The ten best Nonfiction books of 2014

single-man-coverVivek Kaul

It is that time of the year when media houses go around writing about the best of the year that was. Given this, I thought it would be an appropriate time to put out a list of what I think are the best nonfiction books that I read in 2014. The list is biased to the extent of what I read, which are basically books in the area of finance and economics. Also, some of the titles were released earlier and I only happened to read them in 2014. The books are listed out in a random order. So here we go.

Saving Capitalism from the Capitalists by Raghuram Rajan and Luigi Zingales: I had read this book when it was first published in 2003. At that point of time I was basically trying to figure out what to do with my life, having finished an MBA in information systems in 2002 and at the same time having realized that the MBA degree was one big con job. In 2014, the book was published again with a new afterword. I read it again and appreciated the book much more than I had done in 2003. The book is a great read for anyone who believes in the idea of free markets. It tells you loud and clear that the incumbent capitalists are the greatest enemies of the free market. The book also helped me understand why so many big businesses in India manage to default on their bank loans without the industrialists having to face the consequences of the same.

After the Music Stopped by Alan S Blinder: This book was published in 2013, but I happened to read it only this year. The best books on historical events are written many years after the event has happened. Take the case of what I think is the best book on the Great Depression—The Great Crash 1929, written by John Kenneth Galbraith. The book was first published in the mid 1950s almost quarter of a century after the Depression started. One possible explanation for this is the fact that writing many years later, the author can leave out all the noise and concentrate on the most important issues. Over the last six years many books have been written on the financial crisis, but After the Music Stopped, in my opinion is perhaps the best book on it. It summarises the economic, the political as well as the legal angles of the financial crisis very well. If you are looking for a ready reckoner on the financial crisis, this has to be your go to book. Capital in the Twenty-First Century by Thomas Piketty: This was by far the bestselling title in economics during the course of this year, having been the number one book on Amazon.com for a while. It is very rare for an economics book running into 700 pages to be number one on Amazon. In this book the core argument offered by Piketty, who is a French economist, is that capitalism has led to greater inequality among people over the years. Piketty offers a lot of data from the developed countries to make his point. The book did not go down well with the American economists, and after it appeared many of them tried to discredit it by trying to find mistakes in the data and methodology used by Piketty. Who is right and who is wrong is too long a debate to get into here. Nevertheless, Piketty’s book remains a must read for the fantastically lucid way in which its written and the several original ideas that it offers. The Dollar Trap by Eswar S. Prasad: The United States is in a huge financial mess. Nevertheless, dollar remains the go to currency of the world at large. Whenever there is a whiff of a crisis anywhere in the world, money is pulled out and moves to the dollar. Ironically, even when the rating agency Standard and Poor’s cut the rating of the debt issued by the United States government from AAA to AA+, money moved into the US dollar. Prasad explains this “exorbitant privilege” of the dollar and the reasons behind it. While the US may not be in a great financial shape, but the world at large still has faith in the dollar. Prasad summarizes the situation well when he says: “It is possible that we are on a sandpile that is just a few grains away from collapse. The dollar trap might one day end in a dollar crash. For all its logical allure, however, this scenario is not easy to lay out in a convincing way.” The book is a great read for anyone trying to understand one of the most fundamental disconnects of the times that we live in. Flashboys by Michael Lewis: No one quite writes about finance like the way Lewis does. From his first book Liars Poker to the latest Flashboys, each one of his books on Wall Street and its ways has been a bestseller. One reason for the same is the fact that Lewis started as a Wall Street insider in the investment bank Salomon Brothers (which has since gone bust) and has managed to maintain his contacts since then. Flashboys is essentially a story of the people and systems that make up algorithmic trading that has taken Wall Street by storm. A majority of the trades on Wall Street are not driven by humans any more. They are driven by computers with a lot of processing power. And that is the fascinating story of Flashboys. If you are the kind who likes reading thrillers over weekends, this is just the right book for you.

Business Adventures by John Brooks: I first discovered Brooks in the process of writing and researching my books. Someone suggested that I should be reading Brooks’ version of the Great Depression called Once in Golconda: A True Drama of Wall Street 1920-1938. The book was a fantastic read and made me realize that Wall Street had a Michael Lewis even before the real Michael Lewis appeared on the scene. Early this year, Bill Gates wrote a blog on one of Brooks’ other books called Business Adventures. He called it the best business book that he and Warren Buffett had ever read. This blog pushed the book to the top of the Amazon charts. It was re-issued after this. The book is a collection of twelve long articles that Brooks wrote about the American businesses, government as well as Wall Street, for the New Yorker magazine. And it has tremendous lessons for almost everyone connected with business and finance.

