I have often wondered if there is any connection between the prolificity of an artist and the quality of his/her output. Yesterday I was discussing with one of my friends about various rock artists (rather he was educating me about various rock artists) and when we were discussing about Coldplay, he made an interesting remark. He says that Coldplay has come out with too many albums too soon and that sort of diluted their quality a bit as compared to other top league artists. I was absolutely taken back by this observation!
Firstly I like almost all songs of Coldplay and didn’t quite get the point of dilution in quality – but that’s a personal opinion, so lets leave that aside. I was even more amazed by the fact that he called Coldplay a prolific band! A band that has produced 4 (5 if you include “Prospekt’s march” as a separate album) full-fledged albums from 2000 to till date – that’s a total of 51 tracks including a couple of remixes of “Viva la Vida” in “Prospekt’s march”!
Now compare that with the fact that our very own Ilayaraaja used to average almost one film a week in his pomp in the eighties! And any argument that Raaja’s music in the eighties was not as musically rich as western popular music would be the heights of ignorance… One film is a lot more than the 6 or 7 tracks that come out in CD’s and cassettes; it includes the background scores of the films too. Even if every score was already written down, to arrange and conduct the orchestra for the entire film in a week’s time would have been a monumental challenge. The creative part seems to be a natural phenomenon in Raaja’s case, as if that’s the least challenging part in the entire work! In terms of musical sophistication, I don’t think there’s anyone superior to Raaja in any part of the world in the popular form at least. So “the more prolific an artist, the more the dilution in quality" argument doesn’t quite fly in all cases.
Let’s take the case of A.R.Rahman who’s considered to be very choosy ad much less prolific by Indian standards and more prolific by western standards. He produced one of his worst albums ever (trust me when I say that) – “Parasuram” – in a year in which he hardly did half a dozen films. At the same time it is well publicized that he finished Slumdog Millionaire in about 3 months’ time and we all the know the output of that!*
Even in the world of films, is Rajeev Menon’s output better than Mani Ratnam’s because he is less prolific? You gotta be kidding! For that matter one of Tamil Cinema’s very best is also one of its most prolific – the one and only KB. I don’t deny the fact that in some cases there is a good correlation between the prolificacy and the quality of output of an artist but it’s too weak to be generalized.
Maybe its more about demand, supply and artificial scarcity than about the dilution in creative juices…
*On the argument that Slumdog is not ARR’s best work – It may not be his best work, but surely is one of his better work from the perspective of the soundtracks. More importantly in terms of background score, I don’t think he’s done many better than Slumdog Millionaire – “Mausam and Escape” piece fitted in the film so beautifully…
Sunday, September 27, 2009
Sunday, July 19, 2009
It's Bonus time guys, but what the heck?
Oh boy, is euphoria back in the financial world with Goldman Sachs announcing huge bonus provisioning. What was that amount again – some $16 billion in bonus is it? That amounts to some $600,000 per employee on an average it seems. If I am slightly better than the average in GS, I would retire in 2 years if I get that kinda bonus!
But hang on. How’s this possible? Not too long ago, they got money from Warren Buffet to the common man who duly paid his taxes on the pittance that he earns (in the form of TARP funds from the govt) for them to survive and now they are reporting insane amount of bonuses. So now it’s well established that Mr. Buffet made a killing out of his investment but what about the tax payer?
At a time where even his job doesn’t seem safe, he was dutiful enough to pay the exchequer his dues. And what does the government do with that? Bail out greedy investment bankers with such horrible terms that even when they have recovered they merely pay the capital back with some meager returns. All these banks seem to have got a near blank cheque for insuring themselves from the citizens for absolute peanuts. Talk of agency cost! As a citizen I was better off giving my money to Buffet who would have got me much better returns for my ambulance service to investment banks than the government.
