Thursday, May 31, 2012

Nassim Taleb: Worry about the US more than the EU

My favorite author iconoclast Nassim Taleb says that the US and not Europe should be the source of concern

From Bloomberg,

Nassim Taleb, author of “The Black Swan,” said he favors investing in Europe over the U.S. even with the possible breakup of the single European currency in part because of the euro area’s superior deficit situation.

Europe’s lack of a centralized government is another reason it’s preferable to invest in the region, said Taleb, a professor of risk engineering at New York University whose 2007 best- selling book argued that history is littered with rare events that can’t be predicted by trends.

A breakup of the euro “is not a big deal,” Taleb said yesterday at an event in Montreal hosted by the Alternative Investment Management Association. “When they break it up, there will be a lot of fun currencies. This is why I am not afraid of Europe, or investing in Europe. I’m afraid of the United States.”

The budget deficit as a proportion of gross domestic product in the U.S. amounted to 8.2 percent at the end of 2011, government figures show. That’s twice the 4.1 percent ratio for euro-region countries, according to data compiled by Bloomberg.

“Of course Europe has its problems, but it’s in much better shape than the United States,” Taleb said. He voiced similar concerns about U.S. prospects at a conference in Tokyo in September…

Rising interest rates would make things worse for the U.S., said Taleb, a principal at hedge fund Universa Investments LP who also serves as an adviser to the International Monetary Fund.

“We have zero interest rates,” Taleb said. “If interest rates go up in the United States, you can imagine what the deficit would be. Europe is like someone who is ill but is conscious of it. In the United States we are ill, but we don’t know it. We don’t talk about it.”

In my view, decentralization of the EU will likely be the outcome from the collapse of the welfare states where Greece may likely to set the precedent.

And like Dr. Marc Faber and Professor Taleb, for the EU, after the storm comes the calm.

I would venture a guess that the tipping point for the US dollar as global currency reserve, is when the US economy run smack into another recession or into another financial crisis, where the knee jerk or intuitive response will likely be trillions of money printing by the US Federal Reserve. Under such condition, I think Professor Taleb’s risk scenario may unfold.

Chart of the Day: Stereotyping in Europe


From a poll conducted by Pew Research.

I don’t believe in stereotyping, but it must be emphasized that social policies (such as the welfare state or various forms of government interventionism) plays a significant influence on people’s value scales and preferences which consequently shapes work habits.

As former chancellor of West Germany known for his leading role in the "German Miracle" or West Germany's postwar economic recovery, Ludwig Wilhelm Erhard (1897–1977), once wrote,

Social policy must not damage national economic productivity even indirectly, and must not run counter to the basic principles of the market economic order.

If we desire to guarantee a permanent free economic and social order, then it becomes essential to achieve freedom with an equally freedom-loving social policy. That is why, for example, it is contradictory to exclude from the market economic order private initiative, foresight, and responsibility, even when the individual is not in a material position to exercise such virtues. Economic freedom and compulsory insurance are not compatible.

Phisix: Very Impressive Day or Month End Close for May 2012

Considering last night’s carnage in the US and the Europe…


table from

The Philippine Phisix rebounded strongly from an anemic opening to the close at the day’s highs or strength…


Intra-day chart from


Table from PSE

Gains had apparently been concentrated on the blue chips or heavyweights, particularly on holding and financial sectors.

Peso Volume ballooned, probably due to either cross trades or special block sales.

Nevertheless decliners edged out advancers to signify rotation from second and third tier issues to the heavyweights. This should be a good sign.


Finally, while most of Asia’s major bellwethers has been on the red, the Phisix stands out as the day’s best performer and outlier in terms of a few rare gainers.

Some questions begs to be answered: Could this be just window dressing? Question is why the Philippines only and not the ASEAN majors? And why aggressively buy up on the Phisix considering that the overall markets have been down and could have provided better opportunities for bargain hunting (at lower price levels)? Could Philippine government institutions, as SSS or GSIS, signify as forces behind today's magnificent surge?

The quotation has yet to be published so my comments will be limited to this.

Gains has been impressive but general uncertainty remains.

India’s Economic Growth Slows, Choked by Politics

From Bloomberg

India’s economy expanded at the weakest pace in at least eight years last quarter, hurt by a slowdown in investment that has undermined the rupee and set back Prime Minister Manmohan Singh’s development agenda.

Gross domestic product rose 5.3 percent in the three months ended March from a year earlier, compared with 6.1 percent in the previous quarter, the Central Statistical Office said in a statement in New Delhi today. The median of 31 estimates in a Bloomberg News survey was for a 6.1 percent gain. GDP climbed 6.5 percent in the year to March, the office said.

Singh faces a struggle to bolster expansion as Europe’s debt crisis dims the global outlook and elevated inflation and a record trade deficit limit room for more interest-rate cuts to boost spending at home. Discord within the ruling coalition and claims of graft have impeded his push to open up the economy, deterring investment and sending the rupee to its lowest level.

Well, India’s economic deceleration poses as another factor that contributes to the current environment marked by accentuated uncertainty.


The chart above from does not include the today’s data.

Left of center analyst Satyajit Das at the has a pretty good account of India’s lingering economic woes, and a list of obstacles towards attaining a developed economy status. (bold emphasis mine)

In recent years, India has consistently run a public sector deficit of 9-10% of GDP (if state debt and off-balance-sheet items are included). The problem of large budget deficits is compounded by poorly targeted subsidies for fertilizer, food, and petroleum, which amount to as much as 9% of GDP. Currently the official deficit is just over 3% of GDP, but trending higher and the highest in the G-20.

In March 2012, India brought out a budget forecasting an official fiscal deficit of 5.9%, well above its previous fiscal deficit target of 4.6%. India’s strong rate of recent growth (an average rate of 14% between 2004-2005 and 2009-2010) made large deficits, in the order of 10% of GDP, relatively sustainable. Slowing growth will increasingly constrain India’s ability to manage large deficits.

As its debt is denominated in rupees and sold domestically, India faces no immediate financing difficulty. Instead, the government’s heavy borrowing requirements crowds out private business.

