A default can actually be good for the US

May 26, 2011

In this issue:
» The other India's fascination for fast and luxurious cars
» The sure shot way to beat the US stock market
» India to be world's third largest economy by 2030, says Standard Chartered
» Retail investors take a fancy to commodities
» ...and more!
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It is certainly difficult to digest the fact that the US can default on its debt. After all, the world's largest economy can still borrow cheaply. It can also issue debt in its own currency and to top it all, can print wads of dollar bills as and when required. Still, as the Financial Times reports, the cost of one-year US credit default swaps, has almost tripled in six trading days. These swaps, which insure against default, are now implying that the US is more likely to default than Indonesia in the next 12 months.

The default though, if at all it happens, is likely to be technical in nature. A technical default, it should be noted, is not of the kind that countries like Greece and Ireland face right now. In their cases, the ability to repay is really impaired. A technical default on the other hand is the one in which investors may have to wait a short period for a particular interest payment. And it is this technical default that seems like a real possibility in the US. This is because if negotiations in Washington on raising the US debt limit turn out to be a long drawn affair then it can create a short term problem in debt servicing. This would then be akin to a technical default.

Some experts in the US are actually of the opinion that the US should indeed default on a technical basis. They reason that this could then force the policymakers to resort to spending cuts and set the tone for long term financial reform. We believe that there is indeed some amount of merit in this idea. There is of course the possibility that a technical default could lead to huge lenders like China panicking and dumping their treasuries. But it is also safe to assume that once China and other big lenders are made to see their own long term interest in this move, they will most likely exercise restraint. Thus, a huge bond sell off can well be averted. To conclude, a technical default by the US, rather than being viewed as a negative, could actually turn out to be a turning point for the US' long term financial future. Its alternative, a consensus among US policymakers to raise the country's debt limit has far more dangerous consequences we believe.

What do you think? Do you believe raising US' debt limit can do more harm to its economy in the long run? Share your views with us or you can also comment on our facebook page.

 Chart of the day
Global peace index for the year 2011 is out and it does not make a very good reading if you are an Indian. As per the ranking, India has dropped seven places on the list and it is now ranked a lowly 135th out of 153 nations surveyed. In other words, India continues to be amongst the least peaceful nations in the world. Important to add that it ranks even below nations like Myanmar and Bangladesh. As today's chart of the day shows, while Russia is even less peaceful than India, the gap between the two and the other two of the BRIC block viz. China and Brazil looks very difficult to fill indeed. The Global Peace Index is one of the world's leading measure of global peacefulness. It gauges ongoing domestic and international conflict, safety and security in society and militarisation in 153 countries by taking into account 23 separate indicators.

Source: Livemint, Wikipedia

When income levels grow, aspirations tend to multiply. That's exactly the trend that is being witnessed among Indian consumers. Demand for luxury and super luxury cars (Rs 15-20 m) has grown multifold over the years. You would be surprised to know that a lot of new demand is coming from smaller towns and cities. Of the 15,000 luxury cars sold in India each year, about 45% are being sold in non-metros. The buyer could be a rubber estate- owner in Kerala, a diamond merchant in Surat or a farmer in Kolhapur. Not just that, a lot of young customers are now entering the ownership bracket. The average age of such customers has come down from 40-42 a decade ago to 33-34 years. The buyers are quite brand-conscious and want to the products that they buy to reflect their status and personality.

Though an indication of the growing economic prosperity, it also points towards a growing income disparity among the rich and the poor. India's economic story is only set to get more paradoxical.

People invest in stock markets with a single view of earning higher returns. And each person dreams of earning returns higher than that offered by the broader stock markets. It is a burning question in every mind as to how to earn this superior return. A leading daily has found this way for the investors in US. They need to become members of the Congress and get added to the House of Representatives. That's right. A new study has found that investments made by the members of the Congress beat the market returns given by the broader stock markets. An earlier study had stated that returns earned by the Senators were higher by almost 10% as compared to the general stock market returns. Such returns have raised serious questions on governance. Members of the Congress are not permitted to make personal profits by using their official position. Unfortunately the studies have indicated otherwise.

The RBI's website says that nearly 70% of household savings still go into bank fixed deposits. The ratio has only marginally changed over the past decade. Even today investments in equities and corporate bonds are preferred by a very limited section of the society. The reason primarily is ignorance about such investment avenues and adequate guidance. Even where information and guidance has been available, in most cases the same had little to do with the interest of the investor. Brokers and business channels have very little reputation when it comes to offering 'honest advice' to small investors. Many investors therefore shied away from stock markets having burnt their fingers in the market crashes.