But that’s a relatively lesser part of the problem. How does a company whose very existence was in doubt a few months back turn around so quickly? Without getting too technical or jargonic, its sensible to think that this couldn’t have been possible without taking huge disproportionate risks which luckily paid off for Goldman Sachs. “Dude, the government took your money out and gave it to gamblers and worse gets you nothing in return even though the gamble has paid off”
And by the way, what kind of bets could have made you a lot of money in the last one year – any bearish bet actually! And these bets would have extended the bearishness even further. So when everyone is hoping for a turnaround in their fortunes, these banks took your hard earned money and bet that your life is gonna get worse than this and guess what??? They were successful too. I thought governments were meant to help people live a better life….
But hang on. How’s this possible? Not too long ago, they got money from Warren Buffet to the common man who duly paid his taxes on the pittance that he earns (in the form of TARP funds from the govt) for them to survive and now they are reporting insane amount of bonuses. So now it’s well established that Mr. Buffet made a killing out of his investment but what about the tax payer?
At a time where even his job doesn’t seem safe, he was dutiful enough to pay the exchequer his dues. And what does the government do with that? Bail out greedy investment bankers with such horrible terms that even when they have recovered they merely pay the capital back with some meager returns. All these banks seem to have got a near blank cheque for insuring themselves from the citizens for absolute peanuts. Talk of agency cost! As a citizen I was better off giving my money to Buffet who would have got me much better returns for my ambulance service to investment banks than the government.
But that’s a relatively lesser part of the problem. How does a company whose very existence was in doubt a few months back turn around so quickly? Without getting too technical or jargonic, its sensible to think that this couldn’t have been possible without taking huge disproportionate risks which luckily paid off for Goldman Sachs. “Dude, the government took your money out and gave it to gamblers and worse gets you nothing in return even though the gamble has paid off”
And by the way, what kind of bets could have made you a lot of money in the last one year – any bearish bet actually! And these bets would have extended the bearishness even further. So when everyone is hoping for a turnaround in their fortunes, these banks took your hard earned money and bet that your life is gonna get worse than this and guess what??? They were successful too. I thought governments were meant to help people live a better life….
Saturday, May 9, 2009
Why should I vote?
This is election time again in the world’s largest democracy. This is that critical link which fixes all other deficiencies of a democratic system – the power to choose your representative. This is why Democracy is still considered to be the least bad way of governance across the world and blah blah blah. These clichés have been done to death in the mainstream media for years. So let me be little perverse for a while…
What’s this democracy business? Of all the governments that we have had, how many of them are for the people – seriously questionable! And how many by the people - more than half of our population doesn’t even vote! The only aspect of democracy which still works is that it is a government of the people – you better pay your taxes dude…….
Given this background, why should I even bother to participate in this democracy drama? What do I get by voting? Can my vote change the dynamics of the election results? Yes, if everyone thinks that it can then it surely will. Agreed, but what about my choices – what if I don’t want to vote for any of them. Yes, I know there is an option to not vote for anyone also – but that’s a preventive check to avoid manipulation and not an embodiment of the spirit of democracy. So the next argument would be – go contest yourself ala Yuva style! What if I don’t want to contest but still want a legitimate candidate whom I can vote for? Is that asking for too much, then why should I vote?
To add more to my confusion, we have had celebrity propaganda, corporate houses sponsored propaganda and MTV style cool dude propaganda to increase the voters’ turn out for elections, occupying the press pages and the TV space a hell of a lot in the recent times. As if Pepsi has launched a new flavor!!! Some say your voting can change the fortunes of the nation, some say vote because you have to, some say vote because it’s cool! Some even take a moralistic stance – if you don’t vote you are not an honest citizen of the country! Most of these campaigns have been amusing rather than inspiring.
One of the campaigns says that we don’t have a right to complain if we don’t vote – what crap? I don’t vote in US elections, but I have every right to complain about Obama’s policies. There is this celebrity ad which takes the cake. “Is desh ka kuch nahi honewala hain”, they say throughout the ad and then romanticize it filmy style by concluding that your vote has the power to change all that. From a simple question of exercising one’s democratic right (some prefer to call it a duty – I don’t know why), it has turned into a conscientious question now and in some cases it’s even become a style statement courtesy these ad campaigns. But none of them answer the question – Why should I vote?
