Monday, April 21, 2014

In Pictures: Starved Global Investors Reaching for Yields

In his latest outlook, Dr. John Hussman writes
The Federal Reserve’s policy of quantitative easing has starved investors of all sources of safe return, provoking them to reach for yield in more speculative assets, including equities, leveraged loans, covenant-lite debt, and other securities. Having stomped on the pedal for years, all of these asset classes are valued at levels that are strenuously elevated from a historical perspective, and as a result, offer strikingly poor prospective returns for long-term investors.
I’d compliment Mr. Hussman’s observation by showing the updated 1st quarter 2014 charts from the Institute of International Financea global trade group or association (cartel?) with over 450 members comprising world leading banks and financial houses, headquartered in 70 countries (Wikipedia)

From the IIF:


Global bond issuance continues with its record breaking streak led by Euro area bonds. While the Eurozone’s banking system remains broken as manifested by contracting banking loans and falling money supply, most of the Eurozone’s asset chasing dynamic have been financed by the rapidly growing bond markets.

Next global high risk mezzanine financing called “payment in kind” loans are at “a striking record highs”! Again a lot of this growth comes from the Eurozone.

Meanwhile another global high risk loan called “leveraged loans” (loans to highly indebted entities) have been running at growth rates at par with 2013. 


Indeed markets, starved for returns have been desperately chasing markets by expanding debt exposure. Yet such exposure has extrapolated to a substantial decline in credit quality

The IIF conveys her worries and noted that 
a rising proportion of corporate issuance has been done  by high-yield issuers, increasingly of lower credit quality such as CCC and rising proportion of corporate issuance has been done by high-yield issuers, increasingly of lower credit quality
Aside from high yield (lower credit rating) loans or what are known as junk bonds, Covenant lite loans are loans with less restrictions on collateral, payment terms and level of income. 


Any impression that emerging markets “reformed” following the latest tremors have been misplaced. While emerging market corporate bond issuance has marginally leveled off, government bond issuance soared to its highest level since 2005, mostly due to Eastern Europe.

In addition, international loan exposure by emerging market corporates led by the banks have materially increased since 2010.

So what we are seeing today has been a confluence of contradictory forces: rising risk asset markets being funded by ballooning debt—whose quality have been in a substantial deterioration—as bond yields suggest rising rates soon.

Such lethal combination inevitably indicates a forthcoming Wile E. Coyote moment.

Sunday, April 20, 2014

Quote of the Day: What Easter Means

Freedom is the ability of every person to exercise his own free will, rather than be subject to the will of the government or anyone else. Free will is a characteristic we share in common with God. He created us in His image and likeness. As He is perfectly free, so are we.

When the government takes away our free will, the government steals a gift from God; it violates the natural law; it prevents us from having and utilizing the means to the truth. The moral ability to exercise free will to seek the truth is a natural right that all humans possess, and the government may only morally interfere with the exercise of that right when one affirmatively has given it away by using fraud or force to interfere with the exercise of someone else’s natural rights.

We know from the events 2,000 years ago, which Christians commemorate and celebrate this week, that freedom is the essential means to discover and unite with the truth. And to Christians, the personification, the incarnation, the perfect manifestation of truth is Jesus — who is the Christ, the Son of God and the Son of the Blessed Virgin Mary.

On the first Holy Thursday, Jesus attended a traditional Jewish Passover Seder. Catholics believe that at His last supper, He performed two miracles so that we could stay united to Him. He transformed ordinary bread and wine into His own body, blood, soul and divinity, and He empowered His disciples and their successors to do the same.

On the first Good Friday, the Romans executed Jesus because they were persuaded that by claiming to be the Son of God, He might foment a revolution against them. The revolution He fomented was in the hearts of men and women. The Romans had not heard of a revolution of the heart; nevertheless they feared a revolution that would disrupt their worldly power, and so they condemned Him to death by crucifixion.

Jesus had the freedom to reject this horrific event, but He exercised His freedom so that we might know the truth. The truth He manifested is that His acceptance of the destruction of His body would enable Him to die so that He could rise from the dead. On Easter, three days after He died, that manifestation was complete when He rose from the dead. By doing that, he demonstrated to us that while living we can liberate our souls from the slavery of sin and our free wills from the oppression of the government, and after death we can rise to be with Him.

Easter — which manifests our own immortality — is the linchpin of human existence. With it, life is worth living, no matter its costs or pains. Without it, life is meaningless, no matter its fleeting joys or triumphs. Easter has a meaning that is both incomprehensible and simple. It is incomprehensible that a human being had the freedom to rise from the dead. It is simple because that human being was and is God.

Jesus is the hypostatic union: not half-God and half-man, not just a godly good man, but truly and fully God and at the same time truly and fully man. When the Romans killed Jesus, they killed God. When the dead Jesus rose from His tomb, God rose from the dead.

What does Easter mean? Easter means that there is hope for the dead. If there’s hope for the dead, there’s hope for the living. But, like the colonists who fought the oppression of the king, we the living can only achieve our hopes if we have freedom. And that requires a government that protects freedom, not one that assaults it.
This is from Judge Andrew P. Napolitano at the


Happy Easter! (image source)

Friday, April 18, 2014

Quote of the Day: War is a Racket

War is just a racket. A racket is best described, I believe, as something that is not what it seems to the majority of people. Only a small inside group knows what it is about. It is conducted for the benefit of the very few at the expense of the masses.

I believe in adequate defense at the coastline and nothing else. If a nation comes over here to fight, then we'll fight. The trouble with America is that when the dollar only earns 6 percent over here, then it gets restless and goes overseas to get 100 percent. Then the flag follows the dollar and the soldiers follow the flag.

I wouldn't go to war again as I have done to protect some lousy investment of the bankers. There are only two things we should fight for. One is the defense of our homes and the other is the Bill of Rights. War for any other reason is simply a racket.

There isn't a trick in the racketeering bag that the military gang is blind to. It has its "finger men" to point out enemies, its "muscle men" to destroy enemies, its "brain men" to plan war preparations, and a "Big Boss" Super-Nationalistic-Capitalism.

It may seem odd for me, a military man to adopt such a comparison. Truthfulness compels me to. I spent thirty- three years and four months in active military service as a member of this country's most agile military force, the Marine Corps. I served in all commissioned ranks from Second Lieutenant to Major-General. And during that period, I spent most of my time being a high class muscle- man for Big Business, for Wall Street and for the Bankers. In short, I was a racketeer, a gangster for capitalism.

I suspected I was just part of a racket at the time. Now I am sure of it. Like all the members of the military profession, I never had a thought of my own until I left the service. My mental faculties remained in suspended animation while I obeyed the orders of higher-ups. This is typical with everyone in the military service.

I helped make Mexico, especially Tampico, safe for American oil interests in 1914. I helped make Haiti and Cuba a decent place for the National City Bank boys to collect revenues in. I helped in the raping of half a dozen Central American republics for the benefits of Wall Street. The record of racketeering is long. I helped purify Nicaragua for the international banking house of Brown Brothers in 1909-1912 (where have I heard that name before?). I brought light to the Dominican Republic for American sugar interests in 1916. In China I helped to see to it that Standard Oil went its way unmolested.

During those years, I had, as the boys in the back room would say, a swell racket. Looking back on it, I feel that I could have given Al Capone a few hints. The best he could do was to operate his racket in three districts. I operated on three continents.
(bold mine)

This excerpt is from a speech delivered in 1933, by two time medal of honor the late Major General Smedley Butler, USMC. (hat tip Marc Faber/Daily Reckoning). War is a racket has been transcribed by Mr. Butler into a book you can read it here. And you can see a video of his speech here.

