Monday, December 08, 2008

Financial Crisis - Don't Worry, Greed will Prevail

Note: I had posted this article on only my personal Blog since this was an HR only dashboard but i feel this topic transcends all domains, hence i am posting the blog here also. All comments are welcome.

Global financial meltdown - Three words that in all likelihood conjures up the most frightening monster the world has known. This monster is taking away all the things that we cherish, directly or indirectly. First there is a pay freeze, then there is a pay cut and if that was not enough there goes our job. With that goes our 'discretionary' spending capacity, our willingness to buy things that makes our miserable lives slightly bearable, our self esteem. The factories close down, industries vanish and social unrest begins. In the midst of all this, nations along with their policy makers are left scratching their heads. Question: Our goose is cooked...right?.....Wrong!!!

I have a simple solution to this. Forget about it...Dont worry, cause this is not going to last long.

I am sane enough to believe that these so called experts who are telling you that the financial world - thus in every sense the real economy - has come to an end are lying or to put it more subtly, not telling you the whole truth. Being a layman, i will try to tell exactly why i believe that this crisis is infact going to turn around very quickly.

Let me start with simple process flow. I go to work everyday and earn a salary every month. Some part of this salary goes to buy necessary and other products, some goes into savings like Cash, equity (shares, bonds, MF's), Commodities etc, mostly to a bank. Now the place where i am working makes a product and sells it to the consumer to generate revenue and hopefully profits. Again this money is split into buying important raw materials etc, paying bonuses; dividends and saving it in a bank. The bank gets this money and pays interest to the consumer or the corporate who has deposited the money. If my company is doing well, it takes a lon from the bank and carries out expansion plans - increase manpower, get more machines, etc - and from its increased profit pays off the debt. Since the bank needs to make money too, it charges an interest higher than what it has paid for the money and this becomes the profit (after overheads). This way the cycle keeps moving.

Now for some economics. Demand and Supply. Classical theory of economics states that if the demand goes up - the supply remaining constant - prices go up too. This is true for Oil, most precious metals, etc. For other goods, if the prices are higher, then the consumer might shift to substitutes so organizations in an effort to make more profit do not increase the prices. Instead, they increase their capacity to produce goods at almost the same rate as the demand moves up. This creates new expansion plans, new jobs, and hence again the above mentioned cycle continues.

Now to make the explanation clearer lets figure some connections:
If the companies/ individuals do not earn money they have less to saveIf the banks get less money, they give out less money and hence make less moneyIf there is less money for people to spend, they either buy cheaper substitutes or not buy at allIf the consumer does not buy, the companies do not make money and expansions go for a tossIf expansions do not happen/ new companies do not come up, the industry slows downIf the industry slows down, the governments have less taxes to collect and lesser budgetsIf budgets are lesser, social spending decreasesIf social spending decreases, the unrest begins

Now the impact for the stakeholders:
Since banks are making losses/ 'not enough' profit, shareholders get angry; CEO has to goSince other organizations are making losses/ 'not enough' profit, shareholders get angry; CEO has to go. Above corollary is that shareholders are also losing money. Since countries are not making money and hence people are suffering, governments will lose their votebanksInfact due to the extreme lowering of oil prices, terrorists are also not going to have much money since their masters purse strings might just be running on emptyand hence due to all the above except one....the individual loses
Hopefully, you get my drift. This is just not going to happen. Rich individuals/ corporations/ governments can take the fallout for sometime but sooner or later they will realise that there is just no other way to come out of this but to make profits.

Also since the world today is extremely connected (take the example of terrorists - US does not buy oil due to recession and terrorists have lesser money for spreading hate) and mind you this is an extremely delicate connection, making profits is not easy unless the entire global machinery is greased. This grease comes from banking organizations and consumers who will spend the money thay they generate. And banks will spend once they are aware that if they dont, they are the ones who lose the most. They own the money and they need to pay the interest.

I can tell you this and much more in complicated jargon but it all boils down to this. Yes, for a short time (my bet is 6-12 months) things are going to be nasty. But this is just a blip. This can never be the great depression part 2 since the economies are not isolated and global linkages will play its own hand. We have probably seen the worst and things will - hopefully - seem better very very soon. It was greed that got us here and it will be Greed that will get us out of here...

Ritesh Sharan


Saji said...

K. So economics predicts it won't last long. But we knew it right. We all know probably 2 years. not more than that. But I guess, it's the 2 years that pains. If I were worried about lasting beyond my 8th month, economics would make little difference to me.

Peekay said...

what happens if the discontent created during this 'short duration' results in anarchy???it is because of the 'grease' in your machinery that has resulted in this mess...

Robin said...

Well Saji...there is a lot of theories that this is going to be like the great depression which lasted from 1929-39. What i am trying to say is that it is not going to be the case. Its just a matter of buckling up and surviving the 12 months and probably take this as an opportunity since when the growth cycle hits us next, we should be primed to take advantage of it.

Robin said...

Also peekay, please understand that it is the grease that created the large consumer demand and thus the great job market. If it was not for that, the unemployment levels would have still been at this level. Please remember that when Bill Clinton came to power the slight recession was about to end because of the start of the ease of the liquidity. If it had not then the recession probably would have become deep at that time itself and would have continued for a longer period.