Sunday, October 31, 2010

US Midterm Elections: Rebalancing Political Power And Possible Implications To The Financial Markets

``The most enthusiastic supporters of such unlimited powers of the majority are often those very administrators who know best that, once such powers are assumed, it will be they and not the majority who will in fact exercise them." Friedrich von Hayek, The Constitution of Liberty

Trick or treat.

The way we celebrate Halloween will similarly be parlayed into the political sphere next week.

One of which would have an important bearing in the global financial markets.

While everyone will likely be focused on the US Midterm elections, what would seem crucial would be the US Federal Reserves’ formal announcement of its next phase of ‘credit easing’ policies: Quantitative Easing 2.0.

But we will deal with both.

US Midterm Elections: A Rebalancing Act

We shouldn’t expect much from the US Midterm elections. From our perspective, what is likely to change will only be the redistribution of the political power, from a lopsided stranglehold of Congress by the Democratic party into a more balanced exposure with that of the Republicans, that should serve as a control from an abuse of political power.

As political analyst Stratfor’s George Friedman rightly describes[1],

The Democrats will lose their ability to impose cloture in the Senate and thereby shut off debate. Whether they lose the House or not, the Democrats will lose the ability to pass legislation at the will of the House Democratic leadership. The large majority held by the Democrats will be gone, and party discipline will not be strong enough (it never is) to prevent some defections.

In other words, Democrats would likely lose their capability to highhandedly ram down the throats, or railroad unpopular ‘socialist’ policies to the American public, similar to the Obamacare, where polls say that a majority, or 53% of the public, has favoured its repeal[2]. And obviously such a backlash is likely to get translated into votes.


Figure 1: Every Action Has A Consequence; A Likely Political Comeuppance (chart from Danske Bank)

Apparently, the Democrats haughtily put into motion President Obama’s former Chief of Staff Rahm Emmanuel inglorious advise[3],

``You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before”.

And since every action has consequences, the unintended ramifications from these unilateral political actions, perhaps construed as an abuse of power, could likely be a political comeuppance next week. Moreover, there are many signs where public sentiment appears to have shifted incrementally towards accepting more libertarianism[4].

And another very important setback for the incumbent party has been the failed effects of the cumulative stimulus programs in bolstering the US economy, which has been predicated on mainstream economics.

And one of the repercussions from this failure has been the spontaneous emergence of Tea Party Movement groups[5] in 2009, which amazingly has expanded swiftly and now accounts for anywhere 15-25% of the US population according to some estimates[6].

Tea Party groups basically protest on the burgeoning role of government interventionism in the US political economy.

Yet like anywhere else, under a democracy, people will likely be voting, not for idealism or ideology or platform, but against what they would perceive as either proponents of injustice or fear. In short, elections are mostly about symbolisms based on sentiment or voter emotions.

So whether it is the Philippines or in the US, journalist Franklin Pierce Adams (1881-1960) observations should resonate emphatically ``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.

And one reason why I think there wouldn’t be much change even with a prospective rebalancing of political power, or political gridlock as many have labelled them, is that many who run for office only piggyback on so-called principles only when public sentiment supports them.

Eventually once elected into office, these principles usually get sloughed off when personal conveniences weigh in.

And recent history has shown this.

The passage of the Emergency Economic Stabilization Act of 2008[7] should serve as a good example. The bill was initially rebuffed at the first vote at the US House of Congress on September 29th, but following the paroxysm in the financial markets possibly in response to this, the House reversed and ratified it, on October 3rd, in a bipartisan support. Ironically, this law serves as one of the main anchors for today’s monumental swing in political sentiment.

Also, political competition represents mostly a zero sum game where one gains at the expense of another. As Henry Louis Mencken rightly pointed out ``Under democracy one party always devotes its chief energies to trying to prove that the other party is unfit to rule - and both commonly succeed, and are right.”

The implication is that a house divided could translate to more political horse trading and backroom dealing, where the administration may either lean towards more a centrist stance or risk a political impasse from maintaining the present hardcore path of left leaning policymaking.

And unlike the past, where both the Congress and the Executive branch had been controlled by a single party, which seem to have made the Democrats think that they had a blanket mandate to foist laws as they see fit, the reconfiguration of power will likely make prospective policies more public sentiment sensitive.

And I’d like add that those who think that political ‘pragmatism’ equates to politics as operating in a fixed state will likely be been proven wrong again, if current polls will be actualized into votes, this Tuesday.

People’s dependence on government isn’t a constant for the simple reason that economic laws ultimately shape politics.

And where redistributive policies or programs would have reached its limits or to paraphrase Milton Friedman, there is no such thing as a free lunch, politics will have to come home to roost to face the new reality.

The recent lifting of the legal retirement age in France, in spite of the crippling protests and riots[8], should serve as a vivid example of the unsoundness of the welfare state system. Eventually, unsustainable systems crumble under their own weight, regardless of what people think.

Pragmatism isn’t about the false belief of sustained public’s acceptability of free lunch policies, on the contrary, pragmatism is about understanding the limits of redistribution operating under the ambit of the natural laws of economics.

Political Gridlock And The Financial Markets

And how should a divided government fare for the financial markets?

Based on past performance, they would seem favourable.

According to Danske Bank research team writes[9], (bold emphasis mine)

Interestingly, periods with the White House controlled by a Democrat and Congress controlled by the Republicans – a situation that is likely to be in place from 20 January 2011 - have seen the best average equity market performance. One important caveat is, however, that this result is heavily influenced by the fact that the period 1995-99, during which President Clinton faced a Republican-controlled Congress, coincided with the technology equity market boom.

When looking solely at the party controlling Congress, equities have performed better during periods of Republican control than in periods of Democratic Congress majority. This could indicate that from the point of view of investors, a Republican-controlled Congress is generally seen as less likely to put through legislation that is hostile to business, both in terms of tax policies, but also in terms of regulation issues. In the current situation, with financial sector regulation issues likely to remain high on the agenda in 2011-12, a Republican-controlled Congress could be seen as less likely to enact further measures to tighten regulation.

