Nasty Euro (Part IV) - Will Game Theory help to solve Eurozone crisis?

Just a few weeks back, the media was full of news of energetic Sarkovsky and enigmatic Merkel meeting together couple of times in a month and admonishing Greece. But now, both are at logger heads.

Whilst Germany (Merkel) supports Austerity Measures as the way out of crisis of Italy, Greece and other Eurozone countries, including France, who is most affected by Italy and Greece. France disagrees. They believe ECB must support these countries with European version of Quantitative Easing.

The result is there is stalemate, resulting in strong rumours and speculation that the time of Euro is over -it is just  a matter of time the modern "Continental System" of Euro collapses.

Let us see whether Game theory (a mathematical method for analyzing a person’s success based upon the choices of others) can help to find some solutions. It is reputed that Gordon Brown of UK used Game Theory to solve some of the problems, when he was heading the Finance of UK, during the premier ship of Tony Blair.


For those, who are not familiar with the theory of Game theory, let us explain with an example. One of the canonical examples of Game theory is called “ The prisoner’s dilemma”. This shows why two individuals might not follow the most logical action, even if it appears that it is in their best interest to do so. The example of the prisoner's dilemma is given below:

Problem: Two stupid men are arrested for some crime that will put them in jail for 1 year as maximum prison term. But the police do not possess enough evidence to convict them. After separating two men, the police offer both a similar deal- if one testifies against his partner (assists police), and the other remains silent, the testifier goes free and the other receives the full one-year sentence. If both remain silent, both are sentenced to only one month in jail for a minor charge. If each acts stupid, each receives a full 1 year sentence. Each prisoner has following choices (i) either to assist police or (ii) remain silent. What should they do?

The beauty of Game Theory problems are that it is not mathematical. There is no mathematical accuracy in the answer. This is the sort of decisions finance managers and economists face.

Coming back to the problem, each player is concerned with lessening his time in jail. There is a chance that they would want the other to get maximum prison term, both will testify against one another and the result is maximum sentence for both. If they help each other, taking others interest also into account, they will get only one month each, as police don’t have the evidence. In the game, if the sole worry of the prisoners seems to be increasing his own reward (i.e. selfish/egoistic), then they would get one year each. The interesting aspect of this problem is that the logical decision leads both to betray the other resulting in maximum prison terms. While illogical decision not to pursue own interest (of going free) would result in maximum common benefit (both gets just one month prison term) and hence the best choice for both

Applying the above situation to the Eurozone, France and Germany has following options:

Option 1 – Both Germany and France agree to implement some austerity and ECB involvement.

Option 2 – France is forced to go in with German policy

Option 3 – Germany is forced to toe French policy

Option 4 – No agreement between France and Germany. At the time of writing of this article, (21 Nov 2011), both has adopted Option 4.

Using the basics of game theory, the pain of both France and Germany and Eurozone at large will be solved by following the Option 1. All other options involve maximum prison sentences! i.e. Eurozone recession, unemployment, losses for companies and hence to banks, lack of business confidence, lower tax revenues, etc. would be some of the symptoms of this punishment.

Foolish Rate Hike (Part II)

On 26 Nov 2006, a few terrorists landed in a boat in Mumbai and began to attack the economic centres with an aim to bring havoc to Indian economy. They shot down business leaders and foreigners in historical Taj Hotel of Mumbai and a few other five star hotels, besides running amok in the City shooting and killing. They hoped that this will do damage to Indian economy, reduce its growth by scaring away foreign investors and dreamt about loss making Indian companies and a disillusioned population, amongst others.

India brushed aside this incident and marched ahead.

However, what terrorists could not accomplish RBI has achieved!

India once became tantalizingly close to 10% growth p.a. However, RBI beat Don Quixote (who found wind mills extremely dangerous fighters!) in seeing a monstrous threat in single digit inflation level and began to adopt such drastic measures that appeased those who were envious of India’s growth. The leadership of RBI must be able to think independently like Mr. Reddy did when he said no to the aggressive lobbying to allow funny credit derivatives in India.

Why was RBI in a hurry to raise interest rates to beat inflation, when the inflation was mostly caused by oil price hikes? It was evident that blindly copying text books don’t help. As Financial Thoughts highlighted last month, India needs more supplies – just by choking demand, the RBI kills the economy. And it seems that it is almost happening.

