Widely considered the most successful investor of all time, Warren Buffett is a luminous example of the school of value investing. Starting with an initial fund of $105,000 in 1956, Buffet grew it to $45 billion over the next 50 years, making him the second richest man in the world. Though he is widely recognized as being an investor, the bulk of Buffet's wealth was built through intelligent use of leverage offered by his insurance companies. Since most individual investors do not have access to the type of capital that Buffet does, it is not easy to replicate his astounding wealth-building feat. However, by understanding and applying the basic guidelines of Buffett's investment approach to their own investing decisions, most long term investors can comfortably beat the returns of all but the best mutual fund managers.
So, how did Buffet accumulate the huge fortune that he eventually gave away to the charitable foundation run by his best friend, Bill Gates? One of the greatest attractions of Buffett for investors is that his investment methodology is easy to understand. However, it is far more difficult to apply because it calls for large amounts of patience and calm when your stocks move against you. It is also difficult to apply because it requires an orientation towards research and the ability to understand the complexities of accounting and finance. But for those willing to invest time and effort into mastering this approach, superlative investment performance over the long term is guaranteed.
Invest in Businesses, Not in Stocks
"Whenever we buy common stocks for Berkshire's insurance companies (leaving aside arbitrage purchases), we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay." -- Warren Buffett
This is the cornerstone of Buffett's investment style. Whenever he evaluates an investment opportunity he analyses it as a business and not as a stock. This makes him look closely at the company's fundamentals, earnings prospects, financial health and management. Conversely, this style of evaluating a business prevents him from buying a stock just because it is going up even though it has dubious prospects. A lot of investors tend to buy stocks based on tips from friends, acquaintances or brokers. By adopting Buffett's approach, you can save yourself a lot of grief later on.
Only Buy Businesses that You Understand
"Did we foresee thirty years ago what would transpire in the television manufacturing or computer industries? Of course not. Why, then, should Charlie and I now think we can predict the future of other rapidly evolving business? We'll stick instead with the easy cases. Why search for a needle buried in a haystack when one is sitting in plain sight?" -- Warren Buffett
Buffett has a track record of generating 21 per cent annually compounded returns over a 50-year time frame, a feat matched by very few investment managers. Though technology companies delivered some of the best returns during this period, Buffet has never owned one for the simple reason that he could not understand the long term prospects of these companies and evaluate them thoroughly. So the next time you get a tip to buy a "hot" company that you do not understand, you should ask yourself: "If the greatest investor in the world will not invest in something he doesn't understand, should I?"
Buy Companies with Defensible 'Franchise'
"As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label: 'Competition may prove hazardous to human wealth'." -- Warren Buffett
Most of Buffett's portfolio companies, such as Coca Cola, Gillette (now Procter and Gamble), American Express and Washington Post, are businesses which have a significant hold over their market. This is because they have inherent competitive advantages, whether it be a highly recognizable brand, or near-monopoly status in a geographic area. Such companies can typically raise their prices without fear that customers will walk away. This in turn produces fantastic earnings growth and, consequently, great investment performance. So, before you make an investment in future, try to understand whether the company you are investing in has a strong and defensible market position and whether it can raise prices if it needs to.
Hold for the Long Term
"We are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate . . . we do not sell our holdings just because they have appreciated or because we have held them for a long time." � Warren Buffett
Buffett's companies have generated enormous returns for him. For example, his investment of $10 million in 1973 in the Washington Post Company had grown to more than $1 billion by 2003. While a lot of us may be able to do this occasionally, Buffett has generated such returns with startling regularity. One of the reasons he is able to do so is because he holds for the long term and is not quick to enter or exit businesses. In fact, he stuck with WPC for two years even though its price fell below his purchase price because he understood the fundamentals of the business and believed that it was undervalued. Even once it became profitable, he was not quick to exit because he believed that it had greater potential. He held it through several bull and bear markets and no greater proof is needed than the return he achieved to show that he was right in holding it for so long.
Ignore Short-Term Fluctuations in Price
"Charlie and I let our marketable equities tell us by their operating results�not by their daily, or even yearly, price quotations�whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it." � Warren Buffett
The stock market has a tendency to overreact on both the upside and downside. Often the market ignores the fundamentals of a business and reacts sharply to news flow. Sometimes entire sectors become either unduly depressed or overpriced. One of the key pillars of Buffett's approach is to ignore short-term fluctuations in price. He does not sell a stock because the market suddenly decides to drop. Neither does he buy one because it is going up. Once Buffett has calmly evaluated the fundamentals, he will buy the stock if its price is right. If the stock dips after he has purchased it, he does not worry so long as its fundamentals are good. Had he gotten jittery due to short-term price fluctuations, he would have been a lot less richer than he his currently.
Buy Good Businesses When Prices are Down
"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they feel elated when stock prices rise and depressed when they fall. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices." � Warren Buffett
On 19 October 1987, all global stock markets crashed. The Dow Jones Industrial Average actually suffered a decline of 22 per cent, the greatest single-day drop in its history. Every stock on the market fell. Most people sold their holdings in panic that day. Buffett, however, was buying! He made the single largest stock purchase of his life that day. While all others around him hit the panic button, Buffet bought 10 per cent of Coca Cola for $1 billion. Not only was it his largest single stock purchase, he also became the single largest shareholder in the company. In his analysis, Coca Cola had a great business, great long-term prospects and the ability to expand because of globalisation. If the market was willing to sell it at an unreasonably cheap price, he wanted to scoop it up with both hands. And scoop it up he did! Coca Cola became one of the most successful investments in Berkshire's portfolio. By 2006, Buffett had made over $11 billion on Coke since he bought it.
Don't Be an Active Trader
"Indeed, we believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic." � Warren Buffett
Buffett is an atypical investor not only because he is highly successful, but also because he does not even look at stock tickers. He believes that trading too much is a tax-inefficient and costly approach to investing. Consequently, he has a very low turnover portfolio, very low brokerage charges and has not paid very much in the nature of capital gains taxes.
Do Not Over-Diversify
"If you are a know-something investor, able to understand business economics and to find five to ten sensibly priced companies that possess important long-term competitive advantage, conventional diversification makes no sense for you." -- Warren Buffett
A striking aspect of Buffett's portfolio at Berkshire is the small number of stocks in it. This number has rarely exceeded 10 stocks. Buffett believes that there are very few outstanding investment opportunities at any given point of time and that one should invest enough in each of those to make a substantial difference. In contrast, most people fill up their portfolios with more than fifty stocks. As a result, even if a stock appreciates 100 per cent, the impact on their net worth will only be 2 per cent. Investors who want to generate truly outstanding returns should identify a small number of great businesses at the right prices and invest a significant amount of their money in each of them.
Invest Only When There is a Margin of Safety
"Margin of safety" is a slightly difficult concept to understand. It can be loosely defined as the difference between value and price. If the value of what you buy is higher than the price you pay for it, you have a high margin of safety. If the price you pay is greater than value, you have a low margin of safety. When the margin of safety is high, the investor need not worry about short-term fluctuations in price and can buy more if he or she has the resources to do so. Also, if you are investing in a situation with a significant margin of safety, you are likely to make a higher return because you are buying at a relatively low price.
However, how does one quantify this margin of safety? It is admittedly a grey area. There are seemingly scientific approaches, such as the discounted cash flow, which are taught in most corporate finance textbooks. In practice, though, it is both very subjective and very difficult for an individual investor to apply. However, there are other short cuts which are more approachable. Since the discounted cash flow ultimately crystallizes into the price / earnings (P/E) ratio, one way of estimating the margin of safety is to look at the P/E ratio. A low P/E means there is a margin of safety. But even this approach has its pitfalls. Slow growing, lousy companies often tend to have low P/E ratios. And, sometimes, very promising companies have high P/E multiples. One way around this problem is to divide the P/E ratio by the growth rate of the company's profits to arrive at its price-earnings to growth ratio. Thus, if a company's P/E is 20 and the growth rate of its profits is 20 per cent, its PEG is 1. Oftentimes, a PEG of less than 1 implies that there is a significant margin of safety. A PEG of greater than one means that the margin of safety is not very high.
