Is the time ripe to abandon the US dollar? - The 5 Minute WrapUp by Equitymaster
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Is the time ripe to abandon the US dollar?

Oct 19, 2013

In this issue:
» Centre milking PSUs to fund fiscal deficit
» Rs 25 crore lies unaccounted at Hindalco's office
» Ways to improve ease of doing business in India
» India colludes with Switzerland to uncover black money menace
» ...and more!

00:00
 
The US dollar is undoubtedly the world's reserve currency. The rise of the US dollar began when its convertibility to gold was abandoned in 1971. As a result, the US dollar became a fiat currency which is typically not backed by any collateral. This gave Federal Reserve a free hand to print money. As a result, there was an influx of US dollar into the system.

Through political deliberations US made sure that the demand of its currency remains strong in world markets. Critical commodities like oil and gold were being bought and sold in US dollars. This gave US dollar an official reserve currency status.

However, considering the current economic situation of US the status of dollar has come under question. Printing of money seems to be increasingly becoming the government's lifeline. This fact was brought to the limelight this week when a potential default by the US was averted by raising of the debt ceiling. The excessive money printing is likely to erode the value of US dollar further in the long term once inflationary pressures start building up. As a result most countries have started losing faith in the currency.

So, is the time ripe to abandon the US dollar and look for an alternative?

Well, the answer to this question is a resounding yes. But lack of suitable alternatives would mean that it is virtually impossible to uproot the US dollar as of now. As a result, the US dollar wins by default.

Looking at alternatives one can think of Euro or Yuan. However, considering that Chinese currency in itself is pegged to the US dollar it has no intrinsic value of its own. Thus, unless Yuan is decontrolled it cannot replace the US dollar. Even Euro does not happen to be the right replacement considering that faith in it has also depreciated amidst loose monetary policies of Eurozone. Further, since most nations in Eurozone are debt ridden, Euro's position is no different than dollar. All these factors suggest that US dollar might continue to remain the world reserve currency at least for the foreseeable future. That however, does nothing to preserve the greenback's intrinsic value.

Thus while the world stares at a reserve currency that is losing value with each passing day, one wonders which assets would assume importance if global economy actually abandons the US dollar at some point of time. In such an environment investors should look for asset classes which act as safe haven and can preserve purchasing power.

However, which assets should assume importance for Indian investors if the world abandons the US dollar? We know it is questions like these that concern you these days. And your trusted source for views and opinions, The 5 Minute WrapUp, too has unfortunately not helped by staying silent on such questions. We understand that, in addition to broad views on global stock markets, you might also be looking forward to our views on few unexpected movement in stocks. And that is why we are taking steps to make The 5 Minute WrapUp more relevant to you. Watch this space for more details in the coming weeks!

Do you think US dollar has lost its reserve currency status? Let us know your comments or post them on our Facebook page / Google+ page

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01:45
 Chart of the day
 
After rising for 3 consecutive years the under recovery burden of oil marketing companies is likely to fall in FY14. Under recovery is basically the difference between market price and controlled price of the regulated fuel. And this is shared between government, upstream and oil marketing companies. It is natural that when the crude prices increase under recovery burden increases. Further, since India imports majority of its crude requirements depreciating rupee also increases the under recovery burden.

Considering that rupee has recovered from 69-70 odd levels and crude prices have also corrected a bit the under recovery burden is estimated to be lower in FY14. Nonetheless, it would be too early to say that the burden will be lower than what it was in FY13. As highlighted earlier, net under recoveries are dependent upon the movement in crude price and rupee. And both these variables are very difficult to predict. If rupee appreciates and crude prices fall the under recovery burden may fall in FY14.

Under recovery burden of oil companies may drop in FY14
Data source: Press Information Bureau & Business Standard


02:05
 
Their ownership may have been the biggest spoiler for investors. But public sector enterprises in India can hardly be ignored given the huge resources and man power at their disposal. Nevertheless, the government continues to treat even listed PSU entities like its ATM. Demanding higher and higher dividends from cash rich PSUs has been a standard practice for years. After all that is the easiest way to fund its budgetary deficits. The interest of minority shareholders has hardly been a matter of concern. Even if the PSU can use the funds for capex, higher dividend payouts assume priority. The estimate of dividends to be paid by PSUs in FY14 is Rs 298 bn. The growth and health of the PSUs too is grossly ignored. If and when a PSU needs to raise funds from capital markets, the government has a back up plan for that too! The Life Insurance Corporation of India (LIC), yet another PSU, stands as the backup investors just in case the public offering fails to find other takers. At a time when capex funding from banks is both scarce and expensive, having large PSUs like Oil and Natural Gas Corporation Ltd. (ONGC), Steel Authority of India (SAIL), Gas Authority Of India Ltd. (GAIL) and National Thermal Power Corporation (NTPC) to part with their cash and fill government coffers, seems unreasonable. However, milking PSUs has and will remain the most certain way for the government to fund its fiscal profligacy.

02:55
 
What if you came to work one morning and found Rs 25 crores lying in your office. And no one in your office had any idea as to how it got there. Well this fantasy actually became a cruel reality for Hindalco Industries. During an investigation by the Central Bureau of Investigation, the officials reportedly found Rs 250 m of cash at the company's regional office. Interestingly the company's officials have no clue as to how that sum got in their office. The investigation was a following the charge sheet filed against Mr Birla's alleged connection in the coal gate scam.