Thursday, April 17, 2014

Frédéric Bastiat on the Philippine Government’s Massive Infrastructure Spending Program

Today’s headline from one of the major newspapers screams that the Philippine government will undertake a massive infrastructure spending program (worth about Php 113 billion about  US $ 2.55 billion), “to make economic growth inclusive and lift millions out of poverty”

Last weekend I noted that aside from the critical pivot by the BSP in 2009 to reconfigure the direction of the domestic economy from a supposed 'external dependent' economy to a 'domestic demand' based economy via monetary blowing bubble policies and through fiscal expenditure projects (which is this massive spending program), I pointed out how the BSP chief also misstated the context of the great French free market champion Frédéric Bastiat on the latter's message from his work “what is  seen and what is unseen”.

Now I quote Bastiat’s  view of public work spending programs: (bold mine, italics original)
Nothing is more natural than that a nation, after making sure that a great enterprise will profit the community, should have such an enterprise carried out with funds collected from the citizenry. But I lose patience completely, I confess, when I hear alleged in support of such a resolution this economic fallacy: "Besides, it is a way of creating jobs for the workers."

The state opens a road, builds a palace, repairs a street, digs a canal; with these projects it gives jobs to certain workers. That is what is seen. But it deprives certain other laborers of employment. That is what is not seen.

Suppose a road is under construction. A thousand laborers arrive every morning, go home every evening, and receive their wages; that is certain. If the road had not been authorized, if funds for it had not been voted, these good people would have neither found this work nor earned these wages; that again is certain.

But is this all? Taken all together, does not the operation involve something else? At the moment when M. Dupin pronounces the sacramental words: "The Assembly has adopted, ...." do millions of francs descend miraculously on a moonbeam into the coffers of M. Fould and M. Bineau? For the process to be complete, does not the state have to organize the collection of funds as well as their expenditure? Does it not have to get its tax collectors into the country and its taxpayers to make their contribution?

Study the question, then, from its two aspects. In noting what the state is going to do with the millions of francs voted, do not neglect to note also what the taxpayers would have done—and can no longer do—with these same millions. You see, then, that a public enterprise is a coin with two sides. On one, the figure of a busy worker, with this device: What is seen; on the other, an unemployed worker, with this device: What is not seen.

The sophism that I am attacking in this essay is all the more dangerous when applied to public works, since it serves to justify the most foolishly prodigal enterprises. When a railroad or a bridge has real utility, it suffices to rely on this fact in arguing in its favor. But if one cannot do this, what does one do? One has recourse to this mumbo jumbo: "We must create jobs for the workers."

This means that the terraces of the Champ-de-Mars are ordered first to be built up and then to be torn down. The great Napoleon, it is said, thought he was doing philanthropic work when he had ditches dug and then filled in. He also said: "What difference does the result make? All we need is to see wealth spread among the laboring classes."

Let us get to the bottom of things. Money creates an illusion for us. To ask for co-operation, in the form of money, from all the citizens in a common enterprise is, in reality, to ask of them actual physical co-operation, for each one of them procures for himself by his labor the amount he is taxed. Now, if we were to gather together all the citizens and exact their services from them in order to have a piece of work performed that is useful to all, this would be understandable; their recompense would consist in the results of the work itself. But if, after being brought together, they were forced to build roads on which no one would travel, or palaces that no one would live in, all under the pretext of providing work for them, it would seem absurd, and they would certainly be justified in objecting: We will have none of that kind of work. We would rather work for ourselves.

Having the citizens contribute money, and not labor, changes nothing in the general results. But if labor were contributed, the loss would be shared by everyone. Where money is contributed, those whom the state keeps busy escape their share of the loss, while adding much more to that which their compatriots already have to suffer.

There is an article in the Constitution which states:

"Society assists and encourages the development of labor.... through the establishment by the state, the departments, and the municipalities, of appropriate public works to employ idle hands."

As a temporary measure in a time of crisis, during a severe winter, this intervention on the part of the taxpayer could have good effects. It acts in the same way as insurance. It adds nothing to the number of jobs nor to total wages, but it takes labor and wages from ordinary times and doles them out, at a loss it is true, in difficult times.

As a permanent, general, systematic measure, it is nothing but a ruinous hoax, an impossibility, a contradiction, which makes a great show of the little work that it has stimulated, which is what is seen, and conceals the much larger amount of work that it has precluded, which is what is not seen.
From Mr. Bastiat’s point of view, the supposed populist aim to ‘lift of millions out of poverty’ through massive public work projects has been a ‘ruinous hoax’ that has been recycled overtime (Remember Mr. Bastiat lived during the 19th century). And that the only ‘inclusivity of economic growth’ here will be a NET transfer of resources from society to politicians and the cronies through 'foolishly prodigal enterprises', thereby lifting economic benefits again to a select politically privileged and politically connected few. Woe to the taxpayers and to the politically unconnected peso holders.

[As a side note: It's lenten holiday season so I will abbreviate my comment on this.]

Infographics: Taxes Around the World

(hat tip zero hedge)

Taxes Around the World

Possibly one of the reasons for rising food prices in the world can be also be traced to Denmark's bizarre "Cow flatulence tax". 

Anyway, global tax on wages reportedly rose in 2013. The Reuters says that total world taxes on wages rose to 35.9% in 2013 from 35.7% a year earlier based on OECD data. 

You can see the graphic on tax wedge and unemployment rate of the OECD countries by clicking on the link here.

In the US, Food Prices have been Rising FAST

If you talk to members or read articles of the mainstream economic faith, they often imply to you that money printing does NOT lead to inflation. Aside, any discussion about consumer price inflation has mechanically been viewed as strictly a “supply side” issue.

Of course despite their rabid denials, price inflation has been very much present given that central banks around have been jointly blowing bubbles to ensure that bankrupt governments stay afloat.

The mainstream hardly recognizes that first we see monetary inflation expressed via booming asset prices, next we see the same dynamic eventually spillover to consumer inflation.

Since inflation is a political process and represents part of the grand political scheme of financial repression, the effects on the markets and the economy runs in different phases or stages too. Central bank manipulation of money and credit affect specific prices of assets and of goods and services in relative scale and time periods.

We are seeing such phenomenon at work even in the US


Cost of fresh produce are expected to move significantly higher according to a Wall Street Journal report. This supposedly has been  to a “three year drought in California” where the report adds that higher cost of fresh produce will lead to “overall food cost gains are expected to accelerate this year”


The Zero Hedge shows of spiraling prices beef, pork and shrimp. Note these are long term trends. But the recent rate of increases seem to have accelerated.


Another Wall Street Journal chart shows the spreading price inflation in basic commodities


In the US, food accounts for 14.9% of the CPI basket according to Doug Short.

The US Bureau of Labor reported last April 15th of the changes in US CPI stating that the “increases in the shelter and food indexes accounted for most of the seasonal adjusted all items increase. The food index increased 0.4 percent in March, with several major grocery store food groups increasing notably”

In early 2013 I predicted that rising home prices and rents will contribute to higher US CPI. So the US housing bubble is adding to CPI strains.


Finally rising food prices has not just been a US or Philippine phenomenon but a also global one. Again the mainstream blames this on the supply side particularly to weather and to deteriorating events in Ukraine

While this is not to deny that supply have contributed to rising prices, what has been a standard operation procedure for the mainstream has been to deliberately omit or obscure the demand side—which seems to operate in a vacuum—particularly demand that has been influenced by central bank policies 

For instance, as one would note from the FAO chart, dairy prices have been rising prior to the polar vortex or to the escalation of the Ukraine conflict.

The bottom line is that central bank inflationism has been increasingly spilling over to the real economy via rising food prices. And this is being aggravated by supply chain disruptions. This also means incidences of global hunger and poverty will rise. Such also implies of growing risks of a global food crisis.  

And importantly this signals why the era of asset inflation boom is bound to reverse soon as sustained pressures on consumer prices will eventually reflect on interest rates (whether in the US, Philippines or elsewhere).

