Goodbye, Uncle Sam! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Goodbye, Uncle Sam! 

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In this issue:
» Jet and Kingfisher join hands
» Are speculators to blame?
» US turns away from capitalism
» Paul Krugman wins the Nobel Prize
» ...and more!

00:00 Home sweet home
We have a couple of generations that were obsessed with going abroad and convinced about the fact that landing on foreign shores could help them change their destiny. Thus we had clans of doctors, techies, and skilled and unskilled youths frantically desiring to try their luck abroad. Particularly the US and the UK. Sporting a US visa could help them earn in dollars, have a better lifestyle and in some cases, even bargain for a higher dowry during matrimonial alliances. This gave birth to the Dollar Dreams and made chicken curry the national dish of UK.

Now we have another clan. This consists of not just youth qualified in foreign universities but also seasoned techies and Wall Street investment bankers. They are now finding it tempting to fly back home. Not just to get away from their US mortgage and credit card burden but also to seek better jobs. They now wish to cash in on the 'India story'.

According to the 'Economist', immigrants made up 12.6% of the US population in 2007. The largest share since 1920. And Asians were the third largest immigrants to the US after Hispanics and Europeans. Today it is a different story. 11.9 m people migrated out of US without their papers this year. Rising unemployment and lack of social security in US and better economic conditions in home countries have forced many to bid adieu to Uncle Sam.

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00:41 This marriage's not made in heaven...
...but in the air. Companies that were fighting out a bitter battle for a higher share of the market are now talking of alliance to help them see another day. We are talking of the proposed association between India's largest and second largest airline companies - Jet Airways and Kingfisher Airlines. As reported in a leading news portal, the alliance is said to be 'of wide-ranging proportions that will help both carriers reduce costs, synergise operations and improve services'. Both Jet and Kingfisher have been accused of combining into a cartel to guide airfares in recent times. And now with officially combined operations, the bargaining power may further rise.

Mr. Naresh Goyal, the Founder Chairman of Jet Airways says, "It is not a cartel. We are coming together to cut costs. It is for the first time that two major Indian carriers are coming together in difficult times." While the idea to combine might be right, the fact that the two together hold around 60% of the Indian airline market share, the actions might not be so.

01:23 Are speculators to blame?
Commodity prices have been increasingly volatile in the past one year. And what probably stands out the most is the gyration in crude price, which flirted with the US$ 147 a barrel mark in July this year. The cost of a barrel (approx. 159 litres) now stands at US$ 78. And the prediction now is that oil is likely to touch the US$ 50 a barrel mark.

Leaving crude aside, intense volatility in commodity prices per se has prompted various governments to ban futures trading as the problem was attributed to unabashed speculation. The major argument was that hedge funds and foreign investors were pouring in huge sums of money into commodities thereby inflating their prices and distorting spot markets for physical commodities.

In the last one year, the problem became more acute as risky debt instruments led many investors to run helter-skelter before zeroing in on commodities as an investment avenue. However, this is just one side of the coin.

The other one being that speculation cannot be the prime reason attributed to the surge in commodity prices. For instance, as has been stated by the Economist, many of the commodities in which prices have soared over the past few years, from iron ore to molybdenum, are not traded on exchanges thereby offering less opportunity for investors. Further, much of the rise in investments into commodities futures has been due to rising prices. Thus, without putting in new money, even if the price of a commodity went up, so did the value of a commodity-linked fund.

02:02 Learning from the Master
The US government finally seems to be doing the right things. This includes taking a few lessons from the legendry Mr. Warren Buffett who showed his willingness in bailing out US banks even before the government dared to do so. The latter seems to have now also inspired the US Treasury in adopting his tactics when it comes to infusing cash for the US$ 700 bn bailout plan.

The US government will invest about US$ 125 bn in nine of the biggest banks in the country, including Citigroup, Wells Fargo, Bank of America, Merrill Lynch and Goldman Sachs. Another US$ 125 bn will be infused in smaller and lesser-known banks. The proposed cash injections will be in exchange for preferred shares with warrants - similar to investments that Buffett's Berkshire Hathaway made recently in Goldman and GE. Rather than buying equity shares in the companies, which have declined in recent weeks, Buffett bought preferred stock paying a 10% dividend and received warrants that allow him to buy equity shares at a pre-set price. The government's plan to buy preference shares not just assures it of some revenue in the form of dividend but also secures it from the current volatility in stock prices.

