What Ramdev, Biyani, Mallya and Govt can learn from Buffet

Vivek Kaul

So what is common to Baba Ramdev, Kishore Biyani, Vijay Mallya and the government of India, other than the fact that they have all been in the news lately? To put it simply, they all like operate in areas where they lack expertise and in the process make a mess of it.
Let us start Baba Ramdev who became a household name by selling the benefits of Yoga to the masses. He claimed that even diseases like cancer could be cured through yoga. Those who have seen his yoga DVDs will recall the line “karte raho, cancer ka rog bhi theek hoga”.
So far so good. Then he decided that he had enough of preaching yoga and wanted to get into politics and vowed to get all of India’s black money hoarded abroad, back to India. The politicians in the government clearly did not like this (for obvious reasons) and went hammer and tongs after him. Stories were leaked to the media about the wealth he had accumulated over the years and that damaged his credibility as a yoga guru as well. Ramdev has continued in his attempts to establish himself as a politician but with very little success.

Kishore Biyani brought the retail revolution to India, having been inspired by Sam Walton who started Wal-Mart. His retail businesses were doing decently well till he decided to get into a wide variety of businesses from launching an insurance company to even selling mobile phone connections. When times were good he accumulated a lot of debt in trying to grow fast. Now he is in trouble in trying to service the debt and rumors are flying thick and fast that he is planning to sell Big Bazaar, his equivalent of Wal-Mart. This after he sold controlling stake in the cloths retailer, Pantaloons.
Vijay Mallya started Kingfisher Airlines in 2005, going beyond his core business of alcohol. Kingfisher now has accumulated losses of over Rs 6000 crore, and has never made money since its launch. The lack of focus has hurt Mallya’s core alcohol business and United Spirits is no longer India’s most profitable alcohol company. That tag now belongs to the Indian division of the French giant Pernod Ricard.

And finally the government of India, which has been bailing out the troubled airline Air India over and over again. The pilots of the airline keeps going on strike and the government keeps putting a few thousand crores every few months, to keep running the airline.
So the question that crops up here is what is Baba Ramdev doing in politics? Why is Kishore Biyani trying to sell insurance and mobile phone connections to you? And why are Vijay Mallaya and the government of India trying to run an airline?
They would be better off concentrating on things they are good at. These are things they shouldn’t be doing. It is not their area of expertise or what they are good at. The days when individuals, businesses and even governments could be an expert at many things at the same time are long gone.
In the last 100 years there have been only two individuals who have won the Noble prize twice for two different subjects. Marie Curie won the physics prize in 1903 and the Chemistry prize in 1911. Linus Pauling won it twice, the Chemistry Prize in 1954 and Peace Prize in 1962.
So in the strictest sense of the term, Marie Curie is the only person ever to have won a Noble prize in two different subjects and that happened almost 100 years back. This is primarily because as more and more things have been invented and discovered, subjects have become more complex requiring full time attention and expertise.
What is true about individuals is also true about businesses. The expertise and the attention required to run a business has increased over the year. Hence, the moment a businessman tries to go outside its area of expertise, he loses focus, and the chances of the new business doing well are remote.
Let’s take the case of DLF, the biggest real estate company in the country. It tried getting into the insurance and mutual fund business. It had to sell its stake in the mutual fund business and if news reports are to be believed it is trying to lower its stake in the insurance venture by selling its stake to HCL. Now why is a computer major trying to buy into an insurance business which is losing money, is beyond me?
Satyam was in good shape till it remained an IT company. The moments its owner developed aspirations beyond IT and got the company into real estate and infrastructure space, trouble cropped up. Real estate companies have tried unsuccessfully to get into the luxury hotel business and hotels have tried unsuccessfully to get into the luxury apartment business.
Reliance Industries attempts in the retail business haven’t gone anywhere. Anil Ambani who had build a good business in Reliance Capital is struggling with Reliance Communications and Reliance Power. Subrata Roy’s attempts to diversify into the film and television business have come a cropper, with the film business of Sahara, more or less being shutdown. NDTV, a premier English news channel, tried getting into the entertainment channel business with NDTV Imagine. It had to sell out. Cigarette major ITC has been trying to establish itself in the FMCG business for years now. Though it has had some success at it, the business hardly throws up any money in comparison to its cigarette business. All kinds of entrepreneurs have gone into the insurance business in India and are now struggling. This includes Kishore Biyani. At the same time the Tatas have been struggling with their telecom business for years.
There is a thing or two all these guys can learn from internationally renowned investor Warren Buffett. During the period of 1994-2000, the United States saw a whole lot of dotcom companies coming up with their initial public offerings. Some of these shares achieved astonishing highs. The shares of Netscape Communications Corporation, an internet browser company which controlled 75% of the browser market, were sold to investors at $28 per share. When the stock was listed on August 9,1995, it went to $74.75 during the course of the day and finally closed at $58.25, doubling in a single day. Another stock booksamillion.com went up by 973% to $47 in the course of just three days in November 1998. theGlobe.com which listed on November 13,1998, gained 606% during the course of the day and closed at a price of $63.50.
Despite these humungous gains Warren Buffett did not invest a single penny in these stocks. He did not understand the business models of these stocks and remain focused on his investment philosophy of “value investing”. Not surprisingly he had the last laugh as dotcom and technology stocks started crashing after they had peaked in March 2000.
Buffett did not abandon his core philosophy of value investing just because there was “easy money” to be made somewhere else. And he came out on top, for the simple reason that he chose to remain focused on what he knew.
But this is rarely the case. When times are good and there is a lot of easy money floating around every entrepreneur likes to “expand” his business and get into other things. But in this day and age, when things are as complicated and competitive as they are, diversification into different businesses rarely works.
Businesses these days need full time attention from entrepreneurs. Let’s take a look at the airline business. As Warren Buffett put it in a letter he wrote to the shareholders of Berkshire Hathaway “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down…The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”
The reason airline businesses burn capital endlessly is for the simple reason that airlines have very little control over their cost. The major expense in running an airline is oil (the company can lease the aircraft it doesn’t have to always buy them). And oil prices have been over $100 per barrel for a while now. Airline companies have no control over this price, though they can hedge themselves by buying derivatives. But that can be a risky business as well.

