Does the US Fed know something that we don't?

Feb 8, 2012

In this issue:
» Are Buffett's views on the US economy reliable?
» Good times ahead for power sector?
» Eurozone blues could halve China's GDP growth
» Will airline companies finally recover?
» ...and more!

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Few central banks in the world have drawn as much flak from economists and investors across the world as the US Fed has. Even the ECB(European Central Bank) has managed to save itself from the wrath despite several European nations on the verge of bankruptcy. However, the Fed takes the cake when it comes to indifference and arrogance in policy making. Firstly, it created one of the worst asset bubbles in decades with its loose monetary policy. Secondly, it has resolved to keep interest rates near zero for an extended period. This is while steep inflation is threatening to dampen the US' growth prospects. Although the Fed has now set an inflation target, its heavy debt burden seems to be thwarting all its plans. We wonder if the central bank is faking lack of rational thinking. Or does it know something that most of us don't?

For several weeks now we have been reading reports of the US' proficiency in oil drilling. The latest report on Bloomberg makes a claim that really made us sit up and take notice. It claims that the US is now closest it has been in almost 20 years to achieving energy self-sufficiency. In fact that is a goal Uncle Sam has been pursuing since the 1973 Arab oil embargo. But its energy surplus can be more benign to the US' economic prospects than ever before.

The US' domestic oil output was the highest in eight years in 2011. If the output sustains, the US could become the world's top energy producer by 2020. This will have long lasting implications for the economy and its political clout. Besides boosting household incomes, jobs and government revenue; the oil export revenue could help the US cut its debt burden and trade deficit meaningfully. Moreover, it will once again enhance the manufacturers' competitiveness ensuring less reliance on China. Greater flexibility in dealing with unrest in the Middle East will give the US enough political clout.

If these guesses turn out to be true, the US Fed's attempt to keep the economy chugging along with stimulus measure is not unfounded. For it is only a stop gap measure before the economy can unleash its real potential. Imagining that such oil supremacy will be without any pitfalls is wishful thinking. However, it would be dangerous for the developing economies to write-off the US' recovery potential entirely.

Do you think the US can use its energy resources to solve its fiscal problems? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
One look at the Reserve Bank Of India (RBI) data on the growth in banks' loan exposure to small and medium sized business enterprises (SMEs) is encouraging enough. It shows consistent growth in off take barring stagnancy in few years. However, given that these entities rely on banks for nearly 90% of their credit requirement, that their share in bank loans has not crossed 15% over the past decade is worrying. For if these entities do not get sufficient capital support for growth, at reasonable rates, their long term businesses potential could get paralyzed.

Data Source: RBI

Like scores of other value investors, even we wait to hear sound bytes from the world's greatest investor, Warren Buffett. And he seems to have made it a point to oblige his followers more frequently than before these days. But, and quite a big one at that, a doubt about his talent in the field of macroeconomics has increasingly begun to occupy our minds. There is no question that he possesses top notch wisdom about companies and moats. However, the brand of economics that he follows does not quite go down well with us. One need not go any further than his recent comments. In an interview to a leading channel, Buffett opined that the US Fed was under no obligation to investors to warn them about the asset bubble. And this refers to both, the bubble formed under former Fed Chief Greenspan as well as sub-prime crisis.

We don't quite get this. The US Fed can certainly have policies that almost certainly ensure an asset bubble. But when one is created, it is a sin if the US Fed is blamed. All of this under the pretext that bubbles are formed by market forces and not by Fed. We are of the view that the central banks like the US Fed are as much guilty of creating bubbles as say the ratings agencies and Wall Street. To say that US Fed is under no obligation is indeed the wrong thing to say according to us. Sorry Mr Buffett, we are not with you on this one.

Given that the massive debt continues to haunt the European region, hopes are pinned on emerging economies such as China and India to drive global growth. But the irony is that a worsening scenario in Europe is bound to spell trouble for the Chinese economy. The International Monetary Fund (IMF) has warned that China's economic expansion would be cut almost in half if Europe's debt crisis worsens. What this means is that China's growth could drop by as much as 4% points from the fund's current projection, which is for 8.2% this year.

It must be noted that China's economy so far has largely been exports driven and a prolonged recession in the developed world is bound to have an adverse impact on the dragon nation. This means that the country will have to focus more on increasing domestic consumption. The positive for China is that unlike India, it has ample headroom for loosening monetary policy given the government's fiscal discipline. Having said that, loose monetary policy has its own set of disadvantages. Readers would do well to recall that stimulus measures unleashed by China to fuel its economy post the global crisis led to indiscriminate lending by banks especially to the property market causing the formation of a bubble there. Thus, a gloomy world economy outlook will certainly impact China but the extent of the impact remains to be seen.

