In a column published on March 24 I had explained why despite all the money printed by the central banks of the world over the last six and a half years, we haven’t seen much conventional inflation. The central banks have printed money (or rather created it digitally through a computer entry) and used it to buy government and private bonds
By buying bonds, central banks pumped the printed money into the financial system. This was done primarily to ensure that with so much money floating around, the interest rates would continue to remain low. At low interest rates people would borrow and spend. This would help businesses grow and in turn help the moribund economies of the developed countries.
But money printing should have led to inflation as a greater amount of money chased the same amount of goods and services. Nevertheless, inflation continues to remain very low in most of the developed world.
This, as I had explained, is primarily because of the fact that the world is in midst of a balance-sheet recession (a term coined by Japanese economist Richard Koo). Between 2000 and 2007, people in the developed world had taken on huge loans to buy homes in the hope that prices would continue to go up forever.
A recent report titled Debt and (not much) deleveraging brought out by the McKinsey Global Institute explores this point in great detail. As the report points out: “Between 2000 and 2007, household debt relative to income rose by 35 percentage points in the United States, reaching 125 percent of disposable income…In the United Kingdom, household debt rose by 51 percentage points, to 150 percent of income.” Other parts of the developed world also saw similar sort of increases in their household debt.
Much of this increase in household debt came from people taking on more and more home loans (or mortgage) to buy property. “In the United States, for example, household debt grew from just 16 percent of disposable income in 1945 to 125 percent at the peak in 2007, with mortgage debt accounting for 78 percent of the growth. Mortgage debt represents the majority of household debt growth in other countries as well. Our data show that mortgages now account for 74 percent of household debt in advanced economies,” the McKinsey report points out.
What is interesting is that this increase in home loans (or mortgage debt) in particular and overall household debt in general, was not accompanied by an increase in home-ownership rates. “In the United States, for instance, the rate of homeownership rose from 67.5 percent in 2000 to 69 percent at the peak of the market in early 2007, while household debt rose from 89 percent of disposable income to 125 percent. In the United Kingdom, the homeownership rate rose by 1.3 percentage points from 2001 to 2007, while the household debt ratio rose from 106 percent of income to 150 percent,” the McKinsey report points out.
As home loans were easily available at low rates of interest, more and more money was borrowed to buy homes. This pushed up home prices in most of the developed world. Between 2000 and 2007, home prices rose by 138 percent in Spain, 108 percent in Ireland, 98% in United Kingdom, 89%in Canada and 55% in the United States (on a slightly different note, real estate prices in India during the same period would have risen at a much faster rate. But we are talking about developed economies here where home-ownership rates are high and populations are stable or declining).
As home prices went up, this meant that the newer individuals wanting to buy homes had to take on a larger amount of home loan. This pushed up total household debt.
The correlation between rising home prices and increase in household debt to income ratio is very strong across countries. What also encouraged people to take on home loans was the fact that interest rates were very low, which meant that monthly EMIs required to pay off home loans were low as well. Hence, people could borrow much more than they would otherwise have.
Also, as home prices went up, people borrowed and bought homes not to live in them, but to just speculate, hoping that prices will continue to go up forever. A survey of home buyers carried out in Los Angeles in 2005, found that the prevailing belief was that prices would keep growing at the rate of 22 percent every year over the next 10 years. This meant that a house, which cost a million dollars in 2005, would cost around $7.3 million by 2015. So strong was the belief that home prices will continue to go up.
But that wasn’t to be. Once the bubble burst, housing prices crashed. This meant the asset (i.e., homes) people had bought by taking on loans had lost value, but the value of the loans continued to remain the same. Hence, people needed to repair their individual balance sheets by increasing savings and paying back debt.
Further, many of these loans had been issued at low interest rates. Once these interest rates started to go up, the EMIs also went up. As the McKinsey report points out: “In countries where many households have variable rate mortgages [home loans], such as the United Kingdom (and more recently Denmark), households are exposed to interest rate risk. When rates rise and monthly debt service charges are adjusted upward, some households may find they cannot afford their mortgages. This occurred in the United States prior to 2007, when households took out variable-rate mortgages with low “teaser rates,” but had trouble keeping up after a few years when the teaser rates expired.”
As EMIs went up and home prices crashed, more and more income was used to service the home loans. This had an impact on consumption. As the McKinsey report points out: “This dynamic is seen clearly across US states…A similar pattern can be seen across countries: the largest increases in household debt to income ratios occurred in Ireland (125 percentage points) and Spain (59 points), which also had the largest drops in consumption.”
