Sunday, July 31, 2011

How the US Debt Ceiling Crisis Affects Global Financial Markets

In my own time, governments have taken the place of people. They have also taken the place of God. Governments speak for people, dream for them, and determine, absurdly, their lives and deaths. Ben Hecht in Perfidy (via David Harsanyi)

Any moment now the ‘divisive’ issue over the US debt ceiling will likely reach settlement.

And by this I mean that the debt ceiling will be raised and that a landmark deal will be made over fiscal dynamics of the US in the coming years.


The supposed GOP Boehner Bill HR 2693 which recently passed the House[1] but was rejected by the Senate[2] already exposed such eventuality. That’s because the House bill proposed a new debt ceiling from US $14.294 trillion[3] to possibly $16.994 trillion—a figure cited by Zero Hedge[4]!

If this is true then such an increase would largely depend on the willingness of foreigners to finance the US government. Otherwise, we should expect the US Federal Reserve to step up the plate[5] with serial asset purchasing programs or interest rates in the US will rise that could heighten risks of the highly leveraged banking system, and equally, menace the deep in the hock US government.

What is being deliberated in real time is the mechanics governing the debt ceiling bill. On what increasingly seems like ‘staged dispute’ supposedly based on ‘ideology’—cut along party lines of tax increases versus government spending, the emerging compromise will account for a farcical display of attaining fiscal discipline.

As of this writing, the Bloomberg reports a working framework being threshed out[6],

The tentative framework includes immediate spending cuts of $1 trillion and creation of a special committee to recommend additional savings of up to $1.8 trillion later this year. The new panel would have to act before the Thanksgiving congressional recess in late November and Congress would have to approve its recommendations by late December or government departments and programs, including defense and Medicare, would face automatic, across-the-board cuts, the person said.

No more than 4 percent of Medicare would be subject to cuts, and beneficiaries would be unaffected as reductions would apply to providers, the person said. Social Security would be untouched.

These proposed spending cuts will likely signify as reduction in the growth rate of future spending, rather than actual spending cuts. In addition “additional savings” are likely to come in the form of tax increases.

What gradually is being revealed is that the “extend and pretend” or “kick the can down the road” policies would only widen the door for more inflationism that would set up a major crisis down the road that would make 2008 pale in comparison.

The kernel of the US debt ceiling crisis has been encapsulated by the chart below from the Wall Street Journal.


As the Wall Street Journal editorial accurately writes[7],

This is the road to fiscal perdition. The looming debt downgrade only confirms what everyone knows: Congress has made so many promises to so many Americans that there is no conceivable way those promises can be kept. Tax rates might have to rise to 60%, 70%, even 80% to raise the revenues to finance these promises, but that would be economically ruinous.

As writing on the Wall, there have been three credit rating agencies, outside the largest, that has downgraded the credit standing of the US, namely Weiss Ratings, Egan-Jones Ratings Co. and Beijing based Dagong Global Credit Rating[8]

The left believes that an inexhaustible Santa Claus fund exists to finance political programs which would hardly affect the distribution of resources or how the economy operates. They see the world in a prism of social stasis, where people’s actions are homogenous and can be easily manipulated.

The left believes that forcing others to pay for supposed “rights”, or in actuality, for veiled privileges that benefits vested interest groups in the name of social welfare—they would advance the cause of the economy. They ignore the reality that resources are scarce and forced redistribution represents a zero sum game-where one benefits at the expense of the other. Yet, the politically blinded left never seem to realize that restricting choices available to people leads to violence.

And worst, markets are increasingly being held hostage by political brinkmanship as political leaders try to extract negotiation leverage by spooking the marketplace with veiled threats of Armageddon[9]

The great libertarian H. L. Mencken was eloquently precise when he wrote[10]

Civilization, in fact, grows more and more maudlin and hysterical; especially under democracy it tends to degenerate into a mere combat of crazes; the whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by an endless series of hobgoblins, most of them imaginary.

Part of such endless series of hobgoblins to promote expansive government power and unsustainable welfare programs grounded on the antics of ‘default’ has resulted to the dramatic flattening of the US yield curve (


The spike in the 3 month T-Bills runs in contrast to the actions on the longer maturity term structure, which registered declines in the yields and thus the flattening of the curve.

Add to these has been the recent languor seen in major global equity markets and another record run in gold prices.


US equities represented by the S&P 500 fell sharply this week (3.92%) while the volatility index (VIX) spiked along with it. In addition, the debt issue has weighed on the US dollar (USD).

So essentially, gold prices seem to tell us that there would be more inflation ahead.

Hence political bickering and jawboning have placed considerable stress in the marketplace.

Again, this shows that in today’s milieu neither economics nor corporate fundamentals determine the direction of markets but political developments, which runs in defiance of conventional wisdom.

The fact is that the US has been in a covert default mode, through consecutive Quantitative Easing or credit easing, the purchasing power of the US has been on a decline. The current purchasing power of the US dollar has been lower than when these debts had been contracted. Thus the stealth default.

