Archive for the ‘Central Banks / Monetary Policy’ Category

Why it is important to define money correctly..

December 2, 2016

An interesting and timely piece by Frank Shostak.

He says currently we are trying to take out new measures for money just to fit their correlation with economic indicators. This is no way to define money:


Need for Governance at the Central bank boards…(lessons for India?)

December 1, 2016

This is a timely piece by Ashraf Khan on IMF on the need to look at central bank boards. He says Central bank boards are no different from corporate boards and needs similar critical reviews.

This is highly relevant to India.

One of the biggest puzzles (and frustrations) has been role of Indian Central Bank’s Central Board in India’s demonetisation.


Global war on cash: Switzerland bucks the global trend by maintaining a cash tradition

December 1, 2016

Anti-cash movement is all official and moving at a rapid pace.  There are rumors that Euroland is attempting tax on ATMS.

But then some countries are managing to maintain their sanity and believe in cash tradition. If the country happens to be Switzerland, it is a big setback for the anti-cash movement.

The Swiss are rarely late. But a new series of bank notes has been in the making since 2010. The new Swiss franc notes are finally being released, starting with the 50-franc bill rolled out earlier this year.

This latest series of Swiss banknotes arrives as alternative forms of payment are gaining popularity worldwide and cash, particularly in high-denomination notes, is being closely monitored to prevent counterfeiting and crime.

In Switzerland, however, tradition trumps trend. Cash remains the preferred method of payment and is unlikely to lose that position anytime soon. In fact, banknote circulation has increased from a nominal value of 40 billion francs in circulation in 2007 to more than 65 billion in 2015.

“Despite rapid technological developments in the payments arena, cash has yet to be superseded; indeed, it is still a widely used and popular option in Switzerland,” said Swiss National Bank Chairman Thomas Jordan earlier this year.

A recent study by the Bank for International Settlements confirms this trend: the ratio of credit card payments to GDP in Switzerland is only 10 percent, compared with 25 percent in Sweden and 34 percent in the United Kingdom.

The thinking is more on design of the currency:

The Swiss may not be in a rush to change the way they use banknotes, but it’s a different story when it comes to designing them. The new series has moved away from depicting well-known Swiss personalities in favor of more nuanced and abstract concepts.

Under the theme of “the many facets of Switzerland,” each note displays a different concept from a Swiss perspective. “Each characteristic is communicated via an action, a Swiss location, and various graphic elements,” according to the central bank.

The 50-franc note, which previously portrayed Dada artist Sophie Taeuber-Arp (the only woman in the old series of eight notes), now uses wind as the key motif to symbolize the wealth of experiences Switzerland has to offer, represented by a dandelion and a globe on the front and a paraglider traversing the Alps on the back. Other notes will embody time, water, matter, and language.

The new banknotes also include tactile features to help visually impaired people distinguish between the different denominations.

While the final design of the next banknote in the series remains to be seen—the 20-franc note is scheduled for release in 2017—it is safe to say that Switzerland will continue doing some things differently so that other traditions can be preserved.


I don’t know but we get too badly carried away by technology hype. I am sure there will be serious unintended (and intended) consequences of this digital drive. What should have moved as a gradual process has been made way too disruptive.

Infact, one big question is what prevents the governments from banning/restricting digital payments in future?

Demonetisation 2016: Impact on money supply…some initial trends..

November 26, 2016

The data for Nov. 11 2016 shows that M3 declined by Rs 38320 Crore in the fortnight.



Demonetisation 2016: How is RBI adjusting its Balance Sheet? Some initial trends..

November 26, 2016

RBI released its Weekly Statistical Supplement for week ended 25 Nov 2016. It has RBI balance sheet and Reserve Money data for week ended 18 Nov 2016 and Money Supply data for 11 Nov 2016.

What are the initial trends?

In the RBI Balance Sheet, we see a marginal rise of Rs 8539 Crore. The major changes are mainly on items in Liabilities side and marginal ones in Assets (as expected):


India’s 2016 Demonetisation: Quoting John Stuart Mill and lessons from Milton Friedman….

November 25, 2016

Milton Friedman’s one of the most famous and widely read papers is – The Role of Monetray Policy , American Economic Review, March 1967. Each time you read it, you learn something new.

