Vivek Kaul
At a recent family dinner I sat through two younger cousins talking about the love of their lives: their latest mobile phones. The glow and the happiness on their faces was very visible, even though they were on the opposite ends of the spectrum. One had bought the latest version of Samsung Galaxy and the other had bought the latest version of the Apple iPhone.
We live during an era where internet led technology plays a great role in the lives of people. It also gives a lot of meaning to their lives, as is the case with my cousins. Every new gadget, be it the latest mobile phone or the latest tablet, gives us a feeling of progress. And we regard these recent changes as revolutionary.
But do they really make a difference? Of course, they do. It would be foolish to say they don’t. So let me reword the question. Does the progress in information and communication technology, almost all of which use the internet, really make as much difference as lets say the availability of running water or the invention of the washing machine and other household appliances?
Robert Gordon, an American economist, has this to say in a research paper titled “Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds. (You can read the research paper here)
“The biggest inconvenience was the lack of running water. Every drop of water for laundry, cooking, and indoor chamber pots had to be hauled in by the housewife, and wastewater hauled out. The average North Carolina(an American state) housewife in 1885 had to walk 148 miles per year while carrying 35 tons of water. Coal or wood for open-hearth fires had to be carried in and ashes had to be collected and carried out. There was no more important event that liberated women than the invention of running water and indoor plumbing, which happened in urban America between 1890 and 1930.”
Cambridge University economist Ha-Joon Chang makes a similar point in his brilliant book 23 Things They Don’t Tell You About Capitalism “The internet revolution has (at least as yet) not been as important as the washing machine and other household appliances, which, by vastly reducing the amount of work needed for household chores, allowed women to enter the labour market.”
Running water, washing machines and other household appliances helped women save time on the daily chores and thus enter the job market. As Chang points out “Washing machines have saved mountains of time. The data are not easy to come by, but a mid 1940s study by the US Rural Electrification Authority reports that, with the introduction of the electric washing machine and electric iron, the time required for washing 38 lb of laundry was reduced by a factor of nearly 6 (from 4 hours to 41 minutes) and the time taken to iron it by a factor of more than 2.5 (from 4.5 hours to 1.75 hours). Piped water has meant that women do not have to spend hours fetching water (for which according to the United Nations Development Program, up to two hours per day are spent in some developing countries). Gas/electric kitchen stoves…have vastly reduced the time needed for collecting firewood, making fires, keeping the fires alive, and cleaning after them for heating and cooking purposes.”
The impact these developments have had on the way we live has been really fundamental. The same does not stand true for the internet. At least, not as yet. As Chang explains “To be sure, for some, the internet has profoundly changed the way in which we work…However, for many other people, the internet has not had much impact on productivity. Studies have struggled to find the positive impact of the internet on overall productivity – as Robert Solow, the Nobel laureate economist, out it, ‘the evidence is everywhere but in the numbers’.”
Many of us maybe spending more and more time on the internet, but that doesn’t mean it has had an impact on economic productivity and economic growth and in turn made our lives ‘really’ better.
Economist Bill Bonner explained this dichotomy very well in a 2011 column. As he wrote “Nowhere was the Internet revolution more focused than in the USA. Nowhere did people have higher hopes for it. And nowhere were the results more disappointing. The typical teenager now spends half his life…not just half his waking hours, but more than half a day on some sort of electronic device. Does it make him smarter? Richer? More civilized? More coherent? Not so’s we’ve been able to detect! Not every technological advance results in an increase in standards of living. Take Twitter, for example. Or nuclear weapons. Or dozens of other innovations and inventions. The Internet, like TV before it, is a great entertainment device. It is also very useful, improving productivity in a vast number of industries. But it has not speeded up GDP growth or improved living standards.”
To summarise the argument, the internet is not a revolutionary technology that it is made out to be. But such is the fascination for internet that it has distorted our perspectives. And these distorted perspectives have an impact on many political and economic decisions that are being made. “It would not matter if this distortion of perspectives was just a matter of people’s opinions. However, these distorted perspectives have real impacts, as they result in misguided use of scarce resources. The fascination with the ICT (information and Communication Technology) revolution, represented by the internet, has made some rich countries – especially the US and Britain – wrongly conclude that making things is so ‘yesterday’ that they should try to live on ideas…This belief…has led those countries to unduly neglect their manufacturing sector, with adverse consequences for their economies,” writes Chang.
The love for the internet led information and communication technology revolution has distorted perspectives in India as well. The Uttar Pradesh chief minister Akhilesh Yadav has been distributing free laptops to students. While that is a noble idea, it is worth remembering that UP continues to be one of the most backward states in India. Wouldn’t the money be better spent by ensuring that there is a regular supply of water in more villages? Wouldn’t that money be better spent in ensuring that electricity is available for longer hours?