As Murray N. Rothbard wrote[11],

Inflation, then, is an underhanded and terribly destructive way of indirectly repudiating the "public debt"; destructive because it ruins the currency unit, which individuals and businesses depend upon for calculating all their economic decisions.

Unless politicians face up to these realities, the US will default sooner or later. And much of these near term moves to default will be through inflationism.

And again policy choices or political direction is likely to be path dependent in accordance to how political institutions have been designed; fundamentally to sustain or preserve the status quo of the cartelized system of central banks-‘too big to fail’ banking system-welfare based government.

At the end of the day, the debt ceiling will be raised and inflationism will prevail, as day of reckoning will be postponed.

All these will be reflected on the marketplace.

Again profit from political folly.

[1] House passes Boehner’s debt ceiling plan–and Senate puts it on ice, July 29,2011

[2] USA Today House rejects Senate debt bill; Obama wants compromise, July 30, 2011

[3] 2011 U.S. debt ceiling crisis

[4] Zero Hedge, Here Is Boehner's Amended Amended Bill, July 29, 2011

[5] See Falling Markets, QE 3.0 and Propaganda June 12, 2011

[6] Deal Framework Reached on Raising U.S. Debt Ceiling, July 31, 2011

[7] Wall Street Editorial The Road to a Downgrade A short history of the entitlement state. July 28, 2011

[8] US News Money Meet 3 Ratings Agencies That Have Already Downgraded the U.S., July 22, 2011

[9] US debt battle: Showdown on Capitol Hill, July 18, 2011

[10] H. L. Mencken

[11] Murray N. Rothbard Repudiate the National Debt,

The Phisix-ASEAN Alpha Play

It’s simply amazing how the Philippine Phisix-ASEAN bourses appear to have sidestepped the generalized negative actions of global markets.


As the chart above exhibits, ASEAN represented by the FTSE ASEAN 40 ETF (ASEA) has been traipsing on the upper side of price levels while major developed economy bellwethers, the US S&P 500 (SPX), Europe’s Stoxx 50 (STOX50) and Emerging Markets’s MSCI Emerging Free Index (MSEMF) have been foundering.

The apparent dissonance could be traced to mostly political events which has shifted from concerns over the debt crisis in Europe’s periphery to the “divisive” US debt ceiling vote.

It would be tempting to say that the ASEAN region has been “decoupling”, even as we are cognizant that globalization has been deepening the interdependencies of all kinds of markets, and not just limited to financial markets.


Today’s deepening financial globalization, enhanced and facilitated by digital technology has been fueling capital mobility worldwide. Thus, foreign ownership of global equities, particularly in Emerging Markets, has significantly been expanding.

Among ASEAN bourses, levels of foreign ownership has been significant, as evidenced by Thailand and Indonesia where foreigners own more than 20% share of equity, based on market capitalization[1].

This makes the region modestly sensitive to exogenous or geopolitical or financial markets shocks.


From the start of the year, the range of the percentage of foreign trade to total trade in the Philippine Stock Exchange has been at 35-45% or about the median at 40% (see above chart).

While this has changed the complexion of the current market conditions compared to 2003-2007 where foreign trades dominated, foreign trades still remains a pivotal force to be reckoned with.

So it is unclear whether ASEAN and the Phisix would function as an alternative haven, which if such trend continues or deepens, could lead to a ‘decoupling’ dynamic, or will eventually converge with the rest. The latter means that either global equity markets could recover soon—from the aftermath of the Greece (or PIIGS) bailout and the imminent ratification of the raising the US debt ceiling—or that if the declines become sustained or magnified, the ASEAN region eventually tumbles along with them. My bet is on the former.

Therefore, I would caution any interpretation of the current skewness of global equity market actions to imply ‘decoupling’. As I have been saying, the decoupling thesis can only be validated during a crisis.

In the meantime, we can read such divergent signals (between ASEAN and the World) as motions in response to diversified impact from geopolitical turbulence.

Under the current conditions, where political developments have been functioning as the key driver of the marketplace (which seems to continually confirm my thesis[2]), a politically induced marketplace, swimming in a pool of liquidity, may have differentiated returns based on risk-adjusted Alpha[3].

Also, current market actions also appear to tell us that political crisis may have less an influence or has a limited contagion effect than from a fully blown economic or financial crisis. This implies that the marketplace could have been habituated or conditioned to the instinctive and systematic policy responses by governments to reflate the system at any emergent signs of distress or simply to flood the world with money.

One may call this a variant of the Greenspan-Bernanke Put[4] or applied in genre, a central banker’s put, by implementing policies aimed at buttressing the financial markets mostly through the reduction of interest rates and or through asset purchases.

Thus, like the boy who cried wolf, every unfolding political dilemma has gradually been discounted or seen as an opportunity to buy or lever up. Typically such landscape which routinely discounts risks factors through a boost in market psychology particularly overconfidence, which should spillover to risk appetites, sows seeds to the Hyman Minsky[5] Ponzi dynamics.

