"Science never
solves a problem without creating ten more."
—George Bernard Shaw
(Irish, 1856-1950)
Word for the day
Suspiration (n)
A long, deep sigh
Malice towards none
If Lalu Yadav, who needs
people to serve him in jail, is socialist, who is feudal in India?
First random thought this morning
“The world’s largest taxi
firm, Uber, owns no cars. The world’s most popular media company, Facebook,
creates no content. The world’s most valuable retailer, Alibaba, carries no
stock. And the world’s largest accommodation provider, Airbnb, owns no
property.” (Tom Goodwin)
The world is changing like
never before, and some of us are busy debating who first discovered the Law of
Gravity and banning movies. Someone needs to rise and tell the Rajasthan
government "Ok, Brahamgupta-II, discovered the Law of Gravity some 500yrs
before the apple fell on Isaac Newton's head. Get the history books and science
almanacs rewritten. Charge Newton with crime of plagiarism. Celebrate the
legend of Padmavati and kill your daughters in wombs so that they never need to
perform Johar. Make sure no child dares think blasphemy like Brahamgupta,
Newton or Galileo."
Will Murphy's law fail again?
In recent past there have
been many instances when the Murphy's Law failed completely. There were so many
things that could have gone wrong. But none actually did.
The moot point that now confronts me is should I take this defiance as an exception or a trend.
The moot point that now confronts me is should I take this defiance as an exception or a trend.
For example, with developed
world largely standing at full employment level and historic low wage growth,
would wages rise sharply or not?
It is pertinent to note
here that it is for the first time in a decade that the world is forecast to
grow faster in unison. This widespread growth is most likely to unite the
central bankers, also for the first time since the global financial crisis
(GFC), in their monetary policy stance. GFC saw all central bankers easing the
policy in unison. This time we may see them tightening in unison. A glimpse of
what this could mean for the global market was provided a couple of days ago
when BoJ dropped a feeble hint of the shift in policy stance (see here)
The cost of capital ought
to jump higher as growth aims to rise higher and liquidity gets constricted.
It is important to note here that the global
leverage has risen materially in past 4-5years. But this leverage has not gone
into building additional capacities. On the contrary, we have seen low growth
forcing many capacities to shut down or curtailed.
2018 Global growth forecast; Source: Oxford Economics
With two major components
of cost (wages and interest) rising, and supply of key commodities still
constrained, the rise in inflation is inevitable.
The argument could be
whether the spike will happen in 2018 or it may wait for some more time.
The following comments of
Ex RBI governor Dr. Raghuram Rajan, who famously foresaw the 2008 GFC coming a
couple of years ahead, made in a recent interview to Bloomberg are noteworthy
in this context:
"Whenever there is
asset price inflation you have to ask yourself, why is it there? And clearly
there are some supports for it. Growth is strong for the first time
across the world. You’re seeing Europe come back very strongly in the last few
quarters and Japan is going the normal way it goes – a country with a labour
force declining at one percent a year, for it to grow at one and a half percent
every year is great. The U.S. is doing reasonably well. With all the engines
firing, on the real side there is some optimism. The concerns have to do with
two factors, one is the monetary side and second is the financial side. On the
monetary side, when do we see inflation? If in fact you have strong growth, and
economies at levels of unemployment not been seen for long, when do we see more
wage inflation, when do we see that translate more into goods inflation, that’s
the question on the monetary side.
When that happens, you will
find interest rates picking up more strongly and that will have an effect on
asset prices. The other factor is the financial side. How much debt have we built
up in these go-go years. On the retail side, the government side, the corporate
side? Covenant-lite loans are at an all time high at this point of time. The
question is at that point when interest rates start picking up, when liquidity
seems a little less available than it is now, do we see a substantial reaction
on the financial side?"
"I think as you remove
monetary accommodation, you signal also that the financial side needs to adapt
and you give it time to adapt which is Important. So the buildup of leverage
that you see, both the Implicit leverage in positions as well as the explicit
leverage in debt, I think that will start tapering off if in fact there is a
signal that accommodation will be taken off."
There is a strong view that
the respective governments may not like the monetary policies to be tighten as
it may not be congruent to their political ambitions. The fear is that more and
more government may move to compromise the autonomy of central bankers to suit
their political ends. I do not feel strongly about this possibility. But if
this fear does materializes, this may have disastrous outcome. The
hyperinflationary expectations of 2009-10 shall be definitely met in 2019-20,
in this scenario.
There is another argument
that there are no structural conditions prevailing for the inflationary
pressure to sustain for long. Therefore any episode of high inflation shall be
brief and passing.
I mostly agree with this
assessment. The ageing demography, rising economic inequalities, move towards
complete dematerialization of transactions, automation of processes,
digitalization of retail trade, energy efficiency and focus on renewable, a
good proportion of capacities lying idle or underutilized, etc. are some of the
factors that shall keep the inflation low structurally for a long time, perhaps
till a major war breaks out and destroys a good part of the present day
economic infrastructure.
I therefore believe that
any panic reaction due to rise in cost of capital and core inflation, shall
still be an opportunity to buy risk assets.
To conclude, I would like
to quote the following note of caution sounded by UBS's Larry Hathway:
"The maximum damage
from inflation comes if it is unexpected or if it is unpredictable. Unexpected
inflation causes damage, because the investor who holds bonds yielding 1% for a
decade is going to feel cheated if inflation turns out to be 1000%. Of course,
no one would voluntarily buy 1% yielding bonds if 1000% inflation was expected.
Thaler’s Law comes into operation here; people dislike losing money more than
they like making money. As a result episodes of unexpected inflation will lead
to a significant adverse reaction on the part of consumers."
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