In a country where resources are scarce such questions need to be asked. Of course, if Yadav goes about ensuring regular water supply in more villages and better availability of electricity, it doesn’t make for great news. Distributing ‘free laptops’ sounds so much more ‘economic’ and ‘social’ progress than ensuring the availability of water in villages (I mean, we have been trying to do that since 1947. Give me something new).
On the flip side compare this to Nitish Kumar, the chief minister of Bihar, distributing free cycles to girls and boys, so that they could continue attending school. A solution like this, clearly has a greater economic impact than giving away free laptops. (Though it needs to be said that instances of fraud have come to light, where people have collected cheques to buy cycles and then disappeared).
This distorted perspective has also led to more and more state governments in India falling over one another to attract IT companies to set-shop in their states. A similar zeal is not seen when it comes to setting up of manufacturing companies. IT companies also continue to get income tax exemptions. At an individual level almost every engineer now wants to work for an IT company, which means a shortage of talent for companies in other sectors.
But the bigger problem with this distortion is the rapidly growing belief that India can skip the manufacturing revolution. “Especially with the rise of service offshoring, this view has become very popular among some observers in India. Forget all those polluting industries, they say, why not go from agriculture to services directly? If China is the workshop of the world, the argument goes, India should try to become the ‘office of the world,” writes Chang.
But there is a problem with this distorted perspective. It has never happened before except for a country like Seychelles which has a population of around 85,000 people with a per capita income of $9,000. As Chang writes “No country has so far achieved even a decent (not to speak of high) living standard by relying on services and none will do in the future…As for the developing countries, it is a fantasy to think that they can skip industrialisation and build prosperity on the basis of service industries. Most services have slow productivity growth and most of those services that have high productivity growth are services that cannot be developed without a strong manufacturing sector.”
People often talk about Switzerland as having avoided the manufacturing revolution because all the black money of the world goes there. That is not true. “In per capita terms, Switzerland has the highest industrial output in the world (it could come second after Japan, depending on the year and the data you look out)…We don’t see many Swiss manufactured products around because the country is small (around 7 million people), which makes the total amount of Swiss manufactured goods rather small, and because its producers specialise in producer goods, such as machinery and industrial chemicals, rather than consumer goods that are more visible,” Chang points out.
Given these reasons, it is important that we rid ourselves of this obsession that we have for the ‘so called’ internet led information and communication technology revolution. There are other more important issues to think about.
The article originally appeared on www.firstpost.com on May 25, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Month: May 2013
Why Manish Tewari's zero loss theory doesn't hold much ground
Vivek Kaul
If you keep repeating something people might finally start believing you, one day, someday.
Or so seems to go the logic in the Congress Party.
The Party has gone on and on about how the loss numbers regarding the various scams put out by the Comptroller and Auditor General (CAG) of India are largely fictional.
This effort has been led by P Chidambaram, Kapil Sibal and Digvijay Singh upto this point. They have questioned the Rs 1.76 lakh crore loss estimated in the 2G scam and the Rs 1.86 lakh crore estimated in the coalgate scam. They have tried to tell the nation that there has been no loss. And the numbers put out by CAG are largely fictional.
Digvijay Singh, the senior most General Secretary of the Party has even alleged that Vinod Rai, the outgoing CAG, has political ambitions and that’s why he been trying to shame the government.
The latest missive in this direction has come from Manish Tewari, the information and broadcasting minister, and one of the chief trouble shooters of the Congress Party. He has remarked that “We’ve seen this great debate around certain hugely exaggerated and mythical numbers which have been thrown in public debate by certain very responsible institutions and functionaries… I think when institutions start indulging in fiction writing that is the greatest disservice that can possibly be done to an issue.”
What caused this outburst was an interview that the outgoing CAG Rai gave to The Times of India. In this interview he was asked “what was his reaction when Kapil Sibal came with the zero loss theory?” “I felt sorry for them. I have never said this before, but I actually felt sorry for them,” said Rai. In the same interview Rai denied having any political ambitions whatsoever. “Whenever this question has been put to me, I have neither said ‘yes’ nor ‘no’. If I say I will not join, you will not believe me. If I say I will join, you will say “bola tha na“. But I am making it clear today. I have been apolitical all my life. Now, in the 65-years plus age why should I change?” said Rai.
It is important to clarify here that estimates made CAG on the losses are not mythical at all, as Tewari and others of his ilk would like us to believe. Lets try and understand this in case of what is now known as the Coalgate scam, by starting at the very beginning.
The Coal Mines(Nationalisation) Act was amended with effect from June 9, 1993. This allowed the government to give away coal blocks for free both to private sector as well as public sector companies. This was done largely on account of the inability of Coal India Ltd (CIL), which produces most of India’s coal, to produce enough coal.
The coal production in 1993-94 was 246.04 million tonnes, up by 3.3% from the previous year. This rate was not going to increase anytime soon as newer projects had been hit by delays and cost over-runs, as still often happens in India. As the Economic Survey of 1994-95 pointed out “As on December 31, 1994, out of 71 projects under implementation in the coal sector, 22 projects are bedevilled by time and cost over-runs. On an average, the time over-run per project is about 38 months. There is urgent need to improve project implementation in the coal sector.”