And operating in a Alpha environment, national structural idiosyncrasies, such as political economic system, fiscal outlook, divergent effects from local policies and the dissimilar impact from global monetary policies on the region’s economies both of which contributes distinctly to local cycles, and etc…, could serve as interim forces at work.

In simple sense, Philippine and the ASEAN asset markets could be seen as interim beneficiaries from today’s jumbled geopolitical climate.

Again, this line of thought is predicated on expectations where any political resolution from the du jour predicaments of major developed economies, as the US today, would work in the direction of the intrinsic structure of 20th century designed political institutions of reflating the system.

In other words, global political leaders will largely lean on inflationist policies based on artificially suppressed interest rates and the financing of bailouts by money printing applied to politically favored sectors or to governments.

And these policies which results in perennial boom busts cycles, would eventually be ventilated on global markets, including the Philippines and her ASEAN neighbors too.

So far these actions seem to be in the operating handbook or manual of policymakers from the US to Europe to Japan to China to the Philippines, only the scale varies.

[1] Lanzeni, Maria Laura Emerging Markets: Contagion from trouble in the eurozone has not been widespread. Will it remain like this?, Deutsche Bank July 29, 2011

[2] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge? , November 30, 2008

[3] Alpha (investment)

[4] Bernanke Put

[5] Understanding Minsky's financial instability hypothesis

Phisix and the Inflationary Boom

A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply. Fritz Machlup

The Phisix has been creeping higher posting 5 consecutive weeks of incremental gains.

Year-to-date, the Phisix has accrued a nominal local currency based return of 7.2%. Since the Peso has been up by about 3.8% over the same period, a US dollar invested in the local equity market would see gains of over 10% gross and a real (inflation adjusted gain) of 5.4%, based on the latest inflation figure at 4.6%[1].

For local investors real Peso returns would translate to 2.5%.

While some signs for a possible profit taking correction may have surfaced due to the succession of winning streaks, in bullmarkets extended runs are a commonplace.

Yet momentum indicators suggest either a sectoral rotation as major issues consolidate or a continued upswing over the coming sessions.

Along with a briskly Phisix, the Philippine Peso has also shown persistent vigor to reflect on the strength of Asian currencies.


A strong Peso (above window), which is a sign of relatively stronger demand for Peso assets, is hardly a harbinger of a looming major correction.

Again the Peso’s rise is being reflected on similarly buoyant basket of Asian currencies—the Bloomberg JP Morgan Dollar Index (ADXY-lower window).

Over the recent weeks, I have been saying that the Property[2] and Financial[3] sectors could take the market’s leadership from the overheated mining sector.

As I wrote[4] last week,

And part of this phenomenon could highlight a rotation away from the mining sector and into the other laggards, perhaps to the finance and the property sector as the next major beneficiaries of the percolating inflation driven boom as previously discussed.

Well lady luck appears to be smiling anew on us as this outlook appears to have been partially validated this week.


Both the property and the financial sectors took 1st and 2nd spot ahead of this year’s uncontested market leader, the mining sector.

Except for the Industrial Sector, the gains of the Phisix has clearly been lifted by these two resurgent industries.

From the above, it would seem that we are on a roll, as the local markets have been unfolding exactly in accordance to our prognosis.


Yet I am seeing additional evidence of a business cycle boom phase.

The chart above from ADB[5] shows that (except for China) property prices in the ASEAN region have been on an incremental rebound and appears to have been partly fueled by circulation or bank credit.

So the region does not only show similarities in movements in equity prices but likewise in the bank credit growth and correspondingly in housing prices. The general directions have been synchronized, except for the scale.

From this perspective, I expect that the gap filling phase or a “reversion to the mean” dynamic of the property-finance tandem to remain in play as a real property boom will be financed by mostly the banking sector, given the limited options of the underdeveloped domestic capital markets.

This is one major sign of an inflation driven boom.

Another sign can be seen over at the broad market in the Philippine Stock Exchange.

The bullish sentiment has rampantly been spreading as more issues have caught the market’s attention.


While the average daily traded issues (computed on a weekly basis) has recently declined, the extraordinary breadth suggests that even third tier (non-liquid) issues are being revived with pizzazz.


Two examples:

Holding company Zeus Holding Inc. [PSE: ZHI; upper window] skyrocketed by a breathtaking 400+% in just two weeks!

Also Basic Petroleum Corporation [PSE: BSC] zoomed by stupendous 69% over the week!

[disclosure: I don’t own any of the above]

Both issues has trailed the Phisix or has basically missed the two year upside.

To analogize, these issues signify as latecomers to the party but have come crashing into the shindig in a grand entrance. To wit, the lapse in time and scale has been compensated by the recent bouts of explosive upside actions.

Yet we have seen many similar issues go ballistic, mostly piggybacking on Merger and Acquisition rumors, or joint ventures, or other forms of rationalization.

As I pointed out in September 2010[6],

As the growing conviction phase of the bubble cycle deepens, as represented by the recent buyside calls of “Golden Era”, one should expect to see heightened volatility in market actions which means more frequent explosive moves.

