Depression with a Difference?

At last, it seems to be dawning on the world that we may be staring at another Depression. The Greek PM was candid to admit that the country is in a version of Great Depression. But, unlike the other leaders, the Greek PM has an advantage of accepting the fact that they are staring at another economic depression. Greece, of course, will be mired in economic depression/stagnation or whatever name we give it for the next decade, if not two. Luckily for Greece, they are unlikely to be the only one there. The nature of global economy means that it would be very hard to find a textbook definition of depression as of now. So, technically, we can gloat that we are not even in a recession let alone depression. While it may be a long time  before policy makers give up in exasperation, all the indicators seem to indicate that the parts of the global economy will remain in varied forms of depression for a long time. The Japanese are probably the best to listen to in the present situation: they have after all been dancing round the liminal boundary between a recession and a depression for nearly two decades. They have warned that the Chinese slowdown will be far deeper than it was thought. 

Bond yields indicate that the poor state of the economy is likely to continue. Falling bond yields are no more a big event. It is now more profitable to invest in junk bonds rather than private equity. At last, investors have realised that in a financialised world, investing is basically shooting in the dark. It needed the biggest crisis in the history of the human race to understand the true character of finance. Low long-term bond yields are indicative of inability to deploy funds and high present indebtedness. Uncertainty of the future and possible unintended consequence of the future, including the likely bouts of fears about counter party risk, mean that the new long-term is six months. Moreover, we have not yet seen the worst to even think of a recovery. The problems may be starting all over again: this time they may be centered around the core regions of Europe and the Emerging markets - both of which have not been factored by markets other than the bond markets. Downgrade of the core (Germany) have only just started. The Credit Default Swaps of the indebted countries seem to be behaving in a similar pattern: panic leads to a sharp rise, central bank intervention follows, a semblance of normality - small drop and then they start their upward march, and the cycle goes on. The chart below of Spain's CDS reflects the movement of the other countries. (The Chart is sourced from Bloomberg)

More interesting is that the present crisis, if it turns out not to be a depression, will take years for an actual. And, when there is actually a recovery, the global economy will shrink to such an extent that it will still feel like a downtrend. The shrinking of the global economy has already started in some countries, like USA (leave Ireland, Spain and Greece) where companies have already started to attempt to deleverage themselves. Bank of America is one such case that has announced their decision: rest will invariably follow sooner. BoA is cutting the number of ATMs. Next will be branches and then subsidiaries (if they can sell them) and then will be bankruptcy - that is the life-cycle of any over-leveraged companies in Capitalism. 

Unemployment will continue to soar - unless the world adopts the US system where those unemployed for more than six months are deemed to be lazy and hence removed from the labour force statistics. A cursory glance at Spain, Ireland, Portugal, Greece and a long list indicates that instead of adding jobs, the economies are at best stagnant. But, no growth is not an option - especially when indebtedness is all pervading rather than an exception. And, when everybody attempts to deleverage all at once, it only compounds the problem rather than the other way round. 

Emerging markets are likely to be the next shoe to drop. Each emerging market is indeed unique: as are their problems. They seem to believe that low interest rates will solve the problem. The problem with emerging markets is that they never learn and hence over the past 100 years they have continue to attempt to emerge without much success. 

India is in a unenviable position: over the years, we have increased our dependence on commodity exports, software exports and exports to China. None of which seem to be the right place to be in at the present. The government seems to be groping in the dark, though they would not like to accept that their policy of encouraging exports to China was a good move in the first place. Industry has leveraged itself to the hilt, as have the central and the regional governments, individuals from the richest to the poorest are no different - after all they are not islands in society. 

There is however, one particular aspect that the government seems to have overlooked. The nature of social and economic change is such that, once the forces are unleashed, they cannot be controlled. The slowdown is slowly, but surely seems to have begun process of unleashing all the social and economic contradictions and problems that till date were papered over due to the recent economic boom. Boom time meant that various issues were relegated to the background. Now that this has ended the tinder box is being reopened. Look at the recent strike at Maruti plant. Never before have we witnessed striking workers killing senior managers in India. This has happened two times in the past six months: once in Pondichery and now at the Maruti plant. That should be sufficient reasons for policy makers to understand that this downtrend will unleash more violent process of change than the processes at work during 1989-1993 period. 

