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!  

    Friday, July 29, 2011

    Tight Coupling of Financial Markets

    Nassim Nicholas Taleb made famous the concept of "tight coupling" to explain why there were sudden, interlocking failures in different markets or sudden crashes in prices of securities.
    A recent example highlights and illustrates this problem beautifully. An obscure book on genetics of a fly, The Making of a Fly, created a record on when the price quoted for a used copy of this out-of-print book went up to beyond $23 Mn (shipping $3 extra) as recently as in April this year! (At the time of writing, the price was down to $65) 
    What happened? 
    Apparently, two booksellers who listed this book as among their offerings, had an algorithm (i.e., a computer program) that quoted the price of the books, esp. used books, they offered for sale, so that the price that was quoted was never very far from the market price. Quite independently, the algorithm both used took, among other things, the price quoted by the other as a benchmark, and raised it by about 10%. So, effectively these algorithms competed with each other to set a higher price! It is easy, knowing this, to understand how this caused the price to spiral beyond reason. With no human being checking the price quoted, the price soon went beyond the dictates of reason, with no stopper!
    Exactly the same thing happens in stock markets as well. This is especially true in the so-called High Frequency Trading (HFT) firms. Today, well over 70% of the trades by volume as well as value in the US are carried out by HFT firms' computers that initiate orders based on information received electronically, before human traders can even read and process the information they observe, leave alone decide and implement the decision. 
    Algorithmic trading, or algo trading, or simply black box trading, is also used to divide large trades into several smaller trades in order to manage market impact, and risk. Sell side traders, such as market makers and some hedge funds, provide liquidity to the market, generating and executing orders automatically. Algo trading is also used almost every investment strategy for market making, arbitrage, or pure speculation (including trend following). That is the "good side" of algo-trading.
    It is very common for traders to also put in "stop-loss" limits in algorithms - the point to which, if the price falls, a sell order at market is implemented. This is intended to cap the downside of any bet taken. However, there is a major side-effect of this: When prices are falling, when stop-losses are triggered, the number of shares being sold sharply rises - which results in the prices falling further, which then sets off a fresh wave of stop-loss orders ... and so on, till you have a price crash that nobody can stop, because it all happens faster than the human mind can comprehend and act on! This is analogous to how we get pile-ups on high-speed superhighways, but much lesser scale of accidents on very crowded roads.
    That is the reason why, today, sudden single-day (or even single-hour) falls in several markets all over the world are unsettling, but alas, not infrequent occurrences.
    In the next few days, I will be writing more on algorithmic trading. Look out for more!

    Tuesday, July 26, 2011

    Some scary statistics about the US - revisited

    In April, 2010, I had blogged about some scary statistics about the US economy. I revisited these statistics, and here are the results. While everyone is absorbed about whether the Republicans will agree to increase the US debt ceiling, let us revisit some statistics that looked scary to me in April, 2010. Let us see what has happened since then.
    • US National Debt has gone up from 89% of US GDP to 98% of GDP.
    • Total US Public Debt stands at $14.293 Trillion; by August, it will touch $14.3 Trillion, which is the current ceiling.
    • US GDP per citizen has actually gone up by a little over $1,100, in spite of increasing unemployment numbers.
    • However, US National Debt per citizen has gone up by $5,200 in the same period.
    • US Debt held by foreign countries has gone up from $3.875 Trillion to $4.584 Trillion.
    • US external debt to GDP ratio has crossed 100%. The equivalent figure currently for India is 21%. For the UK and France, this ratio is at a staggering 388% and 208% respectively.
    • Assets per citizen has gone up by $8,900 while Liabilities per citizen has gone up by a staggering $674,000. Similarly, Interest burden per citizen is up from $1,493 to $11,664.
    • There has been winding down of about 5% of currency and credit derivative exposures, but a much longer road remains to be traversed.
    • All-in-all, a dismal report card. For a Nobel Peace Prize-winning President who has got the US involved in a third senseless aggression in Libya, and so far failed to unwind its involvement in two other messy wars it has been engaged in for more than a decade. 

    8 Apr, 2010
    26 Jul, 2011
    US National Debt to GDP (%):
    US National Debt per citizen ($):
    US GDP per citizen ($):
    US Total Debt per citizen ($):
    US Personal Debt per citizen ($):
    US Interest Burden per citizen ($):
    US Total Assets per citizen ($):
    US Total Liabilities per citizen ($):
    US Gross Domestic Product ($):
    14.333 Trillion
    14.809 Trillion
    US Debt held by Foreign Countries ($):
    3.875 Trillion
    4.584 Trillion
    US Government Bailout ($):
    6.387 Trillion

    Currency and Credit Derivatives ($):
    648.975 Trillion
    611.499 Trillion

    • One point about India: Gold is a bulwark against uncertainty. Indian Government's holding of gold currently is higher than all countries save 9; if the private hoard of gold in Indian families is taken into account, India's gold holdings would be at least twice that of any other country on Earth. Gold prices are at their record high of $1,600 and John Paulson (the hedge fund manager who made a killing in 2008 by betting that the sub-prime crisis would result in CDO/CMO defaults) says it will touch $4,000 an ounce in the next 3-5 years.

    Sunday, July 24, 2011

    An old haunt gone!

    I squirmed unhappily when I read today that the New & Secondhand Bookshop at Dhobi Talao has closed down. This had been a regular haunt for me during my college days, when, unfortunately, when I coveted so many books in their collection, I made do with lovingly browsing them because my pockets were almost always empty in those days. I squirmed because of the thought that crossed my mind - that my inability to provide them custom when I could afford it partly contributed to their closure. While I regularly visit Strand, either at their flagship store off PM Road, somehow, I never did visit NSB since the time I graduated. Yet, the sheer joy I experienced when browsing for hours without a penny in my pocket to buy any book, was enough to immediately evoke pure nostalgia tinged with regret when I read the news of its closure.
    I also remembered my uncle, Chaitanya D Haldipur, who had first pointed out NSB to me when I was probably still in school - he was also the first person I knew who undertook a project to plot our Family Tree - a task which I had the pleasure of completing last year, culminating in a 76-page self-published book. I was glad to remember him in the preface to that book (p6). I am equally happy to remember him now, as I write, for pointing out NSB to me. The lifelong love affair with books was nourished by my browsing experiences at NSB. I now realize that my uncle had subtly changed my life in more than one way. One of his daughters, Swati, now settled in the US, used to write a scrumptious blog called Khane bhi do yaaro till she got pre-occupied with bringing up her first child. Swati, if you read this, please know that at least one fan is waiting for you to resume writing soon!  
    106 years is a long time to run a bookstore - it was run by at least 3 full generations of the Vishrams. My thanks to the family that ran this unique institution - you have played a great role in my life, and I am sure, in the lives of many others, by inculcating a lifelong passion for books.  

    Friday, July 22, 2011

    Which country does each Indian state compare with?

    We know that we add an Australia every month to our population.

    We know that each state of India is big enough to be a separate country by itself. Like each vertical in an Infosys or TCS could be a respectable-sized company itself.

    But The Economist has done a great job bringing such comparisons alive. We know now that Maharashtra's GDP is as much as Singapore; its per capita GDP compares well with Sr Lanka's and its population with Mexico. Karnataka's GDP is as big as Coratia's; per capita GDP as much as the Phillipines and population as much as Italy's.

    Enjoy this interactive map and gain insight into relative size of India's states and other countries.