Showing posts with label bailout culture. Show all posts
Showing posts with label bailout culture. Show all posts

Tuesday, April 30, 2013

Implied Government Guarantees on BRIC Banking system

Even in the BRICS, there has been an implied guarantee by their respective governments on their banking system, as indicated on their credit ratings.

From Reuters:
The ability of Brazil, Russia, India and China to support their leading banks is tightly correlated to the credit rating on the banks, according to ratings agency Moody’s. The agency compares the ratings of four of the biggest BRIC banks which it says are likely to enjoy sovereign support if they run into trouble…

In a self-perpetuating cycle, ratings will be higher because governments are prepared to provide high levels of support to the banks, reflecting the lenders’ systemic importance and in some cases government ownership.
Bailouts on the politically privileged banking system have become a global standard. And this encourages the moral hazard behavior where banks take unnecessary risks because they know they will be supported once "they run into trouble". This adds to the yield chasing phenomenon that increases systemic fragility.

Moreover this implies that the public's savings, even in emerging markets, will continue to be under duress from indirect and direct confiscations in favor of the banking system.

Saturday, July 28, 2012

The Magic of Central Banking Talk Therapy

The prospects of central banking inflation steroids bring hope to the forefront.

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From Bloomberg,

The Dow Jones Industrial Average (INDU) climbed above 13,000, capping its longest weekly advance since January, amid speculation the European Central Bank will buy bonds to help lower borrowing costs and preserve the euro…

American stocks joined a global rally after two central bank officials said ECB President Mario Draghi will hold talks with Bundesbank President Jens Weidmann in an effort to overcome the biggest stumbling block to a new raft of measures including bond purchases. German Chancellor Angela Merkel and French President Francois Hollande echoed yesterday’s pledge by Draghi that they will do everything to protect the euro.

Bad news is good news: economic slowdown signifies as fodder for central bank support. More from the same article

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Chart from tradingeconomics.com

In the U.S., data showed that the economy expanded at a slower pace in the second quarter as a softening job market prompted Americans to curb spending. Consumer confidence in July dropped to the lowest this year, according to a separate report. Cooling growth makes it harder to reduce unemployment, helping explain why Federal Reserve Chairman Ben S. Bernanke has said policy makers stand ready with more stimulus if needed.

“Growth has decelerated sharply,” said Philip Orlando, the New York-based chief equity strategist at Federated Investors Inc., which oversees $355.9 billion. He spoke in a telephone interview. “We need something to reverse that downtrend and that ‘something’ is policy.”

Consumers are cutting back just as Europe’s crisis and looming U.S. tax-policy changes dent confidence, hurting sales at companies from United Parcel Service Inc. to Procter & Gamble Co. Sales at almost 60 percent of S&P 500 (SPXL1) companies which reported second-quarter results missed estimates, data compiled by Bloomberg show. Still, 72 percent beat profit forecasts.

US equity markets have also been climbing amidst falling growth of money supply...

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chart from St. Louis Fed

...also amidst declining forecasts or expectations for corporate earnings...

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Dr. Ed Yardeni notes

As a result, the 2012 and 2013 estimates are at new lows of $104.11 and $116.41, respectively. These numbers imply earnings growth rates of 6% this year and 12% next year. They may still be too optimistic since revenue growth is likely to be closer to 5% during 2012 and 2013, while profit margins are likely to remain flat over this period.

Well, all these goes to show how financial markets, desperately seeking yields, have become ‘dopamine addicts’.

Douglas French at the Laissez Faire Books explains,

…cheap money combined with the herding animal spirits is a certain cocktail to engender bubbles. Tragically, these booms are followed by the inevitable busts, creating regret that is the difference in investors minds between the value of what is and the value of what could have been.

This is important because of dopamine, which is a chemical in the brain that helps humans decide how to take actions that will result in rewards at the right time.

People don’t get a dopamine kick when they get what they expect, only when they make an unexpected windfall. So, as Jason Zweig writes in Your Money and Your Brain, drug addicts crave ever-larger fixes to achieve the same satisfaction and “why investors have such a hankering for fast-rising stocks with ‘positive momentum’ or ‘accelerating earnings growth’.”

Also, dopamine dries up if the reward you expected fails to materialize.

The brain has 100 billion neurons and only one-thousandth of one percent produce dopamine, but “this minuscule neural minority wields enormous power over your investing decisions,” cautions Zweig.

Dopamine takes as little as a twentieth of second to reach your decision centers, estimating the value of an expected reward and more importantly propelling you to action to capture that reward. “We’ve evolved to be that way,” explains psychologist Kent Berridge, “because passively knowing about the future is not good enough.”

The effect of all this is what Zweig refers to as “the prediction addiction.” Humans hate randomness. We want to predict the unpredictable, which originates in the dopamine centers of the reflective brain, according to Zweig, leading humans to see patterns where none really exist…

The attempt to satisfy the dopamine which has been evoked by central bank policies, leads people to become increasingly more dependent on heuristics based thinking

More from Mr. French

We all tend to constantly feed our confirmation biases, seeking out experts that confirm our view of the world. We read writers that we agree with so that we can feel smarter, while ignoring or dismissing opinions different from our own.

Our brains are great for keeping us alive in the jungle. We look for patterns and motion. These instincts kept the cavemen alive, not to mention Wall Street’s technical analysts, but wreck the portfolios of investors.

Investors love a good story, but are vulnerable to anecdotes that mislead us, says Ritholtz.

No wonder markets are not sources of information, but instead sources of misinformation, according to resource investing guru Rick Rule…

“The information that people derive from markets is spectacularly wrong,” says Rule, a devotee of legendary investor Benjamin Graham. Like Graham, Rule looks for undervalued stocks and only wants to buy them when they are on sale. Quoting Graham, Rule says, “markets in the short term are voting machines, while in the long term they are weighing machines.”

