It’s when markets are running hot that flags need raising

Agustin Cartens in this speech:

At first glance, the skies above financial markets look sunny, notably for credit markets. Term and credit spreads as well as volatility are very low by historical standards, while valuation and asset prices are high. But, as we argue in our just-released BIS Annual Economic Report, clouds are gathering on the horizon.

Indeed, showers have already dampened spirits in some emerging markets. And worse could come if a further rise in the US dollar tightened financial conditions around the world: after all, post-crisis, companies in emerging economies and elsewhere have been all too eager to tap markets, while investors have been all too eager to oblige them.

Will the stresses remain isolated? Or should we be worried about a more intense and widespread build-up of pressure? 

Central banks still find it hard to forecast financial markets, just as meteorologists are not always successful in predicting the weather. At the BIS, we have come to appreciate how unrewarding it can be to flag risks when markets are running hot. Yet that is precisely when risks tend to be highest.

Indeed, our analysis indicates that the risks ahead are material. A decade of unusually low interest rates and large-scale central bank asset purchases may have left many market participants unprepared, and have contributed to a legacy of overblown balance sheets. Financial conditions are easier than before the financial crisis, when many investors, households, corporations and sovereigns were caught out in the rain with no umbrella. And there is no denying that the room for manoeuvre in terms of monetary and fiscal policies is narrower today than at that time.

Hmm..

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Building Europe as a digital financial centre?

One one hand Europe is seen going down the drain. On the other hand, there are hopefuls. Denmark central bank chief said Europe is not doing as badly as it may sound.

Prof. Joachim Wuermeling of Bundesbank has been arguing that Brexit provides Europe an opportunity: to create a digital financial centre. in In a new speech he again makes these points.  

Ladies and gentlemen, as much as we greatly regret the United Kingdom’s decision to leave the EU, we must nonetheless look forward and consider how financial services can be delivered in the European Union in the future.

First, we need to observe the consequences of Brexit from the perspective of each individual bank. Banks have so far avoided making any major changes, not least because they are also busy coping with large-scale acute challenges and their financial implications. So it is easy to lose sight of strategic issues. It’s not just Brexit that’s shifting the tectonic plates under banking – digitalisation and regulation are two other key drivers of change. When traditional structures and markets are broken up this way, the cake will be redivided – some will lose out, but some will get a bigger slice. There is a real danger that adhering at all costs to traditional positions in London risks missing out on new opportunities in the EU – though not by everybody: those who don’t will be the winners. So I would urge you not to lose sight of medium and long-term strategic options.

Second, we also have to consider the repercussions of Brexit in terms of its impact on the EU financial market as a whole. What we are looking at here is nothing less than the financing of the European economy, especially at a time when the global economic and financial order is becoming increasingly shaky. Earlier EU initiatives – the single financial market, the banking union, and the capital markets union – all had an inward focus. And with London, Europe had an international financial centre. This will now change. Hence the question of whether we in the EU 27 should aspire to developing a globally competitive financial centre that is more than the sum of its parts here in Frankfurt, Paris, Amsterdam or Dublin. François Villeroy de Galhau, the governor of the Banque de France, recently spoke of an integrated network with centres specialised in various activities – and I am thinking along the same lines, which include major efforts to harness digital potential as well.

I would like to help kick off a broad, forward-looking debate surrounding the concept of a digital financial centre of Europe.

Hmm..It is quite amazing how Europe continues to compete to have a financial centre on lines of London. This is as historical as it can get.

There are three pillars to this digi financial centre:

It’s an idea based on three pillars.

First, a networking pillar. Today, Europe’s financial services potential is spread over various locations. It does not have a cumulative effect. However, for a fully-fledged financial ecosystem to truly flourish, there needs to be enough providers and users of financial services in the local market. At present, no European financial centre can tick this box. The continental venues could, however, tap into an aggregate potential if they were to form a network in which any financial product can be bought and sold in any quantity at any time, just as you would expect from a globally competitive financial centre.

