Monday, February 23, 2009

World in a Debt Trap.. Who would pay the bill

Almost every country today is in the need of debt. Now when every country wants debt only one thing happens.....

- Someone would end up printing money !!! and lots of it....

Fortunately or unfortunately that someone is going to be the rich nations of the world (rich atleast till now); US, UK and the Euro zone. Now let's say out of these three only Bernanke & company end up printing money. Now the question is would the US dollar really depreciate against Euro and pound. The answer is absolutely No!! and why is that... well let's have a look....

When a country takes debt it has to pay it back (not your fathers money, unless you want to be occupied or sanctioned) and how do you think Europe and UK are going to pay back the debt. You can only pay back debt by:

- Selling assets
-If your future cashflows are high enough to service the debt (in this case the high GDP growth) Such kind 

Assets with Europe!!! What a joke.... All the while Europe was rich because it looted assets from around the world and remember an old adage - Such kind of income doesn't last of eternity. So it's time that this wise saying come true. The party is over boys. Money taken from Papa is gone and you have nothing left but empty coffers.

Next we move to future growth. The dwindling & aging population (poor demographics) and add to it the mounting debt burden doesn't augurs well. So the future cash flows would be insufficient to service the debt.


- Many countries of Europe (including the rich ones) would become bankrupt.
- Euro as currency might fall apart
- Even to disliking of the countries, Europe and Uk like the US would end up printing lots of money.

Now lets come home. Even India's fiscal situation is bad and there are some predictions!!! (astrology) that because of this the long term interest rates would harden thus hampering future growth. Well that might happen but in my opinion the most likely scenario is this-

- The fiscal situation has gone awry because of reduced growth and increased government spending to revive it. The debt India will end up taking would be serviced by future growth and hence the Indian rupee would appreciate again. The appreciating currency vis-a-vis the currencies of the Western world would further reduce the debt burden and this would have a cascading effect leading us into a debt reducing and growth increasing cycle.

So in my opinion the ideal trade a few months down the road would be short dollar long Indian rupee and short Euro and long Indian rupee and even short Euro and long Dollar..... Till then as I always say let there be chaos before the pattern emerges..........

Sunday, February 1, 2009

Rich & Poor Nations and the Process of Natural Selection

In the 18th century Adam Smith came with his opus ' An inquiry into the Nature and Causes of the Wealth of Nations'. In this book he magnificently explained the dynamics of free markets and how some nations become rich. However I always felt that a piece is still missing from what is otherwise an immaculate economic architecture ever written. Don't get me wrong I am nobody to question a genius but understanding economics and wealth creation for mortal minds requires conglomeration of material from various sources even if they seem a little unusual at the first glance.

About a couple of months back I was traveling in a train from Rome to Venice. Trains are usually a good place to learn more about a country and it's people. Sitting a couple of places from me was an interesting person who teaches mathematics in Mestre. The discussion started from countries, interest and religion and went to economics and genetics. How did  genetics came into picture well we were discussing similarities between Indian and Italian culture. But suddenly I realised how genetics and economics are interconnected. How Charles Dickens process of natural selection completes what is missing in the wealth of nation.

Natural Selection is a process by which favorable heritable traits become more common in the successive  generations

Wealth and richness follow the same principle. People become rich by some reason (explained in the Wealth of Nation) of by some accident and then over generations this richness increases exponentially and passed onto successive generations just like good genes are passed on (as explained by natural selection). However unlike in genetics whereby the poor genes are slowly obliterated in economics things behave a little differently. The rich invest their money and the asset value grows over a period of time, hence the rich becomes richer and the sheer weight of their demand push up prices making it unaffordable for poor people so in a way the rich becomes richer and the poor gets poorer. The wealth is not just created but is transfered and in economics the wealth transfer takes place as:

Poor -----> Rich (The flow of wealth)

Hey I am not promoting any socialist ideas here, all I am stating is the process of wealth creation and transfer. This is not just the case with individuals but between countries and within countries. 

So even in India we observe that the rural income growth is just 2-3% while the income growth in services sector is 18-20%. While the Inflation rate is around 6%. This means that people in cities employed in the services sector are becoming richer and the people in villages are getting poorer. This is not a very comfortable situation and can lead to social unrest unless checked quickly by introducing some structural changes in the rural agriculture sector (more on this in some other article)....

So India being a poor country, a part of the reason is because US is rich. Ofcourse I am not blaming US for being rich or shifting blame for ills in this country to US it's just a process and like any process this process ends and reverses. Eons ago Dinosaurs ruled the world but one single event changed all that. Something similar happens in economics. People, countries become rich and richer till some event happens and the pedestal changes. The events happening today may be just that event and if thats the case we are lucky to be witnessing history and being on the right side of the history. So hold on watch as the history unfolds in front of your eyes.......