Mark Buchanan

Yun hota to kya hota?

hitlerVivek Kaul

In August 2014, the world marked the hundredth anniversary of the outbreak of the First World War. Over the years, a lot of analysis has happened on why the First World War happened. But what most historians do not talk about in their elaborate theories is that the War might have started just because a car happened to take a wrong turn.
At around 11 AM on June 28, 1914, a chauffeur of an automobile carrying two passengers in Sarajevo, happened to make a wrong turn. The car wasn’t supposed to make this turn and leave the main street. But due to the mistake of the chauffeur it ended up in a narrow lane and stopped right in front of a Gavrilo Princip, a 19-year-old student. But that wasn’t Princip’s only identity. He was also a member of the Serbian terrorist organization Black Hand.
Princip couldn’t believe his luck. He drew out his pistol and fired twice killing the two passengers in the car. Princip had recognized them and gone ahead and pulled the trigger. They were Archduke Franz Ferdinand and his wife Sophie of the Austro-Hungarian Empire. Earlier in the day, Princip and his friends who “wanted to promote the cause of a greater Serbia,” had unsuccessfully tried toassassinate Archduke Ferdinand by lobbing a grenade at him. The attempt had gone wrong and Princip had escaped and walked into the narrow lane to have a light snack. And there he ran into Archduke Ferdinand.
The assassination led to a series of events in a politically fragile Europe and started what was first known as the Great War and later came to be known as the First World War. As Mark Buchanan writes in Ubiquity “The First World War is the archetypal example of an unanticipated upheaval in world history, the war sparked by ‘the most famous wrong turn in history,’ and one may optimistically suppose that such an exceptional case is never likely to be repeated.
Historians over the years have analysed a number of reasons that caused the First World War. As Ed Smith writes in Luck—A Fresh Look At Fortune “In this version of history, the assassination merely lit the fuse, but the tinderbox would have surely exploded anyway.”
Would that have been the case? “Perhaps. But had Princip not killed Ferdinand in Sarajevo, the outbreak of the First World War would have at the very least been delayed. A war delayed is a war averted.”
Hence, it is a very interesting “counterfactual” to consider as to “what if” the Archduke’s chauffeur had not made that wrong turn that he did in June 1918. Possibly, the First World War would have never happened and the world would have turned out to be a much safer place. As Buchanan writes “When the First World War ended five years later, 10 million lay dead. Europe fell into an uncomfortable quiet that lasted twenty years, and then the Second World War claimed another 30 million. In just three decades, the world had suffered two engulfing cataclysms. Why? Was it all due to the chauffeur’s mistake?”
A few years after the chauffeur’s wrong turn, on December 13, 1931, an English politician “perhaps forgetting that American cars drive on the right-hand side of the road” met with an accident. The car was travelling at the speed of 35 miles per hour and could have easily killed him. But he survived and even wrote a 2400 word article detailing his “near-death” experience and made £600 in the process. The politician was Winston Churchill, who would successfully defend the United Kingdom against Germany during the course of the Second World War.
The question to ask if what would have happened if Churchill had died on that day. “There would have been no Churchill…to take over from Neville Chamberlain, no Churchill to galvanize Britain as it stood alone in 1940. What then? A successful German invasion…an occupied Nazi Britain…an isolationist America staying out of the War…And the whole history of the second half of the twentieth century would have been radically different,” writes Smith.
All this because there would have been no Winston Churchill to take on Adolf Hitler. But what if there had been no Adolf Hitler? A few months before Churchill was knocked down in New York, a young Englishman called John Scott-Ellis was spending sometime in Munich, Germany so that he could learn a new language.
As Smith points out “After a week in his new city, on a clear sunny day, Scott-Ellis bought his gleaming red Fiat and gave it a test drive around the streets of Munich…But a pedestrian crossed the road without looking left – just as Chruchill would do on Fifth Avenue[New York] four months later. ‘He walked off the pavement, more or less straight into my car,’ Scott-Ellis recalled.”
The pedestrian did not seriously injured himself. Three years later while waiting for an opera to start Scott-Eliss ran into that man again and introduced himself. He asked the man, whether he remembered about the accident, the man did.
Scott-Ellis did well in life and “became one of the great British racehorse owners”. As Smith writes “He often told the story of that crash in Munich in 1931: ‘For a few seconds, perhaps, I held the history of Europe in my rather clumsy hands. He was only shaken up, but had I killed him, it would have changed the history of the world.”
Scott-Ellis had run his car into Adolf Hitler.
History is influenced by fairly random small events, which have an overbearing impact on it. But these small random events do not make for ‘sexy’ theories that historians and analysts like to come up with and in the process these events get lost from public memory.
As Buchanan writes about all the history that has been written around what caused the First World War: “On the matter of the causes and origins of the First World War, of course, almost nothing has been left unsaid…The number of specific causes proposed is not so much smaller than the number of historians who have considered the issue, and even today major new works on the topic appear frequently. It is worth keeping in mind, of course, that all this historical ‘explanation’ has arrived well after the fact.”
To conclude, it is worth remembering, what the great Mirza Ghalib, who had a couplet for almost everything in life, had to say on this: “hui muddat ke ghalib mar gaya par yaad aata hai wo har ek baat par kehna ke yun hota to kya hota.”