That said, PEG is not the holy grail of valuation and there are several ways to value a company -- and all these approaches have their flaws. You can consider your time well invested if you spend some time researching valuation by reading a corporate finance textbook.
Thus, Warren Buffet's investment approach is easy to understand, but calls for significant effort on your part to understand businesses, evaluate them and invest successfully but then, nobody said that becoming a billionaire was easy!
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Sunday, 30 September 2007
Will A Google Phone Change The Game?
Mobile biggies are quaking at the idea of competition from a free, ad-based service Imagine your cellphone as a mini marketing machine. As you head into your car after dinner, a text alert pops onto the screen of your handset announcing the 9 p.m. lineup at a nearby cineplex. You choose the Jodi Foster flick The Brave One and a promo video for the next Warner Bros. (TWX ) release, a George Clooney movie, starts running. Afterward, more text appears, prompting you to launch the phone's Web browser so that you can click through to buy the movie's ringtones and wallpaper.
That kind of 24/7 advertising engagement--on a phone, no less--may sound like a nightmare. But what if you could determine the kinds of products you get pitched? Or, when your flight gets canceled in a faraway airport, text messages pop up for the best hotel deals in town? No random insurance ads or airline deals for trips to places you never visit. Best of all: Watch or read the custom ads, and your phone minutes are free.For big cell carriers, that's the real nightmare. And it may be coming in the form of a Google phone. Wireless industry consultants and marketing executives with knowledge of Google's plans say it has been showing prototypes of a new phone to handset manufacturers and network operators for a couple of months. Its plans have been kept top secret, but Google is expected to tap a company on the Pacific Rim that specializes in mobile design and manufacturing to build a handset to its specs. Google could then apply its expertise in operating software and user applications, says Paul Catalano, a partner at consultancy RelevantC Business Group (RCBG). Google officials won't talk about phones, and industry sources don't expect one before the second half of 2008.Still, Google has made it clear it has an interest in wireless. It is experimenting with wireless broadband networks in a couple of U.S. cities. In August, CEO Eric Schmidt announced his intention to participate in a federal auction early next year of the sort of radio spectrum that would help pull off a phone service.So far only a few outfits in Europe and the U.S. have dabbled with ways to serve up ad-based service. Most, like Virgin Mobile USA, have limited control over ad delivery because their service runs over a network leased from one of the big players. Moreover, there are good reasons that advertising accounts for less than 1% of phone company revenues: Consumers remain skittish about ads on their phone. Networks and handsets are only now getting sophisticated enough to deliver colorful, location-specific ads. And Verizon (VZ ), AT&T (T ), and T-Mobile have no interest in giving up their fat service fees.That equation goes out the window, though, once you combine Google's financial heft with its ultra-sophisticated ability to target ads to specific customers. "The day is coming when wireless users will experience nirvana scenarios--mobile ads tied to your individual behavior, what you are doing, and where you are," says Linda Barrabee, wireless analyst at researcher Yankee Group.BILLIONS OF EYESGoogle and advertisers drool over the growth potential in wireless. The more than 2 1/2 billion phones in use worldwide exceed the number of PCs and TVs combined. On Sept. 17, Google announced a Web program aimed at advertisers who have created sites for display on cell phones and other handheld devices. Like its online ad network, Google's AdSense for Mobile delivers ads relevant to the advertiser's mobile audience. "The sheer volume of users across the globe makes mobile the next channel for information," says Dilip Venkatachari, director of product management for Google's mobile team.Why stop there? The core of Google's online ad strategy has always been to help advertisers target their ads so they fit like spandex tights with user interests. Employing technologies that figure out where callers are and where they're headed boosts advertising prices by 50%, according to studies by RCBG.A number of existing strategies by smaller companies offer a glimpse into how Google might play its wireless hand, once all the cards have been dealt. Blyk, a wireless startup that made its debut in Britain on Sept. 24, offers free mobile phone calls and text messages for people aged 16 to 24 who agree to let companies such as L'Oréal, McDonald's (MCD ), and Coca-Cola (KO ) send text ads to their handsets. Blyk leases space on European carrier Orange's network in Britain, but it operates its own billing and marketing system. That lets it retain full control of valuable customer information and avoid sharing ad revenues with the carrier. Users fill out detailed information about their lifestyles, areas of interest, and brand preferences. Those who agree to receive tailored ads get 43 minutes per month of free mobile voice service and 217 free text messages.In the U.S., a service from Virgin Mobile called Sugar Mama offers subscribers a chance to earn free minutes if they agree to view tailored ads. As of August, more than 425,000 people had signed up. They can choose to have text ads in the form of quizzes and games sent to a phone a couple of times a week; play the games and you earn minutes.The big-time carriers already have banner ads from companies such as Avis or the Discovery Channel on the pages of their mobile Web portals. But don't expect the phone giants to change their business model if they don't have to. A Verizon spokesman says the incremental dollar value of advertising pales next to the cost of losing customers who don't like ads. Says AT&T Mobility's Mark Collins, vice-president for consumer data: "We don't believe in a world where you have to give everything away for free."That's precisely what Google represents. Even without a network, Venkatachari says Google plans to connect mobile advertisers with users based on information from its search engine, maps, and other software, just as it has done on the desktop. Via Google search, for example, an advertiser learns a user is at the corner bakery in downtown Chicago. And it learns the person has a taste for sweets. Wireless carriers have customer information as well, but "they are not a data warehouse, the way Google is," explains Richard Siber, principal of SiberConsulting.If Google decides to spend the $4.6 billion that may be needed to win the spectrum auction, analysts speculate that it has several options: continue its broadband expansion, or perhaps buy a wireless carrier, such as beleaguered Sprint Nextel (S ). Then it could launch the first ad- supported, and free, nationwide phone service. "Google is the first gambler sitting down with as big a bankroll as the carriers have," says John du Pre Gauntt, a wireless industry analyst for researcher eMarketer. "By playing in wireless, they have caused people to look at the industry in a different way
That kind of 24/7 advertising engagement--on a phone, no less--may sound like a nightmare. But what if you could determine the kinds of products you get pitched? Or, when your flight gets canceled in a faraway airport, text messages pop up for the best hotel deals in town? No random insurance ads or airline deals for trips to places you never visit. Best of all: Watch or read the custom ads, and your phone minutes are free.For big cell carriers, that's the real nightmare. And it may be coming in the form of a Google phone. Wireless industry consultants and marketing executives with knowledge of Google's plans say it has been showing prototypes of a new phone to handset manufacturers and network operators for a couple of months. Its plans have been kept top secret, but Google is expected to tap a company on the Pacific Rim that specializes in mobile design and manufacturing to build a handset to its specs. Google could then apply its expertise in operating software and user applications, says Paul Catalano, a partner at consultancy RelevantC Business Group (RCBG). Google officials won't talk about phones, and industry sources don't expect one before the second half of 2008.Still, Google has made it clear it has an interest in wireless. It is experimenting with wireless broadband networks in a couple of U.S. cities. In August, CEO Eric Schmidt announced his intention to participate in a federal auction early next year of the sort of radio spectrum that would help pull off a phone service.So far only a few outfits in Europe and the U.S. have dabbled with ways to serve up ad-based service. Most, like Virgin Mobile USA, have limited control over ad delivery because their service runs over a network leased from one of the big players. Moreover, there are good reasons that advertising accounts for less than 1% of phone company revenues: Consumers remain skittish about ads on their phone. Networks and handsets are only now getting sophisticated enough to deliver colorful, location-specific ads. And Verizon (VZ ), AT&T (T ), and T-Mobile have no interest in giving up their fat service fees.That equation goes out the window, though, once you combine Google's financial heft with its ultra-sophisticated ability to target ads to specific customers. "The