Looking Back, Looking Forward : Evaluating Different Probabilities



Well, for starters, let us rule out the ‘consensus forecasts’. The world WILL NOT grow on steroids; a second TARP will have dramatically different consequences, possibly triggering a currency crisis of unimaginable proportions.

Declaimer: This article written was originally in January 2010, and some of the data points may be outdated.

Deflation, Depression:

A bond market collapse looks imminent if a second TARP is announced. Recently, long-term spreads in US Govt bonds spiked up to 300 bps, reflecting inflationary expectations. This could accelerate USD depreciation pressures, exporting various asset bubbles to emerging markets.

The wrong bubble bursting could trigger mayhem all over again, this time from the currency markets. The last time, it was Equity markets collapsing because banks were going bust, this time it will be currency markets collapsing because countries are going bust.

The wrong-est bubble would be China, which is already in trouble-making territory. If China hits (asset-price) deflation, it will be new territory for the giant. And the last straw for a beleaguered world, looking for some peg to pin its growth on. 5 years of deleveraging will create such a severe growth freeze, that there can be no orderly withdrawal.

Oil Melt Down

Most certainly, if such a scenario pans out, oil prices will melt down. Iraq is recommencing production, and there are new assets coming online, so there will be more than enough oil to absorb. Capital flows into the Middle East have already eased, after the Dubai fiasco, so they will have to be replaced with oil surpluses. This will trigger ‘cheating’ on production, which is more bad news for oil producers.

Low oil prices are not an unmitigated blessing for India. While the Current Account Deficit will come down, so will ‘invisible flows’ from the Middle East. More important, it will start to carry trading, if the BoP turns surplus, which will result in a fast appreciation of the Rupee. This would cause a bubble in domestic assets, esp in stocks and real estate.

The Rupee under attack is one of the scariest scenarios that I have for the coming year, at least as far as India is concerned. I am a big believer in the RBI, but on the other hand, I have also seen how Australia and Brazil have seen their currencies appreciate.

The Shining Gold Story

Gold looks sure to hold firm, with very little to bring it down, even though its nominal valuations look high. All in all, a pretty downbeat forecast, in the face of high equity market valuations. The joker in the pack would be a second lousy monsoon for India, in what is predicted to be the hottest year on record. That would create something like a food crisis in India; anyway, the country better gets used to precipitation levels much lesser than the 95% of the Period Average that we have had, in the last 20 years.

Hyperinflation, Recession:

This is the second scenario. Inflation skyrockets in the US, the Dollar depreciates and the money supply explodes. Bad for equity markets and domestic budgets, but we will survive.

India may not be so badly off, especially if the monsoons hold up. The real problem would be if the rains fail and food prices continue with their upward trajectory. Bar that, we should survive pretty well.

Traction and Growth:

This cannot be my short-term expectation, but over the medium term, I am hoping that something good can happen. Mostly, I am hoping that the Clean Energy bandwagon will take off. Last year, very quietly, more money was invested in Clean Energy ($155 bn) than fossil energy. So the world as a whole has already crossed the Rubicon of the Big Trend, of Clean Energy taking over from fossil fuels. With so much awareness floating around, India too will pick itself off and start to trundle towards a Clean Energy future.

Not that it will impact the world as a whole, but in many small ways, very large industries are coming up in the Clean Energy space and its applications. A Rs. 1000 cr Desalination Project is coming up in Chennai, the second in the city. A Sewage Treatment plant is coming up in Delhi, and 2 Water Recycling plants have been announced.

The Shape of Water

Water is an application of energy, not energy itself. In little ways, you can see it already. The Noida McDonald’s has a waterless flushing system, which recycles urine through bacterial degradation. It saves 10,000 liters of water per annum and uses no energy in waste disposal. May their tribe increase…

Water is already an issue, center stage. If Govt support for a water market is forthcoming, we will see a very large recycling and conservation industry come up.

I am not so optimistic about energy trends in India. But the energy sector as a whole will drive a lot of growth in the Capital Goods sector. More importantly, it will be an accelerator for Asian domestic consumption, which could revive at least the Asian economies. China knows it, but India, as usual, is taking its time to understand the Clean Energy opportunity.

Clean Energy itself will shrink GDP directly, but it will act as an accelerator for inclusive growth. Take Solar as an example: apart from the extra cost of Capex, the Variable Cost of Solar will drop to near zero; once the Capital Cost is recovered (or subsidized) from the rest of the economy, the direct cost of energy will drop dramatically.

This will reduce nominal GDP, but as the real cost of energy drops, it will draw in such a huge chunk of poor people into the real economy, that it will act as a multiplier to the rest of the economy. This is not well understood by governments who think that Clean Energy is expensive. Just think what free energy will do for water recycling, sewage treatment, and water transportation. And in turn, once these are huge, ubiquitous industries, what that will do for agriculture and the rural economy? And therefore BOTP demand.

That is one way. I cannot think of many others, maybe biotech manufacturing.

The End of the World As We Know It:

Japan is already bankrupt, and so are 9 countries in the EU. The US is on its way, with the EU struggling. Lots of savers have to lose their savings and earn it back again. So people all over the world will save, the Velocity of Money will fall and nominal GDP will drop. Unemployment rates will spike, and lots of older people need to quietly die in their homes. If the monsoons fail and nature punishes us, lots of poor people need to quietly die in their homes.

I limit myself to Economics, and I am confused about politics and sociology. If these people choose not to sit quietly in their homes, that is where the picture gets fuzzy. What (and who) will survive, why, and in what form, is something I cannot guess.

The Probabilities…

I know for sure that water riots could trigger mass-scale unrest in India, followed by unprecedented human losses, that will make Partition look like a party. We need a Water Recycling industry ASAP, and more important, a water conservation culture. In a country where even Priyanka Chopra argues that water should be free, it will take some time to get home to the point that something can be ‘free’ only when it is provided by nature. Clean water is no longer provided by nature; even if it is, it has to be treated and moved to the point of consumption. That is an application of energy and has to be paid for. The costs can be managed but only provided the industry becomes exciting, a lot of smart people are driven into the industry and then innovation drives the real costs down. None of this will come free…



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