The column originally appeared in Mutual Fund Insight magazine dated Oct 2014

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

Why most economists did not see the rupee crash coming

rupeeVivek Kaul
Economists and analysts have turned bearish on the future of the rupee, over the last couple of months. But very few of them predicted the crash of the rupee. Among the few who did were,SS Tarapore, a former deputy governor of the Reserve Bank of India, and Rajeev Malik of CLSA.
Tarapore felt that the rupee should be closer to 70 to a dollar. As he pointed out in a column published in The Hindu Business Line on January 24, 2013 “With the inflation rate persistently above that in the major industrial countries, the rupee is clearly overvalued. Adjusting for inflation rate differentials, the present nominal dollar-rupee rate of around $1 = Rs 54 should be closer to $1 = Rs 70. But our macho spirits want an appreciation of the rupee which goes against fundamentals.”
Rajeev Malik of CLSA said something along similar lines in a column published on Firstpost on January 31, 2013. “The worsening current account deficit is partly signalling that the rupee is overvalued. But the RBI and everyone else are missing that clue,” he wrote. The current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances
What Tarapore and Malik said towards the end of January turned out to be true towards the end of May. The rupee was overvalued and has depreciated 20% against the dollar since then. The question is why did most economists and analysts not see the rupee crash coming, when there was enough evidence available pointing to the same?
One possible explanation lies in what Nassim Nicholas Taleb calls the turkey problem (something I have talked about in a slightly different context earlier). As Taleb writes in his latest book Anti Fragile “A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys “with increased statistical confidence.” The butcher will keep feeding the turkey until a few days before thanksgiving. Then comes that day when it is really not a very good idea to be a turkey. So, with the butcher surprising it, the turkey will have a revision of belief—right when its confidence in the statement that the butcher loves turkeys is maximal … the key here is such a surprise will be a Black Swan event; but just for the turkey, not for the butcher.”
The Indian rupee moved in the range of 53.8-55.7 to a dollar between November 2012 and end of May 2013. This would have led the ‘economists’ to believe that the rupee would continue to remain stable against the dollar. The logic here was that rupee will be stable against the dollars in the days to come, because it had been stable against the dollar in the recent past.
While this is a possible explanation, there is a slight problem with it. It tends to assume that economists and analysts are a tad dumb, which they clearly are not. There is a little more to it. Economists and analysts essentially feel safe in a herd. As Adam Smith, the man referred to as the father of economics, once asserted, “Emulation is the most pervasive of human drives”.
An economist or an analyst may have figured out that the rupee would crash in the time to come, but he just wouldn’t know when. And given that he would be risking his reputation by suggesting the obvious. As John Maynard Keynes once wrote “Worldly wisdom teaches us that it’s better for reputation to fail conventionally than succeed unconventionally”.
An economist/analyst predicting the rupee crash at the beginning of the year would have been proven wrong for almost 6 months, till he was finally proven right. This is a precarious situation to be in, which economists/analysts like to avoid. Hence, they tend to go with what everyone else is predicting at a particular point of time.
Research has shown this very clearly. As Mark Buchanan writes in Forecast – What Physics, Meteorology and the Natural Sciences Can Teach Us About Economics “Financial analysts may claim to be weighing information independently when making forecasts of things like inflation…but a study in 2004 found that what analysts’ forecasts actually follow most closely is other analysts’ forecasts. There’s a strong herding behaviour that makes the analysts’ forecasts much closer to one another than they are to the actual outcomes.” And that explains to a large extent why most economists turned bearish on the rupee, after it crashed against the dollar. They were just following their herd.
