Unfortunately have been behind in my writing and analysis owing to a recent overload of work. However, did sneak out some time last night to update my computation of liquidity based on RBI data. The downtrend in liquidity does appears to be intact.
However, in the interest of partial discloure, my computation of liquidity is based on multiple factors and data points - some of which unfortunately have a time lag of around as much as 2 months to be reported. Hence the computation of liquidity, as illustrated in the graphic above, lags the actuals by a couple of months. One of the key components in my computation of liquidity is the measure of money supply, where the data is disclosed by RBI fortnightly. Here is what the recent picture of M3 year-on-year growth rates looks to be:
This graph is interesting in the sense that it reflects a minor rise in monetary inflation since the October time-frame. Based on projections based on the variables that I use for my custom measure of liquidity, I feel that it would be safe to assume that liquidity has effectively bottomed out heralding the end of the last phase of the bull markets on the bourses.
The BSE Sensex index appears to be flirting with the 21,000, levels as I write this blog post. There is still an remote possibility of the markets making a top of 22,000 or there-of. However, would advise booking profits and exiting markets at a range of between 21,000-21,500.
NB: The information, tools and material presented here-in are for informational purposes only. This should not be considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities, investment products or other financial instruments, nor to constitute any advice or recommendation with respect to such securities,
investment products or other financial instruments.
"This is what devaluation means. It is a confession of bankruptcy." ~ Henry Hazlitt
Recently I read in the newspapers that a language enthusiast had suggested that the word "Rupeed" be introduced into the dictionary to describe a rapid fall and be used as a verb in conversations like, "I tripped and rupeed." It is nice to note that some Indian's haven't lost their sense of humour despite the economic pain that the tumbling rupee indicates. However I am appalled at the analysis that I come across in the financial press. They seem to attribute the blame for the rupee collapse to almost every factor... but the real one. The blame is billed on multiple factor such as "external shocks", the fiscal deficit, CAD, declining forex reserves, India's hunger for petrol and gold, global economic weakness, sentiments, growing exodus of funds from emerging markets etc etc etc... in short everything but the true reasons. The Indian government has reacted to this crisis through multiple mechanisms - which includes a ban on all gold coin imports, increases in capital controls
, giving USD to oil companies
, making appeals to citizens to reduce consumption of gold and petrol, requests to temples to sell their gold stockpiles, and a ban on duty free on imports of television sets (as if imported TV sets is what is really causing the decline of the rupee). In short the response has been everything that is shy of solving the true problem.
However the true causes of what has caused the real problem stills remains misunderstood by those who have little understanding of economic truths. The attempt I am making with this brief post is to illustrate the true reason for our currency debacle.
Inflation and Devaluation - Two Sides of the same (debased coin)
To really understand what has brought about the crisis it is important to first understand a little bit more about monetary theory. While whatever I am going to discuss now is fairly rudimentary, I feel that most people have an endemic misunderstanding of this topic. My benchmark here is 95% of articles and comments that I see posted on Facebook... some of which even advocate a reduction in consumption of Pepsi and Coke as a way to stabilize our currency (*groan*).
There are two concepts that are in fact intrinsically interrelated - Inflation and devaluation of the currency. For starters, it is important to have a clear definition of what we call inflation. What we call inflation is in fact caused by an increase in the supply of money and credit. According to Austrian School economists inflation is always an increase in money supply and credit. When the supply of money is increased, people have more money to offer for goods. If the supply of goods remains unchanged, then prices of goods will go up. In this sense inflation is caused when the value of money falls because of an increased supply of money. Such a fall in the value of money does not happen instantly. This is a basic economic law... and I completely fail to fathom why there is so much ignorance in popular opinion around what has caused this current crisis. The manifestation of this phenomena also comes by way of movements in the FX rates vis-à-vis other currencies. For example, monetary inflation of the rupee could cause an increase in supply of rupees vis-à-vis other international currencies such as the US Dollar, the Euro, or the Yen.
However, to just attribute increase in money supply as the only factor for inflation may be an over-simplification. There are secondary factors as well... one of which is confidence in the currency which comes from the fear that the value of the currency would fall further. Once this fear sets is economic agents would prefer to exchange money for real goods as soon as possible. Another factor is that inflation tends to "feed on itself" i.e. the longer it lasts the stronger is the expectation that inflation will continue causing people to borrow, spend, and speculate more. There are several other factors... but never-the-less the primary cause for rising prices is monetary expansion engineered by the central bank.
