At a time when our ability to save is reducing on a daily basis, we need to ensure that we take all precautions to avoid any reduction in the worth of what we have already got. We live in a time when our economic future is going to be determined by larger economic forces, and this shift from taking risks to make money to ensuring money is not lost is the key to a safe and painless future. Understanding these forces is the first step towards gaining better control. This article tries to explain the nature of future to come.

 

Context of the article

 

Increasingly, we observe that during debates on financial matters, folks with technical knowledge of the subject matter are able to emphasize the superiority of their logic, even though it does not jive with the common sense interpretation of the world of the other party.

 

This is the first article in the series of 2 articles I am writing to try and explain, with my limited knowledge,

Article 1 (this one): How the nature of money is itself going to change in the coming days?

Article 2: How one can avoid obvious mistakes while planning one’s investments?

 

This is meant for folks who would like to understand but are not too keen to look at hardcore business news for the same.

 

In this article, we are examining how the policies of the rest of the world are impacting their currency and Indian rupee. In the next article, I will mention the implications these changes have on our personal investment approaches.

 

Recall a heist movie first

 

All of us have seen many heist movies where the hero (in reality the anti-hero) is keen on stealing the plates using which he can print money at will. The most recent examples have been Don 2 in Hindi and The A-Team in English where the plot revolved around the stolen plates.

 

In nearly all the plots, the main reason why someone was stealing these was either:

• He/She was in need of money due to personal crisis/blackmail or
• He/She simply wanted to live a peaceful life next to some beautiful beach and not have a worrisome bone in the body.

 

Once the plates were stolen, the basic idea was the same: PRINT YOUR WAY OUT OF THE PROBLEM AND LIVE HAPPILY EVER AFTER….

 

Now Assume It’s Not a Movie At All

 

Imagine that this is indeed what is happening, but not illegitimately! It is actually happening with gay abandon across the world! Let us look at various geographies that matter to India:

 

• USA: The country entered into severe recession sometime in 2008 and then their government did something called “Quantitative Easing or QE”. It sounds important, but essentially what happened was that their central government said, “Look! I will release a lot of money into our internal financial system so that people can get easy loans and using that they can kisk start their business and the economy rebounds back!” Also, their government bailed out a lot of companies in their times of crises.

 

One year ago, I had documented their issues here.

 

US government did QE in 2 phases – QE 1 and QE 2. So in essence they tried to release limited amount of money in 2 different phases as per their assessment of the need to do so. Despite these, their situation did not improve completely!  Their jobs are not picking up and some industries show some sign of improvement but that does not last. So as a final resort, earlier they have announced QE 3. So how will this help if 1 and 2 did not help? Well it’s easy… This time they are releasing unlimited amount of money into the system for an indefinite period!

 

And where will they get with money from? Of course, they will print it silly!

 

 

• Europe: If you have been reading bad financial news for a few years now, you would know Europe had been constantly featuring in it. What’s wrong with it? Well.. as it turns out plenty! One year ago, I had documented their issues here.

 

In essence, they have a problem and each time they try to solve it the problem becomes bigger. Their problems started because they had a common currency but different policies on governance across the Euro Zone. The real solution lies in tackling that problem of removing the difference in approaches of various countries. Instead, each time as a solution they release some money into the European financial system by the way of bail outs (which is like giving money to sick economies as grant) or by the way of bond buying programs (which is like lending money at extremely low interest rates to sick economies as help). As I said the problem only keeps bigger. Each time they do this for one country, some other country says, “Look here! I want the money too. I did not tell you earlier but I am too sick too!” And the gravy train keeps coming.

 

So what they are trying to do as their final solution to take care of their problems? Well it’s easy… This time they are lending unlimited amount of money to those who need in Europe at extremely low interest rates though a bond buying program! Unlike USA there is indeed a case in Europe to increase this supply of money to those who have been absolutely crippled by a long time of austerity, but this is still a wrong solution to the original problem of having a dysfunctional system!

 

And where will they get with money from? Of course, they will print it silly!

                                                                                                                        

 

• China: For a long time now, China’s economy is slowing. Their manufacturing orders are slowing and they have built a lot many more homes than what people can buy. So their industry is struggling.

 

One year ago, I had documented some of their issues here.

 

Since China is a country that exports more than it imports, if the rest of the world is not doing well then it will face the biggest crunch in terms of inventory and finished goods lying in its warehouses. To help this situation, it is allowing its domestic small companies and individual citizens to borrow more and more money at lower and lower interest rates. They believe that when people get cheap money they will spend more and so their economy will avoid something called a hard landing (rapid slowdown in our terms!)

 

So in essence, this money they have decided to release more money into their system at lower interest rates.

 

And where will they get with money from? Of course, they will print it silly!

 

 

• Brazil and Australia: When China coughs, Brazil and Australia catch severe cold. This is because most of the minerals that China imports for its manufacturing are imported from these 2 countries. Apart from revenue from mining, little is going strong in Brazil and Australia that can really support them. For e.g, in Brazil rest of the economy is made up more of agriculture and tourism and in Australia rest of the economy is made up more of tourism and sports!