Housewives are much more rational buying groceries than investors are in buying stocks. While a housewife will turn her nose up at expensive tuna fish, she will load up on it once it goes on sale. Conversely, her investor husband, in Rule’s story, is happy when the share price of his favorite stock goes up and he buys more. When the share price falls, he doesn’t buy more, as his wife does with tuna fish, but instead sells out in disgust.

In short, stock markets (and the financial markets) have been in disconnect with reality. Promises have been taken as facts.

Equity markets have mostly priced in prospective central banking support via QEs…

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chart from Zero Hedge

The question now is how sustainable will this talk therapy rally be? Will talk therapy be enough to reinforce the current reanimated 'animal spirits' and filter into economic reality? What if central banks don't deliver as the markets expect?

P.S. I won’t be making my regular stock market commentary tomorrow.

Friday, July 27, 2012

China’s Hunan Province May Get Steroids, China’s Tax Revenues Drastically Fall

The intensifying urge for government’s opium has been palpable everywhere.

A slowing economy in China has prompted for more babbles of government spending stimulus.

Reports the Reuters

The government of Changsha, the capital of central China's Hunan province, has launched an 829 billion yuan ($130 billion) investment stimulus program to bolster the local economy, state media has reported.

The money would be spent on 195 projects, including airport, subway and urban infrastructure facilities, as well as developing energy efficient industries, said a report by the official China News Service on Wednesday.

The government of Changsha, a city known for its machine-making and non-ferrous metal industries, would also speed up financial reform and innovations, said the report, which provided no details about how the program would be financed.

The China News Service paraphrased Chen Runer, the Communist Party secretary of Changsha, saying that economic pressure on the city could not be ignored, despite relatively stable growth in the face of global headwinds, and it was time for initiative.

There was no reference to the program's existence on the government of Changsha's website on Thursday.

Zhang Zhiwei, chief China economist at Nomura in Hong Kong, calculates that the headline number on the stimulus plan is worth 147 percent of Changsha's nominal GDP in 2011, or 1.8 percent of China's national economic output.

Even if spread over five years, Zhang says the implied investment would be equivalent to 46 percent of total annual fixed asset investment in Changsha.

FINANCING QUESTIONS

Skeptics say a program on that scale is implausible and could not be properly financed with China's banks still nursing bad loans worth an estimated 2-3 trillion yuan after local governments racked up debts of 10.7 trillion yuan in the wake of Beijing's nationwide stimulus program unveiled in 2008.

The mixed signals or tentativeness being shown by Chinese authorities reveal of the ongoing political discord.

Yet the Shanghai index continues with its slomo descent, which seems to have been discounting all the inveigles of inflationism

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Also China’s tax revenues has been posting a marked decline

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Writes Dr. Ed Yardeni (chart also from Dr. Yardeni)

The data confirm a significant slowdown in Chinese economic growth during the first half of this year:

(1) Tax revenues rose only 9.8% y/y during H1-2012, down from 29.6% over the same period a year ago. Growth rates were down across all 11 major revenue sources.

(2) Personal income taxes actually declined 8.0%. A year ago, they rose 35.4%. Corporate income taxes rose 17.3%, but that was down from 38.3% a year ago.

(3) Revenues from property transactions took a hit. The ones from “Land Value Increment” rose 14.7% vs. 91.1% a year ago. “Deed” revenues fell 9.9% after rising 27.5% a year ago.

Dr. Marc Faber lays out the contagion risks from China’s economic slowdown (start at 5:20)


Thursday, July 26, 2012

HOT: ECB’s Draghi: ECB Will Do What’s Needed To Preserve Euro

Steroid starved financial markets suddenly found life from promises of more inflationism.

From Bloomberg,

European Central Bank President Mario Draghi said policy makers will do whatever is needed to preserve the euro, suggesting they may intervene in bond markets as surging yields in Spain and Italy threaten the existence of the 17-nation currency bloc.

“To the extent that the size of these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate,” Draghi said in a speech at the Global Investment Conference in London today. “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” he said, adding: “believe me, it will be enough.”

Economists said the comments suggest the ECB may be preparing to unveil new measures to fight the crisis as potential bailouts for economies the size of Spain and Italy threaten to overwhelm Europe’s rescue funds. Spanish politicians have called on the ECB to do more after yields on the country’s bonds soared to euro-era records this week.

Spanish yields slumped after Draghi’s remarks, with the rate on the 10-year bond dropping 32 basis points to 6.98 percent at 1:26 p.m. in Madrid. It touched a record 7.69 percent on July 22. The euro jumped and stocks rose. The single currency climbed as high as $1.2285 after trading at $1.2118 before Draghi spoke. The Stoxx Europe 600 Index (SXXP) gained 1.6 percent.

Bad news once again is read as good news…that’s until markets wakes up to the reality of either empty promises or real action—meant to buy time before the day of reckoning arrives.

Thursday, July 19, 2012

The Fantasy of Forcing the Rich to Bail Out Europe

In the world of statism, everything operates in very simple terms. Just come up with the numbers (supplied by supposed experts), and expect every edict to deliver the targeted results.

Such insight can be gleaned from the blaring drumbeat of class warfare politics in the Eurozone where political authorities have been eyeing to tax the rich to solve the current crisis.

Writes the CNBC,

To many in Europe, the Continent has two big economic problems: Huge debt, and high inequality between the rich and the rest.

Now some politicians are advocating a plan to solve both.

The idea, first floated by a German economic policy group, calls for imposing a 10 percent tax on the wealth of the richest Europeans and forcing them to lend money to their governments.

The plan calls for placing a one-time 10 percent levy on the total assets for those with more than $309,000 in assets (or couples with more than $611,000). In addition, it calls for a “forced loan” program, in which the wealthy lend money to their governments that could be paid back over time.

Stefan Bach of the prestigious the German Institute for Economic Research (DIW) in Berlin, which floated the plan, said that: "In many countries the sovereign debt levels have increased considerably, and at the same time we also have very high amounts of private assets that, taken together, considerably exceed the total national debts of all [euro-zone] countries."

