Thursday, February 28, 2008

Jessica Hagy's Indexed: Crony Capitalism and Oligarchy fits the "Gap"?

In Jessica Hagy's wonderful Blog called Indexed, she makes an eloquent depiction of how a "banana republic" seems caught between the influences of communism and capitalism...

where she describes "A" as represented by Fidel Castro while "B" as the "Gap"...

I'd like to fill in the "GAP"..."Crony Capitalism" and "Oligarchy" seems to fit the bill. (see preceding blogs)

P.S. We also don't have a shortage of "A" or "Castro" wannabees...I mean, here on this island. Just watch the local news headlines and you'll know what I mean.

Hat Tip Jessica Hagey

Monday, February 25, 2008

Philippine Politics: Systemic Defects of the Pork Barrel Political Economy

``We are taught, from a very early age, to believe in that which is unreal - known in street parlance as B.S. It becomes so ingrained in us that we jeer those who try to talk straight. Nothing can make a person more unpopular more quickly than daring to be truthful - especially when the truth threatens the instant gratification of others. "Woe to him," cautioned Will Durant, "who teaches men faster than they can learn.”-Robert Ringer

Personality based politics is once again the order of the day. Given today’s highly charged atmosphere, mainly juiced up by mainstream media, many people have been impassioned in the belief that we are in desperate times that requires drastic measures.

Amidst the hullabaloo of the unraveling episodes of scandals, exposés and titillating controversies, the basic premise has been this: The incumbent leadership is so morally BANKRUPT that the ONLY RECOURSE to the nation’s salvation is to UNSEAT THEM (by extra legal means).

While we do not disagree with initial premise, what seems to confuse the public is the distinction between the means to an end and the end itself, where a complex problem is reduced to simplicity with a corresponding “simplified” solution.

Hence, the conundrum of “People Power Fatigue” or the seeming irresponsiveness by the general public to calls from certain quarters to undertake the street politics of the past.

We Get What We Deserve

We have to understand we live in a “democracy”. The nation’s leadership did not pop up from nowhere, we PUT them where they are today (by both the extra legal and electoral process).

One may argue that the incumbent may have cheated themselves into the present position, but what is missed is that cheating comes in a tightly contested race (e.g. Erap’s landslide victory in 1998 did not give the FVR administration the opportunity to cheat-yet it was a political statement against FVR too) and next, the alternative or rival candidate was no guarantee of a “moral” leadership (yes, a highly popular but surrounded by traditional politicians, and political interest associated with the deposed president).

What I’d like to point out is that the Filipinos are simply reaping from the sets of leaders we chose from.

Take the 2007 senate elections. As we pointed out in our May 28 to June 1 2007 edition, [see Philippine Elections Determined by The Contrast Principle!], the outcome of the elections, where the opposition trumped the administration bets, was clearly based on sentiment meant to drive a political statement against the administration.

I wrote then ``As Franklin Pierce Adams (1881-1960) American Journalist wrote, ``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.” And Mr. Adams’ aphorism echoes loudly in today’s vote; it was a vote AGAINST somebody rather than for somebody (-ies).”

For as long as the candidates were deemed to be winnable and strongly biased against the administration, regardless of the past performance they were voted upon by the public into office. One even spearheaded the ouster of the previous president via congressional impeachment yet ironically had to seek the latter’s endorsement-it’s a curiosity how it seems like a norm for the public to simply accept political “turncoatism” or “butterflies”.

In the context of the contrast principle or ( the difference between “things” and not absolute measures, this means that the limited options reduce the chances of highly qualified set of leaders being voted into office. In politics it could mean a choice between the proverbial “pot” and the “kettle” where both have been calling each other black!

The lesson here is we do not elect our leaders based on integrity, ideology, platform, performance track record or other quality measures of meritocracy but on superficial traits as winnability, personal familiarity or association or network, sentiment, popularity, machinery or faddish themes, regardless of political baggages.

Thus, we get what we deserve.

This also means that for us to attain our desired “moral” leadership we need to RADICALLY IMPROVE THE MANNER FROM WHICH WE SELECT OUR LEADERS. Otherwise all this political exercise for “change” can easily be labeled as mere blarney.

Abstractions, Value Judgments and Getting Fooled Over and Over

This leads us to the next item. The public seems to have a short memory. Philosopher George Santayana’s famous axiom, ``Those who cannot remember the past are condemned to repeat it” seems so fitting. Or how about this anonymous quote ``Fool me once shame on you fool me twice shame on me.”

Many have been calling for another People Power. The underlying belief is a swift resolution in response to a “simplified” problem. The unfortunate part is that we keep on repeating what philosopher Santayana keeps warning us about: WE NEVER SEEM TO LEARN FROM THE PAST. Or applied to the present situation, we seem to keep on fooling ourselves over and over. The unanswered question is why?

We have seen this script before in 1986 and in 2001. While the difference maybe in the characters and circumstances involved or how these events played out, the patterns and the alleged sins have basically been the same: Abuse of authority and corruption.

For starters, the fanfare about political change is mostly anchored on abstraction. As self-development Robert Ringer defines (highlight mine),

``An abstraction is theoretical in nature - i.e., it is not a tangible reality. It has no form or substance. Examples of abstractions include such concepts as time, infinity, negative numbers, zero, gravity, motivation, resourcefulness, love, justice, fairness, dreams, intuition, common sense, conceptualization, and axioms…What I'm driving at here is that we live in an abstract world, a world filled with abstract thought, existence, and causality. A world where time, being, and substance are not provable.

Let me give you an example.

A terminally ill father is supported by his children. The eldest child gives out a portion of his income as contribution. The second child gives out all of his income, while the third child even borrows aside from shelling out his entire earnings to sustain their father. The youngest child does not contribute because he is unemployed. So which among the children serves best their father?

You see the problem here is one of opportunity costs. It is a problem based on a trade off between the available resources (by the children) and the life of their father. People are likely to have different responses with respect to this dilemma based on their perceived “value”. In other words, the above case represents a mundane abstraction based on value judgments.

Where value judgments, according to, ``is a judgment of the rightness or wrongness of something, or of the usefulness of something, based on a narrow personal view. As a generalization, a value judgment can refer to a judgment based upon a particular set of values or on a particular value system. A related meaning of value judgment is an expedient evaluation based upon limited information at hand, an evaluation undertaken because a decision must be made.” (highlight mine)

The point is what you may define as “morality” or how you perceive the world (or government) should function maybe different from what I or others may perceive as “moral”. While we may share the same definition for a particular abstraction (e.g. altruism or honesty), the degree of application of value judgments is likely to vary according to the existing conditions when the problem is presented.

Example, if I decided to donate to some spare money to some street children of Mandaluyong, then what I give to them means that I don’t give to the street children of Manila, San Juan or to street children of other places or to orphans or to handicapped children or to delinquent juveniles or to abused children or other underprivileged class. Does that make me any less charitable?

