Wednesday, June 30, 2010
And in one of Rotary's tabloid, Dr. von Mises wrote about the principle of solidarity, a message I hope to share with fellow Rotarians.
From Dr. Ludwig von Mises (emphasis added)
"Service" is the device of the Rotarian.
In no sphere of human activity can this principle find an application on a larger scale than in economics. Human society being based on a division of labor, the work of individuals is of necessity piecework only. Every human being performs one task only and his activity is limited to a narrow field. Unaided by the work of others he cannot exist.
The manner in which every individual arranges his life presupposes the activity of other members of society in occupations which harmoniously complement his own work and vice versa. If we consciously specialize in one kind of activity, we can do so only because we count upon other individuals being ready to serve us just as we are prepared to serve them. It is here that the great principle of solidarity, which govern society, comes into play.
The principle of solidarity, however, does not lose its force at the frontiers of a country. Economic solidarity does not unite compatriots only, but it ties together all peoples. The European feeds on, and clothes himself in, the products which America, Asia, Africa, and Australia supply, giving in exchange the fruits of his industrial efforts. The present standard of life of all nations is based on the enormous increase of productivity of human work which has been made possible only by an international division of labor...
To recognize the need for solidarity in economic life and to affirm it by conscious action is service in the sense in which a Rotarian uses the word.
Monday, June 28, 2010
In the book Revolutionary Wealth, Alvin and Heidi Toffler writes,
``It becomes clear that what
America world [strikethrough mine] confronts today is not simply a runaway acceleration of change but a significant mismatch between the demands of the fast growing new economy and the inertial new institutional structure of the old society. Can a hyperspeed, twenty-first century info-biological economy continue to advance? Or will society’s slow paced, malfunctioning obsolete institutions grind to a halt? Bureaucracy, clogged courts, legislative myopia, regulatory gridlock and pathological incrementalism cannot but take their toll. Something it would appear, will have to give. Few problems will prove more challenging than the growing dysfunctionality of so many related but desynchronized institutions." [bold emphasis added]
Some recent examples where such conflict applies (hat tip David Boaz)
From the Washington Post, (bold emphasis mine)
A satellite TV station co-owned by Rupert Murdoch is pulling in Iranian viewers with sizzling soaps and sitcoms but has incensed the Islamic republic's clerics and state television executives.
GAWAD KALINGA (GK) founder Antonio Meloto said the post of housing czar was offered to him by President-elect Benigno Aquino III but he turned it down.
In a media interview on the sidelines of the second Global Summit of the GK Community Development Foundation held here, Meloto said he discussed the offer with Aquino’s sisters, Ballsy Aquino-Cruz and Pinky Aquino-Abellada, recently.
At the end of the talks, Meloto said he refused the offer to join the Aquino Cabinet because he felt he would be more effective as a private citizen and philanthropist.
I can do more for my country by not being a Cabinet official,” said the 2006 Ramon Magsaysay awardee for community leadership.
Meloto was also the Inquirer’s Filipino of the Year in 2006.
Meloto said he would rather focus on strengthening and promoting GK, which is expanding its projects to other Asian countries.
GK is a nonprofit organization that builds houses and develops livelihood programs for poor communities in the Philippines and other developing countries.
According to Meloto, developed countries like Singapore and Australia recognize GK not just as a charity organization but also as “a movement for nation-building.”
Schools and government agencies in these countries send students and representatives to the Philippines, through GK, to learn skills for community-building and conduct research studies.
Some companies send investment projects and financial assistance to the Philippines also via GK.
Meloto said foreign governments and organizations were willing to support GK because it is a private, nonprofit organization not connected to the government.
If he joined the Aquino government, Meloto said foreign governments might not trust GK anymore.
“They don’t trust politicians,” he said.
As Ludwig von Mises once wrote, ``But the substitution of a legally enforceable claim to support or sustenance for charitable relief does not seem to agree with human nature as it is...The discretion of bureaucrats is substituted for the discretion of people whom an inner voice drives to acts of charity."