In other words, the wealth of the wealthy is more than enough to plug government budget holes.

The idea gaining popularity among European politicians. An Austrian member of the European Parliament, Jörg Leichtfried, favors the plan for forced loans, saying the rich could lend to the states at low interest rates. The loans, he said, would not be an “expropriation,” since they would be paid back. The head of Austria’s Social Democratic Group also backs the plan, saying states need to fix their budget troubles.

For statists: legalize the plunder of the wealthy, collect and the problem gets easily solved.

But there are two more problems to reckon with;

one, statists and politicians are dealing with human beings who will act to protect their own interests from political predations, and

second, if taxing has been that easy then what stops government from spending more? Having to confiscate everything else from the rich, these politicians would end up with no one else to tax. So we end up with a crisis again.

A good example of the first scenario is the recent incidents of “runaway luxury yachts”, as blogged by Dan Mitchell of the Cato Institute, where wealthy yacht owners flee Italian taxing authorities by sailing to and docking at foreign “friendlier ports”. These yacht owners would instead access their boats through “low-cost budget flights from Italy for a fraction of the tax bill they might otherwise face”.

In addition, the unexpected consequence from taxing yacht owners has been to penalize the industry which affects mostly the middle income people, who suffer from lost business opportunities.

So tax authorities essentially does an Aesop, kill two birds with one stone.

The moral of the tax story says Dan Mitchell is that

The politicians need to understand that taxpayers don’t meekly acquiesce, like lambs in a slaughterhouse.

  • When tax rates increase, sometimes people engage in tax avoidance, lowering their tax liabilities legally.
  • When tax rates change, sometimes people choose to alter their levels of work, saving, and investment.
  • And when tax rates go up, sometimes people resort to illegal steps to protect themselves from the tax authority.

Heck, even the folks at the International Monetary Fund (a crowd not known for rabid free-market sympathies) have acknowledged that excessive taxation is the leading cause of the shadow economy.

Thus, the idea that forcing the rich to bailout Europe is just that…a statist fantasy.

Tuesday, July 17, 2012

Pavlovian Markets Rise on Hopes of the Bernanke Put

More bad news is good news.

Asian equity markets rises on HOPES that Ben Bernanke will (tonight) deliver the much sought after opiate.

From Bloomberg,

Asian stocks advanced for a third day, oil climbed and the Japanese yen weakened as an unexpected drop in U.S. retail sales stoked speculation Federal Reserve Chairman Ben S. Bernanke will hint at further stimulus today. Corn rose toward a record as U.S. crop conditions worsened…

Bernanke will deliver his semiannual report on the economy and monetary policy before Congress today, after a report yesterday showing a contraction in June retail sales kindled speculation the Fed will introduce more measures to support the world’s largest economy. Corn has risen 55 percent since June 15 as further evidence of damage from the worst U.S. drought in a generation stoked concern yields will drop, hurting output in the biggest exporter and lifting global food costs.

“There is market positioning for Bernanke to deliver something today,” said Joseph Capurso, a strategist in Sydney at Commonwealth Bank of Australia, the nation’s biggest lender. “There is a high risk of more policy easing before the end of this year.”

A third monthly drop in U.S. retail sales showed limited employment gains are taking a toll on the biggest part of the economy. The IMF lowered its 2013 forecast for global economic growth yesterday to 3.9 percent from 4.1 percent as Europe’s debt crisis prolongs Spain’s recession and slows expansions in emerging markets from China to India.

Will hope become reality or will the Bernanke led FOMC give in to the yearnings of the steroid addicted markets?

What happens if the FOMC spurns the markets’ slabbering for more stimulants?

Until when will hope be able to forestall reality?

Sunday, July 01, 2012

Deeper Slump in China’s Manufacturing, Will Bad News Become Good News?

Fresh from Bloomberg,

China’s manufacturing expanded at the weakest pace this year as new orders and export demand dropped, adding to evidence the nation’s economic slowdown is deepening, a government report showed today.

The Purchasing Managers’ Index fell to 50.2 in June from 50.4 in May, the Beijing-based National Bureau of Statistics and China Federation of Logistics and Purchasing said. That compares with the 49.9 median estimate in a Bloomberg News survey of 24 economists. A reading above 50 indicates expansion.

Today’s data increase the odds Premier Wen Jiabao will introduce more stimulus to stem a deceleration in the world’s second-biggest economy that may have extended into a sixth quarter. The central bank will fine-tune economic policies in a “timely and appropriate” manner, central bank Governor Zhou Xiaochuan said on June 29.

“The weaker reading should trigger more-aggressive policy easing,” Sun Junwei, a Beijing-based economist with HSBC Holdings Plc, said before the release. “Economic growth will rebound to over 8.5 percent in the second half once these additional easing measures filter through,” she said.

Steps may include a reduction in interest rates, four cuts in banks’ reserve requirements, more fiscal spending on public works and tax cuts, according to Sun, who forecasts second- quarter economic growth may have slid to 7.8 percent from a year earlier, after slowing to 8.1 percent in the first three months of the year.

When I say bad news is good news, I am talking about the mind conditioning of the financial marketplace. Basically market participants have been programmed to expect of a Bernanke Put or automatic backstops from governments, particularly from central banks, as reflected by this statement “increase the odds Premier Wen Jiabao will introduce more stimulus”.

The problem is that China’s political authorities remains tentative towards aggressive interventions so far.

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The compromise at the EU summit seems to have temporarily put a floor on the Shanghai index, last Friday. But this comes after a technical break down in spite of the repeated assurances by politicians and the media.

And one important thing that many people don’t seem to realize: rescues and bailouts policies are unsustainable, they cannot and will not be self-perpetuating.

Tuesday, June 26, 2012

More On BSP's $1-B loan to IMF as Part of the EU Bailout

Recently I commented about the immorality of the Philippine government’s participation in the bailout of the Eurozone through the IMF.

