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Silk Road (4): We took a bus ride to Iran

12 Friday Oct 2018

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I cursed the sky to open
I begged the clouds for rain
I prayed all night for water
For this burning in my veins
It was like my soul’s on fire
And I had to watch the flames
All my dreams went up in ashes
And my future blew away

Now the oil’s gone
And the money’s gone
All the jobs are gone
Still we’re hangin’ on

Down in dry county

~Bon Jovi

 

Something is happening in Iran and you know it by the way the currency moves…

I had done a lot of research for this Silk Road trip, started in early January to think of an itinerary. But not everything could be planned in advance. When it comes to Iran, nothing could be booked in advance.

As it turned out, this was quite fortuitous. First and foremost, the exchange rate moved in our favour: a month before we entered Iran the Rial lost ⅔ of its value. This was on top of the already quite good value of accommodation, transport etc. which existed there before.

The official money in Iran is Rial, but because of the enormous number of zeros (I constantly carried tens of millions of Rial in my pocket; a dinner for four would cost around 2 million), the locals have a made-up unit called Toman, which simply has one fewer zero. It was very, very confusing at first to get around that because it was not obvious whether the quotes were in Rials or Toman – not for the locals, of course, who were used to the prices of specific items and goods.

It was not easy to know where to exchange though as there is the unofficial exchange rate and the official one, which is about half that. And while we were there, the Rial depreciated by another 30%! And it’s not like a foreigner can just look up the exchange rate online for guidance (no Bloomberg app!). The first time I needed to exchange (at the Armenia-Iran border) I relied on a kind fellow bus passenger to educate me on the intricacies of the Iranian street exchange rate market, and more importantly, to give me the approximately “correct” level from an app on his phone.

In Tehran, we simply stumbled on one of the main exchange points: Ferdowsi Square. It reminded me a bit of “The Magurata” in Sofia, Bulgaria in the late days of communism/early days of capitalism. In terms of the way the crowd worked, though, it might have operated a bit closer to any open-cry exchanges in US in the good old days! This kind of market was though quite unsophisticated: a few blocks away from the square, there opened the possibility of a clear arb.

Second, self-organized trips are cheaper than going through a travel agent anywhere in the world but in Iran they are incredibly so. This is because in Iran it’s extremely difficult to self-organize a tour from abroad. Because of decades-long sanctions, the Iranian payment system is not linked to the rest of the world’s directly: one cannot use foreign-issued credit or debit cards in the country. Therefore, there are agencies outside of Iran which facilitate the booking of all tourist-related activities (for small items, like tickets for buses and tourist attractions, the premium, though, could be more than 100%, especially after the devaluation). The option is either to use them or to carry lots of cash and do it on the go once in the country.

Not knowing the exact date/time etc. we would be in the country, forced us to organise internal traveling ourselves, once on the spot. Incidentally, this saved us a lot of money. The downside of doing this was, though, that the hassle and uncertainty, which normally accompany such activity, were amplified by our inability to speak, understand and read a totally different language and writing. After a couple of days in the country, we realized we should at least learn the written numbers in Farsi (by the way, Farsi is just ‘Persian’ in Arabic – apparently the Arabs had difficulty pronouncing the ‘P’ sound). This was partially spurred by the fear of being too easily cheated!

People trying to take advantage of us being foreigners in Iran were, however, fewer than what we normally experienced in the other countries so far on our trip. Everyone is of course aware how much more foreigners can afford now compared to not only a month ago but also in general. However, I did not see any bitterness on their side. They just accept it as a way of life. As one businessman observed, “We are a country of sanctions and we have learned how to cope with them; there is nothing new with these new ones; but, yes, it is disappointing because we thought we were finally getting along.”

But let me backtrack a bit here: to get to Tehran, in the spirit of this trip, we took a bus ride from Yerevan! That was a long journey – more than 24 hours – with crossing the border in the middle of the night. However, the bus was rather comfortable (it even had a carpet in the middle lane) and, as with all long-range buses on this trip, one gets complimentary food and drinks.

The distance to the border is only around 400 km but it takes at least 10 hours to get to, as the road passes through some very tricky mountainous terrain along where, in the crevices on the sharper turns, we saw the remnants of a few cars. (If you have ever been to the ski resort Les Deux Alpes, imagine the 20 km stretch at the end, to the top, but multiply that by 20, constantly going up and down – that’s Yerevan to the Iranian border). On the positive side, the landscape is absolutely stunning!

I knew that there were daily buses from Yerevan to Tehran but I had no idea where exactly they left from and how much they cost. As it turned out, because they are operated by different companies, they all leave from different places and their cost varies. No easy way to find out this information either online or even through the hotel. Best is to go to a travel agency (of which there are many in Yerevan). There are obviously alternative ways to travel but they are much more expensive (the locals could take us only to the border for the price of our whole trip to Tehran, for example).

Our first impression of the Iranian people, from meeting some Iranians on our bus, coincided with what we had read and what other people told us: they were very friendly and curious to meet and help foreigners. That impression indeed stayed till the end of our journey in Iran. In fact, when we asked people if they are equally friendly to themselves as well, not just to foreigners, they told us that they are friendly to everyone who needs help, but foreigners, obviously, seem to need more help in Iran.

We spent the time on the bus talking with our newly-made friends about everything: from what to see in Iran, to education, history, cultures and even politics. In fact, the one thing Iranians really love is talking politics. They openly discuss current affairs (as one Iranian later pointed out to us, “I can assure you there are more Iranians who like America than Americans who like Iran”).

We intentionally avoided bringing in religion in any of our conversation not to stir sensitivities, however, it was clear that most of the people we met, while religious, did not necessarily agree with the extreme religious requirements in place. For example, throughout our stay, we were super careful not to break any laws or customs having heard how strict the authorities are: we made sure that our 15-year old daughter, who looks more like 10, had the hijab on all the time. But locals kept telling us not to worry, that young girls do not even need to wear a veil. In fact, while having a dinner in one of those open courtyards of their traditional houses in Isfahan, we noticed that even some of the local women had their hijab off, resting on their shoulders (a sight quite common especially in norther Tehran).

A similar attitude of resignation rather than active promotion of was adopted towards the issue of separation between the sexes. While, men and women cannot ride in the same subway carriage, cannot go together to the swimming pool, cannot hold hands or show any kind of affection in public, etc., on several occasions we saw locals disregarding such rules whenever they could get away with it (i.e. kissing and hugging in the street).

As tourists, the daily reality of a society which enforces the separation of sexes barely touched us anyway. We only got a small taste of it when it came to wanting to use the swimming pool as a family (which we couldn’t) or attending a mosque during a religious ceremony. Once, I waited patiently outside the Shah Mosque on Naqsh-e Jahan Square in Isfahan for a long time with my son and a crowd of other men while Georgia and my daughter were visiting inside during prayer time. A few of them struck a conversation with me, probably seeing my worried face and my glazing eyes for a view of my wife and daughter, hopefully, exiting the mosque. They were really surprised that I was worried and assured me the mosque was “the safest place one could possibly find”.

