The next crisis is ten times global GDP

May 31, 2011

In this issue:
» Cancer tops new drug discovery research
» Is the US real estate sector recovering?
» India to become Indonesia's leading coal importer
» Fed's policies to blame for high oil prices
» ...and more!
---------------------------------------------- Don't Miss! ----------------------------------------------

He's the Oracle of Omaha.

He's the world's most successful investor.

Your guess is right.

The Warren Buffett Quiz. Click Here to participate. It's Free!


There were many factors that led to the global financial crisis in 2008, the worst since the Great Depression of the 1930s. These were loose monetary policies by the US Fed, greed of investment bankers and the financial sector, lending to subprime borrowers and the complex instruments called derivatives that were built around these faulty loans to such borrowers. Economies the world over have burnt their fingers badly in this crisis. Much of the rich world at least is still trying to come to terms with it. But does the occurrence of such a big crisis mean that a lesson has been learnt and these mistakes will not be repeated again? Does not appear to be so.

In fact, legendary investor Mark Mobius opines that another crisis could just be lurking around the corner. Simply because enough attempts have not been made to solve any of the issues that caused the previous crisis. Take derivatives for instance. A web of these instruments was woven around loans given to subprime borrowers and marketed by the investment banking community to banks and financial institutions. These transactions were too complex to be comprehended by many. Sso much so that it became difficult to pinpoint the party with whom the final liability lay. Despite this, derivatives since the crisis have continued to thrive. There have been no stringent regulations put in place for these 'weapons of mass destruction'. The market for them continues to grow. In fact, according to Mobius, the total value of derivatives in the world exceeds total global gross domestic product by a factor of 10.

And if you add to that the loose monetary policies being unleashed by the Fed, you have a recipe for another crisis. Indeed, global markets would do well to not let the derivatives fiasco unfold once again. Because recovering from another crisis will be more painful than the previous one. And the next time governments will simply not enough money to prop up economies since they are already heavily indebted.

Do you think that a thriving derivatives market globally could cause another crisis? Share your comments with us or post your views on our facebook page.

 Chart of the day
Indian pharma companies will have to realign their portfolios towards oncology (anti-cancer) in the coming decades. This is because it is an area where most of the global pharma companies are focusing their research efforts in recent times. Today's chart of the day shows that the highest number of new drugs under development is in the field of cancer. Because cancer is a disease with hardly any cure, most of the research is being concentrated on understanding and tackling this disease. Indeed, the scenario is different from a few years back when most pharma companies launched blockbuster drugs for the treatment of cardiovascular diseases and diabetes.

*Central Nervous System, #Cardiovascular
Data Source: The Economist

The FT is running an article with an interesting little title in the form of 'US real estate recovers as hiring picks up'. Wow, we said. We were hoping to get some new insights on an asset class central to not just the US economy but that of the world at large as well. The content though was anything but exciting. It gave an example of a rather obscure real estate developer buying a retail and office centre in a certain fast growing suburb. Based on this, it drew the conclusion that the US commercial property market US commercial property marketis stabilising and that vacancies in the US are on their way down! It also went on to add how the US job market is adding a couple of lakhs of jobs every month and how this is likely to create demand for more real estate.

Nothing new in this we believe. But we seriously doubt whether such a trend is sustainable. Most of the recovery seems to be based on the Fed's loose monetary policy and Government spending. Thus, when the wheels begin to come off there, we don't think job creation will be able to hold on its pace. Then there is the weak consumer demand that is also likely to keep a lid on realty prices for quite some time to come. In view of these factors, it is indeed hard to believe that recovery in US real estate, if there is any, is sustainable in the long term.

Issues relating to ineptness of India's power sector have covered more newsprint in recent months than ever in the past. Shortage of coal supplies and hopelessness about the same being made available to meet the capacity addition targets have driven investors away from the sector. But it seems that import of coal is set to be the solution to India's power woes. As per Mint, India will surpass Japan to become the leading buyer of Indonesian coal this year. The economy will import as much as 60 m tonnes in 2011. India has been able to access such large amounts of Indonesian coal through long-lasting relationships with existing Indonesian producers. Coal India, the world's top coal miner, is in advanced talks to buy up to 40% of Indonesian low-grade coal producer Golden Energy Mines for up to US$ 1 bn. However, the purchase of coal is expected to come at a steep cost. Japan which otherwise buys high-quality coal mainly from Australia is expected to look for lower quality coal from Indonesia. This is while the earthquake ridden nation tries to replace its nuclear power plants. Hence the fortunes of India's power producers seem to be clearly dependant on the government allowing them some pricing power.

The blame game for high oil prices has taken a new turn. The new party to share the blame is Federal Reserve, after the speculators and emerging market demand. And the one pointing finger this time is none other than an ex Fed insider. His charge is that Fed's controversial quantitative easing policy is partly to blame for high oil prices.

The logic is simple. The Fed had used virtual dollars to buy treasuries and keep interest rates low. This forced investors to put their money in the private sector that offers higher returns thus driving up the prices of commodities and stocks. The routing of money from long term fixed income investments led to a global oversupply of dollar, the currency in which oil is traded globally. And hence the rising oil prices to offset the low buying power of the dollar.

The Fed's gamble was that the adverse impact of high oil prices would be offset by benefits of quantitative easing. That has obviously not happened yet. Considering that Fed intends to withdraw its monetary support by June, we doubt that the gamble will ever pay off.