Single Man—The Life & Times of Nitish Kumar of Bihar by Sankarshan Thakur: This book is the joker in the pack. In a list full of books on economics and finance, here is a book on politics. Having been born in erstwhile Bihar, I have always been interested in the politics of Bihar. And there is no better writer on Bihar in English than Thakur, who works as a roving editor for The Telegraph newspaper. Thakur chronicles the rather turbulent life of Nitish Kumar, starting a little before the Emergency, and goes on to chronicle the life of the Bihari politician over the next four decades. As he does that he also goes into the history of Bihar over that period. Unlike a lot of other biography writers, Thakur also goes into Kumar’s unhappy personal life. The book is an excellent model for how to write a biography of an Indian politician. What we normally get to read are either hagiographies or out and out criticism (as is the case with so many books on Narendra Modi which swing at both ends). There is rarely a biography of an Indian politician which takes the middle path. If I had to choose just one book to read this year, then Single Man would have to be it. And this would be more for Thakur’s andaz-e-bayan(the way he tells the story) than Kumar’s story per se. How Not to Be Wrong—The Hidden Maths of Everyday Life by Jordan Ellenberg: This is another joker in the pack. I absolutely love to read good books on Mathematics. Ellenberg in this book goes around explaining the practical aspects of Maths in everyday life. He explains in great detail how media often uses Maths incorrectly to draw wrong conclusions. He also tries to answer some really interesting questions: How early should you get to the airport? What’s the best way to get rich playing a lottery? And does Facebook know you are terrorist? If you are feeling a little adventurous and want to go a little out of your comfort zone, this is just the right book for you.

The End of Normal by James Galbraith: I am reading this book currently and am around half way through it. James Galbraith is the son of John Kenneth Galbraith, who I feel was one of the most lucid writers on economics that the twentieth century saw. Galbraith junior writes in the same lucid way as his father did. Since the financial crisis broke out, economists and politicians have tried to tell the world at large that “all is going to be well,” and that the financial crisis was just caused by bad policy and bad people. Galbraith challenges this world view and offers four reasons against it: the rising cost of real resources, the futility of military power, the labour saving consequences of the digital revolution and the breakdown of law and ethics in the financial sector. Long story short: The global economy will not see acche din(good days) any time soon. Hormegeddon—How Too Much Of a Good Thing Leads to Disaster by Bill Bonner: The regular readers of The Daily Reckoning would know by now that this has been one of favourite books of the year, given the number of times I have already quoted from it in my columns. I have been a big fan of Bonner’s writing since I first met him in late 2008. In this book Bonner goes about explaining how too much of a good thing in public policy, economics and businesses, leads to disaster or what he calls FUBAR (f***ed up beyond all recognition). Bonner offers many examples from history to make his point—from Napoleon’s decision to invade Russia to the outbreak of the Second World War to America’s War on Terror. He then goes on to show that these disasters cannot be prevented by well-informed people with good intentions because they are the ones who cause them in the first place. 

So that was my list of what I thought were the ten best books that I read this year. Happy reading. The India edition of The Daily Reckoning will be taking a year end break and will be back early next year on January 3. Here is wishing you a Merry Christmas and a Happy New Year. Meanwhile you can continue reading the international edition of The Daily Reckoning authored by Bill Bonner. The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 24, 2014

