“India Can’t Possibly Be Growing at Over 7%”

vivekDear Reader,

This is a special edition of the Diary. I was recently interviewed by the Inner Circle newsletter of Bonner & Partners based in the United States.

I am reproducing the complete interview here. These answers are generally themes that I write about and they will give you a good summary of my views on various issues that face Indian economy right now.

Happy Reading!

Vivek Kaul
Inner Circle (IC): Investors expected big things from India’s new prime minister, Narendra Modi, who was sworn into office in May 2014. For a time, at least, those expectations were reflected in a rising Indian stock market. The MSCI India Index surged 24% in 2014. But the “Modi Bounce” peaked early last year. Since then, Indian stocks are down 17% [they have fallen further since the interview happened]. I know you’ve been skeptical of Modi’s ability to push through tough economic reforms. Is he going to prove you wrong in 2016?

When Modi came to power, there was this expectation that he would start what we in India call the “second generation” of economic reforms. The first generation of reforms started in 1991 under prime minister P. V. Narasimha Rao. These were largely focused on opening up product markets – cars, mobile phones, etc. You couldn’t find many of these things in India in the early 1990s, when these reforms were underway. Human desire was limited to buying a Bajaj scooter…or, at best, an Ambassador car.

The other two big, important markets in India – land and labour – were left more or less untouched by this first wave of reforms. So, there was this expectation that Modi would tackle reforms in these two areas.  Also, in the run-up to the election, Modi promised “maximum governance and minimum government.” The maximum governance part is debatable. But the minimum government part has yet to materialize.

Why do you say that?

The government continues to run an extensive network of loss-making businesses. It runs a telephone company that makes huge losses. It runs an airline that makes losses. It is into running hotels. It is into making scooters. There’s a long list of state-owned companies that make losses. And the government continues to take on those losses.

There has been no effort at all to sell those companies or even shut them down. In fact, the Modi government has committed to shutting down just one state-run company – that makes watches! All the other companies continue to operate. Close to where I live, there is a company called the National Bicycle Corporation of India. The company continues to exist.

Is there a lot of corruption and grift going on in these state-run firms? Is that why the government isn’t doing more to shut them down?

There is corruption everywhere in government… in India and elsewhere. To that extent, I’m sure there is corruption in these state-run businesses. But are they surviving because of corruption? I don’t think so. They are surviving because the government wants them to survive.

What keeps them going, then? Why isn’t the government shutting them down?

You know what happens when an unpopular decision is made by the government? There are protests. The media catches on. There’s always a human interest story involved. You know the type of thing – “What will these guys do?”… “They’ve been working here for 30 years”…“They can’t do anything else”… and so on… and so on.

Any government that’s willing to take these state-run companies on has to be prepared to meet these protests head on. For example, say the government decided to shut down our national airline, Air India. The opposition parties would portray it as a national shame… or a national scandal…. then some leftist thinkers will latch on to it. The point is that if the government wants to push through these kinds of reforms, it needs to be firm about it. And that’s not happening.

Why can’t India just chug along as a centrally planned economy? There are people who’d argue that this model of growth is perfectly okay.

Let me give you a concrete example of what I mean…India’s neighbour Bangladesh has a population of about 150 million. But it exports more textiles than India, which has a population almost eight times larger. That’s because an average Indian textile firm employs only about eight people.

As a business, once you hit double digits when it comes to number of employees, you need to follow so many regulations and deal with so much red tape, it just doesn’t make any sense. So, you continue to stay small.

That’s less efficient at a company level. It’s also a major roadblock for the Indian economy as a whole. Because you create employment – and this has been observed the world over – when small companies become big companies. That’s how you employ many, many people. Once businesses are already big, they don’t take on new employees. They even fire people, due to earnings pressure, a squeeze on margins, and competition from leaner, smaller outfits.

Yes…

So, India needs small companies to become big companies. For that to happen, we need better physical infrastructure – more ports, electricity that is reliable, and better roads. We also need better labour laws to make it easier for entrepreneurs to grow their businesses. The Modi government hasn’t delivered on that, except perhaps for roads, where there seems to be some activity happening. That’s bad for job growth… and it’s bad for the economy as a whole.
What else should U.S. investors know about India before deciding whether to invest there?

One big theme I’ve been covering for my readers is the problem with how India calculates its economic growth. The Indian finance minister, Arun Jaitley – who is more or less the official spokesperson for the Modi government – recently boasted that India could shoulder some of the global growth contribution previously made by China.

His comment followed news that Chinese economic growth fell to a 25-year low of 6.9% in 2015. That means, going by the official figures at least, that India is the fastest-growing major economy in the world. From July to September 2015, Indian GDP grew at a pace of 7.4%.

Are you saying you don’t trust the government’s figures?

The gross domestic product(GDP) is ultimately a theoretical construct. For it to be a useful guide for investors, it should reflect economic reality. The Indian GDP numbers aren’t in sync with the reality on the ground in India.

Can you give me an example of what you mean?

Most Indians still can’t afford to buy a car. So, new two-wheeler sales are a better indicator of consumer demand. And two-wheeler sales have gone up by just 1% over the past year. Drill into those numbers a bit further and you’ll find that, although scooter sales have gone up, motorbike sales have gone down.

Why is that important?

Because people in rural India – a major chunk of the population – tend to buy motorbikes instead of scooters because the roads are so bad in rural India that scooters just aren’t an option. That tells us things are not so well at the consumer demand level. Same goes for tractor sales, another good economic indicator for demand in rural India. Tractor sales are down by about 13% over the past year. And liquor sales are also down. Which again tells you that consumer demand is weak.

Give us some more numbers…

Or take railway freight volumes – a good proxy for industrial demand. Railway freight has gone up by only 1% over the course of the past year. This tells us that industrial demand continues to be subdued.

And bank loan growth, another good proxy for consumer demand, has also been in single digits this year – at about 8-9%. That’s around half of what it used to be until a few years back. This tells you that India can’t possibly be growing at over 7%, as the government claims.

Are you saying that the Indian government is fudging the data?

