Tears in Heaven!

People cry when they are overjoyed. And they cry when they are heartbroken. But what happens when the pain inflicted is so deep down inside, that you don’t even cry…What happens when you know you got to live with it for the rest of your life, because dying is not an option… When tears just flow down in a gush and wet your shirt pockets to soak your heart. And then you suddenly come out of your trance and realize that you got a little wet. Why do you feel good then? Is the heart lighter when it is wet or does it absorb tears and become salty and heavier next time.

Well it might not be heavier, but it certainly gets cold. And it is colder than any other years in recent memory. The fog is darker than ever before. Why did it all happen? Why Nirbhaya had to die? Perhaps it’s better to die than being a living dead. She went to a better place and left us struggling with all those questions which only she could have answered. It was her spirit to live that lighted a many dark corners. Would you mind calling us to you, Nirbhaya... Please!

Toeing the trendline

Summary

Due to reduced fiscal flex, the economic expansion is going to be of shorter duration with more frequent contraction. The medium term growth outlook for global economy in general and India in particular is going to be below the previous trend line growth due to various structural changes in economy. Prolonged period of slow growth is going to be new normal.    

The shadow of economic and financial crisis of 2008 has prolonged, casting a serious doubt on trend of industrial growth. The aftermath of political logjam in a fatal mixture of high debt and low growth regime has made it clear that global recovery is going to be very slow. The extremely poor performance of H1 2011 goes beyond the effect of temporary factors related to the Japanese earthquake and MENA unrest. We might have reached where we were before the crisis, but getting on the trend line might take much longer.

The US conundrum

In 1980, the US federal receipt was 19% of GDP and debt was 0.9 trillion. Today share of federal receipt to GDP is 5% lower and debt is 15 time higher. US is on a debt steroid. This mixture of fiscal stress and weak economic growth is a painful potion. “Halting the downward spiral of foreclosure, falling housing prices and dwindling household spending” is the key to halting another recession. US has to grow its economy at a pace fast enough to pay its expenses, by raising taxes and cutting expenditure. In an over leveraged economy with log gammed political system, this seems like a farfetched assumption.

It looks like an accepted norm to assume 6-7 years of expansion followed by 1-2 years of contraction as normal business cycle. The followers of Keynesian school of thought would argue that contraction is caused by slump in aggregate demand and it can be spurred up by deficit spending. The followers of Friedman would say that contractions can be fought by increasing the money stock. Fisher says that major contractions are caused by excessive build up of debt to GDP ratio. Symptoms of the excessive indebtedness are: weakness in aggregate demand, slow money growth, falling velocity and sustained underperformance of the labour markets. Fischer was of opinion that government spending of borrowed funds was counterproductive to stimulating economic growth, a phenomenon observed in 2008.

Reduced fiscal flex to manipulate economic cycle

We can also observe from the chart that post 1980’s the expansions became longer and contraction shorter. This coincides with the increasing level of debt. Most economists are of the view that the economy starts un-stabilizing as level of debt touches 80% of GDP. Going forward, the option to borrow more to elongate the expansion cycle may not be viable.

The other economy of the size of USA (14 trillion UDS) is European Union. In Europe, the problem of liquidity is becoming the problem of solvency. Many of the peripheral European economies are finding it difficult to raise money from market. The large amount of sovereign debt holdings of European banks has to be written off at some point of time, if the peripheral economies have to grow at a faster pace. That would result in losses and recapitalisation needs. The restructuring of Europe is going to be painful. Making sacrifices to save the monetary union is going to be less painful and costly than doing away with the euro. The coordination in a monetary union without strong fiscal oversight would be difficult. “They are going through some truly horrible times. I am very worried about the whole southern European fringe, not just on a 10 month to 2 year view but looking out a decade or longer,” said Philip Whyte from Centre for European Reform, a London think tank.

