by Swaminathan S Anklesaria Aiyar
How long and hard will the US recession be, and how badly will it affect India? Analysis of that issue has currently been hijacked by the sensational events in the US stock market, mirrored by gyrations in Indian markets. The markets surged upward in a burst of optimism at the beginning of this week. Yet this froth will soon be forgotten. We have to deal with the more fundamental problem of US household overspending. Reducing this overspending is both desirable and, ultimately, inevitable. And it will be recessionary.
Last week, the collapse of one of the biggest US investment banks, Bear Stearns, was followed by its takeover by JP Morgan Chase, brokered and underwritten by the Federal Reserve Board. The immediate stock market reaction was that many more financial stalwarts might go the way of Bear Stearns, and the markets plunged. Indeed, many observers pointed out that the Fed might not be able to tackle the crisis through interest rate cuts and provision of additional liquidity, since the underlying problem was lack of trust.
The huge market for mortgage-backed securities and derivatives had suddenly frozen and stopped functioning because many of the biggest traders in the market were tainted with the risk of default. Bear Stearns showed that not even the biggest actors could be trusted to fulfil deals. The stock market slumped at the prospect of more firms going the way of bear Stearns.
But soon afterwards, market staged a recovery on hopes that the Fed had fully understood the problem of frozen markets, and was willing to implement highly unconventional measures to solve the problem. Some economists had earlier proclaimed that, to clear the logjam in the market, the Fed itself would have to emerge as a market buyer, and perhaps even become a market maker in some categories of mortgage-backed securities. The rescue of Bear Stearns, with the Fed guaranteeing $30 billion worth of mortgage backed securities, is in effect a step in this direction.
The entry of a buyer who cannot default — the Fed can always print notes to meet any financial commitment has the potential to unfreeze frozen markets. By making trades possible and safe, this provides actual prices in a functioning market, in place of guesses about the true price in a frozen market. Of course, the Fed has assumed risks that should really be assumed by financial firms, and so market purists are shocked. But others say the need of the hour is to restore normalcy in frozen markets, so this is a worthwhile short-term fix.
Public rescues should be funded by the taxpayer through the US Congress, not the monetary authority. Remember, it was the legislature, heeding the urgings of President Bush Sr, that created the Resolution Trust Corporation that funded the cleaning-up costs of the savings and-loan bust of the 1980s.
Something similar may happen this time too.
In any event, Congress is already working on Bills to partially rescue both lenders and borrowers in the housing market. Over and above that, Congress has enacted an economic stimulus programme, entailing the posting of cheques worth almost $150 billion to all taxpayers, which should be implemented in June. That will pump a lot of purchasing power into a flagging economy.
And so, optimists believe that the worst is over, and that explains why the markets have started climbing again. They hope that the financial crisis is being resolved by both the Fed and Congress, that frozen markets will unfreeze and confidence will return to all markets. This in turn is fuelling hopes that the economy will revive in the second half of 2008.
The aim of US policymakers right now is to avoid an outright recession (defined as quarter-on-quarter declines in GDO for two successive quarters), or at least keep a recession short and mild. The political imperatives for this are strong, obviously. Indian policymakers would love to see a quick end to the US financial-sector crisis, which in turn will end the strain imposed by the crisis on the Indian and world economy.
Yet this is a myopic approach attempting to sustain the unsustainable. The underlying problem is that US households have for years been spending more than their income. The macroeconomic consequence is a huge current account deficit of $700 billion/year, financed by borrowing from abroad. Burdened now with trillions of dollars of debt, even the richest and most creditworthy country in the world is now suffering a falling currency, causing pain through inflation. US overspending is not sustainable, and will at some point have to be reduced drastically, if not eliminated.
Seen in this light, a recession is a solution to US overspending, not a problem. A recession reduces spending and borrowing, and thus helps restore economic equilibrium. The world economy will inevitably slow down along with the US. But countries like India will still be able to attain GDP growth of 7%, lower than the 8.8% of the last four years, but still extremely high by historical standards.
Possibly, the Fed and US Congress will manage to keep the coming recession short and mild. They have powerful monetary and fiscal tools at their disposal. But short-term success will simply mean postponing the day of reckoning on over-spending. That will in time lead to new crises and further recessions.
Pessimists predict worse outcomes. Kenneth Rogoff, former chief economist of the IMF, believes that the US recession will be long and deep, not short and shallow. An increasing number of forecasters believe that house prices in the US have a long way to fall, and may fall another 20%, over and above the 9% fall to date. That looks too pessimistic to me, but if it happens, it will surely abort any early recovery.
In sum, Indian investors should not get euphoric about the latest actions of the US Fed and Congress to unfreeze markets and stimulate the economy. Any success on their part is likely to be partial, and short-lived. The era of mammoth US trade deficits fuelling record growth round the world — including in India is coming to an end. We need to adjust to this new reality
Sunday, March 30, 2008
US recession a solution, not a problem
Monday, March 17, 2008
Sunday, March 16, 2008
Investing in Commodities
Investing in commodities can be done in a number of ways like …
Investing in companies that produce commodities
Many investors already hold shares in such companies or hold units in collective investment schemes such as unit trusts which invest all or part of the fund assets into such companies
Buying or selling commodities on the ‘spot market’ for immediate delivery.
This involves high transaction costs and is not a suitable method of investment for individual investors
Buying or selling thru commodities exchanges for later delivery.
Most trading in commodities is done through ‘futures’ and ‘options’. Taking positions in individual commodities is essentially speculative and should only be undertaken by professional investors who can afford to lose large sums of money if things go wrong.
It seems an obvious statement but commodities make a return for investors if prices rise after purchase. They generate losses if prices fall. Unlike financial assets, commodities offer no gain from interest income or dividends.
What are Commodities?
Commodities are bulk products, such as Coffee, Beef, Gold, Oil, Copper and Wheat, to mention just a few. These are the raw materials that are economically profitable enough to be traded on special commodity markets. They are split into ‘hard’ commodities such as Gold, Copper, Zinc etc, and ‘soft’ commodities such as Cocoa, Coffee, and Sugar etc.
There is strong demand for commodities from the emerging economies, particularly those referred to as the BRIC countries, that is, Brazil, Russia, India and China. This strong demand, combined with a finite and inelastic supply has created a bull market.
Emerging economies generate a disproportionate demand for natural resources. They need hard commodities such as steel, nickel, tin and copper, for their industries and soft commodities, such as cocoa, coffee, soybeans, potatoes, wheat and barley, to feed an increasingly urban population.
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