Thursday, May 27, 2010

Will Stock Market go up or down in coming time?

What's happening in this "recovery" from 2008 recession is something very different than any economic recovery earlier. Generally Market enter into recession after stock market crash, followed by job cuts, which triggers even more reduction in consumption. Banks start looking shaky. This generally goes on and then for few years overall economic activity shrinks. Then suddenly some "new / upcoming sector led by innovation" start capturing attention. It attracts investors, it’s then followed by job creation in that sector, banks start looking better. This creates "Confidence back in Stock Market", and then Rally begins. So typically stock market Rally is the last thing to happen after recession. This time however the first thing that happened as a recovery was Stock Market Rally. Job market is still down in US, Europe, however stock market is up. We have to understand few main reasons behind it.

As a response to credit crisis, in 2008, US Government took below actions.

1) Unprecedented amount of money was pumped into system for "0%" Interest rate. (Stimulus)
2) In US, Federal Reserve was allowed to give "capital" to banks. (This one is very tricky I will explain it in next article).
3) Investment banks became normal banks by which they are allowed to borrow at "0%" Interest. (This is another trick)
4) Due to shaky global situations despite monetary base expansion from around 800 Bn to 2.1 Trillion USD actually gained as currency.

Now all this has exactly caused this rally. I.e. from ~8000 – 18000 on BSE and 6000 - ~ 11200 on Dow.

However in recent weeks we had strong volatility in markets.

As I had mentioned in article posted Apr, 27 2010, volatility began in markets, however I believe this volatility is temporary in context with stock markets and clear Rally is just round the corner.

Soon we will have “all is well” news from media and markets will rally again. Now that soon may be in range of few days or even few weeks to from now I believe.

This does not mean that we need to be very optimistic about economic growth. However when I see above 4 points and understand the fact that there is a “Direct pipeline of Strong Dollar” from Federal Reserve to Morgan, Goldman, DSP and they have direct pipeline in all stock markets in world, I don’t see any reason for markets to correct a lot.

Also if say situation worsens in Oct-Nov this year, US will not hesitate to give another stimulus package as they said, “Last one was indeed profitable”. E.g in case of Citi they bought shares for 1USD and now plan to sell at around 4.00 USD.

concluding rules of game are still same there is no change in policy that “Bull must run by hook or crook”.

Tuesday, May 18, 2010

A Brief History of IMF

Posted on : May, 18 2010

A brief History of IMF.

In order to understand IMF and it's role in global economics, we have to see roots of it. It’s a very interesting case study in itself. IMF was formed just before end of World War II in “Bretton Woods’s conference” and purpose was to "Engage nations in economic co-operations so that they don't get into wars and rather grow together".

In my opinion "IMF is one of the biggest success story of last century when it comes to organization that works to make nations work together". They formed and supported superb and robust foundation for international trade co-operation. Below chart can be a good proof that IMF was successful to a great extent in their vision.

War, Killings Pre and Post IMF.
Killings in War Year Wise 

Let’s see IMF and it’s Role in different eras.

Post WW II, : Global Economic Structure foundation. 1944 – 1971 (Formation of global platform with Gold Standard)

Primary goals in this era i.e. immediately post world war II were to

1)       Assist the reconstruction of the world's international payment system and
2)       “Stabilize exchange rates” those were very unstable in wartime.
3)       Provision for countries contributed to a pool, to borrow on a temporary basis, by countries with payment imbalances (All these transactions were happening in gold).

The IMF was extremely important in that era. It turned out to be a platform to establish, stabilize and support the global economic system.

It sounds odd today but there were Fixed Currency Conversion Rate between USD and other participating countries as per “Bretton Woods’s system” for 27 Years. If you see chart below it becomes very obvious. (In other words there were once a while re-valuation with IMF involvement but there was nothing like daily conversion rate.)


Currency conversion in USD.

So the Structure was that All currencies were pegged to USD and USD was pegged to Gold as below.

Gold Pegging til 1971

Gold Pegging Structure.

Post Bretton Woods’s system : Another Era began in IMF’s history 1972–81. (No more Gold Discipline !  Print Money fast..)

On 15 August 1971 something happened that changed the world economic system dramatically.    United States declared that on “temporary” basis they are abandoning Gold Standard. (Expense of Vietnam War and Ambitious programs of president Nixon mainly drove this and even today it stands abandoned). This step was birth of “Floating Rate” currency system that we have even today. “None of the paper currencies today are backed by anything except faith on Governments and Central Banks.”

