Understanding the basics of National Debt

A recent article in economic times caught my eye...it was about increasing levels of India's public debt. Considering that this, along with inflation, is quoted to be the primary reason of money flowing out of the country, I thought let me put a few points together to put this in a little more perspective for those who don't understand these terms well.

Consider this:

India's GDP is approximately USD 1.5 Trillion (that's USD 1,500,000,000,000)...almost equivalent to the monetary base of the US Federal Reserve (i.e. amount of money floating with the public in US + commercial bank reserves with the central bank). This amount is what all the products and services produced in India within 1 year are worth.

India's Public Debt, or total government debt, is approx. USD 636 bn, which comes to roughly 40% of the GDP. This is the amount the Indian government has raised to finance its projects, and the difference between its revenues (through taxes) and expenditure (salaries, infrastructure, etc.), also known as the fiscal deficit. Every year, some of this debt will come due (mature) and government will decide whether to take on more debt or not depending on its requirements from deficit. Also, every year, Indian government will need to pay interest on servicing this loan, pretty much similar to our EMIs. Any economy that's not growing at all, will have to service this interest burden by either printing more money, or by taking on more debt equivalent to the interest amount. In such a scenario, it becomes almost imperative for the countries to grow just to avoid the debt trap.

Just to put this in perspective, here is a list of some other countries where the public debt is at fairly high levels:

• Japan - 200%
• Greece - 144%
• Iceland - 123%
• Italy - 118%
• Belgium - 102%
• Singapore - 102%
• Ireland - 98%
• France - 83.5%
• Portugal - 83.2%
• UK - 76.5%
• Germany - 75%
• Brazil - 60%
• US - 64%

US GDP is approx. USD 14.7 trillion, which puts their public debt at over USD 9 trillion....or nearly 6 times of India's GDP! The total amount that US would have to pay as interest just in 2011 is over approx. USD 3.5 trillion...and some people even say that by 2020, whatever US earns as revenue, the entire amount will go into paying interest on the debt ! An interesting website to look at for knowing and understanding these figures is the usdebtclock.org.

But the problem is not just with the US, the entire continent of North America has an average of 62% public debt, and a close second is Europe with an average public debt of around 56%. Asia, Africa, South America and Oceania regions all have an average under 45%.

From the look of it, everyone is in a worse situation than the other one, and unlike in EU, most others still have the flexibility to print their way out of their mess. US being the world's largest economy, is also dealing with far larger figures on every front - so a mere 0.1% increase in unemployment makes huge waves in the financial circuit.

As for India, the debt and inflation are high, and so is fiscal deficit at over 5.2% of GDP, but three major points supporting India are growth, demographics, and ability to print money. Moreover, a majority of the debt is payable internally, and terms and conditions with internal parties can be negotiated without bringing in IMF into account in the worst case of sovereign default.

Given this, to me, the fall in the markets, the flight (outwards) of the money, looks like a temporary phenomenon, which is probably also a very good (even last!) chance of buying the lower levels in the market. And as for Gold, till US is printing money, I wouldn't care much about its fall, its primary trend will remain up.

Crude Awakening

It's indeed a crude awakening for Qaddafi, Libya's leader for the last 42 years...and given that Libya supplies nearly 1.6 mbpd (mmn barrels per day), or nearly 2% of world's oil demand, it is literally so too for the rest of the world. Crude prices are on the boil again (touching $ 100 / barrel) after being under control since the 2008 crash. Take a look at the historical crude oil (WTI, NYMEX, in USD / barrel) prices:

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And considering the impact crude usually has on the rest of the asset classes, the whole world is sitting up and taking notice of events unfolding in the African country.

The global markets not impressed, with most markets going down by 2-2.5% in the last 2 days. 

Take a look at the Dow Jones Industrial Average (DJIA) chart for the last 5 days for instance:

(click for a larger image)

Gold is moving up smartly again, touching $ 1415 / ounce, slightly below its recent multi-year high of $ 1431 / ounce. US treasury prices are moving up, implying that people still consider US T-bills safer during times of global crisis. 