So higher the oil price, higher is the cost of running an airline and given the lure of owning an airline, the sector remains a very competitive one, all over the world. Hence companies cannot always pass on an increase in their costs to the end customers though higher ticket prices. Given these reasons airlines are a specialised business, which require full time attention. It is definitely not a business which Vijay Mallya can look to successfully manage, busy as he is running his diverse businesses of alcohol and real estate, indulging in expensive hobbies like IPL and Formula 1, and cheaper ones like commenting regularly on Twitter.
The government of India falls in the same category. Its primary area of activity is governing the nation(which it is anyway making a mess of) and not running an airline. It simply doesn’t have the expertise to run one. Southwest Airlines is successful because it has remained focused on the airlines business. It did not suddenly decide to launch a new beer just because their airline business was constantly throwing up cash over the years.

Kishore Biyani should learn from his inspiration Wal-Mart. The company did not get into the insurance business. They did not say “now that we have so many people coming to our stores, let’s try and sell insurance to them along with fast moving consumer goods”. Or as Warren Buffett puts it ” If you buy things you don’t need, you’ll soon sell things you need.”
That leaves Baba Ramdev. He can learn from his more famous predecessor the Sai Baba of Puttaparthi. Given the following he had he could have easily gotten into politics. But that would have put him at the same pedestal as the politicians who looked up to him as their guru. And thus rightly he did not.
Marketing guru Al Ries has said in the past “Focus is the essence of marketing and branding.” I guess it’s time to rephrase that phrase. “Focus is the essence of marketing, branding and business”. And its time Ramdev, Biyani, Mallya, the government and many others learnt that lesson.

(The article originally appeared on May 10,2012 at http://www.firstpost.com/business/what-ramdev-biyani-mallya-and-govt-can-learn-from-buffett-304770.html).

(Vivek Kaul is a writer and can be reached at [email protected])

