Will the currency war end like this?

Nov 9, 2010

In this issue:
» India's HDI has considerably improved
» Berkshire Hathaway's cash holdings rise
» The problems of fixed income instruments
» Advanced nations to borrow more in 2011
» ...and more!!

------------------------------ More sense than CNBC ------------------------------
"Bill makes more sense in one e-mail than a month of CNBC", says a reader of Bill Bonner's The Daily Reckoning, a financial column. Bill is a three-time New York Times best-selling author. To receive his FREE newsletter on the global economy, click here.

There is a stark contrast in the reputation of the US dollar in the late 1940s and what it is now. Back then, the US dollar rose to prominence as a system similar to a Gold Standard was established by the Bretton Woods Agreements. Under this system, the US dollar was accorded the status of the world's reserve currency. Thus, many countries fixed their exchange rates relative to the US dollar. The US, in turn, promised to fix the price of gold at US$ 35 per ounce.

But as is well documented, the fiscal strain of expenditures for the Vietnam War led the then US President Nixon to end the direct convertibility of the dollar to the gold in 1971. This system collapsed and by then nearly all nations had switched to full fiat currencies.

Now almost 40 years since, the idea of having a Gold Standard has cropped up again. And this thought has been put forth by none other than the World Bank chief Zoellick. He has called for a 'Bretton Woods II' system of floating currencies that would involve the US dollar, Euro, Yen, Pound and Yuan. He also suggested that the system should also consider employing gold as an international reference point of market expectations about future currency values.

The reasons behind this proposal are not hard to find. The US dollar is already under tremendous pressure due to the massive dose of liquidity infused by the US government by printing money. This has sparked fears of currency wars. Especially since Asian economies are seeing their currencies appreciate as this excess money is finding its way into their markets. And because gold is an asset which is tangible and has value, it has gained not only in prominence but also in price. Against such a backdrop, Zoellick's proposal is not really surprising. But implementing it may not be as simple simply because the global economy has been dependent on fiat currencies for quite a while now.

 Chart of the day
Growth in GDP is all very fine. But in the longer term it does not hold much water if the quality of people does not improve. In this matter, India seems to have made huge strides. As today's chart of the day shows, India figures among the greatest improvers in the Human Development Index since 1980. This is in terms of wealth, health and education. That said, India still has much to do in terms of ramping up infrastructure and cleaning up its act if it wants to keep climbing the ladder steadily.

*Human Development Index covering wealth, health & education
Data Source: The Economist

The US citizens could well be broke. But corporate America is swimming in cash. None more so than Berkshire Hathaway, the investment vehicle of Warren Buffett, arguably the world's most successful investor. As per reports, cash at Berkshire climbed up to US$ 34.5 bn for the quarter ended September 2010. This is the highest that it has been in two years. To put things in perspective, this level of cash could almost completely gobble up a company the size of India's largest power utility, NTPC! Buffett may not be done yet. If one takes into account redemptions that are lined up in the coming few months, the cash pile could easily go up by another US$ 10-12 bn.

To sum up, Buffett's Berkshire is ideally placed to do another deal the size of BNSF, the rail road operator that it acquired sometime back. But does this mean that small investors should go ahead and copy Buffett's investments? Certainly not. As per Buffett's own admission, his list of worthy investments has shrunk greatly owing to the enormous mass his company has acquired over the years. Thus, small investors have the luxury of pursuing profitable ideas that will not even move the needle at Berkshire Hathaway.

Investors who tend to shy away from equities and instead put all their savings into fixed income instruments may get rather disgusted to read this. The fixed income instruments are supposed to secure their returns. However, in reality they are only serving the government's interest. These instruments do not just provide sub-par returns but are also characterized by lack of transparency. The reason for this mismatch in their perception and delivery is the nature of the market. The government has a monopoly when it comes to issuing and buying bonds. Banks have to keep 25% of their investments in such bonds (as SLR). For insurance and pension funds, the mandate is 40%. Government entities like PFC, REC etc are also the major buyers of the instruments. Given that most of the securities are to be held until maturity, they are not valued at intervals to determine profitability. Hence, most of the issuances are overpriced and eat into the investors' profits. The government on the other hand uses this bounty to cover up the fiscal deficit.