There is another possible explanation for economists and analysts missing the rupee crash. As Dylan Grice, formerly an analyst with Societe Generale, and now the editor of the Edelweiss Journal, put it in a report titled What’s the point of the macro? dated June 15, 2010 “Perhaps a more important thought is that we’re simply not hardwired to see and act upon big moves that are predictable.”
A generation of economists has grown up studying and believing in the efficient market hypothesis. It basically states that financial markets are largely efficient,meaning that at any point of time they have taken into account all the information that is available. Hence, the markets are believed to be in a state of equilibrium and they move only once new information comes in. As Buchanan writes “the efficient market theory doesn’t just claim that information should move markets. It claims that only information moves markets. Prices should always remain close to their so called fundamental values – the realistic value based on accurate consideration of all information concerning the long-term prospects.”
What does this mean in the context of the rupee before it crashed? At 55 to a dollar it was rightly priced and had incorporated all the information from inflation to current account deficit, into its price. And given this, there was no chance of a crash or what economists and analysts like to call big outlier moves.
Benoit Mandlebrot, a mathematician who spent considerable time studying finance, distinguished between uncertainty that is mild and that which is wild. Dylan Grice explains these uncertainties through two different examples.
As he writes “Imagine taking 1000 men at random and calculating the sample’s average weight. Now suppose we add the heaviest man we can find to the sample. Even if he weighed 600kg – which would make him the heaviest man in the world – he’d hardly change the estimated average. If the sample average weight was similar to the American average of 86kg, the addition of the heaviest man in the world (probably the heaviest ever) would only increase the average to 86.5kg.”
This is mild uncertainty.
Then there is wild uncertainty, which Dylan Grice explains through the following example. “For example, suppose instead of taking the weight of our 1000 American men, we took their wealth. And now, instead of adding the heaviest man in the world we took one of the wealthiest, Bill Gates. Since he’d represent around 99.9% of all the wealth in the room he’d be massively distorting the measured average so profoundly that our estimates of the population’s mean and standard deviation would be meaningless…If weight was wildly distributed, a person would have to weight 30,000,000kg to have a similar effect,” writes Grice.
Financial markets are wildly random and not mildly random, like economists like to believe. This means that financial markets can have big crashes. But given the belief that economists have in the efficient market hypothesis, most of them can’t see any crash coming.
In fact, when it comes to worst case predictions it is best to remember a story that Howard Marks writes about in his book The Most Important Thing (and which Dylan Grice reproduced in his report titled Turning “Minimum Bullish” On Eurozone Equities dated September 8,2011). As Marks writes “We hear a lot about “worst case” projections, but they often turn out not to be negative enough. I tell my father’s story of the gambler who lost regularly. One day he heard about a race with only one horse in it, so he bet the rent money. Halfway around the track the horse jumped over the fence and ran away. Invariably things can get worse than people expect. Maybe “worse case” means “the worst we have seen in the past”. But it doesn’t mean things can’t be worse in the future.” 
Disclosure: The examples of SS Tarapore and Rajeev Malik were pointed out by the Firstpost editor R Jagannathan in an earlier piece. You can read it here)
The article originally appeared on www.firstpost.com on August 26, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Rupee at 64: It’s a Swadeshi crisis, not a foreign one

