Showing posts with label steve hanke. Show all posts
Showing posts with label steve hanke. Show all posts

Saturday, August 15, 2015

Steve Hanke: Why China is in Trouble

Cato Institute's monetary economist Steve Hanke sees China's economy in trouble in the lens of money supply activities
The course of an economy is determined by the course of that economy’s money supply (broadly determined). The relationship between money growth and nominal GDP growth is presented in the accompanying chart. It is persuasive. Indeed, money, not fiscal policy, dominates.


As I listen to all the ad hoc conjectures about the state of China’s economy and its near-term prospects, I am astounded to never hear anything said about the most important determinant of nominal economic growth: the money supply. The second chart tells the tale. The picture is not a pretty one. China’s money supply growth rate has been slowing down since early 2012. It now is growing at an annual rate of about 10%, which is well below the trend rate of money growth: 17.06%. China is in trouble. Slower money supply growth means that slower nominal GDP growth is already baked in the cake.
I would add that China's money supply has been falling mostly due to deepening balance sheet constraints as shown below:


China's debt stock continues to ramp even as the economy has been slowing. In other words, China's economy has reached a point where debt has been a major factor in the stymieing of real economic activities. Or debt signifies the cause of the effect--the slowing economy.

And because of too much debt...as an old saw goes...you can lead a horse to the water but you can't make it drink.

So if the real economy can hardly absorb new credit to boost money supply, then the (political) answer has been to find an alternative source for this.

And that's the role played by the Xi Jinping Put or China's Frankenstein stock market as most of the recent credit growth has been funneled to support the stock market


To quote Barclays Research via the Zero Hedge: (bold mine)
New loans and M2 growth in July surprised to the upside, dominated by one-off measures to stabilise the stock market. RMB new loans totalled CNY1480bn in July, almost double expectations (consensus: CNY750bn, Barclays: CNY790bn). However, more than half of the new loans (CNY886bn from CNY-47bn in June) were extended to non-banking financial institutions, while household loans and non financial institutions loans both shrank to CNY275bn and CNY313bn, respectively (June: CNY458bn, and CNY860bn). This reflects the government’s stock market support measures in the past month, with bank lending to securities corporations soaring. As a result, broad money (M2) growth jumped to 13.3% y/y from 11.8% previously, while base money (M0) growth remained flat at 2.9% y/y. At the same time, the CNY loan balance growth was up notably at 15.5% y/y, from 13.4% in June 
And naturally, since issuing so much money leads to pressures on her currency's exchange ratio with the US dollar, hence, this week's devaluation.

Wednesday, August 07, 2013

Chart of the Day: Troubled Currencies

Cato Senior Fellow and John Hopkins University Professor Steve H. Hanke in the following table shows where the risks of currency crises are 

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Sunday, November 11, 2012

Zimbabwe’s Economic Recovery Prompted by Spontaneous Dollarization

Here are some very interesting developments in post-hyperinflation Zimbabwe.

Hyperinflation has prompted the average Zimbabweans to junk the domestic currency [the defunct 'Zimbabwe Dollar'] while simultaneously gravitating spontaneously to dollarize their economy. This has resulted to a rebound in economic growth.

Writes Professor Steve Hanke at the Cato Institute
So how did Zimbabwe go from economic ruin to an annual GDP growth rate of 9.32 percent in 2011, with estimates of relatively strong growth rates through 2013?  As I predicted in early 2008, the answer is simple: spontaneous dollarization brought an end to the horrors of hyperinflation.

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The important point to emphasize is that the average Zimbabweans responded to failed and repressive regulations and edicts through their own spontaneous initiative (and exactly the OPPOSITE from government imposition) which eventually became the nation’s informal ‘standard’.

Yet the informal dollarized money standard has been reflected on the economy as the informal economy dominates Zimbabwe which accounts for nearly 84% of employment (and could be more).

Yet Zimbabwe’s government continues to force its way on a society which has already rebelled on them economically

Again Mr. Hanke (bold mine)
While these achievements are cause for celebration, there are still problems in paradise: Robert Mugabe continues to hold the reins of power; Zimbabwe’s “Ease of Doing Business” ranking is a dismal 172nd out of 185; and “change” is, in short, hard to come by. In addition, the government’s external debt is now close to $12.5 billion and lending rates between Zimbabwe’s embattled banks are as high as 25 percent. To top it off, the Zimbabwean government is attempting to force banks to buy its treasury bills at significantly discounted rates, after its debt auction flopped in early October. Talk about ruling with an iron fist.
Also the Zimbabwean government, notes Mr. Hanke, continues to manipulate statistics “Lying statistics remain the order of the day” to embellish what has been a monumental government failure.

It’s amazing that the average Zimbabweans, who seemingly remain submissive and tolerant with the incumbent abusive and oppressive government, apparently live in a paradox or in a parallel universe.