``Gold is also an excellent hedge in periods of deflation. What is happening in times of pronounced deflation? Public budgets are strained, the financial sector is faced with systemic problems, currencies are depreciated in order to reflate the system, and the money supply is continuously rising. The creditworthiness of companies and countries is queried, the confidence in paper currencies falls, and gold is subjected to remonetisation."
I don't think this is valid.
In the period of 1814-1897 the US dollar fundamentally retained purchasing power relative to Gold. Post 1914 or the birth of the US Federal Reserve, the US dollar begun its steady decline.
Ergo, the fundamental difference is that GOLD and SILVER had then been money, because of the Gold Standard. Today we have fiat money, where gold has been reduced to "reserve assets" for central banks. Therefore we can't apply gold's exalted past with today.
According to Bloomberg,
``The number of individuals with at least $1 million of investable assets in Asia-Pacific rose 26 percent to 3 million in 2009, matching Europe and almost overhauling North America’s 3.1 million, according to the 14th annual World Wealth Report published yesterday.
``Asia “continues to lead the global economic recovery and this has benefited many of the markets in the region in terms of both growth and wealth creation,” Ong Yeng Fang, market managing director for Indonesia, Philippines and Thailand at Merrill Lynch Wealth Management, said at a conference in Singapore today. Given Europe’s debt crisis, “there is a very high possibility that their numbers will be surpassed.”
To add, the Capgemini-Merrill report says: (bold highlights mine, graphs from Capgemini)
-The Asia-Pacific HNWI population rose 25.8% overall to 3.0 million, catching up with Europe for the first time, after falling 14.2% in 2008. Seven countries within the region actually saw their HNWI populations recover beyond 2007 levels.
-Asia-Pacific HNWI wealth surged 30.9% to US$9.7 trillion, more than erasing 2008 losses and surpassing the US$9.5 trillion in wealth held by Europe’s HNWIs.
-After falling 19.0% in 2008, the HNWI population in North America rebounded, gaining 16.6% in 2009. HNWI wealth there rose 17.8% to US$10.7 trillion. North America remains the single largest home to HNWIs, with its 3.1 million HNWIs accounting for 31% of the global HNWI population
For us, the reason Asia has been fast catching up with the west is that she has been engaged in less relative inflationism, which has been embraced by the west as the orthodoxy. But of course, everything is fluid or subject to change.
``In essence, China is saying it thinks its currency will do a better job than the US dollar of retaining its value over time. Put another way, China is committed to having lower inflation than the US and China seems willing to deal with the natural consequences of that strategy, which is a currency that gains value. Previously, China was hesitant to allow its currency to gain value versus the dollar. From the early 1990s until mid-2005, despite a combination of rising trade surpluses with the US and growing attractiveness for global capital investors, the yuan-dollar exchange rate was fixed by the Bank of China. In other words, China was willing to import US monetary policy.” Brian S. Wesbury - Chief Economist and Robert Stein, CFA - Senior Economist, China Rising
The gap in the performances of the equity markets between ASEAN and western economies has apparently been widening (see figure 1).
Figure 1 Bloomberg: Signs of ASEAN-US Decoupling?
AS the US markets fumbled (signified by the S&P 500 in green, which was down by 3.65%) this week, ASEAN markets has remained surprisingly resilient, as shown by the Philippine Phisix (orange), Thailand’s SET (red) and Indonesia (yellow). The signs above possibly points to “decoupling”.
Since charting in Bloomberg allows for only four variables, other countries as Malaysia and South Korea had been excluded. Nevertheless, these bourses likewise registered modest gains for the week.
But such buoyancy has not been reflected on the regional currencies. Contrary to my expectations, Asian currencies lost material grounds this week, with the Philippine Peso suffering from the largest decline--down 1.2% to 46.45 against the US dollar. The asymmetric price developments in the marketplace seem to exhibit short term volatility or more “noise” than “signals” from the general trend.
In short, falling Asian currencies and strong stock markets appear in conflict with each other, where one of the two markets will likely be proven wrong.
ASEAN Divergence: Signal Or Noise?
