An ideal unemployment solution? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

An ideal unemployment solution? 

A  A  A
In this issue:
» Real interest rates across countries are low
» PIMCO is bullish on emerging market company debt
» China's growth could be slowing down
» 'TBTF' banks have gotten even bigger
» ...and more!

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That the US Fed's quantitative easing policy is a dud is for all to see. The Fed's reasoning behind injecting massive doses of liquidity into the system is that more money will lead to more consumption. This in turn will help the US economy come out of the slump it has gotten itself into and start growing.

But it's been more than two years since the height of the crisis and the QE programs do not seem to have done their bit. Recovery has been tepid at best and unemployment levels still high. The huge debt on the books of the US government is set to blow right in its face.

One of the main reasons why these loose policies have not worked is the unwillingness of banks to lend. Banks burnt their fingers badly in the crisis and many are still smarting under its scars. Thus, although the Fed has been doling out cash to banks, the latter is not willing to lend to sectors and industries where it is most needed for fear that these may turn bad. As a result, creation of job opportunities is being thwarted and economic growth has not really taken off.

Not just that, the prevailing low interest rate scenario has not induced banks to lend either. And it is obvious that keeping interest rates low is not really working simply because consumers are now not willing to borrow and spend when job insecurity is so high.

The US Fed will be better off increasing rates which will stimulate savings that could be ploughed back into the economy. This would then create more employment which will at least ease some pressure of the average American and in turn help the economy grow. Basing the growth of the economy on the premise that the American consumer will consume more is highly faulty indeed!

What the US Fed needs to do is ensure that an average American takes care of his future consumption needs through his own savings rather than depending on the government. A higher savings rate can take care of at least some of the problems that come with unemployment. At least in India the RBI has never had to lower interest rates citing unemployment problems. Can the US Fed please think of a better excuse for keeping the rates low?

Do you think that the US Fed needs to do a complete rethink as far as its policies are concerned? Share with us or post your comments on our facebook page.

01:26  Chart of the day
Today's chart of the day shows that real interest rates in most countries are in the negative largely on account of inflation. Thus, while India has been hiking interest rates for quite some time now, high inflation means that real policy rates are low. Even in the developed economies, which have been following a low interest policy, some increase in inflation has led to the real rates languishing in the negative zone.

Data Source: The Economist

At the most basic level, we believe there are only two ways a nation's real GDP can grow. These are an increase in productivity or an increase in the population of the country. Let us divide the world into developed and emerging markets. It is then obvious that these two parameters are more in abundance in the latter than the former. In other words, it is the emerging economies that are likely to grow at a much faster pace than their developed counterparts. And that too for many years in the future. Little wonder, PIMCO, one of the biggest asset management companies in the world, has set its sights on company debt in emerging markets.

"Companies which are tied most directly into the strong economic growth engine in the emerging markets should have the most pricing power and ability to either pass through rising costs or absorb them without a significant margin hit," PIMCO's global head of corporate bond portfolio management is believed to have said. We couldn't have agreed more. Right now, there seems to be more purchasing power in the hands of emerging market consumers. Their developed counterparts on the other hand are reeling under high debt and not so promising employment prospects. Thus, it is anybody's guess as to who will be able to survive inflation better should it take a turn for the worse.

China's inflation story had two contrasting villains. A major drought on the one hand and a flood of money on the other, caused food prices to shoot up significantly. The government has been trying various ways to cool off the inflationary dragon. And it seems that some success has been achieved on that front. The country's broad money supply (M2) grew by a slower than expected pace of 15.7% in the year to February. This has renewed the Chinese central bank's current year target of remaining within 16%. Apart from targeting the money supply, the Chinese authorities are also striving to set limits on credit.

All these efforts are bound to having a decelerating effect on business. While business has remained brisk so far, it may not continue the same way going forward. Companies are finding credit availability as constrained as it was in June 2008. In fact, if you look at the recent retail sales, the signs of slowing are evident.

So there are fair chances that China may not be able to post double digit growth rates in the coming years. But we believe these are positive developments for an economy facing the dangers of overheating.

One would expect TARP bailouts, Dodd-Frank regulations and the worst recession in history to reduce the size of large US banks. But, on the contrary, those which were termed as 'too big to fail' (TBTF) earlier have gotten even bigger, according to Bloomberg. And the number of these TBTF entities is expected to increase by 40% over the next 15 years. Looks like the only big failures were US regulations and trillion dollar asset purchases.

The top 10 banks in America now hold 77% of all US bank assets. This is as compared with 55% of total assets in 2002. As of December 2010, 35 banks had assets of US$ 50 bn and over. This number is expected to rise to 48 within 15 years. In comparison only 2 Indian banks had assets exceeding this figure, as per the Forbes 2000 list. These were SBI and ICICI Bank, with Punjab National Bank just missing the cut. Along with their larger size, and their TBTF status, US banks are indulging in increasingly risky behavior. They believe that the taxpayers will continue to cover their losses in case the risks do not pay off. Treasury officials say it is wrong for these banks to think that bailouts will continue to happen. But, mistakes once forgiven may just repeat themselves. We believe it is a case of spare the rod, and spoil the child.

Having shed nearly 43,000 employees in FY10 alone, the PSUs are certainly a leaner lot. Most obviously this leanness is expected to filter in the companies' efficiency and profit numbers. However, if one expects the PSUs to be able to share a larger part of their profits with shareholders, there could be some disappointments. For the promoter, the government has social interests in mind. The PSUs may now have to reserve a larger portion of their profits for spending on social welfare schemes. About 2 to 5% of the net profits may be used to ensure compliance with the corporates' social responsibilities. In the case of abstinence they have been warned of being stripped of their preferred PSU status. Select undertakings enjoy the 'mini ratna' and 'navratna' status. This status allows them some degree of independence in decision making and entails better profitability. However, going forward, the companies hoping to announce higher dividends may be able to do so only after upping their welfare spend.

In the meanwhile, Indian stock markets continued to rally with stocks from auto, consumer durables and healthcare leading the pack of gainers. At the time of writing, the benchmark BSE Sensex was trading higher by 181 points. The Asian stock markets were trading firm led by Japan (up 4%) and Hong Kong (up 1%).

04:56  Today's investing mantra
"The list of qualities (an investor ought to have) include patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit mistakes, and the ability to ignore general panic." - Peter Lynch
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2 Responses to "An ideal unemployment solution?"

Manoj Kumar

Mar 27, 2011

Why only the US government? Why not all the countries of the world, who are already there or are going to be where US is today because whole of the world is following the same Keynesian macroeconomic policies including India. The Indian government also thinks that deficit financing is good.



Mar 22, 2011

I am curious. Is raising interest rates the only option for countries to control spending and encourage saving? What US is doing may indeed blow up in its face. Mostly inflation will be stoked further due to excess liquidity in the system. However, I think the US does not have a culture of saving, and hence a move to increase interest rates might send the market into a bearish scheme again. I probably feel the Fed should do its bit to ensure banks let funds flow into markets now. And venture capitalists (the good ones) must take the onus on them to improve performance of companies in their country. The likes of Warren Buffet, George Soros, etc. are more needed in US now than worldwide.

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