How to buy a Life Insurance Policy / Best life insurance policy

Before starting you need to understand your need and how Life Insurance is useful for you.

What is Life Insurance? Life insurance is a cover to provide financial security against your untimely death to people who are dependent on your income.

Please note:

1.       Financial security: Insurance can provide only financial security and cannot save your life or fill the void created in life of your dependents due to your death.

2.       Dependent on your income: The person getting the benefit of insurance should be someone who is dependent on your income (note "dependent on your income" and not "dependent on you") . Your kids and wife who are financially dependent on your income for education, food, housing and other necessities and comforts of life. You will come across idiots who take insurance on life of their minor children or dependent wife, do not ape them.

3.       Untimely death: Insurance is required when sudden unexpected event can impact the normal life of the dependents. In early years of your life when you have limited savings and lot of responsibilities like education of kids etc., life insurance is more important although chances of your death is also remote. When you start approaching your retirement you has enough savings and most of your responsibilities like child education etc. are taken care off and hence there is limited utility of life insurance then, although chances of your death increases substantially. Around your retirement or post retirement you need medical insurance more and not life insurance.

I know everybody knows this but as they say common sense is uncommon. Even when everybody knows this you will come across the following follies by the best of people:

1.       Life insurance saves life: Everybody know that life insurance only compensate in terms of money in case of death but deep down people believe that life insurance cover saves life. And if you see most advertisements would also project that to you. Remember ICICI using ‘sindoor’. Frankly if you die you wife might get enough money to remarry but not your ‘sindoor’.

2.       Life insurance of kids: I know you are laughing that how can someone believe that life insurance policy saves life. Then tell me why people buy life insurance of their kids? God forbid if your kid dies your financial responsibility will only go down. Ask yourself what you would like to do with the money you receive on death of your kid, you will get the answer.

3.       Life insurance of wife: Are you dependent on your wife’s income? If yes, then it makes sense to buy insurance on her life otherwise not. There might be few cases where couple have stretched themselves to buy a house and contracted big EMI which can be paid only if both incomes are intact. In most cases it is not required. Remember if your wife is not there your monthly expenditure might also go down. (Please don’t give an argument that you will have to then hire maids, cook, crèche facility etc. if your wife is not there that would only display your mindset). Again ask yourself what you would like to do with money you receive from life insurance in case of your wife’s death. Of course, there might be ladies who might say why no insurance on my life, is my life not important. Well, tell her insurance cover won’t save her life.

4.       Life insurance for tax benefit: Life insurance premium is money down the drain (at least you hope it’s down the drain). People fool you when they tell you that by taking life insurance you are saving 30% tax. Infact you are putting 100% down the drain. Section 80C provides tax exemption of maximum Rs. 1 lakh and various investments including PF, PPF, child education etc is covered under this limit. Hence, in most cases you would be investing more than 1 lakh in PF, PPF and child education to cover this limit of Rs. 1 Lakh. If you have cash surplus and can afford you should maximize investment in PPF irrespective of tax benefit (I will cover this in separate blog later in details). Investment upto Rs. 100,000 is allowed in PPF and that is enough to take care of Section 80C exemption.

 If you donot have cash surplus to invest in PPF, PF, child education then think whether you can afford life insurance. And in that case either you are not earning enough to be paying taxes or you are spending way beyond your means. Bottom-line: Never take a life insurance for tax planning.

5.       Life insurance is investment: As I mentioned earlier, Life insurance premium is money down the drain (at least you hope it’s down the drain). Do not mix insurance and life insurance. Pure term policy provides the maximum cover at the lowest cost and one should go for that. Tax free bonds, FDs, PPF, VPF etc. all provide better rate of return & security than any ‘life insurance investment scheme’ can ever provide. So if you are paying say Rs. 50,000 per annum under some ‘life insurance cum investment scheme’. I would suggest close that policy, but a term insurance with a premium of around Rs. 12,000 and invest 38,000 in PPF / tax free bonds. I can assure you will get higher cover and higher rate of return in this combination.

Now that concept of what is life insurance and why you need life insurance is clear lets discuss which policy, where, When, how and how much.

WHEN?

When you have dependants: Life insurance is required only when you have dependents. So if you are a bachelor and your parents are not dependent on you it does not make sense to buy a life insurance cover. People will tell you that it makes sense to start insurance policy early as you lock in at lower premium. You will end up sending money down the drain for many more years without any utility. In those years it’s better to invest and full advantage of power of compounding. Anyway due to increased life expectancy, better records, cheaper channels etc. life insurance premium have fallen substantially and if you are having an old policy it might make sense to buy a new policy and surrender the old policy.

WHAT?

Pure term insurance: First of all, as I mentioned earlier go for only “pure term insurance”. Do not mix investment and insurance. If you keep that separate you would not only get better cover but also higher return.