A 400 year old economic theory that the world has forgotten about

yellen_janet_040512_8x10Vivek Kaul

The Federal Open Market Committee (FOMC), which decides on the monetary policy of the United States, had its last meeting for this year scheduled on December 16-17th, 2014. After this meeting, Janet Yellen, the Chairperson of the Federal Reserve spoke to the media.
Everything Yellen spoke about during the course of the press conference was closely analysed by the financial media all over the world. The gist of what Yellen said at the press conference was that she expects that the Federal Reserve will start raising the federal funds rate sometime next year.
The federal funds rate or the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank, on an overnight basis, acts as a benchmark for the short-term interest rates in the United States. The last time the Federal Reserve increased the federal funds rate was in 2006.
In the aftermath of the financial crisis, the Federal Reserve decided to print money and pump it into the financial system by buying government bonds and mortgage backed securities. The Federal Reserve referred to this as the asset purchase programme. The economists called it quantitative easing. And for those who did not want to bother with jargons, this was plain and simple money printing.
This was done to ensure that there was enough money going around in the financial system and interest rates remained low. At low interest rates the hope was that people would buy homes, cars and consumer durables. This would drive business growth, which in turn would drive economic growth, which would create both jobs and some inflation.
While this has happened to some extent, what has also happened is that a lot of money has been borrowed by financial institutions at very low interest rates and has found its way into stock markets and other financial markets all over the world. This has led to bubbles.
The economic theory explaining this phenomenon was put forward by Richard Cantillon, an Irish-French economist who lived during the early eighteenth century. He basically stated 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, that is, 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, that is, money. They would spend this money and thus, drive up the prices of meat, wine, wool, wheat, etc.
This rise in prices would impact even people not associated with the mining industry, even though they hadn’t seen a rise in their incomes, like the people associated with the mining industry had. This was referred to as the Cantillon effect.
Interestingly, Cantillon was also an associate of John Law. In 1705, John Law published a text titled Money and Trade Considered, with a Proposal for Supplying the Nation with Money. Law was of the opinion that money was only a means of exchange and that a nation could achieve prosperity by increasing the amount of money in circulation.
The problem of course was that when it came to gold and silver coins, only so much currency could be produced. But this disadvantage was not there with paper money. Law firmly believed that by circulating a greater amount of paper currency in the economy, commerce and wealth of a nation could be increased.
His theory was in place. But, like a physicist or a chemist, it could not be tested in a laboratory. Law needed a nation that was willing to let him test his theory. And France proved to be that nation. In 1715, France was the richest and the most powerful country in the world. But at the same time it was also almost bankrupt.
This was primarily because the country did not have a central bank of its own like the Dutch and the British had. Law’s idea was to create a central bank which would have the right to issue paper money which would be a legal tender. He also wanted to create a company which would have a monopoly of trade. This would create a monopoly of both finance as well as trade for France and the profits thus generated would help pay off the French debt.
Law went around establishing a bank called the Banque Royale and formed a company called the Mississippi Company, which was given a 25-year-long lease to develop the French territory along the Mississippi River and its tributaries in the United States. The Banque Royale was allowed to issue paper notes guaranteed by the French Crown.
Cantillon was an associate of John Law and observed the entire thing very closely. As Bill Bonner writes in Hormegeddon—How Too Much of a Good Thing Leads to Disaster: “Cantillon noticed that Law’s new paper money backed by the shares of the Mississippi Company—didn’t reach everyone at the same rate. The insiders—the rich and the well connected—got the paper first. They competed for goods and services with it as though it were as good as the old money. But by the time it reached the labouring classes, this new money had been greatly discounted—to the point, eventually, where it was worthless.”
This was the Cantillon effect. As analyst Dylan Grice told me during the course of an interview: “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 printed by the Federal Reserve in the aftermath of the financial crisis has been unable to meet its goal of trying to create consumer-price inflation and getting consumer spending up and running again. 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. They were the ones standing under the helicopter when the money was printed and dropped.
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.
It has also left these investors wondering what will happen once the Federal Reserve decides to end the era of “easy money” and start raising interest rates. In October 2014, the Federal Reserve brought its asset purchase programme to an end. This did not lead to a panic in the financial markets simply because the Fed made it clear that even though it would stop printing money, it would not start immediately withdrawing the money it had already printed and pumped into the financial system over the years.
But that is going to happen one day. Yellen is trying to get the financial markets ready for interest rate hikes starting next year. At least, that is the impression I got yesterday after watching her press conference.
Once the Fed decides to start withdrawing the money that it has printed and pumped into the financial system, and which in turn has found its way into financial markets all over the world, interest rates will start to go up. That will happen sooner rather than later. Maybe 2015. Maybe 2016. Who knows.
And once interest rates start to rise, the arbitrage of borrowing at low interest rates and investing money in financial markets all over the world, won’t be viable any more. It is difficult to predict precisely how exactly the situation will play out.
Nevertheless, Bonner summarizes the situation well when he says: “What exactly will happen, and when it will happen, we will have wait and find out. But it will be bad, that much is certain. We will hit rock bottom.”
All I can say to conclude is—Watch this space.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on December 19, 2014

References:
M. Thornton, “Cantillon on the Cause of the Business Cycle,” The Quarterly Journal of Austrian Economics 9, 3(Fall 2006): 45–60 

J.E. Sandrock, “John Law’s Banque Royale and the Mississippi Bubble.” Avail­able online at http://www.thecurrencycollector.com/pdfs/John_Laws_Banque_Royale.pdf

C. Mackay, Extraordinary Popular Delusions and the Madness of Crowds (Project Gutenberg, 1841). Available online under Project Gutenberg.

