Archive for June 1st, 2007

Why is dollar so high?

June 1, 2007

That is a question posed by Martin Feldstein in his latest paper and as usual he answers it pretty well. (For the uninitiated high means the currency is overvalued….say 1 dollar = Rs 40.50

There are a few economists who put across facts as simply as Feldstein does. The paper has no jargon, no stats and fuzzy maths. His papers are very short, up to the point (few references) and really focused.

First a few basics: (Y= Income, C= Consumption, I+ investment, G+ Govt. Expenditure, X + Exports, M= Imports)

The standard macro identity is: Y = C + I +G+ (X-M)
Now S = Y-C-G
hence S – I =  X-M

or in English, any gap between savings and investment is equal to the gap between exports and imports. So if savings are lower than investments than we have a trade deficit and hence we would need capital flows to finance the trade deficit or the savings-investment gap.

Now the paper summary:

In US we have a high trade deficit (almost $ 800 bn) which is a problem of either little savings or higher investment. As per him savings are low because of:

  • increasing wealth
  • mortgage financing

The puzzle deepens as Investment should fall given the low rate of savings. Feldstein has showed in his earlier paper that I does not drop given a fall in S in the short term. But then US has hade current account deficit for time immemorial.

To which he explains that ‘I’ continued to be high as interest rates did not increase. ( Higher r leads to lower I)  r did not increase as there were huge capital inflows from abroad via China (to maintain its currency), Japan (carry trade) and Middle east (oil).

So his take is that trade deficit would reduce if savings increase and USD depreciates. The former would happen over a period of time as we see wealth reducing (it is a cycle after all) and the latter would happen as Chinese and Japanese are already reconsidering their policies. Chinese are unhappy over huge dollar exposures and Japan is considering allowing interest rates to increase which would reduce yen-carry trade.

He says at the end that what would matter is what happens first whether USD depreciates or savings increase. His idea is it is better if former happens first as that would lead to lesser weakening of the national economy.

The paper is disappointing in 1 aspect. He says most papers (IMF in particular) mention that there is a need to reverse global imbalances i.e. a mix of events are needed- higher US savings, increased productivity in Europe (so capital flows shift a bit there),  Chinese exchange rate felxibility but none mention USD depreciation.

However, he does not  make it clear how the USD would depreciate. Now this is a point he does not make clear or provide references to. I don’t see Japan reducing rates as again signs of deflation have resurfaced and not much of the hype about interest rates rise has died down.

He says in the end:

The best hope for a smooth adjustment of both the global and U.S. imbalances would be a substantial fall of the dollar followed by a significant rise in the U.S. saving rate and a policy of fiscal stimulus in other countries. Achieving this will require both good policies and good luck.

Feldstein is a giant in the profession and I expected some better advice than good luck.  But the, it is the simple analysis by Feldstein that stands out.

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Applying academic work in practice

June 1, 2007

The news is full of unfortunate events in Rajasthan. See some newspaper coverage: Hindu, BBC, Indian Express (an excellent one)

In summary, there is a particular community called Gurjars who were promised by the ruling political party that they would be included as Scheduled Tribe and hence made eligible for reservation, but it did not happen. Hence all this chaos.

What is more perplexing is that another community called Meenas have expressed their views that if above are granted ST status, they would follow-up with more violence. There is a very interesting story in Economic Times on how the latter actually got the ST status.

I can’t comment on the political side of the story but we can certainly pick some cues from the paper done by the deadly combo Rajan & Zingales which I blogged about here.

The paper says there is underdevelopment because of initial factor endowments i.e. interest of certain groups may not be aligned with each other and hence may oppose the reforms.

Whether reservation is a reform or not is questionable but it is considered as a policy measure that aims to bridge the divide between haves and have-nots. It is also open to debate whether reservations have been successful in achieving their purpose or not. However, my idea looks at different aspect completely.

Now just like the paper, we have 3 different constituencies, The government and the 2 communities. The idea is that reservation would give the Gujjars certain rights and help their overall position in the society (certain % of government jobs would be reserved for their community people, same with admissions in schools/colleges, etc).