However, exports are slowing as a result of weakness in India’s trading partners. Higher imports, mainly non-discretionary purchases of commodities and oil, have increased. India imports around 75% of its crude oil from overseas.

India’s weak external position has manifested itself in the volatility of the rupee, which was one of the worst performers among Asian currencies in 2011. Indian businesses, which have unhedged foreign currency borrowings, have incurred significant losses as the value of their debt rises as the rupee falls. Many Indian companies face large debt maturities in the coming year.

India has around US$250-300 billion in currency reserves. Foreign debts that must be repaid in the current year represent about 40-45% of this amount which highlights the increasing weakness in India’s external position.

Further, India is plagued by inadequate infrastructure especially in critical sectors like power, transport, and utilities. While its workforce is young and growing, there is a shortage of skills which has led to large increases in salaries for skilled workers.

The above account shows how India has been TOO reliant on the government.

Since government spending is ALWAYS politically determined, where decisions are usually made according to the needs of the moment or on what is presently popular or on what will accrue to votes for politicians (public choice theory), then the obvious result has been wastage, inefficiency and corruption.

Such dynamic has been the same even in the US, the erstwhile bastion of the market economy where dependence on government spending can be equated to crony capitalism.

Also infrastructure problems represent symptoms of too much politicization, viz., regulations and bureaucracy.

Now for the fun part. Adds Mr. Das… (bold highlights mine)

Corruption and Political Atrophy

Another major problem is large-scale, deep-seated and endemic corruption, highlighted by scandals surrounding the issue of telecommunication licenses and the sale of coal assets.

Used to accessing power and influencing politicians, businesses have advanced their interest in securing rich natural resources, especially land and minerals, and ensured a favorable regulatory framework restricting competition, especially from foreign companies.

India’s economic challenges are compounded by internal and external security concerns. For 2012, Indian defense spending is forecast to be $41 billion, around 1.9% of GDP or the ninth highest in the world. Financing this spending diverts resources away from other parts of the economy.

Political paralysis is another impediment to economic development. Successive governments have failed to undertake meaningful reforms. Complex coalition governments are a barrier to decisive action. The current government failed to implement its own plans to allow limited entry of foreign retailers. The government also failed to get a key anti-corruption bill through parliament.

Changes in land and property laws have not been made. Problems in acquiring land, for instance, are a factor in 70% of delayed infrastructure projects. The land acquisition process falls under a 19th century law and amendments proposed three years ago remain unlegislated.

Tax law reforms, including introduction of a direct sales tax correcting cumbersome differences in individual states, have not been completed. Changes to mining and mineral development regulations to allow proper, environmentally controlled exploitation of India’s mineral wealth have not been made.

Other crucial areas that remain unaddressed include rationalizing unwieldy and economically distorted subsidies; implementing economic pricing of utilities; promoting foreign investment in key sectors; reforming agriculture, especially the wasteful and inefficient logistics system for transporting produce to market. Reform of labor markets and privatization of key sectors has not progressed.

To sum it up, the basic reason why India’s economic advances has stalled has been due to the lack of economic freedom: particularly, too much government spending (crowding out effect), too much regulations (evidenced by stringent labor regulations, corruption), political concessions (subsidies, price controls), protectionism (restriction of foreign investments, and restrictions on agricultural and mining investments) and problems concerning property rights (land and property laws)

Indians have been used to the “License Raj” mentality or a business or commercial environment strangulated by elaborate licenses, regulations, and stultifying red tape, where vested interest groups fervently compete to acquire political power to generate economic clout at the expense of society.

India’s structural problems has important parallels with the Philippine political economy.

Nonetheless people’s opinions signify as the most important force in determining political trends that ultimately affects the state of the economy.

Another quote of wisdom from the great Ludwig von Mises

Many who are aware of the undesirable consequences of capital consumption are prone to believe that popular government is incompatible with sound financial policies. They fail to realize that not democracy as such is to be indicted, but the doctrines which aim at substituting the Santa Claus conception of government for the night watchman conception derided by Lassalle. What determines the course of a nation's economic policies is always the economic ideas held by public opinion. No government, whether democratic or dictatorial, can free itself from the sway of the generally accepted ideology.

Bottom line: the direction of economic growth will run along the prevailing ideology held by the citizenry. The greater the dependence on governments, the lesser the dynamism of the economy and vice versa.

Economic freedom ultimately determines the society's prosperity.

Quote of the Day: On Banking Union

But a banking union just makes the problem worse. Not today, maybe. But certainly tomorrow. What makes government action attractive is the opportunity for the body politic to pool its money to achieve things that individuals cannot achieve on their own. This idea ignores the possibility of voluntary collective action. But more importantly, the romance of this idea ignores the reality that inevitably, politicians are spending other people’s money. One of the simplest and deepest ideas of Milton Friedman is that people don’t spend other people’s money very carefully, especially when they are spending it on other people.

That’s from Professor Russ Roberts at the Café Hayek on proposals for a banking union to solve the EU debt crisis.

Whether it is banking union or fiscal union they are all the same, they ALL depend on the free lunch (Santa Claus) principle or of spending other people’s money.


And this is what makes the touted political solutions unfeasible and unsustainable. The easiest thing to do in this world is to spend other people's money.

video: What Hayek thought of Keynes

On inflationism: the great F. A. Hayek thought that Keynes would have "disapproved of what his pupils made of his doctrines".

Here is more of what Hayek thought of his personal friend Keynes [pointer to Bob Wenzel]

Video: Inflation Propaganda in 1933 Resonates Today

How do you promote more government intervention?

Simple, use demand side macro economics where mathematical aggregates are presumed to replace people's valuations and preferences and therefore people's actions.

The same propaganda made to promote inflation in the 1930s (from an MGM informercial), based on demand side macro, has fundamentally been the same propaganda used today.

For statists, inflation IS the Holy Grail to any SOCIAL ills.

Yeah, based on their naive and absurd logic Zimbabwe should have been the most prosperous nation on earth.
(video: Hat tip: Professor William Anderson)

Here is a reminder why inflation will ALWAYS fail over the long run. From the great Professor Ludwig von Mises, (bold emphasis mine)
The favor of the masses and of the writers and politicians eager for applause goes to inflation. With regard to these endeavors we must emphasize three points.