New normal in the world

The other major economy, China has done massive investment during downturn in real estate sector to boost up economy. The massive overcapacity and its inability to boost up domestic demand can result in hard landing of the economy, which can be a shocker to the world economy. Already the HSBC Purchasing Managers Index is hovering around 51 mark, with below 50 an indication of contraction. Japan is already deep into high debt and slow growth for decades. Is it the beginning of “Japanisation” of the world? Spanish GDP growth has touched 0.1%, from 0.4% two quarters earlier. The CDS spread, a measure to insure against default, of many peripheral European countries is higher than several corporations in those countries.

These structural changes in the global economy would have a profound effect on Indian economy. Exports have a rising share of Indian GDP (~14% in 2011), side lining the decoupling theory of Indian economy from world affairs. The imports in advanced countries are growing marginally in 2011 on a quarter on quarter basis. So India can’t export its way out of trouble.

Structural changes in Indian economy

The medium term growth outlook of Indian economy is based on strong domestic consumption, and thrust on infrastructure development backed by strong banking system. The change in the factors underlying these have more than a cyclical variation, they have gone a structural change due to lower savings, expected higher inflation environment and volatile fund flow.

Household financial savings as percentage of GDP is less than 10% now from 12.1 per cent in 2009-10. It was this savings in banks which was a cheap source of finance for huge government bond purchase by banks (through high SLR requirement of RBI). Some of that financing of India’s growth is not going to be readily available. High inflation environment has resulted into rising prices and more liabilities as higher interest outgo. The fear of downturn and rising gold prices has pushed Indians to buy more gold purging bank investment. Gold purchase in Q2 2011 rose by 60% vis a vis last year and is only second to crude in value of Indian imports. Slower adjustment to bank deposit rates has not helped either. This has resulted in slower deposit growth rate last year.

Government savings and corporate sector savings are also coming down sharply post-recession. Various measures of investment show how national savings and investment rates are around 2-3 percentage points below the pre-crisis highs. That alone can pull down the rate of economic growth by around 0.75-1 percentage point, says Prime Minister’s Economic Advisory Council in its recent report. How much the trend reverses, once the prices of essential items are down, is a thing to watch out for.

Inflationary pangs in Indian economy

The other inhibitor, inflation has to be looked from both supply side and demand side. RBI’s tighter monetary policy attempts to depress demand side effects. However the supply side constraints remain un-tackled due to policy impasse, structural shift, broad macroeconomic scenario and capacity constraints. The food inflation is fuelled by severe draught in 2009, reduced acreage to pulses, weak monsoon, wastage of food grains during transportation, lack of storage capacity with FCI and paucity of private sector warehouses. Indian farm productivity is among the lowest in the world. About 40% of fruits and vegetable perish in storage and transit, mostly because farmers have to rely on middleman and trade associations instead of direct market access.

Crude prices, a major factor of inflation, remain north bound and volatile due to supply side issues arising out of contagious unrest near middle-east, despite opening up of world reserves. The situation in Libya and other Middle East countries would take a lot of time to come back to pre-crisis level. Fiscal consolidation along with targeted policy action especially in manufacturing and infrastructure reforms has definite potential to ease off inflation.

In its latest monetary policy statement, the Reserve Bank of India has already pointed out that its battle against inflation would be a limited success unless the government acted to increase the productive potential of the economy. Inflation may come down if slowing global growth brings down commodity prices. That may also increase the chances of QE3 and chances of that fund flowing in shallow equity and commodity markets of emerging countries, creating asset bubbles.

As policy paralysis dampens investor sentiments, the foreign fund flow, both FDI and FII is going to slow down in India, although it is increasing in Asian markets. Infrastructure projects are clearly going to bear the burnt. Planning Commission of India’s target of $500 Billion investment in infrastructure sector in 12th plan period of 2012 to 2017 is going to be a challenge. Banking sector has regularly been hitting sectorial targets in infrastructure sector, thus making it difficult for them to sustain the momentum alone unless massive increase in asset base.

