Category: Ponzi | Page 3

24 March, 2015

Management lessons we can learn from Rahul Gandhi, but he won’t

Vivek Kaul

Rahul Gandhi, the vice president of the Congress party, is on an extended vacation. This at a point of time when the first half of the budget session was under progress.
The Narendra Modi government has been trying to push a lot of new legislation through the Parliament in the recent past. And the fact that it doesn’t have enough MPs in the Rajya Sabha, it has had problems pushing through legislation. The opposition parties have ganged up together and managed to hold up the land acquisition ordinance, for one.
The point is that Rahul should have been in New Delhi during this time and been leading the opposition against the government. Instead, he is out on a holiday.
The bigger worry for Rahul should be that if he wants to keep his family owned Congress party relevant, he needs to reinvent both himself and his party. A good way to look at the Congress party is as an organization which is failing.
As Cass R. Sunstein and Reid Haste ask in Wiser—Getting Beyond Groupthink to Make Groups Smarter: “Suppose that you are a leader of an organization and that is not doing well, perhaps because it is stuck in old ways of thinking…What can you do?”
After asking this question the authors offer the example of Intel: “Intel Corporation, a large American corporation, faced exactly this problem in the 1980s. After fourteen years of profits it was losing a lot of business in the memory chip market, which it had pioneered. In a dramatic move, the company decided to abandon the entire market,” write the authors.
Why did Intel make this decision? Andrew Grove, who at that point of time was the President of Intel and would later become its CEO as well as Chairman recounts in his book Only the Paranoid Survive: “I remember a time in the middle of 1985, after this aimless wandering had been going on for almost a year. I was in my office with Intel’s chairman and CEO, Gordon Moore, and we were discussing our quandary. Our mood was downbeat. I looked out [of] the window at the Ferris wheel of the Great America amusement park revolving in the distance, then I turned to back to Gordon and I asked, “If we got kicked out and the board brought in a new CEO, what do you think he would do?” Gordon answered without hesitation, “He would get us out of memories.” I stared at him, numb, then said, “Why shouldn’t you and I walk out the door, come back and do it ourselves?””
This a very simple story which has a huge lesson. Organizations which are stuck in the old way of doing things need to get rid of their memories. “For Intel, it initiated a spectacularly successful strategy. The story suggests that when a group is aimlessly wandering or on a path that does not seem so good, it is an excellent idea to ask, “If we brought in new leadership, what would it do? Asking that simple question can break through a host of conceptual traps,” write Sunstein and Haste.
This is something that Rahul and the top leadership of the Congress party need to ask themselves. The party’s core idea of socialism and garibi hatao has been rejected by the voters, for the simple reason that it has been espousing the idea for more than four decades now. And even after four decades the ordinary Indian continues to be poor. So clearly what this tells him is that the Congress party was never serious about eradicating poverty. If it was it would have managed to eradicate poverty by now, given that the party has been in power in each of the decades since independence.
Hence, the party needs a new idea. And that will only come if one of the Gandhis comes up with something given that the party revolves around them. At this point of time this Gandhi has to be Rahul.
Nevertheless, it doesn’t seem likely that Rahul will do anything, if his lackadaisical leadership until now is anything to go by. Gurcharan Das makes a very interesting point in India Unbound about family owned businesses. As he writes: “Pulin Garg, the thoughtful professor at the Indian Institute of Management, Ahmedabad…used to say, “Haweli ki umar saath saal[The life of a family owned business is sixty years.””
The Congress party in its current form was formed when Rahul’s grandmother, Indira Gandhi, split from the original Congress party in 1969. Since then the party became a family run organization and has constantly been run by the Gandhis except for a brief interlude in the 1990s, when Rajiv Gandhi, Rahul’s father, was assassinated and his mother Sonia did not want to enter politics.
Given this, the party since 1969, or for a period of close to 46 years has been a family run organization, and its approaching the 60 year cut off for survival.
Rahul is the third generation of the Gandhi family running the party. And normally family owned businesses shut-down in the third generation. As Das writes: “Thomas Mann expressed…in Buddenbrooks, arguably the finest book ever written about family business. It describes the saga of three generations: in the first generation the scruffy and astute patriarch works hard and makes money. Born into money, the second generation does not want more money. It wants power…Born into money and power, the third generation dedicates itself to art. So the aesthetic but physically weak grandson plays music. There is no one to look after the business and it is the end of the…family.”
Let’s look at the above paragraph in the context of the Congress party. Indira Gandhi built the party in its current form. Rajiv enjoyed the power in the aftermath of her assassination. Sonia entered politics because the Gandhi family was used to power by then. And now Rahul, the weak grandson, is busy driving it into the ground.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Mar 24, 2015