First: Inflationary or expansionist policy must result in overconsumption on the one hand and in malinvestment on the other. It thus squanders capital and impairs the future state of want-satisfaction.

Second: The inflationary process does not remove the necessity of adjusting production and reallocating resources. It merely postpones it and thereby makes it more troublesome.

Third: Inflation cannot be employed as a permanent policy because it must, when continued, finally result in a breakdown of the monetary system.
And it should be noted that in Zimbabwe's case (or many other episodes of hyperinflation) had been the result of the third point--failed attempt at the permanence of inflationary policies.

Let us not forget today's crisis has been borne out of, or a product of EARLIER inflationary policies where the repercussions has been manifested through MALINVESTMENTS and unwieldy DEBT. This is the BOOM BUST cycle.

Yet, the approach by contemporary central bankers and governments have been to resort to more MORE inflationism thereby increasing the intensity of the inevitable crisis. And this is what we are seeing today and will worsen as time goes by.

The idea that inflation can be tamed or modulated represents myopia or presumptuousness or stultified thinking. Once monetary inflation has been set loose, no one will exactly know how and when money will percolate into the economy and this is why hyperinflation exists. (yes inflationistas overestimate on the superiority of their knowledge, when they can't even predict the markets!!!)

The answer to our economic ills is NOT government but ECONOMIC FREEDOM or to allow the necessity of adjusting production and reallocation of resources according to will of the consumers.

Wednesday, May 30, 2012

Will the Eurozone’s Deposit Insurance Policies Hasten the Unraveling of the Euro?

The great dean of the Austrian school of economics Professor Murray N. Rothbard once called deposit insurance a swindle. (bold emphasis mine)

The very idea of "deposit insurance" is a swindle; how does one insure an institution (fractional reserve banking) that is inherently insolvent, and which will fall apart whenever the public finally understands the swindle? Suppose that, tomorrow, the American public suddenly became aware of the banking swindle, and went to the banks tomorrow morning, and, in unison, demanded cash. What would happen? The banks would be instantly insolvent, since they could only muster 10 percent of the cash they owe their befuddled customers. Neither would the enormous tax increase needed to bail everyone out be at all palatable. No: the only thing the Fed could do — and this would be in their power — would be to print enough money to pay off all the bank depositors. Unfortunately, in the present state of the banking system, the result would be an immediate plunge into the horrors of hyperinflation.

Current crisis in the Eurozone seems to be partly actualizing what Professor Rothbard warned about: Europeans appear to be awakening from the “swindle” and have intensified demand for cash, which has been putting severe strains on the EU’s fractional reserve banking system.

From Bloomberg, (bold emphasis mine)

The threat of Greece exiting the euro is exposing flaws in how banks and governments protect European depositors’ cash in the event of a run.

National deposit-insurance programs, strengthened by the European Union in 2009 to guarantee at least 100,000 euros ($125,000), leave savers at risk of losses if a country leaves the euro and its currency is redenominated. The funds in some nations also have been depleted after they were used to help bail out struggling lenders, leading policy makers to consider implementing an EU-wide protection plan.

“These schemes were not designed to deal with a complete meltdown of a banking system,” said Andrew Campbell, professor of international banking and finance law at the University of Leeds in the U.K. and an adviser to the International Association of Deposit Insurers. “If there’s a systemic failure, there needs to be some form of intervention.”

With European officials openly discussing a Greek exit from the euro for the first time, savers in Spain, Italy and Portugal may start to withdraw cash on concern that those countries will follow Greece and their funds will be devalued with a switch to a successor currency. None of those nations has the firepower to handle simultaneous runs on multiple banks.

Pulling Deposits

Households and businesses pulled 34 billion euros from Greek banks in the 12 months ended in March, 17 percent of the country’s total, according to the ECB.

Deposits at banks in Greece, Ireland, Italy, Portugal and Spain fell by 80.6 billion euros, or 3.2 percent from the end of 2010 through the end of March, ECB data show. German and French banks increased deposits by 217.4 billion euros, or 6.3 percent, in the same period. Bank-deposit data for April will be released starting this week.

Using the Argentina crisis as precedent…

Savers pulled 27 percent of deposits from Argentina’s banks between 2000 and 2003 during a currency crisis, Nedialkov wrote. If Ireland, Italy, Portugal and Spain follow a similar pattern, about 340 billion euros could be withdrawn, he estimated.

Companies have already started to remove cash from southern Europe as soon as they earn it. Many already are sweeping funds daily out of banks in those countries and depositing it overnight with firms in the U.K. and northern Europe, according to David Manson, head of liquidity management at Barclays Plc in London, who advises company treasurers.

If the scale of bank run escalates, will the ECB, then, resort to massive inflationism to the point of hyperinflation just to rescue their banks??

Will Gold be a Part of Basel Capital Standard Regulations?

At the, Ross Norman CEO of Sharps Pixley thinks that chances are getting better for gold to take a role in the banking system’s capital standard regulations.

Mr. Norman writes,

Banking capital adequacy ratios, once the domain of banking specialists are set to become centre stage for the gold market as well as the wider economy. In response to the global banking crisis the rules are to be tightened in terms of the assets that banks must hold and this is potentially going to very much favour gold. The Basel Committee for Bank Supervision (or BCBS) as part of the BIS are arguably the highest authority in banking supervision and it is their role to define capital requirements through the forthcoming Basel III rules.

In short, they are meeting to consider making gold a Tier 1 asset for commercial banks with 100% weighting rather than a Tier 3 asset with just a 50% risk weighting as it does today. At the same time they are set to increase the amount of capital banks must set aside as well. A double win potentially.

Hitherto banks have been much dis-incentivised to hold gold while being encouraged to hold arguably riskier assets such as equity capital, currencies and debt instruments, none of which have fared too well in the crisis. With this potential change in capital adequacy requirements. bank purchases of gold would drive up its value relative to other high quality qualifying assets, increasing its desirability for regulatory purposes further. This should result in gold being re-priced to bring it on a par with all other high quality assets.