Asia’s Richest Man Li Ka Shing has been in an asset selling binge in China

Watch what smart money does rather than what they say.

Asia’s richest man has been in an asset selling spree in China. Sovereign Man’s Simon Black explains:
Here’s a guy you want to bet on– Li Ka-Shing.

Li is reportedly the richest person in Asia with a net worth well in excess of $30 billion, much of which he made being a shrewd property investor.

Li Ka-Shing was investing in mainland China back in the early 90s, way back before it became the trendy thing to do. Now, Li wants out of China. All of it.

Since August of last year, he’s dumped billions of dollars worth of his Chinese holdings. The latest is the $928 million sale of the Pacific Place shopping center in Beijing– this deal was inked just days ago.

Once the deal concludes, Li will no longer have any major property investments in mainland China.

This isn’t a person who became wealthy by being flippant and scared. So what does he see that nobody else seems to be paying much attention to?

Simple. China’s credit crunch.

After years of unprecedented monetary expansion that has put the economy in a precarious state, the Chinese government has been desperately trying to reign in credit growth.

The shadow banking system alone is now worth 84% of GDP according to an estimate by JP Morgan. The IMF pegs total private credit at 230% of GDP, jumping by 100% in the last few years.

Historically, growth rates of these proportions have nearly always been followed by severe financial crises. And Chinese leaders are doing their best to engineer a ‘soft landing’.

If they’re successful, the world will only see major drops in global growth, stocks, property, and commodity prices.

If they fail, the spillover could become pandemic.

This isn’t important just for Asian property tycoons like Li Ka-Shing. Even if you don’t know Guangzhou from Hangzhou from Quanzhou, there are implications for the entire world.
Read the rest here

Mr. Li Ka Shing’s last sale concluded last week, from (bold mine)
Despite claims by Asia's richest man that he has not offloaded his mainland investments, Hong Kong multi-billionaire Li Ka-shing has got rid of over 20 billion yuan (US$3.23 billion) in Chinese property holdings since August last year.

The latest is the HK$7.2 billion (US$930 million) sale of Beijing's Pacific Century Place shopping center by Pacific Century Premium Developers, a company headed by son Richard Li. When the sale is completed in August, the company will have no more major investments in the mainland.
This comes amidst more signs of big trouble in the big China.

Officials of a local government have reportedly been scrambling to settle a troubled steel maker’s debt.

Officials in a city in northern China have been busy recently sorting out a steelmaker's debt mess that could involve as much as 20 billion yuan, even as the firm's owner avoids attending meetings on the matter, sources close to the situati0n say.

Highsee Iron and Steel Group Co. Ltd., which is based in Yuncheng City's Wenxi County, ceased production on March 18. It has seen a host of creditors including big banks line up to get their money back.
And the fractures from the humungous credit financed property boom has been accelerating or intensifying as vacancy rates have been ballooning even in prime areas. From South China Morning Post
According to property firm Jones Lang LaSalle, vacancies in Grade A office buildings in the area's major cities will stay high in the coming years due to weaker-than-expected demand.

While a loan default by a developer in Zhejiang sparked fears of a collapse of the residential property sector, the situation in the office sector appears to be even worse . Residential property developers can at least slash prices to dispose of flats to recover part of their investment. Half-empty buildings, however, are not just white elephants but financial black holes.

Jones Lang LaSalle found that at the end of last year, occupancy rates for Grade A office buildings stood at 58 per cent in Wuxi, Jiangsu, and 30 per cent in the Zhejiang capital, Hangzhou . In other major delta cities, which together make up the most vibrant and developed regional economy on the mainland, occupancy rates also hovered around 30 per cent last year.

In Wuxi, the vacancy rate was expected to stand at 48 per cent in 2016, it said. By the end of that year, the stock of prime office space in the city would nearly triple from last year's amount to 565,000 square metres
And here is what delusions that spawns a boom-bust cycle have been made of: (bold mine)
Over the past decade, delta cities have pulled out all the stops to launch one new town one after another. Located on the suburban fringes of each city, they are designed to accommodate millions of residents and attract more corporate investors.

The boom was based on officials' unshakeable faith that sustainable growth of delta cities would last for decades.

Developers splashed out billions of yuan to build office buildings, shopping malls and entertainment complexes in the new towns, believing an affluent population of 75 million would be enough to support their businesses. Unfortunately, reshuffles of municipal officials led to dramatic changes in urban development plans. New leaders would map out their own blueprints, earmarking more untapped land for new high-rise residential areas or industrial zones.
This resonates with what’s been going around in ASEAN including the Philippines. The difference is that China seems at an inflection point while the ASEAN contemporaries are approaching the inflection point where troubles in China (Japan, Ukraine or elsewhere) can hasten the process.


Nonetheless the estimated risks of transmission or contagion via merchandise trade with China from George Magnus (Business Insider)

The bottom line is that the mainstream has been severely underappreciating the risks from China’s boom bust cycle which could also be a major source for a global economic and financial Black Swan.

Wednesday, April 16, 2014

Weak Philippine Peso: It’s hardly about Smuggling, it is about Excessive Money Supply Growth (Credit Bubble)

The mainstream remains incredibly flummoxed by the weak peso which they continue to blame on ‘smuggling’. 


Several years of sound economic management have left the Philippines with what appears to be one of the strongest government balance sheets in Asia: a current account surplus of nearly 5% of gross domestic product and enough foreign reserves to cover more than a year’s worth of imports.

So why has the peso been among Asia’s weakest currencies this year?

One reason could be a smuggling problem that has resulted in significant irregularities in the country’s trade data. Some analysts say a proper accounting might show that the country’s current account is actually in deficit – at a time when skittish investors have been punishing developing economies that are too dependent on foreign funding.
Wow. Did you see the heading of the chart? "False Advertising"? Now this is getting to be quite interesting.
The mainstream have come to question on the credibility of the accuracy of government statistics. Something which I have been repeatedly pounding at.

Yet if the scrutiny over the statistical numbers will be sustained then eventually whatever de facto cosmetic strength will soon reveal its true colors.

And the WSJ excerpted the BSP response last March.
Central bank Gov. Amando Tetangco Jr., in a March interview with The Wall Street Journal, defended the official data and called the studies questioning the Philippines’ current-account position “more sensational rather than rigorous.”

“I’m not saying they’re trying to discredit us, but they should do more analysis,” he said.

Any discrepancies between the Philippine data and those of its trading partners can be explained by different valuation methods, Mr. Tetangco said.
Ah, let me re-quote a favorite from Dr. Marc Faber on government statistics (bold original)
Governments will always publish the statistics that they wish to show irrespective whether that is in China or in other countries. Governments control basically the statistical offices, so they can show whatever they want. As Stalin said, it’s not important who votes but who counts the votes. And the government counts the statistics.
One should ask: who has the incentive to publicize rosy data? For what reasons? Who benefits from these?

Here is my reply:
the Philippines has sold to the domestic and international audiences—a boom story—in order for the government to have easy access to credit. The central bank engineered credit boom combined with the government publicity ‘anti-corruption’ stunt paid off, the Philippines got three credit rating upgrades in 2013.
And the relationship between smuggling and the weak peso? Again as I wrote last March 31, 2014 (footnote tags omitted, bold original)
And why should “smuggling” extrapolate to a weak peso?

The popular argument indicates that “smuggling” enervates the Philippine financial standings via the trade and current account “deficit” channel. This is partly true but hardly provides a sufficient explanation for the rest.

Based on the accounting identity called Balance of Payments (BOP) which “record of all monetary transactions between a country and the rest of the world” the total has to be ZERO

According to “When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries.”

The accounting identity:


In and of itself, this means that deficits are hardly the cause of a currency’s travails, if they are sufficiently funded.