Central banks wouldn’t have printed money if…

3D chrome Dollar symbolVivek Kaul


Cristina Fernandez de Kirchner, the president of Argentina, was visiting the United States in the autumn of 2012. A part of her itinerary included speeches at the Harvard and Georgetown universities.
Students at these universities asked her about the rate of inflation in Argentina. As Bill Bonner writes in his new book
Hormegeddon—How Too Much of a Good Thing Leads to Disaster, “Her bureaucrats put the consumer price index—at less than 10%. Independent analysts and housewives know it as a lie. Prices are rising at about 25% per year.”
Fernandez turned the tables at a press conference and asked her accusers: “Really, do you think consumer prices are only going up at a 2% rate in the US?”
This is a very important question to ask given that inflation is one of the most important numbers that are put out in the public domain. As Bonner writes “The ‘inflation’ number is probably the most important number the number crunchers crunch, because it crunches up against most of the other numbers too.”
What does Bonner mean by this? If your house price has doubled and if the price of everything else doubled as well during the same period, then you haven’t made any gains at all. The same stands true for your salary as well.
At a broader level, the economic growth (as measured by the growth in the gross domestic product (GDP)) is also adjusted for inflation. So, if the growth is 8% and inflation is also 8%, then there is no real growth. For real growth to happen the rate of growth has to be greater than the rate of inflation.
The point being that the rate of inflation is used to correct distortions that creep into other numbers. As Bonner writes “In pensions, taxes, insurance, and contracts, the CPI[consumer price inflation] number is used to correct distortions caused by inflation. But if the CPI number is itself distorted, then the whole [thing] gets twisted.”
Moral of the story: It is very important to measure the inflation number correctly. But is that really happening in the United States? As Nick Barisheff writes in
$10,000 Gold—Why Gold’s Inevitable Rise Is the Investor’s Safe Haven, “The need to distort actual values of inflation became even more important once governments began prodding social programs and indexed government pensions [i.e. government pension went up at the rate of inflation]. A single-point rise in the official rate of inflation would likely cost the U.S. government hundreds of billions of dollars in indexed government pension payments.”
The Boskin Commission was set up in 1995. It was formally called the Advisory Commission to Study the consumer price index. The commission came to the conclusion that the consumer price index overstated inflation. “These findings also concluded that since the CPI was used to measure indexed pensions, the projections for budget deficits were too large,” writes Barisheff.
The recommendations of the commission changed the way inflation was measured in the United States. As Barisheff writes “The changes implemented after the Boskin Commission’s report were significant, with the main distinction being that the CPI used to measure a “fixed standard of living” with a fixed basket of goods. Today, it measures the cost of living with a constantly changing basket of goods, measured with metrics that are themselves constantly changing.”
This change in methodology led to the inflation being understated due to various reasons. A World Gold Council report titled
Gold Investor: Risk Management and Capital Preservation released by the World Gold Council points out “The weights that different goods and services have in the aforementioned indices do not always correspond to what a household may experience. For example, tuition has been one of the fastest growing expenses for US households but represents only 3% of CPI (consumer price index). In practice, tuition costs correspond to more than 10% of the annual income even for upper-middle American households – and a higher percentage of their consumption.”
Then there is the issue referred to as “hedonic” adjustments. Let’s say you go to a buy a computer. The computer is being sold at the same price as last year. But its twice as powerful. “Now you are getting twice as much computer for the same price. You don’t really need twice as much power. But you can’t buy half a computer. So, you reach in your packet and pay as much as last year,” writes Bonner.
Those calculating inflation look at the scenario differently. They assume that since the new computer has more power, it has basically gone down in cost. “This reasoning does not seem altogether unreasonable. But a $1,000 computer is a substantial part of most household budgets. And this “hedonic” adjustment of prices exerts a large pull downward on the measurement of consumer prices, even though the typical household lays out almost exactly as much one year as it did last,” writes Bonner.
Further, hedonic adjustment does not take into account the rapid change in technology. As Barisheff points out “Hedonics overlooks hidden inflationary events, such as the rapid pace of technological development and lower production standards, which combined mean we need to replace appliances more often. In the 1960s, we bought one home telephone every decade, if that. We purchased a new television perhaps a little more frequently. Now we are changing our tech devices every couple of years. Hedonics, to be, fair, should account for this extra cost, but it does not.”
Other than hedonics, the substitution bias is at work as well. In this case, it is assumed that consumers substitute “cheaper goods for more expensive goods when relative prices change.” As Barisheff writes “The government is saying that when steak gets too expensive, people will forgo steak for hamburger. Somehow, this does not account for the fact that steak is getting more expensive, or that consumers do not automatically substitute.” Using, susbstitution, the government determined that food prices rose by 4.1% between 2007 and 2008. Nevertheless, the American Farm Bureau which tracks exactly the same basket of goods said prices rose by 11.3%.
Long story short, the inflation as it is being measured is being under-declared. Bonner points out that if they measured inflation now like they did in 1980, the rate of inflation in the United States would have been 9% and not 2%.
And if that were the case a lot of other things would change. If inflation would have been 9% and 2%, the Federal Reserve of the United States and other central banks around the developed world would not have printed the quantum of money that they have.
Economist John Mauldin in a recent column titled The End of Monetary Policy estimates that central banks have printed $7-8 trillion since the start of the financial crisis.
This was done primarily to ensure that with so much money floating around the interest rates would continue to remain low. At low interest rates people would borrow and spend. This would create some inflation. Looking that prices were going up, people would come out and shop, so that they don’t have to pay more later.
What has happened instead is that financial institutions have borrowed money at low interest rates and invested it in financial markets all over the world.
Nevertheless, if the inflation was 9% and not less than 2% as it stands now, central banks wouldn’t have printed all the money that they have in the first place.
This leads Bonner to ponder that “the problem with the “inflation” number runs deeper than just statistical legerdemain.” “It concerns the definition of inflation itself. Does the word refer only to rise in consumer prices? Or to the rise in the supply of money? The distinction has huge consequences. Because, in years following the 08′-09′ prices, it was the absence of the former that permitted central banks to add so much to the latter…As long as consumer price inflation didn’t manifest itself in a disagreeable way, central bankers felt they cold create as much agreeable monetary inflation as they wanted,” writes Bonner.
And that is something worth thinking about.

