II. Possible Lessons from the Japanease (slump) bear market

(It has been roughly four months that i promised to write on Japanese prolonged bear market).

Boom and depression are the two extremes of business cycle which are generally pursued to be caused by an array of economic factors such as over production, under consumption, over capacity, price dislocation, over confidence, overinvestment, over saving, over spending and discrepancy between savings and investments. The foremost celebrity monetary economist Irwing Fisher attributed the business cycles to the over indebtedness and thereby deflation.  In his own words, depression in the economy is result of over indebtedness which leads to distressed selling of assets. He articulated (in 1930s) the chain of factors that lead to depression in the following way….

Over indebtedness leads to a) distressed selling and b) contraction of deposit currency as bank loans are paid off and to a slowing down of velocity of circulation. The contraction of deposits and of their velocity precipitated by the distress selling causes c) a fall in the level of prices and d) a still fall in the level of corporate net worth, precipitating bankruptcies and e) a like fall in profits leads to concerns to the private – profit society to make f) a reduction in output, trade and employment. These losses, bankruptcies and unemployment leads to g) pessimism and loss of confidence which in turn lead to h) increased hoardings and still more contraction in velocity of circulation. All these factors cause i) complicated disturbances in interest rates.  Here the complicated disturbances in interest rates are vowed to my previous post on counter cyclical regulation.

The above lengthy introduction serves as the basis for my arguments on the possible lessons from the Japan’s prolonged bear market.

 From the humiliating defeat of 1945 war, Japan has raised to the second largest economy by 1989. The tremendous growth has been attributed to the hard work (Popularly known as Japan kind of doing) rendered by its citizens and supply led and export oriented policies adapted by the then governments. During the second half of the 1980s, Japan experienced a sea change, there was a sudden spurt in the asset prices, real estate prices reached unimaginable hights, stock markets were experiencing thumping Bull Run. High asset prices coupled with low/negligible unemployment rates, increased productivity and positive trade deficit prompted the irrational speculating activates. Though inflationary situation forced the Bank of Japan to keep the interest rates high, the capital gains from the asset markets (stocks/real estates) encouraged the investors to go for investing with borrowed money. Banks also added to this malady by promptly sanctioning the loans to the investing activities. There is hardly anyone who has not stepped into the band wagon of making quick buck. By the end of 1989 Nikkie index touched 39,000 mark which raised three times more than the economy’s growth. 

Such a growth led by the speculation coupled with over indebtedness became unsustainable and rate of growth of the asset prices slowed down, interest rates over took the capital gains. Thus as Fisher rightly mentioned way back in 1930s, the over indebtedness and higher interest rates forced the distressed selling resulting in steep fall in asset prices. The crash in asset market and resulted mass corporate defaults increased the proportion of distressed assets in banks’ books. Non repayments, delayed repayments and deposit withdrawals caused the banks to adapt conservative measures. Steep rate cuts by the Bank of Japan could not yield the desired fruits, moreover resulted in debt trap. Hesitant banks keep carrying the distressed assets on their books, resulting many defunct businesses were continued to float. Such an uncertain environment counter acted against all the monetary measures taken by the Bank of Japan, further steep cuts of interest rates forced the economy into deep debt trap. Hence, the failure of the transmission of monetary policies, continued business uncertainty forced the prolonged disarray in the Japanese economic system….(to be continued)

 (Comments and suggestions are welcome)

The author is highly benefitted from the writings of Irwing Fisher and Graham Turner.

Does the Counter Cyclical Regulation ensure the cycle free regime?

During the run up of 2004 to 2007 world economies in general and emerging economies in particular have experienced the highest levels of consumer confidence and corporate optimism. The increased purchasing power driven by increased investments and confidence among the economic agents (I mean corporate entities and individuals) has escalated the inflationary pressures around the world.  To counter such an imbalance in the system, the apex bodies around the world have resorted to counter cyclical monetary measures such as increasing the reserve capital (which may be used in the event of negative outcome). Such a counter cyclical regulated environment has forced the firms to incur more cost of capital than market requires.  In fact during the boom times, given the confidence level in the economy, the probability of default though is very remote; the cost of capital in the economy remained irrationally high. Hence such a regulatory environment prompted the firms to shift to unregulated or less regulated activities such as structured investment vehicles which in a way caused the present trough. 