Many investors have come to that conclusion about official Chinese economic data. I don’t think the Indian government is fudging the data. That would be giving too much credit to our bureaucrats. What happened is that last year, India changed the way it calculates GDP. Even though you’ll read in the mainstream press that this new way of crunching the numbers is in line with international norms, something is not right about it. The official numbers just don’t reflect what we’re seeing happen on the ground.

If you calculate India’s GDP by using the old methodology, what you find is that India is growing at a pace closer to 5%. To me, this is a lot more realistic.

Five percent growth is still fast when compared to the rest of the world. A lot of countries would love to be growing at that kind of clip.

That’s true. But for India, it’s not good enough. A significant part of the Indian population continues to live in poverty. Up until the recent slowdown, China grew at an average pace of about 10% for roughly 15 years. Only because China was able to grow at the kind of pace was it able to pull so many people out of poverty.

The worrying thing in India is that close to 13 million people enter the workforce each year. And that’s set to continue until 2030. This is what we call our “demographic dividend.” But if this dividend is not taken care of, it could turn around pretty quickly and hurt us. What your readers need to be aware of is that there aren’t enough jobs right now for that to happen.

Indian economic data, as I said, can be sketchy. But from what we know, the rate of population growth is outpacing the rate of job growth in India. As one of the speakers at the recent Equitymaster conference warned, if that continues to happen, the reaction from India’s poor could make the Arab Spring could look like a joke.

I’m not saying your readers shouldn’t invest a portion of their portfolio in Indian stocks. But they need to be aware that there’s a lot more to the growth story here than they’ll typically read about in the mainstream press. And in my view, at least, the real story on the ground is a lot less bullish for the economy and for the stock market than most people believe.

Thanks, Vivek.

You’re welcome.

This interview appeared in the Vivek Kaul Diary on February 18, 2016

Bill Bonner: “We Have Got a Lot More Nonsense Coming”

bill bonner
Dear Reader,

This is the second part of the interview with Bill Bonner.

He founded Agora Inc. in 1979. With his friend and colleague Addison Wiggin, he co-wrote the New York Times best-selling books Financial Reckoning Day and Empire of Debt. His other works include Mobs, Messiahs and Markets (with Lila Rajiva), Dice Have No Memory, and most recently, Hormegeddon: How Too Much of a Good Thing Leads to Disaster.

In this interview Bill tells us that “We have got a lot more, a lot more nonsense coming and I think it’s going to come first from Europe where Draghi is going to come up with a lot more QE like stuff.  We don’t know exactly what or when.”

Happy Reading!
Vivek Kaul
Iceland just sent its 26th banker to prison. As far as I know not a single US banker or someone from Wall Street has gone to jail. Rajat Gupta and Raj Rajaratnam have, but their cases were different. They had nothing to do with the financial crisis.

Ah! I am not sure, but as far as I know no banker specifically has been gone to jail as a result of the crisis.  I don’t know what to make of it.  I am hesitant to condemn the bankers.

I mean they were playing the game when in effect, they were the ones who made the rules. They bribed the politicians to make the rules and they played by those rules. Did they break the rules?  I don’t know.

Why do you say that?

I have been involved in the financial industry in America for a long time. What I do know is, those rules are very tough to understand. If anybody wants to put you in jail, they can put you in jail because it’s sure that you are violating some rule somewhere. There are too many of them.  So I am little bit sympathetic to the bankers in that particular aspect about being convicted of crimes. But I am not at all sympathetic to them in the broader sense because as I said they created that system. I don’t think they deserve to go to jail because I would bet those rules are pretty non-screwy. I do bet they deserve to go broke and that’s what would have happened and that’s the way the market works.

But these guys escaped…

The market doesn’t put you in jail just because you bet on the wrong banker.  But the market has a way of taking care of these problems and it was on its way to taking care of these problems in a big way in 2008, when half of Wall Street was exposed to bankruptcy. Half of those institutions probably would have gone broke and half would have been broken up and sold. That would be a punishment and getting what one deserves. That to me makes sense. Instead of that, the government came in and gave these people money. It gave the people who had made such bad bets even more money to make even bigger bets and then it claimed to be enforcing the law. The wrong doers were too close. They all were too cozy there.

That’s a nice way of putting it…

So my guess is that in Iceland their financial industry did not lobby correctly.  But the end of it was that the financial industry got away scot free and got away with all of their ill-gotten gains and went on to make even more money as the Fed gave them money in the terms of zero interest rate financing.  So the whole thing is absolutely preposterous in every sense and offensive.

Your new book is called “Hormegeddon: How Too Much of a Good Thing Leads to Disaster.”  So can you elaborate a little on the subtitle of the book, “How too Much of a Good Thing Leads to Disaster.”  Why do you say that?

Well there is a famous quote in America by Mae West, who said, “Too much of a good thing is wonderful.”  The thing that she was talking about might be the only thing that too much of is wonderful.  But most things are like sugar. You think, well, I will have a chocolate pudding for dessert and one chocolate pudding is wonderful, two chocolate puddings is okay.  By the time the third chocolate pudding comes around, you begin to say um, I am not sure about this and by the fourth you begin to feel a little sick. If you keep eating chocolate puddings, it is not going to be good for you. So that’s true of almost anything.

By the way the economists have a rule for this called the principle of declining marginal utility and it seems to apply to just about everything.  No matter what you try to do or what you think.

Can you give us an example?

It applies to money. When you have no money and somebody gives you 10 dollars, that 10 dollars, each one of those dollars is very very valuable to you and if you have a million dollars and somebody gives you 10 dollars you really are not going to be impressed at all because the value of that money has declined.  Each additional incremental dollar declines to the point where it is almost worth nothing. We read in the papers that multibillionaires like Zuckerberg have given away 50 billion dollars and that is such a great thing. But actually those 50 billion dollars really had no value.

What do you do when you already have the house that you want…you already have the car that you want… and you can’t eat any more chocolate desserts…no matter how much money you have…you cannot buy another car…what are you going to do with it?

