The World of Debt and Default...Part 1

I need to apologize to have just fallen out of the radar. It is important, at times, to just sit back and watch what you have been doing for a while... jot down notes feverishly.. and take stock. The current global scenario also warrants the same, and I would advise our world leaders to do it, Simply because, "It works!!!".
I am back again, and am getting straight to the focuspoint, Greece.

The most talked about topic in around the world is right now the sovereign defaults. The whole brouhaha over the uncertainty involved in European crisis, epicentering Greece.

Interestingly, the first of its kind (sovereign default) also started in Greece in the 4th Century BC. At that time, Greece was governed through small city-states, who had incurred a huge default on the loans taken for state governance from the Delos Temple. This instance of default was neither previously experienced nor encountered as the kingdom/states earned their revenues from trade, extraction of natural resources such as mining and a huge chunk coming from the war booty. The kingdoms simply did not believe in borrowing from the public institutions.

The fact that a state has to be reliant on borrowings underpins the power of the state, and vice-versa its economic and military prowess underpins its power to borrow has not changed. As the conception goes, a powerful (read: economically and militarily superior) state will never borrow.

Now with the changing times, we have come to understand the power of leveraging and so do not see loans from institutions like the IMF as a sin, but a Default is still considered to be the ultimate foreign policy sin, and a sin enough to effect a dire change in the geo-political balance of power.

The concern needs to be highlighted because the default risk, which we might experience, is specifically coming from the developed world countries. Greece is surely the first effective domino in the spread. Portugal, Spain, and Ireland are to be the next in line of casualty. The domino effect is definitely going to bring a lot of pain in terms of stagnant growth, consumption downturn and the ripple effects of the default to countries like Germany, France, the UK, and the US.

The next question which instantly fleets my mind is, “When the big boys are going down, shall we see the emergence of a new developed world (A new world order)?” or in a more Bollywood ishtyle, “Kya picture abhi baki hai, mere dost?”

Well, I think that this time we are going to see a dramatic shift in the geopolitical power mainstay. The Emerging world would be the savior of the world from this mess. I would also not refrain myself from saying that, the kind of widespread default which we are seeing in the West would undoubtedly have a devastating consequences even for the Emerging world too. I would also like to mention a point of my Chinese friend, a student of Economic History in Berkeley, with whom I concur. She thinks that sovereigns who have had floating currencies (not the ones with pegged currency rate), a manageable domestic currency debt, and a Central bank, whose policy making is uninfluenced and independent, have been seen to have negligible credit risk in peace time, a contrarion to the Mundell–Fleming model.

As of record, all the earlier country debt and default crises which we had been through in the last 500 years had more to do with the kind of financial and monetary structural rigidities, an unsteady state of political affairs, military coupe, and severe unprepared shocks and eminent losses such as wars rather than what we are now dealing with; Primary Headline Debt and Deficits.

....to be continued.

Can Vikram Akula do a Yunus...

Microfinance... Can India create another Grameen !!!


Recently I finished reading one of the best books which can or has emphasized the much talked about financial inclusion. More in so, with a narrowed focus towards the Emerging countries like India and Brazil."The Bottom of the Pyramid" by the late CK Prahalad. His idea of looking into things (business) is a visionary one.

The next target segment of the markets will be the one where technology would not come for a price but still would be an indispensable part of the growing system, just like the Internet boomed trading and the style of doing business with ebusiness,take any service- none are untouched or unaffected by the internet.

In the same way lending would evolve where ‘tiny amounts of money to people with tinier assets’ (as The Economist magazine put it in an article published in 2006) will seem to be an obvious way of doing business with what is potentially the largest driver for markets- consumption.

Of late my tryst with the state has grown and thus have been hearing the suicide cases of the borrowers in Andhra Pradesh, which has bought this much talked and expected about business under the microscopic scanner of intellectuals in India.

Media reports about high interest rates charged on loans made to people who appear to be ill-equipped to pay such large sums — and thus the suicides, allegedly — have raised eyebrows, even as other stories have reflected on the crores of rupees in stock options that company executives of microfinance companies appear to have benefited from. The seemingly high interest rates charged by microfinance institutions (MFIs) stem from transaction costs, which is why banks have not been very successful in microfinance. Even in the era of priority- sector lending, the banking system had tended to lose a lot of money on loan defaults — apart from the subsidised interest rates prevalent then. In other words, the banks’ failure lay in their inability to see microfinance as a sustainable business, and more as a social obligation.

The fire had not yet subsided from the issue, SKS Microfinance's CEO,Suresh Gurumani was sacked without citing any specific reason. His 5-year contract was to expire on 2014 March. Interestingly, Ashish Lakhanpal, an Independent Director, is also relieved from his duties. The first company in its category to go public and raise 16.5 billion ruppees from the market, a lot more than the money are at stake with the company.

