(this post is futherence of my last post on economic depression)
Since the begining of FY 2009 we have seen many policy announcements across the globe by governments trying to restore confidence into their respective economies. All possible monetary and fiscal measures have been adopted to abate the impact of recession / potential recession in economies across the globe. However, allow me to speak more on monetray measures rather than fiscal in this post of my blog.
It is really amazing looking at the amount of money that has got printed and is getting distributed to the needy sectors across the globe. Every one now seems to have made up his/her mind up that the worst is past us and we should see better days in the near future. Hmm... interesting! One doesn't have to be Einstein to figure out that when 1 dollar is printed it creates liquidity worth 10 and these 10 dollars are going to hit the market sooner or later. In some cases they already have. The equity markets have validated this fact in the recent past .. so what is happening after all?
My belief is this is 'Reflation'. Reflation usually is an outcome of increased money supply in the economy which clearly is the case this time. Also, the equity markets gave us a reflationary signal with commodity companies being real gainers in the recent rally. If one is a believer in this economic theory; commodity companies should continue to do well in this reflationaty phase as once may expect this reflation to eventually transform into an inflation (no matter how much time it takes) and inflation to push the commodity prices to new levels.
Rising commodity prices should also build a case for investing in emerging markets as most of these countries are producers of some of important commodities. Go long on the oil producing countries (who knows oil can be at $200 in the next 2 years). Similarly with currencies; commodity currencies should do well over the next inflation phase. Go long on the real assets as these are the safest bet against inflation. Inflation overall is bad for equity markets however will certainly boost the commodity companies in the coming year.
Reflation though also needs to be understood in the context of a fall. One may have several reflationary spikes in a recessionary fall and therefore the real question remains: whether this reflation is a rise within a fall or a spike within a rise (the U-Curve)? .. I just hope its the later.
Saturday, June 6, 2009
Wednesday, January 21, 2009
When do they start printing?
In an economic cycle, a downturn can be considered a consequence of an expansion reaching an unsustainable state, and is corrected by a brief decline.
Year 2009 hasn't had the best of start from an economic point of view. We are in midst of a widespread depression (if one may call it so) around the globe and quite honestly future looks bleak at this point in time.
In this post I have tried to identify the precusors of a downturn, tried to decipher what happens during a depression and finally how do we get out of it.
Begining of a Recession:
As mentioned in the first sentence of this post, recession begins when expansion begins an unsustainable state. This depression has been no different. What the world had seen in the past 4 years was a volumenous increase in the Money Supply (essentially coming from the velocity side of it). Securitization (a financial innovation) meant money could be recylced faster than ever before and there was widespread prosperity in almost all economies of the world. Growth was the only mantra for governments world wide with inflation being over looked slightly longer than expected. So here's a list of lesson's learnt (not exhaustive by any means):
1. Money supply widened - velocity effect dominated
2. There was growth in the system - demand economics played a vital role
3. Inflation caught up with growth - again the money supply + demand effect
4. Unemployment was low (usually a low unemployment rate of 4% in US signals begining of a recession)
5. Marginal propensity to save was almost Zero .. people could afford luxuries
Governments woke up one day to realise we are growing too fast and inflation needs to be checked. This led to all governments raising interest rates.
During a recession:
Having read how it all began lets now look at the characteristics of a recession:
1. The phenomenon which begins as an inflation control measures actually stifles out business apetite. Governments raise interest rates to such an extent that Cost of Funding become greater than the Return on investments expected out of a particular business.
2. This leads to production cuts as the marginal produce which was profitable for business would suddenly become unprofitable. Hence, there is no choice but to lay off all resoruces needed to produce this marginal good. This is leads to unemployment.
3. Wide spread unemployment leads to cut in spending and expenditure which in turn affects the economic growth. Typically in a recession it is not surprising to see negative growth for 2 or 3 quarters on a trot.
4. The inflation now starts to moderate as well because prices are no more affordable and producers are willing to cut prices due to cost savings on laid off reseoucres.
Finally the Government starts to cut rates and tries and correct the liquidity mismatch in the sytem. One fine day the monetary policy measures of the government exhaust themselves (interest rate is Zero)
What ends a recession then?
