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Home > Archives (2006 on) > 2008 > April 26, 2008 > Rising Commodity Prices overrides Collapse of the Share Market

Mainstream, Vol XLVI, No 19

Rising Commodity Prices overrides Collapse of the Share Market

Sunday 27 April 2008, by Bharat Jhunjhunwala

We should not get too worried due to the collapse of the share markets. The immediate reason is the huge losses incurred by the American bank, Bear Sterns. This bank had aggressively given massive loans to persons with weak credit ratings known as ‘sub-prime’ borrowers. These loans went into default and the bank incurred huge losses. The bank stopped getting new business while old clients rushed to withdraw their monies. This forced the bank to sell its assets like shares at low prevailing prices and it incurred huge losses. The shares of this bank traded at $ 172 sometime ago. Presently they are quoted at $ 6. The troubles did not end here. The rival bank, JP Morgan Chase, has offered to buy its shares at a price of $ 2. An employee of the bank told this writer that they are unlikely to get a better offer. Another American bank, Lehman Brothers, is also seen to be in trouble. These troubles have forced a sell-off in the share markets across the world including India and lie at the root of our present troubles.

It should be obvious that bad business practices adopted by one shopkeeper should not unsettle the business of others. So also with the American banking crisis. The troubles of a few American banks arising from bad loans should not affect India. Indeed, the world economy appears to be strong and buoyant. Oil prices are at a historical high of $ 111 per barrel even though there is no cut in production. This means that the demand for oil is increasing. Factories can afford to produce goods with expensive energy made from oil because the market is willing to pay high prices. Similarly, the high prices of steel and foodgrains indicate that the real economy is strong. People have the money to build and buy new houses.

The price of gold is also rising. This is, in part, due to the investment demand. Investors are selling shares and buying gold in order to save themselves from a bigger market collapse. But, in part, this is also due to the demand for the yellow metal even at these high prices. Property prices have almost doubled in the the last six months in Rohini and Dwarka areas of Delhi. These and many other parameters indicate that movements in the share markets do not reflect movements in the real economy. Just as fishes swim merrily deep in the sea while huge waves bash the coasts on the surface relentlessly, likewise the real economy is chugging along merrily while there is mayhem in the share markets.

The situation earlier was entirely different. A few years ago the collapse of the American share markets saw a decline in oil prices from $ 27 to $ 10 a barrel. That meant that people did not have money to buy petrol to fill up the tanks of their cars. The prices of other commodities were also low. The decline in share prices at that time was an indicator of the weakness of the real economy. Consumers did not have income to buy petrol or steel. Investors felt that companies will not be able to sell their goods at high prices and profits will decline. The low prices of shares and low prices of commodities went together. The present situation is entirely different. Decline in the Sensex from 21,000 to 15,000 has been accompanied by a rise in the price of oil from $ 80 to $ 111 per barrel. Thus the decline in the share markets is not due to the weakness in the real economy.

THE present decline is in the nature of readjustment of the role of America in the world economy. Truly, this decline had started in 2002 after the bursting of the dotcom bubble. But the US Federal Reserve Bank lowered the interest rates on housing loans at that time and encouraged people to buy houses. This created an artificial demand for cement and steel in the market and the share market remained buoyant. But this did not hold. Ultimately investors began to sense that the American people do not have the incomes to repay their loans. Global investors withdrew their monies from the dollar. That decline raised the cost of imports and pushed more housing loans into bankruptcy. The American share markets are falling because American banks have incurred huge losses. This shake-up is affecting the Indian share markets. Banks like Bear Sterns have had to liquidate their holdings to meet their immediate payment obligations. This impact is likely to be small and temporary because commodity prices remain buoyant.

That said, we can see two negatives in the Indian economy. The GDP growth rate is down to eight per cent from nine per cent. Inflation has increased to five per cent from four per cent. My assessment is that these impacts are nominal. Just as death in the neighbourhood spontaneously creates a melancholic atmosphere in every home, similarly decline in the American economy is leading to sympathic shedding of tears in the share markets of Mumbai. It is noteworthy that foreign investors have not indulged in a big sell-off in the Indian markets. Their behaviour reflects long term confidence. Sales have been made more to meet their immediate needs of liquidity than aversion to the Indian economy.

One section of analysts holds that Sensex at 21,000 was an aberration and now the share markets have stabilised at true valuations. I think otherwise. The continuous rise in commodity prices does not indicate a downturn. It is more likely that the present bear run is the handiwork of a bear cartel. These players see that the Indian economy is strong and likely to remain unaffected by the US meltdown. They sense an opportunity in this. They want to create panic among retail investors in order to get them to sell. The market is likely to bounce back once the cartel has made the purchases.

The decline of the American economy is fundamentally beneficial for us even though we are likely to face some problems in the short run. An example will help. The break-up of the zamindari led to may problems for the poor people of the village. With the zamindar gone, there was no purchaser in the village for the milk or vegetables. They lost their jobs as tractor operators for the zamindar. But soon roads were built and milk was sold at better prices in the nearby cities. Distribution of land led to the coming of ten tractors in the village instead of one earlier. The short-term collapse of the village economy was followed by long-term prosperity. Similarly, the collapse of the American economy will certainly create problems in the short run as seen in the weakness of our share markets. The incomes of our IT companies will face pressure and exporters will face lower incomes from rising rupee. But the fall of the American economy will soon see the flowering of many smaller economies. The world will become multipolar with Europe, Japan, India, China and Brazil acting as anchors. Thus we should not get overly perturbed by the present decline in our share markets. Instead we should celebrate the decline of America and the rise of India.

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