The pain in Spain will get us too; so forget market rallies

Vivek Kaul

If you are the kind who reads the pink papers religiously, you would have come to conclusion by now that good times are back again for the stock market investors in India, now that the finance minister has deferred the implementation of GAAR to next year. But before you open that champagne bottle and say cheers, here are some reasons why the stock market will remain flat or fall in the days to come.
Pain in Spain:
The gross domestic product (GDP) of Spain grew at the rate of 8% every year from 1999 to 2008. This primarily happened because Spain went all out and promoted the Mediterranean lifestyle. As Jonathan Carman points out in a presentation titled The Pain in Spain “Millions flocked to its sun-drenched shores, buying houses along the way. As the demand for houses increased, construction became the industry. Housing prices exploded, tripling in just over a decade.”
So far so good. The trouble was Spain ended up building way too many homes than it could sell. Even though Spain forms only 12% of the GDP of the European Union (EU) it has built nearly 30% of all the homes in the EU since 2000. As John Mauldin and Jonathan Tepper point out in Endgame – The End of the Debt Supercycle and How It Changes Everything “Spain had the mother of all housing bubbles. To put things in perspective, Spain now has as many unsold homes as the United States, even though the United States is six times bigger”.
All this building was financed through the bank lending. Loans to developers and construction companies amounted to nearly $700billion or nearly 50% of the Spain’s current GDP of nearly $1.4trillion. With homes lying unsold developers are in no position to repay. And Spain’s biggest three banks have assets worth $2.7trillion or that is double Spain’s GDP.
What makes the situation more precarious is the fact that the housing prices are still falling. Carman expects prices still need to fall by 35% from their current levels if they are to reach normal levels. This will mean more home loan defaults and more trouble for Spain. The Spanish stock market is already taking this into account and IBEX-35, the premier stock market index of the country is down a little more than 10% in the last one month. Banking stocks have fallen much more.
While countries like Greece may be in more trouble, they are not economically big enough to cause a lot of trouble worldwide. But if Spanish banks go bust, there will be a lot of trouble in the days to come. Spain has now emerged the basket case of Europe, but other countries in the European Union are not doing well either and this means trouble for China.
China’s After Party:
If things are not well in Europe, it has an impact on China because Europe is China’s biggest trading partner. The Chinese exports to Europe in March were down 3.1% in comparison to last year. Chinese exports had ranged between $475billion and $518billion in the last three quarters of 2011. In the first three months of this year the number has fallen to $430million. Falling exports are not the best news for China.
There are other things which aren’t looking good either. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracles “In the last decade the main driver of China’s boom was a surge in the investment share of the GDP from 35% to almost 50%, a level that is unprecedented in any major nation…The investment effort focused on building the roads, bridges, and ports needed to turn China into the world’s largest exporter, doubling its global export market share to 10% in the last decade.”
This spending spree which was responsible for its fast growth is now slowing down. New road construction is down from 5000miles in 2007 to 2500 miles. Railway spending is down by 10%.
The other major factor likely to pull down growth is wage inflation i.e. salaries are rising at a very fast rate. In 2011, the average wage was rising at a rate of 15%, in a scenario where the consumer price inflation was around 5%. As Sharma points out “In fact hourly wages are now rising twice as fast productivity, or hourly output per worker, which is forcing companies to raise prices just to cover the cost of higher wages.” This has led to manufacturers moving to cheaper destinations like Bangladesh and Indonesia.
Given these reasons it is highly unlikely that China will continue to grow at the rates that it has been. Since 1998, China’s economic growth has averaged around 10% and it has never fallen below 8%. As Sharma points out “China’s looming shadow is about to retreat to realistic dimensions.” Sharma expects Chinese growth to slowdown by 3-4% percentage points in comparison to its current growth rate over the next decade.