Perhaps the Zimbabwean political economy could be a seminal manifestation of Étienne de La Boétie’s nonviolent political resistance and civil disobedience through the starvation of the beast.

Sunday, October 07, 2012

More on Iran’s Hyperinflation, Venezuela Next?

Professor Steve Hanke has more on the developing hyperinflation in Iran. 

From Prof. Hanke’s 10 facts on Iran’s hyperinflation (Cato Institute) [bold original] 
1. Iran is experiencing an implied monthly inflation rate of 69.6%. For comparison, in the month before the sanctions took effect (June 2010), the monthly inflation rate was 0.698%. 

2.. Iran is experiencing an implied annual inflation rate of 196%. For comparison, in June 2010, the annual (year-over-year) inflation rate was 8.25%. 

3. The current monthly inflation rate implies a price-doubling time of 39.8 days. For certain goods, such as chicken, prices may be doubling at an even faster rate. 

4. The current inflation rate implies an equivalent daily inflation rate of 1.78%. Compare that to the United States, whose annual inflation rate is 1.69%. 

5. Since hyperinflation broke out, Iran’s estimated Hanke Misery Index score has skyrocketed from 106 (September 10th) to 231 (October 2nd).   See the accompanying chart.

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6. Iran is the first country in the Middle East to experience hyperinflation.  It is the seventh Muslim country to experience hyperinflation. 

7. Iran’s Hyperinflation is the third hyperinflation episode of the 21st century.  The first was Zimbabwe, in 2008. The second was North Korea, whose episode lasted from 2009-11. 

8. Since the sanctions first took effect, in July 2010, the rial has depreciated by 71.4%. In July 2010, the black-market IRR/USD rate was very close to the official rate of 10,000 IRR/USD. The last reported black-market exchange rate was 35,000 IRR/USD (October 2nd). 

9. At the current monthly inflation rate, Iran’s hyperinflation ranks as the 48th worst case of hyperinflation in history. Iran currently comes in just behind Armenia, which experienced a peak monthly inflation rate of 73.1%, in January 1992. 

10. The Iranian Rial is now the least-valued currency in the world (in nominal terms). In September 2012, the rial passed the Vietnamese dong, which currently has an exchange rate of 20,845 VND/USD.
To add, as I have repeatedly been saying—symptoms of hyperinflation have likewise been manifested or ventilated on the stock market. 

The public’s reaction to the destruction of a currency’s purchasing power has been to seek refuge through securities backed by real assets. 

Traditional financial metrics in a hyperinflation ravaged economy has hardly been a concern because “cash” is under fire. When half of what has been used for transactions or when the conditions of the domestic medium of exchange is being questioned by the markets, then this represents a dysfunctional economy. We don't use conventional measures on an abnormal situation.


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Thus, under a hyperinflationary environment, hedges or the stampede for safety or preservation of savings against a run on the domestic currency prompts for what would look like a stock market boom 

The same dynamic seems apparent in Iran. The one year chart of Iran’s bellwether the TEDPIX at the Tehran’s Stock Exchange reveals of a 3-month spike as Iran segues into a hyperinflation mode. 

Over 5 years the TEDPIX has risen nearly twofold even as real GDP growth in constant dollars exhibits a stagnation.

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Iran’s GDP at constant prices (Index Mundi). 

So monetary inflation brings about a parallel universe: rising stocks, stagnating economy.

And another important point: Iran’s experience shows that the emergence of hyperinflation has not been gradual but precipitate. Price inflations as manifestations of monetary disorder always appear suddenly and unexpectedly

People who vastly underestimate the current dynamics of price inflation, as a result of concerted inflationism by global central banks, may likely be surprised by price inflation’s impetuous appearance.

I believe that similar symptoms are being exhibited in Venezuela.

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Yesterday, the Venezuela’s Caracas benchmark, the IBVC, zoomed by an eye popping 7.98%!! This adds to the amazing weekly gain of 30.98%, and for a year to date return of a whopping 244.78!!! (see chart above from Bloomberg)

Some suggests that this week’s Venezuelan presidential elections have been breathing life into the markets

Yet a huge 67% jump in the incumbent’s the socialist populist Hugo Chavez spending in August may have been instrumental in driving the frenzied boom in Venezuela’s stock markets.

This September Bloomberg article gives us a clue
Chavez’s August spending surge is swelling the budget deficit that will compel him to devalue the currency after the vote to bolster revenue from oil exports and shore up government finances, according to Barclays Plc and Bank of America Corp., which said in a report yesterday that spending grew 41 percent on an inflation-adjusted basis…

“The market is pricing in an imminent currency devaluation in 2013 regardless of who wins,” said Carlos Fuenmayor, the Miami-based chief executive officer of BancTrust & Co., an investment advisory firm
So Mr. Hanke may want to train his eyes on Venezuela, a likely candidate for the next Iran.

