Thursday, December 30, 2010

Although Double Dip Recession is Expected and Numbers Justify it, I still don't believe in it.

Yesterday's Housing report sent shock wave in economists in US and there are more and more people saying about Double Dip Recession. Graph Below clearly shows direction towards south in Home Prices.

US Housing Price Graph in % Change.  Ref :

In India, Graph Below shows Interest Rates rising again towards "Previous Crash" level. So definitely it's another number supporting recession.

India Interest Rates Chart
In China, Interest Rates have started going towards North, and there are reports of Real Estate crash already.

China Interest Rate Chart.

With all these Data many are already concluding that we are entering in Phase 5, 6, 7 of economic cycle and Hence Recession !!! 

However I don't believe that Recession is underway because in western world despite Stimulus, Inflation level has not been out of hand. This will give a clear license to Central Banks to have another Rounds of Quantitative Easing / have more easing under current QEII or Simply Allow banks to lend freely. In emerging markets there may not be Stimulate. And they may raise interest rates in "baby steps", Carry Trade (i.e. borrowing money from places where interest rate is low, and investing in other country) will keep liquidity high.

In 2011 / 2012 time frame I think governments across world will be busy in stimulating economies further and convince people by steps like..

1) Raising Minimum wage.
2) Encouraging Employers for Higher wages to counter higher living prices.
3) Never increasing Interest rates aggressively enough to allow bubbles blast.
4) Ask people to compromise on "Prices vs Unemployment".
5) Redefine Comfort Level of Price Index .. e.g 2 is considered as OK in US they will say let's have 5 as OK. in India 5.5 is considered as "Comfortable Level" They may say Let's have 8 as Comfortable level.
6) Asking banks to resume lending activity more generously to help economy grow again.
7) Keep on telling people that as prices are increasing, so will your wages and everything will be normal.
8) Keep on telling people that it's temporary and everything will be fine soon. 
9) At some stage when inflation goes beyond control they will introduce "Price Control" i.e. to restrict food / essential commodities at government control prices.

Concluding central banks and Governments will Prevent Double Dip. Instead by resuming Lending, they can give very good results in short to mid term of course for Wall Street !! .

It will be however very interesting to see how countries like Germany / Singapore react to all this. There is a very good chance that they may opt for entirely different path towards austerity.

Friday, December 24, 2010

The Ball is in China’s Court. Part 1

Last month I was in my home place in India. While traveling, an article in Times of India (leading Indian News Paper) caught my attention. Article was about CBSE Board (One of the Key Educational System) introducing Chinese Language (Mandarin) in Schools. In article it was clearly mentioned that looking into growing economic importance of China, Mr. Vineet Joshi Chairman of the board has decided to introduce Mandarin in schools.

I was happy to read that article. Breaking the barriers of conventional way of education i.e. Local Language + Hindi (India’s National Language) + English, CBSE board decided to go for Mandarin. Obviously China's growth story deserves this attention. Recently China developed a train that can run at 262 Miles per hours (Fastest in World). It's developing Aircrafts now, There are huge number of patents  by Chinese Scientists. So it’s not just low cost manufacturing anymore and there is a lot that china has achieved over years. Clearly we are today in a world where everyone is ready to accept China in its new role of economic superpower (Willingly or unwillingly). Map Below tells us why.

Map of countries by foreign currency reserves and gold minus external debt based on 2009 data from CIA Factbook
While having all these thoughts in mind I turned some pages of Newspaper and found one more article on China. I don’t remember title exactly but it was related to “Attitude Issues of China with its neighbors”. It was clearly mentioning unhappiness of China’s neighbors e.g. India, Japan, S Korea. In recent incidence of arrest of marine Japan found itself in kind of secondary position. (Historically Japan has upper hand in Wars with China and obviously knowing Japan they won’t forget such insults easily) China has issue with India over Arunachal Pradesh, Stapled Visa for Kashmir residents, and hence is not considered partner of trust by Indians (No matter how many times Wen Jiabao visit to Delhi and whatever he says). All this bad “body language” clearly brings clouds of suspicion on China’s position as economic superpower. As George Soros rightly said, China must understand the advantages and responsibilities that come along with Leadership position, looks like probably they still don’t understand it.