Yet in defying conventional wisdom, many are flummoxed by these events. As I wrote at the start of the year[7]

while the mainstream will continue to blabber about economic growth, corporate valuations or chart technicals, what truly drives asset prices will be no less than the policies of inflationism here and abroad that leads to cyclical boom and bust in parts of the world including the Philippines.

Current market actions have only been vividly confirming this ongoing inflationary boom, where too much money has been chasing returns.

Again what mainstream hardly can comprehend or explain, paradoxically is a dynamic which I have been predicting ever since.

Understanding how the market process works is key. Living on a mythical self-imposed sense of reality won’t help[8]. In fact, it can be disastrous.

Bottom line:

Every time the Phisix attains new highs, we should expect high octane performances even from peripheral or formerly illiquid issues as money rotates from issues which has earlier outperformed to issues that have lagged and vice versa, a feedback mechanism that would result to broad market price increases. In short inflation boosted relative price actions eventually end up as general price increase.

In other words, a rising tide will lift most, if not ALL, boats.

This is my Machlup-Livermore paradigm[9].

The Phisix has simply been demonstrating how an inflationary boom works, which should also serve as an example of how inflated money works through the economy (but is more complex)

[1] Philippine annual inflation at 4.6 pct in June, July 4, 2011

[2] See Expect a Rebound from the Lagging Philippine Property Sector, July 17, 2011

[3] See A Bullish Financial Sector Equals A Bullish Phisix?, May 22, 2011

[4] See Confirmation of the Phisix Breakout!, July 24, 2011

[5], Asian Economic Monitor July 2011

[6] See Philippine Phisix In A Historic Breakaway Run! September 12, 2011

[7] See The Phisix And The Boom Bust Cycle, January 10, 2011

[8] See Quote of the Day: Living Out of a Myth, July 29, 2011

[9] See Are Stock Market Prices Driven By Earnings or Inflation? January 25, 2009

Saturday, July 30, 2011

Lessons from the Joint Resignations of the Chiefs of Turkey’s Armed Forces

Turkey’s highest ranking military officers has reportedly resigned en masse.

According to the SFGate,

The chiefs of staff of Turkey's military stepped down Friday as tensions dramatically increased over the arrest of dozens of officers accused of plotting to overthrow the Islamic-rooted government.

The resignation of so many top commanders, a first for Turkey, a NATO member, signals a deep rift with the government, which has confronted a military that once held sway over Turkish political life. The arrests of high-ranking military officers would once have been unimaginable.

The resignations of Turkey's top general, Isik Kosaner, along with the country's navy, army and air force commanders, came hours after a court charged 22 suspects, including several generals and officers, with carrying out an Internet campaign to undermine the government. The commanders asked to be retired, the state-run Anatolia news agency said.

In Brussels, a NATO spokeswoman declined to comment on the resignations. Turkey's military is the second largest in the 27-member alliance. It has about 1,800 troops as part of NATO's 140,000-strong force in Afghanistan.

The Turkish government responded by quickly appointing the remaining highest-ranking commander, Gen. Necdet Ozel, as the new land forces commander and the acting chief of staff, the office of Prime Minister Recep Tayyip Erdogan announced. President Abdullah Gul approved the appointment.

This puts to light the question “who protects us from our protectors?” when men in uniform try to exert political pressure on the civilian government.

Nevertheless, these events can present themselves as windows of opportunities for the Turkish people to even pare down on the vertical hierarchical structure of the world’s sixth largest armed forces that should free up resources for the private sector to use, and importantly, to reduce dependency on so-called ‘protectors’, who in reality signify as instruments of state initiated violence on her people.

Bluntly put, a shrinkage of government equates to the advance of civil liberties.


From Google Public Data

While it isn’t clear in the report on what has prompted for such an incident (except for the charges of plotting to overthrow government), my suspicion is that these protestations could signify adverse reaction to, or symptoms of a resistance to change, to Turkey’s recent transition towards greater economic freedom.

Evidence of this can be seen by the substantial decline of military expenditures as % to GDP.


And coincidental to the diminishing expenditures of Turkey’s government on her military, is the significant liberalization of the economy as shown by the chart above from the Heritage Foundation.

Of course the Turkish people may choose to consider the privatization of national defense route.

As Gustave de Molinari (1818–1912), a prominent Belgian-born French economist, student of Jean-Baptiste Say, and teacher of Vilfredo Pareto wrote in his article “De la Production de la Securit√©” of February 1849. (bold emphasis mine)

If there is one well-established truth in political economy, it is this: That in all cases, for all commodities that serve to provide for the tangible or intangible needs of consumers, it is in the consumer’s best interest that labor and trade remain free, because the freedom of labor and trade have as their necessary and permanent result the maximum reduction of price.

And this: That the interests of the consumer of any commodity whatsoever should always prevail over the interests of the producer.

Now in pursuing these principles, one arrives at this rigorous conclusion: That the production of security should, in the interests of the consumers of this intangible commodity, remain subject to the law of free competition.

Whence it follows: That no government should have the right to prevent another government from going into competition with it, or require consumers of security to come exclusively to it for this commodity. . . .