Monday, September 03, 2012

Hyperinflations and the Mickey Mouse Peso

In a transcript from a lecture, the illustrious Austrian economist Percy L. Greaves Jr. explains the stages of inflation.

Sales to these buyers cannot be continued forever. As the quantity of money is increased and prices rise, injections of larger and larger quantities of money are required to produce the same effects. If the quantity of money increases in ever larger quantities, prices will rise faster and faster as the value of each monetary unit falls. Sooner or later, the increases must be stopped. If they are not stopped before the value of the monetary unit falls to zero, people will eventually run away from the money and spend it on anything they can get, because, in their minds, anything will soon be worth more than a constantly depreciating money.

When governments increase the quantity of money, the effects tend to follow a certain pattern. Of course, the inflation can be stopped at any point. The first stage of inflation is when housewives say: "Prices are going up. I think I had better put off buying whatever I can. I need a new vacuum cleaner, but with prices going up, I'll wait until they come down." During this stage, prices do not rise as fast as the quantity of money is being increased. This period in the great German inflation lasted nine years, from the outbreak of war in 1914 until the summer of 1923.

During the second period of inflation, housewives say: "I shall need a vacuum cleaner next year. Prices are going up. I had better get it now before prices go any higher." During this stage, prices rise at a faster rate than the quantity of money is being increased. In Germany this period lasted a couple of months.

If the inflation is not stopped, the third stage follows. In this third stage, housewives say: "I don't like flowers. They bother me. They are a nuisance. But I would rather have even this pot of flowers than hold on to this money a moment longer." People then exchange their money for anything they can get. This period may last from 24 hours to 48 hours.

56 countries including the Philippines experienced the nasty consequences of inflation run amuck, caused by government’s sustained tampering of money

Below is the table which lists the accounts of world hyperinflations.

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Unknown to most, the Philippines had a short episode of hyperinflation during World War II.

Cato’s Steve H. Hanke and Nicholas Krus in their paper World Hyperinflations narrates,

Another largely unreported hyperinflation episode imageoccurred in the Philippines, during World War II. In 1942, during its occupation of what was then the Commonwealth of the Philippines, Japan replaced the Philippine peso with Japanese war notes. These notes were dubbed “Mickey Mouse money”, and their over-issuance eventually resulted in a hyperinflation that peaked in January 1944. It should be noted that the U.S. Army, under orders from General Douglas MacArthur, did add a relatively small amount of fuel to the Philippine hyperinflation fire by surreptitiously distributing counterfeit Japanese war notes to Philippine guerilla troops (Hartendorp 1958). (Mickey Mouse Peso image from Wikipedia.org)

History gives us lessons of what may happen if governments continue to abuse money.

As the great Ludwig von Mises wrote,

History looks backward into the past, but the lesson it teaches concerns things to come. It does not teach indolent quietism; it rouses man to emulate the deeds of earlier generations.

Unfortunately, in the world of politics, such lessons never sink in, and this is why history rhymes.

Wednesday, June 20, 2012

Emerging Markets Eye Insurance Against the US Dollar, Euro

Aside from the pledge to assist in the rescue of the EU, key emerging markets led by the BRICs and South Africa discussed insurance options that goes around the US dollar.

From the China Money Report,

The BRICS countries said on Monday that they’re considering setting up a foreign-exchange reserve pool and a currency-swap arrangement as financial problems threaten to spread across the global economy.Leaders of the five-member group —Brazil, Russia, India, China and South Africa— also said BRICS is “willing to make a contribution” to increase the International Monetary Fund’s ability to rescue troubled economies. President Hu Jintao joined his counterparts from other BRICS nations on Monday morning in the Mexican resort city Los Cabos ahead of the start of the G20 Summit.

According to the Chinese Foreign Ministry, the leaders discussed the currency swap and foreign-exchange reserve pool ideas and tasked their finance ministers and central bank chiefs to implement them, according to China’s Foreign Ministry.

Swap arrangements, which allow nations’ central banks to lend to each other money to keep markets liquid, and the pooling of foreign-exchange reserves are contingency measures aimed at containing crises such as the one roiling the eurozone, analysts said.

Zhang Yuyan, director of the Institute of World Economics and Politics affiliated with the Chinese Academy of Social Sciences, said the new mechanisms established by the emerging markets themselves, who “know their current conditions and demands
much better”.

Amid the global economic slowdown, the pooling of foreign-exchange reserves will help BRICS countries to fight the lack of market liquidity, beef up their immunity to financial crises and boost global confidence, Zhang said.

Contributions to this “virtual” bailout fund, as Brazil’s Finance Minister Guido Mantega put it, would be tied to the size of each BRICS member’s currency reserves, he said. The five leaders also discussed BRICS’ participation in replenishing the IMF’s lending capital. Hu said the G20 should encourage and support the eurozone countries’ adoption of fiscal controls and spending cuts as efforts to improve confidence in world markets. The leaders also urged the IMF to carry out promised reforms of its quota and governance systems. Mexico, which was hosting the G20 Summit on Monday and Tuesday, has said it will use the meeting to press the world’s largest economies to increase IMF resources and build the fund’s capacity to intervene in the European debt crisis.