 

So in essence, these 2 countries are also going to slow down a lot because of China. To help their situation, they are also doing what the rest of the world is doing! In Brazil, they have already decided to release more money in to the system by reducing bank interest rates to a record low and Australia may do the same in coming days.

 

And where will they get with money from? Of course, they will print it silly!

 

 

• Japan: Same story.. Another country. Japan followed the path of China and released a lot of money into their system earlier this month.

 

And where will they get with money from? Of course, they will print it silly!

 

 

Please note… In all the above cases, we are not talking about some petty thieves! These folks who are making decision are in charge of the financial health of their respective countries! All of them know something that we do not realize: that the health of global economy is not improving for some time to come and the only way to make more money is to print it!

 

The basic intention remains quite noble in all cases: print enough money so that those who need it can get it quite cheaply and then are able to do something worthwhile with it. And when they pay us back, all will be good! They are acting like those heroes who have to resort to desperate measures are desperate times!

 

Can anyone regulate human nature?

 

The basic premise of globalization is that anyone can invest in any part of the world freely and expect to get fair returns on the investment. That means that if there are right incentives, then people who get this money from government may not actually invest back in their own countries but will invest elsewhere to get more returns. It does not necessarily mean that everyone is hell bent on cheating but this statement is simply made to keep us aware that such a possibility exists.

 

So is that beach house even possible?

 

Not sure yet! Let’s investigate.

 

In my childhood, I used to wonder why the government cannot print more money and give for free to all to remove poverty. Now it turns out, I was not the only one to have that dream. Reserve Bank Governors from all over the world have the same dream and are printing their money to get out of bad times!

 

Will it succeed? To answer, let’s ask ourselves first:  if we make one lakh per month while our needs are met by forty thousand, then what do we do about the remaining money? I dare say, we start by thinking that we will save all of that but we lose that discipline over the coming days and the 1^st habit we lose thereafter is the habit of bargaining! In other words, we are more prone to pay a little bit extra for each thing we buy simply because we can afford it. In other words, the utility of the same money in our wallet is lesser in our eyes as we know there’s more where this came from!

 

So if you and I change our behavior in times of cheap money, why will other countries and their citizens not do the same?

 

Before going further, let’s dive into how economics follow common sense.

 

Question 1: What drives price points in any economy? (In essence how things become expensive in such times of plush money)

Answer: If money is available more easily or if it exchanges hands more easily, then price levels in any economy are likely to increase. The only way to reduce those price levels will be make sure that people spend more and on buying stuff which will keep general prices low. Simply put, in times when money is easily available or when money exchanges hands very easily the only way to control price is to make sure people spend more and more frequently buying real goods which need to be made available more and more easily.

So as a bottom-line, till the times people continue to spend, inflation won’t jack up but when money is available easily but people don’t spend on buying real goods from real world then inflation will go up. Typically, this happens a few days/months/years after cheap money is made available when all the people have all the things they need and the only thing they invest anymore are on luxurious goods/value added services. Since all of us feel naturally satisfied after our needs are met, all of us naturally get into a situation where we don’t mind spending on irrelevant stuff and so prices increase.

BOTTOM-LINE 1: PRICES ARE GOING TO INCREASE IN THE WORLD IF UNLIMITED CHEAP MONEY IS MADE AVAILABLE FOR UNLIMITED TIME!

 

Question 2: What determines exchange rates between 2 currencies?

Answer: Each country has to transact with the external world. If a country borrows more from the world than what it produces (trade deficit), then has to spend more of its own money to pay for external obligations. So in essence, the value of its currency decreases. Similarly, if a country has higher inflation as compared another country, then the purchasing power of its currency reduces as compared to the other country and so the value of its currency decreases. Finally, if the interest rates in a country are higher than the lenders in that country will prefer to invest within the country itself as they will get higher return.

 

There are other factors too that determine exchange rates, but the bottom line remains the same that the value of a currency as compared to others will reduce if there is:

• High inflation
• Low interest rates
• High trade deficit

 

I am sure we recognize where all this is leading us to.

BOTTOM-LINE 2: CHEAP MONEY IS BRINGING THE OUTSIDE WORLD TO A SITUATION WHERE THERE COULD BE HIGH INFLATION COMBINED WITH REDUCING INHERENET WORTH OF THE CURENCY THEY ARE PRINTING.

 

So what about that beach house?

 

I think we can all agree that if one can get such currency printing plates then temporarily one can get out of pains and can buy a beach house. But as time progresses, one will realize that the same money one is printing day in and day out will lose its worth and everything else will seem so damn expensive! Eventually, By The Time One’s Children Grow Up One Won’t Be Able To Afford The Same Lifestyle As The Printing Plates Will Be Nearly Worthless By Then!

 

This, in popular parlance, is called: ‘Kicking the can down the road!’ No wonder soccer/football is the most popular sport in most of these countries!

 

Hey Bhagwaan! What about India then?

 

A year ago, I had documented about our country, which was like a train wreck. Many of the factors I had mentioned in the initial part of that article still hold true to me. A discerning reader is asked to make his/her own judgment.