We stopped a few times along the road before we reached Iran – once because the cooling system of the bus stopped working, another time for lunch. We had prepared our own snacks but I had left about $3 worth of ADM and went to buy some ‘ayryan’ (yogurt mixed with water and some spices – it is the best thirst quencher). I struck a conversation with the owner, an Iranian, who was very curious to see an ‘European-looking’ family in this part of the world – only locals and probably a few really adventurous backpackers otherwise take the bus to Iran – tourists take the plane!

I bought some plain rice just so that the AMD does not go to ‘waste’. When he realized this was our last Armenian money he brought us some meat to go with the rice, water and tea! That was even though I kept telling him that I do not have any more AMD to pay for it: he was genuinely very generous! This was going to be one of our many encounters with the amazing Iranian hospitality.

We passed through several small towns before we reached the border. Inevitably, they looked very 1960-70s Soviet style but they were impressive because I had never seen old Soviet block of apartments perched on the rocks in the mountain.

Finally, we reached the border. Its crossing was surreal: we walked through into no-man’s land for almost 1 km. In total darkness. Otherwise, both Armenian and Iranian passport controls were swift and courteous. Once in Iran, however, we had to further wait for the bus to pass customs control – and that took hours!

Past the border we fell asleep only to be woken up a few hours later and ordered to get off the bus! I feared something bad happening but it was only a rest stop – I think the bus driver must get a commission from the ‘restaurant’ for every person who buys something otherwise I do not get it why we had to leave the bus (the kids were very unhappy). Eventually, most people just bought some tea, only the bus drivers entered the restaurant.

I woke up with the first rays of sunlight eager to lay my eyes for the first time on this place I heard and read so much about! Iran is mostly a desert sprayed with some rocky mountains and an oasis here and there. The road system is, however, much better than either Georgia or Armenia: all the main highways even have toll booths! There are plenty of police speed checks, and in general, plenty of police presence. As a result, driving is very civilized, one could say, as good as any European highway (excluding the Mediterranean ones, of course!).

Arriving in Tehran in the early morning or, possibly, at any time of the day is a totally different matter. There are simply no traffic rules. At all! I have never seen anything like this anywhere. Perhaps Mumbai comes close but still not comparable. For cars constantly drive against traffic whenever, on the several-lanes avenues, there is a gap of oncoming traffic (or not!). Motorcycles commonly take to the pavements whenever traffic is slow or the road is one way and they need to go in the opposite direction (what is amazing is that they beep at the pedestrians to move away as if it is the pedestrians who have invaded their territory, not the other way around).

And traffic lights – what are those for? The weird thing is that there is police literally on every major crossing!

On our first day, we attempted to walk for half an hour to reach the Grand Bazaar from our hotel. This was the one and only time we did this given the state of the traffic, the inexorable heat and the awful pollution (on the positive side, this is when we stumbled across Ferdowsi Square and the local foreign exchange market). In the evening, the coolness of the air (Tehran is very close to the highest peak in the Middle East) and the lack of traffic make walking more manageable. We went then looking for a restaurant and as we stopped to ask one man for help, a small crowd gathered, all trying to help or just being curious. Foreign tourists do not randomly walk the streets of Tehran. In fact, we saw very, very few tourists in Tehran and that was in Golestan Palace.

That evening we met an Iranian who spoke fluent Italian who invited us to his brother’s apartment for dinner! The brother also spoke fluent Italian (and a few other languages). As we were not in the mood for spaghetti and in search of local flavours, they took us to this wonderful cafe where we had an amazing evening. This was yet another example of the famous Iranian hospitality.

Tehran was too much for me. Apart from the noise and havoc in the street, the Grand Bazaar was also a disappointment of sort. It is imposing and busy but not that different from the Grand Bazaar in Istanbul: in fact, anything not an artefact or authentic is made in Turkey or China. For a real experience of a different sort of Grand Bazaar, I recommend visiting Isfahan’s. Golestan Palace, though, is definitely worth a visit: our first encounter of traditional Iranian architecture and beautifully coloured tiles everywhere!

We were indeed told that to visit the real beauty of the country, one must really go in the mountains just north of the city for nature or head south towards the Persian Gulf for history, culture and nature combined! This is then what we did by heading to Kashan, about 3 hours bus ride from the South Terminal in Tehran. Kashan is this quiet and quirky little town full of traditional houses. A traditional house is one with an internal wide-open courtyard, a fountain in the middle, and with lots of little passages that lead to different size rooms. These houses are really stunning.

We made a point to stay in one despite our self-imposed backpackers’ budget. But Kashan is much cheaper than Tehran and, especially, our next stop, Isfahan, so it actually fitted us perfectly. I really liked Kashan. Among other things I especially enjoyed playing backgammon with the locals (though I lost). I do not understand why of all places recommended for tourists to must see in Iran, Kashan is the least favourite. Perhaps because it is a little village compared to all the others but is really charming. Plus, there is a lot to see in the surroundings.

It is for this reason that we decided to take a private car the following day, instead of the bus, to Isfahan. On the way, we visited the highest village in Iran, Abyaneh (2,222m above sea level). It is more than 2,500 years old and its houses, which are made of red mud and straw, have mostly survived the centuries. Abyaneh reminded me of many villages perched along the hills in the Italian countryside: it is that different from anything else in Iran. Even the locals wear very different clothes than anywhere else we visited.

While planning Iran, we did not factor in that our stay will coincide with the end of their most important religious holiday: you must have seen the men wearing black and green and beating themselves with branches on TV or online. For two days, everything closes in the country. That reality fully caught up with us while in Isfahan. That was unfortunate for us but it also gave us a chance to learn more about this tradition by visiting these ceremonies: the locals were very eager to explain things to us and they took lots of pictures! On the upside, during those two days there are stands all across the city which give away free food, tea, sweets and fruits (most restaurants are closed as well).

It was business as usual the morning we had scheduled to leave Isfahan, thus we managed to visit quickly the stunning central square, which is surrounded by two imposing mosques, a palace and the Grand Bazaar. A peculiar thing about Isfahan is the Armenian quarters, and particularly Venk Cathedral: one of the most exquisitely decorated churches I have ever seen. The surrounding area is also full of cute cafes where one could finally have a proper coffee (Iranians do not really drink coffee, and if they do, it is nescafé).

Once in Shiraz we visited many mosques, treated ourselves to some proper (European-style) restaurant food – after eating mostly ‘street food’ until then, this was a welcome diversion, though the bill looked astronomical (2 million, 800 thousand Rial), and organised our visit to Persepolis and Necropolis. Persepolis was great, but it is Necropolis that is magnificently different than any other ancient ruins I have ever seen, consisting of carved tombs in the middle of the mountain. In fact, Persepolis reminded me of the Baalbek Roman ruins in the Bekaa Valley in Lebanon.