Or if you happen to see a Php 1,000 bill on the floor right in front of the ATM, with nobody near the premises…do you ignore the bill or do you get the bill and give it to the bank branch manager or surrender it to the police headquarters or donate it to the beggar at the street corner or keep the money for yourself? If you decide on the latter, does it make you any less honest?

Yet the problem is, media portrays the present political predicament as something clear cut; a choice between black and white, or good or evil. Remember, wrong diagnosis leads to the wrong treatment.

In the same plane, in economics, a free market laissez faire advocate, a Keynesian, a Supply Sider, a monetarist or communist while exposed to a similar problem would apply different solutions according to their value judgments.

In politics, we see the same, where you see some leaders call for moral upheaval the unfortunate part is that many of those who were previously privileged have not shown satisfactory performances to validate their claims. Again English Author Samuel Johnson maxim is a perfect working example in Philippine politics ``Patriotism is the last refuge of a scoundrel." In essence morality is term conventionally used for political convenience.

Lets us change the equation from the above example.

Suppose the four children died and you would be asked to regularly give, donate or sustain the terminally ill man, would you do so?

Essentially you probably won’t, if you don’t know the person or his family. You probably would-only if it falls under certain circumstances, e.g. part of the project of your socio-civic group…but perhaps not regularly and perhaps under a limited sum in proportion to your surplus resources.

But this is how exactly government functions, it forces you to do so-it is a coercive redistribution of resources-by taxing you and me-and giving it to the “underprivileged”. It transfers resources from the productive sectors of the economy to the non-productive sources.

If the redistribution process grows more than the required rate of capital investment then the economy suffers. Government would resort to borrowing money (deficit spending), inflating the money supply which eventually leads to a litany of ills- higher taxes, high cost of doing business, a depreciating currency, reduced purchasing power via higher cost of living, capital flight, higher interest rates and social inequality.

Meanwhile, the social costs are deeply rooted sense of entitlement and the dependency culture. Yes, why work or take risks when government pays anyway.

The important point as elucidated by Ludwig von Mises in his magnum opus Human Action, `` There is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity.”

Figure 1 ADB: Comparison of Investment Rates as % of GDP

Yet, to attract capital investments you would need to have a competitive hurdle rate or ( ``minimum rate of return that must be met for a company to undertake a particular project” relative to other investment alternatives as our neighbors. As you can see in Figure 1 from Asian Development Bank, the Philippines has the least investment rate among its neighbors.

ADB imputes this partially to hefty growth in service sector (which is not capital intensive), excess capacity and low domestic savings, and weighted towards infrastructure inefficiencies (e.g. expensive and unreliable electricity and transport networks), high taxes, cumbersome business procedure and overregulation, aside from fiscal deficits, poor governance and small and narrow industrial base. The reason for the highlight is to show you the congruence between my observation and that from ADB.

The Pork Barrel Political Economy

Come to think of it given the way “morality”-honesty, compassion and fairness is tossed about in the media, it would seem to allude of our poor as a “privileged class” since many politicians and experts seem to use them so often and throw in every interventionist “kitchen sink” solution to our problem of more than 45 years! Yet the paradox is while they (experts and politicos) have been in and out of power, the Poor unfortunately remain POOR!

As evidence, our “moralistic” political economy has seen the government intervene in almost every sector or industry such that many state owned enterprises (Government Owned Corporations or Controlled Corporations) are still being subsidized by national government which continues to be a drain and a drag to country’s fiscal conditions (thus constitutes a major growth constraint cited by ADB).

Or take a look at the Pork Barrel system as discussed in our November 12 to 16 edition, [see The Economics of Philippine Election Spending], the purpose of the Pork is to provide benefits and jobs to the local constituents. The idea is-since local elected officials should know more and are “sensitive” to the needs of its constituents, these taxpayer funds are meant to be “moralistically” reallocated according to the discretion of elected authority’s “value judgments”. The problem is where has all the money gone?

If our elected officials have been “efficient” in allocating or dispensing of such funds “productively” then probably ADB won’t be citing much of our infrastructure inefficiencies as another constraint to growth.

On the other hand, who among the elected officials have not encountered requests for special personal favors from one’s political jurisdiction?

Special personal favors such as burial expenses, to medicines, to jobs to tuition fee subsidizes, to loans, to basketball t-shirts to trophies, etc…, yet given the low and limited pay of our officials, they have allegedly been impelled to use the Pork Barrel projects as a source (via SOP – euphemism for kickbacks) for accommodating these personal requests.

So essentially, the Pork Barrel culture reinforces the patron-client relations from which the Patron (politicos) delivers doleouts and subsidies, which is squeezed from the Pork Barrel projects, to the clients who deliver the votes and keeps the former in power. Hence, the Pork Barrel system is essentially a legitimized source of corruption and abuse of power seen from almost every level of the nation’s political structure, an oxymoron from its original “moralistic” intent (unintended consequences). As the saying goes “the road to hell is paved with good intentions”.

As we previously noted, ``Plainly said, when we demand for more social spending or welfare based programs to resolve our problems then we increase the funds allocated to politicians for their dispensation. Essentially, Pork Barrels signify our excessive dependence on government where the correlation of government spending and the price of getting elected are direct.”

Oligarchy, Crony Capitalism and Conflict of Interests

More proof? Look at the recent “oligarchic system” floated in the papers or in speeches by some officials. In my recent post It’s Less About Oligarchy and More About Bureaucratic Crony Capitalism, I demonstrated how the proffered “present ills” of the society is less about oligarchy but more about cronyism. Since the names of the alleged oligarchs seem relatively new (except for one) this does not qualify them under such definition. Oligarchs are those who command powerful economic means to allow them to shape the nation’s political structure to their auspices, hence they are likely to be longstanding well entrenched “oligarchs”.

Yet people look at the surface without parsing through the casual structures; both of these political structures operate on common grounds, Oligarchy and Cronyism essentially signifies overregulated economies.

Oligarchs thrive on regulations that keep away competition (hence, exerting control via “king makers” role) while cronyism makes use of high political connection which takes advantage of the "web" of regulations in order to benefit financially.

In a market economy, capital investment allocation is determined by market forces competing to win the consumer’s vote. Wealth is determined by satisfying the consumers. Regulation is kept at a minimum: mainly to uphold contracts and property rights. Taxpayer burden is thus, marginal.

In overregulated economies, the privileged class is sustained by a wall of regulation and close political ties and not by a level playing field. Wealth comes from getting the right political connections than risk undertakings.

So aside from the benefits of spending other peoples’ money (SPOM) through the Pork Barrel system, today’s struggle for power is also about economic dominance-consorting with the privileged class.