You only have a certain number of hours in a day…you can only watch so many movies…you can only do this…you can only do that…so you reach a point where the extra money that you get has a marginal utility that has declined to zero and then below zero.  Because you have to take care of it, you have to think about it and you have to protect it.  And so when a billionaire has 100 billion dollars and he gives away 50, well I don’t know if he has given away that much.

But anyway, the principle applies to everything.

Can you give us some more examples?

It applies to security, one of the cases that I explained in the book.  Now you would say well security; you can’t be too safe and that’s what they tell you when you go through the line at the airport and there is a grandmother in front of you and they are checking her out thoroughly making her go through twice and panning her down and you are thinking in what way does she pose a threat to anybody and then a voice comes out that says, “you cannot be too safe.”

But in fact you can be too safe and because everything that you do in that direction involves expending money and time and resources that could be used for something else.

Can you give us an example?

In the extreme example that I used in the book—In Germany after the First World War, it felt very unsafe, you know they had capitulated in the war and the allies that is to say France, America and Britain were not at all sympathetic. So Germany felt terribly exposed and they were not allowed even to have an army. 

So along came Adolf Hitler and he said, “Enough of this, I am going have an army anyway.” And he began investing German money in the security industry and at first it seemed like the right thing to do.  And at first the viewers, especially the foreign viewers, who really didn’t know what was going on, they thought that this was great. Germany was getting back on its feet and their factories were hustling again. Everything seemed to be going in the right direction.

But Adolf Hitler did not stop with a little bit of security, he wanted a lot of security and more and more of the German economy, was shifted from domestic production to military production and the result of this was that it shifted people’s minds too, because pretty soon a lot of the German workforce actually worked for the defence industry and a lot of people had children, sons, daughters, nephews in the army. Everybody became very sympathetic to the army, to the defence industry and after years of propaganda to the idea that Germany needed its place in the sun and the way to get it was with military force.

So they launched on this adventurism which they started in 1939 and the result of that we all know.  It was disastrous. It ended in the worst possible way for Germany where all of that security bought them no security at all.  It was counterproductive. It was a negative pay off.  They had gone from when they had too much of a good thing, security being a good thing, to the point where they had no security at all.  And that’s true in a lot of things, I mean that principle.

How do you link this to the current financial crisis?

Well you could say almost exactly the same thing about credit.  A little bit of borrowing is a good thing and the credit has proven to be useful in many circumstances. In fact, credit is as old as the hills and even before there was money there was credit.

Credit right.

Yeah there was debt and people would remember in small tribes. Anthropologists have done a lot of study of this.  They found that people would remember that somebody gave them chicken or somebody gave them an arrowhead or somebody’s daughter was exchanged to one family and they owe them a daughter or something or another.  And they remembered.  They had long memories of this stuff.  So credit is basically something that has been around for a long time and surely a little bit of credit seems to help an economy, but too much credit and then you end up with these funny things happening as we have in the world today.

For sure…

And by the way world credit is astounding in its growth; in 1995, which is 20 years ago, the entire world credit was 40 trillion dollars; today it’s 225 trillion.  That’s in a period in which the GDP has risen like 2% per year.  This is a phenomenal separation of the real economy from the Wall Street economy; The Wall Street economy being an economy of debt, assets, financial instruments, etc.  So we have this huge diversion.

We have seen also the same sort of thing, a declining marginal utility of debt, where each additional dollar invested in debt has produced less and less GDP payoff.  And so at the end, in 2009, we were seeing huge increases in debt with no increase in GDP and that’s what is happening again today, where debt is still going up at a very high rate and the GDP growth has declined in America to about a zero. In fact, it might be zero and it might be negative, we are waiting for the figures for the last quarter to come out, but there are some people guessing that the next quarter is going to be a recessionary.

Given that the next quarter is going to be recessionary, how do you see Janet Yellen and the federal open market committee going about increasing the federal funds rate…

Oh! I don’t think they will and I don’t think they can.  I think that it’s…

Will they reverse the cut?

They won’t want to because you know they have staked their short term reputations on this idea that the economy is recovering and that therefore they can normalise interest rates.  They are all in cahoots by the way. Also, these guys talk to one another. I think what they are counting on is Mario Draghi [the President of European Central Bank] to reinvigorate the European economy with a lot of credit, because he has been generally not done as much.

So Draghi came out and said that he would do whatever had to be done and he said that there were no limits to what he would do.  And right after that the world stock markets went up.  Yellen would much prefer for Draghi to do the heavy lifting this time and my guess is that they have a lot more they can do and I don’t think we have reached the end of this cycle at all.  I think we have got a lot more, a lot more nonsense coming and I think it’s going to come first from Europe where Draghi is going to come up with a lot more QE like stuff.  We don’t know exactly what or when.

You see Yellen going back to QE?

I do, but not quickly.  First they are hoping that the Europeans will do enough. If the Europeans put out enough cheap money it ends up in America any way because the Europeans want to buy US treasury bonds in order to protect their money so that’s probably what will happen.  

I think it really depends on how effective the Europeans are. If the Europeans are not effective and we get another big wave downward in the US markets and we go into a recession in the first quarter, I think then first they will announce that they will not do any further hikes. Then maybe they will come with some QE program or something, but there is no way in which they are going to allow a real correction.  A real correction is the severe serious thing. All of their training and their institutional momentum, all of that goes towards solving these problems rather than letting them solve themselves.

Thank you Bill.

Thank you.

Concluded…

The interview originally appeared on the Vivek Kaul Diary on Equitymaster

You can read  the first Part of the interview here 

Bill Bonner: “It’s 100% impossible for the value of stocks to be divorced from the economy”

bill bonnerDear Reader,

This is a Special Edition of the Diary. In this I speak to Bill Bonner, whose books and columns I have admired reading tremendously over the years. He founded Agora Inc. in 1979. With his friend and colleague Addison Wiggin, he co-wrote the New York Times best-selling books Financial Reckoning Day and Empire of Debt. His other works include Mobs, Messiahs and Markets (with Lila Rajiva), Dice Have No Memory, and most recently, Hormegeddon: How Too Much of a Good Thing Leads to Disaster.

