Effectiveness of Quantitative Easing (QE)

Last week, October 29, 2014, the U.S. Federal Reserve (Fed) concluded its $4 trillion QE programs   saying "there has been a substantial improvement in the outlook for the labor market" and "there is sufficient underlying strength in the broader economy". Many economists’ opinions on QE are divided,  some arguing in favor of it and some against it. Let’s have a look at the things, how they unfolded…

How it all started?

It all started with 2007-2008 financial crisis, to avert the ripple effects of the crisis, Fed started with reducing its fed fund rate and ended up with pumping trillions of dollars of money through three QE programs. After New Century Financial Corporation, a leading subprime mortgage lender, filed for bankruptcy in April 2007, rating agencies became cautious and started downgrading subprime mortgage bonds. Looking at the financial markets’ nervousness and to maintain the liquidity in the system, Fed started with 50 basis points cut in fed fund rate to 4.75% in September 2007 and by April 2008 fed fund rate touched 2%. Within 8 months, Fed reduced its interest rates by 325 basis points.

On September 7, 2008, the Treasury department took control of mortgage giants Fannie Mae and Freddie Mac and pledged a $200 billion cash injection to help the companies cope with mortgage default losses.

World financial markets spooked on September 15, 2008, when Lehman Brothers filed for Chapter 11 bankruptcy protection. As result of Lehman collapse, global money market immediately dried up, equity markets routed like there is no tomorrow, bonds and dollar skyrocketed. After seeing this, U.S. government, Treasury department and Fed took various measures to calm the financial markets.

Immediately after Lehman collapse, Fed and the U.S. government helped the one of the world’s largest insurer, AIG with $85 billion. In other words, AIG was bailed out by Fed and the U.S. government.

Within matter of three months, Fed reduced fed fund rate by more than 175 basis points to keep it between 0 to 25 points in December 2008. In between, when fed fund rate was about reach near zero levels, Fed started realizing the liquidity trap problem in traditional monetary approach. Ben Bernanke at helm of the Fed, who extensively studied Japanese lost decade and 1930s the great depression, started thinking of unconventional ways to pump the money into the economy.

QE1, QE2 and QE3

QE1 began in November 2008, with Fed deciding to buy $500 billion worth of mortgage backed securities (MBS) from financial market participants, $100 billion worth of debt obligation mortgage buying from giants Fannie Mae, Freddie Mac, Ginnie Mae and Federal Home Loan Banks. Fed did extend another $100 billion to Fannie Mae, Freddie Mac and Fed also announced the purchase of another $300 billion worth of long term treasuries. When QE1 ended in first quarter of 2010, Fed almost spent about $100 billion every month on buying mortgage backed securities for 17 months. That means, Fed was sitting up on about $1.7 trillion worth of mortgage backed securities. Overall QE1 can be classified as bailout fund.

In November 2010, Fed restarted its unconventional monetary policy, QE2, with $600 billion worth of long term treasuries buying plan. Fed expected to keep long term treasury rates and interest rates to be lower to speed start the economic activity. As previously announced, Fed concluded its $600 billion bond purchasing program in June 2011. QE2 can be termed as the fund used to kick-start the economic recovery.

In September 2011, Fed came up with yet another program called operation twist, wherein Fed started selling short term treasury bills and notes, and buying long term treasury bonds, to lower the long term treasury yields. Total fund allocated for this program was $400 billion. This showed that Bernanke was shifting the central bank's focus from repairing the damage from the subprime mortgage crisis to supporting lending in general.

In September 2012, Fed announced QE3. It agreed to buy $40 billion in MBS, and continue Operation Twist, adding a total $85 billion of liquidity a month. In December 2012, Fed announced it would buy a total of $85 billion of long-term treasuries and MBS put together. It clarified its direction by promising to keep it until one of two conditions was met: either unemployment rate to fall below 6.5% or inflation rose about 2.0%.

Did QEs Work?

In hindsight it’s always easy to analyze things! But talking about whether Fed’s QEs worked or not, it is somewhat complicated to question to answer and those answers are divided. But many economists agree that Fed accomplished couple of its goals. It’s unimaginable to know what would have happened without Fed's QEs. In the beginning, Fed wanted to stop the financial crisis from getting worse. By buying mortgage securities, Fed prevented more banks from failing and eased the frozen lending and money markets. Also being far more proactive and expansionary in nature of Fed as compared to ECB of European region reflects in the present status of both the regions. Fed helped to stabilize the U.S. economy, providing the funds and the confidence to pull out of the recession.

But whether QEs achieved what they were intended to achieve? Whether they succeeded in creating more jobs, spurring up the economy, boosting the inflation to Fed expectation level? I think answer would be “No”.  

Why QEs didn’t create enough jobs or reduce unemployment rate to Fed’s normal acceptance level of 5%. Why unemployment rate, which rose to 10% in 2009 till today didn’t reduced to before the crisis level of 5%, even after six non-stop years money pumping from Fed. Because monetary policies can't do much to reduce unemployment as liquidity is not the problem. In other words, there is little that expansionary monetary policies can do to increase the job creation.