Financial sector stress

Banking sector is going to be hit with higher capital to risk asset ratio of Basel II as financial inclusion programs, increase in loan requirements of credit intensive manufacturing and infrastructure sector build up. The counter cyclical reserve measure of RBI does not help either. As Joshef Acramana, CEO of Deutsche Bank said at Frankfurt’s annual banks in transition conference “Prospect for the financial sector overall…are rather limited. The outlook for the future growth of revenues is limited by both the current situation and structurally.”

These factors have already started playing out in the economy. June 2011 quarter results of Indian Inc. shows that although top line grew, bottom line is under pressure due to mounting operating and non-operating costs. In a rising inflationary scenario, it may not be possible to pass on these costs to consumers. So the growth in bottom line may not trend the top line numbers. A Credit Suisse report also highlights the increasing trend of leverage in Indian companies. “While world over balance sheet of companies seems to have improved since the last crisis, the same has not happened in India. In fact, the number of companies with high leverage is now higher than it was in FY08.”

Gearing up

Growth is going to be slower and with longer periods of down cycles, taking some points off country’s GDP numbers. The usual bounce back in GDP post-recession is not going to happen. Growth would follow the average normal trend. With options in fiscal and monetary side limited, India needs to take appropriate policy action to stimulate supply and limit the impact. The fear is of it being too little and too late. Firms need to tweak there business model and possibly rejig there portfolio to take advantage of these changes. The winners in the new world order would be the ones who understand the market and love the way it is. As Marilyn Monroe said

“If you can't handle me at my worst, then you sure as hell don't deserve me at my best.

Still alive and kicking ass

This week has  been event full to say the least. Prof. S Bhattacharya, professor of Strategy at NITIE was brilliant with his case analysis. For me it was exciting more so because I was the one to answer some of his early questions.

But they were not the only reasons of high this week. Adjectives bestowed have been like monsoon in Mumbai, raining cats and dogs. One professor called me "a real finance guru" while another professor wanted to send some one to me to get inspiration from the way I gave speech in one of NITIE functions.  One person said I was a "Strategy Guru" while some other called me "Mayank Khanderwal" ( a versatile dude from Class of 2010) of the class of 2011.
Some one called me formal while some other ran away from me...(My current favorite song is "Mora piya mose bolat nahi" from Rajneeti :P)

However the funniest part was when some gal said "....I love..."
More about that later.

P.S. I am still alive and kicking ass.

Dollar Docked

This article was first published in NITIE Finance magazine "InFinNITIE", March issue. The article can also be read at daulatguru.com (Search "dollar collapse" in Google News. This is the first result you get)

"History is a nightmare from which I am trying to awake" -James Joyce

There have been numerous reserve currencies over the centuries, but none more widely accepted than the US dollar is, since 1944. While the US dollar has fluctuated widely in value over the 65 years since its designation as the reserve currency, its credibility has never come under such intense scrutiny ever as in the last few years.

The numerous factors which play in favor of the dollar as the appropriate choice include its size, quality and stability of the dollar asset markets, particularly the short term government securities market where the central banks tend to be the most active. The high liquidity of these financial markets makes the dollar an excellent medium for exchange.

The history of the US Dollar as the choice of the reserve currency dates back to the year 1944 near the end of the World War II. There was a vacuum created in World financial system after WW II due to weak position of pound sterling. With the world economy and the international economic and financial systems in near shambles, delegates from all 44 allied nations gathered in Bretton Woods, New York with an aim of setting up a system of rules, procedures and institutions to regulate the international monetary system. There the US Dollar took over the role that pound sterling/gold had played in the previous international financial system.

In 1971, the Bretton Woods System was revoked by USA. The amount of gold backing dollar have depreciated to low levels. USA felt that many currencies in the world were undervalued at that point of time. No other currency emerged as alternate reserve currency then. Japan was riding on huge current account balance. Although the German mark had a reputation as one of the world's most stable currencies, its contribution in the world economic affairs was not overwhelming. French Franc was also not that strong to play as reserve currency at that point of time. The Swiss Franc was based on a full gold convertibility until 2000. So after a brief marriage with Smithsonian agreement, the world moved on to free float economy and dollar remained as dominant currency in the world market.

