Category: Global Macro

Freedom Corridor vs. Belt and Road

India’s opposition to One Belt One Road makes sense given the whole Kashmir issue, and general geopolitical competition.  Indian think tanks have therefore been warning about risk to both China and target countries(ie this article makes some good points but is a bit cliched and hyperbolic)

Making things more interesting,  India and Japan this month launched their own similar(albeit geographically narrower)  initiative: The Asia Africa Growth Corridor(AAGC), aka the Freedom Corridor.   Right now its still in the  development bank and think tank press release phase,   but India and Japan have strong incentive to follow up with real money pretty quickly.  India and Africa have a deep history of mercantile and maritime connections.  India’s Exim bank has already funded $8 billion in credit in Africa, according to Modi’s speech during an African Development Bank meeting, which was held in India last week.  Port infrastructure in East Africa and the Indian Ocean are likely to be the first priorities, along with agriculture and electricity.  Incidentally,  India and Japan are also  building a LNG terminal in Sri Lanka, a country that is heavily in debt to China as a result of controversial infrastructure projects.

There is a Chinese aphorism,  “When the sandpiper and the clam grapple, it is the fisherman who profits” (鹬蚌相争渔翁得利).  If China and India really end up competing by spending money around East Africa, companies involved in building or benefiting from improved infrastructure could reap a decent reward.    Will the benefits accrue to any outside minority investors in publicly listed companies?  Too soon to tell, but it will be interesting to watch. The usual caveats about EM corruption and waste apply to AAGC as much as they do to OBOR, but the financial media is likely to oversimplify.  India and Japan’s now official strategy could impact select companies listed in India and Japan, in addition to companies in the less developed capital markets of East Africa and Sri Lanka. 

Disequilibrium Analysis

George Soros treats developments in financial markets as a historical process. In The Alchemy of Finance, he outlines his theory of reflexivity, discusses historical developments in markets, and describes a real time “experiment” he undertook while running the Quantum fund in the 1980s.

Markets are an ideal laboratory for testing theories: changes are expressed in quantitative terms, and the data are easily accessible.

Three of the key interrelated concepts in his framework, are anti-equilibrium, Imperfect Knowledge, and Reflexivity.

Disequilibrium

In markets, equilibrium is a very rare special case. Further, adjustments rarely lead to new equilibrium. The economy is always in adjustment.

According to George Soros:

If we want to understand the real world we must divert our gaze from a hypothetical final outcome , and concentrate our attention on the process of change that we observe all around us.

In trying to deal with macroeconomic developments, equilibrium analysis is totally inappropriate. Nothing could be further removed from reality than the assumptions that the participants base their decisions on perfect knowledge. People are groping to anticipate the future with the help of whatever guideposts they can establish. The outcome tends to diverge from expectations, leading to constantly changing expectations, and constantly changing outcomes. The process is reflexive.

The stock market, is of course a perfect example:

The concept of an equilibrium seems irrelevant at best and misleading at worst. The evidence shows persistent fluctuations, whatever length of time is chosen as the period of observation. Admittedly, the underlying conditions that are supposed to be reflected in stock prices are also constantly changing, but it is difficult to establish any firm relationship between changes in stock prices and changes in underlying conditions. Whatever relationship can be established has to be imputed rather than observed.

So its better to focus on nature and direction of ongoing adjustments, rather than trying to identify an equilibrium.

Imperfect Knowledge

Perhaps more problematic with an exclusive focus on rarely occurring equilibrium conditions is the assumption of perfect knowledge. Perfect knowledge is impossible. Everything is a provisional hypothesis, subject to improvement. Soros makes the bias of market participants the center part of his analysis.

Reflexivity

In natural sciences, usually the thinking of participants and the events themselves can be separated. However, when people are involved, there is interplay between thoughts and actions. There is a partial link to Heisenberg’s uncertainty principle. The basic deductive nomological approach of science is inadequate. Use of probabilistic generalization, or some other novel scientific method is preferable.

Thinking plays a dual role. On the one hand, participants seek to understand the situation in which they participate; on the other, their understanding serves as the basis of decisions which influence the course of the events. The two roles interfere with each other.

The influence of this idea is inseparable from the theory of imperfect knowledge.

The participants’ perceptions are inherently flawed, and there is a two-way connection between flawed perceptions and the actual course of events, which results in a lack of correspondence between the two.

This two way connection is what Soros called “reflexivity.”

The thinking of participants, exactly because it is not governed by reality, is easily influenced by theories. In the field of natural phenomena, scientific method is effective only then its theories are valid, but in social political , and economic matters, theories can be effective without being valid.

Effective here, means having an impact. For example, in a bubble, the cost of capital for some companies drops to be absurdly low, relative to the risk of their respective enterprises. Consequently, some businesses that would have otherwise died, may go on to survive. (Example from two decades after the Alchemy of Finance was written: Peter Thiel mentions when being interviewed in Inside the House of Money, that Paypal did a massive capital raise right a the height of the tech bubble, even though it didn’t need the money at the time) On the flip side, a depression can be self fulfilling, if businesses are unable to refinance.

This seems to be especially true in the credit markets:

Loans are based on the lender’s estimation of the borrowers ability to service his debt. The valuation of the collateral is supposed to be independent of the act of lending; but in actual fact the act of lending can affect the value of the collateral. This is true of the individual case and of the economy as a whole. Credit expansion stimulates the economy and enhances the collateral values; the repayment or contraction of credit has a depressing influence both on the economy and on the valuation of collateral. The connection between credit and economy activity is anything but constant- for instance , credit for building a new factory has quite a different effect from credit for a leveraged buyout. This makes it difficult to quantify the connection between credit and economic activity. Yet it is a mistake to ignore it.

This is reminiscent of Hyman Minsky’s Financial Instability Hypothesis

In terms of the stock market, Soros asserts (1)Markets are always biased in one direction or another. (2) Markets can influence the events that they anticipate.