20 March, 2015

Janet Yellen’s excuses for not raising interest rates will keep coming

The Federal Open Market Committee(FOMC) of the Federal Reserve of the United States, which is mandated to decide on the federal funds rate, met on March 17-18, 2015.
The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans.
In the meeting the FOMC decided to keep the federal funds rate in the range of 0-0.25%, as has been in the case in the aftermath of the financial crisis which broke out in September 2008. Janet Yellen, the chairperson of the Federal Reserve also clarified that “an increase in the target range for the federal funds rate remains unlikely at our next meeting in April.” The next meeting of the FOMC is scheduled on April 27-28, 2015.
The question is when will the Federal Reserve start raising the federal funds rate? As the FOMC statement released on March 18 points out: “In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 % inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”
Other than a clear inflation target of 2%, this is as vague as it can get. The inflation number in January 2015 came in at 1.3%, well below the Fed’s 2% target. The Fed’s forecast for inflation for 2015 is between 0.6% to 0.8%. At such low inflation levels, the interest rates cannot be raised.
But the Federal Reserve wasn’t as vague in the past as it is now. In December 2012, the Federal Reserve decided to follow the Evans rule (named after Charles Evans, who is the President of the Federal Reserve Bank of Chicago and also a part of the FOMC). As per the Evans rule, the Federal Reserve would keep interest rates low till the rate of unemployment fell below 6.5 % or the rate of inflation went above 2.5 %.
As the FOMC statement released on December 12, 2012 said: “ the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 % and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2% longer-run goal, and longer-term inflation expectations continue to be well anchored.”
This is how things continued until March 2014, when the Federal Reserve dropped the Evans rule. In a statement released on March 19, 2014, one year back, the FOMC said: “In determining how long to maintain the current 0 to 1/4 % target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 % inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” In fact, this is exactly the wording the FOMC has used in the statement released on March 18, 2015.
What the FOMC meant in the March 2014 statement was that instead of just looking at the rate of unemployment and the rate of inflation, the Federal Reserve would also take into account other factors before deciding to raise the federal funds rate. So what made the Federal Reserve junk the Evans rule?
In February 2014, the rate of unemployment was at 6.7% and was closing in on the Evans rule target of 6.5%. In April 2014, the rate of unemployment had fallen to 6.2%.
If the Fed would have still been following the Evans rule, it would have to start raising the Federal Funds rate. This would have meant jeopardising the stock market rally which has been on in the United States. In the aftermath of the financial crisis, the Federal Reserve had cut the federal funds rate to 0-0.25%, in the hope of encouraging people to borrow and spend more, to get their moribund economies going again.
While people did borrow and spend to some extent, a lot of money was borrowed at low interest rates in the United States and other developed countries where central banks had cut rates, and it found its way into stock markets and other financial markets all over the world. This led to a massive rallies in prices of financial assets. In an era of close to zero interest rates the stock market in the United States has seen the longest bull market after the Second World War.
Any increase in the federal funds rate would jeopardise the stock market rally. And that is something that the American economy can ill-afford to. So, it is in the interest of the Federal Reserve to just let the stock market rally on.
Interestingly, the Federal Reserve has been changing the so-called “forward guidance” on raising the federal funds rate for a while now. In March 2009, it had said that short-term interest rates will stay low for an “extended period.” In August 2011, it said that short-term interest rates would stay low till “mid-2013.” In January 2012, the Fed said that short-term interest rates would remain low till “late 2014.” And by September 2012, this had gone up to “mid-2015.”
In March 2014, it junked the Evans rule. So, what this means is that the Federal Reserve will ensure that interest rates in the United States continue to stay low. Peter Schiff, the Chief Executive of Euro Pacific Capital, summarized the situation best when he said that the Federal Reserve would “keep manufacturing excuses as to why rates cannot be raised” and this was simply because it had “built an economy completely dependent on zero % interest rates.”
Given this, be prepared for Janet Yellen offering more excuses for not raising the federal funds rate in the days to come.

