Risk from U.S.A

Last 2 years there have been many numbers of stories about how many banks went burst, how people lost their life savings, employment and their homes. What started as a sub-prime crisis in U.S. snowballed into a huge credit crisis over the globe, especially developed countries. Countries which topped in quality of life indices like Iceland went burst overnight. Recently it is the turn of Dubai and Greece to go burst. There is a fear that many more countries would go burst in 2010. When a country is unable to honour its credit obligations, it goes burst and this is known as Sovereign risk.

Recent episodes like Greece and Dubai have clearly highlighted that the chances of a sovereign defaulting on its debt is perhaps higher now than any other time in history. Hence, banks do not want to take chance.

As per a leading daily, top managers of some large banks are now discussing whether they need to start making provisions for different forms of sovereign risk, in the same manner as they now make reserves for corporate or emerging market risks. Whether this could be executable is not known for sure. What we know for sure is just as mortgage and corporate risk were the big themes of 2008 and 2009; sovereign risk is likely to emerge as one of the biggest themes in 2010.

 Also there is now a unanimous consensus among leading Economists across the globe that U.S. Dollar would find it very difficult to maintain its supremacy and would be greatly weakened. This would result in reduced global supremacy too. U.S.’s strength has been its dollar, technology and defence. With economic strength reducing it is likely have to reduced power in global affairs. This cannot be palatable for it. So it may start more wars to ‘end all wars’ so that it can have resources plundered from other countries. These wars can be fought under the disguise of eliminating terrorism or protecting western civilization from other ‘barbaric civilizations’ or ending oil monopoly or championing for the cause of democracy. The irony is that modern civilization demands wars are fought under a ‘noble cause’. Even historically, we’ve killed each other for ‘noble reasons’ in the name of religion, language, ethnicity etc.

Let us see how the dollar is going to be weakened.

It is very difficult to find a Chinese central banker getting a chance to air his personal views. But that protocol was broken recently. The Deputy Governor of the People’s Bank of China has let his views known to an academic audience. And it really turned out to be an eye opener of sorts. He feels that there aren’t just enough US dollars around to buy the gigantic US debt that is likely to come onboard in the coming months.

It should be noted that until 2006, the US ran a current account deficit to the tune of US$ 800 billion. This means that exporters to the US got US$ 800 billion annually and they used most of this to buy US debt. But with the US consumer going into a shell after the crisis, the current account deficit has come down an eye popping 50%, thus leaving the exporters with just US$ 400 billion with which to buy US debt.

On the other hand, debt issuance by the US has increased at an alarming pace, thus creating demand supply mismatch of epic proportions. Little wonder, investors are placing huge bets that price of US debt or in other words US treasury, would go into such a free fall that it would be difficult to arrest its decline. Of course, the US Fed can come to the rescue and buy all the excess debt, but this would mean injecting trillions and trillions of dollars worth of cash into the system and giving an open invitation to runaway inflation. Clearly, there seems to be no easy way out for the US out of its current mess.

As stated above, U.S. may resort to increasing its defence spending by waging more ‘noble’ wars which would obtain it control over more global resources (read oil), which would also fuel its failing economy. If you’ve read Samuel Huntington’s ‘ Clash of Civilization and the remaking of World Order’ and look it what’s happening now in the world, one gets a feeling that certain civilizations and countries would disappear from this planet and we may see a new world order in the coming decades. If nuclear weapons are used, Life as we know may cease to exist. If it all there is a destruction of this planet, it won’t be from any external sources (movie like 2012), but by our own mankind. This may very well happen even during our life time.

(with inputs from Equitymaster)

What Jim Chanos is currently bearish about?

We all know that Warren Buffett’s investment style is buying rock solid companies and staying invested in them for the long term. Now, what would be mirror image of this strategy? Shorting companies that look extremely weak fundamentally and holding the position for long periods. And the foremost practitioner of this art is a man called Jim Chanos. Called a short selling guru, Chanos is perhaps the most successful pure equities short seller in the world right now.

 Thus, when he is bearish on something, his words cannot be dismissed lightly. Ironically, he seems most bearish on a country that other investors feel is the most attractive growth story of the next decade or two. Indeed, we are referring to China.

Chanos believes that China is forging its GDP numbers on a massive scale by not providing adequate depreciation for a very, very shaky capital base and further adds that there is no bigger credit excess than China right now. In fact, he has called the China credit excess problem “Dubai times 1,000 or worse”.

There could well be a lot of merit in his argument. It is a well known fact that China’s export driven growth model has crumbled in the wake of the credit crisis and if it were to keep its economy on a higher growth path, the current model will have to be altered dramatically. We are not saying that it may not be able to do it. However, the transition may not be easy and there could be a lot of turbulence ahead. Perhaps, Chanos is pointing out to one such turbulence, which he believes could happen any time soon.

(Courtesy:Equitymaster)

Shaken by the sheikhs

Its since one year we’ve started our web portal cum blog. Ajit Dayal, the founder of Equitymaster is one of  the Investment Genius I admire. I’ve given below his recent article on Dubai crisis.

” The rabbit is a restless and nervous animal.

And investors, like frightened rabbits, went scurrying to safer haven on news that Nakheel, a real estate development company owned by the government of Dubai, would seek a 6-month moratorium on the payment of their interest and debt. Monies due in December 2009 by Nakheel would now be paid after May 2010.

As the Thanksgiving weekend broke in USA, investors rushed back into the US Dollar and government bonds issued by “safe” countries like USA and Germany. The MSCI Emerging Market Index of stocks declined by -5%. It had gained about +65% so far this year.

Long praised for its spectacular growth, Dubai has proven itself to be just another wonder of the era of free money – without a game plan on what to do the day the era of free money would end.