Deficits become a source of concern when the deficit nation’s funding has been perceived as increasingly becoming inadequate or deficient and or when creditors’ confidence are shaken due to an observed deterioration in the nation’s capacity or the ability or the willingness to pay on her liabilities. describes the balance of payment crisis or a currency crisis:
A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency.
So the agonizing peso has hardly been about “deficits” per se but rather about the 38.6% M3 growth last January which according to the BSP has been “due to higher demand for credit”.

Yet it has been simply amazing at how the mainstream experts see money and debt as operating in a black hole when discussing exchange rate values.
Read the rest here.

Nonetheless my conclusion: (bold original)
So this means that for as long as the BSP permits the inflation of credit fueled asset bubbles, surging price levels compounded by deteriorating or massive expansion of debt conditions will persist to manifest on a corrosion of the much vaunted external conditions of the Philippine economy that will be expressed on interest rates and on the peso.
The mainstream will continue to desperately rummage at statistics to explain or rationalize what they can’t see, which ironically, has been staring at them for quite sometime.

US Stocks in V-Shape Intraday Recovery as Bad News is Good news

European stocks got clobbered yesterday reportedly due to the escalation in Ukraine crisis. Ukraine’s government has launched a military offensive against separatist militants sympathetic to the government of Russia from cities in the eastern Donetsk region (Bloomberg). Ukraine is increasingly at risk of a civil war. And worse, if both Russia and the NATO-US intervenes this raises the risks of world war III.

While such sentiment initially plagued US stocks, all these abruptly reversed when a  report saying that the Japanese government is about to release its outlook that will downgrade its ‘overall assessment’ of the economy as private consumption takes a hit from April sales taxes (I must add and inflation). This sent US stocks recovering from the depths of a selloff!


As you can see all three US major stock market indices (Dow Industrial, S&P 500 and the Nasdaq) fashioned out a fantastic simultaneous V-shape intraday recovery. 

Ah, don’t you see? Bad news is good news because the Wall Street’s of the world, like sharks, have smelled blood. They expect that the Bank of Japan to impose additional easing to address faltering Abenomics.

As of this writing Japan’s Nikkei is now on a ramp up by more than 1.5% as the USD-yen soar past 102

Financial journalist Michael Lewis recently raised a controversy saying the stock markets has been rigged in favor of High Frequency Trading. Well, this would seem as  speck considering how central banks “manage” the financial markets.

Tuesday, April 15, 2014

Ghana to Use Chinese yuan to ease burden of the local currency; other implications

I have recently noted that Ghana has been in the league of nations  that has pumped up money supply growth rate at over 30% in 2011 and or  2012.  (The Philippines may be included in this list where money supply rate has been above 30% for the past 8 months!)


The World Bank chart has been unavailable so I show the table instead. The above table reveals why Ghana currency, the cedi, has been in trouble. The Bank of Ghana has been printing money relentlessly since 2009.

Now reports say that the government of Ghana will now liberalize the use of the yuan in order to relieve the stress of the cedi.

From Citifmonline:
Bankers have hailed the imminent trading of the Chinese Yuan as a move that will help ease demand for the US dollar in the country’s forex market.

The value of the cedi, which has plummeted in recent times as a result of the pressure put on traders’ demand for the dollar, will see some recovery when the yuan comes in.

This will mean, businesses and traders dealing in the Sino region will not need to convert to any major currency before transacting business.

Dr. Benjamin Amoah, Head of Financial Stability at the Bank of Ghana (BoG), has said that the central bank has made significant progress in getting the yuan into the country’s currency trading system.

“Work is far advanced in getting the yuan into the system because we have seen that it is needed – and demand always creates supply, so we are trying to make it available and we are working on it; very soon it will start. I don’t want to put a time on it.

“Currently, the demand is for the yuan because a lot of people go to China,” he added.
There are two aspects to cover here. One is the role of money printing in determining the health of the domestic currency and second is the role of the US dollar as international reserve.

Of course the real reason why the demand for the US dollar has been exceedingly strong in Ghana has been due to the frenetic pace of money pumping by the central bank, the Bank of Ghana from 2009-2012, as I noted above.

But since money supply growth has reportedly  declined to 17.7% in 2013, then this should ease some of the cedi woes, with or without liberalization of the yuan. 

However such liberalization will only function as a secondary cause. Considering the competition from the yuan, the Bank of Ghana will now be forced to considerably restrain money printing, otherwise the average Ghanian will gravitate to use the yuan as store of value.

So a recovery in the cedi will come as money printing by the Bank of Ghana eases. But, imbalances brought about by previous money printing will likely surface.

The second aspect in the above story is the role of the US dollar. 

The liberalization of yuan or increased used by the Chinese currency by people in Ghana will deepen the yuan’s role as foreign currency reserve. 

Aside from Ghana, Zimbabwe has reportedly added the Chinese currency as one of the four Asian based legal tender that includes the Australian dollar, the Japanese yen and the Indian rupee (Business Day Live).

The internalization of the yuan can be seen via broadening of dim sum bond floats, numerous swap agreements with various nations, trade in yuan with trading partners as Russia. The yuan is now the eight most traded currency in the world according to the

This shows why the US feels threatened by China, as the increasing exposure by the yuan in world trade and finance risks diminishing the US dollar’s privilege as the world de facto currency reserve.

Yet brinkmanship foreign policies adapted by US authorities will only accelerate the US dollar’s decline.

How Abenomics distorts the JGB markets

More signs of contortions in the Japan Government Bond (JGB) markets emanating from Bank of Japan’s (BoJ) implementation of 'Abenomics' as reported by the Wall Street Journal Real Time Economics blog

First, the draining of liquidity
On Monday, the newest 10-year Japanese government bond — the yield on which is used as a benchmark for bank loans and a barometer of trust in government finances — didn’t trade even once.

Traders say it is another sign of how the Bank of Japan’s massive bond buying program has silenced the market.

If the 10-year JGB goes a full 24 hours without being traded, it will be the first time since Dec. 26, 2000, according to the Japan Bond Trading Co., which publishes rates. That seems likely, since most investors close their books at 3 p.m. Tokyo time.
Second the skewering of the market's incentives:
Investors say it is more costly to trade than to sit on the sidelines with rates so low and supply scarce due to the BOJ purchases.

The central bank has also been buying a disproportionate amount of the most recent issues as dealers sell JGBs they buy at auction almost immediately to the BOJ to earn something, in what traders call “the BOJ trade.”

At the end of March, the BOJ owned about 33% of the current No. 333 10-year bond, the one that didn’t trade Monday.


Japan Macro Advisor’s estimate that as of April 7, 2014, the share of JGBs held by the BoJ has now climbed to 22%

Finally how Abenomics has mangled “price discovery”.
It’s not the first time that a scarcity of JGBs caused by the BOJ has created some unusual market milestones. At the end of March, rates in one funding market briefly fell below zero for the first time, as market participants basically offered short-term cash loans at negative interest just to borrow JGBs.
Such massive misalignment in the JGB markets entails magnified unseen risks in Japan’s banking and financial system who owns a bigger share of JGBs. And the possible channels for these could cover collateral, capital adequacy and more…

In addition, the flagrant mispricing of JGBs also reflects on bank loan rates and other financial instruments. This extrapolates to a collosal distortion of resource allocation in the financial system and in the real economy, which has also been ventilated via the currency the yen

And such is what makes Japan a ticking time bomb, one of the potential sources of the global financial Black Swan.

Interventionism: Using Legal Coercion to Get Ahead in Life

Mainstream media (especially in the Philippines) never ceases to inculcate upon her audience of the need to have the "right" morals (mainly based on collectivism) for the political economy to prosper. Yet what they either ignore or omit to explain is how most of the unethical or unscrupulous behaviors have been products of the interventionist policies previously implemented. They also fail to deal with the potential ethical distortions from populist policies they advocate in addressing real time social problems.