day is coming when wireless users will experience nirvana scenarios--mobile ads tied to your individual behavior, what you are doing, and where you are," says Linda Barrabee, wireless analyst at researcher Yankee Group.BILLIONS OF EYESGoogle and advertisers drool over the growth potential in wireless. The more than 2 1/2 billion phones in use worldwide exceed the number of PCs and TVs combined. On Sept. 17, Google announced a Web program aimed at advertisers who have created sites for display on cell phones and other handheld devices. Like its online ad network, Google's AdSense for Mobile delivers ads relevant to the advertiser's mobile audience. "The sheer volume of users across the globe makes mobile the next channel for information," says Dilip Venkatachari, director of product management for Google's mobile team.Why stop there? The core of Google's online ad strategy has always been to help advertisers target their ads so they fit like spandex tights with user interests. Employing technologies that figure out where callers are and where they're headed boosts advertising prices by 50%, according to studies by RCBG.A number of existing strategies by smaller companies offer a glimpse into how Google might play its wireless hand, once all the cards have been dealt. Blyk, a wireless startup that made its debut in Britain on Sept. 24, offers free mobile phone calls and text messages for people aged 16 to 24 who agree to let companies such as L'Oréal, McDonald's (MCD ), and Coca-Cola (KO ) send text ads to their handsets. Blyk leases space on European carrier Orange's network in Britain, but it operates its own billing and marketing system. That lets it retain full control of valuable customer information and avoid sharing ad revenues with the carrier. Users fill out detailed information about their lifestyles, areas of interest, and brand preferences. Those who agree to receive tailored ads get 43 minutes per month of free mobile voice service and 217 free text messages.In the U.S., a service from Virgin Mobile called Sugar Mama offers subscribers a chance to earn free minutes if they agree to view tailored ads. As of August, more than 425,000 people had signed up. They can choose to have text ads in the form of quizzes and games sent to a phone a couple of times a week; play the games and you earn minutes.The big-time carriers already have banner ads from companies such as Avis or the Discovery Channel on the pages of their mobile Web portals. But don't expect the phone giants to change their business model if they don't have to. A Verizon spokesman says the incremental dollar value of advertising pales next to the cost of losing customers who don't like ads. Says AT&T Mobility's Mark Collins, vice-president for consumer data: "We don't believe in a world where you have to give everything away for free."That's precisely what Google represents. Even without a network, Venkatachari says Google plans to connect mobile advertisers with users based on information from its search engine, maps, and other software, just as it has done on the desktop. Via Google search, for example, an advertiser learns a user is at the corner bakery in downtown Chicago. And it learns the person has a taste for sweets. Wireless carriers have customer information as well, but "they are not a data warehouse, the way Google is," explains Richard Siber, principal of SiberConsulting.If Google decides to spend the $4.6 billion that may be needed to win the spectrum auction, analysts speculate that it has several options: continue its broadband expansion, or perhaps buy a wireless carrier, such as beleaguered Sprint Nextel (S ). Then it could launch the first ad- supported, and free, nationwide phone service. "Google is the first gambler sitting down with as big a bankroll as the carriers have," says John du Pre Gauntt, a wireless industry analyst for researcher eMarketer. "By playing in wireless, they have caused people to look at the industry in a different way
Saturday, 22 September 2007
All about commodity derivatives You would like to know before you start to put the bets on it.
Trading in derivatives first started to protect farmers from the risk of the value of their crop going below the cost price of their produce. Derivative contracts were offered on various agricultural products like cotton, rice, coffee, wheat, pepper, et cetera.
The first organised exchange, the Chicago Board of Trade (CBOT) -- with standardised contracts on various commodities -- was established in 1848. In 1874, the Chicago Produce Exchange -- which is now known as Chicago Mercantile Exchange -- was formed (CME).
CBOT and CME are two of the largest commodity derivatives exchanges in the world.
The Indian scenario
Commodity derivatives have had a long and a chequered presence in India. The commodity derivative market has been functioning in India since the nineteenth century with organised trading in cotton through the establishment of Cotton Trade Association in 1875. Over the years, there have been various bans, suspensions and regulatory dogmas on various contracts.
There are 25 commodity derivative exchanges in India as of now and derivative contracts on nearly 100 commodities are available for trade. The overall turnover is expected to touch Rs 5 lakh crore (Rs 5 trillion) by the end of 2004-2005.
National Commodity and Derivatives Exchange (NCDEX) is the largest commodity derivatives exchange with a turnover of around Rs 3,000 crore (Rs 30 billion) every fortnight.
It is only in the last decade that commodity derivatives exchanges have been actively encouraged. But, the markets have suffered from poor liquidity and have not grown to any significant level, till recently.
However, in the year 2003, four national commodity exchanges became operational; National Multi-Commodity Exchange of India (NMCE), National Board of Trade (NBOT), National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX).
The onset of these exchanges and the introduction of futures contracts on new commodities by the Forwards Market Commission have triggered significant levels of trade. Now the commodities futures trading in India is all set to match the volumes on the capital markets.
Investing in commodity derivatives
Commodity derivatives, which were traditionally developed for risk management purposes, are now growing in popularity as an investment tool. Most of the trading in the commodity derivatives market is being done by people who have no need for the commodity itself.
They just speculate on the direction of the price of these commodities, hoping to make money if the price moves in their favour.
The commodity derivatives market is a direct way to invest in commodities rather than investing in the companies that trade in those commodities.
For example, an investor can invest directly in a steel derivative rather than investing in the shares of Tata Steel. It is easier to forecast the price of commodities based on their demand and supply forecasts as compared to forecasting the price of the shares of a company -- which depend on many other factors than just the demand -- and supply of the products they manufacture and sell or trade in.
Also, derivatives are much cheaper to trade in as only a small sum of money is required to buy a derivative contract.
Let us assume that an investor buys a tonne of soybean for Rs 8,700 in anticipation that the prices will rise to Rs 9,000 by June 30, 2005. He will be able to make a profit of Rs 300 on his investment, which is 3.4%. Compare this to the scenario if the investor had decided to buy soybean futures instead.
Before we look into how investment in a derivative contract works, we must familiarise ourselves with the buyer and the seller of a derivative contract. A buyer of a derivative contract is a person who pays an initial margin to buy the right to buy or sell a commodity at a certain price and a certain date in the future.
On the other hand, the seller accepts the margin and agrees to fulfil the agreed terms of the contract by buying or selling the commodity at the agreed price on the maturity date of the contract.
Now let us say the investor buys soybean futures contract to buy one tonne of soybean for Rs 8,700 (exercise price) . The contract is available by paying an initial margin of 10%, i.e. Rs 870. Note that the investor needs to invest only Rs 870 here.
The price of soybean in the market is, say, Rs 9,000 (known as Spot Price -- Spot Price is the current market price of the commodity at any point in time).
The investor can take the delivery of one tonne of soybean at Rs 8,700 and immediately sell it in the market for Rs 9,000, making a profit of Rs 300. So the return on the investment of Rs 870 is 34.5%. On the contrary, if the price of soybean drops to Rs 8,400 the investor will end up making a loss of 34.5%.
If the investor wants, instead of taking the delivery of the commodity upon maturity of the contract, an option to settle the contract in cash also exists. Cash settlement comprises exchange of the difference in the spot price of the commodity and the exercise price as per the futures contract.
At present, the option of cash settlement lies only with the seller of the contract. If the seller decides to make or take delivery upon maturity, the buyer of the contract has to fulfil his obligation by either taking or making delivery of the commodity, depending on the specifications of the contract.
In the above example, if the seller decides to go for cash settlement, the contract can be settled by the seller paying Rs 300 to the buyer, which is the difference in the spot price of the commodity and the exercise price. Once again, the return on the investment of Rs 870 is 34.5%.
