Random Thoughts

Serendipity, Predictability, Outcomes and Options

The English word serendipity is derived from Sinhaldweep (Island of lions, currently called Sri Lanka). There is an old fable of a king and his three sons whom he sent on a quest to contest his succession. The three princes embark on a journey and by sheer chance meet obstacles and overcome them by good fortune. Thus serendipity came to mean fortuitous good fortune like that of the three princes of Serendeep. The opposite of serendipity in a fashion, is predictability. There is a Sanskrit verse which can explain the predictable turmoil in financial and currency markets.

Markatasya suraapaanam, tatra vrischik danshanam
Tanmadhye bhut sanchaaro, yadvaa tadvaa bhavishyate.

Translation ' 
Take a monkey and feed it copious amounts of alcohol. If that monkey is stung by a scorpion and then its body and mind are invaded by an evil spirit, catastrophic chaos will inevitably occur.

America's travails have a similar trajectory. The current president has a cognitive capability of a lesser order than a normal monkey. He then got intoxicated with the inane and insane ideology of his vice president Darth Cheney. To top that he got stung by the reckless policies of Greenscam and Helicopter Berncranky. The last straw was the takeover of his mind and body by the evil partisan nepotistic spirit of Foulson, intent on saving his buddies, sacrificing the taxpayer and bankrupting the nation. This is how we got to catastrophic chaos.

The outcome is gradually becoming clear. Speculators, hedge funds and Japanese housewives had made humongous bets against the dollar, yen and Swiss Franc in what is called a carry trade. This involves borrowing in low yielding currencies with low interest rates and converting those into high yielding currencies like the Australian and New Zealand dollars, Brazilian reals, Indian rupees, Euros etc. As central banks around the world lowered interest rates and the yen, dollar and Swiss franc rebounded upwards, those short these currencies were forced to unwind the trades and buy back the shorted or borrowed currencies. That set off a ballistic upward spike in the dollar, yen and Swiss franc in relation to the Euro, real, Rupee, Pound etc.

The tightness of the credit market with the reluctance of banks to lend and the worsening jobs and housing numbers led to falling stock prices which became a death spiral of stocks and market indexes by margin calls causing forced liquidation by investors and hedge funs.

Highly leveraged hedge funds were denied credit or charged higher interest rates by banks, brokers and investment banks. Once again margin calls were triggered and investment banks and hedge funds were forced into liquidation with further market collapse. Pension fund and insurance companies portfolios suffered losses from falling stock, corporate and municipal bond values. Others like AIG, Lehman and Bear Stearns were tripped up by bad bets on credit default swaps. Korean, Mexixan and European companies and banks choked on currency derivatives and toxic securities. All this has probably wiped out nearly a trillion dollars of capital. There are unrevealed losses of another trillion or more dollars. No one knows which institutions hold these toxic securities. This generates total mutual distrust amongst banks. Banks are more regulated and have leverage of ten to one or less. The loss of two trillion dollars worth of capital will reduce lending by twenty trillion dollars, a third of global GDP. 

We are thus headed for a global recession with no chance of a sharp 'V' shaped recovery in stock prices or the economy. At best a 'U' shaped or more likely a 'L' shaped scenario of an extended downturn like in Japan is most likely. The nepotistic policies of Poulson with no help for homeowners under water, however undeserved, but limitless help for Wall Street, bankers etc., much more undeserving and the prime malefactors responsible for the crisis, will further sink home prices and send them into a death spiral.

What we are in now ,is a deflationary spiral in almost all asset classes due to necessary but self-reinforcing de-leveraging. Bernanke and his gang of four (Poulson, Cheney, Bush) are throwing torrents of money all around but will not be able to stem home price declines and worsening of credit card, student and car loans, with increasing job losses and bankruptcies of individuals and corporations. Their opening of the spigots of money supply and the burgeoning deficits will sink the credit status of the US government and unleash a tsunami of inflation in two years or less. It seems that the only safe port in this typhoon may become gold and currencies and stocks outside the US, but only of those corporations and countries unburdened by debt, with gold plated balance sheets and a moat of profitability unassailable by the storm. They also have to be geopolitically stable eliminating the Middle Eastern petro-states and maybe even Russia and China. Canada, Norway come to mind. Germany, Japan and Switzerland may become attractive because of their strong industrial base, innovation, exports and positive current account balances. Unfortunately the Euro may unravel because of the differing economics of its many nations with different economic problems. But first we have to cross the fires of deflation before we meet the ogre of inflation.  


More by :  Gaurang Bhatt, MD

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