High unemployment rate is due to two factors: cyclical unemployment and structural unemployment. Cyclical unemployment is caused by the economic downturns and structural unemployment happens when the long-term unemployed people lose their skills, needed to compete in the job market. Even now many economists argue that, present decline in unemployment rate is substantially because of long-term unemployed people quitting the job searching process, which is reducing unemployment rate.

QE didn't achieve Fed's goal of making more credit available and boosting the inflation. It gave the money to banks, which basically sat on the funds instead of lending it out. Though Fed succeeded in lowering the cost for banks to make mortgages, the banks didn’t actually start making more mortgages. Since banks didn't lend out the money, inflation wasn't created in consumer goods. As a result, Fed's measurement of inflation, the CPI, stayed below Fed's target.

However, QE did create an asset bubble kind of situation, first in gold and other commodities, and then in stocks.  An gold price more than doubled, rising from $869.75/ounce in 2008 to $1,895/ounce in 2011. Oil prices more than tripled from around $40/barrel in 2008 to around $120/barrel in 2011. After that, investors shifted to stocks. S&P 500 more than doubled from 700 levels in 2009 to 2000 levels in 2014.

QE could have been better designed. There could have been a better balancing act between monetary and fiscal policies. In retrospect far too much faith was put in the banks to channel the money to where it was needed. Edward Hadas of Reuters Breakingviews once nicely said, QE could have been worse, and it should have been better.

Interesting readings on Economics Nobel Prize

The Royal Swedish Academy of Sciences has decided to award The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2013 to

1. Eugene F. Fama
2. Lars Peter Hansen
3. Robert J. Shiller

Trendspotting in asset markets:
There is no way to predict the price of stocks and bonds over the next few days or weeks. But it is quite possible to foresee the broad course of these prices over longer periods, such as the next three to five years. These findings, which might seem both surprising and contradictory, were made and analyzed by this year’s Laureates, Eugene Fama, Lars Peter Hansen and Robert Shiller.

Nobel Prize winners say markets are irrational, yet efficient
Are stock markets irrational, driven by greed and fear, subject to euphoria and panic? Or are they highly efficient indicators of intrinsic value? Both, says the Nobel Prize Comittee for Economics, with no sense of contradiction.

The economics Nobel matters for India
The recent announcement of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel has gone to three extremely deserving recipients. The combination of deep economic insight and clever methodological contributions that Eugene Fama, Lars Hansen and Robert Shiller have brought to this field has revolutionized our understanding of the determinants of asset prices.

Split Nobel prize shows bubbles are worth watching
Economics is the only field in which two people can share a Nobel prize for saying opposing things.

Economists Clash on Theory, but Will Still Share the Nobel

Nobel Prize U.S. winner warns of 'bubbly' global home prices

Fama, Shiller, Hansen Win Nobel Prize for Asset-Price Work

What is happening in U.S.?

When one of my friends asked me what’s happening in U.S., so I thought of writing about it in a layman terminology, so that non-finance guys like many of my friends can understand.

Most of you might have already read or heard about American government being shut down from last one week or so. You might be wondering, what is this shut down. Why it happened and what is the impact of it?

To start with America follows the financial year from 1^st October to 30^th September just like our financial year, 1^stApril to 30^th March. For every new financial year a new budget is prepared and once it is passed, fund can be transferred to various departmental activities. Means funds allocated for each department can be utilized according to their plan of expenditure.

But if Congress (Parliament in Indian context) does not pass the new budget presented then Congress needs to come up with contingent bill, which allocates funds as per previous year allocation, to work around for time being. If that is also not passed by the majority in the both the houses of the Congress (Senate and House of Representatives) then government needs to shut down some departments which are not exempted from Anti-Deficiency Act (ADA). ADA is legislation, which prevents some government departments spending beyond their allocated funds.

You might be wondering why Congress didn’t pass the budget or contingent bill. Bill is implemented only when both the houses of Congress pass the bill by 2/3 majority or more. Senate, the upper house of the Congress is led by Democrats (52/100) and House of Representatives; the lower house of the Congress is led by Republicans (232/435). So bill should be satisfactory to both the parties.

President Barrack Obama is trying reform the healthcare (bill is also known as Obamacare) by reducing the cost of insurance and increasing the coverage of uninsured Americans (Around 15% of the population is not insured in America). But Republicans are opposing it for obvious political reasons and burden on expenditure, so not ready to negotiate in House of Representatives. President and Democrats are not ready to negotiate the budget without Obamacare. So because of the deadlock and new financial year U.S. government needs to shut down some of the departments until deadlock is resolved and pass the budget.

Now question is what is the impact of the government shut down? Immediate effect is around 8 lack government employees are on forced temporary leaves without pay and around 13 lack government employees need to work without pay. Major tourism spots like historical places, libraries and museums will be closed. And economic impact is different as per different estimations. According to Goldman Sachs estimates 5-6 days shut would shave off around 0.2% of GDP, 10-12 days shut would cost around 0.5% of GDP and 20-24 days will be of 1% of GDP.