The article originally appeared on www.FirstBiz.com on Dec 2, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

A 200 year old economic theory tells us what is wrong with the developed world today

Jean-baptiste_SayVivek Kaul

I like to quote a lot of John Maynard Keynes in what I write. The reason for that is fairly simple—Keynes is the Mirza Ghalib of economics. He has written something appropriate for almost every occasion.
Nevertheless, I’d like to admit that even though I have tried to read his magnum opus
The General Theory of Employment, Interest and Money a few times, over the years, I have never been able to go beyond the first few chapters.
The economist whose books I find very lucid is the Canadian-American economist John Kenneth Galbraith. Galbraith unlike other economists of his era was a prolific writer and was one of the most widely read economists in the United States and other parts of the world between the 1950s and 1970s. He was even the US Ambassador to India in the early 1960s.
His most popular book perhaps was
The Great Crash 1929, a fantastic book on the Great Depression, which he wrote in the mid 1950s. His other famous work was The Affluent Society published in 1958.
But the book I am going to talk about today is
A History of Economics—the past as the present. In this book Galbraith looks at the history of economics and writes it in a way that even non-economists like me can understand it.
One of the laws that Galbraith talks about is the Say’s Law. This law was put forward by Jean-Baptise Say, a French businessman, who lived between 1767 and 1832. “Say’s law held that out of the production of goods came an effective aggregate of demand sufficient to purchase the total supply of goods. Put in somewhat more modern terms, from the price of every product sold comes a return in wages, interest, profit or rent sufficient to buy that product. Somebody, somewhere, gets it all. And once it is gotten, there is spending up to the value of what is produced,” wrote Galbraith explaining Say’s Law.
The Say’s Law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”
And this law explains to us all that is wrong with the developed world today. As Bill Bonner writes in his latest book
Hormegeddon—How Too Much of a Good Thing Leads to Disaster “French businessman and economist, Jean-Baptiste Say, discovered that “products are paid for with products,” not merely with money. He meant that you needed to produce things to buy things; you could not just produce money…has anyone ever mentioned this to the Federal Reserve?”
The central banks in the developed world have printed
close to $7-8 trillion in the aftermath of the financial crisis which broke out in mid September 2008, with the investment bank Lehman Brothers going bust. The Federal Reserve of the United States has printed around $3.6 trillion dollars in the aftermath of the crisis to get the American economy up and running again.
The standard theory that has emerged in the aftermath of the financial crisis is that consumer demand has collapsed in the Western world and this has led to a slowdown in economic growth. In order to set this right, people need to be encouraged to borrow and spend. As John Maynard Keynes put it: “Consumption—to repeat the obvious—is the sole end and object of economic activity.” (There I have quoted him again!)
To get borrowing and consumption going again central banks have printed a lot of money to ensure that the financial system remains flush with money and interest rates continue to remain low. At low interest rates the chances of people borrowing and spending would be more. And this would lead to economic growth was the belief.
Now only if economic theory worked so well in practice. Also, it was “excessive” borrowing and spending that led to the crisis in the first place.
Raghuram Rajan and Luigi Zingales explain this very well in a new afterword to
Saving Capitalism from the Capitalists, “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”
It is worth pointing out here that the share of United States in the global production of goods has fallen over the last few decades. Thomas Piketty makes this point in his magnum opus
Capital in the Twenty First Century. Between 1900 and 1980, 70–80 percent of the global production of goods happened in the United States and Europe. By 2010, this share had declined to around 50 percent, around the same level it was at in 1860. Also, faced with increased global competition, Western workers were unable to demand the pay increases they used to in the past.
Piketty further points out that the minimum wage in the United States, when measured in terms of purchasing power, reached its maximum level in 1969 and has been falling since then. At that point of time, the wage stood at $1.60 an hour or $10.10 an hour in 2013 dollars, taking into account the inflation between 1968 and 2013. At the beginning of 2013, the minimum wage was at $7.25 an hour, more than 28 percent lower than that in 1969.
This slow wage growth has led to Western governments following an easy money policy by making it easy for people to borrow. As Michael Lewis writes in
The Big Short—A True Story: “How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans.”
In case of the United States, trade with China had an impact as well. As the historian Niall Ferguson writes in
The Ascent of Money: A Financial History of the World: “Chinese imports kept down US inflation. Chinese savings kept down US interest rates. Chinese labor costs kept down US wage costs. As a result, it was remarkably cheap to borrow money.”
Ironically, what worked earlier is not working now. What has happened instead is that financial institutions have borrowed money at low interest rates and invested it in financial markets all over the world, in search of a higher return. Despite the central banks printing a lot of money, Japan recently entered a recession, with two successive quarters of economic contraction.
Europe is staring at a deflationary scenario. And the economic recovery in the United States continues to remain fragile.
Further, over the coming decades, a billion more people are expected to join the work force in Asia, Africa and Latin America. This will apply a downward pressure on costs and prices in the years to come and hence, wages in developed countries aren’t going to go up in a hurry.
Moral of the story: Western nations need to go back to making things, if they want a sustainable economic recovery. But as the American baseball coach Yogi Berra once famously said “In theory there is no difference between theory and practice. In practice there is.”

