Does this mark the arrival of next crisis?

Oct 20, 2011

In this issue:
» What's up with European stability fund?
» Power sector threat to Indian banking system
» Who will China prove correct? A bull or a bear
» US' standard of living undergoing a major transformation
» ...and more!
----------------------------- Don't Miss! Best of The Daily Reckoning... -----------------------------

We are proud to present an exclusive publication - The Guide to Gold, a compilation of Bill's most popular articles on Gold.

Join Bill as he discusses the past, present and most importantly, the future of Gold as an investment opportunity. And find out if Gold is still the best bet for you...

Quick! Sign Up Right Away & Get this guide FREE!


How does the world view India's central bank? An idea can be had from a statement made by the famous economist and Nobel laureate Joseph Stiglitz. He once commented that if the US had a central banker like Mr Y V Reddy, the country wouldn't have gotten into so much trouble in the first place. While Stiglitz must be commenting upon a certain Mr Reddy, we believe that most Indian central bankers, past as well as present, have discharged their duties with equal honour and integrity. There is no surprise then that while some or the other financial crises have gripped most big nations in the past, India has managed to escape relatively unhurt.

Thus, in view of Reserve Bank of India's (RBI) stellar reputation on risk management, any warning from its side cannot be taken lightly. One such statement of caution was given by one of the bank's executive directors to a gathering in Singapore recently. The gentleman in question has warned that there is yet again a huge under-pricing of risks in the financial system. Hence, as per him, it is not a question of if but when the generic asset bubbles caused by a multi fold increase in balance sheets of central banks will burst.

And where does he come from? Well, the RBI director is of the view that balance sheets of major banks have grown by almost three times from pre-2007 levels and near-zero policy rates have added US$ 4 trillion to the central bank liquidity. Thus, the asset bubbles that have been built across the world on account of such a huge cache of surplus liquidity are all but guaranteed to burst.

Of course, no one can know for sure when the bubble will burst. But as Buffett says, predicting rain does not count, building the ark does. And the investing ark should be built by nothing else but businesses that are not at the mercy of low interest rate money but have pricing power and the ability to grow by relying entirely on internal accruals. If bought at reasonable prices, no matter how hard the downpour, the ark made of such investments will always protect and even enhance your wealth.

Do you think the global asset bubble will burst eventually or there exists hardly any bubble at all presently? Share your views with us or you can also comment on our Facebook page

 Chart of the day
Most of us know that India is one of the biggest consumers of gold in the world. But does the country have a similar standing when it comes to the production of the yellow metal? Certainly not. As today's chart of the day shows, as per data collected by the British Geological Survey, India stands nowhere as compared to the largest producers of gold in the world. At a little more than 2,000 tonnes of gold, its production absolutely pales in comparison to the largest producers like China and the US. Little wonder, it has to satisfy the needs of its gold consumers by resorting to large scale imports.

Source: British Geological Survey,

China's role in the global economy has mounted significantly in the last few years, especially after the global financial crisis has made the developed economies bed-ridden. So, the most important question currently in the mind of the global economy is: What's going to become of China?

Asking the question was an easy task. But getting an answer is anything but easy. For China is a huge emerging economy with very diverse regional economies. Add to that the communist party's love for secrecy. All these factors make China seem extremely capricious, so much so that people change their views on China in a matter of few weeks. There are economists who believe China is gearing towards some short-term pain while in the long term China will lead the global economy. Then there are those who believe that China could save its face in the short term by pumping up its economy through monetary or fiscal stimuli. But 2 to 3 years from now, China is set for a hard landing. The years of high growth and low inflation would be passe. It seems that both bulls and bears could be right about China. But only time will tell whose timing was right.

The latest suggestion by the Eurozone members is to allow the risky countries to issue bonds to bail themselves out of trouble. The guarantee for these bonds would be by them borrowing 20% of the bond value from the EFSF (European Financial Stability Fund). This way in case of a default on the bonds issued by the borrowing country, the lender will be compensated by the 'guarantee' that would be held by the EFSF.