Over the last several months, short supply of coal has been a pressing concern for coal-dependent sectors in the Indian economy. Of all, the power sector has been the worst hit. The coal shortage has been mainly due to Coal India's inability to increase coal production. While the output from the world's largest coal mining company remained flat at 431 million tonnes (mt) in the previous financial year, for the first 6 months of FY12, there was an 11% decline in production. The government is trying various ways to augment coal supply. The most recent development is that the government is considering reserving forward e-auction of coal exclusively for the power sector. Forward contracts currently account for about 15% of the total 45 mt that Coal India sells through e-auction every year. If the plan gets implemented, it will increase coal supply to the power sector by 6-7 mt. Though a positive development for the power sector, it is too small a quantity to bring about any major relief.

The SEBI (Securities and Exchange Board of India) has given a reason for retail investors to celebrate. The regulator has made it mandatory for companies to reserve 15% in a share buyback for retail investors. This gives an opportunity to investors holding less than Rs 0.2 m worth of shares, to tender their holdings in a buyback. However, it is important to note that this limit is only for buybacks made through tender offers. In an open market operation, the company buys back its own shares through the stock exchanges. However, in a tender offer, the company has to accept the number of shares proportionate to the percentage holding of each party. As a result, retail investors get a very small chance to participate in such offers. As a result this ruling would come as a relief for retail investors in such cases. But considering that a majority of buybacks are made through open market operations, it is doubtful that this rule would have much impact as of now.

After ruling out any chances of bailout for the beleaguered ones, the government is planning to allow airline companies to import jet fuels directly. This move is expected to bring down the fuel costs of the companies by up to 20%. No doubt, this is good news for whole aviation sector which has been reeling under huge debt burden and continuously making losses. However, ground realities may not allow the move to be as fruitful as it promises, at least not in the near term. Why so? Airlines would need to invest in the transportation and storage of jet fuels. Else, they might approach oil marketing companies to handle the imports on their behalf. But again, it would cost them. Hence, the positive impact of the step taken would be offset in the near term. However, in the long run, this is definitely going to help airlines improve their profitability.

After starting close to the dotted line, positive cues from their peers in Asia helped the indices in Indian stock markets pick up momentum. Buying interest in commodity, mining and realty stocks led the indices higher. At the time of writing, the BSE Sensex was trading 162 points (0.9%) higher. Indices across other key Asian markets also closed higher while those in Europe have started on a positive note.

 Today's Investing Mantra
"The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past." - Benjamin Graham

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4 Responses to "Does the US Fed know something that we don't?"


Feb 10, 2012

When the US Fed resorts to steps like QEI, QEII, keeping interest rates at near zero (even in the next 2/3 years) then obviously there is some plan behind it. There must be some trump card which the US is holding and putting the economy through the grind despite the hardships being faced. Unemployment and inflation are relatively small issues when compared to global dominance and given the thought process of American polity for the past 100 years they wouldn't mind putting up with anything to retain their supremacy, especially at a crucial time like this. US would definitely carry on with any war that is going on now till it has a chance and need of playing that card. Could oil be that card ? on the other hand would it be so open for discussion ? is there something bigger?



Feb 9, 2012

First thing for self reliance, if at all US thinks of it SHOULD be start consuming less energy. They are the people who are sucking off all the oil and go for fight with Iraq claiming, Iraq is sucking Kuwait's oil?!!



Feb 8, 2012

" This is while steep inflation is threatening to dampen the US' growth prospects. Although the Fed has now set an inflation target, its heavy debt burden seems to be thwarting all its plans". A more absurd statement was never made ! Inflation in the US is at a mere 1.5% per year and has been at this level for over 4 years !!! Why is this so, if loose monetary policy has flooded the market where borrowing is very cheap ? Answer - demand is low, because of weak economic growth, massive job losses that has dampened consumer sentiment and thus crimped demand in the face of ample supply of everything from houses to cars to consumer goods. If the economy improves, then IF inflation does creep up, then the Fed can start tightening its monetary policy. Not to forget the fact that in the face of an uncertain Europe, a violent Middle East, a geriatric Japan and a malevolent China, everyone finds the US and the US dollar as the last "safe haven" pouring money into US Government bonds, notwithstanding the fact that the US economy itself growing at a snail's pace.

Contrast this scenario with India where inflation rages because the Government raised incomes across the board without increasing supply of food and without removing the policy roadblocks that prevented rapid industrial expansion to meet increased demand. In addition, the capricious manner in which politicians misused their discretionary powers to enrich themselves resulted in many high profile cases landing in the Supreme Court, eroding investor confidence.

Let us not bemoan the travails of the US. We in India are in far worse shape caused mainly by our incompetent and corrupt UPA Government.


Ashok Jainani

Feb 8, 2012

Dear Mr Ajit Dayal,

If the Bloomberg report on record high oil production in the US during 2011 is right (as reported), how come oil prices never took note of it.

The sources who have/control information know and have interest in how/when to release such information to media and through them to analysts - so-called television Gods who sermon to ordinary morons.

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