There are two issues more I want to add.

Because international reserves from the local central bank, will be used to finance the loan to the IMF, there is this notion that tax money isn’t involved.

First of all the Bangko Sentral ng Pilipinas (BSP) is a creation of the Congress via REPUBLIC ACT No. 7653 or the THE NEW CENTRAL BANK ACT

The law says

Section 1. Declaration of Policy. - The State shall maintain a central monetary authority that shall function and operate as an independent and accountable body corporate in the discharge of its mandated responsibilities concerning money, banking and credit. In line with this policy, and considering its unique functions and responsibilities, the central monetary authority established under this Act, while being a government-owned corporation, shall enjoy fiscal and administrative autonomy.

Section 2. Creation of the Bangko Sentral. - There is hereby established an independent central monetary authority, which shall be a body corporate known as the Bangko Sentral ng Pilipinas, hereafter referred to as the Bangko Sentral.

The capital of the Bangko Sentral shall be Fifty billion pesos (P50,000,000,000), to be fully subscribed by the Government of the Republic, hereafter referred to as the Government, Ten billion pesos (P10,000,000,000) of which shall be fully paid for by the Government upon the effectivity of this Act and the balance to be paid for within a period of two (2) years from the effectivity of this Act in such manner and form as the Government, through the Secretary of Finance and the Secretary of Budget and Management, may thereafter determine.

Since the BSP is a government-owned corporation, then the Philippine government stands as an explicit guarantor of the BSP.

There has been a precedent to this.

Central Bank of the Philippines, the predecessor of the BSP, suffered massive losses to the tune of an estimated Php 300 billion as consequence of the series of bailouts provided by then President Cory Aquino to her favorites.

The losses were eventually transferred to the central bank board of liquidators.

This from an ADB study,

In 1993, the new Central Bank Act was approved. This law aimed at ensuring the independence of the conduct of monetary policy from political interference. It also provided for the recapitalization of the central bank and the transfer of over P300 billion worth of losses of the old central bank to a board of liquidators. The new central bank is now known as the Bangko Sentral ng Pilipinas (BSP).

The board of liquidators constitutes an ad hoc government agency (Philippines Executive Order no. 141 Reconstituting the Central Bank Board of Liquidators) headed by the President of the Philippines, and whose other board members include members of the monetary board, Department of Finance, Department of Budget and Management and an executive director nominated by the board.

This means that the losses of the old central bank has been carried over to the Philippine government (at taxpayer’s expense)

The Point is: ALL actions by the Bangko Sentral ng Pilipinas, as a government agency, are underwritten by the taxpayers.

And the second point is that no matter the complexity of the structure of political institutions, in essence, government survive from taxes, central banks notwithstanding.

Another idea is that $1 billion represents a small fraction of the BSP’s portfolio.

This has ethical, institutional and behavioral implications.

First the EU crisis exists because there hardly has been any private sector willing to finance insolvent institutions. Only governments, through the use of badges and guns on their citizenry, have been willing to finance them.

This means that the risks to loans for bailouts are REAL.

As Professor Arnold Kling rightly points out,

For private debt issued within a country, creditors have recourse to the court system to try to recover their money. But there is no court with the power to force the government of Spain to pay anything to its creditors. So, even if the German government, in order to "save the European union," agrees as an agent for its citizens to buy existing Spanish debt at par in exchange for new debt worth 70 cents on the euro, how can we be sure that Spain will pay off the new debt?

In short, governments recklessly expose people’s money to greater risks, and worst, they do this even without the public’s consent.

Next is that a billion here, a billion there, pretty soon, you're talking real money, it’s a quote attributed to the late US Congressman and Senator Everett Dirksen. This means governments freely spend or allocate other people’s money without compunction.

Of course there will always be the issue of opportunity costs or money spent on the EU through IMF could be used for other political expenditures.

Finally, bailouts leads to more bailouts as what we are seeing today. Eventually the accumulation of debts from all these, in the HOPE that bailouts will produce the intended effect, will lead to systemic fragility, which risks dragging along the entire world into a black hole.

Sunday, October 09, 2011

Global Equity Markets: Bottom or Dead Cat’s Bounce?

Fear is the foundation of most governments; but it is so sordid and brutal a passion, and renders men in whose breasts it predominates so stupid and miserable, that Americans will not be likely to approve of any political institution which is founded on it.- John Adams

It’s nice to see global equity markets bounce off newly established lows.

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The ASEAN-4, represented by the Philippines (PCOMP-yellow), Thailand (SET-green), Indonesia (JCI-orange) and Malaysia (FBMKLSE-red), once again demonstrating tight correlations of price actions even on a near term or 3 months basis.

Bottom or Dead Cat’s Bounce?

But has the recent lows been indicative of a bottom or has last week’s actions signified a dead cat’s bounce?

First of all, last week’s highly volatile actions in the global equity markets exhibited lucid conditions of boom bust cycles as the market’s principal drivers

This has been especially evident last Tuesday.

As US equity markets encroached on the bear market threshold of 20%, the announcement of the bailout of Belgium’s biggest bank Dexia SA by French and Belgian governments seemed to have spurred a dramatic 4% upside swing on the final hour of trading session where US major equity benchmarks closed significantly higher[1].

This signifies as the second bailout of Dexia SA.

At the height of the maelstrom in 2008, Dexia was the first among the many European banks to fall and subsequently became one of the major borrowers from the US Federal Reserve[2].

The possible implication of this is that the US central bank could be part of the consortium that determines how the bailout will be conducted.

Although current reports say that Drexia would be split into two banks, where one of the banks will hold troubled assets or serve as a ‘bad bank’[3]; there has been no mention of any participation of the US Federal Reserve yet. So this would signify as speculation on my part.