Finally is the issue of conflict of interest. Ex-US President Thomas Jefferson once said, ``The man who reads nothing at all is better educated than the man who reads nothing but newspapers."

In this case, I would agree with Ex-US President Thomas Jefferson, the obsession with political drama is derived from media’s propensity to paint the proverbial “mountains out of molehill” or to create a crisis of monumental proportions when the problem is all about “personality based” politics and the proclivity for drama and controversies.

Remember, media’s incentive is to sell news. And bad news sells; the more the controversial, the more the sensational, the more sales and advertising revenues for the media outfits. It is the incentive for media to sensationalize bad news. Yet, many believe media as some sort of “gospel wisdom”.

We see the same predicament with the church. The church appears to know how the government should be run and where the economy ought to be steered into. They should be allowed to turn this self-righteous attitude into real politics, let one of their representatives run for the top spot in 2010. Maybe they can clean the proverbial Aegean Stables.

Yet, the problem of the church is one of incentives and not of direct taxes. When the church advocates for more welfare spending to signify “compassionate governance”, it means more burden for the taxpayers. Again where do you get the money to spend for do goodies for the underprivileged (remember the example of the terminally ill father)? Unfortunately, it is us and not them.

Since they do not pay direct taxes (which according to them is not a privilege), taxpayers would shoulder any direct weight of additional social spending, so it is easy for them to tell us where to spend government money because the burden falls squarely on our shoulders.

As for the argument of indirect taxes, according to them while they don’t pay direct taxes they pay indirect taxes. Following such premise we get a double whammy: we pay both direct and indirect taxes. Woe again to us the taxpayers.


All these tells me that this is LESS of a problem about morality, but more of a SYSTEMIC DEFECT which skews on the incentives for the politicians, the investors/capitalists and the voting populace arising from TOO MUCH dependence on government sustained by a pork barrel culture and the defense of the privileged class.

It is my sincere hope that people would start looking at the roots of the problem, rather than deal with superficialities and learn by the lessons of the past as philosopher Santayana warns.

It is easy to make a prediction. 2-3 years after the assumption of a new administration, be it through extra legal change or via elections proper in 2010, we will most likely see similar scandals, but at a varying degree over and over again.

Why? For as long as we don’t change the way we choose our leaders, for as long we depend on the Pork Barrel system of governance and hide behind the walls of regulations to uphold the privileged class, the system remains greatly vulnerable to the abuse of power and its offshoot-corruption.

Moreover, our inherent penchant for melodrama as well as advances in technology-cellphones, the web, would allow us to witness and share more of such controversies.

But all is not without hope though. Happiness is not only measured by money, a recent study by Freakonomics’ Justin Wolfers (posted in our blog) indicates that the Philippines is probably the most conducive place for love. Maybe when we are not busy playing acrimonious politics we fall in love.

A Prospective Boom in Philippine Agriculture!

``Who controls the food supply controls the people; who controls the energy can control whole continents; who controls money can control the world.”-Henry Kissinger

Experts tell us that Philippine government needs to shore up our agricultural sector. While I think they are reading too much of the past to project it well right into the future, I likewise think that they have been underestimating the operating dynamics of today’s macro environment.

A Rush to Hard Assets

Let us look at what’s happening to the world first. While significant parts of the world is now constrained by debt contraction (deflation), consumer price indices continues to march upwards where many countries (especially emerging markets) have been experiencing a surge in food and energy price indices.

Figure 2: Danske Bank: Rising Consumer Prices in G4 Countries against a contracting manufacturing sector

Well it is not actually contained to emerging markets as shown in Figure 2, even G4 countries have seen a spike in consumer prices even as observed by Chief Economist Steen Bocian from Danske Bank ``The past week has brought more surprisingly high inflation figures. In the US, for example, inflation climbed to 4.3% y/y in January. The story is the same every-where: inflation has risen sharply while growth is either already falling or feared liable to fall in the wake of the weaker growth stateside.

``The increase in inflation is still due primarily to rising energy and food prices. Both oil and food prices have continued on upwards in February, and there is therefore a risk of inflation not dropping back as quickly as we anticipated. This could result in an even weaker growth scenario in the short term, as the expectation of gradually falling inflation, and so stronger growth in real incomes is key to stronger private consumption in countries like the US and Japan during the course of 2008.” (highlight mine)

You are probably aware that Crude Oil recently spiked to over $100 anew this week but fell back to $98.8 with a week-on-week gain of 3.52%. Much of the energy markets have likewise exhibited considerable advances too, as Natural gas, US ROB Gasoline and heating oil. Precious metals has also surged, as gold $944, silver $18 and even DR. Copper which now trades only a stone’s throw distance away from its all time high!

Moreover while depressionists insist that the world is recoupling via credit deflation, it looks the opposite is happening-inflation is one factor that appears to be surfacing in most economies. So they look partially right, there is a recoupling-but it is via inflation.

We don’t like to argue against depressionists simply because they could be right, but so far they have yet to be proven accurate. Some of them went on saying that the appearance of stagflation (which generated quite a reaction following the publication of New York Times of “That ’70s Look: Stagflation”), is simply a transition from inflation to deflation and others say that there is not enough meaningful shortages to sustain this dynamic as inflation is a lagging indicator. We beg to differ, as we presented last week, relative to oil prices-if demand slows but supply slows faster then oil prices will spike. It’s not all about demand.

True enough, the high inflation period which marked the 1970s era was followed by an era of a “disinflationary” environment in the 80s until the new millennium. But it was not a global depression though, because boom bust cycles were seen shifting from Japan to Latin America to Asia and Russia then to the US.

We think it is the same dynamic at work; loose liquidity is looking for assets to park into as major global central banks work to debase their currencies to cushion the world economy from a material slowdown. Yes, with socialization gaining momentum, this means a flood of money into the global system. We just hope that protectionism don’t gather momentum.

Some say US monetary aggregates have shown signs of compression (meaning deflation) and thus reinforcing the view of more deflation to come. From the appearance of movements in asset markets, US monetary aggregates seem as an inadequate measure of global liquidity. It looks as if the growth rate of emerging market foreign currency reserves is a better indicator.

Hence, while there is credit deflation in some parts of the world, many parts of the world which have been least affected by the derivatives-securities-mortgage implosion are finding shelter in hard assets as opportunity costs of holding cash or as an alternative store of value.

It is noteworthy too that some equity markets, have already climbed to new record highs mostly found in GCC and African region, such as Kuwait, Nigeria, Oman, Morocco and Tunisia, with a good number knocking on the door of new record highs as Brazil, UAE, Qatar, Egypt, Jordan and Namibia. So what was once touted to as a “recoupling” has not happened so far except during the January 21 meltdown aside from the October decline. Present dynamics suggests of a financial markets “decoupling” or divergence from the US.

Booming Global Agriculture Prices Should Spillover to Philippine Agriculture!

