income. And here is why, quantitative easing (QE ) was designed more or less to keep funding the governments and the financial markets, and based on all the evidence, both the governments as well as the markets did make good money from QE.
And with regards to the spill over worries related to QE. I would say, for discussion purposes, let’s just imagine a situation where the Atlantic Ocean dried up, and then in an effort to save the ocean, we try to fill it up with water, and while the filling process is ongoing there will always be those who will rightly be concerned about spilling over issue, in other words flooding related to overfilling of the Ocean but the problem is filling up an ocean isn’t as similar or as simple as filling up a swimming pool or a pond for that matter. Now let us imagine the global economy to be the Atlantic Ocean that dried up during the financial crisis, and the central bankers as various water pumping stations, and quantitative easing (QE) as the water supply ( money supply in case of the dried up global economy and markets) as a way to fill it up.
So what happens next?. You see folks on the street can only access the water ( QE in this case ) through a utility company ( intermediary or a financial intermediary in case of QE ), and these utilities ( intermediaries or financial intermediaries ) who are and were able to directly tap the water or in other words the QE money pumped by various central bankers into the ocean ( the financial economy ), needed the water i.e. the QE money for themselves first in order to treat the side effects of extreme dehydration, they have all been suffering from caused by the acute shortage of water or in other words short of liquidity in case of financial economy during the financial crisis so since QE was not designed to be a Tsunami but to simply fill up the dried up Ocean i.e. the financial economy and the market, the flooding risk was extremely limited.
And because the average folks in the real economy didn’t really get to see or experience the benefits of QE directly in terms of an improvement in their own bank balance, their disposable income as well as overall living standard, the direct impact of quantitative easing (QE) on the real economy wasn’t strong enough to create consumer driven inflation in the real economy in the developed world.
Read Full Post | Make a Comment ( 1 so far )PERCEPTION and the Need For Greater Global Policy Coordination in a 2014 WORLD
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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Talking About The All Scary Emerging Market, Market Perception and Investing in General
The markets are once again busy with chatter about Emerging Market ( EM ) and the sound of CHOAS seems to be re-emerging and many in the market are starting to wonder, what’s next ? A number of analysts have gone on record suggesting in their daily market commentary that emerging markets could now be a danger to global financial stability. No doubt, these are strong statements so it begs the obvious question, are we looking at another financial crisis, this time coming from the emerging markets ? And I do wonder if the fundamentals of EM have changed so dramatically leading some commentators to believe that a crisis is somehow imminent as evident from the way markets have reacted last week? Well, unlike our friends in the financial world, we ( I am referring to our group ) like many others who operate on a daily basis in the real economy can see and feel that the global economy is shaping up nicely and the IMF’s latest revised up global growth projection of 3.7% for 2014 and it’s growth expectation of around 5.1% for emerging markets from an earlier 4.7% GDP growth rate guidance, more or less reflects the ground the reality of the day. So the obvious question, why this panic and uncertainty ?
Now one could rightly argue that the revised up guidance are just projections and the risks both known and unknown still remains. Also the recent volatility in the markets to a large extent has been driven by downward pressure on the Turkish LIRA as well as Argentine PESOS devaluation and the South African RAND, which is also come under a bit of pressure. And then there are obvious chatters around how good or bad China is doing and how will the leadership manage the US 4.8 trillion dollar worth ( estimated ) shadow banking system along with a relatively high local government debts, and then there are concerns about India as well as Brazil’s fundamentals. These are real and genuine concerns but having said that, I can’t help but wonder, how is all this a SURPRISE to anyone in the market ? For example most of us are aware of the ongoing political uncertainty in Turkey and based on our own common sense, we could safely conclude that if the political turmoil drags on then there will be consequences to the economy.
And also assuming the worst case scenario, one needs to ask and know, did the previous crises in Turkish and Argentine economy kill the overall emerging markets across the board ? the clear answer is NO, so in short it will be unwise to assume that Turkey will some how bring down the emerging markets of Asia, Africa or Latin America, the reality is a potential crisis in Turkey may be more damaging to developed European economies then China or India for that matter. Also it is important to emphasise that there is a crisis of leadership in Turkey today which is weighing down on the economy and a positive resolution could very easily change the overall dynamics of the economy. Now with regards to China, a US 9.4 trillion dollar economy growing at around 7.7% isn’t just going to fall off the cliff under the weight of its shadow banking system and the local government debt. Yes, there are real concerns about how the government may go about handling the whole situation but it will be unwise to assume that somehow the economy will implode bringing down the global economy. There are simply too many opinions on China both bearish and bullish but understanding the structure and behaviour of the overall Chinese economy is an extremely complex task and betting against the government’s ability to deliver on its set forth agenda never really works and this may be one of the reasons why foreign investors tend to struggle in China. And with regards to India, the Indian economy today is in a much better shape fundamentally than last year also the overall investors sentiment around India has improved significantly, the country’s real problem today is a lack of decisive leadership which will hopefully get resolved after the upcoming general election and also most CEOs representing both local and overseas companies are quite upbeat about India’s medium and long term growth prospect. The current government has also made a series of reform announcements aimed at opening up various parts of the economy to overseas investors.
