Friday, September 26, 2008

Religion and Economy....' Money is just a Medium of Exchange'

No I haven't turned socialist and neither has the feeling of greed for more money died down within me....The article is just about an interpretation of what I observed on my trip from Hardwar to Gaumukh. 

Here I enter into Hardwar and I observe the market economy at work to the fullest.....The product of the region..'Religion'....It's a city whose economy drives itself solely on the basis of religion...At every step you can find temple and dharmsalas each selling some USB to attract bakhts (customers), as you step into the ghats for watching the aarti you are appaled by the its untidiness and don't want to sit on the dirty floor (looks like the we had to do the long wait and watch the whole aarti standing) but wait the market economy comes to your rescue....you find children selling paper sheets to put under your b**ts.....and as you settle in would come hoards of people selling you Diyas, milk and flowers to offer to the holy Ganges, so even if you never wanted to take it but when you find other people buying it you are tantalised to do the same...(the usual herd beaviour in the markets thus creating a market for a product out of nowhere)....

Next let's  cut short to Gangotri....almost 300 km from Hardwar....the need for money seems to have subsided here though not completely gone...at 3200 metres above sea level the food is a little expensive and you still need to tip the waiters...though the needs here are limited and so is the need for money...that brings me to the first major point in the article:

1) The need for money is driven by the increase in need and luxury..... Half a century ago a monthly salary of 500 rupees was thought to be good!!! simply because the articles costed much less as there was lesser cash in the world and there were not many funky gadzets. The worlds money supply grows at around 20% annually!!! and at this rate the amount of money the world would have had now would have grown by over 8000 times!!!, however even if someone's assets might have grown at this pace he would still have been the same of as he was some 50 years ago when it comes to luxury articles (articles not essential for survival and basic living) so if you want to become richer make sure that first of all you have a good asset base to start with which then grows at a rate faster than the money supply of the world and add to it the rate of growth of your needs (no idea how you can quantify it though!!!)......

Coming back to the story on the top of Gaumukh glacier with nothing around us but simply ice...money looses its value completely, well not really...we just realize that money practically had no value to start with...it was and is just a medium of exchange and derived it's value mainly from because it can buy you the needs by being the easiest medium of exchange but here at 4250 metres above sea level this medium of exchange doesn't work...One of our fellow trekkers tried to offer some of this medium of exchange to a sadhvi on her way to Tapovan...she just laughed and went passed..probably she was clever to know this at the first place.........

Now back in Delhi...the value of money is back...(Thank GOD!!!)...probably that was a different planet but the lesson I learnt there can be encapsulated in one line:

"Money helps in making the market efficient however its value is derived from the inherent inefficiency in the market"......

In other words just because money is the most convenient medium of exchange it has a value, so its critical that for wealth creation only a small portion of your portfolio is in the form of cash the rest should always be invested in some asset or the other.........

Wednesday, September 10, 2008

The Secular Growth of the World - 'It's a Tangent' - Part 1

After a little pessimistic last article... let me get back to more optimistic talk.... In this article I would discuss the future shape of the global  economic development..........

In the century gone by the world saw tremendous economic growth... infact the kind of economic growth the world saw in the last century was never ever seen in the history of civilized mankind.... There are 2 main reasons for such an occurrence...

1) More areas joined the economic growth
2) But the most important reason why this happened is because of 'technology'.

The economic growth of the world can be expressed as Y= C + I + G-T+X-M, Now keeping every parameter as constant suppose we change investment I from I to I' then the economic growth of the world is (I'-I)/(1-i), where i is the 'marginal propensity to invest', similar marginal propensities could be defined for the rest of the variables. 

What technology does really is change this variable of marginal propensity by bringing about a structural change and let's see how. Earlier man used communicate through letters sent through post...a long drawn affair.... Let's say I post a letter from India to US for the signature of the CEO of my company for some contract the whole process would have taken around 10 days... now such a think happens within flip of a finger!!!, OK for calculations sake I put it at 1 day... but still its 10 times more efficient....I would not be discussing the mathematics of marginal propensity in this part but in part 2, however still let me put some ballpark numbers, let's say a 100 rupees were invested in the world before this invention of email and now the marginal propensity was .2 so the GDP of the world would be 125 rupees. Now with the email as things have become much faster so the marginal propensity changes to .5 and with the same 100 rupees invested the GDP goes to 200 rupees!!!, so without spending an extra penny the world sees a higher growth....So with technology this saying is apt... ' You can have your cake and eat it too' or 'there can indeed be free lunches in the economy'. Such structural changes can be observed in locomotion with the coming of planes, markets with online shopping and trading, better roads and highways, improved productivity in agriculture and industries. 

Take for example an ERP software in companies. First with a central storage and access system time is saved thus improving productivity and using them now the companies can better manage their inventories and sales thus improving their inventory turnover...so if the inventory earlier was kept in warehouse for 60 days, this period because of the use of these systems have come down to 30 days...a 50% improvement in productivity transcending into similar amount of growth....