Either this is logically true, or else the principles on which economic science is based are invalid. (Gustave de Molinari, Production of Security, J.H. McCulloch, trans. [New York: Center for Libertarian Studies, 1977], pp. 3–4)

Read here for a multi essays or treatises of how national defense can be provided for by the private sector—The Myth Of National Defense: Essays On The Theory And History Of Security Production

Or as the letter below from US founding father Samuel Adams to militia James Warren

A standing Army, however necessary it may be at some times, is always dangerous to the Liberties of the People. Soldiers are apt to consider themselves as a Body distinct from the rest of the Citizens. They have their Arms always in their hands. Their Rules and their Discipline is severe. They soon become attachd to their officers and disposd to yield implicit Obedience to their Commands. Such a Power should be watchd with a jealous Eye. I have a good Opinion of the principal officers of our Army. I esteem them as Patriots as well as Soldiers. But if this War continues, as it may for years yet to come, we know not who may succeed them. Men who have been long subject to military Laws and inured to military Customs and Habits, may lose the Spirit and Feeling of Citizens. And even Citizens, having been used to admire the Heroism which the Commanders of their own Army have displayd, and to look up to them as their Saviors may be prevaild upon to surrender to them those Rights for the protection of which against Invaders they had employd and paid them. We have seen too much of this Disposition among some of our Countrymen. The Militia is composd of free Citizens. There is therefore no Danger of their making use of their Power to the destruction of their own Rights, or suffering others to invade them.

Agricultural Protectionism Risks Food Crisis

It’s a popular theme to ‘protect’ society by ‘self sufficiency’ or by closing doors on trade. Well, reality says the opposite—protectionism leads to unintended consequences: mass shortages.

This has been spelled out by Cargrill’s CEO anent the growing risks of a food crisis from increasing government intervention (by hoarding).

From Bloomberg, (bold emphasis mine) [hat tip: Mises Blog]

Cargill Inc. Chief Executive Officer Greg Page, who runs the largest agricultural company in the U.S., has a good idea whom to blame for the global surge in food prices at the end of 2010: governments.

Page urged 708 delegates and guests at the National Grain and Feed Association convention in San Diego in March to take action, Bloomberg Markets magazine reports in its September issue. He said government hoarding was the biggest contributor to the rise in prices, which had soared 15 percent from October through January and pushed 44 million people into poverty, according to the World Bank.

“Ill-timed, ill planned and really a beggar-thy-neighbor strategy,” Page, 59, said of moves by Russia and others to ban grain exports as droughts and floods helped send stockpiles to their lowest levels in two generations.

Page warned that further disruptions might ratchet up costs so much that governments would jump in with more regulations -- not only on grain shipments but also on energy, trade and financial markets. Such moves could discourage investing in agriculture and hurt the poor.

“We have to make sure lawmakers share our understanding,” he said, imploring the executives to increase their lobbying to keep government hands off agricultural markets.

Governments should keep their hands off not only in agricultural markets but in ALL markets.

Where are Germany’s Gold’s Reserves?

That’s essentially the question posed by James Turk of Gold Money below

Mr. Turk writes,

This gold has been entrusted to the Bundesbank and provides peace of mind knowing that it is there. But where is it really? And just as important, how much is there? Unfortunately, we do not know the answer to these questions.

The Bundesbank’s latest Annual Report states: “As of 31 December 2009, the Bundesbank’s holdings of fine gold (ozf) amounted to 3,406,789 kg or 110 million ounces. The gold was valued at market prices at the end of the year (1 kg = €24,638.63 or 1 ozf = €766.347).” The total value therefore reported by the Bundesbank on its balance sheet is €83,939 million. There have been, however, repeated claims suggesting that the Bundesbank's gold vault is empty. The reporting by the Bundesbank in its Annual Report does nothing to disprove these claims.

The Annual Report states that the Bundesbank owns €83,939 million of “Gold and Gold Receivables”. Surprisingly, it does not distinguish between these two fundamentally different assets, nor does it report how much of each it owns.

Clearly, gold stored safely and securely in the Bundesbank’s vault in Frankfurt has a different level of risk than gold that has been loaned out. Physical gold is a tangible asset, and therefore does not have counterparty risk. But a loan – regardless whether you are lending euros, dollars or gold – is only as good as the creditworthiness of the borrower. This lesson was learned the hard way, for example, by the central bank of Portugal. It had loaned gold to Drexel Burnham Lambert, and that gold receivable was still outstanding when this bank failed two decades ago.

By not reporting “gold in the vault” and “gold receivables” separately as two different assets, the Bundesbank is saying in effect that cash and accounts receivables are the same thing. Of course they are not, and their fundamental difference is made clear by Generally Accepted Accounting Principles, which highlights a deficiency in the Bundesbank’s Annual Report.

Are central banks being transparent? Or has central banks been using accounting entries to fudge their actual gold reserve holdings? Or to the point, has major central banks, as the Bundesbank (and Belgium), been short gold (via gold leasing)?