I will actually remember Persepolis for almost choking on water. We had left Shiraz at 8:30 (rather than the suggested 8:00) in the morning. By 11am it was so hot and I was so thirsty, that eager to refresh, I gulped the water in a hurry and it went the wrong way
which is ironic, because one thing that will stay with me from Iran is how dry the country is. All the cities we stayed in had totally dry river beds. And there are so many fountains and water passages everywhere and they are all dry. I can only imagine how more beautiful Iran’s already well-preserved gardens and courtyards would look otherwise.

The changing of the climate globally is partially to blame: it is difficult to imagine that it would snow in the winter in Iran even 10 years ago (and the snow would actually keep) in the middle of the desert. The locals did not remember when it was that it properly rained last time. But this is also Iran’s own doing: the building of an intricate underground water system, eventually completely dried the on-the-ground natural water. This is not something necessarily recent. In fact, almost all cities we visited, but especially the ones in the south, had ancient underground water canals. They run deep and are still open – one could easily go down to the bottom.

In light of this water problem, I was surprised to find out that water is safe to drink almost everywhere we went – and there are public drinking fountains all over the cities we visited. Same holds for public toilets – they are free and they are everywhere (some of them are indeed “ancient”). In fact, the cities are kept in almost pristine condition: there is very little garbage on the street, plenty of bins and sanitary workers attending to the streets even late into the evening.

Another unexpected aspect of Iran for me was how digitalized commerce is. Credit/debit card payments are common everywhere, in the bazaars, on the street, and even in the most run-down taxis. In the major cities, there is a bank literally on every corner. I don’t know if they have the equivalent of Amazon but, they do have the equivalent of Uber called ‘Snap’. One could also easily book bus tickets online. Of course, we could not enter this digital world, but people were happy to book things online for us.

Our last stop before completing our Iran journey back to Tehran was Yazd, the centre of Zoroastrianism and the largest wind catcher in the world. On the way there, we saw a 4000 years old living organism, a cedar tree. In Yazd, I started to get restless about the exchange rate and its massive drop. Having worked in Emerging Markets for so many years, I feared this was not a good omen. My unease was also further exacerbated by the fact that since we had left Tehran it was a constant struggle to find a ‘proper’ place to exchange money (unless one was happy to pay the unrealistic rate at the hotels). The Grand Bazaars were the obvious places but even there, there was not one designated spot. In the Grand Bazaar in Tehran, for example, there is an area where all exchange matters are handled, similar to Ferdowsi Square. In Kashan we had to ask a few shops and finally we were led to a secluded place on the second floor of an otherwise mostly empty building. In Isfahan and Shiraz, it was randomly in the street, mostly around taxi stands. Funnily enough, it was in Yazd that there were several official exchange shops on designated streets, however by then the exchange rate had moved so much that locals were getting so concerned that we would be asked even by everyday workers to exchange.

When it comes to currencies, it is obvious Iranian people prefer EUR to USD now, probably as they see Europe as a viable emigration possibility. But whenever I struck conversation with business people about economic matters, it is interesting that they did not see any other alternative to the US Dollar. They think Europe has no choice but to eventually succumb to US pressure on sanctions: “one thing is for the government not to support these sanctions, but a private company would never take the risk and avoid them for fear of US business repercussions”.

They do not see Russia or China as alternatives either. In fact, they seem to look even more suspiciously at them as well: “Russia is simply a brute force and Russian tourists have a massive attitude of superiority”, while “China is a smart opportunist looking only after itself and Chinese tourists are simply clueless – you talk to them for 5 minutes while they just stare at you and eventually you realize they did not understand anything you said”. Moreover, “what are we going to do with all these RUB and CNY, we can’t buy anything we want from them, so we end up exchanging them back into USD and EUR to have access to global markets”.

This is a stark reminder to China which wants to make the CNY a global currency: they either have to offer something (goods and services) the rest of the world wants to buy with their currency in exchange or to offer safe store of capital, the way the US has done all these years. It seems China has played its goods for exports card already: global consumer markets are swamped with cheap Chinese goods. Which means they have to move up the value chain (which they are trying to, especially in technology) or free up the capital account and develop massively their financial services market. I will come to this after my visit to China.

Indeed, for a country under sanctions for so many years, there is a massive oversupply of goods in Iran (for now). The bazaars are full of consumer goods and there is plenty of food: fruits, vegetables, meat, bread, rice, teas
and rich sweet shops. The best thing was buying freshly baked bread straight from the oven – it is an amazing feeling which brought back memories from my childhood years in Bulgaria when we used to do the same.

And, again, the people are so generous – you can try anything in the shops and they are absolutely not offended if you decide not to buy. We walked one late evening back to the hotel in Yazd and passed by an oven with freshly baked bread. A man had just purchased half a dozen flat breads. Trying to balance them on his motorcycle, he saw us looking curiously inside wondering whether to go in and buy some bread. He just took one of his breads and insisted on giving it to us as a gift.

After Yazd we were once more back in Tehran, the only place where we could catch an international bus. This time we purposely stayed in the north to be able to see another aspect of the city. Indeed, if there is any social separation in Iran, it is most obvious in Tehran, which is clearly divided between the northern rich, residential and full of nature – a stroll in verdant, mountainous Durband is a must – and the southern poor part of the city. In fact, one could say that northern Tehran stands out among everything we saw inside the country.

I don’t know if this new round of sanctions would have a different effect on Iran’s economy than any of the previous ones. While there is still an abundance of some consumer goods, prices of water, rent and some other essentials and services have gone up. In fact, it is inevitable that the price of any good which has an imported component would be rising and with the Rial continuing to lose its value things could become really difficult.

Silk Road Footnote

08 Monday Oct 2018

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Travelling across countries, where everything you know is different, from the language to the food, WC habits, social customs, etc., while knowing it is going to be never-ending, is overwhelming. Being always transient in each place is disorienting. Having to figure out every new encounter in terms of friends or foe, exhausting.

This trip proves to be very tiring on our emotional intelligence. I realized that in most of our daily life before, we rarely used emotional intelligence because everything is more or less a routine. Now, we have to constantly assess the situation: are people genuine, do they mean good, are we doing something inappropriate?

Saying that, I am not yet regretting our choice. Each day feels remarkable in a way that our previous daily routine, which was far from being stress-free anyhow, never was. We are also learning to adjust our expectations quicker, which, I think is improving our capacity to just relax and be… we have had especially a lot of waiting to do at borders, which was a full on training!

Most of my vivid impressions, in fact, on this trip are from crossing land (and now sea) borders because 1) they take a really long time; 2) they set your expectations for the rest of the country; 3) they are at the intersection of sometimes vastly different cultures, religions, customs; 4) they could open up new opportunities; 5) waiting at the borders gives me the time to reflect and also write.

