Saturday, October 11, 2008

Global Economy Web.. how did we get here?

Guest Post by Mani.

Let me make an attempt in explaining this whole mess in layman terms. This is a very complex concept yet simple. Depends on to what extent one would like to understand this. Let us begin with the fact that the economic crisis is more or less worldwide. Let us try and understand how this whole financial web is structured and how countries are interdependent. Each country has its own economic structure and size.

A typical indicator of a country’s economic strength is measured by its GDP (Gross domestic product). By definition what it means is "value of all final goods and services produced in a country in one year". The key components of a country’s economy are national income and output, unemployment rate and inflation. These are the key measures of economic strength of a country. Countries that have higher positive scores in these areas are considered economically strong.


How does the Government run a country?

This is very similar to how you run your home. To run your home you need income, you need governance, you have certain rules, you have needs and wants. To fulfill your needs and wants like shelter, food, utilities, education, entertainment etc, you need to spend money and buy these goods and services. So you see an income side and an expense side. When you budget for your expenses on a monthly or yearly basis you earmark some of your funds towards various categories like house, utilities, education, food, entertainment etc. The budget amount minus the income will give the surplus or deficit. If your income is greater than your expense you have a surplus and vice versa.

Same is the case with the country and the government. Government has categories of expenses like country’s infrastructure, defense, law and order and many more governance related expenses. The income for the country primarily comes from tax incomes and investments that the government has made in various markets and countries.

The following diagram is an attempt to show the macro economic structure:  

 Going back to the concepts of how the countries are interdependent in this world wide economic web. Countries trade between each other. Countries invest in each other. In simple terms, countries like the US when they have deficit in their budget they sell government bonds and treasury bills to investors. In many cases the investors could be a different country. They buy up U.S. companies, real estate, and toll roads. They also purchase U.S. financial assets. They finance the U.S. government budget deficit by purchasing Treasury bonds and bills. They help to finance the U.S. mortgage market by purchasing Fannie Mae and Freddie Mac bonds. They buy financial instruments, such as mortgage-backed securities and other derivatives, from U.S. investment banks, and that is how the U.S. financial crisis was spread abroad.

One reason the U.S. trade deficit is so large is the practice of U.S. Corporation off shoring their production of goods and services for U.S. markets. When these products are brought into the U.S. to be sold, they count as imports.

Where did this crisis start?

Financial deregulation was an important factor in the development of the crisis. The most reckless deregulation occurred in 1999, 2000, and 2004.

In 2004, Henry M. Paulson Jr.(current secretary of treasury), was then the head of the investment bank Goldman Sachs, convinced SEC (Securities and exchange commission – similar to SEBI in India) commissioners to exempt the investment banks from maintaining reserves to cover losses on investments. The exemption granted by the SEC allowed the investment banks to leverage financial instruments beyond any bounds of prudence.

In place of time-proven standards, computer models engineered by hotshots determined acceptable risk. As one result, Bear Stearns, for example, pushed its leverage ratio to 33 to 1. For every one dollar in equity, the investment bank had $33 of debt!

It was computer models that led to the failure of Long-Term Capital Management in 1998, the first systemic threat to the financial system.

How the housing bubble was created?

[Subprime lending is a financial term that was popularized by the media during the "credit crunch" of 2007 and involves financial institutions providing credit to borrowers deemed "subprime" (sometimes referred to as "under-banked"). Subprime borrowers have a heightened perceived risk of default, such as those who have a history of loan delinquency or default, those with a recorded bankruptcy, or those with limited debt experience.]

Lax mortgage lending policies grew out of pressures placed on mortgage lenders during the 1990s by the US Department of Justice and federal regulatory agencies to race-norm their mortgage lending and to provide below-market loans to preferred minorities. Subprime mortgages became a potential systemic threat when issuers ceased to bear any risk by selling the mortgages, which were then amalgamated with other mortgages and became collateral for mortgage-backed securities.

Federal Reserve chairman Alan Greenspan’s inexplicable low interest rate policy allowed the systemic threat to develop. Low interest rates push up housing prices by lowering monthly mortgage payments, thus increasing housing demand. Rising home prices created equity to justify 100 percent mortgages. Buyers leveraged themselves to the hilt and lacked the ability to make payments when they lost their jobs or when adjustable rates and interest escalator clauses pushed up monthly payments. Greed was the primary root cause of this.

