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The Great Unwinding

Easy & cheap money isn’t there anymore & what follows will reset the balance disturbed by the excess cash

Finally, Warren Buffett is scared. Perhaps you should be too. Fifteen months after start of the global credit crisis (which we innocently used to call the US sub-prime crisis in the olden days), the legendary investor has declared that he has never seen so much economic fear in his life. He has likened the crisis to an economic Pearl Harbour and said that if things don't improve, he'll "have to go back to delivering newspapers."

Just last week I'd mentioned how the crisis had left Buffett as a sort of a last man standing on Wall Street and how the crisis had proven the wisdom of what he used to say about financial derivatives and the kind of behaviour they presented. 'Financial weapons of mass destruction,' was his description. Interestingly, while Buffett's words sound more alarming, his actions have indicated hope. He has put down a large amount of cash (about eight billion dollars) to buy major stakes in Goldman Sachs and General Electric.

During this past few weeks, the scale of this crisis has become quite clear. As I'd written two weeks ago, the world has seen easy credit being available for many years, and now the cycle is threatening to reverse itself. Till a few days ago there was a naïve hope that the problem was caused by major global institutions not trusting the quality of assets on each others books. All that was needed was someone like the US government to underwrite the bad assets on these institutions' books and all would be fine.

These simple hopes have now disappeared. It is clear that the great unwinding is upon us. In many ways, what follows will just reset a balance that has been disturbed by the surfeit of money that the world's economy has seen for about five or six years. The easy and cheap money has been used in all sorts of ways from setting up new factories and infrastructure to buying over-priced stocks and real estate. A cycle of asset price inflation came into being in which the only logic for prices to go up further was that they were going up and there was cheap money available to drive them up. That money is gone now.

What exactly do I mean by 'the great unwinding'? Take the example of share prices in India. Almost all the foreign funds that have been driving up the markets are heavily leveraged. Someone has 10 million dollars and they borrow 10 or 20 times on that basis and then bring in the hundred or two hundred million dollars to invest. This could be happening in the hands of the actual fund that invests on Dalal Street or in the hands of that funds' investor but that doesn't matter now. The 10 or 20 times will now be brought down to a much lower ratio. In a different way, the story of the Indian real estate market is also the same. Unfortunately, the story is also the same on many people's credit card statements. Debt fuelled a buying binge, and now debt is suddenly a four-letter word.

But that's the bad news. The good news lies in the actions (not the words) of people like Buffett. The time to buy assets at bargain prices are coming. In the long run, the fortunes will be made not by those who invested in the recent past, but those who will invest in the times to come.