Figure 3: Economagic: Wholesale Price Index, Food and Energy

And the most important development right now is the price surge in agriculture products! In figure 3 courtesy by economagic, shows of the wholesale price (blue) in the US which has been accompanied a broad market surge of soft commodities which includes livestock (red), foodstuffs (green), grains (yellow green) and energy (fuschia pink).

This implies that there is a massive imbalance between the supply and demand dynamics. Since this is a global phenomenon then it means many parts of the world are facing the same conditions. It also tells us that there is a great shortage which means that investors will continue to shift to agriculture investments for as long as price dynamics warrant this.

So in contrast to the opinion of our domestic experts, the Philippines don’t need direct government intervention except to disentangle the restrictions on investments by cutting red tape and facilitate for this upcoming surge of investments.

Philippine agriculture is an underrated but important contributor the Philippine economy. It is one of our ace against global depression. Agriculture accounts for about 16% to the nation’s GDP but employs nearly 35.8% of employed people in 2006. Agriculture exports likewise, contributed 24.54% of total exports during the first half of last year with coconut, banana, and pineapple being top export products. With the soaring prices of agriculture products expect a surge in this sector to support our economic growth.

We have been bullish in Philippine Agriculture as early as 2006, and even devoted an entire article last June 4 to June 8 [see Bond Markets Rout; Signs of Rising Inflation? Bullish on Philippine Agriculture].

There is only one oddity from which our academic experts have long been suspiciously reticent about…among our neighbors, we are the only country that doesn’t have a commodity futures market to support our farmers. Indonesia has Jakarta Futures Exchange, Malaysia has Kuala Lumpur Commodity Exchange and Thailand’s Thailand’s Future Exchange and the Agricultural Futures Exchange of Thailand.

As an agricultural country, future markets will help our farmers hedge their produce from price volatility. Not only that, it allows for savings to be channeled into investments, generates liquidity with the participation of speculators and arbitrageurs and subsequently pricing efficiency, aside from diminished transaction cost.

Of course, not everyone benefits, the role of middlemen will be reduced. But overall, greater profits for the farmers could translate to a lowering of social inequality. All that needs to be done is to set up the infrastructure and teach our farmers the modern way to do farming with financing. The diffusion of technology is a very important factor in addressing this.

Surge of Food Prices Presage Armed Conflicts!

``Anyone who thinks this decade’s problems start and end with credit, in other words, may yet receive a rude shock; sadly, we live in a world where soybeans may yet pack as painful a punch as subprime.”-Gillian Tett, The Next Crisis will be over Food

Rising commodity prices, especially food prices have in the past contributed to rising tensions and belligerence which may lead to more incidences of wars or civil wars.

Figure 4: Marc Faber GBD: War Time Distortion 1830-1950

As we have mentioned, the urbanization and growing wealth in emerging market economies have led to dietary changes on the demand side while climate changes, water shortages, desertification, industrialization, long underinvestments in agriculture, and the unintended effects of biofuel subsidies and other regulations have all contributed to the supply side shortages.

However surging food prices will mean lesser food for those living on the margins, this means increased political pressure or heightened risks for armed conflicts. Surging wholesale prices as shown in Figure 4, courtesy of our favorite Dr. Marc Faber’s Gloom Boom and Doom, has coincided with martial activities.

This from Dr. Faber (highlight mine), ``In his book Cycles (New York: 1971), Edward Dewey devotes a chapter to “The Patterns of Wars”. His research was inspired by an Index of International War Battles and Civil War Battles, which had been created by Raymond Wheeler in the 1930s. (Wheeler had been a professor of psychology at the University of Kansas and president of the Kansas Academy of Sciences, and became well known for his studies into climate cycles.) According to Dewey,

“… the War Index was used by Professor Wheeler to show a relationship between shifting temperatures in the earth’s climate and man’s proclivity for war. Warm periods, he noted, were the time of dictators and international wars, while cold periods produced civil unrest and democracy. His compilations were made without any preconceived notions of cycles, but he did note that there were recurrences of drought and civil war at approximately 170 years intervals and that every third of these drought–civil war periods was more pronounced, thus creating a longer cycle of 510 years. He also observed shorter rhythms, especially one of approximately 23 years.”

So yes, while surging agriculture prices may underpin an investment boom in the Philippines the unseen risks is that this can lead to armed conflicts here or abroad.

Friday, February 22, 2008

Joann Muller of Forbes: Thank You, Asia

The survival of General Motors presently depends on the growth of overseas market, particularly of Asia’s market, as the chart below shows. That’s what Ms. Joann Muller of Forbes recently pointed out…

From Ms. Muller (emphasis mine),

``Well, at least they love General Motors (nyse: GM - news - people ) overseas. While the automaker's North American sales have dropped hard in the last three years, they've been soaring abroad, particularly in developing markets like China, India and parts of Latin America. Last year 60% of the vehicles it sold (9.4 million) were bought abroad, up from half just two years ago.

``For now, the global operations are carrying the company. GM made $2.1 billion in pretax operating profit last year, almost enough to offset the $2.7 billion it lost selling cars and home mortgages in North America. It's a revolution, just not an American Revolution.”

Of course yesterday’s sales composition may not be the same for tomorrow. But it would seem that GM’s overseas sales could serve as an important indicator of how today turbulent credit markets will likely impact Asian consumption as well as the other emerging markets.

All this goes to show how the world has been changing from a unipolar US centric growth dynamic to that of a multipolar one.

(hat tip

Tuesday, February 19, 2008

It’s Less About Oligarchy and More About Bureaucratic Crony Capitalism

It is held by some parties that the “web or ecosystem of corruption” in the Philippines stems from the oligarchic structure encompassing the Presidential seat of power. The following opinion is based on the assumption that such claims has merits.

According to, ``Oligarchy (Greek λιγαρχία, Oligarkhía) is a form of government where political power effectively rests with a small elite (emphasis mine) segment of society (whether distinguished by wealth, family or military powers).”

Now ADB’s Critical Development Constraints says that ``In 2003, the richest 20% (highlight mine) of the Philippine families received more than half of the national income, while the poorest 20% accounted for only one twentieth.” This means that over 50% of national income rests on some 3.3 million of the 16.48 million families (businessworld).

By definition 3.3 million families controlling the entire economy may partially be true but is not a sufficient condition by which to categorize of an oligarchic political economy. 3.3 million is not a small segment. It may be true to some industries but probably not to all.

Further among the persons allegedly cited as oligarchs benefiting from the present administration only one appears to be a valid “oligarch”. Although as a caveat, the magnate has been a known “oligarch” since the Marcos administration. All the rest seem to be new names which mostly belong to the “old rich” families.

What seems to be a more adequate description under the alleged circumstances in our present political economy is "Crony Capitalism".