The demand of dollar was artificially inflated after the collapse of Bretton woods system. USA made good use of its relations with Saudi Arabia, one of the largest oil producers. It supported the power of the House of Saud in exchange for accepting only U.S. dollars for its oil in 1972-73, just after the collapse of the Bretton Woods arrangement. Saudi Arab received military cover and legitimacy of monarchy in exchange. The rest of OPEC soon followed suit. As everybody in the world needed oil, they had to hold dollars. As the demand of oil was increasing at ever increasing prices, the demand of dollar can only increase. Thus oil became one of the most important strategies in the USA policy. Until recently oil could only be bought and sold in dollars (except from 2008 at Kish, Iran), thus inflating the demand of dollar. So after the earlier system of exchanging dollar to gold (Bretton Woods System) was now changed to dollar exchange to oil. USA has never taken any challenge to its oil policy lightly.

Mr. Saddam Hussein is said to have planned to sell oil in non-dollar currencies during 2002. Suddenly biological weapons were said to be present in Iraq and war was imposed on her. It is another fact that these biological weapons and “weapons of mass destruction” were never ever unearthed there. Iran planned a new oil bourse which would trade in any currency way back in 2005. It finally opened in Feb 2008 after a lot of hiccups which were said to be externally influenced. Iran was also on the verge of war because it was said to be in process of manufacturing nuclear bombs.

Not very long in the future, all that may be history. The Independent reported confirmed talks between gulf Arab and Chinese sources in Hong Kong of oil trade in dollar denomination. Brazil has shown interest in collaborating in non-dollar oil payments, along with India.

The recent downturn has shown that we can’t have only one reserve currency. The size of USA economy has become relatively smaller to the amount of global balance it is expected to serve. Its trade deficit is continuously increasing. The US dollar peaked in value in 2000-2001 and has been in a significant decline ever since. There was a relatively brief period in 2008 when the dollar rebounded quite sharply due to the worldwide financial crisis. But since then, the dollar has resumed its long-term downtrend. There were voices which argue that it was excessive dependence on dollar which led to world being dragged into the mess created by USA financial sector. They said that another reserve currency was required to de-risk the world economy from another downturn.

While making a decision about the choice of a reserve currency there are four factors which are largely considered – share of world output and trade, macroeconomic stability, degree of financial market development and network externalities. There had been multifarious reserve currencies over the previous centuries and the dollar has fluctuated widely in the past 65 years also.

The shop till you drop attitude of Americans is showing signs of change with personal saving rate rising to about 7% from less than 1% a year before. With increase in savings, spending is less. As consumer spending accounts for 70% of USA spending, the economy is going to contract in short term due to increased saving rate. Leading economists call it “the paradox of saving”.

The Commission of Experts of the UN General Assembly on Reforms of the International Monetary and Financial System, led by Joseph E. Stiglitz, has suggested a gradual move from the US dollar to the Special Drawing Rights (SDR’s). It wants to increase the share of SDRs in total international reserves in a gradual manner starting from an issue of $ 250 billion.

Hong Kong is issuing bonds denominated in renminbi. Countries are starting to use their currencies in mutual trade instead of dollar (China and Brazil). Thus USA would be having harder time financing its trade deficit. Would China be the next superpower? Only time would have a definite answer.

China was the first economy to pitch for the dollar’s replacement as the world’s reserve currency. “The stability of international financial system can’t hinge on the currency of one single country, even though it is the largest economy in the world” said Hua Ercheng, Chief Economist in Beijing at the China Construction Bank. However, the bigger question remains – which currency will be able to replace the mighty dollar as the currency reserve? China has been criticized roundly for handling of its own currency renminbi. Talks about the replacement of the dollar as the reserve currency had proliferated at the G-20 summit held in London in early April. Thereby nations such as Russia, France and Brazil had suggested that the US Dollar should be supplemented by the other major currencies as a shared reserve currency. President Dmitry Medvedev of Russia had also questioned the Future of the US Dollar as a global reserve currency and had said that using a mix of regional currencies would enable in making the world economy more stable.