Yet such dissonance is hard to relate to the performance of the euro. The euro declined marginally (-.16%) this week to 1.2371 vis-a-vis a US dollar. This comes in spite of the record surge in the CDS spread of Greece, where in the past, an upsurge in default risk translated to an accompanying collapse of the Euro, this time around the Euro appears to be holding ground (see figure 2).
Figure 2: stockcharts.com: Consolidating Euro And Resurgent Commodities
And another part of the picture of mixed actions has also been the advances in the commodity markets particularly, gold, copper and oil.
Seen from a conventional “demand” perspective, rising commodities should exhibit improvements in the global economy. But again, this would be inconsistent with the infirmities manifested by the sagging developed economy equity markets.
Of course, the alternative perspective is the monetary aspect, where rising commodities and weakening major equity benchmark could be exhibiting symptoms of stagflation. Though this would seem consistent with the strength in ASEAN, once known as major commodity producers, this hasn’t been the case today given transformation of the global trade configuration into a supply chain platform (figure 3).
Figure 3: Economist Intelligence Unit: ASEAN Exports
Nevertheless, the significant share of high value (technology based) exports makes ASEAN nations susceptible to the vicissitudes of the global economy. Thus, ASEAN won’t be immune to a recession in the developed world.
Meanwhile, the unexpected picture is that the Philippines had been ranked first among high value exporters. But according to the EIU, what you see isn’t what you get and that’s because internal developments has skewed trade statistics.
Anyway the EIU clarifies, ``In our “high-value exports indicator”, the Philippines ranks first, with about 77% of its total exports made up of high-value goods. This places it well ahead of other individual ASEAN countries, as well as China and India. On the surface, this result might seem surprising, given that the Philippines is by no means a technology leader. However, one explanation for this ranking mined or exported. The industry desperately needs foreign capital and technology, but government policy for many years has kept out foreign investors. As a result, low-value exports from the Philippines have been depressed. It was only in December 2004 that the Supreme Court ruled that foreigners could again get involved in the mining sector. As the consequences of that ruling start to filter through, and as low-value exports pick up, so the Philippines may well slip down the high-value exports ranking.” (emphasis added)
From the above we learn that statistics are not reliable indicators of actual events because many factors influence an outcome, and second, the Philippines made it to the top of the list because the government has suppressed trade activities which pumped up the share of high value exports.
Alternatively, while the increased participation of the low value share is likely to erode the Philippines’ standings as measured by the above statistics, more trade should equate to more output and economic benefit.
Bottom line: Strong performances of ASEAN stocks and commodities defy the bearish outlook suggesting of a double dip recession in the world economy.
The Yuan Factor In The ASEAN’s Divergence
This brings us to the next factor which is likely to influence the ASEAN trade and market dynamics.
It’s the Chinese Yuan.
China’s government has announced last weekend that the Yuan will return to a managed float from the de facto US dollar peg.
In 2005, China went into a managed float but the recent financial crisis had forced China to re-peg the Yuan back to the US dollar as a defensive move.
While a parcel of China’s action may have been in response to ease global political pressures aimed at pressuring the Yuan to revalue out of the perceived “overvaluation” and to “rebalance” the global economy, the geopolitical aspect seems to overstate the case. Instead, for me, China’s response has been due to its serial failure to combat internal inflation which continually flies in the face of government’s tightening policies.
As we wrote in March of this year,
``China has attempted several times since last late year to arm twist several industries to stem credit expansion which has led to inflation. Lately she has threatened to nullify loans granted to local governments and has similarly instructed 78 state owned enterprises (SOE) to quit the real estate market leaving 16 SOE property developers.
``And economic overheating presents as a real risk. There has been an acute shortage of labor where factory wages haverisen by as much 20% as the inland now competes with the coastal areas and reduced migration in search of jobs.
``We are now witnessing a classic adjustment in trade balances as taught in classical economics. As Adam Smith once wrote, ``When the quantity of gold and silver imported into any country exceeds the effectual demand, no vigilance of government can prevent their exportation.” (emphasis added)
``In short, this leaves the Chinese government little or no option but to allow its currency to rise as a safety valve against a runaway inflation.”
And faced with the predicament of recession risks from further credit rollbacks and the intensifying inflation, China has indeed resorted to the currency safety valve.