A Chinese slowdown will mean disaster for nations which have been thriving by exporting commodities to China. In 1998, when China was a $1trillion economy, to grow by 10% meant it had to expand its economy by $100billion. This could have been done by consuming 10% of the world’s industrial commodities, raw materials like oil, steel and copper. In 2011, China is a $6trillion economy. If this economy needs to grow by 10% or $600billion, more than 30% of the world’s commodity production would be needed. With growth slowing down, China’s commodity requirements will come down as well. As Sharma puts it “It’s my conviction that China – commodity connection will fall apart soon”.
China’s stock markets remain largely closed to international investors. But the Hang Seng index listed in Hong Kong has a lot of Chinese companies. This index has gone up 0.9% over the last one month.
The Kangaroo Won’t Jump:
In fact the Aussies are already feeling the heat with a slowdown in Chinese exports. Australian exports to China in 2011 stood at A$72billion (Australian dollar), up 24% from 2010, or around 26% of total exports. An ever expanding China bought coal, iron ore and natural gas from Australia, driving up Aussie exports. But exports for the month of February fell to A$24.4 billion, the lowest in an year. Coal exports were down by 21% to A$3.4billion. The S&P ASX/200 one of the premier stock market indices in Australia, has been flat for the last one month.
Brazil – God’s Own Country:
The rise of China has led to huge demand for Brazilian commodities. As Gary Dorsch an investment newsletter writer points out in a recent column “Brazil has been enjoying an economic boom based on soaring prices for its natural resources including crude oil, agricultural products, such as soybeans, corn, and cattle, and metals such as iron ore and bauxite-aluminum.”
The rise of Brazil was captured very well by Glenn Stevens, governor of the Reserve Bank of Australia. Stevens pointed out that in 2006, money received from shipload of iron ore could buy 2,200 flat screen TVs. In 2011, the same shipload could buy 22,000 flat screen TVs.
Since the start of the financial crisis a lot of money printed by Western governments to revive their economies has flowed into Brazil. This has driven up the value of the real, the currency of Brazil, and made Brazil one of the most expensive countries in the world. As Sharma points out “Restaurants in Sao Paulo are more expensive than those in Paris. Hotel rooms cost more in Rio than French Riviera”.
An expensive currency has meant that imports rising faster than exports. This situation is expected to get worse as China’s slowdown and the demand for Brazilian commodities falls. In fact the impact is already being felt. As Dorsch points out “Brazil’s economy stalled out in the past two quarters, showing near zero growth in Q’3 of 2011 and Q’4 of 2012. Factory output in February was -3.9% lower than a year ago.” The premier stock market index Bovespa is down 4.5% over the last one month.
On a totally different note the most popular television serial in Brazil is a soap opera called “A Passage to India” shot in Agra and Jodhpur and which has Brazilian actors playing Indian roles and as Sharma puts it, they could “pass easily for North Indians”.
India- Done and Dusted:
The economic problems of India deserve a separate article. But let me list a few. In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore. The targeted fiscal deficit for 2012-2013 is Rs 5,13,590 crore. This is likely to go up given the fact that the rupee is depreciating against the dollar and thus our oil bill is likely to go up, pushing up our fiscal deficit. This would mean that higher interest rates will continue to prevail.
The stock market obviously realizes this and hence has fallen by 1.8% over the last one month, yesterday’s brief rally notwithstanding.
Over the last few years stock prices all across the world have moved in a synchronized fashion because the international investors like to move in a herd. Whenever there has been trouble in the United States or Europe it has led to emerging markets all across the world falling. Now we are in a situation where the emerging markets themselves are in a lot of trouble. So it is a no brainer to say there will be no rally in the stock market in the near future. Unless of course a certain Mr Ben Bernanke decides to open up the money tap again and go in for Quantitative Easing Round Three or to put it in simple English, print some more dollars. If that happens, then investors can get ready to have some fun.
(This article was originally published on May 8, 2012 at http://www.firstpost.com/economy/the-pain-in-spain-will-get-us-too-so-forget-market-rallies-302278.html. Vivek Kaul is a writer and can be reached at [email protected])