The second pillar is digitalisation. Financial centres in continental Europe need robust digital market infrastructure that leverages all the state-of-the-art digital capabilities – of which distributed ledger technology (DLT) is but one. Only then can these centres overcome fragmentation and replicate agglomeration effects of physical proximity. The Eurosystem will also be expected to contribute here, seeing as it already provides a key piece of infrastructure for payments in the shape of the TARGET system.

These first two pillars create a digital network across European financial centres. But to make the most of Europe’s potential as a “financial Amazon”, market-driven specialisation will also be needed as a third pillar. Specialisation can help deliver economies of scale, increase the potential for innovation, and achieve excellence. In an environment of “coopetition” – a neologism merging the words cooperation and competition, European financial centres could cooperate, compete and, at the same time, hone their own areas of expertise. But this is a vision for the future.

It’s a picture of the future that is also very much in our own inherent interest as a central bank, because the more that financial flows end up where our system is in force, the more we are able to promote financial and price stability as well as a strong currency.

Hmm..

Reviewing free banking in different US States and lessons for cryptocurrencies

Nice article by Helen Fessenden of Richmond Fed.

The idea of an “unregulated” currency, however, isn’t new. Before the Civil War, the United States ran a vast natural experiment by leaving “free banking” to the states, even while other major economies were adopting central banking. From the demise of the Second Bank of the United States in 1836 until the passage of National Banking Acts of 1863 and 1864, the United States lacked a federal authority to issue and redeem banknotes, act as a fiscal agent for the federal government, or keep banknote issuance in check. Instead, banking was run by the states, and “free banks” could issue their own banknotes. But just how much did this amount to the kind of free-entry, highly decentralized currency competition that some cryptocurrency backers advocate today?

Helen says free banking experiences differed across States. It was successful in New York and New England. This was largely due to the fact that their private notes were backed by safer assets. However, in Michigan, Wisconsin and Illinios free banks suffered as they invested in all kinds of assets. Read the piece for details.

What lessons for cryptos?

What are the lessons from this era? Some banknotes in New York and New England did indeed come closest to fulfilling the functions of money under a regulatory regime, enforced by the government or the private sector. Given that the attraction of cryptocurrencies today lies in the fact that their issuance is not determined by government fiat and that they are not publicly regulated, then, this historical record might give pause to those who see them as a potential substitute for money. The free-banking era also illustrates numerous examples of failures, especially in the Midwest, due to idiosyncratic regulation. This history suggests that effective regulation should involve a way to ensure that a new currency enjoys stable liquidity. This was a clear challenge for some states before the Civil War and for cryptocurrencies today.

Policymakers have recently pointed to some of these fea­tures as constraints on cryptocurrencies’ utility in the long run. Fed Vice Chairman for Supervision Randal Quarles noted in a speech last November that among the dan­gers posed by cryptocurrencies is that during crises, “the demand for liquidity can increase significantly, including the demand for the central asset used in settling payments.”

“Even private-sector banks and certainly nonbanks can have a hard time meeting large-scale demands for extra liquidity,” he added. “Without the backing of a central bank asset and institutional support, it is not clear how a private digital currency at the center of a large-scale pay­ment system would behave … in times of stress.”

In a speech last March, Bank of England Gov. Mark Carney also underscored this point in a broader critique of cryptocurrencies, charging that they are “failing” as money for now. He warned that the inherently “fixed supply rules” of these currencies would run the risk of repeating another, less successful, historical experiment. “[R]ecreating a virtual global gold standard,” he said, “would be a criminal act of monetary amnesia.”

Hmm..

Low-cost Bengaluru-Kochi flights threaten bus monopoly..

Always nice to read stories on competition in transport sector.

There has always been this competition between railways and bus while travelling between Karnataka and Kerala. Apparently, the flight operators have entered the act too by offering cheap tickets from Bangalore to Kozhhikode and then using buses to travel to parts of Kerala.

This is fine but the article minimises the headache of reaching Bangalore airport. Some thought should be given to it too…

 

 

COBOL: The antique code that runs the financial system

As we talk so much about digital and high end technology in finance, here is a crude reminder: The ancient COBOL still runs the financial system.