So do I vote? Yes, I did the last time – to an independent candidate who had the most interesting logo! Would I vote this time – I would if I stay at home, otherwise my favorite film stars would make me feel guilty, but I can’t afford to go home just for the sake of voting ala Shahrukh Khan style. On a more serious note, I like government (I think it’s a fabulous business model too), elections, democracy and everything that goes with it. But let’s not romanticize our democratic process too much. Our Election Commission does a fabulous job of coordinating such a mammoth event in as legitimate and free a manner as it can be done. There is even one polling booth for a single voter, who lives too far from civilization to travel to another polling station – so surely it is as inclusive it gets too.
But the right to vote is an individual’s choice. And every individual should find an answer to the question – why should I vote? – on their own for an election to be a meaningful exercise. It should be based on ideology rather than the TINA factor or the conscientious factor. And if anyone believes that campaigning can create more awareness amongst people to vote, then they should do it by all means. But the efforts should be on rationalizing the importance of voting rather than cry hoarse saying “Go Vote” without substantiating it.
What’s this democracy business? Of all the governments that we have had, how many of them are for the people – seriously questionable! And how many by the people - more than half of our population doesn’t even vote! The only aspect of democracy which still works is that it is a government of the people – you better pay your taxes dude…….
Given this background, why should I even bother to participate in this democracy drama? What do I get by voting? Can my vote change the dynamics of the election results? Yes, if everyone thinks that it can then it surely will. Agreed, but what about my choices – what if I don’t want to vote for any of them. Yes, I know there is an option to not vote for anyone also – but that’s a preventive check to avoid manipulation and not an embodiment of the spirit of democracy. So the next argument would be – go contest yourself ala Yuva style! What if I don’t want to contest but still want a legitimate candidate whom I can vote for? Is that asking for too much, then why should I vote?
To add more to my confusion, we have had celebrity propaganda, corporate houses sponsored propaganda and MTV style cool dude propaganda to increase the voters’ turn out for elections, occupying the press pages and the TV space a hell of a lot in the recent times. As if Pepsi has launched a new flavor!!! Some say your voting can change the fortunes of the nation, some say vote because you have to, some say vote because it’s cool! Some even take a moralistic stance – if you don’t vote you are not an honest citizen of the country! Most of these campaigns have been amusing rather than inspiring.
One of the campaigns says that we don’t have a right to complain if we don’t vote – what crap? I don’t vote in US elections, but I have every right to complain about Obama’s policies. There is this celebrity ad which takes the cake. “Is desh ka kuch nahi honewala hain”, they say throughout the ad and then romanticize it filmy style by concluding that your vote has the power to change all that. From a simple question of exercising one’s democratic right (some prefer to call it a duty – I don’t know why), it has turned into a conscientious question now and in some cases it’s even become a style statement courtesy these ad campaigns. But none of them answer the question – Why should I vote?
So do I vote? Yes, I did the last time – to an independent candidate who had the most interesting logo! Would I vote this time – I would if I stay at home, otherwise my favorite film stars would make me feel guilty, but I can’t afford to go home just for the sake of voting ala Shahrukh Khan style. On a more serious note, I like government (I think it’s a fabulous business model too), elections, democracy and everything that goes with it. But let’s not romanticize our democratic process too much. Our Election Commission does a fabulous job of coordinating such a mammoth event in as legitimate and free a manner as it can be done. There is even one polling booth for a single voter, who lives too far from civilization to travel to another polling station – so surely it is as inclusive it gets too.
But the right to vote is an individual’s choice. And every individual should find an answer to the question – why should I vote? – on their own for an election to be a meaningful exercise. It should be based on ideology rather than the TINA factor or the conscientious factor. And if anyone believes that campaigning can create more awareness amongst people to vote, then they should do it by all means. But the efforts should be on rationalizing the importance of voting rather than cry hoarse saying “Go Vote” without substantiating it.