We can only conclude that the financial market conditions and the economic environment will likely be dependent on the kind of relationship that would emerge and cultivated from political diversity.

Nevertheless our caveat remains, past performance are not reliable indicators of the future, and that many other factors may influence the hue of US politics.

But if the chances of reduced government intervention in the economy are increased from a political gridlock, then the new political arrangement would likely boost business confidence, and thus becomes a positive influence, rather than undermine it.

And only the politically blind and those addicted to unsustainable inflationary big government would see this as some fictitious horror tale.

And as before, they will always miss out being right.

[1] Friedman, George U.S. Midterm Elections, Obama and Iran October 26, 2010

[2] Rasmussen Reports, Health Care Law, October 25, 2010; POLL: Dislike of healthcare law crosses party lines, 1 in 4 Dems want repeal, October 6, 2010

[3] Wall Street Journal OpEd, A 40-Year Wish List, January 28, 2009

[4] See US Politics: A Libertarian Renascence?, October 29, 2010

[5] Tea Party Movement

[6] Video: Tea Party struggling in its efforts to find leadership, April 12, 2010

[7] Emergency Economic Stabilization Act of 2008

[8] Wall Street Journal Editorial, Dissecting French Schizophrenia, October 29, 2010

[9] Danske Bank, Much ado in the week ahead, Weekly Focus October 29, 2010

Trick Or Treat: The Federal Reserve’s Expected QE Announcement

``But on the other hand inflation cannot continue indefinitely. As soon as the public realizes that the government does not intend to stop inflation, that the quantity of money will continue to increase with no end in sight, and that consequently the money prices of all goods and services will continue to soar with no possibility of stopping them, everybody will tend to buy as much as possible and to keep his ready cash at a minimum. The keeping of cash under such conditions involves not only the costs usually called interest, but also considerable losses due to the decrease in the money’s purchasing power. The advantages of holding cash must be bought at sacrifices which appear so high that everybody restricts more and more his ready cash. During the great inflations of World War I, this development was termed “a flight to commodities” and the “crack-up boom.” The monetary system is then bound to collapse; a panic ensues; it ends in a complete devaluation of money Barter is substituted or a new kind of money is resorted to. Examples are the Continental Currency in 1781, the French Assignats in 1796, and the German Mark in 1923.-Ludwig von Mises, Interventionism: An Economic Analysis, Inflation and Credit Expansion

What I think would be the most important driver for the global financial markets over the coming weeks would be the prospective announcement by the US Federal Reserve’s Quantitative Easing version 2.0 on Wednesday.

The Gist of QE 2.0

I do NOT share the view that QE has been FULLY factored IN on the financial markets for the simple reason that estimates of the scale and duration and or terms have been widely fragmented. And there hardly appears to be any consensus on this.

The QE 2.0, in my analysis, is NOT about ‘bolstering employment or exports’, via a weak dollar or the currency valve, from which mainstream insights have been built upon, but about inflating the balance sheets of the US banking system whose survival greatly depends on levitated asset prices.

And all talks about currency wars, global imbalances and others are most likely to be diversionary ‘squid’ tactics to avoid the public from scrutinizing on the Fed’s arbitrary actions.

I see the ongoing QE 2.0 as heavily correlated with the legal issues surrounding the ownership[1] of many mortgage securities that has plagued the industry over the past few weeks.

Of course, it is also possible that Federal Reserve Chairman Ben Bernanke and company maybe pre-empting the results of the midterm elections, which they might think, could upset the current policy directions directed at providing subsidies to the banking system. The possibility of Cong. Ron Paul taking over the banking committee in Congress, they might see as a potential risk that could disrupt the viability of the banking system.

More Evidence Of Inflation

Yet there is hardly any convincing evidence that the US will likely succumb to another recession even without QE 2.0.

Even the credit markets have been saying so as we earlier pointed out[2].


Figure 2: Improvement On US Credit Markets (charts from St. Louis Fed)

For an update (see figure 2): Bank Credit of All Commercial Loans seem to be picking up momentum anew (top window), even Individual loans at ALL commercial which have recently skyrocketed, seem to be in a short pause but still looking vibrant (bottom pane) while Commercial and Industrial Loans of ALL Commercial banks seem to be bottoming out (mid window).


Figure 3: US Monetary Aggregates Points To Inflation (St. Louis Fed)

And even US monetary aggregates[3] appear to be saying the same story: MZM (upper window) and M2 (mid window) have recently been exploding skywards, while the M1 multiplier, a former favourite tool of permabears which tries to measure velocity of money, appears to be emerging fast from a bottom. And this is even prior to the Fed’s supposed renewed engagement with QE.

What all these seem to be pointing out isn’t what the mainstream and the officialdom has been looking at: we seem to be seeing are convergent signs of emergent inflation!

You have seen the actions US credit markets and US monetary aggregates, now the actions of the financial markets.


Figure 3: EM Equities, US Bonds and Commodities In A Chorus

We have argued that the convergence between rallying US bonds and a bullmarket in gold and or commodity markets would seem incompatible, from which the incoherence the markets would eventually resolve.

We seem to be seeing clues of this happening now, of course, going into our direction.

And deflationistas, whom have adamantly argued that bonds will likely benefit from a so-called liquidity trap, and have used the deflation bogeyman as justification for more inflationism, appear to be on the wrong the trade anew.

As one would note in Figure 3, emerging market equities (MSEMF or the MSCI Emerging Market Free Index), the CRB or a major commodity benchmark, a bellwether of Treasury Inflation Protection Securities or TIPS (iShares Barclays TIPS Bond Fund) and 10 year US Treasury Yields appear to be in a chorus.

