Allocation of Resources
On Wednesday, February 11, 2009 15:21 by Sudip BandyopadhyayIs leverage a problem for the world economy? Is the global “savings glut” at the root of the current credit crisis? In my view, the answer is no. Saving is good - provided it is well directed - and leverage per se is not a hindrance to economic growth. If capital can be efficiently allocated to the most productive sectors in the global economy, a high savings rate can enable a high investment rate. In turn, a high investment rate can allow for a higher rate of economic growth in the long run.
In the five years preceding the current crisis, however, excessive leverage and non-productive investment helped fuel both a credit bubble and an economic boom, with global GDP expanding at the fastest pace since the 1960s. The main question is not whether the world economy was running on too much leverage, but whether the financial sector was able to allocate global capital efficiently. In many countries, misguided government policies favoured investment in housing from the mid-1990s. Meanwhile four of the world’s top five largest oil and gas reserves holders, in effect, shut their doors to outside investment from 2000. Financial institutions reacted by channeling excess savings from fast-growing emerging economies into the real estate sector in OECD countries. Attracted by the perceived safety of property markets, capital flows avoided capacity investments in volatile sectors such as commodities. In other words, markets failed to efficiently allocate resources and too much money went into real estate, too little into energy. The spike in energy and food prices that followed - primarily the result of under-investment in productive energy capacity and rapid demand growth - crippled fast-growing emerging markets. The financial turmoil is thus coming from a gross global misallocation of capital, not excess indebtedness.
Sanfu says:
February 11th, 2009 at 8:38 pm
Hi Sudip
Thanks for providing new direction for the reason of financial turnmoil. It is true that global investors invested too much in real estate but don’t you think investor also invested in good proportion on commodity and energy. Last year all commodities hit their life time high, people were paying astronomical prize to companies who have huge mineral resource. Agricultural products also hit their life time high. Investor were also invested huge amount in energy and energy due to high oil price. All power equipment companies in globe whether in wind, thermal, hydro has huge order backlog. It would be great if you provide more insight how asset allocation play more important role in financial turnmoil then leverage. Thanks a lot for making us to think in more than one direction because everywhere we read that leverage is the main cause of turnmoil.
Sudip says:
February 13th, 2009 at 10:40 am
Sudip says :What we have been referring in the related article is Investment in Infrastructure related to commodities which can facilitate increase in Production, Storage and Distribution. In case of crude oil, the leading oil producing countries like Iran, etc. due to political reasons either shut their country or were shut out by the US and European countries for investments. No fresh investments were made to increase capacity either in production or storage. This resulted in both, commodity prices shooting up when demand increased and crashing down when demand decreased. Absence of storage makes the oil producers extremely vulnerable to short-term demand trends.
Sanfu says:
February 14th, 2009 at 5:05 pm
Thanks for clearing doubt
Simmi Harding says:
February 16th, 2009 at 12:57 pm
Sudip, people all across look at you for your advice and suggestions on various matters concerning their financial status and relative financial independence. You are also seen as a subject matter expert when it is the india economy in question or when people are looking for clarity. ONE SMALL QUESTION to you. Pls advice what I as an average retail investor (with about Rs 30 lacs of investible surplus must do in these trying times. I have been staying in the US for the last about 6 years and have just come back to india. regards simmi
Sudip says:
February 18th, 2009 at 10:19 am
My recommendation for deployment of Rs. 30 lacs assuming that you are a young person (age group 25 -40 years) and have a regular income without too much of family liabilities would be as follows:-
a. Please do take adequate Life Insurance cover to protect your income in the eventuality of any unforeseen contingency (death or permanent disability) assuming you earn Rs. 10 lacs per year and the market rate of interest is 10%, you need to take a cover of at least Rs. 1 crore to ensure that in the event of the said contingency, your regular income is protected. Term insurance would be recommended since the cost for the same is low.
b. Do invest 20 -30% of funds in liquid / cash scheme of any good Mutual Fund (Asset Management Company). Please do select dividend option (the income in your hands will be tax free). In the event of any contingency you would be in a position to withdraw this money with a days notice. The same funds can also be used if any interesting investment oppprtunity arises in the near future.
c. Invest 10% of your funds in Gold Coin / Bars or gold ETF. This would be again a contingency reserve.
d. Invest the balance in a large cap equity diversified fund,thru SIP (Systematic Investment Plan ) over the period of next 6 months.
The above is with the assumption that you have a place of your own to stay. In case you dont have same , please look for an opportunity to buy an appropriate flat/house over the next 6-12 months when the prices are depressed.
Simmi Harding says:
February 21st, 2009 at 2:38 pm
many many thanks…. I shall do the same….
grateful for your advice…