The article originally appeared on equitymaster.com as a part of The Daily Reckoning, on Nov 28, 2014

Don’t count gold out: it may be the last man standing

goldVivek Kaul
At the very outset let me confess that this has been a difficult piece to write. When everyone around you is shouting the same thing from their rooftops, it is very difficult to say something which happens to be exactly the opposite.
Gold over the last one week has turned into a four letter word. Last Thursday (i.e. April 11, 2013) the closing price of the yellow metal was $1564.2 per ounce (one troy ounce equals 31.1 grams). A week later as I write this gold is selling at around $1375 per ounce. The price has fallen by around 12.1% over the period of just one week.
And this fall has suddenly turned investment experts (at least the ones who appear on television and write and get quoted in newspapers) all bearish on gold. They have been giving different reasons to stay away from it. But if they were so confident that the price of gold would fall, as it has, why didn’t they warn the investors before fall? Everything is obvious after it has happened.
But as the Nobel Prize winning economist Daniel Kahneman writes in Thinking, Fast and Slow “The ultimate test of an explanation is whether it would have made the event predictable in advance”. Those offering the explanations now, clearly did not predict the massive and sudden fall in price of gold. What is interesting is that before the price of gold started to fall the Bloomberg consensus forecast for gold by the end of 2013 was at $1752 per ounce. Hence, the broader market did not see this coming.
So why is the price of gold falling? One conspiracy theory doing the rounds has the investment bank Goldman Sachs at the heart of it. As John Cassidy 
of the New Yorker magazine puts it “Last December, Goldman’s economic team turned bearishon gold, saying the multi-year upward trend in gold prices “will likely turn in 2013.” And last Wednesday,(i.e. April 10, 2013) the bank’s commodities team advised its clients to start shorting gold.” Short selling refers to a scenario where investors borrow gold and sell it with the hope that as the price falls they can buy it back at a lower price and thus make a profit.
Goldman Sachs was not the only big bank turning negative on gold. On April 2, the French bank, Societe Generale, the also issued a report titled 
The end of the gold era, and turned bearish on the yellow metal.
This many believe is a conspiracy on part of the big banks to drive down the price of gold. As Paul Craigs, a former assistant US Treasury Secretary 
told Kings World News “This is an orchestration. It’s been going on now from the beginning of April…Brokerage houses told their individual clients the word was out that hedge funds and institutional investors were going to be dumping gold and that they should get out in advance. Then, a couple of days ago, Goldman Sachs announced there would be further departures from gold. So what they are trying to do is scare the individual investor out of bullion. Clearly there is something desperate going on.”
Nevertheless, conspiracy theories are easy to talk about but difficult to prove. There are several other reasons being offered on why the price of gold will continue to fall. A major reason being offered is the improvement in the American economic scenario and that leading to the Federal Reserve of the United States, the American central bank, printing lesser money in the days to come.
The Federal Reserve currently prints $85 billion every month in the hope of reviving the American economy. Societe Generale in its report 
The end of the gold era believes that this will continue till September and come down to $65 billion after that, until being fully terminated by the end of the year.
The Federal Reserve on its part has guided that money printing will come down if it sees a ‘significant improvement in the outlook for employment’. The latest U3 rate of unemployment in the United States for the month of February 2013 stood at 7.6%. U6, a broader measure of unemployment, was at 13.8%. Both numbers have declined from their peaks. U6 touched a high of 17.2% in October 2009, when U3, which is the official unemployment rate, was at 10%. In December 2012 U6 stood at 14.4% and U3 was down to 7.8%.
So yes things have improved but they are still far away from being fine. U3 in the pre-financial crisis days used to be at around 5%. Also long term unemployment (where people are out of work for 27 weeks or more) has changed little and is at at 4.6 million or 39.6% of the unemployed people(U3).
