Finding symmetries in an unsymmetrical world ..

Archive for February 2010

There’s an interesting post by Anil Bokil and it proposes some fundamental reforms to deal with the corruption that has so badly gripped the grassroots of India .

The Key highlights of the proposal  —

– abolish all taxes in the country except import and customs duties.

– remove all currency notes above Rs.50 denomination from the system by asking all holders of this currency to deposit it in the bank.

– make it mandatory for all transactions above Rs.2000 to be done through the banking channel, i.e. through cheques, or credit/debit cards.

–  Introduce a flat transaction tax of, say, 2% on every transaction in the banking system in the recipient’s hand.

Here’s my take on the ideas- with a critique on the proposed mechanism design.

The impact of the transaction costs on the money collected, will add up to taxes and revenues for the Government. However it carries a huge risk – dealt in the Chaos theory later in the post.

The point is – If the input functions to this black box- the new mechanism proposed is hazy, it will have severe gaps in terms of what it intends to achieve and how the revenues will be distributed .


The Story of India’s growth is not only the amount of the currency in print- it is the growth of the Virtual money generating instruments. It is the easy accessibility of loans – both high and low interest rates .This proposal also hits the backbone of any economy- the liquidity that is so very essential to the growth.
It is clear that such proposals will not only encourage hoarding of money -to save this “additional transaction charge” levied on them, but also there is a bigger challenge to address .

Firstly, it is not clear how the money will be “BANKED” – i.e collected in the first place. This is equivalent of collecting the statistics about the population and distribution demographics of  a country- which are very difficult to procure.

Moreover this data collected at the micro level which affects the Macro Economics obeys the chaos theory which states that a small change in a variable can make a huge difference in the data that is collected.

Popularly referred to as the butterfly effect. Small differences in initial conditions (such as those due to rounding errors in numerical computation) yield widely diverging outcomes for chaotic systems, rendering long-term prediction impossible in general.

This now brings us back to the question – how do we capture the black money that is both being hoarded and also being used to fund the other operations which are not captured in the legal structure?

One might argue that it will facilitate that the operations used to fund acts of terrorism , criminal operations , political campaigns and like will become more visible , but the question remains – the collating of the data- i.e how much do we have ?

Moreover money is not just hard currency or virtual currency – it is also the basic component that adds in the GDP of any country – the Goods and the services that facilitate this creation .

The proposal attempts to arrest Inflation – but what would happen as a side affect is –

a. It will also arrest the development – thus giving incentive to hoard money

b.It will encourage the investors – as the perceived value of “stalling currency” will encourage to park money in other comparatively safer havens – which promise greater magnitudes of growth.

We have already seen the investors parking money in Banks of other nationalities – like Switzerland and Singapore- coz of the appreciating value of money.

i.e the utility function is what any investor would look at , and attempt to maximize.

Utility function  for any investor –

Original sum = x Units

Appreciated value of x units after n years =

k units in the proposed Mechanism *

j units in the other alternatives

* Includes the transaction cost and the other overheads which includes money that goes in procuring the liquidity + effort and time lost

Now any investor will attempt to compare the maximum payoff between k and j . Simply put, it is not possible for ANY banking system to permit k >> j for the following reasons –

The banking system needs to scale in proportion to the NEW demand of the backbone that is intended now.

This also includes the other Backup infrastructures that are basic to the primary creation –

Internet access to every individual – lack of which creates both a  bottleneck in terms of the liquidity that it intends to provide.

Take an example of a city , or a suburb struggling with huge deficits of  electricity , and poor- or not-up to date internet                                           infrastructure – how do we then scale up these transactions ?

The lack of this basic infrastructure ensures that a lot of money and effort goes in procuring the money – which is both ironic .For one, time is money – this will only increase the trips to the bank – which will have more repercussions for the anathema.

—Collapse or unavailability of any of this channel will create huge pressure and impacts in terms of the .It is not clear how the banking systems will operate.

—Moreover, who monitors that the transactions above Rs 2000 are tracked and done through the banks – If I need to exchange money – I may still do it -as I still have the funds – I can withdraw them – correct?

It looks like we may as well move to barter – than progressing from and upward from what we have already built.

—This does not cater the emergency, life and death situations – immediate needs for travel and cash requirements.