Hence, to encourage more production of coal, the Coal Mines Act was amended with the view of helping at least those companies which used coal as a raw material. As the Economic Survey pointed out “In order to encourage private sector investment in the coal sector, the Coal Mines (Nationalisation) Act, 1973, was amended with effect from June 9, 1993, for operation of captive coal mines by companies engaged in the production of iron and steel, power generation and washing of coal in the private sector.” Using this change in policy the government of India gave away 195 coal blocks for free between 1993 and 2011. What is interesting nonetheless is that prior to 2004,only 39 coal blocks were given away free to public sectors as well as private sector companies. The remaining blocks have been given away since 2004. The Congress led UPA government has been in power since May 22, 2004.
So this shows clearly that around 80% of the coal blocks were given away for free only after the Congress Party led government came to power. What queers the pitch further is the fact that most of these blocks were given away during the period between 2006 and 2009 when the Prime Minister Manmohan Singh, also happened to the coal minister.
When we measure the coal blocks given away for free in terms of their geological reserves, the results get skewed further. The total geological reserves given away for free between 1993 and 2011 was 44,802.9 million tonnes. Of this nearly 41,235.9 million tonnes was given away between 2004 and 2011. As pointed out earlier, for most of this period (except for a period of around 5 months in 2004) the Congress led UPA government has been in power. During the period 1993-96, when the Congress government led by PV Narsimha Rao was in power, nine coal blocks with geological reserves of 917.7 million tonnes were given away for free. Hence, the Congress Party was directly involved in giving away 42,153.6 million tonnes of coal, or around 94% of the total geological reserves.
So Coalgate has largely been a Congress scam. The CAG in its report tried to put a number to the losses on account of the government giving away these blocks for free. There were a number of assumptions made while calculating these losses. First and foremost blocks given to government companies for free were not taken into consideration. And secondly, only open cast mines were taken into account while calculating losses, underground mines were ignored. If these mines were taken into account the loss number would have been greater than Rs 1.86 lakh crore.
The extractable reserves from the coal blocks considered for the calculation came to be at 6282.5million tonnes. The total amount of coal in a block is referred to as geological reserve. But not all of it can be extracted. Open cast mining of coal typically goes to a depth of around 250 metres below the ground whereas underground mining goes to a depth of around 600-700 metres. Beyond this, it is difficult to extract coal.
So 6282.5 million tonnes was the amount of coal that was given away for free. This coal could have been sold at a certain price. Using the prices at which CIL, which produces most of India’s coal, sold coal, CAG arrived at an average price of Rs 1,028.42 per tonne of coal.
There is a certain cost in producing this coal. The average cost of production was calculated to be at Rs 583.01 per tonne using CIL data. Over and above this there was a financing cost of Rs 150 per tonne that was assumed. This meant a profit of Rs Rs 295.41 per tonne of coal (Rs 1,028.42 – Rs 583.01 – Rs 150) had been let go off. Hence the government had lost Rs 295.41 for every tonne of coal that it gave away for free. The total losses were thus estimated to be at Rs 1,85,591.33 crore (Rs 295.41 x 6,282.5 million tonnes).
This loss figure comes with a disclaimer from CAG. “A part of this financial gain could have been tapped by the government by taking timely decision on competitive bidding for allocation of coal blocks,” the CAG report points out.
One criticism of this calculation has been that CAG did not take time value of money into account. All the extractable reserves of the mines considered couldn’t have been mined at once. They would be mined over a period of time. So that should have been taken into account and a present value of the losses should have been calculated. This point is raised by the CAG in its report as well. As the report points out “total extractable reserve of a coal block could be extracted over the lifetime of a block as per its mining plan. In the absence of future year wise quantity of coal extracted, sale price, cost price, financing cost etc pertaining to a coal block over its lifetime, audit has taken the currently available audited figures of CIL as reference values.”
But there are other points which clearly prove that CAG has been conservative in its calculations, like any good auditor would. While calculating losses on account of giving away coal blocks for free the CAG took into account the price at which CIL sells coal directly to companies it has an agreement with. This is the lowest price in the market. The price that CIL auctions through the e-auction route is higher. As the CAG points out in its report on an ultra mega power projects, the average price of coal sold by CIL through e-auctions in 2010-2011 was Rs 1,782 per tonne. If CAG had taken this price instead of the CIL price, then profit per tonne of coal would have stood at Rs 1,050 (Rs 1,782-Rs 583.01- Rs 150). The losses would have then stood at Rs 6.6 lakh crore.
If the price of imported coal would have been taken into account, losses would have been even higher. The average price of imported coal in November 2009 was Rs 2,874 per tonne (calculated by the CAG based on NTPC data).
