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No. of Recommendations: 5
I just finished this book that Tim sent me. A very interesting read indeed. The book does a very good job in explaining various market crashes of the past, Japanese and European economies and the impacts of globalization. It is especially good in giving a very inside view of the current market crash right upto 2009.

My key takeaways from the book:

a) Globalization of capital and financial services is often forgotten when talk about globalization of manufacturing and other services. However, the globalization of financial services is the most significant aspect of globalization. Globalization has taken away the power from central bankes across the globe. Its most glaring impact is the loss of central banks to influence the long term interest rate by manipulating the short term interest rates.

b) I develped an appreciation of the difference between current deficit and fiscal deficit. Current deficit is caused by net capital inflows. US sports a massive current deficit due to large capital inflows from emerging economies. This has created a serious imbalance. If the investing nations were to withdraw capital for any reason, the impact could be severe. While a high current deficit has kept the US economy highly liquid with low interest rates and created a solid backing for dollar there are limits to how high the current deficit can grow.

c) Japan has massive savings. ~$5Tr is controlled by Japanese housewives who invest globally. As a result of this massive control of capital in individuals's hands, the Jap central bank is not as powerful as it used to be. This is however not the only reason for its loss of power. But the idea that these individuals are able to silently influence so much of global trade is almost like dark matter in physics. Currency traders are most sensitive to this phenomenon.

d) Those who point to dangers of US indebtedness nearing 100% of GDP in both public as well as private debt and lament the control of foreigners who hold >$2Tr of US treasuries forget the depth of US bond markets and the flexibility of the US economy. US wealth exceeds $55Tr and $2Tr of treasuries held by foreigners constiture a mere 4%. That is why the collapse of dollar is not going to be so easy. Even Buffet got his bets on the fall of dollar wrong.

e) Euro is in deep trouble as the idea of a single currency works best if all the regions have similar productivity and efficiency. Due to vast differences in these two aspects, the less efficient regions are at a disadvantage. They would like to be able to devalue their currencies but cannot.

f) China and Japan cannot afford to let their currencies rise without causing a massive blow to their exports. At the same time, keeping the currencies low make dollar artificially stronger and AMerican exports weaker than what they could be thereby reinforcing the trade imbalances that contribute to the current deficit. The desire by currencies of EU, China and Japan to be low wrt Dollars is strong and coupled by the fact that the US bond markets are very deep and US economy still very flexible and entrepreneur friendly is unlikely to let dollar undergo a free fall. There are reports that mention that USD over the last 2 decades has declined by only 7% once inflation is taken into account. While the timing is convenient as Nathan points out, it is still a fact. USD will undergo a free fall if the global markets loose confidence in the US and no longer see it as a safe destination for their savings. So far there are no indications of anything happening otherwise but anti-globalization policies could create such a situation.

g) The world has undergone several cycles of globalization in financial services. We had a major cycle in early 1900s and we have another cycle post WW2 that went into overdrive with Reagan and Clinton. Currently there are strong feeling around the world to curb free trade and roll back globalization. Globalization has been a double edged sword. On one side it created record growth and low unemployment levels but on the other hand it dramatically increased income disparities and stagnated the wages of middle class in the US. The greedy bankers with their financial engineering and their successful efforts in circumventing the regulations have created the current meltdown and a massive public opinion against globalization.

h) The greatest danger to the world economy is likely to be from increased taxation, de-globalization, massive fiscal deficits and trade imbalances. In one of the gloom and doom scenarios, Chinese bubble crashes and that leads to massive dumping of finished goods and commodities at firesale prices across the globe leading to wide spread deflation and several market collapses. We know that Chinese bubble is building up and its crash is most likely going to happen at sometime in the future. If and when it happens, it will invariably lead to crash in the prices of many commodities. Currently China is hoarding so much of these commodities to allow its manufacturing machine to work and grow unabated but there is now an overcapacity of production and a global demand recession. But a prolonged demand recession will force China to stop hoarding. Any political or social turmoil could cause the Chinese govt to withdraw its capital from the globe to satiate the masses at home. If that happens the global economy will go into a tailspin. So it seems that forces are aligning for a much bigger market crash. A more than a decade period of stagflation could very well happen.

i) US faces a real danger from its massive defense and entitlement (social securty, medicair etc) programs. But 2030, the entitlement programs are likely to cost almost 75% of the federal budget. Increased taxation to fund the healtcare and pay for the baoilout and for rapidly escalating costs of entitlement programs is likely to happen in a progressive manner.

All of this leads me to think that it is neccessary to have a well rounded portfolio in multiple asset classes (including cash) and markets and be prepared for twice the current tax rates and a stagflation that could last a decade or two.

Has anyone else read this book? Please share and/or comment.

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