|»5 Minute Wrap Up by Equitymaster|
On This Day - 29 JULY 2010
"Read this book now", says Warren Buffett
In this issue:
We all know that enormous amount of money has been printed in most parts of the world, particularly in the US. And this is certainly quite inflationary. The only thing that is keeping it in check is the fact that people are holding on to their money and not spending it as quickly as before. However, such a scenario may not last long. People's willingness to spend money can change so suddenly that it can catch economists completely by surprise. And then all hell can break loose. Inflation can go completely out of control. So out of control that as per the book, during the German hyperinflation of 1920s, it took 1 trillion German marks to buy just one unit of English currency! Money lost its value so fast that it was not unusual to see people taking home their wages in suitcases or covering their wall with paper money because it was cheaper than wallpaper. Rest assured there are even more chilling accounts in the book of how the economy completely broke down in Germany.
We may certainly not have an inflation as bad as that happened in Germany. But we are definitely setting ourselves up for a huge disaster if we do not act on time. As the author of the book recently mentioned, "Politically, now is the only time tightening can be done. In a year or so it won't be possible politically any more". We hope Messrs. Bernanke and company are listening.
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Now, such a step would be fool hardly for the average steel player. Seeking a price increase when demand is beginning to soften is risky. Rivals could come in and offer lower prices. But not for a company with the largest production capacity. In fact, as per L N Mittal, it has already succeeded in passing on the higher raw-materials costs in some of its new contracts with auto companies. He believes the industry will take out production to match supply and demand and keep prices strong. Time will tell whether AcelorMittal can buck the industry trend. Over the long term though, he expects that global steel consumption is on track to rise 10% YoY.
The reason? The relation between deficient rains and agricultural production has come down over the years because of better irrigation. Secondly, the share of agriculture in the overall GDP has been declining. Statistics by Credit Suisse have shown that inflation in India has rarely been caused in Indian by lack of rains. So, what would account for the surge in food prices last year? Mismanagement by the government, letting food grains rot, increase in procurement prices and a structural change in the rural economy. On the first two atleast, the government will seriously have to clean up its act.
Now with most banks having base rate at around 7-7.5%, the short term borrowing rates have become unattractive. And the large corporate can no more exercise their negotiating powers like they did with sub-PLR rates. Hence bankers have appealed to the RBI to allow 'sub-base rate' lending for short term borrowing. If the RBI gives into this request the whole purpose of implementing base rate will be defeated. We hope the RBI stands tall to its claim of being an 'independent banker'.
In the past, gold has had a bull run of 15-18 years in a currency fiat era like the one we are experiencing at present. If the past is an indicator, then we are already midway into the bull cycle for gold. In the uncertain environment, with shocks and surprises still in store, diversification into gold still makes a lot of sense. Therefore while Soros thinks that gold will 'bubble', the indicators suggest that this bubble will last for quite some time.
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