Like Greece, this serves as another example which reveals how bailout policies:

-usually don’t work,

-signify as inefficient approach in rectifying an imbalance,

-account as short term patches that only defers the problem,

-and function like a black hole where scarce economic resources are not only diverted, but drains on the productive sectors which ultimately enfeebles the overall system

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Additionally, while credit margins for commodity markets have been serially squeezed, the CME Group, the biggest futures exchange, recently went to the opposite direction for financial securities, where the CME eased credit margins a whopping 33%[4].

This serves as another evidence where indirect market manipulation by policymakers has been biased towards bolstering the financial sector at the expense of the commodity markets.

The S&P 500 closed the week up by 2.12% while the Dow Jones Industrials and the Nasdaq were higher 1.74% and 2.65% respectively.

Technically speaking, the S&P remains below the 50-day and 200-day moving averages which points to the likelihood of a temporary bounce, until proven otherwise.

Yet the rest of the week has been distinguished by an environment directed towards more bailouts.

The Bank of England (BoE) reactivated her version of Quantitave Easing (QE) 2.0[5], whom will be expanding bond purchases to 275 billion pounds ($421 billion) from 200 billion over the next four months.

The BoE, through governor Mervyn King, has preempted European governments. Mr King claimed that this action has been made because they have lost faith in European governments’ ability to resolve the region’s debt crisis[6].

However, in doing so, Mr. King utilized fear anew to justify such interventions.

To quote BoE governor Mervyn King[7]

This is the most serious financial crisis we’ve seen, at least since the 1930s, if not ever. We’re having to deal with very unusual circumstances, but to act calmly to this and to do the right thing

This essentially validates my theory that markets today are increasingly being massaged, not only through direct policies, but through communications management, or technically known as signaling channel[8], in order for the public to politically accommodate on such interventions.

Fear has served as an ever convenient tool to impose political controls over society.

And just hours after the BoE’s move, the European Central Bank (ECB) announced that they will be expanding her coverage of QE or asset purchasing program, by including ‘covered bonds’ or pooled securities backed by mortgages and public sector loans.[9] The ECB will buy 40 billion euros or $53 billion next month.

In addition, the ECB will give banks unlimited access to cash through January 2013 or loans in the duration of 12 and 13-months[10].

Also, speculations had been rife that ‘policy makers are working on plans to boost bank capital’.

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European stocks have rallied off from a 2 week low as represented the STOX 50[11] or a blue chip index which covers 50 stocks from 12 Eurozone countries.

All these developments reveal of how global equities has been artificially buttressed by serial bailouts and policies of inflationism.

Also, interventionism, meant to prevent markets from reflecting the real values of financial securities, has massively skewed the pricing process that has led to severe volatility or sharp fluctuations.

Moreover, as further manifestation of distorted markets, price actions of so called risk assets have become tightly correlated when strains to the financial system emerges.

Finally price trends or the fate of asset prices are most likely to be determined by the prospective actions of policymakers. This makes governments the ultimate practitioners of insider trading—where governments manipulate markets to benefit certain segments of society.

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With almost every major central banks expanding on their balance sheets today, most notably the very aggressive Swiss National Bank (SNB), see green line from Danske Bank chart[12], I would presume the US Federal Reserve’s participation will be a matter of political timing.

Blanc De L'oeil (White of the Eye)

It is important to note that announcement and implementation of QEs does NOT imply that markets would automatically or mechanically respond favorably. QE policies will likely be size-dependent and or highly sensitive to market expectations based on the timing, scale and duration of the program.

The efficacy on the marketplace from the current programs initiated by the BoE and the ECB which seem to be less in size than the previous measures, has yet to be established. Thus, the sustainability of the recent QE-led rebound can only be arrived at when chatters of bailouts diminishes—which implies that the market has began to discount the momentary adverse impacts of the underlying crisis.

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Also, I am in the camp that sees that the US as unlikely to succumb to an economic recession. For example the chart above shows that the US Purchasing Managers Index PMI of New Orders and Employment remain in positive non-recession territories in spite of the recent slowdown[13]. And as I have been pointing out money supply growth in the US has been growing at a substantial pace[14] which poses as unlikely indicators of a looming recession.

But my stance would be conditional based on factors that may turn out to be shocks, such as further deterioration in the Eurozone or a China bubble meltdown.

In addition, I harbor a deep suspicion that markets are presently being used as fulcrum by politicians to secure their preferred political actions. This can be exemplified by BoE’s Mervyn King recent scare tactics, where such jawboning risks becoming a self-fulfilling prophesy.

And I would think that the US Federal Reserve chief Ben Bernanke may probably be discreetly wishing for more of market stress that would clear the way for him to impose his signature creed contribution to modern central banking—the modified helicopter option or the QE version 3.0.

It is important to note that US Banking and finance stocks appear to be highly dependent on Bernanke’s QE where the latter’s absence has led to declining share prices[15]. So aside from lethargic property markets, falling equity prices may affect the banking sector’s capital adequacy ratios that would prompt for further asset liquidations.

In addition, the interconnectedness of global banking system and the considerable exposure of US banks to crisis affected Eurozone banks leaves US banks highly vulnerable to a contagion[16].

These reasons would have been enough impetus for Mr. Bernanke to resort to QE 3.0. However, Mr. Bernanke appears to be have been inhibited by the recent political impasse with other political agents where his failure to incorporate QE 3.0 during the last FOMC meeting triggered a convulsion in the global financial markets[17]

This turns out to be one instance where supposed transparency of government policies meant to stabilize the markets morphed into an expectations failure because of politics. In short, like typical politicians, promises are meant to be broken.

Furthermore, resonant calls of greater odds of recession by his private sector allies could be part of this campaign to inculcate ‘fear’ in order to warrant political intervention through inflationism.

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And I would add that the price action of gold has been indicative of the current state of limbo.

Despite the newly announced QEs, gold prices continues to fumble along which appears to deviate from the actions of the equity markets. Such variance puts emphasis on the aura of heightened uncertainty.

