Catherine Clark who resided at San Francisco was born in debt, lived in debt and died in debt. When she was born as a beautiful young daughter to a middle aged couple her father paid the hospital bills through credit card. All throughout her life Catherine used the Master card and never reached for her cash and when she passed away her children paid her funeral bills through plastic money . The United States of America with a GDP in excess of US $ 11 trillion is facing its worst ever test in recent memory. Debt levels are rising for the millions of Catherine Clarks across the nation and while the President tries to block outsourcing contracts to India the Fed Reserve prints more and more dollars to keep the ball rolling.
The US faces a Current account deficit of more then US $ I billion per day, the debt to GDP ratio at about 300% is the highest ever, even during the times of the great 1929 depression this ratio was around 260%, the budget surplus that the US used to generate in the early 1990's have given way to budget deficits now forecast at $520 billion this fiscal year at over 4.5% of GDP, spreads between 30 year T- bills and corporate bonds have been on a rise clearly indicating the falling quality of corporate paper. The United States appears set for one of the most eventful eras in the post globalization period.
Allan Greenspan may be known as the man who frowned (and rightly so) when the Nasdaq was reaching for the Mars. His famous `Irrational exuberance' phrase wasn't enough to stop the rampaging bulls till March 2000. Savings as most of the economists say is a personal virtue but a macro curse. A larger amount of consumption creates demand for goods and services, which further generates employment and output. The Americans with their larger then normal propensity to consume have been too far dependent upon the debt form of financing.. The personal savings rate have plummeted to 1.3% of the income in December The need of the hour is for Americans to reduce their debt levels and increase their level of savings.
The easy money policy of the Federal Reserve leading to forceful reduction in interest rates is encouraging households to borrow further rather then repay off old debts. Unemployment seems to be rising forcing the Govt. to substitute employment for productivity, Public protests call for banning out sourcing. Some one rightly remarked even the most intelligent people in the world would not complain being inefficient when it comes to keeping up their jobs. Adam Smith's famous division for labor concept and The Ricardian theory of Comparative costs do not apply to Corporate America. The economic superpower faces deflation with rising debt levels - if only macroeconomics were a bit easier.
Warren Buffet the saga of Omaha and one of the most vocal proponents of long term investing in a recent report to the shareholders of Berkshire Hathway opined "In recent years our country's trade deficit has been force-feeding huge amounts of claims on, and ownership in, America to the rest of the world. For a time, foreign appetite for these assets readily absorbed the supply. Late in 2002, however, the world started choking on this diet, and the dollar's value began to slide against major currencies. Even so, prevailing exchange rates will not lead to a material letup in our trade deficit. So whether foreign investors like it or not, they will continue to be flooded with dollars. The consequences of this are anybody's guess. They could, however, be troublesome - and reach, in fact, well beyond currency markets".
India on the other hand has reflected a current account surplus for the first time since independence. The favorable demographic profile 54 % of the population being below 25 years of age (compared to the ageing population of the United States) indicates that a large number of hands will be added to the productive force every year. Our Foreign Exchange Reserves at over US $ 100 billion would appear miniscule when compared to the US but the heartening factor is not the magnitude but the direction. While the US prepares to avoid recession we are preparing to take on the world. Our knowledge base and competitive advantages in terms of software and pharmaceuticals need no further certification. No wonder foreigners are pouring in money
Goldman Sachs in its famous BRIC(S) report expects the dollar to depreciate against the rupee by 2.5% every year for the next four decades. They have identified Brazil Russia, India and China as the next trendsetters for the global economy. They expect one US dollar to be exchanged for Rs.15 by 2050. Overall, the dollar has fallen by a modest 15% against a basket of major currencies of the World." It therefore makes more sense for investors to reduce their exposure to dollar assets. The flow of investments exceeding US $ 6 billion by foreign Institutional Investors into India last year is just a prelude. Standard & Poor (The US rating agency) expects foreigners to pump in US $ 20 billion into India this year. That is about 8% of India's market capitalization.
