The Great Depression II averted?

Apr 3, 2009

In this issue:
» Has the G20 averted a depression?
» China's ambitious currency moves
» FASB extends accounting flexibility to US banks
» Mumbai home rentals pinch expatriates
» ...and more!

Just before the start of the G20 summit, master investor George Soros had warned that if the summit failed, the global economy might plunge into a depression. The history too was not favorable given the fact that a similar attempt way back in 1933 actually worsened the crisis and prolonged the great depression. The meeting has now come to an end and if the reaction of the global financial markets is anything to go by, the depression may just have been halted in its tracks. We say this because the member countries have pledged a whopping US$ 1.1 trillion towards improving both, availability of capital as well as cross border trade.

----------- Equitymaster Research -----------
Why is this insider buying his own company's shares at 55% above market price?
Read On...

Among other accomplishments of the summit was a unilateral agreement towards more stringent regulation of financial firms and doing away with protectionist policies. The summit also took note of the rising economic power of India and China, evident in the fact that the leaders agreed to restructure IMF management so as to give more representation to emerging nations. Not everything was hunky dory though. The US and European Union seemed split over the issue of fiscal stimulus, with the US wanting more while the latter wanting to adopt a wait and watch approach. The summit was also surprisingly quiet on the problem of 'toxic assets' that lay hidden in the balance sheets of banks across Europe and US. And we believe that unless this issue is tackled, global economy will not be completely out of the woods.

Don't be surprised next time you are in Switzerland and the tour operator asks you to pay in Chinese Yuan and not American dollars. Before you dismiss this as a joke, let us tell you that by as early as 2020 this might become a reality. Infact, the baby steps are already being taken. As per a LA Times article, China has signed deals with a few countries that will enable it to pump in more Chinese currency in the international banking system. The deals would help these countries to pay for their imported goods from China in the Chinese currency itself, thus not bringing the dollar into play at all. China's growing unease with respect to the dollar is now widely known and hence the move is an attempt to slowly diminish the influence of the dollar and at the same time, increase the importance of the Chinese Yuan.

Although the move is quite smart and the timing also impeccable, dethroning the dollar or even emasculating it is still many years away. For one, the Chinese currency is still tightly controlled and its capital markets too will have to be reformed a great deal. Secondly, letting the Yuan float freely will most certainly result in its appreciation against the dollar, a scenario, which is neither good for its vast dollar reserves as also for its exports, on which it heavily relies at the moment. However, all of this does not take away from the fact that based on current trends, the Chinese currency is definitely on the ascendancy while the dollar has nowhere to go but down. Thus, if China takes most of the steps that are required of it, 2020 timeline does not look like a very tall order.

What do you do when a certain rule prohibits misdoings that has caused everyone associated with it great harm? You build adequate safeguards so that the misdoings don't happen in the future. Right? Wrong! If you are someone very influential, you go ahead and change the rule itself. Financial Accounting Standards Board (FASB) that regulates accounting standards in the US has done just that. Under pressure from US lawmakers and financial companies, FASB has decided to relax an accounting rule that will now allow 'greater' flexibility to financial firms in valuing investments on their books including the highly controversial mortgage backed securities.

Till recently, financial firms were required to follow what is known as 'mark-to-market' accounting. But with credit crisis intensifying, few illiquid assets started selling at distressed prices, forcing banks to take major write downs, which in turn led to erosion in their net worth. But not anymore. FASB has now allowed auditors to let the financial firms use their own judgement in valuing assets especially illiquid ones in addition to the market prices. This move, which comes into effect from the June quarter, may enable banks to hide future losses and avoid further equity erosion. We wonder where these people were when the bankers overstated the value of assets and took home bonuses worth billions leaving investors in the lurch.

Gold prices have gained significant ground in the past couple of months due to the global economic crisis and weakness in the dollar against other currencies. The metal has gained consecutively for the past eight years and is up 2.9% in 2009. However, if the IMF's plans are anything to go by, the yellow metal may soon lose some of its glitter. It may be recalled that in April 2008 the IMF's board had approved a proposal to sell 403 metric tons of bullion as part of a plan to reduce its funding deficit.

More recently, at the G-20 summit, Britain has insisted that the IMF should free up money for lending by selling its gold reserves. A decision to sell gold requires the backing of 85% of the IMF's executive board, and the board representative from the US needs the approval of US Congress to vote in favour of any sales. As reported by Bloomberg, it is estimated that IMF gold sales will be used to help provide the world's poorest countries with US$ 6 bn aid over the next two to three years. As per the World Gold Council data, central banks the world over have sold about 85 tons of gold in the first three months of 2009.