Term of Life insurance: Generally life insurance term should be limited to your working life or till people are dependent on you. Generally people retire at 60 and hence beyond 60 there is no need of life insurance. Beyond 60 your dependent kids should be independent enough. For your dependent wife and yourself you should have enough savings to take care of the retirement years. In fact after retirement, when you are not earning, the premium payment, however small, is a total waste. So do not get lured by insurance companies that offer life insurance up to age of 90. If you are having such a policy, you would be forcing your now independent kids to look forward to your death.

Fine print check: Check for exclusions like terrorist activity, nuclear activity etc. Ensure such exclusions are not there. Considering the neighbors we have and their activity like 26/11 you never know.  Suicide exclusion upto 2 years is a fair clause (Anyway I hope this is not a consideration for you).

HOW?

Online term insurance policy: Buy online term insurance policy as generally it’s cheaper because the insurance company is saving cost on agent commission, channel cost etc. An insurance agent might tell you that claim payment record in these policies is bad, but do not believe them. Anyway unlike medical insurance, car insurance etc., denying life insurance payment is difficult for an insurance company as it’s a definitive event and is not open to interpretations of so called experts. One should go to sites like policy bazaar to compare policies and select one for oneself. Then go to company website to apply. Stick to bigger companies which have been in operations for a while like Bajaj Allianz, HDFC, ICICI, SBI etc. I would advise not to go for aggressive newcomers like Religare, Reliance etc. just to save 200-300 rupee in premium. State run insurance companies are good but generally for online term insurance policy they are not competitive enough. Generally for a Rs. 1 crore policy for a 32 year old male, the premium would be around Rs. 12,000 inclusive of taxes.

Medical test is good: Many insurance companies advertise that ‘medical test not required’. I would suggest it’s better to undergo medical test. If you have anything to hide I would suggest that you spend more on doctors, physicians and gyms. Medical test not only give information to insurance company but also to you and would help you improve your life style. Also when you undergo medical test it becomes very difficult for insurance company to later claim that you have hidden something from them while taking policy. Most of the policy donot provide for this excuse beyond 2 years. It’s important you check that in your policy.

HOW MUCH?

Insured value: You are insuring against loss of income due to your death and you hope by this insurance your dependents won’t have to compromise on their current lifestyle. Hence it’s important for you to know what is your current annual expenditure (cost to maintaining the current lifestyle). As today rate of return on tax free bonds and FDs are around 9%, I would suggest that your cover should be enough to provide annual interest equivalent of your annual lifestyle cost @9%. So if your annual expenditure is say Rs. 12 lakhs, then your term policy should be around Rs. 1.35 crores. If you do not know your annual expenditure (which shows how irresponsible you are in your personal financial management, and I would suggest you calculate it today) and do not even have the will power to calculate it, you can use the thumb rule that your insured value should be around 10 times of your net annual income. So if your net annual income is Rs. 15 lakhs then your insurance cover should be around Rs. 1.50 crores.  In most cases both methods would give similar results, but method 1 is a better method. We have presuming 20% savings on income. If you are doing better than that, good job, keep it up. If you are doing less than that, you need to tighten your belt and seek help of professional financial planner. Remember it’s important that you are not under covered. However, it’s equally important that you are not over covered. If you are over covered not only you are putting extra money down the drain every year, you are also creating threat to your life!

Last but not the least you should properly inform your dependents the life insurance cover you have, where the policy document is kept, what is the process of claiming it etc. You won’t be there to claim it and insurance company would not pay on its own. Do you want your family to live a miserable life after you just because you forgot to tell them where you have kept the policy document?

I hope this was helpful. Feel free to write your comments and ask for clarifications, if required.

My article in Business World magazine (22nd July 2012)

How To Prepare For The Inevitable Financial Crisis

http://www.businessworld.in/businessworld/businessworld/content/How-Prepare-Inevitable-Financial-Crisis.html

RIL's broadband Bet: Broadband subscriber base in India to increase 8 times in 3 years

In my blog dated 6th June 2005 NEXT REVOLUTION IS BROADBAND, I predicted that Reliance would lead a broadband revolution. In my OPEN LETTER TO MR. ANIL AMBANI dated May 27, 2005, I predicted that data revenue would surpass voice revenue and Reliance Infocomm’s optic fibre infrastructure is a potential gold mine. Mukesh Ambani’s big bang entry into broadband reconfirms – Broadband is the next revolution and RIL will lead that. Fight between Ambani brothers delayed it by 5 years but now the time has come!!
RIL has bid around Rs. 13000 crores for all India broadband spectrum. My back of the envelop calculation suggest that India’s broadband penetration needs to increase 8 fold in the next 3 years for RIL to break even.