02:27 When capitalism is put on backburner...
So far, the US government's role has mainly been that of a facilitator in the current credit crisis. It has extended loans and allowed sound private companies to take over the unsound ones. But worried that the plan is not having the desired impact, it has decided to go a step further and take ownership stakes in few of the American banks. While policymakers in the US hate to use the word, the US government has effectively decided to 'nationalise' few of its banks. Coming from as ruthlessly capitalistic a nation as US, the step is indeed surprising but this is not the first instance of the same. Many a times in the past, the government has resorted to nationalisation. As per the IHT, the closest precedent of the current plan dates back to as far as the 1930s where an agency called as Reconstruction Finance Corporation not only made loans to distressed banks but also bought stock in 6,000 banks worth about US$ 3 bn. The article has also pointed out that a similar effort in today's day and age could be in the region of US$ 400 bn to US$ 500 bn. Obviously, the risk with such a type of intervention relates to the fact that where should the government draw the line. At present there are quite a few troubled industries in the US. Prominent ones that come to mind are the auto and the airline industries. But given that they do not pose any huge systemic risk, the government is most likely to have capitalism rule the roost here.

03:14 And the Nobel Prize for Economics goes to...
...none other than the US economist Paul Krugman for his work on 'analysis of trade patterns'. Krugman believes that many goods and services can be produced more cheaply in the longer term, a concept known as the economies of scale. Further, while the traditional trade theory explained why certain countries exported agricultural goods and others exported industrial goods, Krugman has gone on to show that trade has in fact been dominated by countries trading in similar products. Globalisation has also been one of the central themes of his theory, which according to him increases the pressure on urban living. Krugman's prize could not have come at a more apt time given that globalisation has wreaked havoc in the financial markets and consequently the economies of the world. When questioned on the current mayhem the world over, Krugman responded, "We're going to have a recession and perhaps a prolonged one but perhaps not a collapse". Amen to that!

03:40 China's dubious distinction
While the current raging financial storm seems to have obliterated all other problems, one that is silently but surely making its presence felt is the problem of food contamination. As per the International Herald Tribune (IHT), there has been a recall of several products contaminated with 'melamine' namely brands of infant formula in China, Cadbury chocolates in Australia, Lipton green tea in Taiwan and Nabisco Ritz cheese crackers in South Korea amongst others. These instances have brought to the fore the growing perils of a global food manufacturing industry. And China is the one that has been embroiled in this controversy in a major way.

The milk scandal in China has resulted in consumers shying away from Chinese made food products. While China has been the largest exporter of seafood and a major exporter of ingredients and additives such as citric acid and a variety of vitamins, Chinese made food products have been failing quality standards on a consistent basis. IHT states, "Although only the world's eighth-largest exporter of food, China ranked in first place last year for the number of hazardous imports detected by regulators in the European Union. China had 352 notifications, its highest level ever, compared with 191 for the United States, which is the world's largest agricultural exporter. Also, as of April 2007, China had the third-highest rate of import refusals in the United States, after Mexico and India".

While the obvious solution is for the governments of various countries to carry out stricter measures of testing, the same may not be that feasible on account of lack of the requisite resources. The fact that the US FDA has the capacity to examine only 1% of all the shipments into country only vindicates this point further.

04:15 Economics, the destroyer
Pakistan's currency has fallen 21% since the beginning of the year, stoking an inflation rate of 25%. Its foreign currency reserves are around US$ 8 bn and Standard and Poor's has given its sovereign debt a rating barely above the default level. Its stock markets have plunged and rumours are flying thick and fast about its banking sector. In fact, President Asif Ali Zardari has said that Pakistan needs a bailout of US$ 100 bn in order to avoid bankruptcy.

The country will try and use its frontline status with US on the 'war on terror' to wriggle out of the mess. After all, if the West needs Pakistani troops fighting its war, it will have to foot the bill.

Pakistan as a nation state has fought many battles since its inception. On the external front, it has fought wars with India. On the internal front, it has struggled with martial law and a Pandora's box of social ills. But its unlikely nemesis might be economics.

04:33 In the meanwhile...
Continuing from where they left off yesterday, Asian and European indices notched strong gains (in the region of 4% to 10%) in today's trading session too as central banks around the world concerted to pump money into banks to ease the liquidity crunch. The BSE-Sensex closed 2% higher. Commodities had a field day too. As per reports on Bloomberg, copper on the London Metal Exchange rose by 7.5% to US$ 5,500 a tonne, bringing gains in the past two days to 15%, the most since at least 1986. Oil rose by 3.3% to US$ 84.5 a barrel. Gold also advanced by 1% to US$ 841.5 an ounce as the demand for the yellow metal as a hedge was boosted on concerns that the infusion of liquidity could stoke inflation. The decline of the dollar against the Euro after European leaders agreed to guarantee bank borrowing also contributed to the rise in gold.

04:55 Today's investing mantra
"The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price" - Warren Buffett
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