Democracy

‘The choice is between democracy and the gold standard’

vivek 2Author Vivek Kaul tells Sanjitha Rao Chaini that his book ‘Easy Money’ is an outcome of how money and the financial system have evolved over a very long period of time.

Why this book? How did the idea of writing this book come to you? 

The book was essentially an evolution of the writing that I do to make a living. I first started writing on the financial crisis after the investment bank Lehman Brothers went bust. The idea was to explain to the readers what is happening in the world. The Indian media (or even the world media) at that point of time had turned into a jargon spewing monster. Terms like sub-prime, securitization, Alt-A, CDOs etc were being bandied around. So, I started writing a series of pieces explaining these terms and the impact they were having on the world at large.

Over a period of time I came to the realization that what is happening now is not just because of things that have happened over the last few years or even decades. It is an outcome of how money and the financial system have evolved over a very long period of time. It has all come together to cause the current financial crisis. Easy Money was an outcome of that realization.

What kind of research did you put into this book?

The research has been extensive. Even before I decided to write the book I had read some 75-80 books on money and the financial system as they had evolved. As I wrote, I read a lot of research papers and historical documents that were written over the past 300 years. These research papers were a storehouse of information. Interestingly, with the advent of the internet a lot of historical material is available at the click of a button. What also helped was the fact that websites like Infibeam.com source second hand books, which are not easily available otherwise, from the United States. I don’t think I would have managed to write the book that I have, 10 years back, sitting in Mumbai. I would have probably managed to do if I had access to a library at a good American university.

You write… “as we have seen throughout history money printing has never ended well. But the same mistake continues to be made.” Why do you think that we haven’t learnt the lesson?

I wish I had an answer for that. I can only make a guess. In every era people who make economic decisions feel that “this time it’s different”. The tragedy is that it is never really different. And hence, the lessons are never really learnt. The same mistakes are made. Money printing never ends well that is a something that the world refuses to learn.

Do you think we would have been better off in any way if we had stuck to the gold standard as a store of value of money?

When I started writing Easy Money , in late 2011, I thought that the gold standard is the answer. During the process of writing the book that idea evolved. The thing with the gold standard is that it limits the amount of money that can be put into the financial system. Ultimately, it becomes a function of the amount of gold being dug up from the earth and that is what makes it work as well. But this is something that no politician is comfortable with. And politicians are essential for democracy.

In fact, I spoke to Russell Napier, a financial historian who works for CLSA, sometime in 2012. And he made a very important point which changed my thinking on the gold standard. “The history of the paper currency system or the fiat currency system is really the history of democracy,” he told me during the conversation. “Within the metal currency there was very limited ability for the elected governments to manipulate that currency. And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn towards paper currency and unless you see the destruction of democracy in the developed world and I do not see that we will stay with paper currencies and not return to metallic currencies or metallic based currencies,” he added.

So, in a way, the choice is between democracy and the gold standard. In fact, the era of the classical gold standard which started in the 1870s and survived till around the time of the First World War, was an era of limited democracy even in most of what is now known as the developed world.

There are contrary views on usage of bitcoins. Recently RBI even said it has no plans to regulate Bitcoins. Do you see a hard-landing for bitcoins? Do you think that central bankers will be able to regulate, and if not, what are the concerns?

That is a very difficult question to answer. One school of thought is that the Federal Reserve regularly lends out its gold to bullion banks, so that they can short-sell it and ensure that the price of gold does not rise beyond a point. Whether they will be able to crack the bitcoin system as well, in the days to come, I really don’t know.

How can policymakers make use of this book?

Policy makers don’t need any books. They do what they feel like doing. Given that, I don’t think this book or any book can be of much help to them. As the German philosopher Georg Hegel once said “What experience and history teach is this —that nations and governments have never learned anything from history, or acted on principles deduced from it.” And why should this time be any different?

What are you reading at the moment?

I have this habit of reading multiple books at the same time. So I read a few pages, drop that book and move onto something else. This loop keeps repeating. Right now I am reading Alan S Blinder’s After the Music Stopped. Blinder is a professor of economics at the Princeton University. He was also the vice chairman of the Federal Reserve of United States, between 1994 and 1996, under Alan Greenspan. His book is by far the best book I have read on the current the financial crisis. Excellent research presented in very simple English.

I am also reading The Bankers’ New Clothes by Anant Admati and Martin Hellwig. The fundamental point they make in their book is that if we need to make the financial system safer, banks need to have much more capital on their books than they currently have. This is one of the points I make in Easy Money as well. As Walter Bagehot, the great editor of The Economist once said more than 100 years back, “the main source of profitableness of established banking is the smallness of requisite capital.” This is something that needs to be set right.
As far as fiction goes I am currently reading a Swedish thriller titled Never Screw Up by Jens Lapidus. It is a sequel to a book which was also titled Easy Money. Ruskin Bond’s Tales of Fosterganj has just arrived and that is what I am looking forward to reading next weekend.

E-books or paper format ?

Paper totally. And there is a practical reason for it. I keep making notes on the edges (horrible habit some might say) as I read. This is a great help when one wants to write something and needs to revisit a book. You don’t have to bang your head against the wall at that point of time, thinking, where did I read that? So this ‘bad’ habit ensures that research and reading happen at the same time.

When and where do you write? And what’s the hardest thing about being a writer? 

Living in Mumbai means that one really does not have much choice about where to write. Also, having worked in extremely noisy newspaper offices, I can write almost anywhere. The place doesn’t really matter, as long as I have a computer and an internet connection.

Most of my writing happens between 11AM to 5PM. Having said that, some of my best writing has happened post midnight. The one time I hate writing is early in the morning between 7 to 10 AM.
I recently finished reading this book titled The Infatuations by the Spanish author Javier Marias. In this book Marias writes “You have to be slightly abnormal to sit down and work on something without being told to.” That is the toughest thing about being a writer. It needs a lot of self discipline and self motivation, knowing fully well that the money you make from your writing will most likely never compensate you for the opportunity cost that comes with it.

