Here's A Solution To The Global Financial Crisis

Jul 15, 2009

In this issue:
» Solution to financial crisis: Convert debt to equity
» Rains cripple India's financial capital
» The economy is beginning to recover, says Nouriel Roubini
» China's forex reserves cross US$ 2 trillion
» ...and more!!
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Nassim Taleb is famous for popularising the concept of 'Black Swans' - occasional extreme events. In an article in the Financial Times, Taleb says that the characteristics of debt markets and the internet make the present financial crisis a particularly nasty black swan.

The debt markets cannot withstand variations in assets prices to the extent equity markets can, and are hence more dangerous. Debt also tends to hide risk till the point default is triggered. That explains why this crisis, emanating from the credit markets, is much more severe than the bursting of the tech bubble. Moreover, a globalised, internet driven financial world functions more smoothly than ever before but, is also more susceptible to Black Swans. As for the solution to the present mess, Nassim Taleb believes debt should be forcibly converted to equity across all sectors. This will provide lenders an incentive to engage with the borrowers and help them in turning around. In fact, he believes that government stimulus packages encourage debt, which will result in another Black Swan event down the line.

We definitely find the logic of Mr. Taleb's arguments quite appealing. He certainly comes up with some startling ideas!

 Chart of the day
The chart below showcases the historical price to book value (P/BV) of the Sensex over the last 19 years. Does a level at around 6 indicate danger and at around 2 indicate fantastic buying opportunity?

BSE-Sensex's historical P/BV
Source: BSE website

The government has obviously not learnt a lesson from the havoc that was wrecked on Mumbai on July 26, 2005 when incessant rains crippled life in the financial capital of India. Poor infrastructure and complete mismanagement were the main culprits. It's been four years since that day and sadly not much seems to have changed. While the rains that lashed Mumbai yesterday were in no way comparable to 26/7 as that day has now been called, life in Mumbai was nevertheless thrown out of gear. And once again poor infrastructure and lackadaisical attitude of the government was to blame.

The Finance Minister Pranab Mukherjee in his Budget speech did talk about the Brihan Mumbai Storm Water Drainage Project (BRIMSTOWA) that was initiated in 2007 with an estimated cost of Rs 12 bn being funded through Central assistance. What's more he also talked about releasing additional funds to expedite the completion of the project. But that is the big challenge - execution. At the end of the day, the government needs to realize that if India has to grow at 9% plus on a consistent basis, infrastructure will have to be improved on a priority basis.

Nouriel Roubini, the man who famously foresaw the global financial meltdown, says that the economy is beginning to make a recovery. He writes in his blog - "After the sharp contraction in economic activity in 2009, growth will re-enter positive territory only in 2010."

However, he warns GDP growth is not the only metric to measure recessions. "Unemployment, industrial production, real manufacturing, wholesale retail trade sales and real personal income (less transfer) are all considered", he says.

As such, while the GDP will stop shrinking at the end of 2009, it will not be at least till mid 2010 before the other indicators turn positive.

Talking of recessions, we are reminded of what Warren Buffett had to say about stock picking during bad times - "You don't want to not buy stocks just because business is lousy at the time. That may be the very best time to buy stocks. In 1954, the Dow was up 50% and the country was in a recession. It was the best year I ever had in my life. And I've had other good years in recessions, so you don't want to say, it's a big mistake to say business is bad therefore I shouldn't buy stocks. That usually is the time to buy stocks."

The stock markets had given a thumbs down to the budget, as it lacked any clear signals for economic reforms. In what seems like a damage control exercise, the Finance Minster Pranab Mukherjee assured everyone yesterday that the reforms are definitely on. He has promised return to fiscal prudence as soon as the crisis is over and also a roadmap for disinvestment.

Mr. Mukherjee has said that while the government's borrowing programme was vital to supporting growth, the debt would not be monetised. He said that monetisation (refers to the printing of banknotes by central banks) occurs when the RBI lends to the government directly. As of now, the central bank will support the government through its open market operations. As for disinvestment, the Finance Minster has said that he is in talks with other ministries for finalising the list of public sector units for divesting the government's stake.

The government has so far signaled a great deal of emphasis on the aam aadmi . While the minister's assurances are welcome, it is finally action that counts. We have nothing against the 'aam aadmi' stand, but we hope it is not used as an excuse for stalling genuine reforms that are critical to improving the standard of living of the same 'aam aadmi'.

If you had the slightest doubt over who would emerge as the foremost beneficiary of the global financial crisis, this should help dispel it. As per Bloomberg, China'a forex reserves, already the world's biggest have topped US$ 2 trillion for the first time ever. Just to indicate how big the number is, it is roughly twice the size of India's GDP. Going back to reserves, the second quarter of the current calendar year, which sort of marked the return of risk capital as investors scooped up assets on the cheap, saw the biggest chunk reserved for China as its reserves rose a record US$ 178 bn. Although US$ 66 bn out of the same could be attributed to trade surplus and FDI, as much as US$ 50 bn has come in the country by way of speculative capital, in other words, investment towards asset classes such as equities and real estate. Little wonder, the country's stock markets are up 74% since the start of the year and have sparked fears that if went unchecked, the inflows could result in asset bubbles and even runaway inflation. However, this might be music to the ears of US authorities as they would be hoping that some of the money could be used to fund their borrowing programme. Unfortunately, there isn't much China could do at the current juncture apart from perhaps hoard a little more of commodities. A bulk of it though will most likely be recycled back into US treasuries; no matter how much the Chinese hate it.

In the meanwhile, while the BSE Sensex traded within a narrow range in the morning session, strong buying activity during the latter half of the day led the index to trade higher by 3% at the time of writing. Also, while all major Asian indices closed in the green, the European indices are also trading in the positive currently.

 Today's investing mantra
"In both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult." - Warren Buffett

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7 Responses to "Here's A Solution To The Global Financial Crisis"

Ch Jagadeshwer Rao

Jul 17, 2009

I am happy here is a "Channel" I would continue to get latest updates on the economies world-wide and opinions of economists and business leaders that matter most. I particularly liked today's chart which indicates great buying opps when market indices hit 2 P/BV. I would urge you to highlight such charts when market hits such buying opps levels. After reading what Warren Buffet said on investing during recession periods, I felt we missed a great investment opportunity offered by markets during 1 Quarter of 2009.



Jul 16, 2009



umesh rakhra

Jul 15, 2009

Ajit Dayal,

When a straight forward bridge that should have taken 3 or 4 years at most can take 15 years, and that is a project starting from scratch is it not unrealistic to expect that the drainage system will be implemented in time?

The amount of rains that caused havoc were the highest this century if I recall correctly, Do we really need investments to cater to once in a century events?



Jul 15, 2009

Pls send me relly market is down in next any few day pls market possion in next 15 day


Rajiv Phadke

Jul 15, 2009

Excellent coverage. Particularly, liked Naseem Taleb & Chart of the Day & Nouriel Roubini pcs...


Kanu K Warriar

Jul 15, 2009

Interesting "Chart of the Day" showing high margin of safety for the Sensex at two times book, an observation is that the first two green circles are at or below the 2 times mark, the third not quiet, maybe, its ahead of us, maybe.



Jul 15, 2009

Any sane man talks about infrastructure but what about the quality of the infrastucture being built in India with "cuts" to all those who matter. How can the contractor give 100%? Please talk about it.
You write so well & to the point, but do the powers that be read your stuff?

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