What the UPA government can learn from B.E.S.T

Vivek Kaul
Ek bandra station,” I told the conductor of the B.E.S.T (BrihanMumbai Electric Supply and Transport) bus number 83, handing over a ten rupee note.
Do rupiya aur,” he replied.
12 rupiya ka ticket hai?” I asked him.
Ji sir,” he replied.
I was travelling from Century Bazar in Worli to Bandra. The ticket till very recently used to cost eight rupees. It has now been increased to Rs 12, a rather steep 50% increase. The prices of tickets of lower denominations haven’t been increased so much. A four rupee ticket is now five rupees. But at the same time a ten rupee ticket now costs fifteen rupees and a twelve rupee ticket costs eighteen rupees.
This got me thinking. Why had the B.E.S.T increased prices? Well for the simple reason that they had to match their income with their expenditure, which is the most basic thing that needs to be done for successfully operating any institution. The fact that it is not allowed to raise prices as often as it probably wants to has led to this very high increase.
While the B.E.S.T believes in at least trying to ensure that its income meets its expenditure, the United Progressive AllianceUPA) which runs the government of India, doesn’t. And this is neither good for the UPA nor for you and me, the citizens of India.
In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore.
Things cannot be quite right when your expenditure is expanding nine times as fast as your income. As Franklin Roosevelt, who was the President of America for a record four times, between 1933 and 1945 famously said “Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.”
So why is the UPA led Indian government headed to the poorhouse? For that we have to dig a little deep and look into this document known as the annual financial statement of the government of India. In this document the government gives out numbers for the amount it had assumed initially as the oil subsidy for the year, and the final oil subsidy it gave.
The data for the last three years has been very interesting. The subsidy assumed at the time of the finance minister presenting the budget has always been much lower than the final subsidy bill. Take the case for the year 2009-2010(i.e. between April 1, 2009 and March 31,2010) the oil subsidy assumed was Rs 3109 crore. The final bill came to Rs 25,257 crore (direct subsidies + oil bonds issued to the oil companies), around eight times more.
The next year (i.e. between April 1, 2010 and March 31, 2011) the oil subsidy assumed was Rs 3108 crore. The actual bill was nearly 20 times more at Rs 62,301 crore. For the year 2011-2012(i.e. between April 1,2011 and March 31,2012) the subsidy assumed was Rs 23,640 crore. The actual subsidy bill came to Rs 68,481 crore.
So in each of the last three years the oil subsidy bill has come out to be greater than what was assumed. For the current financial year (i.e. April 1, 2012 to March 31,2013) the oil subsidy bill has been assumed to be at Rs 43,580 crore. While this is greater than the assumption made over the last three years, it is highly likely that the oil subsidy bill will come to amount greater than this.
There are two reasons for the same. The first reason is that the rupee has been rapidly depreciating against the dollar and since oil is sold in dollars that means that the Indian companies are paying up more in rupees to buy the same volume of oil. Currently oil is priced at around $115 per barrel (around 159litres) of oil. This means that Indian companies pay around Rs 6141 per barrel of oil.
If the rupee falls further and one dollar equals Rs 60 (as has been written about on this website), the Indian companies will be paying Rs 6900 or 12.4% more per barrel of oil. In the normal scheme of things this cost would have been passed onto the customer and everybody would have lived happily ever after.
But that is not the case. Various products coming out of oil like kerosene, diesel etc, are heavily subsidized in India. Hence even with higher prices of oil internationally the Indian oil companies will have to keep selling their products at lower prices and suffer losses. These companies are then compensated for the losses they face by the government of India.
The second reason is that the price of oil is unlikely to go down in dollar terms as well. As governments and central banks around the world run close to zero interest rates and print more and more money (and are likely to continue to do so) in order to revive economic growth in their respective countries, oil has become a favourite commodity to buy among the speculators.
While central banks and governments can print all the money they want, they can’t dictate where it goes. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracles “When money is loose, investors borrow to buy hard assets, which is why the prices of oil, copper, and other commodities have become disconnected from actual demand.”
This means that oil will either continue at its current price level or even go up for that matter. And with the rupee likely to depreciate further this means that India’s oil import bill is likely go up even further.
It is highly unlikely that this increase in price will be passed onto the end customer. This means that the government will have to bear the losses incurred by the oil companies, pushing up the oil subsidy, which has been assumed to be at Rs 43,580 crore.
A higher oil subsidy bill means the government expenditure going up and this in turn means a higher fiscal deficit. Typically, the government finances this deficit by borrowing money. With the government needing to borrow more money it would have to offer a higher rate of interest. At the same time a higher government borrowing will crowd out private borrowing, meaning that the private borrowers like banks and other finance companies will have to offer a higher rate of interest on their deposits because there would be lesser amount of money to borrow. A higher rate of interest on deposits would obviously mean charging a higher rate of interest on loans.
All this can be avoided if the government follows what B.E.S.T did recently i.e. allow oil companies to raise prices of its products. Why can’t a free market operate when it comes to oil products? If the price of oil products changes on a daily basis depending on its international price, like the price of vegetables, people will gradually get used to the idea of a changing price for products like diesel and kerosene.
And of course chances are that with the government borrowing coming down, interest rates might also fall. In 2007, when the government fiscal deficit was low, a 20 year home loan could be got at an interest rate of 8%. A loan of Rs 25 lakh would mean an EMI(equated monthly installment) of around Rs 25,093. A lot of banks are now charging their existing consumers around 13% on their home loans. This means an EMI of around Rs 35,147 or almost 40% more.
The huge subsidy on oil prices has had a role to play in this increasing EMI. Bad economics does not always mean good politics. Its time UPA woke up to that.
(The article was originally published on May 9, 2012,at http://www.rediff.com/business/slide-show/slide-show-1-special-what-the-upa-govt-can-learn-from-best/20120509.htm. Vivek Kaul is a writer and can be reached at [email protected])