The recent economic data shows that the industry production is the lowest in the recent past. Who will go for expansion when the interest rates are uneconomically high and no feasible business transactions is possible? The result is that as expansions are curtailed, there are lots of signals of CAPEX declining. Capital goods production number within the recent IIP was negative 6.8%. As investments in the economy drop, the accelerator and multiplier effect works against the economy. Economic activities drop or dry up. Result is the sharp drop in turnover and profits while interest burden increases. No wonder many companies reported losses in the last quarter (Terrorists who hate India must sent a Thank You note to RBI).

Many say by next quarter, the banks will have higher NPA and the banks shares could drop. Not only that the banks will get scared and reduce lending. That could send the economy into another downward spiral (Well, Terrorists who hate India must sent another Thank You note to RBI)

Add to RBI’s fight against some imaginary hyperinflation, we have one of the most inefficient and corrupt government at the Centre. (When Vajpayee Govt. came to power, for the first time they identified the need for modern roads in India. If you drive at 100km p/h in three or four lane roads in North India, you must remember gratefully Mr. Vajpayee for his vision of linking the corridors through highways. This unleashed lot of investments, CAPEX and filled the pockets of millions of Indians resulting in an economic jump start that catapulted India into high growth from the so called low Hindu growth rate).

All governments that ruled India for more than 64 years (post- British Raj) are answerable to this - their record is just slightly better than British Raj. The Raj also brought in railways, telecommunications, electricity, etc. However, they governed India for their benefit and their Indian associates. Similarly, the post-independence rulers governed India for their benefit and their associates. That is what evident in the corruption and the corrupt politicians have enough connections to walk away with the ill-gotten wealth. British Raj shifted the most of the Indian wealth back to their country, while a bulk of the post-independent India’s wealth is being shifted to Swiss banks and other secret accounts. Although there is cry in India to bring back the wealth, it won’t happen because the ‘fox is the watchman over the pen (i.e. hen house)’.

One of the chief reasons for inflation and declining growth is the Government inertia. Plenty of of projects are being stalled by government departments or denied environment clearance or land acquisition issues and so forth. It saps the energy of Indian entrepreneurs and it impacts the economy.

What no one speaks is the Indian unemployment (already it is more than 20%-25%). The slowdown in the growth results in lesser opportunities. Frustrated youth will get more frustrated! But most of them will blame it on their unknown crimes of the past birth for this life’s troubles!. That is the Indian philosophy. They usually blame their previous birth for the troubles. That is, by the way, a good escape mechanism.

Financial thoughts believe, risking a little inflation and environment is nothing but a calculated risk for India’s growth, well-being of its population by having employment creation, more job opportunities, better price realization for agriculture produce that augur well for its farmers & farm labourers and overall wealth creation.

This means taking the risk of taking some criticism and blame in the foreign media and so called foreign ‘experts’, but Financial Thoughts it is worth taking this risk.

Overall, the situation is not out of totally out of control yet. By initiating steps to reduce the financing costs on borrowers and boosting the economic activity by favourable RBI policies (including immediate slashing of rates) and speedier action by Govt., Indian can still retain its 7.7% growth for current fiscal and ensure growth rates above 8% going forward.

Let us hope for the best!

Or let us emulate French Gunners (French Artillery was best in Europe those days) at Waterloo battle when Napoleon’s stupid decisions ensured that the battle was slipping away from them. Unable to do anything else, history records that that the French Gunners wept!!

Nasty Experiment Called Euro (Part III)

Financial thoughts have been warning about the fundamental weaknesses of Euro creation and the problems it causes to Eurozone and rest of the world. It seems that after Napoleonic Continental System introduced in Europe in early 1800s, Euro is the most unstable, inconsistent and unsustainable proposition Europe has seen.

Under the burden on unbearable terms of Continental System, Russia broke away from  the system in 1810, triggering a massive war that has not seen by the world till then. The war achieved a reverse result. Russia seemed weak and was about to get defeated by Napoleon's aggressiveness, instead the passive strategy of Russia paid off in the end.

In the new gamble of Euro, the Russia's role is taken by Greece, who - just like Russia in 1810- cannot bear the terms of agreement of Euro. Like Russia it has no other option but to break the agreement. In 1810 it brought about the wrath of Napoleon on Russia.