However one must note that the effects of an increase in money supply and a rise in prices of goods and services within the economy are not instantaneous. There is a time-lag (typically between 18-36 months) before this increased supply of money sloshes its way from the financial sector to the real economy increasing prices of goods, services and wages.
Having discussed basic economic theory, let's go and see what is the real cause of the rupee slide.
India's Record of Monetary Inflation
Sometimes charts speak better than words. Here is a graph of India's broad money supply growth since August 1998 till present.
During this period India's money supply (as measured by M3) has gone up by an astounding factor of 8x. During the same period the INRUSD exchange rate has gone from 42.50 to 67.70, INRGBP has gone from 69.58 to 105.14, and INRJPY has gone from 29.47 to 69.22. There are two major reasons why the INR has not collapsed more against other currencies is on account of two factors. The first is a dramatic increase in the quantity of goods available on account of increased productivity over the last 15 years or so which has masked the extent of price rise. The second is a fair share of monetary madness by the Federal Reserve, Bank of England and Bank of Japan who have also continued to steadily inflate their currencies over the years under the guise of boosting growth.
The bottom-line is this - the true reason for the "rupeed" rupee is reckless monetary expansion engineered by the RBI.
Note: I am curious to find out how many of the readers of by blog have come across this chart on telly or in the financial newspapers. Would be appreciated if you could let me know.
The cure for any disease is to treat the underlying cause. Similarly the cure for inflation and a weakening currency is to take away the cause i.e. stop the reckless expansion of money and credit. However we have seen (and will continue to see) every other response but that. This is in part because we are swamped by the financial media and "experts" with false explanations of what causes currency devaluation (and inflation) and hence are also plagued by false remedies to the problems.
However the cure is usually tougher to apply in practice if the government continues to maintain a heavy deficit. Deficits are in part a bi-product of large governments... and the larger the government machinery the more would be the spending needed to keep the machinery working. Government spending is almost always unproductive in the sense that they either encourage direct consumption as compared to capital formation through numerous welfare schemes (notable amongst them are the MGNREGA,
payments for subsidies, and the Direct Benefit Transfer
scheme) or are outright wasteful (some examples are spending on wars, wastes in public resources through pilferage, and the numerous scams
that we seen in India over the last few years). It is nearly impossible to fund these deficits using government revenue receipts from PSU (since almost every public sector undertaking makes losses) and taxation. Specifically taxes cannot be raised indefinitely given that they provide a disincentive for production and disrupt the functioning of the free market system. Hence deficits inevitably will continue to get financed through expansion of money supply since governments can "manufacture" the money out of thin-air to pay for their own expenditure.
With Elections 2014 looming, I don't think we are going to see a major cut-back in deficits. In fact they will get higher with the Food (in-)Security Bill
. To cut-back any welfare transfers or subsidies significantly at this point will also result in a cut-back in vote share... which I honestly could be courageous for the government to do. Hence I would expect to see some patch-work in the near term which could be through direct intervention in the FX markets, attempts to discourage imports, and reduce capital outflows. However the chief cause is likely to go unchecked without which you won't see a strong rupee in the near future.
However the more significant lesson is that pronged inflation can cause FX rates to tank with ferocity. The rupee has lost around 20% of its value in around 3 months. It is just a matter of time before we would see these rapid spells of currency declines with some of the "strongest" currencies in the world such as the US Dollar, the British Pound, Japanese Yen, and the Euro.
The more I think about it, the only permanent solution for inflation and FX stability is through the use of commodity backed money - ergo the gold standard. For those interested in a deeper understanding of currency debasement and inflation, I highly recommend Hazlitt's book What You Should Know About Inflation
Updated my computation of liquidity based on latest RBI data. The downtrend in liquidity remains intact signaling the possible advent of a bear phase in the markets.
For the time being I maintain my view of BSE Sensex made on 20 August 2013 i.e. the BSE Sensex benchmark could make a top of between 21,000-22,000 points by October-November 2013 time-frame before the advent of a prolonged bear phase.
NB: The information, tools and material presented here-in are for informational purposes only. This should not be considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities, investment products or other financial instruments, nor to constitute any advice or recommendation with respect to such securities,
investment products or other financial instruments.