What all these (credit market, monetary aggregates, financial markets) seem to be indicating isn’t what the mainstream and the officialdom have been looking at. (They’ve been fixated with employment figures).

Instead, what we seem to be seeing is a convergence of surging inflation worldwide!

And this is even prior to the Fed’s coming actions.

Not only that.

Last week, the US government sold $10 billion of 5 year Treasury Inflated Securities (TIPS) at minus .55% or negative interest rates for the first time in US history[4]!

TIPS investors don’t just earn from coupon yields, they earn from the adjustment of the securities’ par value[5] along with that of the consumer price index (CPI) thus giving protection against inflation as measured by CPI (which I think is vastly underreported).

This only means that the aggressive bid up of TIPS, which has led to a milestone of negative interest rates, represents a monumental swing in investor sentiment towards a deepening recognition of our transition to an inflationary environment which over the recent past had only been a fringe idea!

And this, in essence, would validate our 2009 prediction that inflation will be a key theme for 2010[6]!

And this also means that the premises of deflationistas are being demolished or dismantled as inflation expectations emanating from central bank policies deepens.

What To Expect

So how does QE 2.0 translate to the actions in the Financial markets?

If the Fed announcement should fall substantially below market expectations (perhaps $ 1 trillion or less) then we are likely to see some downside volatility which should prove to be our much awaited correction.

Yet any substantial volatility in the financial markets would translate to the Fed likely upping the ante on the QE 2.0. Remember falling asset prices would pressure the balance sheets of the banking system, and thus, would prompt for the Fed to make additional injections.

However, given the penchant of the Fed to resort to shock and awe, I wouldn’t be surprised if the FED would equal or go over the previous $1.75 trillion[7] monetization of treasury and mortgage related securities in 2009.

Of course, the other important aspect would be how other central banks would react to the Fed’s actions. We cannot take the Fed’s action as isolated.

If Bank of Japan and Bank of England would augment the Fed’s QE 2.0 by increasing its exposure on its current programs, then we should expect money flows into emerging markets to expand significantly. And this should go along with commodity prices and commodity currencies.

From the current market actions, we seem to be witnessing the early stages of a crack-up boom.

I remain bullish on equity markets, which I see as protection or serving as insurance against the currency debasement programs being undertaken by central banks to promote covert political agendas.

For Emerging Markets and Philippine stocks, we should remain exposed to commodities, energy and property issues.

[1] See The Possible Implications Of The Next Phase Of US Monetary Easing October 17, 2010

[2] See The Road To Inflation, August 29, 2010

[3] M1: The sum of currency held outside the vaults of depository institutions, Federal Reserve Banks, and the U.S. Treasury; travelers checks; and demand and other checkable deposits issued by financial institutions (except demand deposits due to the Treasury and depository institutions), minus cash items in process of collection and Federal Reserve float.

The M1 multiplier is the ratio of M1 to the St. Louis Adjusted Monetary Base.

MZM (money, zero maturity): M2 minus small-denomination time deposits, plus institutional money market mutual funds (that is, those included in M3 but excluded from M2). The label MZM was coined by William Poole (1991); the aggregate itself was proposed earlier by Motley (1988).

M2: M1 plus savings deposits (including money market deposit accounts) and small-denomination (under $100,000) time deposits issued by financial institutions; and shares in retail money market mutual funds (funds with initial investments under $50,000), net of retirement accounts.

St. Louis Federal Reserve, Notes on Monetary Trends

[4] Financial Times, US Treasury sells negative-rate bonds, October 26, 2010

[5] Treasury Inflation Protected Securities - TIPS

[6] See Following The Money Trail: Inflation A Key Theme For 2010, November 15, 2009

[7] The Economist, A roadmap for more Fed easing, December 4, 2009

Friday, October 29, 2010

Example of Government Wastage

This is a good example how government fritter away taxpayer money.

From the Wall Street Journal Blog, (bold highlights mine)

The U.S. Internal Revenue Service had difficulty implementing new tax benefits in 2010, paying $111 million in erroneous benefits related to the stimulus law, a Treasury Dept. report said.

The IRS didn’t have controls in place to stop people who weren’t eligible from claiming the $8,000 first-time homebuyer tax credit, and tax credits for plug-in vehicles, among others. The findings were released Thursday by the Treasury Inspector General for Tax Administration.

To put the errors in perspective, IRS processed more than $81 billion in claims for stimulus-related tax benefits in 2010, involving upwards of 90 million returns.

About 126,000 of those returns were flagged by TIGTA as including erroneous claims that weren’t caught by the IRS before they were processed. In some cases, the IRS put compliance controls in place during the tax-filing season to catch the errors.

The underlying message is that the stimulus programs has led to undue wastage.

And the sad part is that no one seems accountable for such errors. And I don’t think that this is limited to the “stimulus programs”.

To consider, the stimulus is just one aspect of the variable bureaucratic operations, which means there would be many more leakages elsewhere.

And applied to the Philippines where social institutions are weaker than the US, the losses would be magnified.

US Politics: A Libertarian Renascence?

In the Cato Blog, David Boaz posits that in the US, current political trends seem to evolve towards the re-emergence of libertarianism.
Mr. Boaz writes,
This chart, prepared for me by Garrett Reim, shows recent trends in public opinion polls on several issues — support for smaller government, marriage equality, and marijuana legalization along with opposition to President Obama’s health care plan and to the job the president is doing. The latter two have moved more sharply, but all five lines move at least marginally in a libertarian direction:
Read the rest here.
What was popular then may not be popular now.
As we have long been saying—the world doesn’t not operate in a stasis. And this applies to politics too, where public sentiment continuously changes depending on the prevailing conditions.

Thursday, October 28, 2010

Vietnam’s Relative Policy Success Is Mostly Premised On Less Interventionism

In a recent comment at a social web platform, a local politician commented that the reason for the marginal improvements in Vietnam relative to the Philippines had been due to the “effective implementation of their policy”.