From 2010 onwards, Greece is playing Russia’s role of 1810. Recently in late October 2011, Germany and France led a marathon meeting once again that last about 11 hours. One of the results was the announcement of a package for Greece. Instead of agreeing to it, the Greek prime minister put it for referendum, attracting the wrath of France & Germany. This time, Europe does not have a single, mighty, powerful genius like Napoleon, but has several midgets making it for him. They are turning the anger on Greece!

Two hundred years back, it would have been seen by the world that a meek Russia is about to baulk down at the pressure of mighty Napoleon. However by early 1813, it was evident that the glory and mighty days of Napoleon was over as the white winter licked him while Russia stood battered but intact! In the same manner, it may appear now that meek Greece would bow down and the Eurozone powers will bask in glory. But as the currency unsettling battle is emerging in the Eurozone with major European powers try to kick Greece into economic humiliation , little do they realise that it could be the tame end of another 'Continental (currency) System' much like Napoleon’s grand inconsistent and unstable Continental System.

Inconsistencies of Euro are many and well written – i.e. (1) monetary union without political union does not provide any cohesiveness, but a nightmare (2) it is just ludicrous that Eurozone has one currency but different states have to borrow at different rates. Whilst Germany borrows at low rates, Spain and Italy have to pay high interest rates. (Just imagine what it would be like if Delhi state of India borrow at low rates while West Bengal is forced to pay high interest rates). (3) Eurozone has one single currency but has several states with different credit ratings. So, how do you decide currency rating level – someone told me that Euro has mainly replaced Duetshe Mark and hence, one need to look at Germany. Is that true? (4) Why does Germany and France take major role in talking about Euro, what about the rest of the 20-odd states that is supposed to be part of Euro. Is there a class system in action?

Well some of the inconsistencies may not appear immaterial, however no one can deny that there some strong inconsistencies do persist!!

Hold your breath – as the financial markets of the world will go for a tailspin as modern “Continental System’ is preparing itself to break up. Do take a hard-look at your portfolios and decide - this black swan may decide to appear sometime in the near to not so distant future!

Another Foolish Rate Hike?

For the 14th time, since Mar 2010, Reserve Bank of India (RBI) is likely to raise interest rates again on Tuesday.

That could be a record on rate hikes!!

The purpose of all these rate hikes is to curtail inflation, especially food inflation. However, the recent inflation figures show that the overall inflation, especially the food inflation remains high at 10% or slightly higher.

Evidently, the rate hikes are not working. But it seems that RBI is bent upon doing the same thing again and again to reduce inflation (Someone told sometime back that one of the symptoms of lunacy is doing the same thing again and again and expect a different outcome!)

Financial Thoughts view India's inflationary scenario differently as follows:

1) Interest rate hikes + Petroleum product (diesel, etc.) prices will ultimately drive up the cost of production at farm level.

2) The food prices in India are lowest among the world. That means the farm profitability in India ought to be among the worst in the world. No wonder many farmers in Andhra Pradesh decided recently to leave their farm uncultivated. If you travel through the picturesque Kuttanad region of Kerala state you can see hectares after hectares of agriculture land uncultivated, just because it is no longer profitable.

3) A recent article on rice exports has shown that the rice from India is the cheapest in the world. (http://gulfnews.com/business/economy/indian-rice-exports-will-rise-as-floods-cut-thai-supplies-1.903088). This implies two issues (i) there is potential to charge more (ii) if the profitability of the uncultivated farm lands are ensured, the supply would increase, partly contributing to the Supply in the Indian economy which would ease inflationary pressures

4) Those who support further indiscriminate rate hikes must go back to US in 2006 when US Fed was blindly hiking the rates in pursuit of a mirage, which achieved nothing but a fantastic economic collapse in 2008

5) The solution for the inflation in India is increase the Supply side. A booming India has insatiable demand for more vehicles, better food, better & new road networks, travel facilities, more air ports, better ports, more metro railways, and other infrastructure facilities. But the mind boggling corruption at the high places is stifling the Supply side. Billions worth of infrastructure projects are not yet approved or actioned by several government (both central / state) levels either fearful of intrusive media/investigation agencies by honest officials or just because the dishonest ones negotiate better bribes as there seems to a rapid inflation in bribe rates as well.