Also now the more improvement one would find in the marginal propensity(Mp), higher would be the economic growth due to the base effect... For e.g. when Mp was .5 a 20% increase would have taken it to .6 so the GDP growth would have increased by 25%....Next with an Mp of .75 a 20% increase would take it to .9 and the GDP growth would shoot up by a whopping 150%!!!, the flip side though is that this would require a very big technology shift....

So now every big technology shift could take the economic growth of this world to a much higher orbit and so I say that we are likely to see growth rates never ever seen in the past....Based upon this let's contemplate on the technologies one can see in the future, this would also help in betting on the companies in the market.....

- The first technology that comes to mind is that of teleportation method of transport (transport at the speed of light... seems like a Star Trek fantasy!!!, I don't think so...I think this technology is quite realistic)

- Banking would totally shift from credit cards to mobile banking

- Nuclear Fusion reactors.....

- Faster computers with microprocessers not based on transistors but some other components at its core

- New agri and mining technologies that can help us cultivate in artificial environment and mine from asteroids and other planet surfaces

- Electric Storage cylinders

These are some that I can think of.... One thing is for sure though that we are in the most sweet spot of 'Wealth Creation'



Monday, September 8, 2008

Era of Wealth Destruction Begins............

I don't want to sound too pessimistic.. but this how any free market economy works, in cycles... what goes up comes down only to go higher at some later date, I for one firmly believe that the kind of economic growth the world is going to witness, it would have never seen before but let me put this article on hold for some other day; perhaps after this little pessimistic article it would be apt to put write in that article.... so with this optimistic note let me begin............

Oil has seen a sharp pullback of around 30% from its all time high.... now this could simply be a correction in a bull market...bull markets do correct by around 30% (remember 2006 Indian markets) or finally the bear market has set caught up with oil as well.... and with this happening the final piece of puzzle in the process of wealth destruction has been put in place as wit oil falling every asset class across the world is in the process of meltdown... this is what we call 'Wealth destruction', you are loosing wealth no matter what you do....

- If you keep cash, inflation erodes your wealth....
- Similar story with bonds
- Commodities and Equities are loosing their notional values so even your principal is getting eroded in these asset classes
- The new esoteric asset classes including art and sculptures... well let's not really talk about it because they may be asset classes today, but time changes and so does tastes of people...

Now the question that comes to mind is that if asset prices are a function of liquidity then with US (the main source of global liquidity) having interest rates that low, how can every asset meltdown... after all said and done people would invest the new money somewhere... Well the idea is right however asset prices are not just a function of current liquidity but also future liquidity or what we call growth....

Let's assume an economy with just two people A & B... A has a piece of land with him while B has 100 rupees with him... A sells the land to B for 100 rupees... now A goes nerd and throws the 100 rupee note in the river.. while B turns lazy and sleeps/hibernates for 6 months on the land he bought...What happens after 6 months when B tries to sell the land back to A... A has nothing to give him back...The price crashes to zilch..... 

However wait the story is not over yet....Seeing its pupil in distress, enter our angel - 'The Central Banker' ..... and distributes 200 rupees to A... now B sells the land to A for 200 (double of what he had bought for..wow!!! or is it)...any crop A produces on that land would automatically cost almost double of it had 6 months before.....an inflation rate of 100%!!!.... so the 200 rupees B got turns to be really worth 100 and worst still the 200 rupees borrowed by A has to be given back to the bank.....how on earth would that happen when already inflation has eroded the wealth by 100%.....so again the price crashes to zilch............

Now the Central Bank accepts that there is a problem and only a structural change wherein in the A & B starts doing some productive work in the economy can bring the economy out of this hole and for that to happen the Central Bank is bold enough to take in a few periods of economic downturn...However it can do one other thing to prevent the asset prices from doing to zilch...it keeps on printing money...it will keep on inflating asset prices along with prices of consuming commodities leading to HyperInflation.....10000%, 100000%, 1000000%....just pick a number and that could be your inflation figure.....This has serious implication of eroding business confidence as with so much uncertainty no one wants to risk new capital in any business, currency looses its meaning and people switch to barter system which again ultimately means no appreciation of wealth in any asset class....

Unfortunately the Fed of US has taken on to this very last route... ofcourse structurally US economy is much more stronger than countries like Zimbabwe.. but it doesn't take long for the tide to turn... but now there are two routes in front of the Fed.... stop printing easy money and let the world take in some pain... or keep on doing what it has been doing and worse still print more money (reduce rates further) and take this world to a total disaster...... Either ways there is going to be wealth destruction for now... However in the first case there would be short term pain with long term gain... In the second yu might again see some asset classes (may be oil again) propping up.. However it just be the final spark before the total darkness that will engulf the World economy.. Hopefully good sense might prevail atleast this time........