The above example shows that with very little investment, the commodity futures market offers scope to make big bucks. However, trading in derivatives is highly risky because just as there are high returns to be earned if prices move in favour of the investors, an unfavourable move results in huge losses.
The most critical function in a commodity derivatives exchange is the settlement and clearing of trades. Commodity derivatives can involve the exchange of funds and goods. The exchanges have a separate body to handle all the settlements, known as the clearing house.
For example, the seller of a futures contract to buy soybean might choose to take delivery of soyabean rather than closing his position before maturity. The function of the clearing house or clearing organisation, in such a case, is to take care of possible problems of default by the other party involved by standardising and simplifying transaction processing between participants and the organisation.
In spite of the surge in the turnover of the commodity exchanges in recent years, a lot of work in terms of policy liberalisation, setting up the right legal system, creating the necessary infrastructure, large-scale training programs, et cetera still needs to be done in order to catch up with the developed commodity derivative markets.
Also, trading in commodity options is prohibited in India. The regulators should look towards introducing new contracts in the Indian market in order to provide the investors with choice, plus provide the farmers and commodity traders with more tools to hedge their risks
Trading in derivatives first started to protect farmers from the risk of the value of their crop going below the cost price of their produce. Derivative contracts were offered on various agricultural products like cotton, rice, coffee, wheat, pepper, et cetera.
The first organised exchange, the Chicago Board of Trade (CBOT) -- with standardised contracts on various commodities -- was established in 1848. In 1874, the Chicago Produce Exchange -- which is now known as Chicago Mercantile Exchange -- was formed (CME).
CBOT and CME are two of the largest commodity derivatives exchanges in the world.
The Indian scenario
Commodity derivatives have had a long and a chequered presence in India. The commodity derivative market has been functioning in India since the nineteenth century with organised trading in cotton through the establishment of Cotton Trade Association in 1875. Over the years, there have been various bans, suspensions and regulatory dogmas on various contracts.
There are 25 commodity derivative exchanges in India as of now and derivative contracts on nearly 100 commodities are available for trade. The overall turnover is expected to touch Rs 5 lakh crore (Rs 5 trillion) by the end of 2004-2005.
National Commodity and Derivatives Exchange (NCDEX) is the largest commodity derivatives exchange with a turnover of around Rs 3,000 crore (Rs 30 billion) every fortnight.
It is only in the last decade that commodity derivatives exchanges have been actively encouraged. But, the markets have suffered from poor liquidity and have not grown to any significant level, till recently.
However, in the year 2003, four national commodity exchanges became operational; National Multi-Commodity Exchange of India (NMCE), National Board of Trade (NBOT), National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX).
The onset of these exchanges and the introduction of futures contracts on new commodities by the Forwards Market Commission have triggered significant levels of trade. Now the commodities futures trading in India is all set to match the volumes on the capital markets.
Investing in commodity derivatives
Commodity derivatives, which were traditionally developed for risk management purposes, are now growing in popularity as an investment tool. Most of the trading in the commodity derivatives market is being done by people who have no need for the commodity itself.
They just speculate on the direction of the price of these commodities, hoping to make money if the price moves in their favour.
The commodity derivatives market is a direct way to invest in commodities rather than investing in the companies that trade in those commodities.
For example, an investor can invest directly in a steel derivative rather than investing in the shares of Tata Steel. It is easier to forecast the price of commodities based on their demand and supply forecasts as compared to forecasting the price of the shares of a company -- which depend on many other factors than just the demand -- and supply of the products they manufacture and sell or trade in.
Also, derivatives are much cheaper to trade in as only a small sum of money is required to buy a derivative contract.
Let us assume that an investor buys a tonne of soybean for Rs 8,700 in anticipation that the prices will rise to Rs 9,000 by June 30, 2005. He will be able to make a profit of Rs 300 on his investment, which is 3.4%. Compare this to the scenario if the investor had decided to buy soybean futures instead.
Before we look into how investment in a derivative contract works, we must familiarise ourselves with the buyer and the seller of a derivative contract. A buyer of a derivative contract is a person who pays an initial margin to buy the right to buy or sell a commodity at a certain price and a certain date in the future.
On the other hand, the seller accepts the margin and agrees to fulfil the agreed terms of the contract by buying or selling the commodity at the agreed price on the maturity date of the contract.
Now let us say the investor buys soybean futures contract to buy one tonne of soybean for Rs 8,700 (exercise price) . The contract is available by paying an initial margin of 10%, i.e. Rs 870. Note that the investor needs to invest only Rs 870 here.
The price of soybean in the market is, say, Rs 9,000 (known as Spot Price -- Spot Price is the current market price of the commodity at any point in time).
The investor can take the delivery of one tonne of soybean at Rs 8,700 and immediately sell it in the market for Rs 9,000, making a profit of Rs 300. So the return on the investment of Rs 870 is 34.5%. On the contrary, if the price of soybean drops to Rs 8,400 the investor will end up making a loss of 34.5%.
If the investor wants, instead of taking the delivery of the commodity upon maturity of the contract, an option to settle the contract in cash also exists. Cash settlement comprises exchange of the difference in the spot price of the commodity and the exercise price as per the futures contract.
At present, the option of cash settlement lies only with the seller of the contract. If the seller decides to make or take delivery upon maturity, the buyer of the contract has to fulfil his obligation by either taking or making delivery of the commodity, depending on the specifications of the contract.
In the above example, if the seller decides to go for cash settlement, the contract can be settled by the seller paying Rs 300 to the buyer, which is the difference in the spot price of the commodity and the exercise price. Once again, the return on the investment of Rs 870 is 34.5%.
The above example shows that with very little investment, the commodity futures market offers scope to make big bucks. However, trading in derivatives is highly risky because just as there are high returns to be earned if prices move in favour of the investors, an unfavourable move results in huge losses.
The most critical function in a commodity derivatives exchange is the settlement and clearing of trades. Commodity derivatives can involve the exchange of funds and goods. The exchanges have a separate body to handle all the settlements, known as the clearing house.
For example, the seller of a futures contract to buy soybean might choose to take delivery of soyabean rather than closing his position before maturity. The function of the clearing house or clearing organisation, in such a case, is to take care of possible problems of default by the other party involved by standardising and simplifying transaction processing between participants and the organisation.
In spite of the surge in the turnover of the commodity exchanges in recent years, a lot of work in terms of policy liberalisation, setting up the right legal system, creating the necessary infrastructure, large-scale training programs, et cetera still needs to be done in order to catch up with the developed commodity derivative markets.
Also, trading in commodity options is prohibited in India. The regulators should look towards introducing new contracts in the Indian market in order to provide the investors with choice, plus provide the farmers and commodity traders with more tools to hedge their risks
Sunday, 2 September 2007
What has happened to Iraq's missing $1bn?
One billion dollars has been plundered from Iraq's defence ministry in one of the largest thefts in history, The Independent can reveal, leaving the country's army to fight a savage insurgency with museum-piece weapons.
The money, intended to train and equip an Iraqi army capable of bringing security to a country shattered by the US-led invasion and prolonged rebellion, was instead siphoned abroad in cash and has disappeared.
"It is possibly one of the largest thefts in history," Ali Allawi, Iraq's Finance Minister, told The Independent.
"Huge amounts of money have disappeared. In return we got nothing but scraps of metal."
The carefully planned theft has so weakened the army that it cannot hold Baghdad against insurgent attack without American military support, Iraqi officials say, making it difficult for the US to withdraw its 135,000- strong army from Iraq, as Washington says it wishes to do.