Of late the Indian stock markets have seen a choppy ride. Whenever I speak to my stock advisors around where the markets are headed their advice more or less remains the same – forget about the market direction, be stock specific, look at strong fundamentals, good stocks will always outperform etc etc etc. They are wrong... but they don't know they are wrong. They think markets move up and down because of factors such as fundamentals, technicals, and sentiments. However, being a student of Austrian School of economics I know that markets only move up based on one main factor - liquidity which is an outcome of loose monetary policies. Being a student of the Austrian School of economics, I find it difficult to share their enthusiasm about going long on the .
In this report (which is my first in hopefully what would be a chain of helpful reports for my readers) I share my views around:
- The driving factors behind the stock market
- What liquidity signals show us around where Indian bourses are headed [Hint: Down]
- How central banks can warn your portfolio - lessons from Capital Theory
- How I would "play" the markets
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I wrote this article for a friend Jesse Colombo. Jesse is an economic analyst and activist who was called one of the “Ten People Who Predicted the Financial Meltdown” in 2008 by the London Times. He maintains a popular bubble analysis and news site called The Bubble Bubble. My original article is available here http://www.thebubblebubble.com/indian-housing-bubble/. Have reproduced this article on my blog.
There is a common myth which goes like this: “property prices do not fall”. Myths lead to misconceptions, and a common misconception is that real estate investments are supposed to be “as safe as houses”. This is a misnomer that the US housing crash of 2008 should have altered… but unfortunately it takes much more than a catastrophe to get rid of such calcified ideas.
A data point that hasn’t got a great deal of coverage internationally is that of the decade-long gravity defying rise of the Indian real estate sector. To put it into perspective Indian real estate prices have increased by 5x–6x in most regions, and the speed of the price rise in India outstrips that of economies that had a housing bubble (such as Spain, Ireland and the US). This realty boom has all the makings of what could be a spectacular collapse… but the trouble is that most people are unwilling to see it.
I first started warning of a housing bubble in India about a year back – in December 2011. That was when I had finished work on my book, Spot the Next Economic Bubble
, which utilized the Austrian Business Cycle Theory (ABCT) as the cornerstone for
analysis. There were next to no takers for my advice then. There are also very few takers today.
So does a real estate bubble really exist in India? And do my warnings about the impending disaster hold any water? Before examining this point in more detail, let’s first recap what the ABCT tells us about bubbles.
What is a Bubble?
Before attempting to examine a bubble it is important to have a good definition for the phenomena so as to be able identify it clearly. According to Wikipedia
, a bubble is defined as “trade in high volumes at prices that are considerably at variance with intrinsic values”. However this definition is difficult to work with, given that it is difficult to identify and observe the intrinsic value of an asset without the benefit of hindsight. Therefore most individuals attempt look at other tell-tale signs besides trade volumes and prices while analyzing bubbles, including factors such as manias, herd behavior, comparing extrapolation of future asset prices with historic data, moral hazard, etc. However, none of these approaches allow us to clearly define a bubble or attribute it to real
and observable factors – and unless one is able to do that it would be always difficult to clearly identify a bubble.
The biggest advantage that the Austrian view offers is that it enables us to clearly define a bubble. According to Austrian economists, a bubble is a term used to define an activity that has sprung up on the back of loose monetary policies. The main factor behind bubbles is the fuel for speculation – which is low real interest rates. The fuel for speculation comes when the Central Bank
expands credit by creating “mickey mouse” money out of thin air. “Mickey mouse” money has to go somewhere… and it fuels a speculative bubble where it does.
Given that money is non-neutral, the early recipients of new money (or the first movers) always have an advantage since they are able to out-bit late recipients for goods and services. Additionally, these monetary injections act like a steroid given it turbo-charges activity in interest rate–sensitive sectors such as housing construction. Moreover, easy access to credit (enabled in part by monetary injections) also have a role to play in inflating bubbles, given that with the aid of leverages asset prices can be inflated beyond the wildest imagination. Therefore if you want to spot a bubble, you must first examine if asset prices are rising on account of increases in the money supply (and thus credit) or on account of genuine savings.
With this background let’s have a look at the conclusive evidence that suggests the existence of an Indian housing bubble. Towards this I reproduce the analysis I have included in my book Spot the Next Economic Bubble
(in Chapter 9) in the following section.
Bubble Spotting in the Indian Real Estate Sector
In the Indian context, there is strong evidence of an unprecedented growth in money supply where one has witnessed a double-digit year-on-year growth rate of broad money supply or M3 (see chart).
