Tuesday, August 9, 2011

Future looks gloomy!

I recently read an article which went by the name “It’s over for dollar and euro; get ready for Sensex 60000in Firstpost.com. Yeah you read it right, it is no typo it is Sixty thousand. The author clearly seemed to me high on a few gallons of Red Bull, if not smoking Marijuana. Before I go forward let’s get the facts straight. The GDP of US is close to around 14.77 trillion USD. And the debt they are holding as on July 31st 2011 is 14.32 trillion USD. So that puts the sovereign debt at almost 100% of US’s GDP. And going by the US treasury’s website from December 2010 to July 2011, one can see that the debt has been growing at a rate of 5.48 billion USD per day. So that’s about US. I would not go into how it is posed to service its debt, because S&P clearly seems to disagree with Obama on that at least.

With the S&P lowering US’s debt rating has given clear cut signals that now that debt is more risky. And a more risky investment demands more returns hence higher interest rates. Higher interest rate makes it even more difficult for US to service its debt. Whispers if not clear cut speculations have already started about US going bankrupt. If investors panic and start selling treasury bonds, there would be a large supply of US bonds which will far outstrip the demand thus lowering the prices and hence investors might end up getting peanuts for their investments. Now another fear is that due to such factors Dollar will also weaken and that can lead to countries shifting their Forex to commodities such as gold. Now here is bit of a wild assumption, we are all clear about Europe’s position, specially the PIIGS economies and the apprehensions on Euro. So it might happen that Dollar and Euro as the world’s two universal currencies might crash and international trade might start using commodities such as gold in exchange for traded goods.

Another possibility can be the emergence of Chinese Yuan as the accepted currency for trade, but that will surely take its time as it not that wide used today. But here also lies a problem. China is holding 26% of US’s debt, so if the US goes bust and dollar crashes, it will surely have an impact on China and on the Yuan. So even this also looks like a problematic area.

The reason I thought the article was foolish, because the author said the flight of capital will happen from developed economies and investors will invest in developing economies such as India. But he forgot one thing that when US became a superpower it created a lot of wealth and when it crashes, it will diminish a lot of wealth with it too. The investors all will have their wealth mostly in US dollar and when it crashes; their wealth will also be eroded overnight. So from where will the capital come to take the Sensex to 60,000?

Whatever might happen, one thing is for sure, if another recession comes and hits US hard leading to it being bankrupt, its ripples will be felt much more in India than last time and future does look gloomy!