While these may be constitute added signs that much of the world seem to be getting antsy with the unfolding events in the developed economies, swaps and foreign reserve pools won’t do much when the whole paper money system goes into flame.

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The reason for this is that much of the world’s banking and financial system remains anchored on fiat currencies of the western world, where the US dollar and the euro constitute 90% of global reserve currencies (see chart from Wikipedia.org).

Besides, the monetary system of emerging markets operates from the same fractional reserve system as their developed peers, which means that like their developed peers, EM politicians will be seduced to used inflationism to achieve political goals.

Instead, what these economies should do would be to ramp on gold acquisition, and possibly consider a quasi-gold standard possibly through a gold based currency board (as proposed by Professor Steve Hanke) or a return to the gold standard or allow for currency competition with the private sector (free banking, free currency competition as proposed by Ron Paul and Professor Lawrence White).

Since any of the proposed monetary reforms would entail restriction in political actions and simultaneously require massive liberalization of respective economies, these won’t likely be palatable with incumbent political agents, who under such circumstances, lose much of their current privileges (Europe’s deepening crisis are manifestations of these).

Thus, it would likely take a deeper crisis (most likely a currency crisis) to force real reforms in the system.

Wednesday, May 02, 2012

Eurozone’s Farce Fiscal Austerity Programs

I have been saying that the so-called fiscal austerity in the Eurozone has been a farce.

The European Central Bank has continually been bailing out the region’s banking system through inflationism or via the massive expansion of the ECB’s balance sheet.

Meanwhile European governments have been raising taxes matched by partial budget cuts and politically label this as “austerity” programs. [The left, using deliberate semantical distortions, misleadingly blames such failures on the markets].

What has been really happening has been a transfer or a redistribution of resources from both the private and the public sectors into the politically privileged banking system. Taxes have been increased or are in the process of being raised to pay for the bailouts of the banks.

In genuine austerity programs, resources would be made available for the productive use of the private sector. This means growth in the private sector relative to a reduction of government expenditures.

In the current Eurozone programs, this has not been happening.

Professor Steve Hanke in an interview with Streit Talk explains further, (bold emphasis mine)

Member states haven’t delivered on much in terms of fiscal austerity and certainly not structural reform. Fiscal austerity should be about reducing the size of government…governments are bloated and spending way too much in Europe. Austerity should be almost entirely focused on reducing government expenditures and obviously not on increasing taxes. But there’s a lot of tax increase noise within the so-called austerity programs in Europe, so they just have it all wrong. And, in any case, they haven’t delivered much.

As far as structural reforms go, there have been almost none that have actually been implemented, even in Greece. They’ve talked a lot, and spent most of their time blaming markets or the outside world – the Germans, the Dutch, the Finns, and so on – for the problems that they’ve gotten into. So there’s a lot of finger pointing going on and talk about structural reforms, but they’re half-baked.

And when I say structural reforms, what do I mean? What they have to do is put in place growth-friendly policies and get government out of the way. And that means they have to have something like Presidents Reagan and Clinton did in the United States; they have to reduce government expenditures and reduce regulation and red tape. But they’re not in that business in Europe. Their assessment is: we have a crisis because markets failed and we have to regulate markets more now so that they don’t fail in the future. This is just upside down because the crisis was caused by government failure – mainly the European Central Bank and the Federal Reserve Bank of the United States. These were the great enablers and engines that allowed for the blow-up of the bubble that ultimately burst in the fall of 2008, although there were problems in Europe even in the summer of 2007.

So essentially in both the fiscal austerity and structural reform realms, the packages that they’ve been talking about are really almost fatally flawed. And they haven’t even delivered on what they said they would deliver on in the first place. They’ve been wasting their time moving from one meeting to the next and jumping from one fire to the next. They lack the “vision thing.” The long and the short of it is: will these steps toward fiscal austerity and structural reform stabilize the periphery’s sovereign debt markets? The answer is: of course not.

Politicians of developed nations will increasingly resort to more interventionism channeled through central banks, whom the public understands little about, as a way to shield their skullduggery.

And this is why markets will be sensitive to sharp volatilities, and or susceptible to “pump and dumps”, as market actions will be shaped by the feedback loop mechanism between market actions and political responses and vice versa.

Wednesday, February 01, 2012

Mercantilistic US Monetary Policies Has Political Implications

The conduct of ‘imperialist’ US foreign policies somewhat resembles US monetary policies: mercantilism channeled through currency wars.