The last time you used an ATM, chances are the transaction was powered by a nearly 60-year-old computer programming language.

Common Business-Oriented Language—the ancient computer code better known as COBOL—was developed in 1959 as a business-focused standard programming language, and is still relied upon by banks around the world. It’s responsible for $3 trillion in commerce in the US every day. As of 2014, 92 of the top 100 banks, as well as 71% of the companies in the Fortune 500, were still running COBOL programs on mainframe computers.

And if it’s not broke, why fix it? Well, with COBOL, when something does break, there soon may not be anyone left who can. The baby boomers who know the language best are either retired or close to it, and those who would replace them just do not find COBOL very sexy.

So what happens next?

Back to physical world?

Preparing for a world without Libor

William Dudley, Former President of NY Fed in this important speech says how we need to prepare for a world without Libor.

The reference rates are important but Libor has serious defects:

Has inflation targeting become less credible?

New paper by by  Nathan Sussman and Osnat Zohar of BIS.

BIS has also adopted a new way to summarise its research papers:

Focus

Since the 2008 financial crisis, oil prices have become highly correlated with inflation expectations for the medium term. This occurred in several countries, implying a global phenomenon. To trace its origins, we decompose oil prices into two factors: one capturing global aggregate demand and the second capturing oil-specific elements. Our measure of global demand is based on the strong co-movement of commodity prices. The oil-specific elements include OPEC’s strategic behavior and shocks to oil demand caused by the weather. We use this decomposition to explain changes in global inflation expectations.

Contribution

Central bankers were concerned that the increased correlation between inflation expectations and oil prices might indicate an un-anchoring of expectations. If this were the case, the credibility of inflation targeting might be declining. We test for un-anchoring using a framework based on a global Phillips curve. This framework allows us to trace the origins of the change that occurred after the global crisis.

Findings

We find that global aggregate demand has affected inflation expectations more since the crisis than it did in the past. Meanwhile, the effect of oil-specific factors remained low and stable. Since oil prices convey information about aggregate demand, their correlation with expectations has increased. Does this change indicate that expectations became un-anchored? Our model for global expectations suggests otherwise. We find that, after the crisis, inflation itself was perceived to react more strongly to aggregate demand. Rational agents thus adjusted their expectations more strongly when aggregate conditions changed. It appears that inflation targeting has remained credible.

Hmm.. Much simpler to figure research this way..

The Dhoti: From Indus Valley to the Ramp

Another superb piece from Madras Courier tracking history of the mighty Dhoti. What a journey for centuries old garment and how it has been used by Indian politicians for years…

The year 2018 marks the 100 years of Osmania Sicca Rupee

This post is a result of fascinating twitter exchange yours truly had with one of the keen observers of Indian monetary history (Bodhisatva).

The discussions led to paper currencies issued by Princely States of Hyderabad and Jammu and Kashmir. Yes, as per records these were the only two Princely States which issued their own paper currency though some others issued their coins as well. On checking the details of Hyderabad currency, one was delighted to read it started in 1918, making 2018 its 100^th anniversary.

Thus, this post to commemorate the 100th anniversary of the currency. The post was written by picking several sparse resources available on the web and RBI history. It will be great to add on to this post and correct me as well.

RBI should build a dialogue around its financial stability report and make it more interactive..

It could not have been a better coincidence that my Mint article on need for a financial policy committee was released on the same day when RBI released Financial Stability Review for June -2018.

There were couple of comments/suggestions on the Mint article. One of them was that we need to hold authorities accountable for financial stability. It should not be the case that these reports and publications are released with all highlighting “all is well” to suddenly saying “all is unwell”. With so much at stake and pushing people towards financialisation, the authorities should tell us what went from well to unwell stage. We should not have the situation that the RBI Governor tells us that RBI cannot regulate public sector banks when things go bad for these banks. These risks have to be identified and more importantly communicated to people through these publications.