Sr. Ambani would again try to create a “Monsoon Hungama” kind of Hungama and this time wireless broadband launch would be a ‘big bang’ launch. It might take him 12 months to source the equipment etc. They might leverage Reliance Retail network to reach the maximum number of customers.
RIL would expect atleast 30% of its revenue to come from corporate clients and RIL is really good at this. For the first 12-18 months they might focus only on corporate clients and high pay capacity circles like Mumbai and Delhi.
The real challenge is to launch broadband in the interiors of India. The wireless technology is a big enabler, however RIL need to get the decentralized customer focused mindset for that, which till date have proved illusive for RIL.
If RIL is able to get it right this time, it would be no less than a revolution. Interiors of India although today connected by mobile phones are still not great in terms of connectivity of roads, rails etc. Unlike many other developed country, India has the advantage of high density of population which brings down the per capita capital cost of broadband and makes the operation very economical. Secondly, like in mobile revolution India again has the opportunity of skipping 2-3 stages of development in broadband infrastructure and directly moves to the latest technology.
India suffers from grave disparity in land prices, salaries, opportunities due to lack of connectivity infrastructure (like rail, air transport, roads etc). Broadband revolution can change all that. It can improve governance, education, information flow. It can also cure some of ‘constrains to growth’ created by lack of transport and other infrastructure. IT/BPO revolution which is limited to cities till today can move to town and villages. The possibilities are endless. Online shopping, gaming, education, services….. Size of the market will increase and it would be easier to target ‘able to pay’ customers in the hinderland who are today uneconomical to reach due to small size.
Sunil Mittal once mentioned that telecom is like packman. It keeps eating various businesses and growing. Broadband is one such packman it will eat many businesses like retail, banking, transportation, entertainment etc. Broadband revolution, if implemented well, has the capability of pushing India into high growth trajectory which will help it bridge the gap between developed and developing nations. All the best Mukeshbhai! We wish you all the success!!

"Double Dip" coming

Alcoholism can't be treated with alcohol similarly the problem of excess debt can't be treated with more sovereign debt. World should prepare to spend couple of painful years in rehab.

All these bailouts can only defer the problem, it can't cure the problem.

Reliance: Staying sane during insane times (excess liquidity times)

The economic slowdown had hit everybody hard and RIL is no exception. Many of its projects like Reliance Retail, SEZ etc have been affected. But if one looks around RIL has managed to control itself really well during the Insane Years of 2005-2009. Not only it managed to focus and complete its major Greenfield projects – KG D6 oil & gas project, Jamnagar 2^nd Refinery project, East west pipeline project in time, but it also managed to stay sane and avoid the lure of mega international acquisition unlike its peers. And staying sane in such insane times is no mean achievement. If you don't agree, ask Tata, Birla or Mittal.

Last few years had been really mad years. Factor of production (land, labor & capital) prices had hit the roof and most businesses were unviable at market value of factor of production (not to be confused with historic value). The only way people could make money was by selling out stake or the business to public through IPOs, to private equity firms, to strategic investors or to competitors. The best and the biggest company in India fell for the lure of international acquisition including Tata group, Birla group and also the Mittal group. Ratan Tata had been bold enough to admit in public that they ended up buying Corus, Jaguar & Land Rover at peak prices and it had been a big mistake.

Others like Birla, Suzlon and Mittal had been equally foolhardy and now realize that they made a mistake although they might never admit in public. On the other end of the spectrum had been players like Ranbaxy who managed to exit the business at a very good price. We may keep arguing that selling out completely made sense or not but we all will agree that timing was amazing.

So why did it happen? Do these companies don't have smart people who can advise the management properly? I don't think it's a skill set problem (Finance Problem). I believe it's an individual's interest Vs Company's interest problem (HR Problem). I see a systemic problem here. The system has a built-in bias towards occurrence of the deal. The system incentivizes people who vote for the deal and penalizes who vote against the deal.

Today corporate world is designed in a fashion where you are paid incentives and bonuses for making deals and not for voting against it. Investment bankers make money when deal is done; consultants make money when deal is done. Even the company's in-house managers reap benefits in form of bonus, recognition in the organization, additional responsibility when the deal is done and a sane advisor who advises the management against it is a looser both ways. If the management goes ahead with the deal the one who advised in favor of the deal get the recognition, responsibility of the new company and all associated benefit. In case management decides against it for any reason, nobody gets anything. Hence, advising against the deal is a lose – lose strategy.

From Investment bankers to Media, for everybody occurrence of the deal is beneficial and hence in most cases the deal happens. Again, higher the value of the deal, higher is the commission (for I-bankers, consultants and experts), higher is the interest of the public (for media), and higher is the recognition & responsibility (for in-house managers). And to top it all the excess liquidity in the system, thanks to Mr. Alan Greenspan & company made sure arranging funding for it was never a problem.

