Global Inflation - Can't fight this one!!

Things have changed a lot in the last one year. Sub prime crisis has slowed the US economy substantially; Yen carry trade has reduced, as the responsibility to create bubbles around the world is taken over by the Federal Reserve by cutting interest rates below the inflation rate; and the dollar has depreciated against anything and everything.

Inflation has gone up across the globe which is reflected by the “Official numbers” of the Central banks (which are always suspiciously lower than the ground reality). Inflation is far too distant from the “Comfort zones” of the Central banks and yet they are doing nothing about it. And actually they can do nothing about it. Take for example India or China; If Reserve Bank of India raises interest rates it will surely slow the Indian economy down but won’t substantially reduce inflation as the inflation that we are facing today is “Global inflation” fuelled by easy monetary policy in the US. Raising interest rates would be a double whammy as it would slow your economy down without curtailing inflation leading to “Stagflation” which the US and the European economies faced in the 1970’s.

Crude oil prices crossed 130$/barrel last week. The rally in crude is purely investor driven. It is the side effect of the medicine that the Federal Reserve gave to save the US economy. Money will flow wherever yield is more and as the US treasury is yielding less than inflation, money is flowing to the root cause of inflation i.e. the commodities (especially Crude Oil) which is further fuelling inflation around the globe.

We are in a tight situation today. You cannot expect the Federal Reserve to raise rates as that would surely put the US economy in recession; you cannot expect Central Banks in the emerging economies to raise rates as that would lead to stagflation; you cannot expect the inflation to cool off with the continuing easy money policy. But what you can expect though is that there would be a new chapter in the Economics book for your kids and grandkids.

We are back!!!

Its been a long time that we drew up the curtains and let some sunlight come on to this blog of ours!!! Now that we are no longer hibernating and we are back in action. I have a few things to be notified to the blog readers.

Firstly, our sincere apologies for those who missed us for a brief comment on the down-trail of the economies of the world, infamous stories of recessions, the rock-dance-effects of the currency, and the hesitant mergers. (Sarcasm intended)

Another point to be made is that the theme of the blog might be altered for the obvious reasons of interests. We wish to make it interesting and knowledgeable for our patient readers.

Looking forward for a better tenure as a blog writer and the rewards I expect, (Yes I do expect them) is nothing but some good comments and a stimulating discussion.

Liquidity and the resultant "Bubble Bath"

The world economy has witnessed a phenomenal rise in asset prices across all asset classes in the last four years. There are a lot of bubbles floating around. Be it World Equities, US treasuries, Commodities, gold, Crude oil etc. It has generated huge exuberance and has led everyone to believe that we are in a totally new economic era derived from Globalisation. At the same time it has got a few economic think tanks worried.

The most accepted reason for the current asset inflation is “Liquidity”. But no one has yet come up with a proper explanation as to what the word really means. And how long will this liquidity persist in the world economy. The unlocking of this query would help us in guessing whether we are truly in a new economic era or we are witnessing an epic asset bubble.

Two reasons can be associated with this phenomenon. First being the Depreciation of Dollar and Second being Debt.

Depreciation of Dollar:
Dollar has been inherently weak for years now. Economists had been bearish on the Dollar in the late 1990’s. But Dollar never actually depreciated against other currencies. The reason for this was the exporting nations of Asia and South America, who artificially held back their currency to support the Dollar and their exports in turn. Especially China which has been constantly running trade surpluses had till recently not allowed the Yuan to appreciate against the dollar.

So these economies artificially depreciated the value of their currency against an inherently weak dollar. The result of this was that, the purchasing power of these currencies against assets went down thus leading to asset inflation.

Debt:
Banking system is known for its ability to create money through credit. There have been a lot of innovations that were introduced in the past decade which has revolutionized the way credit is given and the way it can be availed. Credit derivatives and Securitisation of debt are two examples of these innovations.

In case of Securitisation of Debt, a lender converts his advances into securities which are purchased by investors. So the lender receives money against these securities which he uses to make further advances. This process continues till the lender faces the statutory hurdles. In the process the lender ends up creating money in the economy which is far more substantial than the money created by the “Classic Banking System”.