At the Epic Times, Austrian economist, Dr. Richard Ebeling explains why this is so (ht: Bob Wenzel) [bold mine]
In an environment in which “public policy” determines individual lives and fortunes and in which social and economic life has become politicized, it is not surprising that many Americans have turned their attention to politics to improve their market position and relative income share. Legalized coercion has become the method by which they get ahead in life.

And make no mistake about it: Every income transfer, every tariff or import quota, every business subsidy, every regulation or prohibition on who may compete or how a product may be produced and marketed, and every restraint on the use and transfer of property is an act of coercion. Political force is interjected into what would otherwise be a system of peaceful and voluntary transactions.

Over time, interventionism blurs the distinction between what is moral and what is not. In ordinary life, most people take for granted that certain forms of conduct are permissible while others are not. These are the Golden Rules we live by. Government’s task in human society is to enforce and protect these rules, which are summarized in two basic principles: Neither force nor fraud shall be practiced in dealings with others; and the rights and property of others must be respected. In the moral order that is the free market economy, these principles are the wellspring of honesty and trust. Without them, America is threatened with ultimate ruin – with a war of all-against-all in the pursuit of plunder.

When individuals began to ask government to do things for them, rather than merely to secure their individual rights and honestly acquired property, they began asking government to violate other’s rights and property for their benefit.

These demands on government have been rationalized by intellectuals and social engineers who have persuaded people that what they wanted but didn’t have was due to the greed, exploitation, and immorality of others. Basic morality and justice has been transcended in the political arena in order to take from the “haves” and give to the “have not’s.” Theft through political means has become the basis of a “higher” morality: “social justice,” which is supposed to remedy the alleged injustices of the free market economy.

But once the market becomes politicized in this manner, morality begins to disintegrate. Increasingly, the only way to survive in society is to resort to the same types of political methods for gain as others are using, or to devise ways to evade the controls and regulations. More and more people, therefore, have been drawn into the arena of political intrigue and manipulation or violation of the law for economic gain. Human relationships and the political process have become increasingly corrupted.

In the 1920s, Ludwig von Mises explained a crucial aspect of this corruption of morality and law:

“By constantly violating criminal laws and moral decrees [people] lose the ability to distinguish between right and wrong, good and bad. The merchant, who began by violating foreign exchange controls, import and export restrictions, price ceilings, etc., easily proceeds to defraud his partners. The decay of business morals . . . is the inevitable concomitant of the regulations imposed on trade.”

Mises was, of course, repeating the lesson that the French classical economist Frederic Bastiat had attempted to teach in the 1850s in his famous essay, “The Law.” When the state becomes the violator of liberty and property rather than its guarantor, it debases respect for all law. People in society develop an increasing disrespect and disregard for what the law demands. They view the law as the agent for immorality in the form of legalized plunder for the benefit of some at the expense of others. And this same disrespect and disregard sooner or later starts to creep into the ordinary dealings between individuals. Society verges on the brink of lawlessness.

So proposals to implement more interventionist solutions is like a dog chasing their own tail.

Monday, April 14, 2014

Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy

In this issue:

Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy
-Has Mr. Bastiat’s principles come to haunt the BSP?
-The Fallacy of Aggregate Demand
-The Stages of Inflation
-The 2009 Pivot Towards the Domestic Demand Bubble
-Costs are NOT Benefits
-Bastiat’s Unheeded Warning for the BSP
-Why a Rotation to Emerging Market Stocks is Unlikely
-Phisix: Market Internals Point to a Steep Correction

Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy

Two of my neighboring “carinderias” or informal retail food (eatery) outlets raised viand prices by 14% this week.

Has Mr. Bastiat’s Principles come to haunt the BSP?

In April 2009, in a speech before the Australian-New Zealand Chamber of Commerce, the Bangko Sentral ng Pilipinas governor Mr Amando M Tetangco, Jr concluded[1]
Frederic Bastiat, a 19th century French economic journalist, once said, “there is only one difference between a bad economist and a good economist: the bad economist confines himself to the visible effect; the good economist takes into account the effects that can be seen and those effects that must be foreseen”.

It may be difficult to perfectly foresee things but this should not discourage us from trying. Thus, I encourage all of us in this venue to remain positive, yet vigilant for any circumstances that could come our way. The BSP, for its part, will remain committed and continue to put forth monetary policy actions and banking reforms that will allow our economy to withstand the road blocks comprising panics, crises and other changes in the horizon.
The good governor had framed Mr. Bastiat in the confused context of merely about foreseeing things or making predictions. But this was not the intended message of Mr. Bastiat. Mr. Bastiat wrote about the importance of the subsequent order effects or the intertemporal tradeoffs (short term versus long term) of political actions to the real economy. 

Let me expand the truncated quote of Mr. Bastiat:
Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.
The excerpt came from the book “That Which is Seen and That Which is Not Seen”[2]. Bastiat’s book has essentially been about exposing the unseen or unintended consequences from the centralization—via the politicization—of the economy, particularly through seeing good news in destruction (broken window fallacy), demilitarization (disbanding of troops), public work spending, taxes and most importantly credit (inflationism) among the many other forms political interventionism also tackled in the book.

You see, the great Claude Frédéric Bastiat was more than just a journalist, a political economist and a legislator; he championed private property, free markets, and limited government and whose ideas have functioned as one of the pillars for the Austrian school of economics[3].

In other words, the essence of the book whence the BSP chief cited Mr. Bastiat has been diametrically opposite to the principles of central planning as advocated by the former. Bastiat was not for “monetary policy actions”

Has Mr. Bastiat’s principles have come to haunt the BSP?

The Fallacy of Aggregate Demand

Strains on the BSP have become increasingly evident.

Despite the melt-UP in the peso this week, the BSP has once again hinted at a supposed “further tightening”. The BSP governor was quoted, “we continue to be mindful of strong domestic liquidity and credit growth that could heighten financial stability risks…[This] was an important consideration for the preemptive move of raising [the reserve requirement] at our last meeting.”[4]

The fact that the BSP chief had to go to the public again (for the second time in less than 3 weeks) to signal “tightening” is a manifestation of political pressures on BSP monetary policies. The BSP have been a promoter of zero bound rates since 2009 (see below).

In addition, March data on Philippine forex reserves or Gross International Reserves revealed a modest decline of $ 700 million ($.7 billion) reportedly partly due to “foreign exchange operations of the BSP”[5]. Since the Peso meltdown came during the third week of March, this has possibly muted on the scale of operations by the BSP. 


The Peso has been this week’s biggest gainer. This has reversed all the previous declines. This comes as most Asian currencies rallied strongly against the US dollar. Given Friday’s close, the Peso now trades modestly up for the year.

Of course as I mentioned last week, aside mainly from intervention, another factor that would support the peso over the interim is the RISK ON environment. This volatile RISK ON environment supposedly comes from what media claims as ‘rotational’ dynamic as international money managers switch out of technology funds and stampede into Emerging Markets funds allegedly out of valuation reasons. [This I will discuss later]

Yet the decline in March forex reserves validates my suspicion that “the BSP may have used anew forex reserves to defend the peso.”[6] And as I have repeatedly been saying, the BSP has adamantly refrained from using the interest rate channel or the self-imposed banking sector limits to the property sector and instead relies on superficial actions of marginally raising reserve requirements, currency interventions and jawboning via signaling channel or information dissemination management.

In terms of communications management, following the official raising of bank reserve ratios 2 weeks back, the BSP announced “lower” inflation for March a week ago. This week the Philippine government released economic data purportedly showing a strong 24.4% jump in exports. Then the BSP chief went on air to hint at “tightening”. Such are intensifying signs that the peso is being “managed” by the BSP.

In other words, aside from the providence temporarily provided by the region’s strong currency vis-à-vis the weak dollar trade, as I recently wrote, any improvement in the peso will have the BSP’s fingerprints on them[7].