Even though Bill writes largely on finance and economics, his writing style is close to literary fiction, and that is precisely what makes it so enjoyable to read him.

In this interview we talk about how the world of finance and economics has changed over the last few years. And how does Bill read the world that we live in. This paragraph summarises everything: “I just didn’t think it [i.e. the financial crisis] will go on this long but that’s also one of the realities that things that you think can’t last, actually do last longer than you expect and they get worse than you expect and then after they have gotten much worse and lasted much longer than you expect then you begin to think well maybe I don’t understand something about it and maybe there is something going on here that can last and then of course it blows up and you were right all along and then at that time of course you are not anticipating it.”

This is the first part of the interview. The second part will appear tomorrow.

Happy Reading!
Vivek Kaul

 

I guess the last time we spoke would probably have been sometime in 2011-2012.  So how have things changed?

It was surprising to me that the authorities were more aggressive than I expected coming in with the QE1, QE2 and QE3 and then the twist. And those things as expected didn’t do anything for the economy.

In fact, it may have actually slowed down the real economy.  But they did wonders for the stock market and the financial industry so they are very very popular and well those things were essentially reducing the cost of credit, making easy money even easier.

So naturally, there is more and more debt and it just seems to be a phenomenon or fact of life that when you make debt cheap, when you make it cheaper than it should be, you get people borrowing money for things they shouldn’t be doing and too much capacity, too many speculations, too many gambles, too many business expansions that don’t really make any sense.

And what did that lead to?

So we saw the effect of that in the commodity market, particularly the oil market which has been really laid low by this combination of cheap money which made it possible for American drillers to get out there all over the place and drill for oil and some marginal producers in Canada and otherwise in Brazil and everywhere to come up to increase the supply of oil. Meanwhile the actual demand for oil was going down because the world economy was actually not in a growth mode at all.

So we have those kinds of things happening and that’s all happening since the last time we talked and the huge expansion and explosion and implosion of the oil market, implosion of the commodity market and explosion in world debt which has gone up about 57 trillion dollars since 2008. So these things were really much bigger than I anticipated.

I just didn’t think it will go on this long but you that’s also one of the realities that things that you think can’t last, actually do last longer than you expect and they get worse than you expect and then after they have gotten much worse and lasted much longer than you expect, then you begin to think well may be I don’t understand something about it and maybe there is something going on here that can last and then of course it blows up and you were right all along and then at that time of course you are not anticipating it.

So why hasn’t all this debt lead to economic growth? Why hasn’t cheaper money led to economic growth because you know this was one of the beliefs that central bankers had and their actions in the last seven- eight years have been built on the belief that we will flood the markets with money, we will have low interest rates, people will buy, companies will do well and economic growth will return. Why hasn’t this happened?

Why doesn’t that happen?  And the answer is hard. I don’t really know. There is a Swedish economist named Knut Wicksell and Knut Wicksell noticed, that whenever the cost of money was too low, he said there were two interest rates.

He said there was a natural rate which is to say the rate that money should cost in a real properly functioning market and then there is the actual rate and the actual rate is jigged up by the authorities in the banking industry. Whenever the actual rate is too low, people do not invest in the kinds of things that will increase real production.

He said what they do, and I never have really fully understood this, but he said what they do when money is too cheap, they tend to go for easy things. So the banks take the easy money which is too cheap and then they invest it in US Governments Securities, you know the 10-year treasury bonds and that way they get guaranteed return, a guaranteed positive carry.

What else did he say?

And then he says that when money is too cheap people make cheap investments, one because they don’t really know what is going on.  You know the cheap money distorts the whole picture.  The cost of money is the critical number in all of capitalism You have to know what it will cost you really to borrow money. And once you know what the money really costs then you should decide whether you should build a factory, whether you should invest in this, buy that.  

You don’t know until you know the real cost of money and by distorting the real cost of money as Wicksell points out what it does is it drives out everybody away from real investment where they don’t really know what they should be doing. They don’t want to invest real money in a project where the returns are uncertain and the value of money is uncertain and everything is uncertain. So they go for these cheap investments.  These easy investments such as US treasury bonds where they know they will get paid and so you get a big increase in these debt investments. Hence, just the quantity of debt goes up where everybody is just counting on being able to borrow cheap and lend a little less cheap in order to pocket the difference without any real risk.

Even though the economies as such haven’t recovered, the stock market and the real estate markets in parts of the world have done very very well.  So how do you explain that dichotomy? Has the link between economic growth and stock market returns broken down?

Oh! It has totally broken down. We have a chart that we use. We go back to 1971, where we believe something fundamental happened when they changed the US money system. Since 1971 what you see if you look at US GDP growth, it looks more or less normal.  I mean the growth rate was higher in the 70s and it gradually went down decade after decade, it got lower and lower.

But you are talking about going down from five to three to four to three to two and now probably about zero percent, but that growth is real…that’s the real economy…that’s Main Street…that’s where people work…that’s where they spend their money…that’s where they earn their money.

When you put that on to that chart, and you put a chart of what the value of America’s stocks and bonds are, then that chart just goes right up after about 1995.

Yes that’s what the chart shows…

And so there is something going on where the stocks and the value of assets is being cut off completely from the value of the real economy that supports them, which is impossible of course.

I mean it is impossible for that to continue because ultimately any asset is only valuable in as much as the economy gives it value.  It’s not valuable in itself.  If you have a blue jeans factory and you are producing five thousand pairs of blue jeans a day but that is not worth a penny unless you have got people who are willing to buy five thousand blue jeans a day and they can only do that if they are earning enough to buy five thousand blue jeans a day.

And you know that was Say’s principle which was that “Supply creates demand”, which is a funny thing. I mean it’s easy for people to misunderstand that.  But what it really means is that it’s only because you have an economy that produces wealth that people have the money to buy what you are making.

So there is no way, it’s absolutely hundred percent impossible for the value of stocks and bonds to be divorced from the value of the economy itself.  And what we have seen is a separation and we call it a divorce. But the two have been separated for a long time and my guess is that they are going to get back together.