Saturday, March 7, 2009
The credit crisis conundrum
We are living in extraordinary times. The foremost capitalist nation in the world is turning more socialistic by the day. Obscene amount of capital is being injected into once reckless and greedy financial institutions out of taxpayers’ money. All this is with the intention of unfreezing the credit market and stabilizing the economy. And what have the experts got to say about this? They are equally divided in their verdicts. Some argue that it’s a much-needed initiative and others argue that this is a shameless approval of moral hazard, which will not yield any real benefits.
It’s important to understand that the current crisis that has engulfed the world is as much a financial crisis as it’s a crisis of confidence. Despite the huge amount of capital injection into commercial banks by governments across the world (especially the United States), the credit mechanism hasn’t recovered much. So, surely capital injection alone is not going to get us out of the crisis. In fact as a standalone measure they have the capability to heighten the damage because they are printing more money inviting future inflation without fixing the problem at hand.
So how do we address the crisis of confidence? Why is it that the banks are reluctant to lend? There seems to be two seemingly opposite problems with the so-called Troubled Assets. No one in the market seems to know how to value them. Some of the vulnerable banks fear that the troubled assets might completely erode in value and therefore keep the additional capital as cushion against such a disaster. Then there are the relatively healthier banks that are locking up the capital to find better investment opportunities in future - waiting for the vulnerable banks to sell their assets at throwaway prices! In addition, there are no signs of this game of hide and seek ending anytime soon.
What should the US Treasury do now? First, it can stop injecting more capital to those banks, which are adequately capitalized and are not lending in anticipation of a bumper harvest! Alternatively, it can absorb all the troubled assets into its books from the vulnerable banks. Or maybe it can do both. And Expand government spending, guarantee deposits, increase fiscal stimulus, do all this and more. Would all these help in unfreezing the credit market?
There are simply no easy answers in sight. The only closest precedent to the current scenario in history is the Great Depression and governments the world over are implementing solutions based on the lessons learnt during Great Depression. But the critical difference between then and now is that we are living in the age of globalization. All the major economies are inter-related and hence require coordinated efforts in order to resolve the current financial crisis. But there are so many conflicts of interest between economies, which will hamper in resolving the crisis at the earliest.
There are protectionist policies being framed in US, Germany is wondering if it should pay more out of its wallet to protect its neighbors, there’s a serious conflict of interest between the euro and the non-euro countries of the European Union. As is always the case, upside is easier to be shared than downside. Can the world rise against nationalist boundaries and narrow-minded policies to withstand the current crisis? If not, we need to seriously contemplate about disintegrating the so-called globalized world. There are no free lunches, if we enjoyed the benefits of globalization in bullish times, we should go through the pain during the bearish times too.
It’s important to understand that the current crisis that has engulfed the world is as much a financial crisis as it’s a crisis of confidence. Despite the huge amount of capital injection into commercial banks by governments across the world (especially the United States), the credit mechanism hasn’t recovered much. So, surely capital injection alone is not going to get us out of the crisis. In fact as a standalone measure they have the capability to heighten the damage because they are printing more money inviting future inflation without fixing the problem at hand.
So how do we address the crisis of confidence? Why is it that the banks are reluctant to lend? There seems to be two seemingly opposite problems with the so-called Troubled Assets. No one in the market seems to know how to value them. Some of the vulnerable banks fear that the troubled assets might completely erode in value and therefore keep the additional capital as cushion against such a disaster. Then there are the relatively healthier banks that are locking up the capital to find better investment opportunities in future - waiting for the vulnerable banks to sell their assets at throwaway prices! In addition, there are no signs of this game of hide and seek ending anytime soon.
What should the US Treasury do now? First, it can stop injecting more capital to those banks, which are adequately capitalized and are not lending in anticipation of a bumper harvest! Alternatively, it can absorb all the troubled assets into its books from the vulnerable banks. Or maybe it can do both. And Expand government spending, guarantee deposits, increase fiscal stimulus, do all this and more. Would all these help in unfreezing the credit market?