Liquidity has to go somewhere. In the case of India, this liquidity seems to have gone into the real estate market creating a false boom. A closer look at India’s real estate price data makes this more evident. India has a housing price index in the form of the Residex (maintained by National Housing Bank). Unlike the Case-Shiller Index in the US, the Residex does not provide consolidated data for the country as a whole. The National Housing Bank, on their website, reports data from 2007 onwards for a cross-section of 15 cities. Data from 2001 is available for only five Indian cities [Check Note 1]. Of the five cities covered since 2001 (including Delhi, Kolkata, Bangalore, Bhopal and Mumbai) by the Residex, real estate rates have been ‘soft’ at Bangalore. All other cities have shown and stellar growth in terms of house prices. The following graph shows the Residex data with the year 2001 as the base for four Indian cities – New Delhi, Mumbai, Bhopal and Kolkata (we will come back to Bangalore a little later). The primary Y-axis shows the percentage increase in the Residex, while the secondary Y-axis shows the broad money supply (or M3) in INR Billions as reported by the RBI for the same period:
A 5x–6x increase in housing prices in under a dozen years is nothing short of spectacular when compared to other cities across the world. What is more astounding is that the actual price rise in Indian cities is likely to be higher than the reported figures suggest given that it is widely acknowledged that the official housing prices are under-reported for computation of tax gains - and this is something that the government is attempting to remediate by reforming the stamp duty transactions in states.
Contrast housing prices for these four cities with the M3 for the same period to observe the similarity in price movements. This is not merely coincidental. This is a common pattern one would observe with any other asset bubbles.
What is actually driving the entire real estate party in India is the ever-increasing monetary injections into the economy by the RBI. Money created out of thin air is like a steroid which turbo-charges what is going on within an economy. Additionally, credit is like heroin where a little is never enough and more and more is needed to sustain the artificial high. Without monetary inflation, prices wouldn’t (or couldn’t) have increased at this pace. There is only one way to test if this theory does hold any water.
From the point of view of Austrian theories, the only thing in the world that preserves its value in the face of monetary infusion is gold [Check Note 2]. Towards this, let us attempt to adjust property prices with gold prices as the base (see below).
One cannot help notice that in inflation (or gold-adjusted terms), the property prices in India have remained flat for the most part of the previous decade. Mumbai, Bhopal and Kolkata have shown an approximate rise of 1%, 7% and 4% respectively, while Delhi has shown a dip of 3%.
The evidence available almost irrefutably points towards the fact that India is in a speculative bubble. While data does suggest and point towards a real estate boom in cities of New Delhi, Mumbai, Bhopal and Kolkata – the outlier Bangalore has had modest price increases during this period. But Bangalore did not miss the Indian real estate boom. Bangalore did have a real estate boom – but a boom of a different nature i.e. where supply increased enormously and consequently real estate prices didn’t.
Deconstructing Argulements against a Bubble
There is something about human nature that resists bad news. Most people exhibit the ostrich mentality (of running away and avoid the topic) or turn to denial. This is true for most folks living in bubble economies where they attribute spectacular returns on assets to “strong fundamentals”. The most common response I have received is something like this: “There might be a slowdown in the Indian real estate sector… but a collapse in India is unlikely”. This is a flawed argument. In this section I present the various arguments that I have come across regarding my view, and show why these arguments are flawed.
Ostrich Argument #1: Cannot happen in India. We have a densely populated country with scarcity of land and growing demands for housing. While both these arguments appear to be logical, this fails to take into account historical evidence. The most spectacular real estate collapse in history occurred in Japan… and the scarcity and population density arguments were the same.
Ostrich Argument #2: India’s fundamentals are intact – and we needn’t fear a bust. Unfortunately this is also an argument that doesn’t seem to be grounded in reality. Closer examination of the ‘fundamentals’ of the Indian economy show Austrian boom patterns and paint a worrisome picture, specifically:
- Faltering GDP growth rate (expected to be sub-5% in 2012 fiscal – the lowest in a decade)
- High budget deficits. Increasing public debt. These would get worse in future owing to welfare (such as Direct Benefit Transfer based on the Aadhar card) and public works schemes (such as MGNREGA).
- Slowdown in industrial production as reflected by IIP data. Weak corporate performance by heavy industries in recent quarters.
- Chronic inflation and depreciating currency.
- An increasing trade deficit.
- Falling domestic savings rate (in single digits – the lowest in a decade).
- Increase of NPA’s on the balance sheets of domestic banks.