For me, this trip is massively going out of my comfort zone and facing my fears on all possible levels with an ultimate goal. To quote Walter Mitty: “To see the world, things dangerous to come to, to see behind walls, draw closer, to find each other, and to feel. That is the purpose of life.”

We just arrived in Bukhara, Uzbekistan, after visiting, Khiva and Nukus, and following a 14h train ride from Beyneu, Kazakhstan. We gave ourselves, roughly a week to go through the country, which is slower than we have done till now (except Iran). Thus I am hoping this might give me a chance to do some writing.

Silk Road (3): Fast Car

30 Sunday Sep 2018

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“You got a fast car

I got a plan to get us out of here

I been working at the convenience store

Managed to save just a little bit of money

Won’t have to drive too far

Just’ cross the border and into the city

You and I can both get jobs

And finally see what it means to be living.”

~Tracy Chapman

I am not sure if Armenians are ‘worse’ drivers than their Georgian neighbors or, actually, ‘more skilled’, considering the incredibly poor state of their transportation infrastructure. The road leading to the Georgian-Armenian border indeed is only one lane and once past it, it becomes one of the worst major roads I have been on so far. Avoiding the humongous holes and the incoming traffic was an incredible feat (our driver even proceeded to overtake an ambulance whose lights and siren were on). We were duly stopped by the police a few kilometers after for speeding.

The driver’s skill was even more incredible considering that a lot of the cars in Armenia are beyond ancient: I have never seen so many old Soviet cars since I lived in Bulgaria in the 1980s. I think literally all the trucks we saw were ‘Zils’ or ‘Kamaz’. Funnily enough though, the Armenians seem to take a lot of pride in their cars. Indeed, our driver – who, despite the fact that we picked up the minivan at the Tbilisi bus station, his lack of spoken Russian and his abruptness, was Armenian – got really upset when we ate some chakapuri (bread with cheese) and a few crumbles fell on the floor of the car. He did not calm down even after we cleaned up everything. All this even though the minivan was an ancient Mercedes with worn-off interior and holes in the plastic dashboard.

The area along the border here is very mountainous but the landscape changes from plush, almost tropical in Georgia to arid, almost desert-like in Armenia (similar to the one around Kars in Turkey). The border crossing itself was very straightforward: modern and absolutely no queuing at all. The kids and Georgia were sitting in the back, while I was squeezed in between a lady with more bags than she could carry and a poker player with just a ‘man’s bag’ in his hand. Still, she asked me, and not him, to help carry one of her bags across the border (was she a ‘trader’ of some sort?).

We arrived in Yerevan under a scorcher. If the driver likes you he will stop anywhere you ask him too. I had developed a connection with the poker player, who was in Tbilisi overnight to play as he had been banned from all casinos in Yerevan, so he helped us get to our hotel. We found tennis in common with him: Andre Agassi, who, according to him, is an Armenian born in Iran and living in US (the lady thought that even Serena Williams is of Armenian origin!).

The old town of Yerevan is like Chernokonevo, the village upon which my home town, Dimitrovgrad, was built after WW2 – a few shanty houses. But unlike Dimitrovgrad, Yerevan is an ancient city with rich history and culture. All the wars and earthquakes must have put a heavy toll on this city. Maybe, this is why there is massive amount of construction going on, much more than I saw in either Istanbul or Tbilisi, or, in fact, in any European city. To see ancient Armenian churches and castles one has to go in the surroundings of Yerevan and across the border in Turkey.

In fact, Yerevan is very modern: there are a lot of art installations and monuments all over the city. But most of the architecture is still Soviet style. Yerevan is also very vibrant. While we were there it was full of street musicians, there was even a live concert of a Russian band, and the singing fountains in Republic Square were on every evening.

Armenian food is somewhat similar to Georgian – just slightly different versions of the same dish. I did not see the khinkali equivalent in Armenia though. And, of course, Georgian wine is out of this world. But I found Armenian fruits sweeter, especially the apricots (I am really gutted I did not try the Georgian watermelon, though). The Georgians have this ‘churchuri’ made out of dried fruits and nuts held together by grape molasses; the typical Armenian equivalent is to take the whole dried fruit and fill it up with nuts – both are absolutely outstanding!

As I mentioned before, we are doing this trip the backpackers’ way, meaning we use as much public transportation as possible. Turkey was perfect in that sense – very easy. Georgia was ok – we used the metro. But while there is more Cyrillic on the signs along the road in Armenia (than in Georgia) Yerevan’s metro is very small and the signs are only in Armenian. Therefore, we walked till, under 34C, at some point it became impossible. So, we took a taxi back and forth to the Armenian Genocide Memorial – it cost us less than $2 equivalent each way and both drivers were very pleasant and polite (I could communicate in Russian).

Having spent some time now also in Armenia, combined with our experience in Georgia, made me reflect on our expectations regarding the service industry and how it affects our views of a country and its people. In Tbilisi, the restaurant waiter may indeed have been less attentive according to our standards, but we felt very welcomed when we were invited to the house of our friend’s friend and treated to tea, coffee and fruits. In Yerevan, even though the hotel’s clerk was clueless when asked basic tourist information and she clearly didn’t seem to think it was part of her job description to help, the doorman kindly helped us.

It made me question whether the level of service we expect is linked to our culture. In particular, I guess, I was surprised at my own Western bias, considering I grew up behind the Iron Curtain. It made me wonder what possible hope we have to teach our kids tolerance and understanding of other cultures by any other means than travelling through them

Silk Road (2): Could beautiful nature and ancient history create a false sense of entitlement?

29 Saturday Sep 2018

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The first thing that struck me in Georgia was the Toyota Priuses. I think that literally every third car was a brand-new Prius. That was in stark contrast to almost all other cars which were very run-down Opels, Fords, BMWs, etc. You could still see the old Soviet Lada, Jiguli and Volga too.

We took the ‘marshrutka’ (minibus) from the border to the rented apartment in Batumi. Needless to say, the exchange rate at the border was much worse than anywhere else in town, so apart from exchanging our leftover TRY and having enough (50 EUR cents = 1.5 GEL per person) to pay for the ride into town, no more money was necessary. The marshrutka itself was a leap into my past – the early 1990s in Bulgaria – I think the vehicle was even older than that. Moreover, it boarded at least twice the allowed capacity and our Turkish driver on the other side of the border was an angel compared to this Georgian one.

The second thing that struck me was that pretty much everyone was reluctant to speak Russian, regardless of age. The military conflict with Russia had left a big impression of some resentment but mostly bewilderment (“What possibly could the Russians want from us?”). The caretaker of the apartment where we stayed however, brightened up when I told him I am originally Bulgarian and gave us a very nice bottle of local homemade red wine.