While this should be good news, gold isn’t structurally compatible with the current form of political institutions (welfare-warfare state-central banking and privileged bankers) highly dependent on inflationism.

Since the Basel standards have in itself been fundamentally flawed, like in the past, governments and their adherents will only use gold as scapegoat for any future crisis. But who knows.

Nevertheless, the above serves as added indications where gold will likely play a greater role in the global economy, perhaps as money.

Quote of the Day: Eurobonds and the Euro

News flash: eurobonds have already been issued. They are called euros. ECB reserves are just particularly liquid floating-rate debt. The ECB issues reserves in return for sovereign debt and lends reserves to banks who load up on sovereign debt. This action is functionally the same as issuing Eurobonds to buy sovereign debts. What happens of the ECB's holdings of sovereign debt or its bank loans turn out to be worthless? If the ECB needs to be "recapitalized," it has the explicit right to call up the member states and demand funds, which means the member states have to kick in tax revenues. This is exactly a eurobond. For better, or, likely, worse.

That’s from University of Chicago Professor John H. Cochrane.

This only shows how governments and their allies resort to magical formulations to desperately prop up an unsustainable system.

China Calls the Stimulus Bluff

Through their press agency, China's government called the bluff.

Rumored stimulus has not been true. Maybe not yet.

From Bloomberg, (bold highlights added)

China has no plan to introduce stimulus measures to support growth on the scale unleashed during the depths of the global credit crisis in 2008 according to the nation’s state-run Xinhua News Agency.

“The Chinese government’s intention is very clear: It will not roll out another massive stimulus plan to seek high economic growth,” Xinhua said yesterday in the seventh paragraph of an article on economic policy, without attributing the information. “Current efforts for stabilizing growth will not repeat the old way of three years ago.” In 2008, policy makers unveiled a fiscal stimulus of 4 trillion yuan ($586 billion at the time).

Any restraint on stimulus this time may reflect concern the record lending boom that helped China weather a contraction in trade in 2008-2009 raised the risk of a bad-loan crisis. While Premier Wen Jiabao’s call last week for a greater focus on growth was endorsed by the State Council, or cabinet, it left out his recommendation to expand credit.

“The State Council is introducing a measured but still significant set of stimulus measures, which should begin to affect growth in August-September,” Standard Chartered Plc economists led by Stephen Green in Hong Kong wrote in a note to clients this week. Concern that a surge in credit would lead to faster inflation and higher property prices will be reflected in “a much more controlled pace of bank lending,” they wrote.

Yesterday’s Xinhua article made no mention of central bank tools including interest rates and the reserve-requirement ratio, previously used to bolster growth. It carried the byline of two reporters and wasn’t labeled as opinion or commentary.

‘Not Sustainable’

Pumping in government money to achieve growth targets is “not sustainable” and China will instead focus on encouraging private investments in railways, infrastructure, energy, telecommunications, health care and education, the story said.

As I pointed out yesterday

Rumors are one thing. Real actions are more important.

If there any lesson to glean from this event, such represents as manifestations of financial market’s deeply seated addiction to government steroids.

Yet the above developments partly or partially validates my suspicions about China’s evolving political spectrum: note "encouraging private investments".

Here is what I wrote last Sunday,

The bottom line is that should this be the case where there will not be material interventions, then economic uncertainty will be exacerbated by political uncertainty which increases the probability of further deterioration of China’s bubble economy.

Yet while the PBoC may likely engage in policies similar to her Western central bankers peers where inflationism has signified as an enshrined creed, it is unclear up to what degree the PBoC will be willing get exposed. That’s because China has made public her plans to make her currency, the yuan, compete with the US dollar as the world’s foreign currency reserve, which is why she has been taking steps to liberalize her capital markets and China has also taken a direct bilateral financing trade route with Japan, which seems to have been designed as insurance against burgeoning currency risks and from the risks of trade dislocations from potential bank runs. It is important to point out that the US has some exposure on major European nations.

Further speculations and rumors have it that China covertly plans to even issue a Gold backed currency as part of her quest to attain a foreign currency reserve status.

In short, the path towards foreign currency reserve status means having to embrace a deeper market economy (laissez faire capitalism) from which boom bust policies runs to the contrary.

Events are turning out to be very fluid. Rumors may turn out to be false. Denials can become real events. Anything can or might happen.

Today’s big surge could be tomorrow’s slump. There has been NO clarity yet on geopolitics (China, EU or the US) and of policy directions mostly by central bankers. This is a period characterized by high uncertainty.

Be very careful out there.

The Coming Colossal Bernanke Bubble Bust

From the Austrian economics viewpoint, US Federal Reserve Chair Ben Bernanke’s policies have set stage for a forthcoming economic bust with colossal and unprecedented dimensions.

The fabulous insight below is from Michael Pollaro at the Mises Institute and Forbes Magazine (bold highlights mine) [blue font my comments]

Yes, there is a real chance that the coming Bernanke bust could pack an even bigger punch than the housing boom-bust. One simple reason: a lot more monetary largesse could be in the offing.

We sight three primary inflationary forces:

1. Eurodollar deposit flows from European to US banks

2. Cashed-up US banks more willing to create uncovered money substitutes

3. The Bernanke backstop

1. Eurodollar Deposit Flows from European to US Banks

It's no secret that the sovereign-debt crisis that is Europe is wreaking havoc with the European banking system. Up to their ears in European sovereign debt and related derivatives undoubtedly marked at prices not likely to be found anywhere in the market, all too many European banks are frankly insolvent. As a result, many safe-haven-seeking European Eurodollar depositors have been taking their dollars out of European banks and redepositing them in the perceived relative safety of US banks. The result has been a nice push for the US money supply. More importantly, it's a push that may still have a lot more oomph. [my comment—this may offset the need for QE 3.0 for the moment, and may mitigate any interim corrections, but alternatively sows the seeds to the colossal bust]

Let us explain.

