On the Critical Role of Credit Growth in Markets and Economies, Emerging Markets and Ayurvedic Life Style Recommendations – Part V!

From: aditya rana
Date: Sat, Feb 15, 2014 at 1:59 PM
Subject: On the Critical Role of Credit Growth in Markets and Economies, Emerging Markets and Ayurvedic Life Style Recommendations – Part V!


With 2014 unfolding to be a volatile year in terms of market movements, it is helpful to get a big picture insight into which factor ultimately drives markets and economic growth – i.e. the growth or the destruction of credit. Bill Gross, CIO of PIMCO, in his recent monthly note highlights (with his inimitable use of allegories!) the central role of credit in financial markets and the real economy and the potentially negative impact of a slowdown in its growth (http://www.pimco.com/EN/Insights/Pages/Most-Medieval.aspx) . To summarise:

-There exist a plethora of valuation yardsticks which investors use to value securities and other assets like real estate – "natural" interest rates, P/E ratios, cap rates, risk premiums and real estate’s "location, location, location". Many of them have a solid foundation in academia and even common sense.

-Add to these the emotional influence of human nature, and we can partially explain "why" prices fluctuate up and down but not necessarily "when" they are likely to do so.

-Asset prices depend on the growth of credit, and an expansion of credit leads to higher prices and vice versa a slowdown in credit leads to softer prices.

-Credit includes money in all its multiple forms – cash, bonds, stocks, and even real estate which can be securitized – i.e. an asset which can be wire transferred from one account to another and ultimately be used for spending money. Credit is really what drives changes in P/E ratios, risk premiums and natural interest rates – but most investors do not fully appreciate this linkage.

-To help understand this imagine an island with only two people, who each occupy half the island to grow crops and own four pigs each for the meat. One day, one of them discovers a new crop which the other person also wants – so he negotiates to buy the crop’s next year’s harvest for 1 pig implying that the crop is trading at a P/E of 1* pig. Later on, the person wants to buy more of the crop but the seller will only settle for 3 pigs – making the P/E now 3*pigs. This works fine until more demand cannot be met as there are no more pigs (i.e. credit) and the process grinds to a halt and the price of the crop crashes to zero as there is no demand for it.

-The amount of credit and its supply is critical to asset prices which are in turn critical for economic growth. The modern fiat/credit/debt based economy depends on credit growth for its well being – and credit needs to be circulated and traded ("velocity") to keep it going.

-Currently, the U.S. has $57 trillion of credit (not including stocks-see graph below) which was growing at 8-10% during the pre-crisis period, but is currently only growing at 3-4%, barely enough to sustain GDP growth at a similar level.

-The main reason behind this slowdown is the reduction in the federal deficit from $1 trillion in 2009-2010 (which added 2% to credit growth) to $600 billion today. The fall in the growth of government credit has not been replaced by the private sector need to borrow and invest.

-The relationship between credit growth and GDP is not a one-for-one relationship as "velocity" of credit matters – which is affected by interest rates and the price of credit (the classical monetary equation MV=GDP should be really be seen as Credit*Velocity = GDP). With QE tapering, and higher rates, velocity will be negatively impacted.

-The implications of slowing credit growth and velocity are lower growth than what is currently forecasted, and deflation may rear its head again. In such an environment, high quality bonds will do well and risk assets will underperform. Caution is therefore warranted – "don’t be a pig" in today’s highly levered markets!.

A delightfully simple, yet deeply insightful, note on the key role of credit in today’s markets – both financial and the real economy. Ray Dalio made the same key point in a video which I had summarised a few months ago. With slowing credit growth, global markets (and the economy) are at risk. While I agree with the basic linkage, I do not believe the central banks are ready to take away the "punch bowl" yet – while the Fed is likely to continue its slow tapering, the process is not irreversible if markets (and the economy) go into a swoon (in market parlance the global central bank "put" still exists albeit with perhaps a lower "strike" price). The key event to watch out for going forward is what action the ECB takes to replenish its declining assets and the likely announcement of a banking union (possibly in March?). So remain cautiously bullish, lightening up when markets get ahead of themselves and adding on dips – and stay well diversified!