Batumi has an impressive beachside boulevard where we spent our day strolling about and riding on mini-scooters. The scooters had their own designated lane but at 20-25 km/h they could still pose danger to the pedestrians who walked nonchalantly in the area: I presume this was part of the Georgian driving experience anyway. Hiring the scooters ‘broke’ our daily entertainment budget but that was an offset from the transportation budget from the day before (the ‘marshrutka’) and the free ride to the train station later which our host was nice enough to offer.

Apart from the popularity which comes with its name from the old Soviet times and the casinos which I presume tourists flock to, I am not sure what else Batumi has to offer though (BTW, again, the bid-offer spread in some exchange bureaus is less than 1%). Yes, the skyline looks impressive and even the modern buildings have a very nice style, which actually blends well with some of the older architecture still visible across. But the beach itself is large rocks and no sand at all: Kobuleti, a half hour drive East, has a better beach.

The train to Tbilisi is very modern with free Wi-Fi and outlets for charging devices. It is not as fast as Istanbul-Ankara, though, as it takes one hour more to cover 100km less in total distance. But then the mountainous landscape does not allow it. The ride immediately after leaving Batumi train station runs for several kilometers literally along the beach where there are still the old Soviet style (very rundown) blocks of apartments alongside some impressive villas. If the mountains on the Turkish side of the border reminded me of Switzerland, this side of the border looked much more like Costa Rica – almost tropical. And while the Turkish side has much more order and the houses looked generally nicer, everything looked rundown in Georgia.

Tbilisi, however, also has a touch of Italy when it comes to its old city (and, of course, the wine): it is a quirk combination of art, imposing buildings, beautiful natural landscape and historical artifacts. It is a city for romance, full of balconies (on a visit to the city during the Cold War, M. Thatcher allegedly said, “Everywhere else they are building shelters, you are building balconies”) and night lights – the stroll to the Sulphur baths is a must. In hindsight, actually, we should have stayed longer in Tbilisi to enjoy its full splendor.

We were very lucky to meet up with a friend of a friend who spent the whole day showing us the city and its surroundings. She was amazing, such a nice and positive person. Most Georgian people in the service industry, however, looked rather miserable and even bitter somehow. I am not sure whether it was my Russian that made them so. That attitude, which sometimes merged into outright rudeness, obviously will not help business: most tourists are Russian. And knowledge of any foreign language is a plus, especially one which is spoken by hundreds of millions of people (Georgia’s population, on the other hand, is just around 4 million).

While in Turkey, I fully expected to be bargaining when engaging in an exchange as part of custom. In Georgia, the bargaining felt as if it was more about not being taken advantage of. Our host in Tbilisi, for example, offered to charge $280 (4 people) to take us to Yerevan (5 hours drive) and lied how much the ‘marshrutka’ would cost ($50 per person), when the actual price was not only $13 per person but there was plenty on offer as long as someone bothered to go to the taxi stand at the bus station.

In the local street flea market my daughter’s leaning to touch an object provoked an extreme reaction by the shopkeeper – she yelled so violently that passers-by stopped to see what happened. In one shop there was even a sign in English that said “Customer is not always right”!

I am only guessing here, but all this could be related to a sense of entitlement, also very common in my home country, Bulgaria. Small countries like these, which are lucky to have amazing nature, are full of ancient history and once had very sophisticated culture, but which were more recently easily conquered by other more populous, but less ‘ancient’ nations, do maybe tend to feel superior and to blame external forces for their issues. In that sense, Georgia is both an old and a very new country at the same time: having gained its independence from the Soviet Union only a few decades ago, it still lacks the proper institutional infrastructure and framework to really make decisions in its own interest. It is naĂŻve to think that having exited one ‘union’, joining another would automatically solve all problems.

Before passing a real judgement about the way a traveler is treated in Georgia, however, I feel we need to complete our journey and revisit, under the light of new experiences, this first opinion I formed.

Silk Road (1): If Turkey is in crisis, it’s not obvious visiting it

20 Thursday Sep 2018

Posted by in EM, Travel

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One year after I left HSBC, and after more than 20 years in the business, I have finally left London with my family to seek other opportunities. We are currently on our land journey to Asia where we plan to relocate for the foreseeable future. That last one year in London went fast into organizing the trip, getting my tennis coaching credentials and actually enjoying time spent with the family. We even managed to squeeze in 6 weeks in our beach house in Italy!

We plan to follow the Silk Road as much as possible without taking any unnecessary risks by visiting certain places along the route. I am typing this at the moment from a very modern and fast train in the middle of Turkey but we started the journey in Italy, of course, the Marco Polo way, on September 1 and stayed for a few days in my home country, Bulgaria. The fact that my parents live one hour away from the Turkish border made the bus trip to Istanbul very easy and convenient. In fact, if it was not that the border crossing takes unreasonably long (due to the fact that Bulgaria is part of the EU and Turkey is not – the incredibly long queue of trucks is a stark warning to what perhaps awaits at the border between France and the UK after Brexit), using Ataturk Airport instead of Vrajdebna Sofia Airport might have been a more efficient option for most people living in Bulgaria close to the Turkish border.

Istanbul is as magnificent as always and as I remember it from visiting it on numerous occasions before both for work and pleasure. In fact, even more so because the ancient history and culture are very well blended with the modernity of the present times: public transportation (bus, tram, metro, ferry) is very efficient and much easier to navigate than many other European cities; getting tickets for attractions is straightforward; even the bid/offer spread in some foreign exchange bureaus is better than some professional retail platforms I used while trading for my own account in London this past year (BTW, best ones I came across are around the Spice Bazaar – that makes exchanging and using physical cash, still infinitely better than withdrawing local currency from a foreign based account or paying by credit card)!

The contrast between ancient and modern is indeed striking when it comes to religion. We were in a small barber shop in Besiktas in which the TV was showing scantily dressed women dancing provocatively on Turkish pop music while the mosque loudspeakers across the street were blaring the daily prayer. The locals in Istanbul still do not get dressed that much differently than the locals of any European Mediterranean country. Are there more women wearing burqas than what I remember from previous visits? I noticed the fully-covered ones but they were mainly in the touristic part of the city and I wonder how many of them were actually foreigners – in fact, London’s Knightsbridge has probably more of them than Istanbul’s Sultanahmet.

If Turkey is in crisis there is absolutely no sign of that in Istanbul… except that everything is much cheaper for a EUR/USD-based foreigner. And when it comes to the service industry at least, Istanbul is no different than London, for example: most of the personnel is foreign. Reality is slightly different than that, of course, for just like London is not a good representation of the UK, Istanbul is not one of Turkey either.

We crossed the whole country west to east all the way to the border with Georgia. We saw small villages and bigger towns. Especially in the villages we would struggle to see women who were not covered. Not the burqas that we know but the square headscarves. But then again, the reality is not that dissimilar in many villages in Bulgaria and even in some European Mediterranean countries: I feel this is more a question of generations’ customs than religion.

