Central bank and foreign exchange rate

The nations of the world have kept shifting from fixed exchange rates to fluctuating exchange rates. New currency crises have led to a shift to one system or another, with economists arguing the merits of them, and how to make them work. It is always said that one has flaws but the benefits outweigh the flaws, so one is better. Maybe the truth is that both systems are bad? And yet, what else explains this overriding fact that the world has shifted from the 1920s Anglo-American dollar-pound fixed exchange, then to the Depression and war-time era fluctuating exchange, to the Bretton Woods fixed exchange, to Smithsonian fixed exchange, to fluctuating exchange again, with no reduction in currency crises?

Obviously, international monetary policy has problems that go way beyond exchange rates. It starts with the central banking system. For any given country, it maintains a portion of reserves from all commercial banks. For all transfers of money between banks, all that is needed to be done is that a check be written between banks, and the central bank in its books simply changes the claim on reserves from one bank to another. No actual transfer or redemption of cash need take place. Banks are unlikely, if ever, to redeem any asset. So obviously the central bank can lend from the reserves and maintain a much smaller portion of those reserves with itself. If any bank needs money, it will lend it the money. And all that will be done is that a check be written, and a claim on assets be given to the bank. So if we had three commercial banks with Rs. 2 billion each in the bank, then from the Rs. 6 billion, Rs. 5 billion may be given to one bank as loan. So two banks have total Rs. 4 billion available in deposits, and the other has Rs. 7 billion for use. What just happened? The money supply increased from Rs 6 billion to Rs. 11 billion. It will have to be repaid by the first bank, of course, but that additional Rs. 5 billion will circulate between bank customers, just by writing checks between them, and between banks, just by writing checks, and even abroad. The truth is that there is still only Rs. 6 billion with the central bank, of course, but is confident that nobody will come to redeem all assets from it.

The central bank can also buy bonds from the government, credit the government’s account in the bank with the money paid for it, which in turn is credited to central bank reserves. As you can see, central bank just increased the money supply again, just the way it did by giving loans to banks. All this monetary and credit expansion is an inflationary practice. With only Rs. 6 billion with the central bank, it can easily just increase money supply to Rs. 20 billion or Rs. 40 billion or Rs. 100 billion without problems. No one is ever going to actually excercise claims from deposits anyway. Except foreigners.

Foreigners obviously can just try to redeem assets from the central bank, which are in their account with the local banks. Japan did this often with the US, resulting in a huge outflow of gold bullion from US to Japan. The fact that someone may actually try to take back his money puts central bank inflationism in check. Foreigners don’t trust or rely on offshore banks as often as the domestic people of that nation do. Of course, many governments don’t like that check on them, and thus free currencies from gold and refuse commitments on them. What instead happens is a large number of competing inflationist currencies. If a fixed exchange rate is established, certain currencies end up in shortages, hurting their trade. If a fluctuating one is established, competing devaluations of currencies bring trade to a standstill.

Somehow, a simpler solution of using precious metals as the medium of international exchange as was once used is not considered. Gold or silver, in whatever shape, form, or size, will be valued according to weight anyway, but currencies are a matter of political gain, rather than economic efficiency.

Natural disasters

There is not much to feel about in such events. Once the damage is done, people are displaced from their homes; the water, sewage, and electricity lines are broken; everyone is left to do the toiletry in the open; they are forced suddenly into large tent camps with no privacy, provided they can get any accomodations at all.  And once the dead are buried, the gigantic sums of money on rescue and relief efforts provided privately or publicly then leave the finances stretched on rebuilding efforts to come afterwards, and the less fortunate are lucky to find paying jobs easily afterwards. Throughout the period, desperation of people unused to sudden deprivement leads them to looting and even killing. No happy beginning, middle, or ending to such stories.

