My presentation to the Bombay Chartered Accountants' Society International Economic Study Circle on Global macro-economics, trends, portfolio implications Aug 7th 2013 Mumbai, India

1. AUG 7TH
2013
Global macro-
economics, trends,
portfolio implications

2. Topics
 Important Schools of Economic thought
 Modern Monetary Realism
 Quantitative Easing Myths
 Kalecki equation / Flow of Funds analysis
 Outlooks on Different Sectors
 Important influencers

3. Important Economic schools
 Mainstream / Orthodox Economics (Paul Krugman)
 Austrian School / inflationistas (Peter Schiff)
 Post-Keynesian
 Modern Monetary Theory (MMT) i.e. Chartalism
 Monetary Realism (MR) (Cullen Roche)

4. Monetary Realism – concepts
 Monetary Realism (MR) is a description of the fiat monetary system
applicable to nations who are issuers of their own currency, but have
outsourced the broader money supply to the private banking system.
 In many market based systems such as the USA, the money supply is
essentially privatized and controlled by private banks that compete to
create loans which create deposits (money).
 Contrary to popular opinion, governments in such a system do not
directly control the money supply or create most of the money.
 The Central Bank (Federal Reserve in the USA) and the Government (US
Treasury) have a symbiotic relationship and together are issuers of the
currency to the monetary system.

5. Monetary Realism – concepts
 The private banking sector issues bank deposits (“inside money”) and the
public sector issues coins, paper cash and bank reserves (“outside
money”).
 Nowadays most means of payment involving private agents are transacted
in bank deposits and, as such, the ins and outs of “inside money” are vital
to understanding how the modern monetary system functions.
 As the issuer of currency, the government has no solvency constraint as
there might be for a household or business. The federal government’s true
constraint is never solvency, but inflation.
 “We generate improving living standards through the efficient use of
resources resulting in the optimization of time”
 System of flows: In the money system, the “health” of the system is based
largely on how this flow results in an improvement in living standards over
time. Are the economic agents using this flow to create goods and services
that improve the overall standards of living for the system as a whole?

6. Debunking Myths
 US government has solvency constraints / it might “have trouble
paying the interest on the national debt”.
 Interest rates will rise if the Fed stops buying bonds. Fact: after QE2
ended, interest rates tanked). There was no shortage of buyers of
government bonds. In fact, Treasury auctions showed stronger bid to
covers just as MR predicted.
 Money multiplier / Fractional Reserve Banking
 Inflation = decline in living standards e.g. purchasing power of US
Dollar has declined 90% since 1913; but living standards have soared.
 US “money printing” will cause hyper-inflation.
 Resource scarcity
 Tapering = tightening
 QE is money printing.

7. QE – impact on money stock

8. Kalecki Equation / Flow of Funds Analysis
Profits = Investment – Household Savings – Government Savings –
Foreign Savings + Dividends

9. Kalecki Equation / Flow of Funds Analysis

10. Kalecki Equation / Flow of Funds Analysis

11. Outlooks on
different sectors

12. USA – first the bad news…

13. USA – next, the good news…
 Still attracts top talent from all over the world with its immigration
policies / opportunities
 Manufacturing renaissance –
 cheap shale gas – lower, local energy costs
 heavy factory automation
 stronger Chinese Yuan and higher Chinese wages
 3-D printing leading to faster prototyping
 Still one of the best places to start / operate a business with minimal
friction due to bureaucracy / corruption – this operation of free
enterprise / profit motive / capitalist structure with adequate checks
and balances works really well
 Innovation and research powerhouse of the world
 Leads the world in higher education, healthcare, technology

14. USA – bottom line
 Despite being the epicenter of the Great Recession, the US response
was largely in the right direction.
 US has been through a “beautiful deleveraging”, by running huge fiscal
deficits when the private sector was weak.
 Now the private sector is ready to run with the baton.

15. Europe
The Euro alliance was ill-conceived with a monetary union but no fiscal
/ budgetary union and no mechanism to resolve trade imbalances.
They further implemented austerity to deal with their debt, which has
landed them in even greater pain. Huge imbalances between the core /
traditional surplus nations (which at this point is just Germany) and the
periphery / traditional deficit nations (PIIGS).
The German election towards September end will be instrumental in
shaping the further course.
Hope is that they come towards greater unity rather than pushing for a
break-up of the Euro (which would be a huge negative for everyone).
Along with that, a move away from forced austerity into some gradual
adjustments with fiscal deficits / monetary support should help bring
Europe out of its malaise.