As for my position in the local equity markets, as stated last week

I would need to see the blanc de l'oeil or the French idiom for seeing ‘the white of their eyes’ before taking my shots.


[1] See Reported Bailout of Belgium’s Dexia Spurs a fantastic US Equity Market Comeback, October 5, 2011

[2] Telegraph.co.uk Belgian bank Dexia was biggest borrower from Federal Reserve discount window, March 31, 2011

[3] Bloomberg.com Dexia Board Meets as France, Belgium Tussle, October 8, 2011

[4] Zerohedge.com Soaring Financial Vol Leads CME To Announce A 33% Margin...Cut, October 4, 2011

[5] See Bank of England Activates QE 2.0, October 6 2011

[6] Bloomberg.com BOE Loses Faith in Europe, Announces Stimulus, October 7, 2011

[7] Telegraph.co.uk World facing worst financial crisis in history, Bank of England Governor says, October 9, 2011

[8] See War on Precious Metals: The Rationalization Process For QE 3.0, May 7, 2011

[9] See European Central Bank expands QE to include Covered Bonds October 6, 2011

[10] Bloomberg.com ECB Keeps Banks Afloat as Governments Act on Greek Risk, October 7, 2011

[11] Stoxx.com EURO STOXX 50

[12] Danske Bank Japan: BoJ can afford to be on hold for now October 7, 2011

[13] Dr. Ed’s Blog US Purchasing Managers Indexes, October 6, 2011

[14] See US in a Deflationary Environment, NOT! (In Charts) September 16, 2011

[15] See The US Banking Sector’s Dependence on Bernanke’s QEs, October 5, 2011

[16] See US Banks are Exposed to the Euro Debt Crisis, October 8, 2011

[17] See Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms, September 22, 2011

Sunday, October 02, 2011

Phisix-ASEAN Market Volatility: Politically Induced Boom Bust Cycles

It’s hard enough for politicians to face the music, to dispense bad news, to make hard choices, allocate pain to constituencies whether it’s spending cut or tax increase. But when the Fed destroys the bond market, which is the benchmark for the whole capital market, and tells the Congress that you can borrow money for two years at eighteen basis points, which is -- as far as Washington’s concerned -- that’s a rounding error. It’s the same as free. When you’re giving that kind of signal, then there is no incentive, there’s no motivation for people to walk the plank and face down this monster of a fiscal deficit and imbalance that we have. Washington thinks you can kick the can down the road, the debt is more or less free, and we’ll get around to solving the problem. But today, let’s not make any tough choices. That’s where we are. - David Stockman

It’s the Boom Bust Cycle, Stupid

Why would global markets fall in sync in September 22nd?

clip_image002It would appear an idiotic idea to suggest that most people woke up on the wrong side of the bed and thus abruptly decided to dump equity holdings en masse.

It would also seem myopic to suggest that this has been a byproduct of liquidity trap[1], where monetary stimulus—low interest rates and an increase in money supply—had been the cause of this.

The chart above of the ASEAN markets has been emblematic of what I have been repeatedly saying long ago—the message of which has been encapsulated from my earlier remarks[2] during the bear market embers of November 2008, (bold highlights original)

The other important matter is that of the understanding of the mutually reinforcing dynamics of inflation and deflation. Deflation and inflation is like assessing the virtues of right and wrong- an ex-post measure of a previous action taken. An action and an attendant reaction. Yet, you can’t have deflation when there have been no preceding inflation. At present times, the reason government has been massively inflating is because they have been attempting to combat perceived threats of equally intense debt deflation

Thus, reading political tea leaves seem likely a better gauge in determining how to invest in the stock markets.

Since 2009, ASEAN markets had climbed on the back of the intensive inflationism employed by global central banks mostly led by the US Federal Reserve, through its zero bound rates and asset purchases or Quantitative Easing (see black arrow).

If this has been about a global liquidity trap then obviously there would have been no antecedent boom in ASEAN or global market equities during the stated period (2009-2010).

Yet during the past quarter where the Eurozone debt crisis has escalated, exacerbated by visible signs of an economic slowdown in the US and parts of the global economy, global financial markets has been strained.

Yet financial market expectations, whom have been deeply addicted towards bailout policies, have increasingly embedded expectations of another US Federal Reserve rescue.

Such expectation had not been realized.

The Liquidity Trap Canard

Before proceeding, it is important to point out that despite the current financial market turmoil, the Eurozone has not been suffering from ‘deflation’ as a result of lack of ‘aggregate demand’.

On the contrary, the EU has exhibited symptoms of stagflation[3].

In the US, aside from exploding money supply, consumer and business loans have been materially improving.

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5 year chart of Business Loans from St. Louis Federal Reserve

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5 year chart of Consumer Loans from St. Louis Federal Reserve

Both charts depict that the current problem or market meltdown hasn’t been about liquidity traps.

Importantly consumer spending in the US has remained robust.

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To quote Angel Martin [4]

real personal consumption expenditures have recovered from pre-recession levels. This recovery can be clearly seen in this graph, which shows quarterly data from the first quarter of 2006 to the second quarter of 2011.

So the recent downdraft seen in the financial markets has NOT been about liquidity traps, which has been fallaciously and deceptively peddled by some.

Politically Induced Monetary Paralysis

So what has been the market ruckus all about?

In a September speech prior to the Federal Open Meeting Committee[5] (FOMC) meeting, which decides on the setting of monetary policy, Federal Reserve chief Ben Bernanke hinted that he would consider the lengthening the duration of bond purchases and possibly include further Quantitative Easing as part of the measures to further ease credit conditions[6].

Apparently going into the FOMC meeting on September 22nd, opponents of Bernanke’s asset purchasing program mounted a publicity assault which included several Republican legislators[7], and most importantly, even Mr. Bernanke’s predecessor Mr. Paul Volker at the New York Times[8].

