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.

Wednesday, June 23, 2010

Stimulating Credibility.

It is said that with money and power one can get everything in life but not credibility. What has happened with economy is exactly same today. With stimulus markets are up but not confidence. People are still concerned a lot about economy, inflation etc.. Nobody is actually able to visualize something like complete collapse but people are still nervous about it. In last 2 weeks there has been more discussion about Double Dip recession that is natural trend of market.

            Another observation that I had in recent week was difference in strategy. While countries like Germany and UK are behind budget cuts, in US, India, stimulus is still considered as preferred way to fight with recession.

            In either ways, gold touching it’s all time high, and overall nervousness in economy; governments are desperately trying to give confidence to system. In general it might mean a time for another stimulus in US or say direct injections in economy or efforts to reduce deficit in some other countries. All they are doing now is to stimulate credibility.

Saturday, June 5, 2010

A Complete U turn?

A Complete U turn?

A News

The meeting of the Group of 20 finance ministers and central bank governors in Busan, South Korea, also dropped proposals for a global banking levy, instead giving countries leeway to do what they thought best for their domestic circumstances.
The communiqué of the meeting made it clear that the G20 no longer thought that expansionary fiscal policy was sustainable or effective in fostering an economic recovery because investors were no longer confident about some countries’ public finances. “The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability,” the communiqué stated.

WOW I can’t believe this. Are they serious? Will they take this bitter but essential pill?

If YES  - > Deflation -> Interest Rates UPà Double dip recession -> Economy survive as currency gains value.

If they act what they say, world enters in deflationary ear in time to come. “Gold will go down so will silver”. Real estate market will simply collapse. Interest Rates will go up so will value of Money. No matter how bitter this step sounds, this can save world from “Complete Collapse of Global Economy down the line if they really do what they say”.

It obviously means accepting clear double dip recession that will allow mal investments to purge. This can also cause depression. But in my opinion both these scenarios will be better than “Zimbabwe style collapse of economic system”.

If NO -> Inflation -> Interest Rate Low-> Hyperinflation -> Currency Crisisà Economy Collapse.

If they don’t act what they say, obviously we will have inflationary era and sky will be limit for gold, silver and in fact all commodities. What we need to be afraid is for the time being they will unwind the stimulus and as effect if S&P falls below 800 and Dow say below 7000. They will again have a meeting to support stimulus. All this will mean only Inflation in step manner as opposed to ramp manner.

Even if Yes / No
In both these situation war is one of the big time possibility as both these environments create frustrations for common man and to divert attention then typically politicians declare war.
Let’s hope I am stupid person and none of these 3 scenarios happen.