Which of these signs reflect prosperity or strong fundamentals? It is likely that the decades of monetary inflation have resulted in over-consumption and malinvestments and have distorted the capital structure of the Indian economy.
Ostrich Argument #3: A definite rise in prosperity as illustrated by sales of luxury cars and designer labels; swanky restaurants and malls. However consumption can never be taken as a sign of sustainable economic growth. A prosperous and growing economy is one that produces more goods, and not one which consumes more. Unfortunately these examples are more reflective of conspicuous consumption which manifests itself during a false boom. Monetary inflation tends to drive money into assets increasing the net worth of the super-rich, ultimately manifesting itself in the form of conspicuous consumption. Additionally, inflated asset prices makes people think they are richer than they really are, and the seemingly surplus funds are likely to get splurged on account of this money illusion. This too is consistent with ABCT.
Ostrich Argument #4: Lending standards of banks and financial services institutions are not lax. There may be an element of truth in this statement. Specifically the Reserve Bank of India (RBI) has imposed a Loan to Value Ratio of 80%, stepped in increased risk weights on housing loans, and increased standard asset provisions on teaser loans. However government regulations have never been able to prevent bubbles from occurring in the past (the case in point being the collapses of companies such as Enron and the US financial houses in 2008 – all of which operated in heavily regulated environments). Irrespective of the regulations in place, funds created by credit expansion out of thin air need to go somewhere, and given money is non-neutral
it would fuel a speculative bubble in the process. Moreover, what goes un-noticed is that the realty boom has also in part been driven by the growing services sector in India – comprising of financial services, outsourcing, and media – all of which would come under heavy weather in the near future on account of global cues arising of the weakening of Western economies.
Ostrich Argument #5: Prices may fall – but not too much. This is the final argument offered when all other arguments are broken down. But the reality appears to be that people have short memories. Real estate that appeared to be over-priced in 2008 appears to be reasonable today given the constant monetary inflation which has fueled price rise. Unfortunately ABCT is also fairly categorical about what the eventual bust would bring with it. Following the end of an artificial boom asset prices are likely to return to pre-boom levels, or even below that. Price adjustment can be delayed through intervention in the form of stimulus, bail-outs, and through more monetary injections…. but cannot ever be prevented. A case in point is Japan which has seen ten rounds of monetary stimuli since their real estate bubble popped; but property prices are still way off the 1980 levels. Also, the attempts of preventing liquidation of poor investments through fiscal and monetary stimulus in the US following the 2008 crisis are less than convincing.
Ultimately one cannot think of any good arguments to refute the case against a bubble. It becomes more obvious if you were to analyze rental yields on housing. In India gross rental yields are around 2.68% in most metropolitan cities which are amongst the lowest in Asia [Check Note 3]. Asset prices disconnected with yields is the most evident tell-tale sign of a bubble.
Don't Tell Me How... Tell Me When!
The ABCT also helps us anticipate when an artificial boom is likely to come to a close. The trigger that will turn the artificial boom to bust is a cessation or even a marked deceleration in the rate of money creation. A slowdown in money creation causes interest rates rise and deprives the economy of its monetary heroin and bubbles begin to pop in the face of a liquidity crunch. Now this is what India’s M3 data shows: it confirms a visible slowdown in the rate of monetary injections (see chart).
According to theory the moment this happens the music will come to a stop slowing bubble activities that arose on the back of loose monetary policy. This is what the economy witnessed in part during the end of 2010 and early 2011 once the effect of the monetary steroid started wearing off.
Given the decline of economic activity, the RBI has attempted to gradually inflate using Open Market Operations (OMO). However this gradual expansion of M3 in H2 2012 is likely to be insufficient to prevent bubbles from collapsing.
There are very few bubbles which can be larger than a housing bubble (maybe with the exception of a bubble in government securities and currency). Housing bubbles are seldom innocuous given that they have a tendency to destabilize the entire banking sector. Specifically almost half the loans extended by banks in India to individuals are towards real estate. Specifically the exposure of the top 10 banks to real estate loans are estimated at approximately $90 Billion [Check Note 4]. The impact is likely to be more significant given that existing real estate is seldom mortgaged by businessmen to banks for raising funds for business expansion. Real estate prices in post-independence India has only gone one way – which is up – given the incessant monetary inflation brought under Socialistic and then Keynesian economic policies.
For those who have real estate investments in India, it might be advisable to stop dancing before the music comes to a sudden stop. And do remember that there is adequate historical proof that real estate prices can also fall – and it is unlikely that India will be a special case.