A stronger yuan allows relatively cheaper imports, which many in the mainstream mistakenly thinks that this will translate to economic “rebalancing”.
Yet in a world of paper money system, the international currency reserve, which essentially expedites the global trading activities, has NO automatic mechanism for adjustments. This implies that aside from adjustments mostly due to political preferences, the higher costs from the attendant currency adjustments simply mean that investments get shifted to the trading partners (see figure 4).
Alternatively, this means that “rebalancing” concept is an illusion, which fundamentally disregards the function of money as a medium of exchange and where an international currency reserve is the politically preferred “medium of exchange.”
The upshot to this is that a firmer yuan would induce the growing number of wealthy Chinese to buy more stuff abroad [provided the government allows for this]. And this should extrapolate to a boon to the major trading partners.
Considering that the share of the China-ASEAN trade has been ballooning (lower window of the ASEAN Export Destinations) at the expense of Japan and the US, the underinvestment seen in Emerging Asia (upper window) exhibited by yawning gap between savings and investment is likely to see significant improvements as a consequence to both a rising yuan and the deepening of intra-region trade. [Note: the Asian Crisis was clearly a result of malinvestments as shown by investments overtaking savings, which obviously was funded by inflated money from domestic and foreign sources.]
Of course, currency valuation is just one of the many factors that influence trading dynamics, yet one of the most important forces is the political desire to accommodate free trade.
Apparently, the process to integrate economically by regionalization has already been set into motion by the China-ASEAN Free Trade Agreement (FTA) in late 2009 and secondarily, by China’s attempt to introduce the yuan as the region’s reserve currency.
The negative facet is that the use of the currency valve triggers more political rather than consumer based distribution which leads to accretion of internal imbalances and an eventual bust.
We are reminded that China’s 9.8% appreciation in 2005 did little to make any dent in the so-called “rebalancing” of trade and that the revaluation of the Japanese Yen through the Plaza Accord in 1985 (15 years ago), had also little impact on Japan’s trade surpluses (Japan remains mostly in the trade surplus position).
Instead, the corollary of the Plaza Accord was that it fueled a massive real estate bubble in Japan which culminated with a colossal bust that lasted for more than ten years, popularly known as the Lost Decade.
However, if China is indeed truly determined to make the avowed currency regime shift, then one can’t help but put into picture how the Philippine Peso has responded to China’s revaluation via the shift to a managed float in July of 2005 (see figure 5).
Figure 5: yahoo finance: USD-China Yuan (top), USD-Philippine Peso (down)
The Peso has strengthened in near conjunction with China’s yuan!
Although China ranks fourth among the largest trading partner for the Philippines, in terms of exports, and ranks third in terms of imports in 2009, China projects that the recent FTA will pole-vault China’s position as the Philippines’ 2nd largest trade partner.
Thus, China’s ascendant “free trade” dynamics combined with the Yuan’s appreciation should lead to a shift in the current trading framework which will likewise be reflected on her trading partners as the Philippines.
Of course, the growing role of China’s trade relations will also redound to the political spectrum. So we should expect to see more of Chinese representation in local politics overtime.
And we should expect all these to be eventually reflected on the region’s financial markets. (see figure 6)
Figure 6: US Global Funds: Indonesia As Prime Beneficiary
The last time the Yuan was revalued in 2005, Indonesia massively outperformed.
However, as noted above, almost every Asian currency profited from this, including the Peso.
According to US Global Funds, ``Indonesia remains one of the major beneficiaries of an appreciating Chinese currency, thanks to the commodity-heavy nature of its exports to China. Coal and palm oil are key categories. During the three years from mid-2005 to mid-2008, when the yuan was unpegged from the U.S. dollar and saw appreciation, Indonesian equities more than doubled in U.S. dollar terms, making them the second-best performer in Asia after Chinese equities. In addition, the government’s improving fiscal status highlights a prudent Indonesia where public sector debt declined to 31 percent of GDP in 2009 from 102 percent in 1999, a confidence booster in a world of apprehensions over sovereign indebtedness.”
Today, Indonesia is once again at the top in terms of equity performance on a year to date basis.