 

Aftermath of the bursting of the bubble in the housing sector, almost all the apex financial institutions around the world resorted to the (traditional) counter cyclical monetary measures which are again proved to be irrational and may contribute to the potentially void results. The trouble in the housing sector has been translated into disastrous crisis in the financial sector by the so called counter cyclical regulations of the boom period. The resulted crisis has evaporated the confidence among the economic agents and drafted vague picture about the future prospects thereby steep fall in consumer demand, accumulated inventories and unimaginable job cuts. Given the present pessimistic environment, market demands a relatively higher cost of capital from the firms and financial institutions requires higher cushion in terms of higher reserve to tide over the potential uncertainty. Counter intuitive to such an end, the regulatory bodies brought down the reserve requirements of the financial institutions and virtually advocating the low cost of capital to the firms. The credibility of these measures in the event of possible corporate mass defaults is not only questionable but they may also pose the terrifying questions about the future systemic cushion…  (to be continued)

(Comments and suggestions are hightly respected)

Japanease Slump and its Implications

Japanease stock index Nikkie touched 39,000 mark in late 1980s, today it is struggling around 9,000. Virtually there was zero growth for last two decades in the Asia's largest and world's second largest economy. Fiscal measures, monetary measures all failed one after another in bringing back the normalcy.  When one look into the reasons (Irrational credit expansion and reality boom) that caused the downfall of the Japnease economy, one certainly get scared of their future prospects from the current juncture.  

Here i would like to initiate for a year end debate on the possible causes for the continued slump in the Japnease economy. Particularly i invite the arguments on the following issues:

• Reasons for the failure of fiscal and monetary measures in Japan
  
• Why an average Japanease citizen save so high? (even after realising that their savings and investments have gone for a vain)
• Possible measures to be adapted to cure the Japanease truma
• Implications of prolonged Japanease slump to the current debacle of the global financial system

As i mentioned it is the year end debate, i request your valuable arguments and comments by the end of the current year.  I also hereby promise that your contribution will be duly recongized in my forth coming blog post on the same issue.

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Unviable Suggestion!!

The present crisis over turned the basic idea of the capitalism that "the state should assume the role of facilitator rather than the role of regulator". It is quiet evident from the recent acts of the notable 'leaders of capitalism' as United Kingdom nationalized the private commercial and investment banks (pearls of capitalism), United States embarked on entering into the governing bodies of yesturdays corporate kingdoms. With the yesturday's statement, the Government of India took the anti-capitalist movement to the next levels.  Given the status of the economic environment, i propose to critically evaluate the Govt of India's move in asking the industry to cut the prices of the goods produced by them.

During the last couple of months, the Govt of India infused Rs. 2,80,000 crore through a host of monetary measures and another Rs 1,00,000 crore through various fiscal measures. Thanks to the cordinated efforts by Ministry of Finance and RBI, the inter bank rates have (virtually) came down to the normal levels (though i suspect the normalcy in terms of transactions among the banks). Here, one should question the effectiveness of the measures so far taken by the MoF and RBI. These have been initiated at a time when the transactions among the banks were virtually non-existent, call money rates were at their hights of around 23% and most importantly the banks were no where near the position of either continuing or renewing the expired credit lines to the corporates. As noted by the pink papers, these measures are successful as they claimed to be drived down the inter bank rates. Here one should understand the real picture  what made the inter bank rates to reach the normal levels?.  It would have been appreciated if the RBI & MoF measures improves the confidence among the banking community over the solvency of their peer and if they transferred the newly infused liquidity to the real economy through continuing and extending the credit lines to the industry. Hardly there is no evidence on this front, there is no evidence of either new or renewed credit lines (without additional restrictions) to the industry; there is no evidence of healthy inter bank transactions. Hence, it is very clear that the RBI & MoF measures reduced the demand for call money (thereby interbank rates) by boosting  the banks with the large chunk of easy money which has no signs of reaching the proposed ends (moreover it is reaching back to government coffers as banks are now heavily purchasing the government securites). Essentially, these measures so far taken have neither yielded  fruits to the (real economy) industry nor to the banking sector as they failed to improve the confidence among the ultimate economic agents (consumers).  Moreover, the steep fall in retail sales have jeoparadized  the industry (which never had the chance of earning super normal profits given the fierce competition resulted from opening up of the economy) prospects by resulting in accumulated inventories, and increased credit bills. At this stage, the viability of the earnest Minster of Finance statement may be questioned? It makes me to suspect that the Govt of India is still in the dreams of "strong fundamentals" and not yet ready to accept its vulnerability to the crisis. 

