Eight decades age J. M. Keynes reportedly remarked “When the facts change, I change my mind what would do sir”. Now facts have changed. Should we create new theories? Let us now look at the new facts relating to global finance.
Old Fact # 1 Bigger means better
For example, Citibank grew overtime to become one of the biggest banks in the world. During the 2008 subprime crisis in the US, it was on the verge of bankruptcy. Now we know that economies of scale are sometimes an illusion. The same could be said about AIG the largest insurance corporation in the world. The 2008 crisis brought it share value to 50 cents from over $ 40.
Old Fact # 2
There are all theories about the market being self-stabilizing. In the long run the stock market index would reflect the true state of the economy and performance of a company. Now, we new but for the intervention by the US fed reserve through QE1, QE2 and QE3 the US economy would have gone in to a serious recession. In fact the fed is hesitating to taper off QE3 because they fear the economy would revert back to low or no growth.
Old Fact # 3
The credit rating agencies are doing a marvelous job by providing an unbiased estimate for the bonds issued by institutions both public and private. This is far from true. Some CDO’s rated AAA during the 2008 subprime crisis have gone bust. Many countries including India are currently questioning the ability of the rating agencies to provide the correct evaluation.
Old Fact # 4
Correct leveraging by companies or government is healthy for good performance and assures some form of security.
This is not true. When adequate equity is not there debt is a problem. Take India’s foreign reserves. It contains mostly borrowed money currently. FIIs have poured in 176 bln $. NRIs have deposited around $ 60 bln and our external commercial borrowing currently at 224 bln $. The current liability is 400.3 bln $ while our reserves are 292 bln $. Indian currency is extremely vulnerable and could massively drop in value barring major intervention.
Ola Fact # 5
During the subprime crisis, using financial innovation all hard assets were converted to liquid assets through CDO’s. People and banks bought these CDO’s promising high return. Many of them became worthless. Liquidity disappeared completely creating the need for QE1, QE2 and now QE3.
Finally, we should become aware that the traditional theories about finance hitherto considered Sacrosanct is no longer true. Who would have ever thought that the discount rate in the US which was around 15 ½ percent in 1980 is around one percent now. Who would have again thought that the value of rupee which was around 16 to a dollar 20 years ago would drop to near 68 to a dollar in August 2013.
If J. M. Keynes was alive today he (probably would have said “nothing in the global financial markets can be taken for certainty”. As Indian’s we shouldn’t be surprised if our currency namely “rupee” which dropped from 16 to 68.8 in 20 years continue to move south to hit a low of three digit figure in due course of time.