Depression 2.0 (2008)
Since 1929 there have been periods of boom & bust in the global economy. The wise say "This time, it's different." It's never different. It's always the same, but with bigger numbers. It reminds me of the quotations from George Santayana’s, Life of Reason, Reason in Common Sense, 'Those who cannot remember the past are condemned to repeat it.'
The economic cycles are associated with the feelings of Greed and Fear. It was greed, rather than the absence of fear that was prevailing in the past few years. Regulation was disregarded, and so was risk, which had been whisked away by whiz-kid ‘quant’s’ They devised exotic financial instruments like derivatives and CDO’s, creating a financial Frankenstein the likes of which had never been seen. Great fortunes were made with the motto ‘profits at any price’. Warren Buffett, the world’s most successful investor called these derivatives, which almost no one understood, "weapons of financial mass destruction." This lack of fear became an orangery of greed and ignorance. When greed exceeds fear, trouble follows. It reminds of Mahatma Gandhi’s famous quote, “The world has enough to meet our needs, but not enough to satisfy our greed”. In 2006 economy was booming and the world was awash in cheap money thanks to the low interest rate regime followed by most Federal Banks. There was little fear of buying a house on ‘No Doc mortgages, by the NINJA’s’ (No Income No jobs). "House-price appreciation" would increase the value of the collateral, if borrowers couldn't or wouldn't pay. The myth that ‘prices of the assets never go down only interest rates do’ fueled the debt binge. A rising tide lifts all boats. Not only households even big Investment Banks took risks of using borrowed money. To keep profits growing, they borrowed huge sums; their debts were about 35 times their capital. If you borrow 35 times your capital and those investments rise only 1%, you've made 35% on your money. If, however, things move against you a 1% or 2% drop in the value of your assets puts your future in doubt. In the US, consumer confidence rose to near-record levels. This high level of confidence, shared in many other countries as well, was related to the booming markets and booming economy of that time. The booming markets and economy were in turn substantially buoyed by the ‘feedback loop’ of Profit and Consumerism. When people expect a good performance from their investment assets; they tend to bid up their prices. People have this idea that the market must keep going up, with no mathematical evidence or model, that confirms that notion, said Robert Shiller, author of the book "Irrational Exuberance".
Economies are built on trust, but now that trust has been replaced by fear and pessimism. “At this moment confidence is even more precious than gold or currency” said Chinese Premier Wen Jiabao. The world now is in the grip of a downward spiral of deleveraging, having accumulated debts beyond what's sustainable. Households and financial institutions are being forced to reduce them. The pressure to do so results from a decline in the price of the assets they bought with the money they borrowed. It's a vicious ‘feedback loop’, a giant ‘snow ball’. When families and banks tip into bankruptcy and ‘throw in the towel’, there is ‘Capitulation selling’, and more assets get dumped on the market driving prices down further and necessitating more deleveraging. This process of ‘panic selling’ has gained so much momentum that Warren Buffet has called it the “Financial Pearl Harbor”. Canadian newspaper Globe & Mail quoted New York Market analyst Steve Yardani, “It is bit like a California forest fire. The fire squads are out there trying to contain it, but it just keeps spreading till you are out of trees or the wind changes”. The bursting of the debt-fueled property bubble and the crippling losses suffered by the banks have set in motion a chain reaction that could lead to a 21st century version of the Depression. The underlying cause of the Great Depression according to Milton Friedman and Anna Jacobson Schwartz in their book ‘A Monetary History of the United States: 1867-1960’, was not the stock-market crash but a "great contraction" of credit due to an epidemic of bank failures. Every financial bust comes with a catchphrase; Tulip-mania, South Sea Bubble, The Great Depression, The dotcom bubble and others described in Charles MacKay’s classic Extraordinary Popular Delusions and the Madness of the Crowds.
