10/03/2008 Is bailout the solution? And future.

I still believe the bailout is just an attempt to cure the symptom rather than a fix to the cause. The root cause of this financial mess is the dropping home prices and the inability of home owners to continue paying their mortgages. Sure, one might argue that the subprime lending practice itself was flawed but that’s more of a regulation failure in my opinion rather than the root cause.

The bailout was certainly a necessary step to keep the situation getting from bad to worse but I don’t think it’ll help any turnaround. The fundamental problem the US economy is facing is the lack of trust between the lender and the common borrower (consumption factor). Sure the inter-bank lending might ease up but the same can’t be said about lending to common Americans, particularly with increasing unemployment rate. This will keep consumption low and continue to hurt the GDP and overall effort to fix the economy.

My belief is that US financial sector has just crossed the core of this problem comet and there is still a long tail it needs to travel before coming out of it. I feel it’ll at least be two years before we start sensing a financial sector revival unless we see appreciation in US home prices or a write down on principals. Another thing we need to note is the ripple effect of this on the overall US economy which hasn’t hit the core yet (since it comes with a lag). So, I feel there is more we are yet to witness before the overall economy revives.

Europe – If I had money, I’d short Euro. The impact of the US financial meltdown will hit Europe with a lag and it’s not too far into the future. The problem I notice with European countries is their sizes. Because of that, none of the countries there is self-sufficient and hence a lot of their fate depends upon the continued trade among one another. As we’ll see more bailouts in Europe, individual currencies will devalue erratically and hurt the trades and unemployment will rise. This will erode the trust on Euro and USD will gain over Euro (I see 1USD = 1 EUR again by end of 2009).

India – Unfortunately India hasn’t seen the worst yet. The rupee will further devalue to 50 or even beyond against the USD. Why? The slowdown in the US and Europe will hit India’s services sector and other exports. Unemployment will rise and the inability to pay rising mortgages payments due to ARMs will lead to crash in housing prices by mid-to-late next year. Banks that have loaned ARMs will feel the heat. In India, govt. comes to rescue the people so it’ll save the banks by covering them (printing more money). As the economy slows, FIIs will pull more of their money out of India. The repatriation of USD and printing money will put severe downward pressure on rupee/USD exchange rate.

The problem with India is its lack of internal demand. True, it has best in class technology available but the penetration is pretty much limited to 5% of the haves. The have nots are still tied to the primary sector and are not in a position to make services demand to compensate for the drying up of the external ones. The increasing wealth gap, unemployment rate, rising inflation (will stay up as money is printed), continued discordant male to female ratio, and dawn of the growth era will push people towards their mundane regional, religion and caste issue. A social unrest can’t be ruled out in the coming years.

China – I don’t know much about internals of China but I feel it will move more towards democracy (more rights, more freedom) and will continue to get stronger. Why? China is a manufacturing powerhouse with about 1.3B population. China’s economy is also export oriented which will face the decreased demand due to global slowdown. However, unlike India, which is a services giant, China is a manufacturing giant. It produces machinery for which internal demand in the primary sector can be created by enabling the farmers. There will be two parts to this enablement. One, making finance available to the farmers and second, training the farmers on the machineries. Increased wealth and knowledge across China will create opportunity as well as demand for more rights.

The USA – The USA will inch a little towards commu… with the govt. overseeing and interfering into more than it should. However, with strong processes and quality adherence in place, it’ll emerge as the strongest economy again with USD gaining against all major currencies. In Asia, Pakistan will not be a close ally to the US (it’ll probably be India to balance China and Russia). I can see US’ and NATO’s interest growing more in African nations, particularly Sudan and Somalia in the coming years to counter China’s influence in the continent.

Well, what if the bailout works?