From, (highlight mine) ``Crony capitalism is a pejorative term describing an allegedly capitalist economy in which success in business depends on close relationships between businessmen and government officials. It may be exhibited by favoritism in the distribution of legal permits, government grants, special tax breaks, and so forth.”

The common characteristics of a crony capitalist society again from ``Crony capitalism is generally associated with more virulent government intervention, however. Intentionally ambiguous laws and regulations are common in such systems. Taken strictly, such laws would greatly impede practically all business; in practice, they are only erratically enforced. The specter of having such laws suddenly brought down upon a business provides incentive to stay in the good graces of political officials.”

As Ludwig von Mises always reminds us "corruption is a regular event of interventionism", a complex web of bureaucracy is the ultimate design that allows for such perverted actuations,

From Ludwig von Mises in his Bureaucracy (highlight mine),

``Under this system the government has unlimited power to ruin every enterprise or to lavish favors upon it. The success or failure of every business depends entirely upon the free discretion of those in office. If the businessman does not happen to be a citizen of a powerful foreign nation whose diplomatic and consular agents grant him protection, he is at the mercy of the administration and the ruling party. They can take away all his property and imprison him. On the other hand, they can make him rich.

``The government determines the height of tariffs and freight rates. It grants or denies import and export licenses. Every citizen or resident is bound to sell all his proceeds in foreign exchange to the government at a price fixed by the government. On the other hand, the government is the only seller of foreign exchange; it is free to refuse ad libitum applications for foreign exchange. In Europe where almost every kind of production depends upon the importation of equipment, machinery, raw materials, and half-finished goods from abroad, such a refusal is tantamount to a closing of the factory. The final determination of taxes due is practically left to the unlimited discretion of the authorities. The government can use any pretext for the seizure of any plant or shop. Parliament is a puppet in the hands of the rulers; the courts are packed.

``In such an environment the entrepreneur must resort to two means: diplomacy and bribery. He must use these methods not only with regard to the ruling party, but no less with regard to the outlawed and persecuted opposition groups which one day may seize the reins. It is a dangerous kind of double-dealing; only men devoid of fear and inhibitions can last in this rotten milieu.”

So if this is true then at the end of the day it all boils down to a systematic backfire on our excessive dependence on government. From which special interest groups has taken advantage of the intricate webs of laws to economically profit using its political connections with the center of power.

As we quoted Ron Paul last Sunday, ``The only effective way to address corruption is to change the system itself, by radically down sizing the power of the federal government in the first place. Take away the politicians' power and you take away the very currency of corruption.

Monday, February 18, 2008

Philippines: The Most Interesting Place for Love?

Amidst the hysteria of obnoxious domestic politics, Justin Wolfers of Freaknomics offers us some relief. In a study to gather insights of how love relates to the economy covering many countries, he identifies the Philippines as the most interesting place to search for love as seen in the chart below….

Mr. Wolfers, “It turns out that love is incredibly democratic, and is as common in poor countries as it is in rich countries. And, encouragingly, about 70 percent of us report feeling a lot of love on any given day. This isn’t as obvious as it may sound, as love’s enemy, anger, is significantly more prevalent in poor countries than in rich.

“The data suggest some interesting places to look for love: the Philippines, Rwanda, and Puerto Rico top the “love tables.” Meanwhile those in Armenia, Uzbekistan, and Tajikistan are feeling the least love. (Unfortunately, the love question wasn’t asked in the United States.)

Wow. The Philippines-the land of “Romeo and Juliet”?

Or could it be that that the Filipinos’ fixation for love is the obverse side to our obsession for domestic politics? If we cannot love then we can do politics.

(Hat tip to Freakonomics)

Sunday, February 17, 2008

Contingent Causes and Consequences of Human Action Should Underpin Decoupling Theme

``The only effective way to address corruption is to change the system itself, by radically down sizing the power of the federal government in the first place. Take away the politicians' power and you take away the very currency of corruption.”-Congressman Ron Paul

What was previously pronounced as the hottest emerging trend easily became an orphan overnight following the synchronous Jan 21st global equity markets meltdown. Even some of the most revered advocates of the so-called Asian “century” went on air to debunk the so-called “Decoupling theory” as a myth or as the emperor with no clothes.

Ironically, it seems like logical fuzziness to claim that Asia will be the next economic powerhouse when supposedly its fate has been declared as being foreordained towards the growth trajectory of western nations due to its trade, economic and financial links.

In a positively correlated economic and financial sphere, does it imply that Asia would outperform only when global economies and markets are accelerating upwards?

Maybe, the difference lies in the definition from timeframe dimensions (not today but tomorrow or sometime in the future perhaps?). Maybe also, too much emphasis has been devoted to a singular event or analysis based on the rear view mirror or recency bias or past performance as guide to future events.

Again as a reminder, we do not deny that under globalization trends which means more heightened interconnectedness, linkages (trade, financial, labor) have been tightening and is likely to get tighter. And such dynamics are likely to be reflected on the markets as had been the case since 2000. But again the caveat is that there is no pure globalization or integration.

We argued the case of positive interrelationships since 2003, and in fact took on the prisms of a bear (last week) to show that under selective dimensions; particularly the induction premised from exports and remittances, a severe US slowdown will negatively impact the Philippine economy.

But unlike then, our idea today is that markets and economies could possibly be rediscovering its individualities due the different dimensions of exposures to what has weighed in on some economies or markets. Besides, under diverse conditions people, societies or even nations react divergently to changing conditions.

To quote Jörg Guido Hülsmann in his article “The Epistemological Case for Capitalism” published at the (highlight mine), ``The causal analysis of individual human behavior must take account of the fact that any human action has certain invariant consequences — that is, consequences that result from like action at any place and any time. For example, an increase of the quantity of money tends to entail an increase of the price level above the level it would otherwise have reached, irrespective of when and where the money supply is increased. The study of such consequences is the task of praxeology and economic science.

``But human action also has contingent causes and consequences. The very same action — increasing the quantity of money — can be inspired by very different ideas and value judgments. And the objective consequences resulting from any action can provoke very different individual reactions at different times and places. In other words, the causal chains through which ideas and value judgments are connected with human action are contingent. The elucidation of these contingent causal chains is the task of historical research.”

Recent examples, in the recent G7 finance ministers meeting, media asked if global central banks would concertedly lower interest rates to help stave off a world recession, here is the reply of Finance Minister Fukushiro Nukaga, ``Each country needs to take a step, and it is important to push that move based on its own economic and fiscal situation”. (highlight mine)

The interview best described by Japan Times, ``…the G7 had dashed any hopes of concerted international action, such as coordinated interest rate cuts and fiscal stimulus packages, because economic and fiscal conditions differ from country to country.” (emphasis mine)

So while global central banks would work to coordinate with each other, policy stimulus would have to be applied distinctly.