If CAG had taken this price, the profit per tonne would have been Rs 2,142 (Rs 2,874 – Rs 583.01 – Rs 150) and the losses would have been Rs 13.5 lakh crore. The CAG did not take into account these prices. It took into account the lowest price of Rs 1,028.42 per tonne, which was the average Coal India price, like a conservative auditor would.
So here is my humble request to Congress leaders like Manish Tewari who have been saying that the various CAG reports have been “indulging in fiction”. Please read these reports. They are documents which have been written with great care and thorough research. The Congress Party may not be agree with the losses for obvious reasons but it cannot dismiss them totally. They can also question the methodology and the quantum of the loss as well. But saying that there has been no loss, makes them look a tad stupid in the eyes of urban Indians, who are the ones majorly concerned with such issues.
In fact Vinod Rai in the interview summarised the situation very well when he said “in my report I have said that there has been loss and that cannot be denied. The quantum of loss can be debated. I told them your own agency, CBI, has said there was a loss of Rs 30,000 crore.”
Now only if Manish Tewari wasn’t so much in love with his voice…
The article originally appeared on www.firstpost.com on May 25,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Gold will rise against USD; it may hit a ‘new high by 2013-end’
Nick Barisheff is the founder, President and CEO of Bullion Management Group Inc. (BMG) and the author of$10,000 Gold: Why Golds Inevitable Rise Is the Investor’s Safe Haven (www.10000goldthebook.com). Widely recognised as an international bullion expert, Barisheff speaks to Vivek Kaul in a free wheeling interview on the future of gold and why the current fall in its price is going to go away soon. As he puts it “I would not be surprised to see gold hit new highs before year end.”
Excerpts:
Has your book $10,000 Gold released at an inappropriate time, given that gold price has taken a big beating in the recent past?
I began collecting notes and research for the book soon after I decided to go into the precious metals business in 1998. Although the material was updated many times over the years, the core long-term trends, that I feel are responsible for gold’s rising price, are still in place today as they were in the late 1990s when gold was trading below $300 an ounce (1 troy ounce equals 31.1 grams). The book will be just as relevant in two years as it is today for this reason. It is about long-term, irreversible trends. Those simply won’t change until there is a complete purging of debt as the trends I follow are all trends that result in greater debt as debt is directly related to the price of gold.
What do you think are the reasons behind the recent fall in the price of gold? How soon do you expect it to start going up again?
Estimates put the sales on the COMEX on Friday April 12th, and Monday April 15th between 125 and 400 tonnes. The most telling evidence that this was a deliberate paper gold attack at the highest levels was the size and speed of the sales that then triggered sell stops and margin calls. (This article provides additional details: http://news.goldseek.com/GoldSeek/1368648060.php)
In contrast to the lows in paper gold, unprecedented buying of physical gold was triggered. If this were truly a natural correction or the indication that gold bull had turned into a bear, then the physical market would be panic selling not panic buying. Over the long term, these artificial declines in the price of paper gold are good for gold as it lets a lot of big players enter the markets. I do not expect this “correction” to extend over a long period of time as it is artificial. However, it is possible this was coordinated to correspond with gold’s slow summer season. I would not be surprised to see gold hit new highs before year end.
One of the major myths about gold is that it is not a good inflation hedge. You suggest that its a great inflation hedge. Can you explain that through some numbers?
The best way to see how gold works to maintain purchasing power and is therefore a good hedge against inflation is to think in terms of ounces rather than the more relative dollars or euros. As I mention in the book, it took 66 ounces of gold to buy a compact car in 1971. Today it would take about 10 ounces. We can see the same ratio with houses and even the DOW. (the Dow Jones Industrial Average, one of America’s premier stock market indices) Today you can buy 3 average size houses for the same amount of gold you would have needed to buy 1 house in 1971 even though the prices of houses have risen significantly in dollar terms since then. That’s how gold serves as a hedge against inflation and maintains its purchasing power. One of the best books on how gold maintains its purchasing power over long periods is the Golden Constant.
Gold bugs have been suggesting people to hold gold because they expect very high inflation to come in given all the money that is being printed by central banks all over the world. But inflation hasn’t set in as yet. What is your view on that?
To begin with, real inflation is running at a much higher level than official figures indicate. I’ve explained this in detail in the book. If we use the original basket of goods used to measure inflation before the Clinton government began understating inflation through substitution and other deceptive metrics, it is running at about 10 percent. (For a more detailed description please see: http://www.shadowstats.com/article/no-438-public-comment-on-inflation-measurement)
Can you elaborate on that?
As I mentioned above, real inflation has set in, but it’s hidden through doctored government inflation reports. Anyone who eats, heats their home, drives a car or sends their children to college knows this, but governments need to hide this fact because, for each official point in inflation they would have to pay out hundreds of billions in indexed pensions. As well, the method they are currently using to keep the bond market strong is through low or negative real interest rates. I have discussed in several recent articles, the methods governments use to secretly rob pensioners and savers through these low interest rates using a program called “financial repression”. Richard Russell, the famous newsletter writer, once stated that gold will preserve wealth equally well in an inflationary or deflationary environment as it is the ultimate store of wealth. This is also confirmed by the data in the Golden Constant.
