First Dubai, then Greece. Is the US next?

Feb 9, 2010

In this issue:
» India lags China in patent filings
» RBI comes out with new norms on pricing
» China's bubble burst could be different
» Stimulus may be withdrawn for exporters
» ...and more!!

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The credit crisis dawned and the US government injected gargantuan doses of liquidity into the economy to prevent it from collapsing. But what it also did at the same time is aggravate its massive debt problem. And therefore, Marc Faber, author of the Gloom and Doom report, opines that if the US was a corporation it should have been given a 'junk' rating and not 'AAA'. Further, gold prices have soared over the last eight years. This means that even investors perceive something to be wrong with the US economy and the dollar. Interestingly, Faber acknowledges that there has been increased interest in US Treasuries. But he believes that those who seem to be buying the most of these Treasuries are other central bankers who are no better than the Fed chief Ben Bernanke.

Noted economist Nouriel Roubini has also sounded the death knell on the US economy. He believes that the Obama administration lacks the 'political capital' for serious financial reform. According to him, the fiscal deficit is likely to remain near US$ 1 trillion and exceed 5% of GDP over the next decade. A persistently high unemployment rate is not helping matters either. Thus, the recovery seems to have come piggybacking on government support and not due to growth in business or employment opportunities. This would mean that government revenues would come in lower. Little wonder then that Roubini has labeled the US as a 'ticking fiscal bomb.'

We believe that whether it is a corporation or a country, being overleveraged is a dangerous situation to be in. This was amply demonstrated in the current crisis with companies going bust and even governments defaulting on payments (Dubai and Greece are notable examples). Therefore, in such a scenario how the US will dig itself out from such a deep hole is anybody's guess.

Well, it's not just the 'big picture' economic experts who are sounding trouble for the US. Even the 'big picture' stock market experts toe the same line. Talk about Jeremy Grantham of the US based asset management firm GMO. For beginners, Grantham has built much of his investing reputation over his long career by correctly identifying market bubbles and steering his assets clear of the subsequent crashes. For instance, he avoided investing in Japanese equities and real estate in the late eighties, as well as technology stocks in the late nineties.

So, what's Grantham suggesting now? Staying clear of overpriced US stocks.

As he says, "Up until the last few months, I was counting on the Fed and the US government to begin to get the point that low rates held too long promote asset bubbles, which are extremely dangerous to the economy and financial system. Now, however, the penny is dropping, and I realize the Fed is unwittingly willing to risk a third speculative phase, which is supremely dangerous this time because its arsenal now is almost empty." Dire warning for US investors indeed!

 Chart of the day
India may be chugging along at a strong pace as far as economic growth is concerned, but the same cannot be said of its R&D prowess. As today's chart of the day shows, India filed less than a thousand patents in 2009 while China filed almost 10 times that. The US stood apart by a mile. This means that India has a lot of work to do if it wants to become a knowledge based economy that spurs innovation. From the looks of it, it seems to be a long time before India manages to come on par with its Chinese counterpart let alone the US.

Data Source: The Economist, Business Standard

The controlled interest rate regime in the Indian banking sector has its days numbered. Tired of persuading banks to do away with lending rates that are meant to 'tease' the borrowers, the RBI now has another solution. Instead of allowing banks to price their loans as per their benchmark prime lending rate (BPLR), the RBI will settle for a base rate. This will ensure that no lending takes place below minimal spread to lure borrowers. Also the base rate will ensure parity in loan pricing amongst PSU and private sector banks. Thus while banks will have lower competence in terms of loans pricing, the key will be to ensure a higher composition of CASA. Having said that, the abolition of BPLR will also bring in better transparency in the banking system.

Let us come back to one of the hottest topics these days. The China bubble. Will it pop or will it not? Well, we may not have an answer to that. But we can assure you something else. We can assure you that if at all the Chinese bubble pops, its bursting is going to be quite different from what happened in the US and Europe. China, as we all know is a communist society. And communists control most of the things in China. Thus, it is quite possible that when for e.g. The Chinese property bubble bursts, strict price controls are put in place. This would effectively mean that the authorities prevent any major wealth destruction that could arise. What more, the communists in China could also force banks to lend some support to the affected sectors.