"What gets us in trouble is not what we don't know. It's what we know for sure that just ain't so." ~ Mark Twain
Economics perhaps is one of the most misunderstood disciplines in the planet. A faulty understanding of economics results in fallacies - which people don't seem to be able to get rid of. A fallacy that has bubbled over from economics to the field of finance is that a bull run on the stock markets are a sign for a strong economy. The case in point being that of India. India's GDP growth rate for the current fiscal is likely to be the lowest in a decade (with most analysts pegging the rate between 5-6%). However, the BSE Sensex index stands at around 19,900... the highest in 24 months and a shade under the all-time high of 20,827 (which it made in January 2008). So how do you reconcile stock market performance to solid economic growth?
In fact rising prices are no a sign of growth. instead the unmistakable sign of growth is falling prices. For example, consider how much laptops and mobile phones costed a decade ago... and contrast that is how much they cost presently. Laptops and mobile phones today are more sophisticated than they were a decade ago, and yet they are cheaper. And it is not to say that companies such as Apple, Dell and Samsung haven't grown in a decade. In fact they have gone from strength to strength.
Specifically, the converse relationship is the more correct one: rising prices (including that of financial assets and equities) are a bad sign. So let's attempt to understand why that is so. So Why Do Prices Rise?
Mainstream economists define inflation as a rise in the general
price level of goods and services. For the time being lets put stock prices aside and first look at understanding how prices rise. The explanation for this comes via what is known as the quantity theory of money
. In monetary economics
, the quantity theory of money is the theory that money supply
has a direct, proportional relationship with the price level. For example, if the central bank were to print an additional $100 note, then it would reduce the value of all $100 dollar bills floating within the economy. This manifests as a loss in purchasing power of money, manifesting as a rise in prices. Almost all economists across the world agree with this relationship - though there is debate if this takes place in the short run or in the long run.
Now here is where the Austrian School economists differ with mainstream economists (Austrians disagree with mainstream economists is almost everything). The Austrians do not say than an increase in the money supply causes
inflation. In fact what we say is that inflation is
the increase in the money supply. Without monetary inflation price rise is not possible since over time producers would be able to produce goods and services more efficiently resulting in reduced prices in the form of increased competition. A more detailed explanation of this is provided here
by this great article by Frank Shostak (Frank is an economist who I respect a great deal - and I do suggest that you follow his writing).
Now having established how inflation takes place in the economy, let's turn to the question of stock prices. Stock Markets and Monetary Inflation
Prices can only rise when there is monetary inflation within the economy. With monetary inflation all prices are affected - not only consumer prices as measured by the CPI and WPI. Why this effect goes unnoticed is because the common person does not associate rising stock and bond prices, rising real estate prices, rising services (such as education) cost and others. Additionally even corporate profits would rise though monetary inflation (this is due to what we call money illusion given that cost components such as wages are slower to catch-up with rise in prices for finished products).
Austrian economist Fritz Machlup stated this in this 1940 book The Stock Market, Credit and Capital Formation
when he said:
It is impossible for the profits of all or of the majority of enterprises to rise without an increase in the effective monetary circulation (through the creation of new credit or dishoarding).
Likewise it is not possible for the stock market indices to show sustained increase without constant monetary inflation. So what really happens? When the Central Bank creates money out of thin air by credit expansion, funds invariably enter the banking system and flows into the capital markets - including the stock markets. Hence any attempt to bring about credit expansion out of thin air results in a (temporary) bull run in the stock.
Specifically this is what Machlup had to say about how stock markets really work:
Specifically it is neither possible for corporate performance to see additional gains in profits, nor for the stock market indices to show sustained increase without constant monetary inflation. So what really happens? When the Central Bank creates money out of thin air by credit expansion, funds invariably enter the banking system and flows into the capital markets - including the stock markets. Hence any attempt to bring about credit expansion out of thin air results in a (temporary) bull run in the stock.
I would love to have written more to explain this further in more detail... but instead suggest that you look at a very good explanation of this here
in this great article by Kel Kelly.
Unfortunately, as the Austrian Business Cycle Theory enables us to understand, credit created out of thin air is like heroin. As the physical body of a drug addict starts getting used to heroin, more and more heroin is needed to sustain the high. Any stoppage, or even a slowdown, in the dose of heroin would cause withdrawal symptoms. It is likewise for credit expansion out of thin air - as economic agents start getting accustomed to credit injections, more and more are needed at ever increasing rates to sustain the artificial boom in economic activities and asset markets. Hence if there were to be a marked slowdown in credit creation the music would come to a halt.
