Dawn of Depression and the Era of Changing Goal Posts

The last week has seen a subtle shift among businesses and Central banks the world over,  India excluded. The shift, more akin to dipping their toes to test the waters, is indicative of a new trend in the making. Since the collapse of the hedge funds of BNP Paribas in August 2007, policy makers have been in denial that the crisis is likely to drag on for years and that the problems are a mirror image of those in 1929. However, due credit needs to be given to them since without the intervention of the Central Banks, the world would have been mired in a depression that would have made 1929 seem like a walk in the park. The Central Banks saved the day by postponing the crisis but they now seem to have realised that their efforts have more or less been wasted by the politicians and the ability of global capital to see to it that their short-term interests are not hurt beyond a scratch. Even as bond yields of the supposed safe havens reach record lows (below that of the Great Depression era), Central Banks seem to have realised that they will soon run out of bullets and hence have started one last attempt to salvage the economies of the world. One, change the goal posts so that they can postpone the inevitable to buy some more time and, two concurrently gradually prepare the masses for the inevitable: the Dawn of the first Depression of the 21st Century. Bankers seem to have joined the effort. First to release the balloon was the CEO of RBS warning that the crisis in Europe will take years. That was actually the best effort at being frank because, he knows very well that if he is too candid then he will lose his job. Next came Morgan Stanley warning that the world was short of US$2 trillion, then came the Chief of the Austrian Central Bank, who is so nervous about the situation in Europe that he blurted out what is  probably  being discussed in hushed tones by the central banks: compare the situation with the Great Depression.Clearly, the Central Banks know very well that the present situation is irretrievable unless they follow what we have long advocated: write off debts on a biblical scale so that everybody starts on a clean slate. Ultimately there will be such write offs because all the junk paper currency has been exchanged for junk bonds - in the form of bonds that banks are depositing with ECB and borrowing Euros which will anyway will collapse sooner than later.Even the Germans are scandalised by this!!!

It is indeed surprising that there is so much complacency that the economy is going to recover soon. Recovery at a time when there is such great austerity is either a joke or will require a complete overhaul of our understanding of every discipline as it has been taught since 1789. Take the case of Italy which will have to cut 3.2 percent of GDP due to tightening; US will have to cut nearly US$ 1 trillion over the next few years due to fiscal discipline related causes. Greece has to tighten nearly 4.5% of a shrunken GDP, France and a host of others will follow. Such a collapse will only make the ugly balance sheets look worse one year down the line.

The best option, writing off debts, is something that is not palatable at the present juncture. Governments would have the bondholders lose gradually than all at once. Sounds scandalous? Look at those who lent money to Greece over the past five years, and especially those remarkable finance whizkids who lent money over the past three years (since the first package): they have already lost 75% of their principal.

So what is to be done?

For Starters: in the next five years, be prepared for the biggest bull run in the history of the US Dollar Index. The Chart below shows the long-term charts of the US Dollar Index (since 1985) and all the technical patterns seem to indicate that the markets are preparing for the worst. Nothing that seems to be more safe than the US dollar in the era of fiat currencies. After all it is better to loaded up on lousy dollars than being loaded on a sinking currency in the form of Euro.

Two, learn from India: We can still function with active cartels, crony capitalism, an economist PM whose sole USP  can do nothing - like even winning a panchayat election for himself and yet has been the PM for so many years, a Finance Minister who is hoping to retire peacefully with a promotion though his skills never went beyond helping over leveraged promoters become directors of the Central bank,  and we have a central bank that has solved the problem of bad loans very easily - simply reschedule as many loans as possible. That postpones the problem for up to seven years and after that who really cares, there will always be a new theme. And worse may be in store: if the raingods forget us.

After all this is the era when ignorance is bliss and people will anyway forget that the present list of emerging markets have remained emerging for the last century and those like South Korea which are supposed to have 'developed' will be back to the list of emerging markets that tried to emerge but failed. Remarkable how beautifully useless the rating agencies are in practice: they upgrade an economy that is 95% dependent on exports at a time of the most important economies that consume are suffering from indigestion. 

Three, Avoid China - we have highlighted the problems of that country innumerable times and hence no need to repeat it again. 

But, all is not lost for Indian speculators. Indian charts seem to indicate that our speculators are all set to rig stock prices once again.

Is Government Welfare a Bull Market Story?

One cannot but marvel at how 'lucky' our generation is! We are witnessing events that normally occur a century or two apart in the span of a few months or years. When was the last time that history recorded tumult on such a large scale in the world? 1789, 1848-1870, 1914-1950 and the present. Unlike a few decades back, this time around technology will make sure that we will not be overawed beyond the first 48 hours with the events that are likely to overtake us in the near future. The speed of the collapse is however an important new trend. The collapse in wealth in ashort span has been aggravated by the fact that finance has become the  tail that wags dog. US is a classic example of the consequence of this: 18 years of economic advancement were wiped out in about three years - and we are probably only half way through the crisis.  However, what is remarkable is that following the economy over the past few weeks has been quite 'boring' except for speculation about the quantum and form of QE3. 