(There are various ways in which the bureau of labour standards in the United States measures unemployment. This ranges from U1 to U6. The official rate of unemployment is the U3, which is the proportion of the civilian labour force that is unemployed but actively seeking employment. U6 is the most broad definition of unemployment and includes workers who want to work full time but are working part time because there are no full time jobs available. It also includes “discouraged workers”, or people who have stopped looking for work because the economic conditions the way they are, make them believe that no work is available for them.)
Another measure of the US economy turning around is the increase in real estate prices. As per the S&P Case-Shiller 20 City Home Price Index, real estate prices have gone up by 8.1% between January 1, 2012 and January 1, 2013. This after falling by 3.9% between 2011 and 2012.
One of the reasons the Federal Reserves prints money is to ensure that there is enough money going around in the financial system and interest rates continue to remain low. This ensures that people borrow and spend more. Hence, the low interest rates have helped in reviving the real estate sector in the United States.
But lets think for a moment on what will happen if the Federal Reserves stops printing money? Interest rates are likely to go up. People will take on fewer home loans to buy homes and that in turn will mean the real estate sector will go back to the dumps that it was in. So will the Federal Reserve take the risk of going slow or stopping money printing? Also, economic growth for the three months ending December 2012, was at -0.1%. So much for the American economy improving.
In this scenario it is unlikely the Federal Reserve will go stop money printing anytime soon, even though its Chairman Ben Bernanke, its Chairman, may keep dropping hints about doing the same.
As Stephen Leeb writes on www.Forbes.com “The Federal Reserve also wants to beat up on gold, via its drumbeat, suggesting that liquidity may be drying up and monetary easing might end soon. Never mind that recent economic data, on the whole, appears much weaker than expected, or that any halt to U.S. monetary easing could only follow higher inflation and commodity prices.
And as long as United States keeps printing money gold will remain a good investment bet, its current huge fall notwithstanding.
The last bull market in gold ended soon after the legendary Paul Volcker took over as the Chairman of the Federal Reserve in August 1979. As
 economist Bill Bonner wrote in a recent column “Paul Volcker replaced G. William Miller as chairman in August 1979. A loose money policy became a tight money policy. Volcker jacked up interest rates…But what’s the Fed doing now? Has it reversed course? Has Ben “Bubbles” Bernanke been replaced with a tough-as-nails inflation fighter? Has the Federal Open Market Committee(FOMC) vowed to stop printing money? Has the loosest monetary policy in US history given way to a tight policy?”
And the answer on all the above counts is a big no.
Moving on, another reason given for the gold price falling is that Cyprus is selling gold worth $500 million in order to raise cash to pay its debt. As Peter Schiff 
president of Euro Pacific Capitalwrote in a recent column “Concerns quickly spread that other heavily indebted Mediterranean countries with large gold reserves like Greece, Portugal, Italy and Spain would follow suit. The tidal wave of selling would be expected to be the coup de grace for gold’s glory years.”
The stronger countries of the euro zone (the countries which use euro as their currency) led by Germany have been rescuing the heavily indebted weaker ones for a while now through multi billion dollar rescue packages. In case of Cyprus the rescue came with terms and conditions which included seizing a part of its banking deposits and selling its gold.
This experts feel is likely to be repeated in the days to come with other countries as well. What they forget is that if the euro zone makes a habit of seizing deposits and selling gold, countries are likely to opt out of the euro and move onto their own currencies. As James Montier writes in a recent research paper titled 
Hyperinflations, Hysteria, and False Memories “If one were to worry about hyperinflation anywhere, I believe it would have to be with respect to the break-up of the eurozone.” Another reason to keep holding onto gold. If there is even a slight whiff of a euro breakup gold is going to fly.