As confusing as this process sounds, it is actually very simple at heart. What the Eurozone is suggesting is that they solve the problem of debt through more debt. This process would help the risky countries that are on the brink of a default appear risk free as they have the 'guarantee' of the EFSF borrowing. So the new debt now acts as a guarantee instead of a risk. We really wonder when these policymakers would understand that hiding behind fancy words would really not solve the problem. The only way to solve the problem of debt is to pay it back and reduce it. Not create more of it.

Is the power sector emerging as the biggest threat to the stability of India's banking system? Policy inaction, lack of coal linkages and financial distress of select State Electricity Boards (SEBs) have brought the fortunes of the otherwise high potential sector to its knees. However, it is the 70:30 debt to equity financial structure of power projects that is most worrying. With several new capacities coming up, banks are worried that the power producers may not be able to service the loans if fuel scarcity affects utilization rates. Also, lack of recovery from SEBs may put the power producers' finances in distress.

Having said that we do not think that the power sector is in the same condition as the steel and cement companies were in the late 90s. Neither is the sector in a state of overcapacity, nor are its problems incorrigible. Re-pricing of tariffs and coal mining rights to power producers can solve most of the problem. Also, increased private sector participation in electricity distribution will go a long way in making the sector more economically resilient. We do not think that the sector will heap NPAs on banks unless the government keeps sleeping on policy reforms for a very long time.

The standard of living for US citizens has fallen longer and sharper over the past 3 years than at any time since the government began recording it 50 years ago. Americans now have US$ 1,315 less disposable income than they did at the onset of the financial crisis. People are spending money on just the necessities. So what has led to this dramatic drop in the US standard of living which is the worst since the 1960s? Real income is down almost 10% since the start of the recession till June 2011. Another reason is falling net worth. Real estate investments and even retirement funds have all tanked in value. A third reason is rising consumer price inflation. This has eroded people's buying power by 3.25% since mid-2008. All in all, this means that the American economy is less vibrant. The spending giant is cutting back. And this is having repercussions across the world. Even emerging markets like China and India are seeing a slowdown. Plus the middle class in America are becoming more and more restless and disillusioned. Movements like 'Occupy Wall Street' are becoming ways for them to showcase their frustrations. Living the American dream is now becoming harder with each passing day.

Meanwhile, indices in the Indian stock market seemed well on their way to giving up almost all the gains from yesterday and in fact, some more. At the time of writing, the Sensex was down in the region of 320 points, with heavyweights like HDFC and ICICI Bank putting the maximum pressure. While nearly every Asian index is bathing in a sea of red, Europe too seems to head down the same path.

 Today's investing mantra
"As I grow older, I pay less attention to what men say. I just watch what they do." - Andrew Carnegie

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 "Does this mark the arrival of next crisis?". Click here!

2 Responses to "Does this mark the arrival of next crisis?"

Som Nanda

Oct 21, 2011


I completely agree with Parag. Always some economics like PIIGS pull down all the goods done by others. Anyways, I belive the initial stage of individual conuntries in the Europe region was a better idea than the Union system. Atleast the problems were curtailed and isolated to these countries and don't spread to rest of the zone.




Oct 20, 2011

Euro Crisis: Sovereign problem; corporate solution

European Monetary Union is in crisis.
Greece is likely to default on its monetary commitments.
There is talk of kicking Greece out of the European Union (EU).
Greece has PIIGS for company (Portugal, Italy, Ireland, Greece & Spain). All have weak Sovereign finances.
It is believed that if Greece becomes independent of EU it could devaluate itself out of its problems.
But this surgical treatment has many side effects.
Once Greece is out, Currency speculators will cause havoc with the other PIIGS. It would kick-start a contagion in Europe. The treatment may itself turn into a disease.

The suggestion proposed is similar to corporate restructuring / Split.
Split Euro into two.
Euro (S): representing strong countries like Germany, France and others, and
Euro (W): representing weak PIIGS.

Euro (W) will gradually devaluate itself and come out of its problems. The union will have sufficient size to take the currency speculators head on. And it will be a full and final solution, unlike the piece meal breakup of each country.

A corporate example to a similar exercise is the split of Reliance Industries into
RIL and
R. Com, RNRL etc.

Equitymaster requests your view! Post a comment on "Does this mark the arrival of next crisis?". Click here!