Then, what exactly is new? The answer may be the macro economic problems that may be round the corner for countries in such as India and the emerging markets. The attendant consequence is that it is clear that in countries such as India, welfare seems to be nothing more than a bull market story. Remember the decade from 1989 to 1999! It is pertinent to note that economic problems do not come on a stand alone basis: buy one, get two free (social and political problems/uncertainties) is almost a foregone conclusion that needs to be factored . In India, the problem is aggravated due to the fact that we have all forgotten what a severe economic downturn is like. Everybody has built their livelihood and/or business models around continuation of high commodity prices, easy liquidity and the India story continuing for another 20 years. However, the pendulum is swinging the other side in almost all the positives.

A cursory glance at government expenditure indicates that India is heading into a prefect storm. And, it seems to be riding into the biggest economic challenge it has faced when it is least prepared. Tax-GDP ratio has dropped from about 12% in 2007-08 to the present approximately 10.5%. Fiscal Deficit is rising. Revenues are bound to start falling (there is always the lag). The government response has been very typical: cut expenditure by restricting subsidies to less than 2% of GDP. That goal is plausible on paper, but practically it would be impossible to achieve considering that the GDP will keep falling, thereby making the target bigger than possible to achieve.

It would be interesting to see which segment suffers. Historically it has been the middle and lower classes. There is no reason to think that it would be any different this time. Government always claim that it will cut wasteful expenditure or even welfare, which at time is also termed as 'unproductive subsidy'. However, the question that we often forget to ask is, if it is wasteful expenditure, why was it allowed in the first place?

The interesting change that has occurred, largely unnoticed, in the immediate aftermath of the collapse of Lehman. The impact of the collapse of Lehman Bros was remarkable in India. Businesses stopped preaching that subsidies should be cut - instead they started blatantly demanding that they should get larger subsidies. That is always the best way to ask for more. The clock has turned a full cycle. Presently it is claimed that subsidies should be cut: invariably the corporate sector means that it should be cut for everybody else while they are exempt. Yes, they should be cut - but the steepest should be for those who have accessed them the past or those who have already benefited in too many ways - that would mean cutting them first for Ambanis, Birlas, Tatas, et al. There are a number of indications that clearly show that Welfare is going to be cut substantially. Till 2014 elections, it is likely to be small cuts but, once the elections are over we should be prepared for big cuts. The reason? Corporate sector and along with it the banking sector in India needs to be bailed out. And if that has to happen, some body has to pay, after all post-Lehman events have taught us that it is easy to socialise losses. Good thing for India is that Everybody is so fixated with Eurozone crisis that they seem to be overlooking our own home grown crisis.

India's banking sector and the government seem to be on the verge of a crisis that will unfold - if the truth was disclosed. The present crisis is such that we would probably be better off if the truth was never disclosed. If that sounds scandalous look at China!

A cursory glance at the monies owed to the banking sector by troubled sectors show us that the magnitude of the problem we have at hand. This problem is compounded because it has been under-estimated and remarkable complacency of policy makers. There are a number of sectors in India in the line for a bailout.

• Textile industry has debt of nearly Rs.1,55,000 crores (yes you read it right) and it wants to restructure Rs.35,000 crores of debt at present. But rest assured, by the time, the crisis is over it is likely to be at three times the present estimate - especially if the history of textile industry is an indicator.
• Real estate companies have to repay at least Rs.35,000 in the present quarter - that is the last sector that is likely to repay their loans. The banks can safely write off at least 75% of that. The total exposure of the banks to unlisted companies has been estimated at more than Rs.1,00, crores. 
• The power sector requires rescheduling of nearly Rs.1,00,000 crores. 
• Telecom sector? Could be in excess of Rs.1,00,000 crores (A.Raja will be the first to vote for a bailout of the sector). 
• Add another Rs.10,000 crores of loans already restructured for the MFI sector.

To the above list we may add the need for about Rs.3,00,000 crores needed annually for various direct subsidies like petroleum products (about Rs.1,81,000), fertiliser,etc.All this excludes the subsides that our political class gives itself - including the money carted out in the form of over/under-invoicing of trade, hawala, etc.

The list is actually never ending, yet in a recent report CRISIL claimed that it expects nearly Rs.2,00,000 crores of loans to be restructured in the next two years. I believe that figure will be at least three times that amount.

To answer the question we have raised, is government welfare a bull market story? The short answer in India is a resounding YES.

After all, ignorance is really bliss!!!