A whole host of other commodities will start moving up too, since this rise in crude oil is going to trigger a rise in demand for bio-diesel (an alternative to crude), which needs, among other things, ethanol...made from sugarcane...sending the prices of sugar higher. Elsewhere in the world, import duty paid to bring in bio-diesel in the country is by-passed by bringing in bio-diesel as blended oil...for which some portion of palm oil is mixed with bio-diesel to pass it off as "blended oil". Later, through some fractionation process, these two are separated, and pure bio-diesel obtained. [That's what I've heard from some of my sources in this industry, can't confirm it though]. So an increase in demand for Bio-diesel also increases the demand and prices of palm oil, and since soybean oil is a good substitute of palm oil (for cooking), that too moves up in tandem...and since soybean oil is derived from soybean seeds, the prices of those  move up as well...and so it goes.

Given inflationary issues in almost all the countries world-wide, with an exception of the US among the bigger ones, this increase in crude prices is going to further aggravate the situation. Already high unemployment in US is going to go further up, as squeezed margins force companies to go even leaner. In India, already another price hike for diesel and petrol is being talked about...and it might come sooner rather than later.

However, at such times, solace comes from such pronouncements as given by an organization, that crude might hit $ 220 / barrel if Libya and Algeria stop oil production / exports. Usually, such "eye-catching" forecasts are given only at the end of a rally...so may be...just may be, the top is near. Let's wait and watch...and yes, in the meanwhile, stock up on cooking oil if you want to save a few bucks.

The silver lining in Chinese Inflation

China has increased its Reserve Ratio Requirement (RRR, the amount required to be set aside by the banks, not to be used for lending) yet again...by 0.5% to mop up an additional USD 54 bn from the market with an intention to reduce liquidity and control inflation. Let's take a quick look at the different problems confronting China:

The Liquidity Problem:

Consider this, Chinese banks lent around USD 1.6 trillion (almost equal to India's GDP) in 2010, most of it for infrastructure, and lent almost around USD 160 bn in January alone (!), a figure that's almost twice that of December 2010.

The Inflation Problem:

Inflation in China is already quoting around 5%, according to official figures. I've covered Chinese Inflation issue in my earlier posts, consider reading Betting on China Crash and Understanding China and Japan. Also, while food prices are under control for now, the housing market continues to hog limelight. House prices rose in Jan 2011 in 68 out of 70 Chinese cities surveyed. This, despite the introduction of property tax (though a measly 0.6% to 0.8%) and frequent increases in RRR.

The Currency Problem:

China has been under pressure from various international organizations with sovereign members to let its currency appreciate. Currency appreciation will make its exports less competitive though it might play some part in checking inflation. Currency depreciation will boost its economy but increase the inflation problem. So China has constantly let its currency appreciate, and shows this as compliance to currency non-manipulation to better manage international relations. See the USD Yuan chart below which shows how yuan has appreciated against dollar:

Though the appreciation is there, but its too less, too slow...over the last 1 year, yuan has appreciated by about 4% against dollar.

Soft landing measures:

On the face of it, it looks like Chinese measures are failing to keep both inflation and real estate bubble in check. But just think about it, how difficult would it really be for the Chinese government to dictate terms and functioning to Chinese Banks if they really wanted to curb lending to infrastructure? And please bear in mind, Chinese Banking industry is considered by many investors as fairly opaque and government driven...(part of the reason why Chinese banks don't openly participate (except through proxies) during sale / purchases of various sovereign debt instruments). 

China cannot afford to have a real estate bubble crash now...and they know it pretty well. The introduction of property tax also reeks of a gesture to please foreign investors more than anything else. They're completely abstaining from increasing interest rates to avoid a "Yuan Carry trade" situation (read more about this here) which will further worsen the inflation problem. In essence, all efforts are being made to not shake-up the real estate bubble, which has long assumed the position of "too big to fail".

