Did it ring a bell? Marlon Brando addressing the Chiefs of the 5 families in Godfather. I, couldn't help quoting it, my apologies to Mario Puzo and Copolla. Also couldn't help my mind, which is at Cross roads on non applicability of contemporary Economics on the current Economic situation? George Soros in his theory of reflexivity has said history is a good teacher,hence this effort. By no strech of imagination this should be assumed as an original work. At best it is an assimilation of articles on finance , geo politics and Economics that I have read in the past 10 years. Irrespective of your success or failure in capital markets, the pursuit of knowledge lets you feel that you are putting in some efforts in the process of money making as the investment profession is otherwise viewed as devoid of any effort and is more depended on your equation with lady luck. Be as it may, my effort is open to constructive criticism. I would like to clarify that I prefer the top down approach as against bottom up approach as it is a more concentrated way to investment decisions. I am not against bottom up approach but it requires more flexibility. However I concede the World has become more machiavellian in practice and with an increase in the bank balance at the end of the day , the end justifies the means.
"If finance is a gun, politics is to know when to pull the trigger",if we recall the dialogue in Godfather,where Don Luchessi Speaks to Vincent Mancini on the link of politics and finance. All capital/financial markets have a direct correlation to the political mistakes/successes of the past. As Soros explains in his theory on reflexivity that everything that past is ,is uniquely determined and the future is uncertain.Thus it is easier to explain how the present situation has been reached than it is to predict where it will lead.He adds that history although is uniquely determined is so overcrowded that it would be incomprehensible unless the processes and singular events involved were reduced to manageable numbers.This is possible by the theory of super bubble hypothesis wherein only the events which deserve consideration in history are selected. To put this hypothesis into practice, 3 events and the subsequent periods thereof have been selected which had an extraordinary effect on mankind :-
A) Period Post World Ward II (Period from the year 1939 to 1989) I have briefed certain events which are intertwined, one leading to other.
i) Marshall plan
ii) Bretton Woods System & Establishment of IMF/World Bank
iii) Cold War
iv) Abolishment of Bretton woods system
v) Importance of Oil & Stagflation
vi) Fall of Berlin Wall.
B) Period Post breakup of Berlin Wall (period 1989 to 2001)
C) Period Post attack on the World trade Centre Towers (period from 2001 till date)
World War II we know led to the economic/religious/cultural devastation of all industrial economics except U.S.A. During and even after the war the USA could capitalize on the huge business opportunities that were presented by destruction of Europe/Japan. Also there was a heavy migration of intellectual minds from Europe to USA As if to prove its benevolence, USA introduced the Marshall Plan which was a financial aid for reconstruction of Europe /Japan. Marshall plan was more of a camouflage to repress the communist uprising that was sweeping across eastern European countries due to soviet occupation of this territories and also in countries such as Italy, France and East Germany due to lack of any growth and widespread misery due to war. The plan was a turning point in the world history as it not only ended the British hegemony of being a dominant player in International politics due to it's Colonial Empire but also kick started the industrial engine of Europe more so of West Germany which was the industrial hotbed of Europe. In the long run it was expected that such European /Japanese recovery would benefit USA by widening markets for U.S.A.
The American dominance of the World trade became inevitable on the establishment of the Bretton Woods System that was established in 1945. The chief feature of the Bretton Wood system was an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the US dollar. Also IMF was established which was given the overall responsibility to bridge temporary imbalances of payments among Nations which were prevalent during the depression. The Soviet union did not join IMF which was one of the reasons for the Cold War. Thereafter USA pegged dollar to gold at the price of $35 on ounce and this further led to a regime of fixed exchange rates among the countries. 5 out of 7 oil producing companies in the Gulf were American and they billed their invoices in dollars. Every nation procuring oil from this companies was to pay in dollars. Immediately after the war there was mistrust among countries at war and thus they accepted only dollars against trade done with each other. All this led to a huge demand and hoarding of dollars by countries leading to dollar crunch and the dollar became the reserve currency of the World.