Disappearance of the 'Old Elite'

The past two decades have been quite momentous in a literal sense. Close observation of the socio-economic, cultural and political landscape invariably raises more questions than ever. And, most of these questions cannot be answered to our own satisfaction, let alone to the satisfaction of others. 

Over the past decade, one question has frequently come across my mind. I keeping asking this question but have never got any help. It is a question that nobody has been able to answer. The first time, the question came up was during research on the Culture of Finance Business in the Vijayawada Region of Andhra Pradesh. The interesting aspect of the Krishna district (and the neighbouring districts) is that the present day elite invariably consists of one that has climbed the social, economic and political ladder in their own life time. Most of them started their career as either handymen (cleaners) or drivers, clerks, small time commission agents or those doing odd jobs graduating into small time business men and subsequently growing. Coming from the lower rungs of the economic pyramid, they would invest all their surplus in land (agricultural land in rural areas or urban real estate). This investment in land may have also been due to their intention of making known their own success to their peers and kinsmen in their community. It had its own advantages: it increased their assets and also their creditability (they could now be lent money since they had some asset). Rising land values invariably increased their economic and social status.

The rise of the new elite is by itself not surprising. However, what is very surprising is that the 'Old Elite', especially those who dominated the economic and social landscape of the region a few decade back are conspicuous by their absence. Interestingly, none of their descendents are anywhere close to the top of the social and economic matrix. The only exception seem to be those who belonging to the Andhra Sugars Group. They seem to have simply faded into the background and from there into oblivion. It has become almost impossible to track them to even find out, even from an academic point of view. 

This seems to be happening in a number of other districts of Andhra Pradesh. The photos below are from Wanaparthy Town in Mahabubnagar district of Andhra Pradesh. The buildings that belonged to the former Raja now house the Polytechnic college. The Raja was magnanimous to donate it in 1954. The Raja's daughter's, like a number of other descendents of the elite have migrated to the USA and his adopted son is in Hyderabad, governing a school which became more famous for the supposed riches buried deep underneath rather than his activities beyond it. It is now the centre of the town. Despite its majestic appearance from the distance, the close we get the more it reflects the status of their former owners: either crumbling or in a state of fading into the oblivion. This particular structure it is a bad state and requires urgent repairs though not completely dilapidated.

The  occasional maintenance expenditure apparently was possible when some film producers decided to shoot Telugu films about Factions and related stories. Ironically, the Rayalaseema faction films were shot in Telengana region of Andhra Pradesh.

A View from the Balcony of the building

The picture below is a well in the college compound that was built first built in 1868 and then rebuilt in 1904.

Hopefully, we can find a way to protect our heritage, even if we were to remind our posterity of the existence of a different kind of socio-economic environment from the present.

Bailouts, Banks and Bankruptcies: Consequence of Asking the Wrong Quesitons

The immediate present seems to be so eerily similar to the very distant past to such an extent that sometimes (with cynicism) I feel that those who claim that history is useless may actually have a point. At the end of the day, there is absolutely nothing more blessed that being ignorant or even better dementia is in the present economic conditions quite a blessing, albeit in the short-term. The fact that we seem to be blissfully ignorant of the economic crisis speaks volumes of our ability to be selectively demential. Every sector of our economic life has innumerable examples of crisis or near crisis level situations that are very recent, leave alone those going back a couple of decades. The problems in India during the period 1995-2000 should have provided sufficient lessons to our businesses and policy makers. Obviously, they have not. We have not made any new mistakes, we have essentially made the same mistakes. Little wonder that Einstein (who lost heavily in the markets) defined insanity as 'doing the same thing over and over again and expecting different results'. That these mistakes have occurred when we have sufficient information is indicative of the fact that information is not the problem and, the problems lie elsewhere - in the changing social forms and connotations in the way we construe money and wealth. 

