How much cash will really become scrap?

Long queues at Banks tell the story of changing India. At the same time, the impact from the move seems to be exaggerated too. I formed that opinion after creating the following decision tree. Take a look:

First of all, all the cash in supply is not with the public. A major share is in banks and a good amount of money is with corporate in the form of working capital and Utilities companies too are sitting on cash in the form of customer receipts. It is all unaffected by the move to ban Rs.500 and Rs. 1000 notes.

Let us come to Public holding. Salaried people have already paid tax through TDS, so they do not have issue getting the cash on hand converted. The low wage labors are unlikely to have more than Rs.2.5 lakh cash on hand per person. If they don’t have a bank account, they will get one and the cash will be converted too. Their money is unaffected.

Then we have self-employed people like Doctors, Film actors and people in many other such professions, some of them earn handsome pay while others just earn a comfortable living. These people receive their earning mostly through cash payments and if they had remained on cash, they would be in trouble. And if that money is less than Rs.10 lakhs, they will likely declare it, pay tax and rest of the money goes back to their pockets. Few celebrities may lose good money but they are very few. But yes, some of them will have to part at least with their cash.

Small businesses, like the neighborhood grocery shop keeper, who mostly operated on cash, will face serious troubles. But they can do damage control by depositing their money in the family member’s names, paying advance salaries, settling dues etc. Yet, they are the one to lose considerable money. They looked street smart until now but now their fate has changed for bad.

The real trouble is for the people in the cash-heavy businesses. They are going to lose significant cash wealth. Real Estate looked as a promising business for them but now the rules have changed. But the challenge is to know how much cash is with them.

While the data for distribution of cash is not publicly available, we can do some guess work to get an estimate. Majority of it is likely to be with Banks and utility and service provider companies which is perfect legal and valid. If we assume 1/3 rd of the cash remains with public and half of may be on its way to become scrap. Let us put this into equation:

Scrap Money = % of Rs.500 and 1,000 bills x % with public x % of likely scrap

= 87% x 33% x 50%

= 14.35%

Since this is all guess work, actual numbers might vary. But if my guess work holds good, actual cash to be destroyed will be in the range of 10% to 15% of total cash in the system. It is still huge money but rumors say it would be in the range of 30% and that seems overrated to me.

Master stroke and deflation on the way

For Indians, it was always the inflation which caused troubles. Deflation was a foreign thing for us. But the whole world is sinking into depression. Now it will be India’s turn but the reasons are different. When other central bankers are expanding their balance sheets, India is going the opposite direction. Banning Rs.500 and Rs.1000 currency notes will result in shrinking the balance sheet of RBI. It was a necessary bold step to curb black money, corruption, fake notes etc. And the impacts on the macro-economy would be as follows.

o   Drop in Interest Rates: Bank deposits and liquidity in the banking system increases (not the cash supply). This will lead to drop in interest rates both for depositors and borrowers.

o   Consumer Spending to go down: Since the unaccounted black money will disappear, cash based transactions will take a big hit. Since most transactions will happen through organized retail in the cashless economy, all of the transactions become accountable and consumers will have to pay relevant taxes. Consumers will be left with less surplus money, so their spending too will come down.

o   Widening the tax net: For the reason cited above, tax collections are set to increase. And the disappearance of a portion of black money will lead to wind-fall gains for the Govt. in this fiscal year. And that amount will be huge, may be to the tune of 30% to 50% of yearly budget of central Govt. While how the Govt. plans to spend is not known, it will lead to a situation of fiscal deficit turning into fiscal surplus this year.

o   Value of Rupee to go up against Forex, Gold and Real Estate: As Rupee is set to become a scarce commodity; its value is set to rise. Though Gold can go up momentarily for couple of months, it is likely to lose its attraction next year. Similarly lack of cash supply and absence of black money will put pressure on real estate. Same the case with forex too. While the conversion rates are also dependent upon the strength of other currency, Rupee is likely to maintain its value if it is not going to strengthen against any particularly currency. This is bad news for exporters but good news for importers.

o   Inflation to slow significantly: As cash becomes tight, and there is no need for Govt. to borrow, it means there is no need to print new money (except the replacement of existing currency notes), so inflation will come down. Both demand side and supply sides will see a drop. So forget inflation, we may have to stare at deflation.