None of this stops Hollywood movies from glorifying natural disasters as exciting blockbuster events, and summer-time sees a large number of movie studios eager to inflict another devastation on humanity as a whole. Most natural disaster movies made since the 1970s aren’t even particularly interesting, and often quite forgettable. Like war movies, they involve a dirty and morbid subject, except war is easier to glorify due to the typical human sentiments involved. Disaster movies are often rather banal, because the negative realities of disasters outnumber any positive ones, and Hollywood can not afford to focus on the former. A few implausible escape sequences are the most they can throw in there. To make up for the rest of the runtime, petty personal matters of some disparate protagonists is thrown in, like fathers dealing with difficult divorces, a young man trying to reconcile with his girlfriend, or the feuding professionals who must put their differences aside. As if any of that matters when thousands of people are dying or trapped under rubble.

It cries out for explanation why so many people in film studios are so out of touch with reality to think disasters are something amusing enough to make a movie on. It’s partly because they don’t hurt western developed nations as much. Chile (the most privatised and liberalised South American nation) was rocked by an earthquake of great magnitude recently, but it didn’t get much press, because the earthquake-proof glass-fronted buildings there didn’t get so much as a scratch on them, or even shook much. Yet, the earthquake of a similar scale in Haiti which happened much before the one in Chile was still getting press after the Chilean earthquake, because a poor country like Haiti would face the earthquake’s effects for months, even years. The actual earthquake was the tip of the iceberg compared to what happened there afterwards.

Another reason why developed nations don’t often realize the bleak horror of disaster is that developing nations suppress information on them out of pride. The earthquake that hit China and killed something above 70,000 people there was followed by a few activists protesting that public buildings in the region were substandard and below safety norms. They were arrested quickly, and nobody was allowed to find out too much about what happened there. Even when floods hit eastern India, officials refused aid and underplayed the effects of the disaster. The contrast here is that property damages from disasters in First World nations can reach billions of dollars with almost zero loss of life, while Third World nations see low property damage, but enormous loss of life.

All this aside, it seems Hollywood is getting a little more clever with its action-drama-comedy-romance disaster movies; they are starting to research their material beforehand. The book ‘The Coming Global Superstorm’ from back in 1999 was used as the basis of a 2004 disaster movie by Roland Emmerich, which was nonetheless considered to be among the top ten most scientifically inaccurate movies ever made. The same person got drawn into to some recent (sensational) talk going on by some fringe scientists about magnetic reversals and the resultant supervolcanism, and then made another movie called 2012. He perhaps doesn’t fully understand the science behind the movies he makes, but who knows – all the people who provide the hundreds of millions of dollars to consume this disaster entertainment may just be seeing an exaggerated version of disasters they will face soon in their own lifetimes.  Supervolcano eruptions and new Ice Ages have happened in times of prehistoric animals before, and unlike these movies, they are not pretty.

Dumping duty on China by India

In the past year, Vilasrao Deshmukh declared that India shall not be a dumping ground for Chinese heavy electrical equipment, and demanded safeguard duties slapped on them. Last month itself, Chinese stainless steel had a duty imposed of $2254.69 per tonne and Chinese tyres had another duty imposer of $99.05 per set. These actions are nothing but paranoia and a further detriment to industry in both India and China, but far more so for India.

Dumping allegations are based on claims that certain goods are being sold far below cost. But cost of something is very difficult to determine. Costs change from second to second, hour to hour, day to day, supplier to supplier, location to location, and raw material to raw material. Costs are not a fixed definite. They are just prices, from the perspective of those who supply businesses with those services.

If a particular government offers subsidies with respect to some goods produced by manufacturers, that government has no idea what the cost of production for thousands of factories across the country is. It would be varying for all of them, and even across time periods, it would keep varying. We have no idea how much of the cost the government has relieved from these goods, and it could be very high or very low.

Moreover, if those subsidies end up encouraging purchase and thus the production of particular industrial goods, then the increase in production of those goods by exporting manufacturers could push up the costs of the services and raw materials being supplied to them. They’d all be competing for the same raw materials, fuel, and power sources. And that itself would make you wonder how far they can stretch the production of those goods which are being dumped.

Whether dumping is the cause or not the cause of very cheap goods being exported, I can’t say. I don’t have evidence. Nobody has evidence. Except the burden of proof is never on the person to prove the negative. All the same, the huge industrial production of Chinese manufacturers required them to have a lot of capital to begin with, and capital is itself lacking in India in the first place. Somehow, the entire issue comes back to who has more capital and thus who can produce more for less. And that makes dumping nearly irrelevant. The capital available in China means that they can pay workers more than what is paid to the Indian worker and yet still have lower  costs per unit produced. Somehow, you wouldn’t even need to subsidise Chinese goods to make them as cheap as they are.