So liquidity control without raising interest rates is probably the best way they've got. And this they're doing not just by increasing the RRR, but even, to a smaller extent, by acquiring Gold mines outside and simultaneously promoting consumption / investment in Gold / Silver in China. So people are just converting their yuan into Gold / Silver, which eventually will go to the owner of these mines from where the metals are being procured...the Chinese government held companies. [This, by the way, is also helping them control inflation through currency appreciation - as yuan supply reduces, it appreciates against its basket of currencies.]

In fact, so strong has the demand been off late, that even China's appetite for Gold and Silver is making frequent headlines. Here's an article from Zero Hedge giving various news items (most of them recent). The result...take a look at the silver prices:

Now, if this is indeed the case, and encouraging gold and silver consumption domestically is indeed a strategy adopted by the Chinese government, it's only a matter of time before both break their all time high and surge further ahead...Now, that's a silver lining in a dark inflationary cloud...

Random Walk - Econo blogging

Apologies for not writing for such a long time...guess I've been hit by the Writer's Block. Nevertheless, this post is about econo-blogging...and about how some digging into it almost took the steam off my writing...

Came across this website econdirectory through Mish's site. The website gives a huge list of all the blogs which write on economy (and does not include those which restrict to just plain and simple stock tips). It covers some 165 websites, most of which have public page views, and some others which don't. Overall, the top 5 guys in the list take up the major portion of readership...here's a sample of what it looks like...

A massive 61% of all page views are with the top 5 blogs, and a good 54% with just top 4. The rest of the 160 blogs consist of the remaining 39% page views. The page view by the latter segment is small enough for each one to not sustain any meaningful ad revenues. 

The NY Times even listed DIY (Do It Yourself) Macroeconomics as one of the top trends of 2010...in which, says NY Times "ordinary citizens pull apart the data and come to their own conclusions". So while more and more econo bloggers are joining the band-wagon, the pie is not undergoing any major expansions, resulting in traffic being held as captive audience by the top few websites.

Its tough getting into the top 20 list, and like even Mish pointed out, that would, under current circumstances, result in having just 5% of the traffic of the top blog...! But just like they say for Euro zone, there's hope...things could've been worse...

Golden movements

Gold has been falling for quite some time now...giving rise to talks about whether it has seen its peak for some time to come...take a quick look at the 30-day Gold Price chart below:

This fall came in the backdrop of US showing signs of recovery, quoting better unemployment  numbers and good consumption increases. This led to people moving out of emerging markets plagued with unsustainable inflation and prospects of lower growth and overall shrinking corporate margins; just as investors moved out of gold as well. People were again backing  dollar denominated assets, US and European markets. Take a look at how US and European markets have performed over the last 1 month.

But still, its not that investors have started looking at dollar any more appreciatively...the US Dollar Index, which shows the strength of dollar against various currencies, continued its downward journey over the last 1 month.

All this points towards some sort of portfolio reallocation among some major funds of the world. As a part of their strategy, they are taking some profits off the table from Gold, liquidating their positions in emerging markets, and increasing the weight of US and European stocks in their overall portfolio.

However, to me, Gold still looks like a minor correction before the rally resumes...nothing more. Egypt is on the boil due to political unrest, creating tensions in almost whole of middle east...which is spooking the investors worldwide. Once that settles down, Europe will come right back on the radar. And then may be Japan, who knows; with 200% of GDP as debt, 1 in every 4 persons above the age of 65 and no longer contributing to the savings (which was being used by government to raise debt), Japanese government will sure have to look for other avenues to raise debt just to keep paying off its interest on the debt..leave alone retiring the debt. China's real estate bubble can now be seen from outer space (;)), and once that crashes, it'll take a whole lot of other asset classes with it, right from Copper and Soybeans to Equities and Bond prices. Asia, just because of these two big shaky giants...is a risky place to invest.

But fundamentals for Gold still look intact. Central banks are still buying Gold...and these are the biggest players in the market - please bear in mind, they don't get in into the market to make a quick buck and move out as soon as profit targets are achieved...they're in for long.

