Sunday, August 26, 2007

In Defense of the Philippine Stock Exchange From Political Correctness

Now when markets become an instrument for POLITICAL CORRECTNESS we are compelled to respond.

Where the allegation is…

In rising markets, the rich benefits with a miniscule “trickle-down-effect” to our economy…

In falling markets, the poor ‘non market participant’ gets clobbered by losses transmitted by changes in financial conditions…

While the rich is implied to remain “rich” or “unaffected” by the reversals of financial fortunes…

Of course, the obvious implication here is that the financial markets including the PSE becomes an agent of “inequality”, where gains are limited to a select few while losses ripple across the country.

First, our response on the issue of losses

In absolute terms, a LOSS is a LOSS is a LOSS…regardless of economic status!

Let us put that in an OBJECTIVE perspective…

In 1997 as we previously described, the Phisix fell by 70% in the wake of the 1997 Asian Financial Crisis from 3,400 to about 1,000. Then, whether one’s investment was Php 100 million, 1 million or 10,000 pesos, in absolute terms a 70% write off is a loss of Php 70 million, Php 700,000, or Php 7,000 respectively!...

Regardless of how one views the RELATIVE VALUE of money or…

Regardless of the wealthy’s “reserve” status (besides how can we categorize or know about the depth of their vaults?).

What we want to emphasize is that, losses DO NOT DISTINGUISH between people attired in COAT AND TIE or those wearing only tattered SANDOS, SHORTS AND SLIPPERS. Anyway, should there be one?

Second, is the issue of categorization; how certain are we that the “wealthy” dominates stocks investing?

Are we talking of Peso investment volume per capita or the average net worth of the average investor? Does the PSE have a data on such demographic make up?

What's more, investing in the stock market is NOT an exclave reserve for the “rich” since a neophyte or practically anyone from any income stratum can buy stocks for less than P 10,000.

To suggest another angle, what if LOCAL INSTITUTIONS and not retail investors dominate the Peso volume of trades? How does one classify them? Are they still part of the cyclically “immune” much loathed “Elite” brigade?

How about FOREIGN MONEY, are they also part of the complicit team of “inequality drivers” too?

Anyway, RISING markets DOES have the tendency to attract a wide variety of investors, again regardless of social status (one can just look at China.)….

When lower income levels troop into the market, STATISTICALLY you can bring down the averages…oops, remember the Gaussian Curve?

Does a population of more retail investors AUTOMATICALLY EQUATE to “wealthy” class of investors dominating our stock market trades? Not necessarily I suppose...

What we are trying to painstakingly point out here is…unwarranted POLITICALLY COLORED sweeping conclusions have been punctured with a lot of observational biases…

Nicolas Nassim Taleb, in his book Black Swan, the Impact of the Highly improbable, calls this kind of cognitive bias as the ROUNDTRIP Fallacy….

The flawed circular logic goes something like this, “the RICH profits from the STOCK MARKET, the STOCKMARKET is for the RICH”…

Or simply, the UNFAIRNESS of stereotyping!

Where the driver of my broker, invests in the market, I presume that he must also be “Rich”!

The third point is the issue of “market prompted inequality”.

For an economic class to assumingly reap the benefits from a collective activity it implies uniformity of actions, which is hardly the case.

One should realize that being rich and a rising market is NO guarantee of stock market investing success!

We should remember that every security yields a different price and varies in the degree of volatility…

Remember those “Greek” letters in “Alpha”, “Beta” and etc…

Then there are different perceptions and set of actions from different market participants on how to manage their portfolios…

Together these variables combine to facilitate the trades in the stock market.

But like every type of enterprise or even careers, there would always be winners and losers. Of course, rising markets are likely to produce more winners than otherwise and vice versa.

And this equation is UNIVERSAL to the investment spectrum…or in any other entrepreneurial endeavor….

Be it investments in tourism projects, schools, restaurants, computer shops, sari-sari stores, farming, or others.

Under ALL types of markets (financial or otherwise), the accurate anticipation of future events coupled with the corresponding action determines the success of an investor (regardless of economic status), unless the participant is a government sponsored entity such as the hybrid “sovereign wealth funds”.

``Like every acting man, the entrepreneur is always a speculator. He deals with the uncertain conditions of the future. His success or failure depends on the correctness of his anticipation of uncertain events. If he fails in his understanding of things to come, he is doomed. The only source from which an entrepreneur's profits stem is his ability to anticipate better than other people the future demand of the consumers. If everybody is correct in anticipating the future state of the market of a certain commodity, its price and the prices of the complementary factors of production concerned would already today be adjusted to this future state. Neither profit nor loss can emerge for those embarking upon this line of business.”- (highlight mine) Murray Rothbard, the Market, Man, State and the Economy

You see, under such conditions, even the “POOR”, which supposedly is a “victim” of the market fluctuations, can benefit from the stockmarket! One must remember, RISK TAKING IS ESSENTIAL TO WEALTH CREATION! In other words, markets provide the opportunities for ANY SOCIAL CLASS to benefit either from LUCK OR SKILLS, which in itself is a GRAND EQUALIZER.

On the other hand, to even entertain the thought of a “class struggle” presupposes the contrary; the “POOR” CANNOT BENEFIT from the markets. This seems to be dangerously discriminatory since it essentially DENIGRATES their capacity to think (anticipate) or even be lucky. So such assumption is UNDEMOCRATIC and sows the seeds of further INEQUALITY.

