Is this how the global debt problem will end?

Sep 20, 2012

In this issue:
» John Bogle urges US money managers to speak up
» Will the US return to Clinton era prosperity?
» Are numbers coming out of China bogus?
» Will the Government roll back diesel price hike?
» ...and more!

-------------------------------- BSE Sensex headed for a massive rally? --------------------------------

The best recommendation ever made when it comes to investing in stocks has to be this - Turn off the TV.

Just the other day, India had no future. And then a day later, India was the place to be!

It was said that the Sensex is now headed to 23,000 because conditions for a new bull markets were slowly getting satisfied!

All this because of a few statements made by the Government, which by the way, may not have any significant impact for years to come.

That's why in our view, the best way to go about generating real wealth from stocks is to turn off the noise, and instead focus on solid, long-term investment opportunities.

And one great way of doing this is to be on the lookout for Blue Chip stocks that are available for dirt cheap.

How do you go about doing this? Well, we just recorded a view in which we reveal how we go about selecting such stocks.

We recommend you watch this video right away...------------------------------------------------------------------------------------------------------

A fundamental question to begin with. Is the concept of debt a good concept at all? Well, since it is in existence for thousands of years, it does sound like a concept that has stood the test of time. However, what has happened is that time and again, it has been carried too far. And any idea, no matter how good, can cause problems when carried too far.

Something similar seems to be happening to most developed nations around the world. Initially, most of them did use debt intelligently, thus enabling their economies to grow faster than what could have been possible without debt. But as Warren Buffett points out, leverage or the use of debt is highly addictive. And once someone profits from it, going back to more conservative practices becomes very difficult for that person.

As is often the case, Buffett was bang on. No sooner did the western Governments profit from the wonders of debt; it became extremely difficult for them to turn conservative. And the end result is for all of us to see. So mired is the developed world in debt that there has perhaps never been a more uncertain period in the history of the global economy than now.

However, a lady who answers to the name of Philippa Malmgren and who's also worked for the White House as an economist has made an attempt to lift the fog of uncertainty that has enveloped the global economy. Her prediction though is not for the faint hearted. She has argued that the vast majority of debt in today's world is almost impossible to be repaid. As per her, there seems no other choice than to default. However, what even she is unclear about is the manner in which the default will take place.

Will the Governments just wake up one day and say that we will not be able to pay back all our debts? Or will it say that we will pay you back but you may have to take a bit of a haircut? Then there is default by way of inflation which the Governments can deny all along until it becomes too obvious to be denied anymore.

Well, even if we don't know which of these routes the Governments will eventually take, a couple of things cannot be denied. First, the fact that until the debt problems are sorted out, Government bonds and currencies will be a bad place to park one's hard earned savings. And secondly, since fiat currencies will be in great risk of losing their value, it may not be a bad idea to make gold a decent part of one's portfolio. Agreed that it has had a strong run up, but as long as the policymakers continue to grapple with the problems of debt, gold may continue to inch steadily upwards.

Do you think there is no other option in front of the Governments but to default? Share your views you can also comment on Facebook page / Google+ page

 Chart of the day
The US economy could well be struggling with a large amount of debt and its economy barely inching forward but there's no denying that it is still an extremely wealthy country. Today's chart of the day further drives the point home. As highlighted, not only has the number of ultra high networth population in the US increased in 2012 as compared to 2011, the total number of such people is head and shoulders above those found in other nations. And besides UK, it is the only country on the chart that has seen the list of such individuals swell in the current year.


What is common between Vanguard, BlackRock, State Street Global, Fidelity, and American Funds? It is not only their status as the top five funds in the US. It is also the fact that they own two-thirds of virtually every stock listed in the US. Needless to say that this gives the firms total voting control on the boards of these US companies. However, these giant firms have been conspicuous by their absence in offering support to shareholder proposals on management remuneration. In an article in Financial Times, legendry fund manager John Bogle, founder of Vanguard , calls this silence of top fund managers 'deafening'!