Whether there is a short, relatively mild recession like that of 2001, or a version of what the world went through in the 1930s: Depression 2.0, is a million dollar question? This is no longer an exclusively American crisis. European banks are going under as well. Growth rates in the euro zone and Japan have turned negative. Emerging markets too are suffering. Stock markets in the ‘BRIC’ economies (Brazil, Russia, India and China) are now down about 60% or more on the year. The notion that Asia has somehow "decoupled" itself from the U.S. now seems fanciful. How could they after all, having pegged their currencies to the Dollar, under the ‘Bretton Woods’ system, to avoid a repeat of the ‘Butter wars’. When Fannie and Freddie were on the brink of collapse, many were surprised to learn that a fifth of China's currency reserves were composed of their bonds. China has accumulated a huge hoard of dollar-denominated bonds. No foreign nation stands to lose more from a U.S. financial collapse. A quarter of exports from Asia are bound for America, and with consumer spending in the U.S. slipping, the manufacturing engines that drive many Asian countries are starting to sputter. The most vulnerable are those with high dependence on exports, such as Taiwan, South Korea and Vietnam. In China, weak export orders combined with rising costs are forcing tens of thousands of small factories to close raising unemployment. China and India will be affected with the drop in American demand for goods and services. The crisis may have originated in the US, yet Asia’s shiniest growth stars may be among those paying the biggest price.
It is indeed true that “when U.S. sneezes the entire world catches a cold, some even get Pneumonia”. No country has enough ‘raincoats’ to weather the global financial ‘storm’. A year ago, people were questioning if the subprime crisis that began in the summer of 2007 in the United States would spread to India. It was pointed out that since India was not a major investor in US subprime mortgages; the institutions of subprime lending were not prominent in India. Moreover, the Reserve Bank of India did not follow the policy of the Federal Reserve in the US of cutting interest rates to near zero levels at the height of a real estate boom. The Indian economy had ‘Decoupled’ from the west. Now, a year later, after a September 2008, which showed massive financial collapse in the US, India too has been hit by the crisis. The seemingly inexorable rise in the Indian stock market has been clipped. The Sensex rose about eight-fold from 2003 to the beginning of 2008, but now has had a correction; it is down about 60% from its peak. India's property market, which has seen a 30% to 50% annual price growth in recent years, is weakening. Consumer confidence locally is being dented by sliding share and property prices. Steep declines in asset values pose worry not only for economic growth, but also social stability, as ordinary folk watch their personal wealth evaporate. Even though the commonly-identified causes of the crisis in the US, the subprime mortgage revolution and the extremely loose monetary policy, were not in evidence in India, outcomes have been similar.
Should we be surprised? Actually, the similarity of market behavior across countries is evidence that something else, deeper is at work. The fundamental problem is the swings of overconfidence and greed & now pessimism and fear shared by millions, billions of people. Projections of gloom & doom can become self-fulfilling prophecy. The Great Depression was greatly depressing because it was global. The combined output of the world's economies declined nearly 33% from 1929 to 1932. The unemployment rate soared in the U.S. and Germany to a peak above 25%, World trade collapsed by two-thirds. Booms & busts were transmitted from one country to another through trade & financial flows. We no longer live in isolated glass houses. Today when the ‘world is flat’, linked together by instant communication, ‘Geography is History’ and global capital movement is a difficult servant to master. Internet & Television have transmitted fear at lightning speed across the globe. Former Prime Minister of U.K. Tony Blair speaking at the Hindustan Times Leadership Summit on the theme ‘We stand together or we fall together’ said that be it the economic challenge, terrorist threat, climate change or the battle for resources; all are global, interconnected and interdependent. To rephrase John Donne, “Now no nation is an island, entire of itself”. International affairs and business not only intersect but are interlinked. That’s how it was supposed to be post 1940’s, under the Bretton Woods financial architecture, that brought an end to the old colonial order of imperial trade & ushered in an era of open world economy of interdependence.
That the world is a global village is best represented by the Sanskrit phrase ‘Vasudhaiva Kutumbakam’ which means the world is one family. Swami Vivekananda began the era of Globalization in 1893, at the world parliament of Religions, by opening his speech with the line, “Dear brothers and sisters of America”. I strongly believe that if my brothers and sisters of America are going to face financial hardship, my brothers and sisters of India or for that matter anywhere in the world are not going to be immune from the affliction.