Now this is what the percentage year-on-year's change in India's money supply growth looks like (see chart):
If there is anything called "noticeable slowdown" then this is it. India dodged the Great Recession brought about by the US housing collapse in 2008 partly because of the policy response of injecting more and more liquidity into the stock markets. There was a significant slowdown in the rate of monetary injections during the first quarter of the 2010 fiscal year. However, any changes in the money supply (or any other policy variable) do not have instantaneous effects on economic activity or the capital markets. As the effects of the monetary heroin starts wearing off the economy beings to experience financial convulsions as the economic activity starts to come to a grinding halt. This is a sense was witnessed in the form of a correction in the stock markets during the end of 2010 after it almost made a new high (see chart).
As the growth rate of money supply tapered off the stock markets began to stagnate with a negative bias. Eventually the Reserve Bank of India (RBI) started inflating again - albeit gradually via Open Market Operations (OMO) which has again been observed in the form of gains in the stock market.
My understanding of the current situation is that stock markets (and the BSE Sensex) is showing gains on account of a round of credit expansion in anticipation of RBI cuts in the policy rates in early 2013. Hence this is that i feel should happen:
- The stock markets should continue to rise a bit more over the next month. I would feel that the upside is fairly limited.
- I do not anticipate new highs this year... though this could happen if there is a surge in the amount of monetary inflation engineered by the RBI. Given current inflationary concerns, I do not expect any unexpected surge.
- The markets should start to give up their gains after another brief upward movement - possibly around the time when a triple-top chart pattern becomes evident. I expect this to happen by March 2013 (or earlier).
- I expect markets to be soft in 2013. I do expect a 20-30% correction (if not more). I expect corporate performance to disappoint.
- A fall in the stock markets would be signal for a long and extended bear phase in the market peppered with brief bull phases.
While I am not a perma-bear, I find it difficult to remain bullish when economic bubbles are forming all over the world (including in India) as I have explained in by book Spot the Next Economic Bubble
. I am personally reducing my exposure to the stock markets by using any higher levels to book profits. I do believe that you would get an opportunity to purchase stocks later in this year at a good discount.
Caveat: The use of any maths and/or empiricism in economics can be hazardous to your health (and to your wealth).
Disclaimer: This article is my personal view on market trends. None should rely on this view for investment or trading decisions.
In 2011 Soros called Gold the ultimate bubble when it was trading at $1,275 per ounce.
Soros changed his position in 2012 as he began to acquire huge quantities of gold. So is gold a bubble? What should be the outlook for gold going forward in 2013? These are questions that I shall attempt to answer momentarily using a few charts. But before that let us attempt to understand the historic position of gold as an commodity.
Gold is a special commodity that has traditionally been considered to be a store of value over centuries. In an ever changing world, gold is supposed to be the only constant in the sense that it preserves its value. This is reason why gold has historically been used as money over the ages. If one were to hold this view, then it is quite likely that gold should neither appreciate or depreciate in value and should remain constant. However, gold has seen a bull run for over 10 years with its value rising exponentially. So how can this be reconciled? Actually it wasn't gold that appreciated - instead it was money that lost its value on account of inflation. Inflation in an economy only occurs if the central banks prints money out of thin air (every time the Fed prints a $100 bill, the value of all $100 bills in the economy goes down given the increase in $100 bills in the economy manifesting as inflation or loss of purchasing power of money).
Now have a look at this chart which shows you how gold has reacted to the expanding balance sheets of central banks (or to inflation):
I guess this chart addresses the first question - gold is not a bubble. Now here is coming to the next question - the outlook of Gold in 2013. The subsequent chart depicts the projected expansion in balance sheets of central banks for 2013.
With so much printing expected, it is likely that gold prices will only do one thing in 2013 - go further up! Even central bankers tend to think so. Why else would the central bank of Brazil double its holding of gold in 3 months?
By the way, the Central Bank of Iraq has also followed suite by doubling their gold reserves.
While it is difficult to predict how things will pan out a few years hence, there is one thing which is certain. There is a lot of printing yet to come. My view is that gold is likely to go up 3x-4x in the coming high inflationary periods. If you are wondering how many ounces of gold and silver are needed t cover expenses in high inflationary periods, here is an highly recommended article by Jeff Clark that i urge you to read
This post is going to be a very short one. Came across this graph that shows student costs vs. earnings after graduation.