So ultimate question would be what is the way going forward?  How long deadlock can continue? As long as both parties come to table with some amendments from both of their demands deadlock can continue. Historically the longest deadlock has been for 21 days in 1995-96. So what if present deadlock continues for more than 2-3 weeks like one in 1995-96? That’s the worst thing to happen to U.S. as it will be facing debt ceiling negotiation on October 17. Debt ceiling means, the limit on the amount of debt America can issue. If this deadlock continues till October 17 then there is possibility that debt ceiling may not able to increase. If that happens then treasury department may not able to repay the amount on debt maturities beyond a point, where it runs out of its reserves. After this treasury department needs to prioritise its debt service obligations and there might be partial defaults or in worst case full default, which is unthinkable and unprecedented! Because of the debt ceiling issue and the way it was handled in 2011, Standard & Poors downgraded U.S. from AAA rating.

Conclusion: Hope American politicians realise and recall the phrase “it’s the economy, stupid” and resolve the issues as early as possible.

Raghuram Rajan questions his peers’ policies!

Recently the Center for Financial Studies (CFS) awarded the Deutsche Bank Prize in Financial Economics 2013 to Raghuram Rajan. He presented his recent research paper on monetary response after the crisis.

He started his keynote lecture by saying “we seem to be in a situation where we are doomed to inflate bubbles elsewhere to boost the domestic demand” to question the low interest rate, “whether ultra low interest rates are part of the solution or part of the problem”. He called central bankers as “heroes” for rescuing the world from the brink of the collapse but warned his (now) counterparts, they may not be addressed same for the second half of the crisis i.e. recovery, as growth is not as expected!

He accepted the fact that he doesn’t have answers to the questions, he is raising, but he would like ask the questions!

He goes on to question the usage of monetary policy (over targeted fiscal policy) to drive the growth with the help of ultra low interest rates. He argues retirees as well as other people (who used to spend before the crisis) may not start spending in ultra low interest regime. In fact they may start saving more because spenders are under the water of debt over burden due to the crisis and retirees may not be able to get anticipated returns in these ultra low rates. Also he mentioned about “debt fuelled demand” is highly localised by quoting different spending patterns of Las Vegas and New York.

Moving on he questioned the credibility of the central bankers’ forward guidance like keeping interest rates low either time bound or conditional (like unemployment) dependent. Since recently markets started questioning the guarantee of central banks credibility and their talk.

He talked about amount of tapering may not alter much in long term Fed’s bond holding portfolio, which in turn should not have much impact on bond stock and flow.  But in reality it is not happening as per theory.

Talking about Bank of Japan, he hoped the balancing act of raising inflation expectation not too high and not too rapidly while maintaining bond yields low so bond portfolios don’t get beaten up, BOJ will succeed.

Unintended consequences of unconventional monetary policy

He said unconventional monetary policies may be intended to take more risk from entities like insurance companies and other financial corporation’s but he is not sure about that risk taking translates into real risk taking in real economy! But unintended consequences like spill-over and capital flow to emerging markets leading to asset price boom in those countries might raise the question. Politicians in emerging markets may forego the countercyclical policies during the capital inflow phase.

Even in industrial countries, monetary policy doing too much may take away the pressure from government and politicians and their focus. Because when central bankers say monetary policy is the only game in town they become the only game in town as everybody else then willing to wait. Damned if you do and damned if you don’t!

Pointing at taper talk confusions, he said we should plan our exit when we enter into something! Because of this stress he thinks emerging markets may decide not to run current account deficit, build safe structure by building reserves, focus on export led growth.

He said we need to break the cycle of one crisis to other like Asian crisis to Industrial world crisis and back to emerging market crisis again.

He ended his presentation by saying “I think I posed more questions than answers, but that’s the state of my thinking”.

POST-crisis, PRE-recovery dilemma

The great recession 2007-08 is history now and world is in the brink of recovery (different opinions about shape of recovery) with different pace in different places. Now almost all central bankers (both developed and developing countries) are worried about the future course of monetary actions.

Developed countries like US, UK, European Union and Japan have maintained their respective interest rate at very low levels almost equal to zero to avoid the depression. Since economy is now trying to recover from the crisis, these above mentioned country's central bankers are facing their own issues and are in dilemma whether to reverse the monetary stimulus or to go ahead with the present status for some more time?

US is getting mixed data from its economy as it Job data, and inflation data are on the positive side where as housing data is still under the pressure. UK is under the threat of Inflation and Japan is bombarded by Tsunami, nuclear crisis and 2 lost decades. European union is in dilemma as its different constituents are in very widely diverged due to countries like Germany and Ireland (or Greece) are like south and north poles in all aspects of economy.

Coming to developing countries like BRIC (Brazil, Russia, India and China) are clearly under the tremendous inflation pressure. India and China's central bankers increased their respective interest rates almost on an average once in a two month (from more than a year) to control the inflation. Brazil is under the threat of "hot money" flow due to interest rate parity and threating its currency competency. Russians are facing bubble kind of formation in almost all asset class due to rapid increase in their valuation.

Now the big question for all the central bankers is what next?