Since a majority of these investments would flow into the top 100 stocks the sensex would rise by around 12% on the simple demand supply analysis. After all more money chasing few stocks would make stocks dearer. Even if the FII were to hold money in rupee terms through the debt route they would make around 7.5% (5% as interest and 2.5% for the dollar depreciation). The message is ringing loud and clear FII's stay back from India at your own peril.
The US Government retirement accounts presently financing federal expenditure spending through its US $ 250 billion surplus every year will evaporate over the next few years as the ageing population of the US spends more on health care and medicines. Health care costs are set to spiral upwards as the population is painfully skewed towards the older generation. George Bush has aggravated the problem by pushing through a Medicare prescriptions law the cost of which over the next decade will work out to US$ 530 billion
The outflow of dollars from US will make their deficit more difficult to handle and hence greater reliance on the printing machines of the Federal Reserve leading to additional downward pressure on the dollar. Perhaps there ought to be a better way out from this vicious cycle then I am able to fathom.
As dollar depreciates vis-à-vis domestic currencies, countries would price their products more in dollar terms to keep the purchasing power in parity. It is estimated that Commodities, which are predominantly imported by the United States, would see a gradual price rise. The US imports a substantial quantity of Crude oil . If Steel and Cement could be termed as the bones for an economy crude oil is certainly the blood. The American Adventure in Iraq was undertaken to get a hold of the country's oil reserves and more so for creating a foothold in the Middle East. Poor Saddam Hussein was just a scapegoat and Indians thought that goats were offered to the goddess only by the superstitious and the ignorant. While it is easy to estimate the dollar to depreciate each year no country would like its currency to appreciate against the dollar as appreciation of the currency encourages imports and discourages exports. Each of the Countries across the world would like to artificially keep their currency low towards. The Chinese Yuan is a classic case in example.
The artificial forces that keep the dollar afloat is the amount of Treasury bills that the Asian Economies buy each year to keep the dollar strong. It is estimated that China and Japan could finance the total American borrowing program this year. It suits these countries to keep their currencies weak (this will encourage exports and discourage imports) as a result they are betting on buying promissory notes of an Economy who is repaying old debt through fresh borrowings - for smaller economies they call it a debt trap I hope the US is not falling into a death trap fresh foreign borrowings is keeping US bond yields suppressed and also supplementing the borrowing needs of the US.
The US Stock market Capitalization to GDP ratio exceeds a factor of one. Empirical evidence does not encourage bullishness on this count. The GDP also does not indicate any significant signs of moving up further. The only case for being bullish on US stocks would be to expect a higher Market Capitalization to GDP ratio - if that happens it would make US Stocks more over valued. Any body betting on US stocks is betting on the greater fool theory that is you buy an over valued stock expecting it to get over valued further before a greater fool buys it back from you at a higher price.
The objective of this article is not to make an absolute comparison between Gulliver and Liliput but to show that while Gulliver weakens or takes breath Liliput grows stronger by a much larger degree. The absolute comparison is not only meaningless but also absurd. The exercise is one of relative out performance in terms of growth, productivity and capital flows. Although how much pessimistic I may sound the elephant does not die easily and whenever it catches cold the small animals cry pneumonia only to be terrified by the sneeze that the animal takes. While in School we were told that Economics is a science of assumptions and as long as it represents a tendency it is all right but when it sets to put down an inflexible mathematical formula it falls to the ground.
Although how much pessimistic I may sound the elephant does not die easily and whenever it catches cold the small animals cry pneumonia only to be terrified by the sneeze that the animal takes. While in School we were told that Economics is a science of assumptions and as long as it represents a tendency it is all right but when it sets to put down an inflexible mathematical formula it falls to the ground.
Disclaimer: Basant Maheshwari is a Cost Accountant and a Post Graduate Diploma in Equity Research and Analysis from ICFAI (Hyderabad), the basis of assumptions on which this report is prepared may or may not happen As always readers are expected to consult their financial advisors and exercise their own judgment in deciding whether to buy or sell a stock on the basis of these assumptions Comments are invited at &