To me, these represent as more signs of the growing fissures of the paper money system. And fresh record prices of gold attest to such development.

Graphic: A Prospering World

From USAID (sourced from Professor Don Boudreaux's Cafe Hayek)




More interesting is the shift over the last two decades of countries out of the bottom two groups and into the top two groups (see Chart 1). The number of Low-income and Lower Middle-income countries, often referred to as ‘developing economies’, is clearly diminishing.

A further look at total population by World Bank Income Group shows that the majority of the world’s population in absolute poverty cannot possibly be in the Low income group. In fact they are in the two Middle income groups (see Table 3 and the ESDB’s Data by Sector: Poverty and Income Distribution).

Thanks to Globalization, the world is indeed getting richer.

Friday, July 29, 2011

Big Mac Index: Brazil’s Real Priciest, India’s Rupee Most Affordable

The Economist has an annual update of their Big Mac Index


The Economist writes, (bold emphasis mine)

THE Economist’s Big Mac index is a fun guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of a basket of goods and services around the world. At market exchange rates, a burger is 44% cheaper in China than in America. In other words, the raw Big Mac index suggests that the yuan is 44% undervalued against the dollar. But we have long warned that cheap burgers in China do not prove that the yuan is massively undervalued. Average prices should be lower in poor countries than in rich ones because labour costs are lower. The chart above shows a strong positive relationship between the dollar price of a Big Mac and GDP per person.

PPP signals where exchange rates should move in the long run. To estimate the current fair value of a currency we use the “line of best fit” between Big Mac prices and GDP per person. The difference between the price predicted for each country, given its average income, and its actual price offers a better guide to currency under- and overvaluation than the “raw” index. The beefed-up index suggests that the Brazilian real is the most overvalued currency in the world; the euro is also significantly overvalued. But the yuan now appears to be close to its fair value against the dollar—something for American politicians to chew over.

My two cents:

As per the Economist, the mercantilist’s imputation of the massive overvaluation of the Chinese yuan would be a mistake. I have been saying these here here and here. A China bubble bust would deflate and expose on these protectionists’ canard.

ASEAN, China and India remains as most undervalued in terms of local currency prices of Big Macs (original index).

The surprise is that the augmented GDP based Big Mac index reveals that Brazil’s real has topped the Eurozone as the world’s most overvalued currency

This reminds me of the great Ludwig von Mises who once wrote

the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one.

Below is an interactive graph from the Economist

Competition Fueled Global Stock Exchange Automation

Transition to electronic trading in global stock exchanges only gained traction after the derivatives exchanges gave them a challenge

Professor Michael Gorham of the Illinois Institute of Technology narrates (World Federation of Stock Exchanges) [bold emphasis mine]

As we have seen, the early pioneers of electronic derivatives trading created brand new exchanges starting in the mid 1980s. It took almost another decade before existing floor-based exchanges began fully converting to screens. Aside from the fact that conversions from floors to screens met stiff resistance from member-owners whose livelihoods were threatened, derivatives trading, especially in financial products, was still in its infancy and many countries did not yet have derivatives exchanges. New Zealand, Sweden, Switzerland, Germany, South Africa and China all had no derivatives exchanges. So during the mid 1980s and early 1990s, all these countries created new derivatives exchanges, and they were all electronic right out of the box.

Stock exchanges, on the other hand, were relatively mature institutions, and most countries of any size already had one or more stock exchanges and were not generally building new ones. And given the natural resistance of member-owners, the existing stock exchanges, just like the existing derivatives exchanges, were not likely to quickly convert to screens. Consequently, early electronic activity on the securities side was carried out on an experimental basis, typically only for stocks that were relatively inactive. So in figure 6.2, we see that except for the isolated event of the Cincinnati Stock Exchange becoming electronic in 1980, it was not until 1989 that stock exchanges began to start converting to electronic trading in earnest


Some observations;

Most stock exchanges being monopolies or oligopolies have been slow to adapt to changes.

It took the introduction of derivative markets which threatened to compete with these traditional exchanges to prompt the latter to automate.

Nevertheless automation revolutionized trading. It facilitated increases in transparency, enabled outsourcing of traditional functions such as trading floor operations, product development, marketing, legal, regulatory and often clearing and settlement, which has contributed to the precipitous decline in the cost of trading, promoted direct access to exchange matching engines, introduced new order types, and fuelled a leap in merger and acquisitions activities.

Automation has been a significant part of financial globalization which means that the trend for stock exchanges here (in the Philippines) and abroad will likely incorporate new trading platforms/services.

For instance, the Philippine Stock Exchange has derivatives on the pipeline (via Red Hat) and has seen participation in new Exchange Traded Funds (ETFs) traded offshore, e.g. for ASEAN, the FTSE ASEAN Index Series and iShares MSCI Philippines Investable Market Index Fund (EPHE)

Deep and sophisticated capital markets are prerequisites to progressing market economies.

Quote of the Day: Living Out of a Myth

Excerpt from the always eloquent marketing savant Seth Godin

Myths allow us to project ourselves into their stories, to imagine interactions that never took place, to take what's important to us and live it out through the myth.