Yesterday, Tuesday, April 5th 2011 PBOC (People's Bank of China) has increased the lending and deposit rates by 25 basis points to from 6.06% to 6.31% and 3.0% to 3.25% respectively to curb the inflation. According to last available data China's CPI data for the month of February was 4.9% which is almost 1% higher than the PBOC's comfort (target) zone. But the problem PBOC might face in coming days is slower growth as it has forecast a lower GDP for coming years. Remember China spent massive amount (more than 4 trillion yuan) during the crisis times and its banks lent more than double the government spending/stimulus. So the base effect along with reverse the stimulus effect and lesser(than earlier) advantage of currency competence (due to international pressure to yuan pegging) may cause hindrance to Chinese.

Indian central banker, RBI (Reserve Bank of India) has already raised repo rate 8 times (200 basis points) from last one year and still it is indicating the targeting of the inflation. According to latest available data, WPI for February is 8.3% which above 8%, a revised target of RBI (RBI revised its inflation target from 7% to 8%). And RBI hinting to increase the interest rate in first week of May, 2011 when RBI is scheduled to meet. But in the process of inflation target RBI might loose out on GDP growth which has already shown some deceleration in IIP data and also due higher oil imports and high commodity prices cutting the margins of corporate houses and etc.

Tomorrow, April 7th 2011 ECB (European Central Bank) is meeting and many analysts are expecting ECB to increase the interest rates to target the inflation. ECB might be worried about the December inflation of 2.2% which above its target of 2%, but what about Greece, Ireland and other debt ridden Euro zone countries growth! Will it start the process for other developed countries to follow?

MPC (Monetary Policy Committee) of Bank of England is in traction to take the first step to increase the interest rates from 0.5% to 0.75% to target the inflation, but question of the hour is when? According to latest available inflation data for February is increased to 4.4% (from 4%) above the Bank of England's comfort zone of 2%. So will it bite the bullet?

Now there is lot discussion is happening around the FED's possible about QE2 (Quantitative Easing 2), FED rate, Inflation (is 2.1% and FED's target is 2%). FED might be worried about its history of 1936-37 of recession after great depression in 1930. (In the course of 10 months between 1936-1937, FED doubled its interest rates by causing recession!). It also might be wondering about the consequences of premature stimulus exit.

Bottom line:
In almost all the cases of central bankers, everybody is targeting inflation and inflation, mainly increased due to spike in oil prices, high commodity price and higher primary food articles. And inflation in most of the cases is supply side issue also instead of just increase demand! Whether mere increase in interest rates (further more in the case of developing countries) will curb the inflation immediately, without derailing the growth prospects? Global economy may not be ready to face another credit crunch! At the same time, artificial asset boosting by keeping near zero interest rates is also not good for the longer term economy, as fast history is in front us!

Bloodbath in Asian Markets due to fear of Japanese nuke leakage

Decoupling theory depends on structural issues

Whenever world is in economical crisis or in boom period, a school thought start talking about decoupling of certain regions or countries from rest of the world saying that particular region is well protected due to certain reasons.

Many times in my previous postings I talked about the cent percent decoupling in present globalized is not possible. But to a certain extent a region or a country can be decoupled from the rest of the world only on its own structural issues.

Starting from present financial crisis we can take lot of examples where certain parts of the world are in crisis and other parts are not or not affectedly as badly as those. Now so called developed countries like US, UK, Japan, and majority part of Euro Zone are in the threat of double dip recession of deflation, where as BRIC (Brazil, Russia, China & India) countries, Australia and certain African countries are facing threat of Inflation or we can say they are reaching their previous growth trajectory.

India is on the high growth trajectory due to structural issues like domestic savings' pattern (which is of 33% to 35% compared with 2% of US), consumption oriented economy (60% of total country's GDP consumed within India), demographics (55% to 60% of the population is under the age of 26 years), cost effective nature of the companies (which applies to China also), fiscal schemes like NREGS adopted by central government during the slowdown (rather than just monetary policies or so called quantitative easing which have limitation of after certain level like liquidity trap or leakage of money supply due to Interst Rate Parity). Now talking about Inflation which presently is the biggest threat to India's real GDP growth, again due to structural issues like: sudden increase in expendable income of rural household due to NREGS scheme, non-efficiency of public distribution system (PDS) along with supply side problem due to uneven rainfall in certain parts of the country and as usual growth comes with some inflation. According to yesterday's mint, IMF advised India to keep on hiking the interest to cool the inflation, an example of decoupling compared with problem facing countries'.

Now coming to China, the second fastest growing economy, as everybody knows its an export oriented country, but if it is only dependent on export oriented then it should have been in the same position that of US. But its not, in fact it is clicking double digit growth, due to:
1. Massive stimulus package of 4 trillion Yuan, they got from Chinese government of which they spent more than 80 percent, (i.e. more than 3 trillion Yuan on overall infrastructure, which is stepping stone for a country)
2. More than 9 trillion Yuan (more than double of government stimulus) loan disbursement of Chinese banks towards their countrymen lead to massive spending from Chinese towards their internal consumption.
3. Solid current account surplus of whopping $2.6 trillion due to continuous intervention in the forex market to keep Yuan undervalued to help the exporters.

