Taking a break

I am taking a mental vacation for an unspecified period. The phoenix is being rebuilt for flight.

Gold versus Stock Markets

Read a very interesting post in the Economic times a couple of days back. The author of the article compared the returns of gold with that of the stock market and concluded that stocks yield better returns in the long run. Data points are quite convincing but then they should! After all, world is filled with data which can support any theory. Only that we have to be smart to select those which suits us and hope that no one notices those which can prove the exact opposite. One of the favourite jokes among us academicians is that there is an equal and opposite thesis for every proposed thesis. Be that as it may, without offering solutions or tips, let me raise a few issues that bother me.

First issue is, how do we calculate long term returns on stocks? Most of the financial advisors will jump up and say "Use the index!" "Take the market capitalisation."        Smart!!! The question which may arise is the dates of comparison. For example if I compare sensex of 1991 and sensex of 2011 I find that the composition has changed. Few of the original members now exist and so many new ones have come in. It is easy for the stock exchange to show the exit to one company and welcome the other. How easy is it for the investor to switch over? When does the investor switchover? Will the switching be neutral in costs? How easy is it for the investor to maintain a portfolio of  stocks which mirror the sensex? When the index tracking funds run by well reputed asset managers do not match the gains or losses of the index how do we mere individuals who do not have similar resources do that? What happens if something like enron  or satyam happens? The stock exchange will merely substitute the dud stock for a better one. Where does that leave us? These are existential issues which generally get brushed away in times of euphoria.

The next issue is the contradiction in comparing gold and stocks. Investment decisions in these classes are made with different considerations. Here I do not bring in those who are investing in gold for returns. They form a small portion of investing class. The gold bought by Indian citizens over decades and those held by central banks of countries is many times more than the quantum of gold held by exchange traded funds. 

   My logic says stocks and gold are two different asset classes existing at the opposite ends of investment spectrum. One is insurance (gold) and other is returns with risk (stocks). Can we compare the two? One deals with uncertainty and the other with risk. Is there a difference between uncertainty and risk? 

Let me give the example of an insurance policy. The policy holder takes the insurance because of uncertainty. He does not and should not look for profits in the policy. The investment decision has been made because of uncertainty. What the policy does is to reduce that uncertainty and helps the policy holder to plan the future of his family with some degree of certainty. He can take some other investment decisions like house, retirement funds etc because the financial consequences of the uncertainty of life expectancy have been mitigated and addressed to a large extent. Look at the issue from the side of the insurance company. It does not sell the policy because of uncertainty issues. The selling decision is based on assessment of risk. It has the numbers which tell the company how many of the policy holders are expected to die and it needs to make full payments before the end of the policy. It prices that risk, calculates the premium, offers the policy to a group of people and still expects to make profit.

It is foolish for an individual to work out the statistical probabilities of his own death and plan for future without accounting for that event. Death occurs only once in his life whereas an insurance company can work out statistical probabilities of mortality. One death less or more will affect its profit margins. That is all. 

Lesson: Risk assessment assumes that probabilities of  all eventualities are known apriori. Uncertainty offers no such comfort. Gold provides insurance in times of uncertainty. Stocks offer returns with risks. All is well as long as we understand the difference.

The Moon Shot: Power of Ideas

"We choose to go to the moon. We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win, and the others, too."

John F Kennedy

      As we stand and face the future today, the State of India seems rudderless. It is said, "If you do not know where you are going, any road will take you there". The nation seems bereft of governance and direction. Youth of India are protesting against corruption but do they actually know what they are fighting for? If it is to support Anna Hazare in his right to fast, what after that?  Progress is a vector quantity and movement should not be mistaken as a substitute for that. Chaos cannot be a substitute for inept governance. The brains of India, safely ensconced in their ivory towers are silent. While we know the view point of Congress on Lok Pal or Jan Lok Pal (which precisely amounts to nothing because there is no view except for parroting that Parliament is Supreme) what do the opposition parties say about Lok Pal? Except for some informed views the bulk of the political class is equally clueless as the citizens as to what the fuss is all about. The debate is increasingly becoming divisive and the more the noise that is made the more is the obfuscation. Can all this random energy be channelised? I think it is possible.