In the paper, he quotes John Stuart Mill (page 12):

My own studies of monetary history have made me extremely sympathetic to the oft-quoted, much reviled, and as widely misunderstood, comment by John Stuart Mill.

“There cannot . .. ,” he wrote, “be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order” [7, p. 488].

True, money is only a machine, but it is an extraordinarily efficient machine. Without it, we could not have begun to attain the astounding growth in output and level of living we have experienced in the past two centuries-any more than we could have done so without those other marvelous machines that dot our countryside and enable us, for the most part, simply to do more efficiently what could be done without them at much greater cost in labor.

But money has one feature that these other machines do not share. Because it is so pervasive, when it gets out of order, it throws a monkey wrench into the operation of all the other machines. The Great Contraction is the most dramatic example but not the only one. Every other major contraction in this country has been either produced by monetary disorder or greatly exacerbated by monetary disorder. Every major inflation has been produced by monetary expansion-mostly to meet the overriding demands of war which have forced the creation of money to supplement explicit taxation.

The first and most important lesson that history teaches about what monetary policy can do-and it is a lesson of the most profound importance-is that monetary policy can prevent money itself from being a major source of economic disturbance……

The words are just so profound. They sum up monetary history and experiments across world and across time in very few words.

There is a reason why history of India’s demonetisation tells us the reluctance of Indian central bank of going ahead with the move. There is a reason very few central banks and countries have gone ahead with the move at the first place.

Infact, why go far in monetary history. Just see today’s world economy. Its major source of instability is the monetary policy conducted by central banks which has made money a major source of economic disturbance.

The anti-cash movement rising across world and its unrealised wide implications..

November 25, 2016

Joseph Salerno of Mises Institute has been warning us against the rising anti cash movement across the world.

In an earlier talk Salerno tells us how these are just attempts by the State to ensure you are always under their radar.

Governments, at least modern western governments, have always hated cash transactions. Cash is private, and cash is hard to tax. So politicians trump up phony reasons like drug trafficking and money laundering to win support for bad laws like the Bank Secrecy Act of 1970, which makes even small cash transactions potentially reportable to the Feds.

Today cash is under attack like never before. Ultra low interest rates are the norm for commercial bank accounts. In Europe, as the ECB ventures into negative nominal interest rates, certain banks threaten to charge customers for depositing cash. Meanwhile, certain European bonds now pay negative yields, effectively turning them into insurance products rather than financial assets. And some economists now call for the outright abolition of cash, which shows just how far some will go in their crazed belief that economic prosperity can be commanded by forcing us to spend rather than save.

The War on Cash is real, and it will intensify. Here to explain is Dr. Joe Salerno, who spoke on the subject at our recent Mises Circle event in Stamford, Connecticut.

In this piece, Ryan McMaken sums up the talk:

As Joseph Salerno has observed, the elimination of physical cash makes it easier for the state to keep track of private persons, and it assists central banks in efforts to punish saving and expand the money supply by implementing negative interest rate schemes. 

A third advantage of the elimination of physical cash would be to more easily control people and potential dissidents through the freezing of their bank accounts.

Joseph Salerno further points that post-India, there is a similar movement in Australia as well:

The global war on cash is remarkably well coordinated. Less than a week after the Indian government announced it was withdrawing its two highest denomination currency notes (equivalent to about $15.00 and $7.50, respectively) from circulation, the Anti-Cash Axis, which comprises a witch’s brew of national governments, establishment media outlets, international bureaucracies and, especially, gigantic multinational banks, has launched a concerted attack on Australia. Two days ago, Citibank announced that it was going cashless at some of its Australian bank branches.

Yesterday, Swiss giant UBS called for the elimination of the Australian $100 and $50 bills because it would be “good for the economy and good for the banks.” The Australian government in cahoots with the media prepared the way for these brazenly self-serving antics by two of the largest banks to have failed and been bailed our during the financial crisis. Back in February a leading Sydney newspaper published a series of articles, some authored by officials from Australia’s Treasury Department, suggesting that abolishing cash would “save billions” and that  “a cashless society is the next step for the Australian dollar.” 

