Tuesday, August 31, 2010

Is Sound Money Incompatible With Democracy?

One of the recent feedbacks I received is the attribution that sound money can’t be compatible with democracy. The implication is that inflationism is an indispensable instrument for democratic survival.

Of course, this assertion accounts no less than an arrant bunk (nonsense) for the following reasons:

One, this serves as an example of argumentum ad populum (appeal to popularity), where the belief of the many holds that the argument is true.

Just because many seek to live off at the expense of the others this doesn’t mean that their demands are necessarily justifiable or valid and should be provided for.

This is similar to the unwisdom of the crowds which we have recently critiqued. Moreover, these proponents seem oblivious to the fact that populist policies tend to self-destruct overtime. What is unsustainable won’t last.

Second, the alleged incompatibility is also misleading because this operates on the premises of the 'tyranny of the majority' or the rule of the mob.

Say for example, 10 persons get stuck in a remote island where only one of them is a woman. Yet 6 of the male elected to force themselves on her. Is the majority’s action justified? The answer is obviously NO. The means to an end isn’t justified by mere numbers.

What is needed is the rule of law, of which inflationism chafes at.

As Friedrich A. von Hayek wrote in the Decline of the Rule of Law, Part 1

The main point is that, in the use of its coercive powers, the discretion of the authorities should be so strictly bound by laws laid down beforehand that the individual can foresee with fair certainty how these powers will be used in particular instances; and that the laws themselves are truly general and create no privileges for class or person because they are made in view of their long-run effects and therefore in necessary ignorance of who will be the particular individuals who will be benefited or harmed by them. That the law should be an instrument to be used by the individuals for their ends and not an instrument used upon the people by the legislators is the ultimate meaning of the Rule of Law.

Three, the collectivist charade is to sell popular wisdom to the economic ignoramus. The collectivists forget to tell everyone that inflationism is a redistribution scheme which benefits the minority at the expense of society.

As Jörg Guido Hülsmann wrote in Deflation and Liberty (emphasis added)

``Inflation is an unjustifiable redistribution of income in favor of those who receive the new money and money titles first, and to the detriment of those who receive them last. In practice the redistribution always works out in favor of the fiat-money producers themselves (whom we misleadingly call central banks) and of their partners in the banking sector and at the stock exchange. And of course inflation works out to the advantage of governments and their closest allies in the business world. Inflation is the vehicle through which these individuals and groups enrich themselves, unjustifiably, at the expense of the citizenry at large. If there is any truth to the socialist caricature of capitalism—an economic system that exploits the poor to the benefit of the rich—then this caricature holds true for a capitalist system strangulated by inflation. The relentless influx of paper money makes the wealthy and powerful richer and more powerful than they would be if they depended exclusively on the voluntary support of their fellow citizens. And because it shields the political and economic establishment of the country from the competition emanating from the rest of society, inflation puts a brake on social mobility. The rich stay rich (longer) and the poor stay poor (longer) than they would in a free society.”

Fourth, what collectivists see as essential is actually the opposite. History reveals that democracy and sound money has had and can have a symbiotic relationship.

In The Gold Standard, Indirect Exchange section of the epic Human Action, Ludwig von Mises wrote, (bold emphasis mine)

``The gold standard was the world standard of the age of capitalism, increasing welfare, liberty, and democracy, both political and economic. In the eyes of the free traders its main eminence was precisely the fact that it was an international standard as required by international trade and the transactions of the international money and capital market. It was the medium of exchange by means of which Western industrialism and Western capital had borne Western civilization into the remotest parts of the earth's surface, everywhere destroying the fetters of age-old prejudices and superstitions, sowing the seeds of new life and new well-being, freeing minds and souls, and creating riches unheard of before. It accompanied the triumphal unprecedented progress of Western liberalism ready to unite all nations into a community of free nations peacefully cooperating with one another.”

Finally, the hucksters of false promises of inflationism are no less than blinded by economic dogma whose foundations seem to operate outside the realm of the law of scarcity—yes fantasyland.

As Ron Paul wrote on Why Governments Hate Gold, (bold emphasis mine)

``Time and again it has been proven that the Keynesian system of big government and fiat paper money are abject failures in the long run. However, the nature of government is to ignore reality when there is an avenue that allows growth in power and control. Thus, most politicians and economists will ignore the long-term damage of Keynesianism in the early stage of a bubble when there is the illusion of prosperity, suggesting that the basic laws of economics had been repealed.”

Hardly does any of these fanatics have ever explained why throughout the centuries, experiments with paper money has ALWAYS failed.

Of course if one believes redistribution is a way or a path to prosperity, then apparently they are merely deluding themselves.

As Henry Hazlitt once wrote,

Any attempt to equalize wealth or income by forced redistribution must only tend to destroy wealth and income. Historically the best the would-be equalizers have ever succeeded in doing is to equalize downward. This has even been caustically described as their intention.

The collectivists amuse us with their logical fallacies, incoherent theories, misleading definitions, short term nostrums, and misinterpretation and deliberate twisting of facts.

For them it’s not about being right, but about blind faith.

Beware of false prophets.

More Taxes Equals More Revenues?

More Taxes Equals More Revenues?

Not so fast.

The fundamental law of economics are always at work to defy conventional wisdom.

Here is a great example.

From Reuters, (bold highlights mine)

Cash-strapped Bulgaria and Romania hoped taxing cigarettes would be an easy way to raise money but the hikes are driving smokers to a growing black market instead.