This is similar to Special Drawing Rights (SDRs) created by International Monetary Fund in 1969 in an effort to stabilize the international foreign exchange system. The basic definition of SDRs given by the IMF is as follows - The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies – US Dollar, Euro, Yen and British Pound. The US Dollar itself makes up almost half of the value of the SDR. The exact amounts of currency making up SDRs are determined by the IMF Executive Board in accordance with the relative importance in international trade and finance every five years.

The IMF’s so-called special drawing rights could be used as the basis for a new currency. First Deputy Managing Director John Lipsky said “There are many, many attractions in the long run to such an outcome,” Lipsky told a panel discussing reserve currencies at the St. Petersburg International Economic Forum.

Arguments against making SDRs the world's reserve currency include the fact that the US dollar, the Euro and the Pound – which make up the large majority of SDRs – have all lost value since late 2007 when the recession began. Why replace a falling dollar by an index which so heavily includes the dollar? Also, SDRs do not contain the Chinese renminbi, Indian Rupee, Australian Dollar or Canadian Dollar, all of which are important benchmark or secondary global reserve currencies. However if the dollar is started to be replaced by SDR, then IMF nowhere has the financial prowess to grantee the exchange risk.

SDRs would have to be delinked from other currencies and issued by an international organization with equivalent authority to a central bank in order to become liquid enough to be used as a reserve. Russia has proposed several regional reserve currencies including the ruble as a part of the response to the global financial crisis. Dominique Strauss Kahn, MD of IMF said that remnimbi can be added in the future to the basket of currencies of SDR So “This is not a quick, short or easy decision,” said Mr. Lipsky, adding that it would be “quite revolutionary.”

The status of the dollar as the reserve currency may also be challenged by the euro, the other global currency. It has equivalent advantages and fewer risks offered against the dollar. The euro area does not have a large current account deficit as a whole (although Germany has a large surplus and Spain has a large deficit). The euro area intra trade is very high. However euro, in spite of its huge success in Europe remains to be a regional currency. Euro has not overcome its self-imposed limits on usage and adoption moving beyond the boundaries, due to the maintenance of the ERM-II Exchange rate stability requirements and the Maastricht deficit, inflation and interest rate criteria. The share of dollars in global reserves stands almost thrice of the euro.

The power of "incumbency" is conferred by the "network-externalities" that accrue to the currency that is dominant. Together these factors make it unlikely there will be a large or abrupt change in the dollar's reserve currency status. The sheer magnitude of dollar assets in the official reserves of foreign central banks and the realistic prospect of continued, and perhaps disorderly, depreciation of the dollar against most currencies, place central banks at considerable risk of incurring large capital losses on their dollar asset holding. With more than enough dollar reserves to meet liquidity needs, prudent asset management would seem to dictate some diversification away from the dollar and toward the euro.

The only reason why the Dollar hasn’t collapsed completely is because economies largely continue to recycle their surplus wealth and trade surpluses back into dollar-denominated assets. One columnist connects the dots with regard to the forex implications: “Less Chinese intervention to prevent renminbi strength would mean China, slowly over time, would build up fewer dollar reserves.” In other words, economies no longer concerned with pegging their currencies would have very little reason to build up large pools of reserves.

We all are entitled to our opinions, but not to our facts. So let’s get the facts right before we fell into the folly of stumbling to forecasting. As much as 70 percent of the world’s currency reserves are held in dollars, according to the IMF, leading to calls for nations to diversify their cash piles to avoid excessive exposure to the U.S. economy as it quadruples its budget deficit in a bid to counter the worst recession since the Great Depression. To quote the Economist “It is hard to think of a parallel in history. A country heavily in debt to foreigners, with a government deficit it is making little effort to control, is creating vast amounts of additional currency. Yet it is allowed to get away with very low interest rates. Eventually such an arrangement must surely break down and a new currency system will come into being, just as Bretton Woods emerged into the 1940’s.” Cost of an abrupt switch over from dollar to other reserve currency is prohibitively high. Its replacement as the reserve currency of central banks would be slow and painful process. As IMF chief Mr. Kahn said about a new global currency based on SDR “it is not going to happen tomorrow, but it may happen in 10 years.” The replacement seems imminent. When and which currency is a question which only time would tell.