While it is true that political policies serve as fundamental framework to social activities, the question that needs to be identified is the kind of policies involved and to what extent the so-called ‘effective implementation’ which results to positive externalities.

For instance, the politician further noted that domestic agricultural issues had signified as a seemingly timeless unresolved imbroglio which needs to be addressed. Unfortunately, he didn’t say how.

Yet in citing Vietnam, what was not elaborated was that the so-called the ‘effective policies’ in agriculture had been the decollectivization or privatization of agricultural lands which served as a crucial step in the transition to a market economy.

As World Bank’s Martin Ravallion and Dominique van de Wallel wrote,

Vietnam's land reform of 1988 abandoned the collective farming system that had been introduced in the 1960s. The 1988 Land Law and its key implementation directive-"Resolution 10"-gave individual households long-term use rights over the collectives' land and other resources. Four million hectares of land were thus scheduled for effective privatization.

Opaque generalized political statements frequently leads to confusion. Statements like this would seem mellifluous to hear for the economic ignorant, yet lack the teeth in terms of specific actions.

Essentially, the fundamental reason for the apparent relative policy success of Vietnam is because of the thrust towards trade liberalization or economic freedom, which implies less government interventionism or political meddling in distributing scarce resources. And this runs contrary to the intone of the local politician.

This from McKinsey Quarterly,

Vietnam began to liberalize its economy in the 1980s, when the country’s leaders launched doi moi (or “renovation”). It was only after President Clinton lifted the US trade embargo in 1994, though, that multinationals began to pile in. Since then, Vietnam has taken off. In 2007, it joined the World Trade Organization (WTO)—just in time for the global financial crisis. The country weathered the storm well, posting 5 percent growth in 2009.

The remarkable embrace of globalization by Vietnam has prompted for a sharp recovery from a once war ravaged economy.

The following chart from the KOF Index of Globalization


Vietnam has undertaken substantial steps to reduce bureaucratic red tape.

The following chart from World Bank’s Doing Business presentation


Vietnam has also reduced and streamlined taxes.

According to World Bank’s Doing Business 2010

Vietnam cut the corporate income tax rate from 28 percent to 25 percent and eliminated the surtax on income from the transfer of land. It also adopted a new enterprise income tax law and value added tax law. In addition, increasing competition in the logistics industry and the application of new customs administration procedures as part of the World Trade Organization (WTO) membership reform program have reduced trade delays.

So overall, the marginal edge Vietnam has over the Philippines isn’t because of more politics but because of MORE TRADE.


As one would note from the above illustration, Vietnam has surpassed the Philippines in attracting investments by reducing hurdles to investments or has made the political and legal environment more conducive to trade and investments.

And the following chart from Google’s Public data seems to corroborate this.


Vietnam’s external trade (% to GDP) has sharply surpassed the Philippines. (Caution: currency values appear less of an influence compared to ease of business environment)

Economics shapes politics.

It is true that Vietnam remains politically a one party authoritarian regime, where according to the Heritage Index of Economic Freedom, “political repression and the lack of respect for basic human rights remain serious concerns.”


Chart above from KOF Index of Globalization

Nevertheless if economic trends should continue to influence politics, political trends may also gradate towards more openness or democracy. But this isn’t certain, specially not over the near term, as Vietnam may be following China ‘dualistic’ model.

Meanwhile, economic freedom is also reflected on social freedom.

Again from KOF Index of Globalization


And here is more proof that Vietnam’s society have been integrating with the world, this from McKinsey Quarterly,

In 2009, the General Statistics Office estimated that Vietnam had 5 million Internet subscribers and 18 million Internet users. Those figures are impressive for a country at a relatively early stage of digital development, and other estimates suggest the number is even higher. In Hanoi and Ho Chi Minh City, for instance, up to half of the population is now online, spending more than two hours a day, on average. Expenditures on digital marketing for the country as a whole, however, are still very low: only $15 million, according to Cimigo, a market research firm. As Mai Huong Hoang, the chairwoman of one of Vietnam’s leading advertising agencies, the local branch of Saatchi & Saatchi, noted, “TV is still king in Vietnam, because women are the decision makers in the family and they spend a lot of time watching TV.” However, recent McKinsey research in other emerging markets, such as China, India, and Malaysia, suggests that the pace of digital change can be rapid, especially with younger people. Therefore, businesses—particularly consumer goods companies—shouldn’t ignore digital media in their marketing plans.

Bottom line: “Effective policy implementation” means less political interventionism, where people will be incented to harness their innate talents and skills in an environment fertile for business growth.

In other words, Vietnam’s success formula has been the relatively more aggressive adaption of economic freedom compared to the Philippines.

And more politics won’t serve as the elixir to the Philippines’ dismal and lagging performance.

Wednesday, October 27, 2010

Power of Slow Change: Dying Mass Media, Endangered Traditional Politicians

Another marvelous stuff from marketing guru Seth Godin (all bold highlights mine)

Now, though...When attention is scarce and there are many choices, media costs something other than money. It costs interesting. If you are angry or remarkable or an outlier, you're interesting, and your idea can spread. People who are dull and merely aligned with powerful interests have a harder time earning attention, because money isn't sufficient.

Thus, as media moves from TV-driven to attention-driven, we're going to see more outliers, more renegades and more angry people driving agendas and getting elected. I figure this will continue until other voices earn enough permission from the electorate to coordinate getting out the vote, communicating through private channels like email and creating tribes of people to spread the word. (And they need to learn not to waste this permission hassling their supporters for money).

Mass media is dying, and it appears that mass politicians are endangered as well.

As the information based economy deepens, knowledge will likely be more dispersed, aided by the web. And that the power of traditional influences will get diminished, as the public’s attention gravitate towards niche based interest groups, founded on fragmented and specialized knowledge.