So where will all this money printing that is happening ultimately lead us to?
All world fiat currencies eventually end in hyperinflation followed by complete collapse. Throughout all of history there has not been a single example that did not follow this pattern. The U.S. dollar will fail for the same reasons the others failed, because politicians cannot resist the urge to print unlimited amounts of unbacked currency. This eventually appears as inflation brought about through currency debasement. The main reason this positively affects the gold price is because gold is not rising in value, currencies are losing purchasing power against gold. Therefore, gold can rise in price as high as currencies can fall. As Voltaire said, “Paper money eventually returns to its intrinsic value—zero.”
What is the link that the oil, ageing population and population growth have with the price of gold?
As I write on Page 71 of my book “Ultimately, we are most concerned with one measure when it comes to the price of gold: government debt. How will decreasing oil supplies impact gold? They will impact gold in the same way as the other irreversible trends: the rising population, the aging population and outsourcing. All create the need for more debt to compensate for slowing growth, and increased government debt equals more currency, lower purchasing power and a higher gold price.”
Can you elaborate on that?
The debt based model depends on perpetual growth as it, like a spinning top will collapse if it stops moving. When natural economic growth does not come through productivity, manufacturing of the production of natural resources, then the government must fuel growth through debt creation. Dr. Chris Martenson does an excellent job of demonstrating how much of the growth of the past century, growth that led to a population explosion, was due to cheap land-based oil. The trends described in your question along with the huge interest payments necessary to finance the debt are costing the government many more dollars to grow the GDP. In 2012, it cost the U.S. government $2.47 to grow the GDP by $1.
And that is a problem?
Stimulus works while the major portion of the population is working. Right now baby boomers in the US are retiring at a rate of 10,000 a day. Despite the claims of energy independence because of shale oil in the United States, the world’s growth has been fueled by cheap land-based oil, located mainly in the Middle East. Oil sands and shale oil are extremely expensive to produce by comparison and are therefore inflationary. Apart from money printing creating inflation, the rising price of oil will also be inflationary as it is used for virtually everything. The trends described in the book all impact growth negatively, they reduce taxation revenues, cause inflation and require ever greater government expenditure leading to ever increasing government debt. Therefore, this creates a need of more currency debasement, which naturally causes the value of gold to appear stronger against currencies.
Anything else that you would like to tell our readers regarding this?
We can also add that over the past three thousand years the most effective solution to runaway inflation brought about through currency creation is the re-establishment of some type of relationship between currencies and gold. It doesn’t need to be a 1:1 relationship, but whatever percentage it is, it will cause gold to trade much higher. We are in uncharted territory here. Several reputable analysts are calling for $10,000 gold for this reason, such as Société Générale’s Edward Alberts and the man Barrons labeled “Mr. Gold” because of his proven understanding of the gold market—Jim Sinclair, who stated he expected gold to eventually trade at $50,000 an ounce. Again, this is easier to understand why currency debasement will result in rising gold prices when we realise gold is not rising in value, currencies are losing value against gold.
You suggest in your book that the Chinese government is buying gold big time, though there is very little evidence available for the same. Can you get into that in some detail?
China leads the world in gold production. All of that domestic production remains in China. We know that China and India purchased 2000 tonnes of the 2,700 tonnes of global production in 2012. This includes the public as well as official purchases and unofficial purchases by sovereign wealth funds. In the past, we know the Chinese government purchased its gold in a circumspect, but secretive manner. They accumulated through sovereign wealth funds that can bypass the red tape and the transparency required of official central banks. It is safe to assume they are still doing this. In 2009, China announced its official gold purchases after the fact. In 2009 the world thought China had 454 tonnes, the same as it held at the time of the country’s last official announcement in 2003. In 2009, they announced they had 1,054 tonnes.
Why are they being so secretive?
Of course, China is not interested in having the world know how much gold they have at this point because it is trying to accumulate as much as it can. I believe China hopes their yuan will replace the U.S. dollar as the next world reserve currency. If the Chinese follow the pattern of announcing every 6 years, we may be in for a major surprise in 2015, especially since Ji Xiaonan, who chairs the supervisory board for the Chinese State Council’s biggest state-owned companies stated in 2009 that China planned to add 10,000 tonnes to their gold reserves before 2019.
Gold has always been seen as an anti-dollar. People who have no confidence in the paper dollars being printed by the Federal Reserve buy gold. To what extent do you think the US will go to protect the dollar and discredit gold?