Criminal gangs and impoverished Roma communities near borders with countries where prices are lower -- Serbia, Macedonia, Moldova and Ukraine -- have taken to smuggling which has wiped out gains from higher excise duties.

Bulgaria increased taxes by nearly half this year and stepped up customs controls and police checks at shops and markets. Customs office data, however, shows tax revenues from cigarette sales so far in 2010 have fallen by nearly a third.

"The government created something unique. We actually now have a whole industry that provides for a big group of people," said Tihomir Bezlov of anti-corruption think-tank Center for the Study of Democracy.

Cato’s Dan Mitchell calls this the wonkish Laffer Curve at work.

But I like Professor Mark Perry’s simple quote, “If you tax something, you get less of it”

The higher the taxes, the likelihood of a larger informal economy, smuggling, corruption and inefficient allocation of resources as shown above.

Even the IMF has pointed this out as we have shown in an earlier post

Signs of Bond Bubble: Clashing Price Dynamics of US State CDS And The Treasury Market

Here is an example of the market’s current cognitive dissonance.

In the US, as many as 5 states appear to be having serious credit problems and are presently being reflected on the Credit Default Swaps (CDS) or the cost to insure a bond.

One might say that they are the US equivalent to Europe’s version of the PIIGS. We made an earlier similar observation here.


According to Bespoke Invest (chart also from them),

The number next to each state represents the cost per year to insure $10,000 worth of state bonds for 5 years. The higher the price, the higher the default risk. As shown, Illinois has the highest default risk of all states at 303.2 bps -- even higher than California. California ranks 2nd, followed by Michigan, New York, and New Jersey. Not to anyone's surprise, these are basically the five states in the country with the biggest fiscal problems at the moment. States that appear to be in pretty good shape include Texas, Virginia, Maryland, and Delaware.


As you can see the credit problems are NOT being reflected on US treasury yields (10 year TNX), which seem to ignore the developments in the CDS markets.

In contrast, the Eurozone recently had a fit of convulsion over the Greece-led PIIGs episode.

And instead, the US sovereign papers are seen “safety” assets where an ongoing onrush appears to be taking place as the mainstream hollers about “deflation (!)”.

In short, you have two markets seemingly headed for a collision course. This means one of them is decisively wrong.

For me, this represents part of the massive distortions engendered by interventionism. And vastly skewed prices have been misleading investors (led by the retail-dumb money). The treasury markets increasingly look like a time bomb, in the perspective of a ‘bond bubble’, set to implode.

The other way to say it is that if those credit woes exacerbate, then eventually, they will be vented on the treasury markets.

Caveat emptor.

Sunday, August 29, 2010

The Road To Inflation

``The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptising it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.”-Ludwig von Mises

As expected, like the dogs in Pavlov’s experiment, US markets passionately cheered on the assurances provided by the US Federal Reserve to provide support to her economy even by possibly resorting to unconventional means or by taking the nuclear option to the table.

In a speech last Friday, Chairman Ben Bernanke[1] said that the Federal Reserve ``is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly”. (emphasis added)

US markets, of late, has been reeling from successive weekly losses giving rise to intensifying anxieties over a re-emergence of another recession or what many calls as “double dip recession”.

And for the mainstream, the prospect of another bout of ‘deflation’ has provided them with the ammunition to demand for more intervention from her government.

Unfortunately, as we have been repeatedly saying, inflationism is simply unsustainable. Like narcotics, it will always have soothing effects that are ephemeral in nature, but whose repercussions would always be nasty, adverse and baneful that would result to capital consumption or a lowered standard of living emanating from the unravelling of malinvestments or the misdirection of resources and on relative overconsumption. And at worst, persistent efforts to inflate could lead to a breakdown of the monetary system (hyperinflation). The 2007 US mortgage crisis had been a lucid example of the boom bust cycles from inflationism yet the public refuses to learn.

And since the time preferences of the masses are mostly directed towards the short term, the elixir of inflationism always sells. The illusion of free lunch policies is just too beguiling to reject.

As Ludwig von Mises once wrote[2], ``The favour of the masses and of the writers and politicians eager for applause goes to inflation.”

And such dynamics is exactly how the present environment operates.

Economic Hypochondria


Figure 1: Danske Bank[3]: Worries Are Intensifying

And as we previously noted[4],

For the mainstream, anything that goes down is DEFLATION. There never seems to be within the context of their vocabulary the terms as moderation, slowdown and reprieve. Everything has got to go like Superman, up up up and away!

The weakening of some economic indicators such as the manufacturing index has led many to envision the same scenario as in 2008 (see figure 1). But this seems more like an economic hypochondria, where the apparent infirmities today seems more like a manifestation of the countercyclical or reactive forces following a V-shape spike in 2009 (right window). The point is NO trend goes in a straight line.

And also this seems to be an extension of the Posttraumatic Stress Distorder (PTSD) which we accurately exposed on the mainstream’s false attribution on the crisis as being prompted by the lack of aggregate demand in 2009[5].

The follies from the same cognitive biases have reared their ugly heads, or perhaps have merely been used to justify government’s actions.

The main mistake of the mainstream is to ignore the interplay of relationships, in terms of stimulus-response action-reaction, between markets or the economy on the one hand and the policy actions from the government on the other.

The mainstream believes that ALL human actions are uniform and consequently discern linearly from such premises. They disregard the diversity of human actions which encapsulates the markets/economy and the political leadership, as well as the bureaucracy which incidentally government is basically run by human beings too. The difference lies in the incentives which drive their respective actions.