—Stocking huge amounts of money in the banks will not help till the system scales up to distribute the funds that would go to fund the interest that it needs to distribute. This would require “Finding “what to fund- and an easy availability of loans .This gives extra incentives and red signals of what happened with the housing bubble – plethora of loans – in this case – to distribute the stocked otherwise money that would otherwise not appreciate.

Overall it needs much work, and must accommodate all the repercussions  .

To sum it up , the manufacturing, like all the other Asset backed sectors requires huge access of liquid cash . “Moving” money through the bank transactions looks good on its face, but it is flawed- because

For this to happen the banking sector needs a revival and a complete makeover , it needs to scale to meet the challenges of a complete globalization in its true sense .That will not happen unless we have invested enough in the infrastructure .

~

ek

Mathematics is the language of Nature .  Patterns emerge, when you look hard enough .

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India is a largely agricultural land. But given that, it is both ironic and shame that each year we have thousands of deaths due to malnutrition, starving, and farmer suicides.

Here, I (attempt) to describe the anatomy of the increasing suicide cases year after year

Problem –

Farmer suicides due to inability to pay loans , low returns on the produce , famine -adversary conditions, poverty, cheating on the interest rates by landlords and deceptive and spurious/vicious circle of loans which are required for the initial investment into crop produce , to find and fund alternative sources of irrigation .

Insurance instruments existing in the market –

Currently a few players are in the market who “cover the risk” of vagaries of bad weather, rains and famine, lesser/low return(S) produce due to large scale damages due to pests and crop disease .

Agricultural insurance company of India (Estb1956)

Insurance for Agriculture ,LLC (Estb 1986)

What we , however need – is a safeguard against the price controls affected by the government as a policy measure of vote bank politics , the adequate and cheap availability of Agricultural produce backed loans and insurance installments , the removal of middle men, better Inventory management , storage and retrieval systems. Crops being a perishable commodity, we need quick access to take this produce to the market.

That calls for a massive change in the infrastructure. But a fundamental question remains- If we perceive it according to the thumb rule of Game theory- would enough incentives remain with the government to support the farmers?

For the change to happen the governments must perceive it as a “threat” that it must act, or its utility function will reduce overall.

In a democracy, and yet not so answerable government, it gets even tougher .This is not to say that there is not adequate transparency, just a “lack of will” to implement these decisions.

As Adam Smith quoted in his much known – “An inquiry into the wealth of nations “

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. “

Given we all are driven by different order, dimensions and magnitude of self Interest – what is the interest for the government to vest effort to do something about it ?

This question is more important than it looks- simply because it has both the problem statement and the answer in itself ,at the same time . And that is precisely what is interesting.

Let’s see what drives most of the farmer suicides –

The Government often lowers the price of the basic commodities like rice, wheat, potato, onions, and tomatoes to create popularity – vote bank Politics .This however hits the farmer as he still has to take the produce to the local market where it is sold at a subsidized rate, and consequently it hits his returns .

Let us now see what this means for the farmer to maximize his utility function –

The options available to the farmer now are –

  1. To produce the commodities/produce which are not subsidized and give him maximum Return on Investment and labor to ensure that he can pay off a part of the loans and sustain himself (and his family)
  2. Driven by the adverse loans and consequently being hag-ridden by the land lords (Most of the farmers in India grow produce on leased lands ,and borrow part of most initial investments from local landlords and other private(local) money lends , this being in major due to lack of adequate loans available )
  3. To create an artificial lack of supply by destroying the produce, throwing it off hoarding it, hence giving the supply and demand a gentle tremor. This is very damaging to the GDP of the country as the goods and the services produced are lost after sufficient man hours are invested in it .

Let us now evaluate the options for the government –

  1. Being indifferent – it can gain unpopularity if sufficient people are aware of the suicides driven by facts aforementioned. Also the opposition party can challenge this question in the parliament, mostly for its vested interests though.

b.    Taking action – and not subsidizing produce –

—Can cause a lost of substantial votes due to inflation and its subsequent un popularity from the middle class families who do not have their primary occupation as agriculture ,and the section using the loan instruments to  make money betting on the produce of the farmers .