Almost every segment of economy and society is craving (or demanding) bailouts: Sovereigns are demanding one too - from other sovereigns. IMF, for once seems to have decided that their legitimacy is at stake and seem to have warned the world about the magnitude of the problems in each country (p.3 of their report). Though, they got it right, nobody seems to care because they are like the Indian police - always late to the scene and always state the obvious. 

The IMF report cited below provides a stark picture of our economy: 

Name of Country	Projected Fiscal Deficit (% of GDP)
	2012	2013
USA	8.1	6.3
Japan	10	8.7
UK	8	6.6
Italy	2.4	1.6
Spain	6.0	5.7
France	4.6	3.9
Germany	0.8	0.6
China	3.2	3.0
India	8.3	8.2

Source: http://www.imf.org/external/pubs/ft/fm/2012/01/pdf/fm1201.pdf

The irony of this deficit is that unlike, the other countries' India's economic position is precarious and hence cannot even think of fiscal austerity. But, rest assured over the years as Indian's we have mastered the art of creative accounting so in the next two years, the deficit will decline, not rise.
Considering the fact that this blog has served as some sort of 'canary in the coal mine' over the past three years, we will be right again. The reason for this confidence is the fact that we are still in a stage where we have to provide large scale bailouts: Power sector needs a bailout and the need for a bailout: they have a 40% gap between costs and revenues while debt has reached Rs.200,000 crores. Add the telecom, real estate, mining and every other industry and it becomes hard to count the zeroes. To this add: the debts of the Central and State Governments, we get the picture, or do we?

We have forgotten the banks, which will themselves need a bailout. Deja Vu all over again!

All the above is not very surprising, considering that we prefer selective long/short term memory loss when it is very convenient. But, how we come to such a situation? The short, albeit bitter answer, is that we have conditioned ourselves to ask the wrong questions. Over the past decades, we have not trained ourselves to ask one simple question: who is taking the other side of the bet or what is on the other side? This pervades through the public and the private sector. 

Take for example the government: a large number of our policy makers do not like being asked uncomfortable questions. In order to avoid this inconvenience, they take the easy way out: appoint cronies who are beautifully useless to positions where one can ask uncomfortable questions. That has created a situation where the army of clerks and beautifully useless cronies excel at exactly one thing: follow procedures. Just as anywhere else in the world, there are extremely smart and intelligent policy makers who well intentioned and attempt to get the system to work by granting greater independence. All their reforms end up creating new rent-seeking institutions. Following procedures means that more often then not, the beautifully useless end up in control. Independence and functional autonomy means more money through rent seeking behaviour. Apparently, this independence has reached an extent where a very elastic interpretation of the law has led to the courts to crack the whip. Ironically, we have reached a stage where a private consultancy has to be approached to tutor a regulator agency about how to function!!! Would it not have been better for SEBI (the more recent of the regulators) to simply imbibe a culture of asking uncomfortable, but right questions at the right time rather than the wrong questions at the wrong time with the wrong intentions? If only the government can come out of 'governmentality' we would not be in this place.

The private sector is even worse. Historically, they have never understood that trees do not grow to the sky. Their excessive dependence on the valuation model of wealth creation and their inability to understand the secular change in the global market place may be doing more harm. The past 18 years has seen capital appreciation as the primary vehicle for wealth creation. It is for this reason that we have mastered price rigging of commodity, equity and real estate prices as the best way to create wealth rather than dividends.

Pointless Interest Rates and Economic Recovery

Since the onset of the Global Financial Crisis in 2008, the hallmark of policy making has been the hope that lowering interest rates will lead to recovery in spending. The cuts in interest rates have been accompanied by other incremental measures. One reason for such insistence on interest rates is invariably their non-controversial nature. Ardent fiscal hawks prefer that to other forms of stimulus. But, the world economy has reached a point where we have doubt the utility of these rate cuts as an attempt to stoke recovery. 

Sometime back we had put up a third party chart that showed that the US bond yields were at their lowest in more than a 100 years. The fact that low interest rates have not helped is again reinforced by the US 30 year mortgage rates. It reached around 3% recently. The chart below points to the secular downtrend in the mortgage rates for the last more than 30 years. The fall since 2008 has been particular steep. A day may not be far when banks and governments plead (and pay) borrowers may not be far off. 