The U.S. government is highly motivated to maintain its reserve currency status and to maintain pricing of oil in US dollars. The US is the world’s largest debtor nation and the only reason the United States has been able to run up such a large debt is because it had the world’s reserve currency thanks at first to the Bretton Wood’s agreement in 1944. When they broke the peg with gold in 1971, the dollar’s status came under scrutiny, but there were no other currencies challenging it at the time. In 1973 the Americans secured their position as world’s reserve currency when OPEC agreed to denominate oil in U.S. dollars alone. This is now being challenged as China has entered into trade agreements with Japan, Australia, Brazil, Korea, and numerous others to bypass the US dollar and settle trade with each other’s currencies. This is a direct threat to the US dollars reserve status.
The interview originally appeared on www.firstpost.com on May 24, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Wilful blindness links BCCI, Murdoch and Lehman Bros
Vivek Kaul
News of the World was a British newspaper, owned by media moghul Rupert Murdoch, which published its last edition on July 10, 2011. The newspaper shutdown after it came to light that the employees of the newspaper had been hacking phones, using private investigators and even bribing the police to acquire confidential information, which could be turned into sensational news stories.
On July 19, 2011, nine days after News of the World shutdown, Rupert Murdoch and his son James, gave oral evidence to the Select Committee on Culture, Media and Sport of the British Parliament. The Committee asked a stream of questions to the Murdochs.
Adrian Sanders, a member of the committee, asked the question number 269, which put the Murdochs in a lot of bother. This is how the brief conversation that followed the question went:
Q269 Mr Sanders: Finally, are you familiar with the term “wilful blindness”?
James Murdoch: Mr Sanders, would you care to elaborate?
Q270 Mr Sanders: It is a term that came up in the Enron scandal. Wilful blindness is a legal term. It states that if there is knowledge that you could have had and should have had, but chose not to have, you are still responsible.
James Murdoch: Mr Sanders, do you have a question? Respectfully, I just do not know what you would like me to say.
Q271 Mr Sanders: The question was whether you were aware—
James Murdoch: I am not aware of that particular phrase.
Q272 Mr Sanders: But now you are familiar with the term, because I have explained it to you.
James Murdoch: Thank you, Mr Sanders.
Rupert Murdoch: I have heard the phrase before, and we were not ever guilty of that.
In the days the discussion was picked up by the media and there was a lot of discussion around the topic. The Select Committee finally concluded that “If at all relevant times Rupert Murdoch did not take steps to become fully informed about phone hacking, he turned a blind eye and exhibited wilful blindness to what was going on in his companies and publications.”
Before Murdochs were accused of ‘wilful blindness’ the term was used even for the Enron debacle by Judge Simeon Lake. Enron was an American company which went bust more than 10 years back after it came to light that it had been growing by simply fudging its numbers. Jeffrey Skilling and Kenneth Lay, the CEO and Chairman of Enron, pleaded that they just did not know what was going on in the company and hence could not be held responsible for it.
In his summary of the trial, Judge Lake told the jury that “You may find that a defendant had knowledge of a fact if you find that the defendant deliberately closed his eyes to what would otherwise have been obvious to him. Knowledge can be inferred if the defendant deliberately blinded himself to the existence of a fact.”
As Margaret Heffernan writes in Wilful Blindness- Why we ignore the obvious at our peril “Judge Lake was applying the legal principal of wilful blindness: you are responsible if you could have known, and should have known, something which instead you strove not to see. Skilling and Lay could have known, and had the opportunity to know, just how rotten their company was. Their claim not to know was no excuse under the law. Since they could have known, they were responsible…The law does not care why you remain ignorant, only that you do.”
The concept of ‘wilful blindness’ first appeared in the English courts in 1861. “A judge in Regina v. Sleep ruled that an accused could not be convicted for possession of government property unless the jury found that he either knew the goods came from government stores or had ‘wilfully shut his eyes to the fact’,” writes Hefferman. “Over time, a lot of other phrases came into play – deliberate or wilful ignorance, conscious avoidance and deliberate indifference. What they have all in common is the idea that there is an opportunity for knowledge and a responsibility to be informed, but it is shirked.”
In fact, the current case where three players of the Indian Premier League (IPL) team Rajasthan Royals have been accused of spot fixing, fits excellently into the concept of ‘wilful blindness’. The Board of Control for Cricket in India (BCCI) which runs the IPL has been trying to underplay the scandal and at the same time trying to distance itself from it. N Srinivasan, the President of BCCI, had this to say after the scandal broke out “We will do whatever is necessary. The sport is clean and we are running it clean. We have taken all the steps (to keep it clean). One or two bad eggs here and there cannot sully the entire game.”
The BCCI has taken pains to elucidate that the scandal concerns just one team i.e. the Rajashtan Royals and they have nothing to do it. That possibly also explains why the Rajasthan Royals have filed a first information report (FIR) against the three players and the BCCI has been doing nothing, except for holding meetings and appearing to talk tough.
The few bad eggs explanation has now ended up as an egg on the face of President Srinivasan as Mumbai Police gets ready to question Gurunath Meiyappan, who other than being the Team Principal of the best performing IPL team Chennai Super Kings (CSK) also happens to be married to Srinivsan’s daugther Rupa.
