Dow Fall, senate elections and Thomas Piketty

Dow Jones started the year on a turbulent note as it dropped 382 points yesterday. At one point it was down close to 600 points from the 31^st Dec 2020 close. The impending election for 2 Senate seats in the US state of Georgia were attributed behind the reason for the weakness. The convoluted reasoning goes like this, the two seats which were in initial estimates were expected to go to republicans are now slated to witness a much tighter race. In case both the seats go to the democrats, it will give them a majority in the senate and will result in one party dominance in the US polity.

Now from what we have seen in the past in terms of democrats’ penchant for higher fiscal stimulus, any political development which gives them full authority should be celebrated by the markets. Don’t we remember that the entire tussle around the stimulus was that the democrats wanted a very generous pay out whereas republicans wanted to play conservatively. So, the logic for market weakness is that the tax structure which the new Biden administration wants to put in place is not clear and they might end up rolling back the Trump tax cuts to fund the fiscal deficit. We will come back to this point in a bit firstly the market roundup.

Apart from the US markets, the equity markets like Hang Seng and Nikkei are also trading a bit soft in the trading today. Gold is trading around 1940 $/oz which is around its near-term peak of 1950$/oz seen in November 2020. Dollar index is trading around 89.75 which is close to its 2-year lows. Chinese onshore Yuan is also trading close to its 18-month peak around 6.45. Readers would reckon that a weak Dollar, strong gold indicates a sort of mixed signalling. Gold generally moves up when risk haven buying happens and also when the markets are a bit suspect about the fate of fiat money. The same (fiat money) argument goes in the favour of crypto currencies when their prices move up. A weak dollar on the other hand indicates that market is not expecting any impending liquidity crisis for which they need to shore up dollars. On the Covid front the new mutant strain is again pushing some countries towards lockdown. Though the panic around such actions is limited only.

Coming back to our initial discussion around fiscal deficit and taxes, French economist Thomas Piketty in his majestic 2014 book Capital in the 21^st century tackles the issue in detail. He discusses about what should be the ideal debt to GDP ratio in an economy. As per Piketty there is no formal economic thought which can pin-point what is the ideal number. Only in Maastricht Treaty while the formation of Euro, the member countries were supposed to formally keep the Debt to GDP ratio at 60% (even that rule was only sparingly followed). Readers would remember that we have multiple times written about a new concept called MMT (Stephanie Kelton in her book The Deficit Myth) which totally moves away from the concepts like debt/GDP etc and urges the policy makers to issue more and more debt. The only condition being that it should only be issued in their own currency. Where Pikkety’s analysis takes an interesting turn is when he talks about how to fund the deficit and the moral angle attached to it. Due to the paucity of space today we will cover this point in our upcoming notes.