Saturday, October 11, 2008

The Sum of All (economic) Fears

The FIIs are withdrawing money from India because they need it to meet margin requirements back home. This demand for the USD has meant a weakening in the INR-USD exchange rate, which is actually good for the Indian economy. Because they are getting less and therefore are repatriating less bucks for their rupees.

The Indian economy is not as export oriented as China's or South Korea's, and that is why perhaps we will not experience the full impact of the US recession that those economies will. The US system has so far been able to stave off the worst, yet there is still a chance that the worst case scenario could be realized. Here is a snippet of a crisis scenario from the September 19 Martensen Report:

Day 1:  Four major banks are suddenly revealed to be insolvent, and money begins to be withdrawn from these banks at increasing rates. That night, foreign investors quietly begin to retreat from a stricken US banking system, and the withdrawals spread beyond the four stricken banks. As bank servers begin to log more and more withdrawals, alarm bells go off, and late-night emergency meetings are convened. 

Day 2:  The next morning, US government and banking officials assure the world that everything is fine and that a new program has been put in place guaranteeing the solvency of the US banking system. Behind the scenes foreign money continues to flee as wealthier individuals and institutions with a better view of the real state of affairs retreat to the safety of their home countries. 

Days 3-7:  The expatriated money is converted into anything other than dollars, resulting in a dollar slump that confuses all but the most astute of observers. Simultaneously, US interest rates begin to climb, as US bonds are sold off in preference for non-US assets. 

Day 14:  Fearing a massive run on the dollar and a collapse of the capital markets, the US imposes an emergency order, requiring a 2-week delay in money flows out of the country. This is, of course, nothing more than a capital control, a favored but ultimately inflammatory tactic of countries suffering a currency run. Around this time, a growing proportion of domestic bank account holders realize that, 
because of the interlocked nature of the banking system, simply moving money from one bank to ‘a better one’ is not a fool-proof strategy. 

Days 15-21:
  Over the next week, cash is demanded with increasing frequency, exacerbating the troubles of an already beleaguered banking system. A cash shortage rapidly develops, leading the Treasury Department to make a high profile show (on television, of course) of armored trucks pulling up to banks with large bags of cash. Assurances are made that everything is fine and that there is enough cash for everyone. Commentators on television make snide comments about the people lining up for cash, suggesting that they are over-reacting. But the Treasury is caught off guard, and even a 24/7 printing regimen cannot keep pace with cash withdrawals.

Day 25:  
Currency controls are announced over the weekend, limiting cash withdrawals to no more than $250 over every 48 hour period. A few days later, the government announces that the US banking system, and, by extension, the US stock markets, will be closed for a period of two weeks while the situation is “evaluated” and solutions are identified. 

Day 50+:  A month later, the markets finally open up again, with the Dow down several thousand points, the dollar worth 50% of its pre-close price, and people everywhere suddenly trying to convert their cash holdings into things. Rampant inflation ensues. The dollar continues to fall.

Remember that this is a worst case scenario. The chances of this actually coming to pass are remote. But if it does happen, the shock waves will be felt around the world and people everywhere will be affected.

P.S. Gold had a trading range in excess of a hundred dollars yesterday, 10-10-2008, breaking all previous records.


Vinod_Sharma said...

Indian stock markets have tanked much more than they should have due to the external reasons highlighted by you. Perhaps just the time to start buying Indian shares. What do you think?

Sagarone said...

Exactly what I commented on your post:
This is the time to start a staggered buying phase, if you are a long term investor and not a speculator.