He also tries to reason why fund managers have chosen to stay away from shareholder activism. Bogle believes that the profession of fund management was earlier focused on stewardship. However, it has now become a business focused on salesmanship. Shareholder activism attracts attention and controversy and has no marketing value. The latter is what funds seek these days. Secondly these money managers also manage the retirement funds of the giant corporations they own. Hence there is a clear conflict of interest. Needless to say they have little interest in "biting the hand that feeds them". We think Bogle has hit the nail on its head by pointing out the flaws of the investment management industry. While in India institutional investors are still a minority lot, having some precedents for their governance will help.

Data happens to be the primary input for future forecast. It is also a mathematical representation of past performance. But when its credibility itself comes into question, the output becomes unreliable. This is what seems to be happening with the Chinese economic data now. In the past, many economists have doubted the credibility of Chinese data. And Federal Reserve Bank of Dallas is another addition to this list of non-believers. It thinks that China cooks its growth figures. As per two economists of that bank, the Chinese economic data is fudged. While the official data shows that the economy is slowing, they predict that the on ground situation is much worse.

While it is difficult to ascertain the truth here; why there is no universal standard to calculate the growth rates which are free from potential biases? Well, it's a question only China can answer. As long as the world believes in its numerical growth story it would continue to attract capital. But if something fishy erupts anytime soon, the repercussions could be beyond imagination.

It was policy logjam that the Government was known for until few days back. And then came the sweeping reforms, perhaps the most important post liberalization. These reforms are crucial to limit bloating fiscal deficit and ward off a rating downgrade. However, good economics and good politics can hardly go hand in hand. Especially with a Coalition Government at the centre. With the threat of a major ally pulling out, the Government may take a U turn on reforms including hike in diesel prices. While the roll back may let it roll on for some more time, it will do so at the risk of losing its credibility and ability to govern.

The excesses of the past have put the US economy on a difficult path. The massive debt burden and slowing growth prospects are making the recovery process challenging. The obvious question at the moment is: how will the US regain its era of prosperity? Of course, such questions lend themselves to endless debates. But one point that has been doing the rounds is the 'Clinton Recovery'. What does that mean? The term is referred to the period from 1992 to 2000. It is noteworthy that this was the most prosperous era for the US economy in the post-war period. For instance, average equity returns during this period were 19%. The average real GDP growth (adjusted for inflation) was 3.8%. In addition, average budget deficit during this period was less than 2% of GDP.

So what was so peculiar about this period that led to such a remarkable economic performance? On the fiscal side, the Clinton administration raised taxes on the wealth. But at the same time it reduced taxes on capital gains. Secondly, it cut down military spending. Apart from these, the administration also reduced government entitlements, while encouraging free trade and deregulation.

Can the US government pull off a similar feat this time around? There are certainly some lessons that the incumbent government can learn. But the current global economic environment is much different from what it was two decades ago. As such, replicating the Clinton-era policies may be a very challenging task.

Meanwhile, indices in the equity market of India have traded weak right from the beginning today with the Sensex lower by around 120 points at the time of writing. Heavyweights like Gas authiority of India Ltd. (GAIL) and Bharath Heavy Electricals Limited. (BHEL) were amongst the biggest losers. Asian indices have closed in the red today with Europe too opening on a negative note.

 Today's investment mantra
"Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success. I've seen a lot of very smart people who have lacked these virtues" - Warren Buffett

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    2 Responses to "Is this how the global debt problem will end?"

    Borkar M.R.

    Sep 25, 2012

    For that matter u cannot trust figures supplied by any Govt/Govt
    agency. Long back, as far as I am concerned, if Govt says
    inflation is 7% u straightway say it is not less than 14% to
    plan ur personal finance. And for that matter China cannot be
    relied upon (I am purposely not using the word "TRUSTED".) Is
    there anything to show their any claim can be verified
    So as we say in India "it is RAMBHAROSE" meaning leave it on the
    GOD (If u have a faith in HIM).



