Easier to read, then react...

Dear Reader,

Such a simple concept so well crystallised by Mr. Gross in the previous blog, however, has many routes it can take moving forward. We do not want to give an exhaustive list, but do want to touch lightly on some of the events that can occur considering the current environment to highlight that understanding is not the same as solutions!

Lower cost of debt servicing is reducing the return of countries lending money (those that have large cash reserves), especially since countries like China are generally lending in currencies which are not their own, hence they do not determine the cost of borrowing. The theme of currencies is one that will re appear continuously in the years to come as China becomes more of a core , rather than a periphery, country/economy.

Such a low return on accumulated cash and reduced demand from previous debt driven developed countries will reduce exports. This will be an important driver to force many developing countries to focus more on internal demand to maintain stability, especially since countries like China have experienced huge population migration from rural to urban areas.

There is a possibility that developed countries can reduce their debt burden sufficiently so they can be lean enough to grow satisfactorily in the future. This can occur if debt servicing costs are less than growth rates for a period of time, hence excess earnings can be used to pay down debt. This can be supported by low interest rates. Growth rates could be supported by:-

1.Lower costs (i.e. less wages for you and me, and less jobs in general, as we are seeing)

2.Selling the same product for a higher price. This can be possible when there is a strong competitive advantage in generating that product, or a patent

3.Developing and selling higher value products (i.e. with larger margins)


Points 2 and 3 depend on increasing the export of high quality products. Consequently, this will require other countries to import more in financial terms (unless the currency of the exporting country decreases, hence volumes may increase, but financial volume may be similar in the importing countries currency).

Please note point 1 can be deflationary, and point 2 inflationary. Point 3 is the best option. It simply means we are generating a higher rate of return on invested capital, and therefore, make more profit as we generate a higher return relative to the cost of capital. Point 3 is supported by a weaker currency, which can occur in an inflationary or deflationary environment.

Furthermore, note both points 1 and 2 reduce the quality of life of individuals as they either reduce our wages or increase our cost of living. Wealth is effectively being transferred from the consumer to the corporate in the hope that future profits will be larger. It is therefore vital corporates generate returns on capital greater than their cost of capital moving forward to allow future generations to enjoy that transfer back to the consumer.

Whether this event is probable or not in developed economiems will depend on how countries react. We remain watchful of events.


Yours sincerely,

Alessandro Sajwani