       We need a moonshot. A goal that can energise the nation just like what President JFK did. A nation shocked by the the progress of Soviet Union was put on a path of unprecedented scientific advancement by the vision of one man. To those who are interested, I am pasting the link to that famous speech of one of the greatest leaders we will ever see.

http://www.jfklibrary.org/Research/Ready-Reference/JFK-Speeches/Special-Message-to-the-Congress-on-Urgent-National-Needs-May-25-1961.aspx

  

What can be that moon shot?

Just for laughs

Laugh if you want to or curse if you feel like. Both are dedicated at the Lotus feet of Baubo!! (The bold lettering is my work)

I am flagging a few gems for your entertainment. Lest you throw stones at me, these are extracts from the report submitted by Congressional Research Service. As to who exactly these people are, I am pasting the information as given in Wiki

    " The Congressional Research Service (CRS), known as "Congress's think tank", is the public policy research arm of the United States Congress. As a legislative branch agency within the Library of Congress, CRS works exclusively and directly for Members of Congress, their Committees and staff on a confidential, nonpartisan basis. Its staff of approximately 900 employees includes lawyers, economists, reference librarians, and social, natural, and physical scientists."

 I started by crossing out IMF because I can substitute it with the US Fed or the ECB, the central banks operated by the patron saints of IMF. After a feeble effort, I gave it up. 

Here go the extracts from CRS Report: The 1997-98 Asian Financial Crisis.

"With respect to moral hazard, the opinion of the IMF is that governments in trouble usually are too slow in approaching the Fund for help because of the conditions the IMF places on such support. According to the IMF, the real moral hazard is not with governments engaging in unsound lending but that, because IMF support is available, the private sector may be too willing to lend. Private sector financial institutions know that a country in trouble will go to the Fund rather than default on international loans.  Others, moreover, assert that the IMF is perpetuating the moral hazard that lies at the heart of the problem for troubled economies like South Korea-the absence of bankruptcy. 

"The IMF also placed certain conditions on Thailand. These reportedly included that the country commit itself to maintaining foreign exchange reserves at $23 billion in 1997 and $25 billion in 1998, slash its current account deficit to about 5% of GDP in 1997 and to 3% of GDP in 1998, and show a budget surplus equal to 1% of its GDP in FY1998" 

" In return for accepting the IMF emergency loans, Korea agreed to several conditions and reforms in order to strengthen its economy. On the macroeconomic side, the conditions included:

• reducing its current-account deficit to no more than 1% of GDP for 1998 and 1999 (about $5 billion),
• capping its yearly inflation rate at 5% in 1998 and 1999,
• building international reserves to more than two months of imports by the end of 1998, and
• recognizing that economic growth (in terms of GDP) for 1998 would likely fall from 6% to around 3%. In terms of financial restructuring, the IMF required a comprehensive restructuring and strengthening of Korea' s financial system in order to make it more sound, transparent, and efficient. The strategy comprised three broad elements: a clear and firm exit policy, strong market and supervisory discipline, and increased competition. The measures included:
• requiring that all banks that fail to meet the Basle Committee capital standards be restructured and recapitalized to include mergers and acquisitions by foreign institutions and losses by shareholders,"

"IMF assistance to the above three countries has been criticized for "bailing out" commercial banks and private investors at the expense of other less-favored groups and U. S. taxpayers"

There are many more gems yet to be extracted. I just thought a few samples are enough. Neither Europe nor USA are practicing what they enthusiastically preached. There are accidents (bank collapses) waiting to happen in Europe and I am not so confident about BofA either. I have reserved the best gem of the report to end this post.

Here it goes,

"Some corporations in certain countries have not been allowed to fail because of political or other reasons. In the words of one commentator, "Capitalism without bankruptcy is like Christianity without hell. There is no systematic means of controlling sinful excesses."