Our journey across Turkey was mostly by train. In fact, we are doing this trip the ‘old-fashioned’ way, the way I remember my school years: a backpack, hostels, and public transportation as much as possible. I want to see these countries not through the eyes of the Ministry of Finance or the central bank, which is the way we used to do it in the business, but through the people and their daily lives. I also want my kids to understand how privileged and lucky they have been so far.

Istanbul-Ankara was a modern, fast train with Wi-Fi and all the amenities. The train station in Istanbul, strangely enough, was just two tracks one hour away from the city center. Ankara’s one, on the other hand, was a modern spacious building, resembling more Heathrow T5, but right in the center of the city.

Ankara-Kars is an overnight train, slower and less modern (no Wi-Fi) than Istanbul-Ankara but better than London-Glasgow (friendlier service, fridge with complementary food and drinks and slippers!), for example (compared to when I last did that journey about 5 years ago). We used the time on the train to just look out and reflect. In fact, we did this for hours and we did not mind because it brought back memories from when we used to do that kind of travelling with our parents on long journeys. When I say ‘we’, I meant I and Georgia. Our kids’ attention span is infinitely smaller and their idea of entertainment profoundly different. Not that there was much of it (they do have to study on our trip) but they had to constantly be reminded to leave the digital distractions so easily available to them.

The one thing that stuck me while passing through the interior of Turkey was the heavy presence of the military: there are military barracks literally in every town we passed. Kars, itself has a few. We arrived late in the evening and while walking to the hotel we merged with the backpackers’ ‘crowd’. Kars is the eastern-most large city for visiting Georgia and Armenia (latter indirectly as the border is closed). There is heavy influence of either Armenian or (further northeast) Georgian culture. If you are looking for a financial or economic crisis, you are not going to see any traces of it in Kars either.

The drive to the Georgian border was through what I can best describe as the Switzerland of Turkey: the landscape changes from flat arid land to picturesque mountains literally immediately. The Turkey-Georgian border crossing would have been straightforward too if it was not for walking in no man’s land for half a kilometer under torrential rain (and make-up cover). By the way, the queue of trucks waiting to cross the border was at least twice longer than at the Bulgaria-Turkey border crossing.

Share buybacks must be seen through the shareholder primacy doctrine

12 Sunday Aug 2018

Posted by in Equity, Politics

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  • Buybacks are a direct and natural response to the shift in corporate management structure in the late 1970s which ushered in the period of ‘shareholder primacy’. It was Rule 10B-18 in 1982 which legitimized them.
  • Banning share buybacks without also changing the focus away from maximizing shareholder value will accomplish little because companies will simply find other ways to reach that objective.
  • The 1970s were a tumultuous period for the global economy with the two oil crises leading to stagflation and to enormous pressure on corporate profits. But the ground was set already in 1970 when M. Friedman published “The Social Responsibility of Business is to Increase Profits”.
  • In 1976 M. Jensen & W. Meckling published “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure” which explored the idea of equity-based compensation for professional managers.
  • Finally, six years later Rule 10B-18 provided safe haven for companies to buyback their shares, allowing them another option to reward shareholders, in addition to dividends. The results were explosive.
  • Equity-based compensation rose from 0% of the median executive’s pay in 1980s to at least 60% in the 2000s; just in 1983, the aggregate amount of cash spent on share buybacks tripled and by 1985 it was 5 times higher than the average in the period 1972-1982.
  • With the incentive structure thus created in the 1980s, companies NOT doing buybacks would not be fulfilling their objective of maximizing shareholder value, notwithstanding that managers are also large shareholders.
  • Thus, banning buybacks makes no sense as it goes against the shareholder primacy doctrine unless, of course there is solid evidence that buybacks erode long-term shareholder value. So, therefore, the issue is not with buybacks but with the corporate management structure which has emerged since the 1980s.
  • Profit maximization and focus on shareholders has created extremely efficient companies boosting aggregate supply(AS), in many cases at the expense of aggregate demand(AD) at home, thus forcing those same companies to shift sales increasingly abroad.
  • It has also contributed to the concentration of both companies and shareholders, the former leading to the monopolization of US industries, the latter to US inequality->continuing with the shareholder primacy thus could indeed be damaging to corporate profits long terms once AD dries off even in EM.
  • I think it is difficult if not impossible to gauge the size of the effect of share buybacks on stocks prices or EPS, but there is no doubt that there is one: JPM, for ex. thinks effect on EPS growth is less than 10%, UBS thinks it is more than 30%.
  • Fed’s Z1 Flow of Funds reports a break-down of the major equity buyers each quarter: since 2008 corporates buying back their shares is absolutely dominant; the second biggest ‘buyer’, ETF, is three times smaller; pension funds and households net sold equities during that period.
  • The stock price of profitable companies like Apple should be rising on its own merit , but that does not negate the possibility that buybacks ‘juice up’ stock prices even higher than ‘justified’. It goes the other way too: with 22 consecutive quarters of declining revenues the stock price of IBM probably should  be lower -where would IBM stock price be if not for buybacks?
  • If we are adjusting R&D to GDP, we might as well adjust share repurchases to GDP as well (and yes, they are also at record high). Tech companies raising their R&D – that’s great – but if they did not do any buybacks, could they have raised it even more?
  • The recapitalization argument (shifting from equity to debt refinancing) is probably the most logical argument in favor of buybacks, if it was not for the agency conflict of interest (managers are equity holders) and the fact that they could have also boosted dividends instead.
  • The argument that giving money back to shareholders could boost wages and investment somewhere else (therefore, where is the problem?) – yes, it could – but as far as I am aware there is not much evidence of this.

Domestic vs. foreign capital flight in EM

04 Monday Jun 2018

Posted by in EM

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Domestic capital, rather than foreign capital, flight is the bigger issue for most EM now

A country with a small domestic capital base has little choice but to borrow from ‘strangers’ (Wynne Godley’s sectoral balances approach) and thus be subject to foreign capital flight whenever (foreign) interest rates rise and/or the external BoP situation worsen considerably. The inevitability of this outcome, of course, leads to the boom and bust scenario we have been so used to in EM in the past. Monitoring US economic business cycles and local external debt statistics, current and capital account balances, FX reserves, etc., becomes essential for forecasting local currency value.

However, as the EM middle class has progressively grown for the last two decades, so has the domestic capital base, and so has the importance of monitoring what the locals are doing with respect to their savings and investments. There is, therefore, also the case of domestic capital flight, which is much more difficult to quantify as its causes are much more subjective.

EM countries have responded to this development by gradually shifting to borrowing in their local currency. Thus, the ratio of local debt to external debt in EM has risen. In many cases, however, the growth of local government bond instruments has not been fast enough for the growth of the domestic capital base. Traditionally, locals have invested in real estate and some equities. If local financial markets remain underdeveloped relative to the growth of the domestic capital base, with fewer domestic investment options available, there is a bigger incentive for capital to search other investments in foreign currencies.

