Posts tagged ‘debt’

FDI in retail – Another form of debt financed consumption

One wonders if he should be happy or sad with the govt’s decision of allowing FDI in retail. The decision marks a sad day for the country but happy that it will hasten to conclusion the obituary of reforms and reformists thus paving the way for a new beginning.

FDI is another form of debt that will attempt to temporarily avert the crisis of falling rupee and rising inflation but alas! only at the cost of greater future pains. FDI gives us capital account surplus, which is a liability. It is a debt which has to be paid back. We have been using this money on capital account not to open factories but to pay FOR OUR IMPORT BILLS because we are a trade deficit (Import > exports) nation. Now when FII’s starts cashing in their profits and pull out from markets, we need to pay them back their money. The point now is that how do we do it? Because we are a trade deficit nation (read it as a poor nation) , options available before us are fairly limited.

1) by raising more debt either by selling our assets or interests to FIIs and asking for investments


2) by taking loans from IMF, World bank etc which also we have been doing aggressively last few years.

Any 3rd option of meeting this pull out demand from current account, which is possible for a trade surplus country like China has, in not available to us. From the last 2 decades, we have been adopting both methods to pay our rising import bills and enjoying this debt financed prosperity. This exposes how successful these reforms have been all these years. Recently, we saw another example of how hollow and dangerous this debt financed growth has been, when our rupee was in free fall a few days back and have reached all time low and RBI was scared of intervening due to lack of reserves. The reason was that our foreign exchange reserves is close to external debt. So what good FDIs have been doing in last 20 years? It has made us no wealthy a nation but one that is more on debt than it was earlier.

Wallmart is not here for charity. All it will do is to kill our entrepreneurs and create a few slaves with lesser buying power. It will take the profit out thereby increasing the outflow. When it will do that, rupee will fall and our import bills will drastically rise. On top of it, massive unemployment, that it will cause will mean less purchasing power with people therefore low production. And eventually after sucking the nation when these foreign firms will shut their shops and move out, we will face the same consequence as southeast asian countries had faced in 1997 during the asian tigers crisis. Our rupee would have been devalued to a greater extent thereby giving way to rampant inflation marked with low growth, and massive unemployment. This STAGFLATION causing series of unrest, anarchy and chaos will be the order of the day. That surely looks like the trend unless some intervention saves or change the course.


