Quote of the Day: How Different Policies Affect Entrepreneurs

1. In a nation with poor rule of law and weak protection of property rights, entrepreneurs are undermined in their efforts to innovate, expand, and create.
2. In a nation with bad monetary policy, entrepreneurs are hampered because the basic unit of account and medium of exchange is unstable.
3. In a nation with onerous fiscal policy, entrepreneurs are discouraged because government is misallocating resources and imposing punitive tax rates.
4. In a nation with protectionist trade policy, entrepreneurs are denied the ability to buy and sell in ways that enable the most productive use of labor and capital.
5. In a nation with interventionist regulatory policy, entrepreneurs are saddled with extra costs that make it more expensive to mix labor and capital in ways that most effectively satisfy consumer desires.

That’s from Cato’s Dan Mitchell.

Presidential Approval Ratings and Stock Market Returns

An interesting insight by Bespoke Invest on the correlations of Presidential approval ratings and stock market returns.

This from Bespoke Invest, (bold highlights mine)

``When looking at the complete history of approval ratings, it was hard to believe that even though he left office as one of the most unpopular Presidents ever, at one point George W. Bush's approval rating was higher than any other President in the post-WWII era. Ironically, the prior record appears to be held by his father, whose popularity also hit its lowest levels near the end of his first and only term. Likewise, while Reagan has been viewed positively by both Republicans and Democrats, he and Nixon (and Obama so far) are the only post-WWII Presidents who never saw their approval ratings break above 70%.

``Taking the USA Today's look at Presidential approval ratings one step further, we added a chart of the S&P 500's year over year (y/y) performance during each President's term to see how a President's popularity was tied to the stock market. Not surprisingly, there is a strong relationship between the stock market's performance (which reflects the economy) and how a President is viewed. Presidents who were in office while the stock market was strong typically have been more popular and vice versa."

``In recent history, however, the relationship has been less consistent. For example, George W. Bush's popularity peaked when the market was weak, and as the stock market improved up until 2007, his popularity continued to decline. Likewise, while it's still early in his first term, President Obama came into office with an approval rating of 64%, but even though the markets have shown considerable improvement, his approval rating has seen a decline to 55%."

Think of it, the last paragraph suggests that falling popularity for President Obama has been coincidental with rising stock markets so there seems to be a loose connection.

Aside from the attractively colored chart which are meant to amuse, popularity measures seem to be an inaccurate way to evaluate, gauge or predict stockmarket activities, trends or returns. That's because popularity is mostly about superficiality and inherently fickle.

For instance, a popular president who undertakes populist policies may generate short term gains, but reap long term pains and vice versa.

What seem to matter more is the substance and direction of the policies employed.

Has The Underperformance of Philippine Markets Been Due To Policy Credibility?

``In our opinion, global economic conditions are fraught with potential difficulties but Asia’s economic position puts the region in a strong position relative to the developed world. Budgetary and fiscal surpluses mean that countries have the scope to provide domestic stimulus. The banking sectors have ample liquidity and low non-performing loans; real estate prices are not in a bubble phase; corporate debt levels are low and after years of low investment there is not much excess capacity.” Edmund Harriss-Guinness Atkinson Funds, Asia Brief June 2008

So what else is new? The Philippine financial markets continue to get whacked. Again everything is being blamed on either high oil prices or “inflation” as if this whole episode is a restricted to a Philippine only affair.

Figure 1 from Dankse Bank shows the monthly returns of the Peso (left) and the Phisix (right)

Figure 1 from Denmark’s Danske Bank shows the Philippine Peso have been the worst hit among emerging market currencies (see red circle left), while the Philippine stock market benchmark has been the fifth worst performer among emerging markets (red circle right).

The Danske research team suggests that this has been all about central bank credibility. They for instance noted that Indonesia has far outperformed emerging market rubric in both currency (even gained last month) and stock market terms (the least losses) because investors perceived government actions as fitting to the present conditions.

From Danske (highlight mine) ``government has cut subsidies to avoid serious worsening of the fiscal situation and the central bank has moved fast to maintain its credibility. Indonesia has been rewarded by becoming the best currency in Asia, while India and the Philippines have been punished for dragging their feet on both fiscal and monetary policy.”