Writes Professor Steve Hanke at the Financial Post, (bold emphasis mine)

The United States has a long history of waging currency wars in Asia. We all know the sad case of Japan. The U.S. claimed that unfair Japanese trading practices were behind the ballooning U.S. bilateral trade deficit.

To correct the so-called problem, the U.S. demanded that Japan adopt an ever-appreciating yen policy. The Japanese complied and the yen appreciated against the greenback, from 360 in 1971 to 80 in 1995 (and 77, today). But this didn’t close the U.S. trade deficit with Japan. Indeed, Japan’s contribution to the U.S. trade deficit reached almost 60% in 1991. And, if that wasn’t enough, the yen’s appreciation pushed Japan’s economy into a deflationary quagmire.

Today, the U.S. is playing the same blame game with China. And why not? After all, China’s contribution to the U.S. trade deficit has surged to 45%.

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Above is the USDollar Japan Yen chart since 1970 (St. Louis Federal Reserve)

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Yet in spite of the massive appreciation partly from US behests, Japan’s trade balance remained positive until last year (for the first time in 31 years; chart from the Economist)

Well, Professor Hanke points out that a currency war with China has had a precedent.

To appreciate just how dangerous currency wars can be, let’s lift a page from the U.S. government’s old currency war playbook. During his first term, President Franklin D. Roosevelt delivered on his Chinese currency stabilization “plan.” China’s yuan was pegged to the price of silver, and it was asserted that higher silver prices would benefit the Chinese by increasing their purchasing power. Congress granted the Roosevelt Administration the authority to buy silver in massive quantities. The administration pushed the price of silver up by 128% in the period between 1932 and 1935. As the dollar value of silver went up, so did the value of the yuan.

America’s “plan” worked like a charm, but it had consequences that Washington had not quite advertised. The rapid appreciation of the yuan threw China into the jaws of the Great Depression. Between 1932 and 1934, its gross domestic product fell by 26% and wholesale prices in the capital city, Nanjing, fell by 20%. China officially abandoned the silver standard on Nov. 3, 1935. This spelled the beginning of the end for Chiang Kai-shek’s Nationalist government.

Every political policy has designated winners and losers, which means that monetary policies too have political dimensions. And perhaps anytime the US government sees a serious contender to their economic tiara, their political-bureaucratic stewards intuitively resort to what seems as bullying or intimidation or “beggar thy neighbour” policies: currency war. [Brazil in 2010 raised the spectre of an escalation of a currency war or competitive devaluation.]

Yet such political stratagem of scapegoatism seems contrived to divert the attention of the average Americans from the policy mistakes committed by the US government (boom bust cycles, fast expanding welfare state, war on terror policies and etc…).

We can even fuse together monetary and US foreign policies—the EU’s recent sanction on Iran seems parceled into the US Federal Reserve’s bailout.

Also, the US has even been selling China as a military threat to advance US military’s exposure in Asia, simultaneously while the Obama administration has been criticizing China’s trade and currency policies. All these seem to be part of the psywar operative.

Never mind if the US seems on path towards internal policy induced decadence.

For what seems intended is the preservation of the status quo, or the entitlements of the entrenched patrons—the political class and their clients—the banking and military industrial complex—all at the expense of everyone else.

The philosophy of mercantilism or protectionism, once wrote Ludwig von Mises,is indeed a philosophy of war.

Saturday, November 12, 2011

Video: Steve Hanke on the Eurozone Crisis

Here is Cato's Steve Hanke's take on the Eurozone crisis (interviewed by Reuters)

Some pointers from the interview:

-Glaring 'lack of sense of history' by "Euro-crats" in dealing with the crisis leaves them unable to accurately diagnose the problems which subsequently means applying wrong prescriptions (2:18)
-the ECB may be forced to provide unlimited support for EU's bond markets
(3:08)
-two fundamental scenarios: One, the EU will evolve into a fiscal transfer union which will be very messy and take lots of time (3:50) 'My guess is that the cartel may fall' because of political problems. (4:20) Second, the Eurozone may split (4:40). Prof. Hanke says that the mainstream's popular panacea for an exit option, just to be able to resort to devaluation, would be 'a chaotic situation' as all companies and the households in Greece would effectively go bankrupt (4:56).


Monday, June 28, 2010

Why China’s Currency Regime Shift Is Bullish For The Peso

``In essence, China is saying it thinks its currency will do a better job than the US dollar of retaining its value over time. Put another way, China is committed to having lower inflation than the US and China seems willing to deal with the natural consequences of that strategy, which is a currency that gains value. Previously, China was hesitant to allow its currency to gain value versus the dollar. From the early 1990s until mid-2005, despite a combination of rising trade surpluses with the US and growing attractiveness for global capital investors, the yuan-dollar exchange rate was fixed by the Bank of China. In other words, China was willing to import US monetary policy. Brian S. Wesbury - Chief Economist and Robert Stein, CFA - Senior Economist, China Rising


The gap in the performances of the equity markets between ASEAN and western economies has apparently been widening (see figure 1).


