``But the administration does not want to stop inflation. It does not want to endanger its popularity with the voters by collecting, through taxation, all it wants to spend. It prefers to mislead the people by resorting to the seemingly non-onerous method of increasing the supply of money and credit. Yet, whatever system of financing may be adopted, whether taxation, borrowing, or inflation, the full incidence of the government's expenditures must fall upon the public. With inflation as well as with taxation, it is the citizens who must foot the total bill. The distinguishing mark of inflation, when considered as a method of filling the vaults of the Treasury, is that it distributes the burden in a most unfair way, overcharging those who are least able to bear it.”-Ludwig von Mises The Truth About Inflation
I received 4 text messages and 2 telephone calls anew this week from different banking institutions offering me loans. This seems like a defining activity since the start of the year. I don’t recall of such persistency to promote access to credit even prior to the Asian Crisis in 1997.
Yet I assume that this could be a national dynamic. Nonetheless, I can’t help but associate the actions in the Phisix to such anecdotal evidence.
Obviously, the domestic banking system which functions as the primary source of funding, has only been responding to regulatory policies.
While we don’t have available national data yet as proof for our assumption, a prolonged accommodative monetary environment will imply further space for mass speculation and a greater degree of consumption growth-that is likely to be reflected on our economic statistics.
And this seems to be the case for Asia, see Figure 1.
Figure 1: Danske Weekly: Recovery Gets More Visible
As Danske’s Fleming Nielsen wrote in his Weekly Focus, ``June’s economic data confirmed that Asia is experiencing a pronounced upswing, with strong industrial production numbers across the board. Countries such as South Korea and Thailand, which were hit exceptionally hard by the global financial crisis, are seeing industrial production recover to pre-crisis levels at a surprising clip. There are also signs throughout Asia that domestic demand is picking up – especially private consumption, with rising retail and car sales in the past couple of months.” (emphasis added)
For us, aside from the government policies, such intense reaction has been a manifestation of the “anomalous” collapse in the last quarter of 2008, which had been due to the seizure in the US banking system which rippled globally- a shock we called as Posttraumatic Stress Disorder (PTSD) [see What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis].
Apparently the current actions in the financial markets and economic stats have strongly been validating our views.
Moreover, we see other national and regional quirks posing as significant influences that can electrify the pricing of regional financial assets.
As discussed in Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble, ``it is likely that high savings rate combined with loose monetary policies to induce speculation, fiscal stimulus applied, largely unblemished banking system, and low systemic leverage that has impelled a bidding war in the stock markets and commodity markets.”
The Growing Inflationary Bias Of Asia’s Markets
For the longest time we had been advocating that in a world of central banking and virtual free lunch money polices, bubble cycles emanating from these are likely to be imbued more by Asia and emerging markets since developed economies have debts that have been “hocked to their eyeballs”.
Doug Noland in his Credit Bubble Bulletin says the same, `` The most robust inflationary biases are today domiciled in China, Asia and the emerging markets generally. The debased dollar has provided China and the “developing” world Credit systems unprecedented capacity to inflate (expand Credit/financial claims without fear of spurring a run on their currencies). Asian and emerging markets are outperforming, exacerbating speculative flows. Things that the “developing” world needs (energy/commodities) and wants (gold, silver, sugar, etc.) should demonstrate increasingly strong inflationary pressures. Their overflow of dollars provides them, for now, the power to buy whatever they desire.”
And the transmission mechanism from US Federal Reserve policies into global assets have nowhere been more explicit see figure 2.
Figure 2: Stockcharts.com: US dollar Index’s Inverse Correlation
As we pointed out in Asia Sows The Seeds Of The Business Cycle, a breakdown in the US dollar index (USD) seem likely to propel a reacceleration of the asset bidding wars.
The USD indeed broke down last week which likewise brought many global stock market benchmarks to new post crisis highs (the Philippine Phisix nearly touched the 2,900 level). However, Friday’s announcement of the US unemployment data, which showed a modicum of progress, may have incited a USD short covering.