Indeed, pertinent to interest rates, Indonesia has ‘aggressively’ raised its benchmark rate for the third successive month (Bloomberg) compared to the Philippines which has reluctantly lifted only once (last June) for the first time in 3 years (Philippine Inquirer).

But for Indonesia to get “rewarded” for cutting subsidies where the Philippines has none is to assume the analogy of rewarding Indonesia for the transition from worst to bad when we are punished for maintaining the bad level. I don’t think this is the correct angle look at figure 2.

Figure 2 PIMCO: Real Policy Rates Are Negative in Emerging Markets

If negative real policy rates extrapolate as the fuel to the inflation fire, then certainly Singapore’s Central Bank should be interpreted as a paradigm or representative of the “bad policymaking” for having the steepest negative rate environment and should have been correspondingly meted with a market “penalty”. Likewise, Thailand, whose monetary regime has been similar to the Philippines, should also feel the heat. But where?

So if the conduct of policy doesn’t reflect the issue of real rates, then it can’t be about subsidies too. Look at figure 3 from the IMF.

Figure 3: IMF study: Change in Fuel Price Subsidies as a percent of GDP: 2006 to 2008

In IMF’s recent study “Food and Fuel Prices—Recent Developments, Macroeconomic Impact, and Policy Responses” it notes, ``Thirty-eight countries increased or decreased fuel price subsidies between 2006 and 2008. The increases (in 29 countries) range from near zero to 4.0 percent of GDP, with a median increase of 0.7 percent. The biggest increases have occurred in countries with large pre-existing subsidies. The decreases (in 9 countries) range from 0.2 to 5.3 percent of GDP, with a median of 0.6 percent, with the largest decreases in countries that were restructuring their subsidy programs.”

If the market’s “reward or punishment” system stems from policies of either subsidy reduction or subsidy gains, then those bars on the left (reduction) should see their currencies and stock markets outperform relative to those on the right (increases). Unfortunately the markets apparently don’t reflect on this line of thought.

Now of course currencies are valued based on relative terms. Or if we apply policy as a measure in valuing national assets classes then we have to parse on the obverse side-particularly policies governing the US dollar.

With 36 states in the US facing a decline (recession) as of May see figure 4, government’s fiscal positions risk getting slammed from declining revenues or tax collection in the face of rising government expenditures.

Figure 4: Nelson A. Rockefeller Institute of Government: 36 States on Decline

This from the Nelson A. Rockefeller Institute, ``The national economic slowdown—or recession —is depressing state tax revenue and restraining local government tax revenue. To date, the tax revenue weakness has been mild compared with past recessions. However, the seeds of greater fiscal stress are already sown: economic weakness is spreading rapidly and tax revenue from the “continuing” base should be very weak in the April-June quarter, although perhaps partially masked by payments with 2007 tax returns. After June, tax revenue is likely to be extremely weak as most states begin their fiscal years — and such weakness may linger as the year progresses. Many states finalized their 2008-09 budgets during the April-June quarter, when conditions may have misled forecasters into revenue projections that were too rosy. Governors in some states may, then, face difficulty implementing their new budgets —raising the prospect of midyear cuts and other actions to eliminate emerging gaps.” (emphasis mine)

What this suggests is that fiscal conditions in the US are likely to worsen. It would have to address this by painstakingly cutting expenses or inflating its way to cover such budget gaps or increase borrowing by issuing more debt instruments from foreigners or raise taxes. Whatever route taken is unlikely to be “positive” based on relative fiscal positions when compared to the Philippines.

All this go to show that while policymaking direction could be a factor influencing the market’s action, it certainly doesn’t show up in straightforward linkage.

However, we do share the frustrations over the Bangko Sentral ng Pilipinas’ dilly-dallying. In addition, we get even more concerned when we hear of our officials proposing to borrow money-$900 million from World Bank and ADB (Bloomberg)-in order to intervene in the currency markets to shore up the Philippine peso. This is like throwing money to a sinkhole, whose unnecessary losses will be charged to the taxpayers.