Figure 1 Bloomberg: Signs of ASEAN-US Decoupling?


AS the US markets fumbled (signified by the S&P 500 in green, which was down by 3.65%) this week, ASEAN markets has remained surprisingly resilient, as shown by the Philippine Phisix (orange), Thailand’s SET (red) and Indonesia (yellow). The signs above possibly points to “decoupling”.


Since charting in Bloomberg allows for only four variables, other countries as Malaysia and South Korea had been excluded. Nevertheless, these bourses likewise registered modest gains for the week.


But such buoyancy has not been reflected on the regional currencies. Contrary to my expectations, Asian currencies lost material grounds this week, with the Philippine Peso suffering from the largest decline--down 1.2% to 46.45 against the US dollar. The asymmetric price developments in the marketplace seem to exhibit short term volatility or more “noise” than “signals” from the general trend.

In short, falling Asian currencies and strong stock markets appear in conflict with each other, where one of the two markets will likely be proven wrong.


ASEAN Divergence: Signal Or Noise?


Yet such dissonance is hard to relate to the performance of the euro. The euro declined marginally (-.16%) this week to 1.2371 vis-a-vis a US dollar. This comes in spite of the record surge in the CDS spread of Greece[1], where in the past, an upsurge in default risk translated to an accompanying collapse of the Euro, this time around the Euro appears to be holding ground (see figure 2).

Figure 2: stockcharts.com: Consolidating Euro And Resurgent Commodities


And another part of the picture of mixed actions has also been the advances in the commodity markets particularly, gold, copper and oil.


Seen from a conventional “demand” perspective, rising commodities should exhibit improvements in the global economy. But again, this would be inconsistent with the infirmities manifested by the sagging developed economy equity markets.


Of course, the alternative perspective is the monetary aspect, where rising commodities and weakening major equity benchmark could be exhibiting symptoms of stagflation. Though this would seem consistent with the strength in ASEAN, once known as major commodity producers, this hasn’t been the case today given transformation of the global trade configuration into a supply chain platform (figure 3).


Figure 3: Economist Intelligence Unit[2]: ASEAN Exports


Nevertheless, the significant share of high value (technology based) exports makes ASEAN nations susceptible to the vicissitudes of the global economy. Thus, ASEAN won’t be immune to a recession in the developed world.


Meanwhile, the unexpected picture is that the Philippines had been ranked first among high value exporters. But according to the EIU, what you see isn’t what you get and that’s because internal developments has skewed trade statistics.


Anyway the EIU clarifies, ``In our “high-value exports indicator”, the Philippines ranks first, with about 77% of its total exports made up of high-value goods. This places it well ahead of other individual ASEAN countries, as well as China and India. On the surface, this result might seem surprising, given that the Philippines is by no means a technology leader. However, one explanation for this ranking mined or exported. The industry desperately needs foreign capital and technology, but government policy for many years has kept out foreign investors. As a result, low-value exports from the Philippines have been depressed. It was only in December 2004 that the Supreme Court ruled that foreigners could again get involved in the mining sector. As the consequences of that ruling start to filter through, and as low-value exports pick up, so the Philippines may well slip down the high-value exports ranking.” (emphasis added)


From the above we learn that statistics are not reliable indicators of actual events because many factors influence an outcome, and second, the Philippines made it to the top of the list because the government has suppressed trade activities which pumped up the share of high value exports.


Alternatively, while the increased participation of the low value share is likely to erode the Philippines’ standings as measured by the above statistics, more trade should equate to more output and economic benefit.


Bottom line: Strong performances of ASEAN stocks and commodities defy the bearish outlook suggesting of a double dip recession in the world economy.


The Yuan Factor In The ASEAN’s Divergence


This brings us to the next factor which is likely to influence the ASEAN trade and market dynamics.


It’s the Chinese Yuan.


China’s government has announced last weekend that the Yuan will return to a managed float from the de facto US dollar peg[3].


In 2005, China went into a managed float but the recent financial crisis had forced China to re-peg the Yuan back to the US dollar[4] as a defensive move.


While a parcel of China’s action may have been in response to ease global political pressures aimed at pressuring the Yuan to revalue out of the perceived “overvaluation” and to “rebalance” the global economy, the geopolitical aspect seems to overstate the case. Instead, for me, China’s response has been due to its serial failure to combat internal inflation which continually flies in the face of government’s tightening policies.


As we wrote in March of this year[5],


``China has attempted several times since last late year to arm twist several industries to stem credit expansion which has led to inflation. Lately she has threatened to nullify loans granted to local governments and has similarly instructed 78 state owned enterprises (SOE) to quit the real estate market leaving 16 SOE property developers.


``And economic overheating presents as a real risk. There has been an acute shortage of labor where factory wages haverisen by as much 20% as the inland now competes with the coastal areas and reduced migration in search of jobs.