And from inflation point of view, China is also facing similar kind of situation as that of India. Chinese real interest are deep in red due to as low as almost 2% deposit rate and about 5% inflation, which is again divergence from US, UK and Japan.

So similar respective things helped different countries domestically keep the growth momentum

--- Will be continued...

Ultra low interest rates in certain regions may cause global imbalance

To avoid present financial crisis developed countries like US, Japan, UK and European Countries are keeping ultra low interest rates [0.1% of Japan, 0.25% of US, 0.5% of UK and 0.25% of ECB (deposit) ] and more over governments & central banks of these countries flooding the their respective economies with lot of Quantitative Easing (QE) by printing more money as that is the last resort in monetary policy to boost the economy.

Countries opt for QE which are facing the problem of low inflation or threat of deflation and they might have already substantially lowered the interest rate nearer to Zero. So to boost the money supply in the economy central banks are compelled to print more money and purchase government bonds from different financial institutes like banks and NBFC (Non Banking Financial Services), in turn flooding these financial institutes with lot of cheap money.

Most of the economist and policy makers provide Keynes theory of "General Theory of Employment, Interest and Money" basis for their move towards monetary easing and QE.

But Sir John Maynard Keynes proposed this theory in 1930s then world was not so globalized as it is today and world was facing double dip recession or popularly known as The Great Depression mainly due to some bad moves like liquidity tightening by FED and protectionism by global leaders.

Where as now world is more globalized than ever and we are era of "BUTTERFLY EFFECT" of Chaos theory. No country is no longer 100 percent closed economy, so no country can say it is totally delinked from rest of the world. Ultra low interest rates in these countries and QE is flooding their banks with cheap money. And this cheap money is leaking to emerging markets. This "HOT MONEY" is creating its ripple effects in commodity market, emerging country's stock markets and their macro economy.

Commodities like Copper, Silver are trading at their peaks in last 2-3 decades and Gold is trading at all time high.

And hot money from these countries is flowing to emerging markets like there is no tomorrow. For example Indian markets witnessed highest ever inflow of FIIs in September month in last 17 years, from the day FIIs allowed. More than 5 billion dollar hot money flooded in Indian markets boosting Indian markets 13% rise in September. Srilankan stock exchange "Colombo Stock Exchange" has given more than 100% return in one year from sub 7000 levels to 16000 odd levels.

Brazilian currency "Real" is appreciated a whopping 30% from March 2009. Indian currency appreciated almost 7% in last 6 months and currency appreciation is common problem to all emerging markets. Already US-China currency war is on and Brazil is shouting at its full strength.

Due to this their respective central banks will (or would have already started) intervene in forex markets by selling their own currencies leaving their local banks with lot of liquidity. This liquidity is in turn creating a pressure on inflation which is already high in certain countries like China and India.

Ultimately its a "ZERO SUM GAME". In past also lower interest rates in initial parts of 2000 (to avoid ill effects of dot com bubble burst) lead to asset bubble in US which caused present crisis.

Is there a threat of liquidity trap and "W" shape recovery part 2

Continuing from last week's my posting of liquidity trap and W shape recovery, I am of the opinion that every region, state or country undergoes a broad macroeconomic cycle of different time frame depending on their structural issues in terms of age, gender, income/saving/spending nature, export/import oriented, regulations in financial systems and etc.

Here I would like to give comparison between US and Japan because they are World's largest economies (except China overtaking Japan recently) and almost they are in same position now.

Japan experienced rapid growth from 1960s to 1990s, helped by post 2nd world war massive US investment, high savings led to high investment in their own country due to currency appreciation, low interest rates & etc. Japan witnessed an average GDP growth of 10% in 1960s, 5% in 1970s & 4% in 1980 indicating a slowdown in real growth after 1980s. It experienced asset price bubble in late 1980s followed by Bank of Japan's sudden increase in interest rate & crash of Nikkie in 1989 when it was around 39000.

Many economists feel, after crisis Japan didn't act quickly, it took 5 years to boost money supply in real economy, which was definitely very late reaction. Out of ten years from 1990 to 2000 Japan witnessed 9 times deflation measured by WPI, Nikkie has given 4 times negative annual return, 4 times less than 10% and just 2 times positive.

Now coming to US, it witnessed the Great Depression in 1930s which produced great economists like Sir John Maynard Keynes and in turn the great Keynesianism theory. From 1945 to 1970s US witnessed higher growth helped household income increased 55% or 1.6% annually but since 1973 household income growth rate fell to 10% or 0.3% annually due to various reasons like fall of Bretton Woods System(Nixon Shock) in 1971, followed by Oil shock or crisis in 1973, Recessions in 1981-1982 and after that several economical cycles of recessions in successive intervals.

In 1980, the US Debt was equal to 33.3% of America's GDP, by 1990 it became 56% of GDP. Debt levels rose quickly in the following decade and based on the 2010 US Budget, total national debt will grow to nearly 100% of GDP, versus a level of approximately 80% in early 2009.