Inflation, like a termite, continues to be a problem for the Indian economy. Like a termite slowly eating away a tree, inflation is slowly eating away the country's growth. As per FICCI, India's GDP growth rate is likely to slip from 8.6% to 8% for this fiscal. This is due to increase in prices of diesel, LPG, kerosene and other commodities. While the government is busy praying for a normal monsoon, the RBI is busy planning for the 10th round of interest rate hike since March 2010 to control inflation. No doubt a bumper crop would provide some relief from inflation. But unless concrete steps are taken to remove the bottlenecks on the supply side and crude oil prices come down in the global markets inflation is a reality we will have to face. We believe that one should be prepared for further downward revisions in GDP growth as the year goes by.

In the meanwhile, the Indian stock market indices continued to trade firm on account of buying interest in heavyweights. At the time of writing, the benchmark BSE Sensex was trading up 229 points (1.2%). Jindal Steel and Power and Sterlite Industries were seen gaining the most amongst blue chips. All major Asian indices were trading in the green today and Europe too has opened on a positive note.

 Today's investing mantra
"Often, there is no correlation between the success of a company's operations and the success of its stock over a few months or even a few years. In the long term, there is a 100 percent correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies." - Peter Lynch

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 next crisis is ten times global GDP". Click here!

14 Responses to "The next crisis is ten times global GDP"


Jun 10, 2011

It is for sure that next crisis is certain, the question is not if but when. The fact of the matter is tht globally so much of capacity has been created in manufacturing in the name of growth that small downward correction in world GDP growth will snowball into bigger crisis. Add to that Geopolitical tension and you have sure recipe of steep down ward correction in asset prices. How long the patient can be kept on ventlator when it needs serious operation ? Till now the pain has been somewhat eased by pumping trillions which are mostly finding their way in derivative markets. The truth is that these derivative instruments just facilitate earning millions in Bonus to Wall street people



Jun 7, 2011

f a balance has to struck, then at the Global stock bourses, the derivatives exposure should be only 40% that of the cash transactions. That way there will be some form of realism in the global stock bourses. There needs to be an introduction of some better regulations concerning derivatives in these times of unprecedented QE's by the US fed. More the easy money being pumped in more the fictitious exposures will prevail. Need an Equilibrium to bring about reality in the global stock markets


uday pasricha

Jun 3, 2011

Derivatives and other descriptions that no one can quite explain are all okay as long as the trend towards "greater leverage" is regulated. Trading billions using only a few million through electronic tools, looking for profit on the 3rd and 4th decimal place is the real evil which will destroy the world economy. The average holding time of investments is now few minutes and a few days is considered a long time, and yet the same guys give advice on long term. How can this be called investment? Every wall street firm and now even in india everything is based on day trade. We should thank our stars that the erstwhile hallowed names are gradually being vanquished based on greed, but in the bargain they have and will bankrupt nations. The last big one around would likely be the creator and cause of the next disaster as despite all the scandals they are still around and only getting bigger. Size is no longer an intent for efficiency but now a form of protection and black mail - too big to fail! They will hold the world to ransom for another bail out and reward themselves millions again and again despite failure.
The problem is that our systems are still in jurassic park as far as measure ability is concerned. As long as we have only OUTPUT as the measure, we will continue to think for the shortest possible term. Gestation and values based on time will become subjects of history. After all we refer to Buffet as the Oracle. The last of an era who may have to change himself at this age if he is to play in this short term non linear era.


Adi Daruwalla

Jun 1, 2011

If a balance has to struck, then at the Global stock bourses, the derivatives exposure should be only 40% that of the cash transactions. That way there will be some form of realism in the global stock bourses. There needs to be an introduction of some better regulations concerning derivatives in these times of unprecedented QE's by the US fed. More the easy money being pumped in more the fictitious exposures will prevail. Need an Equilibrium to bring about reality in the global stock markets


M. Sunil

Jun 1, 2011

derivatives will definitely lead to collapse of world economy.



Jun 1, 2011

Regulations should be there for derivatives.FED policy must also be changed.Why IMF is sitting quiet in these issues ?It is anybody's guess!!!


Brijesh Trivedi

May 31, 2011

We cant understand why US is not ready look at the
situatuon and not trying to control such things. Are they
trying all these to just avoid the devaluation of dollar. But
they may end up in more trouble by not controlling these.



May 31, 2011

The inevitable would happen whether it is today or tomorrow. The economists & politicians are greedy for wealth amassing than the average ordinary citizens. The more the so called poitical economists would try to solve the present econmic crisis the more catastrophical would be the result! Because the fundamental priciples of their intentions based on greediness. So in my frank opinion I would say the inevitable has to happen either today or tomorrow. This tomorrow may be prolonged to 5 to 10 years and by the time the GOLD would be in the peak high nobdoy can just imagine!!


Rawel Singh

May 31, 2011

You are doing a very good job in information dissemination. But please consider to stop treating the likes of Buffet and Mobious as gods. They are quoted too often like scriptures are in congregations.



May 31, 2011

Eq.Master Team,
In all my humility/ignorance I am prompted to observe as under:(I honestly state that I am neither an economist nor a political thinker !!)
The fast brewing crisis as I could understand after going through your eloquent article,is like a person who has one of his legs entangled in the "QUICKSANDS " and when he wants to pull out his one leg struck therein the other leg goes slightly deeper !!
I do not wish to make a prognosis of the ultimate fate/destiny of that person which is indeed very PATHETIC like the position of so many nations at present ??
I hasten to conclude !!

Equitymaster requests your view! Post a comment on "The next crisis is ten times global GDP". Click here!