So what helped RIL stay sane when others could not resist the temptation? This is despite Mukesh Ambani declaring in two consecutive AGM, the company's ambition for international acquisition and change of strategy towards inorganic growth. It seems there were few in RIL who were ready to take lose-lose strategy for self in the interest of the company. I hope RIL if not rewarded, at least recognized these selfless employees.

How the Financial crisis could have been handled better by the Bush Government

The way USA government is handling the Financial crisis is blasphemous and I believe they are living in fool’s paradise. A country which is threatened by outsourcing of jobs to country like India & China is able to dole out bailout of a Trillion dollar with such frequency!! To put things in perspective India’s GDP is around $ 1 Trillion per annum and that of China is around $ 4 Trillion per annum. (USA GDP is around $ 14 Trillion per annum). According to my estimates USA government has doled out around $ 8 Trillion as bailouts in the last 12 months. It works out to 8 times India’s GDP, 2 times China’s GDP and almost 57% of USA’s GDP!!! If USA government is made to payout 12% interest (rate of interest in India) on the bailout amount, USA would be paying interest equivalent to India’s GDP each year!!!

I believe everybody agrees that the financial crisis had been handled very poorly by USA and they have managed to survive due the Dollar Hegemony, otherwise they would have had the fate similar to that of Zimbabwe – mindboggling inflation rate with domestic currency rendered worthless. (I believe eventually USA will have to pay for it and dollar will crash soon).

I believe the Financial crisis could have been handled by following simple steps listed below. Why it was done the way it was done puts in question both - Bush government’s intelligence and the vested interest:

1. Guarantee total current, saving and fixed deposits in banks for 5 years: (currently FDIC guarantees deposit upto $ 200,000 per customer per bank). This would have taken care of the confidence crisis and people would have deposited money in banks without fear. It would have helped increase liquidity with banks and increased their deposit : lending ratio
2. Make all deposits in banks tax free for 5 years: This would have given incentive to save to US nationals. Currently savings rate in USA is almost negative and is one of the biggest reasons for the current crisis. This would have also reduced the cost of funds for the banks as deposit rate expectations of customers would have decreased. It would have also made bank deposits more attractive investment option in comparison to other options.
3. Provide banks with tax holiday on interest income for 5 years: This would have reduced the cost of funds in the economy and would have increased investment activities in the economy. This would have also made the banks balance sheets stronger.
4. Let the weak bank to fail and file for bankruptcy under Chapter 11: No bailout should be provided to any bank or company before it files for Chapter 11. Chapter 11 has been designed to provide businesses an opportunity to reorganize and survive if the possibility exists. If the banks / companies donot have inherent strength to survive they should be allowed to die. Contrary to the myth created by the Bush government, closing of few banks will not destabilize the system if depositors are protected. Jobs are not lost or created by such bailouts. If the business makes sense somebody will buy out in part or whole of the bank otherwise some other banks will grow to fill the void left by the failed banks – creating more jobs and business activity.
5. Strictly penalize wrong doers: The current US government plan is rewarding the wrong doers by giving out bailout. It should be doing exactly reverse. Negligent and reckless traders and bankers should be strictly penalized to create examples for others.

The above plan is superior to the plan used by USA government due to following reasons:

1. Incentivizes savings rather than expenditure: USA government has created a myth that an economy grows by spending more rather than saving (& investing) more. And hence they had been spending recklessly specially during the last 8 years. Sooner they get rid of this false notion the better.
2. Takes care of the confidence crisis: Full security of deposit creates confidence in banking system. People will park their saving in banking system without any fear as it would be as safe as US government security. We can see that there is so much fear currently that people are willing to park their funds in US government securities at almost 0% rate of return.
3. Makes banking fundamentally stronger: Tax holiday of 5 years on both deposits and advances makes the banking business fundamentally stronger. The spread for the banks improve, thus improving their profitability. It also reduced the cost of fund in the economy, which would stimulate investment and demand.
4. Fair and equitable: One of the most important reasons why this system is better than the Bush government’s plan is that it’s fair and equitable. It doesnot protect only the banks which are “too big to fail”. It spreads the benefits to depositors, borrowers, mortgagees, small and medium enterprise & businesses. Who should survive and who should not is decided by the market forces and not by Mr. Paulson.
5. No moral hazard: The proposed system doesnot provide any incentive to wrong doers. It also doesnot create a feeling of being cheated to people who had been handling their finances properly. It stops the practice of expecting bailouts on the pretext that others have got the same.
6. Lets the market decide: The incentive (in form of reduced taxes) is fairly divided among people who are saving and people who are borrowing for justified causes. On the other hand banks which are reckless and negligent are thrown out of the system. It’s the survival of the ones who manages their business well and Chapter 11 for the one who can’t.
7. Substantial less cost to the taxpayers: The cost to taxpayers in form of reduced tax collections from deposits and advances and from protecting of deposits would be substantially less than the billions of dollars of bailouts currently being doled out.