So why then the market is projecting a risk of contagion and giving a sense that somehow an imminent crisis is brewing up in the Emerging market ? I must say, I do wonder if by holding an emerging market stock or bonds or taking up speculative positions in local currency an overseas investor is ever able to get the full picture and flavour of the overall economy ? And the answer is, most likely not because in reality most emerging markets are layered and quite different to each other and also it must be said that there is a reason why they come under the category of being classified as ” emerging markets ” but this is not to say that developed markets are somehow immune to crisis as evident from the financial crisis of 07/08.
In the big picture scenario understanding a market or an asset class isn’t just about reading opinions from various experts of the subject and one must not forget that even in good times people and companies do fail so yes some emerging markets may struggle but today the global economy is in a much better shape than it was few years ago and it is quite unlikely that from here on we are looking at an imminent collapse. However, the inherent risk in the global economic system as well as the financial markets by design still remains so the system isn’t CRISIS proof and never was. Also opinions and projections are part and parcel of how a markets operate but people do need to be rationale and honest because clearly there are those in the market who may prefer a free ride and to keep making money on the back of easy money printed by the central bankers. This is not to suggest that the global economy has now reached a stage when all the loose monetary policy stimulus should be withdrawn right away, the tapering and tightening of traditional monetary policy tools will most likely be gradual.
But having said that the market will continue to make tapering related bets. Vanguard, PIMCO and BLACKROCK lost roughly over 35% in value on their investment in the last 6 months of 2013 by getting their inflation bet wrong on Treasury Inflation Protection Securities (TIPS ). These firms made bets on the assumption that Quantitative easing (QE ) will deliver inflation down the road and although it is quite evident that they got their bet wrong but we mustn’t forget the fact that QE did in fact create Inflation in ASSET PRICING and also across various Emerging Markets, but obviously not where it was expected so clearly those who held a view that QE will create inflationary mayhem in the economy killing the dollar down road most likely didn’t incorporate the fact that the economy of today works and behaves a bit differently. There needs to be a realisation that too much money in the system and ultra lose monetary policy will not necessarily create an immediate spectacular growth trajectory especially when the economy is coming out of a MASSIVE HEART ATTACK. And there are clear evidence that QE has created ASSET pricing inflation through misallocation of capital and this may be what is eating up growth ( growth rate below market expectation ). Also while some managers did get their inflationary bet wrong they should also realise that central bank’s ability to create or control inflation in a 2014 world isn’t always guaranteed or straight forward but having said that inflation will slowly but surely show up in the real economy but most probably not tomorrow.
Investment is about taking risk by relying your own assessment of a specific risk and then taking a decision based on your own judgement. MARKETS OR COMPANIES are all run by Human ideas and thought process so the market or a company is only as good as people behind them. And without being philosophical, we all know that life comes with no guarantee so what do we do? well, we learn to take risks and the same goes for creating a business and how we invest. There are no guarantees and the guarantees you may have or seek could easily become worthless when the circumstances change. And whatever investment decision you make or take will always come with an inherent RISK so there is always a chance that it may or may not work out as planned. You can only make a decision based on what you can see and know today but there are always many unknowns that you may not be able to factor in and going forward these unknowns may very well influence the outcome.
So investing in general isn’t all about following a trend or analysts reports or getting overwhelmed by the sound bites coming from various corners of the market or committing yourself to a fancy model. In most cases, a good investment is generally about following your own intuition or in other words your own inner radar just like many decisions we make or take in our lives and you can always use the information available in the market to make up your own mind in a similar way as you would seek advice from friends or family when taking an important decision in your life but always remember you will have to live with outcome and blaming others for an undesired outcome never helps although it might be quite tempting to play the game but if you do then you are denying yourself an IMPORTANT OPPORTUNITY TO LEARN and there is nothing scary about learning. So the all scary emerging market as projected by some in the market today in fact may not be that scary after all and remember a perception doesn’t always equal reality.
