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Things are worse than people say they are (As appreared in DNA Wednesday, December 23, 2009)
Vivek Kaul. Mumbai
“So they are calling it The Great Recession,” she said one morning, throwing the newspaper at me and placing a cup of green tea by my side.
“Oh. We are back to green tea. What happened to my coffee?” I asked groggily.
“No milk. So no coffee. Plus green tea is healthier,” she retorted. “And whats this thing about the great recession that the international press has been talking about?”
“Human beings rarely like things being told to them as they are. Its like when you ask me Do I look all right? And I reply Yes, you look wonderful tonight. When you ask that question you are fishing for a compliment. And I have to give you one, because thats what you are looking to hear.”
“So you mean things are really worse than they are being made out to be? And I thought we will end the year on a good note.”
“You guessed right. The press cant be negative all the time, so they have to sell hope, especially with the New Year around. The term great recession is a euphemism at best. As David Rosenberg, an economist, said in a recent report: Mainstream economists called this downturn The Great Recession. This is truly a gentle way of saying Depression.”
“And why do you say that?”
“You know when people use the term the great recession, they are essentially in a denial mode. Let me throw some numbers at you. As per official projections for the year 2010, the debt-to-gross domestic product ratios of several governments will reach extremely high figures. For Japan, the ratio is at 227%. For Italy, at 120%. The UK and the US are at 94%. If that is not scary enough, Germany and France are at 83% levels. So things are clearly worse than they are being made out to be,” I explained.
“Hmmm. So as per the numbers Japan looks to be in a lot worse situation than the US.”
“Well, it is in a bad situation. But probably not as bad as the US. The Japanese government is borrowing from its citizens. Only 8% of the Japanese government debt is in the hands of foreigners. In the case of the US, the situation is reversed. The US citizens are as broke as their government and hence, the government is dependant on overseas borrowings. Now take the case of the household debt in the US. Currently, the ratio of household debt to disposable income of the citizens is at 125%. This is way above the average ratio over the years of around 60%. To get back to that ratio, citizens need to extinguish debt worth more than $7 trillion. That sure is a lot of dues to repay.”
“And then? she asked.
“Let me scare you a little more. The US government has to repay around $2.5 trillion of its total debt next year. This stands at around 35% of its overall debt. The big question is where is the money to repay this debt going to come from? The government doesnt have the money and even the citizens dont have the money. So the government will essentially have to borrow more money from foreigners and repay the debt that is maturing. But even the foreigners dont have this kind of money. So the US government will get its central bank, the Federal Reserve, to print money and use those dollars to repay. This is something that countries like China and Japan, which are major lenders to the US, do not like. With every extra dollar being printed, the value of every existing US dollar plummets.”
“Good point. But tell me something you have been saying for sometime — that all the money printing happening across countries will show up in inflation, as too much money will chase, the same number of goods, leading to price rise. But that isnt happening. How do you explain that?”
“Yeah that hasnt happened. How does the central bank of any country, pump money into the broader economy? It pumps the money into the banks in the country and then hopes that the banks will go and lend money to people. At the same time, the central bank keeps interest rates at very low levels, in the hope that people will have an incentive to borrow. When people borrow money and buy things, the economy starts to pick up again. At least, thats how it is supposed to work in theory. But the printed money has not left the balance sheets of banks. Take the case of the US. The banks have $1.2 trillion of cash on their books, but arent lending to the common man. This money has been lent to the US government. Essentially, the money printed by the government has been round tripped back to the government.”
“Interesting, the way you put it,” she said. “But all this printed money will someday lead to inflation”
“Yes. And the chances are sooner rather than later. In the last two years, money supply in the US has gone up from $827 billion to a mind-boggling $1.93 trillion. Of course this money has not permeated into the broader economy. But as and when that happens, you know that high inflation will be the order of the day. In fact, former Fed chairman Paul Volker said recently: It is difficult, but necessary, for the Fed to start draining the billions of dollars in liquidity even while unemployment remains high as the US battles out of recession… If you wait, its too late.”
“And how can all the printed money be drained out and inflation be prevented?” she asked.
“By raising interest rates. When you raise interest rates, people are more likely to deposit money with banks than go out there and send it. Also, the chances that they will borrow money to spend come down. So that prevents a price rise. Also, as Gary Dorsch, who writes an investment newsletter said: “Behind the scenes, Americas two largest creditors might be demanding a credible defense of the US-dollar… which can only be engineered with higher interest rates.” In fact, the US economy has rebounded faster rate than expected. In fact, for October to December, some economists expect it to grow at 4-5%, even though the consensus estimate is around 3%. With things looking better, people are likely to borrow more, which might mean higher inflation. This means that the chances of higher interest rates are much higher in 2010 than people currently expect them to be. And rising interest rates will kill the dollar carry trade, which has currently been driving the stock and commodity markets all over the world into higher zones. Investors have been borrowing in dollars at close to zero percent and investing that money worldwide. But with interest rates likely to go up, dollar carry trade investors might be in trouble.”
“But isnt that a very contrarian view to take?”
“Yes it is. But when have I had a normal view on anything? Now could you please go get milk and make me some coffee?”