First, have a look at the recent trend in Eurodollar deposit balances in the European banking system, as sourced from the Bank for International Settlements (BIS) database:


According to the latest BIS statistics, European banks were seeing some fairly chunky Eurodollar-deposit contraction during the fourth quarter of 2011. All told, deposits were off $380 billion or 5.5 percent from September's $6.9 trillion balance, bringing that balance to the lowest level since December 2010. No doubt, some of this deposit contraction was actual deposit destruction (the result of outright Eurodollar asset sales or loan repayments). [my comment: this represents monetary deflation]

But in our estimation the bulk of that contraction had more to do with European depositors liquidating their Eurodollar deposits and redepositing the dollar proceeds stateside in on-demand deposits, the proceeds of that liquidation in no small part "funded" by the latest US and European central-bank currency-swap pact (where the central banks of the United States and Europe exchange newly created dollars for newly created euros, sterling, and francs). In other words, what we have here is US monetary inflation via safe-haven-seeking European Eurodollar depositors, with a big assist from the central banks of the United States and Europe. As anecdotal evidence suggests, this was a trend that likely made its way into the first quarter of 2012, meaning European Eurodollar deposit flows had a material impact on that 14.5 percent year-over-year rate of increase in TMS2. [my comment: this is the grand inflation designed to offset monetary deflation]

The question then becomes, What next?

To us, as long as European sovereign-debt woes continue to mount (something many experts think is pretty much guaranteed) and as long as the central banks of the United States and Europe continue to lend a hand to the Eurodollar market in times of market stress via inflationary currency swap or lender-of-last-resort programs (something they do as a matter of policy), US-bound Eurodollar deposit flow should remain inflight. Indeed, if European sovereign-debt problems reached levels worrisome enough to cause European Eurodollar depositors to cut and run en masse, the sheer size of the European Eurodollar market vis-à-vis the US money supply ($6.5 trillion against $8.5 trillion) would suggest a virtual explosion in the US money supply. [my comment: oops, grand CPI inflation ahead. Forget a risk ON environment, as markets shifts to stagflationary setting]

Having said this, we are certainly not projecting an imminent 75 percent increase in the US money supply via the European Eurodollar market. In fact, if the central banks of the United States and Europe backed away from their support of the Eurodollar market, we think we would have a whole new ballgame — outright and pervasive Eurodollar-deposit destruction outweighing whatever Eurodollar-deposit flow was able to make its way to US banks and, because of transatlantic contagion, the real possibility of US bank-deposit destruction too. But until central-bank policies change — that is, until the central banks of the United States and Europe stop responding to each and every successive wave of sovereign-debt-induced market stress with lender-of-last-resort programs — it's the same old ballgame. Each successive wave of sovereign-debt-induced market stress means more and more worried European Eurodollar depositors looking for safe-haven US banks. And with central-bank help, that means more and more US monetary inflation. Yes outright deposit destruction along the way too, but a real chance that the US money supply could very well be poised to receive a goodly portion of that $6.5 trillion Eurodollar deposit stash.[my comment: the seesaw battle between the grand inflation vis-a-vis monetary deflation]

One final but important thought. Note that the Eurodollar deposit space is almost entirely composed of time deposits. Now, under the Austrian formulation of the money supply, time deposits are not money but rather credit claims to money at a specified date in the future, claims that must first be liquidated into on-demand deposits or standard notes before they can serve as money. This means that European Eurodollar deposit flows into US bank on-demand deposits not only means the US money supply is benefiting from European deposit flows but world money supply too.[my comment: US-EU policies means inflationism has been on a global scale which is why contagion risks signifies a clear and present danger]

2. Cashed-Up US Banks More Willing to Create Uncovered Money Substitutes

As we discussed in March's essay, with excess reserves of some $1.5 trillion (owing to three plus years of Federal Reserve asset purchase and loan programs) yield-starved banks — buttressed by improved liquidity and capital ratios, a Federal Reserve and US government still cleansing bank balance sheets of mortgage and mortgage related debt and near zero rate funding costs maybe as far out as 2014 — seem more and more willing to pyramid up those reserves into money and credit; i.e., to create uncovered money substitutes by making loans and buying assets. Have a look at the recent rate of change metrics in uncovered money substitutes and a proxy for its obverse, commercial bank credit as compiled by the Federal Reserve (the later which represents roughly four-fifths of total bank credit). Both have been marching steadily higher and are currently touching two and a half year highs.


As we noted in that same essay, assuming a conservative reserve ratio of 10 percent on bank deposit liabilities — the highest reserve requirement ratio on the books — banks could theoretically triple the money supply, and do it simply by buying government securities.

Now, we are not saying that banks are poised to triple the money supply, full stop. For one, banks have to be continually willing to forsake the 25 bps they receive on their excess reserves, as well as the instant liquidity those reserves provide, for higher yielding, riskier assets. Not a huge obstacle for yield starved banks that are back-stopped by the Federal Reserve, especially if the trade-off is US Treasuries or some other government-backed investment, but an obstacle that could give banks pause at some point along the way. Similarly, bank capital ratios will almost assuredly act as a constraint on bank credit expansion short of a triple — voluntarily or through regulatory edict — particularly if banks are stretching the credit curve. Then, of course, given our debt-laden economy, there is always the real possibility of a major credit event, carrying with it the ability to derail even the most yield-hungry banking system. And last but not least, if the money supply took this kind of explosive path we think it wouldn't be long before the US dollar was trashed, making price inflation a national issue and thus forcing the Federal Reserve to halt its easy-money policies. Having said all this, such constraints on bank money creation appear to be of secondary importance for now, meaning there could be ample room for some serious money creation via the banks before any of those constraints kick in. [my comment: regulatory obstacles may inhibit credit growth and cause volatility, but is of secondary importance compared to deposit flows and FED-ECB policies]

3. The Bernanke Backstop

Last but not least, if European deposit flows or banks can't muster enough monetary largesse to temporarily juice the US economy and payrolls at a level sufficient to suit a deflation-wary Federal Reserve headed by a chairman scared to death of a 1937-style double dip (which he attributes to the Federal Reserve's move away from an accommodating monetary policy), rest assured there is always QE3 or some other creative monetary tool lying in the wings ready to spike the money supply on the false belief that this will spur long-term economic growth.

