Saturday, July 30, 2011

The US Debt Crisis: What does it mean for the World?

Let us do some crystal-ball gazing. 
  1. The US debt crisis would certainly have spooked central bankers the world over - they will already have stopped thinking of the dollar as impregnable. If dollar is not reliable as a reserve currency, what is? A few years ago, the Euro would have been seen as a viable alternative. No longer. The Euro and the Dollar are locked in a waltz on a downward sloping dance floor. 
  2. No single alternative will emerge. Over a period, before the US gets hit with its next politico-financial crisis (see para 7 below for a more detailed explanation), central bankers of smaller countries will move out of the dollar, eventually maintaining (maybe) no more than 3-4 weeks' US$ transactions worth of dollars. China will do it slowest of all, because they will get hit the most if they were to enter the market as sellers - China is an 8,000-pound gorilla in this arena. Three alternatives come to mind: (a)  more bilateral, regional and broader multilateral initiatives will emerge, for transacting in currencies other than the USD. (b) Gold will be a natural alternative for both, central bankers and the population in general, and (at least in dollar terms), gold will soon zoom past $2,000 per ounce though the present price, an all-time record, (at the time of writing) was at $1,637 in the spot market. (c) some strong currencies like will emerge as temporary havens, for example, Swiss francs.
  3. Rating agencies will have to revisit their sovereign rating norms. Currently, it is unthinkable in their models to question the rating of AAA to the US. The rating is maintained even though the country is (by their President's own admission on prime-time television) four days away from default. India's rating was junk grade in 1991, when India teetered on the brink of default, having forex reserves to pay for three weeks of oil imports.  Today, besides the US, Ireland, Portugal, Spain, and Italy (all these countries are either on the brink of default or have been bailed out at least once) are rated higher than India in Euromoney's 2011 country ratings. This already looks so untenable as to damage the reputation of the rater, rather than the country that is rated low! What's worse, rather than downgrade countries, Moody's created three sub-categories within countries with the same rating: resistant (the highest), resilient and vulnerable. So you have countries considered vulnerable in the sense that there is high probability that it may default on its debt. Yet, they have a credit rating of AAA. A higher rating means that companies in these countries can raise money more cheaply from anywhere in the world. 
  4. So it is ridiculous that world-beating companies from India have to pay a higher rate of interest on their borrowings when: 
    • both, the country and its companies boast of far better than average financials and economic projections,
    • very stable Government and political establishment, where successive Governments headed by different political parties have demonstrated continuing commitments to reform and globalization, 
    • the world's most transparent and efficient secondary capital markets (with T+2 settlement cycle), 
    • healthiest banking sector compared to almost any country in the Western world, overseen by the world's most competent central bankers, 
    • higher GDP growth rates and projections than most countries in the world of any consequence bar China,  
    • and world-beating companies and innovators that are major contenders in every major acquisition of any consequence in almost every country in the world.
    1. About gold, there is something strange going on: the record prices are bringing people in Europe to the jewelry stores, selling their necklaces and earrings. In India, the reverse is happening. Indians are buying up more gold than before, even at never-before prices! Make no mistake, the Indians are the wise guys. 
    2. The US debt crisis is worse than one thinks. The US Government has gotten used to record fiscal deficits. There is no way they will mend their ways. Even if the August 2 crisis is averted, President Obama himself has said that the current law raising the limit will only enable the US to pay for what they have already spent. Nobody seems to notice, especially the sovereign credit raters, that this is the classic definition of a debt trap - struggling to borrow to pay for what you have already spent. Before long, the US will need more limits, to pay for the deficit they are already building up. Obama will end up specializing in going to the House to ask for more money to pay for his predecessor's follies and his own inability to entirely reverse them. A simple statistic is telling: From April 2010 till today, the average per capita GDP has gone up by $1,100 with rising unemployment ("jobless growth") while US per capita National Debt has gone up by $5,200. 
    3. China has to manage the other end of the sword - while the US's declining influence will mean its rise, economically, it will hurt more than any other country save the US, from a declining dollar, because they have trillions of them in their coffers.
    4. I was amused to read that Apple Inc is today more cash-rich than the US Government, the most powerful Government on Earth!  

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