Present financial crisis caused by sub prime mortgage, securitization structures and financial engineering along with FED's low interest rate policy to avoid the 2001 dot com bubble effects. Between 1997 and 2006, the price of the typical American house increased by 124% and at same time household debt v/s annual disposal income was 127% at the end of 2007, versus 77% in 1990.

So both the countries experienced rapid growth for 2-3 decades and after that they are feeling the heat of slowdown in their respective economies due to different reasons, which is nothing but natural economical cycle.

Prof. Raghuram Rajan, economic adviser to Prime Minister Mr. Manmohan Singh, in an interview about Currency conflicts mentioned same structural issues in US which I pointed above. Click here to read the full interview. I read an article in mint on similar note (about Japan & US similarities & differences of crisis, advise of Mr. Bernanke to Japan in late 1990s and he being at top job at present crisis!) its good article, click here to read. The paper presented in late 1990s from present FED chairman Ben Bernanke to Japan about its crisis. It contains lot of important data & structural issues with good explanation, click here to read that.

In the long run we are all dead: Importance of Profit Booking

Couple of days back, somewhere I read that Dow Jones was @ 7000 in 1997 and in march this year it broke that same level. So over a decade the return on Dow Jones is nothing? That does not mean Dow Jones has not gone beyond 7000 range at all! It went up to 15000 levels in mid 2007 from where this present crisis started and with this Dow Jones also started falling.

For your reference I am providing a graph of DJIA (Dow Jones Industrial Average) Index below...


And if you observe the above graph Dow has touched 1997 levels somewhere in 2003 also.

Not only Dow Jones, but if you take our Indian Stock market, it faced bear market for almost every 4-5 years for different reasons.

If you see the below graph where in I have mentioned 4-5 broad bear markets...


In every bear market, market came down almost 50% of its previous peak respectively each time. For example in 92 due to bear market crashed from 4000 odd points to 2000 points, in 2000, market came down from 5500 odd points to 3000 points & if you take the present crisis here also market came down from 21000 points to 8000, more than 60% here.

This is the story of index & index dependent funds. Now if you consider some high beta stocks which moves erratically on both up as well as down side then think about them with respect to above crashes or bear market situations.

Bottom line:

So here what I am trying to say is at certain times booking profit is very necessary from stock market point of view. And even well known economist John Maynard Keynes also said that only: "In the long run we are all dead".

RBI's Annual Policy Review

As expected today RBI reduced the repo rate [rate at which RBI lends to banks] & reverse repo rate [rate at which banks lends/deposit to/with RBI] by 25 basis points to 4.75% from 5% & 3.25% from 3.5% respectively.

Apart from these few other important things from RBI policy reviews are as follows...

After clocking annual growth of 8.9 per cent on an average over the last five years (2003-08), India was headed for a cyclical downturn in 2008-09. But the growth moderation has been much sharper because of the negative impact of the crisis. In fact, in the first two quarters of 2008-09, the growth slowdown was quite modest; the full impact of the crisis began to be felt post-Lehman in the third quarter, which recorded a sharp downturn in growth. The services sector, which has been our prime growth engine for the last five years, is slowing, mainly in construction, transport and communication, trade, hotels and restaurants sub-sectors. For the first time in seven years, exports have declined in absolute terms for five months in a row during October 2008-February 2009. Recent data indicate that the demand for bank credit is slackening despite comfortable liquidity in the system. Dampened demand has dented corporate margins while the uncertainty surrounding the crisis has affected business confidence. The index of industrial production (IIP) has been nearly stagnant in the last five months (October 2008 to February 2009), of which two months registered negative growth. Investment demand has also decelerated. All these indicators suggest that growth will moderate more than what had been expected earlier.

You can see how the 3rd quarter has become disaster due to NEGATIVE growth in Agriculture & heavy slowdown in the industry sectors. You can click on the image for enlargement.




Business Confidence:

The Industrial Outlook Survey of the Reserve Bank for January-March 2009 indicates a further worsening of perception for the Indian manufacturing sector. The overall business and financial sentiment, which touched a seven-year low in the preceding quarter, slid below the neutral 100 mark, for the first time since the compilation of the index began in 2002. According to the survey, the demand for working capital finance during January-March 2009 from external sources dropped due to slowdown in business, even as the availability of finance eased. The business confidence surveys conducted by other agencies are also consistent with these findings.

Inflation



The analysis of the last four years suggests that WPI inflation and CPI inflation moved, by and large, in tandem till April 2007. Thereafter, inflation measured in WPI and CPI tended to diverge. However, the divergence in the recent period has been unusually high reflecting the volatilities in commodity prices which have a higher weight in WPI. With the decline in WPI inflation, CPI inflation is expected to moderate in the coming months. For its overall assessment of inflation outlook for policy purposes, the Reserve Bank continuously monitors the full array of price indicators.

Monetary Conditions

Growth in key monetary aggregates – reserve money (RM) and money supply (M3) – in 2008-09 reflected the changing liquidity positions arising from domestic and global financial conditions and the monetary policy response.