As Infosys Chairman Mr Moorthy mentioned, after all it may be better to legalise corruption in one way or other - as some of the western countries legalised prostitution!

6) Let the food prices increase and let it stabilise at a higher level (than current levels) so that the farming becomes a highly profitable venture so that the teeming millions of India can turn to farming, instead of turning away from it and migrate to cities, which in turn chokes them and create infrastructure nightmares.

Based on the news and information, it appears that the rate hike is highly likely. That could trigger a stock market correction. Hence, I am going to take protection for my portfolio through some cheap puts and preparing to buy selectively as the market crash could possibly offer some good stocks at deep discounts.

Happy investing! 

Another proof that Warren Buffet is the Most Intelligent investor !!

In 1934, Ben Graham has written one of the best investment books “Intelligent Investor” and a very wise and intelligent investor read it at the age of 19. The reader of the book (who till then tried his luck with charts and technical analysis) understood the value of the book and complied with the principles religiously. And he became the most intelligent investor in today’s world and currently enjoys position as the second richest person in the world.

Almost every investor ought to know this person - None other than investing genius Warren E Buffett.

Now he asks American rich to give back some of their wealth to the government so that it can balance itself while walking on the tight rope of fiscal balance. US deficits are so high that it can topple the fiscal balance and drive its economy deep into recession and stagnation over the next decade.

Warren Buffett supports taxing the rich and knows a lot about becoming wealthy.

BUT most of the American rich class refuses to do this. The stupid rich who refuses to help their own Nation at this moment of crisis lacks the intelligence of Warren Buffet due to the following reasons:

1. Rich can become richer only in a growing economy. Hence, by paying more taxes and saving the US economy, the rich is helping themselves. A decade of recession doesn’t benefit anyone, including the Rich. Whatever tax they pay now, can be recouped easily through higher profits from their businesses and increasing asset values. Warren Buffet knows this.

2. China growth during the last decade averaged about 9%-10% and even if it slows down (as desired by some myopic western economists), it will easily clock a growth rate of 8% while US economy will face recession. This will accelerate the takeover of No1 slot by China as the wealthiest (& largest) economy in the world. The humiliation of China overtaking the American pride as the No 1 economy will add salt to the injury. Let rich US American be greedy and stingy and cling on to their wealth as their own Nation’s pride goes down the drain.

3. Some writers speak about Warren Buffet being stingy and miserly. I don’t think so. (His middle class attitude gave him robust health and balanced approach to life that helps him to think on his feet. This attitude is comparable to Ben Franklin). On the other hand the rich class of the US who doesn’t want to help the US Govt by agreeing to more tax to reduce the debt burden of the Nation is the real miserly and misery lot.

4. Well, if the statistics provided in the recent press is correct, the poor class in the US is the fastest growing in the world. With the next possible recession in the US, the poor class in the US would rapidly rise and you can see sorrowful souls in soup kitchens burgeoning. Don’t know how the rich class in the US with see this – possibly the villain character (i.e. Scrooge) in Charles Dickens novel 'Christmas Carol', would look a gentleman compared to them.

By refusing to go by the most intelligent investor Warren Buffet’s advice, the rich class of the US is helping China, torpedoes their own future wealth and proves Mr. Scrooge is better than them.

US Economic sluggishess = 1990 Japan. World economy will grow, as in 1990s

Recently, Fed came out with the most funny statement that meant there is 'significant risk' to global economy. Are they still think too much of themselves?!. Of course, US could follow Japan of 1990s thanks to the stupidity of US Fed leadership, but the world won't follow the recession of US.

World will brush aside US just as the economic sluggishness of Japan - then the 2nd largest economy - was ignored by the world. Nikkei Index crashed during 1990s from 20000 to 8000. But during this period US Dow and SPY recorded sharp increase. So did the European indices. So, going forward, you will see corrections in stock indices of US, but Emerging Markets - especially China and India - will march ahead. And of course, those US companies with global reach and focus on these markets could also do well.