It would be a better option for the BSP to raise interest rates and reduce the negative real rates environment if they aim to defend the Peso and contain the consumer goods and services inflation pressures. But if the BSP is concerned about the impact to economic growth from higher interest rates, the market is doing it anyway for them through higher yields in domestic treasuries and from rising consumer prices. By closing the real rates gap at least they can’t be held solely responsible for “bad” policymaking. Besides, we read this labeling of bad policymaking as “reverse psychology”, maybe foreigners could be hoping for higher rates from the Peso to allow for them opportunities from a wider yield arbitrage.

Noteworthy Insights on the Rice Crisis

Some important insights on the Rice Crisis…

All highlights mine

From Tyler Cowen published at the New York Times…

“Restrictions on the rice trade run the risk of making shortages and high prices permanent. Export restrictions treat rice trade and production as a zero- or negative-sum game where one country’s gain comes at the expense of another. That’s hardly the best way to move forward in a rapidly growing world economy.

“This lack of support for trade reflects a broader and disturbing trend. An increasing percentage of the world’s production, including that for agriculture, comes from poor countries. Over all, that’s good for rich countries, which can focus on creating other goods and services, and for the poor countries, which are producing more wealth. But it can slow the speed of adjustment to changing global conditions.

“For example, if demand for rice rises, Vietnamese farmers — who remain shackled by many longstanding regulations of communism — aren’t always able to respond quickly. They don’t even have complete freedom to ship and trade rice within their own country.

“Poorer countries also tend to be the most protectionist. To make matters worse, about half of the global rice trade is run by politicized state trading boards.

“The reality is that many of today’s commodity shortages, including that for oil, occur because ever more production and trade take place in relatively inefficient and inflexible countries. We’re accustomed to the response times of Silicon Valley, but when it comes to commodities production, many of the relevant institutions abroad have only one foot in the modern age. In other words, the world’s commodities table is very far from flat.

“Many poor countries, including some in Africa, could be growing much more rice than they do now. The major culprits include corruption in the rice supply chain, poorly conceived irrigation systems, terrible or even nonexistent roads, insecure property rights, ill-considered land reforms, and price controls on rice.

“The ability of a country to grow rice depends not just on its weather, but also on its institutions. Burma, now Myanmar, was once the world’s leading rice exporter, but it is now an economic basket case and many of its people go hungry.

“Of course, wealthy countries are partly at fault, too. Japan, South Korea and Taiwan all protect their native rice farmers; you’ll even see rice being grown in Spain and Italy, aided by European Union subsidies and protectionism. The United States spends billions subsidizing domestic rice farmers.

From Steve Hanke published at Cato.org...

“The economics of commodity markets provides the key to unlocking this mystery. The net cost of carrying inventories is equal to the interest rate, plus the cost of physical storage, minus the "convenience yield".

“The convenience yield is driven by the precautionary demand for the storage. When the convenience yield is zero, a market is in "full carry", future prices exceed spot prices and inventories are abundant.

“Alternatively, when the precautionary demand for a commodity is high, spot prices are strong and exceed future prices, and inventories are unusually low.

“As the term structure of rice prices makes clear (see chart), the precautionary demand in Thailand is not elevated and inventories are ample. Indeed, for the term structure of prices to be signaling unusually low inventories, the term structure would be negative in slope, not positive.

Chart courtesy of Cato.org

“In most countries, rice production and trade are subject to a plethora of laws and regulations. Subsidies to rice producers and consumers are widespread. Tariffs on imports and exports are common, as are import and export quotas.

“Many of these policies derive from a food security rationale and the desire to keep a large proportion of rice production at home. In consequence, rice markets are segmented, with wide differences in rice prices (adjusted for rice quality and transport costs) among countries.

“Not surprisingly, a relatively small proportion – only 6%-7% – of world production is exported.

From IMF’s Dominique Strauss-Kahn

“Although aid is the first step, we must be bolder in tackling the long-term challenges of food supply.

“Many farmers are not increasing output because they are not equipped to gear up production or because market distortions mean they do not benefit from higher food prices. So, just waiting for the market to self-correct is not a satisfactory option.

“We must not lose sight of longer-term solutions. This calls for a more global approach to policies. Agricultural policies must change. Higher food prices over the past few years in part reflect well-intentioned, yet misguided policies in advanced economies, which attempt to stimulate biofuels made from foodstuffs through subsidies and protectionist measures.