Reduction in the CRR has three inter-related effects on reserve money. First, it reduces reserve money as bankers’ required cash deposits with the Reserve Bank fall. Second, the money multiplier rises. Third, with the increase in the money multiplier, M3 expands with a lag. While the initial expansionary effect is strong, the full effect is felt in 4-6 months.

Bottom line:

Growth Projection

The India Meteorological Department in its forecast of South-West monsoon expects a normal rainfall at 96 per cent of its long period average for the current year. The fiscal and monetary stimulus measures initiated during 2008-09 coupled with lower commodity prices could cushion the downturn in the growth momentum during 2009-10 by stabilising domestic economic activity to some extent. However, any upturn in the growth momentum is unlikely in view of the projected contraction in global demand during 2009, particularly decline in trade. While domestic financing conditions have improved, external financing conditions are expected to remain tight. Private investment demand is, therefore, expected to remain subdued. On balance, with the assumption of normal monsoon, for policy purpose, real GDP growth for 2009-10 is placed at around 6.0 per cent.

Is this crisis worst than THE GREAT DEPRESSION!

There will be multiple opinions if you ask this question. Depending upon the which segment of the economy you are comparing there will be different answer for this question.

But for all the segments like crash of stock markets, industrial production indicator, interest rate response & etc are showing worst indication than the THE GREAT DEPRESSION itself! See this article from Barry Eichengreen & Kevin H. O’Rourke.

The New International Currency

From 2nd world war there is a constant approach towards a new international currency. But every time it was opposed by the MAJOR INDUSTRIALIZED COUNTRIES. Now in this crisis time also there is this talk is going on. And this got substantial boost after the G20 meeting.

Here are the some of the opinions...

Mr. Swaminathan's article in STOI

Mr. Nageswaran's article in mint

Financial Express article

In related to this see what Mr. George Soros thinks about the US economy.

NIPFP-DEA Seminar

As a daily routine when I checked Ajay Shah's blog yesterday, I came to know about the seminar conducted by NIPFP (National Institute of Public Finance and Policy) & DEA (Department of Economic Affairs), Ministry of Finance.

In that seminars various papers & presentations about the present micro & macro economical conditions, are presented & discussed. All those materials are uploaded to their "website". There is very large material not only about the recent seminar but some of the old seminars which are happening from 2007. So interested people can download the required materials.

NIPFP-DEA has got a blog also where in they update all the happenings. People those who are interested can subscribe free of cost so that all the updates will be at your doorstep whenever they update.

FE Editorial: India’s strength in this slowdown

PROJECTIONS by the IMF that India’s GDP growth will slow down from 6.3% in 2008-09 to 5.3% in 2009-10, after the conclusion of the Article IV consultations last week with India, shows that the pessimism levels have perhaps finally bottomed. This optimism hinges on the assumption that the stimulus packages and a good domestic harvest should support domestic demand. India, where the final consumption expenditure of households constitutes around 60% of the GDP, is certainly better placed to stimulate domestic demand than most other major markets. Share of consumption expenditure in GDP is much lower in China (33%), Russia (50%), and most of the low and middle income countries (averaging 56%), or even the EU (57%). India’s growth in recent years has been spurred by consumption spending, where growth has peaked at a real rate of 8.1% in 2007-08. Though the slowdown is expected to dampen the pace of consumption growth, it will still be significantly higher than in most low and middle income countries and even the euro area, where the growth of consumption spending has averaged 4.7% and 1.4% respectively, in the current decade.

Consumption demand in India will also be bolstered by substantial additions to the workforce, even though most of the labour flows are mainly to the informal sector. It should be noted that India has generated 11.3 million new jobs annually in the first half of the decade as compared to 7 million in China, 3.7 million in the OECD area and 2.7 million in Brazil. And there is also no ground for excessive pessimism on the external front. India’s inability to fully exploit its export potential will inadvertently help, given that its low (23%) ratio of exports of goods and services-to-GDP puts its on a better footing to stave off the slump in external markets, compared with countries with larger export dependence like the EU (40%), China (40%) and Russia (34%). India’s export prospects have also been bolstered by the trends in real effective exchange rates (Reer). Most recent numbers for the period September 2008 to February 2009 show that the Indian rupee has depreciated marginally during the period, and this should help as the Reer of other major currencies like the renminbi, dollar and yen has appreciated between 5% and 25%.

Monetary Stimulus/Fiscal Stimulus-->Helicopter Money

All countries & companies are trying save themselves from the recession or depression by various tactics. In these tactics Fiscal & Monetary policies are major ones and remaining are the part these policies or slightly related to these policies.

Today when I was posting this article Dow Jones was down by 200 points mainly because of the negative news from General Motors & US Economy, which may be heading for another depression. After receiving 13 Billion US dollars package also, General Motors is on the verge of the bankruptcy. City bank, after getting stimulus packages also, its stock was trading below 1 US dollar because of lack of investor's faith in it.

To counter the cycle of the recession [which may lead to depression] UK has reduced the its interest rates to historical low of 0.5%. Today's UK move is towards the liquidity trap about which I have explained in the below paragraphs. Along with UK, European Region which is in recession technically, today its central bank, European Central Bank (ECB) has reduced the interest rates to 1.5% from 2%, lowest since it formation in 1999.