The economic cycles are associated with the feelings of Greed and Fear. It was greed, rather than the absence of fear that was prevailing in the past few years. Regulation was disregarded, and so was risk, which had been whisked away by whiz-kid ‘quant’s’ They devised exotic financial instruments like derivatives and CDO’s, creating a financial Frankenstein the likes of which had never been seen. Great fortunes were made with the motto ‘profits at any price’. Warren Buffett, the world’s most successful investor called these derivatives, which almost no one understood, "weapons of financial mass destruction." This lack of fear became an orangery of greed and ignorance. When greed exceeds fear, trouble follows. It reminds of Mahatma Gandhi’s famous quote, “The world has enough to meet our needs, but not enough to satisfy our greed”. In 2006 economy was booming and the world was awash in cheap money thanks to the low interest rate regime followed by most Federal Banks. There was little fear of buying a house on ‘No Doc mortgages, by the NINJA’s’ (No Income No jobs). "House-price appreciation" would increase the value of the collateral, if borrowers couldn't or wouldn't pay. The myth that ‘prices of the assets never go down only interest rates do’ fueled the debt binge. A rising tide lifts all boats. Not only households even big Investment Banks took risks of using borrowed money. To keep profits growing, they borrowed huge sums; their debts were about 35 times their capital. If you borrow 35 times your capital and those investments rise only 1%, you've made 35% on your money. If, however, things move against you a 1% or 2% drop in the value of your assets puts your future in doubt. In the US, consumer confidence rose to near-record levels. This high level of confidence, shared in many other countries as well, was related to the booming markets and booming economy of that time. The booming markets and economy were in turn substantially buoyed by the ‘feedback loop’ of Profit and Consumerism. When people expect a good performance from their investment assets; they tend to bid up their prices. People have this idea that the market must keep going up, with no mathematical evidence or model, that confirms that notion, said Robert Shiller, author of the book "Irrational Exuberance".
Economies are built on trust, but now that trust has been replaced by fear and pessimism. “At this moment confidence is even more precious than gold or currency” said Chinese Premier Wen Jiabao. The world now is in the grip of a downward spiral of deleveraging, having accumulated debts beyond what's sustainable. Households and financial institutions are being forced to reduce them. The pressure to do so results from a decline in the price of the assets they bought with the money they borrowed. It's a vicious ‘feedback loop’, a giant ‘snow ball’. When families and banks tip into bankruptcy and ‘throw in the towel’, there is ‘Capitulation selling’, and more assets get dumped on the market driving prices down further and necessitating more deleveraging. This process of ‘panic selling’ has gained so much momentum that Warren Buffet has called it the “Financial Pearl Harbor”. Canadian newspaper Globe & Mail quoted New York Market analyst Steve Yardani, “It is bit like a California forest fire. The fire squads are out there trying to contain it, but it just keeps spreading till you are out of trees or the wind changes”. The bursting of the debt-fueled property bubble and the crippling losses suffered by the banks have set in motion a chain reaction that could lead to a 21st century version of the Depression. The underlying cause of the Great Depression according to Milton Friedman and Anna Jacobson Schwartz in their book ‘A Monetary History of the United States: 1867-1960’, was not the stock-market crash but a "great contraction" of credit due to an epidemic of bank failures. Every financial bust comes with a catchphrase; Tulip-mania, South Sea Bubble, The Great Depression, The dotcom bubble and others described in Charles MacKay’s classic Extraordinary Popular Delusions and the Madness of the Crowds.