What next?

Easy Money is a trilogy. The first book ends around the time of the First World War. The second book starts from there and goes on till the time of the dot-com bubble burst. The third one deals with the current financial crisis. I have just finished the final edit of the second book, which should be out very soon. In about a week’s time I will get back to the third book. I had last looked at it in January 2013. So to give the readers a complete perspective the third book needs to be updated because a lot has happened in the last one year.

The interview originally appeared in the Business World

Would India have grown faster if it wasn’t a democracy?


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Vivek Kaul
The India growth story as it was originally envisaged to be, is more or less over. Days when 8-9% growth was taken for a given are gone. The gross domestic product (GDP) for the period July 1 to September 30, 2012, grew by 5.3%. GDP growth is a measure of economic growth.
Further, what is true about India, is also true about China. As Ruchir Sharma head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management told me in a recent interaction “As far as China was concerned the growth expectations were too high out of China. People kept expecting China to grow at 9-10%. But there has been a reset of expectations. This year the growth rate is going to be 7.5% officially. Some suggestions have been made that the actual number would be lower than that if you look at the corresponding data.”
As was the case in the past, expectations are that China will continue to grow at a much faster rate than India. To me this raises the question whether countries with authoritarian governments, or countries with lower levels of democracy or even countries run by dictators, do better during the initial few decades of economic growth than countries which are democracies?
Or to put it simply is India’s democratic form of government slowing down its economic growth? This is a question that makes for engaging discussion in the business circles of Mumbai and the power circles of Delhi. Would have done better if we were more like China or Singapore, than the way we actually are, is a question which is often asked?
Vivek Dehejia and Rupa Subramanya discuss this question in some detail in their new book Indianomix – Making Sense of Modern India(Random House India, Rs 399).
As they write “When you look back on the history of the twentieth century – in fact through human history – you notice periods of very high economic growth are associated with autocratic, not democratic regimes. Just think of Chile under the dictatorship of Augusto Pinochet or the ‘miracle’ economies of East Asia – Hong Kong, Singapore, South Korea, and Taiwan. Starting in the 1960s these four economies went from being poor to being rich in just over a generation. The first one was a British colony, the second an oligarchy, and the latter two essentially one-party states. It’s true that Chile, Taiwan and South Korea democratised – but that was after they’d experienced a generation of rapid growth, not before.”
As Dehejia told me in an earlier interview “You need to have some sort of political control, you cannot have a free for all, and get marshalling of resources and savings rate and investment rate, that high growth demands.” And this is more possible in an authoritarian regime than in a democracy. 
The same stands true for China now. It has had a generation of fast economic growth without any democracy. The country is ruled by one party, the Chinese Communist Party (CCP). As Richard McGregor, the author of The Party: The Secret World of China’s Communist Rulers told me in an earlier interview “The CCP is basically a political machine, as well as being a permanent governing party. As a political machine, it does not consider that its internal mechanisms should be open to public view. The top leaders are unveiled to the country at the end of five years and very little is revealed in the process. After the 2007 Congress, the nine men – and they are all men – walk out onto the stage, all wearing dark suits and all but one wearing a red tie; they all displayed slick, jet-black pompadours (a style of haircut), a product of the uniform addiction to regular hair dyeing of senior Chinese politicians; and they had all worked their up through the same system for all their lives.” Conformity is the name of the game. 
The Western nations which grew at a very fast rate towards the end of the nineteenth century and early twentieth century also had very little democracy back then. As Dehejia and Subramanya point out “All of the rich countries of the West achieved rapid growth and economic development when they weren’t democracies. Just think of Britain during the Industrial Revolution. While it’s true that Britain was a parliamentary democracy it came with one catch, the fact that most people couldn’t vote. Franchise restrictions based on property ownership meant that the poor and the lower middle class were prevented from voting.”
The same stands true about the United States of America as well, the biggest economy in the world right now. “Britain was really an oligarchy, not a democracy, and so too was the US and every other Western country that industrialised and got rich.. The US, for example, legally enfranchised the African-Americans after their emancipation from slavery, but this was ‘offset’ by franchise restrictions that meant most Southern blacks couldn’t participate in the political process until the civil write movement of the 1960s. And let’s not forget that women didn’t get the vote in all of these Western countries till very late – well into the twentieth century in many cases,” the authors point out.
India on the other hand was a unique case. As Dehejia told me in an earlier interview “The India story is unique. We are the only large emerging economy to have emerged as a fully fledged democracy the moment we were born as a post-colonial state and that is an incredibly daring thing to do.” 
This despite the fact that the Constituent Assembly which drafted the Indian Constitution had been elected under a very limited franchise by 5 to 10% of the Indians at the top of social and the So has Indian economic growth suffered because we are a democracy? Dehejia and Subramanya point out the research of William Easterly, an economics professor at the New York University. “The historical data on growth over time in many different countries that Easterly has analysed show that if you’re a fast growing country then there’s a 90 per cent chance that you’re an autocracy. The problem is that you should be asking the reverse question: if you’re an autocracy, what’s the chance that you’ll be a growth success? The answer to that question is an underwhelming 10 per cent?”
What that means is that fast growing countries are almost inevitably autocracies but not all autocracies are fast growing countries. An excellent recent example is Zimbabwe under Robert Mugabe who now functions like a dictator. “What was once a break basket has now become a basket case,” write the authors. The continent of Africa is full of authoritarian regimes which have made a mess of their respective economies.
Closer to home under General Zia-Ul-Haq, Pakistan first turned into an Islamic state and now has turned into a full fledged terrorist state. The horrors that Pol Pot perpetuated as the dictator of Cambodia are well known.
And the biggest example of an authoritarian regime gone wrong was Adolf Hitler. Hitler first rode to power on popular discontent and then used a lot of Keynesian economics ( which John Maynard Keynes was still in the process of formulating) to create economic growth by building roads and then lead his country into a disastrous World War.
So yes, fast growing countries are authoritarian regimes but as explained above things can go terribly wrong as well under these regimes. Hence, we really don’t know which way will the authoritarian regimes go, towards economic growth or towards social disaster.
But then why does the myth of authoritarian regimes always creating economic growth prevail? This is because of what is known as the ‘availability heuristic’. “This refers to the fact that human beings tend to attach too high a probability to an event that’s very vivid in our minds. A classic example is natural disasters like earthquakes and tornadoes. Because they’re splashed all over the news on the rare occasions they do occur, people always think they’re far more likely than they really are,” write the authors. “Compiling data from news stories in the New York Times from 1960 to 2008, Easterly shows that successful autocracies are heavily over-reported compared to failed autocracies. Compared to a little under 6,000 stories on failed autocracies and about 15,000 on those in the middle, there were a staggering number of stories – more than 40,000 on autocratic successes. So if China has been on your mind rather than Zimbabwe you’re not entirely to blame,” they add.
Hence, India’s democratic form of government may impact its economic growth to some extent but it saves us from other problems as well. “What the data do show is that autocracies have many more highs and lows than democracies: they tend to be spectacularly successful or unmitigated disasters. Democracies generally are found somewhere in the middle. India, for example, hasn’t yet achieved Chinese-style double digit growth rates, but nor has it ever had negative double-digit growth as in Zimbabwe,” write Dehejia and Subramanya.
The article originally appeared on www.firstpost.com on December 3, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected]) 
 
 

“We are in for another deflation shock…So actually it’s time to own cash”


Russell Napier a consultant with CLSA and one of the finest financial minds in the world, sees another deflationary shock coming. “Yes I am looking at a global deflation shock. So I see all the markets global equity markets coming down,” he says. When asked to predict a level he adds “I will just go back to my book the Anatomy of the Bear which was published in 2005 and in the book I forecast that the equity market, the S&P 500(an American stock market index constructed from the stock prices of the top 500 publicly traded companies) will fall to 400 points (On Friday the S&P 500 closed at 1,428.5 points)….So I am happy to stick with the number of 400 and then just tell everybody else who sort of reads this interview to work out what that means for the rest of the world,” he told Vivek Kaul in an exhaustive free wheeling interview.
How do you see thing in Europe right now?
My focus of the way I try to look at these economies is really to look at the financial conditions, the banking systems, credit availability etc. Those numbers are about bad for Europe. If you look at bank lending in Europe it is contracting to the private sector. The money they are lending is going to the governments. The key issue really is that is lack of credit going to the European private sector due to lack of supply or demand? There is more and more evidence that it is actually demand, and that just makes it just a more difficult problem to solve.
Why is that?
When your banking system is incapable of providing credit there are lots of things you can do to help it. But when people fundamentally don’t want to borrow and corporates don’t want to borrow then it’s a different situation. What would normally happen is quantitative easing and trying to keep money growing at a time when bank credit is contracting. But for political reasons that is difficult in Europe. So  Europe is facing a very difficult and nasty economic downturn, and things are going to get significantly worse. It’s worth adding on Europe as well that there is a chance that somebody is going to have to leave the Euro as early as next year. All seventeen members have to ratify the fiscal compact which is a major constitutional change. Still quite a few of them haven’t ratified it and maybe that  early as first quarter next year some country may be unable to ratify that fiscal compact. And at that stage we would have a crisis for the euro because the country that fails to ratify wouldn’t be able to stay in the euro. So we are all rolling into a European crisis next year.
So what can keep the euro going?
Ultimately the only thing that can keep Europe going is can they become a Federal States of Europe?
Can they?
No.  that is highly unlikely. There are seventeen members of the euro zone and all of them have to make the same constitutional changes and the same surrenders of sovereignty.  And this is not an economic call. This is a political and social call. And it is highly unlikely that all sovereign states will end up surrendering their sovereignty to a Federal government of Europe.
How do you see the things in the United States?
There is a much more mixed picture coming out of the United States of America. Bank credit is expanding and the private sector is borrowing. What is interesting is that small and medium enterprises have been borrowing and we have been seeing a growth there for over a year now.  That is normally a very good sign of thing because those are normally the people who create jobs.
What about other borrowing?
Banks balance sheets have premium components to them in terms of credit. And one is credit to small and medium enterprises. The other is mortgage credit. There is no sign of growth of mortgage credit. The other is consumer credit.  There is no sign of growth in consumer credit either. At this stage one can be more optimistic about the United States simply because small and medium enterprises are borrowing.
But what about the long term view?
I have a longer term problem with the United States which isn’t going to show up quarter to quarter in the growth numbers but it is structurally the most important thing that is going on there. The rate at which foreign central bankers particularly the Chinese are accumulating treasuries has dropped very dramatically. The Chinese are not buying and actually seem to be selling United States treasuries. Along with the Federal Reserve of United States they are the biggest owners of treasuries. They are neck and neck. When the biggest owner of treasuries is effectively a forced seller, it has to make you cautious on America despite the shorter term positive data coming out.
What will be the impact of this?
If the Chinese are not going to be funding the American government it’s more of an onus on the American savers to fund the American government. With savings being a reasonably finite number then there is less to lend to the private sector. I see us already in a larger picture trend of America where the savings of America will be increasingly be funding the American government and not the private sector. At the minute that is not having any negative impact or particularly negative impact on private sector credit availability. But ultimately it will.
That being the case are Americans saving enough to bankroll the American treasury?
The answer to that is no. They are not saving enough to bankroll the American treasury and the private sector. You have to put them both together. If you look at a country like Italy in Europe the government always gets funded. The governments always get funded someway. Likewise, the American government will always be funded. And if has to force the American people to buy treasuries it will force the American people to buy the treasuries. The question is are they saving enough to fund the government and also fund the demand of the private sector for capital as well. My answer to that is definitely no. But if it comes to push whether the government is funded or the private is sector funded, even in America which is ideologically more to the right, more free market than elsewhere, even there you will find the savings are forced towards the government and away from the private sector.
That being the case how do you expect the US government to finance its unfunded liabilities over like social security, mediclaim etc, over the years? One estimate even puts the unfunded liabilities at $222trillion.
In the short term as long as they can keep borrowing at this level they will probably keep borrowing at this level.  There is a basic rule.  A government that can borrow at 2% will borrow at 2%. That’s an entirely and completely unsustainable path for the American government. But it is just so easy to borrow at 2% that they will continue to do that. So that reality for America will not dawn for unfunded liabilities until it has to borrow at a more realistic interest rate, which is inevitable. The numbers you point out are absolutely huge but it’s becoming incredibly difficult to say when that will happen, when they will have to live with proper real interest rates. It could be several years. It could be several days. But eventually of course they will have to do that. And there is a whole host of solutions for the United States government.
Like what?
There is a thing called financial repression which is effectively forcing people to lend money to the US government or forcing financial institutions to lend money to the US government. That  is the path to travel for all the developed world countries. But there will have to be a renegotiation of benefits to the baby boom generation. Every society has to choose where the burden has to fall. Does it fall on tax payers? Does it fall on savers? Or does it fall on people who are recipients of this dole of money from the government. It will be a mix of all of these. So at some stage we will have to see a major renegotiation of the obligations that were signed for the baby boom generation in the 1960s. But it could be many years away.  I have to stress that this will be political dynamite. No society wants to withdraw benefits from its retired or elderly population. But the entire western world faces the reality that is exactly what it will have to do.
Do you see what they call the American dream changing?
It has massively changed over the last two decades already. American people sustained by going from one person working to two persons working and then adding significant leverage to it.  So the dream has been extended through those two mechanisms and clearly it is not going to go much further from here. It’s a much harder slog from here given excessive levels of debt on the starting position. It’s not only an American phenomenon but it’s a developed world phenomenon. It’s easy to be negative but the only possible positive way out of this is some technological innovation which gives us some very high levels of no inflationary growth and very high levels of productivity.
Could you elaborate on that?
If you read financial history sometimes these things just come along. They surprise everybody.  One thing that is that could do it is cheap energy.  Shale oil and shale gas are the main places we would be looking at for cheap energy. But it is worth stressing that we are going to need a very high level of real economic growth. So in America it will have to be in excess of 4% or maybe as high a 4.5%.  That’s the sort of real economic growth that would help countries grow their way out of the debt problem and meet most of the potential liabilities going forward. One shouldn’t rule out that we have that wonderful outcome but it still does seem like very unlikely.
Talking about technological innovation can you give me some examples from the past?
Yeah absolutely. They have really been energy related. In United Kingdom the canals were such a revolution that the transportation cost collapsed. The price of coal in some major cities came down by 60-70% due to the introduction of canals.  Obviously when energy prices fall by that much you get a productivity revolution. The railways had several impacts. Electricity which we didn’t really get going into the industrial process until the start of the last century, had a major impact. The automobile had a major impact. These are the types of major technological innovations which can change the world. When you can give the world cheap energy then that’s when you can begin to talk about much higher levels of growth.  It is almost impossible to tell where these things come from but one that is sort on the horizon is shale oil and shale gas and potentially what that can do. But I want to stress it is going to have to produce levels of real economic activity in America, which haven’t seen for a very very long period of time, perhaps ever.
Do you the American government defaulting on all the debt it has accumulated?
They will not default in the technical term of the word default which obviously means refusing to pay back in dollars the debt in principle. That would be definition of default. That seems unlikely.  But we are already in a situation where the Federal Reserve of the United States has intervened in the treasury market to hold the treasury yield below the level of inflation. Now that is not a default. But if you own treasuries and the yield is below the rate of inflation then the real value of your investment is declining in dollar terms. In terms of you and I investing in that treasury market it means that we are losing capital and therefore I would call this a democratic default. The second democratic default which I will come to America and the whole developed world will eventually be restrictions of free movement of capital. We are heading towards a world of controls and capital restrictions, which was a norm from 1945 to 1980-81.
Do you see them printing money to repay all the accumulated debt?
The answer is that partially they are already doing it. Quantitative easing is a form of printing money. Therefore you can say that is a process that is underway. So I have no doubts whatsoever that the Americans will be printing money to satisfy their foreign creditors.
Do you see that leading to a hyperinflation kind of scenario?
No. It is always assumed that if there is a dramatic sale of the treasuries by the Chinese, the Federal Reserve will simply buy all those treasuries and simply create lots of money in the process. If that mechanism happened you would end up with hyperinflation. But it’s worth remembering that there is a technical definition of hyperinflation and that is a rate of inflation of 50% per month or more. So it’s a very high number. Sometime people think that 20% per annum is hyperinflation but its 50% per month technically. The Federal Reserve is not stupid enough to do that. It would not simply print all the money it could to do to repay its creditors.
So what will happen?
What will happen is that there will be some money printing and as I stressed inflation will be higher than yield of treasuries. But Plan B is financial repression which is to effectively force the financial institutions and the people of America to buy the treasuries. Now this does not involve printing of money. I am sure that if the Federal Reserve sees inflation climbing to anywhere near 10% it would go to the government and say that we cannot continue to print money to buy these treasuries and we need to force financial institutions and people to buy these treasuries. In India you must be aware that banks have to compulsorily buy government debt. We can force banks and government companies to have a minimum amount of their assets in government debt. The road to hyperinflation is well known by central bankers. It has never ended well even though it can wipe out your debt very very rapidly indeed. Nevertheless, the political and social implications of that are truly dire. It tends to throw up despots and destroy democracies.  Financial repression if you are a saver is a terrible but is much less painful than hyperinflation.
But what about the Western world practicing austerity to repay its debt?
True austerity is when you if you simply closed down on the government spending and accepted the economic consequences of that and still kept taking in the tax revenues. But that’s apolitically painful way of doing it. True austerity is highly unlikely. What Europe has nothing like sufficient austerity to take them to a situation where they can repay the government debt. So the only way out is repression, which is simply funding the government by forcing the people and financial institutions to buy government securities. That’s a very painful thing if you are a saver, but so much better than austerity, default and hyperinflation. It is ultimately the most acceptable form of getting out of this problem. Even with repression we are talking about a couple of decades before we could gain levels of gearing in the developed world drawn towards normal levels.
Do you see the paper money system surviving?
Yes I do see the paper money system surviving. To say that it doesn’t survive means we replace it with something that is based or anchored on metal. But the history of the paper currency system or the fiat currency system is really the history of democracy. Within the metal currency there was very limited ability for the elected governments to manipulate that currency. And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn towards paper currency and unless you see the destruction of democracy in the developed world and I do not see that we will stay with paper currencies and not return to metallic currencies or metallic based currencies.
What about gold?
Gold is never easy to predict and it is particularly difficult at the moment. In the long run view which I have just run through that repression is ultimately the best choice for democracies, gold is the best asset class. It is the standout asset class. In a world of negative real interest rates prolonged for some decades gold does really well. And secondly in a world where tax rates are going up where the government needs to get more private wealth under its own control then gold is small, portable and hidable and therefore becomes an asset of choice. So my long term prognosis for gold remains very good. In the short run I am concerned that if we get another economic setback from here and we see growth coming down from here, the price of gold may come down. But I would say any declines in the price of gold are wonderful opportunities to buy some more and for the long term holder gold remains essential.
What are the other asset classes you would bullish is on?
I tend to believe that we are in for another deflation shock. The Asian crisis of 1998 was a deflation shock and we had one in 2002 when the American economy slowed and Mr Bernanke had to make his helicopter speech. We had another one post Lehman Brothers. So what you would want to look at is what asset classes did well during those periods? And really very little does well when we have deflation shocks. Whether deflation turns up or not the shock is very bad for pro-growth assets. So actually it’s time to own cash.  Cash has historically been a good preserver of health during periods of deflation. It is worth buying debt of some of the governments that don’t have very much debt. There are some countries out there with small amount of government debts and they are small such as Singapore and Norway. So I would recommend cash and very small holding in government debt in markets where the governments don’t have very much debt. Also when markets have come down a bit we are looking to buy equities and we are looking to buy gold.
By when do you see this deflationary shock coming?
Well its coming. It is very rare for these things to erupt in the morning. Lehman Brothers was the exception a bank with $600billion of liabilities going bust suddenly threatens the stability of the entire financial system. Sometimes it happens like that but rarely. It happened like that in the 1930s with the bankruptcy of Creditanstalt (An Austrian bank which went bankrupt in 1931 and started a chain of bankruptcies). Occasionally it can be a major event. But it can be just like it was in 2003 just slower and slower growth.  The only sort of one red flag which could suddenly jump and signal deflation is if someone leaves the euro because clearly if it’s a major currency leaving the euro they will be re-denominating their debts in their domestic currency which is tantamount to a large default on the global banking system. That is a small chance of that early next year.
What if the country is Greece?
Frankly Greece defaulting on its debts isn’t going to make much difference to a banking system but makes a big difference to the IMF and the government. But more likely it’s just going to be slower and slower growth coming forward particularly in China.  The world has bet a lot on Chinese growth. The more the growth slows in China and capital flows out of China, the more the world begins to realise that its China which has been the source of global growth and global inflation, and if that’s not there we are more likely to get deflation. So that’s the more likely scenario rather than a Lehman Brothers style event.
So you are basically saying that the high Chinese growth rates will now be a thing of the past?
Yes unless they do some major reforms. And in my opinion that they need to do is reforms which will encourage private Chinese capital to remain in China and invest in China. And at the minute where is very limited reason for the Chinese private capital to remain in China because the returns are so poor. So anything they could do to open up the financial system for private sector investment and private sector competition would be good. And more importantly allow the private sector to take over some state owned enterprises and restructure them. If they are prepared to make that giant leap in terms of reforms then there is every prospect that keep they will keep capital in China. The good thing is we are getting a new administration. The bad thing is it is very difficult to predict what a new Chinese administration stands for. But soon enough we will know and if they come up with some policies like this, then there are many reasons to be more optimistic about the outlook for global growth.
By what levels do you see the stock markets falling in the coming deflationary shock?
I will just go back to my book the Anatomy of the Bear which was published in 2005 and in the book I forecasted that the equity market, the S&P 500(an American stock market index constructed from the stock prices of the top 500 publicly traded companies) will fall to 400 points (On Friday the S&P 500 closed at 1,428.5 points). As you know in March 2009 it got to 666points. It got somewhere there but it did not get to 400. So I am happy to stick with the number of 400 and then just tell everybody else who sort of reads this interview to work out what that means for the rest of the world.
The interview originally appeared in the Daily News and Analysis on October 15, 2012. http://www.dnaindia.com/money/interview_we-are-in-for-another-deflation-shock-so-actually-its-time-to-own-cash_1752471
(Interviewer Kaul is a writer. He can be reached at [email protected])
 

Reform by stealth, the original sin of 1991, has come back to haunt us


India badly needs a second generation of economic reforms in the days and months to come. But that doesn’t seem to be happening. “What makes reforms more difficult now is what I call the original sin of 1991. What happened from 1991 and thereon was reform by stealth. There was never an attempt made to sort of articulate to the Indian voter why are we doing this? What is the sort of the intellectual or the real rationale for this? Why is it that we must open up?” says Vivek Dehejia an economics professor at Carleton University in Ottawa,Canada. He is also a regular economic commentator on India for the New York Times India Ink. In this interview he speaks to Vivek Kaul.
How do you see overall Indian economy right now?
The way I would put it Vivek is, if I take a long term view, a generational view, I am pretty optimistic. The fundamentals of savings and investments are strong.
What about a more short term view?
If you take a shorter view of between six months to a year or even two years ahead, then everything that we have been reading about in the news is worrisome. The foreign direct investment is drying up. The savings rate seems to have been dropping. The economic growth we know has dropped. The next fiscal year we would lucky if we get 6.5% economic growth.
How do we account for the failure of this particular government to deliver sort of crucially needed second generation economic reforms?
The India story is a glass half empty or a glass half full. If you look at the media’s treatment of the India story, particularly international media they tend to overshoot. So two years ago we were being overhyped. I remember that the Economist had a famous cover where they said that India will overtake China’s growth rate in the next couple of years. They made that bold prediction. And then about a year later they were saying that India is a disaster. What has happened to the India story? The international media tends to overshoot. And then they overdo it in the negative direction as well. A balanced view would say that original hype was excessive. We cannot do nor would we want to do what China is doing. With our democratic system, our pluralistic democracy, the India that we have, we cannot marshal resources like the way the Chinese do, or like the way Singapore did.
Could you discuss that in detail?
If you take a step back, historically, many of the East Asian growth miracles, the Latin American growth miracles, were done under brutal dictatorial regimes. I mean whether it was Pinochet’s Chile, whether it was Taiwan or Singapore or Hong Kong, they all did it under authoritarian regimes. So the India story is unique. We are the only large emerging economy to have emerged as a fully fledged democracy the moment we were born as a post colonial state and that is an incredibly daring thing to do. At the time when the Constituent Assembly was figuring out what are we going to do now post independence a lot of conservative voices were saying don’t go in for full fledged democracy where every person man or a woman gets a vote because you will descend down into pluralism and identity based politics and so on. Of course to some extent it’s true. A country with a large number of poor people which is a fully fledged democracy, the centre of gravity politically is going to be towards redistribution and not towards growth. So any government has to reckon with the fact that where are your votes. In other words the market for votes and the market for economic reform do not always correlate.
You talk about authoritarian regimes and growth going together…
This is one of the oldest debates in social sciences. It is a very unsettled and a very controversial one. For any theory you can give on one side of it there is an equally compelling argument on the other side. So the orthodox view in political science particularly more than economics was put forward by Samuel Huntington. The view was that you need to have some sort of political control, you cannot have a free for all, and get marshalling of resources and savings rate and investment rate, that high growth demands.
So Huntington was supportive of the Chinese model of growth?
Yes. Huntington famously was supportive of the Chinese model and suggested that was what you had to do at an early stage of economic development. But there are equally compelling arguments on the other side as well. The idea is that democracy gives a safety valve for a discontent or unhappiness or for popular expression to disapproval of whatever the government or the regime in power is doing. We read about the growing number of mysterious incidents in China where you can infer that people are rioting. But we are not exactly sure because the Chinese system also does not allow for a free media. Also let’s not forget that China has had growing inequalities of income and growth, and massive corruption scandals. The point being that China too for its much wanted economic efficiency also has kinds of problems which are not much different from the once we face.
That’s an interesting point you make…
Here again another theory or another idea which can help us interpret what is going on. When you have a period of rapid economic growth and structural transformation of an economy, you are almost invariably going to have massive corruption. It is almost impossible to imagine that you have this huge amount of growth taking place in a relatively weak regulatory environment where there isn’t going to be an opportunity for corruption. It doesn’t mean that it is okay or it doesn’t mean that one condones it, but if you look throughout history it’s always been the case that in the first phase of rapid growth and rapid transformation there has been corruption, rising inequalities and so on.
Can you give us an example?
The famous example is the so called American gilded age. In the United States after the end of the Civil War (in the 1860s) came the era of the Robber Barons. These people who are now household names the Vanderbilts, the Rockefellers, the Carnegies, the Mellons, were basically Robber Barons. They were called that of course because how they operated was pretty shady even according to the rules of that time.
Why are the second generation of reforms not happening?
What makes reforms more difficult now is what I call the original sin of 1991. We had a first phase of the economic reforms in 1991 where we swept away the worst excesses of the license permit raj. We opened up the product markets. But what happened from 1991 and thereon was reform by stealth. Reform by the stroke of the pen reform and reform in a mode of crisis, where there was never an attempt made to sort of articulate to the Indian voter why are we doing this? What is the sort of the intellectual or the real rationale for this? Why is it that we must open up? It wasn’t good enough to say that look we are in a crisis. Our gold reserves have been mortgaged. Our foreign exchange reserves are dwindling. Again India’s is hardly unique on this. Wherever you look whether it is Latin America or Eastern Europe, it generally takes an economic crisis to usher in a period of major economic reform.
So the original sin is still haunting us?
The original sin has come back to haunt us because the intellectual basis of further reform is not even on anyone’s agenda. Discussions and debates on reform are more focused on issues like the FDI is falling, the rupee is falling, the current account deficit is going up etc. Those are all symptoms of a problem. The two bursts of reform that we had first were first under Rao/Manmohan Singh and then under NDA. If a case had been made to build a constituency for economic reform, then I think we would have been in a different political economy than we are now. But the fact that didn’t happen and things were going well, the economy was growing, that led to a situation where everybody said let’s carry on. But now we don’t have that luxury. Now whichever government whoever comes to power in 2014 is going to have to make some tough decisions that their electoral base, isn’t going to like necessarily. So how are they going to make their case?
So are you suggesting that the next generation of reforms in India will happen only if there is an economic crisis?
I don’t want to say that. Again that could be one interpretation from the arguments I am making of the history. It will require a change in the political equilibrium and certainly a crisis is one thing that can do that. But a more benign way the same thing can happen that without a crisis is the realization of the political actors that look I can make economic reform and economic growth electorally a winning policy for me. But India is a land of so many paradoxes. A norm of the democratic political theory in the rich countries i.e. the US, Canada, Great Britain etc, is that other things being equal, the richer you are, the more educated you are, the more likely you are to vote. In India it is the opposite. The urban middle class is the more disengaged politically. They feel cynical. They feel powerless. Until they become more politically engaged that change in the equilibrium cannot happen.
What about the rural voter?
The rural voter at least in the short run might benefit from a NREGA and will say that you are giving me money and I will keep voting for you. We have all heard people say they are uneducated and they are ignorant, no it’s not like that. He is in a very liquidity constrained situation. He is looking to the next crop, the next harvest, the next I got to pay my bills. If someone gave him 100 days of employment and gives him a subsidy, he will take it.
How do explain the dichotomy between Manmohan Singh’s so called reformist credentials and his failure to carry out economic reforms?
One of the misconceptions that crops up when we look at poor economic performance or failure to carry out economic reform is what cognitive psychologists call fundamental attribution bias. Fundamentally attribution bias says that we are more likely to attribute to the other person a subjective basis for their behaviour and tend to neglect the situational factors. Looking at our own actions we look more at the situational factors and less at the idiosyncratic individual subjective factors. So what am I trying to say? What I am saying is that it has become almost a refrain to say that Dr Manmohan Singh should be an economic reformer. He was at least the instrument if not the architect of the 1991 reforms. There are speculations being in made in what you can call the Delhi and Mumbai cocktail party circuit, about whether he is really a reformer? Was it Narsimha Rao who was really the real architect of the reform? Is he a frustrated reformer? What does he really want to do? What’s going on his head? That in my view is a fundamental attribution bias because we are attributing to him or whoever is around him a subjective basis for the inaction and the policy paralysis of the government.
So the government more than the individual at the helm of it is to be blamed?
Traditionally the electoral base of the Congress party has been the rural voter, the minority voters and so on, people who are at the lower end of the economic spectrum. So they are the beneficiaries just roughly speaking of the redistributive policies. Political scientists have a fancy name for it. They call it the median voter theorem. What does it mean? It means that all political parties will tend to gravitate towards the preferred policy of the guy in the middle, the median voter.
Was Narsimha Rao who was really the real architect of the reform?
Narsimha Rao must be given a lot of credit for taking what was then a very bold decision. He was at the top of a very weak government as you know. And he gave the political backing to Manmohan Singh to push this first wave of reforms more than that would have been necessary just to avert a foreign exchange crisis. And then he paid a price for it electorally in the next election. This again the intangible element in the political economy that short of a crisis it often takes someone of stature to really take that long term generation view. IT means that you are not just looking at narrow electoral calculus but you are looking beyond the next election. That’s what seems to be missing right now. Among all the political parties right now, one doesn’t seem to see that vision of look at this is where we want to be in a generation and here is our roadmap of how we are going to get there.
Going back to Manmohan Singh you called him an overachiever recently, after the Time magazine called him an “underachiever”. What was the logic there?
The traditional view and certainly that was widely in the West at least till very recently has been that it was Manmohan Singh who was the architect of the India’s economic reforms. But then how do you explain the inaction in the last five, six, seven years? The revisionist perspective would say no in fact the real reformer was Narsimha Rao to begin with. The real political weight behind the reform was his. And Manmohan Singh that any good technocratic economist should have been able to do which is to implement a series of reforms that we all knew about. My teacher Jagdish Bhagwati had been writing about it for years. In that sense maybe Manmohan Singh was given too much credit in the first instance for implementing a set of reforms. If you look at his career since then he has never really been a politically savvy actor. We have this peculiar situation in India since 2004 where the Prime Minister sits in the Rajya Sabha, the upper house. That kind of thing is not barred by our constitution but I don’t think that the framers of the constitution envisaged this would be a long term situation. It is a little like the British prime minister sitting in the House of Lords. I mean that practice disappeared in the nineteenth century. He has not shown from the evidence that we can see any ability to get a political base of his own to be a counterweight to the more redistributive tendencies of the Nehru Gandhi dynasty. And that’s the sense that in somewhat cheeky way I was using the term overachiever.
Do you think he is just keeping the seat warm for Rahul Gandhi?
It increasingly appears to be that way. If that is true then it suggests that we shouldn’t really expect much to happen in the next two years.
Does the fiscal deficit of India worry you?
If you look at some shorter to medium term challenges, then things like fiscal deficit and the current account deficit are things to worry about. Again other things like the weak rupee, the weak FDI data, things that people tend to fixate at, but those at best are symptoms of a deeper structural problem. The deeper concern is the kind of reform that will require a major legislative agenda such as labour law reform for example to unlock our manufacturing sector. And managing the huge demographic dividend that we are going to get in the form of 300-400 million young people. They will have to be educated.
But is there a demographic dividend?
That’s the question. Will it become a demographic nightmare? Can you imagine the social chaos if you have all these kids just wandering around, not educated enough to get a job, what are they going to do? It’s a recipe for social disaster. That according to me is going to be real litmus test. If we are able to navigate that then I don’t see why we won’t be on track to again go back to 8- 9% economic growth. I want to remain optimistic at the end of the day.
(The interview originally appeared in the Daily News and Analysis on August 6,2012. http://www.dnaindia.com/money/interview_reform-by-stealth-the-originalsin-of-1991-has-come-back-to-haunt-us_1724348)
(Interviewer Kaul is a writer and can be reached at [email protected])