The Rise & Rise of Prices

Many people tend to blame commodities markets for the rising food prices but they fail to recognise that high leverage based commodity market is just a resultant contributing factor and not the root cause. Infact, by selectively putting a bar or “max retail price” on food prices alone or artificially manipulating the rules of the game by selective intervention in the commodity markets, while ignoring the inflation in other sectors e.g., services sector (in form of salaries), will only discourage food production. This is because farmers will always get less money forcing them to quit their current occupation and move to better paying avenues. Why not, for example, ever increasing pay packets of the service class is considered to put under check? If we play by fair rules then while every one has a right to choose the price for the product of his labour, then why a farmer has to work under controled price regime? Why not a bar on the fat-salaries of CEOs, politicians, Film Stars, crickters, Journalists, bureaucrates etc? If the prices of commodities goes up, it is the producer of commodity who gets benefitted (though a major share is still looted by the middlemen).  How can a farmer from the rural area pay for rising education or medical expenses or rising prices of industrial commodities without getting a raise in their earnings too?
This ever increasing pay packets for unproductive people which is a result of massive money printing or stimulus economics, is causing prices to rise. There are two types of workers in an economy. Producers and service sector. Producers produce for themselves and for the service sector. In return service sector exist to service the producers. If producers are not satisfied and do not see a value in the service, in an ideal world such jobs should cease to exist and people from service sector should return to production. But that is not happening. Instead it is the service sector that is playing the shots and getting benefitted from the currency devaluation while the producer’s are loosing. Phony and unproductive service sector jobs are being created with huge salaries that a hard working honest farmer can not even dream off.
Further to that a farmer, as all savers in the economy, suffers from the theft of purchasing power. Infact it is this theft of purchasing power that enables sustainence of this huge unproductive service sector. This day light theft by inflation is invisible and therefore simple common man can’t see it. Let us try to understand it with an example. After a full day of toiling in the field, a farmer gets Rs 100 note which he tries to save in the bank. At the same time govt creates many more such notes without enough production in the economy. This devalues or dilutes the purchasing power stored in Rs 100 note owned by the farmer and the same purchasing power is now shared by new money that has come into the economy. Due to this currency devaluation, money is loosing one of its key function “store of value” (Functions of money: Unit of account, Measure of value, Medium of exchange, Store of value). PRODUCTIVE CLASS HAS TO COMPETE WITH UNPRODUCTIVE CLASS FOR THE SAME AMOUNT OF SUPPLIES. THIS CREATES INFLATION.
It is the Fiat money system that is the root cause of price rise where in, it is believed that causing inflation by raising the salary of people results in high production because the pain of price rise will force people to produce more. This however completely ignores that production is a function of hard work and natural resources are constrained. So while it is always easy and cheap to print money exponentially, it is not the same for production.
Price rise is often blamed on hoarders, speculators, weather etc. But Hoarding happens when you know prices are going to rise. Why would somebody do hoarding when prices are falling? And why prices will fall when there is “too much money (which is also increasing) available to chase too few goods”? Prices will fall WHEN THERE IS MORE PRODUCTION. But why would somebody choose the hard work of production when money can be gained through easy routes i.e., by phony service sector jobs sustained by loose monetary policy. In Oct 2008, when TARP stimulus (which is massive money printing to prevent bank default) was first rejected by US congress, all prices including that of Gold fell down and markets crashed. Why no one was interested in hoarding then? Because the bubble was busted and all the money percieved to exist in the economy was gone. Money creates demand; and in the absence of demand, prices fell down. Commodity traders makes money by betting on inflation. They know that more money is coming to the economy which will increase demand and prices will go up. So by hoarding they will win and make money. An example is the recent spike in Gold and Silver prices when Federal Reserve Chairman Ben Bernanke announced that a QE3 (3rd round of massive and unprecedented money printing since 2008 crisis to avoid a financial collapse) is being contemplated. The moment this news came, prices shot up across the countries. We can’t say that hoarders are acting suddenly in an organised fashion across the world in all economies. Prices are rising as a result of central banks’ money printing.
Inflation is the increase of money supply and price rise is its impact. As people become aware of the fraud that inflation is the creation of none other than govts, more and more people will buy commodities as a hedge against inflation. I love this line from Peter Schiff, “It is not prices of commodity going up but the value of currency going down”. Root cause of price rise and resultant social evils, including the casino economy, is Fiat money system.
In 1971 when Richard Nixon brought down the brettonwoods system and decoupled dollar with gold, he used the same excuse “threat of speculators”. An excuse was made to hide the fact that US had defaulted since it has printed massive money and was not having Gold to back it. In the bretten woods conference 1946, US has pursuaded the world that it will only print money according to the gold it has and other countries will peg their currency to dollar. US dollar was accepted as a reserve currency or internationally accepted medium of exchange. So a fixed exchange rate was decided and it was the order until 1971. Now since US was spending recklessley to meet the expenditures from its space mission, korean, vietnemese wars, cold war etc. It started printing massively than the gold it had. This started creating inflation in countries that were exporting to US because they had to print currencies in line with falling dollar to maintain the exchange rate as promised in the Brettonwoods system. This resulted in countries like France getting suspicious and they in 1970 started reducing dollar reserves for gold thereby threatning US economy because it was not having enough gold to pay back. Result was “Nixon shock” when on 15th Aug 1971 Richard Nixon unilaterally announced cessation of direct convertability of dollar to gold thereby breaking the promise it had done to world. The reason cited was “threat from speculators”. Since 1971 we are living in a world with Fiat money system. Fiat money is that money which is not backed by anything and it just need the consent of government to print money as much as they like.
Result of this reckless money printing was runaway inflation in the decade of 70. Later what came to the rescue of US economy were lenders of America, primarily Japan and later China. Goods worth trillions of dollars were loaned to America in the last few decades which temporarily solved the supply side problem while money printing continues to grow at exponential rate thereby creating an impression of growth. GDP growth is measured in terms of growing money while discounting inflation but does not take into consideration the debt which helps to control the inflation. Growth was basically the exponential growth of paper money while inflation was temporarily checked in by raising debt levels.
It was important to discuss United States, because it was US that created this system of Fiat money and the world leadership including that of India emulated it because it saw United States flourishing, prospering, though little did they realise that debt financed prosperity is always at the cost of future pains.
The situation today, however is different. The payback time started in 2008. Exponentially growing Debt requirement has gone up so high that its lenders can not afford it. Lenders like China are supplying goods to America in return for cheaply printed paper that is not backed by anything, most of which they are investing again in buying US treasuries (govt debt). As a result, while the trade surplus of China is growing, inflation is sky rocketing due to shortage of goods as goods that could have otherwise been available for local consumption are being exported.