Even the outcome of the FOMC meeting, where Mr. Bernanke’s telegraphed policy of manipulating the yield curve via “Operation Twist” had been formalized or announced, the decision arrived at had not been unanimous and reflected internal political divisions.

Except for the inattentive or those blinded by bias, it has been obvious that only half of what had been impliedly promised by the Mr. Bernanke became a reality.

The net result has been a global financial market jilted by Mr. Bernanke[9].

Lately, even Federal Reserve of the Bank of Dallas President Richard Fisher acknowledged that their institution has been under siege “from both ends of the political spectrum”[10].

Such political impasse is not only seen in the US Federal Reserve, but also over fiscal policies in Washington, as well as, the schisms over prospective measures required to deal with debt crisis in the Eurozone. A good example has been the rebuff US Treasury Secretary Tim Geithner received from the German Finance Minister[11].

This has been coined by some as ‘political paralysis’ which continues to plague the markets[12].

As proof of politically driven markets, this week’s furious rally in global markets has been bolstered by renewed expectations of bailouts, as the German parliament overwhelmingly voted to beef up their contributions to the European Financial Stability Facility bailout fund. There are still 6 of the 17 euro zone countries[13] whom will need to pass the agreement reached in July 21st.

Rumors have also floated that IMF might expand her exposure towards Euro’s bailout to a whopping tune of $3.5 trillion[14], which means the world, including the Philippines, will be part of the rescue team to uphold and preserve the privileged status of Euro and US bankers as well as the Euro and US political class.

Yet all these seem to have helped market sentiment and partly reversed earlier losses.

The point of all of the above is to exhibit in essence, how global financial markets have been substantially dependent on policy steroids. In other words, markets have been mainly driven by politics than by economic forces or that the current state of financial markets has been highly politicized and whose price signals has been vastly distorted.

And most importantly, the latest financial market meltdown represents as convulsions over failed embedded expectations from the apparent withholding of the expansion of rescue programs from which the financial markets have been operating on.

To analogize, today’s jittery volatile markets are manifestations of what is usually called as ‘withdrawal syndromes’ or symptoms of distress or discomfort from a discontinuation of a frequented or regularized activity.

In addition, financial markets appear to be blasé on merely promises, and seem to be craving for concrete actions accompanied by “big package approach[15]” from global policymakers. In short, policymakers will have to positively surprise the markets with even larger dosages of bailouts.

Non-Recession Bear Markets

I would like to further point out that it is not a necessary condition where recessions presage bear markets.

While some global equity indices have broken into bear market territory[16], the US and ASEAN markets have not yet reached the 20% loss threshold levels enough to be classified as bear markets.

Bear markets occur mainly because of political actions that creates boom bust conditions. This has been the case of China and Bangladesh[17].

The US has also experienced TWO non-recession bear markets.

The first instance was in 1962 which was known as the Kennedy Slide[18] where the S&P fell 22.5%.

Ironically the Kennedy Slide coincided with the failed original experiment of Operation Twist in 1961, as Ben S. Bernanke, Vincent R. Reinhart, and Brian P. Sack wrote in a 2004 paper[19],

Operation Twist does not seem to provide strong evidence in either direction as to the possible effects of changes in the composition of the central bank’s balance sheet.

Except that the authors thought that the limits to the size had been responsible for this policy inadequacy, and Ben Bernanke today is conducting this experiment in a very large scale.

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The Kennedy Slide’s boom phase appears to be triggered by the dramatic lowering of interest rates following the recession of 1960-61.

The bear market turned out to be short lived as the S & P 500 had fully recovered in a about a year later.

The second non-recession bear market is the notorious Black Monday Crash of October 1987.

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The expansionary policies of the Plaza Accord[20] which represented coordinated moves by major developed economies to depreciate the US dollar, fuelled a boom bust cycle which eventually paved way for the lurid global one day crash.

As the great Murray N. Rothbard wrote[21],

To put it simply: the reason for the crash was the credit boom generated by the double-digit monetary expansion engineered by the Fed in the last several years. For a few years, as always happens in Phase I of an inflation, prices went up less than the monetary inflation. This, the typical euphoric phase of inflation, was the "Reagan miracle" of cheap and abundant money, accompanied by moderate price increases.

By 1986, the main factors that had offset the monetary inflation and kept prices relatively low (the unusually high dollar and the OPEC collapse) had worked their way through the price system and disappeared. The next inevitable step was the return and acceleration of price inflation; inflation rose from about 1% in 1986 to about 5 % in 1987.

As a result, with the market sensitive to and expecting eventual reacceleration of inflation, interest rates began to rise sharply in 1987. Once interest rates rose (which had little or nothing to do with the budget deficit), a stock market crash was inevitable. The previous stock market boom had been built on the shaky foundation of the low interest rates from 1982 on.

The crash had been a worldwide phenomenon according to the Wikipedia.org[22]

By the end of October, stock markets in Hong Kong had fallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.45%, the United States 22.68%, and Canada 22.5%. New Zealand's market was hit especially hard, falling about 60% from its 1987 peak, and taking several years to recover. (The terms Black Monday and Black Tuesday are also applied to October 28 and 29, 1929, which occurred after Black Thursday on October 24, which started the Stock Market Crash of 1929. In Australia and New Zealand the 1987 crash is also referred to as Black Tuesday because of the timezone difference.) The Black Monday decline was the largest one-day percentage decline in the Dow Jones. (Saturday, December 12, 1914, is sometimes erroneously cited as the largest one-day percentage decline of the DJIA. In reality, the ostensible decline of 24.39% was created retroactively by a redefinition of the DJIA in 1916.)

Yet many experts had been misled by the false signal from the flash crash to predict a recession, again from the same Wikipedia article,

Following the stock market crash, a group of 33 eminent economists from various nations met in Washington, D.C. in December 1987, and collectively predicted that “the next few years could be the most troubled since the 1930s”. However, the DJIA was positive for the 1987 calendar year. It opened on January 2, 1987, at 1,897 points and would close on December 31, 1987, at 1,939 points. The DJIA did not regain its August 25, 1987 closing high of 2,722 points until almost two years later.