That was the background for setting the stage for the case of deflation. Now how to handle the deflation is next part of my blog post. Since the value of cash is set to go up, you should get out of other asset classes to get onto cash. And there would be other ways too. And I suppose they are these.

o   Pre-close existing loans now and reborrow at low rates: Use cash on hand, liquidate some Gold and convert any forex you own and use the proceeds to pre-close existing loans. As rates are set to go lower, you can re-borrow at a lower rate later.

o   Avoid investing in real assets for some time: Let deflation take its course and wait for it to complete. That would take a year at least. You are likely to find the property you wished to own at a lesser price and since the interest rates will be lower, you will find it affordable to pay the EMI.

o   Economy will rebound: Though economy is rebooting now, after the initial shake-up and adjustments, it will come back to normal course probably in 2-3 years time frame. In that period, wages may go up along with GDP as money velocity is better with more money in the hands of poor and middle-class than the black money hoarders. As the Govt. will have higher tax inflows, they can use it to improve the infrastructure of the country and that will pay in the form of productivity increase. That would help wages to go up. Higher incomes and lower interest rates will keep the economy rolling at a better pace. Though it is difficult to time the changes, one can watch the economic indicators and adjust the decisions accordingly.

Modi’s Govt has given a golden opportunity and you can use it to your benefit. Don’t hurry now to get into asset classes and when things begin to turn around; don’t wait to get into them. Use the time in between to prepare for what it is needed. Clean-up your finances; improve your credit score as it will come in handy when you want to borrow big to ride the next wave of growth.

Book Review: Mein Kampf by Adolf Hitler

History has created a villain in Adolf Hitler, but he was a hero for the community he represented. After going through volumes of books on second world war and watching the movie ‘Schindler’s List’ several times (and some more movies on Holocaust too), I had stayed away from reading much about Hitler. So this book bought out of curiosity stayed in my book rack for years untouched. Now I believe History is perspectives of who wrote it, so I did put my hands on this autobiographical work of Adolf Hitler to get to know his perspectives and to understand the personality which made him a leader with an influence significant enough to cause a world war.

He was a student of Fine Arts. Along with painting, he spent considerable time in studying ‘German nationalist ideas’. From there you can find the traces of how his dis-likening towards the Jews gradually turned into hatred. He got transformed from a less talkative as a student into an effective orator who can hold on masses and impress them with his thinking and arguments. He was just a soldier in the First World War but became powerful enough to cause the Second World War.

Except in the first two chapters, there is not much info on his personal life and the rest of the book is about his ideas on Politics, German Nationalism and so on. So instead of an autobiography, this appeared to me like a textbook of Political Science. This book was published in 1925 much before significant political events happened. But this still serves an important purpose of deciphering how his thinking shaped him into what he became later. Many of his observations about history, psychology of masses, role of media, and importance of arms were so sharp which you don’t find them often in other political leaders of his time though they were deeply opinionated and skewed towards the welfare of German Society at the expense of other races. His knowledge and oratory skills were so good, he invoked pride in Germans in all his speeches and he was on the path to leading them as the book ends.

Hitler mentions in this book that the majority of population lacks ability to think and they believe whatever media or history books say is true, but there are few who have ability to critically analyze and they are outnumbered by the majority. Since the majority chooses their leader or Govt. the outcome may not be intelligent choice always. He also believed that degeneration of German society was due to the grip of Jews on that society as traders and he wanted to put an end to it. His similar arguments made him a natural leader of Germans and his rise in the political career began.

Those who write history ensure it favors them, so it is one sided. It is important to hear the other side of the story too. You like Hitler or not, it is important to hear his version of story. As I have already mentioned, this was written twenty years before the Second World War in which life of Hitler came to an end. This book do not have details of war or personal life of Hitler but is more about political ideology. If you like history or politics, this book is for you and Hitler will impress you like how he had impressed his people as an orator.

History, Religion and Analytics

For a person to be a good analyst, he needs to know his data well, the data created by history. Knowing the times the data was created helps to get the setting right. History repeats itself is an old saying. Those who do not know history take the same paths and make us believe in the saying. But there is scope for improvement for those who can analyse and take better decisions. Modern day Machine Learning programs do learn from history. With time they fine tune themselves. Since their capacity to read, memorize and synthesize data is higher than human beings they will evolve at a faster pace than human evolution. As long as we (humans) remain masters of master algorithm they would serve us well. But in essence the more granular data we get from history better are our chances to improve though we outsource the learning job to machines. Without proper study of history our understanding of empirical models will be flawed. It isn't just data analytical skills but the way we study history is critical for our success.