India is different case since it has been following same path as the US did. While the money supply has been growing exponentially, it is the trade deficit which is increasing unlike the trade surplus of China. This clearly shows that we are importing to meet our growing demands (money). And this import is consumption which is financned by debt. India’s external debt is almost similar to foreign exchange reserve.
In context to India, while the money printing is growing at exponential rate of 15% to 22%, debt levels are rising almost at the same rate. Please see the chart showing GDP, M3 (Broad money supply) and National debt and notice how they all are growing together. More availability of goods helps in controlling prices but if goods are financed by debt then this period of prosperity is only temporary as debt has to be repaid with interest. So more debt is taken to pay for the previous debt and this creates a debt trap. When debt becomes difficult and cost of borrowing (interest rates) increases, govt is forced to control imports. Imports can be controlled by raising the prices of imported commodities (such as crude oil), which is what currently happening in the economy. (Note: Please notice in the chart that how in 2008, M3 crossed over national debt, thus marking a period where debt is becoming difficult and M3 has to be increased to meet fiscal deficit targets.)
Another problem that India has is that a major share of our exports comes from service sector such as IT. We are exporting to countries like US and Euro zone where the trade deficits are enormously high and who are struggling to prevent a default by a series of Quantitative easing or stimulus or in other words money printing. When our customers will go bankrupt, our service sector will be in deep trouble, thereby widening the gap between our income (exports) and expenditutre (imports). Even today our trade deficit is a matter of concern but with financial crisis deepening in west, the situation will be even worse.
The times ahead are extraordinary. From east to west (Japan to US), a threat of debt crisis is looming large. Growth of debt is becoming impossible as the lenders are suffering from their own problems e.g., earthquake in already debt ridden Japan and massive runaway inflation in China. In the absence of debt, supplies are becoming difficult. But money printing (QE1 -Oct & Mar2008, QE2-Nov2010, QE3-an inevitable reality) has to be continued to sustain the unproductive service sector jobs. If the QE (quantiative easing or money printing) is not done then to prevent the default and to run the govt massive austerity is required. This means massive cut in service sector jobs, resulting in a series of defaults, causing a domino effect and bringing the liquidity crisis of 2008 back to life. But if the QE is done, it will further create inflation or price rise, eventually, some day, leading to hyperinflation as happened in Zimbabwe, Yugoslavia, Weimar republic etc. It was the debt that was supressing inflation and creating a mirage of growth but as debt becomes difficult, inflation will explode with an accelerating frequency.
RBI is continuing to raise interest rates but at the same time pumping money into the system to prevent default by government (to bridge the fiscal deficits). While raising the interest rates sucks the money from the system thereby reducing demand, increasing money supply does just the opposite i.e., helps in creating demand. Therefore there is high probability that there will be no respite from inflation because no government will have the guts to embrace a bust and prices will continue to rise until money dies or currency collapses. But even if a bust is embraced it will mean total revolution and as Gerald Celente says “when people loose everything and they have nothing left to loose, they loose it”. The double dip recession or a depression, however is inevitable either by way of hyperinflation (currency collapse) or a liquidity crisis

Greed, Inflation, Debt and Nirvana?

Even though I see much sense in the arguments forwarded by free market supporting classical economists in the diagnosis of current economic crisis, I have not yet made any opinion that it is always right and a general solution available for economic prosperity. However I am convinced that the current economic path of producing little and consuming more on borrowed money and then punishing the real wealth generators by printing currency and raising inflation is nothing but a daylight robbery of those who are producing for the economy and enabling its sustenance.

It reminds me the story of that farmer who was having a hen that used to lay golden eggs. One day he thought, why not take all the eggs together: and he ripped apart the stomach of the hen thus loosing what he had. Much in the same way, we should understand that the hen in our economy are our farmers and producers who are producing essential commodities for us, so that others can invest labour, in either producing goods for them or providing welfare to them, through services. We must not forget that these farmers and producers, invest their hard earned wealth and bear the burden of service sector and deserves in return the fruits of services, such as research and development, education, supporting administration etc or goods produced by secondary sector like car, TV, furniture etc. But if you look at our society in India, what is that we have done for the people employed in primary sector? What is their standard of living? What incentives our system provides one to work in rural areas, agriculture or primary sector.

Due to availability of supplies in villages, people living in the rural areas undertake employment in agriculture and related industries. They require better irrigation facilities, electricity to produce etc but they are left on their own to arrange means for their living. In the absence of any cold storage these people are forced to sell their produce in less than their cost prices. Rising cost of agriculture combined with inflation has forced farmers to commit suicides and according to India’s National Crime Records Bureau estimates; approximately 184000 farmers have committed suicide from 1995 to 2007. Isn’t this a tragic irony, that those who toil hard in the fields, bear high risks and generate real wealth for the economy are the ones who are given least of the share in the wealth of economy?