The column originally appeared on The Daily Reckoning on Mar 20, 2015

11 December, 2014

As tax collections slow down, govt fiscal deficit shoots to its highest level in 16 years

Vivek Kaul

The Controller General of Accounts declares the fiscal deficit number at the end of every month. The cycle works with a delay of month. So, at the end of November 2014, the fiscal deficit for the first seven months of the financial year (April to October 2014) was declared.
The fiscal deficit for this period stood at a rather worrying 89.6% of the annual target of Rs 5,31,177 crore. Fiscal deficit is the difference between what a government earns and what it spends.
One reason the fiscal deficit is number is so high is because the government’s expenditure is spread all through the year, whereas it earns a substantial part of its income only towards the end of the year. But even keeping that point in mind, the fiscal deficit for the first seven months of this financial year is substantially high than it usually has been in the years gone by.
For the period April to October 2013, the fiscal deficit had stood at 84.4% of the annual target for that year. In fact, the accompanying table shows us that the fiscal deficit for the first seven months of this financial year has been the highest over the last sixteen years.

Period	Fiscal deficit as a proportion of the annual target
April to Oct 2014	89.60%
April to Oct 2013	84.40%
April to Oct 2012	71.60%
April to Oct 2011	74.40%
April to Oct 2010	42.60%
April to Oct 2009	61.10%
April to Oct 2008	87.80%
April to Oct 2007	54.50%
April to Oct 2006	58.60%
April to Oct 2005	60.90%
April to Oct 2004	45.20%
April to Oct 2003	56.00%
April to Oct 2002	51.50%
April to Oct 2001	54.50%
April to Oct 2000	45.70%
April to Oct 1999	72.20%
April to Oct 1998	67.00%

Source: www.cga.nic.in

Also, I couldn’t look for data beyond 1998, given that it wasn’t available online. The table makes for a very interesting reading. The fiscal deficit level up to October 2007 was under control. It took off once the government decided to crank up expenditure to meet its social obligations.
Further, the average fiscal deficit for the first seven months of the year between 1998 and 2013 stood at 61.75% of the annual target. Hence, the number for this year at 89.6% of the annual target, is very high indeed.
Why has this happened? The income of the government during the period has gone up by only 5.3%. The budget presented in July earlier this year assumed that the income would grow by 15.6% in comparison to the last financial year.
The collection of direct as well as indirect taxes has been significantly slower than what was assumed. The direct taxes (corporation and income tax primarily) were assumed to grow at 15.7% in comparison to the last financial year. They have grown at only 5.5%.
The indirect taxes (customs duty, excise duty and service tax) were supposed to grow at 20.3%. They have grown by only 5.9%. In fact, within indirect taxes, the collection of customs duty has fallen by 1.7%.
What this clearly tells us is that the finance minister Arun Jaitley made very aggressive assumptions when it came to growth in tax collection and will now have a tough time meeting the numbers.
What makes the situation worse is the fact that Jaitley’s predecessor, P Chidambaram, had made the same mistake. In fact, in 2013-2014, Chidambaram had projected a total gross tax collection of Rs 12,35,870 crore. The final collection stood around 6.2% lower at Rs 11,58,906 crore. Given this, Jaitley could have avoided falling into the same trap and worked with a more realistic set of numbers. But then those projections wouldn’t have projected “acche din”, the plank on which the Bhartiya Janata Party had fought the Lok Sabha elections.
Even with such a huge fall in tax collections, Chidambaram managed to beat the fiscal deficit target that he had set by essentially pushing expenditure of more than Rs 1,00,000 crore into the next financial year (i.e. the current financial year 2014-2015).
Chidambaram essentially ended up passing on what was his problem to Jaitley. Jaitley cannot do that because he will continue to be the finance minister (or someone else from the BJP government will).
So what can Jaitley do if he needs to meet the fiscal deficit target of Rs 5,31,177 crore or 4.1% of GDP that he has set? The first thing that will happen and is already happening is that the plan expenditure will be slashed. The plan expenditure for the first seven months of the year fell by 0.4% to Rs 2,66,991 crore.
This was the strategy followed by Chidambaram as well in 2013-2014. The plan expenditure target at the time of the presentation of the budget was at Rs 5,55,322 crore. The actual number came in 14.4% lower at Rs 4,75,532 crore. This is how a major part of government expenditure was controlled.
The government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. These expenses cannot be postponed. Hence, the asset creating plan expenditure gets slashed.
The second thing that the government is doing is not passing on the benefit of falling oil prices to the consumers. It has increased the excise duty on petrol and diesel twice, since deregulating diesel prices in October.
The third thing the government will have to do is to get aggressive on the disinvestment front in the period up to March 2015. The disinvestment target for the year is Rs 58,425 crore. But until now the government has gone slow on selling shares that it owns both in government and non-government companies because of reasons only it can best explain.
The recent sale of shares in the Steel Authority of India Ltd(SAIL) was pushed through with more than a little help from the Life Insurance Corporation of India and other government owned financial firms. This is nothing but moving money from one arm of the government to another arm. It cannot be categorised as genuine disinvestment.
This is something that Chidambaram and the UPA government regularly did in order to meet the disinvestment target. Despite this they couldn’t meet the disinvestment target in 2013-2014. The government had hoped to earn Rs 54,000 crore but earned only Rs 19,027 crore.
Also, selling assets to fund regular yearly expenditure is not a healthy practice. If at all the government wants to sell its stake in companies, it should be directing that money towards a special fund which could be used to improve the poor physical infrastructure throughout the country. Right now, the money collected through this route goes into the Consolidated Funds of India.
In the months to come we could also see the government forcing cash rich companies like Coal India (which has more than Rs 50,000 crore of cash on its books) to pay a special interim dividend to the government, as was the case last year.
This is the way I see things panning out over the next few months. Nevertheless, the proper thing to do would be to put out the right fiscal deficit number, instead of trying to use accounting and other tricks to hide it.
The first step towards solving a problem is to acknowledge that it exists.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 11, 2014

