In India, analysts and commentators were poring over the contents of the rare speech that Prime Minister Manmohan Singh delivered to the country last week. He had taken tough reform decisions to save India from a crisis that his government had created. Intelligent readers will be able to see through the hollowness of reform claims in this news-item that appeared in The Times of India. The government apparently wishes to help the real estate sector through better terms and more loans from banks. Every aspect of this news is as interventionist as it militates against economic efficiency. The inability of real estate developers to cut prices to meet demand is rather touching. Perhaps, all concessions extended to the handicapped should be extended to them, too, as they seem to suffer from intelligence and ethical handicaps.
The only consolation—if it can be called a consolation—is that kleptocracy in the name of the poor is now a global phenomenon. Measures announced by the US Federal Reserve Board on 13 September are eminently eligible to be included in this exclusive list of delusional and hypocritical policy interventions.
All market participants should read the speech delivered by Richard W. Fisher, the president of the Federal Reserve Bank of Dallas on 19 September to the Harvard Club of the New York City. Some statements are an open challenge to the leadership of the chairman of the US Federal Reserve, Ben Bernanke(“I felt an urge at the meeting last week to tie the chairman to the mast, Odyssean-style, and to stuff wax in the ears of my fellow committee members, in order to resist the siren call of further large-scale asset purchases. But, I have no such powers. I am only one officer in the loyal crew that sails under the command of Admiral Bernanke.”) He calls the emperor naked:
“…nobody on the committee, nor on our staffs at the board of governors and the 12 banks, really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. And nobody—in fact, no central bank anywhere on the planet—has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank—not, at least, the Federal Reserve —has ever been on this cruise before.”
In his prepared remarks after announcing the decisions of the Federal Open Markets Committee, Bernanke, reflexively reiterated that their decisions would affect stock prices and home prices. The chairman’s faith in the transmission from asset prices to real economic activity is unflinching, but it might be simply wrong. Even as the value of their stocks in their 401(k) accounts rise, Americans realize that their savings in the bank accounts earn nothing and, if anything, are being eroded by inflation.
Therefore, they may end up saving more to offset the loss of interest income. This is the well-known New York (or, for that matter, in any other city) cab driver behaviour. On a good day—more passenger rides and more collections—they go home early and on a difficult day, they stay very late on the road. The reason is that they have a minimum threshold for their daily collections. Anything below that is a loss. Humans react with twice as much pain and intensity to losses as they do, to gains. The minimum threshold is also seen as their entitlement. Therefore, they are prepared to work harder to “earn” what is “entitled” to them.
Similarly, corporations might slash back their investment spending because lower interest rates reduce the annual income accruing to their pension funds, while they increase the present value of their future pension liabilities. Thus, lower rates increase their funding gap, possibly crimping their investment plans. A recent Duke University survey of corporate financial officers reveals as much. Incremental 25 basis points of reduction in the interest rate, most of them conceded, would do nothing to boost their hiring or investment plans.
William White, former chief economist of the Bank for International Settlements at Basel, in his paper presented at the Jackson Hole Symposium in August, lists the consequences of ultra-easy monetary policy. He mentions inequality and re-distribution of wealth in favour of the rich as potential consequences. To the extent that investment and job creation are not on the radar of the US corporations, low interest rates will only encourage speculative activity in financial markets. Research by the Bank of Japan has made a compelling case for this outcome. To the extent that speculation is possible only for those who have money to post as margin, it is reasonable to expect that easy money policies boost the incomes and wealth of the already rich.
Restoring economic growth is desirable and will be sustainable only if the underlying imbalances are eliminated. These imbalances are as much ethical and moral as they are economic and social. Wannabe and anointed superpowers are still not paying heed.
V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk
