Greece

The stories that business media and market analysts tell us

bullfightingVivek Kaul

Over the last few days I have had great fun watching business news channels. After the BSE Sensex crashed by 855 points or over 3% on January 6, 2015, all kinds of explanations have been offered for the fall by the business media in general and market analysts in particular. Greece will soon be in major trouble. The dollar is rising against other currencies. The global cues are not good. Oil price has fallen to below $50 per barrel. This means that the world is entering an era of deflation (Deflation, a scenario of falling prices, is the opposite of inflation, and I am amazed how easily market analysts who appear on television use this term). The Modi effect is slowing down. The foreign investors need to realign their portfolios with the changing global economic scenario. And the proverbial, Indian economy is not doing well and corporate investment is needs to pick up. Two days later on January 8, 2015, the Sensex rallied 366 points or 1.4%. Market analysts and the business media told us that value buying was now coming in and this had led to the rally. What amazes me is that investors suddenly saw value in stocks with the market falling by just 3%? Benjamin Graham must be turning in his grave. He clearly never would have envisaged a day like this. Also, the investors did not see value on January 7, 2015, when the Sensex was almost flat. It fell by around 78.6 points or 0.3% on that day. But they suddenly saw value on January 8, 2015. What changed overnight? That no market analyst bothered to explain. In the Indian context, the foreign institutional investors have been driving the market for a while now. On January 6, 2015, they net sold stocks worth Rs 1,534.23 crore. But this was neutralized to some extent by domestic institutional investors buying stocks worth Rs 1,079.6 crore on the same day. Markets go up. Markets go down. And just because analysis exists doesn’t mean we analyse everything. I haven’t heard a single market analyst or a journalist in the business media till date say that today’s stock market movements were due to random fluctuations. As John Allen Paulos writes in A Mathematician Reads the Newspaper: “Almost never does a stock pundit say that market’s or a particular stock’s activity for the day or the week or the month was largely a result of random fluctuations.” With so many numbers and stories going around it is always possible to say something which on the face of it sounds very sensible. “The business pages, companies’ annual reports, sales records, and other widely available statistics provide such a wealth of data from which to fashion sales pitches that it’s not difficult for a stock picker to put on a good face…All that’s necessary is a little filtering of the sea of numbers that washes over us,” writes Paulos. This is precisely what has been happening over the last few days. The information and analysis being provided is essentially adding to the clutter. As Nassim Nicholas Taleb writes in Fooled by Randomness: “The difference between noise and information…has an analog: that between journalism and history. To be competent, a journalist should view matters like a historian, and play down the value of the information, he is providing.” This Taleb, feels can be done by saying: “Today the market went up, but this information is not too relevant as it emanates from noise”. But in an era of 24 hour news channels this is easier said than done. “Not only is it difficult for the journalist to think more like a historian, but it is, alas, the historian who is becoming more like the journalist [and to add my two bit so are market analysts]…If there is anything better than noise in the mass of “urgent” news pounding us, it would be like a needle in a haystack. People do not realize that the media is paid to get your attention. For a journalist, silence really surpasses any word,” writes Taleb. To be fair to the business news channels, the business newspapers follow the same formula of trying to come up with an explanation for market movements all the time. It’s just that since they do not have to react instantly to everything, some amount of noise gets filtered out in their reporting. A few years back I happened to interview valuation guru Aswath Damodaran and asked him a fairly straightforward question: How much role does media play in influencing investment decisions of people? The reply he gave was very interesting: “Media and analysts are followers…Basically when I see in the media news stories I see a reflection of what has already happened. It is a lagging indicator. It is not a leading indicator. I have never ever found a good investment by reading a news story. But I have heard about why an investment was good in hindsight by reading a news story about it. I am not a great believer that I can find good investments in the media. That’s not their job anyway.” This is something that investors need to keep in mind while following the media in their quest to understand why are the markets moving the way they are. It is worth remembering that business news channels and the business newspapers need to operate even when there is no major news. As Maggie Mahar writes in Bull—A History of the Boom and Bust, 1982-1984: “The perennial problem for the media is that balance sheets do not fluctuate on a daily basis. Once a reporter has laid out a company’s assets and debts, how does he fill the news hole the next day? Only by tracking market’s daily performance.” Analysts help the business press in filling up the daily space. This is something that former Morgan Stanley analyst Andy Kessler writes about in his book Wall Street Meat: “The market opens for trading five days a week… Companies report earnings once every quarter. But stocks trade about 250 days a year. Something has to make them move up or down the other 246 days [250 days – the four days on which companies declare quarterly results]. Analysts fill that role. They recommend stocks, change recommendations, change earnings estimates, pound the table—whatever it takes for a sales force to go out with a story so someone will trade with the firm and generate commissions.” And once analysts have a daily opinion, the media gets some masala to fill up its daily space. The trouble is that while the media ends up filling up space, investors who follow the media are bound to end up confused if they follow the media on a daily basis. It is worth remembering here what hedge fund manager Bill Fleckenstein told Mahar: “The trouble is that investing doesn’t lend itself to play-by-play reporting…Speculation does, but investing doesn’t.” The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 9, 2015

No "acche din" for govt finances any time soon

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010Vivek Kaul 

So what do the finance minister Arun Jaitley and the Hindi film industry have in common? They both love the number “Rs 100 crore”. The Hindi film industry cannot stop talking about the films that have done a business of Rs 100 crore or more. Jaitley, in his maiden budget speech, used the Rs 100 crore number 29 times, while making allocations to various government schemes.
This has led a lot of experts to comment that Jaitley has spread himself too thin. Whether that turns out to be the case, only time will tell. Nevertheless, in the budget speech, Jaitley, like finance ministers before him, did not talk about the single biggest expenditure of the government.
The single biggest expenditure of the government of India is debt servicing i.e. the interest that it pays on its debt and the money that it spends in repaying it. Governments all over the world, including the Indian government, spend much more than they earn. This difference is referred to as the fiscal deficit and is financed through borrowing. The money is borrowed for a certain period. During the period a certain amount of interest needs to be paid on it. And at the end of the period, the borrowed money needs to be repaid.
Over the years, the government has been spending more than it has earning. Given this, the fiscal deficit has shot up. In 2007-2008, the fiscal deficit of the Indian government had stood at Rs 1,26,912 crore or 2.6% of the GDP. This had shot up to Rs 5,15,990 crore or 5.7% of the GDP, by 2011-2012. The fiscal deficit projected for 2014-2015 stands at Rs 5,31,177 crore or 4.1% of the GDP.
This increase in fiscal deficit has been financed by a greater amount of borrowing. A greater borrowing has meant that the cost of debt servicing for the government has gone up over the years. In 2009-2010, the total debt servicing cost of the Indian government had stood Rs 2,94,857 crore. The fiscal deficit during the course of that year had stood at Rs 4,18,842 crore. Hence, the ratio of the debt servicing cost to the fiscal deficit worked out to 0.7.
By 2013-2014, the total debt servicing cost had shot up to Rs 5,43,267 crore. As the amount of money borrowed went up, so did the interest that needed to paid on it. And, so did the repayments. The fiscal deficit for the year stood at Rs 5,24,539 crore. Hence, the ratio of debt servicing cost to the fiscal deficit shot up to 1.04.
For the current financial year, the total debt servicing cost has been estimated to be at Rs 6,43,301 crore. Interestingly, in the interim budget presented by P Chidambaram in February earlier this year, the number had stood at Rs 6,74,184 crore. How has the number come down by more than Rs 30,000 crore, that Mr Jaitley did not explain. The fiscal deficit for the year has been projected at Rs 5,31,177 crore. Hence, the ratio of the total debt servicing cost to the fiscal deficit is now at 1.21.
What does this ratio tell us? It tells us that the entire borrowing(and a part of the income) of the government of India is being used to repay past borrowing and to pay interest on it. In simple everyday terms it means that I am using one credit card to pay off what is due on another credit card.
In such a scenario, it becomes very difficult for the government to spend money on other important areas. It also explains to a large extent why Jaitley made so many allocations of just Rs 100 crore. If he had the money, he would have probably preferred a higher amount of allocation. Of course, Mr Jaitley cannot be blamed for this mess which he has inherited from the Congress led United Progressive Alliance (UPA) government.
So what is the way out of this financial hole? The revenue receipts of the government(i.e. the money that it earns through tax and non tax revenue) for the year 2007-2008 had stood at 10.2% of the GDP. For the year, 2014-2015, the revenue receipts are at 9.2% of the GDP.
What this tells us clearly is that the revenue receipts of the government have come down and need to go up. How can that be done? The Modi government has been gung ho about getting the black money of Indians stashed abroad back to India. But what about all the black money that is there in the country? Wouldn’t that be easier to recover? While the intention to get back all this black money from abroad is certainly noble, how practical is it? Also, if the idea is to recover black money then why discriminate between those who have managed to transfer the money abroad and those who haven’t.
The Modi government can borrow an idea or two from what happened in Greece. In order to recover black money, the Greek government used Google Earth to track those who have swimming pools and then cross indexed their address with the amount of tax they are paying. Ideas along similar lines which use information technology extensively in order to identify people who are not paying the correct amount of income tax, need to be come up with.
In the budget speech made in February 2013, the then finance minister P Chidambaram had estimated that India had only 42,800 people with a taxable income of Rs 1 crore or more. What this clearly tells us is that a lot of people are not paying income tax.
In a country where 27,000 luxury cars are sold every year, the number of individuals with a taxable income of Rs 1 crore has to be more than 42,800. These individuals, who include property dealers, doctors, chartered accountants etc., need to be made to pay their fair share of income tax.
Of course, any such move will not immediately lead to results. The way to do is to execute a few pilot projects in different parts of the country and identify the big defaulters and get them to pay the income tax. This should be extensively publicized as well, so as t ensure that other similar people start paying the right amount of income tax.

The piece originally appeared in The Asian Age/Deccan Chronicle dated July 11, 2014 under a different headline.

(Vivek Kaul is the author of Easy Money: Evolution of the Global Financial System to the Great Bubble Burst. He can be reached at [email protected]) 

Question after Cyprus: Will govts loot depositors again?

A woman walks out of a branch of Laiki Bank in Nicosia
Vivek Kaul 
So why is the world worried about the Cyprus? A country of less than a million people, which accounts for just 0.2% of the euro zone economy. Euro Zone is a term used in reference to the seventeen countries that have adopted the euro as their currency.
The answer lies in the fact that what is happening in Cyprus might just play itself out in other parts of continental Europe, sooner rather than later. Allow me to explain.
Cyprus has been given a bailout amounting to € 10 billion (or around $13billion) by the International Monetary Fund and the European Union. As The New York Times reports “The money is supposed to help the country cope with the severe recession by financing government programs and refinancing debt held by private investors.”
Hence, a part of the bailout money will be used to repay government debt that is maturing. Governments all over the world typically spend more than they earn. The difference is made up for by borrowing. The Cyprian government has been no different on this account. An estimate made by Satyajit Das, a derivatives expert and the author of Extreme Money, in a note titled The Cyprus File suggests that the country might require around €7-8billion “for general government operations including debt servicing”.
But there is a twist in this tale. In return for the bailout IMF and the European Union want Cyprus to make its share of sacrifice as well. The Popular Bank of Cyprus (better known as the Laiki Bank), the second largest bank in the country, will shut down operations. Deposits of up to € 100,000 will be protected. These deposits will be shifted to the Bank of Cyprus, the largest bank in the country.
Deposits greater than € 100,000 will be frozen, seized by the government and used to partly pay for the deal. This move is expected to generate €4.2 billion. The remaining money is expected to come from privatisation and tax increases.
As The Huffington Post writes “The country of about 800,000 people has a banking sector eight times larger than its gross domestic product, with nearly a third of the roughly 68 billion euros in the country’s banks believed to be held by Russians.” Hence, it is widely believed that most deposits of greater than € 100,000 in Cyprian banks are held by Russians. And the move to seize these deposits thus cannot impact the local population.
This move is line with the German belief that any bailout money shouldn’t be rescuing the Russians, who are not a part of the European Union. “Germany wants to prevent any bailout fund flowing to Russian depositors, such as oligarchs or organised criminals who have used Cypriot banks to launder money. Carsten Schneider, a SPD politician, spoke gleefully about burning “Russian black money,”” writes Das.
It need not be said that this move will have a big impact on the Cyprian economy given that the country has evolved into an offshore banking centre over the years. The move to seize deposits will keep foreign money way from Cyprus and thus impact incomes as well as jobs.
The New York Times DealBook writes “Exotix, the brokerage firm, is predicting a 10 percent slump in gross domestic product this year followed by 8 percent next year and a total 23 percent decline before nadir is reached. Using Okun’s Law, which translates every one percentage point fall in G.D.P. (gross domestic product) to half a percentage point increase in unemployment, such a depression would push the unemployment rate up 11.5 percentage points, taking it to about 26 percent.”
But then that is not something that the world at large is worried about. The world at large is worried about the fact “what if”what has happened in Cyprus starts to happen in other parts of Europe?
The modus operandi being resorted to in Cyprus can be termed as an extreme form of financial repression. Russell Napier, a consultant with CLSA, defines this term as “There is a thing called financial repression which is effectively forcing people to lend money to the…government.” In case of Cyprus the government has simply decided to seize the money from the depositors in order to fund itself, albeit under outside pressure. 
The question is will this become a model for other parts of the European Union where banks and governments are in trouble. Take the case of Spain, a country which forms 12% of the total GDP of the European Union. Loans given to real estate developers and construction companies by Spanish banks amount to nearly $700 billion, or nearly 50 percent of the Spain’s current GDP of nearly $1.4 trillion. With homes lying unsold developers are in no position to repay. Spain built nearly 30 percent of all the homes in the EU since 2000. The country has as many unsold homes as the United States of America which is many times bigger than Spain.
And Spain’s biggest three banks have assets worth $2.7trillion, which is two times Spain’s GDP. Estimates suggest that troubled Spanish banks are supposed to require anywhere between €75 billion and €100 billion to continue operating. This is many times the size of the crisis in Cyprus which is currently being dealt with.
The fear is “what if” a Cyprus like plan is implemented in Spain, or other countries in Europe, like Greece, Portugal, Ireland or Italy, for that matter, where both governments as well as banks are in trouble. “For Spain, Italy and other troubled euro zone countries, Cyprus is an unnerving example. Individuals and businesses in those countries will probably split up their savings into smaller accounts or move some of their money to another country. If a lot of depositors withdraw cash from the weakest banks in those countries, Europe could have another crisis on its hands,” The New York Times points out.
Given this there can be several repercussions in the future. “The Cyprus package highlights the increasing reluctance of countries like Germany, Finland and the Netherlands to support weaker Euro-Zone members,” writes Das. The German public has never been in great favour of bailing out the weaker countries. But their politicians have been going against this till now simply because they did not want to be seen responsible for the failure of the euro as a currency. Hence, they have cleared bailout packages for countries like Ireland, Greece etc in the past. Nevertheless that may not continue to happen given that Parliamentary elections are due in September later this year. So deposit holders in other countries which are likely to get bailout packages in the future maybe asked to share a part of the burden or even fully finance themselves.
This becomes clear with the statement made by Jeroen Dijsselbloem, the Dutch finance minister who heads the Eurogroup of euro-zone finance ministers “when failing banks need rescuing, euro-zone officials would turn to the bank’s shareholders, bondholders and uninsured depositors to contribute to their recapitalization.”
“He also said that Cyprus was a template for handling the region’s other debt-strapped countries,” reports Reuters. In the Euro Zone deposits above €100,000 are uninsured.
Given this likely possibility, even a hint of financial trouble will lead to people withdrawing their deposits. As Steve Forbes writes in The Forbes “After this, all it will take is just a hint of a financial crisis to send Spaniards, Italians, the French and others scurrying to ATMs and banks to pull out their cash.” Even the most well capitalised bank cannot hold onto a sustained bank run beyond a point.
It could also mean that people would look at parking their money outside the banking system.
“Even in the absence of a disaster individuals and companies will be looking to park at least a portion of their money outside the banking system,” writes Forbes. Does that imply more money flowing into gold, or simply more money under the pillow? That time will tell.
Also this could lead to more rescues and further bailouts in the days to come. As Das writes “If depositors withdraw funds in significant size and capital flight accelerates, then the European Central Bank, national central banks and governments will have intervene, funding affected banks and potentially restricting withdrawals, electronic funds transfers and imposing cross-border capital controls.” And this can’t be a good sign for the world economy.
The question being asked in Cyprus as The Forbes magazine puts it is “if something goes wrong again, what’s stopping the government from dipping back into their deposits?” To deal with this government has closed the banks until Thursday morning, in order to stop people from withdrawing money. Also the two largest banks in the country, the Bank of Cyprus and the Laiki Bank have imposed a daily withdrawal limit of €100 (or $130).
It will be interesting to see how the situation plays out once the banks open. Will depositors make a run for their deposits? Or will they continue to keep their money in banks? That might very well decide how the rest of the Europe behaves in the days to come.
Watch this space.
This article originally appeared on www.firstpost.com on March 26, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)

By 2015, gold price will average significantly below $1,200 per ounce


Gold, the yellow metal, has been touching new highs in India. But the international price in dollars has been largely flat since the beginning of this year. Nikos Kavalis, Strategist in the Commodity Research Team of RBS feels “By 2015, we expect the gold price will average significantly below its current levels, at $1,200/oz. As the road-map to more normal macroeconomic conditions is laid, we believe that more attractive opportunities will emerge for investors and, eventually, higher interest rates will also reduce gold’s appeal.”
In this interview he speaks to Vivek Kaul.
The price of gold has been largely flat in dollar terms since the beginning of the year. Why is that?
For most of last year, gold behaved like a “safe haven” asset and was negatively correlated with risk. For example, it rallied by 28% from end-June to its all-time-high of $1,920/oz in early September, whereas the S&P500 fell by around 15% over the same period. Aft/er the sharp September correction, when gold dropped to a $1,600-1,650/oz range (per ounce, where one ounce equals 31.1grams), the story changed dramatically. Since then, gold has been trading in line with risk.
Can you explain that further?
2012 so far can be divided in two periods. The first period was the euphoria of the first two months of the year. A series of good economic data and hopes that the worst of the Eurozone crisis was behind us, pushed investors to risky assets. This helped gold, which was also boosted by a weakening US dollar at the time – gold has traditionally been negatively correlated with the US currency. By late February, gold had rallied to $1,790/oz, from around $1,560 at the start of the year. The period since the end of February has been the mirror image of the first two months. The first hit for gold came after Ben Bernanke’s speech at end-February, which hurt market expectations of QE3. Renewed concerns about the Eurozone crisis, poor economic data out of Europe and concerns that China’s growth is slowing boosted risk aversion over the following few weeks. Greece’s election added fuel to the fire and intensified fears of a break-up of the Eurozone. Gold trended downwards and by the end of May its price had virtually erased all the previous gains, returning more or less where it started the year. The price rebounded somewhat in early June, but remains far below the late-February high.
But it’s been going up in terms of rupees…”
Since its peak in September, the gold price has declined by 15%, in dollar terms. In rupee terms, and here I am looking at the nearest gold futures contract on the MCX, the price has recently made new highs! The story here is one of currency depreciation. As you know, the Indian rupee has been under pressure, partly because of fundamental reasons and partly due to the wider “risk off” environment hitting emerging markets currencies. It has depreciated by 5% against the US dollar since the beginning of the year and by more than 27% since the summer of 2011. This has boosted the Indian rupee denominated gold price. The rise in the rupee-denominated gold price has hurt Indian demand. High inflation eating into disposable incomes of local consumers has not helped either. This is evident in the World Gold Council data, showing weak jewellery and bar investment demand in the country, both in the fourth quarter of 2011 and the first three months of 2012. You no doubt will have also seen the numerous anecdotal reports that suggest demand has remained weak over the course of the second quarter.
How do you see the performance of gold in dollar terms during the course of the year?
I am moderately bullish towards gold for the rest of 2012. I think that the current uncertain macroeconomic environment still provides good reasons to own it, particularly against the backdrop of negative real interest rates. Moreover, we at RBS commodity research expect that the wider commodities sector will move upwards later in the year. We expect Chinese commodity demand to accelerate and I think that the latest interest rate cut and other steps taken by Chinese authorities towards a more accommodative stance will help in this. As risk appetite grows, flows into the space should also emerge. We believe that all this will benefit gold. Specific to the gold market, continued central bank buying should also help gold, both directly, by taking metal out of the market, and indirectly, by boosting investor sentiment. Lack of producer hedging and limited growth in scrap supply, are other positive factors.
Any target?
Finally, I want to note that at the moment speculator positioning in gold is very light. Look at the CFTC data on net positions in Comex futures for example – the net investor long is at the lowest since December 2008 and short positions are significant. When sentiment changes, I think this situation will be reversed and therefore believe there is some very good upside to be had. Our projections see gold average at $1,800/oz in the fourth quarter of this year.
What about the performance in terms of rupees?
We have a team of Emerging Markets economists at RBS and their outlook for the Indian rupee is cautious, owing to the imbalances (fiscal & current account) that weigh on the currency. The recent reduction in the petrol subsidy and the possibility for further fuel subsidy cuts are all steps in the right direction and some better news in Europe could also help, but our economists cannot see a material appreciation any time soon. Based on this and our forecast for a higher dollar-denominated price, we expect the rupee price to also rise in 2012.
What is the scene on the investment demand for gold?
There are a few different “segments” of gold investment and activity in them has varied. Investment in physical gold continues, although at a slower pace than last year. You still have the risk-averse retail players buying bars and coins in Europe and North America and of course the Indian and Chinese demand. We are seeing a lot less large scale metal account buying than in 2011 and before, but on the positive side, we have also not really much selling from these positions. We had some good inflows into gold ETFs earlier in the year, but these were in large part offset during the recent liquidations. Finally, as I mentioned earlier, positioning in Comex futures is very low and has declined year-to-date. Our outlook for investment demand in gold is positive and this assumption is an essential part of our bullish outlook for the price of the yellow metal. We think that, for reasons discussed earlier, investor appetite for gold will continue and actually grow later in the year. A very important driver for this growth will likely rising speculative investment in gold futures. These guys have actually been net dis-investors in 2012-to-date and many of them are now short gold (based on CFTC data).
Quantitative easing carried out by countries all over the world was one reason for the bull market in gold. Is that still a reason? I think that the expectation of QE3 in the US has been a very important driver of gold investment in the past. This was illustrated by the sharp correction following Ben Bernanke’s statement in late February that dampened expectations of further quantitative easing. Recent developments continue to suggest that QE3 is very much in gold investors’ minds. For example, look at the early-June rally (from ~$1,550/oz to ~$1,640/oz); it came after the poor US payrolls data on 1st June and dovish comments by Federal Reserve officials, which rekindled QE3 expectations. Similarly, the sharp correction that followed was triggered by Ben Bernanke’s latest testimony, which, again, lacked any clear indication that QE3 is on the way.
What are the chances of QE III happening, and that in turn pushing up the price of gold?
Our US economists ascribe better than even (60%) odds of Federal Reserve action, but think that an extension of “Operation Twist” is more likely than outright QE3. Having said this, if QE3 were to materialise, I think that gold would clearly benefit, for a number of reasons: the risk-on trade that would follow; the negative impact on the US dollar; and rising inflationary expectations (perhaps to a lesser extent now than in the past).
What can be the newer reasons for a bull market in gold?
As I mentioned earlier, we are only modestly bullish on gold, for the reasons I explained earlier. Moreover, our projections see the end of the gold bull market is in sight and we see a downtrend emerge from next year onwards. By 2015, we expect the gold price will average significantly below its current levels, at $1,200/oz. As the road-map to more normal macroeconomic conditions is laid, we believe that more attractive opportunities will emerge for investors and, eventually, higher interest rates will also reduce gold’s appeal.
If a country like Greece were to decide to leave the euro zone, do you see that having any impact on the price of gold?
Absolutely. I think the immediate reaction would be for gold to fall sharply, as investors sell all risky assets and there is a flight to cash. Further down the line, “after the dust settles”, I would expect that such an event would re-ignite safe haven buying of gold and as such drive the price higher.
What can pull down the price of gold?
I think the biggest headwind for gold at the moment is the strength of the US dollar. If the US currency continues to strengthen, gold will remain under pressure. Further into the future, there are a number of potential factors which we indeed expect will push gold down, such as flows into other asset classes and, eventually, higher interest rates.
Do you see more central banks buying gold in the time to come?
Yes, we expect central banks will continue to be net buyers of gold and that purchases will amount to 400 tonnes overall in 2012. As I mentioned earlier, we think that this is supportive for the gold price both directly, as these purchases take bullion out of the market, and indirectly, as central bank buying confirms gold’s status as a key reserve asset and boosts investor sentiment towards the metal.
What sort of retail consumption of gold does China have?
Chinese demand for high-carat gold jewellery and for investment products is huge and in 2011 was the second largest, after India. Chinese jewellery demand amounted to nearly 500 tonnes and bar investment to 250 tonnes last year. Importantly, it is a market with potential for further growth and I would not be surprised if in 2012 Chinese demand surpassed India, particularly given the recent weakness of demand in the latter.
There is a lot of speculation about how the Chinese central bank is quietly buying up gold. How true is that?
In 2009 China did publish revisions to its official gold reserves which suggested it had been buying and there indeed is much speculation that this continues. In April, net imports of 67 tonnes were one of the highest figures on record and twice the average of the previous three months. As I do not believe there was a similar increase in jewellery and investment demand, this does suggest more gold entered the country than was consumed privately and one possible explanation for this could be official sector buying, although it is also possible that local commercial banks were building inventory. Ultimately, I can only comment with certainty on published information and, as you know, there is no data or announcements confirming Chinese official sector purchases of gold have taken place recently.
(The interview originally appeared in the Daily News and Analysis (DNA) on June 18,2012)
(Interviewer Kaul is a writer and can be reached at [email protected])

If PIIGS have to fly, they will need to exit the euro


Vivek Kaul

I’ve long said that capitalism without bankruptcy is like Christianity without hell. – Frank Borman
If you have been following the business newspapers lately, you would have probably come to the conclusion by now that a break-up of the euro will lead to a huge catastrophe in Europe as well as the rest of the world.
Yes, there will be problems. But the world will be a much better place if the countries like Portugal, Ireland, Italy, Greece and Spain opt out of the euro. To know why read on.
How it all started
The European Coal and Steel Community was an economic organisation formed by six European nations in 1958. This gradually evolved into the European Union (EU) which was established by the Maastricht Treaty in 1993. The EU introduced the euro on 1 January 1999. On this day, 11 member countries of the EU started using euro as their currency. Before the euro came into being the German currency deutschemark used to be the premier currency of Europe. The euro inherited the strength of the deutschemark. The world looked at the euro as the new deutschemark.
The move to euro benefitted countries such as Portugal, Italy , Ireland , Greece and Spain (together now known as the PIIGS). Before these countries started to use euro as a currency, they had to borrow money at interest rates much higher than the rates at which a country like Germany borrowed. When these countries started to use the Euro they could borrow money at interest rates close to that of Germany, which was economically the best managed country in the EU.
Easy money and the borrowing binge
With interest rates being low, the PIIGS countries as well as their citizens went on a borrowing binge. Greece took the lead among these countries. The Greek politicians launched a large social spending programme which subsidised most of the key public services. In fact a few years back, the finance minister of Greece claimed that he could save more money shutting down the Railways and driving people around in taxies. In 2009, Greece railways revenues were at around $250 million and the losses of around $1.36billion. All this extravagance has was financed through borrowing.
Greece was not the only country indulging in this extravagance, other PIIGS nations had also joined in. Also other than the low interest rates, the inflation in the PIIGS countries was higher than the rate of interest being charged on loans.
As John Mauldin and Jonathan Tepper write in Endgame – The End of the Debt Supercycle and How it Changes Everything “In plain English, that means that if the borrowing rate is 3 percent while inflation is 4 percent you’re effectively borrowing for 1 percent less than inflation. You’re being paid to borrow. And borrow they did. And the European peripheral countries (PIIGS) racked up enormous amount of debt in euros.”
This was because loans were being made by German, French and British banks who were able to raise deposits at much lower interest rates in their respective countries and offer it at a slightly higher rate in the PIIGS countries.
The citizens of Spain borrowed big time to speculate in real estate. All this building was financed through the bank lending. Loans to developers and construction companies amounted to nearly $700billion or nearly 50% of the Spain’s current GDP of nearly $1.4trillion. Currently Spain has as many homes unsold as the United States (US), though the US is six times bigger than Spain. With homes lying unsold developers are in no position to repay. And Spain’s biggest three banks have assets worth $2.7trillion or that is double Spain’s GDP, are in trouble.
The accumulated debt in Spain is largely in the private sector. On the other hand the Italian government debt stands at $2.6trillion, the fourth largest in the world. The debt works out to around 125% of the Italian gross domestic product (GDP). As a recent report titled A Primer on Euro Breakup brought out by Variant Perception points out “Greece and Italy have a high government debt level. Spain and Ireland have very large private sector debt levels. Portugal has a very high public and private debt level.” Debt as we all know needs to be repaid, and that’s where all the problems are. But before we come to that we need to understand the German role in the entire crisis.
The German connection
Germany became the largest exporter in the world on the strength of the euro. Before euro became a common currency across Europe, German exports stood at around €487billion in 1995. In 1999, the first year of euro being used as a currency the exports were at €469billion euros. Next year they increased to €548billion euros. And now they stand at more than a trillion euros. Germany is the biggest exporter in the world even bigger than China.
With euro as a common currency took away the cost of dealing with multiple currencies and thus helped Germany expand its exports to its European neighbours big time. Also with a common currency at play exchange rate fluctuations which play an important part in the export game no longer mattered and what really mattered was the cost of production.
Germany was more productive than the other members of the European Union given it an edge when it came to exports. As Mauldin and Tepper point out “since the beginning of the Euro in 1999, Germany has become some 30 per cent more productive than Greece. Very roughly, that means it costs 30 per cent more to produce the same amount of goods in Greece than in Germany. That is why Greece imports $64 billion and exports only $21 billion.”
German banks also had a role to play in helping increasing German exports. They were more than happy to lend to citizens, governments and firms in PIIGS countries. So the way it worked was that German banks lent to other countries in Europe at low interest rates, and they in turn bought German goods and services which are extremely competitively priced as well as of good quality. Hence German exports went up.
The PIIGS countries owe a lot of money to German banks. Greece needs to repay $45billion. Spain owes around $238billion to Germany. Italy, Ireland and Portugal owe $190billion, $184 billion and $47billion respectively.
Inability to repay
When the going is good and everything is looking good there is a tendency to borrow more than one has the ability to repay, in the hope that things will continue to remain good in the days to come. But good times do not last forever and when that happens the borrower is in no position to repay the loan taken on.
Greece tops this list. It has been rescued several times and the private foreign creditors have already taken a haircut on their debt i.e. they have agreed to the Greek government not returning the full amount of the loan. Between Spain and Italy around €1.5trillion of money needs to be repaid over the next three years. The countries are in no position to repay the debt. It has to be financed by taking on more debt. It remains to be seen whether investors remain ready to continue lending to these countries.
In the past countries which have come under such heavy debt have done one of the following things: a) default on the debt b) inflate the debt c) devalue the currency.
Scores of countries in the past have defaulted on their debt when they have been unable to repay it. A very famous example is that of Russia in 1998. It defaulted both on its national as well as international debt. Oil prices had crashed to $11 per barrel. Oil revenue was the premier source of income for the Russian government and once that fell, there was no way it could continue to repay its debts.
If the country’s debt is in its own currency, all the government needs to do is to print more of it in order to repay it. This has happened time and again over the years all over the world. Every leading developing and developed country has resorted to this at some point of time. The third option is to devalue the currency and export one’s way out of trouble.
Exit the euro
The PIIGS countries cannot print euros and repay their debt. Since they are in a common currency area there is no way that they can devalue the euro. A straight default is ruled out because German and French banks will face huge losses, and Germany being driving force behind the euro, wouldn’t allow that to happen.
So what option do the PIIGS then have? One option that they have is to exit the euro, redominate the foreign debt in their own currency, devalue their currency and hope to export their way out of trouble.
A lot has been written about how you can only enter the euro and not exit it. The situation as is oft repeated is like a line from an old Eagles number Hotel California “You can checkout any time you like / But you can never leave.” A case has also been made as to how it would be disaster for any country leaving the euro.
Let’s try and understand why the situation will not be as bad as it is made out to be. A report titled A Primer on Euro Breakup, about which I briefly talked about a little earlier explains this situation very well.
The first thing to do as per the report is to exit the euro by surprise over a weekend when the markets are closed. Many countries have stopped using one currency and started using another currency in the past. A good example was the division of India and Pakistan. As the report points out “ One example of a currency breakup that went smoothly despite major civil unrest is the separation of India and Pakistan in August 1947. Before the partition of India, the two countries agreed that the Reserve Bank of India (the RBI) would act as the central bank of Pakistan until September 1948….Indian notes overprinted with the inscription “Government of Pakistan” were legal tender. At the end of the transition period, the Government of Pakistan exchanged the non-overprinted Indian notes circulating in Pakistan at par and returned them to India in order to de-monetize them. The overprinted notes would become the liabilities of Pakistan.”
Any country looking to exit Euro could work in a similar way. It will need to have provisions in place to overprint euros and deem them to be their own currency. Then it will have quickly issue new currency and exchange the overprinted notes for the new currency. Capital controls will also have to be put in place for sometime so that the currency does not leave the country.
Despite the fact that there are no exit provisions from the euro, after the creation of the European Central Bank, the individual central banks of countries were not disbanded. And they are still around. “All the euro countries still have fully functioning national central banks, which should greatly facilitate the distribution of bank notes, monetary policy, management of currency reserves, exchange-rate policy, foreign currency exchange, and payment. The mechanics for each central bank remain firmly in place,” the report points out.
Technical default
By applying the legal principle of lex monetae – that a country determines its own currency, the PIIGS countries can re-dominate their debt which they had issued under their local laws into the new currency. As the report points out “Countries may use the principle of lex monetae without problems if the debt contracts were contracted in its territory or under its law. But private and public bonds issued in foreign countries would be ruled on by foreign courts, who would most likely decide that repayment must be in euros.”
The good thing is that in case of Greece, Spain and Portugal, nearly 90% of the bonds issued are governed by local law. While redomination of currencies in their own currencies will legally not be a default, it will be categorized as a default by ratings agencies and international bodies.
Another problem that has brought out is the possibility of bank runs if countries leave the euro. Well bank runs are already happening even when countries are on the euro. (The entire report can be accessed here: http://www.johnmauldin.com/images/uploads/pdf/mwo022712.pdf).
The PIIGS coutnries can devalue their new currencies make themselves export competitive and hope to export their way out of trouble. This is precisely what the countries of South East Asia after the financial crisis of the late 1990s. As the report points out “history shows that following defaults and devaluations, countries experienced two to four quarters of economic contraction, but then real GDP grew at a high, sustained pace for years. The best way to promote growth in the periphery, then, is to exit the euro, default and devalue.”
The German export machinery
A breakup of the euro will create problems for the highly competitive export sector that Germany has built up. The PIIGS countries would start competiting with it when it came to exports. Given this they will not let the euro break so easily. As the bestselling author Michael Lewis said in an interview sometime back “German leadership does not want to be labeled as the people who destroyed the euro.”
But as Lewis also said “If you put Germany together with Greece in a single currency, it’s a little like watching an Olympic sprinter and a fat old man running a three-legged race. The Greeks will never be as productive as the Germans, and the Germans will never be as unproductive as the Greeks.” So it’s best for PIIGS countries to exit the euro.
In the end let me quote my favourite economist John Kenneth Galbraith as a disclaimer: “The only function of economic forecasting is to make astrology look respectable.”
(The article originally appeared at www.firstpost.com on May 19,2012. http://www.firstpost.com/world/if-piigs-have-to-fly-they-will-need-to-exit-the-euro-314589.html)
(Vivek Kaul is a writer and can be reached at [email protected])