The industry runs on three types of costs which matter: the cost of funds, the cost of associated risk (of defaults) and administrative costs, all of which are integrated into deriving the final interest rate charged to borrowers. Microfinance depends heavily on personal contact, limiting loan officers’ reach to a small number of borrowers, unlike banks that rely on technology for credit scoring (almost all microfinance lending is cash based, and collections take up significant personnel time).The most critical factor in simpler terms is the administrative costs, which incidentally are not proportional to the loan size. The transaction costs of making a single loan of Rs 1 crore by a bank are significantly lower than the costs of making 500 loans of Rs 20,000 each (a typical microfinance loan). Loans by banks are repaid quarterly; microfinance loans are collected with greater periodicity, perhaps or actually every week.

Dealing with barely literate borrowers with no collateral and credit bureau records, requires time-consuming personal interaction, all of which drive up costs high enough that can only be covered by high interest rates. It is a simple principle of business that if you cannot cover costs, you will not stay in business. If there is one area that microfinance institutions need to focus their energies on, it is building technology platforms that will reduce their high administrative costs. A lot of light on the other side of the tunnel comes from the interest being seen in exploring, researching aspects of Mobile Banking and Electronic transfer.

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The battle between a Capitalist Ego and a Communist Strategy...

Communism has known to be the direct opposite of the capitalists and the very concept of communist ownership of a business in a capitalist economy is irrelevant. In reality, it creates a controversy and clash of policies and actions. There has been a wave of takeover, some hostile and some amicable, of American companies by Japanese firms in the 1980s. Since the acquisition of Germany based Mannesmann by Vodafone in 2000 to the recent plethora of increasing private equity and venture capital firms and their acquisitions have often irked the social fabric of national pride and anxiety of superpowers.

Social and Business Economists have highlighted the concerns which will not be easy to slide under the carpet and definitely will intensify over the next decade, as the BRIC countries and specifically Chinese state owned firms keep themselves active on the inorganic activity growth radar. Chinese companies have surpassed record numbers in terms of foreign M&A in 2010. They have been bidding for everything ranging from gas (Americas), oil (US) and electricity (Brazil) to cars (Swedish Volvo).
The very idea of communists buying the companies of capitalist is a disparity as far as economic theory of liberties is concerned. This is what has been irking the Republics and the Democrats alike. Take a 2009 story, where the National Energy Administration (US) agreed to establish a special fund for China's state-owned companies to buy oil and gas firms overseas. The beneficiaries being the Petrochina, Sinopec and CNOOC, which enabled benefit in terms of low interest loans and direct capital injections.

Chinese companies were seen as an example and epitome of state capitalism. Economic factors like emerging world's non credit culture and the huge reserves of public saving, their resource wealth and the collapse of free market model led to a hailing of state capitalism. The value of the globe’s emerging stock markets have risen fivefold ($80,000 billion from $14,000 billion), taking the emerging market share of global equity markets from 31 % to 55 %.

The so called ‘first world ‘has coped up with countries such as South Korea and Singapore, who have been on an acquiring spree of companies outside their countries. The developed world has the experience of tackling the rise of mercantile economies but China stands apart, it is already the world’s second biggest economy, and in another two decades is rightly poised to overtake America. Chinese firms, till the outbreak of recessionary times, have looked inwards. The rising oil prices and the recessionary pressures on the US have made them potential targets for their vast resources abroad. Nothing could be more apt then the case of Unocal.

China stands fifth in outbound investments globally. Unearthing the pages of history shows that both Britain and America had shares of about 50%, in 1914 and 1967 respectively at their prime of supremacy. The biggest weight on the scales will be the Chinese rate of government investments powered by the per capita savings of the people. These monies today are invested in government bonds and treasuries of the first world counties; tomorrow this will serve a pool which can be used to buy companies and insulate the Chinese people against the first world countries currency devaluations and financial defaults.

Taking a cue from the chapter of globalization, very similar to the old way of annexation of countries, a company (country) tries to inorganically for primarily three reasons: secure raw materials for future production, acquire better technical know how and the most important, to gain access to foreign markets.
In a normal situation, private companies around the atlas, find and allocate their resources towards the attainment of perfecting its strategy to maximize its customer’s base. These are governed by market and economic logic. So far so good, now the idea that a communist government might dominate the realms of global capitalism scenario is unappealing. The very idea of shift in the control of global resources to a body which would not be market driven but official driven, an establishment principled on politics (principle, if you please) and not profit are the real concerns. Developed countries like Australia and Canada, which were once open for takeovers from the foreign countries, are now escalating the barriers for Chinese, especially in the arena of exhaustible resources like oil and gas.