Gold is about to touch Rs 30,000. What to do now?

The price of gold has been rising and might touch Rs 30,000 per ten grams very soon(it is currently around Rs 29,300 per 10 grams). If you had invested Rs 1 lakh in gold five years back, it would currently be worth around Rs 3.1lakh. In comparison Rs 1 lakh invested in the stocks that constitute the BSE Sensex would now be worth Rs 1.22 lakh.
So clearly gold has done much better than Indian stocks have. But will it continue to give the kind of returns that it has in the past? Before I try and answer that question, let’s get into a little bit of history and try and understand why people buy gold.
Queen Elizabeth I who ruled England in the sixteenth century used to have a financial advisor by the name of Sir Thomas Gresham. Gresham had been appointed to clear up the financial mess created by the Queen’s father Henry VIII and her brother Edward VI, who had ruled before her.
Between them they had completely destroyed the pound by debasing it and ensuring that there was very little silver left in it. Kings and governments throughout history have had a habit of debasing coins and other forms of money. Nero, King of Rome, and who watched it burning, was one of the first Kings to debase coin.
Debasement was a practice where the ruler or the government of the day decided to lower the metal content of the coin while keeping its value unchanged. Let us try and understand this through the example of a coin which has a face value of 100 cents (or any other unit for that matter). The face value of a coin is referred to as its tale. This coin is made up of a metal (gold or silver) and the metal content of the coin is worth 100 cents as well. The metal content in a coin is referred to as specie.
So in this example the tale of the coin is equal to its specie, which is the ideal situation. Now the ruler decides to debase the coin by 20%. So he reduces the metal content or the specie value of the coin by 20% to 80 cents. But at the same time he maintains the face value of the coin at 100 cents. And thus debases the coin.
In most situations the rulers used to pocket the metal (gold or silver) they had saved by debasing the coin. The situation in Britain at the start of Elizabeth’s rule was similar and the market that was full of debased coins.
She wanted to correct the situation and decided to launch new silver coins where the tale of the coin was equal to its specie i.e. the face value of the coin was equal to the amount of metal in it.
But her financial advisor Gresham thought that there would be a major problem in doing that. He felt that the bad money would drive out the good. This essentially meant that the citizens of the country would hold onto the full metal new coins and try and carry out their transactions through the existing debased coins.
They would melt the newer coins for the greater amount of silver in them and sell them for their precious metal content. Hence bad money would drive out the good. This phenomenon came to be known as the Gresham’s law. Gresham decided to solve problem by exchanging all the old coins for new coins. This would ensure that there would be no old coins in the market and people would move onto using the new coins as money.
Even though Gresham’s name came to be attached to this phenomenon, this had been happening for thousands of years. “,“Under the Greeks and Romans, when gold coins were debased, few people were dumb enough to want to exchange their old coins that had high gold content for newer ones that had low gold content, so older good coins disappeared as people hid them,” writes hedge fund manager John Mauldin.
In fact it is even being observed today, though in a different form. Central banks and governments around the world have been printing money in the hope of tiding over the financial crisis and reviving economic growth in their respective countries.
When the governments print money there is much more money in the financial system than before, and hence the money gets debased. To protect themselves against this debasement people buy gold, something that cannot be created out of thin air and thus is expected to hold value.
So as governments have been printing money, people have been buying gold and the price of gold has been going up. Till early 1930s, paper money around the world used to be backed by gold or silver. This meant that citizens at any point of time could go to the central bank of the governments and its various mints and exchange their paper money for gold or silver.
Hence whenever people saw that the government was resorting to money printing, they could get their money converted into gold or silver, and thus ensure it did not lose its value. Now the paper money is not backed by anything except a fiat from the government which deems it to be money.
Given this, now whenever people see more and more of paper money, the smarter ones simply go out there and buy that gold. Hence, as was the case earlier, bad money (that is, paper money), drives out good money (that is, gold) away from the market.
But that’s just one part of the story. The governments around the world are likely to continue printing more money, in the hope that people spend this money and this revives economic growth. This in turn would mean that the price of gold is likely to go up in dollar terms. It is important to remember that gold is bought and sold worldwide in dollar terms and not in terms of Indian rupees. Hence whether Indians will continue to benefit from the price of gold continuing to go up will depend on a few other factors.
Let us examine four possible scenarios:
1) The price of gold goes up in dollar terms and the rupee continues to depreciate against the dollar: This is what has happened over the last one year. In dollar terms gold has given a return of 6.1% over the last one year. But in rupee terms the return is almost four and a half times more at 27.3%. Why is this the case? A year back one dollar was worth Rs 44. Now it’s worth almost Rs 54. So the gold price has increased in dollar terms but because of the depreciation of the rupee, the returns of gold in rupee terms are a lot higher. If gold quotes at $1600 per ounce (around 31.1grams), and one dollar is worth Rs 44, then the price of gold in rupee terms is Rs 70,400(1600 x 44) per ounce. If one dollar is worth Rs 54, the price of gold increases to Rs 86,400 per ounce. So the depreciation of the rupee against the dollar can spruce up returns for the Indian gold investor. Even if gold prices remain flat, and the Indian rupee keeps depreciating against the dollar, there is money to be made in gold. But the ideal situation for an Indian gold investor is that the price of gold goes up in dollars and at the same time the rupee depreciates against the dollar.
2) The price of gold in dollar terms falls and the rupee depreciates against the dollar, so as to knock off the fall in price in dollar terms: This is a phenomenon that has been observed over the last six months. The price of gold in dollar terms had gone down by around 7.4%, whereas in rupee terms the return on gold has been around 1%. This is because six months back one dollar was worth around Rs 51, now it’s worth Rs 54. So even though the price of gold has fallen in dollar terms, a depreciating rupee has more than made up for it.
3) The price of gold in dollar terms falls and the rupee appreciates against the dollar: This is a scenario that the Indian gold investor does not want. An appreciating rupee will further accentuate the negative returns of gold. This is a scenario that is highly unlikely. The chances of gold price falling majorly remain low as there is no end in sight to the financial crisis. Also with the government of India being in the mess it is, the chances of rupee appreciating also remain very low.
So the moral of the story is that even if the price of gold goes up in dollar terms, for Indian gold investors to continue to make money, the rupee has to either depreciate against the dollar or to at least remain flat. The rupee is likely to continue to lose value against the dollar and thus there are still more gains to be made on gold. But these gains will be rather limited till gold does not rally majorly against the dollar, which it hasn’t for the last one year.
The moral of the story is that stay invested in gold. But don’t bet your life on it.
(The article originally appeared on http://www.firstpost.com/investing/gold-is-about-to-touch-rs-30000-what-to-do-now-299622.html on May 7,2012. Vivek Kaul is a writer. He can be reached at [email protected])

‘US, India are now on the verge of a social revolution’