Oh, speaking of surprises, just when mainstream experts had been almost unanimously bearish brought upon by the “contagion” effects from the US mortgage crisis saga, Japan’s last quarter GDP unexpectedly soared.

From Bloomberg (highlight mine), ``Japan's economy grew 3.7 percent last quarter, twice the pace economists forecast, as business investment rose and exports to Asia helped companies weather the U.S. slowdown.” So contrary to most expectations capital expenditures (based on rising demand from Asia, Russia and the Middle East according to Bloomberg) and exports have remained resilient in the face of a US downturn during the last quarter of 2007.

We don’t like to read too much from a single event. Yet this imparts an important message- analysis based on “sterilized” conditions exhibits vulnerability. While some analysts call this a “blip”, one said that Japan’s GDP was not the appropriate indicator. A seeming case of denial?

Since a quarter does not imply a reinforced trend, it could be that the mainstream will be proven correct; as the downdraft in the US economy intensifies these positive variables could reverse. In the meantime some even assert that Japan will be the next country where the next wave of Pandora’s Box of toxic papers will surface, as measured by the recent spike in iTraxx Japan (a measure of default risks of Japan’s top 50 companies). So the global credit crisis is popularly expected to further curtail its economic activities. But on the other hand, again they could be wrong.

We read that Japan’s economic problems have been mostly about the unintended effects as a consequent to the recently imposed policies more than the ramifications from a global contagion, this from Takehiro Sato of Morgan Stanley (highlight mine),

``Japan’s “errant policy-induced slump” is already widely acknowledged among investors as “Kansei Fukyo”. The three main components are 1) heightened liquidity concerns for SMEs with de facto volume restrictions and caps on the loan interest rate for consumer financing and a shared responsibility program launched by the Credit Guarantee Corporations (CGCs) in October 2007, 2) a sharp downturn in residential investment under the revised Building Standards Law, and 3) diminished investment in risk assets following implementation of the Financial Products Transaction Law…”

``We think that liquidity restrictions from cutbacks in consumer credit and loans guaranteed by the CGCs, though for very different reasons than in the US and Europe, might be interfering with corporate activity in Japan as well. The scaled-back credit guarantee program is not having a major impact yet since the changes were accompanied by transition measures to cushion the blow.”

Of course, Mr. Sato like most of the mainstream believes that external conditions combined with internal forces are making Japan’s situation ``increasingly difficult to envision a convincing upside scenario for Japan.”

Figure 1 Japan’s Nikkei 225

We don’t know much about Japan except through the reports we read. So our outlook depends on the accuracy of the information we gather. From our perspective, many analysts have deduced Japan’s present woes as having been more internally generated, whereas the impact from external factors has yet to be actualized or has yet to surface on the economic data.

This means that if economic data continues to prove that the contagion impact from the US may have been exaggerated then Japan’s dramatic swan dive (a peak-to-trough decline of about 32%-see figure 1) could have been an overshoot.

In other words, Japan’s decline appears to have priced in more of the expected “global contagion related” bad news than is otherwise reflected in the present economic data. The major benchmark the Nikkei 225 is down about 11% year to date.

This implies for two scenario, one market is wrong (overshoot) and the Nikkei should start bottoming out 13,000-14,000 before recovering. Or two, Japan’s economic conditions will likely deteriorate further and may fall into a recession (from which the Nikkei could decline somewhere into 11,000 to 12,000).

We can’t say if the Nikkei has reached its bottom, time will make the cycle apparent but for the moment it looks like the major Japanese benchmark is poised to test its resistance level.

From the above examples (G7 and Japan), we can conclude that the battle between a globalized and a divergent outcome has yet to be resolved decisively.

Monetary Conditions Remain Supportive of Emerging Market Assets

``Inflation is a societal evil. It redistributes real wealth from creditors to debtors. It impairs the role of money as a means of exchange. The efficiency of the market's price mechanism is greatly reduced, encouraging bad decisions, which in turn harm peoples' economic well-being. At the end of the day, inflation is a serious threat to freedom. The majority of the people, suffering badly from inflation, would most likely blame the free market for their plight, rather than blame the central bank for the debasing of the currency.”- Dr. Thorsten Polleit, Honorary Professor at the Frankfurt School of Finance & Management

Last week I presented the idea that the Phisix would likely be cushioned by negative real interest rates. Negative real interest rates are essentially consequences of policy actions which is either deliberate (government taking up “pro-growth” stance to induce borrowing) or unintentional (outcomes from policies directed at a different agenda).

Since the Consumer Price Indices (note: I don’t use inflation) have been at record low levels in 2007, Philippine authorities have utilized such environment to slash interest rates in order to cut interest rate differentials between the US dollar to stem portfolio flows into the country, whose implicit aim is to curb the pace of the rising Peso. In short, the country’s central bank, the Bangko Sentral ng Pilipinas (BSP) has been acting to control the Peso’s appreciation by manipulating interest rates, among other policy tools.

And as we also noted last week, the BSP had been surprised by the sudden upsurge in the local CPI which appears to have limited its policy options in following the US Federal Reserves into similar policy measures aimed at providing stimulus to the economy in order to shield the economy from a potentially sharp downturn.

While the projections for domestic CPI remains moderate, my take is that the BSP will likely be “surprised” anew by the continued surge in commodity prices globally (this week: record high soybean, soybean oil, platinum).

This means that if the BSP opts to maintain rates at present levels despite a resurgent “sticky” CPI, then it is thus adopting a “pro-growth” stance, or attempting to expand credit to drive domestic consumption and investment. On the other hand, the BSP may move to increase rates as now reflected in the bond market (both dollar and peso denominated).

As we have said before, negative interest real rates relates to the function of money as a “store of value”. When inflation is higher than the income stream received via coupon yields of fixed income “risk free” investments then effectively the purchasing power of a currency erodes, thus the populace would find alternative means of maintaining the “store of value” in a currency by buying into other assets or by speculating in the expectations of returns above inflation rates.

If the BSP elects to maintain at these levels then we are likely to see expanded borrowings from domestic investors from which some assets may benefit. On the other hand, if the BSP raises policy rates, foreign portfolio inflows could be magnified.

As Ludwig von Mises wrote in Man, Economy, and State: A Treatise on Economic Principles,

``Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.”

Again boom bust cycles are essentially driven by incorrect signals sent by policy makers to the capital markets. If a boom will be triggered by a prolonged negative interest rate environment, then a bust in the future should likewise be expected.

Such is the dilemma facing the BSP, as the credit squeeze in the US and Europe continues to unfold (see figure 2), attendant policy measures by the US or Europe could be expected to target or address the ongoing tightness in these markets.