If at all the IMF takes this extreme step, should we also abandon gold. Ajit Dayal, the founder of Equitymaster thinks otherwise. In a recent WebSummit exclusively for our paid subscribers, he opined that irrespective of the economic scenario, one should always have some portion of one's wealth invested in gold.

While the Indian real estate developers have shelved their hotel plans, global hotel chains are going ahead with their plans in India, literally unfazed by slowdown. As many as 37 international hotels brands like MGM Mirage Hospitality, Wyndham Hotel Group, Langham Hotels , Jumeirah Group and Movenpick Hotels among others are knocking at India's doors. The Planning Commission's High Level Group on services sector has pegged the room shortage in the country at 150,000 rooms by 2010, out of which more than 100,000 will be in the budget category. Official estimates peg the number of hotel rooms in the country at 1 m. The room crunch is further evident by absolute figures - the number of rooms in Bangkok (60,000) far exceeds the number of rooms in Delhi (20,000) and Mumbai (25,000) put together. Investments of US$ 11 bn over the next 2 years are expected to be earmarked for the hotel industry in India. The huge demand supply gap coupled with strong economic growth (India is expected to be second fastest growing economy) and rising domestic tourists provides a huge potential for these global players to 'check in'.

It seems that the economic slowdown has not really dented Mumbai's image as the fourth costliest city in terms of rents for expatriates. This is despite the fact that overall rentals have been coming down and the dollar has appreciated sharply against the rupee in the past one year. According to a survey conducted by Mercer and published in the Mint, only Moscow, Tokyo and Hong Kong score over Mumbai on this front. Obviously, the global economic downturn has not done much in terms of bringing the rentals down in these cities and to a large extent volatile currency fluctuations have played a role in determining rentals.

The other two Indian cities, New Delhi and Bangalore are ranked 8th and 29th respectively. But the current slowdown has seen some changes in terms of housing being offered to expats and whereas earlier MNCs provided expat employees with luxurious housing such as farmhouses, the focus has now shifted towards providing condominiums, which provide the same facilities but at a lower price. Thus for instance, in Mumbai, Powai has emerged as a preferred option to either Colaba or Malabar Hills.

Source: Wall Street Journal
The once flourishing renewable energy industry now finds itself at the receiving end of the credit crunch in the US. As of now, while the government funding is yet to come, private sector money is fast drying up. Renewable energy, which includes sources of energy like wind power, solar power and biofuels, reported new investments of only about US$ 13 bn in the first three months of 2009, down 53% from a year earlier, as per a Wall Street Journal report. Government stimulus money that seeks to give a fillip to the industry has so far been slow to materialise. Approximately US$ 150 bn in global government stimulus spending has been proposed for clean energy projects, about half of which is from the US. The situation is expected to improve as the stimulus money starts trickling in. But for now the sudden scarcity of financing is hitting equipment manufacturers especially hard.

The US auto task force's action on the chief of General Motors was not the last leg of what seems to a string of reprimanding measures on inefficient chief executives. More so, after the bonus fiasco at AIG that has blemished the Obama government's reputation. The US Treasury Secretary Timothy Geithner has in fact warned that lest the chief executives of bailed out banks get complacent, he would not hesitate from firing them! In an interview with CBS, Geithner said made it very clear that since the economic recovery depends on the efficient provision of credit, the government would hold companies receiving public aid accountable. The Treasury Secretary's reaction seems to strike the right balance between salvaging firms that are vital to the economy and acknowledging taxpayer resentment over a series of increasingly costly bailouts.

In the meanwhile, the Asian markets continued their upwards journey with major stock markets such as Japan (up 0.3%) and Hong Kong (up 0.2%) ending the day in the green. However, China (down 0.2%) remained the sole loser today. Stocks in Europe are currently trading mixed. Today, the Indian markets remained closed on account of Ram Navami. US crude for May delivery ended the day up US$ 4.3 at US$ 52.6 a barrel. It is believed that oil prices jumped as signs of an economic recovery seem to appear on the horizon.

 Today's investing mantra
""Charlie and I think it is both deceptive and dangerous for CEOs to predict growth rates for their companies. They are, of course, frequently egged on to do so by both analysts and their own investor relations departments. They should resist, however, because too often these predictions lead to trouble." - Warren Buffett

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "The Great Depression II averted?". Click here!