Regarding emerging markets, the recent turmoil is yet another temporary bout of pessimism which has been occurring periodically over the last three years (see graph below), and will perhaps continue for a while longer.

However, improving growth in the U.S. is likely to have a positive impact on EM economies (see graph below) , supporting the "buy on dips and lighten up on rallies" strategy for EM assets which has worked quite well over the last few years.


-Monitor the "risk-on, risk-off" sentiment carefully as exhibited by the VIX (market implied volatility) index – which is highly correlated with flows to EM markets.

Capital flows to emerging markets and risk/uncertainty

Notes: Data on private capital flows from IMF’s IFS database, Dec. 2013. Capital flows are private financial flows to emerging markets and developing economies. Volatility index measured by the Chicago Board’s VIX or VXO at end of period. 2013 data are estimates.

Lastly, watch for signs of the Fed signaling a change in its rates policy (Q4, 2014?) which will impact markets and capital flows globally (see graph below).

Capital flows to emerging markets and US interest rates

Notes: Data on private capital flows and policy rates from IMF’s IFS database, Dec. 2013 version. Capital flows are private financial flows to emerging markets and developing economices. Policy rates measured at end of period. Data for 2013 are estimates.

Ayurvedic Life Style Recommendations – Part V (Dr. Vasant Lad):

Ayurveda lays great emphasis on maintaining an appropriate lifestyle as a means to enjoying a long and mainly disease free life. Dr. Vasant Lad, a former professor of Ayurveda medicine at Pune University in India, is credited with being one of the pioneers in bringing Ayurveda to the U.S. by founding the non-profit Ayurvedic Institute in New Mexico in 1984 (http://www.ayurveda.com/). He has written numerous books on Ayurveda, and also writes on health in a quarterly publication produced by the Ayurvedic Institute. This is final part of a serialisation of a note he wrote a few years ago on the Ayurvedic recommendations on lifestyle:

Kapha pacifying lifestyle:

-Kapha people should avoid fatty fried foods and meat, and too much oil in their food (small amounts of ghee, mustard oil, olive oil are fine). They should also minimize wheat, dairy, avocado, bananas, lemons, plums and salt.

-Good fruits for khapa include apple, apricot, berries, cherries and pomegranates. The best vegetables are asparagus, cooked beets, bitter gourd, broccoli, cabbage, cooked carrots, leafy greens, okra and potato.

-Suitable grains for khapa are barely, corn, millet and buckwheat and most legumes are good. Clear vegetable soups, and spices like turmeric, cumin, pepper, asafetida, clove, onion, ginger and mustard are good for khapa.

-Khapa types often do emotional eating, and should not eat between meals and avoid overeating, iced drinks, and sweets such as candies, cookies and chocolate.

-Khapa people often get a thick, white coating on their tongue, so tongue scraping is essential for them, followed by ginger tea. Large amounts of mucous is usually associated with increased khapa dosha, so nasal irrigation with warm salt water (and lubricating nasal passages with warm ghee applied by the index finger before bedtime) can be very beneficial.

-Khapa people can get slow, sluggish and sticky bowels so they should take a teaspoon of triphala (classic ayurvedic formulation of three fruits) powder every night before bedtime and drink a cup of hot water with lime juice, honey and a tsp of cider vinegar in the morning.

-It is difficult for most khapa people to rise early, so they should eat a light and early dinner and try to rise by 5am. They should do at least half an hour of vigorous yoga in the morning, followed by specific yogic breathing exercises and meditation. They should not sleep during daytime which slows down the metabolism and add to weight problems.

-Brisk walking and vigorous exercise are good for reducing excess khapa, and they can engage in running or jogging. They should also do a self-massage for 10 minutes before bathing, focusing on the parts of the body which store excess fat.

Ayurveda believes that proper food and lifestyle are the best medicine for good health, and following appropriate lifestyle recommendations (as described above) will balance the doshas and result in healing and a sense of well being.


Apologies for the month long hiatus from the newsletters – but moving houses and the Chinese New Year break intervened! Wishing my readers a happy, prosperous and healthy Year of the Horse!




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