The net of all this monetary largesse — what's already been created and what's likely still to come — is that the Bernanke monetary boom could very well be on its way to one of the great monetary inflations in US history and, as a consequence, one of the great economic busts in US history too.[my comment: The Bernanke doctrine has been the standard tool to combat deflation. People hardly realize that this hasn’t been working as the same set of problems confronts us]

The Trigger for the Bernanke Bust

Don't tell me what; tell me when, right? Enter the trigger that will turn the Bernanke boom to bust: a cessation, even a marked deceleration in the rate of money creation.

You see, once the economy is deprived of its monetary steroids, the malinvestments created on the back of all this monetary largesse, indeed sustained by it, will be revealed as wasteful, misplaced capital and labor. The Bernanke bust will ensue as those malinvestments are liquidated, the debt supporting them purged and the capital and labor they absorbed released. A look at the housing boom-bust timeline is instructive and offers a glimpse into what's in store:


Note the deceleration in the money supply beginning in the back half of 2003 and its precipitous decline thereafter, knifing through the 10 percent mark in the second quarter of 2004 on its way to a trough low of 1 percent in the third quarter of 2006. Shortly thereafter, the subprime crisis was upon us. Roughly 18 months after that, the Great Recession.

The events that might bring on a cessation or marked deceleration in the rate of monetary inflation are many. We alluded to some of them above, such as a major credit event or a return of price inflation as a national issue, forcing the Federal Reserve to reverse its easy-money policies. But at the risk of sounding too simplistic, we think such events, while important, should be of secondary focus. Given the predictive nature of the ebb and flow of the money supply, all eyes should be on the money supply.

Just Keep Printing Money: Problem Solved

You might ask, What if the money supply continues to boom ad infinitum, even if that simply means Chairman Bernanke is the last man standing at the printing press? Could the Bernanke bust then be avoided? Delayed yes, avoided no. The endgame in this case would be a bust too; only this one would be the result of an inflationary collapse of the US dollar. Indeed, the surest way to create massive economic misery is via a concerted effort by a central bank to forever expand the supply of money and credit.

Quoting the great Austrian economist, Ludwig von Mises,

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

In other words, the Bernanke bust is coming, sooner or later, one way or another.

In today’s environment, people have been conditioned to think and BELIEVE that the governments will always provide the required backstop to the marketplace (at no costs) and that such rescue programs will always work.

They forget that inflation is a policy that will not and cannot last.

Eventually delusions of grandeur will be exposed for the untruth they really are.

How Italian Renaissance Bankers Bought off the Church

From at Mary Tao at the New York Fed Research Library (hat tip Bob Wenzel)

What do the Italian Renaissance and the Great Depression have in common? Commissioned works of art, Italian Renaissance methods of fresco painting, and themes of banking and money.

During the fourteenth through the sixteenth centuries, many Florentine bankers hired artists to produce devotional paintings and then donated those pieces to the Catholic Church to offset the Church’s disapproval of interest-bearing loans. Since usury was very much frowned upon, this practice of buying penance did not sit well with one Friar Girolamo Savonarola. He was such a vocal critic of the donations that he arranged for bonfires of “vain, lascivious, or dishonest things” (including many Renaissance artworks) in 1497 and 1498. The Medici Bank, the largest bank at that time, had much success in evading the ban on usury; its collapse in 1494 gave Savonarola leverage in his cause. The recent Florentine exhibit Money and Beauty. Bankers, Botticelli and the Bonfire of the Vanities depicts “how the modern banking system developed in parallel alongside the most important artistic flowering in the history of the Western world.”

Buying penance is as relevant today as it has been during the Renaissance. Many wealthy citizens indulge in huge donations to their respective churches or lavish on pilgrims in the hope of acquiring spiritual salvation.

While the activities of Italian bankers in the renaissance may not be about salvation, it had been about political influence peddling. It could also be seen as the natural impulse to arbitrage politics.

Of course flourishing of trade has been a critical factor in the “artistic flowering” or the “rebirth of learning” in the history of the Western world.

To quote the late Professor Sudha Shenoy,

It was the Muslims who saved the Latin and Greek texts during the European dark ages. This led to the Renaissance in due course. The Italian merchants learned their business methods from Islam. There is a commercial history, and a history of tolerance, that needs to be recaptured.

Tuesday, May 29, 2012

The Lessons and Validity of Public Choice Theory Applied to the Chief Justice’s Corona Impeachment

This quote of the day applies to the conviction (or the impeachment) of Supreme Court Chief Justice Renato Corona

One key conclusion of public choice is that changing the identities of the people who hold public office will not produce major changes in policy outcomes. Electing better people will not, by itself, lead to much better government. Adopting the assumption that all individuals, be they voters, politicians, or bureaucrats, are motivated more by self-interest than by public interest evokes a Madisonian perspective on the problems of democratic governance.

That’s from Professor William F. Shughart II at the (bold emphasis mine)

Many see this as votes for “principle”.

Contrary to the popular, as quoted above, I see this milestone event as fundamental confirmation of the public choice theory, especially with 2013 elections in sight. Here is a list of Senators whose term expires on 2013.

Of course, there is much to deal with here, but I will leave at that.

Rumored Stimulus for China Boosts Asian Markets

Rumors about another massive ‘stimulus’ from China has reportedly bolstered the Asian markets.

Reports the,

China is set to ramp up stimulus spending to help stabilize the economy, with a program of interest-rate cuts and infrastructure-related spending being planned, according to analysts, who caution the program won’t be big enough to bring about a rapid turnaround in the slowing mainland economy.

In a research note Monday, Credit Suisse said the new policy emerged from a meeting by the State Council, or China’s cabinet, last week when Premier Wen Jiabao urged “greater emphasis on growth.”

“We believe that government has started a new round of fiscal stimulus,” Credit Suisse analyst Dong Tao wrote in a note to investors.

Last week, the central government unveiled a 2 trillion yuan ($316 billion) credit line to the Ministry of Railways, 170 billion yuan in subsidies to environmental projects and about 78 billion yuan in support to social-housing projects, according to Credit Suisse.

Local governments were also encouraged to submit infrastructure project proposals for approval before the end of June, with the government promising to speed up funding support, according to Credit Suisse.

“All of these moves seem to suggest that the Chinese government has become more active in dealing with growth downturn,” Tao said.

