Economy Dec 16, 2013
One of the job requirements of being a central banker is to make absurd pronouncements with a straight face. This is particularly true about the US Fed, where Alan Greenspan and Ben Bernanke comment on, or rather deny their role in, the formation of bubbles and on the monetisation of deficits. But it's almost as much true for our own Reserve Bank of India (RBI) governors - I am saying "almost as much" because I am not very certain if their statements are because they don't know better, or because they are just great actors.
Without exception, every RBI governor to date has stated that a 5 percent inflation rate is either "good" for the Indian economy, or within their "comfort" zone. Now there is nothing particularly "Indian" about economic sciences (except that if you belong to RSS, you might think of Indian Economics, Indian Physics, Indian Medicine, Indian Astronomy, etc.). If you define inflation more accurately as the "theft of purchasing power...by the government to fund deficits by creating currency units out of thin air", it is easy to see why we as citizens should not tolerate any inflation.
Another favourite issue is how every RBI governor has stated on record that they will not tolerate high consumer price increases while being very brazen about the fact that the RBI is the one and only reason why we have high consumer price increases. In fact, as I have written earlier, their job is to debase the currency while pretending to be the guardians of the purchasing power of the Indian rupee. Incidentally, a statement to the above effect from a central banker ought to be booed, though they are usually cheered by a gullible media and unsuspecting citizens.
Raghuram Rajan, since he began his term a few months back, has avoided making such observations, perhaps consciously. Though there has been a dramatic fall in standards from his opening day speech to his pronouncements in his lasts policy speech, he was still operating at a much higher intellectual standard as compared to his predecessors. And despite whatever I am going to write further in this article, he still is. But the degradation has been rather continuous, though most people would not notice it.
Consider his recent statement where he has asked regulators to be vigilant against Ponzi schemes. That is quite a fall from an earlier speech where he spoke of the need for "zero regulations", though that is not my point in this article. The main issue here is that Raghuram Rajan is enabling the most blatant and abrasive Ponzi scheme that is being run in the country under the guise of deficit financing while he is asking regulators to be vigilant about Ponzi schemes. The very first institution these regulators should be closing down should be the RBI and not some XYZ chit fund. The scale of damage being done by the RBI is so enormous and yet so subtle that most people cannot see it.
Most people would not agree with me when I say that the RBI is running a Ponzi scheme. So let's start with the basic definitions. Wikipedia defines a Ponzi scheme as "a fraudulent investment operation that pays returns to its investors from existing capital or new capital paid by new investors, rather than from profit earned by the individual or organisation running the operation".
So a government that is running gargantuan deficits for several decades (twice the revenues or more), it cannot be repaying the investors legitimately. (When a government states its deficits as percentage of the GDP, it does so to make the number appear smaller. A deficit said to be 5 percent of GDP appears smaller when we should be saying that it is 100 percent of revenues, though both mean the same. But yet, we do not hear of governments defaulting on their obligations - atleast in terms of their own currencies.
This is where the RBI steps in. But before that, why I am saying that governments default when they have been honouring their obligations all these decades? That is because the default does not happen through a one-time event of bankruptcy, as is the case with private entities, but on a continuous basis through the mechanism of inflation. Consider Rs 100 invested in a government bond where we get a return of 7 percent after-tax. We know that we lose about 10 percent on the average in terms of inflation and so the net loss is around 3 percent in terms of purchasing power without even considering the loss of pleasure in the delayed gratification. So this 3 percent is the "implicit default through inflation" that the government indulges in continuously and the RBI is the enabler of this process by printing up new currency units to pay the additional monies required to avoid an explicit default.
Incidentally, Bernie Madoff, who ran a Ponzi scheme for almost two decades till he was arrested in 2008, actually compared his operations with the "US treasury" and said that he was doing a similar thing. What he implied was what I have explained above and we can surely trust Madoff's judgment to recognise a Ponzi scheme when he sees one!!! After all he ran one of the biggest private Ponzi schemes to date.
So what does Raghuram Rajan expect his regulators to do? If these regulators were to take his advice to curb Ponzi scheme seriously, this is what they should be doing:
• Audit the books of the central and state governments.
• They will realise that the deficits are massive even without using accrual accounting and by the government indulging in all types of Enronesque accounting.
• They can easily see that there is no investment in government expenditures and what they have spent is "gone". There is no legitimate way to service the interest, let alone the principal.
• A further investigation will reveal that the RBI is masking the default in payments that should legitimately happen by printing up trillions of currency units, besides indulging in QE (quantitative easing) to suppress bond yields.
• That the RBI has been enabling this Ponzi scheme to continue for decades and the loss to citizens is happening through a massive debasement of the currency.
• Then conclude that the person who asked them to be vigilant about Ponzi schemes is running the biggest Ponzi scheme in the country.
Funny, isn't it? It would be so, if it were not for the tragic consequences for the holders of rupee-denominated investments!
Given the monetary policy meeting on 18 December, it's probably worthwhile to add a bit on what's likely to happen. Rajan would hopefully raise policy rates from 25 basis points (bps) to 50 basis points (100 basis points make 1 percent). A 25 bps hike at this stage would be seen as "twiddling his thumbs while Rome burnt". Of course, this was the case even the last time around when he stuck to his 25 bps increments, hoping against reason that the consumer price index would moderate. But he's likely to have learnt by now that twiddling doesn't help. But maybe I am hoping against reason.
Most analysts have predicted increases in the 25-50 bps range. But where they are getting it wrong is in speculating that we are at or very near the end of a rate hiking cycle. My guess is that we are still closer to the beginning than the end of a cycle - we still have a few years and few 100 bps hikes ahead of us. After all, the debasement of the currency with the CPI at well over 11 percent continues unabated. And there seems to be no end to the "spending without revenues" policy of governments.
The media would without doubt paint this still-negative-real-interest-rate-policy-by-a-few-100-bps as a very hawkish move by the RBI. And Raghuram Rajan would be declared as a fierce inflation hawk!
Shanmuganathan "Shan" Nagasundaramis the founding director of Benchmark Advisory Services - an economic consulting firm. He is also the India Economist for the World Money Analyst. He can be contacted firstname.lastname@example.org