Do it yourself

I shared some of my random thoughts with the readers last week (see here). Many readers have commented on my post. Some readers have raised some pertinent questions and also provided very useful feedback. Based on the readers’ comments, questions and feedback, I would like to share some more random thoughts. It is however important to note that I am a tiny insect living in a cocoon of my own. I cannot comment intelligently on the international markets, policy matters and geopolitics. Nonetheless, I reserve my rights to form strong views on global and domestic developments concerning markets, policies and geopolitics, for my personal strategy purposes.

The US debt end game

The current state of the Fed balance sheet and the US public debt is certainly not sustainable by any parameter. It is a matter of debate how the US government and the Federal Reserve would make fiscal and monetary corrections and eventually return to an acceptable level of public debt without pushing the economy into a deep recession (hard landing). One of the most talked about resolutions to this conundrum is to keep bond prices lower and buy back aggressively over the next few years. That may be one of the easiest ways to return to fiscal sanity. Creating an artificial shortage of USD and forcing UST holders to sell cheap could be one of the means to achieve this target. To create USD shortage, a reverse carry trade might be induced, by narrowing the yield spreads, besides reducing CAD through tariffs and other trade restrictions.

For context, the US is running a quarterly current account deficit in excess of US$260bn; a fiscal deficit of over US$1.7trn (2023) and USD supply (M2) of over US$21trn. The US GDP was US$27.4trn in 2023, accounting for roughly 26% of the global GDP.

The great gambler

The RBI governor's job in India might be the most unenviable one. He has to struggle 24X7 to maintain a balance between fiscal requirements, political consideration (inflation and small saving interest), growth needs (real rates) and balance of payment (USDINR exchange rates). Repo rate and open market operations are the only two major tools available to him.

The RBI has been maintaining a status quo on the repo rates for over a year now. This has sustained the US-India yield gap (to protect flows) to some extent, but the efficacy of high repo rates in ensuring price stability, which is the stated primary objective of the RBI’s monetary policy, is questionable. Besides, the RBI has been meaningfully enlarging its balance sheet in the post Urjit Patel era, while stated policy objective, until the last week, has been “withdrawal of accommodation”. This aspect is not talked about much in the public domain. One may speculate that the real objective of the RBI’s monetary policy has been to prevent USDINR appreciation (even if it means high imported inflation) and ensure sufficient inflow in small saving schemes, which are funding almost 45% of the union government’s fiscal deficit. It has been obviously playing a gamble with high stakes, US$700bn forex reserve notwithstanding.

 Indian lenders face challenges

The persistent negative credit deposit ratio of Indian banks has been a subject of discussion at all levels. The government, regulators (RBI and SEBI), bankers and analysts etc. have all expressed concern over the poor deposit growth, while the credit demand remains strong. The finance minister and RBI have even attributed the flow of funds towards capital markets as one of the reasons. In my view, high household inflation, poor real wage growth and very low real rates on deposits are the primary reasons for this trend. Besides, for most lenders the asset quality improvement trend that started five years ago may have already peaked.

I feel most Indian lenders may now face three challenges – declining margins as the cost of funds rises; flat to declining asset quality and slowing growth. Investors are cognizant about these challenges but as the response to a recent IPO of a housing finance company indicates, they may not have yet adjusted their respective investment strategies.

Focus on finding opportunities

As a wise man suggested, the small investors like me should not be wasting energy on bothering about these macro things and focus on finding the investment/trading opportunities which may be opened by policy missteps, fund flows, geopolitical tensions etc. I fully agree with this thought. For the next 4-5 months, I shall be focusing on finding opportunities and taking advantage of traders’ mistakes.

 One of the major trends in the post global financial crisis (GFC) world is the weakening of the United States of America’s (USA) clout as an undisputed global economic and strategic leader. In the past 15 years, the US administration has consistently failed in achieving its economic, financial, technological, and strategic objectives.

The economic performance of the US has been below par in the past decade. The handling of the pandemic has been highly questionable. Both monetary and fiscal policies have not yielded the stated objectives of price stability (inflation has been persistently high and rates have become growth restrictive) and financial stability (many regional banks have failed, delinquencies are rising and capital adequacy & reserves of banks have deteriorated, particularly in the past couple of years). Fiscal profligacy has benefited the rich much more than the poor.

The efforts to restrict the benefits of advanced technological innovations flowing to China through tariff and non-tariff means have mostly failed. In fact, these efforts have led to a greater focus on China to successfully develop indigenous technology, forge new alliances, and diversify its market and vendors. The Sino-Arab technoscientific alliance is one prominent example.

The exit of the US forces from Afghanistan and the installation of the Taliban government; failure to prevent Russian invasion in Ukraine and protracted (21st months) conflict there; continued ISIS aggression in Syria and alienation of Turkey; virtual failure to reign Iran’s nuclear ambitions; and now escalation of hostilities between Israel and Palestine are only some recent examples of the strategic failures of the US.

To make things worse, the demography of the US started to worsen. In 2022, the US population grew a meager 0.4% and is estimated to shrink in 2023. Whereas the number of homeless and jobless may be rising.

Consistent deterioration in the quality of political leadership; sharp rise in income and wealth inequalities leading to a conspicuous rise in domestic unrest and violence; unmindful fiscal profligacy; the emergence of an alliance of nations having quasi, pseudo, and non-democratic regimes led by key adversaries China, Russia & Iran and including key allies like Saudi Arabia is seriously undermining the US supremacy.

The education and skill standards of the average US youth are deteriorating fast, raising the reliance on immigrant workers for jobs requiring high skills. The political rhetoric, even from the likes of Vivek Ramaswamy who himself comes from a family of immigrants, further explains the goal incongruence in the US policy.

In my view, it might be a matter of years, not decades, when the fabled “US Consumer” diminishes. The average American household becomes spendthrift; the social security system collapses and fiscal profligacy is forced to reverse the course. An entire global ecosystem that is based mostly on the indulgent US consumer could potentially come down crashing. Also, while most money managers and businesses in India are talking about the “China+1” opportunity, I have not heard anyone talking about “China is number 1” in new technologies including 7G, 8G, AI, smart chips etc.

As an investor, I would like to build these probabilities into my strategy. I am keen to filter my investments for the US consumer and technology dependence.