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The 'D' word - Views on News from Equitymaster
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  • Sep 15, 1998

    The 'D' word

    There are a lot of "D" words floating around these days. In the United States, stock markets juggle with a few of these "D" words at any given point in time. The US stock markets swing between the "denial" syndrome and the "deflation" syndrome. In October 1997 just after the Korean currency went into a free-fall, the Dow Jones Index stood at the 7,200 level. A wall of money and soothing words from equity analysts and corporate chiefs took the Dow to the 9,500 levels. Now, it stands at 7,300 - back to the October, 1997 levels - despite the fact that the world economy looks a lot sicker than it did when Korea threw in the towel. And yet, many people in the US are still in a "denial" mode. Russia has been described as a "rounding off" error and Asia as a 1% effect on corporate profits of US companies. Yet, it was these same companies and equity analysts who a few years ago, told us that the future growth of the multinationals was the potential demand in the emerging economies. How many more cars can Ford sell in USA and Europe? How much more toothpaste can Colgate sell in the developed world? Yes, the demand that was supposed to be there in the developing world still exists but the people living in the emerging economies are a lot poorer today than they were twelve months ago and cannot afford to pay for a lot of the products that the multinationals hoped to sell to them.

    Which takes me to the next "D" word spoken by a few brave people: deflation. With so many car, toothpaste, and petrochemical factories built all over the world and fewer people to buy them, prices of various products will decline. That takes us to a deflationary environment. Deflation is bad for economies: if the price of a car will be lower tomorrow, then most people will buy the car at tomorrow's lower price and not today's higher price. Since deflation is a lot of tomorrows, people will stop buying many things and that will reduce economic activity further and lead to a self-fulfilling depression. Now that ("depression") is a "D" word that some really courageous folks are beginning to whisper.

    And the last truly global depression is best characterised by the Crash of 1929 when wealth was decimated on a global scale. In the 1920's, it was the European markets that led the downturn to the US stock market. Seventy years later, history may record that the Asian economic crisis caused the domino (another "D" word) effect that has rattled Latin America and impoverished Russia. Suddenly, the new world and the new paradigm of technology leading us into a golden era of sustained prosperity has been shattered. Economic cycles have proven that they are not dead (another "D" word) and that the humans who make decisions are apt to make blunders and mess things up. We may not be getting smarter, but we could be getting dumber (the "D" word again) in latching on to false gods. The theme for much of the past fifteen years has been de-regulation (the "D" word again) and many governments did away with capital controls and allowed the free movement of money. Six bankers in a musty room were not smart enough to determine a country's exchange rate, but thirty year-old traders manning computer terminals were assumed to be a lot smarter than those six safari-suited men. Well, the world has got it wrong. The markets know as little as the men in the safari suits and, what is worse, the markets now have a time horizon and attention span of a few minutes.

    It is still a fashionable view in Delhi (the guru of all "D" words) that depreciating (note the "d") the Indian currency is the path that India must follow. India, you see, must track the Japanese yen in its "d"ownward spiral and stay competitive with products manufactured by the Japanese. Sure, the next time you see a tourist buying a Sony walkman, advise him to buy the better Indian version. By allowing the currency to weaken, India only succeeds in forcing the multinationals to "d"elay their investments in India. And any delay in fx inflows only hurts the "d"elicate fx reserves position of the country. Weakening your currency causes it to weaken more than what you really wanted it to and can take an economy to the brink of "d"isaster. See how "d"angerous one action can be.

    Which takes me to another "D" word: if President Clinton had only kept his " d" under control, we would not have to be here reading all these "d" words!



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