By Dinesh Verma - March 19, 2023
43 minutes ago
The global financial system is once again in turmoil. We Indians, despite being thousands of miles away from the epicenter of the crisis, face its effects. Today, I’ll explain what key lessons can be learned from the recurring crises in the Western world, and how much better off our lives would be if the lessons were followed.
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It is necessary to understand the crisis coming one after the other. Let me explain in simple language.
nature of crises
First of all, There came the global financial crisis which started with the US housing market in 2008. This in itself was a result of the US Federal Reserve’s loose monetary policy since 2001, which extended credit to undeserving customers (in the housing market) and spread risk around the world.
After the painful period the whole world went through, there was an apparent calm since 2010, which was a phase of ultra-loose monetary policy in the western world.
The second blow came in the form of high inflation in 2021, Which was anyway anticipated for a long time, but got delayed due to various other factors like Covid pandemic.
To respond to rising inflation, Panicked, the Federal Reserve began to rapidly increase interest rates. Its effects are being felt today, in markets and companies, and now in banks (like the Silicon Valley bank that suddenly closed).
5 key lessons from the last 20 years
There are important lessons to be learned from these recurring crises in the Western world. These can help India and Indians stay safe in the long run.
1) The response to the crisis should be proportionate
The first major mistake was made after 2001–02, when Fed Chairman Alan Greenspan adopted a low interest rate regime that pushed credit into the US market very strongly.
This was in response to the recession in the US caused by the dot com bust (2000–01), which itself was the result of a crazy run of ‘dot com firms’, which from 1999 suddenly had ‘no path to profitability’. model). When they collapsed, the economy slowed down. So the Federal Reserve started the ‘Easy Money Policy’. And a whole housing market bubble began to form that burst in 2008.
Lesson – Don’t overreact to any crisis. Be proportionate in response. Otherwise, you will have to pay a big price later.
2) Stop a crisis, don’t spread it
The US housing market crisis spread to the financial system, and then to the US economy, and eventually to the world economy. Why did this happen? Because smart finance managers (working in investment banking firms) turned boring mortgage loans into fancy securitised products and sold them to gullible investors around the world.
By doing so, they were spreading the risks of the US housing market around the world. When the market fell, all such investors (in other countries) suffered losses. India narrowly escaped in 2007-08, because the investment from India in such products was less. But the government then had to spend heavily to prevent the economy from coming to a complete halt.
Lesson – don’t spread internal risks around the world. Do not let others suffer for your lack of foresight.
3) Repeating the same sin will not make it a virtue
What have US regulators and the Central Bank done since 2010? He repeated the same mistake of 2002, by adopting excessively loose monetary policy, and by injecting more liquidity into the system. While some of this was necessary to prevent financial institutions from collapsing, they did it again, and began sowing the demon of inflation that now surrounds us.
Lesson – repeating the same sin at different times and places does not convert it into virtue.
4) Eventually the hidden demons come out
Inflation, which had been building up automatically as a result of these policies, did not appear until 2021, and when it did, the US Federal Reserve panicked and took drastic measures. Rising rates hit everyone hard – the stock market, the bond market, the corporates, the common man – everyone. This is the stage we are in now.
All other central banks were forced to raise rates. The RBI has also failed to bring down inflation in India, which has been living above its own ‘upper tolerance zone’ for a long time.
Lesson – be prepared for the monster that will eventually come, and when it does, don’t overreact. Otherwise a new cycle of problems starts.
5) Easy money doesn’t last
The easy money that was around the world in the 2010s led to a ‘startup boom’ in India. But a lot of it was pure gas, because cheap money financed even the worst ideas. Now it’s all coming to an end, and painfully, jobs are coming to an end. So, assess the business model based on the underlying strength and not on the basis of access to cheap money (from the west). The sudden collapse of the Silicon Valley bank reflects extreme short-sightedness as management had invested in long-term bonds, and the Fed was raising rates. The downfall was bound to happen.
Lesson – Nothing is better than long term fundamentals. Easy money doesn’t last.
So Sunday Motivational Career Funda is that we can save ourselves from ruin by learning simple lessons of life from big financial crisis.
Will do and show!
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