The US' recipe to become Zimbabwe!

Jan 5, 2013

In this issue:
» Is Indian govt. fighting a losing battle on gold?
» Why bond markets could shine in 2013
» Government betting big on ETFs!
» Inflation may subside in 2013
» ...and more!

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A trillion dollar coin! Are you already thinking of Zimbabwe with its billion dollar notes? Wait till we tell you that the coin is to be minted in platinum. That too by none other than the US! If you are still wondering if this is a figment of our imagination, rest assured it is not. On the contrary, Nobel laureate economist Paul Krugman has recently suggested this very option to the US Fed. He believes that this could be an exceptional solution to thwart the fiscal risk. At least that is what his blog in the New York Times cites.

Allow us to elaborate on this. The US government cannot legally print money to any extent to pay its bills. Instead, money has to be created by the Federal Reserve (US central bank). The Fed needs to then put the money into circulation by buying Federal debt. However there is one peculiar exception to this clause. The exception allows the Treasury to mint platinum coins in any denomination it chooses. Notably, the intention of this was to allow the government to issue commemorative coins. It was certainly not meant to be a fiscal measure. But Krugman believes that minting a trillion dollar platinum coin and depositing it in the Fed is the US' best bet. That way the US would overcome the fiscal cliff without issuing further debt.

Ironically Krugman himself acknowledges in the same note that the 'free lunches' would come to haunt US economy sooner than later. And once the demon called hyperinflation rears its head, the Fed could have a tough task at hand. But for the time being, it seems even the sanest advisors are making a case for using whatever gimmicks come to hand!

Well, we will not be surprised if not just the US but several European economies too adopt this 'Zimbabwe recipe'. But at the same time, we would prefer to keep a close watch on the excess liquidity sloshing around in global economic system. One that is set to give rise to massive asset bubbles. Also this is once again a request to the Indian government to allow Reserve Bank of India (RBI) to act independently. Save RBI the trouble of such trillion dollar gimmicks.

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 Chart of the day
Unlike its predecessors, the Twelfth Five Year plan (2013-17) document did not get too much media attention. The government too finalised the draft after much introspection. After all, the execution of the investment outlay of the previous plan left a lot to be desired. The focus this time was therefore on making feasible projections. Particularly keeping the low GDP growth and global economic risks in mind. But what particularly drew our attention was the estimation of under recoveries on diesel, kerosene and domestic LPG during the XIIth plan period. While petrol prices are now market determined, that data makes a strong case for diesel too to gradually take the same route. Else the estimated under recoveries to the tune of a massive Rs 8.3 trillion could weigh heavy on India's fiscal problems. Out of this under recoveries from diesel alone would be Rs 4.7 trillion.

Data source: Planning Commission

One of the most popular financial innovations this side of the 21st century has certainly been the Exchange Traded Fund. More popularly known as ETF, it has also been the fastest growing. Estimates put the growth of ETFs globally at an impressive 34% per annum over a ten year period. What more, even the assets under management (AUM) is a whopping US$ 1.5 trillion. For the uninitiated, an ETF is nothing but an asset class whose price is linked to the price of an index, a commodity or a basket of assets. It can be called pretty much similar to an index fund in its composition but with an important difference. The difference being that unlike an index fund, an ETF trades like a stock on the exchange. Thus, it can be called as more liquid.

Clearly, with these many advantages, it hasn't taken long for the Government of India to cash in on the popularity of ETFs. As per reports, it is into the last lap of launching an ETF that will track a basket of 20 of the most profitable PSUs in the country. The fund, whose size is estimated to be as big as Rs 300 bn, will aid the Government in its disinvestment programme. How it will work is when price of the ETF turns attractive, the Government can sell some of its holdings in the fund. Not a bad idea indeed as it will save the Government the effort of going in for piecemeal disinvestments we believe.

Indians buy gold when prices go down. Interestingly we also buy gold when prices go up because we think they would go up further. Our penchant for gold has led gold imports to spiral upwards. As a result, the government and the Reserve Bank of India (RBI) have been trying to curb the import of gold. They have thought about raising import duties on gold but beyond a certain point such an increase would only lead to an increase in smuggling. The two in tandem are also thinking of other steps to try and curb the demand for gold. But essentially they appear to be fighting a losing battle. For the government is not addressing the main reason as to why we buy gold.

An article in Firstpost has tried to figure out the reasons behind our penchant for gold. On the investment side we buy gold as it acts as a hedge against inflation. Given that the government has not done much to bring inflation under control, it is no wonder that gold has not lost its shine. Moreover, there is still a firm belief that the real assets of gold and real estate provide better returns as compared to the financial assets. Gold is also a preferred avenue for black money investments, something the government has not bothered to think about as of now. And last but not the least it is a part of our culture to buy gold. Unless the government addresses these issues, it is unlikely that our demand for gold will wane anytime soon.