Crash of 2008 has brought turning point in the story of China. Awkward position on reserves may also be a key source of frustration on their side, which fumes out on neighbors as they can’t say /do much to US. But they must understand that winner especially new winner has many enemies and one mistake can turn success story into catastrophe.

In short I think ball is in China’s Court. By building environment of trust and harmony with its Asian counterparts China can make 21st Century truly as “Century of Asia”. Else if they are not able to cope up with pressure / continue with attitude issues, their mistakes even can convert Asia into the battlefield of Major WAR. (May be WW III)

Thursday, November 18, 2010

Impact of Paper Currency on Equity Market, Income Inequality, Marriage rate, Divorce rate, Health....

By now I believe regular readers of our blog know that we have a Big time problem with "Paper currency system" that started on 15th Aug 1971.(Recently, writing in the Financial Times, World Bank President Robert Zoellick called for a new monetary system to replace the floating rates adopted in 1971 known as Bretton Woods II.). So there is a thought process coming in mainstream that agree on flaws of paper currency.  

In this article I have tried to see "Before 70s" vs " After 70s" pattern for many aspects. Although I don't like to use maths and stats in sensitive issues such as Marriage rate, Divorce Rate or even on Health, few graphs below were too shocking for me. So I just thought of sharing with our friends.

Historic Dow Jones Before and after Paper currency

As we all know Dow Jones Industrial Index is one of the TOP Indicator of equity health of US and in turn whole world, We can clearly see "Before 70s" vs " After 70s" pattern here.

widening income Inequality 

This is pretty interesting one. (Income inequality has Increased in Paper currencies ). There is "Before 70s" vs " After 70s" pattern here. What might be reason ? Is that the previous Graph ? are people investing in Stocks (By understanding / not understanding magic of paper currencies) becoming richer? Leaving rest all poor in comparison?  Is equity Investment only best way to make money in paper currencies?

Median Annual Earnings over decades.

Here there is co-relation for Men's income. It remains in same bracket while women's income growing steadily. This should make us proud as a human race that women's are bridging the gap of income. Although  for Woman's graph increasing trend is from mid 50s and has gone up steadily so there seems no pre 70 and post 70s correlation.
Divorce Rate over decades.

This was a simply shock to me. Here I see correlation to Before 70s and After 70s . What has changed? There was a discussion within friends on this. One said "Now a days males are having more bad habits like Smoking, over Drinking, etc... That is causing all this" Another friend who suggested that "May be women's have better income now (Previous Graph) which "helps" them to take a call if they are not happy in their married life. In old days even if women was not happy she had no option but to stick with husband as she had no economic freedom so in fact it's good development due to economy". Another more conservative friend had strong argument on that comment. He said, "Look no one divorce for pleasure. But if what you are saying is correct, then after 1st divorce, their life should be better off. In reality study shows that in US, Divorce rate for 1st Marriage is 50%, for 2nd Marriage it's 68% while for 3rd marriage it's 78%. Which means that something is wrong in thinking that capacity to take divorce is "helping" factor for happy life!!!."

I had no counter argument on that ... But what worries me is are we going in right direction as a society.

Decreasing Marriage Rate.

I see a correlation here Well. There is impact on Marriage rare as well. What may be the reason ? Need to think more ... ?

Health Data from official Web Site

What to say here .. Is easy money and credit bubble making us fat also ? at least graph shows it.

Now to counter all these arguments someone may say that these social issues have nothing to do with paper currency etc..Don't blame all our problems in paper currency...  it's a new era and this is bound to happen..... To me it makes a lot of sense in believing that all this has some co-relation with each other and is connected. But I think this is a topic of debate and I welcome comments and arguments here.

P.S:  To add the data I have taken is of 50 Years + ( Thanks to Prof Reeve Vanneman at University of Maryland for her great work on .. ).

Sunday, November 14, 2010

Good Investment in Nov 2010 “Real Food Investment Habbit”!!

Well, environment seems changing again.  Out of PIIGS (Portuguese, Irland, Italy, Greece, Spain) This time Irland is on verge of default and need money (bail-out). This can create some amount of disturbance in markets. Although “Next Euro bailouts” are designed to be least vocal and painless, they will still have same consequences as money has to come from somewhere. If no one pays then of course currency devaluation pays. Which means you and me have to pay more for gas, food, and everything.