In addition, the larger the domestic capital base, the bigger the risk of domestic capital ‘flight’ if locals start fearing that a currency depreciation is forthcoming. In this case, money does not need to necessarily leave the country; all it takes is to be deposited in foreign currency in the domestic banking system, thus not directly available for local currency lending. For example, the level of dollarization in both Argentina and Turkey is quite high (more than 50% of all deposits are foreign currency denominated).

Finally, some locals can decide not only to convert their savings/investments in foreign currency for the reasons above but also to take them out of the country. This can happen if they also fear ‘currency appropriation’, i.e. they believe the local institutional framework is inadequate to protect their assets. For example, in 2004 Argentina decided to pay local foreign currency deposits in pesos at an exchange rate which had nothing to do with reality. There have been also many occasions where governments have re-possessed real assets (real estate or productive assets, like factories, resources, etc.).

So, a growing domestic capital base combined with an underdeveloped institutional (financial, legislative) infrastructure increases massively the risk of domestic capital flight. For a lot of EM countries currently, the case can be made that domestic capital flight is a bigger issue than foreign capital flight at the moment. How to monitor this is not that obvious though. The IMF measures reserve adequacy ratios taking into account domestic money supply, imports, external debt and other external liabilities.

The case of China and Russia

In a wonderful blog post, Brad Setser addresses the issue of how much FX reserves a country needs using this IMF framework. I do agree with his reasoning that, applied broadly, this measure tends to overstate the FX reserve adequacy ratio in some BoP surplus countries and understate it in others (large external debt borrowers). However, I do not think it is that straightforward. For example, China falls in this unique category where, despite running a BoP surplus there is a bigger risk of domestic, rather than of foreign capital, flight and the IMF measure rightly implies so.

China also has the largest single country FX reserves position. In addition, it has very little public foreign debt (though it does have a lot of corporate foreign debt). By these measures, it does look like China has more than enough of FX reserves. However, China also has a very large and growing domestic capital base, an underdeveloped financial markets infrastructure (few domestic investment options) and untested institutional framework, which are the main ingredients for a potential domestic capital flight. Indeed, we saw the risk of capital flight in 2016 when, despite of the capital controls, a lot of money found its way out of the country for the reasons mentioned above.

It will be a big test for China once it lifts its capital controls. Obviously, the level of FX reserves is extremely inadequate to keep the Yuan stable if even a small portion of the domestic capital base decides to convert to USDs. In fact, if other EM countries are an example, the prospects are not bright.

Russia experienced massive capital flight between 2006 and 2015 despite boasting higher CA surplus, higher FX reserves to GDP and lower foreign debt to GDP than China’s now. These good economic numbers were irrelevant to stop locals from converting their domestic deposits into foreign ones in the face of an untrustworthy domestic institutional framework. And despite more than seemingly adequate FX reserves, the RUB depreciated as a result.

Conclusion

So, is the IMF overstating the adequacy of FX reserves for BoP surplus countries but with large domestic deposits? It depends on people’s perception of how trustworthy the domestic institutional framework is (and what, therefore, the prospects for the currency are) and what domestic investment options are available. On the other hand, is the IMF understating the importance of bigger FX reserves for countries with large external deficits? It depends on people’s view on how high foreign interest rates could rise.

It is much more difficult to quantify the risk of domestic capital flight, and once it starts, it is also much more difficult to reverse it. On the other hand, one could say that the risk of foreign capital flight is not only smaller now, because developed markets terminal rates have been steadily declining, but also the recipe for reversing it is also more obvious – raise domestic interest rates to offset the rise in developed markets interest rates. I therefore think it is better to lean on the side of caution and allow for larger FX reserves relative to the domestic banking system for those EMs with a weaker (and untested, i.e. capital controls about to come off) institutional frameworks.

A much more efficient solution, obviously, would be to develop the domestic financial infrastructure, something which China has indeed been doing in the last few years.

From golden fetters to debt shackles

18 Friday May 2018

Posted by in Monetary Policy

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It is the prerogative of the state to issue money. In the past, some states did it better than others: Roman Republic, Song China issued money in line with economic expansions and under the checks and balances of a solid institutional framework. During the Dark Ages, however, European states issued money to fund disastrous wars waged on the back of economic stagnations. The gold standard, introduced in part to limit the state powers in monetary affairs, did exactly that: it severely restricted the flow of money to the availability of gold, thus cutting the wings of any economic expansion.

When the Bretton Woods agreement in 1971 eventually put an end to the gold standard, and fiat money finally became the norm, governments, however, chose to delegate that function of money creation to their banking system: banks could issue new mediums of exchange only in the process of also issuing debt. This was a massive improvement over any monetary transmission mechanism of the past because it linked money creation directly to economic activity (assuming that the debt is used to fund projects leading to economic growth).

So, it worked well at the beginning: debt levels were very low to start with, the financialization of the economy in the 1980s made it much easier to obtain new debts and the 1st Digital Revolution made sure there were plenty of good project to fund. However, even that was not bullet proof: the system was set-up by default to encourage the creation of debt so that money is created. However, with good projects to fund becoming scarce, funding moved to less productive endeavors: junk bonds in the 1990s, mortgage debt in 2000s, and the pinnacle to top it off, corporate debt for share buybacks in 2010s!

With debt levels high and continuing to rise, how high can interest rates go before they nip the whole process of money creation in the bud? We had a glimpse of that post the S&L crisis in the early 1990s which eventually gave rise to shadow money; we had something similar post the 2008 financial crisis when debt deleveraging gave rise to crypto money. Both shadow and crypto money were designed as substitutes of the medium of exchange which had gone scarce as debt origination slowed down. The problem with that is, because they are not regulated, they do not carry the safety/convertibility features of inside money and thus at some point the whole process badly backfires.

In a sense, we ended the gold standard, only to put the monetary fetters back using debt as the anchor. Even though this process was an improvement, it is questionable, however, whether the banking system has done a better job than the state would have done, if it had taken full advantage of the fiat monetary system post 1971.

‘State’ money creation – this ghost from the past is badly needed for the future

17 Thursday May 2018

Posted by in blockchain, Monetary Policy

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At present, majority of money (medium of exchange=inside money) creation in the developed world gets done by private banks. The state (government and/or the central bank =outside money) does create money but it is either as a medium of exchange within the banking system only, or on the back of demand for physical cash in exchange for inside money.

I have written about this before here (‘A simplified hierarchy of money’). The problem with the current monetary transmission mechanism (‘A simplified version of the monetary transmission mechanism’) is that it is set up almost by default to produce a scarcity of money. One alternative could be that the central bank distributes money directly using all the available data management techniques and recent advances of technology (central bank digital cash).