Inflationism To Protect The Banking Cartel and Gold’s Status

True, the US housing sector reveals renewed feebleness (left window). But this again is a manifestation of the failure of inflationism or the waning temporal positive effects, where the US government has tried to keep prices from reflecting the natural ‘market’ levels by using manifold interventions such as the manipulation or artificial suppression of the interest rates, quantitative easing (or printing of money), the tweaking of the accounting standards (Financial Standards Accounting Board reversed itself on FAS 157[6]), and the substantial exposure of GSE (Government Sponsored Enterprises) as Fannie Mae and Freddie Mac which currently accounts for $5.7 trillion of the $11 trillion market and provides 75% of the funds in the mortgage market[7].

In my view, whereas the official declaration (propaganda) has always been about the economy (social good), this conceals the true intent, which is to provide support and redistribute taxpayers resources to the banking cartel, whose balance sheets have been stuffed with toxic assets and thus the seeming stagnation in credit conditions.

True, the Federal Reserve has absorbed considerable part of questionable assets via the massive expansion of her balance sheets, but without the sustained redistribution from the US taxpayers to the cartel via more inflationism, this would extrapolate to the collapse of the fractional reserve banking system. Hence, the underlying economic moderation in the economy is sold to the public as requiring more inflationism.

As Murray N. Rothbard wrote[8],

It should be clear that modern fractional reserve banking is a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts

And the market seems to be validating such an outlook (see Figure 2)


Figure 2: Deflation? Recession? Not Quite (from stockcharts.com)

First of all, as said above we don’t believe that the US is anywhere near a recession. The gold market seems to be saying so.

We don’t believe gold is a deflation hedge. The recession of 2008 clearly indicates this phenomenon as gold’s prices materially fell along with the bear market in the S&P 500 and the strength in the US dollar or the obverse weakness of the Euro (green circles).

So gold does not elude the forces of recession, much more the forces of deflation as signified by the collapse of prices of gold along with all the other markets as the effect of the Lehman bankruptcy rippled in October of 2008.

And those making a comparison of gold’s performance during the depression days of the 1930s have only been looking at patterns without noting of the differences in the underlying conditions.

Gold during those days had been part of the monetary system. It was a gold standard then until its temporary suspension following the enactment of the Gold Reserve Act of 1933[9]. Today gold is only part of the assets of central bank reserves. It is only now where gold has seen increasing recognition as ‘store of value’ among global central bankers as gold prices continue with its winning streak[10]. So in accordance to the reflexivity theory, prices changes have been influencing the fundamental factors surrounding gold.

And also today, we have a fiat money standard backed by nothing but empty promises of government to settle.

The Function of Market Prices

Second, those “tunnelling” or obsessively fixated at the treasury markets who scream “deflation” have been misinterpreting markets.

The treasury markets have been the one of key targets of interventionism. The other way to say it is that the prices of US treasury do NOT reflect activities of free markets in relative terms as compared with gold (main window), the Euro (XEU) and the S&P 500. This means prices represent distorted or highly skewed or artificial information.

This seems apparent with indications that small or retail investors have been fleeing the US stock markets and have been gravitating into the bond markets[11]. Yet these are likely symptoms equivalent to the Pied Piper of Hamelin[12] leading the rats to their perdition as they interpret erroneously current price signals to represent reality.

We are reminded of the unwisdom of the crowds[13] which we recently wrote about, and would quote anew Gustave Le Bon who wrote[14] ``The Masses have never thirsted after truth. They turn aside from evidence that is not to their taste, preferring to deify error, if error seduce them. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusion is always their victim.”

The crowd has been seduced by the siren song of government propaganda called “deflation”.

Remember prices serve not only as information to account for the relative balance of demand and supply, prices are the most essential tool for economic calculation.

According to Gerard Jackson[15],

``Without market prices it is impossible to engage in economic calculation and thus have a rational allocation of resources. Now the market is a coordinating process that assembles fragments of continuously changing information from millions of people; information that can only be known to them personally and expressed as preferences. The market transforms these preferences into prices which then act as signals to producers and consumers. It is this process that enables consumers to achieve the best possible outcome. If a socialist had invented the market it would have been hailed as one of man's greatest achievements. At any time there is always a configuration of prices determined by market data each price is closely interrelated with the others. No price is independent or exists in isolation. It therefore follows that to interfere with one price means interfering with others. Another fact the significance of which ardent price controllers and their supporters cannot seem to grasp. (bold emphasis mine)

Importantly, prices represent property rights which allows for voluntary exchanges between parties to happen that leads to social cooperation.

Bettina Bien Greaves says it best[16],

``Without private property, there would be no private owners bidding for goods and services, and no exchanges among real owners. Without private owners, each guided by the desire for profits and the fear of losses, there would be no market prices to indicate what people wanted and how much they were willing to pay for it. Without market prices, there would be no competition and no profit-and-loss system. And without a profit-and-loss system, there would be no network of interrelated, consumer-directed, independent producers. Without private property, competition, market prices, and a profit-and-loss system, the planners would not know what to produce, how much to produce, or how to produce it.” (emphasis added)

Thus, marginal utility (the cardinal order of want satisfaction or the scale of values), time preferences, rationing, coordination, the dynamic process of spontaneous order in the marketplace and property rights are all jeopardized when government undertakes interventionism or inflationism.

At worst, interventionism represents an assault on private property, which consequently means an attack against civil liberty.

In addition, it is important to recognize that ALL bubbles (boom-bust) cycles have been engendered by the illusion of perpetually rising prices which mainly accounts for the massive systemic distortions built from a variation mix of interventionism channelled via interest rates or monetary policies, tax policies, administrative and legislative policies all of which may combine to encourage irrational behaviour fuelled by credit expansion.