Retrogression in agriculture of rural India

Aggregates are useful, because they hide essential things. The Indian economy grew by 6.1% in the past year. Indian agricultural output, on the other hand, has fallen by $7 billion in the same period. The soaring manufacturing growth rate pushes the aggregate high enough to conceal the fall in agricultural output. If we see the tonnes of food produced in India, then starting from the year of 2001-02 till date, there has been an 18% fall in quantity produced PER YEAR. 2001-02 showed food production of 212 million tonnes of food, 2002-03 showed 174.2 million tonnes, and the trend seems to have continued. If you ever make the effort of finding nominal GDP growth rates in agriculture from 2001 to 2009, and the consumer price inflation for each of those years, and then adjust each of those figures for inflation, you will find something interesting. Real growth rare in agriculture has shown a fall of 12% in 2009, a fall of 10% in 2008, a fall of 3.1% in 2007, a fall of 0.4% in 2006, a fall of 2.6% in 2005, a fall of 4.8% in 2004, a rise of 7.4% in 2003, and a fall of 4.5% in 2002. I really hope I have made an error of principle here, because these basic calculations reveal a 27% fall in agricultural output from 2001 to 2009.

Growth is taken for granted, because it tends to be typical in most nations; only concern being whether it is slow or whether it is fast. However, retrogression, instead of growth, is also very common. Retrogression happened in Uganda after Dada Idi Amin threw the Indian industrialists out. Retrogression happened in Argentina which fell from being a First World nation to a Third World nation in the 20th century. Various industries can show retrogression, even if the whole economy does not. Agriculture in Soviet states has shown retrogression, especially in Ukraine, Russia, Moldova, and others – the long lasting effects of central planning policy. Indian agriculture now shows classic retrogression.

Retrogression itself is just a fall in economic activity, but it’s related to aggregates. It still doesn’t reveal how much is being produced per worker, because having more workers for more output doesn’t tell whether each worker is able to produce more. If there is an increase in what is produced per worker, we call that development, which is different from growth. And when the opposite happens, we simply call it backwardness. By and large, agricultural growth has been meager and less significant in total GDP across the past few decades, even with a rising agricultural population. So there is less increase in agricultural production, and more increase in number of agricultural workers.

When we consider these basic facts, we arrive at the chilling conclusion that India’s agriculture has become more and more backward since Independence, and hasn’t merely just been falling in the last decade. The nation’s poverty rate was falling drastically in the 1950s, but doubled across the 1960s and 1970s, before it started falling again in the 1980s thanks to urban migration. These facts should contradict the fact that we have had huge food surpluses and have better fertilisers and seeds after the Green Revolution. And yet here it is. Considering the fall in what is produced per worker, we arrive at the other chilling conclusion that our agriculture has been sent back by more than a hundred years, and is at the level of feudal era agriculture. No doubt that there is no comparison – we grow a far wider range of food grains and commercial crops in this era, but there is less produced per worker and less to be earned per worker.

You can’t avoid the laws of diminishing returns, which is why labour needs to be combined with more capital in order to produce more per worker. But capital is the exact thing lacking in rural India. Foreign investment is not allowed, “exploitative” middlemen are to be prohibited, large land ownership is not allowed, agricultural property rights are severely restricted, and no liberal markets may exist in food grains. The intention of India’s agricultural policy was to liberate enserfed farmers, but the farmers are nothing but serfs now, who are votebanks for policies of price supports and subsidies, while all other agricultural allocation of resources is strictly controlled by government, and still under central planning.