As I have explained earlier that service sector does not produce. In other words, society consumes through service sector which means people in the service sector should act in the welfare of the state and at all point of time society should strive to keep only bare minimum people in service sector so that the producers should not feel the pinch. In fact in the ideal society it is the producer who should be able to decide if he needs any service or not because he is the one who pays for that with his labour. However government spending on the unproductive service sector with no or limited accountabilities combined with fat salaries only attract producers towards it. Due to fewer incentives, people who have options are moving to areas where the return on investment is higher to an individual so that he can lead a better life. So unsurprisingly people chose to quit their fields and move to cities seeking employment in service sector which thrives on the support of government. Even though this migration is, for most, humiliating and painful, poor people are forced to embrace it to escape from the desperate circumstances they were going through and which has lead others to commit suicide. A recent example highlighting this plight is the egregious attack on migrants by Raj Thackeray’s goons. Apparently, this does no help in increasing production in the economy.

Last 20 years of government policies have only compounded the problems. A large and unproductive service sector with plentiful artificially created wealth of paper money has encouraged reckless imports for consumption resulting in a rising trade deficit for the country, while at the same time, ripping apart the stomach of the hen that lays golden eggs for us and pushing our producing class to commit suicide. Not only this indigenous production by large network of small scale industries has been allowed to wipe off by pitting them against large foreign multinational companies who have glutted their goods in ultra low prices thereby making manufacturing unviable by the small industries. Result: We are borrowing heavily to run our nation and imports and trade-deficits are rising at horrendous rate threatening our economy with a debt default. S&P rating only substantiates that.

One argument that is often given to justify the import bill is that the import is being done in capital goods to increase exports. First I disagree with it because the data published by ministry of commerce does not suggest so, but well, if 20 years of compounding trade deficit, horrendously increasing debt has not given us a trade surplus then I wonder when our investment will pay off? Similarly arguments are given in favour of pitting our small manufactures against foreign multinationals. One argument is that the MNCs will bring with them technical knowledge. There are no shortcuts to gain technical knowledge especially when it is the bread and butter for these companies who will never allow it to be shared or leaked out. We can see how apple, Google and all these company fight for IP rights. Another argument that is given is about quality due to competition. First of all by destroying our small scale manufacturers who were competing with each other we have ourselves destroyed competition and left the field empty for the small number of big players, who once are firmly settled, thereafter start dictating terms. Not going into further arguments, the proof of the pudding is in the eating. The results shows us 20 years and where we are: We have a large trade deficit that is only increasing, external debt increasing, inflation increasing resulting in poor credit ratings that was negative until recently and now just stable (even though I believe these agencies are only too kind and late riser).

Every year our country, similar to US, UK, PIIGS (Portugal, Ireland, Italy, Greece and Spain) and many countries of the world, borrows more than it produces (fiscal deficit), accumulating debt. They borrowed money from countries that produces for the world like China, Japan, and Germany etc. This borrowed money enables more spending which is then taken into account for calculation of growth. It is these figures and indexes which are shown to us by Governments and vested interest groups who have attained mastery in the art of manufacturing complexity in otherwise simple economic principals so that the poor common man loose his economic common sense and start trusting those who rob them of their wealth. The problem is compounded when the borrowed money is not spent to increase production but spent on unproductive service sector enabling high consumption. This coupled with government policies supporting unproductive people and punishing real wealth generators only acts as a catalyst towards the fall of economy.

Rising inflation caused by printing of money ultimately results in increase of price of the commodities if the supply is not increased. What if the prices are contained by external and internal borrowings? This will help temporarily in containing the prices but eventually result in accumulation of debt and a possible default. This means that there are not enough goods in the market because internal production was never sufficient and that’s why borrowings were done. Due to higher debts or default the continuing borrowings becomes unsustainable, leaving people only with loads of paper currency that was printed to create artificial growth. This is called currency crisis or hyperinflation: A similar situation as the world has seen in Argentina, Yugoslavia, and Zimbabwe etc.

Those who take pride in our “highly skilled” IT-ITES and other service class who provides services to countries like US and UK must understand that the present arrangement also is unsustainable. This is because these countries to which we provide services are already bankrupt as they have long back abjured their path of hard work and labour but due to their past reputation are still able to thrive on borrowed money. This irresponsible behaviour has resulted in accumulation of massive debt which can not be thought to be repaid by any ray of imagination. Their house of cards is set to fall. But when this will happen and US dollar will loose its reserved currency status, countries like India will go through much pain. As everywhere in the world, the food prices and essential commodities will sky rocket and people will have loads of money that won’t buy them anything. Even in creditor countries like China, Japan, Germany, over dependence on exports and external markets will result in deflation and job losses in short run.

As great masters have said, I firmly believe that we are heading towards an unprecedented time when the events will unfold in such a way that shatters many perceptions, believes, faiths, prejudices while at the same time making people learn the real principals for economic prosperity first hand from their own experiences leading to a renaissance or new age of truth and righteousness.

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