The “growth-by-debt” junkies

In many ways, Dubai is like a Citibank – built on the illusion that being “large” is the solution to every possible risk.

Just as Citibank saw every global citizen as a potential customer, Dubai saw every grain of sand as the foundation of a new real estate development project.

Just as Citibank added customers and businesses to get a larger share of your wallet, Dubai was busy building the largest buildings, the largest man-made islands, and the largest indoor ski-slopes.

“Build and they shall come” is the policy that the Chinese followed in the late 1990’s. Eventually the Chinese got hit by the write-offs in their state controlled enterprises (like the PSU companies in India).

And don’t forget the dusty business plans of private banks like ICICI Bank and most of the real estate firms in India.Many of the private sector banks wanted to “acquire customers” so that they could increase market share and have a “large” loan book.

Maybe these Indian companies have learnt their lessons and will be more careful in the future. Maybe.

Those managements that built their businesses on excessive debt and weak risk assessment were under severe strain after the bankruptcy of Lehman Brothers in September 2008. Dubai is a minor – but necessary reminder – on how a failure in one corner of the geographical world can shut down global credit markets.And hurt companies that rely on sucking money from any corner of the world to fund their growth.

But Dubai is by no means the only place being built on dreams.

The real estate firms in India saw every square foot of agricultural land as a way to use their political connections to sell you 0.6 square feet of property at exorbitant prices – and charge you on a per square foot basis. The real estate robber barons lived off their unabashed use of debt and the art of pricing on a super built-up area.

The US consumer must also have been a role model for Dubai’s ambitious debt-fuelled plans. Every item in a store was a “must-own” on the shopping lists of US consumers. And the same Citibanks of the world were willing to lend the US consumers money for their insatiable demand. The financial geniuses at Lehman, Goldman, and Merrill only did what any good financial engineering firms would do – found ways to trade that debt and make fees on it. The rating agencies – blinded once again by glamour and the fees they get from the issuers of debt – were once again behind the curve. 

Why is it shocking?

 
Any visitor to Dubai knew that the end was near.

 There were the newspaper articles on how people were leaving their debt-financed cards and unpaid credit cards at the airports and flying away to safety.

I guess the fine for not repaying debt must be pretty severe in Dubai.

Businessmen in Dubai knew that business was slow.

The fact that the government of Dubai was in trouble was not new.

It was as public as could be without really being written about in the press.

 But the surprise may have been in the fact that Abu Dhabi, the energy and cash rich Emirate “allowed” Dubai to make its statement on debt restructuring.

Or, worse, is it possible that Abu Dhabi was not even aware that its neighbour was about to seek a debt rehabilitation package?

Over the past few years, Abu Dhabi has seen its glamorous neighbour build monuments to the gods. With no energy reserves to speak of, Dubai was keen on establishing itself as the financial capital and trading capital of the Middle East and Africa. It was also presenting itself as the gateway to Pakistan and India.

Not a bad objective.

But, because it was funded by debt, the business plan was susceptible to cracks in global financial markets and to the changing sands of lending policies of nervous rabbits.

And, like the US consumers buying 5,000 square feet atrocious Mac Mansions for a family of three people, Dubai’s grand sizing was probably a bit idiotic.

As author Jim Krane noted on CNN, the tall buildings meant that every time someone on the top floor flushed the toilet, the water pumps had to send water half a mile up to refill the tanks for the next flush. A few tall buildings and a Palm complex, Krane noted, could use as much electricity as an entire city.Not very efficient for a country short of energy.

Should we sell Indian stocks?

Dubai is geographically closer to India than Lehman Brothers was.And we have more business links to Dubai than to Lehman.

Millions of Indians work and live in the Middle East and send their money back home. Indian banks lend money to some of these India-connected businesses. And Non-Resident Indians deposit their money in NRO and NRE accounts.

Yes, Dubai is more real and closer to us than Lehman was.

And will have more of an impact on the Indian economy.

But the negative fallout will be minimal.

Here is an extract from a comprehensive report in Economic Times: “Over 5 lakh Indians have returned from Dubai since September 2008, of which two lakh are Malayalees. Almost 60% of these people are technical or non-technical skills professionals. ‘Over 50 lakh Indians work in the Middle East of which 20 lakh are from Kerala. We do not expect large number of returnees now,’ K V Mohankumar, CEO of Kerala NRI group, Non Resident Keralites’ Affairs (Norka).”

Kerala has an estimated 20% of the total Middle-East exposure in terms of remittances. So there could be some localised problems in that state.

And there will be company specific problems: banks with loans to the sheikhdoms and companies with projects in the Middle East will declare their potential exposures in the next few days.

But the Dubai debt issue pales when compared to the Lehman bankruptcy. Lehman shocked global markets – the Dubai bankruptcy will re-price risk for companies in emerging markets. That is the big difference in the financial aspect of things. Lehman’s bankruptcy made all the rabbits around the world run for cover – they refused to lend money to anyone. The Dubai bankruptcy will make the rabbits search for patches of grass where they can eat their carrots in peace. India will be one such patch of grass where they will continue to chew away.

So, don’t sell Indian stocks because of what happens in Dubai.

And gold?

Gold will have a 2-way pull.

The flight to safety will move people towards gold.

But the flight to safety will also move people towards the US Dollar and weaken other currencies like the Indian Rupee.
So, while the price of gold in dollars may decline its value in Indian Rupee may stay the same

Well, the sheikhs have caused quite a stir.

Dubai’s government-controlled Nakheel went out to build the famous Palm Islands. Abu Dhabi – whether it likes it or not – will have to help build a Calm Island.

Moral: a mirage, built on debt, is still a mirage.
And a bunch of nervous rabbits looking for carrots in a mirage is a recipe for disaster.”