And as we long been saying, politics is NEVER static, they always evolve. The reshaping or the ‘digitalization’ of the economy will likewise reconfigure politics. Perhaps, seen in the line of niche marketing which could likewise evolve into realm of niche politics.

The Silent Revolution: Election Boycotts

In reading Frank Chodorov’s fantastic article, it dawned upon me that I have been an unwitting 6-year practitioner of Mr. Chodorov’s ‘silent revolution’: I haven’t exercised my rights to suffrage in protest to what I perceive as the current farcical ‘social democracy’ which hallmarks the Philippines’ political system.

Here are some rudimentary reasons how and why election boycotts could be utilized as one avenue to institute political change.

These great excerpts from Mr. Chodorov: (all bold highlights mine):

Why should a self-respecting citizen endorse an institution grounded in thievery? For that is what one does when one votes.

In the quiet of his conscience each citizen pledges himself, to himself, not to give moral support to an unmoral institution, and on election day he remains at home.

the fact that every election is a seizure of power. The balloting system has been defined as a battle between opposing forces, each armed with proposals for the public good, for a grant of power to put these proposals into practice. As far as it goes, this definition is correct; but when the successful contestant acquires the grant of power toward what end does he use it — not theoretically but practically? Does he not, with an eye to the next campaign, and with the citizens' money, go in for purchasing support from pressure groups? Whether it is by catering to a monopoly interest whose campaign contribution is necessary to his purpose, or to a privilege-seeking labor group, or to a hungry army of unemployed or of veterans, the over-the-barrel method of seizing and maintaining political power is standard practice

Remember that the proposal to quit voting is basically revolutionary; it amounts to a shifting of power from one group to another, which is the essence of revolution.

All this would change if we quit voting. Such abstinence would be tantamount to this notice to politicians: since we as individuals have decided to look after our affairs, your services are no longer needed. Having assumed social power we must, as individuals, assume social responsibility — provided, of course, the politicians accept their discharge.

Revolutions starts with the individual.

By refusing to exercise our rights to suffrage we should put notice to the everyone, especially to the power hungry politicians, that we expect genuine “change” by fundamentally allowing individuals to assume greater social power and not some pretentious cycles of ‘personality based welfare-free goodies based politics’.

All it takes is to stay home.

Tuesday, October 26, 2010

Will A Weak US Dollar Boost The US Economy?

Conventional thinking says that a weak currency should boost the economy via promoting exports.

But the Wall Street Journal Blog argues otherwise. (bold highlights mine)

The financial markets are focused on how nations, including the U.S., would prefer weaker currencies in order to make their exports cheaper on global markets. Indeed, multinational companies Caterpillar and McDonald’s reported Thursday that their bottom lines benefited from stronger international sales.

The flip side of that weak-currency strategy, however, is that imports into the U.S. become more expensive. If so, that will be a problem for millions of companies that don’t have an export presence. These companies, especially small and medium-sized firms, will see their profit margins squeezed because of higher costs…

Michael Trebing, senior economist who oversees the survey at the Philly Fed, says that in the past, respondents have said the prices-received index is weak because of competition and the inability of businesses to pass along cost increases. As a result, profitability is under attack.

“Accounting 101 tells us that if a company’s input costs go up, and they are unable or unwilling to pass those costs on to the consumer, their margins get squeezed,” says Dan Greenhaus, chief economic strategist at Miller Tabak.

The squeeze could get worse as import prices adjust to a weaker dollar because U.S. business depends on imported supplies. Excluding energy commodities, industrial materials and supplies account for 14% of all U.S. imports. In the first eight months of 2010, nominal shipments of these imports increased 30% compared with the same period in 2009.

To be sure, many global contracts are priced in U.S. dollars. But as the dollar weakens, foreign producers themselves will soon come under margin pressure when the dollars are translated into local currency. Over time, new contracts will carry higher prices for the components and materials that are important inputs for U.S. manufacturers and service-providers.

In one respect, higher import prices would please the Fed because bank officials want to see overall U.S. inflation head higher.

image Some quick stats: (all charts from Google's public data explorer)

Exports make up only 12% of the US economy (above chart) compared to imports at 17% (below chart)

imageOverall, US merchandise trade constitutes only 24% of the US economy.


A weak dollar policy not only punishes imports, which ironically represents a much larger component of the US economy, importantly, it would hurt domestic trade which comprises 76% of the GDP.

So when Fed officials say they would like to see higher inflation through a weaker currency, they are simply implying that exporters should be subsidized, shouldered by the rest of the economy, at the cost of vastly lowered standard of living through higher consumer prices.

Of course, as mentioned above, instead of adding jobs, a profit squeeze on domestic non-export enterprises, through higher prices of inputs, would translate to high unemployment.

And an environment of high prices and stagnating economy is called stagflation, a dynamic the US had encountered during the 70s to the 80s.

Yet that’s how ‘subtle’ protectionism works, the rhetoric and ‘noble’ intentions depart from real events, where a few politically handpicked winners would emerge at the cost of everyone else.

Update: I forgot to add: There is another unstated beneficiary here, i.e. holders of financial assets. And the sector that requires an asset boost is no more than the banking sector, which have been severely distressed by the recent crisis. And this is why I think that a weak dollar isn't directed mainly at bolstering exports but to keep the banking system afloat.

Profits And Social Responsibility

In a book review, the Economist hits the nail on the head.

``In poor countries the problem is not that businesses are unethical but that there are too few of them.”

More from the Economist, (bold highlights mine)

Ann Bernstein, the head of a South African think-tank called the Centre for Development and Enterprise, thinks that advocates of corporate social responsibility (CSR) tend to miss this point. In her new book, “The Case for Business in Developing Economies”, she stresses the ways companies benefit society simply by going about their normal business. In a free and competitive market, firms profit by selling goods or services to willing customers. To stay in business, they must offer lower prices or higher quality than their competitors. Those that fail disappear. Those that succeed spread prosperity. Shareholders receive dividends. Employees earn wages. Suppliers win contracts. Ordinary people gain access to luxuries that would have made Cecil Rhodes gasp, such as television, air-conditioning and antibiotics.