'A rupee saved is a rupee earned' goes the old wise saying. The same also holds true when it comes to investments. Here, a rupee not earned is a rupee lost! And if this is true, Indian retail investors have lost a lot of money by, well, staying away from the stock markets over the past few months. We are not talking here about investors who directly invest in stocks. Instead we are talking about mutual fund investors, who have exited their mutual fund investments as advised by their banks or financial advisors.

The reason for this is not far-fetched. With the ban on entry loads and subsequent loss of commissions, advisors and distributors (including banks) have not been pushing investors into mutual funds. Instead they have been advising investors to come out of funds and invest in other avenues (like PMS) where they (the advisors) earn commissions. What this has meant is that retail investors who have come out of mutual funds over the past few months have left a lot of money on the table. Call it a case of being 'mis-sold' yet again!

QE II has fans and critics from within the Federal Reserve itself. On one hand Bernanke & Co have expressed that QE II will help lift US out of the doldrums. On the other hand, critics have criticized their stand. Latest to join the bandwagon of critics is Federal Reserve representative for Tex, Mr. Ron Paul. As per Mr. Paul, the Fed's plans of spending an additional US$ 600 bn will not work as it will destroy the value of the dollar around the world. He feels that other countries will stop buying the US dollar and this would slowly erode its value. In addition to this, Mr. Paul feels that the programme would lead to inflation that will eventually spiral out of control and create asset and speculative bubbles in the economy.

The world's wealthiest nations may soon lose their title. Very soon, they will go from being most admired, to most indebted. Governments in advanced nations will need to borrow at least US$ 10.2 trillion by 2011, according to the Wall Street Journal. Fifteen of these countries including USA, Japan, UK, and Greece will need this money for debt repayments and to finance their ballooning deficits. The amount needed exceeds 1/4th of their combined GDP! With sovereign debt in a sorry state, governments are taking the easy way out. More quantitative easing and currency devaluing are thus in order.

In the meanwhile, strong selling activity led the Indian markets to shed their morning gains and drop below yesterday's closing levels during the post noon trading session. The BSE-Sensex was trading lower by about 20 points at the time of writing. Leading the pack of losers were stocks from the banking, energy and engineering spaces. The situation was similar in rest of Asia with Japan, China and Hong Kong ending the day on a weak note.

 Today's investing mantra
"The extravagance of any corporate office is directly proportional to management's reluctance to reward the shareholders." - Peter Lynch

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5 Responses to "Will the currency war end like this?"


Nov 10, 2010

All this augers well for reverting to gold standard, there is a powerful school of thought that the world has to have some standard for the currency that is being printed by the countries so that every time printing of currency is done it has to be backed by some kind of reserve there by a regulation is in place .... its high time this is done and the G20 summit in Korea this week will highlight this issue and also see how the currencies of the world can be protected there by not creating any currency war.


bhuwan sharma

Nov 9, 2010

i totally agree to what has been written on..it was rightly mentioned that these measures are more prone to corporate america rather then the common man in there.
I think the money would slowly start getting into the developing economies and also into gold and other commodities. slowly it may also help them for more acquisitions outside or inside their own territories.



Nov 9, 2010

It is an excelent report in my mail box daily. It gives a very good idea about world happening related with financial management.

Peer Mohamed



Nov 9, 2010

Response to "chart of the day"
Your information is quite misleading. Infact India's HDI is pathetic according to Human Development Report. It has put a big Question mark on India's status as a welfare state. One of the reasons may be due to the inability of the governments in power to bring the policies and welfare measures into practice. There indeed is a lot of gap between the cup and the lip! Obviuos reason is all pervading corruption and its trickle down effect on the various policies and programs. Once we plug this problem India can indeed be a "Ram rajya" of "Aam admi"


Adi Daruwalla

Nov 9, 2010

Well fans or not, QE2 is not the right move for the FED. Mr. Bernanke should justify this by enough reserves in gold, uranium and copper. In yesterdays write up in 5 minute Wrap Up, it was mentioned that there would be no end to the number of Qe's that can be put in by the FED. The dollar is going to weaken, and that will also shake up the trade between India and USA.
It was also rightly mentioned sometime back that India needs to look to the EAST and neighbouring countiers, ME and Asia for future trade to balance the situation. Mr. Bernanke should see that there is enough trade between USA and various countries of the world to balance the amounts he is introducing in the QE intitiatives. I dont think that, such a balance has been tought about.

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