Anyway while many people will be busy in figuring out on direction of stock, what happens to Ireland, credit default swap, ECB reaction, derivatives, and so on, I believe it will be good “investment” to stockpile rice, wheat, salt, beans, lentils, pigeon pea, coffee, tea, and other food items that you need on day to day basis for personal consumption. If possible for next 2 Years! Here are the reasons why I believe this.

# Baring few exceptions like India and China, Food prices are still relatively low in many countries. (Even in India and China, though they are high, 2-3 years down the line they will be possibly much higher)
# With amount of stimulus injections, everyone knows that there will be inflation for years to come so what you buy this year will always be cheaper than next year.
# Inventories of food are lowest in decade across the world and there are multiple reasons for the same.
            # Due to constant urbanization across world, labor is not available for farming.
            # There is no reverse flow of labor from cities to villages for farming.
            # Weather has turned unpredictable resulting possibility of very bad weather in any year.
# If the fear of hyperinflation turns into reality, 3-4 years down the line, people who maintain habit to stock “basic grains” will survive better out of situation.

Like every investment there are risks for this. E.g. grain that is accumulated can catch various pest, infections etc.. so we should learn some good techniques for the same. Also we need to consider expiry date / best before date for things we buy. On cost side if the cost goes down suddenly, we can buy from market for temporary consumption and keep our stock intact. Some grains like rice are in fact better when they turn older. One of the very interesting case I saw in one video over YouTube where American person explaining rice and bean as good combination. Reason it is interesting is rice is not typically consumed in US.

To add there is no need to assume we are doing this for preparing for war etc..:) but there is nothing wrong in being  planned for everything in life.

Sunday, October 31, 2010

8 Phase Economic Cycle in Central Banking System and Fed's Next Stimulus

                October was a busy month and hence could not write much, but a lot happened over this month. Federal Reserve started talking about confirming Stimulus II / QE II (Printing Money out of thin air and Spending it once again). It was highly anticipated since last few months. Now before jumping into impact of Quantitative Easing on us, let's try to understand some basic economic cycle in Central Banking.

Here is the presentation that I believe will be useful to understand the same. I have articulated "8 Phase Economic Cycle in Central Banking System"  that has been running since beginning of Central Bank system e.g. (1913 in US). Please open it in separate window to see completely.

In order to prove demonstrated cycle, see graph below from Federal Reserve's site that shows both Interest Rate and (Recession periods with gray bars.) What you can clearly observe is,

# Every time recession comes i.e. we enter in gray area, Central Bank lower interest Rates.
# Baring early 90s recession for all other cases, higher interest rates have become pin for recession.

US Recessions

From 1980s till date Interest Rates are clearly going down as a trend. In US. (Reason why everyone has some connection with US monetary policy is that USD is world reserve currency and all currencies are pegged to USD except few. Hence everyone is impacted by USD in some or other way)

What differentiates 2008 crisis than all previous recessions are below facts.
# Continuing it's downward trend, Interest Rates are actually touched "0" (indicating weak and phony system) and economy still could not come up.
# So as additional measure, Lot of money was printed out of thin air in 2008-2009 (Which has never happened to this extent) and FED is speaking to "Act More"!!! 
#Graph below shows base money which is very sensitive thing. As you can see since 1910, this is the first time it has been increased this high.
#During 80s, Reason for 20% + Interest rate was to soak out 13% additional liquidity introduced in 70s. Here Base has increased by 120% and they are speaking of increasing it even more in QE II. Just imagine interest rates in 2020. 

US Money Supply

In short since we are stuck in Phase 1 out of 8 Phase cycle, as demonstrated on Presentation above, FED is printing huge money to send economy to Phase 2,3, 4. Obviously consequences are clear as there are only 3 Roads that go from here.

# If we succeed to Go to Phase 2, 3, 4 we will have great economy to begin with and very low unemployment in theory, but later it will turn out to be Zimbabwe style Hyperinflation, Price Controls and so on in whole world except few creditor nations.
# If we never succeed Go to Phase 2, 3, 4 (like till now ) we will end up in Stagflation i.e. both high unemployment and high inflation (But not hyper).
# If someone like Paul Volker comes again, who understand system better, for restoring currency value he will raising interest rates significantly and will allow severe but essential recession  (this is rare as it won't get political buy in.). But the only possible solution for survival in long term.

Let's see where we go...