Terror Attack: What India should do now?

Everybody agrees its time to take hard decisions and our soft approach is costing us dear. At the same time world economic situation is grim and we should not loose focus on Economic growth. We should remember that the terrorist were targeting our economic growth and we should not let them win.

So what should we do now?

Diplomacy – Foreign Ministry

The need of the hour is tough diplomatic stand by India. The world is in far worse financial condition than India and they too can’t afford an India – Pakistan face off. Its time we assert ourselves and claim our rightful position in the world. I suggest following diplomatic steps:

1. Stop all diplomatic talks with Pakistan as Pakistan is a divided nation without a single command. The elected representatives are just lame ducks with no control over armed forces, ISI and other organizations. We should communicate to the world the futility of any talks with such lame duck government. We should cite example of Kargil war where Nawaz Sarif admitted that army / ISI acted without informing the elected government. The coup that followed is enough proof of that. Condition is no better today.
Declare that India will not enter into any talk with Pakistan until we have 24 terror free months. No cricket, no sadbhavna buses and trains and no trade.

2. Take a hawkish stand in front of the world. Tell USA that we supported them when they needed us and now its time for them to return the favor. Play back the video to them with Bush’s famous lines like “either you are with us or against us. There can be no fence sitters.” Tell USA, Israel etc that we have common enemy and we need to destroy them. Anyway USA is bombing Pakistan border which is a proof enough that we have ‘commonality of purpose’.

3. Show to the world that we have enough proof of Pakistan hand in the terror attack. Ask US and other intelligence agencies to come and work on the case with India team and see the proof themselves. Satellite phones, level of training, sophisticated weapons will provide enough proof of its origin. We don’t care which part of Pakistan – elected government / Armed forces / ISI is behind the attacks. For us all three is Pakistan and we need to ‘neutralize’ them. Tell the world that proof is much more than ‘weapon of mass destruction (WMD)’ proof provided by USA government and failing to support India this time would be a proof of ‘double standards’. (Famous lines of Obama where he admitted that he didn’t understand why USA attached Iraq during election campaign should be used to rub the point in)

4. Force the world to deny any bailout package for Pakistan. Recently IMF gave a bailout package of around $ 8 billion to Pakistan to tide over the economic crisis. India should fight hard against any such financial support to Pakistan. We should clearly communicate that Pakistan is using these funds to fund terrorism against India and financial support to Pakistan is equivalent to supporting terrorism. Similarly force USA to stop all financial and equipment aid being provided to Pakistan armed forces on the pretext of war against Al-Qaida / Afghanistan. Tell them that indirectly they are providing sophisticated weapons to India’s enemy which is promoting terror attacks in India.

Internal systems - Home Ministry

1. Modernize the security system: Need to make use of best technology available. Make sure we atleast have equipments better than those of terrorist like Satellite phones, AK – 56 / MP 5 etc. We should be investing in sophisticated weapons & armored vehicles for our forces and not luxury cars for bureaucrats.

2. Transfer 50% VIP security budget to anti-terrorism security: Transfer 50% of the budgeted amount meant for VIP security to security of public places. This would show that politicians are concerned. It’s important that politicians feel more venerable to terror. Otherwise we will breed RR Patil (Maharashtra’s home minister) like thought process that “in big cities such small things happen.”

3. Have a single Anti-terrorism body with enough decision making powers during emergency: We all must admit that the way we handled operations after the attack happened left too much to desire. The time taken by NSG to come to Mumbai, decision time to send them, availability of aircraft for them, weapons and training, communication systems, everywhere we were lacking. There was obvious lack of coordination between different forces which was evident from handling of general public and media at terror sites, sharing of information between different forces etc. Again we here that information relating to terror attack was available in parts with different government bodies. We need to have a single body where all such information flows so that we can solve the zig-saw puzzle in time.

4. Spend more on intelligence gathering & information systems: Every country has intelligence system which generally is beyond the petty politics. We also need to invest in a high-tech information system. We need to place more CCTVs in public places / have central control rooms to monitor these cameras placed at railway stations, markets, malls, hotels etc. Al five star hotels have CCTVs. We should team up with communication companies and use their unutilized optic fibre to have option of transmitting these feeds to central control centre in times of need. We also need to guard our borders better. Accepting bribe to allow any kind of traffic across border should attract highest level of disciplinary action.

5. Cut support to terrorism: Terrorism can’t survive without support from insiders. We need to make sure that all funding to terror organizations is nibbed from the bud itself. These organizations collect contributions in name of religion from people who are generally unaware of the purpose for which these funds would be used. We need to communicate in clear terms to people that any direct of indirect support to these organizations knowingly or unknowingly would be treated as act of supporting terrorism and would be dealt with strongly. Ban all organizations like SIMI etc. that support taking law in their own hands in name of militancy / freedom etc. Any donation in cash or kind to these organizations should be considered as an act of supporting terrorism. Also make strict laws against other sources of funding for these organizations like drug trafficking, etc. Generally drug trafficking and other such traffic across international borders and terror traffic use the same routes.

