Mish Shedlock notices India's credit-fueled bubble

Mish Shedlock has noticed that like China, India too is in the late stages of a credit-fueled boom. From is blog post Food, Fuel Inflation Hits India; Primary Price Index Up 15%, Credit Expansion Up 23%:

"The sustained growth assumptions of India and China at about 10% each are simply not going to happen. Both countries are overheating and there is a not so little constraint called peak oil that will get in the way. Should India maintain its rate of growth, do not expect to see any containment in price inflation. The same holds true for China."

Interestingly, Credit Expansion this year is up 23% whereas deposits are up only 15%. (The RBI had projected 20% & 18% respectively) . The banking system is using repo lines from the RBI to fill the 8% gap.

The RBI, on its part has raised rates to try and stem inflation. At the same time it is cutting the SLR to ease the strain on banks. Buying up the released government bonds is also issuing more liquidity into the system. Its a classic credit-bubble conundrum as I previously described here - how do you keep the musical chairs playing while keeping inflation in check? An impossible task!

As a nation India is borrowing and spending - on food, goods and services - and on leveraged property. Anecdotal evidence is that property flipping using bank loans is back in vogue in NCR (any views on Mumbai?).

See a detailed article on the RBIs moves here.

Inflation at the bottom of the Pyramid

I think this link sent by Abhishek speaks volumes. It is a clear illustration that the worldwide tsumani of QE type money printing is finding its way to the bottom of the purchasing power pyramid.

Indebted governments (who vest monetary authorities with their power) hate deflation more than anything else. It causes the value of their debts to go up in real terms. It also reduces their power to buy votes through government programs, which enables them to stay in power. QE style government debt monetization suits them just fine ... killing 2 birds with one stone – no deflation and no check on their spending habits.

As long as the monetary authorities do their best to “print their way out of trouble” the worldwide inflation in “things we need” will be unstoppable.

Those looking for a deflationary collapse will have to wait for a complete breakdown of the system. There may be mild deflation in leveraged assets such as housing but basics like food, oil, precious metals cannot be “printed” or “manufactured”. Their demand is constant and unyielding. Their supply is limited.

We live on a spherical planet. There is only one outcome of an exponential growth in the money supply and it is plain to see. Agri-foods may be one of the top investments of the coming decade given this scenario. From http://www.safehaven.com/article/19434/agri-food-thoughts :

The $200-Trillion Debt Which Cannot Be Named

The $200-Trillion Debt Which Cannot Be Named

If the Western monetary system were a person, it would long ago have been declared clinically insane and shipped off to an asylum. What is worse is the conspiracy of silence about the "real" US debt, which we have to assume parallels at least partially the debt of other Western nations. The whole of the West is busted, pretty much – and the "austerity" plans being put in place are just more window-dressing, albeit of a very nasty sort.

India's conundrum - High Growth and High Inflation

This speech by Dr Subir Gokarn (Deputy Governor, Reserve Bank of India ) is fairly typical. Take for instance the following statement:
I will begin by discussing the current inflationary scenario in India, which, as we have been saying in our recent assessments, is not very reassuring. I will then place this scenario in a broad historical context, with the intention of demonstrating that India has a good record of reining inflation in, regardless of what has driven it.
Anyone who doesn't know that inflation in India has always run rampant is either lying, or deluding himself with false statistics. All he is doing in his speech is to talk on about the components of inflation and a brief history of how it occurred.

To me this speech is the equivalent of a layman standing beside a volcano talking about the what happened during an eruption. He is describing the ash, smoke and fire. However he has no understanding of the geology behind volcanic eruptions or how to predict them.

So, what really explains the unusually high inflation in India? To understand inflation you have to understand the most important thing about inflation. And that is the following statement by Milton Friedman and Anna Schwartz, made in their influential book, A Monetary History of the United States, 1867-1960:

Inflation is always and everywhere a monetary phenomenon

"Friedman advocated a central bank policy aimed at keeping the supply and demand for money at equilibrium, as measured by growth in productivity and demand. The monetarist argument that the demand for money is a stable function gained considerable support during the late 1960s and 1970s from the work of David Laidler. The former head of the United States Federal Reserve, Alan Greenspan, is generally regarded as monetarist in his policy orientation. The European Central Bank officially bases its monetary policy on money supply targets. " - Wikipedia