I am taking a brief hiatus from posting to catch up on work and take some rest. The last 12 months months have been very taxing with respect to completion of Spot the Next Economic Bubble.
Would be posting over my Twitter feed @the_austrian_in.
In economics one does hear of the law of unintended consequences. While it is often cited it has been rarely defined clearly. The basic concept behind unintended concequences is that the actions of people (especially the actions of government) always have effects that are unanticipated or unintended. During the first half of the nineteenth century, the famous French economic journalist Frédéric Bastiat brought this concept up in his essay “What Is Seen and What Is Not Seen”. According to Bastiat the seen were the obvious visible consequences of an action or policy. The unseen were the less obvious, and often unintended, consequences.
The interesting thing is that unintended consequences is that it occurs more often in real life than people tend to think. To give you a hint, I post this cartoon that I found floating around Facebook that depicts the central idea of a reality about to strike the US soon.
You guessed it right... I am referring to what some are calling the US student loans bubble. [Note: This is one bubble that I didn't spot during the time I was writing 'Spot the Next Economic Bubble'... I am sure that there would be others that I have would have missed given that so many bubbles are forming all over the world... but will do my best to keep you updated about the significant
. This seems to be another major bubble that has been forming, and would be something as disastrous as the US sub-prime crisis... ok maybe not so bad, but like a smaller version of sub-prime. A really closer look at the data reveals similarities of this bubble with the sub-prime bubble. For example, have a look at these two charts the first one which depicts a history of house values in the US (Source here
), while the second depicts student loans (Source the popular bubble warning site by Jesse Colombo
Does this give you a sense of deja vu?
So how this this bubble come about? According to the Austrian Business Cycle Theory (ABCT), bubbles are activities that arise on the back of loose monetary policies of the central bank (in this case the Fed). With a view to stimulate the US economy following the sub-prime crisis of 2008, the Fed has embarked upon epic cycles of monetary easing fueled by programs such as the Quantitative Easing programs (QE1, QE2 and QE3). While the Fed can inflate out of thin-air, they cannot control where the injected liquidity goes within the economy. The prevailing low interest rates along with the depressed job markets following the housing bust would have been likely to have made people consider getting a college degree so as to improve job prospects during the eventual recovery. This this is what appears to have happened - you can see a lift-off on sorts in students credit following September 2008.
Now here is what makes the problem worse. Years of constant monetary expansion would necessarily cause price inflation. However, the complete effects of inflation are not so easy to see given that productivity gains offsets the effects of price rise. This is the reason consumer goods are cheaper today (than say a decade ago) despite the fact that the prices of raw material and labour has increased during the period. However, here is the catch. There cannot be major productivity gains in education and hence the visible effect of monetary inflation is more easily visible in terms of a rise in tuiton fees. To put this in context, during the 1950s, the tuition fees at Harvard were approximate $600 a year... but in 2012 the tuition fees are to the tune of $36,000. This is a huge increase! Given that tutition fees are rising rapidly, students have attempting to borrow more money to keep up.
However, the jobs markets across the economy continue to remain depressed. This is hardly surprising given that incessant monetary pumping cannot generate real resources (such as land, labour and capital goods) which are needed for sustainable growth and recovery. Printing money out of thin air does not confer any social benefit and hence is unlikely to improve the unemployment problem... but would instead exacerbate it given that it prevents efficient liquidation of malinvestments from the boom. Hence while education costs (and student indebtedness) is on the rise, wages do not appear to be keeping up. Hence a crisis becomes inevitable.
Now to put the magnitude of the current problem in perspective, consider the following stats as provided by this infographic
- Student debt exceeds $1 Trillion
- The magnitude of student debt exceeds that of credit card debt
- Student tution fees has risen over 5x since 1985 and has almost doubled in the past decade
- Two years after graduation the 45% of graduates make only $15,000 a year
This seems to be another accelerating problem. Over $120 Billion in Federal student loans appear to be in default
and the situation looks bleaker given that graduating during a recession leads to low earnings growth making it even harder to service loans... which would get much worse once interest rates begin to eventually rise. What is worse is that financial institutions would be hurt much more given that these loans are unsecured (unlike housing there is no collateral that can be used for recovery).
The students loans crisis appears to have the makings for the next sub-prime crisis. And irrespective of what happens, the Fed will print more money. I guess some people will never learn.