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An Ocean of Money

The near-zero interest rates in the U.S. may have an unwelcome impact on Indian stock markets

This is the editorial that accompanied the Mutual Fund Insight magazine's November 15-December 14, 2009 issue that points out the dangers that the U.S. Federal Reserve is posing with its loose money policy.

The huge amount of money that the U.S. government is bringing into the world is a problem, and this is something that is being recognised more and more widely. Last week, China’s chief banking regulator made an uncharacteristically blunt statement in this regard. He said, “The continuous depreciation in the dollar, and the U.S. government’s indication that, in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12-to-18 months, has led to massive dollar arbitrage speculation,” and that this had “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

This statement was in response to the U.S. Federal Reserve making clear recently that the interest rates in that country will remain at almost zero levels for the foreseeable future, perhaps as long as for two years. What the Chinese official (and many others) are scared off is that the massive amount of money that is being poured into the U.S. economy is making its way around the world into all kinds of assets, from commodities, to real estate, to stocks. This asset price inflation is leading to a vicious circle of easy money, rampant speculation and higher prices. In short, generically, this is the same sort of a problem that led to the crash from which we are still trying to recover. 

Should we be worried about this in India? Our stock markets have doubled in about eight months, a rate of increase that has never been seen except, briefly, during the strange days of 1991 and 1992. Yet, there is a pervasive belief that this change is justified because of the way the economy has recovered from last year’s crisis. However, no matter what may have happened in the economy, or with corporate results, the last cause for this tremendous rise in stock prices is liquidity. There’s as much evidence of a glut of money in India as outside. Look at the evidence in mutual funds’ assets under management (AUM) data. The AUM of debt funds at the shorter end is now Rs 5.4 lakh crore, up from Rs 2.7 lakh crore at the depth of the crisis in November, 2008 and much higher than the Rs 3 lakh crore that it was in November, 2007, when things were just fine. It’s clear that there’s a great deal of money sloshing around in the Indian economy too, and not many places for it to be productively put to use.

Globally, just as in India, the asset price inflation that people are referring to is not limited to just stocks. Gold and oil are in a tearing hurry to rise too and, in many parts of the world, real estate has resumed its upward journey. If these were the heady days of 2007, then our attitude would have been different, but then, these are not. This is the morning-after of the world economy’s darkest night in a generation and it isn’t difficult to see what’s happening.

However, for the individual investor, defining this problem doesn’t automatically point to a solution. It’s easy to say that here’s a bubble so don’t get caught up in it, but it’s also useful to take advantage of asset price inflation while staying wary of its worse excesses.