Rumors are one thing. Real actions are more important.

Considering that the euro and China’s markets have been oversold, rumors may indeed provide rationalization to an oversold bounce.

Let me repeat what I wrote last Sunday on China,

Again, developments in China will MAINLY be hinged on the response by political authorities on the unfolding economic events.

I’d prefer to see the Chinese government make good on such a rumor before making my move.

The risk is that official actions may be less than the expected stimulus which may incite another intense downdraft.

A report suggested that political consensus over more stimulus remains uncertain. According to an Op Ed at the Sydney Morning Herald

Commentary in China, though, is far from unanimous that Beijing's leadership is ready - and able - to kick the economy up a gear.

A senior Chinese economic official, indeed, has said that the country is unlikely to start another round of massive stimulus package to spur growth.

And like Pavlov’s Dogs, this should be added proof of the intense addiction to steroids by global financial markets which means sharply volatile days ahead, again in both directions.

And this also represents further evidence that China's economy, mainly dependent on Keynesian policies, has been a ballooning bubble.

Be careful out there.

Risk OFF Environment: Surging US Dollar

The Bloomberg reports

The dollar is proving scarce, even after the Federal Reserve flooded the financial system with an extra $2.3 trillion, as the amount of the highest-quality assets available worldwide shrinks.

From last year’s low on July 27, the greenback has risen against all 16 of its major peers. Intercontinental Exchange Inc.’s Dollar Index surged 12 percent, higher now than when the Fed began creating dollars to buy bonds under its extraordinary stimulus measures at the end of 2008.

International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The U.S. is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category, data compiled by Bloomberg show.

“The pool of high-rated assets has been shrinking, not just in the euro zone but elsewhere as well,” Ian Stannard, Morgan Stanley’s head of Europe currency strategy, said in a May 22 telephone interview. “With the core of Europe shrinking, and the available assets for reserve purposes shrinking, it makes the euro zone less attractive.”

In a world where debt has been the elephant in the room, especially for major economies then it would be obvious that once there will be pressure on the claims to debts then this would mean an increased demand for the US dollar. This is because debts have been denominated in fiat currencies mostly on the US dollar. Some people may have forgotten that the world still operates on a US dollar standard.

For instance, intra-region bank run in the Eurozone will likely extrapolate to higher demand for the ex-euro currencies, mainly the US dollar


From Kyle Bass/Business Insider

This means that anxieties over a shrinking pool of “high-rated assets” has also been misguided, because much of these so-called high-rated assets revolve around the problems which we are seeing today: DEBT!!!

In short, what has been discerned by the mainstream as risk-free or safe assets epitomizes nothing short of a grand myth, founded on the belief that government edicts can defeat or are superior to the laws of economics.


Yet the US dollar has not been immune to debt, except that current instances reveal that the locus of market distresses have mainly been from ex-US dollar assets or economies, particularly the EU and China.

And since current predicament has been about debt deleveraging where central bankers have been fire fighting these with intensive money printing, then the pendulum of volatility swings from either asset deflation to asset inflation—or the boom bust cycles.


As one would note, gold has mostly moved in the opposite direction of the US dollar index. The euro has the largest weighting (about 58%) in the US dollar basket.

This simply debunks the flawed idea that gold is a deflation hedge under a paper currency system.

And as Professor Lawrence H. White aptly points out on an essay over monetary reforms,

We should not expect a spontaneous mass switchover to gold, or to Swiss francs, as long as dollar inflation remains low. The dollar has an incumbency advantage due to the network property of a monetary standard. The greater the number of people who are plugged into the dollar network, ready to buy or sell using dollars, the more useful using dollars is to you.

Where the US dollar continues to surge amidst staggering gold prices, then this only means central banking actions have been momentarily overwhelmed by apprehensions over debt mostly via political stalemates, whether in the EU or in China.

Yet we should not discount that central bankers to likely step on the inflation gas to save the current political institutions based on welfare-warfare state, central banking and the political clients—the banking sector.

Prices of commodities will now serve as crucial indicators as to the conditions of monetary inflation-debt deflation tug of war.

The Risk ON Risk OFF conditions may not last, we may morph into a stagflationary landscape.

Monday, May 28, 2012

Quote of the Day: The Religion called Environmentalism

The hallmark of science is a commitment to follow arguments to their logical conclusions; the hallmark of certain kinds of religion is a slick appeal to logic followed by a hasty retreat if it points in an unexpected direction. Environmentalists can quote reams of statistics on the importance of trees and then jump to the conclusion that recycling paper is a good idea. But the opposite conclusion makes equal sense. I am sure that if we found a way to recycle beef, the population of cattle would go down, not up. If you want ranchers to keep a lot of cattle, you should eat a lot of beef.

Recycling paper eliminates the incentive for paper companies to plant more trees and can cause forests to shrink. If you want large forests, your best strategy might be to use paper as wastefully as possible — or lobby for subsidies to the logging industry. Mention this to an environmentalist. My own experience is that you will be met with some equivalent of the beatific smile of a door-to-door evangelist stumped by an unexpected challenge, but secure in his grasp of Divine Revelation.

This suggests that environmentalists — at least the ones I have met — have no real interest in maintaining the tree population. If they did, they would seriously inquire into the long-term effects of recycling. I suspect that they don't want to do that because their real concern is with the ritual of recycling itself, not with its consequences. The underlying need to sacrifice, and to compel others to sacrifice, is a fundamentally religious impulse.

That’s from Professor Steven Landsburg, from his book "The Armchair Economist," (source Professor Mark Perry)

Essays on Proposed Monetary Reforms

I am supposed to take my day off today.

But I stumbled upon a gem of collection of wonderful essays on proposed monetary reforms from my favorites: Ron Paul, James Grant, Gerald O’ Driscoll, George Selgin, Lawrence White, Judy Shelton, Roger Garrison, Kevin Dowd, Kurt Schuler and more.

Read them at Cato Institute Journal called Monetary Reform in the Wake of Crisis (Volume 32 Number 2), a forum which was held in November of last year.