The fun part is identifying the apparently synchronized inverse correlation of oil (WTIC), Emerging Market stocks (EEM) and Asia ex-Japan (DJP2) where the crucial inflection point has been vividly demarcated in March (see the red horizontal line).
So those arguing on the basis of the traditional fundamentalist metrics seem to be looking at the wrong picture. Inflation appears to be increasingly the principal moving force behind the motions of the progressively interconnected global financial asset markets.
The Global Crack-Up Boom
Where financial markets once functioned as signals for economic transitions, it would now appear that financial markets have become the essence of global economies, where the real economy have been subordinated to paper shuffling activities.
What was once a feature dominated by the West, seem likely to get assimilated rapidly by the East as government policies appear to be directed at either juicing up or controlling the “animal spirits”.
Nonetheless today these dynamics have been “globalized”.
Proof?
We pointed out last week (see The Inflation Cycle Accelerates; Asia As Chief Beneficiary) how China has been dithering over the explosive rise of its stock and property markets wherein policymakers signaled intentions to rein the markets by restricting flow of credit. However, the violent response in the stock market compelled a retraction from authorities.
This week we see more of the same.
Publicly listed state owned China Construction Bank President Zhang Jianguo reportedly resolved to materially prune its credit expansion. According to Bloomberg ``the nation’s second-largest bank will cut new lending by about 70 percent in the second half to avert a surge in bad debt.”
The result had been the same, after a reaching a new high, China’s Shanghai Index crumbled over the last 3 sessions to end the week down 4.4%.
In the US, the path to serfdom continues, the Federal Trade Commission has issued new rules to ``crack down on fraud and manipulation that can drive up prices at the pump.” (Bloomberg) Oil prices which had been on a tear mostly reflecting on the US dollar’s earlier breakdown, had been tempered anew by the realized regulatory actions (more than just threats), aside from the sharp rally in the US dollar.
Still the WTIC rose by over 2% the week.
In the UK, the Bank of England (BoE) surprised the markets when it announced additional quantitative easing measures. This means that the central bank will be issuing ‘money from thin air’ to acquire domestic sovereign instruments (Gilt) as well as “high” quality corporate debt (Marketwatch). While directly such policies are aimed at propping up the financial system, implicitly it further implies support to financial asset prices. The British pound fell .21% over the week.
In anticipation of prospective inflation, Australia will be resurrecting issuance of inflation indexed bonds as a hedge. According to Bloomberg, ``Australia will sell its first inflation-indexed bonds in six years as record stimulus spending worldwide prompts speculation price increases will resume once the global recession ends…
``Asia-Pacific governments including Australia, Japan and Thailand had signaled they may sell inflation-linked bonds as improving economies threaten to boost the price of goods and services. Australia, which considered scrapping its bond market in 2003, boosted its debt outstanding by 67 percent to A$101.1 billion ($85 billion) in the year ended June 30, about 10 percent of its gross domestic product.”
The significance:
One, when government and financial claims grow more than real output or available economic resources the outcome is materially higher prices.
Two, governments are in a predicament, while they want to see sustained elevated or high financial asset prices, to give the impression of economic growth and to further unleash “animal spirits” or expand risk appetite, the demand from excessive money has also diffused into scarce economic resources which has compelled them to impose price controls [as previously discussed in The Inflation Cycle Accelerates; Asia As Chief Beneficiary].
Price controls will only cause arbitrages into markets that are more open, it would also reduce market pricing efficiency by distorting them and enhance shortages which would fuel more volatility.
Here, as expected governments are bent to deal with the symptoms than the cause. The superficial nature of policy actions enhances nurturing the bubble cycle.
Three, bubble affected economies will likely prompt for more borrowing (see figure 3) and more money issuance activities as signified by Bank of England’s QE or Secretary Tim Geithner’s request to the US Congress to expand debt limit to $12.1 trillion (HT: Craig McCarty).