"My greatest challenge has been to change the mindset of people. Mindsets play strange tricks on us. We see things the way our minds have instructed our eyes to see"— Prophet Muhammad

References

1. http://windowtowallstreet.com/oildollarvalues.aspx

2. http://whatmatters.mckinseydigital.com/currencies/china-s-exchange-rate-policy-and-what-it-means-for-the-dollar

3. http://en.wikipedia.org/wiki/Special_Drawing_Rights

Brush with a B school @ NITIE, Mumbai

Someone was tapping on my shoulders. Turning away from the mesmerizing scenes outside the window, I came back to the mumbo jumbo of the registration hall. A beautiful girl was asking for a pen. Soon we struck a chord and I came to know that she had flown air force planes! A few minutes later, I came across a regional movie actor. Moving along, that day I met plethora of people from all walks of life. My first day at NITIE. Oh! What a day that was.

Seniors stood up to their reputation of being very friendly and helpful. They told us about the beautiful view from Vihar and Powai lakes and I decided to explore it. She joined me and we went on to the top of MDP hostel to watch the scenic lakes. Not only the lakes, entire Mumbai was in front of us. Someone had truly said it was like a hill station in the middle of Mumbai. To top that all, we had the beautiful NITIE pond in the middle of the campus. “Ok. Out of here” She dragged me to reality.” We have a meeting at 6 in the baddy (badminton) court.” This was our first meeting with the seniors. Or was it the welcome party? Nobody knew.

Well it was definitely not the kind of welcome party we have thought of. What was in for us, was a complete surprise. After the introductions were over, grilling started. At 12:30am when the session was announced to be over, we were so tired that we could not wait to go to bed. But surprises continued. We were given a marketing case study to be analysed and submitted by 6:59 am next morning. We also had to be present on the PPO road (the road leading to the famous 96 steps) at 6:30 am sharp for campus tour. Most of us did not sleep that day! Later we came to know that it was better than what our friends at many other B schools went through!

The bombardment of case studies, group discussions and management games continued for the next few days. Burning the midnight oil became a common phenomenon. We could not wait for the “fuccha” week to get over. However our dream of relaxation soon evaporated. Professors took over the mantle from seniors. Weekdays were hectic, weekends were even more hectic. On normal days we had to meet only one deadline! No wonder, they say NITIE never sleeps. The overnight Nescafe outlet in the campus does brisk business. Once at 4:45 am in the night, I was coming back from some committee interview. I saw the sweeper cleaning the hostel then. He came running to me. “Sir, room cleaning?” “Please come.” I chuckled. “Not his fault.” This has become the way of life here.

Snapshot of our first class at NITIE: Three professors entered the classroom at the same time. One was an Organizational Behaviour professor (Dr Prasad), other from Marketing (Prof Dhume) and another one from Behavioural Studies (Dr. Mehta). The professors got a standing ovation. Everybody recognised them from the previous day’s introduction session. What a session! But this session unlike previous one was on a bit serious tone. The professors discussed about MANDI, an annual event in NITIE when students get down to the streets of Mumbai to sell toys. They kept addressing the class one after another, analysing the situation from different perspectives, novel dimensions and new fangled angles. The observations from my classmates were none the less revealing. It was like being in an august company! I thought “Wow. I have heard about case method of pedagogy in Harvard, role plays in Kellogg. But this is different!”

The bell rang. Oh. No. I thought. Not so soon. I did not want to come out of that feeling of trance. I felt some one tapping my shoulders vigorously again. It was my roommate, Amitabh trying to wake me up. “Dude, the alarm has been buzzing for long. Wake up. Its class time already.”