Figure 3: St. Louis Fed: Loan Conditions of US Commercial Banks

Another, I’d be careful to listen to pay heed to experts who claim that the US credit system remains totally dysfunctional (see figure 3).

At this time when the mainstream has been audibly shouting “deflation!”, bank credit of all commercial banks (upper window) seems to be ramping up.

Moreover, while commercial and industrial loans remain depressed, on an annual rate of change basis, we seem to be seeing a bottoming phase (middle window). To add, consumer loans at all commercial banks remain buoyant (lower window).

So in my view, industrial loans still remains problematic or has been the laggard, but may have already bottomed out which could likely see some improvement over the coming months.

Now if all these credit activities advances as I had long expected them to, mainly as a function of the belated effects of the yield curve[17], all the monster excess reserves held by the commercial banks at the Federal Reserve could simply turn into massive inflation. And this would be the rude awakening for the mainstream.

Therefore, deflation, for me, is no more than political propaganda, made by the major beneficiaries—the government and their clique of institutional and academic “experts”, in order to justify inflationism or extend more government control over our lives.

It would be foolish for people to simply read through economics without comprehending the indirect implications of the actions by the incumbent political leaders.

[1] Bernanke, Ben The Economic Outlook and Monetary Policy, Speech Given At the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 27, 2010

[2] Mises, Ludwig von The Import of the Money Relation, Human Action Chapter 17 Section 10

[3] Danske Bank, Weekly Focus, August 27, 2010

[4] See Why Deflationists Are Most Likely Wrong Again, August 15, 2010

[5] See What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis, February 1, 2009

[6] North, Gary Translation of Bernanke's Jackson Hole Speech, marketoracle.co.uk August 28, 2010

[7] Laing, Jonathan What's Ahead for Fannie and Fred? Barron’s online, August 28, 2010

[8] Rothbard, Murray N. Mystery of Banking p. 97

[9] Wikipedia.org History of the United States dollar

[10] See Is Gold In A Bubble? November 22, 2009

[11] See US Markets: What Small Investors Fleeing Stocks Means, August 23, 2010

[12] Wikipedia.org Pied Piper of Hamelin

[13] See The UNwisdom Of The Crowds, August 15, 2010

[14] Le Bon, Gustave Le Bon, The Crowd The Study of the Popular Mind, p.64 McMaster University

[15] Jackson, Gerard Are price controls on the way? Brookesnews.com December 29, 2008

[16] Greaves, Bettina Bien A Prophet Without Honor in His Own Land, Mises.org

[17] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010

Market’s Seasonality Accentuated By Macro and Political Developments

``All political theories assume, of course, that most individuals are very ignorant. Those who plead for liberty differ from the rest in that they include among the ignorant themselves as well as the wisest.” Friedrich A. von Hayek

In my opinion the effect of the prospective US government actions to shore up her banking system, aside from the other factors is likely to work against the expectations of the consensus.

Yet if seasonality performances would be our guidepost, assuming a certain material degree of accuracy, then September for the US markets could see some extension of the current weakness while October through December could likely be the strongest months (see figure 4).


Figure 4: Chart of the Day[1] /US Global Funds[2]: Seasonality of The Dow Jones and Mining/Metal issues

In other words, for the US markets, September could signify as a viable buying window for a 6 months trading opportunity.

Now of course, while any assessment of seasonality factors should be taken with some degree of caution, as patterns should NOT be interpreted from a single dimension, I’d say that based on the belated effects of the yield curve, the seasonality pattern could possibly play out because it would NOT only be backed only by statistical percentages (of patterns) but by four other factors as:

-the high likelihood of markets factoring in an improvement in general credit conditions,

-the bottoming of the current slowdown of the growth cycle or a pick up in the recovery phase from the current slack

-and importantly, the impact of global policies (steep yield curve) on inflation could intensify on the markets (oil $90-100?).

-outside the yield curve, one shouldn’t discount the realization of another set of quantitative easing as the political authorities resolve to shore up their banking system. As caveat, all current actions will have future negative ramifications.

And it would also seem that our observation about the rotational effects to the mining sector isn’t limited to only the Philippine markets[3] as US markets appear to highlight the same cycle (right window).

Outside of the recession of 2007-2008, the mining and the metal sector has had pronounced gains during the last 12 years, as gauged by sector’s annual performances over the last FOUR months of every year. As the commodity boom was enhanced during 2003-2006 boom cycle, this had similarly been reflected on the mining and metal issues.

We should see a redux of the same dynamics probably with accelerated momentum.

So the policy divergences between emerging markets and the major developed economies and the prospective money printing measures by the Ben Bernanke and US Federal Reserve which is likely to flood the world again with liquidity should lend support or drive up emerging market stocks and commodities.

And I’d recommend that any interim price weakness of mining issues as opportunities to accumulate for trade or to position against the emergence of the broadening impact of consumer price inflation.

[1] Chartoftheday.com, Dow Jones Average Monthly Gain

[2] US Global Investors, Investor’s Alert- August 27, 2010

[3] See How To Go About The Different Phases of The Bullmarket Cycle, August 23, 2010

Saturday, August 28, 2010

The Power of Slow Change: Older Adults Adapt To Social Media

In the US, older adults (ages 50-64) are now steadily adapting to social changes brought about by technology. (who says they’re luddites?)


Slowly but surely, the penetration of web usage has been diffusing into a larger segment of the US population. I’d say that this represents a worldwide phenomenon, not limited to the US.

