Sunday, April 03, 2022

Symptoms of Crony Capitalism: How the BSP’s Zero-Bound Regime Fueled Historic Pumps and Dumps of March

 Free markets depend on truth telling. Prices must reflect the valuations of consumers; interest rates must be reliable guides to entrepreneurs allocating capital across time; and a firm's accounts must reflect the true value of the business. Rather than truth telling, we are becoming an economy of liars. The cause is straightforward: crony capitalism—Gerald P. O'Driscoll Jr. 

Symptoms of Crony Capitalism: How the BSP’s Zero-Bound Regime Fueled Historic Pumps and Dumps of March

 

The Monetary Aspects of Crony Capitalism 

 

Inquirer, March 31: With President Rodrigo Duterte as its chief executive, the Philippines remained among the countries where crony capitalism — where a few favored businessmen close to the government enjoy more economic advantages than others — has been flourishing. The Economist’s latest crony-capitalism index showed that the wealth of billionaires in the Philippines surpassed 10 percent of gross domestic product (GDP) in 2021. As a share to GDP last year, nearly a tenth were wealth generated in sectors regarded as crony-friendly. The Economist defined crony sectors as “a host of industries that are vulnerable to rent-seeking because of their proximity to the state, such as banking, casinos, defense, extractive industries and construction.” 

 

 

Figure 1 

 

Dragged down by -1.47% in March, Q1 returns of the headline index slid to a mere 1.13%. 

 

Rent seeking, according to investopedia.com, is an economic concept that occurs when an entity seeks to gain wealth without any reciprocal contribution of productivity. The term rent in rent seeking is based on the economic definition of “rent,” which is defined as economic wealth obtained through shrewd or potentially manipulative use of resources. 

 

Yet, the PSEi 30 registered an unparalleled frequency of pre-closing pumps (mostly) and dumps (some) in March 2022. (March 3 and 4 pumps not included in the diagram) 

 

In short, manipulating prices shaped or dominated the road to 7,203 last March. 

 

Such incredible scale and frequencies of pumps and dumps signify a massive transformation of the PSE. 

 

How is this related to crony capitalism? 

 

For the mainstream, the visible links to cronyism are the direct economic relations or interactions with the government through (rent-seeking) political projects: "a host of industries that are vulnerable to rent-seeking because of their proximity to the state, such as banking, casinos, defense, extractive industries and construction." 

 

There are invisible channels as well. 

 

Cui bono? 

 

The monetary policies of the central bank are political actions. It is an avenue to redistribute finances via mandates and regulations to the banking and financial industry. 

 

For the BSP, keeping assets elevated serves several policy purposes.  

 

First, it keeps away the dreaded "deflation," which may imperil the banking system.   

 

Next, it also promotes "trickle-down economics," where consumption spending of the wealthy is supposed to get converted into jobs and development. (Tetangco, 2015). Another term for trickle-down is the wealth effect. 

 

Third, through negative "real" rates, such policies implicitly channel the transfers of resources from savers to borrowers, popularly known as Financial Repression 

  

Fourth, bailing out a distressed financial system can be implemented through such policies.  

 

This premise applies to the current conditions.  

 

Figure 2 

 

For instance, aside from low rates, the record Php 2.2 trillion injections to the financial system bailed out the PSEi 30.  

 

The full market capitalization of the members of the PSEi 30 expanded by Php 3.89 trillion from the nadir of March 2020 to April 1, 2022.  How's that for a bailout? At whose expense? 

 

How Central Bank Policies Engender and Nurtures Cronyism 

 

Zero-bound rates redistribute credit favoring the wealthiest, who may command cheaper rates through the economies of scale.  

 

Owned by the top elites, firms of the PSEi 30 are among the nation’s largest borrowers. 

 

Furthermore, the elites are also the owners of the banking industry. Aside from lending operations, banks are likewise the largest borrowers.  

 

Low borrowing rates enable and facilitate firms of the elites to expand horizontally through acquiring competition or expand vertically through investing in upstream or downstream industries.  