There are simply no easy answers in sight. The only closest precedent to the current scenario in history is the Great Depression and governments the world over are implementing solutions based on the lessons learnt during Great Depression. But the critical difference between then and now is that we are living in the age of globalization. All the major economies are inter-related and hence require coordinated efforts in order to resolve the current financial crisis. But there are so many conflicts of interest between economies, which will hamper in resolving the crisis at the earliest.
There are protectionist policies being framed in US, Germany is wondering if it should pay more out of its wallet to protect its neighbors, there’s a serious conflict of interest between the euro and the non-euro countries of the European Union. As is always the case, upside is easier to be shared than downside. Can the world rise against nationalist boundaries and narrow-minded policies to withstand the current crisis? If not, we need to seriously contemplate about disintegrating the so-called globalized world. There are no free lunches, if we enjoyed the benefits of globalization in bullish times, we should go through the pain during the bearish times too.
Sunday, January 18, 2009
Why should we trust markets?
The financial crisis that had its origins in the United States sometime in the middle of 2007 has engulfed the whole world by now and India is certainly not insulated from it. What seemed to be a housing bubble has turned the world economy on its head. When the inflated housing prices in US collapsed coinciding with rising interest rates, large-scale defaults on mortgages started which resulted in huge capital erosion for banks. And that has ballooned into a global credit crisis with almost all central banks acting in unison to pump in as much as liquidity as they can to negate the adverse impact of credit crunch. Amidst all this, banks have gone bust; auto sector has joined the bailout bandwagon, a few million people have lost their jobs, a long-run ponzi scheme has been exposed and accounting frauds have raised their ugly heads again.
As has always been the case, asset bubbles are a creation of greed and hubris. When housing prices were going up, banks started lending to people without credit history safe in the knowledge that even if they defaulted the inflated house value would act as good security and amazingly rating agencies agreed too! But this was not greed; banks tend to take risk to enhance their profitability. Where greed came in was when they started to package these loans and sell it on large scale to be able to book immediate profits and release the locked up capital to be able lend more! If banks were greedy, rating agencies suffered from hubris. However, who is paying the price? In fact, the very same banks are getting bailouts out of taxpayers’ pockets!
Is this all pointing to failure of markets? Are free-markets actually as self-correcting as its proponents make it out to be? Had there been no free market for Mortgage Backed Securities, sub-prime crisis would have never happened. So why should we trust markets at all? Is it doing more harm than good? Shouldn’t we go back to planned economies? I have interacted with so many people who have asked me these questions of late. It seems people have lost faith in markets and then we had the Madoff fraud and now Satyam. What lies ahead?
It is convenient to blame the failure of markets for the current crisis that we are in, but not necessarily correct. In his book “Sub-prime Solution”, Prof.Robert Shiller makes an opposite case that it is the lack of a full-fledged market, which triggered the housing bubble in US. The housing prices shot through the roof in US because everyone was bullish about the future and thought that there is no better place to live than the US in these bullish times. If there were a complete, liquid, global market for houses, people in India or China would have disagreed and would have gone short on US houses that would have rationalized the housing prices. It was because the housing market was narrow and illiquid that there was a housing bubble in the first place! So blaming the market inadequacies for the crisis is not sound logic.
Markets are indispensable and are still the least bad way of functioning for an economy. For all the recent setbacks, India has achieved tremendous growth only after the opening of the economy, which is a sound evidence for the positives of the markets. How many Indians would like to go back to pre-1992 days? My guess is not many. Of course, there are negatives to a market economy but the positives outnumber them comfortably. It is also important to remember that market is not an artificial entity; it is made up of human beings and is a reflection of us, infact an exaggerated reflection of us. If markets are efficient and progressive (Google, Microsoft, Wikipedia), it is because we are so and if markets are greedy and irrational (Enron, Madoff, Satyam), it is also because we are so. No system can hide these realities!