Again the implication: changes in the way things are going to get done (commerce, social relationships, lifestyle, regulations, and more).

Read the rest from Pew Research here

Thursday, August 26, 2010

The Power of Slow Change: Leadership Changes In International Ports

The power of slow change is ubiquitous.


This from the Economist, (all bold emphasis mine)

THE changes in distribution and cargo-handling capabilities of the world's biggest container ports show the shifts that the world economy has undergone over the past two decades. The volume of cargo traded through the world’s biggest container ports has increased nearly sixfold in the past 20 years as globalisation has taken hold. Singapore has now nabbed the top spot and every other big port in 1989 has moved down the list. Twenty years ago more than half of the top 20 container ports were in America or Europe reflecting imports into both regions from around the globe. Now, Asia's strength as an exporter is more in evidence. Fourteen of the top 20 container ports are in that region, with eight in China.

This is obviously has NOT been about cheap labor (otherwise Africa should have been at the top of the list), but about trade openness.

As Asia (led by China) begun to embrace economic freedom, given the inherent economies of scale emanating the largest population combined with a start from low base, volume accrued over the years and displaced the former leaders.


From US Global Funds

The Philippines which used to be in the top 20, considering our “cheap labor” relative to our ASEAN neighbours seems to have been booted out by high labor cost economies as Malaysia (has 2 in the top 20 2009 ranking) and Thailand (1 in 2009 ranking).

Besides as we always say there are many other factors that make up operational “competitive” advantages of a country. For instance in China, low taxes and a small welfare state may have been an important contributor.

As Cato’s Alan Reynolds observed,

``Lacking the equivalent of Social Security or Medicare/Medicaid, China has no payroll taxes at all, no capital gains tax, and only a 15-25% tax on corporate profits.”

Therefore, people who argue based on specious analysis from “single aggregate variable” such as cheap labor will always be wrong.

9 Principles of Economics

At the Mises Blog, Art Carden lays out the 9 foundations of economics:

1. People Act.

2. Every Action Has a Cost.

3. People Respond to Incentives.

4. People make decisions at the margin.

5. Trade makes people better off.

6. People are Rational.

7. Using markets is costly, but using government can be costlier still.

8. Profits tell businesses that they are helping others, while losses tell businesses that they are wasting resources.

9. We shouldn’t ignore the long-term and unintended consequences of policies and actions.

Read Mr. Carden's explanations here.

Tuesday, August 24, 2010

The Bloodbath At Rizal Park Hostage Drama Demonstrates The Pathology of Government

I am greatly saddened by the news that the Rizal Park hostage drama, which involved innocent foreigners as victims, had ended violently and at the cost of precious lives.

Yet it wasn’t long that we’ve written that government can’t prevent man-made disasters. It’s sad to say this view has again been validated- government can’t stop a self-inflicted mayhem.

As usual, it’s only the visible things that are always seen by the mainstream. For instance, there has been a big misplaced focus on the botched attempt to conduct a bloodless rescue.

And as we always say, governments are merely human beings and subject to the same follies (mostly emotional) like anyone else. [Haven’t noticed how the “large number” of police had been seemingly afraid to enter the bus to take upon a lone ‘wolf’ assailant?]

So the gruesome event essentials reveal how inefficient governments are.

The moral is—the emperor had been caught apparently NAKED!

Again, this primarily had NOT been because of the lack of funding or preparation, but because the problem always is FUNDAMENTALLY PREDICATED ON KNOWLEDGE.

Yet, this isn’t the first time where a bus-hijack occurred (the last bus hijack occurred in 2007).

The problem is, in contrast to past, is that this time the assailant had been part of the government- a former police captain!

So fundamentally the ambit of possible government operations is one that is familiar to the felon, such that he probably knew how to make countervailing moves.

In other words, the government fought against part of her own shadow, which has probably prompted the conspicuous hesitance by the police to undertake forceful operations (aside from the fear of collateral damage which has always been the excuse).

Of course, the other factor is that the aggressor was also a fellow man in uniform.

So again, one shouldn’t always dismiss the human factor among the participants in the unfolding of political events.

But there is more.

News reveals that the antagonist justified his provocations because of perceived injustice committed by the government on him.

This from the Inquirer,

The Office of the Ombudsman said that Mendoza was among five officers charged with robbery, extortion and grave threats and dismissed after a Manila hotel chef filed a complaint alleging the policemen falsely accused him of using drugs to extort money...

Gregorio earlier told a local TV station that his brother was upset by his treatment and dismissal from the force.

His problem was he was unjustly removed from service. There was no due process, no hearing, no complaint,” he said.

Two important factors here:

One, government actions are ALWAYS POLITICAL. Whether his dismissal was valid or not (which we aren’t qualified to make any judgments), the adverse relationship developed with perhaps some of the citizenry which probably resulted to alleged lack of “due process” reveals that government actions are almost always arbitrary.

Two entrenched sense of political entitlement. The assailant felt that he deserved a permanent place as part of the bureaucracy, regardless of what the institution or what political leaders thought of him.

While it is true that the aggressor could signify as one of the extremes (fat tail), the point is that political power is always addictive. The addiction comes in different degrees. And in the case of the hostage taker, he felt the need to be a part of it. (Lord of the Rings, anyone?)

Bottom line: Almost every facet of this sordid episode represents the innate pathology of government actions.

Asia-US Stock Market Decoupling?