Interest rates are set to go down and thus activity in the bond market is heating up. It is widely expected that the Reserve Bank of India, the monetary watchdog will cut its repo rate by at least 25 basis points from the current 8% in its January policy review. Plus, with more easing expected going forward, bond market activity will only increase. Traded volumes in bonds soared to an all-time high of Rs 762 bn on Thursday. This compares with average daily volume of Rs 200 m seen in December. Bond yields have decreased from 8.15% to 7.97%, which will in turn increases the price of bonds. Well, with equities seeing 26% returns in 2012, probably it is time for bond markets to shine in 2013.

The entire North India is engulfed in cold wave. While spine chilling cold has upset normal lifestyle it has also sown seeds of bumper crop harvest for the future. Favorable climatic conditions (fall in temperature and mildly sunny) in the North for plantation are likely to cool food prices in the future. And early signs are already visible with prices of potato, wheat and pulses seeing a downward trend. Vegetable prices have also been falling in the recent past. Mustard harvest is also expected to be good this year. Palm oil and soyabean oil prices have also ebbed. As such, edible oil prices are expected to head down wards. Chana acreage has also increased due to favorable weather conditions in parts of Maharashtra and Andhra Pradesh.

Thus, with strong crop output it seems that food inflation will no longer be a worry for India in the current year. This is likely to pave way for rate cuts in the future. It may be noted that until recently Reserve Bank of India (RBI) was reluctant to cut rates amidst high inflation. With food inflation expected to cool down overall inflation is also expected to subside. Thus, one can expect dovish comments by RBI in the near future.

The 2008 financial crisis wrought havoc in the US economy. In the years following the crisis, the economic superpower has been struggling to revamp its sagging economy. Despite several rounds of quantitative easing, the prospects of the US economy continued to remain bleak. However, if the recent auto sales data is anything to go by, the US could be witnessing a slight recovery. As per an article in Money News, auto sales during the month of December witnessed a rise of 9% year-on-year (YoY). During the full calendar year 2012, US auto sales rose 13.5% YoY. With sales of 14.5 m vehicles during the year, this has been the best performance since 2007.

The main reasons for the sales growth could be attributed to a slowly recovering economy, more credit availability and replacement demand. For the current year, auto sales are expected to be in the range of 14.7 m to 15.3 m vehicles. It is worth noting that in the decade prior to the financial crisis, auto sales averaged around 17 m vehicles per year. This means that it will take several years before the auto sales can get back to the pre-crisis level. While the recovery in auto sales is a good sign, it would be too early to ring the optimism bell. This seeming recovery is yet very fragile. Several major risk factors in the form of a bulging fiscal deficit still loom large.

The global markets kick started 2013 with gains as all major global markets ended the past week on a positive note. The positive sentiments were largely led by the US lawmakers reaching an agreement, just in time to avert the financial crisis. Further, positive economic indicators - Purchasing Managers Index remaining steady - from China also added to the positive sentiments.

With gains of about 3.8%, the US markets were the top gainers last week followed by France and Hong Kong with gains of about 3% each. China and Singapore reported weekly gains of about 2% and 1% respectively. As for the Indian equity markets, the same were up by 1.7% for the week.

Barring stocks from the FMCG sector - which was down by about 0.8% - all sectoral indices ended the week in the green. Gains were led by stocks from the realty, oil & gas and consumer durables spaces with their respective indices ending up by 5.2%, 4.1% and 3.5% respectively. Smallcap stocks also seemed to be in favour as the BSE Small Cap Index ended with weekly gains of 3.7%. The BSE Mid Cap Index however ended marginally lower as compared to last week.

Data Source: Yahoo Finance

 Weekend investing mantra
"There's no reason we should become fearful if a stock goes down. If a stock goes down 50%, I'd look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month." - Warren Buffett, 2008 Berkshire Hathaway shareholders meeting.

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    3 Responses to "The US' recipe to become Zimbabwe!"

    Mokan Rajagopal

    Jan 15, 2013

    RBI should be allowed to function without any interference. They should be allowed to act on their free will



    Jan 7, 2013

    Of course, the govt should allow RBI to perform their job independently- for the simple reason that RBI is manned by professionals who know their job as well as what is best for the country ; and RBI is not driven by populist agenda so they don't need to take decisions with an eye on the next elections. regds


    r v iyengar

    Jan 5, 2013

    The RBI, Election Commission, CAG, CBI and the LOKPAL and LOKAYUKTA should all be independent of the Government.

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