The quote comes in the context of a “myth” or vicarious brand based marketing strategy.

But I think this valuable quote applies to many aspects of social activities.

In my field, they are represented by the rigid mechanical chartists and micro fundamentalists in the financial markets, hydraulic econometric-statistics-quant based economics or in the political sphere—ideologies based on utopianism.

These people tend to live out or rationalize their morals or beliefs or their fantasies as reality.

The tragic bombing and shooting massacre which left 68 people dead in Norway by deranged Anders Breivik seems an example.

Quoting Stratfor’s Scott Stewart, (bold emphasis mine)

Breivik also is somewhat unique in that he did not attempt to escape after his attacks or become a martyr by his own hand or that of the authorities. Instead, as outlined in his manifesto, he sought to be tried so that he could turn his trial into a grandstand for promoting his ideology beyond what he did with his manifesto and video. He was willing to risk a long prison sentence in order to communicate his principles to the public. This means that the authorities have to be concerned not only about other existing Justiciar Knights but also anyone who may be influenced by Breivik’s message and follow his example.

Living out of a myth can be fatalistic.

Thursday, July 28, 2011

Quote of the Day on Rent Seeking and Regulatory Capture

You think that the predicament of crony capitalism through the unholy stealth relationship between government agencies and big corporations, which results to revolving doors, corruption, regulatory capture and rent-seeking are about ethics or virtues?

It’s not.

Professor Steve Horwitz explains, (bold emphasis mine)

The problem is not regulatory or ethical, but institutional. If you want to change the pattern of outcomes, change the rules. The only possible way to end the corporate control over the state is to reduce the state's sphere of influence down to as little as possible and ideally nothing. As long as there's the dead animal of the state (really: the citizenry) to feed on, the vultures of the private sector will keep showing up to get their share.

Graphic: Global Distribution of Livestock Supply

Interesting data from the Economist

THE world’s average stock of chickens is almost 19 billion, or three per person, according to statistics from the UN’s Food and Agricultural Organisation. Cattle are the next most populous breed of farm animal at 1.4 billion, with sheep and pigs not far behind at around 1 billion. China’s vast appetite helps make it the world leader in the number of chickens, pigs and sheep, whereas beef-loving Brazil and cow-revering India have the greatest number of cattle. Expressed as livestock per person, New Zealand lives up to its reputation as the world’s most productive shepherd, with 7.5 sheep for each New Zealander. It is also the second biggest cattle herdsman, with the equivalent of 2.3 cows per person, second only to Uruguay's 3.7. For chickens, Brunei rules the roost, counting 40 birds for every person.


That’s the supply side. It’s interesting to see how global trade coordinates these supplies to meet with demand. Global trade of Livestock in 2005 was reported at $33 billion

Wednesday, July 27, 2011

George Soros on Closing Hedge Fund: Do As I Say, Not What I Do

Sad to say that billionaire philanthropist George Soros does not practice what he preaches when it comes to ideology

He recently wrote,

“I have made it a principle to pursue my self-interest in my business, subject to legal and ethical limitations, and to be guided by the public interest as a public intellectual and philanthropist,” he wrote. “If the two are in conflict, the public interest ought to prevail,” he said.

Mr. Soros has been an strong advocate of government regulation/intervention which he blames on (market fundamentalism) or capitalism. Of course today’s world has not been operating on a laissez fair capitalism but rather a crony-state-corporatist-patron-client capitalism.

From Conservapedia

In a Der Spiegel interview in 2008, Soros advocates European-style socialism for America, "is exactly what we need now. I am against market fundamentalism. I think this propaganda that government involvement is always bad has been very successful -- but also very harmful to our society."

Soros's answer to America's problems involve more regulation and more government intervention in the marketplace. Soros pours billions of dollars into the following anti-USA causes

Well, ironically he recently announced the closure of his 4 decade long of hedge fund in protest of Dodd Frank bill, a regulation which he sees as not be beneficial for him.

From Bloomberg

Soros’s sons said they took the decision because new financial regulations would have made it necessary for the firm to register with the Securities and Exchange Commission by March 2012 if it continued to manage money for outsiders. Because the firm has overseen mostly family assets since 2000, when outside money accounted for about $4 billion, they decided it made more sense to run it as a family office, according to the letter.

The rule calls for hedge funds with more than $150 million in assets to report information about their investors and employees, the assets they manage, potential conflicts of interest and their activities outside of fund advising. Registered funds will also be subject to periodic inspections by the SEC.

“We have relied until now on other exemptions from registration which allowed outside shareholders whose interests aligned with those of the family investors to remain invested in Quantum,” the executives said in the letter, referring to its flagship Quantum Endowment Fund. “As those other exemptions are no longer available under the new regulations, Soros Fund Management will now complete the transition to a family office that it began eleven years ago.”

Mr. Soros’ stern reaction signifies a dose of his own medicine. So what happened to your so-called cardinal priority in the name of public interest, Mr. Soros?