Srinivasan other than being the President of BCCI, happens to own the CSK team. Talk about conflict of interest. Gurunath, more popularly known as Prince Gurunath, is in trouble because of his close links to small time actor turned bookie Vindoo Dara Singh (more popularly known as Jack in betting circles).
While just knowing another person does not amount to guilt, but the fact that Singh had access to the inner echelons of CSK and was even seen watching a match seated next to Sakshi Dhoni (wife of Mahendra Singh Dhoni, who also happens to be the captain of CSK ) does muddle the waters. Even within IPL circles Singh’s role as Jack was pretty well known (a senior functionary of an IPL team has said so clearly on Facebook). So wasn’t this an act of wilful blindness on the part of Srinivasan? Shouldn’t he have wondered what was a bookie doing inside the VIP section, sitting next to the wife of the captain of his cricket team?
The BCCI was also wilfully blind given that last year in a sting operation India TV, had shown that various fringe players in the IPL were ready to be bought for money. There were also allegations of spot fixing. The BCCI suspended some players, but beyond that nothing happened. Of course Srinivasan did make a strong statement. “We will not tolerate this nonsense. We have zero tolerance on corruption and you will not be disappointed by the action we take,” he said.
What makes all this even more interesting is the fact that BCCI is run by politicians from across parties. Sharad Pawar, Arun Jaitley, Rajeev Shukla, Anurag Thakur, Jyotiraditya Scindia, Narendra Modi, etc, are all a part of it. It is difficult to believe that they were totally unaware of what was going on in the league. In face of all this the explanation of there being only a ‘few rotten eggs’ doesn’t really hold.
Margaret Heffernan wrote a very interesting column for the Huffington Post in the aftermath of the Murdoch owned New of the World being shutdown. In this she pointed out that “After every institutional debacle, the arguments are the same: it was just a few bad apples. Nobody at the top is to blame. A few rogue, or over-zealous employees just went off piste. Then the full scale of the debacle emerges and another face-saving fiction emerges: no one could possibly have seen this coming. Both arguments were wrong in Abu Ghraib, at Enron, WorldCom, BP, Countrywide and Lehman Brothers and both are wrong today at News International.”
When the credibility of big institutions like BCCI is damaged, they tend to react in a very similar sort of way. They tend to blame it on a few rotten eggs, even though the entire institution has been wilfully blind.
As Heffernan wrote in another column for the Guardian: “Richard Fuld, the Lehman Brothers CEO, was also wilfully blind. He organised his life to ensure that he never encountered employees unexpectedly. The chief executive of Bear Stearns (a big Wall Street investment bank that went bust a few years back) chose not to implement a form of risk analysis that might actually have revealed how much debt the bank carried. And the Catholic church, when first confronted with the fact of child-abusing priests, chose first of all to take out insurance. All these institutions were blindsided by their choices – that is, they can’t blame their blindness on others.”
The same now stands true for the BCCI as well.
The article was originally published on www.firstpost.com on May 23, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Decoding the great Indian real estate ponzi scheme
Vivek Kaul
A headline can sometimes tell you the complete story. The May 20, 2013, Hindi edition of the Business Standard had one such headline. “Intehan ho gayi intezar ki, aayi na kuch khabar ghar bar ki (Its been a long time waiting, and there is still no news of the house),” went the headline.
The headline was a play on the hit Amitabh Bachchan-Kishore Kumar song “Intehan ho gayi intezar ki, aayi na kuch khabar mere yaar ki (Its been a long time waiting, and there is still no news of my love) ,” from the movie Sharabi.
The story which appeared in the English edition of Business Standard as well with a rather drab headline ‘Supply blues persist in realty sector‘, basically made two points:
a) More and more real estate companies were delaying the promised delivery of homes due to various reasons. As the story pointed out “The year 2013 was projected as the year of delivery for residential projects which had been stuck for years. While developers claim they are on course to supply a large number of units this year, sector watchers doubt it.”
b) This delayed delivery had not stopped real estate companies from announcing and launching new projects. As the story pointed out “Notwithstanding the delays in ongoing projects, a number of real estate companies, including DLF, Unitech, SVP and Supertech, are going ahead with launches, to generate cash flow in a tight market situation.” What this means is that people who have paid for homes continue to wait, whereas the real estate companies continue to launch new projects.
These two points basically tell us very clearly that the Indian real estate sector has degenerated into an out an out Ponzi scheme. A Ponzi scheme is a fraudulent investment scheme where the money being brought in by newer investors is used to pay off older investors. The scheme offers high returns to lure investors in and it keeps running till the money being brought in by the newer investors is greater than the money needed to pay off the older investors whose investment is up for redemption. The moment this breaks, the scheme collapses.
The important point here to remember is that in a Ponzi scheme the money being brought in by newer investors is used to pay off the older investors whose investment needs to be redeemed. Lets apply this in the context of real estate companies and understand why they have become Ponzi schemes.