Here is Bespoke’s comment on the correlation of Asia and the US which has been seen by many as “diverging” (bold emphasis mine)

we highlight the number of times over rolling 50 trading day periods that the S&P 500 has gone in the opposite direction of the S&P Asia 50 Index. Historically, the average number of trading days that the US has gone in the opposite direction of Asia over a 50-day period is 22. That means that the US trades in the same direction as the Asian markets on a daily basis about 56% of the time. As shown in the chart, this indicator does fluctuate from low levels of correlation to high levels of correlation, and we just ended a period where the two were trading in tandem with each other more often than not. Over the last 50 days, however, the two have gone in the opposite direction 22 times, which is right inline with the historical average.


My observations:

1. This only shows that there is still a meaningful correlation (56%) between the actions of Asian stock markets and the US markets.

2. This only validates our view that Asia has outperformed more than decoupled with the US.

3. Decoupling is a theme that has yet to be “proven”.

4. Globalization means more integration in many aspects of life-trade, finance, investment, labor, knowledge and even culture and etc...

In short, the underlying trend of globalization is more of convergence. Thus decoupling runs to the contrary.

While there remains to be many aspects that can construed as “local” (regulations, political framework, political trends, taxes, compliance costs, and etc...), financial markets are likely to show signs of greater degree of correlation than in the past where globalization had been less of a factor.

5. Decoupling is a misplaced focus. The crux of the matter is to determine the main drivers of the current and future economic growth of the world.

Fact is, there is more than just Asia or the US, there is the entire Emerging market spectrum and also Europe.

So it would be rather faulty to “tunnel” on to just two variables when life is dynamic, complex and multifaceted.

Monday, August 23, 2010

US Markets: What Small Investors Fleeing Stocks Means

Monday supposedly should be my rest day and thus I usually refrain from making any post.

However this development is simply too compelling to ignore.


This from the New York Times,

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.

If that pace continues, more money will be pulled out of these mutual funds in 2010 than in any year since the 1980s, with the exception of 2008, when the global financial crisis peaked.

Small investors are “losing their appetite for risk,” a Credit Suisse analyst, Doug Cliggott, said in a report to investors on Friday.

One of the phenomena of the last several decades has been the rise of the individual investor. As Americans have become more responsible for their own retirement, they have poured money into stocks with such faith that half of the country’s households now own shares directly or through mutual funds, which are by far the most popular way Americans invest in stocks. So the turnabout is striking.

Retail investors are usually called the OPPOSITE of smart money.

That’s because they signify as the extreme of the crowd actions-the HERD.

They usually account for as the frenetic buyers during the euphoric top and panicky sellers during market depressions.

Thus, massive moves by retail investors could likely herald signs of INFLECTION points.

In this case, US retail investors have reportedly been FLEEING stocks and BUYING bonds. I’d suggest that, like always, they are wrong and betting against them (in stocks) would likely be a profitable exercise.

As a caveat, it wouldn’t be prudent to bet against them on bonds, that’s because they’ve been backed by the printing presses of the Federal Reserve. However, once inflation starts rearing its ugly head, then that would be time to pounce on them.

The Importance of Peripheral Vision

``Entrepreneurial profit and loss emanate from the dedication of factors of production to definite projects. Stock exchange speculation and analogous transactions outside the securities market determine on whom the incidence of these profits and losses shall fall. A tendency prevails to make a sharp distinction between such purely speculative ventures and genuinely sound investment. The distinction is one of degree only. There is no such thing as a nonspeculative investment. In a changing economy action always involves speculation. Investments may be good or bad, but they are always speculative. A radical change in conditions may render bad even investments commonly considered perfectly safe.”-Ludwig von Mises

ASEAN Markets Ablaze!

Here is an update of the seemingly majestic performances of ASEAN bourses (see Figure 1).


Figure 1: Bloomberg: ASEAN Bourses On Fire!

Of course, the reason why we should take the BIG PICTURE into perspective is primarily to avoid getting mired with the FALSE impression that domestic politics has been the DRIVER of these dynamics.

As one would note from the above, despite the tremendous showing of the Philippine Phisix (yellow trend line), which has been up over 17% on a year-to-date basis (as of Friday’s close), the fact is the local benchmark TRAILS the fiery actions of Thailand’s SETI (red line) and the Indonesia’s JCI (green line), up nearly 22% and 23% over the same period respectively.

Incidentally, the turbocharged Thailand’s SETI has already caught up and surpassed Indonesia’s JCI based on a one year basis and has been closing in fast even based on the year-to-date as reference point.

Now Asia markets have been uneven in terms of performances. What I am saying is that the inflationary milieu hasn’t lifted all boats similarly, and this simply validates the theory that inflationism has relative effects on almost everything, whether applied to financial assets, commodities to consumer goods or services. This also disproves the fictitious Keynesian construct of neutrality of money and of the obsessive fixation on aggregatism.

Yet the ASEAN bourses, while stirring hot, would seem only a shadow to the spitfire actions of South Asian bourses, particularly, Sri Lanka and Bangladesh up 64% and 49% respectively. Outside South Asia, Mongolia seems to be another bourse ablaze and has been likewise up 65% as of Friday’s close.

In other words, the trajectory of impact from global inflationism has been conspicuous in the markets (financial and non-financial) of the periphery nations. And I also would infer that these effects have been amplified by globalization.

The China Influence

Although China has been getting most of the news, such as having to successfully overtake Japan as the second largest economy in the world[1], the kernel of important actions again are in the peripheral markets but somewhat related to China.

Despite an up week, both of China’s bourses have been significantly down on a year to date basis (see figure 2).