As Doug Noland aptly observed of the inflationary pyramid being erected (from the same article), ``The deeply maladjusted U.S. “Bubble” economy requires $2.5 Trillion or so of net new Credit creation to stem systemic (Credit and economic Bubble) implosion. Only “government” (Treasury, agency debt, GSE MBS) debt can, today, fill the gigantic void created with the bursting of the Wall Street/mortgage finance Bubble. The private sector Credit system is severely impaired, and there is as well the reality that the market largely lost trust (loss of “moneyness”) in Wall Street obligations (private-label MBS, CDO, ABS, auction-rate securities, etc.). The $2.0 Trillion of U.S. “government” Credit creation coupled with the Trillion-plus expansion of Federal Reserve Credit over the past year has stabilized U.S. financial and economic systems.” (emphasis added)
Figure 3: Bloomberg Chart of the Day: Addiction To Debt
The above chart shows that in the US it now takes about $4 dollars of debt to generate $1 of economic output (left window), while debt to GDP ratio has soared to 372%, which is clearly unsustainable.
Yet the policy direction is assuredly headed towards engaging in more borrowing and issuance of paper or digital money. Recently the US extended $2 billion “cash for clunkers” program which incentivize people to replace old cars with new ones supported by government subsidies (Bloomberg) is another example of debt addiction.
As Ludwig von Mises warned, ``But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a ‘crack-up boom’ and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis." (emphasis added)
The end result would likely be a nasty choice between that of market compelled deflation or hyperinflation.
The institutional bank run in the US that triggered the 2008 meltdown (in financial markets and global trade) was a classic example of the near “collapse of the credit system”.
In short, what is unsustainable won’t last. Artificial measures will only aggravate the imbalances.
In sum, all these account for the phenomenon known as the “crack-up boom” applied on a globalized scale.
Hence a bubble based boom equals a prospective bubble bust and another crisis down the road. So relish the fun while it lasts.
Interim Pause, The Bubble Blowing Dynamics At Least Until The 2010 Elections
Friday’s torrid bounce in the US dollar index could signify as a worthwhile pause for the vastly overheated Asian-Emerging Market stock markets (see figure 4)
Figure 4: US Global Investor: Asia Technically Overbought
According to US Global Investors, ``For the first time since mid-1999, stocks in emerging Asia are trading at more than 35 percent premium to the 200-day simple moving average, an overbought condition which historically has resulted in sizable corrections in the following months.”
So if this should hold true, then a correction would likely be in the range of 10-20%.
Nonetheless we can expect any material decline would likely be met by anxious officials who would hastily act to restore boom conditions.
Remember, in today’s era where policies are skewed towards favoring paper shuffling activities and where the financial sector acts as the principal growth engine of the economy, rising prices are construed as the norm (for statistical purposes) regardless of the substance of the growth. So lofty prices in financial assets will likely be the undeclared policy thrust.
Nevertheless in a bull market hiatus, which is likely a function of profit taking than policy reversals, declines are less likely to move in tidal fashion, as some stocks may generate speculative attention because the marketplace would continually seek for yields in response to the loose monetary environment.
And applied to the Philippine Phisix, foreign buying, which has largely been absent for most of the first semester of the year, appears to have returned. For three successive weeks, we have seen a net buying from foreign funds in both nominal terms and in the broader market.
So the recent approach towards the 2,900 level could be interpreted as the bidding up of Philippine stocks compounded by foreign buying as we had been expecting. In Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble, we said, ``So renewed interests from foreign investors on emerging markets are likely to even propel stock prices to higher levels! We should see the same dynamics reinforced locally. This time it will probably be foreigners chasing stock prices.”
Nonetheless, foreigners entering the local market appear to have been responding to the decline of the US dollar index.
If the US dollar is expected to fall further especially against Asian currencies then such dynamics are likely to be sustained. This would function as an important support to key components of the Phisix which also means a cushion from any major correction.
Figure 5: PSE: Share of Foreign Trade
Yet, despite this foreign trade improvement, the shape of today’s rally has departed from the 2003-2007 paradigm, where this time, local investors have powered the market as shown in Figure 6. Foreign trade from the start of the year have seen only occasional bouts where it gone beyond the 50% level which characterized the previous run.
At the end of the day, domestic policymakers will also want to see such trend persist going into the local national election season, as this would boost the odds of reducing the negative rating of the incumbent President PGMA thereby improve the chances for her appointee during the national election derby.
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