—Can cause a lost of substantial votes due to inflation and its subsequent un popularity from the middle class families who do not have their primary occupation as agriculture ,and the section using the loan instruments to  make money betting on the produce of the farmers .

—Might result into increased popularity (and votes) – from the learned section and the section having agriculture as the primary occupation

Has the potential for increased returns from the exports – if the additional produce is not “killed” to create an artificial supply tremor .

Thus, as is seen, the risks or the rewards materialize only near its end terms – so being indifferent is the major chosen “Action” – rather inaction.

Here’s what we need to change –

Getting both private players and public players into the agriculture insurance sector

Creating more answerability (Will be taken in more detail- in a day or two)

Easy and quick accessibility of loans

Encouraging more social entrepreneurs to solve the challenges in the rural sector

Adding more value to the lifestyle of the rural populace – this could mean lower suicide rates

Building more efficient “systems” – and inventory and supply management systems to do away with the loss due its perishable nature .

Initiatives which connect the farmer to the market – like e-choupal (ITC) , and other such ventures .

Organizations like ITC echoupal are already making the impact through its initiates – here is the time for a bigger impact .

In sum ,

The more stronger the self interest is – the stronger will be the Impact -and the potential CHANGE that can happen to this largely ignored sector .

The nature of commodity prices affecting the commodities is a little uncertain .However it has a huge potential for the betterment of an average farmer.

Anyone willing to answer this ?

~
ek

Do the new ..

Survivorship bias is the logical error of concentrating on the people or things that “survived” some process and ignoring those that didn’t.In other words , focusing on the victories to mask the wrong that has been done .

That is to say masking the results of poor performing assets/instruments to cosmetically improve the appearance of the lot .That being said,it happens all the while withe the Mutual funds and other Financial Instruments , or with the Top performers of every college being idolized and revered with the Marketing Clinches.

With top performers , any college masks out the droppers, mediocre students who did not get a job  (worser still got a non- value add job – say selling burgers – or documenting- figures don’t account this “averaged” cases )  – Which is to say that Averages is always misleading .What we need to look at is Random numbers , probability of the distribution of the top performers in each of the specialization ,and consequently mapping this with your abilities -and finding out your chances of survival !

Also , finding out the standard deviation from the mean gives a fair estimate of the deviation to be expected , or that which is both normal and acceptable .

Now let us see what that means in game theory,and how could we detect the same ?  Let see this with an example of Money Markets (simply because the payoffs and the utility function are better understood in this context -and there is a measurable set of parameters to evaluate this “bias “ on .)

The rule of thumb in Game Theory ascertains to know the strategy of the other player-and hence predict what would be in his self interest to make the move .

That in an Asset Management organization could mean – to better reflect and sell other “far better performing ” funds  –

a. To close the funds that have higher risk and comparatively low returns .

b. To Mask the data by first implementing (a) ,and then taking an average of the subset of the better-off funds -and declare the weighted Performance average to be far better than it is .

Now let us see the risks – i.e what this means to an individual investor

There are two cases here –

a. That this investor invested in the “bad” funds .

b. That this investor invested in the subset of funds minus the bad funds (i.e the better off funds) – so no impact

* potential impact discussed in point (c)

c. That this is a new investor seeking to distribute his portfolio across the different funds of the AMC .

In case b and c , the misleading data hurts because – it gives an overall impression and hence the incentive for further/future investment ,which harms the investor by increasing the risk,and lowering the returns .

The safeguard – To find what the average actually means – is it a weighted average of all the funds of the AMC , how long have the funds being running since inception, the debt/ equity exposure and hence the risk vs the returns , the brand image of the AMC , the returns quoted against per year performance or averaged over three/five /other periods – mostly the firms “use” 1 year retuns- simply because they look lucrative and better instruments .

Also , these are the things to look at –

What were the market conditions that the performance intends to capture – bull, bearish , averaged markets .

Is the firm comparing apples with apples – Is the comparison between different funds of different AMC ‘s taking the market conditions into account . Is it evaluating it against the same averaged overall period ?

Are the figures exaggerated -what else is potentially beautifying it ? Is the mathematics correct ?

~

ek

You don’t need newer landscapes to make new discoveries – just a pair of new eyes  – Raffael  Lomas


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