Recession's can be long lasting and every measure taken to overcome them may not help in the short run (short term may even be 10 years). However, like every expansion, every recession ends as well. Once the recession is well recognised in the system, governments across the world start resorting to Fiscal measures:
1. Cutting taxes and duities: Reducing corporate and personal taxation may serve as a useful trigger in countering recession. As previously mentioned, if the post tax ROI is greater than cost of Funding business apetite would rise, leading to new employment and circularity of spending.
2. Deficit financing: A deficit financing means that the government is spending more than what its earnings. In other words local government would borrow from foreign governments. However in this recession money is in short supply all round the globe and hence governments all arounnd the world would have to start printing currencies and supply it into the markets. Printing currencies may not lead to inflation if there is very high unemployment in the economy (I wonder if governments all round the globe are waiting for this to happen). Also printing money may change the foreign currency dynamica, however, its surely better to slow death.
It remains to be seen now when goverments resort to this last emasure of countering recession. Hopefully soon...they should all start priting.
Year 2009 hasn't had the best of start from an economic point of view. We are in midst of a widespread depression (if one may call it so) around the globe and quite honestly future looks bleak at this point in time.
In this post I have tried to identify the precusors of a downturn, tried to decipher what happens during a depression and finally how do we get out of it.
Begining of a Recession:
As mentioned in the first sentence of this post, recession begins when expansion begins an unsustainable state. This depression has been no different. What the world had seen in the past 4 years was a volumenous increase in the Money Supply (essentially coming from the velocity side of it). Securitization (a financial innovation) meant money could be recylced faster than ever before and there was widespread prosperity in almost all economies of the world. Growth was the only mantra for governments world wide with inflation being over looked slightly longer than expected. So here's a list of lesson's learnt (not exhaustive by any means):
1. Money supply widened - velocity effect dominated
2. There was growth in the system - demand economics played a vital role
3. Inflation caught up with growth - again the money supply + demand effect
4. Unemployment was low (usually a low unemployment rate of 4% in US signals begining of a recession)
5. Marginal propensity to save was almost Zero .. people could afford luxuries
Governments woke up one day to realise we are growing too fast and inflation needs to be checked. This led to all governments raising interest rates.
During a recession:
Having read how it all began lets now look at the characteristics of a recession:
1. The phenomenon which begins as an inflation control measures actually stifles out business apetite. Governments raise interest rates to such an extent that Cost of Funding become greater than the Return on investments expected out of a particular business.
2. This leads to production cuts as the marginal produce which was profitable for business would suddenly become unprofitable. Hence, there is no choice but to lay off all resoruces needed to produce this marginal good. This is leads to unemployment.
3. Wide spread unemployment leads to cut in spending and expenditure which in turn affects the economic growth. Typically in a recession it is not surprising to see negative growth for 2 or 3 quarters on a trot.
4. The inflation now starts to moderate as well because prices are no more affordable and producers are willing to cut prices due to cost savings on laid off reseoucres.
Finally the Government starts to cut rates and tries and correct the liquidity mismatch in the sytem. One fine day the monetary policy measures of the government exhaust themselves (interest rate is Zero)
What ends a recession then?
Recession's can be long lasting and every measure taken to overcome them may not help in the short run (short term may even be 10 years). However, like every expansion, every recession ends as well. Once the recession is well recognised in the system, governments across the world start resorting to Fiscal measures:
1. Cutting taxes and duities: Reducing corporate and personal taxation may serve as a useful trigger in countering recession. As previously mentioned, if the post tax ROI is greater than cost of Funding business apetite would rise, leading to new employment and circularity of spending.
2. Deficit financing: A deficit financing means that the government is spending more than what its earnings. In other words local government would borrow from foreign governments. However in this recession money is in short supply all round the globe and hence governments all arounnd the world would have to start printing currencies and supply it into the markets. Printing currencies may not lead to inflation if there is very high unemployment in the economy (I wonder if governments all round the globe are waiting for this to happen). Also printing money may change the foreign currency dynamica, however, its surely better to slow death.
It remains to be seen now when goverments resort to this last emasure of countering recession. Hopefully soon...they should all start priting.
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