consumption and investment led booms and price distortions
Citibank: : see, the rate of interest is 7.5 % and you can easily invest it elsewhere at 8%.
(from my previous post based on a conversation with Citi)
This i belive is the crux of the current boom in equities and real estate. it is driven by investments hoping to get a higher rate of return than the costs. and these are often leveraged.
the issue with investment led booms is that largely amounts of capital - theoratically infinite can flow in seeking a rent higher than the cost.
to explain further, think of a middle class individual. if he believes that his investnments can fetch a high rate of return, he can leverage and deploy large amounts of capital. and when he invests is such a manner he causes price distortion because his need is not backed "true demand" but percieved returns. such investments is now being practiced by all class of investors and the price distortions can be very severe. also, when such investment led boom come to an end the pain levels can be very extremely high.
consumption led booms such as one in the US is a far better option in my view. a person can consume only a finite amount - a house , car, another car, fancy clothing and food on the credit card. but the incentive to practice this is no so widespread or large in financial terms. this also causes less distortions in asset prices.
to me the US-led consumption boom looks less riskier than India and China led investment boom.
tailpiece: if i act on Citis generous offer to loan 4.5 lakhs to my mom and leverage further on it, i can easily raise rs 12-15 lakhs with it!
(from my previous post based on a conversation with Citi)
This i belive is the crux of the current boom in equities and real estate. it is driven by investments hoping to get a higher rate of return than the costs. and these are often leveraged.
the issue with investment led booms is that largely amounts of capital - theoratically infinite can flow in seeking a rent higher than the cost.
to explain further, think of a middle class individual. if he believes that his investnments can fetch a high rate of return, he can leverage and deploy large amounts of capital. and when he invests is such a manner he causes price distortion because his need is not backed "true demand" but percieved returns. such investments is now being practiced by all class of investors and the price distortions can be very severe. also, when such investment led boom come to an end the pain levels can be very extremely high.
consumption led booms such as one in the US is a far better option in my view. a person can consume only a finite amount - a house , car, another car, fancy clothing and food on the credit card. but the incentive to practice this is no so widespread or large in financial terms. this also causes less distortions in asset prices.
to me the US-led consumption boom looks less riskier than India and China led investment boom.
tailpiece: if i act on Citis generous offer to loan 4.5 lakhs to my mom and leverage further on it, i can easily raise rs 12-15 lakhs with it!
posted by tvm at 2:39 PM
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