As has always been the case, asset bubbles are a creation of greed and hubris. When housing prices were going up, banks started lending to people without credit history safe in the knowledge that even if they defaulted the inflated house value would act as good security and amazingly rating agencies agreed too! But this was not greed; banks tend to take risk to enhance their profitability. Where greed came in was when they started to package these loans and sell it on large scale to be able to book immediate profits and release the locked up capital to be able lend more! If banks were greedy, rating agencies suffered from hubris. However, who is paying the price? In fact, the very same banks are getting bailouts out of taxpayers’ pockets!
Is this all pointing to failure of markets? Are free-markets actually as self-correcting as its proponents make it out to be? Had there been no free market for Mortgage Backed Securities, sub-prime crisis would have never happened. So why should we trust markets at all? Is it doing more harm than good? Shouldn’t we go back to planned economies? I have interacted with so many people who have asked me these questions of late. It seems people have lost faith in markets and then we had the Madoff fraud and now Satyam. What lies ahead?
It is convenient to blame the failure of markets for the current crisis that we are in, but not necessarily correct. In his book “Sub-prime Solution”, Prof.Robert Shiller makes an opposite case that it is the lack of a full-fledged market, which triggered the housing bubble in US. The housing prices shot through the roof in US because everyone was bullish about the future and thought that there is no better place to live than the US in these bullish times. If there were a complete, liquid, global market for houses, people in India or China would have disagreed and would have gone short on US houses that would have rationalized the housing prices. It was because the housing market was narrow and illiquid that there was a housing bubble in the first place! So blaming the market inadequacies for the crisis is not sound logic.
Markets are indispensable and are still the least bad way of functioning for an economy. For all the recent setbacks, India has achieved tremendous growth only after the opening of the economy, which is a sound evidence for the positives of the markets. How many Indians would like to go back to pre-1992 days? My guess is not many. Of course, there are negatives to a market economy but the positives outnumber them comfortably. It is also important to remember that market is not an artificial entity; it is made up of human beings and is a reflection of us, infact an exaggerated reflection of us. If markets are efficient and progressive (Google, Microsoft, Wikipedia), it is because we are so and if markets are greedy and irrational (Enron, Madoff, Satyam), it is also because we are so. No system can hide these realities!
Wednesday, October 1, 2008
Illusion of Rf
Is there anything called a Risk-free rate at all? If an investment is completely risk-free then why should it yield a return? Admittedly there’s an implied risk of inflation. Fine, then Rf rate should be nothing but the inflation. So if Rf is more than inflation, is that a violation of the efficiency hypothesis? What about compensation for giving up on current consumption – shouldn’t that have a premium? Even in a world without inflation risk-free rate has to be greater than zero. So there’s a risk-free rate but where do I find it?
Typically the only investment that’s considered to be risk free through out the world is an investment in domestic government bonds and why? Because of their power to print currency. So no matter what happens in the economy the government can print money and repay and hence no risk! Well if only life is so simple. Is paying out of hard earned money the same as paying by printing new money? Is money the same as the paper in which its represented? What about Seigniorage? Isn’t this a problem of circular reference?
If a major part of Rf is explained as compensation for inflation, in this case the very fact that we consider a government as a risk-free entity is its sovereign power to print money. And printing money without a corresponding increase in productivity leads to more inflation. So initially a compensation for lending is agreed on a benchmark(inflation), and still the counter party is considered risk free even though it has the power to change the benchmark from the agreed upon compensation rate making the investment risky in real terms!
In fact I even wonder (an exaggerated wonder at that) if government bonds are more risky than high rated corporate bonds because if corporate bonds default only the lender loses but if the government can’t repay hard money then it brings more paper into play and hampers the economy. If given a choice, would a Zimbabwean invest in the risk free domestic government bonds now or a risky S&P index? FYI - the last heard inflation figures in Zimbabwe was a few lakh percentages. Also not so long ago the Government of India defaulted on its guarantee in Dabhol power project – Where’s the sovereign power gone? So not only there is a risk of Seigniorage but also the risk of the government not exercising its sovereign power!