The above statement provides a clear explanation and a solution to the problem of inflation in India as below:

1. Friedman says that inflation is due to money supply growth outstripping economic growth
   
2. A free-market economy has a natural DEFLATIONARY tendency due to innovation and efficiency.
   
3. Inflation is neither a precondition for, nor a consequence of sustainable growth in an economy.
   
4. When growth is accompanied by inflation it is a sure sign of a disproportionate growth in the supply of money
   
5. Inevitably this due to a DISPROPORTIONATE GROWTH in BANK CREDIT.
   
6. When banks lend short-term deposits over the long-term, it causes a growth in DEMAND DEPOSITS through the money multiplication mechanism.
   
7. These new deposits bid up the prices of goods and services because they appear in advance of an increase in production of new goods and services.
8. This MONETARY GROWTH shows up in the monetary statistics as an increase in the money multiplier.
   
9. Traditional central banking policy instruments such as tinkering with reserve requirements and raising repo-rates can not effectively restrict this credit expansion. Credit demand is a function of CONFIDENCE. The central bank can only dampen this confidence to a small extent.
   
10. Fast growing liquidity created by this credit growth fuels a high demand for a slow-growth in the quantity goods and services. This creates a feedback loop that increases CONFIDENCE further as businesses seek further bank credit to meet this demand.
    
11. This feedback loop increases the money supply further. In due course this process creates a CREDIT FUELED BOOM in the economy.
    
12. A CREDIT FUELED BOOM is typically accompanied by high inflation and assets bubbles. Witness the stock markets and property markets, wherein assets are priced above what is economically justifiable.
13. Eventually this BOOM turns to a BUST as frenzied investment in capacity outstrips real demand and highly leveraged businesses end up with no customers.
14. MISALLOCATED capital is written off. This BUST causes a disaster on the commercial banking system's balance sheet.
15. Addicted to easy credit the commercial bankers and industry will cry for bailouts and claim "NO ONE SAW THIS COMING."
16. Austrian economists will say "We did" and point to many versions of the above explanation that are ignored by the mainstream.
    
17. At this point Central Banks panic. They lower interest rates, inject liquidity, purchase distressed assets and print money.
18. Slowly, confidence will return. Low interest rates will fuel the next asset bubble and/or credit boom.
19. This time it will be worse because the entire system will expect the bailout even though they know the boom is unsustainable. This is a moral hazard which will lead to a generation of "Fed-watchers" who spout absurd things like "bad new is good because it will result in QE-II".
    

ALTERNATELY ....

1. A sustainable economic system is possible - where virtuous, sustainable growth is driven through capital markets, not bank credit.
   
2. Growth is accompanied by low inflation because money supply only increases to finance clearing of goods through self-liquidating credit, and not to finance capital expenditure.
   
3. In a sustainable system, investment of SAVINGS (deferred consumption) in capital goods and assets is NOT accompanied by any increase in DEMAND DEPOSITS.
4. In a sustainable system, BANK CREDIT only expands to satisfy demand for SELF-LIQUIDATING CREDIT. The venerable Letter of Credit system can expand bank credit efficiently to FINANCE the PRODUCTION and DISTRIBUTION of consumer goods in immediate demand. Its shrinks bank credit when this demand is satisfied.
   
5. In a sustainable system, CAPITAL INVESTMENT, including asset purchases, factors and facilities of production takes place in CAPITAL MARKETS, away from the commercial banking system.
6. Therefore, the solution to India's inflation problem is fairly simple:

Restrict COMMERCIAL BANK LENDING to financing the production and distribution of goods via self-liquidating credit.

... OR ALTERNATELY ADOPT A FREE MARKET APPROACH AS FOLLOWS ...

1. Open the mint to gold and silver. Issue the Indian Golden Rupee 100% backed by Gold and the Indian Silver Rupee 100% backed by silver. Declare them to be legal tender. There will be no further need for a central bank issued, debt-backed paper currency.
   
2. This one act will unlock India's biggest asset - the capital that is currently lying idle in India's enormous private gold hordes amounting to 25,0000 tons. A fraction of this will prove to be more than sufficient to power India's growth.
3. Dissolve the Reserve Bank of India. The absence of a lender of last resort during financial panics will automatically teach commercial banks to restrict lending to the highly marketable, self-liquidating credit that finances the production of semi-finished goods on their way to satisfy immediate consumer demand.
4. The only notes in circulation will be those issued by commercial banks, not the RBI. The market will judge the health of a bank by discounting its notes just it does for any other corporation.