Another logic being bandied around (especially by some of the Indian analysts) is that with the price of gold falling the investment demand for gold is likely to go down. Fair point. But a falling gold price can also push up the jewellery demand for gold. In 2011, gold jewellery consumed around 1972.1 tonnes of gold. This was down to 1908.1 tonnes in 2012, as prices rose.
A slowdown of Chinese growth has been offered as another reason for gold prices falling. As Cassidy of New Yorker writes “Many of today’s 
news storiesabout the gold price emphasized disappointing economic figures from China, which showed economic growth slowing down slightly in the first three months of 2013. China is a big consumer of virtually all natural resources, and gold was but one of many commodities that fell sharply after the report from Beijing.”
But this theory doesn’t really hold either. “The purported slowdown in the Chinese economy was very slight. First quarter growth came in at 7.7 per cent, compared to 7.9 per cent in the last three months of 2012. Allowing for the vagaries of the statistics, the difference is inconsequential,” writes Cassidy.
Also the gold bears who have suddenly all come out of the closet are not talking about what is happening in Japan. Japan has decided to double its money supply by printing yen to create some inflation. The hope is hat all this new money will create some inflation as it chases the same amount of goods and services, leading to a rise in prices. When people see prices rising, or expect prices to rise, they are more likely to buy goods and services, than keep their money in the bank. This is the logic. And when this happens businesses will do well and so will the overall economy.
A side effect of this money printing which is expected to be thrice as large as that in the United States, is the Japanese yen losing value against other major currencies because a surfeit of yen is expected to flood the financial system.
A weak yen also makes Japanese exports more competitive. (
For a detailed argument click here). But it puts countries like Taiwan, South Korea, China and even Germany in a spot of bother. As Societe Generale analysts write in a report titled How to make profits from the Sushi-style QE in Japan “In effect Korea, Taiwan and China are losing competitiveness while Japan regains it.”
Printing money is not rocket science, if Japan can print money, so can the other countries in order to weaken their currency and thus keep their exports competitive. Hence there are chances of a full fledged global currency war erupting. And this is another reason to own gold.
The final argument against gold has been that central banks have been printing money for more than four years now. But all that money has not led to high inflation, as the gold bulls had been predicting that it would. So central banks have managed to slay the inflation phantom. “After more than four years of quantitative easing in the United States, the inflation rate, as measured by the consumer price index, is running at just two per cent…In Britain, where the Bank of England has followed policies similar to the Fed’s, the inflation rate is 2.8 per cent—a bit higher, but hardly alarming,” writes Cassidy.
But just because money printing hasn’t led to inflation till now doesn’t mean we can rule out that possibility totally. There is huge historical evidence to the contrary. Let me quote Nassim Nicholas Taleb here, something that I have done in the recent past. As Taleb writes in 
Anti Fragile “Central banks can print money; they print print and print with no effect (and claim the “safety” of such a measure), then, “unexpectedly,” the printing causes a jump in inflation.” James Rickards author Currency Wars: The Making of the Next Global Crises says the same thing “They can’t just keep printing…All major central banks are easing…Eventually so much money will be printed that this will lead to inflation.”
And in a situation like this, gold will be the last man standing.
To conclude, this is how I feel about gold. I maybe right. I maybe wrong. That only time will tell. Hence its important to remember here what John Kenneth Galbraith, an economist who talked sense on most occasions, once said: “
The only function of economic forecasting is to make astrology look respectable.”
Given this it is important that one does not bet one’s life on gold going up. An allocation of not more than 10% in case of a conservative investor is the best bet to make. And if you are already there, stay there.

The article originally appeared on www.firstpost.com on April 18, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)