25 November, 2014

Sensex @28,500 : Stock Market as a beauty contest

Vivek Kaul

We never know what we are talking about – Karl Popper

The Sensex closed at 28,499.54 points yesterday (i.e. November 24, 2014). The fund managers are confident that this bull run will last for a while. Or so they said in a round table organised by The Economic Times.
Prashant Jain of HDFC Mutual Fund explained that during the last three bull markets that India had seen, the market had never peaked before reaching a price to earnings ratio of 25 times. The price to earnings ratio currently is 16 times, and hence, we are still at a “reasonable distance” from the peak.
This seems like a fair point. But how many people invest in the stock market on the basis of where the price to earnings ratio is at any point of time? If that were the case most people would have invested in 2008-2009, when the price to earnings ratio of the Sensex through the year stood at 12.68.
By buying stocks at a lower price to earnings ratio, they would have made more money once the stock market started to recover. But stock markets and rationality don’t always go together. Every investor is does not look at fundamentals before investing. “In investing, fundamentals are the underlying realities of business, in terms of sales, costs and profits,” explains John Lanchester in How to Speak Money.
A big bunch of stock market investors like to move with the herd. Let’s call such investors non fundamentals investors.
So when do these investors actually invest in the stock market? In order to understand this we will have to go back to John Maynard Keynes. Keynes equated the stock market to a “beauty contest” which was fairly common during his day.
As Lanchester writes “Keynes gave a famous description of what this kind of non-fundamentals investor does: he is looking at a photo of six girls and trying to pick, not which girl he thinks is the prettiest, and not which he thinks most people will think is the prettiest, but which most people will think most people will think is the prettiest…In other words the non-fundamentals investor isn’t trying to work out what companies he should invest in, or what company most investors will think they should invest in, but which company most investors will think most investors will want to invest in.”
Or as Keynes put it in his magnum opus The General Theory of Employment, Interest and Money“It is not a case of choosing those [faces] that, to the best of one’s judgement, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.”
Hence, a large bunch of investors invest on the basis of whether others round them have been investing. That is the beauty contest of today.
Nilesh Shah, MD and CEO of Axis Capital pointed out in The Economic Times round table that nearly Rs 25,000-Rs 30,000 crore of money will come into the stock market through systematic investment plans (SIPs).
Anyone who understands the basics of how SIPs work knows that they are designed to exploit the volatility of the stock market—buy more mutual fund units when the stock market is falling and buy fewer units while it is going up. This helps in averaging the cost of purchase over a period of time, and ensures reasonable returns.
Investors who are getting into SIPs now are not best placed to exploit the SIP design. Nevertheless, they are still investing simply because others around them have been investing. This also explains why the net inflow into equity mutual funds for the first seven months of the this financial year (between April and October 2014) has been at Rs 39,217 crore. This is when the stock market is regularly touching new highs.
And if things go on as they currently are, the year might see the highest inflow into equity mutual funds ever. The year 2007-2008 had seen Rs 40,782 crore being invested into equity mutual funds. This was the year when the stock market was on fire. In early January 2008, the Sensex almost touched 21,000 points. It had started the financial year at around 12,500 points.
So, now its all about the flow or what Keynes said “what average opinion expects the average opinion to be.” And till people see others around them investing in the stock market they will continue to do so. This will happen till the stock market continues to rise. And stock market will continue to rise till foreign investors keep bringing money into India.
No self respecting fund manager can admit to the fact that these are the reasons behind the stock market rallying continuously all through this year. This is simply because all fund managers charge a certain percentage of the money they manage as a management fee.
And how will they justify that management fee, if the stock market is going up simply because it is going up. Nobel prize winning economist Robert Shiller calls such a situation a naturally occurring Ponzi scheme.
As he writes in the first edition of Irrational Exuberance: “Ponzi schemes do arise from time to time without the contrivance of a fraudulent manager. Even if there is no manipulator fabricating false stories and deliberately deceiving investors in the aggregate stock market, tales about the market are everywhere. When prices go up a number of times, investors are rewarded sequentially by price movements in these markets just as they are in Ponzi schemes. There are still many people (indeed, the stock brokerage and mutual fund industries as a whole) who benefit from telling stories that suggest that the markets will go up further. There is no reason for these stories to be fraudulent; they need to only emphasize the positive news and give less emphasis to the negative.”
And that is precisely what fund managers will do in the time to come. In fact, they have already started to do that.
They will tell us stories. One favourite story that they like to offer is that India’s economy is much better placed than a lot of other emerging markets. This is true, but then what does that really tell us? (For a real picture of the Indian economy check out this piece by Swaminathan Aiyar).
Another favourite line you will hear over and over again is that “markets are never wrong”. This phrase can justify anything.
The trick here is to say things with confidence. And that is something some of these fund managers excel at. Nevertheless it is worth remembering what Nassim Nicholas Taleb writes in The Black Swan: “Humans will believe anything you say provided you do not exhibit the smallest shadow of diffidence; like animals, they can detect the smallest crack in your confidence before you express it. The trick is to be smooth as possible in personal manners…It is not what you are telling people, it how you are saying it.”
And this is something worth thinking about.