Most of the money was supposedly spent buying arms from Poland and Pakistan. The contracts were peculiar in four ways. According to Mr Allawi, they were awarded without bidding, and were signed with a Baghdad-based company, and not directly with the foreign supplier. The money was paid up front, and, surprisingly for Iraq, it was paid at great speed out of the ministry's account with the Central Bank. Military equipment purchased in Poland included 28-year-old Soviet-made helicopters. The manufacturers said they should have been scrapped after 25 years of service. Armoured cars purchased by Iraq turned out to be so poorly made that even a bullet from an elderly AK-47 machine-gun could penetrate their armour. A shipment of the latest MP5 American machine-guns, at a cost of $3,500 (£1,900) each, consisted in reality of Egyptian copies worth only $200 a gun. Other armoured cars leaked so much oil that they had to be abandoned. A deal was struck to buy 7.62mm machine-gun bullets for 16 cents each, although they should have cost between 4 and 6 cents.
Many Iraqi soldiers and police have died because they were not properly equipped. In Baghdad they often ride in civilian pick-up trucks vulnerable to gunfire, rocket- propelled grenades or roadside bombs. For months even men defusing bombs had no protection against blast because they worked without bullet-proof vests. These were often promised but never turned up.
The Iraqi Board of Supreme Audit says in a report to the Iraqi government that US-appointed Iraqi officials in the defence ministry allegedly presided over these dubious transactions.
Senior Iraqi officials now say they cannot understand how, if this is so, the disappearance of almost all the military procurement budget could have passed unnoticed by the US military in Baghdad and civilian advisers working in the defence ministry.
Government officials in Baghdad even suggest that the skill with which the robbery was organised suggests that the Iraqis involved were only front men, and "rogue elements" within the US military or intelligence services may have played a decisive role behind the scenes.
Given that building up an Iraqi army to replace American and British troops is a priority for Washington and London, the failure to notice that so much money was being siphoned off at the very least argues a high degree of negligence on the part of US officials and officers in Baghdad.
The report of the Board of Supreme Audit on the defence ministry contracts was presented to the office of Ibrahim al-Jaafari, the Prime Minister, in May. But the extent of the losses has become apparent only gradually. The sum missing was first reported as $300m and then $500m, but in fact it is at least twice as large. "If you compare the amount that was allegedly stolen of about $1bn compared with the budget of the ministry of defence, it is nearly 100 per cent of the ministry's [procurement] budget that has gone Awol," said Mr Allawi.
The money missing from all ministries under the interim Iraqi government appointed by the US in June 2004 may turn out to be close to $2bn. Of a military procurement budget of $1.3bn, some $200m may have been spent on usable equipment, though this is a charitable view, say officials. As a result the Iraqi army has had to rely on cast-offs from the US military, and even these have been slow in coming.
Mr Allawi says a further $500m to $600m has allegedly disappeared from the electricity, transport, interior and other ministries. This helps to explain why the supply of electricity in Baghdad has been so poor since the fall of Saddam Hussein 29 months ago despite claims by the US and subsequent Iraqi governments that they are doing everything to improve power generation.
The sum missing over an eight-month period in 2004 and 2005 is the equivalent of the $1.8bn that Saddam allegedly received in kick- backs under the UN's oil-for-food programme between 1997 and 2003. The UN was pilloried for not stopping this corruption. The US military is likely to be criticised over the latest scandal because it was far better placed than the UN to monitor corruption.
The fraud took place between 28 June 2004 and 28 February this year under the government of Iyad Allawi, who was interim prime minister. His ministers were appointed by the US envoy Robert Blackwell and his UN counterpart, Lakhdar Brahimi.
Among those whom the US promoted was a man who was previously a small businessman in London before the war, called Hazem Shaalan, who became Defence Minister.
Mr Shalaan says that Paul Bremer, then US viceroy in Iraq, signed off the appointment of Ziyad Cattan as the defence ministry's procurement chief. Mr Cattan, of joint Polish-Iraqi nationality, spent 27 years in Europe, returning to Iraq two days before the war in 2003. He was hired by the US-led Coalition Provisional Authority and became a district councillor before moving to the defence ministry.
For eight months the ministry spent money without restraint. Contracts worth more than $5m should have been reviewed by a cabinet committee, but Mr Shalaan asked for and received from the cabinet an exemption for the defence ministry. Missions abroad to acquire arms were generally led by Mr Cattan. Contracts for large sums were short scribbles on a single piece of paper. Auditors have had difficulty working out with whom Iraq has a contract in Pakistan.
Authorities in Baghdad have issued an arrest warrant for Mr Cattan. Neither he nor Mr Shalaan, both believed to be in Jordan, could be reached for further comment. Mr Bremer says he has never heard of Mr Cattan.
A week of violence in Iraq
* SUNDAY 11 SEPTEMBER
Gunmen killed a senior Iraqi judge, his brother and a Major General in the Iraq army. A British and a US soldier were killed in bomb attacks.
* MONDAY 12 SEPTEMBER
Gunmen killed nine civilians and two policemen in Baghdad and a roadside bomb killed six Iraqi soldiers in Fallujah.
* TUESDAY 13 SEPTEMBER
A car bomb killed five people and gunmen killed another four in the Mansour district of Baghdad Two civilians were killed by a suicide bomber on a bus in Hilla.
* WEDNESDAY 14 SEPTEMBER
At least 167 people were killed and 570 wounded in 14 bombings in Baghdad.
* THURSDAY 15 SEPTEMBER
Three suicide car bombers killed 28 policemen and eight civilians and gunmen killed four more people Baghdad.
* FRIDAY 16 SEPTEMBER
Two suicide car bombers killed 13 people, and gunmen shot dead eight more in Baghdad, including a local mayor in Iskanariya district and an imam in Sadr City.
* SATURDAY 17 SEPTEMBER
At least 52 people were killed or found dead throughout the country.
* SUNDAY 18 SEPTEMBER
At least three Iraqi soldiers were killed in a roadside bomb and an Iraqi MP and four others were shot dead by gunmen. Two dozen bodies of murder victims were found in the Tigris.
The money, intended to train and equip an Iraqi army capable of bringing security to a country shattered by the US-led invasion and prolonged rebellion, was instead siphoned abroad in cash and has disappeared.
"It is possibly one of the largest thefts in history," Ali Allawi, Iraq's Finance Minister, told The Independent.
"Huge amounts of money have disappeared. In return we got nothing but scraps of metal."
The carefully planned theft has so weakened the army that it cannot hold Baghdad against insurgent attack without American military support, Iraqi officials say, making it difficult for the US to withdraw its 135,000- strong army from Iraq, as Washington says it wishes to do.
Most of the money was supposedly spent buying arms from Poland and Pakistan. The contracts were peculiar in four ways. According to Mr Allawi, they were awarded without bidding, and were signed with a Baghdad-based company, and not directly with the foreign supplier. The money was paid up front, and, surprisingly for Iraq, it was paid at great speed out of the ministry's account with the Central Bank. Military equipment purchased in Poland included 28-year-old Soviet-made helicopters. The manufacturers said they should have been scrapped after 25 years of service. Armoured cars purchased by Iraq turned out to be so poorly made that even a bullet from an elderly AK-47 machine-gun could penetrate their armour. A shipment of the latest MP5 American machine-guns, at a cost of $3,500 (£1,900) each, consisted in reality of Egyptian copies worth only $200 a gun. Other armoured cars leaked so much oil that they had to be abandoned. A deal was struck to buy 7.62mm machine-gun bullets for 16 cents each, although they should have cost between 4 and 6 cents.
Many Iraqi soldiers and police have died because they were not properly equipped. In Baghdad they often ride in civilian pick-up trucks vulnerable to gunfire, rocket- propelled grenades or roadside bombs. For months even men defusing bombs had no protection against blast because they worked without bullet-proof vests. These were often promised but never turned up.
The Iraqi Board of Supreme Audit says in a report to the Iraqi government that US-appointed Iraqi officials in the defence ministry allegedly presided over these dubious transactions.
Senior Iraqi officials now say they cannot understand how, if this is so, the disappearance of almost all the military procurement budget could have passed unnoticed by the US military in Baghdad and civilian advisers working in the defence ministry.
