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Global economy: The lost world - Views on News from Equitymaster
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  • Jul 23, 2007

    Global economy: The lost world

    The Dow Jones Industrial Average, representing in the US what the BSE-Sensex is for Indian stock markets, touched a record high of 14,000 last Thursday. However, the very next day saw the index dropping by over 1%, or 150 points to 13,850 levels. Lacklustre quarterly performance reported by some large corporations and fears of a slowing housing market seem to have rattled investors in US equities.

    If that is not all, the dollar is also dropping on its knees against the Euro and most of the other major currencies. Oil remains at its historically high levels, bringing to light fears that the world is indeed moving towards an 'oil shock' as supplies decline while demand shows no signs of cooling off. In the meanwhile, the US Federal Reserve, alongwith its other global central bank peers, remain focused on controlling the demon of rising prices of consumer items - foods prices are rising, oil for cooking and traveling and heating is all going up, global travel is getting expensive (for the Americans, each dollar converted to a foreign currency will fetch them a lower disposable amount).

    Even when we talk of India, the policymakers and stock markets are cheering the cooling off of inflationary pressure. But where are the prices falling. We are paying higher prices for food each passing month. Housing and its maintenance is getting expensive (some experts say that house prices have peaked). Electricity no more costs what it used to. Continued supply of water remains a concern even in cities like Mumbai, so there is higher cost in form of 'scarcity premium'. And if, by chance, you consume un-drinkable water provided by the municipal corporation and get ill, you get to know the rising cost of doctors, hospitals and medicines. So, where is the inflation coming down?

    And not to forget, the cost of labour is rising as salaries jump through the roof across India Inc. (not really adhereing to the Prime Minister's call for social responsibility from Indian corporate honchos!). People are getting paid better, and they are spending higher on consumer durables and non-durables. But not before they manage to pay higher EMIs on the loans that they took from their bank for that 'dream house' that is now giving them nightmares. That is truly the story of an Indian middle class, which has otherwise been christened as the 'next big opportunity' by so many economic and industry experts.

    The 'easy' money has been made in the past few years has been a child of the easy money policy of central bankers worldwide, more so of the US central bank. Money became cheap for the Americans -> they bought more homes and splurged on consumption items -> more goods and services were imported from cheaper locations like East, Central and South Asia -> the export receivables, which were in US dollars, were bought by central banks in exporting countries to be invested in US dollar reserves -> these fund that flowed back to the US markets as investments by 'foreigners' again provided ample liquidity to consumers to spend on more of cheap imported merchandise -> this led to upward pressure on inflation which kept the real cost of borrowing low for American consumers.

    In the meanwhile, higher demand for goods from US consumers kept factories in exporting countries running at full steam, thus aiding the economic growth of the entire region. This economic growth and corporate growth attracted more of foreign (this time American and European) investors to invest in 'attractive' emerging markets assets like stocks, debt, commodities and real estate. Asset prices in these regions rose stupendously as there was strong and continued demand. Foreigners from the West started to buy anything and everything that was 'emerging' and local investors, believing that these assets will continue to rise as foreigners will continue to buy come what may, began investing their savings (which increased over the past few years due to reason mentioned in the above paragraph) into these assets, and all kind of them, hoping that the foreigners will come the next day and next month to take the asset prices up, up and away!

    But the foreigner is now facing troubles at home. His second house, on the back of which he had been on a consumption spree over the past 4-5 years, is not selling and he does not have enough money to pay mortgage installment on the first one, which is actually much larger and lavish than is required. And he plans to reduce his consumption expenditure as the debt on his head still stands at US$ 1.3 compared to his income of US$ 1.

    So, what happens if the US consumer stops of even reduce his spending of all those cheap 'Made in East' goods? What will happen to all those export oriented capacities created in China and elsewhere in Asia to cater to the 'unending' needs of this foreigner?

    We are yet to figure that out. Currently, we are busy trying to figure out why the consumer price inflation in India is falling while cost of consumption items, both durables and non durables) are on a rise. Why are the stock markets rising when they generally should not have a direct correlation between rising cost of living of domestic investors, a perilous global economy, high energy prices and confused central bankers? We are yet to figure that out!



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