The article originally appeared on www.equitymaster.com on Nov 25, 2014

27 September, 2014

A 400 year old economic theory explains who really runs the Indian stock market

Vivek Kaul

On September 12, 2008, the Bank of England, had total assets worth £83.8 billion on its books. In the six years since then, the total assets of the British central bank have gone up by a whopping 385.6% to £ 404.3 billion, as on September 17, 2014.
Things haven’t been much different in the United States. The Federal Reserve of United States had assets worth $905.3 billion as on September 3, 2008. Since then it has jumped to $4.45 trillion, as on September 17,2014. An increase of close to 392%.
The total assets of the Bank of Japan have more than doubled since the start of 2011. In January 2012, the total assets of the Japanese central bank had stood at 128 trillion yen. Since then, it has more than doubled to 275.9 trillion yen at the end of August 2014.
Since the start of the financial crisis in the middle of September 2008, Western central banks have printed money big time. This money has been pumped into the financial system by buying bonds. These bonds have ended up as assets on the balance sheet of central banks.
The idea behind this, as I have often mentioned in the past, was to drive down long term interest rates, leading to people borrowing and spending more at lower interest rates. This would, in turn, lead to economic growth, the hope was.
When central banks started printing money, the Cassandras (which included yours truly as well) started to point out that the era of high inflation was on its way. The logic offered was fairly straight forward. With so much money being pumped into the financial system, it would lead to a lot of money chasing the same amount of goods and services in the economy, and that would drive prices up at a rapid rate, and lead to high inflation.
But that did not turn out to be the case. The Western world had already taken on huge loans before the financial crisis broke out and was in no mood to borrow and spend all over again.
This lack of inflation has been used by central banks to print and pump more money into the financial system. The hope now is that with all the money that has been pumped into the financial system some inflation will be created. This inflation will lead to people spending more. The logic here is that no one wants to pay a higher price for a product, and if prices are going up or likely to go up, people would rather buy the product now than wait. And this will lead to economic growth. That in short is the gist of what the policy of the Western central banks has been all about over the last few years.
The economist Milton Friedman had suggested that a recessionary situation could be fought even by printing and dropping money out of a helicopter, if the need be, to create inflation.
And this is what Western central banks have done since September 2008, in the hope of reviving economic growth. While they may not have been able to create “some” conventional inflation as they wanted to, there is a lot else that has happened. And that needs to be understood.
When central banks print money, they do so with the belief that money is neutral. So, in that sense, it does not really matter who is standing under the helicopter when the money is printed and dropped into the economy. But the Irish-French economist Richard Cantillon who lived during the early eighteenth century, showed that money wasn’t really neutral and that it mattered where it was injected into the economy.
Cantillon made this observation on the basis of all the gold and silver coming into Spain from what was then called the New World (now South America). When money supply increased in the form of gold and silver, it would first benefit the people associated with the mining industry, i.e., the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines.
These individuals would end up with a greater amount of gold and silver , i.e., money. They would spend this money and thus drive up the prices of meat, wine, wool, wheat, etc.
