Additions to History Is not a Closed Book

In reply to a comment from a reader, I'd like to make additional clarifications.

Age of Derivatives.

According to BIS, derivatives turnover has reached $431 trillion in October to December alone. According to Financial Week, the notional amount of outstanding OTC (over the counter) was $370 trillion for the first half of 2006 alone. OTC means these are private contracts and are unregulated by authorities.

In addition derivatives is a financial instrument “derived” from some other underlying securities.

Our global economy is only about $45 trillion, while estimated global capital stock is $143 trillion which means derivatives are about 7 times global economy or three times global capital stock.

Since derivative contracts should "derive" from collaterals of other securities this means that the world is 3 times as much leveraged than existing global capital stock.

As Lord Rees Mogg says “Now we have a fashion for high leverage – in derivatives, in private equity and in hedge funds. The global financial system has spread its sails. The momentum is awe-inspiring. There is less transparency than there used to be – investors do not understand derivatives; hedge funds are less transparent than old fashioned investment businesses; private equity is less transparent than public companies.”

While derivative products are meant to reduce risk by diffusion, they do not imply a risk free environment, to quote Kevin Warch, member of the board of Governors of the FED in his speech on Market Liquidity Definitions and implications, ``Even the most sophisticated financial products are not immune to the physical Law of Conservation of Matter – the risk must rest somewhere.”

Well, Warren Buffett, from his personal experience, thinks that Derivatives are a menace and even labels them as Financial Weapons of Mass Destruction.

Keynesians and inflationary policies.

When we say no country wants a strong currency, it means that in order to preserve or gain from the market’s export share, countries’ tend produce or “manipulate” far more money relative to that which is required for economic growth.

For example, if EU’s GDP growth is at 2.5% and money growth is 9.8%, effectively you are seeing a greater supply of money relative to demand. And when supply is larger than demand effectively you reduce the value of the goods or services which is in surplus, such is Economics 101.

The problem here is that all countries are engaged in mass money production and such is the reason why Gold, which is neutral currency, has progressed relative to ALL major currencies and such is the reason why you also see rising consumer prices all over the world.

Best explained by Paul Van Eeden ``When we understand that monetary inflation means an increase in money supply and that an increase in money in money supply causes a devaluation of all the money outstanding we can make sense of the world even as economists, journalists and politicians attempt to obscure the truth.”

You can read more of about this through his link.
http://www.paulvaneeden.com/pebble.asp?relid=506

Even John Maynard Keynes, in his The Economic Consequences of the Peace (1919) piece acknowledges the dangers of monetary inflation or “no country wants a strong currency” phenomenon, ``There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

Yet practicing Keynesians (or government interventionists) believe that savings is not an applicable function today simply because they think they are fungible (transferable to assets) and governments will always be the buyers or liquidity providers of last resorts.

As evidence we cite Wharton’s famous Jeremy Siegel, ``Could they precipitate a crisis? Not with the Fed on top of it. The Fed can diffuse any crisis. If everyone gets on one side of the market and things are out of control, the Fed is the ultimate source of liquidity. I think that they can prevent that from spinning out of control.”

Oh, am not Keynesian, as I mentioned, I lean on the Austrian School of Economics persuasion, where real savings matter.

Moreover into currencies, while one may think that the world is trying to “stabilize fluctuations”, what appears to be is not what is. Do you know that Warren Buffett, Bill Gates and George Soros have all bet against “stability” such that they understand the risks of a potential US Dollar Crisis? All the imbalances chatters seem to stem from one source, today’s US Dollar Standard system or Fiat/Paper money system.

Japan and Selective Arguments

The reason I made a comparison on Japan is that self-righteous arguments present only one side of the coin, as earlier explained as cognitive biases. For a balanced view, I injected a broader dimension which considered the suicide rates, credit rating and more importantly demographic trends. The intent is to show a BIGGER picture.

Yes, while I agree that Japan is a homogenous society, investors look to the FUTURE to position for returns. And we understand that economies will NOT thrive under a population that is NOT growing, NOT increasing its TAX base and ECONOMIC base to quote analyst John Maudlin. Therefore, demographic trends will mean a CHANGE in the societal structure of the Japanese in order to maintain their economic weal. What used to be will not be.

As I earlier argued CHANGE is the defining structure of today’s economic landscape from which investors should pay heed to. You may read more about demographic trends in UN’s Replacement Migration.

With regards to India, I’ve said my case.

On Rapid Population Growth

The problem of rapid population growth is not the growth per se. It is the inability of investments to keep up with the pace of its growth, which leads to productivity loss.

In today’s world, aggregate investments are low compared to the past, according to the IMF. And we simply see an upswell of financial markets relative to global GDP which means people are deploying capital derived from thin air to outright speculations rather of direct “productive” investments, hence the global imbalances.

In addition, the context of rapid population growth straining resources has been a longstanding Malthusian argument. To quote Elliot Gue, of the Energy Letters, ``Nevertheless, Malthus’ prediction has proven spectacularly incorrect in the two centuries since his Essay on Population was published. While the global population has continued to grow at the geometric, accelerated pace that Malthus projected, food production also rapidly accelerated after 1750 to more than keep up with that growth. The UK’s population exceeded 17.5 million by 1850 and topped 60 million by the latter part of the 20th century. More importantly, the total world population is at least six times what it was when Malthus penned Essay on Population. Not only has the population increased but so, too, has the consumption of food per capita.”

In other words, today’s commodity cycle has not been solely driven by the dynamics of growing population but of the dynamics of RISING purchasing power from a BROADER base of population. Again Elliott Gue says it best (emphasis mine),

``The United Nations predicts that by 2050 the global population will rise from the current six billion to exceed nine billion, with 5.2 billion living in Asia. Clearly, a growing population spells more demand for all sorts of food. But population growth in Asia plays only a tiny role in the boom in demand for food already apparent in the region. A far more important factor is rapidly rising Asian incomes and the emergence of a middle class. As nations develop and consumers become wealthier, food consumption patterns change. Not only do consumers eat more food, they tend to eat more meat and greater quantities of packaged and processed foods. Income is not the only determinant in these shifts--local tastes, religious practices and regional supplies certainly have an effect--but it is the primary factor behind differences in food consumption between countries and shifts in diets over time.”

I hope this helps.