``We are now witnessing a classic adjustment in trade balances as taught in classical economics. As Adam Smith once wrote, ``When the quantity of gold and silver imported into any country exceeds the effectual demand, no vigilance of government can prevent their exportation. (emphasis added)


``In short, this leaves the Chinese government little or no option but to allow its currency to rise as a safety valve against a runaway inflation.


And faced with the predicament of recession risks from further credit rollbacks and the intensifying inflation, China has indeed resorted to the currency safety valve.


A stronger yuan allows relatively cheaper imports, which many in the mainstream mistakenly thinks that this will translate to economic “rebalancing”.


Yet in a world of paper money system, the international currency reserve, which essentially expedites the global trading activities, has NO automatic mechanism for adjustments. This implies that aside from adjustments mostly due to political preferences, the higher costs from the attendant currency adjustments simply mean that investments get shifted to the trading partners (see figure 4).

Figure 4: IMF[6]: Savings-Investment, WEF[7]: ASEAN Exports By Destination/


Alternatively, this means that “rebalancing” concept is an illusion, which fundamentally disregards the function of money as a medium of exchange and where an international currency reserve is the politically preferred “medium of exchange.”


The upshot to this is that a firmer yuan would induce the growing number of wealthy Chinese to buy more stuff abroad [provided the government allows for this]. And this should extrapolate to a boon to the major trading partners.


Considering that the share of the China-ASEAN trade has been ballooning (lower window of the ASEAN Export Destinations) at the expense of Japan and the US, the underinvestment seen in Emerging Asia (upper window) exhibited by yawning gap between savings and investment is likely to see significant improvements as a consequence to both a rising yuan and the deepening of intra-region trade. [Note: the Asian Crisis was clearly a result of malinvestments as shown by investments overtaking savings, which obviously was funded by inflated money from domestic and foreign sources.]


Of course, currency valuation is just one of the many factors that influence trading dynamics, yet one of the most important forces is the political desire to accommodate free trade.


Apparently, the process to integrate economically by regionalization has already been set into motion by the China-ASEAN Free Trade Agreement (FTA)[8] in late 2009 and secondarily, by China’s attempt to introduce the yuan as the region’s reserve currency[9].


The negative facet is that the use of the currency valve triggers more political rather than consumer based distribution which leads to accretion of internal imbalances and an eventual bust.


We are reminded that China’s 9.8% appreciation in 2005 did little to make any dent in the so-called “rebalancing” of trade and that the revaluation of the Japanese Yen through the Plaza Accord[10] in 1985 (15 years ago), had also little impact on Japan’s trade surpluses (Japan remains mostly in the trade surplus position).


Instead, the corollary of the Plaza Accord was that it fueled a massive real estate bubble in Japan which culminated with a colossal bust that lasted for more than ten years, popularly known as the Lost Decade[11].


However, if China is indeed truly determined to make the avowed currency regime shift, then one can’t help but put into picture how the Philippine Peso has responded to China’s revaluation via the shift to a managed float in July of 2005 (see figure 5).

Figure 5: yahoo finance[12]: USD-China Yuan (top), USD-Philippine Peso (down)


The Peso has strengthened in near conjunction with China’s yuan!


Although China ranks fourth among the largest trading partner for the Philippines, in terms of exports, and ranks third in terms of imports in 2009[13], China projects that the recent FTA will pole-vault China’s position as the Philippines’ 2nd largest trade partner[14].


Thus, China’s ascendant “free trade” dynamics combined with the Yuan’s appreciation should lead to a shift in the current trading framework which will likewise be reflected on her trading partners as the Philippines.


Of course, the growing role of China’s trade relations will also redound to the political spectrum. So we should expect to see more of Chinese representation in local politics overtime.


And we should expect all these to be eventually reflected on the region’s financial markets. (see figure 6)

China_Stronger Chinese Yuan

Figure 6: US Global Funds: Indonesia As Prime Beneficiary


The last time the Yuan was revalued in 2005, Indonesia massively outperformed.

However, as noted above, almost every Asian currency profited from this, including the Peso.


According to US Global Funds[15], ``Indonesia remains one of the major beneficiaries of an appreciating Chinese currency, thanks to the commodity-heavy nature of its exports to China. Coal and palm oil are key categories. During the three years from mid-2005 to mid-2008, when the yuan was unpegged from the U.S. dollar and saw appreciation, Indonesian equities more than doubled in U.S. dollar terms, making them the second-best performer in Asia after Chinese equities. In addition, the government’s improving fiscal status highlights a prudent Indonesia where public sector debt declined to 31 percent of GDP in 2009 from 102 percent in 1999, a confidence booster in a world of apprehensions over sovereign indebtedness.


Today, Indonesia is once again at the top in terms of equity performance on a year to date basis.