This rise in prices would have impacted even people not associated with the mining industry, even though they wouldn’t have seen a rise in their incomes, like the people associated with the mining industry had.
This is referred to as the Cantillon Effect. As analyst Dylan Grice puts it : “Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter.”
The money printing that has happened in recent years has been unable to meet its goal of trying to create consumer-price inflation. But it has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit.
Institutional investors have been able to raise money at close to zero percent interest rates and invest it in financial assets all over the world, driving up the prices of those assets and made money in the process.
As the economist William Bonner put it in a column he wrote in early 2013: “The Fed creates new money (not more wealth… just new money). This new money goes into the banking system, pretending to have the same value as the money that people worked for. And people with good connections to the banks take advantage of the cheap credit this new money creates to aid financial speculation.”
This financial speculation has led to massive stock market rallies all over the world. As I wrote in a piece last week “The Dow Jones Industrial Average, America’s premier stock market index, has rallied more than 30 percent since October 2012. This when the American economy hasn’t been in the best of shape. The FTSE 100, the premier stock market index in the United Kindgom, has given a return of 15 per cent during the same period. The Nikkei 225, the premier stock market index of Japan has rallied by 53 per cent during the same period. Closer to home, the BSE Sensex has rallied by around 43 per cent during the same period.”
Let’s take a closer look at the Indian stock market over the last two years. The foreign institutional investors have invested Rs 1,82,789.43 crore during this period (up to September 19,2014). During the same period the domestic institutional investors sold stocks worth Rs 1,07,327.65 crore.
It is clear from this that foreign money borrowed at low interest rates has been driving the Indian stock market. The domestic investors have continued to stay away.
So, even though a lot of domestic investors may talk about the India growth story being strong, they really don’t believe in it. If they did, they would invest money and not simply talk about it.
Hence, even though the economic growth through large parts of the world continues to remain subdued, the stock markets can’t seem to stop rallying. The explanation lies in the access to the “easy money” that the big institutional investors have.
And this access to easy money will continue in the days to come. The Bank of Japan, the Japanese central bank is printing around ¥5-trillion per month and is expected to do so till March 2015. The European Central Bank is also preparing to print €500-billion to €1-trillion over the next few years. All this money will be available for big institutional investors to borrow at very low interest rates.
The Federal Reserve of United States has made it clear that even though it will go slow on printing money in the days to come, it is unlikely to start pumping out all the money that it has put into the financial system any time soon.
Hence, the stock market bubbles around the world are likely to continue in the days to come. As Claudio Borio and Philip Lowe wrote in the BIS working paper titled Asset prices, financial and monetary stability: exploring the nexus “lowering rates or providing ample liquidity when problems materialise but not raising rates as imbalances build up, can be rather insidious in the longer run. They promote a form of moral hazard that can sow the seeds of instability and of costly fluctuations in the real economy.”
The worst, as they say, is yet to come.
The article originally appeared on www.FirstBiz.com on Sep 27, 2014

(Vivek Kaul is the author of Easy Money trilogy. He tweets @kaul_vivek)