If we add these two things together what we get is first of all - weak cash and secondly -too much of it. Thus weak cash makes assets expensive and the excess cash chases these assets further inflating their prices.

How long can this continue?
Dollar has started depreciating against the Asian currencies like the Yuan and Rupee. Thus pressure from this angle is somewhat deteriorating. But Debt has still not moderated. The recent debacle in the Subprime mortgage in the US has still not smartened the regulators. So this aspect of the equation still prevails.

pricecatch.blogspot.com

Hugo Chavez nationalizes oil assets - Threat to US energy security

Venezuela is the Fifth largest oil producer in the world. On May 1 2007(May day) Hugo Chavez the President of Venezuela nationalized Orinoco Belt crude projects. Thousands of workers wearing red hats, helmets and flags backed by troops marched to occupy the multi-billion-dollar installations.

"Today, we are ending this perverse era," Chavez shouted, "We have buried this policy of the opening up of our oil ... an opening that was nothing more than an attempt to take away from Venezuelans their most powerful and biggest natural resource".

Behind him was a huge banner reading "Full oil sovereignty. Road to socialism".

This is a major event as Chavez has anti-American sentiments which has led him to befriend Iranian President Ahmadinejad. Iran is the fourth largest oil producer in the world. This is a severe set back to the US, which gives high priority to its energy security. Infact one can say that Iraq war was much more to do with energy security than "Weapons of mass destruction". Saudi Arabia is the biggest oil producer in the world followed by Iraq. US virtually controls the Saudi oil assets and oil assets of Kuwait and today Iraq. If the US does invade Iran, US would control the biggest oil assets in the world.

Russian military intelligence services are reporting a flurry of activity by U.S. Armed Forces near Iran's borders. U.S. Naval presence in the Persian Gulf has for the first time in the past four years reached the level that existed shortly before the invasion of Iraq in March 2003.

Balance of Trade

The balance of payments accounts capture two sides of an equation: the current account and the capital account. The current account side of the ledger covers the flow of goods, services, investment income, and uncompensated transfers such as foreign aid and remittances across borders by private citizens. Within the current account, the trade balance includes goods and services only, and the merchandise trade balance reflects goods only. On the other side, the capital account includes the buying and selling of investment assets such as real estate, stocks, bonds, and government securities.

If a country runs a capital account surplus of $100 billion, it will run a current account deficit of $100 billion to balance its payments. If a country is buying more goods and services from the rest of the world than it is selling, the country must also be selling more assets to the rest of the world than it is buying.

The necessary balance between the current account and the capital account implies a direct connection between the trade balance on the one hand and the savings and investment balance on the other. That relationship is captured in the simple formula:

Savings - Investment = Exports - Imports

Thus, a nation that saves more than it invests, such as Japan, will export its excess savings in the form of net foreign investment. In other words, it must run a capital account deficit. The money sent abroad as investment will return to the country to purchase exports in excess of what the country imports, creating a corresponding trade surplus. A nation that invests more than it saves--the United States, for example--must import capital from abroad. In other words, it must run a capital account surplus. The imported capital allows the nation's citizens to consume more goods and services than they produce, importing the difference through a trade deficit.

Now, foreigners can use dollars to purchase U.S. assets: stocks, bonds, bank deposits, government debt, real estate, businesses. When Toyota buys land and equipment for a factory in the United States, when a British investment fund buys stock in a U.S. corporation, when a German bank purchases U.S. Treasury bonds, then the United States is said to be "financing" its current account deficit by selling assets. In 2002, foreigners acquired $612 billion in U.S. assets.

The United States has run persistent and increasing current account deficits since the 1980s, and foreigners have used the dollars to stake significant claims on U.S. assets. At the end of 2007, the value of U.S. assets owned by foreigners exceeded the value of foreign assets owned by U.S. residents by around $3 trillion. This is the reason the United States is often said to be a debtor nation, with a net debt to the rest of the world of. This "debt" is denominated in their own currency. For that reason, dollar is weakening.