    Sep 22, 2012

    The Neeti shastras of almost all Indian languages speak eloquently of the dangers of borrowing both for business and for personal consumption. One Tamil quartet of very ancient vintage goes so for as to say that if you spend more than your capital, (obviously leveraging is implied) you will end up destitute, without any social esteem, bereft of ratiocination, and branded as a thief wherever you go. Kamba Ramayanam which is an unparallelled poetic rendering of Valmiki's Ramayana in chaste and delectable Tamil describes Ravana's state of mind as Rama tells him to go home and come back the next day for the battle as “the perturbed and depressed mind of a man who had borrowed”. Shakespeare in Hamlet speaks through Polonius's advice to Leartes “costly thy habit as thy purse can buy”, and goes on, “neither a borrower nor a lender be”. Hard working and sincere people the world over do not borrow even today beyond their means.
    Many of the farmers' suicides in India are rooted in the feeling of ignominy of the creditors' knock on the door as much as alienation of lands and assets owned.
    What applies to the individual must apply to a country as well.
    Borrowing with gay abandon is just not par for the course.
    Warren Buffet had warned early on that the mortgage derivatives in which banks and other very large institutions had invested merrily for several years in the first decade of this millennium were “weapons of mass destruction”.
    Maybe they are weapons of “mass instruction” now.
    We're all learning pretty fast about the “financial mushroom clouds” and the “fiscal deficit radiations” these weapons of mass destruction are now bombarding us with.
    Opaque derivatives dealings, reckless speculations with both proprietary and investors' funds, fudging in the risk-weighting of doubtful and bad assets by Banks, Banking cartels that went so far as to rig the LIBOR, price fixing, insider trading, you name it, they were all going on merrily. Came the meltdown and we now know where to keep the lights on and let the watchdogs do their jobs without political interference. Many more Preet Bararas will likely take on the Goliaths of the financial universe from now on.
    I had always maintained that welfare economics without morality is a sure recipe for collective disaster. Morality in personal life maybe beyond our scope in the context of these comments. But morality in business that should express itself as sound ethics, fair practices, tax compliance in particular and transparent compliance of all regulatory norms and statutes in general would certainly have contributed much more to the exchequer of any State, thereby reducing the need for borrowing.
    Next comes leakages and misplaced humanism in welfare delivery. The Indian context is sorely in need of improvement here. As for the debt-ridden richer economies the culture of entitlement has perhaps weakened the motivation for hard work and earning one's living. Slowly the sense of shame associated with doles might have given way to parasitism. The welfare burden is crippling major economies.
    Latvia, a small Balkan country, can teach us some lessons. The Latvian businesses have restructured and adapted to the tough measures adapted by the Government after the bailout. (Latvia is one of the first countries in 2008 to get a bail out.) Its currency's peg to the Euro is intact, the current account deficit which used to be around 20% of GDP has vanished. In 2009 and 10 it was in surplus. The economy grew by about 5% in 2011. Though unemployment is high at about 15% a well laid out safety net under the aegis of the IMF has kept social unrest well at bay. The important thing is, Latvia cut expenses and raised revenues to the extent of about 15% of the GDP and successfully implemented structural reforms. Of course the independent currency pegged to the Euro was helpful but the political will and social solidarity of the people must have played some role indeed. This needs on-the-ground, detailed, qualitative and quantitative studies by economists. If there are concrete 'doables' and 'don't doables' here they must be replicated elsewhere. See this link http www imf org external pubs ft survey so 2012 int020712a htm of the International Monetary Fund.)
    It may be true that 'haircuts' and debt defaults are inevitable as stated by Philippa Malmgrem and as quoted by you. But a lot can be done by a sense of solidarity among the significant players whose attitude and actions impact the economic and financial life of any country. It is all a matter of Will, Motivation and Vision.

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