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Making Sense of The Policy Debate Inside The Financial Market
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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People across Europe and other parts of the world are increasingly feeling disconnected with the financial world and in all likelihood the discontent will only grow if the sector is unable to connect or reach out to the common folks on the main street.
I believe people do understand that an efficient and a well functioning financial system is essential to the development of society and the overall growth of any business and entrepreneurship around the world. Their discontent is not with the importance or the role the financial sector plays but how the system that was supposed to deliver prosperity has let them down.
It is important for us to understand the growing dissatisfaction and mistrust of many in the society with the world of finance and how it operates. The general sentiment of people on the street is that financial markets operated as casinos and the banks along with other financial institutions laid bets with people’s money and walked away unpunished giving a financial horror show for folks on the street who are still struggling to keep afloat. Also the recent unfolding events of the past few months including of the LIBOR scandal, JP Morgan hedging fiasco among others has dented the reputation of the financial market even further.
I remember having a number of discussions with my colleagues in the financial world on this subject and before critiquing folks protesting on the streets of Greece or Spain we all need to retrospect and ask ourselves just how many of us operating in the financial sector came in with a passion to change the world and create a system that worked for common folks everyday. The reality is sheer greed of some in the market and profit making at all cost drove the entire industry to its current mess. The financial system as we know it is BROKEN.
Since its humble beginning in 14-17th century the sector has gone through many CRISES and has also kept getting complicated or as others would say sophisticated for the understanding of common folks on the street. Over the years the generic description of the financial world for many on the street got limited to indices i.e. DOW, FT 100, S&P 500 among others and tracking their daily performance became a trend with the help of financial media who developed platforms to report the daily performance of these INDICES on a minute by minute basis to the world. So in short the financial world got INDEXED and these indices became a gauge of the overall health of the economy.
As the market grew so did the creation of complicated financial products and the sector got populated with a large pool of service providers to create demand for the such products. So imagine a common man who could pop into a shop and buy a shoe of his or her choice after trying it buying a complicated financial investment product became a totally different experience. This meant most folks bought products without a clear understanding of what it was and had to rely on the expertise of their financial advisors or firms selling those products and some entrusted their savings to professional firms to invest wisely on their behalf.
Any system that works on trust requires the practitioners to take responsibilities and maintain integrity at all times but unfortunately the system was let down by people and firms who were mainly in it to get RICH quick and were driven by sheer greed. If the only goal and aim of an enterprise is quick profit at any cost it is not hard to understand why mis-selling will thrive in such environment.
The big picture is, businesses derives profit from folks in the society which is always the end customer. Unfortunately some of us ignore that perspective but without real interaction and developing a strong relationship with customers no business survives. So for the financial system to work efficiently on a sustainable basis the society should feel that the system is fair, accountable and serves as an important pillar supporting its general well being otherwise we will always find ourselves in them and us type situation and this we know is a recipe for disaster. So the onus is on the policy makers and the financial market to deliver a financial system that is safe and fair and connects closely to the folks on the street.
The markets need to understand that complicated products are not the answer and in all honesty, no one understands them fully. This does not mean the death of INNOVATION. In fact innovation is good for the market and also for the folks on the main Street, but innovation should bring simplicity.
Fixing the financial system will require re-inventing it. Regulatory oversight and the policies governing the financial markets will need to be focused on removing the existing complicated layerings and simplifying the markets and its operation. Firms creating and selling financial products or assets should be willing to take responsibility and explain in simple terms the pros & cons of the product they are selling. I believe it’s Einstein who said “If you can’t explain it simply, you don’t understand it well enough”. The local community banks and financial advisors will need to be more proactive and transparent.
On the macro level the central banks, the government agencies and the market participants have all got a very important role to play. They will all need to develop new skills and tools to better understand the financial market of 2012 and the future.
It will also require going back to basics and creating a system where the market participants will look beyond just profit and their usual what’s IN IT for me approach. It will require leaders who truly believe that they aren’t just responsible to their shareholders but also to the folks on the main street who make up the society with a clear understanding that their action or inaction will sooner or later have a direct or indirect impact on others.
A society is made up of many actors with different interests and needs so it is worth noting that envisioning a financial system where everyone was happy is probably not a realistic expectation but without a prosperous society a company won’t be able to survive in the long run. The contribution of the financial sector and the role it plays in the overall growth and development of the real economy which directly benefits the society is a very significant one. Banks and other financial institution across the world have served their local communities for centuries.
The CRISIS serves as a reminder on how closely linked the main street and wall street really is and it is in the interest of wall street to have a vibrant main street and vice versa.
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