RBI clearly can make tremendous progress on both accountability and communications front.

The opposite of populist nationalism is not globalist elitism; it is economic realism.

Hard hitting piece by Anatole Kaletsky.

He says populist waves usually meet with economic realism which is usually unpleasant

Muslin: The finest ancient fabric

Another Superb piece in Madras Courier on Muslin fabric.

Have economists changed since the 2008 crash?

Cédric Durand Prof of economics at the University of Paris says some progress has been made but long way to go: 

Economists are not innocent people. The 2007-08 financial crisis that almost sent the world economy into a great depression was, to a large extent, a consequence of the designs dreamt up by leading economists. This raises three concerns about the economics profession. The first is a basic moral failure resulting from a lack of integrity in some of its prominent representatives; the second is the idiotic collective fascination with the technicalities of the discipline, reinforced by an inclination for group-thinking; the third is a deeper, intellectual challenge that questions the very role economics ought to play in society.

In 1971, neoliberal icon Milton Friedman was paid by the Chicago Mercantile Exchange for a report that decisively tilted the balance in favour of opening a market that allowed betting on the variation of currency values – a kind of financial product that was illegal under the strict regulation imposed in the post-war era. Ever since, studies by economists have played a legitimating role in each phase of finance’s liberalization. This close connection was not without its ethical problems. Take the lesson learned from Charles Ferguson’s documentary Inside Job (2010). This notes that Larry Summers – former Harvard president, Treasury Secretary in the Clinton administration and an adviser to President Obama – untiringly defended financial liberalization throughout the 2000s, a period in which his ties with the industry brought him more than $20 million. In the wake of the financial crisis, a study of 19 eminent financial economic specialists showed that, in addition to their university posts, most had affiliations with the private sector that were not publicly disclosed.

On this front, some progress has been made. The American Economic Association has set up a new disclosure policy stating that authors submitting papers to academic journals should identify each interested party from whom they have received at least $10,000 in the past three years. Moreover, it calls for disclosure during media appearances. Professor Gerald Epstein, who was at the forefront of this battle, calls the change ‘a very big step forward’. He particularly stresses that disclosure in non-academic work could help ‘set norms of behavior that colleagues, the press, students and citizens can help make economists accountable to’.

Another, more mildly positive, evolution concerns the content of economic curriculain universities. Academic thought influences political decisions; or, as JM Keynes memorably put it: ‘Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.’ In the realm of university teaching there has, during the past few decades, been a growing fascination with the technical sophistication of analyzing abstract dynamics of markets at the expense of thinking about economic history and institutions. This created an intellectual climate favorable to opening a Pandora’s box of financial ‘innovation’ during the neoliberal era. It supported the comforting view that by spreading the risk, complex products – like the subprime mortgages that were sold to low-income Americans and then bundled up to be sold to institutional investors like pensions funds – were reducing financial instability. Of course, as it should be clear now, it was the exact opposite.

In 2014, the International Student Initiative for Pluralism in Economics sounded the alarm: ‘A lack of intellectual diversity,’ they claimed, ‘does not only restrain education and research. It limits our ability to contend with the multidimensional challenges of the 21st century – from financial stability, to food security and climate change.’ They call for bringing the real world into the classroom through paying greater attention to economic history and developing a deeper dialogue with other social sciences. They also demand a greater diversity of theoretical perspectives by adding post-Keynesian, ecological, feminist, Marxist and other economic traditions to the commonly taught ‘neoclassical’ approach. Thanks to student pressure, some openings have been made. For example, CORE, a new open-access online syllabus funded by the Institute for New Economic Thinking, is introducing some elements of intellectual variety into the economics departments of tens of leading universities.

Hmmm..

More in the piece..

Axis Bank opens a branch in Kargil: Old strategy to restore faith in banking

I had written this Mint piece: What’s in a name? Ask banks.

I document this history of bank names in India over a 200 year period. The bankers choose names pretty wisely looking at broad sentiments and economic trends. So the names are based on founder family names, locations, nationalistic sentiments, catering to religious sentiments and so on. You see a particular pattern when certain names are chosen by most new banks during that time. And these sentiments keep coming back. Read the piece for more details.