The real estate companies have offered various reasons for the delay in delivery of homes. “Builders cite several reasons — not getting requisite approvals, slowdown in the market, land acquisition and farmers issues, among other,” the Business Standard points out.
Anyone who is not familiar with the way Indian real estate companies work would be surprised at this. You would expect a company to have sorted issues like land acquisition and getting the requisite approvals before a project is launched. If there is no land where will the homes be built? If there are no permissions how is the real estate company going to get around building the homes? And given this why is a project even being launched?
But typically this is not how things work (at least in large parts of Northern India, and particularly in and around Delhi). The real estate company first launches a project, collects money for it, and then gets around to acquiring the land and getting the permissions in place. And once it has raised some money, only then does it finally getting around to building homes. So when a real estate company says that homes have not been delivered due to these reasons, then they are largely true though not fair on those who have bought homes hoping to live in them.
However, that is just a part of the problem. The real estate companies loaded up on debt during the few years running up to 2008. Money back then was cheap and the possibilities of what you could do with it were endless.
Take the case of DLF, India’s largest listed real estate company. It had a net debt of Rs 21,350 crore as on December 31, 2012. Interest needs to be paid on this debt. At the same time this debt needs to be repaid as and when it matures.
But the slowdown in the real estate market due to the high prices has ensured that these companies are not selling enough to be able to repay these debts. In case of DLF, the sales for the period between April 1, 2012 and December 31, 2012, were down by 9% to Rs 6,777 crore.
What has happened because of this is that companies are using money that has been raised for new projects to pay off interest on debt as well as repay debt. Hence, there is no money left to build homes. In this situation, the only way left for the company to raise more money to build homes, is to launch newer projects. It can also hope to raise money from big private money lenders, where the interest can be as high as 3-4% per month. So launching newer projects is an inherently cheaper way of raising money.
So the money lets say raised for Project A is used to pay off interest on debt and repay debt that is maturing. To build homes that have been already sold under Project A, a Project B is launched. This money is now used to build homes for Project A, assuming its not used to meet debt payments. So, this ensures that Project A is delayed. Now to build homes promised under Project B, a Project C is launched. And so the cycle continues.
So money being brought in by investors into Project B is being used to build homes for Project A. Money being brought in by investors into Project C is being used to build homes for Project B. A perfect Ponzi scheme is one where money brought in by the newer investors is used to pay off older investors. In this case money brought in by newer investors is used to build homes for older investors.
The important part here like any Ponzi scheme is that it will keep running as long as the money keeps coming in. And the money will keep coming in as long as people continue to have faith in real estate as a great investment that has given fabulous returns in the past.
This faith is built on various myths. The biggest myth is that India has a huge population and hence a large amount of land will be required to house this population. And land is scarce. As the great American writer Mark Twain once remarked “Buy land, they’re not making it anymore”.
Given this scarcity of land, real estate prices will only go up. The argument though doesn’t quite hold against some basic number crunching. As economist Ajay Shah wrote in a recent piece in The Economic Times “Some claim that India has a large population and there is a shortage of land. A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.”
But as they say perception is reality. And given this money keeps coming into the Indian real estate sector. What helps in keeping this perception going is the fact that politicians have their black money invested in the real estate sector and it is in their interest to ensure that real estate prices do not fall.
One way of doing this is having some sort of a control on supply of new homes. The best way to do this is having a low FSI, which ensures that real estate companies cannot build enough to meet demand. As Shah points out “The biggest story about the future of real estate prices in India is the FSI. In most of India, the FSI is below 2. This is an abysmally small number by global standards. All over Asia, FSIs are above 5, going up to 20 or to no limit….A higher FSI results in lower rental rates for households and firms, as was seen in Hyderabad which was a pioneer in FSI reform. When FSI goes up, this will unleash supply on a big scale. As an example, if Bombay(the city is now called Mumbai) moves from an FSI of 1 to 2 — which would still make it worse than the FSI seen anywhere else in Asia — this would trigger off a doubling of supply.”
The other way politicians ensure that real estate prices continue to remain high is by nudging the banks to give newer loans to cash starved real estate companies. As Ajit Dayal wrote in a column in 2009 “Their act of giving the loan to real estate developers gives them badly needed cash. The real estate developers no longer need to sell their real estate to get “cash flow” to stay alive.”
If at that point of time banks hadn’t bailed out real estate companies, they would have had to sell homes at lower prices, and real estate prices would have thus come down. And that would have meant lower returns for real estate investors. This would have led to the real estate Ponzi scheme that is in operation breaking down because investors would have had some doubts before parking more money in real estate. But that was not to be.
What is interesting is that loans that banks give to what the Reserve Bank of India calls commercial real estate(i.e. to companies and not individuals buying homes) continues to grow at a much faster rate than overall bank lending.
Given these reasons, real estate companies will continue to launch new projects and delivery of homes will continue to be delayed.
The article appeared originally on www.firstpost.com on May 22, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)