Take a look at this article here, that talks about how Russia added 135 tons of Gold in 2010...an increase of almost 21% from their 2009 end Gold holdings ! Saudi Arabia has disclosed a purchase of 180 tons which has come in due to "adjustment of gold accounts". Take a look at the latest Official Gold Holdings for countries:

World_Official_Gold_Holdings_January_2011

Getting back to brass tacks, it means that US has almost USD 350 bn of Gold with it. Germany has nearly USD 147 bn, Italy and France has USD 105 bn each, China has USD 45.5 bn worth of Gold, while Russia and Japan have 33 bn dollars worth of Gold each and India has around 24 bn dollars worth of Gold.

The Gold reserves of US, though the largest in the world, are still far away from its Debt levels of USD 9 trillion (not accounting for contingent liabilities - like medicaid and Social security). Germany, France and Italy will need these reserves to boost world confidence in their ability to come out of this crisis...any selling by these central bankers in time of crisis might trigger a sharp fall in Gold prices which will further depress the reserves status of almost all nations with substantial Gold holdings - and so is fairly unlikely to happen. 

China has a long way to go  as far as diversification in gold is concerned since its gold reserves are just 1.8% of its nearly USD 2.5 trillion reserves. This thought has also been propounded recently by Xia Bin - adviser to China's central bank (see here).

The world is still quite close the uncertainty in several aspects...China's hunger for Gold will not go down, central banks will not sell their gold in a mad rush...these, and many such aspects are bullish signs for Gold...so for me, its still a good buy on all dips.

Addendum: See this article from Financial Times that talks about some gold traders estimating that China has probably bought around 200 tonnes of Gold in the last 1 month ! That's nearly 36% of India's Total Gold reserves ! Let's wait for China to release data on Gold reserves again...and we'll know how true these estimates were...

Betting on China Crash

The rumblings of an imminent Chinese crash are getting louder by the day...giving an eerie feeling that something too big is so close that we're not able to see it!

Consider this article in Telegraph a couple of weeks back, which says how many hedge funds are now betting that China would crash sometime soon. It says:

"One academic said: “Economists have contrarian views all the time. But these hedge funds have their shirts on the line and do their analysis carefully. The flurry of 'distress China’ funds is a sign to sit up.” ...A recent study by Fitch concluded that if China’s growth falls to 5pc this year rather than the expected 10pc, global commodity prices would plunge by as much as 20pc."

This is understandably so, given the huge amount of fears from Inflation, asset bubbles (especially real estate) and uncontrolled lending spree by the banks. Its not as if China is not aware of these issues...or not working on them. It has been tightening its bank's reserve ratios to absorb excess liquidity available with the banks. It has been buying European Union's debt to prop up Euro against the dollar and also yuan (Chinese currency). Keeping yuan lower with respect to Euro will help China in boosting their exports to Europe and give them some breathing space in terms of trade deficit (Exports - Imports).

The article further says:

"According to Corriente (Advisors), China has consumed just 65pc of the cement it has produced in five years, after exports. The country is outputting more steel than the world’s next seven largest producers combined. It has 200m tons of excess capacity. In property, Corriente said it had found an excess of 3.3bn square meters of floor space in China – yet 200m square meters of new space is being constructed each year."

Besides, Chinese real estate bubble is fairly well documented...an average apartment in Shanghai costs more than 22 times of disposable income there...making it beyond reach for most people. HK was recently reported as the costliest city in the world for housing. Despite several efforts to curb speculations on housing, China has been able to achieve little by way of increases in reserve ratios. However, recently it has put up a property tax for the first time...(read here). But with the rate at about 0.6%, it looks like a case of too little too late.

Take a look at another recent article in Telegraph that talks about how the real estate bubble could be growing bigger in China. The article mentions:

"The property tax would have "a big psychological effect on potential home buyers," said Ge Haifeng, head of research at China Real Estate Index System in Beijing. "China's housing market may get really quiet in coming months," he said. "

Big Impact !! A 0.6% property tax rate? In India, retail investors pay that much as brokerage (each leg) for all equity transactions ! Does that kind of rate stop them from trading? I don't think so...In India, property tax rates are fairly high and vary from state to state...and to me, a 10% + service tax (of 2%) is a normal rate for property taxes....that's how much people pay in India as their property tax...8-15% of property value...and it still does not stop people from speculating. And many Chinese, who are traditionally gamble-happy people, are expected to stop speculating the housing market because of a 0.6% property tax ! Let's just say, this is being made up to send a message to the markets that a lot is being done to keep bubbles in control...but obviously, the markets are not impressed.