Whether there is a short, relatively mild recession like that of 2001, or a version of what the world went through in the 1930s: Depression 2.0, is a million dollar question? This is no longer an exclusively American crisis. European banks are going under as well. Growth rates in the euro zone and Japan have turned negative. Emerging markets too are suffering. Stock markets in the ‘BRIC’ economies (Brazil, Russia, India and China) are now down about 60% or more on the year. The notion that Asia has somehow "decoupled" itself from the U.S. now seems fanciful. How could they after all, having pegged their currencies to the Dollar, under the ‘Bretton Woods’ system, to avoid a repeat of the ‘Butter wars’. When Fannie and Freddie were on the brink of collapse, many were surprised to learn that a fifth of China's currency reserves were composed of their bonds. China has accumulated a huge hoard of dollar-denominated bonds. No foreign nation stands to lose more from a U.S. financial collapse. A quarter of exports from Asia are bound for America, and with consumer spending in the U.S. slipping, the manufacturing engines that drive many Asian countries are starting to sputter. The most vulnerable are those with high dependence on exports, such as Taiwan, South Korea and Vietnam. In China, weak export orders combined with rising costs are forcing tens of thousands of small factories to close raising unemployment. China and India will be affected with the drop in American demand for goods and services. The crisis may have originated in the US, yet Asia’s shiniest growth stars may be among those paying the biggest price.
It is indeed true that “when U.S. sneezes the entire world catches a cold, some even get Pneumonia”. No country has enough ‘raincoats’ to weather the global financial ‘storm’. A year ago, people were questioning if the subprime crisis that began in the summer of 2007 in the United States would spread to India. It was pointed out that since India was not a major investor in US subprime mortgages; the institutions of subprime lending were not prominent in India. Moreover, the Reserve Bank of India did not follow the policy of the Federal Reserve in the US of cutting interest rates to near zero levels at the height of a real estate boom. The Indian economy had ‘Decoupled’ from the west. Now, a year later, after a September 2008, which showed massive financial collapse in the US, India too has been hit by the crisis. The seemingly inexorable rise in the Indian stock market has been clipped. The Sensex rose about eight-fold from 2003 to the beginning of 2008, but now has had a correction; it is down about 60% from its peak. India's property market, which has seen a 30% to 50% annual price growth in recent years, is weakening. Consumer confidence locally is being dented by sliding share and property prices. Steep declines in asset values pose worry not only for economic growth, but also social stability, as ordinary folk watch their personal wealth evaporate. Even though the commonly-identified causes of the crisis in the US, the subprime mortgage revolution and the extremely loose monetary policy, were not in evidence in India, outcomes have been similar.
Should we be surprised? Actually, the similarity of market behavior across countries is evidence that something else, deeper is at work. The fundamental problem is the swings of overconfidence and greed & now pessimism and fear shared by millions, billions of people. Projections of gloom & doom can become self-fulfilling prophecy. The Great Depression was greatly depressing because it was global. The combined output of the world's economies declined nearly 33% from 1929 to 1932. The unemployment rate soared in the U.S. and Germany to a peak above 25%, World trade collapsed by two-thirds. Booms & busts were transmitted from one country to another through trade & financial flows. We no longer live in isolated glass houses. Today when the ‘world is flat’, linked together by instant communication, ‘Geography is History’ and global capital movement is a difficult servant to master. Internet & Television have transmitted fear at lightning speed across the globe. Former Prime Minister of U.K. Tony Blair speaking at the Hindustan Times Leadership Summit on the theme ‘We stand together or we fall together’ said that be it the economic challenge, terrorist threat, climate change or the battle for resources; all are global, interconnected and interdependent. To rephrase John Donne, “Now no nation is an island, entire of itself”. International affairs and business not only intersect but are interlinked. That’s how it was supposed to be post 1940’s, under the Bretton Woods financial architecture, that brought an end to the old colonial order of imperial trade & ushered in an era of open world economy of interdependence.
That the world is a global village is best represented by the Sanskrit phrase ‘Vasudhaiva Kutumbakam’ which means the world is one family. Swami Vivekananda began the era of Globalization in 1893, at the world parliament of Religions, by opening his speech with the line, “Dear brothers and sisters of America”. I strongly believe that if my brothers and sisters of America are going to face financial hardship, my brothers and sisters of India or for that matter anywhere in the world are not going to be immune from the affliction.
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