I noted that BSP has been a promoter of zero bound rates since 2009. I have recently discovered that this bubble commenced in 2009, after the BSP chief exhorted for a shift in policies in order to promote ‘domestic demand’ via aggregate demand policies of low interest rates and fiscal spending.

From the Trade Union Congress of the Philippines[8]: (bold mine)
“There are views that Asia must boost domestic consumption and end its dependence on exports,” Tetangco said. “In the longer term the view is that Asian economies may need to look more at their own domestic economies as the engine of growth.”

According to Tetangco, counter-cyclical support to aggregate demand in the form of expansionary fiscal and monetary policies, along with strong policy actions to ensure financial and corporate sector health could contribute to faster recovery.

“Maintaining an expansionary monetary policy stance to the extent that the inflation outlook allows, could support market confidence and assure households and businesses that risks to macro-stability are being addressed decisively,” he said.
In a barter economy, exchanges are conducted through direct exchange of product/s or service/s without the use of the medium of exchange. Say for instance, a shoemaker will exchange an agreed number of his produce (shoe/s) with a baker for an agreed amount of the latter’s product/s (bread/s). In short, trade is simply an exchange of agreed outputs between two producers or service providers.

The problem with a barter system is in the matching of people’s wants and needs to encourage transactions. Such is called the ‘coincidence of wants’[9]. For example, during a given moment, a shoemaker wants to trade his shoes only with the farmer’s vegetables. But the farmer solely desires to trade his vegetables for the baker’s bread. On the other hand, the baker wants to exclusively trade his bread for shoes with the shoemaker. So the mismatch between the wants and needs of each producer becomes an obstacle (or high transaction costs) to the facilitation of exchange in a barter system. 

The introduction of the money or an intermediary as medium of exchange solves this discrepancy by providing liquidity to the producers.

So what am I attempting to point out? All these shows that demand is a function of supply. Money is just a medium of exchange. And the purchasing power of money equals the extent of supply.

Example: If a person carrying a bag of N million of currency units (US dollar or Peso or Euro or etc…) due to an accident is stranded in a remote island inhabited by primitive tribes who lives on fish and coconuts and whose contact with the outside world is severely restricted, then the purchasing power of such currency unit (if accepted by the tribes at all) is only fish and coconuts.

We have seen the value of money in action recently during a supply shock brought about by Typhoon Yolanda in the hardest hit area of Tacloban City in Leyte. Despite the availability of money as I noted here[10]
Trade or voluntary exchanges has been incapacitated for the simple reason of lack of access to basic goods (food, water, medicine) to fulfill physiological needs (Maslow’s Hierarchy of Needs).
And the lesson of money being…
The unfolding developments from the unfortunate Typhoon Yolanda tragedy represent a testament to the fundamental economic truism where money, in and of itself is not wealth, rather it is the purchasing power of money (or what money can buy) that reflects on wealth.
This brings us back to domestic aggregate demand based policies pushed and implemented by the BSP chief in 2009.

What the BSP chief effectively ordered was to inflate the system or to blow bubbles. 

Yet in the knowledge that much of the Filipino consumers have little access to the formal banking system, credit inflation was tacitly designed to boost the supply side, who in their vast expansion programs, would add to the demand side that would boost revenues of the government and simultaneously indirectly and covertly divert the society’s resources towards subsidizing government spending via suppressed interest rates on sovereign liabilities

Credit creation and expansion to bubble industries has affected relative price levels and has distorted economic coordination of resources aside from altering the production process. This has become very conspicuous now.

Inflated profits from earlier credit creation and bigger capital expansions facilitated by greater bank lending provided a significant boost to consumer demand too. People within the bubble industries, as well as in the adjunct industries have more disposable income to buy consumption goods and spend on leisure activities. So alongside from OFW based remittances and income and profits from BPOs, disposable income from bubble industries artificially bolstered or padded revenues of retail outlets, hotels and many other consumer based products. This gave property developers, shopping mall and hotel operators and financial intermediaries of asset bubbles (financial assets and property related) the impression of the boundless potentials of the Filipino consumers.

But of course, contra the mainstream, nothing is ever aggregate. Even companies from within the industries benefiting from the bubble do not benefit evenly. Some benefit more than the others. Some clues of such dynamics can be seen from the variance in the compounded annualized growth rates of earnings per share and book value of the 30 member Phisix components.

Moreover given the predisposition by the banking system and the credit markets to lend to big named and politically connected borrowers, such entails that the distribution of benefits and risks tend to be concentrated. The corporate bond market is a shining example of this, as I earlier noted “because of the small size of the corporate bond market, the top 10 share in terms of % to the total is at 90.8%. Said differently, the benefits and risks of Philippine corporate bonds have been concentrated to these top 10 issuers.[11]

You see the farther the distance a firm or an enterprise is to the epicenter of the credit inflation, the lesser the benefits from the Cantillon spillover effects. So essentially, for the Philippines, the informal economy would signify as the last link in the credit process. Yet as farthest in the monetary economic link, they are to be the hardest hit by the effects of BSP’s bubble policies.

For the informal sector to raise prices is a sign of trouble. For instance, informal sector eateries (or even “sari sari stores” mini convenience stores) operate in highly competitive markets where the typical business model have been based on slim margins and are highly dependent on the scale of volume. Since most of their consumers are from the minimum wage levels, such consumers are heavily sensitive (elastic) to price changes given their limited purchasing power. So raising prices would signify as a drastic recourse in response to changes in prices of entrepreneurial operations. Yet an escalation of price inflation will put many informal enterprises out of business. 

And I pointed out last week, money from credit growth simply means additional purchasing power, which will be spent or allocated in the real economy. The temporary-short term increase in purchasing power in favor of select groups will impact prices and the distribution of goods and the production process over relative time frames. Thus additional money from credit growth from the fractional banking system marginalizes existing money which means a long term loss of real purchasing power. Yet despite government data, this process has now been intensifying

To make clear, whether inflated money stems from bank credit growth or from government monetizing spending via deficits, the effects will be the same. As the great Austrian economist Ludwig von Mises wrote, “Today the techniques for inflation are complicated by the fact that there is checkbook money. It involves another technique, but the result is the same. With the stroke of a pen, the government creates fiat money, thus increasing the quantity of money and credit”[12].

The difference will be from the source/s of risks. Since the 68% of the 30+% money supply growth comes from banking loans to the private sector then this means the immediate risks for the Philippines is one of bubble implosion from a credit fueled asset bubble.

Meanwhile the risks for countries like Argentina and Venezuela or the rest of the other nations that saw money growth at over 30+% in 2011 and or 2012 or in both years based on World Bank data—such as Sudan, Tajikstan, Myanmar, Malawi, Liberia, Iran, Guinea-Bissau, Ghana, Ghana, Equatorial Guinea, Congo Republic, Belarus, Azerbaijan and Angola—has been mostly on hyperinflation or total bankruptcy. [As a snarky side remark, a very impressive lists of colleagues.]

Yet in 2012, Belarus recently suffered from hyperinflation[13]. Meanwhile, Myanmar property bubble[14] appears as being accommodated by the huge money supply increase.

The Stages of Inflation

Inflation in essence signifies a series of political actions whose effects on the marketplace can be identified as having 3 stages which vary in time periods. 

The first stage is when consumer prices barely rise at all even if the rate of money supply growth significantly expands. That’s because most people think that price inflation will be transient. Therefore instead of spending, the people tend to save more money in anticipation of lower prices. [As a side note, this seems as the case in Japan today[15]]

Such action would imply an increase in social demand for money. The gestation period tends to be longest here. Yet this phase represents the sweet spot for the invisible transfer of resources from the society to the government. The great dean of Austrian economics Murray N. Rothbard explained[16],
The government obtains more real resources from the public than it had expected, since the public’s demand for these resources has declined
The second stage is when the public comes to realize that prices continue to rise, so they step up the rate of goods purchases. So the social demand for money falls. The rate of price increases now accelerates. They will rise to the proportion of rate of growth of the money supply. This would be the rigid quantity of money theory[17]. The second phase serves as a springboard to the third phase, thus has a very much shorter time frame. Argentina’s inflation seems as in the second stage.