I have a better proposal for our brothers and sisters Down Under: don’t acquiesce in the elimination of your cash; eliminate the banks by immediately reclaiming all your cash that is “on deposit” at these institutions that cannot exist without government guarantees and bailouts.  

What is interesting to see across are huge double standards across the globe. We are hardly seeing a natural evolution towards e-payments.

There is this supposed crony capitalism where these large banks/payment providers are using Governments to push people towards their products. Then these very large corporate/financial players along with these e-payment providers build a story that how these things are about development of markets and making them efficient!

Part of the blame is on economics education as well. Earlier history of money was known to most students. Now we hardly discuss about historic evolution of money and State’s deep interest and manipulation in the matters of money. The way we have moved from commodity money to fiat money and all fiat money declared as legal tender with very little State accountability is a fascinating tale untold. And now this jump towards plastic money which gives State powers to monitor you as well. What better?

It is shocking that earlier most economists would have raised questions on this State involvement in monetary matters. Now most are backing it!

Digging India’s Demonetisation History Part -2: Case of Pakistan demonetising Indian Rupee notes post Partition….

November 24, 2016

The history of demonetisation continues to be fascinating. After posting about two episodes of Demonetisation in India in 1946 and 1978, one came across another one reading RBI history during Partition.

There are various economic history issues in Indo-Pak partition. The currency usage was one such issue. Before Partition, the Indian Rupee was used across the sub-continent. Post-partition, how did Pakistan move onto a new currency? How was Indian currency removed  or in other words demonetised from Pakistan monetary system?What was the process?

In RBI’s first history volume (1935-51), there is some interesting discussion on these issues. (Let me warn upfront. This one is both a long and confusing post):


Currency Notes across the world in 2016..

November 23, 2016

Currency notes have become a new obsession with this blog. After seeing some surprising interest by viewers on the blogpost on new notes in Norway, one decided to see what is happening across the world.

Here are some links of new notes issued across the world in 2016:

If visitors know of other new launches, please add to the list. Thanks.

Meanwhile meet Norway’s new bank notes…

November 22, 2016

Norway has announced launch of new notes as well. But hardly as disruptive as we have done. These notes will come into circulation in Summer of 2017.


Demonetisation 2016: The notification on withdrawing cash for marriages…(recovering lost art)

November 22, 2016

One was assuming whether Indian government has lost the art of writing detailed notifications which they wrote so often before the 1991 era.

In those days, everything for you was planned by the government and written painstakingly in the notices. The language and details stunned one and all as it was so meticulously written. One  often asked how is it that Government knows so much about me which I also don’t know. But then such were the times.

With all this liberalisation and markets, one would have thought this art too would have been lost somewhere. More so in the twitter and whatsapp generation where brevity is of utmost importance, who has time to think and write in such details.

But one is wrong. If the recent RBI notification is to be believed, the skills are intact.




Bank of England should resist appointing yet another “pale, male and stale” economist…

November 21, 2016

Mark Gilbert of Bloomberg View advises Bank of England to not look at  another male elite economist from London as its DEputy GOvernor. Instead it should appoint  a Female, Northern Brexiteer..

The Bank of England is advertising for a new deputy governor to start next year. As you’d expect, the job posting lists several desired features aspiring candidates should have. But let’s hope the winning applicant possesses some attributes not listed in the official job description; ones that would make the central bank’s monetary policy committee more representative of the community it serves. That might also help restore public faith in a valuable and somewhat beleaguered institution.

Research suggests managers typically prefer to hire people who remind them of themselves. So there’s a risk that the recruiters for the 270,000 pound-per-year ($335,000) role will opt for yet another white, male economist. That would be a mistake, and a missed opportunity. Given the recent assaults on central bank independence and criticism that monetary policy has disadvantaged huge swathes of the electorate, it’s more important than ever that policy makers reflect the diversity of society as a whole.

Here, then, are some of the attributes the government should be looking for as it trawls through the applications for this prestigious post.