Stalin had said it is not the voters but those who count the votes matter. In the digital world, those who control the data have the highest power. In other words any influence on the creation of data has the power to change the direction or the trend. To influence or to control the change has been attempted in the ancient time too and it was by religions. If we look at our actions in daily lives, the way we talk, eat, dress or shop they are influenced by the culture and the social setting we live in. Religions tried to create a framework around this social setting to control the change in patterns. That framework did know that the society transforms and they associated a God to each transformation. They correlated the creation of new things with mythological God Brihma, sustainability with Vishnu and obsoleting the irrelevant as the works of Shiva. Brihma was aided by Saraswati, the Goddess of knowledge in creation of new things. Lakshmi, the Goddess of Wealth helped Vishnu to keep things going. Parvati, the evil destroyer Goddess helped Shiva to help the world move on with the transformation. All these mythological gods were creation of those who played as analysts during the times unknown to influence and control the system of evolution. Man has evolved from generation to generation, from stone-age to modern age. He used different materials and developed new tools with every passing generation to ease his work. Modern day analysts and data scientists have new tools at their disposal, like Artificial Intelligence, Machine Learning but they are attempting the same job what our ancestors did to understand the system of evolution in order to influence it. The new tools will help deepen our understanding and fare better than our forefathers. But that does not undermine the work done in the past as that was the precursor itself.

When I read articles on web about how Maths is more important than History, I do wonder if it is really so. When people argue that religions have lost the relevance, I ask myself have not they made the first attempt to create a theoretical framework for social evolution. When someone says the world is changing, I say to myself, it is just the tools.

Money: The zero sum game and the cycles of money distribution

Let us say, cash supply in a system in constant. Then if one person has to become richer, it will be at other people’s expense as it becomes a zero sum game. More money one person accumulates is the outflow from the rest.

But in the practical world, money supply increases every year. But inflation too catches up. Let us say money supply got increased from 100 units to 105. And also assume that inflation too went up by 5%. In such a scenario, 5 units of newly printed money helped to increase the monetary transactions but due to inflation, it’s buying power went down so there was no increase in value of money. In another words, 105 units of money has the same value of 100 units of money in the previous year. With this background, if one has to increase his or her wealth, still it would be at other’s expense. We can also say that whoever makes most of the newly created money will become richer. If one still has the same amount of money he had last year, he lost it to winner through inflation.

Now we need to explore how the money is earned. Broadly two classes are present. Majority of world’s population earns through labor, in the form of wages or salary. Other smaller segment put their capital to work. Profits or interest earned on that is their income or way to make money.

Now, it is time to introduce interest rates and wage growth rates. Every year new money is created. And if wage growth rate is more than interest rate, then the labor class gets more portion of that new money. If rates are higher than wage growth, then it is capitalists who will make more money than labor class. But that is not all, we cannot forget the impact of inflation, so we need to look at the real rates of growth.

Real Interest rate = Nominal Interest Rate – Inflation

Real Wage growth rate = Nominal wage growth rate - Inflation

These equations will decide if rich are becoming richer or the rich-poor gap is getting closed. Let us say interest rates are at 6% and inflation too is at 6% but wage growth rate is 7%, you know that capitalists could not increase their wealth in that year and the labor class made most of the newly created money. But it is not like that same all the time. Most of the times real interest rates are positive and will be higher than the real wage growth rates, that gives an advantage to capitalists. Their money works for them, throughout their lives. So you know how the system helps  rich to remain in top positions for decades unless they make some blunder mistakes losing out their wealth.

But the interesting point is, interest rates are common across market but the wage rates are not. There are many professionals (like in IT industry) whose pay checks showed higher growth than that of interest rates. They are able to reduce the gap with capitalists. Or they might become new capitalists if they learn the tricks of savings and investing. So we find many Merc’s and Audi’s on our roads and they do not belong to Tata or Birla families.

Coming to the common man, if his earning growth is better than inflation rate, he is getting ahead. If it is same, he is just catching up with the transformation. But those earning less are losing out to the winners of the race. If one wishes to get out of labor class, savings and re-investments are the keys. If one person earns a handsome salary but spends it all, he is no better than daily wage labor in the long run despite the high lifestyle he could afford in the earning years.

When you read an article of rich becoming richer, take a look at difference between interest rates and wage growth rates, you will know how the money got distributed for such an outcome. Though it is happening everyday in front of our eyes, we do not realize it and wonder what’s happening in this world. Well, nothing dramatic but very systematic.