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.

150! be next...

If you are related to the field of finance in any small way .. u cant ignore but discuss about one instrument which could have made a jackpot for you this year. No prizes for guessing that this instrument is 'Oil'. Yesterday (friday - june 6th) saw highest intraday move for oil .. the price was $138.54 up 8.41% to a life high!

Now the question is who would buy oil at $138.54 a barrel? and most important who brought it upto $138.54 a dollars? .. answer to both these questions is not only difficult but devious. Here is just a possibility of reasons which have led to oil price explosion.

If you recollect; just recently Calpers had decided to increase its global allocation to commodities and so did other pension funds and endowments. An increase in unemployement rate; decelarating US economy and global infaltion fears have prompted these pension / endowment funds to re-think their asset liability mismatch. To the extent now that US interest rates trade at a negative real yield and fear of losing substantial capital through inflationary pressure has spurred a huge investment demand for oil. As we all know that only commodities serve as an anti-inflationary hedge; investment demand for Oil, gold and other soft commodities will continue to rise. Fact of the matter is oil is not a replacable input into industrial production; and a stable production demand coupled with this investment demand is spuriing up oil prices. Even if the global growth rate was to go down 2% this year and assuming 50% industrialization of growth; the demand for oil would be down just 4% ( 2%/50%); however, the investment demand has already covered up this difference. This is now becoming a problem for economies with current account deficits; as widening deficits are leading to currency devaluation which turns into a higher cost of input and further an inflation which is impossible to contain. And the mother of all problems is that no one can dare raise interest rates now to contain inflation as the financial market is already in midst of an impending credit distress. Any weak data now is an impetus for commodities like oil and there is no reason why Oil can't reach $150 in a months time.

Second reason for this spree in oil price is less of an issue but still a cause!... Being into the structured products world; i remember that during jan/feb/march many of the investment banks were engaged in selling Structures on oil which profitted from a fall in oil price. Infact one of the ideas we sold to our client was shorting Oil at $117 when the spot was $90; I am glad we didn't sell this one to our client. Such structures were caught by the investment demand mentioned earlier and resulted in a Bear trap. When these structures were squared off eventually it resulted in a price push to an already inflated price.

On the supply side nothing much has changed and to be honest nothing much has changed in terms of the real demand for Oil. However, we have just added two more dimensions to the demand-supply balance; Capital Protection (investment demand) and Leveraged trading (structured products) and unfortunately both of these are on the demand side of things.

There is reason to believe that this price of oil has no fundamental justification .. however I cant be sure to short Oil till the I know some god father has raised interest rates; killed inflation (or alteast put it to bed); our investment banking friends have sqaured their structures and most importantly there is investable real yield avaliable for pension funds in the markets.

Stay Delta nuetral! (Long Straddle)