Are We in a 'Death Spiral'?

Feb 16, 2016

In this issue:
» Defensives back in demand?
» Dr. Rajan's stance on Rupee devaluation
» ...and more!
Devanshu Sampat, Research analyst

On 4 February, Citi released a report about the world economy. We haven't read it. But it was widely covered in the financial press. It was nothing short of a doom and gloom report. The analysts at Citi came up with a catchy metaphor: 'Death Spiral'. They seem to believe that the global economy is trapped in a 'self-reinforcing death spiral'.

At Equitymaster, we don't get distracted by such gloomy macro forecasts. We have stated time and again that the Indian economy won't go into recession. However, we believe it is important to understand why people think the developed world is staring down the barrel. After all, the Indian economy is not insulated from the problems of the developed world.

So what's at the heart of Citi's doomsday forecast? Are things really so bad? The answer has many aspects to it. It also depends who's asking this question. If it's the financial elites of the developed world, then we know they are already in big trouble.

It certainly does not look good for Wall Street. Ever since the debt-fuelled boom ended in 2008, Wall Street has been dependent on the US Fed. The same is true for most other developed nations as well. Easy money policies of central banks have only delayed the day of reckoning. Markets have now realised this. Their faith was misplaced. They have now stopped believing central banks can create inflation with more easy money.

So what happens now? Will the Fed, ECB, and others stand back and allow global markets to fall? We don't think so. They may seem powerless right now. But that's only because of the problem known as 'zero lower bound'. In simple words, central banks can't stimulate the economy because interest rates are already at or near zero. The zero lower bound is at the heart of all the doom and gloom.

Here's how it works.

Developed economies are driven by consumption and not by savings. To boost growth, at least in the short term, central banks cut the benchmark interest rate. This makes credit cheaper. It encourages more spending. This policy hasn't worked since 2008 because people just can't handle any more debt. With interest rates already at zero, and the US economy slowing down, the Fed is in a bind.

It was way too slow to raise interest rates. Now that it has started to do so, markets have crashed. How can the Fed get out of this? A negative interest rate policy (NIRP) is being openly discussed. The Eurozone, Switzerland, Sweden, and Japan have implemented it. But to no avail. There's no sign of inflation in these countries.

The reason why NIRP does not work is simple. If your bank decides to charge you for holding your money as a deposit, why would you keep your money in the bank? Wouldn't you prefer to keep your cash at home? This is exactly why the zero lower bound scares central banks. There is only one way around this and it's not pleasant: A ban on cash transactions.

Think about it. If your local grocery shop will accept payments only via credit and debit cards, you would have no choice but to keep a lot of your money in the bank. In such a scenario, NIRP can be implemented. If the inflation rate is -2% and your bank's interest rate is -4%, you would be forced to spend rather than save. If given enough time, this policy can trigger inflation. And the 'death spiral' can be averted.

At least, that's the theory. However, we are not convinced. NIRP raises serious moral questions. Can people be forced to park their hard earned savings in banks? And then be charged for doing so? This is a deeply disturbing thought. Savings are your asset and your bank's liability. But NIRP would turn that on its head. Your savings will become your liability and an asset for your bank! No wonder markets are afraid of the future.

Do you think negative interest rate policy is feasible? Can it prevent a 'death spiral'? Let us know your comments or share your views in the Equitymaster Club.

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Speaking at a conference, RBI Governor Dr. Rajan shared his views on currency devaluation as a mechanism to boost growth. India's Asian counterparts, particularly China, have been utilising this mechanism to 'spur growth'. Dr. Rajan believes this strategy would in fact become detrimental over the long term. We completely agree with the RBI governor's logic that boosting exports through artificial means is not sustainable.

As a country we would want reasonable, predictable and stable growth from exports to come from capabilities of large and small enterprises. So cost effectiveness, innovations, and ideas, rather than some kind of exchange rate valuation should be factors that drive growth. As far as the RBI is concerned, it needs to play the role of minimising extreme volatility in currency rates. Intervention in the market forces by the central bank has never proven to be a successful model so far.

3:45 Chart of the day

At a time when the markets are going all topsy-turvy, it seems the mutual funds equity allocation to evergreen marking darlings - the information technology, pharmaceuticals, and FMCG sectors - has risen. On the other hand, allocation towards the 'not-so-long-back' preferred sectors like banking and auto have been on a decline.

