Of Products & Assets: Explaining Cycles of Virtue



‘England is a very rich country with very poor people’, remarked my host as he tried to comfort me. My usually conservative persona was totally shaken as I stepped out of London’s Heathrow Airport. Within the first half hour, I found the entire pre-paid charge on my mobile (lasts me nearly a year in Delhi) going up in smoke over just 5 international calls, as I tried to locate the car which had come to receive me. When I tried making a local call, I found it costs a minimum of 30 cents, i.e., Rs.25.

Terror into my Indian  Heart

The thought of taking a taxi struck terror into my poor rupee-thinking Indian heart. A trip from Heathrow to Central London would cost a hundred pounds (roughly Rs.7600). You lose your appetite if you look at prices in a patisserie: a bun costs Rs.125, a cuppa coffee could set you back Rs.100. Don’t even think of sitting down in a café: waitresses (albeit the prettiest in the world) expect tips starting from Rs.80- Rs.400. Leching is free, however.

How do the British live? I already knew they had no savings. But the pound, so valuable in international exchange markets, was virtually worthless in its home country. “Try buying a house”, remarked a lady at Madame Tussaud’s, when I showed incredulity at the entry fee of Rs.2000.

The Highest House Price in the World

So that’s where it all starts, I thought. With some of the highest house prices in the world, people were reduced to commuting up to 2 hours just to get to work. Even Citibankers, the most privileged class of any country’s population, cannot afford to live in the city anymore. I know of one who takes an hour to get into the City.

So what kind of people live in London, I thought. Most of Central London is converted into hotels and inns, paid for by an itinerant tourist population, there to look and flee. Apart from that, there is the aging pensioner, who owns the older building stock. Some of them are selling and running off into the countryside. High house prices have inflated wages, even though there is some downward pressure from East European migrants. But this is limited to low-skill jobs.

White-collar technocrat jobs are usually priced roughly 50% above the dollar costs of similar jobs in even the developed world. For example, the average CFO costs nearly 50% more than the equivalent European. So how do Londoners maintain competitiveness to stay a premier world city?

They Own And Trade Things

“They own and trade things”, said a banker. The quarterly deficit of Govt was recently covered by the jump in bonuses of the City (a nickname for the square-mile financial center of London). That would mean that intermediation is the major business in London. The city lives off asset markets, while the making-and-doing has all shifted to Asia. Britain (or at least London) has returned to being “a nation of shopkeepers”, which is where they started all 500 years back.

The British Empire and its flagship currency have been in decline for a century now. Against Gold, the pound (sterling, it is ironically called) has dropped 98% since its halcyon days before the First World War; 3.85 pounds bought you an ounce of gold. Today, it buys you a cup of coffee and a bun, with just enough left over for a tip to the pretty East European waitress.

The History Repeats Itself

How long will this artificial state of being last? Rome took 300 years to decline, the last example of a Great Empire that spanned the “free world”. There is not enough economic data from that period to draw a significant conclusion, but England offers a preview of where the current “Great Empire” of Washington is headed. In the first phase, the Romans too stopped “doing things” and started to “own things”. Politics, Govt, and entertainment took over the city in the first phase of Roman decline, just like London emerged as the “seat of the British Empire” in the 19th century. The making-and-doing of Manchester, Leeds, and Birmingham died a slow death. London’s major industries were now Govt, entertainment, and tourism. The latest one is “moving money around”.

In the first phase of ‘development’, people sweat…….they make and do things. They are insecure, so they save large proportions of whatever they make. Poor countries like India and China have household savings rates varying from 25- 40%, regardless of income level. New millionaires remain caught in old “behavior traps”, and savings rates zoom to 80-90% as their income levels rise. They keep their old houses, cars, and wives, refusing to allow money to change their core winning behaviors.

Accumulated Sweat in Asset Market

All this “accumulated sweat” finds its way into asset markets. In the stock markets, they buy companies that are still making things……..sugar, food, steel, and textiles. Some of it goes into real estate, meant to buy ‘security’ for self and children. The money is earned money, which can wait for a return. “Asset bubbles” don’t burst as long as the underlying income (and savings) streams, which come from product markets (i.e. making-doing markets) continue. In some cases, they continue to infinity.

This first phase is evident in India. In Abohar/ Fazilka, the affluent farmer earns a regular surplus from agriculture.  Their children go into Govt service and politics. They earn their salaries and bribes. All this creates a regular pool of savings, interminable in extent and longevity. These savings are looking for a ‘store of value’. The land is convenient, visible, and physical (as opposed to stocks which are relatively conceptual and cerebral, perhaps too cerebral for the average Sardar).

So from a producing asset whose price should be determined by its earning power, divided by the Cost of Capital, it turns into a “store of value”, to be sold to the bigger fool, as long as he keeps coming. The value of this “asset” is now dependent on the flow of income and savings. Ultimately, an acre of land in Fazilka is available on lease for Rs.3500 per annum, but a price tag of over Rs.10 lacs.

But wait, it does not stop there. This interminable rise creates the perception that “real estate does not fall” and is, therefore, ‘safe’. A consensus evolves and it becomes easy and ‘safe’ to lend against such ‘assets’. Lo and behold, a housing mortgage industry is born and you are now a ‘developed country’.

Source Of Liquidity

A fresh source of liquidity is created and these ‘assets’ are bought wholesale. Income for future years is mortgaged and leverage is created. These flows are a multiple of the ‘equity’ that the borrower puts in from his savings. Demand for such assets goes up, so do prices and speculation is rampant. A ‘virtuous’ Govt, wary of funding ‘speculation’ in the markets, thinks nothing wrong with allowing huge leverage in ‘asset’ markets……….after all, housing is a ‘necessity’ and the money is used virtuously.

What proportion of houses in today’s housing boom are bought by first-time buyers? I know of one spectacular case where somebody in Mumbai has raised Rs.2.4 cr of debt on an Rs.1 lac per month income. He only lives on the price appreciation of his portfolio.

From Doing Things to Buying Things

The turning point comes when the flows reverse, as we are seeing in the developed world. Instead of saving money from making-doing and putting it into store-of-value markets like real estate, people start to “make money” from asset markets and consume it away in product markets, buying widgets and gadgets with money taken from debt. This happens because of the “wealth effect” of asset markets, which gives them the feel-good needed to blow up their income. This can go to insane levels, as can be seen in the West.

High house prices are a tax on a country’s young, who need ever-higher savings for longer periods of time to buy their most important asset. The flow of excessive leverage into housing markets in India has ensured that a house, which I bought for 1.5 years’ income in 1996, is now going for 7.5 years’ income for an incoming young buyer at the same age/ stage of life as I was when I bought the house.

Simultaneously, all input prices suffer a cost push as we see so spectacularly in London. This drops savings rates, sometimes to zero. That increases the number of years needed to pay off your mortgage. The young BPO executive in Gurgaon will not pay off his mortgage till age 50. Compare that to my father, who owned his first house at 40. So are we better off as a nation?

Who is better off? Only savvy investors like me, people who ‘own things’, but don’t make them. This is the beginning of the London-faction of Delhi.





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Career Guru

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