1996-1998 All over again?

Cicero once observed, 'everything has a history, therefore history is everything'. Alas, we are in a age when most of us tend to belittle history to such an extent that we are always condemned to repeat the same mistakes in different forms. It is probably for that reason that Hegel once noted that 'we learn from history that man can never learn anything from history'. Almost always we forget that the cost of forgetting history are immense.
 

The present state of the Indian economy is a typical example. The remarkable aspect of the present situation is that our collective memory does not seem to go beyond a few days, let alone 1996-1998.Of course, we did not have Google, though we had Netscape, we did not have digital papers - connecting to the net was still expensive. But not that these make any difference. After all, we have forgotten the consequences of the drought of 2002-04 as well. But, worrying about the rains is probably the last thing that we should worry about at this moment. Considering the fact that we are going to be effected by El-Nino, don't be surprised if there are floods in September.

There are a number of reasons why the present economic conditions reflect the problems that plagued the conditions that existed then. As in the present, Indian  corporate sector was working off the excess of the borrowing binge after the liberalization of the norms for raising money through ECBs/GDRs. Industries, that had built capacities far in excess of the requirement thinking that trees grow to the sky were shutting down due to lack of demand (sounds familiar - China). The United Front Government, ruled by regional satraps pulled in different directions, and the list goes on. 

The present seems eerily like the past: demand is slowing (but as Indian's we don't accept that there is a problem), bad loans were piling up: then it was Steel and other basic industries, now we have added to the list and now call them 'infrastructure'. Now, as in the past, we were in denial: we still insist 6% growth is possible, when it clear that the world and emerging markets are slowing and there are riots in Eurozone against austerity. At that time we were hopeful that exports would help India - it took the collapse of South East Asia, Russian Default, and collapse of Long-term Capital Management to realise that the world was different than what we had thought. After those events occurred there was an interesting change in the attitude of the banks: rather than lending, they started investing in Government bonds: it was called the phase of 'lazy banking'. Interest rates were high and it was safer to invest in Government securities than to lend it to crooks in the corporate sector. Ironically, this process is well under way in 2012.

Our politicians are a mirror image of our Equity markets: always hopeful and always wrong, especially when faced with reality. Again the present is illustrative: India a capital deficient country, and globally in the present context capital is a scare commodity, yet we are hopeful that our economy will withstand the present turbulence. Nobody elaborate how this is possible. What is odd is that despite the global bond markets factoring major slowdown in the economies, we refuse to learn from history. Our policy makers are still talking in terms of 6-7% economic growth when the world is talking about another bout of deflationary spiral, emanating from China. One has to wonder where India can hope to gain growth: We know for sure that the power sector is in trouble because our dependence on Hydel power and lack of capital. Exports are going to keep coming down in the next few years (not even months) due to problems everywhere. Oh yes, there is one way they can keep growing: slow return of all the illegal money stashed away in foreign banks. The likelihood of this happen is bright: banking sector in all the countries is in trouble plus interest rates are high in India. In deflationary time there is nothing better than steady income.

Indian corporate sector seems to completely unprepared for at least two important global consequences that plagued the Indian economy during 1996-98 and is likely to return in the next few quarters: dumping by Chinese and Russian companies. Chinese companies are likely to dump their goods for the simple reason that China in the throes of a deflation spiral and banking sector riddled with bad loans but a government with sufficient surplus would continue to subsidize their products. The result will be large scale dumping all over the world.

The other consequence that Indian corporate sector is completely unprepared is the consequence of the Union Government cutting its expenditure drastically. The last time this happened (1997-2000) there was a drastic slowdown. The rise in oil prices and the fall in the rupee only aggravate the problems. The expected rise in the diesel price may help avoid a ratings downgrade immediately but in the medium term it will not stop the inevitable (a ratings downgrade). India attracted foreign capital as due to its domestic consumption story. Since that is likely to end sooner rather than later, it remains to be seen how we can avoid the 'junk' status.