Today's chart of the day given a short term indication of the change in equity assets under management (AUM) allocation in these sectors. On a month on month basis, the banking and auto sectors have seen their weightage wane off. On the other hand, allocation to IT, pharma, and FMCG sectors has increased.

Defensives Back in Demand?

As per the Business Standard, banking stocks have declined to levels of 19% of total AUM in January 2016 as compared to levels of 22% a few months ago.

Whether this change in allocation is a function of the market movement or change in stance towards these sectors by fund managers, it does give a sense of how these sectors will play a big role in meeting investor expectations going forward. As of January 2016, these five sectors contributed to more than half of the AUM allocation.

If one were to compare this to the sector wise weightage of the benchmark index - the Sensex - there is a considerable difference. After all, three sectors - information technology (about 21%), finance (20%) and oil & gas (12%) contribute to more than half of the market capitalisation of the index. Bring in FMCG and pharma and the total figure rockets to about three-fourths.


At the time of writing, the Indian stock markets were trading below the dotted line with benchmark indices - the BSE-Sensex and NSE Nifty trading lower by about 70 points and 25 points respectively. Stocks from the mid and small cap spaces were out of favour as well with their representative indices down by 1.2% and 0.6% respectively. Within the sectoral preference, pharmaceutical and capital goods stocks were off the most, while power stocks were in demand.

4:50 Today's investing Mantra

"The inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business (i.e., ordinary income tax on dividends and capital gains tax on retained earnings) - can be thought of as an "investor's misery index". When this index exceeds the rate of return earned on equity by the business, the investor's purchasing power (real capital) shrinks even though he consumes nothing at all. We have no corporate solution to this problem; high inflation rates will not help us earn higher rates of return on equity." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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4 Responses to "Are We in a 'Death Spiral'?"


Feb 19, 2016

Consumption driven vs savings driven distinction is on the spot. However, banning cash transactions will not work till govt stops printing cash and distributing same. with cash under pillows, there will be a rise in crime...

Ethics have failed, religion has failed. Leaders have failed. The earn your bread culture is most of todays trouble due to excessive debt...which are difficult to pay off.

How can a nation that is the greatest debtor in human history be the most powerful ? Only by manipulating the rest of world. Japanese were good savers, efficient manufacturers - US bought cars, sold dollars (printed money) which Japs invested in US as govt bonds to keep afloat the paper they received...and also bought properties in US. Same story with China now. There was Taiwan, Korea, who were beaten into submission by currency manipulation and external tension / promise of military protection into buying arms / ceding bases.

The oil economies are mostly under control of dictatorships, benign or oppressive, and allowed to issue & use a "sovereign" currency...but these are just dollar painted with the face of the ruler ! These currencies also keep the mighty dollar afloat.

What nags me is what moral do I teach my children...that having a very strong military machine is the basis to strong currency..what about hard work, savings, investment in future...?? Turbulent times indeed...till west returns to original ethos that built the great countries. . West will try to impose their new stuff on us - CFC, Carbon tax, GM crops (to cut our food independence and enslave us again) like they exported textiles 250 years back and broke the village economy. India should reduce dependencies on export and try to hold on to domestic manufacture and consumption by disallowing dumping and giving unfair share of our market to foreigners...


Suresh P. Vasudevan

Feb 17, 2016

No, NIRP is destined to fail.
One of the FOUR pillars on which any economy stands is activities that generates employment. If any proactive action is required by the Feds, or the Banks, it should be to support job generating industry. Most industries, including farming, barring the 'Arms manufacturing industry' 'is almost stagnant in providing new jobs. An example is of how new jobs turned over "The Great Depression", by the "New Deal" of Franklin Roosevelt.
It is time we, in India, too, revisit a few of the Nehruvian Policies, something that took a leaf out of The Great Depression and made India respected in the World. Think about it as a way out...



Feb 17, 2016

Does the current situation in markets allow for higher equity allocation? This is apart from setting cash for safety


Gopal Kalpathi

Feb 16, 2016

It is really the wester capitalists'catch phrase the "There is no free lunch - someone has to pay for it". It has been pointed out several times that the ZIRP or NIRP or "Money Printing" is only a band-aid. The real culprit is the belief that "bigger-the-better" and consumption of luxury without commensurate production of essentials will always create imbalance. This was not that apperant till the 2008 crisis by when the global economy got so integrated that the crisis was not contained with a country or region, but spread throught. The world economy is going to be muted for a long time and it can limp back only if every nation works to minimise the inequality where there are millions who starvee on one side of the globe and there is a colosal waste on the other.

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