  • Shatter the Glass Ceiling (select a woman)
  • Location, Location, Location (No more Londoners please)
  • Brexit Means Brexit (someone who believes in Brexit)
  • Hire an Entrepreneur, Not an Economist (well well well)

The last bit is an egg on the face on econs:

The advert says the successful candidate “will have an advanced understanding of economics.” I’d argue that professional economists are increasingly having to admit that even they don’t really understand what makes economies tick. Given the amount of time the new deputy governor will be forced to spend in the company of other officials — “He or she will be a member of the Monetary Policy Committee, the Financial Policy Committee, the Prudential Regulation Committee, the Court of the Bank of England and will also represent the Bank on several international bodies,” the job description states — it might actually be more helpful if they are not a professional economist so they can resist groupthink and bring a different experience and viewpoint to the discussion.

I’ve argued before that the lack of businesspeople on monetary policy boards is a serious shortcoming. No-one understands the labor market and the economy quite like someone who’s built a business from scratch. Nothing focuses the mind quite like having to make payroll on a Friday. Conservative lawmaker Andrew Tyrie, who heads the Treasury Select Committee, said earlier this week in a discussion about central bankers that “their capacity to create a theology is virtually boundless.” He’s absolutely right. Given the newfound enthusiasm among central bankers for all things blockchain, perhaps a bitcoin entrepreneur is the ideal candidate.

As well as having well-rounded and diverse personalities, monetary policy makers should empathize with the interests, desires and ambitions of their constituency. (Governor Mark Carney revealed under interrogation by a gang of schoolchildren in September that the culinary television program The Great British Bake Off is his guilty pleasure.) The next deputy governor doesn’t need to be a fan of fondant fancies and three-dimensional gingerbread structures, but being aware of cultural context doesn’t hurt.

At this point, it would be nice if I could at least come up with a shortlist of candidates for consideration. Unfortunately, the world of business and finance remains a white male bastion; only seven of the U.K.’s 100 biggest businesses, for example, are run by women (see what I mean about the glass ceiling still being firmly in place?). I’m at a bit of a loss. But if you know anyone who fits the bill, the Cabinet Office is taking applications until midday Nov. 21.

Amazing times..

Understanding RBI Board’s role in Demonetisation 2016…

November 21, 2016

This is a great time to learn about role of law in monetary affairs. It is so crucial as we will see.

One question that is central to the demonetisation strike is “What gives government the powers to declare legal tender illegal?”

These powers come from RBI Act. Not surprisingly, the act was made by the British government and we have just followed! They ensured that amidst all this legal language which shows an independent central bank, the power to make a currency legitimate or illegitimate remains with the government.

Section 26 (2) of RBI Act gives these powers:

(2) On recommendation of the Central Board the [Central Government] may, by notification in the Gazette of India, declare that, with effect from such date as may be specified in the notification, any series of bank notes of any denomination shall cease to be legal tender 2[save at such office or agency of the Bank and to such extent as may be specified in the notification]. 

It says on recommendation of the Central Board government may declare a currency as illegal tender by issuing a notification in the Gazette of India.Why Gazette? Well it contains all the notices of the government. One can see the Gazette notification on 8 Nov 2016 here and here.

If you notice it says “On recommendation of the Central Board….” this can be done. What is the Central Board? It is the main body of RBI which governs the central bank and has 21 members . These directors are divided into official and non-official:


Questions over Indian central bank role in demonetisation rising…

November 21, 2016

I had worried about this aspect very early on. It is strange that not a word has come from Indian central bank on the decision except for confusing notifications. This is such a matter that no talk only creates more suspicion around the problem. If the Governor is reticent and fighting behind the scenes, why not appoint someone else to do the talk? I mean someone has to say atleast something.


Now, we have questions like: RBI’s silence on demonetisation raises questions on its independence. Even worse, the Bank Officers’ Union demands resignation of RBI chief given the chaos.

I am really surprised no banker/policy expert etc has made this request. Tons of paeans were sung by one and all on the appointment and more funnily connecting all kinds of powers to the central bank. Even post demonetisation, similar experts hailed it as one of the best moves ever. None have asked now why is the central bank not speaking on the matter? If RBI is not saying things as it has been kept off the loop and so on, then it is even a more serious matter.