Comments welcome. Feel free to distribute this to others.

How to stabilise the economic system

The origin of the boom and bust business cycle and the inherent instability of the modern financial system is due to the fractional-reserve banking system.

Banks and investment houses borrow short-term and lend long-term. This undercuts the very foundation of capitalism by distorting the price of long-term credit. For capitalism to work, the term structure of credit should accurately reflect the economy's time preference for future consumption - i.e. how much are people are putting away for future consumption and in what time frame.

Industry relies on an accurate signal from the capital markets to plan future production. Easy availability of long-term capital for industrial projects implies future demand. Scarcity of long-term capital implies no new projects should be undertaken because there are no savings which will absorb the additional production.

Borrowing short-term to lend long term creates an illusion of long-term savings where there are none. The resulting economic activity is doomed to fail because the consumption promised by the capital markets will never materialize. The bust that we face now is a necessary corollary to the boom. Nothing can be done to prevent it. All that the central bank and government interventions will do is to redistribute (read socialize) the pain.

To fix the system we have to take away the powers of banks to change the term structure of capital. After that laissez-faire policies with suffice.

Awakening the dream: A Paul Levy Article

A Paul Levy Article

About the military-industrial-financial 5th state running America.

Three years of rate rises - keeping the $ afloat

Over the past 5 years, the dollar has lost 30% against the pound and 20% against the Rupee.

In Nov 2003 the outlook for the dollar then (as now) was very bad indeed. Over the next four months the dollar slid 15% against the pound.

This was a MAJOR slide for the dollar, not just against the pound but against all currencies. For instance, the Reserve Bank of India had to keep the Rupee low otherwise Indian exporters would lose ground against the Chinese (who had a fixed exchange rate against the dollar) but the selling pressure on the dollar was massive. By April 2004 the dollar was down 12% to the Rupee from the start of the chart and looking to go further.

At this time, the US interest rates had been low because the Federal Reserve was trying to pump up the money supply in the economy to help it grow out of the post Sept 11th/dot-com bust slowdown. Although the Fed just about managed to prevent a recession, it created massive debt and a massive property & equity bubble as consumers and hedge funds took advantage of the low rates to borrow way too much to acquire houses and stocks.

Since the US was (and is still) running HUGE trade and budget deficits, it desperately needed some way to attract continue to attract foreign loans to finance these deficits. However, no one wants to loan to a falling currency and this can cause a downward spiral on the dollar value which would have been a cause for recession and inflation.

To stem the dollar decline the Fed was forced to announce the end of easy credit and had to start steeply increase interest rates from Spring 2004 (see chart below). The dollar "bounced" and stabilised as the world rolled back their oversold positions in the dollar. As the tightening cycle proceeded, the dollar "only" lost 10% against the pound over 2 years (until mid-2006) and held steady against the Rupee.



However, since the tightening has stopped, the dollar has resumed its decline and has again lost 10-15% against both the Pound and the Rupee.

At this point the Fed is between a rock and a hard place. Further rate hikes will worsen the property price falls across the US, reduce consumer spending, and lead to a recession.

NOT hiking rates on the other hand will cause the dollar to continue its downward path, losing about 10% an year. If the markets decide that a loss of 10% a year is not worth the 5% interest they get in US treasuries (which to me is a no brainer but Saudis & Chinese seem to be kinder than I am to the US), the dollar decline will accelerate. So any which way you look at it, the risk of holding dollars is too much unless you have some sort of political favour you are doing to the US.

Stick your monies in Rupees/Pounds/Euros/Gold until then. If you are in the U.S., you can do this if you have a brokerage account. Just purchase a Gold Exchange Traded Fund (ETF) (Symbols: GLD or IAU; Charts: http://finance.google.com/finance?q=IAU). Generally, gold goes up when the dollar goes down. A currency ETF can give you convenient exposure to other currencies, but the best idea is to get an excellent Fixed Deposit in India which will give you nearly 10% per year via your NRO account. You can bring back $50k per year so don't worry about the NRE/NRO distinction.

It would be a great idea to get a dollar loan to purchase gold. What you pay in interest will more than compensated for by the likely decline of the dollar while you are paying it back.