China has been most active in deal making for the natural resources, yet its way off the needed quantities to control the rigging capacity of the markets for such commodities. The Americas, Australasia and the Europe should consider subsidized capital of the Chinese. The major focus in these terms should be dealt with strengthening and plugging the loopholes in the competition law rather than trying to stop the investment flow, thus constraining the movement of capital around.
Taking the example of Geely, the new owners of Volvo. It made complete mutual sense for both the parties. Geely had been trying to launch itself into European markets but was losing on the pricing factor and Volvo was in deep crisis since it could not find distribution partners in Asia to sell its cars. Volvo's existence was threatened due to its inability to sell more care in Asia.

The Chinese firm, CNOOC was one of the greatest finds of Warren Buffet n the last century. Chinese firms are believed to come with a lot of perks such as lower operational costs and access to newer and fresh markets to otherwise flagging companies in the saturated markets. In BRIC, Indian and Brazilian firms have the maximum advantage of being the free and open market policy adopters. But China is catching up fast . . . really really fast.

The Evolution of a World Currency and its implications...1

The idea struck with the recent release of the trailer of Ice age 4. The kind of deranged systems in place is leading us to destabilizing the trade and investment correlation of economies, or to adopt a new standard dismantling the United States status of superpower in regards to its structural credit dependency and deficit balance of payments which can never be repaired.

Tracing back the system of exchange of economies prior to 1971, when the balance of payments were settled in precious metals like gold and silver formed the basis of domestic currency as well. Till that time, the Fed Reserve's note was backed 25% by gold, and an ounce was pegged at $35. If the economies wanted to increase their money supply even for general economic expansion, they had to keep gold in their hand by circulating trade and payments surpluses. The sovereigns reduced the supply of domestic credit in order to raise interest rates and either allied or lured other economies in order to attract foreign financial inflows when the rulers faced issues of trade deficits or had to undertake military campaigns.

The international financial dynamics self-operated itself with checks and balances. The countries reeling under the pressure of trade deficits, went ahead spiking their interest rates and lured foreign capital, on the other hand, it undertook measures such as reducing government spending, raising taxes on consumption, which in turn forced economic slowdown thereby reducing the purchase of imports. What a novel approach.

The only system destabilizer then, was spending on military and war. Such kinds of transactions which spanned across the World Wars, enabled the US to aggregate 80 % of the world's monetary gold deposit by 1950, giving the dollar the status of an substitute/proxy for gold standards. Lets now statistically be aware of the overseas military spending by US, the entire payments deficit for the next three decades happened with the expenditure cost of the Korean War. On the other hand, its private-sector trade and investments was exactly in tandem.

The scale of spending in the Vietnam war and other foray's of interference in the economic peace and war in the recent years made the US deficit volatile in international arena and thus making the dollar status of gold convertibility was suspended through the London Gold Pool. The status in the ground reality was not so easily detached as the Central Banks of countries, continued to settle their balance of payments in U.S. Treasury securities, just by the virtue of non-availability of any other asset in sufficient supply to signify the strength and reliability for central bank monetary reserves to replace a pure asset such as gold. This quality of the dollar made the US overconfident and its currency strength gave it the leverage to shift from an asset based country to a debt-based. Such kind of power to the T-bill standard made the US insulated from any disorder of balance-of-payments and financial restraints. Power corrupts, Absolute power absolutely; Such grant of invincibility status to its currency enabled its capital markets and the economy to be increasing debt-leveraged, allowing US the power to play with innovation of financial instruments. Politically, It also enabled the U.S. Govt to structure foreign policy and military campaigns without much thought for the consequences in regards to the balance of payments.

Currently, the problem is the potentially infinite supply of dollar credit. The subsequent growth in the reserves of central bank and the sovereign country funds ultimately, has been recycled into the dollar inflows by inducing more purchases of U.S. Treasury securities. Thus, in a sense, the foreign central banks and (indirectly the taxpayers) YOU are responsible for financing most of the U.S. federal budget deficit. The fact that this deficit is largely military in nature - for purposes that many foreign voters oppose - makes this lock-in particularly galling. So it hardly is surprising that foreign countries are seeking an alternative.

US is not suffering from a trade deficit, as one would like to think and believe. The country's foreign military spending has been accelerating, even after the end of Cold War. The other pointer has been the incessantly increasing capital outflows from the US. The reasons being the status of the "God Status"(check the reason in the next blog) of the financial institutions, especially Fed Bank and its money lending spree to foreign governments from the third world countries. It has also loaned money to countries who have been suffering from deficit to cover up their payments deficits, and even to private borrowers (people who have declared bankruptcy in 2008) to buy foreign infrastructure wen it was being privatized, foreign stocks and bonds, and even to the arbitraging industry, so that they can borrow at a low interest rate to buy higher-yielding securities abroad.

The manipulation for quick returns by banks and their arbitraging customers will be always distorting the prevalent exchange rates dynamics in the currency world. The Fed has been and will be flooding the economy with (QE) liquidity in their attempt to increase growth, but in reality they would be creating bubbles in the US asset prices.... more to come ... in this article..