The favorite topic of RBI independence has suddenly disappeared when it matters quite a bit. For all you know, one of the most reputed newspapers is reporting that PM indicating a rate cut post the strike yesterday. We would imagine such news coming from central bank and atmost from FM who can at best say – one wishes RBI does cut rates.

I mean reports saying that post demonetisation case for rate cuts has increased is like a joke.  The entire effort and noise around so called central bank reforms and making our policy like a developed one has become almost a joke. It looks more a case of monetary policy being run from Delhi now…

Does this demonetisation drive undermine so called RBI independence?

November 15, 2016

I am surprised no one is asked this question yet.

History of two previous demons tell you that both the times, RBI chiefs had reservations about the idea. It still went through, as government is the final boss. The real fear for RBI was the move could destabilise the economy for what were perceived as fiscal and political goals. In 1946, RBI chief thought the exercise was aimed at increasing taxes and in 1978, he said it was on political grounds!

We really do not know what RBI views have been on a demonetisation exercise as big as this. In 1978, it juct knocked of 0.8% of currency and still RBI was worried. This time more than 100 times of the amount or 86% has been knocked off  and we do not know how central bank reacted to the initial idea. The key persons of RBI were involved in the secret planning (which has been inadequate to say the least) of the event. So, it is not as if they were kept off the loop. But since the whole thing was secretive, one does not know how much details will be shared when history of this period is written in future. This is as big a moment in India’s monetary history as any but may be we will never know,

However, one thing is really puzzling. How is it that the central bank has agreed to go ahead with this hammer of a tool to control/manage ills of the society (if one can call it that) at such a large scale? Did the Government completely ignore caution or warnings made by RBI on this matter? Or RBI just gave into Government’s demands?

All this is important as no one cared about central bank independence or autonomy in 1946 0r 1978 when last demonetisations were done. It matters a lot now. Perhaps it is the only thing that matters in debates around central bank – it should be independent. We all celebrated when the new RBI Governor was appointed using all kinds of adjectives and finally saying thank god, RBI will remain independent given the credentials of the new Governor!

Though, this blog has never really cared much for independence noise as one knows that the final call is that of the govt. But there are certain matters where central bank has to strongly oppose or warn even if it has no independence as earlier ones did. Now we think it has independence so one just hopes there is enough defense of the turf.

One is already seeing some signs of people questioning all this. In this piece, Ashok Swain says:

The decision of withdrawing Rs 500 and Rs 1000 notes in such an abrupt manner was Modi’s alone. Like many other important decisions of his government, on this one too he had not taken his acquiescent cabinet into confidence.  He even handpicked a pliant Reserve Bank of India governor to go along with him in his precarious choice.

Ila Pattnaik says this decision puts the recently constituted MPC into a puzzle:

There is a widespread sense that the decision of the government is bad news for bad people but for the rest we will be fine. This thinking may be too complacent. In the last few months, RBI, government, the newly constituted MPC and many observers have realized that demand in the Indian economy is weak and there is a need for monetary easing. 
In the decades before the policy rate was used for monetary policy, the main instrument of monetary policy used to be money supply. Now we have got a huge reduction in money supply. The timing of the monetary tightening is inconsistent with the stance of monetary easing. We expect that this sudden tightening will negatively impact production in the quarter Oct-Dec 2016. 

She does not question independence per se, but the MPC easing has created a really awkward situation. What does it do in next meeting?

Though, section of markets are believing it makes the case for rate cuts given slipping demand etc. I mean it is getting so bizarre. You ease with rates, then tighten the supply suddenly and then again ease rates as economy is not generating demand.


A good friend and regular follower Mumbai Paused told me someone did ask the question. RBI staff itself!


Effect of Demonetisation 2016: Parallel currency developing in marriages!

November 14, 2016

This is a great time to understand basics of money, currency and many other things.

A currency note is nothing but an “I owe you” note. The RBI Governor on behalf of the government on a 100 rupee note says” I promise to pay the bearer the sum of hundred rupees”.  Earlier, this 100 rupees meant one could exchange it for Rs 100 of Gold or silver. But in the era of fiat currency, there is no such backing. So the currency runs as per mere order of Government. The entire thing is based on trust in the government.