In this situation, the government should have the sole goal of 'improving the confidence' among the economic agents.  It may be effectively achieved by relying heavily on fiscal policy measures. That is increasing the benefits to the unemployed (social security measures), infrastructure spending  to boost the aggregate demand. The agrument against infrastructure spending in the prevailing situation is that they take too long to show the impact, but such an arument has no validity as the chances that this slump will be over anytime soon are virtually zero.  Hence, it may be reasonable to get such projects get rolling and slowly injecting the confidence among the economic agents.!! (as i blogged for quite some time ago).

 (http://surenderkomera.blogspot.com/2008/10/current-recession-policy-implications.html) 

(Constructive comments and suggestions are encouraged!!)

II. Derivatives and Monetary Policy: Implications for the Transmission Mechanism of Monetary Policy

The goal of the monetary policy is to ensure non-inflationary growth in the economy.  The intentions of the monetary policy are mostly transmitted through the financial sector, mainly through influencing the interest rates, exchange rates and availability of bank credit. Though there are wide variances in the financial structures in various countries, these issues assume greater significance in almost all the institutional arrangements.

Through Interest Rates:

With their low transaction costs and flexibility of product designs, derivatives increase the speed of portfolio adjustments and thus lead to the faster transmission of interest rate changes. On the other hand, financial derivatives are also the perfect instruments for the individuals who now can seperate the interest rate risk of an investment from its production risk at least for a while. The influence of monetary policy will sooner or later will get reflected in the real economy because the insurance obtained through derviatives will eventually expire. Moreover, the monetary policy so heavily influences the cost of such insurance. In a way financial derviatives provide inexpensive and efficient transmission of information to the modern and globalized economy.

Through Exchange Rates:

In the world with financial derivatives, it is much easier to engage in speculative positions on a particular country's currency without having any relationship to that country. It is not posible in the world without such derivative products. These kind of transactions effectively transmits the impulses of monetary policy to other parts of the region.

Through Bank Credit:

Monetary policy influences the volume and structure of bank credit if it were to control credit costs. The availability of financial derivatives in such an economy would likely to undermine the efforts of monetary policy given their capacity for substitution. This implies greater significance for the 'interest rate channel' than a 'credit chennel'.

(The author is greatly benefited from the writings of Gerd Hausler)

Constructive comments and suggestions are encouraged!!

I. Derivatives and Monetary Policy: An Introduction

I deeply regret for the delay in posting my discussion on this issue at the promised time. I really put a lot of effort in gathering and analysing the existing information about this topic.  After a deep thought i have decided to post my arguments on this issue through a series of 5 blogs.  At the outset, here i will provide the framework for such a proposed series. I hope you will receive it with the right spirit.

Introduction:

It is generally perceived that the central banks deal with derivatives exclusively in the context of supervision and regulation. There are few central banks (small) that gained the first hand experience with derivatives when trying to manage their exchange reserves more professionally. Ofcourse, this is a commercial action which may be significant in individual cases, but is not of a core cencern of a central bank. Given the exploding size of derivatives markets today, it is crucial to understand the impact of derivatives on monetary policy in particular and on today's financial environment in general.

The possible issues araising from the interaction of derivatives and monetary policy may be classified into four categories:

1. Impact of derivatives on the various aspects of the transmission mechanism for monetary policy.
2. Influence of derivatives on the targeting of monetary policy.
3. Usefullness of derivatives market in designing the monetary policy especially in providing policy makers with the valuable information about the market expectations.
4. Derivatives as an operational tool for the monetary policy purposes.

The discussion over these issues will be presented through the following series of five blog posts.

Constructive comments and arguments will receive due recognition!!

Break the Path Dependent Ideas!!

Eversince sub-prime crisis  initially unearthed during April 2007 in United States, it has been widely written and extensively discussed by the independent scholars, policy makers and so on saying that: the fundamentals of the Indian economy are extremly strong, India has not yet been integrated to the world economy. Hence, the possible impact of the crisis in the western financial system will be very mild on the Indian economy.  By naively subscribing to this view, RBI has maintained the real interest rate as high as 4% (three month rates), SEBI continued to control capital inflow by many ways such as restricting Paricipatory Notes untill early September 2008. Where as the central bank of US (Federal Reserve) kept the credit policy so loose that short term interest rates are in the negative territory during the period.