Wall Street analysts pushed financial institutions to increase their earnings, which they did by leveraging their assets and by insuring debt instruments instead of maintaining appropriate reserves. This spread the crisis from banks to insurance companies.

These phenomena have forced banks and investment banks to fail. This coupled with the economic recession has caused hundreds of thousands of jobs. When people lose their jobs, they lose their ability to pay back their debt and they default. Enormous default has caused a major strain on the banking system and insurance systems. This has created an infinite loop of catastrophe. This has created credit crisis which means that the banks are tightening their lending process and in many cases stopped lending. There are millions of small businesses in the US that depend heavily on the credit and even the ordinary house hold in America run on lot of credit. This is triggering more job losses and hence aggravating the economic crisis. People are not able to sell their houses as there are no buyers. Why no buyers? Because of the credit issues, banks are not lending money to people who want to buy houses. This is in turn causing liquidity issues in the system. Overall the whole economy is in a total mess.

The US government is trying to rescue this by pumping in $700 billion to bail the economy out. Earlier I mentioned about how government get money to meet their expenses. When your GDP is falling and when your economy is weakening, it is difficult for the government to borrow money. The interest rates will be very high and this in turn will cause a lot of strain in the financial system. Also when the government decides to print more money, this will sky rocket the inflation through the roof and will impact the economy negatively.

Coming to the question of how ICICI bank was impacted due to this?

Like I have explained above, Indian economy is also dependant on the global economy and our financial markets are impacted because the foreign institutional investors have started pulling their money out of India and that is why you see the market plummet the way it did in the last few weeks. ICICI bank had a good exposure to Lehmann Brothers which went bankrupt recently. So the investors and depositors of ICICI bank in India thought, ICICI bank will go under and that was the reason for the panic.

Tough times ahead.

Tuesday, February 26, 2008

Outsourced

I was surfing through the net.. digging up some past.. and I found Senator Barack Obama's speech after the Virginia Massacre. Bill Smith glorifies Obama's speech. He says "his instinct for abstraction and larger themes" is what endears Obama to the people! See the full article here. Quoting Obama...
"There's also another kind of violence that we're going to have to think about. It's not necessarily the physical violence, but the violence that we perpetrate on each other in other ways," he said, and goes on to catalog other forms of "violence."

There's the "verbal violence" of Imus.

There's "the violence of men and women who have worked all their lives and suddenly have the rug pulled out from under them because their job is moved to another country."

I read this and went "Whaa...". I can imagine a lay man talking about this.. but a senator, a prospective president? What was he thinking... Now I am irate that this is about outsourcing.. but that is not all, I am very upset because I thought Obama was a level headed guy.

(Pict Courtesy : http://www.kuleuven.be/thomas/secundair_onderwijs/in_de_kijker/37_globalisation.php)

But apparently he doesn't have the faintest clue about globalization. Did he know that globalization is a two-way street.. That it affects other countries in the world too? Come on did you really think outsourcing was only a problem in the US and everything was hunky dory on the other side? Oh yes, the other side of the grass is green is not it?

In India Globalization opened free trade. While we are on that, let me point out that America was always the advocate for free trade, as for India they were dragged in Kicking and Screaming. For America it opened up a huge market for their goods. A consumer market of over billion people, imagine that!

Dell and Microsoft sell their products to the billions in India. Coke and Pepsi have replaced the local Thumbs Up and Gold Spot of erstwhile years.. Ford and GM not only sell their cars there, slowly replacing Ambassdor's and Maruti's. They even have factories there and make use of the cheap labor. And where do you think the money goes.. to the US of A!!!

Subway, Mc Donald, Pizza hut and KFC adorn every corner slowly replacing the Indian fast foods. Further Nike and Adidas, Tommy and Channel have discovered a huge market in India. And many others are going there too. Including the supermarket chain Walmart. Imagine what this means to Indian brands and age old companies. This means more competition and the urge to do even better. In the end the consumer is benefited by the variety and competition.

Here is a 2002 report on India-US Trade and Economic relations. In the current year alone $830 million was the outflow from India to the US. Read more here. And the trend is only increasing with more and more revenue coming in every year!