Forecasts by The Economist magazine

From the Economist Intelligence Unit
Source: Country Forecast

India:
The booming economy is likely to keep the United Progressive Alliance (UPA) government, led by the Indian National Congress, in power in 2007-08. The prime minister, Manmohan Singh, will continue to push for economic reforms but will be constrained by the practicalities of governing on a coalition basis. The outcome of the next general election, which must be held by May 2009, is likely to be another coalition government. Monetary policy will continue to be tightened during 2007, but will be eased gradually thereafter. Real GDP growth is forecast to remain very strong during the forecast period, averaging 8.3% in fiscal year 2007/08 (April-March) and 8% in 2008/09. Inflationary pressures will be difficult to control. Strong domestic demand will lead to a significant widening of the merchandise trade deficit over the forecast period, but surpluses on the services and transfers accounts will limit the current-account deficit to less than 3% of GDP in 2007-08.

USA:
The Republican president, George Bush, faces a Congress dominated by the Democrats. Given constitutional checks and balances, this will make it difficult for both Democrats and Republicans to advance their often competing agendas. Instead, both parties will focus on preparing for the 2008 presidential and congressional elections. Federal finances have improved, but there is limited resolve to tackle looming holes in healthcare and public pensions programmes. Monetary policy tightening has ended, with the next move by the Federal Reserve (central bank) expected to be an interest rate cut in September 2007. But higher interest rates are having an adverse effect on the housing market, with knock-on effects on the consumer sector. Real GDP growth is thus forecast to slow from 3.4% in 2006 to 2.5% in 2007. Growth will pick up to 2.8% in 2008, but will not be as consumer-led as in recent years. Imbalances in the economy could trigger a much less benign scenario. The US dollar will come under further downward pressure in 2007 from the prospect of lower rates. The current-account deficit will average 5.6% of GDP in 2007-08.

China:
The main priority for the ruling Chinese Communist Party over the next two years will be to maintain political stability in order to ensure the success of its 17th party congress, due in late 2007, as well as the Olympic Games in the capital, Beijing, in August 2008. As the party congress approaches, the president, Hu Jintao, will continue to strengthen his influence through the appointment of allies to key positions. Real GDP growth will slow from an estimated 10.5% in 2006 to 9.5% in 2007 and 9% in 2008. The government will continue in its efforts to rebalance the economy, as it attempts to make growth less dependent on exports and investment, while introducing measures to boost consumption. The current-account surplus will narrow from an estimated 7.8% of GDP in 2006 to 6.3% of GDP in 2008.

The Red Signal: Rise of Communism

Karl Marx introduced the “communist society” concept in the 19th century, where the means of production are jointly owned by the society, a society that aims at achieving equitable economic growth.

The communist society is a great concept. And that is what it should remain – a concept!

Every communist society has ultimately failed its objective. The Soviet Union failed and China today is more capitalist than the capitalists. But that does not mean we have seen the last of Communism.

Communist ideals are impressive enough to influence any person into total submission. It sounds real and its arguments sound rational. Communism has a tendency to spread rapidly because of its populist agenda. But a society having income disparities is more vulnerable to Communism. And communism feeds on income inequalities. Income disparity today is a global phenomenon. It is one of the main issues which the Democrats have taken up for the presidential elections in the United States. Corporate bosses in the US are getting fat pay packages and this has caught the eye of the media and especially the shareholders and the working middle class. In India income disparity was always present but today the rural-urban divide has increased further. The only silver lining about India is that income inequalities in the urban population have reduced and urban population as a whole has prospered thanks to globalization. But the ‘trickle down’ effect hasn’t yet fructified. China hasn’t changed much from the time of the communist revolution, in terms of income disparity. Before the revolution power and money was in the hands of the monarchy, today it is in the hands of members of the communist party. In China a rural worker who has migrated to urban areas for work does not get the same rights as the urban worker. While the urban worker gets social benefits (School, healthcare) a rural migrant has to work for lower salaries. There is a lot of unrest within China which it has been trying to suppress. Only time will tell how well they are able to manage it.

Today communism is seen with disrespect. So even the proponents of communism wont call themselves communists! Disguised communism is what I am talking about, like the one sweeping across Europe today. Take for example the French presidential candidate Segolene Royal, she is not only the first female candidate in the French presidential race she is also a die hard communist. The Labour Party in the UK was always a communist party in disguise. In India we have the UPA with communist allies. So communism isn’t dead yet.

Communism sounds great in theory but it will always be a red signal for economic rationality.