Rahul Gandhi is paying for the mistakes of Indira Gandhi


Vivek Kaul

Some twenty eight days before my tenth standard exams I started reading William Shakespeare‘s Julius Caesar, seriously, for the first time. And I am still trying to figure out why the world fusses so much over plays written in a form of English that went out of fashion a long long time ago.
My memory of the play is very hazy now, given that it’s been two decades since. But what I do remember is that in Act 3 scene ii of the play comes a line which I found very relevant to the way world operates. “The evil that men do lives after them; The good is oft interred with their bones,” says the character of Mark Antony in that scene.
The evil that men (and women) do lives after them and in some cases the coming generations have to bear the consequences for it. Take the case of Indira Gandhi who systematically destroyed the institution of democracy. As historian Ramchandra Guha recently told CNN IBN “Nehru nurtured institution of democracy – an independent election commission, an independent judiciary, bureaucracy autonomous of political interference, pluralism, secularism. Indira systematically undermined all of this.”
This included democracy within the Congress party as well. During her heydays she first had Dev Kant Baruah installed as the President of the Congress party. Baruah is best remembered for saying “Indira is India and India is Indira”. Such was the level of the sycophancy that was prevalent when Indira Gandhi was at her peak.
After Baruah, Indira Gandhi took the presidency into her hands and was the president of the Congress party from 1978 to her death in 1984. Her younger son Sanjay more or less ran things within the party as well as the government (when Indira was in power) for a major part of this period.
She was succeeded as the President of the elder party by her son Rajiv who remained the President of the party till his death in 1991. This more or less institutionalized “dynastic” rule within the Congress. As Guha said “Even Nehru’s fiercest critic wrote at that time that the Nehru has no interest in promoting dynastic rule… Indira promoted first Sanjay and then Rajiv.”
With no democracy at the top of the Congress party, it simply wasn’t possible for the party to remain democratic at the state or the district level for that matter. The lack of internal democracy and the centralized nature of the Congress party led to the coining of the legendary phrase “high command”. It was also ironic that the world’s largest democracy was and is governed by a party with very little “internal” democracy.
More recently the party has seen Rahul Gandhi, fifth generation of the Nehru-Gandhi dynasty, at the helm of things, trying to correct the lack of democracy within the party. In October 2008, while addressing girl students at a resort near the Jim Corbett National Park, Rahul referred to “politics” as a closed system in India. “If I had not come from my family, I wouldn’t be here. You can enter the system either through family or friends or money. Without family, friends or money, you cannot enter the system. My father was in politics. My grandmother and great grandfather were in politics. So, it was easy for me to enter politics. This is a problem. I am a symptom of this problem. I want to change it.”
Rahul has tried to change this by trying to introduce some internal democracy within the Congress party by trying to ensure free internal elections. As Rasheed Kidwai writes in 24 Akbar Road – A Short History of the People Behind the Fall and Rise of the Congress, “Rahul Gandhi took it upon himself to bring about inner-party democracy in the Congress. He hired retired election commissioner JM Lyngdoh to design processes and implement policies to ensure that there were free internal elections within the party and that all initiatives and representatives were backed by elected representatives.”
While this is a good move but it is not going to lead to instant rejuvenation of a party that has constantly lost hold over the Indian electorate over the last two decades. Also, any move to initiate democracy within the Congress remains a non-starter given the lack of any democracy at the top.
Rahul’s mother Sonia Gandhi has been the President of the Congress since March 14, 1998, when the Congress Working Committee members led by Pranab Mukherjee invoked the Clause J of the Article 19 of the Congress constitution to throw out the elected President Sitaram Kesri. They then installed Sonia Gandhi as the President. This was unprecedented in the history of the party where an “elected” President of the party was thrown out by invoking a vague clause. The clause did not clearly point whether an elected President could be removed, by invoking it.
As The Hindu wrote after the death of Sitaram Kesri:
“The constitutional coup was hailed widely as restoring the party’s leadership back to the site of its only natural entitlement – the Nehru-Gandhi family. When the historians get to chronicle the import of that eventful day, most of the honorable men of the Congress would be shown to have acted way less than honourably; even those who owned their rehabilitation and place in the CWC to the old man had no qualms in abandoning him. The transition that day cast the Congress (I) once again in the dynastic mold, and the consequences are visible.”
Sonia Gandhi has been the President of the party ever since. Even if the party had presidential elections regularly the chances of anyone else other than Sonia Gandhi (assuming she continued to contest) winning the elections remained low. As Jitendra Prasada found in November 2000, when he ran against Sonia Gandhi, in the hope that she would ask him to withdraw his nomination and reward him with a senior position. Sonia never did and got nearly 99% of the votes polled. As Rashid Kidwai writes in Sonia – A Biography “As the date for the withdrawal of names drew nearer, Jitty Bhai waited in vain for a call from 10 Janpath offering a face saving, last-minute withdrawal. Humiliated and marginalized, Jitty Bhai realised that this gambit had failed. Accompanied by a handful of leaders from Uttar Pradesh, Prasada filed his nomination papers and was humbled in the party polls as Sonia went on to get nearly 99 per cent of the votes. The peacemakers and many of those who had encouraged Prasada to teach Sonia a lesson were nowhere in sight.”
Prasada never recovered from the humiliation he suffered at the hands of Sonia and died of a brain haemorrhage a few months later.
So try as much as Rahul might to revive the democratic process within the Congress party, it doesn’t really matter. To paraphrase what Dev Kant Baruah said about Indira Gandhi: “The Nehru-Gandhi family is the Congress. And the Congress is the Nehru-Gandhi family”.
The only constant in a party which lacks any ideology is the Nehru-Gandhi family. Given this, it doesn’t really matter if the Congress party has internal democracy or not. What matters is whether there is someone around from the Nehru-Gandhi family around to lead it.
It’s time Rahul Gandhi realised this and moved on from a full time party role to a role in the government while continuing with his role in the party as well. This will go in a long way in motivating the party cadre than all the moves to promote democracy within the party. There is nothing more that a Congress party worker likes than being led by a scion of the Nehru Gandhi family. This move also becomes even more important in a scenario where Pranab Mukherjee the principal troubleshooter for the party has decided to retire and move to the biggest house in the country.
It’s been nearly twenty three years since Rajiv Gandhi lost power to Vishwanath Pratap Singh. A Nehru-Gandhi family scion has not been a member of the Indian government since then. It’s time for Rahul and the Congress party to set that anomaly right.
(The article originally appeared on www.firstpost.com on July 30,2012. http://http://www.firstpost.com/politics/rahul-gandhi-is-paying-for-the-mistakes-of-indira-gandhi-396001.html/)
(Vivek Kaul is a writer and can be reached at [email protected])