Saturday, August 6, 2011

It’s over for dollar and euro; get ready for Sensex 60000

So it’s a choice between two hair-cuts: lower repayment of debts, or lower ability to earn from America. In both situations, the world economy will slow down, and the dollar will have a reduced future as a reserve currency.

The real worry is that if too many holders of dollars suddenly decide to stay away from the greenback, we will have a precipitate fall in the currency’s value. This is what India did last year when it bought 200 tonnes of gold in 2009, in a dramatic rejection of the dollar.

The results are there for all to see: while returns on our reserves saw a Rs 25,000-crore drop in value in 2009-10, gold’s value in our reserves gave us Rs 15,000 crore gain. And gold is now 8 percent of our reserves. It bids fair to rise above 10 percent, if gold continues its upswing.

India’s experience suggests that the world will be looking to diversify away from the dollar, little by little. If it lurches away from it suddenly, there will be a short-term catastrophe.

Second, the euro. The problem with the euro is that the European Union (EU) is a political union and a fiscal non-union. You cannot have one currency when the fiscal policies of the EU’s constituent states are completely divergent. You can’t have one Germany running a great fisc and the PIIGS (Portugal, Ireland, Italy, Greece, and Spain), running huge debt bills.

If you want to do that, you should run separate countries so that those who want to run profligate spending policies can allow their currencies to depreciate and correct the imbalance through slow inflation.

This is why the PIIGS are imploding — first Greece, then Ireland, and now Portugal and Italy. The markets are speculating that sooner or later something’s got to give. They’re right. It will be either the euro, or the EU itself.

Sure, Germany can bail them all out — by angering domestic public opinion, which is against saving the sick children of Europe with German taxpayer wealth. So the PIIGS’ debts held by German and other banks will be in for another “hair-cut” — either by inflation or by a tightening of fiscal spending all around.

Like the US, this means less people will be willing to hold the euro, and the eurozone will have to contract in terms of economic growth for a while to balance its books.

If the US, Europe, and Japan — the three biggest economies and economic zones of the world are all going to be contracting in the foreseeable future, who will save the world? Who will drive world growth?

It has to be Asia, and Latin America. Asia means China and India – though the south-east Asians, including Vietnam, are revving up.

This brings us to funds flows: the problem is the world has assumed that the US will always be the safe haven it has been for much of the 20th century. It no longer is.

This is how this writer believes the future will unfold:

First, all incremental investments will flow away from the US dollar and euro. This will boost commodity prices marginally (since deflation in the US and Europe will reduce demand, the incremental demand for commodities will come from the need to hold them as investments). Emerging market currencies, once they become more convertible on the capital account, will start appreciating.

Second, fund managers in the west – starting with risky hedge funds – will start recalibrating what constitutes risk and what does not. The decline of the US and Europe – which is imminent – will force them to re-write the investment rules to classify the developed markets as slow growth markets, while the so-called emerging markets will have to be categorised as high growth.

The old classification of developed and emerging is wrong: it has to now be about growth and no-growth.

In future, risks will rise everywhere, but fund managers will have to choose between different kinds of risks: risk with no growth or the risk of undergoverned markets like India and China, which give higher returns.

Methinks, we are going to see an equity boom of the kind we have never seen before in this decade. This does not mean the markets will not fall in the short run. They probably will – as the news of the US’s downgrade will have to be digested. But by 2020, our equity markets will more than treble from current levels.

Get ready for a turbulent ride to riches.



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