Given the state of our economy, and in order to properly address the level of technological advances we are experiencing, i.e. to minimize the risk of disruptions which could lead to social upheavals and loss of our prosperity, it could be a good idea to look at history to see how money was created and distributed in similar periods of development.

(Click to enlarge)

Indeed, inside vs. outside money creation is only a recent phenomenon (late 20th century) while state money creation had been the norm for the majority of human existence. And that’s the thing. Unfortunately, our current views of state money creation are really shaped by the most recent examples which had been disasters. For example, the Gold Standard came into existence to curb the rampant money creation to fund wars during the European Dark Age. In addition, that was a period without any major commercial innovations and characterized by population stagnation across Europe.

The late 18th and the 19th century, on the other hand, saw the 1st and 2nd Industrial Revolution which introduced new modes of production. The second half of the 19th century up to early 20th century was also characterized by a period of general peace (Pax Britannica). By then the great innovations of the previous two centuries were also commercialized. As a result of all this, Europe, in particular, became very prosperous.

Unfortunately, the existence of the Gold Standard, prohibited the state to issue enough money to correspond to the increased potential of economic activity. The Great Depression in the 1930s was thus characterized by a positive supply shock, on the back of these innovations, and a negative demand shock on the back of insufficient supply of the medium of exchange.

Early 20th century was probably the first time humanity was experiencing the fruits of progress on a basis similar in scale to the period of the Song Dynasty (960-1279) in China and the Roman Republic (509BC-27BC). Yet, policy makers failed to take full advantage of this by unnecessarily restricting the flow of money. It took a global war which destroyed/redirected a large part of Europe’s industrial capacity to re-address the imbalance between supply and demand.

Even then, policy makers, still did not take note that there was a paradigm shift in the late 1800s after the 1st Industrial Revolution, when a period of innovations massively shifted our economic potential much higher. While the developed world was slowly moving away from ‘scarcity’ and closer to ‘abundance’, they continued to operate from the basis that supply of resources is the bigger issue. The period from the end of the WW2 to the early 1970s continued to be characterized by a restrictive flow of money, the quasi gold standard. Luckily, it did take some time for capacity to come back on line after the war, so there were no major financial disasters.

In fact, it was quite ironical, that as soon as President Nixon decided to finally fully abandon the gold standard and introduce the age of fiat money, the world experienced a supply side crisis: due to problems in the Middle East, the supply of oil became restricted leading to a rise in inflation. This actually emboldened policy makers even further to focus on issues emanating from insufficient supply of resources and thus manage the demand side of the economy more closely to reflect that. The problem on the supply side, however, was short-lived, and as soon as the Middle East crisis subsided, oil started flowing back and ‘equilibrium’ ensued.

Nevertheless, even to the present day, our economic policy is still dictated by the mantra of supply side economics and inflation targeting.

Alongside these developments, the second half of the 20th century was also characterized by the start of the 1st Digital Revolution with the invention of the computer in the 1950s and its commercialization in the 1980s. Starting in the 1990s, globalization also took off. These developments boosted even further potential supply, while at the same time, money flow, despite no restrictions on actual money supply due to its fiat nature (but actual restrictions due to the separation of outside and inside money) continued to be restrictive.

These were the developments which led to the Great Financial Crisis in 2008, which, just like the Great Depression before, was characterized by a positive supply shock due to a burst of the commercialization of previous innovations and a negative demand shock due to insufficient money supply. The present time seems also to be the beginning of what could be called the 2nd Digital Revolution of AI and VR, which has the potential to even further increase our economic potential. Yet, when it comes to money creation, we are still operating with the mentality the Gold Standard: money is kept excessively restricted for fear of rising inflation.

In light of this, it could be worthwhile to point out that there were actually periods of successful state money creation in the past: Rome in the last five centuries BC and China between 10th and 13th century. Why did state money creation work back then? Three main reasons:

  • massive prosperity on the back of the commercialization of previous innovations,
  • a period of relative peace, and
  • a properly working institutional framework

It is important also to note that both in the beginning of the 20th century and now, all these three reasons above are present. If history is any guide, failure to supply the necessary amount of medium of exchange to ‘record’ this existing prosperity could lead to war, followed by disappearance of the economic prosperity, and in the worst possible scenario (did not happen during the Great Depression) the dismantling of the institutional framework. Or, if more recent political developments are any guide, could this time be different and the decline starts with the dismantling of the institutional framework, followed by war and the natural disappearance of prosperity?

To sum up:

  • state money creation is good when it is done within a solid institutional framework, and it follows (or is accompanied) by a positive supply shock brought about by previous innovations leading to economic prosperity (past examples: the Roman Republic, China during the Song Dynasty; no current examples);
  • state money creation leads to negative outcomes when it follows a negative supply shock brought about by war, natural population declines, or inadequate institutional framework (Europe during the Dark Age, the Gold Standard; more recent examples: Zimbabwe, Turkey, Argentina, etc.)

Is Japan doing that bad?

16 Wednesday May 2018

Posted by in Questions

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Latest GDP numbers out of Japan came out overnight and though the decline in GDP was expected, it was worse (-0.1% vs -0.6% actual). But is this really a surprise given the continuous decline in the Japanese population – deaths outnumber births now by more than 1,000 per day?

  • The growth rate of Japan’s population started declining in earnest in the mid-1970s, but it turned negative only in 2009. Absent massive rises in productivity, it is natural for GDP growth rate to decline as well in line with the decline in population growth.
  • Still, Japan’s GDP growth rate has been consistently above the growth rate of its population (another way of saying GDP per capita rises) except for a brief period post the 2008 financial crisis. Nevertheless, the average GDP growth rate since 2009 is still above the average growth rate of the population (0.6% vs -0.1%, respectively).

What does this mean? Positive labor productivity growth rate.

  • Since the 2008 financial crisis, Japan’s annual GDP per capita growth rate averaged the same as US’. Even since the 1990s, when Japan’s supposed stagnation started, its GDP per capita was on average just 35bps lower than that in the US.

  • GDP per capita growth can be broken by growth in labor productivity (GDP per hour worked) and changes in labor utilisation. Measured by GDP per hour worked, Japan surpassed USA in 1989. But measured by labor productivity growth, it has outperformed the US since the 1970s at least.

  • High labor productivity can come from many things (greater use of capital, low labor utilisation, innovation). In general, Japan tends to have a lower labor utilisation rate than US. That could mean more automation/ less employment of low productivity workers.

  • Perhaps that is why, Japan also tends to have a lower labor compensation (per hour worked) growth rate than US. However, in 2016, for the first time, that changed.

Bottom line is as long as population continues to decline, GDP should also be expected to decline given also lackluster productivity growth. However, as long as productivity growth is positive, GDP rate of decline should stay above population rate of decline. It could be better, but there is nothing bad about that either.