Tuesday, October 5, 2010

Billionaire Beggars

“Billionaire Beggars” It may sound funny / crazy / or even stupid term, but looking into speed at which liquidity is flowing into the system with no control whatsoever, this term will become reality one day in near future. May be as early as next (5-10 Years). Unless Central banks act aggressively in reverse direction than their current approach.

I heard story of one such “case study” from an old respectable man last Sunday  here in Milwaukee at Coin exhibition. He and his wife sell world paper currency as a side business. Old man is highly knowledgeable in history, currencies and economics, and very kind to share his knowledge. According to him “Every currency note has a story”. 

This time around we bought currency notes of 5 Million-Deutsch Mark during Weimar Republic and asked him story behind it. He said, “This is a 1923 Vaimar Republick note” pointing to his wife he continued, “ Her father was in Germany during those days (1918 – 1923). He was paid twice a day with notes that may fit in a large suitcase. With those notes they used to stand in line for bread and soup. By the time they enter in queue till they reach the window, prices used to increase.” He added that “There used to be around 60 Printing presses all over the Germany that run 24*7 to print money”.

In short “Billionaire Beggar was reality of those days” As if one don’t have job, even if he possess a billion Deutsch Mark cash, he is not able to buy anything with it since 1 pound of bread would cost 3 billion by Nov 1923. And there was Inflation rate of 29,500% making price double every 3.7 days. So with just 1 Billion-Deutsch mark in hand and no Job, one is both Billionaire and Beggar.

As you can see in image, Inflation in the Weimar Republic made it cheaper for this woman to burn money than firewood to keep her home warm.

When I asked him that is that not the same thing we are doing now a days (Printing Money like crazy) and will there be similar results in his opinion? With a big pause he said, “I hope we are not. But I am worried that we actually are. Nixon just declared that currency is not backed by anything and we accepted the dollar the way it is… And see what’s happening today… And you know who wins at the end? …… It’s Farmer. As you have to give your everything to him… If you are left with anything ”.

So definitely it’s a big time possibility that we are about to enter in that era. Let’s see this time how high the price of bread goes. Also this era will be slightly different as it will be global synchronous phenomena.

However on very interesting note, Germany who has this history of hyper inflation is now very worried about stimulus and it’s impact and is 1st to at lease speak about unwinding stimulus and introducing austerity. It will be interesting to see if Germany can learn from history and avoid repeating it. Or will eventually join the flow…

Wednesday, September 29, 2010

Small Update Uncertainty, Pressure again on !! - Correction ??

China, Japan, US
China who is praised for it's economic policies and growth by Very Important Persons like "George Soros", "Jim Rogers", is passing through tough phase. Recently there has been some "ego issues" with Japan over sea dispute. Although China came out of it with upper hand, with historical reference, China can never take Japan lightly..

At the same time, US has been "very seriously" behind China for quite a some time. Looks like current administration is going to follow it up till China takes concrete steps. It will be very very interesting to see how China reacts to this. But hopefully both parties will find mid way path over the time.

European Union
In Europe, PIIGS are again under pressure. Despite 1 Trillion fund created to help PIIGS, Portugal had done Salary cuts of 5% in Govt Jobs. So there is pressure on Euro again.

In short US, China, Japan and Europe That constitute 70% of World GDP,  (14.26, 4.909, 5.068, 16.24, 58.15 respectively out of total $58.15 World GDP) are still not out of woods and hence there will be volatility to continue. 

However unless something unbelievable happens, I do not see a change in UP Trend in Stock Markets except possible major correction (that may appear as change of trend) in time to come.

Wednesday, September 22, 2010

Does weak Currency really Help Exports .

Recently, there have been huge arguments between US and China on "Yuan appreciation" with both sides sticking to their points. US firmly believe that China is getting "unfair advantage" in export due to pegged currency; while China believes their currency is "their own call". We don't know what is right or wrong, but we thought of checking if there is any "real" correlation between Exchange Rate and Export.

* Figures in Million
Source: CIA Facts.

Taking Data from CIA facts and just looking at it we can see that saying "there is direct co relation between currency and export" is misleading. As If there would have been one, Zimbabwe should have been biggest Exporter or at least on improvement trajectory. Germany on the other hand should have been smallest exporter. In reality it's exactly opposite.

Although China has taken over Germany's No 1 Position as largest exporter, Germany has been there for a while, and in Ratio of Export to GDP at this volume, it's still No1. This is despite having one of the Strongest Currency (nominally); so for sure there is lot more to be " Successful Export oriented Nation" than just currency.

