|»5 Minute Wrap Up by Equitymaster|
On This Day - 18 JANUARY 2011
Will US Fed need a bailout?
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Imagine if this were to happen to the world's most powerful central bank. Yes. We are talking about the US Fed. The bank's liabilities have been going up thanks to the rounds of quantitative easing that it undertook. But at the same time, asset creation has lagged behind. The central bank has been using most of its money in buying the treasury bonds. If and when inflation starts to kick in, the value of these bonds would start to take a hit. As a result, experts have started to question - will the US Fed need a bailout in times to come?
As per its Chief, Mr. Bernanke, this is impossible. In case such a situation should arise, then the bank would just not put its profits back into the treasury as it normally does. The theoretical way out is to sell bonds and suck up the excess liquidity. But this would impact the country's growth rates. Another way to avoid this from happening is to just open up the money printing press and shower notes from the helicopter. We are all aware that Mr. Bernanke is only too happy to resort to the latter method.
Note: Data is for the BSE-200 companies excluding banking & finance companies
Ever since the US Fed slashed lending rates to near zero, the difference in the interest rates to that in India has only got wider. The RBI sees this as a potential risk that could attract hot money into Indian markets. It has tried to cap FII investments into Indian debt. But there is one risk that is being overlooked. That of Indian companies deserting domestic markets in search of cheaper funds. This is a trend seen in the early stages of every interest rate hike cycle. However, for the Indian economy to grow, it is important for the homegrown corporates to access local funds. Else, the country's financial system may lose a big pie of lending opportunity to the corporate sector. In addition, currency risks may eventually take a toll on the borrowing costs.
Dr. Subbarao is right in expressing his fear on rising prices - of anything and everything we consume in our daily lives...right from onions to cars. A large onus of this i.e., rising inflation lies on supply side factors (like poor crop this year). But more than that, the easy money policy of western central banks has played a key role in exporting such inflation to the developing world, including India.
Anyways, Dr. Subbarao said in a lighter vein, "Other central bank governors tell me: why don't you give us a bit of your inflation. That shows how desperately they want some inflation and how desperate we are to control our inflation."
FT reports that China has actually ended up lending more money to other developing countries than the World Bank over the past two years. It is estimated that while the dragon nation loaned out US$ 110 bn in 2009 and 2010, World Bank could manage to lend about US$ 10 bn less during roughly the same period. We believe that while the move is indeed a smart one, all bets would be off should the dollar start losing value rapidly.
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