Note: MANDI was awarded Gold Medal for Innovation Pedagogy by Dr. Deepak Jain, Dean Kellogg Business School, at All India Management Institutions' annual Convention held at ISB, Hyderabad on August 29, 2009

Summer heat in October sky

Tankes and Rollers: Two types of people in any B schools. All others get crushed in between them.
Placement is like shit, and Constipation is a major problem...
The factors which matter for placements:
Acads? Are u kidding me!!
Good looking girl, girl, acquaintance with Placement committee, good looking boy, Jack, acads, knowledge and relevant work ex...errr…in that order.
ok ok. My status? Here it goes.
I have all (G)ot (S)et to (K)iss the world and am preparing to be a (C)arrying and (F)orwarding (A)gent.

One thing, I don’t know why……….in the end…. it doesn’t even matter!—Linkin Park

N.B.:
Poetic licenses have been used where ever necessary.
GSK and CFA are global brands.
Cryptic language have been used keeping in mind the sensitivity of the topic.
Brickbats (sexist, chauvinist, Cryptic language) and bouquets (??) are welcome.

The Collapse of Wall street

The articel was published in IIM Shillong finance Magazine Niveshak August 2009 edition (page 52).

Introduction

The current financial crisis has been described by many as unprecedented in living memory. It was so sudden and so powerful that many were caught unaware. Many tumbled and could not climb back up. The “golden period of finance” is said to have come to an end. A new world order is emerging from the ashes of the old one. But who was responsible for it. Was it due to the bozos at investment bank or the louts among the regulators or were it the nimrods in the banks who played with our lives. Lets go back and find out.

Lessons from 1929 collapse

Stock market crash of October 1929 still inspires political and economic debates. "Many people blamed the crash on commercial banks that were too eager to put deposits at risk on the stock market. " We can’t be sure if it was a credit inspired economic bubble which burst. But we know that it very quickly sucked out huge amount of consumer credit and they instantly stopped spending. The collapse of Wall Street might have acted as the precursor to the great depression.

The banking industry was divided in two segments, lending firms and brokerage firms i.e. investment banks. To rein in the stock market, the uptick rule which prevented the short sellers driving the bear market further down, was implemented after 1929 crash. It also inspired Keynesian economic which says that Governments should spend the money they don’t have in order to save capitalism.⁶ It is this theory which emerged as saviour of world economy in 2008.

History of USA policy

After WW II, international monetary policy revolved around USA as it agreed to make dollar convertible to an equivalent amount of gold. Subsequently dollar emerged as the reserve currency of the world.  In early 70’s USA failed to honour its promise and this system came apart. However dollar remained as the reserve currency of the world due to lack of other currency options.

From 1960s USA adopted a strategy of diverting its attention from core manufacturing to Finance, Insurance and Real Estate (FIRE) sectors. The economy became overly dependent on services sector. The savings rate of US consumer declined from 11% in May 1985 to -2.7% in Aug 2005.¹

"In two generations it seems that we've lost the culture and habit of savings," says Nancy Register, of the Consumer Federation of America. Federal Reserve Chairman Alan Greenspan warned that the low savings rate is impairing the nation's long-term economic prospects. An improved savings rate would provide investment money for businesses, which would create jobs, he said. ² Hence the absence of diversified economy placed it on a high risk of finance and real estate markets collapsed.

USA engaged in military driven trillion dollar expenditure instead of concentrating these funds in high end manufacturing and technological advancements. The domestic market was ignored and the power shifted from Detroit to wall street.³

Bursting of housing bubble and credit crunch

The nadir of Soviet central planning was supposed to be a heap of left shoes without any right pair to match them. The housing boom of USA which started in late nineties witnessed a series of empty houses in 2008 without any buyer for them. Many people were lured into buying home with “teaser rate mortgages” and “Adjustable Rate Mortgages (ARM).” As interest rates climbed up, they found it difficult to pay interest as the instalments rose substantially. This resulted in increased home loan foreclosure rate.

“One in six mortgages is upside down, and 50 million families can’t pay off their credit card bills. Last year one out of seven households was called by a debt collector. More than a million people declared bankruptcy. Foreclosure has reached levels unmatched since the Great Depression.” ⁷   Washington was forced to bail out two of the biggest US mortgage banks, Fannie Mae and Freddie Mac, to prevent the American home loan system from collapse. Lehman brothers which had invested most in the American real estate of all banks saw its portfolio shrink very fast and could not sustain in the end.