Figure 2: Danske Bank: Widening Spreads Indicate Monetary Tightness

Doug Noland from the Credit Bubble Bulletin (highlight mine) identifies the broad market tensions, ``In the markets, various indices of investment grade Credits widened sharply to record levels. The key “dollar swap” (interest-rate derivative hedging) market saw spreads widen sharply. Agency spreads also widened significantly. Benchmark Fannie Mae MBS spreads widened a remarkable 20 bps against 10-year Treasuries, while agency debt spreads widened a noteworthy 12.5 basis points to 69.5 bps (high since November).”

This means that as policy rates in the US become accommodative, the interest rate spread or differentials or “carry” widens in favor of the peso, coupled with stronger economic growth, these factors are likely to signify as strong incentives for foreign money to bid up on Philippine assets.

On the other hand, if the BSP moves to increase rates in the face of rising CPI, it would only add fuel to such motivations. So PSE President Francis Lim shouldn’t be “unhappy” because the evolving events are likely to turn the tide in his favor (a return to portfolio inflows) overtime. All he has to do is to wait for Chairman Bernanke to deliver his gift.

Again as a reminder, the problem of the Philippine markets is not due directly to the worldwide credit crunch or our banking system “infected” with toxic papers (according to BSP Governor Armando Tetangco and Fitch Ratings- Philippine bank exposure to the CDO market is only .2% to total banking assets or $180 million) or seizure in the Philippine credit system but one of forcible liquidations by foreign funds or institutions impacted by the mortgage securities crisis to raise capital, and subordinately, readjustments on economic growth expectations following a considerable downshift in the US.

Experiences of Negative Real Yields

So how powerful does a negative interest rate impact asset prices?

According to Barry Ritholtz, ``In the United States, real interest rates were negative between 2002-03. The crisis hit five years later. (Real Interest rates just flipped negative again in 2008).” Ergo, negative interest rates have basically been a crucial variable in shaping the US real estate boom bust cycle.

Negative interest rates have also accelerated a boom in the Hong Kong property markets despite the swoon in the equity counterparts.

According to the (highlight mine), ``The unintended result is that home loan rates are so cheap that they are throwing more fuel on a hot property market that looks set to get even hotter.

``A typical mortgage here now carries interest of about 3.1 per cent. But compared with Hong Kong's inflation rate of about 3.8per cent, which now hovers at a more than nine-year high, that looks inviting, creating a so-called negative real interest rate.

``For many potential home buyers in Hong Kong, mortgage payments are now effectively cheaper than rents, which are slower to adjust to rate changes.”

So if the Hong Kong property markets are the assets directly boosted by negative rates, we earlier said that Zimbabwe (hyperinflation-66,000% last December!) found its “store of value” in stocks and in Venezuela via “Cars”.

And so with China, see figure 3.

Figure 3, World Bank China Quarterly: Interest rate differential with the US has reversed (left), Interest rate increases lagged behind the rise in inflation (right)

This from the World Bank, ``With monetary policy remaining constrained by the exchange rate policy, administrative measures continue to play a role in monetary policy. High balance of payment surpluses put upward pressure on the RMB. Much of the surpluses are sterilized using open market operations and reserve rate increases. With the interest differential between China and the US having turned positive, policy makers are concerned that high interest rates would attract more portfolio flows (although it is not clear how high interest rate sensitive capital inflows are). This external constraint has kept domestic interest rates lower than they otherwise would be. Interest rates were increased during 2007, but these increases lagged behind the rise in inflation. Thus, on the metric of real interest rates (deflated by current inflation) there was no monetary tightening in 2007. As a result, administrative measures and window guidance are used to affect bank lending. The tightening of window guidance at the end of 2007 have been relatively successful in reducing credit expansion, although the success of such measures is difficult to maintain for long periods without economic costs.”

Monetary Policies As Leading Indicator

For us, monetary policies have served as marvelous reliable leading indicators in determining performances of asset classes, more than “micro” fundamentals or technicals.

In my January 21 to 25 outlook [see Bernanke’s Financial Accelerator At Work, US Dollar As Lifeblood of Globalization], I wrote,

``If there is any one-single most important link to globalization, it is not exports, reserves, capital flows or remittances, it is the US dollar standard system. Since most of the trade or capital flows, which shapes trading patterns and cross border flows influences a nation's economic and monetary structure, are conducted still in the US dollar, US policies (fiscal and monetary) will continue to be asymmetrically transmitted to the rest of the world. As to its unintended effects is one matter to reckon with and speculate on.”

Well, David Kotok of the Cumberland Advisors (highlight mine) appears to corroborate our view, ``The power of the Fed projects globally because there are many jurisdictions which peg or manage their currency exchange rate against the dollar. China manages its currency and does not allow the market place to set the exchange rate. China was 31% of our trade deficit in 2007 and is 7.5% of the world’s non-US GDP. Saudi Arabia pegs its currency. It is 3% of the US trade deficit and 1% of the world’s non-US GDP. Tom Russo of the Group of Thirty estimated the world’s cumulative numbers on this issue…He sees more than half of the US trade deficit to countries that are either managed or pegged. They collectively represent about 16% of the world’s non-US GDP. The US is about 27% of world GDP.

``We must understand that a stimulative monetary policy in the US transfers stimulus to those countries as well as applying it here. That is why we are optimistic that the Fed’s power will reach beyond our borders and that the outlook for the growth of world economies is looking better because of it.”

Again, what we are trying to say is that policy responses from a financial architecture built around the US dollar standard system will likely be distinct across geography depending on the currency regime, the economic and capital structures aside from present policies and the prospective policies adopted in the face of changing conditions.

Because the linkages from the interest rate channel commands a significant heft, it has the potential to impact markets materially or offset the liquidity contraction experienced in some other parts of the world. Thus, the assumption of a “one-size-fits-all” argument is for us a logical fallacy of composition.

So like the BSP, China as shown above has been living through a negative interest rate environment, which has been an important contributor to the ongoing boom in its real estate industry, aside from the previous boom in stocks in 2007 (The Shanghai composite is down 14.5% year to date and down 26% from its peak in October 2007). Nonetheless, like all cycles greased by credit expansion, a bust in China is likely to follow its boom-at a yet to be defined timeframe-2010 or 2011, perhaps?

And importantly, as rate adjustments in the US have brought upon a “negative carry” this should reinforce the case of additional weakening of the US dollar relative to Asian currencies.

Respected fund manager John Hussman of the Hussman Funds, expects a dollar crisis arising out of the US-China negative carry (emphasis mine), ``Presently, the U.S. economy is running the deepest current account deficit in history, even as the Federal government has promised to run up another $150 billion in debt to run a “stimulus package. At the same time, the carry between Chinese interest rates and U.S. Treasury yields has now turned negative, meaning that there is no longer a favorable interest rate differential to encourage Chinese investment in U.S. government debt. Moreover, the gradual appreciation of the yuan continues, meaning that the Chinese are also taking losses on their holdings of U.S. Treasuries due to dollar devaluation. The only remaining allure of Treasuries has been for capital gains due to investors' flight to safety, but with yields already compressed, it is increasingly risky to expect continued downward pressure on long-maturity interest rates. This places the U.S. in the difficult position of having to finance an enormous volume of capital needs from foreigners, particularly for Treasury debt, yet without being able to offer competitive yields or strong prospects for additional capital gains.