Ravi Batra is an Indian American economist and a professor at the Southern Methodist University in Dallas, Texas. Unlike most economists who are in the habit of beating around the bush, Batra likes to make predictions, and he usually gets them right. Among these was calling the fall of communism in the Soviet Union more than ten years before it happened. Batra is also the author of many best-selling books like The Crash of the Millennium, The Downfall of Capitalism and Communism, Greenspan’s Fraud and most recently The New Golden Age. In this interview he speaks to Vivek Kaul.
You are a great proponent of the Law of Social Cycle. What’s it all about?
In 1978, to the laughter of many and the ridicule of a few, I wrote a book called The Downfall of Capitalism and Communism, which predicted the demise of Soviet communism by the end of the century and an enormous rise in wealth concentration in the United States that would generate poverty among its masses, forcing them into a revolt around 2010. My forecasts are derived from The Law Of Social Cycle, which was pioneered by my late teacher and mentor Prabhata Ranjan Sarkar. Lo and behold! The Berlin Wall fell in 1989 and Soviet communism vanished right before your eyes. And in 2011, the United States witnessed the birth of a social revolt in the form of the ‘Occupy Wall Street Movement’, which opposes the interest of the richest 1% of Americans. The nation now has the worst wealth concentration in history.
So what is this law?
It is an idea that begins with general characteristics of the human mind. Sarkar argues that while most people have common goals and ambitions, their method of achieving them varies, depending on innate qualities of the individual. Most of us, for instance, seek living comforts and social prestige. Some try to attain them by developing physical skills, some by developing intellectual skills and some by saving and accumulating money, while there are also some with little ambition in life. Based on these different mentalities, Sarkar divides society into four distinct classes: warriors, intellectuals, acquisitors and labourers.
Can you go into a little more detail?
Among warriors are included the military, policemen, professional athletes, fire fighters, skilled blue-collar workers, and anyone who displays great courage. The class of intellectuals comprises teachers, scholars, bureaucrats, and priests. Acquisitors include landlords, businessmen, merchants, and bankers. Finally, unskilled workers constitute the class of laborers. The division of society into four classes based on their mentality and occupations, not heredity, is at the core of Sarkar’s philosophy of social evolution. His theory is that each society is first dominated by the class of warriors, then by the class of intellectuals, and finally by the class of acquisitors. Eventually, the acquisitors generate so much greed and materialism that other classes, fed up by the acquisitive malaise, overthrow their leaders in a social revolution. Then the warriors make a comeback, followed once again by intellectuals, acquisitors and a social revolution. This, in brief, is The Law Of Social Cycle.
That’s very interesting. Can you explain this through an example?
Applying this theory to western society, we find that the Roman Empire was the Age Of Warriors, the rule of the Catholic Church the Age Of Intellectuals, and feudalism the Age Of Acquisitors, which ended in a social revolution spearheaded by peasant revolts all over Europe in the 15th century. The centralised monarchies that then appeared represented the Second Age Of Warriors, which was, in turn, followed by another Age Of Intellectuals, this time represented by the rule of prime ministers, chancellors and diplomats. Since the 1860s the west has had a parliamentary rule in which money or the acquisitive era has been prevalent.
What about India?
India’s history is silent on some periods, but, wherever full information is available, the social cycle clearly holds. For instance, around the times of Mahabharata, warriors dominated society, then came the rule of Brahmins or intellectuals, followed by the Buddhist period, when capitalism and wealth were predominant; this era ended in the flames of a social revolution, when a great warrior named Chandragupta Maurya put an end to the reign of a king named Dhananand, and started another Age Of Warriors. Dhan means money and ananda means joy, so that dhan + ananda becomes Dhananda or someone who finds great joy in accumulating money, suggesting that the Mauryan hero overthrew the rule of greed and money in society.
How do you see things currently through The Law Of The Social Cycle?
Today, the world as a whole is in the Age Of Acquisitors, while some nations such as Iran are ruled by the clergy or their intellectuals. Russia is in transition from the warrior era to the era of intellectuals, while China continues in the Age Of Warriors, which was founded by Mao Tse Tung in 1949 after overthrowing the feudalistic Age Of Acquisitors in an armed revolution. As regards Iran, applying the dictum of social cycle, I foresaw the rise of priests or the Ayatollahs in a 1979 book called Muslim Civilization and the Crisis in Iran. For ten thousand years, the law of the social cycle has prevailed. Egypt went through three such cycles before succumbing to Muslim power. Muslim society as a whole is now in the Age Of Acquisitors. Some Muslim countries such as Saudi Arabia, Kuwait, Jordan, Pakistan, Malaysia and Bahrain are still in the acquisitive age, while some others such as Egypt and Libya have recently seen a social revolution and are in transition to the next age. The wheel of social cycles has thus been turning in all societies, albeit at different speeds; not once in human history was it thwarted.
Any new predictions based on this law?
The United States along with India are now on the verge of a social revolution that will culminate in a Golden Age. That is what I have predicted in my latest book, The New Golden Age. The American revolution is likely to occur by 2016 or 2017, and India’s should arrive by the end of the decade. This is the way I look at some popular movements such as the Occupy Wall Street Movement in the United States, and those started by Anna Hazare and Baba Ram Dev in India. They reflect people’s anger and frustration with the corrupt rule of acquisitors. Such movements are destined to succeed in their mission, because the rule of wealth is about to come to an end.
One of your predictions that hasn’t come true is that about the Great Depression of the 1930s happening again