After success over Nazi Germany and their temporary alliance during World War II the USA and USSR became enemies based on their basic ways of life i.e the conflict was between capitalism and socialism coupled with communism. USSR did not allow the countries it controlled/occupied after the war to participate in the Marshall plan. Hence there was complete lack of growth and prosperity among this nations. The Cold war as it was termed was the continuing state of political conflicts, military tensions, proxy wars and economic competition among Soviet union and its allies and USA and its allies. The competition was even extended to technology ,space race and sports.
The post war period with the establishment of United Nations proved to be one of the finest period industrially not only for Europe but the World in general. With prosperity came back trust among the countries, they started accepting their own currencies out of the trade done with each other. The shortage of dollars turned into glut overnight which was termed as Triffin Dilemma. Robert Triffin on recognizing this suggested
a) Either to limit the supply of dollars due to which the peg against the gold can be maintained or
b) Increase the supply of dollars and abandon the peg to the gold.
In the former case it would have led to a severe recession among the countries which had just recovered after the War. As is always the case, the USA chose the later part and kept the money flow going. The major problem was the manner in which USA was to deal with the dollars not being backed by the requisite amount of gold. Finally, in 1971 America unilaterally abandoned the Bretton Woods system and President Nixon announced a New Economic model which temporarily cut the link between gold and dollar. This temporary phenomenon has lasted for four decades till date. In a way it abolished the system of fixed exchange rate to floating rates thereby increasing the uncertainty in International trade. President Nixon also further devalued the dollar by 10% in the hope it would revive American Exports.
In 1959, USA on insistence of local oil companies decided to impose quotas on oil imports from other counties. This imposition of quotas led to establishment of OPEC at the insistence of Venezuela whose major market had been the USA. This also led to a major upswing in the oil consumption by the World as the American policy led to an increase in price in USA but price reduction all over the World. General Gaddafi of Libya with his policies on oil,1967 oil embargo which was a result of six day war between Israel and the middle eastern counties, the end of Bretton Woods system, the Iranian revolution led to the increase in the price of oil from $4 in the year 1969 to $40 per barrel till 1981. This clearly derailed the World economy's growth and brought a phase of inflation due to higher oil price. This effect was termed as stagflation. However as all good things come to an end so did the price of oil for OPEC. Some of the member countries of OPEC decided to cheat and sell in the black market below the quoted price of oil from 1981 to 1985. This then led to the gradual reduction of oil prices and at one point of time the prices reached $14 to a barrel. Some of the oil exporting nations such as Russia could not sustain its military programmes in such type of economic environment with oil at an all time low. All the efforts and the programmes of the cold war were not feasible in such an environment with no accretion to govt. treasury of foreign currency earnings .
The fall of the Berlin Wall was symbolic in nature. It in effect destroyed Soviet control not only over East Germany but also Eastern Europe and thereby USSR conceding to the world that they were defeated in the cold war. It was more as a result of pragmatic approach by Mikhail Gorbachev who had become the General Secretary in 1986 by not sending soviet troops in East Germany to control the uprising as a result of Migration of people from East to West germany .He announced an agenda of economic reforms called Perestroika in 1987 which repealed the production quota system, allowed private ownership of business and paved the way for Economic development .This measures were intended to redirect the country's resources from costly cold war military commitments to more productive areas in the Civilian Sector. However all this was too late for the inevitable. Capitalism had triumphed. (John Meynard Keynes would have smiled in his grave).The theories of Adam Smith of the invisible hand ,way back in the Eighteenth Century to Keynes preaching's of capitalism were proved correct. It would bring about a total shift in the perception of nations on the approach to construction of economic system. It also would bring about in USA an unprecedented growth in the coming decade.
Thus, this period from 1945 to 1989 was a period in which USA proved its complete domination over the world in every field, be it International trade, defence, space programmes , sports, innovation, research etc. Today the USA with its approximately 15 Trillion dollar GDP constitutes 25% of the World GDP of 65 trillion dollars . Every fourth trade in the international Markets is with USA. Every nation in the World exports directly to USA or to countries that export to USA. In my next month's write up, I intend to cover the period from 1989 till date which will cover the period that led to the financial annihilation of USA. Would you believe in 1989 China was not even heard of in financial circles, the word BRIC was not even coined by Jim o Neal
Warm Regards
CA Parikshit Pradip Joshi
Pradip J Joshi & Co/Nayshaa Investments.
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