Some time back I wrote about the "helicopter money". Today I am posting about the "helicopter money" because, present situation is leading to that condition.

Before presenting the present condition, I would like remind my readers about the what is helicopter money? And when it arises?

Helicopter money is the ultimate solution to the liquidity trap. Now you may ask what is liquidity trap?

A liquidity trap is a situation in which a country's interest rate has been lowered nearly or equal to zero to avoid a recession, but the liquidity in the market created by these low interest rates does not stimulate the economy. In these situations, borrowers prefer to savings rather than spending. This makes a recession even more severe, and can contribute to deflation. And interest rate cant be negative. This situation leads to helicopter money.

Helicopter money is situation in which Governments/Monetary Authorities gives the money directly to the consumer/resident of the country bypassing the financial intermediaries like banks. Keynes is considered is as the inventor of the Liquidity trap & Milton Friedman has coined the Helicopter Money.

Now coming back present conditions, Japan has cleared the cash in hand bill to the every resident of the country. This is nothing but helicopter money concept where in every Japanese resident is expected to get the 12000 yen costing total about 20 billion US dollars. Children under 18 and people aged over 65 would get 20,000 yen as part of the scheme. Japan took this controversial step because, it left with no other option. Every thing has been tried & tested including the fiscal stimulus & lowering interest to 0.1% level.

Good Articles

Yesterday I read an article in rediff which talks about India's growth in these 5-6 years & present problems in agriculture sectors. Its a good article from Kunal Kumar Kundu, COH, Global Market Research, Infosys BPO Ltd. Click here to read that article.

As I have written in my yesterday's post about the rate cuts by RBI, business standard got an article which almost talks about the issues which I raised in post. To read that business standard article click here.

Bloomberg's article on RBI's rate cut...

Rate Cuts By RBI

As I was posting from many days, yesterday [04/03/09] finally RBI reduced the Repo & Reverse Repo by 50 Basis Points. Repo rate reduced to 5% from 5.5% & Reverse Repo to 3.5% from 4% with immediate effect.

And in previous posts I clearly mentioned that there is no need to reduce the CRR further as liquidity is not the problem for us now. It has been reduced to quite substantially from its peak levels of 9% in October to present 5%. Compared to October & November when Lehman Brothers collapsed, suddenly international lending/transaction stopped for some movement. This lead our call money rate go beyond the corridor of repo & reverse repo and reached round about 20%. And as of yesterday's closing call money rate is in the range of 2.25% to 4.30% which is well within the range of repo & reverse repo limits.

This move was expected by many experts & economists, because there are various indicators which were indicating towards RBI. For example Inflation coming below 4%, to be precise 3.36%, GDP growth of 3rd quarter contracting to 5.3% from expected 6.1%, fiscal stimulus should be followed/supported by monetary stimulus, no room,time & authority [with the central government] for further fiscal stimulus packages, fiscal deficit going beyond the expectation & etc.

As I said before also cut in reverse repo will force the banks to lend rather than going for safer route of depositing with the RBI for assured returns. Now because of low returns with the reverse repo rates, banks will be forced to think of other alternative, that is lending to clients & customer for higher lending rates varying from 10% to 18% [depending upon the purpose], as lending rates are yet to come down. Once the lending starts towards the various sectors & various sizes of the sectors [small, medium & large scale], the economy will start productive work. This lead to more jobs across the all working capable men/women. If you see the call money rates there is room to cut reverse repo further but that can be done in subsequent stages by looking at the conditions.

And talking about the Repo rate it has come down from 9% in October to 5% now. Because of this cost of capital will be a lesser burden to banks as compare to October condition. But only this move cant help the normal person. As in the time crisis everybody including banks wants to play safely as there is risk of default & rise in their NPA [Non Performing Assets]. So this move should be accompanied by cut in reverse repo as RBI has done/been doing.

But in addition to this there should be some clear cut criteria for lending norms. There should be clear regulation & ratings for corporates & individuals depending upon various parameter like risk aversion quality, past history, line of business, scope for the business, effect present conditions to business & etc.

Now government & governor of RBI should persuade the various bankers to lend & transform the benefit of RBI cuts to end user. Because banks, financial intermediaries can act as very important role in both development as crisis situation. In 1930s great depression time, situation aggravated because banks stopped lending & ultimately causing problems themselves also since almost 11000 out of 25000 banks collapsed in US at that time. So somebody has to take the initiation in reducing the rates. SBI, India's largest bank already reduced the deposit rates for various maturity periods. So I hope it will be followed by reduction in lending rates & other banks will also follow the path...

Warren Buffett's Letter To His Share Holders

Due to some reason I am unable to provide the exact letter of Warren Buffett to his share holder this year. But I got three analysis on his letter to his shareholders...

One from Bloomberg

Another from Yahoofinance

Here in Business Standard, they hinted an Indian could be Warren Buffett's Successor according to his letter.

Newspaper Articles

Guys please read the article regarding "learn to live with slowdown" in swaminomics in TOI...

Read the article in Financial Express,"Buffett, the lender of last resort"