In the book ‘The Age of Stagnation’ Satyajit Das makes a very interesting point about how lower interest rates have not led to increased consumption and he gives a very interesting reason for it. What he says is that when the return on fixed income investments comes down, people put their money in the stock market and when they do that the pressure on companies to keep increasing their earnings so that they can keep giving dividends increases.

You know people are looking at stocks as a mode of dividend [regular income] than a mode of capital gains because the money they used to earn through the fixed income investments has come down [dramatically].  So when there is pressure on companies to give dividends in a scenario where the sales are not really growing, they fire their employees. They [also] borrow money so that they can buy back their stocks and when they buy back their stocks the earnings per share goes up and the dividend per share [as there are fewer shares than before] also goes up.  So that is why even with cheap money, easy money and low interest rates, consumer buying hasn’t picked up and hasn’t translated into economic growth.  Does this makes sense?

Well I think it totally makes sense. I saw an example of that just in today’s press which unfortunately I can’t recall. The company announced simultaneously that it was laying off 10,000 employees and had a big [stock] buy-back program. 

I think it’s just a shift that in America has been widely described as the ‘financialization’ where the money goes from Main Street to Wall Street. You can see that shift very clearly, if you look at the salaries paid on the Main Street, which have gone nowhere for decades and the salaries paid on Wall Street which have gone straight up and you could also look at the profit share of the economy.

The whole of the financial industry earned about 10% of the US profits in 1980 and by 2007 it was 40%. This is wealth that is going from Main Street economy where people work, live, eat, earn their lives, earn their retirements to Wall Street where its speculation, gambling, investing of sorts.  And that change has transformed the entire economy and eventually that is what I keep saying—trees don’t grow to the sky. I feel this cannot go on forever and how much longer it can go on of course is a subject of great interest.  But I really don’t know.

You know you talked about Wall Street, do you think Wall Street in 2015 -2016 has gone back to the way things were in 2006, 2005 and 2007. Would you say that?

Oh yes! I would say that that’s generally the case.  You don’t want to pin point and you don’t want to be too tied to historical rhythms but it certainly looks that way.  We don’t have a housing bubble of the same sort now in America.

But there is a bubble…

There is a bubble in housing but it is not the same sort.  But the bigger bubbles in the US today are the bubbles in the student debt and auto debt.  We have a heck of an auto debt bubble and the corporate debt bubble that we didn’t have before.

Corporate debt is huge because all the money that has been used to buy back shares…

It is mind boggling to think that a corporation would borrow money to buy some shares and you wonder what business is this corporation in.

Is the student bubble has big as the housing bubble?

No. It’s not that big. The housing bubble was worth $4 trillion or something and this is $ 1 trillion.

Which is big anyway. $1 trillion is not small.

It’s huge, but it’s not the same kind of huge.  It’s an entirely different thing because the housing bubble was exposed to the value of the collateral.  In the housing bubble there is something there and eventually it was obvious that what was there was not worth what they thought it was because at the end of it the typical house costs something like twice as much as the typical family could afford.  So it didn’t take a genius to figure out that cannot go on for much longer and by the way salaries were not going up.  There was no way that a person was going to catch up to that.  But now what is the collateral on a student loan?  It’s nothing.

There is some intellectual capital…

This student loan is interesting because the collateral is essentially worthless.  They have done studies to show that if people borrow money, get educated they don’t earn more money and it’s a bit of a fraud.  Its money that a bank lends, secured by the government, goes to the student, goes to the education industry, which is just lobbying Congress for the whole thing to continue.

How big is the auto bubble?

The auto bubble is big but I don’t remember the numbers. And there is a huge transformation of the auto sales system where it is all directed.

So essentially what we can say here is that low interest rates have had some impact on the auto industry, I mean people have been buying cars.

Big effect yes and without those low interest rates there wouldn’t be these car sales and the car sales like employment have been held up by the central bankers and the economists as evidence that the economy is healthy.

Why they are buying cars is because the interest rates are held down.  This is the equivalent of those low interest loans in the housing industry in 2007.  Now they have the auto industry that has loans that stretch out. The average loan goes more than four years.  And yeah four years for cars is a long time.

To be continued…

The interview originally appeared in the Vivek Kaul’s Diary on February 4, 2016

“The build-up of debt over last 25 years has been excessive, beyond repayment capacity.”

satyajit das
Dear Reader,

This is a special edition of the Vivek Kaul Diary. This is the first time I am interviewing someone for the Diary. In this interview I speak to Satyajit Das, an internationally respected commentator on financial markets, credited with predicting the current financial crisis. He has also featured 2010 Oscar-winning documentary Inside Job.

I would like to say here that personally I have learnt a lot from reading what Das has written over the years. His two books Traders, Guns and Money and Extreme Money have been a master class on derivatives as well as how they caused the financial crisis.

Honestly, if you were to read only one book on the financial crisis, it has to be Extreme Money.

In this interview I speak to Das around his new book The Age of Stagnation—Why Perpetual Growth is Unattainable and the Global Economy is in Peril. Like his earlier books this book is also a terrific read and a must for anyone who seriously wants to understand how things haven’t really changed in the aftermath of the financial crisis, and why the future continues to remain bleak.

This is the first part of a three-part interview. The other two parts will appear over the next two days.

Happy Reading!
Vivek Kaul

I would like to start with a clichéd question. Why did very few economists and experts see the economic crisis coming?

I think Richard Breeden, a former chairman of the SEC, probably identified the reason best: “It’s probably a better question for a psychologist. There’s a group dynamic…nobody likes to be the person who sends everybody home from the party when they’re having a good time.”

People rarely see what is front of them because of a mixture of ideology, biases and incentive structures. Proponents of markets are never going to concede that the mechanisms had failed or were even capable of failure.

Most economists and experts are guilty of ‘groupthink’. People with similar backgrounds and largely insulated from outside opinions tend to make decisions without critically testing, analysing and evaluating ideas or evidence. They collective rationalise, convinced about the inherent morality of their views, their unanimity and invulnerability. They also hold stereotyped views of outsiders and do not tolerate dissent. People work in neat silos and don’t look outside their narrow specialisation.

