The dollar could collapse

May 7, 2009

In this issue:
» Chinese are losing patience
» Indian consumer showing no slowdown signs
» NFOs are back in India
» US banks are not that vulnerable
» ...and more!

Andy Xie, one of the better known economic analysts in China believes that his countrymen are losing patience with the US currency. Faced with a deficit to the tune of trillions of dollars, US authorities are opting for the easy way out i.e. printing money. This is reducing the value of dollar and is punishing those savers that have for years used the US dollar as the store of value. The better way out for the US could have been to sell some of its huge natural resources or other assets like stocks and property. But by resorting to printing money, the government is perhaps setting itself up for a huge depreciation in the value of the greenback. If the Chinese decide to dump the US dollar en masse, the damage could only be imagined. The US better take some confidence building measures.

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Speculation regarding the solvency of US financial institutions or the lack of it was put to rest last night. The US government made public the results of the stress tests it conducted on few of the nation's largest banks. And Timothy Geithner, the US Treasury Secretary, called the results rather reassuring. The US banks, he asserted, now have the capability to withstand whatever damage the recession could cause them once capital to the tune of US$ 54 bn is pumped into few of the more vulnerable banks. The results also mean that the government may not have to go back to the congress to raise more funds, an issue that was threatening to become quite ugly.

Regarding the assumptions made for the tests, Geithner opined that they were neither very punitive nor very liberal and the government tried its best to maintain a balance. As per Bloomberg, the tests were conducted to ensure that firms could sustain lending even if house prices, gross domestic product and the job market deteriorate more than most economists anticipate. The results have possibly opened up a new chapter in the US Government's efforts to battle one of the worst recessions since the Second World War. It could help open up financial markets further in a really big way.

As per a leading financial daily, sales of discretionary items such as watches and TV are holding up quite well in India despite the economic slowdown. The report goes on to cite the success of the recently introduced high-priced collection of Titan Industries, India's largest watch maker. The response to the product has taken even the company by surprise.

Similar trends were being observed in other categories like electronic goods. And it is not just the metros. Even Tier-2, 3 and 4 towns are warming up to the concept of consumer durables and contributing to growth. Thus, while the country's government may be broke and may have faced credit downgrades, its consumers are showing little signs, if any, of the economic slowdown.

While there could be a debate on whether the US dollar will retain its status as the world's reserve currency, as far as US influence on global economic matters is concerned, it is definitely on the wane. Further proof of the same came few days back when ASEAN (Association of South East Asian Nations) and three of the biggest economies in Asia - China, Japan and South Korea - came together to form an Asian Monetary Fund. Interesting to note that a similar attempt to form the fund was made way back in 1997-98 in the aftermath of the Asian financial crisis. However, the idea was nipped in the bud by the US as it argued that such a fund would weaken the IMF and in turn, loosen America's grip on Asian financial matters.

This time around though, things are drastically different. For one, it is not the Asian region that has created the current financial crisis and hence the US has little moral ground to preach other nations. Secondly, courtesy humungous economic growth in recent years, China has become much more ambitious and wants to play a bigger role in shaping global economic policy. Surprisingly, despite being the third largest Asian economy, India has been kept out of the equation. The blame seems to once again lie at the door of its anxious neighbour.

Although financial markets may be opening up, Nassim Nicholas Taleb, who has given the world the black swan theory (refers to a large-impact, hard-to-predict, and rare event beyond the realm of normal expectations), believes that the current global crisis is far worse than the one in 1930s, largely on account of a greater interdependence of global economies and financial systems.

As has been quoted on Bloomberg, Taleb says, "The global economy is facing big deflation, though the risks of inflation are increasing as governments print more money. Navigating the world is much harder than in the 1930s." He also believes that hedge funds are at a greater risk than banks because, as he says, "The banks are no longer going to be in that business of taking risks; they're going to be facilitating other risk takers."

The global economic crisis may have dampened the appetite for investment in equities and equity related mutual funds. But the recent rally on the bourses seems to have sparked a new wave of interest. Mutual fund houses now have lined up a slew of equity new fund offers (NFOs) with atleast a dozen offer documents piled up with the market regulator, SEBI, for approval. Obviously, the revival in interest is a shadow of the frenzied activity witnessed in 2006 and 2007. But that is hardly surprising given the scale and scope of the crisis. As reported in a leading business daily, the NFOs lined up for approval include Reliance Target Appreciation Fund, Shinsei Industry Leaders Fund, DSP Blackrock World Energy Fund and Religare Business Leaders Fund. More importantly, smart investors have realized that this is the best time to buy into some good quality stocks at bargain prices and mutual fund houses only too aware of this subtle but perceptible change are looking to cash in on this opportunity.

Indian economic experts take pride in the country's high savings rate of more than 30%. One may only look at the American example to understand how not having a decent enough savings rate could hurt the recovery process. While India's savings rate is good enough, the Chinese are even better. At more than 50%, its savings rate is the envy of the world. However, too much of anything could be a bad thing and the dragon nation's savings rate is no different. Stephen Roach, one of the world's most respected economists believes that Chinese save more because there is no social safety net in place and this is resulting in the country depending more on exports than its own domestic consumption.

Although investments did help China come out of the slump in the previous two slowdowns, exports may not recover quickly this time around thus hurting China's economic growth. Hence, if the economy has any chance of returning back to its historical growth rates, the government should start spending more on social security so that the Chinese feel more secure about their future and start consuming more. Roach believes that if this is not done, the country could be at a serious risk of slowing down.

The world of business is all about linkages. Slowing economy means pressure on corporate topline and bottomline. That leads to lower hiring. In turn, the recruitment industry suffers. A leading business daily reports how job portals are finding the going tough, with some even shutting down. The job portal industry had a turnover of Rs 3 bn in 2008, a 25% to 30% YoY growth. However, that figure is expected to decline drastically. In fact, even Sanjeev Bikhchandani of feels that the next 2 quarters will be tough. This should not really come as a surprise. After all, middlemen in all markets - financial, real estate or jobs - experience difficult times when transactions dry up.

To say that economics and politics are intertwined is to state the obvious. Yet, the financial impact of elections is surprising. As per the Economic Times, the amount spent by political parties on campaigning and by the Election Commission on conducting the polls will provide a stimulus of 0.5% of India's GDP during the first half of this year. It may be noted that political campaigns involve transportation, services, food & beverages, materials & service providers and media & entertainment. Interestingly, this stimulus reaches the needy effectively because most of it goes to cottage industries. While this stimulus is welcome, much of the money is not accounted for. Reforms in election funding are a must if the entire chain of money flow is to be made more transparent.

In the meanwhile, major Asian indices ended the day in the green on signs that US banks may not need a lot of capital and the worst of the recession may be over as per Bloomberg. BSE-Sensex, the Indian benchmark, also closed higher with gains of a little over 1%. Major European indices are also trading in the positive currently.

 Today's investing mantra
"The competitive nature of corporate acquisition activity almost guarantees the payment of a full - frequently more than full price when a company buys the entire ownership of another enterprise. But the auction nature of security markets often allows finely run companies the opportunity to purchase portions of their own businesses at a price under 50% of that needed to acquire the same earning power through the negotiated acquisition of another enterprise." - Warren Buffett

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