Almost a year later now after September 2008 which experienced the major collapse of financial system in the western world, we are now feeling pinch and observing the worst part of the effect in our economy.  Our stock markets have fallen steeply by almost 40%, inter bank call rates touched the peak of 23% unearthing the worst ever credit crunch. This resulted in either fully or partially abondened credit lines to the corportes and there by affected the indusrial production. The real estate markets in India have slowed down and the home prices in most of the cities are falling sharply.  In a way high degree of distress has been witnessed in the overall economy. This has disproved the perception of our policy makers over the 'strong fundamentals' and 'decoupled of the economy with the rest of the world', that is based on the position of India 10 years ago. 

 Coordinated effort of RBI, SEBI and Ministry of Finance:

Similar to most of central banks of the developed world, Ministry of Finance and SEBI led by the Indian central bank has now (after realising the true picture) come out with a series of positive steps to correct the system during the last three weeks. a 250 bps cut in CRR, a special window of Rs 20,000 crores to MF to ease the redemption pressure, reliease of Rs 25,000 crores under the loan weaver scheme, a 100 bps cut in the (repo rate) policy rate, a de facto 100 bps cut in SLR, the reversal of the mistakes on PNs of October 2007 and ease of FDI norms. All these measures seems to bringing back the normalcy in to the system as they resulted in bringing down the call rates to around 6% and reduced the panic selling in our stock markets (Indices have taken the northward direction!!) In a way RBI and SEBI exhibited the greater maturity in dealing with the present borrowed crisis without resorting to possible politically motivated measure of "banning of short selling".  Hence, it may be highly commendable to break the subscribing to the path dependent thinking process and accept the Indian economy as nascent market economy in arraiving at policy decisions !!

(The author has highly benefitted from the writings of Ajay Shah, Ila Patnaik and Arthur M Okun)

Comments and suggestions are encouraged!!

Current Recession: Policy Implications

Before going ahead with this weekend blog let me Congratulate PAUL KRUGMAN who has been honoured with the Noble prize for the year 2008 in Economics. His theoretical contributions to International trade and economic geography are detrimental in bagging the highest honour. In his recent piece in Newyork Times, the 2008 Noble Laureate in economics said that "it is politically fashonable to rant against government spending and demand fiscal responsibility.  But right now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold". In the following piece of my blog, i will try to relate his statement with the current global financial condition (I dislike to call it as "crisis").

Stock markets are finding new depths in most of the days, money markets, credit markets are vitually shut down. In addition to that we saw the falling retail sales so as the industrial production. All these prevailed conditions makes me to remember the recent recession of late 1990s resulting from technology bubble. The policy response to such recession was a success story.  The Federal Reserve could engineer that recession by cutting interest rate which resulted in the increased employment opportunites. But the current prevailing situation is different from that of the situation prevailed during late 90s in many ways. For quiete sometime Federal Reserve has been resorting to  interest rate cut to prevent the unemployment rates from raising for several other reasons of global slow down. This brought us to see the fed rate at around 1%, but there is no sign of declining trend in unemployment rates. Moreover, the decline in the retail sales caused the accumulated inventores, forced reduction of the industrial production and further retrenching of jobs. As per the old dated economic text books the current economic situation is precisely referred as the "Economic down turn" as a synonym to "recession".  How long our markets have to suffer from such epidemic? , is the trillion dollor question!!

In this situation there is not much can be done by the central banks. On the other hand, as J.M. Keynes advocates a lot that government can do through its fiscal measures - increasing the benefits to the unemployed (social security measures), infrastructure spending  to boost the aggregate demand. The agrument against infrastructure spending in the prevailing situation is that they take too long to show the impact, but such an arument has no validity as the chances that this slump will be over anytime soon are virtually zero.  Hence, it may be reasonable to get such projects get rolling and slowly injecting the confidence among the economic agents.!!

Constructive comments are honoured!!

Derivatives and Monetary policy

Issues:

1. How the growth of derivative markets affecting the influence of monetary policy?

My arguments will be posted during this Diwali holidays (I deeply regret for the delay)!!

Constructive comments/arguments are encouraged!!