Posts tagged ‘swadesi’

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.

Why the prices are rising?

One is surprised that how clueless the government is in controlling the price rise in India. Equally clueless are those who are reluctant to look beyond the conventional arguments of hoarders, traders and weather, to blame for price rise, as if these are responsible for the across the boundary inflation in all emerging economies. One wonders, if the hoarders are such an organized group with excellent cold storage facilities and where they can keep significantly large perishable goods for a long period of time and in a coordinated way across the country or globe? A recent sting operation by a news channel even failed to find any hoarders or groups who can be held responsible for a general price rise across the country. While hoarders and speculators take advantage of a situation and add salt to the wounds, they are not the prime reason of price rise which is happening in all emerging economies as a result of inflationary economic policy.

The price rise is due to the systemic issues in ours and global economy which are coming to the fore everyday. When loads of money is printed and distributed to the unproductive service sector, people who are feeding the society starts turning away from production. The decreasing productive class has to compete with increasing unproductive class who have got almost all the share of this cheaply printed money to make a claim on the same amount of supplies. This results in prices to rise. It is not the prices of commodities going up but the value of currency going down because more cheaply printed money is being pumped into the economy and which is devaluing the currency. When this is being done globally, thanks to the the economic policy of globalization, we have to devalue our currency in line with dollars to keep our exports competitive. Debt based consumption combined with reckless printing of money and the fractional reserve system is the real cause of price rise.

Let us first understand what a fractional reserve system is. Owing to what is called as fractional reserve system, when government creates money, the total money that is created in the system is increased many times more. To understand, Let us say initially there is a 100 unit of new money deposited in the bank. The bank is allowed to loan all except a certain minimum percent which is called as cash reserve ratio. In India this ratio is currently 6% but for convenience let us assume this ratio is 10%. The bank will then keep 10% and loan 90 to other customer. The borrower will then make a payment to avail goods and services at the cost of this loaned amount which is a “promise to pay”. The person whom the borrower has made the payment deposits this Rs 90 to some bank thereby returning this money to the banking system. The banking system will then loan 81, and keep 9 with it. So 100 unit of new money by way of loans can create a money of 1000 unit in the economy. While the actual money is 100, the money created in the economy is all loans or promise to pay. The money was created from thin air and banks have been loaning what was actually not there, with them.

For more clarity please visit fractional reserve system video else where in my blog.

Quantitative easing or printing of money coupled with fractional reserve system creates a flood of money in the economy. Increase of money if not in proportion to supply of commodities will create prices to rise. When the supply side is taken care of, by increasing debt and importing goods from outside, inflation is controlled but trade deficit and external debt rises. Since the cheaply printed money can now buy loads of goods available in the market with low prices, it results in people believe “Wow! What a prosperous economy?”. But what we forget is that this prosperous life is at the cost of future consumption since the debt can not grow indefinitely and has to be repaid with interest. The bubble has to burst. When the continuous debt becomes difficult, supply of commodities is affected and inflation goes up. It is precisely happening in ours and many other economies now. Due to the sovereign debt crisis that we are seeing in Europe, many economies like India have become conscious of their increasing debt levels. Since they are now trying to contain the debt, the supply is affected, resulting in price rise. Note that recently our imports growth rate has reduced and was overtaken by exports growth rate. While many cheerleader journalists considered their job done by applauding the trend, few have attempted to understand the impact on supply because the government is now conscious of the debt levels and is trying to contain the imports. This will inevitably have an upward pressure on the prices as while the demand is being sustained by the availability of money, the supply is reducing.

Due to our dependence on high imports and debt, foreign exchange becomes extremely necessary. The dollars we get from our exports have been the result of same economic policy of stimulus or quantitative easing coupled with fractional reserve system. This leads to devaluation of currency. Due to devaluation of dollars, our currency appreciates and therefore exports suffers. Therefore the country need to devalue the rupee in line with the devaluation of dollars so that exports remain competitive. This is done by printing of money and increasing liquidity. So next time when we hear something like “government is injecting capital in the economy through xyz bank.”, we will know that this is devaluing the currency. The contradiction is evident in the government policy when on one hand they increase the money supply, on the other hand raises the interest rates to absorb the liquidity.

The reason for the contradiction I explained above is the shortsightedness in the leadership. When Friedrich Hayek asked John Maynard Keynes that his theory is dead in long run, he said “In the long run we all are dead”. Well that explains the chosen shortsightedness that prevailed over the world leadership after the 2nd world war. Shift in fundamental values do not necessarily show its result within a span of a few months or years but may be in decades or centuries. And this is what precisely happened here. The shift from fundamental principal such as Say’s law “supply creates demand” to Keynes’s principals of inflation or quantitative easing creates demand, helped to create a prosperous society in the west which thrived for decades, on debt based consumption until recently when their growth on debt became unsustainable. We have been simply following the west who adopted keynesian principals during and after 2nd world war. Inflation does not create demand but does a smart theft of purchasing power of common masses without them realising that they are being looted everyday thus making them poor and increase disparity in the economy. Inflation is devaluation of currency. It is printing of money and increase of money supply. Its not the price of commodities going up but the value of currency going down simply because too much cheaply created money is chasing too few available goods.

Says law of supply creates demand puts a descipline in place. It tell us that before one make a claim on goods produced by others one must meet his obligations of producing goods to pay back in return. In vedic principals this can be translated as “Ten tyakten bhunjitha” which means one should only consume after making a sacrifice. An example of supply creates demand is that if a shoe-maker wants to earn more money, he needs to produce more shoes to earn it. Money eventually is a claim to others labours by ways of commodities. We can’t just print money out of thin air and give it to a person who does not produce and spend, thus competing with those who produce. For the limited set of goods if unproductive people are made to compete with productive people, prices will rise. Today we see around us all the service sector based jobs who are getting a large share of this cheaply printed money while the poor farmers who bear the burden of this phony service sector are made to live a life of abject poverty.

In near future, I expect that eventually whether willingly or due to global events such as dollar crash, it will be difficult for the government to increase the debt to import and increase the supply. Government will put the burden of national debt on tax payers and to reduce imports bill will increase the prices of fuel. Increase in the prices of fuel has a direct bearing on prices of all commodities as transportation prices increases. At this situation, I expect that the government will try to absorb the liquidity, by exorbitant rise in taxes and interest rates. This will cause economy shrinking and GDP growth will be affected and go down significantly.

The timing may be debatable though I strongly expect it to happen in 2011 but the downward pressure of the GDP will require a stimulus to prevent a 2008 style bust. This is because a series of job losses caused by austerity or savings will result in defaults causing a crisis in the banking system. A quantitative easing on the other hand will cause massive inflation and if continued then eventually end up in zimbabwean style hyper inflation. The government will have to adopt one of the two evil choices, either to default which means liquisity crisis or to choose hyperinflation which means the paper money will loose its value. It is not just a problem limited to India but many countries including Europe and US who have been doing the same will face the same problem. Europe is still facing the same problems and many countries like PIIGS (Portugal, Ireland, Italy, Greece and spain) have been facing the same debt crisis and looking for one round of quantitative easing after another to bail them out. They have been bailed out in May 2010 by a round of quantitative easing and they are now again requiring another stimulus. Uncle sam though with unique advantage of reserve currency is leading this road but surely will be the first to fall from the cliff as it has unsustainable levels of debt. The inevitable crash of US dollar will result in the collapse of global financial system.

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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