16. Japan
 The “Abenomics” experiment is a bold move by the Japanese Govt to
shake the giant from its sleep.
 After a couple of lost decades of deflation, Govt is trying to prod
growth and inflation into the system:
 inflation targeting at a 2% annual rate
 correction of the excessive yen appreciation
 setting negative interest rates
 radical quantitative easing
 expansion of public investment
 buying operations of construction bonds by Bank of Japan (BOJ)
 It will be very interesting to see how this unprecedented experiment
plays out in reality.

17. China
 China has become a red flag, as they’re beginning to experience signs
of a minor credit crisis due to overinvestment / overcapacity .
 But their government tends to be particularly proactive regarding
private sector problems so that could alleviate near-term problems
even if it creates more long-term problems.
Longer-term trends:
 They have run out of the demographic dividend, growing old before
they grew rich – one of the first and largest countries to do so.
 Political resentment / upheaval risk similar to USSR cannot be ruled
out, unless Govt adopts a policy of steady democratization
 Some of the worst pollution in the world
 Two “Chinas”

18. Gold
 Not in favor of the gold standard: the biggest problem is the inherent trade
imbalances.
 Any single currency system like the gold standard is a lot like the Euro in which
everyone uses the same currency so there’s no floating exchange rate, the Govts
can’t print money and have trouble redistributing funds from imbalances to
rebalance economies and so deflation is the only real answer.
 Deflation tends to be catastrophic if prolonged e.g. Spain and Greece. They’re
locked in a single currency, trade doesn’t rebalance through FX because they all use
the same currency, the Govts can’t print money and so they’re suffering through a
depressionary deflation. It’s a disaster. So the gold standard is like putting ourselves
in handcuffs.
 Some people want to put the Govt alone in handcuffs, but that’s not entirely
rational. Govt should work with us and for us. We shouldn’t have to lock it up. Let’s
understand our system better. Not revert back to broken ones.
 Having said that, Gold is a special component with both commodity and currency
aspects and is recommended as a small component in a balanced portfolio.

19. Commodities
 Despite Wall Street pushing Commodities as an “alternative”
investment class, commodities have not delivered either the promised
returns or the hedging.
 Correlation between commodity and equity returns has substantially
increased after the onset of the recent financial crisis.
 Commodities are a cost input that rarely outperforms the pace of
inflation over long timeframes.
 Commodities have no place in a long-term portfolio.

20. Oil
 Do not subscribe to the “peak oil” theory
 Consensus is slowly shifting to the idea that it is oil usage that has
peaked instead. Great article in the current Economist.

21. India – first the bad news…

22. Corruption

23. Education

24. Ease of Doing Business

25. India – my thoughts
 Strong demographic dividend: its young population is an asset not a
liability if properly harnessed and given the right opportunities.
 If governance (both political and corporate) can be improved and
bureaucracy and corruption can be reduced, we have a great potential
ahead of us. Personally, I am pinning my hopes on the next election.
 Property observations:
 Lack of other investment opportunities
 Black money
 Rental yields at 2-4%
 Overbuilding and overcapacity, yet a decent home remains out of reach for a
large section of the middle class
 Prices of ~Rs. 5 Cr. in middle class suburbs – eerily reminiscent of 2006 US
 Only saving grace is leverage is in check

26. My sources / Influencers
 Cullen Roche:
 Blog: www.pragcap.com
 Paid service: www.orcamgroup.com
 Ray Dalio
 Felix Zulauf
 Marketfolly.com

27. Thank you!
Nikunj Sanghvi
nikunj.sanghvi@gmail.com
www.linkedin.com/in/nikunjsanghvi

28. Backup Slides

29. Visual Impact of QE - 1

30. Visual Impact of QE - 2

31. Visual Impact of QE - 3

32. QE Summary
 QE is just Open Market Operations (Fed buys bonds from banks and
credits them with reserves) – it is NOT money printing
 QE can occur with or even without a deficit. If the US govt were running a
budget surplus while also running QE, no one would refer to it as “debt
monetization”. But it’s convenient to intermingle fiscal policy with
monetary policy when pushing the monetization myth. So it’s important to
understand that the idea of QE “funding” the US Treasury would really
mean that demand for US debt has dried up (that is, with a deficit, they
cannot sell debt to the public). That’s very clearly not true and QE2 ending
proved this as yields tanked and demand at US government bond auctions
remained very strong despite the end of the program.
 QE in Europe can actually “work” because it is essentially a form of fiscal
policy that actually helps to fund the countries in Europe (or at least help
them avoid losing funding). This would be like the Federal Reserve buying
municipal bonds from states in distress who can’t find Federal funding (this
would essentially be a form of fiscal policy and would be “money printing”).