I think this is more likely a warning signal to speculators to move out of the market and not get caught with their open positions when the rates are increased. The idea in such a case would probably be to remove the panic from the market when property rates are raised further, and thus ensure that a crash in real estate prices would not happen. But how it actually unfolds, only time will tell.

Chinese Automakers are also facing tough times with restrictions on selling cars being put up in most populous Chinese cities to reduce traffic jams. It'll again have a cascading effect as the automobile ancillary units are also an industry in themselves and will suffer major losses due to loss of revenue.

Also, with China talking of "no need for yuan to appreciate" since exports will slow down in 2011, it looks like even the pretense of letting yuan come up over a period of time is over now. This is not going to help the geo-political equations, look forward to comments from the US.

Even the credit default swaps (CDS) rates - the instruments through which people bet for a sovereign nation defaulting on payment of its debt, have been increasing for China...it means that more and more people are buying these instruments at ever higher prices, in the belief that when Chinese economy really looks weak, or even tumbles, they'll make a handsome gain on these investments. I have a rather dated article mentioning this, take a look at that here.

Will China really go bust? Its difficult to predict, given the fact that we don't even know that the numbers that we're talking about are true or not (these are, and can be massaged by government agencies). China's public debt is reportedly just about 20% of its GDP compared with 40% for India, 60% of US and nearly 200% for Japan. It can no doubt continue to build bridges to nowhere for some more time, and hoard gold to protect itself from a dollar bust scenario, but eventually, all this lending spree and housing bubbles have gotta give...and they will. But when? Now, that's a trillion dollar question!

Guest Post - "The Business of Resolution" by Arun Varma

I'm kicking off a brand new section on this blog - Guest Post. The intent here is to find emerging experts in various domains, not necessarily from Finance & Economy, and provide them a platform to express what they feel most passionately about...as long as it follows the basic tenets of being Simple and Applicable.

This Guest Post is from Arun, a good friend who has taken some time out of his busy schedule to give me an interesting piece to share with all of you. You'll find his details at the end of the article. So here goes our first Guest Post...Thanks Arun !

The Business Of Resolution

It was the 28th of December, an exceptionally cold evening in Boston going along the expected lines. David, Mark and I were frittering away time at Karen’s, following the latter’s invite to what she called an ‘exotic’ dinner. I was more hopeful than curious, as I badly wanted some fiery Paneer tikka masala and Tandoori Roti, but I was getting ready to delude the host with my ‘That was exquisite’ praise (It wasn’t my first time after all!). My hope was butchered when I found Quesadillas and Tacos. Mexican and exotic? I'm telling you, people have to use words more carefully, just so that you don’t raise hopes. So the acclaim went on, animatedly!

Post dinner the caboodles were kicking back by the fire place and the conversation was again along expected lines. (Something about this evening was so predictable!) Year-gone-by-problems, Anticipations…you know what I mean right? And then abruptly something unexpected happens.

David: Mark, so any New Year resolutions this time around?

Mark: Well not really.

David: What do you mean? How can you not have New Year’s resolution? (Flabbergasted!)

Mark: Well…You know, I really haven’t thought about it.. I guess…You know…Maybe…. (Almost apologetically with the look of a kid caught stealing candies)

The comments that followed almost crucified Mark instantly for the baleful sin of not having thought of a New Year’s resolution. As much as I was empathetic for Mark’s misery, I was glad that I got away without any damn resolutions.

Cut to the 31st of December. It was time for possibly the most hyped and over rated New Year eve party – the crystal ball drop at Times Square New York. Because my idea of a great new years eve is not blasting my urinary bladder (Folks who have been there will tell you why!) in acute East Coast winter (-8 C for the record) in the middle of a million inebriated demented lunatics, I was chilling at home and watching the ‘party’ live on TV. 