People employed by financial organisations are deeply compromised, forced to propagate the party line. Upton Sinclair was correct in noting that “it is difficult to get a man to understand something when his salary depends on his not understanding it”.

What made you feel that a crisis was on the way?

My only advantage is that I am not beholden to anybody or any organisation. I don’t have strong ideologies. My interest is in facts and trying to understand them. I am extremely pragmatic, adhering to what works or doesn’t. It is a luxury.

But you also need to be lucky, especially on timing of events.

One of the first things you write in your book is “future generations may have lower living standards than their parents”. This I would guess is one of the key points of the book as well. Why do you say this?

Future economic historians may come to regard the last two centuries and especially the post WW2 period, as an exception in terms of large improvements in livings standards.

Ultimately, prosperity depends on economic growth. If growth is slower and more volatile in the future then future generations will have lower living standards. The reasons are fairly simple.

First, much of the recent prosperity was built on debt funded growth which is not repeatable. An unknown portion of this debt will have to written off either explicitly (default/ restructuring) or implicitly (through reduction in purchasing power through inflation or financial repression). A large amount of wealth will be wiped out.

Second, environmental damage will restrict future growth. This will be through acceptance of lower levels of economic activity as the world restricts the use of fossil fuels which is unlikely. The alternative will be lower growth as a result of the catastrophic costs of climate change, in terms of damage, dislocation or shortages of essential goods and services.

Can you give us an example?

For example, India will have to accept the problems of water shortages and lower food production as well as having to deal with the forced displacement of a large part of the population of Bangladesh. There are also ancillary costs like health costs from air, water and soil pollution.

Third, resources like water, food and energy will get scarcer and therefore more expensive.

Fourth, our model for dealing with these issues is simply to extend and pretend and kick the problem further down the road. In effect, past and present generations will have enjoyed the benefit but the costs will be borne by future generation, reducing their living standards.

The problem will manifest itself at an individual level in three ways. A large part of future generations will find employment, particularly secure and well-paid jobs, more difficult to obtain. A commentator in Greece argued, with black humour, that the government could save money on education because it was unnecessary to prepare people for jobs that did not exist.

Purchasing houses and large capital goods may become harder. Also, the idea of a finite working life followed by retirement will become a luxury for most. People will have to work till they die or are unable to work.

We see all these trends already in many societies.

Much of the world’s population (probably 5-6 billion of the 7 billion on earth) are already in the position that I have described. It is the other 1-2 billion who aspired to a better life for themselves and their children who will have to adjust their expectations, which have been set too high.

You write that “we may never know the real cost of the financial crisis”. Why do you say that?

Costs of crisis are always complex. There are measureable losses in the value of financial assets like equities, property and loan write-offs. There are structural effects which economist refers to as hysteresis; that is a single disturbance which affects the course of the economy. An example is the delayed effects of unemployment. As unemployment increases, more people adjust to a lower standard of living. There is reduction of potential output. There are complex questions about what period we measure losses over.

The 2007/2008 financial crisis illustrates this point. Large financial institutions throughout the world collapsed or suffered near fatal losses. Values of houses and financial assets, like shares, fell sharply. In the real economy, there was a sharp downturn in economic activity, unemployment often for prolonged periods, housing foreclosures and evictions and failures of businesses.

What is the biggest number you have come across with regard to the cost of the financial crisis?

In 2009, the IMF estimated the cost to that stage at around US$12 trillion, equivalent to around 20 percent of the entire globe’s annual economic output. In 2013, Tyler Atkinson, David Luttrell and Harvey Rosenblum, three economists at the Federal Reserve Bank of Dallas, tentatively quantified the loss to the US economy as between US$6 and US$14 trillion, around US$19,000 to US$45,000 per person. Under certain assumptions, they found that the loss could be higher – US$25 trillion or over 150% of GDP, almost US$80,000 per American. No one may ever know the full cost.

There are huge indirect costs like lost human potential and suffering, which we do not measure. A diary entry at the time of the Great Depression in Siri Hustvedt novel Sorrows of An American reads: “A depression entails more than economic hardship, more than making do with less. That may be the least of it. People with pride find themselves beset by misfortunes they did not create; yet because of this pride, they still feel a pervasive sense of failure… People become powerless.” We don’t measure that.

On page 34 you write: “everybody, it seemed, agreed with Oscar Wilde that living within one’s income merely showed a lack of imagination”. Why do you say that? Isn’t it a very fierce indictment of the Western World?

Developed economies are now 60-70% consumption.

If we look at the post war period then you see a persistent pattern of promoting consumption. Initially, it was about meeting unsatisfied needs. Over time, it shifted to manufacturing demand though a variety of strategies ranging from advertising to planned obsolescence.

Consumption driven economies require you to keep consuming to drive economic activity to provide employment to give you income to buy more things you don’t really need. There is a piece of graffiti art by Bansky which I have always liked. It reads: “join a hilarious adventure of a lifestyle – work, buy, consume, die”.

In Das Kapital, Karl Marx identified this inherent tendency of capitalism towards overproduction. Theologian Reinhold Niebuhr saw society as enslaved to its productive process, reversing the normal process of producing to satisfy consumption needs. Economists dismiss overproduction, arguing that supply creates its own demand (known as Say’s Law). They view consumer needs as essentially unlimited, with people wanting more and better goods.

It may be an indictment of Western economic system.  My objective was not judgemental. It was to describe what was happening. In essence, economic growth and prosperity were by-products of consumption, unsustainable resource exploitation and serious environmental damage. It would be fair to say in recent decades nobody was took the advice of 19th century philosopher John Stuart Mill “[seeking] happiness by limiting … desires, rather than in attempting to satisfy them”.

There is a great belief among economists that borrowing leads to economic growth. How true is that? Has the impact of debt on growth come down over the years?

There is nothing inherently good or bad about debt. It can be used to drive economic growth, allowing immediate consumption or investment against the promise of paying back the borrowing in the future. Spending that would have taken place normally over a period of years is accelerated because of the availability of debt.