(The example is hypothetical)
k_vivek@dnaindia.net
Vivek Kaul. Mumbai
“So they are calling it The Great Recession,” she said one morning, throwing the newspaper at me and placing a cup of green tea by my side.
“Oh. We are back to green tea. What happened to my coffee?” I asked groggily.
“No milk. So no coffee. Plus green tea is healthier,” she retorted. “And whats this thing about the great recession that the international press has been talking about?”
“Human beings rarely like things being told to them as they are. Its like when you ask me Do I look all right? And I reply Yes, you look wonderful tonight. When you ask that question you are fishing for a compliment. And I have to give you one, because thats what you are looking to hear.”
“So you mean things are really worse than they are being made out to be? And I thought we will end the year on a good note.”
“You guessed right. The press cant be negative all the time, so they have to sell hope, especially with the New Year around. The term great recession is a euphemism at best. As David Rosenberg, an economist, said in a recent report: Mainstream economists called this downturn The Great Recession. This is truly a gentle way of saying Depression.”
“And why do you say that?”
“You know when people use the term the great recession, they are essentially in a denial mode. Let me throw some numbers at you. As per official projections for the year 2010, the debt-to-gross domestic product ratios of several governments will reach extremely high figures. For Japan, the ratio is at 227%. For Italy, at 120%. The UK and the US are at 94%. If that is not scary enough, Germany and France are at 83% levels. So things are clearly worse than they are being made out to be,” I explained.
“Hmmm. So as per the numbers Japan looks to be in a lot worse situation than the US.”
“Well, it is in a bad situation. But probably not as bad as the US. The Japanese government is borrowing from its citizens. Only 8% of the Japanese government debt is in the hands of foreigners. In the case of the US, the situation is reversed. The US citizens are as broke as their government and hence, the government is dependant on overseas borrowings. Now take the case of the household debt in the US. Currently, the ratio of household debt to disposable income of the citizens is at 125%. This is way above the average ratio over the years of around 60%. To get back to that ratio, citizens need to extinguish debt worth more than $7 trillion. That sure is a lot of dues to repay.”
“And then? she asked.
“Let me scare you a little more. The US government has to repay around $2.5 trillion of its total debt next year. This stands at around 35% of its overall debt. The big question is where is the money to repay this debt going to come from? The government doesnt have the money and even the citizens dont have the money. So the government will essentially have to borrow more money from foreigners and repay the debt that is maturing. But even the foreigners dont have this kind of money. So the US government will get its central bank, the Federal Reserve, to print money and use those dollars to repay. This is something that countries like China and Japan, which are major lenders to the US, do not like. With every extra dollar being printed, the value of every existing US dollar plummets.”
“Good point. But tell me something you have been saying for sometime — that all the money printing happening across countries will show up in inflation, as too much money will chase, the same number of goods, leading to price rise. But that isnt happening. How do you explain that?”
“Yeah that hasnt happened. How does the central bank of any country, pump money into the broader economy? It pumps the money into the banks in the country and then hopes that the banks will go and lend money to people. At the same time, the central bank keeps interest rates at very low levels, in the hope that people will have an incentive to borrow. When people borrow money and buy things, the economy starts to pick up again. At least, thats how it is supposed to work in theory. But the printed money has not left the balance sheets of banks. Take the case of the US. The banks have $1.2 trillion of cash on their books, but arent lending to the common man. This money has been lent to the US government. Essentially, the money printed by the government has been round tripped back to the government.”
“Interesting, the way you put it,” she said. “But all this printed money will someday lead to inflation”
“Yes. And the chances are sooner rather than later. In the last two years, money supply in the US has gone up from $827 billion to a mind-boggling $1.93 trillion. Of course this money has not permeated into the broader economy. But as and when that happens, you know that high inflation will be the order of the day. In fact, former Fed chairman Paul Volker said recently: It is difficult, but necessary, for the Fed to start draining the billions of dollars in liquidity even while unemployment remains high as the US battles out of recession… If you wait, its too late.”
“And how can all the printed money be drained out and inflation be prevented?” she asked.
“By raising interest rates. When you raise interest rates, people are more likely to deposit money with banks than go out there and send it. Also, the chances that they will borrow money to spend come down. So that prevents a price rise. Also, as Gary Dorsch, who writes an investment newsletter said: “Behind the scenes, Americas two largest creditors might be demanding a credible defense of the US-dollar… which can only be engineered with higher interest rates.” In fact, the US economy has rebounded faster rate than expected. In fact, for October to December, some economists expect it to grow at 4-5%, even though the consensus estimate is around 3%. With things looking better, people are likely to borrow more, which might mean higher inflation. This means that the chances of higher interest rates are much higher in 2010 than people currently expect them to be. And rising interest rates will kill the dollar carry trade, which has currently been driving the stock and commodity markets all over the world into higher zones. Investors have been borrowing in dollars at close to zero percent and investing that money worldwide. But with interest rates likely to go up, dollar carry trade investors might be in trouble.”
“But isnt that a very contrarian view to take?”
“Yes it is. But when have I had a normal view on anything? Now could you please go get milk and make me some coffee?”
(The example is hypothetical)
k_vivek@dnaindia.net