This leads us to the final point of our contention: The true source of Inequality.

Putting the blame on the markets for economic inequality is truly unfortunate and strays from the root of the issue.

As we have noted above, inflation is the core to society’s inequalities.

Again let me lengthily quote the illustrious economist Henry Hazlitt, in his book “What You Should Know about Inflation” (highlight mine),

``Inflation never affects everybody simultaneously and equally. It begins at a specific point, with a specific group. When the government puts more money into circulation, it may do so by paying defense contractors, or by increasing subsidies to farmers or social security benefits to special groups. The incomes of those who receive this money go up first. Those who begin spending the money first buy at the old level of prices. But their additional buying begins to force up prices. Those whose money incomes have not been raised are forced to pay higher prices than before; the purchasing power of their incomes has been reduced. Eventually, through the play of economic forces, their own money-incomes may be increased. But if these incomes are increased either less or later than the average prices of what they buy, they will never fully make up the loss they suffered from the inflation.”

``Inflation, in brief, essentially involves a redistribution of real incomes. Those who benefit by it do so, and must do so, at the expense of others. The total losses through inflation offset the total gains. This creates class or group divisions, in which the victims resent the profiteers from inflation, and in which even the moderate gainers from inflation envy the bigger gainers. There is general recognition that the new distribution of income and wealth that goes on during an inflation is not the result of merit, effort, or productiveness, but of luck, speculation, or political favoritism. It was in the tremendous German inflation of 1923 that the seeds of Nazism were sown.”

``An inflation tends to demoralize those who gain by it even more than those who lose by it. The gainers become used to an "unearned increment." They want to keep their relative gains. Those who have made money from speculation prefer to continue this way of making money instead of working for it.”

In other words, subsidies, bailouts (which includes the market’s expected FED cuts (!) or Bill Gross’ suggestion for Fiscal Policy rescue package or Willem Buiter’s proposal for the Fed to act as a “market maker of last resort”), social welfare, wars, price control, dole outs (aids, grants, etc…), taxes or other redistributive programs fundamentally TRANSFER RESOURCES FROM PRODUCTIVE TO NON-PRODUCTIVE activities are inflationary in nature, because they tend CONSUME capital.

Burned capital signifies “SUNK COSTS” from which taxpayers would have to shoulder at the end of the day, despite the other ephemeral options of borrowing and printing money.

Figure 6: American Institute for Economic Research: US Dollar’s Purchasing Power

Figure 6, courtesy of the American Institute for Economic Research reveals of what inflation does to the public—the LOSS OF PURCHASING POWER or it lowers the standard of living for its citizenry!

As an example, the US dollar’s purchasing power plunged by 95% since the FED came to being in 1913 that’s according to the US Bureau of Labor and Statistics. You can check on website’s INFLATION CALCULATOR via the provided link…where $100 today has the same buying power of only $4.75 in 1913!


Figure 7: BSP: Peso-US dollar Rate: The Peso’s Anguish

In the same context, see figure 7, the Philippine Peso’s foreign exchange value relative to the US dollar fell from 2.733 in 1960 to 51.3143 in 2006 (BSP-thanks Vina)! During the same period, the US dollar’s purchasing power lost 85%, which even AMPLIFIES the loss of the Peso’s Purchasing Power! Yet in contrast to the claims where a LOWER PESO will help jobs or the public simply has not been supported by evidence.

By logic, we should have been one of the top exporting countries by now if PRICE ALONE, as reflected by the currency, had been the key measure of success…but where (see Figure 8)?

In practice, as any entrepreneur knows, price, while important, is NOT the only factor that shapes business transactions. Consider labor cost, China’s export might is often attributed to its low labor cost, but this is not entirely accurate, because Africa has even cheaper labor costs, so they should have been the export leaders, but not- because they suffer from other aspects of impairment such as the lack of infrastructure to security to governance concerns which increases the cost of doing business.

So after four decades of peso devaluation which area of trade have we then topped? Yes, you guessed it right again…human exports! Why? Because of our depressed standards of living as a consequence to the enormous purchasing power gap relative to the developed world prompted the LARGE SCALE EXPORT OF OUR CITIZENRY instead of goods of services! Essentially, an arbitrage of income disparities even in the Labor markets!

Figure 8: Yardeni.com: Exports Benefit from Lower Peso?

On the other hand, instead of the increased market share and profits via efficiency and productivity gains aided with lower prices, as our neighbors, what we saw is the opposite: MOUNTING HOMEGROWN INEFFICIENCIES aggravated the loss of competitive edge for our enterprises, which reduced our standards of living, discouraged productive risk taking ventures which thereby brought about the present outbound migratory trends.

The financial markets are to blame? In all 47 years until today, the domestic financial markets remain a small segment of the economy (see below: Stock Market: Boon or Bane to the economy?).

So, again despite the tremendous loss of purchasing power transmitted via the declining PESO-US dollar exchange during the past 47 years, why is it our economy remains uncompetitive and still mired in poverty?

In effect, the issue of inequality is LARGELY an OFFSHOOT to persistent government interventionist activities and does NOT emanate from the markets. The markets or financial conditions simply reflect on such policies, whether internally generated or from external influences.

To quote Milton Friedman anew, “There is no FREE LUNCH”.

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