Saturday, May 30, 2009

Second tsunami of greenbacks

Stock markets worldwide are booming. They have notched up record gains since march this year after a record free fall since start of last year. As usual markets participants and observers are divided in two camps. One say that this rally is for real and is going to continue, the others say that its nothing but suckers rally. Both have put forth cogent arguments to prove their points and its hard to side with one. One thing I have learnt in stock markets is that its a very futile and dangerous exercise to predict the direction or quantum of market movement. Your chances or being right are around 50%, which is as good as a coin tossing experiment. What we can do instead is to analyze the causes of market movements. That does help is in taking informed decisions for future.

Last bull rally ended somewhere in 2000 - 2001, with the burst of tech bubble coupled with social/political disturbances around the world, caused markets across the globe to fall. There was an economic slowdown and the central banks responded to this by lowering the interest rates and pumping in lot of money. Leader in doing this was the central banking system of USA, commonly known as the "Fed". It lowered the interest rates to record low of 1% and pumped in lot of greenbacks. From a negative issue of T-Bills in past 4 years preceding 2002, it issued around $1 Trillion T-Bills in next three years from 2002 to 2004. (And I am not including other GSE backed securities like raised by Fredi and Fannie and muni bonds). With so much of money raised, it started percolating into the system, where it should not have gone. First it went down the lane of less credit worthy borrowers, which today we all know as sub-prime and Alt-A mortgage crisis. There was still lot of money supply left and it then started moving into emerging markets. These markets which usually ran a thrifty economy, were not used so much of "hot" money into their system. All this barrage of freshly minted greenbacks created a sort of tsunami in their economies. Asset prices of all types of assets rose to dizzying heights. We all remember crude at $150 per barrel and not to speak of property prices in your neighborhoods.

This eventually led to inflation and then to combat inflation central bankers fired another arrow from their quivers. This was raising interest rates to suck the abundant liquidity. This had another fallout, which resulted in huge default in mortgage loans, as the interest payment rose, and this led to sub-prime crises. With asset prices falling world wide, interest rates rising, one thing lead to another and soon we were in another economic crises (worldwide). Economies across globe went into tailspin around mid of 2007, with some countries even declaring bankruptcies. Crises which emerged from developed economies actually affected emerging and under developed economies far more that developed ones. This recession was (or is) much deeper than the last one of early 2000's and some drawing parallels with the great depression on 1930s.

So it looks like the life came back in full circle to bite us in the rear. Once again central banks resorted to lowering the interest rates to all time low. Much lower than the previous recession. Even the money pumped into the system by central bankers was far more that last time. Some estimate that around $4 trillion has been pumped world wide so far. The issue of T-Bills by Fed itself amount to $1.5 - $2 trillion in past two years. This so far has done some work (or at least have appeared to) have done some work in ameliorating the disastrous impact of this economic crisis. So the question here is, once again doing the same things which were done last time which resulted in even a bigger crises, won't lead to a even bigger crises next time.

All this money, now in the system is finding ways to be allocated. In west especially US, credit worthy borrowers don't need loans. Lenders being just bitten from the sub-prime bug don't want to lend to credit worthless borrowers. So again all these greenbacks floating in the system are waiting to hit the emerging economies. Is a second tsunami of greenbacks waiting to happen? We have got some trailer of this in past two - three months with stock market indexes rising as much as 75%. Around 30% in just this month alone! Question we need to ask is won't it lead to another inflation bubble and to combat that once again excess liquidity would be sucked so again money would move out of these economies leading to another crash.

When would this happen (if at all it would happen), what would be the story next time (like sub-prime last time), no one knows. What we do know is similar experiment is past yielded some results and those are the results we should watch out for or anticipate for, or at least worry for.

Happy new world!


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