Round tripping and financial meltdown
Background: The military buildup and world war two had destroyed wealth and the global economy was in danger of slipping in to major economic chaos – worst hit would be the nations that were deeply involved in world war two. This included USA, Europe, Russia and Japan. To leave growth on hard work would take the world a hell of a long time to even show signs of recovery. The only forward was short cuts.
The strategy: The US, Western Europe (primarily Germany, UK, France and Italy) and Japan (Famous Three) with the tacit support of Russia (USSR) decided to print money. But printing money by itself would have fueled inflation and caused more problems. So, they leaned in favour of round tripping.
Round tripping: As the words mean: the money goes on trips round and round and the practice that followed was that the Famous three would show trade between themselves and with actual funds flow. So, US bought from Japan, sold it to Europe who in turn sold it to Japan.
Then the same thing was repeated but at a higher price. Wonderful, there was growth in trade and profits were also there for everyone. Funding the difference (margin funding), if not done from own sources, got dependent on credit build up.
Boom: All that was required a pin prick and whole thing would explode. Lehman was the prick. And that is where it all started before the meltdown 0f 2007-2008. It threatened to unravel all the spin that the series of round tripping had piled up.
Life support: The developed economies went on life support with ‘stimulus’ packages. Countries (like China) which were dependent on the Famous Three also had major problems. China recovered fastest due to the huge savings it had pile up but countries like Spain, Portugal, Greece, Latvia etc who had a huge proportion of external debt compared to their GDP and their growth had become structurally damaged.
The stimulus packages by the big three is causing a fresh set of liquidity related problems in the emerging markets. Since there are lack of investment opportunities in the developed countries, the funds are moving to the emerging markets. This brings about an appreciation in the investee country’s currency and the fear of money rushing back to the country of origin at a moment’s notice. The currency war is already started and it threatens to stop the globalization process.
Life support again and again till death: After being hit in the guts, having a damaged heart and lung, the life support system gets extended till the eventual collapse.
Whats’ in this for India: There will be minor hiccups since India also gets affected due to the collapse of Famous three. Gandhijis theory of ‘Swadeshi” now bears wisdom. India will have to take care that it’s growth does not bring in liquidity. It is for sure that money will move from the slowing Famous three to growth areas like India, china, Malaysia, Indonesia, Africa (amongst other MEs) The test will be telling NO to portfolio funds that will seek to come in to the Indian Stock market because FDI will be most welcome.
Future of hedge funds and Mutual funds: No one would want them when the life support system of the Famous three start failing!!
Lesson: There are no short cuts
Understanding Swadeshi: Gandhi’s vision of a free India was not a nation-state but a confederation of self-governing, self-reliant, self-employed people living in village communities, deriving their right livelihood from the products of their homesteads. Swadeshi avoids economic dependence on external market forces that could make the village community vulnerable. It also avoids unnecessary, unhealthy, wasteful, and therefore environmentally destructive transportation. The village must build a strong economic base to satisfy most of its needs, and all members of the village community should give priority to local goods and services.
Prof. Kishore Nair
Faculty – Finance
International School of Management Excellence, Navi Mumbai
Prof. Kishore Nair (Associate Member of ICWAI, Masters in Commerce) Prof. Nair has extensive experience in areas of corporate finance. Prof. Nair successful ran his own investment firm with more than 50 corporate over a dozen industries in India and Mid-east which included a successful track record of in project / corporate financing with a clear focus on originating, structuring project financing (Greenfield, JV, FDI, M&A) and executing debt syndication, Private and Public Equity Offerings, Privatization, Investment Promotion, real estate fund structuring and other Capital Markets transactions – across sectors. Prior to joining ISME, Prof. Nair was the VP – Corporate Finance of a diversified conglomerate and has previously headed the investment banking and corporate finance of a major bank Saudi Arabia.