Concluding remark

First step towards solving a problem is to understand the problem and admit the nature of the problem. We need to admit that Pakistan is no more a single nation with single head of state. Pakistan is a fragmented divided nation where various government and non government bodies are trying to exercise control. We also need to admit that they are getting support from Muslim fundamentalists inside India and they are prospering due to our vote bank politics.

Once we admit and understand the problem solution would be simple. As done in a war first cut the supply lines of the enemy and then strike when they are weak. We need not go into war against Pakistan immediately although we should act hawkish and should be mentally ready for it.

We should kill Pakistan by isolating them & cutting all their supply lines. We should make sure that they don’t get the promised IMF package and any other bailout. We should go for war only if the world tries to act soft on Pakistan, in which case we Indians will have to take an assertive stand. And if and when we go to war we should make sure that then there is no looking back. We should divide Pakistan into bunch of primitive tribes which would keep fighting among themselves with primitive weapons and let us live in peace.

Admit it! The root cause of current crisis is OVERVALUED DOLLAR

….and the only solution is to devalue it.

The world leaders are giving the current crisis different name like “Sub Prime Crisis”, “Liquidity Crisis” etc etc. But any person with basic common sense can tell that sub-prime or liquidity can’t be a big enough issue to put the world economy in doldrums. The root cause needs to be diagnosed. Until we admit to the problem, we would be taking wrong medicine.

Let’s diagnose the disease. We have divided the symptoms based on the partial diagnosis made by leaders till date:

So called “Sub-prime Crisis”

1. US consumers are defaulting on housing loans & other loans in big numbers
2. Per capita consumption of US nationals has been 2x-3x in comparison to that of nationals of other developed nations. (per capita consumption of cars, steel, cement, crude oil etc)
3. USA’s fiscal deficit for the last few years is in excess of $ 400 billion each year

So called “Liquidity Crisis”

4. The world holds their savings / foreign currency reserve in USA securities. As it’s the world’s standard currency. And as the return on govt. securities has been falling other the years, nations have started investing in quasi-government organization’s securities like Feddie Mac and Fannie Mae.
5. The world has been buying these debts having faith in USA’s credit worthiness and credit worthiness of its institutions
6. USA financial institutions have packaged and repacked housing, credit card and other debts in form of CDOs etc and sold it to the world. Now these financial institutions are going bankrupt

So called “Outsourcing” problem

7. USA is dependent on China and other countries for most of its consumption. USA is importer of almost everything. Salary and cost differential in USA is leading to outsourcing of major chuck of goods and services from developing countries
8. Most of USA manufacturing industry is dead. US automobile companies are about to go bankrupt. Japan & others are able to build better cars at lower cost. IBM has sold out the hardware business to Lenovo.
9. Salary level in USA is substantially higher than in developing countries, which is leading to brain drain problem for developing nations and job loss problem for USA.

So called Consumption led "growth”

10. Standard of living is higher than rest of the developed world. Per capita consumption of US nationals has been 2x-3x in comparison to that of nationals of other developed nations. (per capita consumption of cars, steel, cement, crude oil etc)
11. Consumption has been growing without increase in jobs. Salaries are high despite of limited skill advantage. Imports has been growing and exports have been falling
12. China & other countries had been investing their foreign exchange reserve in US securities against nominal return of 2-3% when opportunity cost of the fund is much higher

Diagnosis:

Point 1-3: USA as a nation and US nationals has been living beyond their means. Consumption led growth has been financed by debts which has started to haunt USA

Point 4-6: World has been duped by the financial engineering of US financial institutions and misplaced faith in USA’s credit worthiness. However, now the world is slowly realizing the risk & mistake

Point 1-6: The world economy growth in last few years was led by unsustainable debt driven consumption by USA. Problem in servicing of debt is leading to world economy going into financial crisis.

Point 7-9: USA has become inefficient and high cost economy. They are unable to compete even in traditionally strong sectors like automobiles, IT hardware etc.

Point: 10-12: Consumption in USA has been growing despite of fall in production activities because developing countries had been subsidizing USA consumption by investing in dollar denominated securities with nominal return.

Actual Disease:

Dollar is Overvalued

Point 1-12: USA currency is overvalued. Due to overvaluation imports are cheaper and exports are costlier. Hence import led consumption is increasing while manufacturing is falling. Overvalued dollar has killed domestic industry and has made US economy inefficient.

“Invisible hand” is absent

Point 1-12: If it was any other country the demand and supply of Dollar would have corrected the currency imbalance. However, as Dollar is the world’s standard currency of trade – the excess supply of dollar had been leaking away into foreign currency reserves of other countries in form of US securities. As other nations were ready to lend to USA against its nominal rate securities USA has accumulated unsustainable amount of debt which it is not in a position to pay back.