Thus, it was interesting to read that Axis Bank is opening a branch in Kargil.

As Sweden goes cashless, it also worries about banknote supplier..

Interesting bit of news from Sweden:

The Riksbank has today, 19 June, given notice of termination of its contract with Crane AB, the company that prints Swedish banknotes. The reason for the termination is that Crane has announced that it will be closing its banknote printing operations in Tumba at the end of this year and moving them to its plant on Malta. As the agreement with Crane states that they will print Swedish banknotes at the printing works in Tumba, the Riksbank is now giving notice of termination of the contract. The Riksbank is now working on finding a new supplier to manufacture Swedish banknotes.

The Riksbank had its own production of both coins and banknotes until the early 2000s. In 2001, the Swedish Mint was sold to Mint of Finland and in 2002 Tumba Bruk was sold to the American company Crane. Since then, the Riksbank has procured the manufacture of both banknotes and coins on the international market. Banknotes have continued to be printed in Tumba, while coins have been manufactured abroad since 2008. The Riksbank is now working on finding a new supplier to manufacture Swedish banknotes. The Riksbank has very stringent requirements of both quality and security in its public procurements. As the Riksbank observes the Public Procurement Act, Swedish banknotes could also be manufactured abroad.

Recently Denmark outsourced both coinage and printing notes to countries abroad.

Does India need a financial policy committee?

New Mint piece by Yours Truly.

The idea comes from this interesting speech from Prof Anil Kashyap of University of Chicago. He is also a member of Bank of England’s Financial Markets Committee and shares his views on how FPC came into being and its utility in the broader scheme of macroeconomic policy.

 

The economic consequences of Arvind Subramanian’s grandchild

Mans Chakravarty has a tongue in cheek piece:

The economics profession is in a tizzy. Chief economic adviser Arvind Subramanian’s announcement that he was quitting his post because he was expecting a grandchild in the US in September has bitterly divided economists.

Some have speculated whether there could be other reasons for Subramanian’s exit. An economics student, for instance, wondered aloud whether Arvind Subramanian, Arun Jaitley and Piyush Goyal constitute—what in economics is known as—the impossible trinity. Some believe Goyal to be exogenous variable that upset the general equilibrium. But ceteris paribus, we must take Subramanian at his word.

A guilt-ridden macroeconomist, shedding tears of repentance, regretted he had missed his daughter’s childhood because he was busy giving lectures on free markets. “I thought the invisible hand would take care of it,” he sobbed.

But many of his colleagues disagree. “It’s a matter of comparative advantage,” said a trade economist. “Does Subramanian think he has a comparative advantage in nappy changing or gurgling and cooing to his grandchild, rather than being a chief economic adviser?” he asked rhetorically. He claimed global productivity would rise if everybody did the things they were good at—economic advisers at dishing out economic advice and baby-sitters at baby-sitting. Adam Smith, he said, was a firm believer in division of labour, subtly adding there is no record of Smith having played with his grandchildren.

Read the whole thing 🙂

Lecture on economic history by Deirdre McCloskey

Here is video of Prof McCloskey’s recent lecture given on 30 May 2018.

The Sindhi Merchants of Gibraltar..

Nice story by Madras Courier.

It tells us about how Sindhis sensed business opportunities in Gibraltar.

How Treasury Head of Bank of Baroda made profits in Indian bond markets when most others made losses..

Nice story by Anto Antony and Kartik Goyal of Bloomberg Quint. The financial media rarely profiles fund managers in bond markets and even rarer to see the fund manager from a public sector bank.

Recently fund managers in Indian bond markets went through a tough ride as yields of government bonds rose significantly. There was one fund manager Kamal Mahajan of Bank of Baroda who did well. Why?

The answer is simple: He went contrarian. When all others were buying as RBI was cutting rates, Mr Mahajan started selling as he though rate easing cycle was about to end.