Obviously, it is story with US, despite USD being still a strong currency (in nominal terms relative to other currencies) Export figure is still huge. What's common in between these 2 nations is their technological edge led by innovation. e.g. no matter whether their currency become stronger or weaker, Intel Chip has to be bought from US. Steel that is used in orthopedic operations has to be bought from Germany, as it does not rust for 200 Years there is no alternate.

China on the other hand has slight different story, as their "Export Model" is slightly different. As I see it's based on strong will power from government, great Infrastructure and most importantly "conservative living standards".
On the down side, cloths and shoes and other daily use items that China export can be technically manufactured by others countries as well.

However making Chinese Yuan strong can have very interesting implications in short, mid and long term. In short term, it can alleviate inflation in china while it can stoke inflation in US as Wal-Mart won't change their vendors immediately and Vendors will raise price as they won't do business in loss.

In Mid term, it depends on whether China and Chinese People continues their policy to keep low profile and continue "Low Profit High Volume" Export or encourage internal consumption becoming a developed nation in itself. They can do both as e.g. If today Chinese household is getting 60,000 and is saving 30,000 If Yuan gets double, Technically Chinese Household will have same purchasing power with 30000 Yuan and even if he saves 15,000 he is good. In short higher purchasing power and possible efficiency improvement programs in Supply Chain can absorb the loss of competitiveness due to currency appreciation.

Another aspect to it is in Transition phase, countries like India, Philippines, Indonesia can take advantage of this phase and develop their manufacturing base leveraging their high population and weak currency becoming a strong competition for China. However doing so need a lot of planning and determination at political, social and Industrial level. If not, Higher Yuan will just mean higher prices for whole world in short term and even stronger economy for China in Mid and Long Term.

Monday, September 20, 2010

Short Update - India BSE Sensex Rocks 20,000 thanks to .... ? FIIs ?

Couple of weeks ago I predicted... 

Dow may have Huge upside i.e. even in range  of 35000 - 45000 i.e from 2012 - 2016. (World Markets will follow the trend e.g. Say FTSE UK may touch 20000, BSE Sexsex India may touch 60000 - 70000)

Obviously current market rally is part of same. There will be some interesting advantages and threats India as a country will experience out of this huge upcoming rally. Since this is capital inflow, INR will become stronger gradually against USD till the music is on e.g. at the end of 2016 or whenever this Rally finds it's top, INR - USD conversion may become in bracket of 30 - 35 or even better. However if there in intervention by RBI to keep INR down, That can prove very very costly down the road. 

Because when the music stop, there will be huge capital flight out of country and currency may swing back from it's position to downside may be 45 - 65 even may be 75 when measured in USD. very suddenly. This itself will trigger to Currency Crisis of India.

Inflation would have reached far high by then however since market will be doing good overall liquidity will take care of people's sentiments. But when music is off and Inflation is at it's top, There will be lot tough time to fact. 

Another interesting opportunity that may arise of this is if currency crisis first start in Western world, and INR is fully convertible by then, there is also a remote possibility of huge surge to INR vs USD or Euro e.g. in Range of 20 - 25 

Both these possibilities are there and events to come in years ahead will decide where it will go.

P.S. : Every bull market will have corrections I am not sure of that will be as radical as Robert Prechter says but there can be corrections. " However till the time there is a Direct pipeline between Fed to all Brilliant Wall street  Investment Banks and Investment Banks to BSE I do not see any reason for change in Trend"

Monday, September 6, 2010

Robert Prechter says Dow can go as low as 1000. Dr. Marc Faber says as high as anything to whom should we listen to?

It is said “If you ask same question to 10 economist you get 10 different answers.”

I have been following Dr. Marc Faber for a while and I am one of the big time fans of him. Robert Prechter who is another “Gray hair Wall street guru”, believes in Elliott Wave Principal can not be ignored. Even Dr Marc Faber says that we cannot dismiss him.

Dr Faber’s prediction is based on philosophy that till the time Fed keeps “Money Tap” ON and does not soak any liquidity out of system (by keeping ~ 0% Interest rate), markets will go up and up!! What we saw from Mar 2009 till date is exactly the same. None of the economic parameters have improved unemployment is at it’s record high. Still market is UP. And hence Mark Faber is right.