Government officials in Baghdad even suggest that the skill with which the robbery was organised suggests that the Iraqis involved were only front men, and "rogue elements" within the US military or intelligence services may have played a decisive role behind the scenes.
Given that building up an Iraqi army to replace American and British troops is a priority for Washington and London, the failure to notice that so much money was being siphoned off at the very least argues a high degree of negligence on the part of US officials and officers in Baghdad.
The report of the Board of Supreme Audit on the defence ministry contracts was presented to the office of Ibrahim al-Jaafari, the Prime Minister, in May. But the extent of the losses has become apparent only gradually. The sum missing was first reported as $300m and then $500m, but in fact it is at least twice as large. "If you compare the amount that was allegedly stolen of about $1bn compared with the budget of the ministry of defence, it is nearly 100 per cent of the ministry's [procurement] budget that has gone Awol," said Mr Allawi.
The money missing from all ministries under the interim Iraqi government appointed by the US in June 2004 may turn out to be close to $2bn. Of a military procurement budget of $1.3bn, some $200m may have been spent on usable equipment, though this is a charitable view, say officials. As a result the Iraqi army has had to rely on cast-offs from the US military, and even these have been slow in coming.
Mr Allawi says a further $500m to $600m has allegedly disappeared from the electricity, transport, interior and other ministries. This helps to explain why the supply of electricity in Baghdad has been so poor since the fall of Saddam Hussein 29 months ago despite claims by the US and subsequent Iraqi governments that they are doing everything to improve power generation.
The sum missing over an eight-month period in 2004 and 2005 is the equivalent of the $1.8bn that Saddam allegedly received in kick- backs under the UN's oil-for-food programme between 1997 and 2003. The UN was pilloried for not stopping this corruption. The US military is likely to be criticised over the latest scandal because it was far better placed than the UN to monitor corruption.
The fraud took place between 28 June 2004 and 28 February this year under the government of Iyad Allawi, who was interim prime minister. His ministers were appointed by the US envoy Robert Blackwell and his UN counterpart, Lakhdar Brahimi.
Among those whom the US promoted was a man who was previously a small businessman in London before the war, called Hazem Shaalan, who became Defence Minister.
Mr Shalaan says that Paul Bremer, then US viceroy in Iraq, signed off the appointment of Ziyad Cattan as the defence ministry's procurement chief. Mr Cattan, of joint Polish-Iraqi nationality, spent 27 years in Europe, returning to Iraq two days before the war in 2003. He was hired by the US-led Coalition Provisional Authority and became a district councillor before moving to the defence ministry.
For eight months the ministry spent money without restraint. Contracts worth more than $5m should have been reviewed by a cabinet committee, but Mr Shalaan asked for and received from the cabinet an exemption for the defence ministry. Missions abroad to acquire arms were generally led by Mr Cattan. Contracts for large sums were short scribbles on a single piece of paper. Auditors have had difficulty working out with whom Iraq has a contract in Pakistan.
Authorities in Baghdad have issued an arrest warrant for Mr Cattan. Neither he nor Mr Shalaan, both believed to be in Jordan, could be reached for further comment. Mr Bremer says he has never heard of Mr Cattan.
A week of violence in Iraq
* SUNDAY 11 SEPTEMBER
Gunmen killed a senior Iraqi judge, his brother and a Major General in the Iraq army. A British and a US soldier were killed in bomb attacks.
* MONDAY 12 SEPTEMBER
Gunmen killed nine civilians and two policemen in Baghdad and a roadside bomb killed six Iraqi soldiers in Fallujah.
* TUESDAY 13 SEPTEMBER
A car bomb killed five people and gunmen killed another four in the Mansour district of Baghdad Two civilians were killed by a suicide bomber on a bus in Hilla.
* WEDNESDAY 14 SEPTEMBER
At least 167 people were killed and 570 wounded in 14 bombings in Baghdad.
* THURSDAY 15 SEPTEMBER
Three suicide car bombers killed 28 policemen and eight civilians and gunmen killed four more people Baghdad.
* FRIDAY 16 SEPTEMBER
Two suicide car bombers killed 13 people, and gunmen shot dead eight more in Baghdad, including a local mayor in Iskanariya district and an imam in Sadr City.
* SATURDAY 17 SEPTEMBER
At least 52 people were killed or found dead throughout the country.
* SUNDAY 18 SEPTEMBER
At least three Iraqi soldiers were killed in a roadside bomb and an Iraqi MP and four others were shot dead by gunmen. Two dozen bodies of murder victims were found in the Tigris.
Study shows London has taken over as the new centre of world commerce
An influential new report claims that London now tops a list of 50 cities as the world's centre of commerce - beating New York, Tokyo and Chicago.
The UK capital has overtaken New York in four of six areas including economic stability, the ease of doing business, volumes of financial flows and attributes as a business centre, according to the report by credit card company MasterCard.
The study is the latest to say New York lags behind London as a global commerce centre.
It follows in the footsteps of a report earlier this year by internationally renowned management consultants McKinsey, which stated that New York is losing its place to London as the world's leading financial centre.
And it follows a series of articles by newspapers and magazines that have celebrated London's global success.
In March, the respected American magazine New York admitted that London is 'shaping up to be the global capital of the 21st century'.
Two years before this, Newsweek said London's success means it is leaving other European cities behind.
In the latest report - MasterCard's first annual worldwide centres of commerce index - the authors state: 'Once considered the unchallenged financial capital of the world, New York cedes to London a key dimension measuring financial transactions primarily because bond market regulations in New York affect the volume of listed sales.' London has the biggest financial services network of all cities, with more banking, financial services and insurance companies based there than any other, said MasterCard.
London vs New York
London
Population - 7.5 million
By last year, a total of 419 international firms listed on London's Stock Exchange
318,000 people are employed in the financial district
New York
Population - 8.2 million
By last year, a total of 174 international firms listed on the New York Stock Exchange or Nasdaq
328,000 employed in the financial district
The UK capital has overtaken New York in four of six areas including economic stability, the ease of doing business, volumes of financial flows and attributes as a business centre, according to the report by credit card company MasterCard.
The study is the latest to say New York lags behind London as a global commerce centre.
It follows in the footsteps of a report earlier this year by internationally renowned management consultants McKinsey, which stated that New York is losing its place to London as the world's leading financial centre.
And it follows a series of articles by newspapers and magazines that have celebrated London's global success.
In March, the respected American magazine New York admitted that London is 'shaping up to be the global capital of the 21st century'.
Two years before this, Newsweek said London's success means it is leaving other European cities behind.
In the latest report - MasterCard's first annual worldwide centres of commerce index - the authors state: 'Once considered the unchallenged financial capital of the world, New York cedes to London a key dimension measuring financial transactions primarily because bond market regulations in New York affect the volume of listed sales.' London has the biggest financial services network of all cities, with more banking, financial services and insurance companies based there than any other, said MasterCard.
London vs New York
London
Population - 7.5 million
By last year, a total of 419 international firms listed on London's Stock Exchange
318,000 people are employed in the financial district
New York
Population - 8.2 million
By last year, a total of 174 international firms listed on the New York Stock Exchange or Nasdaq
328,000 employed in the financial district
We Need a NewWorld Financial Architecture
Dr. Sergei Glazyev, an economist and a member of Russia's State Duma (parliament), addressed the second panel of an EIR-sponsored seminar in Berlin on June 28. Glazyev has authored many books on economics, including Genocide: Russia and the New World Order, which was published by EIR in 2000.
First of all, I'd like to thank Mr. LaRouche for this initiative, which is very important, and to my mind has a crucial sense.
A few years ago, when he wrote a lot of articles about the collapse of the present financial system, very few people were thinking about that. Now this collapse is taking place. Each year, the crisis is going deeper and deeper, and now it's time to think about the new architecture of the world financial system. And this initiative, which was launched by Mr. LaRouche, is just in time. And nowadays, when unfortunately, heads of state, the heads of the central banks, and the heads of the largest financial corporations are trying to close their eyes to the growing problems, and imitate a good policy, we have a chance to sit here to discuss the future—which inevitably is coming in the nearest years—the future with a new, I am sure, financial architecture, which will emerge in any case, after the collapse of the present one.