The third and final stage will be when trust in the domestic currency continues to substantially erode. People will go into a panic buying spree in order to dispense of their currency in exchange for real goods. Here price inflation will far outpace money supply growth. This phase is known as the runaway or hyperinflation.

For the Philippines, if the 30+% money supply growth rate continues then we should expect a significant pick up in price inflation rates, no matter what the mainstream or official data says. This also shows that the Philippines may be in the basketball equivalent of the third quarter of the first stage of the inflation cycle.

Yet all the financial price “management” measures by the BSP (applied to the peso and to bonds) will eventually fail for they continue to deal with the symptoms rather addressing the root cause of the present imbalances.

Nonetheless given the propensity to attack the symptoms, it is not farfetched that the Executive Branch will join the BSP to impose populist ‘price control’ measures.

But should this be the case, then we should expect an aggravation of shortages. What will happen is that statistical price inflation will fall but the peso will also plunge. But if the peso will be controlled, then either we see the vaunted forex reserves decline significantly or that a foreign exchange black market will emerge.

The 2009 Pivot Towards the Domestic Demand Bubble

Importantly, as noted above it was in 2009 where the Philippines economy made a critical pivot towards a bubble economy. This has been a consequence of BSP’s bubble blowing policies aimed at refocusing to the economy towards domestic demand via aggregate demand policies.

Essentially Mr. Tetangco’s call to action for a shift in focus by sacrificing external trade in 2009 essentially validated my observation last week[18],
we shouldn’t expect material improvements in domestic export industry even amidst a weak peso environment due to substantial resources already committed by a large segment of the formal economy in the redirection of their efforts towards bubble blowing industries rather than to the production for exports. In short, current easy monetary policies have incented a shift in the Philippine economy’s production structure favoring bubble industries at the expense of external trade.
By politically choosing winners and losers through monetary policies, the BSP has fundamentally “crowded out” resources available to the export industry via transfers to the bubble sectors and to the government. Along with restrictive regulations, the weak peso will hardly pose as subsidy for exports as massive resources have already been sunk into future malinvested projects that will soon be exposed as unprofitable. 

So while the Philippine government reported[19] a 24.4% spike in February 2014 export growth last week (see chart via this link), this only represents half of the real picture. Why? Because the supposed extraordinary growth came from a vastly depressed February 2013 export data (see chart here). In nominal terms, February 2014 data has even been below many of the monthly data for the 2nd and 3rd quarter of 2013. So the so-called ‘strong’ growth seems all been about framing and the contrast principle or compared to what?


This brings us back to the inner sanctum of the BSP’s fulcrum towards bubble policies.

Let us do some legwork on the recent data.

In 2013, Philippine government revenues grew by 11.8% year on year based on the data provided by the National Statistical Coordination Board (see left window). This rate is way above the CAGR of 8.07% over the past 17 years or from 1996-2012 and was obviously influenced by the half year 30+% money supply growth. Since the BSP reconfigured the nation’s economic structure, government revenues jumped by a CAGR 8.85% from 2009 until 2013. Again the latter has been skewed by the hefty increase in the 2013 data.

To reemphasize, this substantial growth in government revenues has largely been brought about by a boom in the mostly the bubble sectors of the formal economy due to bank credit inflation, as evident by the 30++% money supply rate growth, that has inflated revenues, income and earnings.

Meanwhile expenditures grew by only 5.8% in 2013. This has largely been below the 17 year CAGR (1996-2012) of 9.1%. Since 2009, the annualized growth rate has been slower than the earlier years at 5.75% or about the same rate as 2013. This has eased on the fiscal deficit which should signify as good news.

But media yammers about restrained government spending. A report insinuates that anti-corruption measures have diminished government spending in Asia (including the Philippines) therefore involuntary “austerity” comes at the cost of statistical growth[20]. For media anything that slows spending is bad. Such is an example of the Bastiat’s “seen” effect while at the same time discounting the “unseen” benefits of the diminished government spending.

And signs of “prudence” may just be jettisoned in 2014, as I previously noted[21],
The BIR, which accounts for 70% of the government’s total revenues, expects a 16.16% increase in her 2014 target. That’s because national government budget will expand by 13% to Php 2.265 trillion in 2014. So government spending will grow about twice the statistical economy….

All these means that the incumbent government will have to increasingly rely on a sustained credit financed boom of assets in the formal economy in order to fund her fast expanding spendthrift appetite, as well as, to maintain zero bound rates or negative real rates (bluntly financial repression) to keep her debt burden manageable.
Now let us move on to debt (right window)

According to the data from Bureau of Treasury, Public debt (domestic and internal) in 2013 has grown by only 4.5% in 2013 as against the CAGR of 9.54% from 1996-2012. Since 2009, the total public debt has grown by only 5.3% compounded annualized. [note: not included is the government guaranteed debt]

And here is the beauty: the Philippine government has shifted the share of debt burden in 2009 which was at 44:56 in favor of domestic debt to 2013’s 34:66 share, again in favor of domestic debt. While public debt continued to grow modestly, the Philippine government deftly transferred the weightings significantly towards domestic debt (again from 56% in 2009 to 66% 2013) in order to optimize the capture of the subsidies provided by the Philippine society to the government from negative real rates—financial repression policies.

The statistician cum economic analyst will see this as good news. Yehey, great debt management they say! But if we apply the great Bastiat’s methodology of looking at the “unseen” long term consequence from current policies that have brought about the current benign “visible” effects, we will see a vastly different picture.

Costs are NOT Benefits

Well the above figures reveal to us that costs are not benefits.

What seems as prudent is in fact reckless. The principal cost to attain lower public debt has been to inflate a massive bubble. The current public debt levels have been low because the private sector debt levels, specifically the supply side, have been intensively building.

And yet the secondary major cost from inflating a bubble in order to keep debt levels low has been to diminish the purchasing power of citizenry, so aside from domestic price inflation, this can now be seen in the falling peso. Government debt has been and continues to be subsidized by the private sector in possession of the currency, the peso.

A third major cost has been the illicit and immoral transfer of resources not only to the government but also to politically connected firms who has and continues to benefit from the BSP sponsored redistribution. Such has concentrated benefits to a few but has distributed the risks and the costs to the rest of non-beneficiaries, including this analyst.

A fourth major cost is that bubbles have effectively heightened “financial stability risks”. The BSP has created and unleashed an inflation ‘Godzilla’ which they proclaim they wanted to slay but seem to have second doubts.

Yet credit inflation has increasingly been concentrated to a few Philippine version of “too big to fail” companies. Meanwhile stock Market PE ratios of blue chip companies are at a stunning 30-60 and equally shocking has been the price to book value which have significantly been valued above 3. Such financial instability risks include the suppressed yields of Philippine treasuries which continue to reflect on the artificially priced convergence trade. The latter has been instrumental in the misallocation and redistribution of resources transmitted via the interest rate channel.

A fifth major cost is that resources channeled to the bubble sectors are resources that should have been used by the market for real productive growth. Much of these resources are now awaiting reappraisal from the marketplace via a shift in consumer’s preferences which will render much of these misallocated capital as consumed capital.

A sixth major cost is that once the bubble implodes, government revenues will dramatically fall while government spending will soar as the government applies the so-called “automatic stabilizers” (euphemism for bailouts). This would also extrapolate to a phenomenal surge in debt levels. All these will unmask today’s Potemkin’s village seen in the fiscal and debt space.

And the most likely response would be to increase taxes which should further penalize real economic growth. I expect sometime in the future the Philippine government will raise E-VAT to 15%[22].