It is true we have not had another Great Depression like that of the 1930s, although the slump since 2007 is now being called the Great Recession. The difference between the two may be more semantic than real. The Great Depression was not a period of one long slump lasting for the entire 1930s. Rather, there were pockets of temporary prosperity. The first part of the depression lasted between 1929 and 1933. Then growth resumed and the global economy improved till1937, only to be followed by another slump. This time there has been no depression, but at least in the United States people’s agony has been nearly as bad as in the 1930s. Farming played a great role in society at that time so that the unemployed could go back to agriculture and survive. This time around, that has not been possible. Millions of Americans are homeless today as in the1930s. Still the 1930s were the worst ever, but my point is that American poverty today is the worst in fifty years. The wage-productivity gap, consumer debt and the stock market went up sharply in the 1920s, just as they did after1982. The market crashed in 1929 and then the depression followed. So I concluded that since the same type of conditions were occurring in the 1980s we would have another great depression. However, what I could not imagine was that, China, one-time America’s arch enemy, would lend trillions of dollars to the United States. Note that so long as debt keeps up with the rising wage gap, unemployment can be avoided. In other words, China’s loans postponed large-scale unemployment in the United States for a long time, but not forever.
Can a depression still occur?
Yes, it can, but only if countries are unable to create new debt. Such a likelihood is small but cannot be ruled out. On the other hand, if for some reason oil prices shoot up further to say $150 per barrel, the depression will be inevitable.
How do you see the scenario in Europe playing out?
In Europe and elsewhere the nature of the problem is the same, namely the rising wage gap, so that production exceeds consumer demand, and the government has to resort to nearly limitless debt creation. But the PIIGS — Portugal,Ireland, Italy, Greece and Spain — show that government debt cannot rise forever and when debt has to be reduced there is further rise in unemployment. The European troubles are not over and we should expect the debt problem to linger for years to come.
The dangers in Europe have suddenly taken away the attention from the United States. What is your prediction about the United States the way it currently is?
So long as the United States is able to borrow more money either from the world or from its own people, its economy will remain stable at the bottom. But there is a strong sentiment now among most Americans that the budget deficit must come down, and the laws already passed aim to bring it down from 2013 on. This is likely to raise unemployment in that year and beyond. 2012 could also see real troubles after June when the already rising price of oil and gasoline starts hurting the economy. If the speculators succeed in raising the oil price towards their goal of $150, there could be another serious slump by the end of the year.
Do you see a dollar crash coming in the years to come?
Yes the dollar could crash against the currencies of China and Japan, but I don’t see this happening before July. After that the global economy could be as sick as it was in 2008. The scenario would be reminiscent of what happened in 1937 when the global depression made a comeback. Something similar could materialise again in that the Great Recession could make a resounding come back. However, I don’t see an alternative to the dollar at this point because the whole world is in trouble. For the dollar to fall completely from grace, Opec would have to start pricing its crude in terms of a different currency and I am not sure if that is possible.
What do you think about the current steps the Obama administration is taking to address the economy?
The Obama administration has followed almost the same policies that George W Bush did, and in the process wasted a lot of money to generate paltry economic growth and some jobs. In fact, the government has been spending over $1.5 million to generate one job. This sounds bizarre, but here is what has happened since 2009. The administration’s tack is that we should keep spending money at the current rate to lower unemployment, even though the annual federal budget deficit has been around $1.4 trillion over the past two years. It seems apparent that the main purpose of excessive federal spending is to preserve or generate jobs. This is a point emphasised by every American president since 1976, and especially since1981 when the federal deficit began to soar. This is also how most experts defend the deficit nowadays.
Could you elaborate a little more on this?
In 2010, according to the Economic Report of the President, as many as 800,000 jobs were created, and the government’s excess spending was $1.4trillion, which when divided by 800,000 yields 1.7 million. In other words, the US government spent $1.7 million to generate one job. The economy improved in 2011, providing work to 1.1 million people for the same expense. So dividing $1.4 trillion by the new figure yields $1.3 million, which is now the cost of creating one job. Thus, the average federal deficit or cost per job over the past two years has been $1.5 million.
Is it prudent to be wasting precious resources like this?
I don’t think so. The trillion dollar question is this: where is it all going, when the annual American average wage is no higher than $50,000? Obviously, it must be going to the so-called 1% group or what the Republican Party calls the job creators, i.e., the CEOs and other executives of large corporations.
Could you explain that?
Let us see how the main culprit for the mushrooming incomes of business magnates is the government itself. This is how the process works and has been working since 1981. The CEO forces his employees to work very hard while paying them low wages; this hard work sharply raises production or supply of goods and services, but with stagnant wages, consumer demand falls short of growing supply. This then leads to overproduction and threatens layoffs, which in turn threatens the re-election chances of politicians. They then respond with a massive rise in government spending or huge tax cuts, so that total demand for goods and services rises to the level of increased supply. As a result, either those layoffs are averted or the unemployed are gradually called back to work. This way, the CEO is able to sell his entire output and reap giant profits in the process, because wages are dwindling or stagnant even as business revenue soars. In the absence of excess government spending, companies would be stuck with unsold goods and could even suffer losses. In other words, almost the entire federal deficit ends up in the pockets of business executives. With such a vast wastage of resources, the economy has to falter once again, and I think the second half of 2012 will be just as bad as 2008. The Fed will then revive Quantitative Easing III, but it will not help.
What about the entire concept of paper money?
Paper money is here to stay, but in the near future there will be some kind of gold standard as well, so that money will be partially backed the government’s holding of gold. This way there will be a restraint on the government’s ability to print money.
Any long term investment ideas for our readers? Are you gold bull?
Gold and silver may still be a good investment for 2012, but not for the rest of the decade. However, if there is excessive violence, then the precious metals could shine for a lot longer. I used to be very bullish on gold, but with the metal having appreciated so much already, I am now on the side of caution.
(A shorter version of this interview was pubished in the Daily News and Analysis (DNA) on May 7,2012. Vivek Kaul is a writer and can be reached at [email protected])