Here is a little discussion I had with an ex-student who wanted to understand his future by posing these questions to me:
With about $2 trillion from banks lying with the Fed and with no quick end to QE in sight, why are people so hopeful of an end to the commodity bull run--especially of gold? Large amounts of money has been created which can do one of the following things:
1. Do nothing
2. Create domestic credit
3. Create international credit
It seems that almost 80 per cent of the newly minted money is with option 1, which should be equal to a significant portion of the total tradeable emerging market debt.
Now either this money is always going to do nothing, or it will at some time in future switch to option 2 or option 3. I am not sure what the global growth rate would need to be to absorb this money without triggering significant inflation. Whatever it is, if the US growth rate is not a significant contributor of this global growth, it should lead to devaluation of USD, and consequently appreciation of prices of all commodities priced in USD including gold. At present the US story is being re-built around energy (commodity) export which is clearly a level below its usual technology leadership story.
What other implications of such a massive paper build-up could there be apart from the possible impact on commodity prices?
It is a game of 'chicken'...you remember Aamir Khan running up towards a train, just to get off in time; if you get off the tracks too early, you lose the girl...if you leave it too late, you get run over by the train!
Before the Velocity of Money goes back (it used to be 5, now I think it is down to 1.7), the Fed will have to start shrinking its balance sheet. Yes, this will show up in inflation; it has already shown up in asset inflation, which is why the markets were behaving like spoilt children at the very thought of 'tapering'. The S&P hit a historic high, the moment people started to believe that tapering will not kick in till 2014. When it shows up in product inflation, Yellen will really have to brake hard....or the US Dollar will tank.
Will she, won't she? You can already see that she is being pushed to delay leaving the tracks longer and longer...till one day, she might be hit by the train.
The dollar stockpile in the Fed balance sheet will reverse if and when the US Budget goes into surplus for many years (which can only happen with growth), the US govt buys off the Fed assets and then holds them to maturity. Otherwise, we will see inflation when the velocity of money starts to go up. Take your pick....
Low growth is a given, unless there is some technological revolution that changes the world (probably energy).
How do you see the evolution of technology in the energy sector? You talked about a possible game changer coming from this field. What in your opinion are strong contenders?
Lots of them are contenders, but solar (with some huge improvements in battery, other energy storage and the ability to shift energy production from daylight to night)...these are huge game changers. These technologies are not very far.....solar plants that melt salt (at 650OC) and then allow it to cool back...to store energy. Or pumps that take water to a height and then bring it down in the night.....or giant capacitors and chemical “stores”...et al.
Or smart grids that know how to switch from one source to the other, like in Germany. Another 10 years, and the real cost of energy will go to zero, like in case of communications this last 2 decades. And then world poverty will drop like a stone. Prepare for a post-industrial (and agricultural) world; if you can find work after that, the world is at your feet. The key will not be the cost of things, but how do you find the (little) money to buy them, i.e. where are the jobs?
I don't understand what you mean by the statement 'another 10 years, and the real cost of energy will go to zero, like in case of communications this last 2 decades.'
In 1979, when my father's monthly salary was Rs 7,000, phone calls in Kolkata used to cost Rs 3 per minute, the “call completion rate' (i.e. the number of calls that got through over the number of calls that were attempted) was 43 per cent, and phone rents were Rs 180 per month. The P&T department used to make a profit of Rs 700 crore, a chunk of the government's revenue surplus.
Think of the real value of Rs 700 crore in a world where the Head of Personnel of a good company got a salary of Rs 7,000 per month.
My last monthly salary was Rs 7 lakh, i.e., 100 times my father's salary (32 years later), and the typical phone call cost Rs 0.3 per minute, one-tenth the cost my father paid. I have 7 phones in a family of 4, no landlines though. Total phone bills are about Rs 5,000 per month, Rs 700 average per phone. I don't know how much time is spent on the phone, and how many calls are made.
Trunk calls used to cost Rs 7 per minute and had to be booked in advance. Today, STD stands for sexual diseases....
What is the 'real' cost of communications, compared to 1979?
Think of what would happen if the real cost of energy dropped (in current terms) to Rs 500 for your house, and Rs 1,000 for your car. And in similar proportions to the rest of the industrial economy (where 10 per cent of the typical company's cost sheet is energy cost)....
By 2020, we will be down to $30 per barrel of oil equivalent (boe) in energy costs, with just shale oil playing a major role. Grid parity in solar should happen by 2017, and it takes just 9 months to set up a project.
Amara Law: “We always overestimate change in the short run, and under-estimate it in the long run”. By 2025, it will be visible.
What you are saying is a general truth for the entire semiconductor industry...or any industry with an exponential law like Moore's Law. Telecom is just a special case of the entire computing industry...and the energy revolution is also only a special case of the same...Solar PV. If the lessons from this industry over the last 4 decades are anything to go by, the scale of the revolution is limited as demand seems to grow faster than supply...also in the case of energy...the incident energy is also an absolute limitation. Battery technology unfortunately is not part of an exponential curve.
So I am not really sure how this affects my employment in the short to medium term. Is my contention right?
Yes, I will agree that the “semiconductor” industry has this Moore's Law operating in many parts of the industry. To the extent Solar PV is really “chips” (or binary circuitry, if you like), it will follow Moore's Law.
When improvements in productivity from a technological innovation are evenly (and quickly) distributed across the economy, there is no “differential” effect on GDP, and nobody captures any “value”. That is, when everybody goes from cycles to cars, everybody's productivity goes up the same. It does affect the quality of life materially, but does not show up in the numbers. In the same way, when Moore's Law pushed computer RAMs from 64KB to 512 KB, everybody went up together, so nobody did “better”.
Just when computers first came on the scene, some people with computers would “type on a computer” and give you a print-out for Rs 8 per sheet, when my salary was Rs 50K per month. There was a company selling electronic type-writers.
It won't be like that in the solar revolution. The uses of energy are too many, and value will get captured. While the oil industry will disappear ($ 12 trillion of GDP affected), the explosion in activity that takes place by the users of energy will more than replace that. All agriculture and manufacturing input costs (except labour) will go down to zero, and services industries will be the only thing left. To answer your last question, finding jobs will be difficult, but most of the basic necessities of life will be available at near-zero real costs. The future of jobs is really uncertain; in fact, the future of work is also uncertain. Somewhere in that (future) is written the demise of man...we won't die because of a shortage of food, but because of sheer boredom...suicides because of frayed relationships in a world of social media...loneliness in an over-populated world...the loss of innocence in a knowledge-filled world.This column first appeared in the December 2013 issue of Mutual Fund Insight. The concluding part of the column would appear in the January 2014 issue of the magazine.