The use of debt can be beneficial, where the economic activity generated is sufficient to repay the borrowing with interest. This requires borrowing to finance assets or investments which generate income or value to repay principal and interest. A significant proportion of current debt does not meet this test.

Only (around) 15-20% of total financial flows went into investment projects with the remaining 80-85% being used to finance existing corporate assets, real estate or unsecured personal finance to facilitate consumption. Borrowings were frequently used to finance pre-existing assets where anticipated price rises were to be the source of repayment.

Under these conditions, a slowdown in the ability to borrow ever increasing amounts can lead to a sharp fall in asset prices to levels below the outstanding debt creating repayment difficulties. This is precisely what happened in 2007/2008 and is likely to happen again, sooner than people think.

The build-up of debt over the last quarter of a century has been excessive, beyond repayment capacity.

Could you elaborate on that?

In the lead up to 2007/2008, there was a rapid build-up in debt in developed economies. Between 2000 and 2009 total global credit grew from US$57 trillion to US$109 trillion, equating to a growth of 7.5% per annum, around double the growth in economic activity. In many countries, debt reached three to four times Gross Domestic Product (“GDP”), levels not normally reached other than in wartime (i.e. 1914-1918 and 1939-1945) when the result was losses for creditors of the losing states.

The other problem is that you need to borrow ever increasing amounts to both repay existing borrowing but also to maintain economic growth. By 2007/2008, the US needed $4-$5 of debt to create $1 of economic growth, compared to an additional $1-$2 of debt per additional $1 of GDP in the 1950s.

To be continued…

Disclosure: Satyajit Das wrote the foreword to my book Easy Money: Evolution of Money from Robinson Crusoe to the First World War

 

“When you expand your brand, you weaken your brand”

laura visual hammer

Laura Ries is a leading marketing strategist, bestselling author and television personality. In 1994, Laura founded Ries & Ries, a consulting firm with her father and partner Al Ries, the legendary Positioning-pioneer. Together they consult with companies around the world on brand strategy. With Al, Laura is the co-author of five books on branding that have been worldwide bestsellers. Her first solo book was Visual Hammer. Her latest book Battlecry was published in September 2015. In this interview she speaks to Vivek Kaul.


In the foreword to your new book Battlecry, Al Ries writes that “over time, companies drift sideways. They get into many different businesses and lose their focus.” Can you give us a few examples.

There are so many, but here are a few. Yahoo was the leading search engine, at one time worth $120 billion on the stock market. Then Yahoo turned itself into a “portal” by adding a host of new services. Yahoo Mail, Yahoo Games, Yahoo Groups, Yahoo Pager, etc.
Those additions allowed Google to move in and dominate the search market. Today, Yahoo is worth only $29 billion on the stock market and most of that value is due to its investment in Alibaba stock. (Google is worth $428 billion on the stock market.)

Any other examples?

Dell was once the largest maker of personal computers with 17 percent of the global market. Today, Dell has fallen to third place with 13 percent. Dell stock once sold for $60 a share. Two years ago, was Dell bought out by a private-equity firm for $13.75 a share.

What caused Dell to collapse?

Expansion. Dell once sold computer direct to businesses. That was it. Then Dell started selling to the consumer market, including such products as television sets, digital audio players, computer printers and smartphones. The company also made many acquisitions in such areas as storage, services, data centers, security, virtualization, networking and software. In the three years from 2009 to 2012, Dell spent $12.7 billion on 18 acquisitions.

IBM, General Electric and a host of other companies have tried to expand their businesses by introducing many new products and services. Today, these and other companies have gotten smaller, not larger.

Why does this happen?

Because when you expand your brand, you weaken your brand.      

How do you correct this mistake at the branding level?

First of all, a company should narrow its focus so it stands for something. Dell once stood for “Personal computers sold direct to business.” What does Dell stand for today? Nothing. As a result, Dell has to sell its products and services based on low prices.

Years ago, Dell had a powerful slogan. “Direct from Dell,” a slogan that implied that companies could save money by buying their PCs from Dell’s website. Furthermore, the slogan was memorable because it used “alliteration,” one of the five techniques mentioned in my Battlecry book that can increase memorability.

What is Dell’s slogan today?

“Better technology is better business.” That’s a generic slogan that could apply to any company.

Why is a narrow product line better than a broad product line? Because a narrow product line is needed to build a powerful brand.

Can you give us an example?

Take Subaru, a Japanese automobile brand. In the American market in the year 1993, Subaru sold 104,179 vehicles, but the company lost $250 million on sales of $1.5 billion. So a new president was hired. The new president found that 48 percent of Subaru’s sales were four-wheel-drive vehicles and 52 percent were two-wheel-drive vehicles.

So what did he do? He decided to focus on four-wheel-drive vehicles only. Sales declined the first two years, but then they took off. From 104,179 vehicles in 1993 to 515,693 vehicles in 2014, an increase of 393 percent. (The total automobile market in those 21 years increased only 19 percent.) In 1993, Subaru was the ninth-largest Japanese vehicle brand in the American market. Today, Subaru is the fourth largest, trailing only the big three: Toyota, Honda and Nissan.

So what is the moral of the story here?

It’s hard to find cases like Subaru because most brands are taken in the opposite direction. Companies expand their brands; they don’t contract them. That’s logical, but that’s not good marketing strategy.

Why do companies like formal words in their marketing campaigns? You recommend colloquial expressions. Why? A few examples would be great.

Formal words like “motion picture” sound important. But consumers invariably use shorter words like “movies.” Or “TV” instead of “television.” Or “SUV” instead of “sport-utility vehicle.”

One of the most-famous charities in America, organized by the United States Marine Corps, collects toys for children at Christmas time. Instead of calling the charity “Toys for Children,” they called the charity “Toys for Tots,” a colloquial expression that is also alliterative.

You also talk a lot about abstract words. Can you tell us a little bit about that and how they hurt a marketing campaign?

You have two brains. A left brain which handles words and a right brain which handles visuals. The right brain is also the site of your emotions. There are also two kinds of words, abstract words and specific words. “George Clooney” are specific words. “World-famous movie star” are abstract words.