These are not new arguments, but Ms Bernstein makes them fresh by writing from an African perspective. Citizens of rich countries often fret about the occasional harm that corporations do, yet take for granted the prosperity they create. People in developing countries do not have that luxury.

If you pay heed to the mainstream, you’d have the impression that “labor costs” ultimately determines economic activities. Hence, the undeserved fixation towards currency values.

Of course in real life this is only fractionally true.

Economic activities are mainly about business enterprises seeking to serve consumers in return for the prospects of profits, where labor costs signify as one of the many factors or inputs necessary to produce a service or a good.

What ultimately determines profitability are respect for property rights and the rule of law which serves as the cornerstone for free trade to exist.

While the Economist article assails the issue of corporate social responsibility, the implied message is that poor countries have not sufficiently been exposed to competition for the anti-business environment reasons mostly out of the prevailing political or legal regime.

On the other hand, what needs to be understood is that profits are not necessarily “selfish”.

Since businesses are mostly established towards achieving long term relationships, profits have inherent social responsibility aspects such as maintaining or enhancing social relationships via charitable actions (donations and charities) or even addressing environmental concerns.

As Murray N. Rothbard wrote, (bold emphasis mine)

Whereas the opportunity for voluntary charity acts as a spur to production by the able, coerced charity acts as a drain and a burden upon production. In fact, in the long run, the greatest “charity” is precisely not what we know by that name, but rather simple, “selfish” capital investment and the search for technological innovations. Poverty has been tamed by the enterprise and the capital investment of our ancestors, most of which was undoubtedly done for “selfish” motives. This is a fundamental illustration of the truth enunciated by Adam Smith that we generally help others most in those very activities in which we help ourselves.

Hence, capitalism equates to mutually beneficial actions.

Integrating Asia: Japan-India Trade Pact

More signs that Asia continues to deepen her trade ties with each other.

This from the Japan Times

Prime Minister Naoto Kan and visiting Indian leader Manmohan Singh officially agreed Monday in Tokyo to activate an economic partnership agreement as soon as possible and to speed up talks on civilian nuclear cooperation.

The deal to strengthen economic ties between Japan and India, a fast-growing democratic nation with a population of 1.2 billion, comes at a time when Asian nations are becoming increasingly concerned about China's activities in the East China and South China seas….

The two countries will continue working-level preparations for signing the EPA. Tokyo aims to sign it around the end of the year so it can be submitted to the Diet early next year for ratification, Japanese officials said.

Under the EPA, the two countries will abolish a wide range of tariffs on products ranging from car components and electronic goods to bonsai plants. Broader than a free-trade agreement, the EPA is a more comprehensive pact on economic and trade cooperation that also includes promoting investments.

"This is a historic achievement that signals the economic alignment of two of the largest economies in Asia," Singh said. "It will open up new business opportunities and lead to a quantum increase in trade and investment flows between our two countries."

Japan and India began discussing the possibility of a civilian nuclear energy deal in June that would allow Tokyo to export its nuclear power technology to New Delhi. But India is not a signatory member of the Nuclear Non-Proliferation Treaty, and it is unclear how soon the two nations can conclude a deal, given the strong antinuclear sentiment here…

The EPA will eliminate tariffs on 94 percent of two-way trade in 10 years after the pact takes effect. The tariffs to be abolished include those on Indian exports of car components, DVD players, video cameras, peaches and strawberries to Japan, while Japan would improve access to most industrial products, as well as durian, curry, tea leaves and shrimp.

If there is anything to be bullish about, it is that the direction of geopolitics seems headed towards embracing broader ‘free’ trade.

Popular Sentiment Over Deflation Recedes

Aside from failed effects of the fiscal stimulus, one of the factors that could have been swaying political sentiment against Keynesian economics is the inordinate focus on “deflation”.

Yet for all the supposed threats that deflation would bring, there has been little signs of the emergence of the bogeyman since the culmination of the crisis.

This popular sentiment may have reached a "tipping point".

This from the Wall Street Journal Blog,

Deflation anxieties may be about to spur the Federal Reserve to do more to help the economy, but for bond traders, fears of a downward spiral in prices appear to be pretty low.

A paper published Monday by the Federal Reserve Bank of San Francisco said that based on pricing levels in the inflation indexed government bond market — the securities are commonly called TIPS — investors are sanguine the economy can escape a crippling bought of falling prices…

Fed officials fear that while growth remains positive, it is not powerful enough to overcome the ground lost over the course of the recession, leaving inflation at dangerously low levels, and unemployment unacceptably high. They want to act to help get growth levels higher, even though many economists and some in the Fed wonder if the institution can be effective in boosting activity, given that borrowing rates are already near historic lows and the financial system is flush with liquidity.

The TIPS market has long been one of the ways policymakers, economists and market participants could get a handle on the outlook for inflation. That said, the use of TIPS to tell a broader story is a complicated task.

The rap against the TIPS market goes like this: It is a relatively new market sector, and it has less liquidity than other parts of the Treasury trading world. That means price movements can be signaling something other than a shift in investors’ inflation outlook. In the market’s favor, however, is the fact that it at least represents a real money bet on something — an investor can lose cash if they predicted the pricing outlook incorrectly. In any case, Christensen argued his model compensates for these factors.

The gold market has been saying this ever since.

And as we long been saying here, false premises will eventually be unmasked.

Monday, October 25, 2010

Consumption-Led Growth Is A Myth

Even experts from the World Bank seem to be getting it, this from Ivailo Izvorski, (East Asia & Pacific On The Rise) [bold highlights mine]

“Consumption-led” growth is a myth. Output growth results from the accumulation of factors of production – capital, labor, land and others – and from technological progress. Consumption is not a factor that drives growth, it is the residual. And at early stages of development, rapid consumption growth – as we have observed in East Asia – is possible only with rapid investment growth. Cut down on investment to boost consumption and given the low level of capital in the region, output growth will plummet, and with it consumption growth.