 

Despite all the chest thumping we do about how strong we are, we are not the most important economy in the world. We are still in our pre-teens as compared to the near mature growitth of many of our competitors. We are not the biggest investors within India itself, let alone the world. Strength of the manufacturing sector of any big country determines the inherent strength of that country. That is the ONE SECTOR that generates real wealth in the country. In India, manufacturing is a much smaller component of our economy (less than 20%) as compared to any other developed country (60% at least). On a side note, this is one reason I believe one should oppose FDI and should explore an alternate set of reforms that will help our economy.

 

Net-net, we don’t contribute enough back to the world to be compared a serious player. We retain the world’s interest as we have enough opportunities for them to explore.

 

From our own side, we continue to spend more and earn less. We have tried a temporary fix by earning money by selling some of our profitable government firms (divestment) and by making sure we don’t invest when the rest of the world can do so on our behalf (reforms), but as I said.. That’s temporary. Next year, with elections coming, we will again start our spending spree with social initiatives (like Nrega/Farmer Loan Waiver before the previous election) and that will mean that government will again spend much more and to boot, populate the marked with cheap money.

 

Recall what we discussed about prices some time back. When people suddenly get a lot of free money, and/or if the money exchanges hands really fast then prices rise if all that money is not spent immediately buying goods.

 

So what we are doing?

• Government has initiated scheme for direct cash transfer: This is to contain corruption in subsidy schemes. The idea is good, but it is tackling the issue of corruption rather than solving the issue of subsidies. So net-net, we will have cheaper money available directly in hands

 

• There is a chance that government will allow more welfare schemes for 2014 elections: This will mean that a speed with which money will exchange hands in economy will increase and the deficit in our finances, which is already high, will keep getting higher.

 

• Instead of asking people to spend more, government is spending more on behalf of people. This is not only reducing the productivity of our labor, but is also increasing the wages in rural India. That means we are already destroying our ability to profitability produce quality goods and services in the future.

 

 

That can lead to nowhere else but I one direction.

BOTTOM-LINE 3: INFLATION IN INDIA IS NOT COMING DOWN ANY TIME SOON!

 

So is all doom and gloom! No, there are a few Indians who are genuinely gurarding us against total disaster that can come out of our policies.

 

Hail Subbu – The Governor of RBI

 

Recall how a few minutes ago we realized that when inflation is high and the government finances are bad then the currency of the country loses its flavor. Well those 2 are happening in India. But there is one superman trying to save us. He is none other than Dr Duvvuri Subbarao, the Reserve Bank of India (RBI) Governor. Subbu has refused to release cheap money into the country’s economy by reduction of something called Repo Rate. It is the rate at which banks borrow from RBI and so if they get money cheaply then they will lend cheaply and so the country will be awash with cheap money.

 

This has 2 advantages:

• Controlling of exchange rates: If rates were reduced, our Rupee would have fallen further as compared to other currencies and so all our imports (which are more than exports) would have become that much more expensive. Our domestic manufacturers would have been killed more by that loss than saved by gaining in low rate finance.

 

• Prevent Misuse of Cheap Money: People with money know that won’t invest in India because there’s simply too much hassle. So if they had got money from government at low rates they would have been more interested to invest outside India, thereby making a complete mockery of the government’s intentions.

 

So where does this lead to?

 

BOTTOM-LINE 4: THOUGH INDIAN RUPEE HAS LOST A LOT OF VALUE IT WOULD HAVE INVARIABLY LOST MUCH MORE OF ITS VALUE AS COMPARED TO THE WORLD IF NOT FROM THE SOUND POLICY OF OUR RBI AND ABSOLUTELY POOR CONDITIONS OF THE REST OF THE WORLD (DESCRIBED ABOVE IN THE ARTICLE). FOR NOW, WHETHER IT LOSES ANY MORE VALUE WILL DEPEND ON WHETHER OUR RBI GOVERNOR REDUCES ANY RATES AND WHETHER THE SITUATION IN THE REST OF THE WORLD IMPROVES.

 

So what are the forces we have learnt about?

 

From the above logic, it is evident that in the coming days we are going to see:

a)      Cheap money in the rest of the world,

b)      The currencies of the rest of the world are sure to lose their value

c)      A period of high inflation in India,

d)      Whether Indian rupee will gain as compared to others will depend on how better we can control our finances (very low chance) and how long can we prevent interest rates from going down (Hail Subbu for this!).

 

ABOVE FACTORS HAVE OBVIOUS IMPLICATIONS ON HOW THESE POINTS IMPACT THE VALUE OF RUPEE WE HAVE IN OUR WALLET, THE VALUE OF WHAT WE HAVE IN OUR BANKS, HOW WE SHOULD PLAN TO INVEST IN STOCKS, HOW WE SHOULD PLAN TO INVEST IN METALS AND HOW WE SHOULD ENSURE WE DON’T LOST AT ANY COST.

 

WE WILL COVER THAT IN THE NEXT ARTICLE.

 

<<An earlier version of the article was published with a lot of typos. Those have been corrected by me to the extent possible>>