Amidst the current credit crisis, scrambling to safe haven US treasury bonds seem to be in vogue. But the irony is that the more people buy the treasury bonds, the more they push the yields down but at the same time inflation is showing no signs of receding! It’s fair to argue that inflation spikes may be of temporary nature which doesn’t necessarily need to get reflected immediately in the treasury yields. But for people investing in treasury bills for a shorter term amidst the high inflation times, aren’t they just better off consuming all that they have!
And by the way, amidst the bail out concerns the market was recently pricing the chances of Fed defaulting at 0.25%. So where’s the Rf?
Typically the only investment that’s considered to be risk free through out the world is an investment in domestic government bonds and why? Because of their power to print currency. So no matter what happens in the economy the government can print money and repay and hence no risk! Well if only life is so simple. Is paying out of hard earned money the same as paying by printing new money? Is money the same as the paper in which its represented? What about Seigniorage? Isn’t this a problem of circular reference?
If a major part of Rf is explained as compensation for inflation, in this case the very fact that we consider a government as a risk-free entity is its sovereign power to print money. And printing money without a corresponding increase in productivity leads to more inflation. So initially a compensation for lending is agreed on a benchmark(inflation), and still the counter party is considered risk free even though it has the power to change the benchmark from the agreed upon compensation rate making the investment risky in real terms!
In fact I even wonder (an exaggerated wonder at that) if government bonds are more risky than high rated corporate bonds because if corporate bonds default only the lender loses but if the government can’t repay hard money then it brings more paper into play and hampers the economy. If given a choice, would a Zimbabwean invest in the risk free domestic government bonds now or a risky S&P index? FYI - the last heard inflation figures in Zimbabwe was a few lakh percentages. Also not so long ago the Government of India defaulted on its guarantee in Dabhol power project – Where’s the sovereign power gone? So not only there is a risk of Seigniorage but also the risk of the government not exercising its sovereign power!
Amidst the current credit crisis, scrambling to safe haven US treasury bonds seem to be in vogue. But the irony is that the more people buy the treasury bonds, the more they push the yields down but at the same time inflation is showing no signs of receding! It’s fair to argue that inflation spikes may be of temporary nature which doesn’t necessarily need to get reflected immediately in the treasury yields. But for people investing in treasury bills for a shorter term amidst the high inflation times, aren’t they just better off consuming all that they have!
And by the way, amidst the bail out concerns the market was recently pricing the chances of Fed defaulting at 0.25%. So where’s the Rf?
Thursday, September 4, 2008
Blame it on the Speculators!
We are living in uncertain times. A month back the OPEC was under tremendous pressure from the rest of the world to increase their output to cool off the spiralling oil prices across the world. And now there are reports of OPEC reducing the output because the oil prices have fallen to less than $110 from the all time high of $145. How do you explain this? When oil prices started going up, they reasoned that it’s because of the rising demand for oil from growing economies like India and China with no drop in demand of the developed economies. And then it went up further and what was the response from policyholders, politicians and shockingly even from some neoliberal economists? Its that Speculator animal who’s pushing up the prices!
If this explanation is to be believed then 1987 crash wouldn’t have happened. “LOR” would have been the greatest company and ‘Portfolio Insurance” the greatest idea ever! In a panic market even arbitrageurs are not safe as we had witnessed during the 1987 crash when the spot and futures market went out of sync. If this is the case in an equity market where prices are not exactly the equilibrium between Demand and Supply, What of the commodities market where neo classical economics works better than greed and luck? Surely something is missing in this “blame it on the speculators” reasoning.