As the government itself decided to take out the legal tender from the market, there is total chaos. After all money is the essence of a market economy. Anything could be money but in India and most parts of the world, money is meant as cash atleast for settling basic transactions.

Within the chaos comes out some interesting innovations from people. This is one such innovation where people are giving empty envelopes in marriages. Outside the envelope it is written the words of central bank governor in Hindi with a promise to pay in future. So, once the guests get money they shall pay the family.

This wedding season, newlyweds have started receiving IOU (I owe you) envelopes from relatives promising them their ‘shagun’ on a later date. After the Centre’s demo netisation move, several wedding guests in Jaipur approached designers to print informal signed envelopes which promise that the bearer will be paid a sum varying from Rs 500 to Rs 2,100.

 Sixty-year-old Praveen Nahata, a senior marketing consultant, got some such IOU envelopes printed. “My family has to attend a dozen weddings this season. I am gifting them an empty envelope with a promise to pay a sum varying from Rs 500 to Rs 1,100. I will pay them the amount when the flow of new currency notes becomes normal,” Nahata said. There have also been reports of people opening envelopes in front of guests and returning old currency notes.
Parents of some brides and grooms have requested guests not to gift old currency notes. “The father of the bride or groom is already troubled with a lot of things. After my daughter’s marriage, I don’t want to be waiting in long queues to deposit old currency notes. I got many things done on credit for the wedding,” said Jyoti Prasad Sehdev, the father of a bride.

Interesting bit.

This is nothing but development of a parallel currency at a much smaller scale. Now, if people trust and circulate this envelope amidst themselves as currency, it just becomes a currency. The promise to pay statement has to be trusted and credible. However, one place where this currency will not be accepted is you guessed it – government offices and departments. They say we shall only accept our issued currency for paying taxes and other services. As governments typically are the largest economic entities, one has little choice but to accept their currency.

This is also how governments eventually pushed their currencies for broader usage. Gradually, they generated economies of scale from their operations and govt issues currency became the only circulating currency in most economies.

Digging through India demonetization history — 12 Jan 1946 (Saturday) and 16 Jan 1978 (Monday)

November 11, 2016

Warning upfront: This is a long long post..

One is trying to break his head over both ongoing effects of demonetization (demon) and the historic bit as well. There are so many articles on the history bit that one is just confused. So here is more to the confusion.


Let me start with some trivia. It is interesting to see the similarities in the dates of previous two demons. Both were in Jan with just four days away from each other – 12 Jan 1946 and 16 Jan 1978. One could call it the Jan demon! Even the days are just seperated by the Sunday. In the third one, the date is 8 Nov 2016 which was a Tuesday. So you have 8, 12, 16 series. Next one whenever could be on 4th or 20th of perhaps December!

First Denom — 12 Jan 1946 (Source: RBI History 1935-51, pg 706)


Probable impact of demonetisation on RBI balance sheet and monetary system…

November 10, 2016

As this blogger was wondering about the economics and logistics of the demonitisation (demon) and some trends too), was woken up by friends from markets. Their worry and sense of excitement was completely different. Keeping these basic problems aside, the interest was mainly in arbitraging from this demon exercise. The questions were what happens now to RBI balance sheet? Will rise in deposits lead to lower or higher money market and G-sec rates? Will it lead to lower or higher liquidity? Whatever it is, financial market players are always looking to arbitrage whatever the situation. Take it or leave it.

One decided to take it and atleast think through the circle of events. Given one’s earlier work on the topic one started from some basics.

Right at the start one must admit that this post is laced with loads of assumptions. In one stroke it is assuming people will find it easy to exchange or deposit cash, have bank accounts and so on. The reality is obviously different. The main purpose is to just understand the flows  in the abstract monetary system.

First of all, demon should mean RBI Balance sheet should decline as that is what leads to money being taken away from the system. But this is not the case here as we have swapping with new notes. So things get complicated. Moreover, the swapping may not be one on one as some might not disclose the entire cash given penalties and charges.

So say before demon RBI Bal sheet is like this:

Liabs                                                Assets
Currency              100                        G-sec                                100
Bank Reserves     100                       Foreign assets (forex)   100

So say 20% of currency does not came back to RBI. This leads to lower liabs.