As the accompanying table(from the McKinsey report) shows, households in many countries have been deleveraging since 2008, after the start of the financial crisis.
What this tells us clearly is that people are using more and more of their income to pay off their existing loans. Hence, even though central banks have ensured that low interest rates continue to prevail, people are no longer interested in borrowing and spending money. They are more interested in paying off their existing loans.
And that explains why all the money printing hasn’t led to conventional inflation though there has been a lot of asset price inflation. Investors have borrowed money at low interest rates from developed countries and invested them in financial markets all over the world, leading to stock markets rallying.
The column originally appeared on The Daily Reckoning on April 2, 2015
McKinsey
Rajat Gupta may never have got convicted in India
Vivek Kaul
Rajat Gupta will be spending two years in prison, which will be followed by one year of supervised release (The supervised release starts after a person is released from prison. After the release the individual goes through a period of supervision in the community. You can read the complete definition here). Gupta will also have to pay a fine of $5million.
Gupta, a former managing director of management consultancy McKinsey & Company, who happened to marry the only girl in his IIT Delhi batch, and a member of the boards of Goldman Sachs and Proctor and Gamble, had been accused of passing on sensitive board room information to hedge fund manager Raj Rajaratnam. The information leaked by Gupta turned out to be enormously profitable stock tips for Rajaratnam. Rajaratnam is currently serving 11 years in jail for securities fraud.
The Securities and Exchange Commission (the stock market regulator in the United States) had filed an administrative civil complaint on March 1, 2011, against Gupta for insider trading with Rajaratnam who ran the Galleon Group of hedge funds. The case from start to finish lasted for a period of around twenty months. The dispensation of justice was fast and quick and it did not take a life time as it does in India.
Take the case of Lalit Narayan Mishra who was the Cabinet Minister for Railways. On January 2, 1975, Mishra was in Samastipur to declare open the broad gauge railway line between Samstipur and Muzaffarpur. A bomb exploded and he was seriously injured. He died the next day.
The case against the accused is still on, thirty seven years later. Eight people were accused in the case. One has of them has since died. As Gurcharan Das writes in India Grows At Night–A Liberal Case for a Strong State “The case against the accused dragged on for thirty-seven years…Meanwhile, thirty one of the thirty-nine witnesses for the defence had died gravely prejudging the case…No less than twenty-two different judges had heard the case over the years. The trial was still going in 2012.”
And there are other cases in which justice is delivered after a generation has passed in the meanwhile. In 1992, four teams of government officials landed up in the adivasi village of Vachathi in search of the sandalwood smuggler Veerapan. On not finding him there the government officials accused the villagers of harbouring Veerapan. The officials took 18 teenage girls from the village into the forest where they were stripped and raped. 133 villagers were arrested and put in jail as well.
Justice was delivered only 19 years later. As Das writes “On the sweltering afternoon of 29 September 2011, principal district judge S Kumarguru began to hand out sentences. There was a hushed silence in the packed courtroom in Dharmapuri, Tamil Nadu. He began at 3.30pm but could not finish until 4.40pm because he had to read aloud punishments awarded to 215 government officials. Among those convicted were 126 forest officials, 84 policemen and five revenue officials. Seventeen were convicted of rape and they received prison sentence from seven to seventeen years; others received from one to three years on counts of torture, unlawful restraint, looting and misuse of office.” Fifty four accused had died in the meanwhile.
Since delivery of justice takes so long, frivolous cases are filed to cut short promising careers. S Nambi Narayanan’s case is a very good example of the same. Narayanan was a senior official in charge of the cryogenics division of the Indian Space Research Organisation. In 1994, he was accused of espionage. The Central Bureau of Investigation (CBI) concluded as early as 1996 that the entire case was a fabrication. The National Human Rights Commission ordered an interim compensation of Rs 10 lakh for Narayanan in 2001. The Kerala government got a stay against this order. The stay was finally vacated by the high court on September 7, 2012. In the meanwhile a lifetime had passed. (You can read the complete details of the case here).
The system is also used to their advantage by those who do not like the idea of working. The famous case of Uttam Nakate a helper at Bharat Forge illustrates this point. Nakate was found sleeping at the workplace at 11.40am in the morning in early 1984. This was the fourth occasion this had happened. The company started proceedings against him under the Industrial Employment Act, 1946, found him guilty and dismissed him.