SOLUTION – DEVALUE DOLLAR!!!!!!!!

Therefore the only solution to the current problem which we prefer to call ‘Dollar Hegemony’ is to devalue dollar. My estimate is: 40 to 50% devaluation in dollar is required to bring it to parity. And of course dollar should loose its “World’s standard currency of trade” status.

The implications:

Positive for US:

1. Fall in real value of outstanding debt: As dollar value will fall by 50% the value of debt in real terms will also fall by 50%. Again value of houses in dollar terms would double. This would be a big relief for the mortgage market and can help turn it around. It will help US nationals deeply in debt.

2. Manufacturing will become competitive: Salaries in USA will adjust automatically. They are at unsustainably high levels which is making USA uncompetitive. Once dollar is devalued by say 50% automatically salary in USA would fall in 50% in real terms. Making USA industry competitive again. Companies like General Motors etc will be able to compete against Japanese and German cars. Salaries & other retirement benefits of US employees is the major issue pulling these companies down.

3. Imports will become uncompetitive: Imports from countries like Chine etc are undervalued due to overvalued US dollar. Once exchange rate is readjusted imports will become uncompetitive restricting unsustainable level of import driven consumption

4. Job creation: Increased manufacturing activities and reduced imports will lead to job creation in the economy. Foreigners like Indian nationals who are taking up large chunk of US jobs in IT, technology research, doctors, nurses etc will find it no longer viable to move to US as in rupee terms their salary is US would be reduced substantially. Outsourcing problem would be solved to a great extent.

Negatives:

International Impact: Devaluation of Dollar will have a huge international impact. Countries like China which hold substantial foreign reserve in dollar denominated securities will suddenly see their reserves depreciating by as much as 50%. Devaluation of dollar will make their exports to USA uncompetitive leading to large scale unemployment and bankruptcy in their country. This will create social unrest through out the world. It can lead to war between nations for resources.

Crash of financial system & global trade: The whole financial system which is today based on faith in US dollar will come crashing down. The world will need to devise a new order for trade and financial settlement.

Elasticity of import & exports: Not all exports and imports are perfectly elastic. Oil imports will not fall substantially in volume in short term. Similarly replacing IT talent of India would be difficult in short term. Similarly for exports, even if the prices fall substantially volume of exports might not increase for arms and ammunition etc.

Savings & Retirement fund: People who had been saving rather than going for debt driven consumption would be penalized due to wrong doing of borrowers. It will create a moral hazard. Their saving would depreciate by 50% overnight in real terms and they might not have enough retirement funds to take care of their old age.

Conclusion:

The international repercussion of Dollar devaluation is so grave that it can’t be done overnight. It has to be a slow process with enough time for nations to adjust. Countries need to be given time to liquidate their dollar denominated foreign exchange holding. World also need time to device and operate new financial and trade order.

But what need to be done immediately is to recognize the real Disease. The world currently suffers from Dollar Overvaluation. Admitting to the disease is the first step. Denial will only aggravate the disease and create other complications due to wrong medicine. Unless we come out of denial mode world will not start moving in the right direction. Bush & Paulson of the world might say that ‘fever’ called sub-prime crisis / liquidity crisis has been cured but it will come back again and again in some form or other – Bear Stearns / Lehman Brothers / AIG / Citi Bank / General Motors / Ford / Chrysler / …………………………………………

Open letter to Prime Minister of India (Sh Manmohan Singh)