Political India – The Cost of Wanting to Look Right

For most people, choosing between losing a little pride and losing a large amount of money and their future livelihood is not hard. The former tends to be the less costly option, and hurt feelings are easy to shrug off anyway. It’s why Tulsi Tanti of Suzlon realized it was a mistake to go into textiles and chose to give wind energy to textile farms instead. It’s why Tata Motors gave up on their project in Singur. It’s why just about anybody who has to do business with his own time, money, and effort often has had to admit to being wrong, swallow their pride, and change their course of action. Even when a major mail order housing company in the United States back in the 19th century fired an executive for daring to suggest the company go into the department store business, they eventually moved into it anyway, when the most competitive retailers did. They could either choose to be wrong, or they could choose to be insolvent. Even in simpler cases, if a parent sees that his child has become ill-mannered and irresponsible, he can admit to his own failings as a parent, if he still has a vested interest in his child’s future. That too involves the parent’s time, money, and effort.

But flip it the other way round. What if it was not your time, money, and effort? What if it was somebody else’s? And what if you were the sole means of determining whether something is right or wrong? What if it was a little more difficult to judge your ideas from end result or output, as it is for businessmen or other professionals like doctors? Then, of course, your job need only be to make the fallacy convincing, and making the fallacy seem fact either way. You would not have to bear the cost of wanting to look right about something; you can just pass that cost on to somebody else.

Interestingly, that’s where a large number of professions come up where you can make a living out of nothing but a life of fallacies. When public sector enterprises were running into heavy losses already by the 1960s and 1970s, all the Indian economists who promoted central planning had to say was that these losses were ‘socially beneficial’. Those particular economists were not running these businesses with their own money, they did not have to preside over their management, and they were not accountable for results. Universities run on donations and grants, not from sale of marketable goods or services. Those economists were given their own fixed pay from the government either way, and only had to say whatever public policymakers wanted to hear. The policymakers too never had to worry about the cost of making wrong decisions. They only had to look as far as the next election, and thus making themselves look right. The results of loss-making PSUs goes far into the future, while results of poor political campaigning comes right into the present. And it was only other people’s money which was at stake in these PSUS, and the establishment could shift the costs onto those very people. When Subramaniam Swami attempted to criticize the faults of the central planning system, Indian economists hushed him away, and ostracized him from Indian academia. It would not matter whether he was right; it would just matter that any consensus given by Indian economists would have been listened to, in spite of their own knowledge of facts to the contrary.

Just about any profession where the end product is only ideas tends to have this quality. Journalists can maintain that price supports are uplifting farmers all over the country, while the result is that the rural poor might be starving to death even while surplus wheat rots in the granaries. It’s a positive news which helps sell papers, and nobody has to check the full validity of price support policies. For anybody who feels collectively invested in seeing his prospering country, of course he would want to think that price supports are benefiting the poor. When the end result of implementing such ideas, especially in public policy matters, goes off far into the future, anybody can claim otherwise in the present. Even if it goes contrary to past empirical analysis and fundamental theories of how prices work, journalists can sell their own version of the story better in the present anyway. They can thus continue to fuel support for the current policies of the establishment.

Journalists, intellectuals, and public policy elite - no matter how well-intentioned, no matter humane and decent – are not subject to incentives and constraints that normally come with being right or wrong. They must merely look like they are right, and the cost of being wrong is only to be borne by other people. Thus, they can live entire lives as being believed to be right. And the gamble they make is to be left on us and our lives. In modern civilization characterized by division of labor and specialization, none of us can be expected to both specialize in intellectual fields and simultaneously handle our own day jobs and household matters. A man can’t spend an hour on mathematics and an hour on harvesting crops, and expect to become a mathematician. And yet, while most goods and services are voted in their validity by the market, and thus through votes of people’s own private property, economically wrong ideas of the political establishment are voted on by other members of the establishment, and through the votes of other people’s property. Thus, we can’t afford to be ignorant on these matters either.

But the truth is that we would be just as powerless knowing that the wrong policies were pursued. Knowledge doesn’t count for much votes in even well educated democracies. The worst mistake we may have made on independence was to not choose liberalism as an option. While Hong Kong, Australia, New Zealand, and Pre-Civil War USA had constitutions written with suspicion of government, constitutions that severely limited powers of government and its ability to vote on actions that affect other people’s lives and property, we may have chosen the path of being allowed to be the subjects of many failed experiments in centrally regulated plans and economic policies, and continuously bearing the cost of this trial and error of one policy after another.