Nakate then appealed to the Maharashtra labour court and challenged his dismissal under the category of an unfair trade practice. The labour court directed that Nakate be taken back and at the same time also be given 50% of his wages. The company then appealed to an industrial tribunal which struck down the decision of the labour court. Nakate then went to the Bombay High Court which decided in his favour and also directed the company to pay him Rs 2.5 lakh. The case finally made its way to the Supreme Court which ruled in the company’s favour. The two judges on the case said “we cannot say the quantum of punishment imposed was wholly disproportionate to his act of misconduct”. If all this would have happened in a period of 20 months or so as it did in Gupta’s case in the US, things would have been fine. By the time the Supreme Court decision came in 2005, two decades had passed.
But the people who gain the most from the way our judicial system has evolved are the politicians. Take the case of former telecom minister Sukh Ram. In 1996, the CBI had seized Rs 3.6 crore from his official residence which he had collected as a bribe in awarding a telecom contract. The case dragged on for years and Sukh Ram was finally found guilty in late 2011, nearly a decade and a half later. By this time Sukh Ram was 85 years old and in hospital.
“If this happened in the case of Cabinet ministers, where was the hope of justice for an ordinary person? But former chief justice of the Supreme Court J.S.Verma had a different take. He claimed that although Article 21 of the Constitution guaranteed a speedy trial to every citizen, in reality the status of the person did matter. A powerful person with connections or money could speed up or delay the justice system to suit his needs,” writes Das.
Look at what happened to the Ruchika Girhotra case. The accused SPS Rathore got out of the courtroom smiling in December 2009, after a six months sentence was announced and he got bail immediately.
The late Harshad Mehta is another brilliant example of the system gone wrong. The scam he was running on the Bombay Stock Exchange was revealed in 1992. He died of a heart attack in a Thane jail on the last day of 2001. When he died Mehta was facing trial in 28 cases but had been convicted only in one case which involved the use of funds to the tune of Rs 30 crore belonging to the Maruti Udyog being used in the stock market. All the other cases were pending.
The economist Bibek Debroy carried out a project for the government in the 1990s and found out that nearly 2.5 crore cases were pending in Indian courts. This number has gone up to 3.2 crore since then. Debroy found that it takes up to twenty years to settle a dispute. And it would take nearly 324 years to settle all the cases. Debroy further suggested that a major reason for the huge number of cases was the fact that a large number of laws were simply obsolete. As Das writes “He also concluded that 500 out of the 3500 central laws were obsolete and needed to be scrapped, and half of the 30,000 state laws as well.”
But this was not a major reason for the large number of cases in the Indian court. “The main culprit of the judicial delay was the government, which appealed all judgements automatically and proceeded to lose them again in the higher courts. This crowded out the private individual. The problem lay in the fact that the decision to litigate was made at the lowest level in the bureaucracy but the decision not to litigate was made at the highest level. If this process were simply reversed, government litigation would come down,” writes Das. So for the burden on the Indian judicial system to come down, the tendency of the government to litigate left, right and centre, also needs to come down.
Now let’s get back to Rajat Gupta. What would have happened to Rajat Gupta if he was accused of a similar wrong doing in India? Being at the position that he is he could have easily influenced the judicial system. The case would have dragged on for 20 years. And by the time it would have reached the Supreme Court, Rajat Gupta, like Sukhram now, would have been 85 years old by then and more or less lived his life. Gupta is around 64 years old now.
Of course all this would have happened only assuming that Gupta would have been taken to court for what he did. Passing on stock tips to fund managers isn’t really a big deal in an Indian context. Harshad Mehta who carried out a far bigger scam than what Gupta has been accused of in the United States (actually it’s not even a comparison) got convicted in only one case between 1992 and 2001. And even that wasn’t one of the main cases. And what ever happened to Ketan Parekh and his scams? Look at Sahara and the excuses it keeps coming up with for not paying back the Rs 24,000 crore it owes to its 3 crore investors, the latest one being that 90% of its investors do not have bank accounts. This, despite being directed by the Supreme Court to payback its investors. Even their latest excuse doesn’t quite work. When the Sahara collected the money even then their investors mustn’t have had bank accounts? So if it could collect the money, it should also be able to return it.
What all this tell us is that India is a weak state which cannot enforce things. Das summarises it best when he writes “Weak enforcement is at the heart of a weak state in which the most vulnerable and the weakest are its chief victims.”
The article originally appeared on www.firstpost.com on October 26, 2012. http://www.firstpost.com/business/rajat-gupta-may-never-have-got-convicted-in-india-503668.html
(Vivek Kaul is a writer. He can be reached at [email protected])