As economy first began to stall, the underlying problem of consumer and corporate indebtedness in USA totalled about 380% of GDP, nearly two and a half times the level at the beginning of the Great Depression.

Market collapse and decline of organisations

The financial market witnessed a lot of consolidations. J P Morgan chase bought Washington Mutual and Bear Stearns. Merrill Lynch was bought out by Bank of America. Citigroup acquired Wachovia. Lehman Brothers filed for bankruptcy. Investment Banks like Morgan Stanley and Goldman Sachs converted themselves from securities firm model to financial holding company model i.e. commercial banks.

Thus ended the last of five standalone investment banks in Wall Street, marking the end of an era which has started with the Glass-Steagall act of 1933 when investment banking was separated from street banking. Bill Isaac, a former chairman of the Federal Deposit Insurance Corporation, said “They are the only two left and the handwriting was on the wall, It's a shame because this country was built, in part, on risk-taking by Goldman and Morgan and by a whole bunch of firms before them.”

The conversion allowed them to take public money but bought them under regulatory scrutiny. The risk which their traders could take was severely limited and the amount of money which the firms could borrow was severely restricted.

Many countries in the world including El Salvador and Iceland suffered. The depreciation of krona along with the exposure of the large banks of Iceland (the total assets of banks is 10 times the GDP of Iceland)⁸ to huge foreign debt and high inflation created major problems for the country.

Ordinary citizens saw their investments melt away in front of them. The borrowers had no access to credit. The unfortunate participant in pension fund scheme saw his/her life’s savings evaporate because a trader in some distant place decided to take too much risk.

Huge stimulus packages were announced all over the world to suck up toxic underperforming mortgage-backed assets. IMF says that world has already spent $11.9 trillion to fight the financial crisis. That comes out to be 1,779 pounds per person on this planet. British government led by Mr. Gordon Brown started nationalising financial institutions such as Northern Rock, Bradford & Bingley etc  which was followed all over the world. Britain witnessed its first bank run case after 1870s. We again saw the resurgence of state capitalism.

Rise of new world order

Voices are being raised to replace dollar as the reserve currency. The Commission of Experts of the UN has suggested a gradual move from the US dollar to the SDR. It wants to increase the share of SDRs in total international reserves in a gradual manner starting from an issue of $ 250 billion. Hong Kong is issuing bonds denominated in renminbi (currency of China). Countries are starting to use their currencies in mutual trade instead of dollar (China and Brazil). USA would be having harder time financing its trade deficit. Would China be the next superpower? Only time would give a definite answer for that.

The shop till you drop attitude of Americans is showing signs of change with personal saving rate rising to about 7% from less than 1% a year before. With increase in savings, spending is less. As consumer spending accounts for 70% of USA spending, the economy is going to contract in short term due to increased saving rate. Leading economists call it “the paradox of saving”. The new America is going to inherit more from the “savers” which would spur investment of long term nature in the American economy, thereby reducing trade imbalance.⁹

Current condition and outlook

The financial results of the recent quarter show that few things are getting worse and many are getting better. However the consolidated sales of the companies are still below what it was last year. Banking sector credit in India grew at 27 % in 2007-08, 18%in 2008-09 and is expected to grow at 12-14% in 2009-10 as per Crisil.

Financial products have been brought under great regulatory control now. Hopefully like foods and beverage, financial consumers would be having greater options and protection. When the market picks up, the consumer is likely to look for one thing in any financial product-‘trust’, thanks to Mr. Bernie Madoff.

Kabirdas, the famous medival saint said “Kadli seep bhujang much, swati ek gun teen.” When the first drop of rain falls on the banana tree, it forms camphor, in the oyster’s mouth, it forms pearl and in the snake’s mouth forms venom. It is our choice what financial system do we want to gift to future generation, venom or pearl.