A seventh major cost is that not only will a bust imply possible curtailment of civil liberties but the onslaught against economic freedom in particular the informal economy will likely intensify. This will come with more mandates, regulations and other restrictions. A government deprived or starved out of taxes for her insatiable spending appetite will desperate seek a larger tax base whose resources they intend to seize by taxation.

There may more but grant me the leeway such that I do not possess all the knowledge required as of this writing.

Nonetheless the cost benefit tradeoff reveals why the BSP will unlikely use the interest rate policy tool unless they have been forced by the marketplace.

Bastiat’s Unheeded Warning for the BSP

Going back to the BSP’s citation of the great Bastiat

I’m sad that the good BSP chief may not have read the book he excerpted. It would have given him a gem of an insight that may have prevented such risks from spreading and burgeoning. But yet again in doing so he may not be the anointed.

Here is Mr. Bastiat’s response to state guaranteed loans, or we might say the BSP’s aggregate demand policies.

This solution, alas, has as its foundation merely an optical illusion, in so far as an illusion can serve as a foundation for anything.

These people begin by confusing hard money with products; then they confuse paper money with hard money; and it is from these two confusions that they profess to derive a fact.

In this question it is absolutely necessary to forget money, coins, bank notes, and the other media by which products pass from hand to hand, in order to see only the products themselves, which constitute the real substance of a loan.

For when a farmer borrows fifty francs to buy a plow, it is not actually the fifty francs that is lent to him; it is the plow.

And when a merchant borrows twenty thousand francs to buy a house, it is not the twenty thousand francs he owes; it is the house.

Money makes its appearance only to facilitate the arrangement among several parties.

Peter may not be disposed to lend his plow, but James may be willing to lend his money. What does William do then? He borrows the money from James, and with this money he buys the plow from Peter.

But actually nobody borrows money for the sake of the money itself. We borrow money to get products.

Now, in no country is it possible to transfer from one hand to another more products than there are.

Whatever the sum of hard money and bills that circulates, the borrowers taken together cannot get more plows, houses, tools, provisions, or raw materials than the total number of lenders can furnish.

For let us keep well in mind that every borrower presupposes a lender, that every borrowing implies a loan.
Has Mr. Bastiat’s principles come to haunt the BSP?

Why a Rotation to Emerging Market Stocks is Unlikely

Developed economy stocks led by the US have been showing signs of pronounced weakness.

Unlike in January where the correction has been led by the blue chips (S&P—lower right and Dow Jones—lower left), we seem to be seeing a change in complexion.

First, volatility in both directions has become more pronounced. The downside bias appears to be picking up momentum. If the degree of fluctuations continues then this will reinforce my perception that this has been a topping process.

Two, as pointed out earlier[23], market breadth has significantly been deteriorating where the average stocks have been falling faster than the cushioned fall in the blue chips.

Third, one key barometer, the Nasdaq biotechnology index has been the first index to fall into a bear market.

Fourth, there are increasing signs of the periphery to the core in progress.

The periphery to core dynamic of the bubble bust cycle appears to be gaining strength. This can be seen through the growing signs of divergence[24]

This has been a long term process.

First to be affected has been commodities, then emerging markets. This has now spread to the developed economies. The initial impact in developed economies has been in the fringes: overpriced technology stocks. Now even the blue chips are affected.

Falling yields of the 10 year notes reinforces the sign of pressures on risk asset deflation.

Some experts have said that there has been an ongoing rotation from high flying technology stocks to emerging markets due to valuations.

I doubt that this logic has merit. First of all emerging markets like the Philippines has hardly been cheap at all. Emerging markets may seem cheaper than high flying technology but such comparison would be fallacious as this has been based on the contrast principle.

This leads us to the second factor: What drove popular stocks to their high flight status? If they are driven debt and if the current meltdown means liquidations from earlier leverage build up, then this would have an impact to the real economy. Sustained market pressures will hit overleveraged Wall Street firms first before the real economy—where the latter has hardly benefited from the FED’s subsidies.

Emerging markets have been slammed last year, but despite the sharp rallies in risk assets they haven’t been clean from debt. In fact the recent rallies have only whetted the appetite for debt where much of these may have been used to push up prices of risk assets.

Third just look at where the biggest rally in emerging markets comes from. In terms of emerging market debt, Argentina and Venezuela has been the biggest gainers from the recent rally according to JP Morgan see chart from February 3 to April 8th here.

Ukraine has been said to be part of the “tantalizing trio”. Ukraine’s stocks have also been astoundingly up by 40% year to date. And as I noted in the past Ukraine’s has the tendency to go stock market bubble blowing, she had two bubble bust in 2008 and in 2012 or in a span of 4 years. Ironically, Ukraine seems headed for a civil war.

And this is a striking comment as quoted by the New York Times[25] on the character of people piling into emerging markets.
“Many of the funds that are buying these companies don’t even know what they are buying,” said Elizabeth R. Morrissey of Kleiman International Consultants, an emerging-market investment monitoring and analysis firm. “All of a sudden, we have Joe Middle Class loading up on emerging-market bond E.T.F.s. That is a little frightening.”
My guess is that these are the same category of desperately seeking yield funds stampeding into Philippines equity assets with 30-60 PE ratios.

Phisix: Market Internals Point to a Steep Correction

As for the market breadth, I think retail punters have become exceedingly or wildly bullish on outrageously mispriced and overvalued Philippines equity markets.


Retail players have been trading a broader segment of the market as shown in the Issues traded (averaged on a weekly basis) left pane. So the small number of moneyed retail punters has been bidding up on illiquid second-third tier issues, hoping to squeeze marginal yields. 

Yet the last two times such level has attained, the Phisix had a 6% correction in March of 2013 and a 20+% in June 2013.

Such aggressiveness can also be seen in the average daily trade where retail punters have been churning more frequently. I don’t expect much new accounts. Average daily trade has surpassed the May highs and is at the August levels. 

The last time such levels were reached we saw significant corrections.


I spoke about the likely class of foreign funds buying into outlandishly priced Philippine stocks, yet recent actions suggest that foreign buying though still positive has been in a slowdown.

Since foreign money accounts for a little more than half of the peso volume daily trade, the slackening of foreign activities has been mirrored by the Daily Peso volume.

The above only suggest that another interim significant correction may likely be next phase.

Nonetheless if the declines in the stock markets of developed economies worsen, then the supposed “animal spirits” that has backed much of the statistical growth figures will be exposed as a charade.

And as I recently wrote[26],
Such sustained risk off scenario will ricochet back to emerging markets where both the stock markets and the economies of developed-emerging market in tandem will substantially sputter. Then the Global financial-economic Black Swan manifested by the Wile E. Coyote moment appears.
If this becomes true, then what seems as a likely correction to occur may morph into a full bear market.

[1] Amando M Tetangco, Jr: Philippines – navigating through the global financial turmoil Australian-New Zealand Chamber of Commerce Philippines Annual General Membership Meeting, Makati-City, 14 April 2009 Bank of International Settlements 

[2] Frédéric Bastiat What Is Seen and What Is Not Seen Library of Economics and Liberty

[4] BSP hints at further monetary tightening, April 10, 2014

[5] Bangko Sentral ng Pilipinas End-March 2014 GIR Stands at US$79.8 Billion April 7, 2014

[8] Trade Union Congress of the Philippines Bangko Sentral urges government to end dependence on exports July 2, 2009

[9] Coincidence of wants

[12] Ludwig on Mises Inflation Economic Policy Thoughts for Today and Tomorrow(1979), Lecture 4 (1958)] p 62

[15] See Japan’s Ticking Black Swan February 24, 2014

[16] Murray N. Rothbard E. The Government as Promoter of Credit Expansion Chapter 12—The Economics of Violent Intervention in the Market (continued) Man, Economy & State

[19] National Statistics Office Merchandise Export Performance : February 2014 April 10, 2014