``My impression is that the markets will respond to this difficulty with what economist Rudiger Dornbusch referred to as “exchange rate overshooting.” In the present context, that means a dollar crisis.”

``Specifically, if there is a weak prospect that foreign lenders will achieve a total return on U.S. Treasuries competitive with what they can earn in their own country, and every prospect that short-term interest rates in the U.S. will remain depressed or fall even further, the only way to attract capital is to immediately drive the value of the U.S. dollar to such a sharply depressed level that it will be expected to appreciate over time.”

Proof of Liquidity: Soaring Emerging Market Reserves

So based on a returns perspective, such prospects may not be attractive for the Chinese (as losses on reserve holdings mount) as they could restrain their accumulation of US assets. But an important point to consider is that the Chinese buying of US assets have not been due to return basis but more for economic and political consideration, hence the “competitive depreciation” of currency.

The perceptive and very meticulous analyst Brad Setser makes a very important point (highlight mine), ``Central banks aren't building up dollar reserves because they want dollars. They are building up dollar reserves because they don't want their currencies to appreciate against the dollar. The dollar's fall against the euro and the growth in emerging economies dollar reserves are thus both manifestations of the same basic trend -- a lack of private demand for dollars, relative to the US current account deficit, and the resulting pressure for the dollar to fall.”

Yes, private sector investments could likely to veer away from US assets, as they have been. But it is unclear whether this should impact the emerging market governments from accruing US assets in order to control or manage their currency values. Based on recent performances this has not been the case.

Figure 4: Brad Setser: Surging Dollar and Total Reserves Amidst A Slowdown in US Current Accounts

Figure 4 courtesy of Brad Setser shows how Emerging markets continue to aggressively accumulate reserves in both US dollar (yellow) and total reserves (blue line) even in the light of an improvement in the US current account deficit (red line).

And for 2008, the pace of accumulation is likely to pick up. According to Brad Setser, ``And 2008? Well, the early data for January suggests that global reserve growth remains very, very strong. India, Singapore, Malaysia and Thailand combined to add over $30b to their reserves (counting the increase in Thailand's forward book). Japan chalked in another $20b, though its total was inflated by the impact of falling long-term rates on its long-term dollar portfolio (Japan marks its bond portfolio to market). Brazil is still intervening as well.

``Then throw in China. Or really through in China's reserves, the CIC and the state banks, as not all of China's foreign exchange is now showing up at the central bank.

``Then add in the oil exporters ...

``There is a reason why the Fed's custodial holdings rose so strongly in January.

``The scale of the increase in emerging market government assets right now is truly mind-blowing.”

This simply shows that even if the US current account has been improving substantially enough to raise the alarm bells from the depression advocates of a global liquidity crunch, the continued “massive” accumulation of surpluses evidenced by the rapid surge of emerging market (dollar and total) reserves spotlights on the liquidity dynamics generated elsewhere (euro zone, intraregion Asia?).

The surge of China’s January bank lending and money supply growth appears to validate this view. In short, some parts of the world have been experiencing credit deflation while in other parts of the world, liquidity remains abundant. Inflationary dynamics are likely to end up in assets or channels unspecified by the authorities.

Is it a wonder why commodities (agriculture, energy, precious metals) continue to surge in face of the gloom and doom scenario parlayed by depression advocates? This comes in stark contrast to the scenario where US money contraction is said to feed in through world prices (some of them hit mainstream press saying that the depression risks would prompt the US government to buy a broad range of assets to support the economy).

Projecting Oil Prices is Not All About Demand

Mainstream analysis also declares that as the US segues into a recession, world demand for oil would crimp and thus be reflected in its prices. Some have even argued for $70 oil by mid year. They could be right. But this has not yet been apparent.

Figure 6: Simmons and Company: Contracting World Oil Supplies

The problem with this view is that many high profile experts seem to focus on one side, the demand side (shows of their economic ideology-the Keynesian school). Rarely has there been an objective perspective dealing with the balance-such as ascertaining the actual state of the supply side as shown in Figure 6, courtesy of Matthew Simmons of Simmons and Company International.

The theory is if demand slows more than the supply then prices should go down. However what is greatly overlooked is that if supply declines faster than the decline in demand then prices will remain levitated. Now supply appears to be rapidly “peaking out” even when demand seems to stall (IEA-Forbes).

Moreover, if speculation is indeed responsible for oil at its current levels then depressionists will be proven right. However, we have read this oversimplified “speculation-driven” rationalization ever since oil prices hit $30, $40, $50, $60, $70, $80 and now $90 oil. Even at today’s seizure in auction rated securities as evidence of a spreading credit crisis we are seeing continued elevated oil prices.

In addition, global oil supply forecasts won’t be reliable for as long as there is a lack of transparency in terms of field audit, or checking on the validity of claims of real proven reserves by oil producers or exporters, aside from some government’s move to nationalize the industry, limit exploration access, increase tax revenues by arbitrary contract changes and containing private sector participation. In short, government’s restrictions to access oil have been contributing to the inefficient allocation of resources, distorting the marketplace and subsequently today’s high prices.

Besides it has been reported by U.K.-based Oil Depletion Analysis Centre that 60 of the world’s 98 oil producing countries have already hit peak oil production according to energy analyst Sean Brodrick. So as recent discoveries have not been enough to replace declining production wells, supply pressures will remain.

WTIC crude soared by 4% over the week to $95.5 per barrel, only $4.5 away from the psychological threshold high of $100. Rising crude oil adds to the pockets of OPEC and other oil producers, even as interest rates are likely to head lower especially for countries with its currency regime tied to the US dollar, as the US Federal Reserves adjusts its policies in order to provide enough cushion to its downshifting economy. In addition, a decline in the US dollar (prompted by China’s negative carry or as an offshoot to ‘stimulative’ policies) is negatively correlated to the price of oil or ensures higher oil prices.

Rising oil and commodity prices translate to more foreign exchange reserves for emerging markets central banks. This also means more money for placements by government owned sovereign wealth funds. This also suggests of abundant liquidity for the emerging economies marketplace. As well, negative interest rate environment could foster an environment that could absorb some of the excess liquidity. Or if Dr. Hussman is right, where China slows on buying US assets then a realignment of capital flows to within the region is a likely alternative.

Bottom line: Negative real yields, widening spreads between US dollar and Philippine Peso, negative carry between China and the US, growing foreign currency reserves in emerging countries and higher commodity prices should underpin emerging market assets as the Phisix.