I don't think that this collapse could be prevented. What we should think about, first of all, is how to—not to avoid the crisis, but how to minimize the costs of transition; and what could be the new, optimal, and sustainable system, financial system, which will give mankind an opportunity to continue economic development.
We really need a new architecture of the world financial system, because those which exist couldn't be improved. I don't think that the present dollar-based speculative financial system could be improved. It is going to collapse anyway, and the question is only, what will be the shortcomings of this collapse, and how we can minimize the costs.
I agree, that this financial crisis and collapse of the financial system is a disaster for the whole of mankind. And of course, all nations are trying to maintain the stability of the present financial system, and to avoid new risks. But the problem is that the risks are embodied in this system, and they are growing higher and higher.
What could we do, to save this system, which is based on injustice, on fraud, on unequal and imbalanced exchange in the world, and this imbalance is going higher and higher? In fact, the dollar-based financial system now, is what we call a "financial pyramid." It's just being maintained, due to the growth of financial speculations; and financial speculations determine the demand for the dollar; and the supply of dollars couldn't be really limited, because of the internal nature of the American financial system. They have to print more and more dollars to service the growing debts. And this is the endless process which finally leads to the collapse, as we see in the history of mankind: a lot of cases like that—of course, of much less scale—of the collapse of the financial pyramids.
Nowadays, this financial pyramid is supported by various financial speculations, including the speculations with raw materials, which we see in the growing oil prices, which are purely speculative. And the United States is trying to maintain the demand for dollars also with the help of wars, and trying to pressure various nations to keep their currency reserves in dollars. But this couldn't go on endlessly. Nowadays, the American Federal Reserve doesn't control dollar circulation: About 60% of the dollars which were created by the Federal Reserve System are circulated abroad, and they are out of the American jurisdiction entirely. At the same time, if you will look at the present structure of the dollar-based financial system, we shall see that the amount of dollars in circulation, together with Treasury bonds, is 25 times higher than the amount of the American gold and currency reserves. It means that there is nothing under the dollar, except the demand which is generated by growing speculative activity.
I don't think that somebody will push the American financial system into deep restructuring, which will balance this. How can we balance the reserves and the monetary base of the dollar, if the scale of difference is 25 times? It is completely impossible to decrease the amount of dollars by a factor of 25, except through massive devaluation.
We Need To Declare Bankruptcy
So, in order to improve the dollar-based system, trying to introduce some kind of New Bretton Woods principles, including fixed exchange rates, we need to, in fact, declare the bankruptcy of the Federal Reserve and bankruptcy of the dollar financial system. This is the only way to get rid of this surplus of 25 times, in comparison with the monetary base. But, if somebody does that, of course, it will create a huge panic in the world market, and everybody will run away from the dollar, which will inevitably lead to the devaluation of the dollar, not by 15 or 30%, but I think maybe by a factor of 10 or 30.
So, I don't think that anybody on Capitol Hill will have enough courage to take responsibility for restructuring on such a scale.
And it means, to my mind, that collapse will take place in spontaneous ways, and we should be ready for that. But, what could we do in this situation? At least I think we can try to elaborate some principles of the new world financial architecture. And, to my mind, at least we can discuss the following principles: First of all, no one country could privatize the creation of the world reserve currency. The weak point of the present financial system, is precisely that the United States privatized the function of the world reserve currency. In 1971, they pushed Western countries to take dollars instead of gold, and, in fact, privatized the right to creation of the world currency, and used this right for their own purposes, to finance the budget deficit and to finance the balance of payments deficits. So, America used its right to create the world currency, as a worldwide tax: Because those countries which used this currency as a reserve currency, in fact, paid a tax in the form of zero-interest-rate loans to the United States, in growing and growing quantities.
So, I think the first principle, from this lesson, should be that no one country could privatize the right to create the world currency.
The second principle is, that all countries which agree to participate in this new world financial architecture, should agree to keep a certain financial discipline in money creation and the structure of currency reserves. Maybe they should keep, also, some rules of determining interest rates and budget deficits. But at least, they should agree concerning the principles of money creation, the structure of currency reserves, and come to agreement concerning the basket of currencies which participate in this new financial architecture.
The third, I think quite elegant principle, is that in order to maintain stability in international exchange, you need some kind of international reserve: like, maybe, the IMF could play the role of this international reserve fund, which will work to stabilize currencies, which will come out of an agreement concerning the fixed rates, or some other proportions of world exchange. But we need to maintain stability, some kind of international reserve fund, which will work under multinational supervision.
To finance this international reserve fund, we can propose both financial contributions, in national currencies of countries which participate in this scheme, or—maybe, and—an additional source: the worldwide taxation of financial speculation, which was already mentioned today.
Who Will Create a New Financial System?
What countries could participate in this new financial architecture? I don't think that we can come to an agreement on the worldwide scale—under the United Nations, or some other international organizations. Perhaps only those countries which are ready to make steps in this direction, can take on the burden of the creation of the new financial architecture, not waiting for others. Because the time is limited, and the main players, namely the United States and Japan, in fact are not ready to limit their opportunities to create the world currency.
Both Japan and the United States create their currencies, not on the basis of their reserves, but on the basis of growing national debt. And these currencies, in fact, are pure national debts. And in order to go to the new financial architecture, the financial authorities of the United States and Japan should declare bankruptcy (I'm not sure about Europe), but this, to my mind, is quite evident, and, of course, these countries are not ready to do that.
What countries are ready, to my mind? Those countries who still keep control over their currency creation, money creation, and have enough reserves to protect their currencies from devaluation. Russia, for instance, has now currency reserves twice [the size] of the monetary base. So, each ruble has reserves—each ruble in circulation, which was created by the Central Bank, has reserves equal to two rubles. Of course, it is a crazy policy—I shouldn't comment on that now. But, at least it will give enough room for maneuver, for Russia to participate in any kind of new financial architecture based on fixed exchange, or other rules of currency exchange.
China and India are countries which are also ready to participate in the new financial architecture, because they are keeping control over their monetary system. And as you know, they were not affected by the financial crisis of 1997-98, exactly because they kept control over their monetary systems, and didn't liberalize them. For these reasons, having enough currency reserves and keeping control over money creation, these countries could easily participate in the new financial architecture.
The Arab countries could do the same, because of the large currency reserves which they have. I mean the Arab countries trading with oil.
So, at least we have a couple of countries, which are dominant, together, in the Eurasian continent. If the European Union joined this, it means that the whole Eurasian continent would be the platform to establish the new financial architecture.
I don't think the United States could participate in this new system, because their currency simply has no reserves. They have no reserves, and they have to limit their currency creation several-fold—and they're not ready to do that. And if you wait for the United States, I'm afraid that we shall go into collapse altogether.
So, my suggestion is, perhaps, we can elaborate some recommendations, at least for those countries which have opportunities, to start to think and negotiate about the new financial architecture.
Of course, it is not an easy question. And, for instance, I can tell you, that when I proposed to the Russian Central Bank and to the Russian President, to launch an initiative to switch to a new financial architecture, I didn't get any real answer. Because such steps, of course, will have immediate results. If at least two or three superpowers, in the Eurasian continent, will try to discuss together the new financial architecture, it could be a trigger for the financial crisis. So, it is a very delicate issue, but at least, I think we should think about that, and there is no other way than to push those who will be ready to make a first step—not wait for when the whole system will go into collapse.
First of all, I'd like to thank Mr. LaRouche for this initiative, which is very important, and to my mind has a crucial sense.