 

Low borrowing rates enable and facilitate the concentration of the industry or lead to monopolization. Instead of expanding through internal means, elite companies go on a merger and acquisition spree for growth. 

 

See Jollibee’s Fantastic Paradigm Shift: From Consumer Value to Aggressive Debt-Financed Pacman Strategy, March 3, 2019 

 

Low borrowing rates enable and facilitate the same firms to buy back shares of their companies to either support or boost share prices. 

 

Higher share prices may increase collateral values, which may be used for more leveraging or swapping of assets for either internal financing or expansion.  

 

The firm with the largest market cap recently acquired an energy firm through a share swap. 

 

Low borrowing rates also encourage high-risk activities, such as excessive speculation, overtrading, misconduct, and fraudulent behavior. 

 

As historian Charles Kindleberger wrote, "The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom. Crashes and panic, with their motto of sauve qui peut, induce still more to cheat in order to save themselves."* 

 

*Charles P. Kindleberger, Chapter 5, The Emergence of Swindles, Manias, Panics and Crashes, Third Edition, p .66 John Wiley and Sons 

 

The takeaway: the political-economic elites acquire wealth through political subsidies also channeled through monetary policies, amplifying their competitive advantage over smaller and less politically connected competitors. 

 

Because such subsidies are hardly about enhancing productivity but securing strategic advantages, firms of the elites seem to qualify as rent-seekers or "crony capitalists." 

 

Crony Capitalism or Economic Fascism are Anti-markets, The Consequences of Distortions 

 

By the way, crony capitalism, also known as economic fascism, is a form of socialism/collectivism.  

 

Wrote economist Richard Ebeling**, (bold added) 

 

What is sometimes called “crony capitalism” is just Pareto’s “bourgeois socialism.” Pareto also understood, in the 1890s, with amazing clarity one of the insights of modern Public Choice theory, that “participatory democracy” of the community as a whole is a theoretical and practical illusion in an complex society. Politics in an unrestrained democracy always becomes a contest among special interest groups capable of gaining concentrated benefits from State intervention and redistribution at the diffused expense of the rest of the society.  

 

**Richard M. Ebeling "Liberal Socialism" — Another False Utopia, August 28, 2017, Mises.org 

 

Unfortunately, political allocations of finances and credit subsidies foster unsustainable systemic imbalances. 

 

As the late great dean of the Austrian school of Economics, Murray Rothbard explained***: 

 

Subsidies prolong the life of inefficient firms and prevent the flexibility of the market from fully satisfying consumer wants. The greater the extent of government subsidy, the more the market is prevented from working, the more resources are frozen in inefficient ways, and the lower will be the standard of living of everyone. Furthermore, the more government intervenes and subsidizes, the more caste conflict will be created in society, for individuals and groups will benefit only at one another’s expense. The more widespread the tax-and-subsidy process, the more people will be induced to abandon production and join the army of those who live coercively off production. Production and living standards will be progressively lowered as energy is diverted from production to politics and as government saddles a dwindling base of production with a growing and more top-heavy burden of the State-privileged. 

 

***Murray N. Rothbard, CHAPTER 12—THE ECONOMICS OF VIOLENT INTERVENTION IN THE MARKET, Man, Economy, and State with Power and Market, p. 942; Ludwig von Mises Institute, Scholar’s Edition   

 

Figure 3 

 

In sum, pumps or dumps, a form of price control, distort the price signals of shares of the publicly listed firms at the PSE, which also affects the indices represented by these.  

 

The skewed distribution of the index, overvalued assets, mounting leverage, and false price signals emitted to the economy that drives economic allocations signifies the massive scale of malinvestments from such distortions. 

 

 

Yours in Liberty, 

 

The Prudent Investor Newsletters 

 

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Notice:  This newsletter is intended to apprise readers of the market conditions based on the information available at the time of the items’ writing, whose accuracy and timeliness of the issues concerned are subject to change without prior notice.  The contents of the newsletter are not expressed solicitation to trade and that the positioning on particular issues discussed merely reflect the opinions of the writer. 

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