Liabs                                                Assets
Currency                80                        G-sec                                100
Bank Reserves     100                       Foreign assets (forex)   100

The question is should RBI reserves or give govt profits? Then balance sheet is like this:

Liabs                                                Assets
Currency                80                        G-sec                                100
Bank Reserves     100                       Foreign assets (forex)   100
Profits to Govt       10
Reserves                 10

The higher one time profits will lead to lower fiscal deficit and this will lead to lower yields. This is one of the hypothesis.  However, this defeats the purpose of demon. As any reserves or profits will eventually come back to the system.

For demon to make sense, ideally RBI should cut the assets by 20%. . Come to think of it this is what demon should mean. Mon means rise in reserve money or RBI Bal sheet and demon means decline.

The next q is how does rbi cut assets. Two ways. By reducing GSec or forex.

Liabs                                                Assets
Currency                80                        G-sec                                90
Bank Reserves     100                       Foreign assets (forex)   90

If forex, then RBI sells fores and sucks liquidity. This means  liquidity should tighten and money market rates should go up. There will be downwards pressure on rupee as well.

If G-sec via OMO sales then yields should go up and liq again declines. Either way liquidity declines and in OMO sales we see yields also going up.

What eventually happens will depend on currency coming back and RBI deciding what to do of demon. Though if history is any guide, then the opposite happened. Last time demon happened in 1977-78, we saw both currency in circulation and RBI Balance sheet actually rising in 1978-79! So no case of tight liquidity etc but liquidity actually rising…

Another point is inflation back then. If inflation was high than nominally these values will rise. Mid 1970s inflation was very high due to oil shock and then started to decline a bit. After this demon ideally inflation should have declined but it rose significantly as there was no demon really as explained above. Inflation also rose as we see fiscal deficits also rising from 1978 onwards…

However, story does not end here. Another angle is rise in bank deposits. People are going to exchange currency in two ways. One is the direct exchange and another is deposits via the banking system. The above changes in currency in RBI liabs will happen via the banking system. The cycle is likely to be this:

  1. People come to a bank.
  2. Some choose to exchange. This gets reflected in RBI liabs straight away with some lag.
  3. Others choose to deposit first and then take out money when needed.
  4. So first the deposits with banks go up. This leads to rise in so called CASA balances of the bank. Thus, banks may not need to go for deposits etc for sometime.
  5. This rise in CASA will lead banks to park 4% of proceeds as CRR with RBI.

How does this show in RBI balance sheet eventually. Let us say 50% choose to deposit and 50% choose to exchange. So the Rs 80 aboe is divided into Rs 40 between currency and deposits.

The balance sheet of RBI in near future will be like this:

Liabs                                                Assets
Currency                40                        G-sec                               ??
Bank Reserves      111.6                   Foreign assets (forex)   ??
Total                      151.6

We see steeper decline in balance sheet here from 180 to 152. This is because as explained above it takes time for deposits to be converted to currency. So we have a case for a steeper cash crunch in the economy in near term. So on one hand rise in CASA deposits puts downward pressure on interest rates. On the other as it takes time to be converted back to deposits, it indicates cash crunch at RBI end. It will again depend on net net between central bank and banks. Banks might not be impacted as they have deposits but other players could face the crunch.

Another factor which has to be added is cost of printing these massive number of notes. This cost needs to be taken into account as well which also shrinks the balance sheet.

So lots of stories and linkages. What I have tried to do to best of my ability is to list these linkages. There could be some missing as well. The reality could be very different as seen in 1978. Moreover, what we have tried here is the accountancy angle. We could see no cash crunch at all due to several other known and unknown factors.

Things are different this time as Rs 500 and Rs 1000 notes with many people unlike 1977. How eventually people decide to exchange/deposit is what will matter.

I think I have only confused people more by this post. There are just no easy answers. Markets are dynamic in many ways and will move based on every bit of cue…

Is issuance of long term bonds sign of financial market maturity or destruction of the market economy?

November 8, 2016

Pick a macro or financial eco textbook and the standard narrative on bond market goes like this. Earlier, the governments just printed currency to finance deficits. This was called deficit financing which led to uninterrupted inflation. Then agreements were signed and this auto financing was stopped. The role of inflation management was given to central banks who started with monetary targeting and then gradually moved to inflation targeting.