Ingredients Of A Bubble: Pegged Currency And Lack Of Convertibility
None the less, this isn’t 2005.
Then, the US dollar weakened as global growth surged behind the US centric housing mortgage bubble. This means the Yuan appreciated on the back of weak dollar.
Today, the US dollar has emerged as safehaven from ongoing credit prompted woes in Europe, hence, the Yuan’s appreciation arises out of the US dollar strength. Besides, in contrast to 2005 where global economy was running on full throttle based on a US bubble, today, emerging markets and Asia has reportedly done most of the weightlifting of the global economy out of the recession.
In my view, the attendant underperformance of developed economies is likely to attract even more of hot money flows into China, Asia and the Emerging Markets.
In addition, the gradual appreciation of the yuan amidst the lack of convertibility is likely to prompt for more the same bubble predicament.
The problem isn’t China’s alleged “currency manipulation”, instead it is the lack of convertibility or the freedom to convert local currency to foreign currency and vice versa. The lack of convertibility means that the pricing mechanism via concurrent exchange rate or monetary policies (e.g. monetary base) has been severely distorted from which creates arbitrage opportunities. Speculative money sees this and gets “smuggled in” through unofficial channels, which causes “huge surpluses”. Naturally, such policy contortions lead to malinvestments throughout the country’s economic structure.
In addition, having both the exchange rate and monetary targets, likewise create mismatches from which imbalances will ultimately be expressed via a crisis. This characterises the pegged currency regime. Contrary to public wisdom, a pegged currency and fixed currency framework are different.
A fixed currency, according to economist Steve Hanke is either established by a currency board which “sets the exchange rate, but has no monetary policy — the money supply is on autopilot — or a country is "dollarized" and uses a foreign currency as its own. Under a fixed-rate regime, a country's monetary base is determined by the balance of payments, moving in a one-to-one correspondence with changes in its foreign reserves.”
An example of the symptoms from imbalances of a pegged currency is China’s battle to control inflation and the subsequent reaction to appreciate the yuan following the failed attempts to arrest inflation.
Hence the lack of convertibility and the ramifications from conflicting goals of a pegged currency framework are likewise recipes to bubbles.
And one way to alleviate this dilemma is to engage in free market mechanism and to eliminate controls again, Mr. Hanke, ``Beijing should adopt a fixed exchange rate regime. This would force Beijing to dump exchange controls and make the yuan fully convertible. Such a "Big Bang" would muzzle the China-bashers and put Beijing in the driver's seat. After all, China would then have a stable, freemarket exchange-rate regime.”
Considering the earlier or previous bubble policies, this is not going to be a painless solution.
But the point is, free markets operating under a under currency regime with free market mechanisms and without exchange controls will reduce, if not eliminate, incidences of bubbles.
But this isn’t likely to happen under a central banking system.
Therefore, China’s regime shift isn’t likely to do away with the formative bubble in process.
To conclude, China’s purported regime change is likely to result in an appreciation of Asian currencies, including the Philippine Peso.
This would be further amplified by the ongoing region’s trade integration. And the possible decoupling signs we seem to be witnessing today could likely be the evolving repercussions from China’s currency shift.
So unless we see further deterioration in the economic conditions of developed markets which would result to a liquidity squeeze, the effects of the China’s actions will likely be evinced positively in the region’s financial markets.
Therefore, like in our previous outlooks, the case of the China’s currency regime shift adds to why the Philippine Peso, Asian currencies and equity markets should a buy.
Nevertheless, China’s currency makeover doesn’t eliminate the ongoing bubble process.
Perhaps in the future we will deal with “buy what the Chinese buys, and sell what the Chinese sells” story.
 Businessweek, Greece Swaps Surge to Record, Signaling 68.5% Chance of Default, June 25 2010
 Economist Intelligence Unit ASEAN Exports Today, tomorrow and the high value challenge
 Wall Street Journal Blog, China Issues Statement on Yuan Exchange Rate Flexibility, June 19, 2010
 Xinhuanet.com China to become 2nd largest trade partner of Philippines as recovery takes hold, December 30, 2009