Of course, all these measures would require enormous money. And even here, things could shape up quite differently from the US. Unlike US, China does not stare at a twin deficit. Infact, it is both budget as well as current account surplus. Hence, for providing support, the communists may not have to resort to debt financing. Thus, you would be forgiven for assuming that it would be business as usual even after the bubble pops. But there is no such thing as a free lunch in economics. By not allowing inefficient firms and institutions to fail, China would undertake a massive misallocation of resources. And this may come back to haunt its economy in the long term. It could lead to years of subpar growth. Thus, as the US is now realizing, there is no easy way out once a cheap-money based massive bubble emerges on the horizon.

It's an open secret every middle class Indian knows. Home prices never come down. Price corrections in real estate, especially in the residential category, are limited to the newspapers. When the broader economy and financial markets correct, home prices stagnate. But they don't come down. When the economy picks up, home prices dutifully march forward. As per a leading business daily, large real estate companies expect an increase of 15% to 20% in their average price realisations by the end of calendar 2010. Given India's demographic trends and increasing income levels, there is always demand for housing. However the key issue in our view is that of supply. The complete lack of transparency in the supply of land and lobbying ensure that housing remains a sellers' market. Unless that is remedied, the average middle class Indian will continue to get a raw deal.

With India's exports showing some signs of revival, Commerce and Industry Minister Anand Sharma is in favour of withdrawing some of the stimulus measures provided by the government to those sectors that are now showing strong growth. At the same time, he is has warned that a sudden pullout would halt the growth of the industry as a whole. Readers would do well to recall that Indian exports had taken a turn for the worse when the crisis began as demand slumped in the US, Europe and Japan.

Exporters in India then received many benefits in the form of extension of interest subvention, additional fund allocation for certain schemes, abolition of the fringe benefit tax amongst others. Although these rich countries are not completely out of the woods yet, the positive impact of a gradual recovery has rubbed off on certain export sectors in India. And so the view is that many of these exporters should now focus on diversifying their markets and improving productivity. We couldn't agree more!

After witnessing a volatile trading session during first half of the day, the Indian stock market were trading well above the dotted line at the time of writing. The benchmark index, the BSE-Sensex was up by around 85 points (0.5%), while its smaller peers, the BSE-Smallcap and the BSE-Midcap indices were up by around 0.3% and 0.1% respectively. Stocks from the IT and telecom sectors were amongst the top gainers today, while those from the realty and energy sectors were amongst the top losers.

 Today's investing mantra
"The investor of today does not profit from yesterday's growth." - Warren Buffett

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5 Responses to "First Dubai, then Greece. Is the US next?"


Feb 10, 2010

I specially like chart of the day. Every time it gives broader picture in very simple way. plus subject in chart of the day feature is very much on spot.


Kersi Pirojshah Mahudawala

Feb 9, 2010

Indian banking industry is very sound and there will never be buble like China.



Feb 9, 2010

Is there a case for the US letting the dollar depreciate or preemptively devalue the $? Should the US bother that it the flight to safety currency of the world? Your thoughts?



Feb 9, 2010

EVerybody is srying foul at the American economy printing money. But it looks like the world is in such a bad shape, that the world is still buying dollars and in fact the value of the dollar has actually increased since 2006 (I remember 44 levels in 2006 and 46 levels now).
I believe that since all trade is in dollars, America will get away with printing the same (and no one else can print these anymore). If I could, I would advise the Preseident of usa, just print those trillions of dollars in USD 100 bills and pay off your debt in cash (and be generous to give your creditors a few extra bills).... this world is a sucker for dollar bills and will buy any amount printed....


Amal Shah

Feb 9, 2010

Patent filing - Everybody seems to be blaming product developers for lack of innovation!! Whats the govenment doing??

As a small scale industry I have filed for more than 6 patents in India in the past few years and one patent in the USA about 8 years ago. I received the US patent within about a year of filing ( US Patent no 5678770 )but have not yet received the Indian patent filed at the same time!

Just like cases filed in Indian courts --- all Indian patents I filed are still pending. Being a small industry I dont have the financial muscle or resources or manpower or patience to follow up with the patent authorities. The government must play an important role in ensuring timely disposal of patents filed by Indians in India. This would be a positively encouraging step for Indian developers.

I do hope that you make this a public issue so our politicians act in the matter.

Thank You

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