Though gold standard was abandoned and currencies started flowing freely, UDS -> INR went in range of 50 (on which whole outsourcing is based), IMF’s role still continued due to fact that it was well-established global balance of payment network. Also IMF had huge gold. Even today they posses 3,005.3 Tons of gold which they accumulated as interest payment (during gold standards), common pool contributions, etc..

So in this era of 1972 –1981, IMF started playing a role of Lender due to Oil Shocks. Also the IMF created a new concessional loan program called the Structural Adjustment Facility for poor countries.

Debt and painful reforms : 1982–89  (Money Supply Shrink ! Very high Interest Rates.)

In  order to control runaway inflation of 70s, Central Banks hiked interest rates in 80s. (e.g. Paul Volker hiked Interest Rate to 21% in US thereby allowing dollar to regain it’s value. This created debt crisis worldwide. IMF supported world even during this crisis by lending money. Though austerity measures took years for nations to come out of that crisis completely.

New political maps :  1990-2004 (The fall of the Berlin wall in 1989 and the dissolution of the Soviet Union)

The fall of the Berlin wall in 1989 and the dissolution of the Soviet Union kept IMF busy in developing economic structure for new countries that separated from formal Soviet Union. 

Also in this era IMF helped Indonesia, Korea in financial crisis. IMF started HIPC initiative to help poor countries as well.

Credit Crisis (2005 till date) Burst of Housing bubble.

This is nothing but today’s era and IMF has been busy in helping nations across globe e.g. Greece recently. It has responded to this crisis by tripling it’s lending capacity as well.

So, this is where we are in this whole financial history since WWII. Let’s see what someone write about IMF and world Financial History in 2030 how many new eras come and what they do in those.

Wednesday, May 12, 2010

Real Value vs Nominal Cost vs Relative Cost

Hi All, 

Welcome once again. We renamed it as “Common Man's hub of Economics” as it is now going to too many people. Initially it was just sort of debate between few friends so “Gangal School of Economics” was name, which was ok then but now it needs to be changed. I have changed it in all the posts.

Anyways, let’s see difference between “Real Value vs Nominal Cost vs Relative Cost”.

Real Value 

Well we all probably will agree that Single smallest and most valuable thing in whole world is “Koh-I-Noor” Diamond. Question is why. And simple answer is it’s “rare”. So “What is rare is valuable there should be no doubt about it”. What about gold well that’s also valuable why is again because you can not increase it’s Supply at any rate. Whole process of gold extraction is pretty tough and max supply that we get per year is 2000- 2500 Tons. Due to very high density 19.3 if you make a cube of it, it can fit in medium size Room. Yes that’s it. We cannot produce more gold than that per year. "It has been estimated that all gold ever refined would form a single cube 20 m (66 ft) on a side (equivalent to 8000 m3)". In other words it’s rare as well hence not as high as diamond but still gold is precious. What about Silver, same story again rare but not rare as gold so in value less than gold but still it’s a precious metal.

Nominal Cost.

Well this is bit complex. Nominal Cost has many aspects to it. Let’s take an example of a Father who earned 20,000 and spend 10,000 per month (4 Rs School fees, 1000 Rs max for groceries). Now if his son earns 1,00,000 per month and spends 70,000 per month (5000 School Fees, 40000 Home EMI and so on) despite “Numbers” son has weaker economy. In other words it’s just time that has inflated these numbers and son is in “illusion of wealth” whereas he will face all same challenges during his retirement that his father faced. At the same time if he earns 20,000 and even if saves 12,000 his economy is still weak. And this is because the “Value of 12000 Rs saved now as compared to value of 10,000 Rs his father saved (During his time) is low dramatically.

This is typically known as currency depreciation and is caused by inflation (Increase in Money supply, Printing of money to fund government deficits that we discussed for some time now.)

Relative Cost

This is tougher to understand. It’s basically Einstein’s theory of relativity that becomes applicable even in economics.

Well, if you see graphs below you can understand that even great peak of Dow of 2006-7 when measured in gold it was a complete bear market. Think more and more about it. This can be understood with better clarity by looking at graphs below.

Dow Jones in Nominal Terms. from 1900 till 2010
at 25000 on x Axis there is 1971 on 40000 there is 2010.

Dow Jones when measured in Gold

So bottom-line is we are in world where everything is going up in nominal terms and down in real terms and as I see we have left no path for U turn. Obviously this system is unsustainable so let’s wait and watch and enjoy till it breaks or repairs in hard way :) 

P.S: Gold crossed all time high today making new all time high. Since beginning of this forum i.e since many Months now, I have been mentioning importance of gold and silver in upcoming time. I hope we all including me will be able to make it this time before it makes new all time high.