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From Moses to Mullah

The distortion of Keynesianism...

Keynes is the son of the Great Depression. His great contribution to economic thought was the equivalent of the auxiliary engine: he postulated that when there is a slowdown in economic activity in the private sector, it is usually because of cyclical factors that include psychology (exhaustion of animal spirits), debt drawal followed by debt repayment (phases) and the (partial) misallocation of capital that needs to kill the flawed private enterprises who indulged in the excesses of the bull market.

During this period, he said, the government should step up Investment Demand (through massive investment in infrastructure), work-creation schemes that put money in the hands of the unemployed ("dig holes in the ground and fill them up") and, as a last resort, pay the unemployed a dole. This is both a humanitarian good, and saves the economy from the excesses of the downturn. The money to fund all these additional recession-busting initiatives (a.k.a. pump priming) can come from 'deficit financing', i.e. the running of huge budget deficits, which are sometimes funded by the printing presses of the Central Bank.

What he also said is not remembered as well, simply because it is (politically) painful to implement: that once the economy recovers, the (temporary) dummy money should be returned to the coffers, by running budget surpluses, which will come from the tax increases and spending cuts during the next boom. Such tax policy will also dampen the animal spirits of the next boom, thereby reducing volatility on both sides of the business cycle.

By itself, this was a good philosophy, which turned Keynesianism into a religion for political leaders of all hues over the next 80 years. A lot of them took to quoting the Keynesian Bible to justify many of their economic policies. So Moses (i.e. Keynes) may have laid out the word of God, but it was left to the mullahs to now interpret his Commandments for the hoi polloi at the foot of the mountain (if you pardon the mixing up of religious metaphors). When the mullahs took over, they implemented half-truths, justified it in the name of the Prophet (a.k.a. Keynesianism) and used the Bible to suit their own ends. The economics and political establishment conspired to deceive the unwashed masses, 'pump priming' cash into a system that saw a never-ending cycle of successive bloating up of government balance sheets, ensuring permanent inflation. This created a Debt Supercycle over the last 80 years, which has now reached unimaginable proportions, at hundreds of per cent of GDP…….Japan at 540 per cent, US 360 per cent, etc.

The Great Depression happened because, like in all recessions, people ran out of cash at the bottom of the cycle, and the 1929 Fed squeezed out the last drops of blood from a wheezing economy. The 'lessons' learnt since then gave politicians over the next 80 years the right to spray cash whenever the R-word cropped up, real or imaginary. Different types of political mullahs used this to have fun in different ways; at one extreme, there was the Indian variety who used it to feather their own nests, and at the other extreme, there were the German puritans who remembered the ghosts of the Weimar Republic only too well.

Post-2008, we saw a new phenomenon. There was no dearth of cash, yet everybody was poor. How did we achieve this? And how do we handle this new problem? What would Keynes/Moses say, if they were not too busy turning in their graves?

And this is when the new mullahs have taken over, the self-appointed interpreters of the New Testament. Just like in the period 1930-2007, when Keynesianism has been 'stretched' to be a panacea for all economic ills from the common (cold) recession/slowdown to a proper (full blown HIV) credit default crisis, there is a new religion needed to articulate the current problems at the end of this debt supercycle. Inflation (like hell) is the natural consequence of listening to the wrong mullah, while the right mullah may 'deliver' you from your sins by hiding inflation under the carpet of currency devaluation. So right now, we have this debate among the mullahs over the 'right sin' of printing money to pump prime the economy, versus the 'wrong sin' of printing money to debase your currency and maintain your trade competitiveness.

For the right sin, you will be rewarded with 72 virgins in 'heaven', i.e. an American retirement (where a firefighter in California can get a $240,000 pension in appreciating Dollars). For the 'wrong sin', you are doomed to an Indian retirement (with depreciating Rupees) in Chennai, with just your ageing wife for company...

You have, in the left corner, Nobel Laureates like Paul Krugman recommending a game of 'playing chicken' with the Bond markets; keep printing and see what happens....look, inflation is dead, let's do some more, it still hasn't moved...in the right corner, you have noble laureates like almost-Vice President Paul Ryan who want to abolish the printing press (i.e. Fed) itself.

As a little aside, during my day job as a currency trader, I often wonder whether those 'technical traders' on the RBI Fx Intervention Committee (don't pay attention to me, these are just my hallucinations; there is no such thing) are going to Keynesian heaven or hell. It depends on what the FM really means when he says everything will be all right...

For example, while the RBI Governor holds the hawkish fort on interest rates, standing up to the mandarins in the MoF, could it be that the unsterilised inflows that are being accumulated by the RBI, has the effect of increasing liquidity and bringing down bank spreads, at least for top Indian corporates. These, by the way, are the only ones with Free Cash Flow, and the ones most likely to still have the firepower to invest. Would this count as 'right sin', it weakens the currency and pump primes the economy, feeding inflationary pressures, of course, but who cares? Have you noticed that quietly, India's total external debt now far exceeds its Fx Reserves (back to 1991), and that 57 per cent of these Reserves is because of portfolio inflows, while 27 per cent is short-term commercial debt? That makes for 83 per cent of Fx reserves being volatile, while total external debt is already greater than Reserves. Setting you up for a right royal Currency Crisis, from which only the (hallucinatory) Fx Intervention Committee can save you. Few countries have a motive for joining the (non-existent) Currency Wars like India does...

But coming back to praying for The Second Coming, who will be the next Christ, sorry, Keynes? Does anybody know how to reduce government debt without actually paying it back? There is a Nobel Prize hidden somewhere here....and this would be the domain of some economist from Kolkata. I don't know whether my Commerce graduation from that quaint city qualifies me to apply, but here goes...

How about Bank Nationalisation followed by Loan melas, combined with SLR ratios that (mis)appropriate retail public deposits to keep interest rates down for government debt? Anyway, most banks in the developed world now belong to the government; if only they could find their own Indira Gandhi, they would be able to 'directly lend' to the unemployed, sub-prime borrowers who created the problem in the first place. Writing off those loans would create a new base of unlevered consumers, who would be 'feeling good' as new again. The resultant economic boom would create new deposits in the self-same bombed-out Banks, who would come back painfully, the way Indian Bank (or more generally, Indian banks) did. Nobody will shed any tears for the expropriated bankers anyway. Pump priming would now be done through 'directed lending' to these now healthy customers, with money taken from the RBI. As the banks revive, these loans are turned into equity through conversion clauses in the loan documents, and then sold off to the public again. That way, the government owns the entire private sector that ever dared to take a loan; with low interest rates, you have high equity markets to sell these ill-gotten gains into...next thing you know, your budget is balanced. See, no hands?!!! I will mention socialism in my Nobel acceptance speech, but not CK Jaffer Sharief.