Dear Sir,
The financial crisis faced by the world is a graver situation than that of managing the stock market. What Finance Minister Sh P. Chidambaram is doing currently is pushing the dirt under the carpet and hoping it is not uncovered before the next elections.
To be fair to you the current problem is US making and not of your making but this Financial Tsunami is not fair in its impact any would destroy everything that comes on its way. In 1991 you built the dam of Globalization that powered & irrigated our fertile land for almost two decades. But today this dam is in risk and it can destroy the fertile land. You being the architect of the dam knows better than anybody else how to save the dam of globalization destroying own lands.
We need to do two things urgently to avoid importing the US financial crisis:
1. Diversify the foreign exchange portfolio and move out of US treasury bonds and other dollar denominated financial instruments.
2. Start trading in Crude and other major foreign trade items in Euro and other currencies rather than dollar. At least diversify
As you know law of demand and supply applies to all currencies except dollar due to dollar hegemony. The dollar is already over valued due to this even after years of fiscal deficit and relentless borrowing. However, the current financial crises pose a real risk to dollar and dollar hegemony. All the billion dollar looses that US government is nationalizing has to be paid somehow and ultimately it would be paid by printing more dollars. And as you know very well, printing more dollars means distribution of USA loses to the world.
The printing of dollar, inflation and depreciation of currency is a very slow process and something that can be handled in the long run. The risk current situation poses is sudden devaluation or crash!!
The world is currently standing on thin ice which is melting with each passing day and everybody is wishing that it never reaches a situation when we go down under. The current crisis is sign of crack on the thin ice floor. If we all keep standing till the end we all will go down into great depression soon. As the cracks become big, grave panic would be created and one or few of the members would try to run to the safer place. And we should remember that goliath named China is also standing with us on the same thin ice and if he moves, due to its weight the ice floor will surely break. We have to make sure that we more to a safer place before the goliath begin his move.
(The thin ice here is Dollar based financial system where all major international trade is done in dollars including crude & petroleum products and major share of foreign exchange reserve is kept in dollar denominated securities. People standing are nations who are part of the international financial system and the cracks are the financial crisis. Going down under is Great Depression & the safer place is a world of neutral currency with no single currency hegemony).
China has more than trillion dollar of foreign currency reserve and most of them are parked in low interest paying dollar denominated securities of US institutions like Freddie & Fannie. Sooner than later China will realize that US government with its increasing nationalization of loses would not be in a position to return back these reserves. The only option for US govt is to print more currency to pay back China and others and that would create excess dollars in the world economy leading to collapse of the currency. China to reduce the loss would start moving out of dollar into other currencies or Gold. Or if it’s a fools and doesnot understand the risk of thin ice would force US government to increase the interest rate on these securities. Either ways, the US will be faced with increased financial crisis and the current financial system will collapse.
Again shift of oil trade to other currencies would reduce the demand for dollar required for oil trade and hence the currency will collapse.
Believing that not moving can save us all is foolhardy. One: sooner or later somebody will panic and run across the cracking thin ice floor. (in fact few countries have already started the move). Otherwise the foolhardy US financial management will ensure that the ice melts so much that the whole world goes down into great depression. USA is rooted in his own system and it can’t run. Its time that we desert him otherwise we all will go down with him.
Its time the world decide to move to a world of neutral currencies where value is derived from demand and supply and no single country has enough power to govern the world financial system. The only thing that is stopping us all is the ‘fear of change’. In the long run, the new world would be better than the current one for all of us.
Sir, I hope as in 1991 you will be bold enough to drive the change rather than closing your eyes to the thinning ice hoping that we don’t go down under before the May elections.

Regards,
Neeraj Gutgutia

“Distress Sale” is keeping Dollar Strong temporarily

The US financial companies are falling like bunch of cards, the economy is in recession, and import bill is rising still Dollar is becoming strong. What’s happening?

“As our U.S. trade problems worsen, the probability that the dollar will weaken over time continues to be high. Running a huge trade deficit is costing us money, sooner or later. Already the prediction I made last year about one fall-out from our spending binge has come true: The ‘investment income’ account of our country - positive in every previous year since 1915 - turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay ever-increasing amounts of interest on interest.” – Warren Buffett

The USA economic performance and current financial crisis should and will lead to depreciation of dollar. My bet is this crisis would dethrone Dollar from being the “standard currency” of the world and this phase would go down in history as end of dollar era. (Read: End of Dollar Hegomony)*

Against the general logic dollar is appreciating due to fire sale or distress sale by US companies. US companies are selling out their investments (equity investments in developing markets, bonds etc), subsidiaries (Citibank, Lehman Brothers) to strengthen their balance sheets. They are also selling out stakes (Citibank, Merrill Lynch etc) to Temasek and Saudi funds of the world at ‘fire sale’ price in distress attempt to survive. This temporary phase of ‘fire sale’ is leading to fall in buyer country currency and appreciation in Dollar. The temporary upside blip is due to unsustainable capital inflow.

For the time being this may lead to appreciation in Dollar but it is also reducing the future income of USA from abroad. Temasek and Saudi investors of the world will be taking out dollars from USA every year in form of dividends, salaries and expenses.

Apart from future income this fire sale is also reducing the US aura that was derived from these financial institutions. USA is no more ‘the land of endless opportunities’. Soon US B-Schools won’t be as attractive place to study as finance institutions retrench jobs. The fall of these might corporations like Bear Stearns, Lehman Brothers, General Motors, Merrill Lynch, Citi group would end the awe that people have for USA. And with the awe “Made in America” brand would loose its premium.

Biggest Export of USA is neither Intel Chips, nor Boeing Aircrafts, nor McDonald burgers nor Microsoft Windows. The biggest export of USA is Dollar (as investment good). As a result of this financial crisis the world will stop seeing dollar as an attractive investment and that would be the demise of Dollar. And then Dollar depreciation would lead to further depreciation of dollar as US exports & imports are fairly inelastic.

*PS: Sanjay Kaler thanks for sharing this Ron Paul speech. This is the best piece of info I have read on this topic till date.