First of all in most of the commodities exchanges of the world, all forward and derivative contracts on commodities are delivery based. Lets understand the significance of this with an illustration. Assume a 1 year oil futures contract is trading at $100 in CBOT, now a speculator (A) wants to come to the party. So he buys the contract at $100 expecting it to go up. Then another specualtor wants to play this game too, so he buys it from A at $110. He inturn sells it to another specualtor for $120 and it goes on for a few more cycles. Finally the consumer who wants to buy oil can buy it from the last person in the chain holding the forward contract at the time of expiry. And if the last specualtor in the chain can sell it at $180 to the ultimate consumer pocketing a handomse profit for himself, the speculators chain would have succeded in pushing the price of oil from $100 to $180. If only life was so simple!
What if the last person in the chain bought the contract at $170 and the consumer is not willing to pay more than $100? At the end of the day the consumer pays the price that he thinks the good is worthy of and that is nothing but the equilibrium between Demand and Supply (excluding the information assymetry that is). Then the speculator burns his fingers and how does that matter to the rest of the world! And what if the final speculator in the chain is able to sell it to the consumer at $180.Well, then it’s the appropriate price at which oil should have traded in the beginning because that’s what the consumer feels the good is worthy of! So isn’t this a better method for price discovery? Without these speculators, a good which is worthy of $180 would have traded at around $100. And another factor to consider is that even selling at $180 would have been a case of winner’s curse. Maybe the consumer would have been ready to pay even more!
So a few months back the rise of Chindia along with the Speculators playing spoilsport resulted in skyrocketing oil (also other commodities) prices. And now the theory has turned topsy turvy. Chindia’s not expected to grow so fast, there are fears of stagflation in the US, UK and the rest of Europe. So there you have the answer for drop in oil prices! But where are the speculators gone now? As has always been the case, Economists and Policymakers have a very elegant explanation to every event in life in retrospect! But the “blame it on the speculators” argument is not one of them.
If this explanation is to be believed then 1987 crash wouldn’t have happened. “LOR” would have been the greatest company and ‘Portfolio Insurance” the greatest idea ever! In a panic market even arbitrageurs are not safe as we had witnessed during the 1987 crash when the spot and futures market went out of sync. If this is the case in an equity market where prices are not exactly the equilibrium between Demand and Supply, What of the commodities market where neo classical economics works better than greed and luck? Surely something is missing in this “blame it on the speculators” reasoning.
First of all in most of the commodities exchanges of the world, all forward and derivative contracts on commodities are delivery based. Lets understand the significance of this with an illustration. Assume a 1 year oil futures contract is trading at $100 in CBOT, now a speculator (A) wants to come to the party. So he buys the contract at $100 expecting it to go up. Then another specualtor wants to play this game too, so he buys it from A at $110. He inturn sells it to another specualtor for $120 and it goes on for a few more cycles. Finally the consumer who wants to buy oil can buy it from the last person in the chain holding the forward contract at the time of expiry. And if the last specualtor in the chain can sell it at $180 to the ultimate consumer pocketing a handomse profit for himself, the speculators chain would have succeded in pushing the price of oil from $100 to $180. If only life was so simple!
What if the last person in the chain bought the contract at $170 and the consumer is not willing to pay more than $100? At the end of the day the consumer pays the price that he thinks the good is worthy of and that is nothing but the equilibrium between Demand and Supply (excluding the information assymetry that is). Then the speculator burns his fingers and how does that matter to the rest of the world! And what if the final speculator in the chain is able to sell it to the consumer at $180.Well, then it’s the appropriate price at which oil should have traded in the beginning because that’s what the consumer feels the good is worthy of! So isn’t this a better method for price discovery? Without these speculators, a good which is worthy of $180 would have traded at around $100. And another factor to consider is that even selling at $180 would have been a case of winner’s curse. Maybe the consumer would have been ready to pay even more!
So a few months back the rise of Chindia along with the Speculators playing spoilsport resulted in skyrocketing oil (also other commodities) prices. And now the theory has turned topsy turvy. Chindia’s not expected to grow so fast, there are fears of stagflation in the US, UK and the rest of Europe. So there you have the answer for drop in oil prices! But where are the speculators gone now? As has always been the case, Economists and Policymakers have a very elegant explanation to every event in life in retrospect! But the “blame it on the speculators” argument is not one of them.
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