Figure 2: stockcharts.com: China, Emerging Market Bonds and the Baltic Dry Index

One must NOT forget that the actions in China’s stock markets have been repeatedly tampered by with government interventions since late last year. This has been aimed at preventing a homegrown policy induced bubble from inflating into an unwieldy monster, and thus the material underperformance of China’s stock market indices.

And most of financial markets of developed Asia seem to either track the actions of China (e.g. Australia) or the market motions of the West (e.g. Singapore, Hong Kong and Japan).

Nevertheless following a steep decline last quarter, the Shanghai index (SSEC) seems to be manifesting of a rebound.

We can’t say if the momentum will persist until she successfully breaks out of the 2,700 level. A successful breach would possibly suggest that the Shanghai index will attempt for the threshold level of 3,000-3,150.

And China’s stock market actions appear to synchronize with the actions of the copper market (COPPER-the window below the Shanghai Index).

While we are NOT suggesting that China’s stock market has influences on the copper market, what both of these markets seem to say is that they could be responding to the current crop of policies being effected by the Chinese government.

The ongoing slowdown in China’s economy appears to reduce China’s government’s interest to tighten the monetary landscape, and thus, the prospects of lesser government intervention could be giving China’s stockmarkets a boost, especially in the light of the still generally loose credit environment.

Whereas the rebound in the copper market, while possibly partially influenced by these developments, could also be exhibiting signs of “inflationary pressures”. Monetary easing for China could extrapolate to more “speculative” flows from, or “reservation demand”[2] for, commodity buyers. As previously pointed out[3], the commodity price inflation appears to be rotating or diffusing into the “soft” or agriculture based commodities.

Debunking Selective Perception

Another thing that I’d like to point out, which the bears have been pounding on in the recent past, has been the Baltic Dry Index (BDI).

The recent collapse of BDI had been used to prognosticate a market collapse from what we see as fictitious “deflation” in a world of fiat money and central banking. And like US monetary aggregates, such as the M2 which we earlier discussed[4], these indicators have now tilted against them hence the apparent reticence or the deliberate omission of this indicator in current “deflation” discussions.

The selective use of the perma bears of these indicators to prove their case has gradually and repeatedly been falsified. Now to turn the tables, we use these indicators to disprove them.

They never seem to run out of materials to throw in, after the earlier “death cross” and the ERCI leading indicator, whose effects remain to be seen, now they point to the Hindenburg Omen[5] as a reason to take flight.

While September-October tend to be the seasonally weakest month for the stockmarket—where most crashes tend to occur—the dynamics for a crash doesn’t seem to be in place.

Not with the Federal Reserve already embarking on to replace the maturing mortgage bonds with fresh Treasury purchases[6] and certainly not with interest rates at zero bound for an extended period for key developed OECD economies.

Selective use of data for interpretation apparently disregards other things that matter more. For instance, the underlying ‘mixed’ actions (albeit mostly bullilsh) for emerging markets stocks doesn’t seem to be congruent with the actions in emerging bonds which has been exploding (JEMDX)!

Moreover we’d like to add that the steep yield curve has definitely had diversified or distinctive impact on the asset markets (see Figure 3) as we have repeatedly been pointing out[7].

clip_image005Figure 3: Asian Development Bank[8]: Yield Spread Between 2 year and 10 year bonds

We can still say that the US and Europe has very steep yield curves (as of August 13-green bar) despite recent signs of flattening.

Moreover, outside these crisis affected economies, where the effects of the yield curve could be muted due to balance sheet constrains on the respective domestic banking system, in crisis free Asia, the Philippines still has the steepest yield curve.

What this seem to imply is that Philippine banks will likely take advantage of the maturity transformation[9] (converting short term liabilities to long term assets) in a system which has relatively higher savings, less systemic leverage and unimpaired banking system. In short, credit growth is likely to explode here.

And I would discern that many of the new credit issued could be finding its way into the domestic asset markets including the domestic stock market.

And I would also suspect the same dynamics in operation in other ASEAN economies which has fuelled her recent outperformance.

And one can’t ignore the influences of the divergences of monetary policies between developed economies and emerging markets, where the expectations in the changes of policies seem to induce international capital in favour of emerging markets.

For many, the temptation to get into the bandwagon would seem irresistible. And as the region’s stock market continues to flourish, short term momentum trades would be appear to very lucrative.

In addition, these shifts appear to hallmark the seeds of the bubble.

[1] See The Power of Slow Change: The China-Emerging Market Story

[2] See Financialization of Commodities: Boon Or Bane?, May 31, 2010

[3] See Breakfast Inflation, August 5, 2010

[4] See Why Deflationists Are Most Likely Wrong Again, August 15, 2010

[5] Kahn Michael, Taking Stock of a Scary Market Signal, Barrons, August 18, 2010

[6] Bloomberg.com Fed Buys $3.609 Billion of Notes to Keep Yields Low, August, 19, 2010

[7] See What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?, February 1, 2010

[8] Asian Bonds Online, Weekly Debt Highlights, August 16 2010

[9] Wikipedia.org, Financial intermediary

How To Go About The Different Phases of The Bullmarket Cycle

``I’m hopeful that the answer is obvious: the market reflects vastly more information than the individuals. Yet we persist in listening to individuals in order to explain the markets. Executives point to analyst reports or discussions in the media to try to understand what’s going on with their stock. The media find an esteemed strategist to explain yesterday’s market move. Don’t ask the ants, ask the colony. The market is the best source for understanding expectations.” Michael J. Mauboussin

I’d like to point out that NOT all bullmarkets are the alike.

Bullmarkets come in different phases which effectively translate to different approaches in the management of portfolios under such evolving circumstances.

