The news in the western world is not good.
Europe's prescription for the excessive debt-fuelled growth of previous years has been to cut government spending. With decades of higher labour costs resulting from guaranteed pensions and guaranteed medical benefits the tax collections of the various countries can no longer meet these higher expenses. During the boom years, sovereign nations were able to borrow money at cheap interest rates and use that money to maintain the illusion of a welfare society.
In the bust years, debt is not available. Businesses earn less money and the sovereign nations have lower revenues from lower tax collections. They can no longer meet their annual expenses and their obligations and promises to pay the pensions and medical benefits. They cannot repay the debt that is due. To set things straight, the European governments have reduced spending and propose to reduce their pension liabilities. This is led by the Germans who fear inflation, don't like debt, and berate the immoral practice of living beyond one's means - as their poorer southern European cousins have done. Greece and Spain have seen badly hit by these "austerity measures" and the people have taken to the streets. Iceland, Ireland and Spain had the added issue of a property bubble - borrowed money was used to speculate in property.
No one likes austerity.Unemployment in the Eurozone, reports Bloomberg, is at 10.9% and is at a 15 year high. Other reports suggest that unemployment in Spain among the youth is at 25% - one in four young is not employed. Promising more government cut backs and belt-tightening is political suicide in this environment.
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No politician can stand up on a podium and lecture his voters to expect less from their government. We all want more. We want roads, homes, energy, food, and health care. And we want it cheap. We will never vote for a politician who tells us we have to suffer.
That is why the incumbent governments of Europe are falling one by one. Greece, France, Netherlands. The newly elected are elected because they promise growth, they promise to print money to get things "going again". For a continent that was hoping to displace the US as the economic engine of the world, Europe and the Eurozone area have taken a mighty fall. The UK is in equally bad shape. The economy is slipping again and there is no manufacturing base that has any hope of being globally competitive. Much as the Euro as a currency is under pressure, so is the British Pound.
The US has a problem
The politicians lie. And economists have theories and models that help the politicians to lie. The US has been printing money to force growth. Growth will solve all problems, is their mantra. Growth will create more jobs, those jobs will mean more income for the people, and the higher income will result in more consumption. And that will lead to more profits for companies, who will then hire more people and pay their existing staff well: the virtuous cycle of prosperity will begin.
A good theory. But it can only work when the people employed are producing something useful that society wants. In the US the biggest employers have become the IRS (their tax department) and the Homeland Security (the men who guard the US airports and borders). Their usefulness to the US society is questionable. In the meantime, they tens of thousands of people employed in these divisions of the government will all be promised a pension and medical benefits. Many see this as an "extraction"; as a compulsory diversion of money from tax payers to fund real threats that have now become guzzling government departments.
Then there is the "natural aging" of the developed world. An estimated 7,000 people retire every day in USA as they approach the age of 62 years. And, given their life expectancy of 85 years, the city, state, and national government has to pay them a monthly retirement cheque and pay for their medical benefits for 23 years. The estimated future cost to the US government, in today's money, is about USD 1 million per person. So, if 7,000 people retire every day, there is an inherent obligation - an inherent debt - of USD 7 billion a day. That is USD 2.5 trillion dollars every year. The total output of the US today is USD 15 trillion. This means that 17% of the national output needs to be kept aside to pay for those 7,000 people retiring every day. With a savings rate of less than 1%, that is not happening. Commentators suggest that the states of Illinois and California are already bankrupt. And their debt obligations are worse than those of Portugal, Ireland, Greece, and Spain (the PIGS) - combined!
The US has a problem, just like Europe does. Except they have not forced the unions to accept fewer and lower "entitlements". It is an election year. President Obama came to power on the platform of "change". But, his critics say, he is not willing to change anything. He needs the votes of the unions and labour to get re-elected. Getting back into power is the focus - not doing the right thing.
Meanwhile, the data in the US suggests that the share of American adults who are working or are seeking work is at its lowest level in thirty years. Many people have given up looking for a job. And there are still 13.7 million unemployed people in the US. For a country that stood tall on a pedestal of freedom and economic dynamism, the US has climbed down a few notches.
Rocky times ahead
India could have offered investors a partial safe haven or an oasis of calm, steady growth. But we are saddled with incoherent policy making from a government that has little economic conviction and no political spine to defend FDI in retail or a railway budget that was presented "by an Indian". The government, though, is willing to flex its muscles and change taxation laws with retrospective effect so that it can bypass and dishonour treaties with other sovereign nations. By wielding its tax axe, all that the Indian government has done is succeed in scaring domestic and foreign investors - whether in real businesses or in stock markets.
China has its own issues of dealing with an export slowdown that will upset its job creation. Lack of jobs could be a problem in a controlled economy where individual frustrations have been bottled up for long. The unwritten social deal of a better standard of living for surrendering freedom could be at risk.
But we should recognise that for all their hype and future potential, China and India are still small in the global scheme of things and together these economies account for less than 15% of global GDP. Even a 10% growth adds only 1.5% to the global GDP whereas a -3% decline in the US, Europe, and Japan which account for approximately 70% of global GDP will offset the gains from China and India.
Times could be tough for a while. Just as things were difficult in the September 2008 period when Lehman went bankrupt. But that decline was cushioned by the printing presses of the various governments. These global "imbalance" crises could last for another 3 years or so if governments allow the natural economic forces of excesses to get flushed out of the system. It will mean more pain for the US, more pain for Europe, and tougher times for all the economies that rely on the consumption of the western economies. Currency agreements and arrangements will come under stress. Banking systems could be tested in many countries as slower growth puts pressure on the ability of companies - and governments - to pay interest and repay their debt.
Gold should be a relatively safer place to be in - but speculators may sell gold to book profits and offset losses in other asset classes. That decline in pricein the near term does not change the inherent reason to own gold: as a currency that can retain value and which you can exchange at any time. Gold declined when Lehman went bust and then it gained in price, possibly as a reaction to the money printing acts of the governments.
In a slowing economy, in deflation times, cash is king. But you need to be careful where that cash is stashed. Banks owned by governments are presumed to be safer, provided the governments themselves are safe! So a bank in Greece may not be a great place to deposit your money no matter how attractive the interest rate!
No, it all sounds difficult. But this is not the end of the world. This is part of a natural economic cycle that needs to be unwound. After an excess, there is always a correction. You eat too much food, you feel sick the next day. You let your system flush out the excess. Yes, you take some medicines to help you take better. But you don't do what the governments have been doing: forcing you to eat more!
People in the developed world need to have more modest consumption patterns, they need to save more. Will that happen? Not easily. We see the riots in Greece and Spain. We see the changes in governments. But there is no other solution. The IMF and governments can lessen the pain, can smoothen the transition, but they cannot use printed money and false promises to reverse the direction. No, we have to all fall down before we can rise and move ahead again.
Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
||Quantum Long Term Equity Fund
||Quantum Gold Fund
(NSE symbol: QGOLDHALF)
|Quantum Liquid Fund
|An investment for the future and an opportunity to profit from the long term economic growth in India
||A hedge against a global financial crisis and an "insurance" for your portfolio
||Cash in hand for any emergency uses but should get better returns than a savings account in a bank
||Keep aside money to meet your expenses for 6 months to 2 years |
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