rupee
Vivek Kaul 
The government of India has tried to blame the recent depreciation of the rupee against the US dollar on everything but the state of the Indian economy. Rupee has fallen because Indians buy too much gold, we have often been told over the last few moths.
Rupee has fallen because foreign investors have been withdrawing money in response to the decision of the Federal Reserve of United States to go slow on money printing in the time to come, is another explanation which is often offered. While there is no denying that these factors have been responsible for the fall of the rupee, but the truth is a little more complicated than just that.
Mark Buchanan uses the term disequilibrium thinking in his new book Forecast – What Physics, Meteorology and the Natural Sciences Can Teach Us About Economics. As he writes “one of the key concepts of disequilibrium thinking is the notion of ‘metastability’ which explains how a system can seem stable, yet actually be highly unstable, much like the sulfrous coating on a match, ready to explode if it receives the right kind of spark. Inherently unstable and dangerous situations can persist untroubled for very long periods, yet also guarantee eventual disaster.”
The situation in India was precisely like that. The rupee was more or less stable against the dollar between November 2012 and end of May 2013. It moved in the range of Rs 53.5-Rs 55.5 to a dollar. This stability in no way meant that all was well with the Indian economy.
In a discussion yesterday on NDTV, Ruchir Sharma, Head of Emerging Markets Equity and Global Macro at Morgan Stanley Investment Management, provided a lot of data to show just that. In 2007, the current account deficit of India stood at $8 billion. In technical terms, the current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
The foreign exchange reserves of India in 2007 stood at $300 billion. So the foreign exchange reserves were 37.5 times the current account deficit. For 2013, the current account deficit is at $90 billion whereas the foreign exchange reserves are down to around $275 billion. So the foreign exchange reserves are now just three times the size of the current account deficit, in comparison to 37.5 times earlier.
Another worrying point is the import cover (foreign exchange reserves/monthly imports). It currently stands at 5.5 months, the lowest in 15 years. This is very low in comparison to other emerging markets (like China has 18 months of import cover, Brazil has 11 months).
Now what does this mean in simple English? It means that the demand for dollars has gone up much faster than their supply. And this did not happen overnight. It did not happen towards the end of May, when the rupee rapidly started losing value against the dollar. The situation has deteriorated over the last five to six years, while the government was busy doing other things.
Sharma gave out some other numbers as well. In 2007,the short term debt (or debt that needs to be repaid during the course of the year) stood at $80 billion. Currently it stands at around $170 billion. As and when this debt matures, it will have to repaid (unless its rolled over) and that would mean more demand for dollars and a greater pressure on the rupee. Given this, its not surprising that analysts are now predicting that the rupee soon touch 70 to a dollar.
What remains to be seen is whether companies which need to repay this debt are allowed to roll it over. The situation is very tricky given that 25% of Indian companies do not have sufficient cash flow to repay interest on their loans. The amount of loans to be repaid by top 10 Indian corporates has gone up from Rs 1000 billion in 2007 to Rs 6000 billion in 2013. This makes the Indian economy very vulnerable.
Politicians like to compare the current situation to 1991 and tell us that the current situation is not a repeat of 1991. In 1991, the import cover was down to less than a month. Currently it is around 5-6 months (depending on whose calculation you refer to). Hence, the situation is not as bad as 1991.
But the import cover is just one parameter that one can look at. The current account deficit in 1991, stood at 2.5% of the gross domestic product. Currently its around 4.8% of the GDP. Hence, the situation is much worse on this front than in 1991.
The government has tried to control the fall of the rupee against the dollar by making it difficult for Indian companies as well as individuals to take dollars abroad. But that was already happening. The amount of money Indian corporates invested abroad in 2008, stood at $21 billion. It has since come down to $7 billion. The amount of money taken abroad by individuals through legal channels remains minuscule.
The point is that the Indian economy has been extremely vulnerable for sometime, “much like the sulfrous coating on a match, ready to explode if it receives the right kind of spark.” It is just that where the spark will come from leading to explosion of the match, is hard to predict in advance.
As Buchnan puts it “the disequilibrium view….explains in simple terms why the moment of collapse is hard to predict: the arrival of the key triggering event is typically a matter of chance.” And this matter of chance in the Indian context came when Ben Bernanke, the Chairman of the Federal Reserve of United States, the American Central Bank, addressed the Joint Economic Committee of the American Congress ,on May 23, 2013.
As he said “if we see continued improvement and we have confidence that that is going to be sustained, then we could in — in the next few meetings — we could take a step down in our pace of purchases.”
Over the last few years, the Federal Reserve has been pumping money into the American financial system by printing money and using it to buy bonds. This ensures that there is no shortage of money in the system, which in turn ensures low interest rates. The hope is that at lower interest rates people will borrow and spend more, and this in turn will revive economic growth.
After nearly 5 years, some sort of economic growth has started to comeback in the United States. And given this, the expectation is that the Federal Reserve will start going slow on money printing in the months to come. This has pushed interest rates up in the United States making it more interesting for big international investors to invest their money in the United States than India.
This has led to them withdrawing money from India. Since the end of May nearly $10 billion of foreign money has been withdrawn from the Indian bond market. When these bonds are sold, foreign investors get paid in rupees. They need to convert these rupees into dollars, in order to repatriate their money abroad. This puts pressure on the rupee.
And this is how the decision of the Federal Reserve to go slow on money printing in the days to come has led to the fall of the rupee. This is the story that the government officials and ministers have been trying to sell to us.
But the point to remember is that the decision of the Federal Reserve of United States to go slow on money printing was just the ‘spark’ that was needed to explode the ‘sulfrous coating on the match’ that the Indian economy had become. The spark could have come from somewhere else and the ‘sulfrous coating on the match’ would have still exploded leading to a crash of the rupee. Also, it is important to remember that foreign investors have not abandoned India lock, stock and barrel. When it comes to the bond market they have pulled out money to the tune of $10 billion. But they are still largely invested in the equity market. Since late May around $2 billion has been pulled out of the Indian equity market by the foreign investors. This when they have more than $200 billion invested in it.
Ruchir Sharma’s panelist in the NDTV discussion referred to earlier was Arun Shourie. He called the current rupee crisis a swadeshi crisis. It is time that the government realised this as well because the first step in solving any problem is recognising that it exists.
The article was originally published on www.firstpost.com on August 21, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)