As per Firstpost, the company is 'taken aback' by the discovery of the cash. Given the huge sum involved, it is curious that no one in the company has any clue about it. The company has formed an internal team to investigate the same. This incident certainly brings to light the company's governance standards. We are not saying that keeping cash in the office is a bad idea. But stating that no one has any idea as to how the cash got there certainly raises doubts. How can the management not know what they do in their own office? From an investor's perspective, it would bode well to keep a close eye on the events surrounding the company. If it has more skeletons hidden in its closet, then it would certainly affect the company's standing in the investor community.

03:25
 
In an interesting development, the country considered to be the safe haven for illicit cash, has signed an international tax evasion agreement. Switzerland has signed the agreement that will allow countries including India access to information on concealed money. This move would come as a blow to all those who had used their Swiss bank accounts for stashing away their black money. As per the think tank, Global Financial Integrity, Indians have stocked nearly US$ 462 bn of cash in Swiss accounts over the years. If only this money could be brought back to the country, it could save quite a lot of economic woes. But the question here is will the Indian government take the necessary steps for this? Over the years allegations have been made against political leaders for using Swiss accounts for their black money. Therefore they may not share our enthusiasm for using this agreement to get the black money back into the Indian financial system. Nevertheless, if they really want to, then at least the agreement is in place to make sure that the whole process works out.

04:05
 
What should be the solution to improve transparency and reduce caterlisation in a sector? One would not be surprised setting up of a regulator or increasing regulations would be amongst the solutions floating around. As reported by the Economic Times, the committee headed by former SEBI chairman M. Damodaran believes that these seem to be solution for anything that goes wrong in business in India. As per the report, the regulatory bodies tend to be inadequately empowered. Plus they also tend to be insufficiently manned in terms of both, numbers and skills. Amongst other suggestions, the report also provides other suggestions including regular self evaluation of regulatory organisations and disclosing the outcomes in public domain. Further, it also touched upon on retrospective taxation and how it has impacted India's credibility; especially from a foreign firm's perspective. Not only would this create uncertainties but would also be a disincentive for investors.

While we do agree that most of the points recommended by the committee would be useful to improve the ease of doing business, the fact of the matter is that there is huge scope in improvement of corporate governance in India. With disclosures and transparency of sectors such as real estate being far from what is desired, a good and practical solution is required to bring in improvement in disclosure processes. Especially considering the well know fact that politicians have vested interests in real estate projects.

04:30
 
Up against the debt-ceiling deadline of 17 October, the US Congress ended its 16-day government shutdown and extended the country's ability to borrow. However, the standoff hurt millions of people and was costly to businesses and the economy in general. Fitch placed the US credit rating on a negative watch, and Standard & Poor's reported that the overall economic slowdown lowered the country's fourth-quarter gross domestic product by an estimated 0.6%, or US $24 bn. Economic uncertainty is expected to persist, as the US government will be financed only until 15 January, 2014 with the debt ceiling issue to be revisited on 7 February, 2014. The US market ended the week up 1.1%.

The Eurozone showed more signs of having emerged from recession, with stronger-than-expected industrial production in August. Output grew 1.0% in August after a 1.0% drop in July. Economists had forecast a 0.8% growth in output for the month. Output grew in four of the region's five largest economies. However, industrial production declined 2.1% from a year earlier.

China's economy grew at its quickest pace this year, expanding by 7.8% in the third quarter from a year earlier. GDP growth accelerated slightly from the 7.7% and 7.5% pace of the first and second quarter, respectively. Economists expect China's economic growth to subside in the fourth quarter, as export data in September indicated a decline in global demand. Despite upbeat data, the Chinese markets ended the week down 1.5%.

BSE-Sensex was among the top gainers among the various global markets. The Indian stock market closed up 1.7% for the week gone by. The week for Indian markets started on the negative note. High inflation, doubts over US debt ceiling and the downward revision of GDP growth estimates by IMF and World Bank played on investors mind. But markets recovered over the course of the week after the US uncertainty ended and strong data from China came out.

Performance during week ended Oct 18
Source: Yahoo finance

04:50
 Weekend investing mantra
"Only when tide goes out you discover who is swimming naked." - Warren Buffett

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2 Responses to "Is the time ripe to abandon the US dollar?"

CHIDAMBARANATHAN

Oct 19, 2013

I personally know that many big companies do keep large cash with a team of persons to oversee. All these are used for distributing to politicians small and big, union leaders etc. for smooth running of the company.
AVB & Co can not be an exception.

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H K Prakash

Oct 19, 2013

Yes. US$ is being misused by US authorities to buy foreign goods "for free": buy goods, pay in US$, creditor gives back US$ by buying TBills! But TINA: there is no alternative currency
Countries could consider doing sophisticated 2 way, 3 way swaps. Eg India buys 100,000 barrels Iran crude and Iran gets a notional credit of, say, 1000 Special Currency (1 SC value determined as a mix of 25% Swiss Fr, 20% Chinese Yuan, etc) When India sends 5000MT basmati rice, India gets credit of say 400 SDR based on rice value on that day. This leaves India owing 600 SDR and so on.

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