One thing which developed due to this was the bond market. The governments needing money could not print currency so they started to issue bonds. Overtime, the governments issue bonds across time tenors to “manage the cashflows across time”. These bonds began to be traded and we eventually got an active yield curve. Then yield curve in turn becomes this public good which helps price other securities as well. So, if one is looking at pricing a security over a 10 years, then one uses the 10 year bond yield and so on. Thus, longer a yield curve it shows the markets are matured and so on. This leads to enormous literature on pricing financial securities across the yield curve and also figure whether it is efficient. There were later linkages of slope of yield curve to recessions etc.

This seems to be the standard narrative across most courses and books. However, most omit any criticism of  this standard narrative.

Joseph T. Salerno has a piece reflecting on the recent 70 year bond issue by Austria. He says bond issuance is the in thing given such low yields compressed artificially by the central banks. But a bigger question is why should govt issue bonds given they anyways issue fiat currency:

Nearly seven decades ago, Ludwig von Mises explained the seemingly irrational hunger among capitalists for long-term government bonds as based on an illusion. The illusion is that wealth once painstakingly accumulated in risky ventures can be removed from the competitive and uncertain sphere of the dynamic market process and preserved forever intact in a changeless realm of perfect certainty created by an imaginary political sovereign who is eternal, all-powerful, and unchanging.


The issue of government bonds is actually more insidious and destructive of the market economy than the issue of fiat money for two reasons.

First, politically, the issue of long-term bonds and the relentless piling up of government debt perversely bolsters and perpetuates the myth that the State is an eternal entity that somehow is not subject to the disturbances and uncertainties of human affairs.

And second, economically, the existence of government debt as a safe haven for wealth and an inexhaustible fount of income diverts capitalists and entrepreneurs from devoting all their attention and resources to their vital function of allocating scarce resources to the most urgent of the anticipated demands of consumers.

In fact, in an economic system burdened with fiat money, it would be preferable to ban government borrowing altogether. This would force the government to cover all of its deficits with irredeemable paper fiat money, which does not pay interest. There would be substantial benefits from this course of action. It would demystify the inflationary process for the average citizen. Instead of the Fed camouflaging its creation of money by the hocus pocus of “setting interest rates” via buying and selling bonds, financing government budget deficits would entail a completely transparent operation in which the Fed prints up money and directly hands it over to the U.S. Treasury.

Also the Fed would become a division of the Treasury and would no longer be involved in manipulating interest rates, which is the root cause of business cycles. And lastly, banks and other financial firms, which now hold vast quantities of government bonds and are a powerful constituency in favor of maintaining the political status quo in order to keep their interest payments flowing, would no longer be “a partner of the government which ruled people and exacted tribute from them.” Keynes infamously called for the “euthanasia of the rentier”; Mises’s theory of the public debt leads us to call for the euthanasia of the parasitic, government rentier.

Hmm. An argument which turns the standard narrative upside down. The standard narrative argues for bond markets to limit printing of currency. This one says bond market just covers the issue without really solving it. Central banks were issuing currency earlier now also they do the same but show it as a bond exercise.

These are issues which need to be debated at the foundation level but hardly any attention is paid. What we are taught as market economics in macro/finance texts is just a variant of the managed one which we are warned against.


Bank of England member joins HSBC…

November 4, 2016

There are several classes in the world. But I guess the highest class is that of top echelons in world of banking and money. It is just shocking to see how one on reaching this class continues to move from one organisation to the other with aplomb. It is as if the entire class takes care of you.

The crisis has exposed the ill-effects of this arrangement but it just does not end. One keeps moving from private bank to central bank/finance ministry and then back to the private world with amazing ease. Countries like Nepal are trying to put an end to the exercise but there is no such thing in the developed part of the world.

Infact, the whole thing is getting bolder. There seems to no cooling period whatsoever. How else does one explain this recent Bank of England revolving door? In this case, one Financial Policy Committee Member quits the central bank and the decision to appoint her at HSBC came in quick succession. Even worse is that newswires knew of the moves much in advance.

Just keeps getting worse..