A few years ago, when he wrote a lot of articles about the collapse of the present financial system, very few people were thinking about that. Now this collapse is taking place. Each year, the crisis is going deeper and deeper, and now it's time to think about the new architecture of the world financial system. And this initiative, which was launched by Mr. LaRouche, is just in time. And nowadays, when unfortunately, heads of state, the heads of the central banks, and the heads of the largest financial corporations are trying to close their eyes to the growing problems, and imitate a good policy, we have a chance to sit here to discuss the future—which inevitably is coming in the nearest years—the future with a new, I am sure, financial architecture, which will emerge in any case, after the collapse of the present one.
I don't think that this collapse could be prevented. What we should think about, first of all, is how to—not to avoid the crisis, but how to minimize the costs of transition; and what could be the new, optimal, and sustainable system, financial system, which will give mankind an opportunity to continue economic development.
We really need a new architecture of the world financial system, because those which exist couldn't be improved. I don't think that the present dollar-based speculative financial system could be improved. It is going to collapse anyway, and the question is only, what will be the shortcomings of this collapse, and how we can minimize the costs.
I agree, that this financial crisis and collapse of the financial system is a disaster for the whole of mankind. And of course, all nations are trying to maintain the stability of the present financial system, and to avoid new risks. But the problem is that the risks are embodied in this system, and they are growing higher and higher.
What could we do, to save this system, which is based on injustice, on fraud, on unequal and imbalanced exchange in the world, and this imbalance is going higher and higher? In fact, the dollar-based financial system now, is what we call a "financial pyramid." It's just being maintained, due to the growth of financial speculations; and financial speculations determine the demand for the dollar; and the supply of dollars couldn't be really limited, because of the internal nature of the American financial system. They have to print more and more dollars to service the growing debts. And this is the endless process which finally leads to the collapse, as we see in the history of mankind: a lot of cases like that—of course, of much less scale—of the collapse of the financial pyramids.
Nowadays, this financial pyramid is supported by various financial speculations, including the speculations with raw materials, which we see in the growing oil prices, which are purely speculative. And the United States is trying to maintain the demand for dollars also with the help of wars, and trying to pressure various nations to keep their currency reserves in dollars. But this couldn't go on endlessly. Nowadays, the American Federal Reserve doesn't control dollar circulation: About 60% of the dollars which were created by the Federal Reserve System are circulated abroad, and they are out of the American jurisdiction entirely. At the same time, if you will look at the present structure of the dollar-based financial system, we shall see that the amount of dollars in circulation, together with Treasury bonds, is 25 times higher than the amount of the American gold and currency reserves. It means that there is nothing under the dollar, except the demand which is generated by growing speculative activity.
I don't think that somebody will push the American financial system into deep restructuring, which will balance this. How can we balance the reserves and the monetary base of the dollar, if the scale of difference is 25 times? It is completely impossible to decrease the amount of dollars by a factor of 25, except through massive devaluation.
We Need To Declare Bankruptcy
So, in order to improve the dollar-based system, trying to introduce some kind of New Bretton Woods principles, including fixed exchange rates, we need to, in fact, declare the bankruptcy of the Federal Reserve and bankruptcy of the dollar financial system. This is the only way to get rid of this surplus of 25 times, in comparison with the monetary base. But, if somebody does that, of course, it will create a huge panic in the world market, and everybody will run away from the dollar, which will inevitably lead to the devaluation of the dollar, not by 15 or 30%, but I think maybe by a factor of 10 or 30.
So, I don't think that anybody on Capitol Hill will have enough courage to take responsibility for restructuring on such a scale.
And it means, to my mind, that collapse will take place in spontaneous ways, and we should be ready for that. But, what could we do in this situation? At least I think we can try to elaborate some principles of the new world financial architecture. And, to my mind, at least we can discuss the following principles: First of all, no one country could privatize the creation of the world reserve currency. The weak point of the present financial system, is precisely that the United States privatized the function of the world reserve currency. In 1971, they pushed Western countries to take dollars instead of gold, and, in fact, privatized the right to creation of the world currency, and used this right for their own purposes, to finance the budget deficit and to finance the balance of payments deficits. So, America used its right to create the world currency, as a worldwide tax: Because those countries which used this currency as a reserve currency, in fact, paid a tax in the form of zero-interest-rate loans to the United States, in growing and growing quantities.
So, I think the first principle, from this lesson, should be that no one country could privatize the right to create the world currency.
The second principle is, that all countries which agree to participate in this new world financial architecture, should agree to keep a certain financial discipline in money creation and the structure of currency reserves. Maybe they should keep, also, some rules of determining interest rates and budget deficits. But at least, they should agree concerning the principles of money creation, the structure of currency reserves, and come to agreement concerning the basket of currencies which participate in this new financial architecture.
The third, I think quite elegant principle, is that in order to maintain stability in international exchange, you need some kind of international reserve: like, maybe, the IMF could play the role of this international reserve fund, which will work to stabilize currencies, which will come out of an agreement concerning the fixed rates, or some other proportions of world exchange. But we need to maintain stability, some kind of international reserve fund, which will work under multinational supervision.
To finance this international reserve fund, we can propose both financial contributions, in national currencies of countries which participate in this scheme, or—maybe, and—an additional source: the worldwide taxation of financial speculation, which was already mentioned today.
Who Will Create a New Financial System?
What countries could participate in this new financial architecture? I don't think that we can come to an agreement on the worldwide scale—under the United Nations, or some other international organizations. Perhaps only those countries which are ready to make steps in this direction, can take on the burden of the creation of the new financial architecture, not waiting for others. Because the time is limited, and the main players, namely the United States and Japan, in fact are not ready to limit their opportunities to create the world currency.
Both Japan and the United States create their currencies, not on the basis of their reserves, but on the basis of growing national debt. And these currencies, in fact, are pure national debts. And in order to go to the new financial architecture, the financial authorities of the United States and Japan should declare bankruptcy (I'm not sure about Europe), but this, to my mind, is quite evident, and, of course, these countries are not ready to do that.
What countries are ready, to my mind? Those countries who still keep control over their currency creation, money creation, and have enough reserves to protect their currencies from devaluation. Russia, for instance, has now currency reserves twice [the size] of the monetary base. So, each ruble has reserves—each ruble in circulation, which was created by the Central Bank, has reserves equal to two rubles. Of course, it is a crazy policy—I shouldn't comment on that now. But, at least it will give enough room for maneuver, for Russia to participate in any kind of new financial architecture based on fixed exchange, or other rules of currency exchange.
China and India are countries which are also ready to participate in the new financial architecture, because they are keeping control over their monetary system. And as you know, they were not affected by the financial crisis of 1997-98, exactly because they kept control over their monetary systems, and didn't liberalize them. For these reasons, having enough currency reserves and keeping control over money creation, these countries could easily participate in the new financial architecture.
The Arab countries could do the same, because of the large currency reserves which they have. I mean the Arab countries trading with oil.
So, at least we have a couple of countries, which are dominant, together, in the Eurasian continent. If the European Union joined this, it means that the whole Eurasian continent would be the platform to establish the new financial architecture.
I don't think the United States could participate in this new system, because their currency simply has no reserves. They have no reserves, and they have to limit their currency creation several-fold—and they're not ready to do that. And if you wait for the United States, I'm afraid that we shall go into collapse altogether.
So, my suggestion is, perhaps, we can elaborate some recommendations, at least for those countries which have opportunities, to start to think and negotiate about the new financial architecture.
Of course, it is not an easy question. And, for instance, I can tell you, that when I proposed to the Russian Central Bank and to the Russian President, to launch an initiative to switch to a new financial architecture, I didn't get any real answer. Because such steps, of course, will have immediate results. If at least two or three superpowers, in the Eurasian continent, will try to discuss together the new financial architecture, it could be a trigger for the financial crisis. So, it is a very delicate issue, but at least, I think we should think about that, and there is no other way than to push those who will be ready to make a first step—not wait for when the whole system will go into collapse.
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