Now, the Meenas would obviously oppose the move as it would lead to reduction of their reservation quota (hence fewer jobs, lower quotas in schools/colleges etc.)

But why would the government delay the move? After all they promised it. Well, couple of possible reasons:  

  • if govt agrees to them then other communities may also demand for such a reservation
  • the govt would not have any new thing to offer to this community before next elections hence by delaying it they can promise the same in next elections

And then there can be some more reasons for which I have to know the details of polity in Rajasthan.

The next question is why do Gujjars resort to violence for getting their demand met? Well, in India (and in most of the world) that is how most of the demands are met and hence the community follows this well-tested approach.

I hope I am thinking right.

I was not quite right

June 1, 2007

I had mentioned sometime back that RBI presents us with facts on different aspects of the economy and leaves the analysis to analysts like me. I was not quite right though.

Yesterday, RBI released one of its annual publication called ‘Report on Currency and Finance’. The title may sound boring but then that is just about it. Rest of the report is pretty interesting. Easily one of the best reports from the Central bank stable.

The report always has a central theme and the entire idea floats around the theme. In usual RBI style the report is divided into chapters and one can simply read on the chapter he/she is interested in.

Last year the theme was Central Banks and this year it is Financial Markets.  Just a quick glance through this year’s report provides a very interesting analysis on Financial Markets. The theme states:

What are then the key objectives of financial market development? From the viewpoint of an emerging economy like India, the basic aim of financial market development must be to aid economic growth and development. The primary role of financial markets, broadly interpreted, is to intermediate resources from savers to investors, and allocate them in an efficient manner among competing uses in the economy, thereby contributing to growth, both through increased investment and through enhanced efficiency in resource use.

Financial markets in India have existed for a long time. However, they remained relatively underdeveloped for a variety of reasons. India introduced financial sector reforms as a part of structural reforms in the early 1990s. Since then, momentous changes have taken place in the Indian financial sector, including financial markets. Reforms in the financial markets encompassed all segments -the money market, the credit market, the government securities market, the foreign exchange market, the equity market and the private corporate debt market.

What is more interesting is the very rich reference section the study provides. Excellent stuff.

Kevin Pietersen is quite a dude

June 1, 2007

I just like this batsman quite a bit. I have not seen such flamboyance and attitude on the cricket field for a longtime. He has little regard for any bowler. He first ruffled feathers by shunning South Africa – he was disenchanted with the quota system – in favour of England; his eligibility coming courtesy of an English mother.

S. Rajesh in his usual lucid style puts some great facts about this upcoming English star. I liked this in particular:

Pietersen’s 226 against a friendly West Indian attack at Headingley led England to a thumping victory by an innings, and lifted his aggregate to a staggering 2448 runs after 25 Tests – that’s very nearly 100 runs per Test. That’s more runs than Viv Richards, Everton Weekes, and Neil Harvey had managed at a similar stage in their career. In fact, the only batsman to have scored more runs after 25 matches answers to the name Don Bradman, who had a whopping tally of 3194.

However, he needs to be very cautious.

Pietersen will have to beware, though, that he doesn’t slide the way the leader of the pack did: Jimmy Adams had a phenomenal start to his Test career, with five hundreds and an average of more than 61 after 25 games. In his next 29 tests, though, the average slumped to 26.95, and he finished with a career average of just 41.26, a drop of more than 20 runs from his 25-Test figure.

Keep up the good work Mr. Rajesh.

Assorted Links

June 1, 2007

1. National Stock Exchange has begun futures trading on Nifty Junior and CNX 100. Ajay Shah has blogged some very interesting stuff on the development.

2. Retail investors lend their PAN cards to brokers for a flat fee and helps latter corner shares in an IPO!! Read on

3. Sanjay Sinha on Financial Inclusion.

4. M.R. Mayya says SEBI should do something about Regional Stock Exchanges and ensure they do not die out.

5. I am a big fan of the column by TCA Srinivas Raghavan in Business Standard. He is taking a break and laments that no Indian economist does any research in microeconomics. He presents a nice short picture that Indian economists don’t believe in research.

6. Read Bill Gates and Steve Jobs Interview. Thanks to Apurv for the pointer

7. Happy B’Day Helevtica. This is hilarious


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