At the same time if you were tracking the news and market carefully since Sep 2007 (when Sub Prime issue was open to public) you can see that Markets were going down though FED was “co-operating”. Since Sep 2008 Fed started lowering Interest rates and made it effectively 0 in early 2009. At the same time via various means Fed “bailed out” number of Financial Institutes like never before. Still Dow travelled from 14000  - 6600 From Oct 2007 to Mar 2009.

So saying that If Fed Print money market will go up may prove wrong in Short term.

In March I remember mood was extremely pessimistic despite all bailouts money and support from governments. Dow was going down daily by 4-5% and there was not a single “good news” in media. People were angry on Banks, governments. Suddenly news came from Citibank saying they are expecting profit in Q1 2009. According to me that was a turning point in this recession. So we can’t ignore that even “news” can change the trend of market. And of course once city says that they expect profit their competitors have to say that they are expecting profit sooner or later and that changed the direction. So if that news would not have came Robert Prechter's figure of 1000 was perhaps only few weeks away. 

Once the direction was changed, 0% Interest rate and bailout money started working and it gave a huge rally of almost 6600 – 10600 in same year.

Concluding: For Common man it’s best to remain diversified strictly as all these big names can be correct in some or other way and if you are not diversified it can be very risky at times. Before ending let me put one sentence that I heard in this week from David Morgan “If all are thinking same then perhaps no one is thinking really”.

Amaresh Ashok Gangal

Wednesday, July 28, 2010

Will my Mortgage Installment (Home Loan EMI) go up or down in coming Years?

Before trying to figure out what’s going to happen in coming years, let’s see what happened in last few years.

As discussed in last article, recently (2002-2007) it became very easy to borrow money as Loans were in distributed easily by banks and Assets e.g. “Real Estate” / “Equity” that were bough with borrowed money were appreciating at much higher rate than rate of interest.

So it was in fact a great time as borrower. While everything was going perfect, somewhere in 2005-06 Rate of interest started going up steadily. This created little discomfort for people in countries like India, China, Brazil as their Mortgage payment (Home Loan EMI) went up slightly. However they were not many foreclosures in those countries mainly because of better regulations e.g. 10 % Down payment, Monthly repayment must not be more than 55% of Salary. So despite slight discomfort of higher mortgage, overall picture was looking good. (This does not mean housing market in India, China and Brazil is healthy one, it’s just that it could sustain at those Interest Rates).

In western world however “system sustainability” to Increase in Interest rate turned out very poor. One may call it as pin for bubble or whatever, but “Housing Bubble Burst” It was obviously due to reasons like no down payment requirements, Sub prime lending etc.

In order to fight with this recession then Central Banks lowered interest rates to historic low and in fact pumped money into system to not allow prices fall further. Due to this borrower got relief on Interest Side but worry shifted on paycheck continuity itself. And it was genuine worry as well.

Now based on this background, let’s figure out where Rate of interest goes from here.?

In order to understand this, let’s see why rate of interest goes up or down in first place and who does it?

Rate of interest is one of the most effective tool for Central banks to reduce inflation / excess liquidity in system. In simple terms when cost of essential commodities (Food cloth and Shelter) goes upside, to curb that inflation Central banks has to raise rate of interest and suck the money out from system. To give simple perspective, if inflation is a smuggler, Interest rate is a police and Police must run faster than smuggler to catch him and arrest. Once the  excess money is removed from system, cost comes in control automatically. Countries like India, China are in middle of inflation already and hence there is no direction for interest rates than going UP. Infact in whole world they have to go up as all Central banks have artificially lowered it during recession and have pumped money. This has always led to very high inflation down the line. As in system we have more money chasing same goods.

So Real Question is how much up interest Rates can go and when?

I can imagine 3 Scenarios here.

Scenario 1) Increase by slow Speed (Interest Rate always lower than inflation)
            This is what is happening now e.g. in US they increased by .25 %. In India reserve rates has been hiked by 25 points on 3 occasions in last few months, (See Chart Below). Though these steps demonstrate willingness to tackle inflation, they won’t be enough necessarily. It’s like catching smuggler that runs faster than police. You can’t catch it just by increasing speed slightly, because then Smuggler runs even faster and you have to catch him at that high rate. So effectively you end up in much higher interest rates and Home Loan EMI in this Scenario. At the same time Home Prices may also appreciate.