Read the rest here

More signs that the mainstream appears to be moving away from Keynesian economics.

Differentiating Cheerleading Biases From Predictions

``In the modern world, science and society often interact in a perverse way. We live in a technological society, and technology causes political problems. The politicians and the public expect science to provide answers to the problems. Scientific experts are paid and encouraged to provide answers. The public does not have much use for a scientist who says, "Sorry, but we don't know". The public prefers to listen to scientists who give confident answers to questions and make confident predictions of what will happen as a result of human activities. So it happens that the experts who talk publicly about politically contentious questions tend to speak more clearly than they think. They make confident predictions about the future, and end up believing their own predictions. Their predictions become dogmas which they do not question. The public is led to believe that the fashionable scientific dogmas are true, and it may sometimes happen that they are wrong. That is why heretics who question the dogmas are needed." - Freeman Dyson "The Need for Heretics"

People often confuse cheerleading for predictions.

Most mistakenly think that they are seeking for the “right” answers on specific dilemmas when in fact they are only latently searching for confirmations on particularly predetermined perspectives.

When we watch a sports game and take sides with one of the protagonists, we don’t “predict” the outcome, rather we “cheerlead” or desire that our handpicked team wins or accomplishes a particular goal, regardless of extraneous ‘analysis’. Faith precedes the rational.

So whether we apply this way of thinking into sports or into analyzing financial markets or the economy or the political spectrum; faith based preferences represent no more than our inherent biases that should not be confused with objective predictions or opinions or studies.

Causality versus Superstition

Yet everyone has their innate way of seeking for answers for real life activities, as Ludwig von Mises wrote[1] in his magnum opus,

There are for man only two principles available for a mental grasp of reality, namely, those of teleology and causality. What cannot be brought under either of these categories is absolutely hidden to the human mind. An event not open to an interpretation by one of these two principles is for man inconceivable and mysterious. Change can be conceived as the outcome either of the operation of mechanistic causality or of purposeful behavior; for the human mind there is no third way available. It is true, as has already been mentioned, that teleology can be viewed as a variety of causality.

And faith based analysis are mostly anchored on teleology or the doctrine or the belief that holds purpose and design as a part of or are apparent in nature[2].

Where people cannot ascertain or relate with the cause and effects of a phenomenon, they submit to the teleological interpretation usually by attributing these to some mysterious, cosmic or mystical forces.

As Professor Mises described[3], ``They invented deities and devils to whose purposeful action certain phenomena were ascribed. A god emitted lightning and thunder. Another god, angry about some acts of men, killed the offenders by shooting arrows. A witch's evil eye made women barren and cows dry.”

There seems little difference even in the modern world.

In making predictions, the same phenomenon seems to take effect: Where most people can’t ascertain valid causal linkages, they frequently ascribe to various mental heuristics and or use sloppy reasoning (logical fallacies)—and this applies even to institutional analysts or professionals. Have you ever wondered why the mainstream ‘experts’ had largely missed out on anticipating the occurrence of the last crisis? Mainstream economists had even been implicitly chastised by the Queen of England[4] for failure to predict and stop the crisis!

Yet since predictions are basically interpretations of current and past events which are extrapolated into the future, prediction essentially deals with methodology.

So whether it is about prophecy—via water divining, astrology, numerology, fortune telling, interpretation of dreams, and many other forms of divination or about prediction science—statistical probabilities, mathematical equations and models, computer simulated models[5] or the physici[6] or the search mechanistic explanations, the methodology for prediction matters.

Of course as stated above, objective predictions and biased faith based predictions can be distinguished.

Objective predictions are mostly premised on the methods that generate potential outcomes or using the ‘means to establish potential ends’. Whereas cheerleading or biased or analysis are mostly ‘cart before the horse’ reasoning or selectively choosing theories or facts to retrofit into a desired outcome.

As stated above, in cheerleading, analysis serves to cosmetically embellish or improve on the seeming cogency of the issue. To put bluntly, analysis acts only as a façade.

Critical Changes Occur At The Margin

Let me further state that mainstream predictions are largely mistaken for their idée fixe on current events, whose key players or factors they see as the main driving factors, which impels them to bypass the several other critical variables that affect the ongoing changes.

For instance, in the advent of the 20th century the mainstream hardly predicted the US to supplant Britain as the world’s economic and military power.

On the other hand, hardly anyone had also seen how Argentina, one of the most prosperous nations then, degenerated into a third world country or an emerging market economy[7] as her economy was gutted by protectionism and rampant cronyism.

In the same context, when Japan became the world’s economic and financial cynosure in the 1980s, there had been little notice of how China would emerge as an economic power a decade forward. And some of the geopolitical angst then had been focused on Japan’s resurgent economy, which turned out to be an illusion.

And now that China has gotten into everyone’s radar screen, political talking points and political correctness have been transfixed towards China, as if China holds the world by the jugular.

While I do not discount the growing importance of the role of China, I see the excessive focus on her as missing out the other important variables at work.

And today, the same people (mostly the politically blind) who claim to know what should be ‘morally’ good for the world, are the same people whom has constantly misread the future.

Of course these people, who presume to hold the moral high ground, have not seen or predicted the explosion of mobile telecoms technology (see figure 1) and how it has substantially affected and altered people’s lives.


Figure 1 ITU[8]: The Rise of 3G

How big an impact of the rapid progress and evolution in the telecom world to the real economy?

This from the ITU, (bold highlights mine)

-By the end of 2010, there will be an estimated 5.3 billion mobile cellular subscriptions worldwide, including 940 million subscriptions to 3G services.

- Access to mobile networks is now available to 90% of the world population and 80% of the population living in rural areas.