As most socialists are, claims of upholding the interests of the collective are exposed as demagoguery, hypocrisy and a matter of convenience when actual cases are applied on them--yes only regulate those that do not apply to me!

After all, motherhood statements are almost always about projecting “feel good” or generating applause or ‘likes’ or portraying heroic self importance for social acceptability rather than reality.

Cities, Mathematics and Human Action

Below is an interesting talk by physicist Geoffrey West at the TED forum on Cities.

Some points he makes;

-It’s hard to kill a city.

-He places tremendous emphasis on the scalability phenomenon where he connects size with social impact, e.g. bigger city bigger wealth more AIDs

-However he says that optimism bias tends to prevail over the city’s growth dynamics where people tend to see ‘wonderful things and forget the ugly and bad’

-He rightly points out that social networks are key to the growth of cities; ‘We are the city’ which is a result of people’s “clustering interaction”.

-Further he says that for cities to develop it needs ‘faster innovation in a continuous basis’.

-Lastly he says that he can predict the size of a city or company given the sublinear scaling from ‘sigmoidal growth’

Here are my thoughts

It’s interesting to see how mathematically inclined people try to quantify people’s actions.

In the past killing a city or a decline of relevance or marginal utility of a city comes in the form of war (Nineveh, Babylon, Selucia, Carthage, Rome, Pagan and Angkor Wat as examples), change in economic patterns (introduction of Cape Good lead to the decline of Venice) natural calamity (Pompeii) or cyclical-behavioral-political elements- such as overconfidence, which led to overexpansion or lack of diversity (fall of Rome).****

In addition, scale does not automatically translate to magnitude.

In history, autonomous small cities played vital role as Amalfi, Cadiz, Goa, Batavia, Geneva, Abu Dhabi and Monaco.*** Today we have semi-independent city states as (pre-China) Hong Kong and Singapore.

Social network is indeed important. But Professor West does not specify how social network would result to “clustering interaction”. Are cities politically or economically driven?

In the past, strong arm societies depended on the capability of leaders, such as Alexander the Great, Attila the Hun, Genghkis Khan, Timur, Akbar, and Kublai Khan***. When they passed away so did their respective empires and cities.

History shows that many cities emerged from trading routes and proximity thereof, particularly in coastal areas (Tripoli, Sidon, Carthage, Athens, Marseille, Syracuse, in recent centuries Venice, Famagusta, Genoa, Constantinople, Kafffa, Lisbon and etc.)***

Many factors are involved in city dynamics: some of the important ones are economic growth cycles, legal systems, economic freedom, infrastructure, adherence to property rights, (in the past) military power [Assyrians, Romans, Mongols], political climate or conditions (interaction between minority and majority, in the past conflict resulted to dislocations which have caused diasporas of Jews, Huguenots, Armenians) innovation and intellectual tolerance.

To quote the legendary investor Marc Faber***,

A dynamic society arises where there is also intellectual tolerance freedom of conscience, social mobility, freedom of ideas, and the expression of ideas which may be hostile to established beliefs or to the government. Where intellectuals, scientist, and philosophers were persecuted, imprisoned, tortured or murdered, they fled. But it is in their know-how on which progress depends.

Deidre McCloskey would call this the Bourgeois Virtue.

And it is upon this climate of free interaction by people which induces Professor West’s innovation dynamics.

An example from the local setting:

In the Philippines, Manila as the Philippines’ capital played a pivotal role economically (Manila-Acapulco Galleon Trade) and also had been politically important; under American rule Daniel Burnham planned a government center spanning Luneta to Taft which almost like every centrally planned projects failed.

Today, Manila’s relevance has been apparently declining, in terms of population growth and per capita income.


While Manila still has the second largest population second only to Quezon City, the growth rate has been stagnating and relatively underperforming against a vibrant Quezon City according to the 2007 census. The fastest growth rate is seen in Taguig, Paranaque and Kalookan City.


Manila still has the largest population density

However, in terms of per capita GDP, Manila ranks 5th to the following order Makati, Mandaluyong, San Juan and Muntinlupa (Wikipedia).

The obvious point is that city scale and magnitude while having some correlation does not exhibit strong causation. The huge gap in Professor West’s talk is how social interaction has led to city dynamics.

I have stated why I am a skeptic of centrally planned urbanization as this runs contrary to the forces of technology enabled decentralization. The obvious evidence can be seen in several 'huge' but empty ghost cities in China which are products of politically induced bubble cycles.

Finally Professor West says that he can predict growth dynamics of companies and cities from “sublinear scaling”.

My guess is by now he should have bettered the record of Warren Buffett as an investor.

I am reminded by the admonitions of the great Ludwig von Mises of relating natural sciences with social or human actions,

Nothing could be more mistaken than the now fashionable at­tempt to apply the methods and concepts of the natural sciences to the solution of social problems. In the realm of nature we cannot know anything about final causes, by reference to which events can be explained. But in the field of human actions there is the finality of acting men. Men make choices. They aim at certain ends and they apply means in order to attain the ends sought.

***Nury Vittachi Doctor Doom Riding the Millennial Storm