The ad aficionado that I am, my focus was more on the ad intervals than the ‘party’. To my surprise, Chantix (A Nicotine patch brand from Pfizer) was running their ad slots back to back. Pharma ads apart from being incredibly expensive (due to their lengths related to legal compliance) are usually not placed midnight. For a while, I thought it was a misadventure of some godforsaken media planner. But then I was surprised even more, when ads related to legal agencies offering to help one get out of debt appeared, again back to back. And then it hit me, and almost immediately astounded me! Quitting smoking and getting out of debt are 2 top resolutions Americans make and marketers were trying to milk the opportunity right there! So this resolution thing is that behemoth of a business!

Picture this. GSK which spends a whopping $15 Million only on the promotion of their smoking cessation product, Nicoderm, generated a sales of more than 1 million boxes just in the month of January last year in the US. If online search traffic on Google is anything to go by, look at the worm below:

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From a low of 20 index points on the 26th of December, the query volumes for the keyword ‘Chantix’ (Pfizer) touched a peak of 90 points on the 3rd of January. This despite all the news of Chantix incited violence doing rounds!

The next most popular resolution – getting fit, is another money spinner. Gyms see the greatest membership growth in the first three months of the year, with approximately 12.4% of new members signed in January, 9.5% in February and 8.7% in March. Overall, Gyms, Health & Fitness Clubs posted 3.2% growth in 2010, reaching revenue of $25.09 billion. 

Additionally, Weight Loss Services are expected to grow 1.9% to reach $3.87 billion. ‘Planet Fitness’ the chain of basement gyms that I patronize, ran a $10 per month campaign until the 12th of January, that’s cheaper than a jug of beer at a decent bar. Oops we are talking fitness here! I almost suffocated in my gym the first 2 weeks, when the place was packed like sardines in a can!

It’s not the gym alone, people do anything to lose the flabs gained over the year. Even ‘demanding’ (strenuous?) tasks like popping pills, using ‘fat burning’ belts, lie down mats with poking pines (Search Acushakti on Google) and  wacky ways like applying creams, tans and hypnosis! Look at the ‘how to lose weight’ graph for the last 30 days:

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The traffic spiked up from a low of 40 points around Christmas to an incredible high of 90 around the 3rd January. Additionally, unlike quitting smoking, losing weight does not seem to lose steam that soon!

Managing one’s personal finance seems to be another problem people battle against. Household revolving credit debt declined for the first time in 20 years in 2009, and is expected to decline even further in 2010. Furthermore, the personal savings rate will hit a 16-year high in 2010, as consumers continue to focus their efforts on managing their balance sheets.

As a result of this, the Financial Planning & Advice industry is expected to expand 4.1 percent, increasing to $39 billion. Portfolio Management companies are also expected to experience strong growth, expanding 33.4% and a huge part of this growth is inclined towards the first quarter of the year.

New Year Resolution industry is wider and broader than we imagine. Think about a certain average Joe deciding to spend quality time with family starting January 2011. This can mean more holidays (Impacting the travel industry), more movies, more eat-outs and more anything as quality time just means better life.

Another angle is what I would call ‘Cumulative effects’. Joe who decides to join a gym opts for better diet which means demand for healthy food goes up. Joe needs sweat shirt for his gym leading to more cumulative effects. Joe needs an MP3 player / Ipod for a groovy work out. The domino effect is mind boggling!

No wonder then marketers agree to part with heaps of moolah to cash in on the resolution craze. Like people who wait until the next year to meet their goals, start a project or reform a habit, marketers keep their budget apart to influence these vulnerable minds precisely when and where its most delicate.

As for Mark, maybe he should resolve to think faster from next year!

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Arun Varma is a Boston-based digital media professional who previously worked with Google. He is a contributor columnist to Socialnomics.com, one of the top 10 social media blogs in the US as ranked by the PC Magazine. He enjoys conceptualizing and hosting business quizzes and is all set to complete his MBA from HULT International Business School. 

Follow him on Twitter @varmaarun

Feedback: arunvarma100@gmail.com
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