Thus it would be a darned big mistake to treat bullmarkets like a one-size-fits-all or a “whack a mole”[1] game- where everytime a mole randomly pops out of the hole, one takes a whack at them with a mallet in the hope to score a point.

Unlike the whac-a-mole, the goal isn’t about scoring points. In the financial markets, the goal is about maximizing profits—unless there are more important sublime goals that supersedes the profit motive such as thrill-seeking or ego tripping (i.e. the desire to brag about the ability to “time the market”—which bluntly speaking is based MOSTLY on luck).

Nevertheless it always pays to first to identify the phases of the bullmarket before deciding on how to approach deal with it.

To borrow the bubble cycle as defined by market savant George Soros, we can note of the following phases[2]:

-the unrecognized trend,

-the beginning of the self-reinforcing process,

-the successful test

-the growing conviction, resulting in a widening divergence between reality and expectations,

-the flaw in the perceptions

-the climax

-the self reinforcing process in the opposite direction

Bubble cycles reveals of these recognizable patterns from the hindsight view (see figure 4).


Figure 4: Stages of The Boom Bust cycle

But unfolding bubbles can be identified real-time by the prevailing market actions, the psychology that undergirds market action, as well as economic data on credit dynamics. Remember, booms are always lubricated by credit—a sine qua non of all bubble cycles.

And this has been NO stranger to us.

For instance, the Philippine Phisix has had minor boom-bust cycles within the secular bullmarket cycle of 1986-1997 (right window).

One would note of the Soros boom tests in the two marked red ellipses which closely resembled the typical boom bust paradigm (left window).

In 1994-1997, the climax or the “massive flaw of perception” had been highlighted by the prominent label of “Tiger Economies”[3] (new paradigm) on the ASEAN-4, which of course, turned out to be a massive flop.

As a side note, let me tell you that the Philippines won’t be anywhere near a Tiger Economy UNTIL we learn to adapt and embrace economic freedom as a way of life. Boom bust cycles will not substitute for real growth from free trade. Instead what these policy induced actions will bring about is a false sense of prosperity and security which eventually will be unravelled.

Yet, if we read or watch media, and assume that the people imbues what media says as gospel of truths, then the prospects of a “Tiger Economy” remains an ever elusive dream. As corollary to this, the belief in the salvation by the political leadership who is assumed to take the role as economic messiah is a sign of either ignorance or immaturity or dogmatic espousal of superstition as truth.

Going back on how to read market cycles, the point I wish to make is that one should be cognizant of the operational phases of the market cycle, and adapt on the actions that befit the underlying circumstances.

At present, I would say that the Phisix has been transitioning from the “successful test” towards the “growing conviction” phase.


Figure 5: PSE Sectoral Groups: Industry Sector Rotation and Tidal Flows

And this phase will be characterized by sporadic explosive moves on select issues. But these activities will be rotated among specific issues or among issues within sectors.

So issues or sectors that may seem to have been in dormancy or has materially lagged will likewise see rejuvenated price movements overtime, while current market leaders may stall or temporarily underperform. Remember the axiom—no trend moves in a straight line, this should always apply. Otherwise those that manages to move in temporary defiance of this, would eventually pay a steep price later (Remember the BW scandal?). Hence, every action has its corresponding consequence.

And as the major benchmark continues to rise; the price levels of almost ALL issues will likewise keep in pace but differ in terms of degree, the timing and the time-motion of each price actions. But eventually, the cumulative actions would produce a net effect of having the “rising tide lifts all boats” phenomenon.

This has long been our Machlup-Livermore model.

For instance, today’s top performing sectors used to be last year’s laggard and vice versa (see figure 5).

During the last quarter of last year, the mining industry (black candle) and the service sectors (light orange) led the Phisix (red circle), and all the rest (red-banking, blue-holding, green-commercial Industrial and maroon-property) performed dismally.

And up to this point, last year’s top performers have essentially traded places with last year’s laggards, where the latter have taken much of the today’s limelight. Remember the proclivity of the crowd is to read today’s action as linear, hence while crowd may be right in major trends they are always wrong during turning points. And this applies both to specific issues and general activities on the marketplace.

And one of the latest spectacular moves has been in the property sector (maroon) which has likewise been among laggards going into July (the property sector was the third worst performer then).

But last week appears to be payback time for key property issues, as the property benchmark spectacularly skyrocketed by over 8% to nearly take the top spot which it now shares with the leaders.

And I’d venture a guess that based on the relative impact of inflation on stock market prices, today’s laggards will be doing a redux of last year’s actions soon.

To be blunt, the rotational effects will buoy the service sector and the mining industry. And a glimpse at the chart seems to show that such phenomenon may have already commenced!

Let me add that as the growing conviction phase deepens (I would presume that a break above the 2007 high should underscore this), the frequency of rotational explosive moves will increase.

Thus, trying to “time the market” will only result to missed opportunities, the chasing of higher prices and an increasing risk exposure to one’s portfolio.

Bottom line: We shouldn’t essentially “time” the market per se as the mainstream would define it, instead we should identify, read, analyse and act according to the whereabouts of the bubble cycle.

In other words, any “timing” must focus on the possibility of the emergence or rising risks of a major inflection point, in accordance to the stages of a bubble cycle. Meanwhile, all the rest of the one’s subsequent actions should be focused on the virtues of “waiting” and some “rebalancing”.

[1] Wikipedia.org, Whac-A-Mole

[2] Soros George, The Alchemy of Finance p.58

[3] Wikipedia.org Tiger Cub Economies