Ingredients Of A Bubble: Pegged Currency And Lack Of Convertibility


None the less, this isn’t 2005.


Then, the US dollar weakened as global growth surged behind the US centric housing mortgage bubble. This means the Yuan appreciated on the back of weak dollar.


Today, the US dollar has emerged as safehaven from ongoing credit prompted woes in Europe, hence, the Yuan’s appreciation arises out of the US dollar strength. Besides, in contrast to 2005 where global economy was running on full throttle based on a US bubble, today, emerging markets and Asia has reportedly done most of the weightlifting of the global economy out of the recession[16].


In my view, the attendant underperformance of developed economies is likely to attract even more of hot money flows into China, Asia and the Emerging Markets.

In addition, the gradual appreciation of the yuan amidst the lack of convertibility is likely to prompt for more the same bubble predicament.


The problem isn’t China’s alleged “currency manipulation”, instead it is the lack of convertibility or the freedom to convert local currency to foreign currency and vice versa. The lack of convertibility means that the pricing mechanism via concurrent exchange rate or monetary policies (e.g. monetary base) has been severely distorted from which creates arbitrage opportunities. Speculative money sees this and gets “smuggled in” through unofficial channels, which causes “huge surpluses”. Naturally, such policy contortions lead to malinvestments throughout the country’s economic structure.


In addition, having both the exchange rate and monetary targets, likewise create mismatches from which imbalances will ultimately be expressed via a crisis. This characterises the pegged currency regime. Contrary to public wisdom, a pegged currency and fixed currency framework are different.


A fixed currency, according to economist Steve Hanke[17] is either established by a currency board which “sets the exchange rate, but has no monetary policy — the money supply is on autopilot — or a country is "dollarized" and uses a foreign currency as its own. Under a fixed-rate regime, a country's monetary base is determined by the balance of payments, moving in a one-to-one correspondence with changes in its foreign reserves.


An example of the symptoms from imbalances of a pegged currency is China’s battle to control inflation and the subsequent reaction to appreciate the yuan following the failed attempts to arrest inflation.


Hence the lack of convertibility and the ramifications from conflicting goals of a pegged currency framework are likewise recipes to bubbles.


And one way to alleviate this dilemma is to engage in free market mechanism and to eliminate controls again, Mr. Hanke, ``Beijing should adopt a fixed exchange rate regime. This would force Beijing to dump exchange controls and make the yuan fully convertible. Such a "Big Bang" would muzzle the China-bashers and put Beijing in the driver's seat. After all, China would then have a stable, freemarket exchange-rate regime.


Considering the earlier or previous bubble policies, this is not going to be a painless solution.


But the point is, free markets operating under a under currency regime with free market mechanisms and without exchange controls will reduce, if not eliminate, incidences of bubbles.


But this isn’t likely to happen under a central banking system.


Therefore, China’s regime shift isn’t likely to do away with the formative bubble in process.


Conclusion


To conclude, China’s purported regime change is likely to result in an appreciation of Asian currencies, including the Philippine Peso.


This would be further amplified by the ongoing region’s trade integration. And the possible decoupling signs we seem to be witnessing today could likely be the evolving repercussions from China’s currency shift.


So unless we see further deterioration in the economic conditions of developed markets which would result to a liquidity squeeze, the effects of the China’s actions will likely be evinced positively in the region’s financial markets.


Therefore, like in our previous outlooks, the case of the China’s currency regime shift adds to why the Philippine Peso, Asian currencies and equity markets should a buy.


Nevertheless, China’s currency makeover doesn’t eliminate the ongoing bubble process.


Perhaps in the future we will deal with “buy what the Chinese buys, and sell what the Chinese sells” story.



[1] Businessweek, Greece Swaps Surge to Record, Signaling 68.5% Chance of Default, June 25 2010

[2] Economist Intelligence Unit ASEAN Exports Today, tomorrow and the high value challenge

[3] Wall Street Journal Blog, China Issues Statement on Yuan Exchange Rate Flexibility, June 19, 2010

[4] See Currency Values Hardly Impacts Merchandise Trade

[5] See Spurious Mercantilist Claims And Repercussions Of A Strong Chinese Yuan

[6] IMF, The Regional Economic Outlook, April 2010

[7] World Economic Forum, Enabling Trade in the Greater ASEAN Region

[8] See Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone

[9] See The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency

[10] Wikipedia.org, Plaza Accord

[11] Wikipedia.org, Lost Decade (Japan)

[12] Yahoo Finance, Currency Converter

[13] Economywatch.com, Philippines Trade, Exports and Imports

[14] Xinhuanet.com China to become 2nd largest trade partner of Philippines as recovery takes hold, December 30, 2009

[15] US Global Investors, Investor Alert, June 25, 2010

[16] See Another Reason Not To Bet On A 2010 'Double Dip Recession’

[17] Hanke, Steve H. The Dead Hand of Exchange Controls