Frankly I have been trying to make sense of whats going on over the last one week and its impact on the future course of events. I am more confused trying to get an idea of it all. Over one week we have seen a return to fears of economic slowdown, US government rating being revised and the intervention of governments to keep their currencies down. Before trying to anticipate the future lets understand what is the impact of each these.
1. Currency interventions
It was only expected that with the slow fall in value of dollar, people are looking at other assets like Gold, Swiss franc and yen. This is creating issues for people and governments of these countries. At the start of the financial crisis, I had commented that the current problems are due to structural problems created due to artificial currencies. Are we in the same mode now, with few countries struggling to keep their currencies in line ? Or are we seeing that the markets are now forcing the governments to correct the structural problem rather indirectly? Continued fall in dollar, would only increase inflationary pressures in countries which have kept their currencies low in order to keep exports competitive. Eventually these countries will have to let their currencies rise. This would mean they need to stimulate their domestic consumption in order to keep their gdp's growing. This is task easier said than done as it is a very painful exercise. an exception to this is EU. A strong euro would destroy whatever chances southern European countries have of having growth. This would only lead to increased pressures which would lead to the EU region breakup.
2. Derating of US
The impact of the fall in the rating of US by one notch will be driven by the need for these export surplus countries to keep their currencies low. This would only help to keep the yields low.But the greater danger is the reluctance of US to increase government spending to support the little growth. In case in face of increased pressures from the Congress, the US government starts decreasing government, spending, then the US economy is in for a big trouble. We will have a case of government de leveraging and public de leveraging happening at the same time. The only way this can be sustained without increasing pain, is if the country attracts investment or if its exports become competitive. Both of which are currently difficult to achieve. A slowdown in US economy would mean, that all the export oriented Asian countries would also face a slowdown.
3. Global slowdown
In case countries still follow the path of the same few countries exporting and the same few consuming as we followed in last decade, we will only aggravate the situation further. The time has come for governments to realise the export/consumption story has run its course. Now the tide has to reverse for equilibrium to be realised again. Consumption in asian countries has to increase and consumption driven countries of the west have to regain their competitiveness.
All the events of the last week are only indicating that the problems which had to be solved at the end of 2008 have only been postponed, we are again back to the same issues. What does this all leave various asset classes, my view is that Gold would keep rising...the fall has only been postponed. Emerging markets which are not balanced but dependent on consumption or export only would face issues.
One of the countries best placed to face the uncertain times in my view unexpectedly is India. The risks India economy faces are more internal than external. If the government gets its act together, in improving investment climate, then we are readily looking forward to a period of strong growth. The uncertain environment would only help in keeping commodity prices low, aiding Indian economy. The big question mark is the Government..what is it going to do?