And in typical fashion, central banks intuitively reacted to crash by pumping mass amounts of liquidity into the system[23].

It took 2 years for the S&P to return to its pre-crash level.

The non-recession bear markets reveal that in the case of the US, such an occurrence would likely be shallow and the recovery could be swift.

But it would different story in China as the Chinese government continues to battle with the unintended effects of their policies which has spilled over to the real estate or property markets. Apparently, China’s tightening policy drove money away from the stock market, which continues to drift near at September 2009 lows, but shifted them into the real estate sector.

In short, like the crisis afflicted West, the current depressed state of China’s stock market signifies as an extension of the bubble bust saga which crested in October 2007, a year ahead of the Lehman episode. China’s cycle remains unresolved.

Should the US equity markets suffer from a technical bear market arising from the current stalemate in Federal Reserve policies, but for as long as a recession won’t transpire from the current market distress, then the downside may be mitigated.

So far, the risk for a US recession has not been that strong and convincing as shown by the above recovery in lending.

Conclusion: Navigating Turbulent Waters Prudently

And as I concluded two weeks ago[24],

I would certainly watch the US Federal Reserve’s announcement and the ensuing market response.

If team Bernake will commence on a third series of QE (dependent on the size) or a cut in the interest rate on excess reserves (IOER), I would be aggressively bullish with the equity markets, not because of conventional fundamentals, but because massive doses of money injections will have to flow somewhere. Equity markets—particulary in Asia and the commodity markets will likely be major beneficiaries.

As a caveat, with markets being sustained by policy steroids, expect sharp volatilities in both directions.

The point of the above was that my expectations had conditionally been aligned to the clues presented by Ben Bernanke of putting into action further bailouts which apparently did not occur.

And since Mr. Ben Bernanke appears to be politically constrained to institute his preferred policies, it is my impression that he would be holding the financial markets hostage until political opposition to his policies would diminish that should pave way for QE3.0. This means that the balance of risks, in my view, have now been tilted towards the downside unless proven otherwise.

Remember, it has been a dogma of his that the elixir to US economy emanates from asset value determined ‘wealth effect’ spending via the transmission mechanism which he calls the Financial Accelerator[25]

To quote the BCA Research[26],

But until QE3 is credibly articulated by Bernanke, there could be more downside for risky assets and further upside for the dollar.

And converse to my abovestated condition or premises, and because I practice what I preach, I materially decreased exposure in the local markets, as I await further guidance from the actions of policymakers.

Although I still maintain a bullish bias, in order to play safe, I would presume a worst case scenario—current global bear markets are signifying a recession—as the dominant forces in operation.

It’s easy to falsify the worst case scenario with incoming policy actions, data and unfolding market events.

Alternatively, this means that for as long as a non-recession scenario becomes evident then it would be easy to position incrementally, hopefully with limited downside risks.

In other words, for as long as there remains no clarity in the policy stance, I see heightened uncertainty as governing the markets. Thus I would need to see the blanc de l'oeil or the French idiom for seeing ‘the white of their eyes’ before taking my shots.

Bottom line: In the understanding that incumbent markets have been driven by politics, reading political tea leaves or the causal realist approach will remain as my principal fundamental analytical methodology in ascertaining my degree of market level risk-reward exposure.


[1] Wikipedia.org Liquidity trap

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

[3] See Stagflation, NOT DEFLATION, in the Eurozone, October 1, 2011

[4] Martin Angel The Stagnant U.S. Economy: A Graphical Complement to Higgs’s Contributions, Independent.org, September 23, 2011

[5] US Federal Reserve Federal Open Market Committee

[6] See US Mulls ‘official’ QE 3.0, Operation Twist AND Fiscal Stimulus, September 9, 2011

[7] Yahoo News Republican lawmakers warn Federal Reserve against action on economy, September 21, 2011

[8] See Paul Volker Swings at Ben Bernanke on Inflationism, September 20, 2011

[9] See Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms, September 22, 2011

[10] Bloomberg.com Fisher Says Central Bank Is Under Attack From Ron Paul, Barney Frank, September 28, 2011

[11] See German Minister Calls Tim Geithner’s Bailout Plan ‘Stupid’, September 28, 2011

[12] New York Times, Stocks Decline a Day After Fed Sets Latest Stimulus Measure, September 23, 2011

[13] New York Times, Germany Approves Bailout Expansion, Leaving Slovakia as Main Hurdle, September 29, 2011

[14] See Will IMF’s bailout of Euro Reach $ 3.5 trillion? September 30, 2011

[15] Johnson Simon What Would It Take to Save Europe?, New York Times September 29, 2011

[16] Bloomberg.com Global Stocks Drop 20% Into Bear Market as Debt Crisis Outweighs Profits, September 23, 2011

[17] See Can Bear Markets happen outside a Recession? China’s Shanghai and Bangladesh’s Dhaka Indices October 1, 2011

[18] Wikipedia.org Kennedy Slide of 1962

[19]Bernanke Ben S., Reinhart Vincent R., and Sack Brian P. Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment, 2004 US Federal Reserve

[20] Wikipedia.org Plaza Accord

[21] Rothbard, Murray N. Nine Myths About The Crash, Making Economic Sense Mises.org

[22] Wikipedia.org Black Monday (1987)

[23] Lyons Gerard, Discovering if we learnt the lessons of Black Monday, thetimesonline.co.uk, October 19, 2009

[24] See Definitely Not a Reprise of 2008, Phisix-ASEAN Equities Still in Consolidation, September 18, 2011

[25] Bernanke Ben S. The Financial Accelerator and the Credit Channel, June 15, 2007 US Federal Reserve

[26] BCA Research U.S. Dollar: Waiting For More Policy Action, September 27, 2011