Read some of the statements by Ron Paul, Ben Steill (CFR), Allan Meltzer (Carnegie Mellon University), Lawrence White (George Mason University), Gerald O’Driscoll (Cato Institute) and Robert Zoellick, Jr. (World Bank) at the forum here

Is Greece Falling into a Failed State?

According to the mainstream media and establishment experts, Greeks supposedly loathed austerity. They wanted “growth”, which is a euphemism for continued unsustainable government spending. If true, then this means that Greeks wanted free lunch.

But many Greeks may have come to realize that there is NO such thing as a free lunch. They needed to pay taxes in return for political entitlements.

Yet Greeks have been balking at doing so.


With anxiety mounting that Greece might vote for anti-austerity parties in the June 17 elections and be forced to leave the Eurozone of 17 countries using the euro as a currency, more Greeks – already legendary tax evaders – have stopped paying taxes. A senior Finance Ministry official on May 23 said that tax revenues have fallen 10 percent while two tax officials who declined to be named told Reuters that May revenues fell by 15-30 percent in tax offices away from the major cities and relative wealth centers of Athens and Thessaloniki.

So Greeks have been refusing to pay taxes. The left hand does not know what the right hand is doing. That’s if the establishment’s assertion is true. Greeks cannot have it both ways.

Yet Greeks realize that if they cannot pay, then they would have to default on their debts.

But the establishment says that the only way to salvation is through devaluation that can only be actualized from an exit. So their prescription: Default by devaluation.

So this ‘exit’ prospect gives further jitters not just to the average Greeks, but to foreign businesses based on Greece, as well. Foreign businesses have been apprehensive about having inadequate laws to cover or protect them once Greece decides to exit.

From the New York Times,

What can companies do when the legally impossible becomes reasonably probable?

Under European Union law, Greece cannot leave the euro. That is the theory. But in practice, any protection the law offers investors could be difficult to enforce, according to lawyers trying to protect their corporate clients against the upheaval sure to follow if Greece were to default on its debts and adopt a new currency.

So their advice is blunt: Remove cash and other liquid assets from Greece and prepare to take a short-term hit on any other investments…

But, apart from trying to ensure that debts are paid promptly and therefore in euros, legal options for companies are limited. Contracts covered by Greek law, particularly for services delivered in Greece, provide little protection against the currency’s being redenominated and devalued — a development regarded as unlikely until recently.

“Greece would, through its laws, be able to amend contracts governed by Greek law or to be performed within the territory of Greece,” Mr. Clark said. “It is the governing law and the place of performance of the contract that is most important.”

International contracts, which might be covered by British, German or Swiss law, would be more likely to be honored in the designated currency, though in some cases the wording of the legal document may be vague.

And even if the law is on their side, companies would find that to extract payment from a Greek company, they would need a judge in Greece to enforce a ruling from a foreign court.

When the average Greeks doesn’t want to pay taxes, and when foreign businesses are either closing shop or transferring elsewhere, then this means that there will be insufficient tax revenues for the current government to finance her survival.

This also means that parasites have severely impaired the hosts, which may mean the prospective extinction of the parasitical relationship.

From FT/

Greece's public finances could collapse as early as next month, leaving salaries and pensions unpaid unless a stable government emerges from the June 17 election, according to Lucas Papademos, the technocrat prime minister who left office after this month's inconclusive vote.

Mr Papademos warned that conditions were deteriorating faster than expected with cash flow likely to turn negative in early June amid a sharp fall in tax revenues and a loosening of spending controls during two back-to-back election campaigns.

Mounting anxiety that Greece is headed for further political instability and a possible exit from the euro has prompted many Greeks to postpone making tax payments, and has also accelerated outflows of deposits from local banks.

Athens bankers estimate that more than €3bn of cash withdrawn since the May 6 election has been stashed in safe-deposit boxes and under mattresses in case the country is forced to readopt the drachma.

Austerity becomes a NATURAL process as economic reality has been reasserting itself. This exposes the promises of a "state based elixir" as monumental delusion.

The prescription of devaluation has been provoking a bank runs and has been blowing up right ON the faces of establishment experts calling for devaluation.

This brings us to where the Greece might be headed for.

The new Deutsche bank boss calls Greece as a "failed state".

From Irish Times,

The incoming co-chief executive officer of Deutsche Bank today described Greece as a "corrupt" and "failed" state.

"Greece is the only country, I feel, where we can say 'it's a failed state,' it is a corrupt state, corrupt as far as its political leadership is concerned, and obviously other people had to be willing to support this," Juergen Fitschen, who takes up his post next week, said in a speech at a conference in Berlin.

Failed states, are characterized according to by

  • loss of control of its territory, or of the monopoly on the legitimate use of physical force therein,
  • erosion of legitimate authority to make collective decisions,
  • an inability to provide public services, and
  • an inability to interact with other states as a full member of the international community.

Often a failed state is characterized by social, political, and/or economic failure.

In reality “failed states” are mainly products of unsustainable parasitical relationships, whether in Somalia, Chad or Sudan as rated by US think tank Fund for Peace and Foreign Policy.

But this does not necessarily mean social, political and economic failure as commercial operations exists. Otherwise logic says that these nations will have been uninhabited or deserted either through diaspora or death. But this has clearly not been the case.

Ironically, the US Central Intelligence Agency even admits that the number one “failed state” Somalia as having a “healthy informal economy”.

Thus the “inability to provide public services” does not represent reality. The difference is that mainstream cannot swallow or fathom such ideas. And the global political establishment has been repeatedly attempting for “failed states” to go mainstream through foreign interventions.

Instead, what a “failed state” means is that there is no standing government or that imposed government will mostly likely be ignored by society or what could be called “stateless society”.

I am not sure if Greece will technically become a failed state.

What is certain is that we are witnessing the accelerating collapse of a parasitical relationship anchored upon the spendthrift welfare and bureaucratic state.

This validates anew the great Ludwig von Mises who presciently warned more than half a century ago that

An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: The Santa Claus principle liquidates itself.

And like Dr. Marc Faber, the collapse of the current Greece form of government should be bullish for Greeks over the long term (whether through exit or as part of the EU), as Greeks will be compelled to live within the laws of economics through greater economic freedom, and eschew feeding on political parasites.