- People are moving rapidly from 2G to 3G platforms, in both developed and developing countries.

-In 2010, 143 countries were offering 3G services commercially, compared to 95 in 2007.

- Towards 4G: a number of countries have started to offer services at even higher broadband speeds, moving to next generation wireless platforms – they include Sweden, Norway, Ukraine and the United States.

Question: Have these so-called experts and the political ideologues seen how the explosion of technological innovation in various fields, such as the telecoms, has transformed or revolutionized the way people has conducted commerce or the how these changes has influenced the political playing field or how 86% of the world’s wired population has reconfigured their lifestyles based on these new instrument and platforms? The simple answer is HARDLY.

Du jour politics have largely obscured the contribution of technology in today’s current developments. In other words, while substantial changes has been happening at the margins, the mainstream tunnels in on what is quite evident (trading patterns misconstrued as imbalances, debt as impeding growth).

Of course from the hindsight, everything has not only been fait accompli but looks linear or deterministic such that we simplistically presume to know how history is made, which has been used by many to make flimsy and tenuous arguments.

History is mostly narrated from the lens of a single observation, rather than taken into consideration the underlying conditions and the alternative options which had been available at the time that had led to such an outcome.

As Nassim Taleb explains[9] along the lines of assailing teleology,

``While we know that history flows forward, it is difficult to realize that we envision it backward…Our minds are not quite designed to understand how the world works, but, rather, to get out of trouble rapidly and have progeny.”

Legg Mason’s Michael J. Mauboussin[10] sees the importance of critical points (or changes at the margin) in identifying trends,

``Many complex systems, including markets, have critical points where small incremental condition changes lead to large-scale effects. Researchers in both the physical and social sciences have known about these critical points for a long time; so much so that terms like phase transition and tipping point have slipped into our day-to-day language. Still, critical points throw a monkey wrench into our mostly linear cause-and-effect thinking.

Bottom line: In a world of complex systems, predictions should be anchored on the ongoing changes at the margins that could snowball into a major trend than to excessively fixate on popular issues frequently regurgitated by media and their phalanx of experts with terrible batting averages in terms of prediction.

Here is more evidence on the evolving paradigm shifts at the margins from which the mainstream has vastly ignored (see figure 2)


Figure 2: McKinsey Global Institute[11]: Economic Freedom Spurs Growth In Africa

People today see the growing role of emerging markets in the global economy for mostly the wrong reasons: they have overlooked the role of economic freedom as fuel to economic growth.

As the McKinsey illustration shows, as many nations in Africa have undertaken vital reforms in the direction of economic freedom, trade exposure has been bolstered and vibrant economic growth has followed.

And how has progress in technology coped with the ongoing reforms in Africa? (see figure 3)


Figure 3: ITU: Africans Online Likely To Catch Up

Mobile penetration level is reportedly at an estimated 41% at the end of the 2010 compared with the global average of 76%, whereas only 21% are online compared to 71% in developed economies.

According to ITU[12], ``By the end of 2010, Internet user penetration in Africa will reach 9.6%, far behind both the world average (30%) and the developing country average (21%).”

Since Africa has lagged the world in terms of economic development, the recent economic reforms has translated to a catch up role even in the realm of connectivity. Nonetheless a promising room for growth for industries.

Yet these are examples of “changes at the margins”…important changes that may be gradual but could play a substantial role in shaping the future.


In conclusion:

-We should not confuse predictions with that of cheerleading or biased analyses that are influenced or shaped by political or economic dogma.

For views ossified by such biases, hardly any amount of valid or worthwhile reasoning will be sufficient to apostatize a recalcitrant ‘faith’ based outlook. It’s like debating religion which is usually a futile exercise that would only lead to strained personal relationships.

Instead, people with such biases ought to put money where their mouth is. For instance, if they believe that the world is on path to a meltdown then they should just ‘short’ the markets or the economy/-ies or just run to the hills for cover. Let convictions be parlayed into monetary votes than unduly spread political canard. Some use their ivory tower positions to spread miasma.

-Many cheerleaders look for ‘expert’ opinion only either to CONFIRM their biases or to get ENTERTAINED. If they are not pleased with what they read about, they scrounge for opinions that match with their biases.

-The framework of any forms of predictions depends on methodology. Applying the wrong method would likely bring about misdiagnosis, and consequently misguided conclusions and erroneous predictions. Being accurate then, will account for as a product of lady luck or provident coincidence, rather than having their analysis to conform with actual or the “run of mill” developments[13].

-Quality predictions avoid biases, particularly generalizations predicated on limited sample/s, data mining and selective use of theories and facts in order to justify a preconceived conclusion. Prediction analysis should consider objectively, the broader picture, aside from the micro developments that incorporates interpretation from sound theory, which are supported by evidences.

-The most important changes or ‘critical points’ are happening at the margins, something which most predictions don’t discover until they become major trends.

[1] Mises, Ludwig von Human Action: Chapter 1. Acting Man: The Alter Ego,

[2] Teleology

[3] Mises Ludwig von, Theory and History Positivism and Behaviorism, Chapter 11,

[4] This is how we let the credit crunch happen, Ma'am ... July 26, 2009

[5], Prediction

[6] Lilburne, J. Grayson Prelude to Natural Philosophy, Mises Blog, March 17, 2010

[7] Glaeser Edward L. What Happened to Argentina?, New York Times Blog, October 6, 2009

[8] The Rise of 3G, The World In 2010, ICT Facts and Figures

[9] Taleb, Nassim Nicolas Fooled By Randomness, Random House Trade, p.56

[10] Mauboussin Michael J. Fat Tails and Nonlinearity, Legg Mason Capital, December 20, 2007

[11] McKinsey Global Institute: Lions On The Move The Progress and Potentials of the African Economies, June 2010

[12], Op cit. P.4

[13] See Distinguishing Luck From Skills In The Financial Markets, September 19, 2010