But a new breed of investors is tasting success while dabbling in commodities. Once restricted only for institutions, commodities like gold have become increasingly accessible to retail investors. In fact there are some investors who have also tried their hands at investing in metals and oil as well. Unfortunately here too it is the 'accessibility' factor rather than the 'knowledge' factor that is driving investor interest. Most commodity investors continue to act on broker advice. And we fear the trend is not sustainable. For without sound and honest advice, the investors could risk their investment getting wiped out. Especially given the volatility in commodity markets. While investment in commodities can certainly offer very lucrative opportunities to small investors, the same is best done with some honest guidance.

In 2010, if one were to look at a list of the world's largest economies, USA, China and Japan bagged the top spots in that order. India did not even figure among the top 10. But come 2030 and this scenario could witness a big change. Global banking behemoth Standard Chartered is of the view that India could emerge as the world's third largest economy by 2030, benefiting from strong domestic demand and favourable demographics. Not just that, the growth in the Indian economy could outpace that of China over the next two decades. But reaching there is not going to be simple.

Although growth in India has been robust so far, sustaining it on a consistent basis over the next 20 years will be a huge challenge. It is not that India cannot achieve this. It can, but the government needs to show more determination and will power in this regard. This means a huge focus on reforms, ramping up infrastructure, creation of jobs for its expanding workforce and bringing poverty levels down. Quite a lot on the plate indeed! But efforts in these areas would certainly go a long way in enhancing India's growth even if does not don the mantle of being the world's third largest economy in the years ahead.

Meanwhile, indices in the Indian stock market were seen having yet another strong outing today with the BSE Sensex trading higher in the region of 70 points at the time of writing. Energy majors like Reliance and ONGC were seen driving most of these gains. Other Asian indices also closed strong today whereas Europe has opened the day on a mixed note.

 Today's investing mantra
"The stock market is a no-called-strike game. You don't have to swing at everything--you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'" - Warren Buffett

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6 Responses to "A default can actually be good for the US"

Sanjay Ranade

May 27, 2011

Can a person be Technically Dead - but practically alive ? Yes - but such state is possibaly termed medically as "Coma" and he / she may / may not come to life from that stage therafter !!!

In such situation in Hindi pictures it is Duwa (best wishes) which works rather than Dawa (Medicine)

Let's pray Duwa for wold's largest economy



May 27, 2011

About the higher returns earned by US Congressmen:

I am surprised that they were able to earn ONLY 10% above the market returns !!!
They should take a few lessons from their Indian counterparts !
Then their wealth would show 5x growth within 5 years :-|

At least one area in which India can claim to have beaten the US by miles ... ... ...


Aubrey Fonseca

May 26, 2011

How can India be a peaceful place to live in, when Pakistan
sends terrorists to blow up our people, when China claims
the whole of Arunachal Pradesh and is now openly siding with the maoists in Nepal. While some politicians like
Kalmadi, Raja etc. are only interested in filling up their
own pockets. Accountability is the only answer and hopefully the Jan Lok Pal bill will see the light of day.


Gopal Kalpathi

May 26, 2011

Technical Default or otherwise, it is amply clear that US is living way beyond its means or is it? Maybe today its debt is very close to the limit of $14.3 tn, however, it still has huge stash of assets that is not very well know to all. US has a lot of technology which are 'classified' meaning it is not open to public, large oil deposits which are just being scraped at the surface and minerals and other natural resources (mainly huge amounts of water- which is going to become the next cause for wars)that are not tapped adequately. These are done with a purpose. Some may view the plight of US today with glee, but what seems on the surface is not what is its strength. However, if US continues to view the world as it has been, then it is going to be isolated from the more realpolitik of the world. Its double sides nature is getting exposed as never before and it is time that the country and its politicians realize that they are living in a more flatter world than their forefathers.


Ganapathy Sastri

May 26, 2011

Western nations have been living BEYOND MEANS for several decades and have as a result enjoyed low inflation, high standard of living. The main issue that nations will have to solve is the LARGE IMBALANCES in trade and how to finance them. So far surplus nations have been accepting USD that US can print at will. At some time in the future export surplus nations will stop accepting USD.
Western nations are not likely to give up their standard of living and will not hesitate to default. Creditors and creditor nations are at SERIOUS RISK of losing of large amounts of paper wealth they have accumulated like bees and ants over the years.


Ankur Jain

May 26, 2011

I tend to disagree. Why the US default would only be technical in nature and not be a real default? If you haven't given detailed reasons.

If they print a lot of currency, it would only reduce the value of their currency and doesn't therefore seem to be the right solution.

I think defaulting is still the better option but it can't be only technical in nature. It would be a real default and is overdue...

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