Scenario 2) Increase Rate of interest higher than Real Inflation and keeping them there for couple of years.
            In this Scenario Interest Rate  (Police) runs faster than real inflation (Smuggler) Keeps him in custody for couple of Years. It sucks money out of system and actually do not allow that money going back in circulation. Once system is stable, central bank may lower interest rates slightly to make a comfortable level (leaving smuggler in society after 2 years punishment).
            Though, this is the best possible solution, this obviously has side effect. I.e. it can crash real estate market completely and can create “politically Incorrect situation”. It may mean Total outstanding Loan money on Mortgage much more than market value of the Property. Not only in real estate, but also in many other sectors businesses with weak fundamentals will die.

Scenario 3) Let anything happen with inflation don’t raise rate of interest.
            This will be dream scenario for “Borrowers” as inflation itself will take care of everything. Wages will increase in dramatic way making it cakewalk to repay loan, Also asset inflation will be so dramatically high that it will create huge wealth illusion. If there is too much of delay then no matter how high we raise rate of interest, inflation just goes out of control. E.g. in Weimar Republic (Today’s Germany) They raised Interest rates to 900% but it was too late to avoid currency collapse. Also in Zimbabwe recently they raised it to 800% but still inflation was so high that it just could not save currency and economy.

Scenario 4) Continued Recession or Double Dip .. 
              In this scenario also Interest rates will be down for a while. But then Housing prices also will be down. I think this is a very remote chance looking into "commitment" of central banks to fight against it. And even if it happens it will be temporary.

Concluding, Rate of Interest and Mortgage / Home Loan EMI has no direction but to go UP. Sooner Interest Rate  (police) Catch Inflation (Smuggler) it’s better for society in long term. Of course its not comfortable for 
governments. So let’s see how it goes in coming years.

Interest Rate United States
US Long Term Interest Rates US.. Yes they were 21 % in 1980!!

Interest Rate India

Interest Rate China
Amaresh Ashok Gangal

Monday, July 12, 2010

Lending, Borrowing, Then and Now

Lending and Borrowing has been going on since history of mankind. It used to be Lender’s game earlier. In other words one who has capital always had upper hand in loan transactions and not the one who receive loan. In early days, on some very good reference + convincing business plan + some conditions (Interest rate 20%, timeline 1 Year) lender would lend money to Borrower say (10000 Rs). Borrower then uses that capital, adds his hard work, talent and performs business activity (Say starting a small workshop). With combination of capital and hard work he earns money say (15000 Rupees) and become successful. Now he has enough money that he can return principal + interest (12000 Rs after year 1). Money that he saves after returning what he owes to lender becomes his capital (3000 Rupees).
At end of day borrower used to be very much thankful to lender. In a country like India that young entrepreneur who received loan in his early days; would talk about lender and one who gave reference as “They are like god for me. They are the one who trusted me when I had nothing in my hand”. As time passed both lender and borrower became comfortable to transact with bank (Which I would define as big-brother between lender and borrower who reduce risks on both sides). But even while approaching bank, borrower had to provide viable project plan that would get questioned + guarantor who is responsible to pay loan back if lender fail to do so...................

Gone all those old days and somewhere in 2004-5 time, while working in office, I got call on office phone saying, “Sir you have got loan approval of 50000 Rs. No guarantor required. Interest rate only 7%. Should I send pay order to home or office address?”. First time when I received this call I was about to fall down from my chair. Quickly enough I told them “I am not interested in any Loan at moment”.  But conversation did not stop there. Some boy / girl in their early 20s advised me in polite tone that “Sir you keep the money it will be useful for you, you can invest in equities, also let me know if you are interested in Home Loan our bank has very attractive interest rates on Home Loan”. Somehow I used to politely refuse those people but also a thought used to touch my mind “Should I have taken it?”
So something had changed dramatically. From time when borrower used to convince lender on viability of his plan to a time when bank (representing lender here) is busy convincing new and new borrowers who have never applied for loan. The concept of taking capital adding hard work and becoming successful had gone. New concept was take capital (loan), buy shares / home / land / anything; it will raise in value automatically you will get success -- no hard work required. Many people called it “Golden Era” but I never believed so. Time that allow people to succeed without hard work cannot be golden era on other hand it undermine hard working people and set a wrong message that just by buying and selling something everyone can be prosperous.
Back then we were not smart enough to understand what is “easy monitory policy” and how central banks can inflate all these bubbles. Now when we have learned some of this, I am amazed to see efforts by governments to go back to “that kind of era” via simulation. One of the key parameter that made lending as borrower’s game was “Interest Rate”. In next articles we will see how interest rate can inflate bubbles and crash those.