“High food prices also reflect imprudent agricultural pricing policies in some developing countries, and these too need to be improved.

“No one should forget that all countries rely on open trade to feed their populations. But we are already seeing actions at the national level, such as curbs on food exports, that have a damaging global impact. Completing the Doha round would play a critically helpful role in this regard, as it would reduce trade barriers and distortions and encourage agricultural trade.

“The International Monetary Fund and the World Bank are also engaged in discussions to improve both industrial and developing country policies. Multilateral agencies are stepping up lending to the agricultural sector in poorer and middle-income countries to encourage and support good policies. But there is more to do, and the World Bank's New Deal on Global Food Policy is a big step forward.

“We also need a new approach to risk mitigation and insurance at the level of both individual farmers and countries. Important steps are being made in this direction by aid donors with regard to catastrophe insurance and developing robust futures markets. This can greatly help assure farmers that, if they make investments, they will reap the rewards.

“We should consider adopting a similar philosophy to dealing with shocks - including, but not limited to, energy and food prices - at the macroeconomic level. Countries need to feel more assured that insurance-type financing will be available in times of need. The IMF will play its part in this regard.

From Martin Wolf of the Financial Times...

“Are prices going to remain high? Two opposing forces are at work. The first is the market, which will tend to bring prices back down as supplies expand and demand shrinks. But the latter is also what we want to avoid, at least in the case of the poor, since reducing their consumption is not so much a solution as a failure. The second force is the current intense pressure on the world's food system. This is true of both demand and costs of supply. Prices are likely to remain relatively elevated, by historical standards, unless (or until) energy prices tumble.

“This, then, brings us to the big question: what is to be done? The answers fall into three broad categories: humanitarian; trade and other policy interventions; and longer-term productivity and production.

“The important point on the first is that higher food prices have powerful distributional effects: they hurt the poorest the most. This is true both among countries and within them. The Food and Agricultural Organisation in Rome recently listed 37 countries in substantial need of food assistance. Moreover, according to the World Bank, soaring food prices threaten to make at least 100m more people hungry.

“Increases in aid to the vulnerable, either as food or as cash, are vital. Equally important, however, is ensuring that the additional supplies reach those in greatest difficulty. The options depend on the sophistication of a country's bureaucratic machinery. But they include work paid directly with food (which is a good way of screening out the better-off), a rationed supply of cheap food for the poor or cash vouchers. Those most in need will be the landless, both rural and urban, and marginal subsistence farmers.

“Now turn to the policy interventions. Protection, subsidies and other such follies distort agriculture more than any other sector. Alas, the opportunity to eliminate protection against imports offered by exceptionally high world prices is not being taken. A host of countries are imposing export taxes instead, thereby fragmenting the world market still more, reducing incentives for increased output and penalising poor net-importing countries. Meanwhile, rich countries are encouraging, or even forcing, their farmers to grow fuel instead of food.

“The present crisis is a golden opportunity to eliminate this plethora of damaging interventions. The political focus of the Doha round on lowering high levels of protection is largely irrelevant. The focus should, instead, be on shifting the farm sector towards the market, while cushioning the impact of high prices on the poor.

“Finally, far greater resources need to be devoted to expanding long-run supply. Increased spending on research will be essential, especially into farming in dry-land conditions. The move towards genetically modified food in developing countries is as inevitable as that of the high-income countries towards nuclear power. At least as important will be more efficient use of water, via pricing and additional investment. People will oppose some of these policies. But mass starvation is not a tolerable option.

From Caroline Baum of Bloomberg,

“Many Asian countries, including India and Vietnam, are banning rice exports to ensure adequate domestic supplies. Last week, Indonesia stepped up border patrols to guard against rice smuggling.

“By barring producers from selling overseas, demand for rice in any given country is lower than if the Asian food staple were freely traded internationally. The demand curve shifts back, the price and quantity demanded are reduced….

“It may be a noble idea for poor countries to transfer income from producers to consumers, but it's one that comes with a long history of unintended consequences.

“Governments continue to interfere with the law of supply and demand; that's to be expected. What's surprising is that so many practitioners of the dismal science can't seem to get it right either.