Soon US will become the SECOND largest economy in the world as China claims No 1 slot. Already they are ahead of US in many fronts. e.g the largest car market is in China now, the largest number of new millionaires. There are many who wants to see China to go down economic recession route along with US just because they export to US. But China is moving into their untapped potential of huge population with increasing wealth. China will never enter the recession zone! on the other hand it will continue to grow

On the heels is India, which will topple Japan as the third largest economy during this year or early next year. India's growth momentum is unstoppable and they do not have any significant exposure to US except IT. Hence, they are very safe in today's global economic environment.

Both China and India will benefit from reducing commodity prices.

Hence, even if US hits recession zone, these two giant economies will act as the counter balance.

Don't worry , be happy and enjoy the Discount Season in the stock markets!

Clash of Financial Titans

It is almost two months since this blog has been updated. The reason is that I was on vacation and had several other issues to be tackled including a possible shift in career. However, financial thoughts never left me because the last two months were really crazy. Major financial events were:


1. Fear of USA defaulting on its debt as the President and Congress quarreled on debt ceiling. Once again, after the disputed election of George Bush, it proven again that USA is not far from becoming a 'banana' republic.

2. Downgrade of USA by S&P and its consequences. Whilst the person who showed the courage to downgrade USA (which I believe is apt given their debt burden) has lost his position (of course USA does not use coercion!) the world financial markets went for a topspin. I made the opportunity to make some long term investments in affordable quantities of some good companies. Warren Buffet makes jokes of folks pursuing diversification as an investment strategy and states that diversification is required by ignorant investors. Well I have to admit that I am one of those ignorant ones and given the kind of corporate governance these days, I have no courage to make concentrated investments. In fact, I revisited my investment portfolio and reduced the certain investments, which I felt suffered from concentration risk.

3. Fear of Greece default and its consequences on French and German banks. British, as has been consistent with their historical record, is adept in keeping distance from the continents problems until dragged on to it, is proudly claiming that their banks are immune from the catastrophe that will hit the banks in the continent. However, this confidence may be misplaced as the 'liquidity winter and freeze' that will hit the European Banking & Financial Sector should Greece default (= 2xLehman?). It will blow cold chills winds into the British Isles as well, which will force them to act. Although not in financial front, this happened during Napoleonic times, First World War and Second World War. (During my recent visit to UK, the woes of economic crisis were visible almost everywhere, which recently culminated in riots. It is a wonder how this Small Island commands respectable position in the world. It seems that the nations prayer "God Save the Queen/King' is being answered through generations)

During my vacation, as I focused the thoughts on the financial safety of my investments, the near future outlook offers no comfort. Threats of double dip in US, weak Eurozone, possible collapse of Euro, slowing Indian & Chinese growth, are major challenges. All started with the fall of US real estate market in 2007, which is caused by Ben Bernanke’s "Himalayan Blunder" of fast interest rate hikes. Allan Greenspan open the doors of Real Estate boom with low interest rates and Ben crashed it with higher rates. A handful, mainly hedge funds, FIs, HNWIs,etc made tons of money (but many and the most of the retail investors lost) when the real estate crashed. Whilst banks and institutions who lost money were supported by Govt (bail outs) whose senior management continue to enjoys bonuses, the middle class is now being pushed in poor class.. see the latest news of increasing poverty in the US.

I believe there is two schools of thoughts caused this crisis – a clash of Financial Titans ( Thoughts). Allan believed in credit, somewhere I read that he has stated that a person can be born in credit and die on credit if the welfare state looks after his needs like hospital, education, old age, etc. He believed in credit and it is stated that this reflects in the book he authored after retirement from Fed Governor position.

Ben on the other hand is a traditionalist and doesn't like too much credit and hence tried to de-leverage the US economy too soon too fast, resulting in a spectacular crash and made mess of everything. After Lehman crash, confused Ben hurriedly slash the interest rates to all time lows. (May some one ask Ben, why he hiked the interest rates in 2007 in the first place, if only he had to slash it lowest levels in just one year? No wonder there are many who believe US and World would be better if Ben is replaced!!). Remember Ben and his team could even know how the interest rates could impact the economy and wide social fabric- economic mismanagement is evident by all US admin and they are making predictions!!

Some economists say it will take a decade to clear the things up. If so, the stock market may remain sluggish. Hence, I have also decided to give equal emphasis to equity derivatives to make some gains out of it, possibly through some option condors.