So?

Both abstract and specific words are processed in the left brain. But specific words like George Clooney also conjure up images in your right brain, the emotional half of your brain. Emotion is the biggest, single, memory stimulant. What events do you remember the most? The day you graduated from college. The day you got married. The day you had your automobile accident. These “emotional” events are also visual. You can never forget them. That’s why slogans using specific words are much more memorable than slogans using abstract words.

Can you give us an example?

“The ultimate driving machine” made BMW the world’s largest luxury-vehicle brand. BMW could have said “The ultimate performance machine,” a broader and more inclusive slogan.

But “driving” is a word that can be visualized. (Two hands behind the wheel.) But “performance” cannot.               

What is the difference between slogans that consumers remember and the ones that they don’t? How is related to the concept of Battlecry?

Two things make a slogan memorable: Money and memory-enhancing techniques. If you have enough money (and enough time), you can make any slogan memorable. “Just do it,” the Nike slogan, is memorable because Nike has spent billions of dollars to promote it over the past 27 years.

But most companies don’t have the resources of Nike. Nor do they have the time. What can they do?

They need to consider one of these five memory-enhancing techniques.

(1) Rhyme. Folgers became the No.1 coffee brand in America by focusing on breakfast with the slogan: “The best part of waking up is Folgers in your cup.”

(2) Alliteration. M&Ms became a leading candy brand by focusing on a feature of the brand with the slogan: “Melts in your mouth. Not in your hands.”

(3) Repetition. Federal Express, an air-cargo carrier, entered the American market to compete with the market leader, Emery Air Freight. FedEx (the current name of the company) decided to focus on overnight delivery. They could have said, “The overnight carrier.”

Instead, they used repetition to create memorability. “When it absolutely, positively has to be there overnight.” Within a few years, FedEx became the leader in the category.

(4) Reversal. Secret became the leading antiperspirant/deodorant for women with a simple reversal slogan: “Strong enough for a man, but made for a woman.”

(5) Double-entendre. This is perhaps the best way to create a memorable slogan. The two meanings contained in a single slogan oscillate back and forth in your mind, thereby creating memorability.

Can you give us an example?

“A diamond is forever” is a typical example. A diamond (the hardest substance known to man) can presumably last forever. A love symbolized by a diamond can also last forever, too.

You write: “Apple is an enormously successful company…But it wasn’t because of abstractions like “Designed in California”.” What is it that you are trying to say here?

Even successful companies can fall into the trap of using grandiose, abstract words instead of down-to-earth specific words. Apple’s “Designed in California” campaign had exceptionally-low viewer ratings and was discontinued within a year.

Three successful brands made Apple the world’s most-valuable company. And they all used specific words or concepts in their introductions.

The iPod: “A thousand songs in your pocket.”

The iPhone: “The first touchscreen smartphone.”

The iPad: “The first tablet computer.”

Yet when Apple introduced the Apple watch, the company did not try to position the brand with specific words on concepts. Many people, including me, think the Apple watch will not turn out to be nearly as successful as the three brands that came before it.  A sign of trouble ahead: Apple regularly provides data on iPhone sales, but refuses to disclose Apple watch sales.

Why are companies in love with the word “innovation”?

“Business has only two functions,” wrote Peter Drucker, “Marketing and innovation.”

Innovation, like many other abstract words, is both important and useless. Important in business and useless in marketing.

Inside a company, management should focus on innovation. Long-term, a company cannot be successful unless it is innovative. When it communicates to prospects on the outside, however, it should forget about innovation. That’s inside-out thinking. Instead, companies should practice “outside-in thinking.” Start with the mind of the consumer and try to fill an open hole in the mind. “Innovation” is a typical abstract word that has no real meaning for consumers. Instead, a company should look at its innovative product and try to express that innovation in specific words like “The first touchscreen smartphone.”

But that doesn’t seem to be happening…

Many, many companies, however, continue to try to pre-empt “innovation” in their marketing slogans. Some recent examples:
ASUS: Inspiring innovation. Persistent perfection.

Bosch: We bring innovation.

Firestone: A tradition of innovation.

Ford: Driving American innovation.

NEC: Empowered by innovation.

Nissan: Innovation that excites.

Siemens: Global network of innovation.

Toshiba: Leading innovation.
It’s highly unlikely that consumers will associate the word “innovation” with any of these companies. They will, however, associate “innovation” with Apple because Apple had launched innovative products with specific slogans.

How can a slogan provide protection from future competition?

A slogan can build a brand. And a strong brand is the best protection a company can have from future competition.

How do you build a brand that will last a lifetime?

There are four critical steps.

Step one: Be first in a new category. Coca-Cola, introduced in 1886, was the first cola. It’s still the leading cola today, 129 years later.

Step two: (Which isn’t a step at all, but it’s the most important thing you can do.) Don’t line-extend the brand. Keep the brand focused on its category. If you want to introduce another product or service, use a different brand name.

Step three: Create a slogan that communicates your leadership. Coca-Cola is widely known as “The real thing.” That’s the slogan the brand should be using because it communicates the fact that Coca-Cola is the original, the authentic cola.

Step four: Hammer the slogan with visual hammer. In Coca-Cola’s case, it’s the contour bottle which the brand has been using extensively.

You just talked about a visual hammer. Can you explain that in a little more detail?

The objective of a marketing campaign is to “own a word in the mind.” But the best way to own a word is to find a visual that can hammer that word in the mind. Marlboro was the first cigarette targeted to men only. But to drive that idea in the mind, Marlboro used a cowboy. The cowboy is the visual hammer that made Marlboro the world’s best-selling cigarette.

Corona beer is the only Mexican brand that has made Interbrand’s annual list of the 100 most-valuable brands in the world. How did Corona achieve this? With a lime. When Corona was introduced in the American market, the importers insisted that the beer be served with a lime on top of the bottle. (America is a lemon country. Mexico is a lime country.) The lime communicated the fact that Corona was the authentic Mexican beer.

The interview originally appeared in the Forbes India magazine