That is the other side of the globalization coin.. if it is outsourcing in the US, it is free trade in India and China! But still outsourcing is talked of akin to violence. I mean get some perspective!! Gone are the days when Indians were replacing Americans and taking their jobs as Obama put it! Now Indian companies are recruiting Americans and creating opportunities in America, Britain, Australia , China and many other countries. Opening development centers in the US and offering jobs to the fresh engineers and management graduates from US Universities. This is globalization for you. If this had not been done, the same job would have gone to an Indian! But that is the beauty of globalization.. breaking the barriers. The 21st century is here, we better gear up and get ready for a global world and a global economy!

(Pict Courtesy: http://www.newint.org)

[Edited to add. Here is a video from Discovery Spotlight. Thomas Friedman the author of "The World is Flat" visits India to explore the other side of outsourcing

]

Thursday, February 21, 2008

Be forewarned... Global Warming!

(Pict Courtesy - http://alternative-energy.everything-fine.com/)

I watched the National Geographic documentary series Six Degrees Could Change the World. Like everything else in Nat Geo this was very graphic and reached out to me at a personal level like nothing else I have read or seen about Global Warming ever did.
On the first episode I watched the melting ice in Greenland.. slowly melting away and if the global temperature increases they could start melting at a faster pace! Later that week I watched another documentary on Antarctica. (I can't seem to remember on which channel that was) In the documentary a researcher on the base station in Antarctica spoke in a matter-of fact tone .. "When I came here a few years ago, there was Ice everywhere and I could not imagine a ship coming here " (Pointing to the ship that brought in the explorers - oh yes an antarctic expedition no less). "Choppers landed where the ship stands today he said". This was like a Deja Vu for me.. and fear gripped my heart!
I also watched the part about the Australian corals getting bleached.. no more Great Barrier Reef.. and this is true too.. In 2002 the Great Barrier Reef experienced the worst coral bleaching on record.. about 60% in Australia alone.. The cause a rise in the water temperature ..the result of global warming.
Today it was talk about a disappearing Ganges... the sacred Indian glacier.. The Glacier Gaumukh above the Gangotri where the Ganges starts has receded by about a kilometer in the past 20 years or so... So what happens if the glaciers disappear? What happens if Ganges disappears.. will this mean an end to the Spirituality of India as we know it? Ganges is believed to flow from Lord Shiva's head after all.. in an effort to stem the force of her flow from heaven to earth. So what will happen to the culture that stems from this belief?
Ever wonder what happened to the Dinosaurs? The end of the cretaceous era .. Either by a meteorite or huge volcanic eruptions..resulting in global warming, acid rains, reduced sunlight and finally ice age! How did the earth bounce back? All the carbon from the atmosphere was absorbed by the oceans and the plants and the soil. And the air was good to breathe again. The irony? We burn the very same fossil fuels today and start the cycle yet again!

Do watch the series Six Degrees Could Change the World on National Geographic. This is based on the book by Mark Lynas - Six Degrees. Its alarming to say the least and hopefully will awaken us to the effects of Global Warming.. What can we do to help? Recycle, burn less fuel.. car pool, walk, cycle... and lend your hand!

Like the trailer says "Global Warming isn't out of control but it soon could be. Warning signs are all around us. " It is up to us to take notice and be forewarned!

Tuesday, February 19, 2008

Drawing Parallels

We are so advanced in comparison to our co-inhabitors on this planet. We are the six-sensed human beings. And how do we have foresight and hindsight as we so call it. By a beautiful thing we do, called pattern matching. We love to pattern match and derive/ extrapolate from these matching patterns. Hence we predict anything from weather and catastrophes.

I recently watched heart in mouth this series on Nat Geo called Six Degrees. National Geography does have its way of keeping us in constant fear of the perils we are bound to face in the future! And they do this by extrapolation. All statements start with "With the rate at which the ice is melting...", "With the rate at which the global warming happens ..." and so on.

But that is science for you and we all accept it, as it seems very rational to us ,this analysis.

Now I ask you, what do you think of astrology? Astrology is the art of studying the position of the celestial bodies at the time of one's birth. Further with the movement of these celestial bodies and the patterns they take, the person's fate is predicted.

This to me seems to be pattern matching again. How did the astrologers know that certain celestial patterns/ movements characterize certain behavioral patterns/ events in the person. Because over the years they have pattern matched and extrapolate these learnings to come up with a science called Astrology.

So why do we believe one when we reject another?