Sunday, June 27, 2010

Inflation vs Deflation.

Mainstream economist or rather Keynesian economists who believe in “spending” as economic driver are always concerned about deflation. On the other hand Austrian economists (Which is very similar to our Indian traditional style of saving based economy) are worried about inflation. 

            In Simple terms today what central banks, governments and even major banks think that if Stock market crash, Real Estate tumble we can have deflation and that can cause economic catastrophe. Hence they stimulate (or rather try to stimulate) the economy by inflation (Printing money out of thin air and lowering interest rates).

Prima-facie their concern appears very genuine. The sequence of event that they believe then is ..
1)      If stock market crashes, it creates panic on main st.
2)      Businesses become very conservative in spending, resulting in job cuts.
3)      Real estate market crash.(This is more relevant only for this time as it is the root cause of 2008 panic from which we are not out yet.)
4)      In other words say if you have Rs 5000 /- per sq ft as rate in certain area, because of slow economic operations and uncertain future, no one buys new homes.
5)      Obviously that led to lower prices say Rs. 4000/- Sq ft.. Now when prices start going down, that itself becomes a reason for “not to buy” as people think it will go down further.
6)      This creates even less demand and prices drop even further.
7)      People who have bought at say 5000 Rs / Sq ft realize that it was way overprized and then “buyer turns into seller”
8)      Suddenly in system there are “all sellers and no buyers”.
9)      If no one buys people may opt to default on loan and give estate to bank.
10)  This create ”toxic asset “ on bank’s balance sheet.
11)  Banks possibly go under pressure and might collapse.
12)  Keynesian economists explain this as “uncontrolled deflationary spiral”.
13)  This obviously leads to very strong recession.

Well ..Doesn’t it make a sound business case to do something by government? Obviously everyone think yes.. but if we think more we realize that it’s really not required as there is always an auto corrective mechanism to this “Natural Recession”

Let me explain how.

For a common man.. If a home of Say 50 Lakhs becomes available in lower and lower price, is that not a great News. For common Man deflation is good because prices go down. His worry on the other hand was during boom time say 2002 – 2007 he was just not able to afford it. I agree that if there would have been no Stimulus spending, prices can go even down say 30 Lakhs or even 20 Lakhs  or 15 Lakhs ..… No Buyers …

However this co called “uncontrolled deflationary spiral” has a natural way of “auto correction” and at certain stage people find the cost rational (Say a flat worth 50 Lakhs if you say get in 10 Lakhs. Isn’t that a good buy then for common man). Obviously it is and  that is where deflation stops. In system we have buyers now. This obviously leads to a very cautious market in beginning and then possibly a big bull market down the road. That then becomes natural, robust and sound recovery.

Of course this is not painless way to recover though its natural way. We will have people who bought overpriced homes in deep water for few years. But if they have “bought home to live” it doesn’t matter. If they have bought it as investment then obviously you loose lots of money. But that’s risk that every investor takes and risk is risk.

Also it may mean collapse of few banks.. So what? Shouldn’t they have thought twice before giving loans of like 30 Lakhs / 40 Lakhs to individuals in their 20s for assets that goes up 30 – 40% every year. Shouldn’t their risk department experts should have thought that “something was wrong somewhere”. In our parent’s time, only government employees were entitled to Loans on home and private employees where not getting it (of course that was may be little too conservative but giving it to everyone was too risky and risk was that banks could have failed). In my opinion they should have failed.

Concluding. Deflation is not bad it’s a natural phenomena and an opportunity for people to buy. During periods of deflation getting money becomes very tough, many businesses that have weak fundamentals die. New strong businesses emerge as for new entrepreneurs deflation is golden time to buy assets, get resources at cheap rate. Also business that start in those times generally have strong and sound fundamentals as they remain cautious and realistic in their approach. Most importantly people realize incentive of "saving"

Added on Aug 06 2011: Long term Inflation vs Deflation for US.

US long term inflation Chart

Graph here clearly say that whole previous century was inflationary.