Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux)

Early December, my daughter went with her cousins to watch a movie at one of the long established popular mall. I went to fetch my daughter after. And as we exited the mall, my wife’s relative made a striking remark, “This is strange. It’s December. But the crowd seems distinctly sparse compared to last year.”

Such observation doesn’t seem to meld with the overall atmosphere which is supposed to showcase an economic boom. Thus my initial intuitive response was to ignore this, thinking that perhaps this had been merely been a mall and time specific quirk.

And given the holiday ambiance, I didn’t have the motivation to pursue further research on this fresh micro perspective. Yet somehow, her piquant observation stuck into my mind: has there been a shopping mall bubble in the Philippines?

The perspective of the shopping mall bubble got rekindled and reinforced when I came across an article which narrated of the demolishment and of the impending deconstruction of some shopping malls in the US.

It dawned on me that the Philippines could be faced with a real risk of a shopping mall bubble bust. So I delved further.

Shopping Malls have not just been a way of life for the Philippines.

Instead, the Philippines have become the shopping mall mecca of the world, hosting 9 of the world’s largest 38 malls, according to Wikipedia.org[1]. The Philippines essentially beat the US and China or any developed economy for that matter.

Moreover, the Philippine international marquee malls are mostly located in the Metro Manila area. To consider, these 7 Metro Manila establishments are collectively larger than the combined 8 biggest malls in the US, considering that on a per capita basis[2], the US has $48,112 (World Bank 2011) or $48,328 (IMF 2011) which dwarfs the Philippines at $4,1119 (World Bank 2011) or $4,080 (IMF 2011).

And we are just talking of the largest malls, which are manifestations of the broader picture/pathology: a shopping mall bubble. There are countless of smaller scale malls which compete for the same peso from the Filipino consumer.

Aside from the publicly listed SM and Ayala, other competitors[3] are publicly listed Robinsons, Gaisano, Megaworld Lifestyle, Walter Mart Malls, Ortigas Malls, Starmalls, Greenfield Development, the NCCC Mall and many more

In short, while the public has been mesmerized by financial and economic growth prospects from a supposed ‘consumption economy’, nobody seems to even question the basic economic premises: How can a consumption based economy be sustained?

Everybody has been made hardwired or brainwashed to believe that consumption has been an incontrovertible ‘given’ or a fact. Nobody dares question the limits of the Philippine consumer.

This reminds me of the logical fallacy of the proof of assertion[4] embodied by Vladmir Lenin’s famous quote “A Lie told often enough becomes the truth”

And the behavioral reason why people readily embrace myths is the intuition to seek certainty via ‘cognitive ease’ or ‘coherence’

As Nobel Prize winner Daniel Kahneman explains[5],

An unbiased appreciation of uncertainty is a cornerstone of rationality-but it is not what people and organizations want. Extreme uncertainty is paralyzing under dangerous circumstances, and the admission that one is merely guessing is especially unacceptable when the stakes are high. Acting on pretended knowledge is often the preferred solution.

Thus political agents and their academic and institutional accomplices has mastered on how to indoctrinate society via plausibly coherent but false theories which essentially feeds on the bubble mentality.

But basic economics suggests that the rate of Shopping Mall boom relative to consumer spending or demand seems unsustainable.

ON the demand side, based on the consumer spending trend chart from Tradingeconomics.com[6] (sourced from National Statistics Coordination Board) from 1998 to early 2012, the average growth rate has been about plus or minus 6%.

ON the supply side, which is guesswork on my part—based from past growth rates, estimates on future growth rates and capex announcements of some the largest malls, perhaps we can deduce that the Philippine shopping mall industry operate on a baseline rate of 10%.

In 2012, SM Malls in the Philippines expanded by 10% according to SM Investment’s 3^rd Quarter media and analysts briefing presentation[7] (based on Gross Floor Area).

Yes, SM [PSE: SM] has exposure to China which we exclude from this analysis.

In 2010, in a speech[8] by Teresita Sy-Coson, eldest child of magnate and SM founder Henry Sy Sr., Ms. Coson noted that SM malls have grown from 23 in 2005 to 37 in 2010 or an average growth rate of 12%.

In addition, SM Investment’s reported capex which will fund shopping mall and other property projects has been slated to increase[9] by 16% to Php 65 billion in 2013 from Php 56 billion in 2012.

So the SM group will likely expand their shopping mall business at the baseline rate of at least 10%.

On the other hand, Ayala Land [PSE:ALI] will like raise capex to SM levels.

Ayala has reportedly been targeting a capex of P70 billion in 2013 from the original target of P37 billion due to “unbudgeted property acquisitions”, according to the Manila Standard[10]. Of the Php 34.9 billion capex for 2012, 11% has been allotted for shopping malls.

Ayala’s “unbudgeted property acquisitions” reveals of the current accelerated pace of snapping or bidding up of land areas to increase inventory for prospective development. Property developers seem to be in a frenzied pace of momentum land acquisition.

Robinson’s Land Corporation [PSE: RLC] has also reported an increase shopping malls by 11%, that’s according to their analyst briefing last August 15 2012[11]. The planned mall expansion will translate to over a million of sqm of Gross Leasable Area (GLA) [see right window]. This has been backed by a reported Php 20 billion in capex[12] over two years, which does not cover the $1 billion gaming complex recently concluded partnership with Japanese gaming tycoon Kazuo Okada. 

The bottom line is that from the supply side perspective, major malls, as benchmark for the industry’s growth, seem to have set the 10% level as the baseline growth for the retail shopping mall industry.

If the rate of supply grows faster than the rate of demand then eventually we will have an oversupply, Economics 101. Applied to the above, theoretically, if consumer spending demand grows at a sustained rate of 6% per year, while supply swells at a constant 10% over the same period, then, whether you like it or not, there is bound to be an oversupply and the consequential undesirable effects that go along with it.

And at the rate of 6% growth, Filipino consumers would need to nearly double consumption in the hope to fill in such a chasm. This means we should expect a miracle in productivity growth in the domestic real economy and in the global economy (to increase the rate of remittances from our OFWs). This may well be a delusion considering that this government, like all the rest, seeks every opportunity to tax away productive opportunities.

The other means is to resort to the depletion or of the running down of savings rate, and or by massively resorting to the use of credit, which represents the frontloading of consumption at the expense of the future.

Of course, foreigners may be lured to compliment spending, but this will still remain small given current political environment.

As I recently posted on my blog[13], (italics original)

The current shopping mall boom will not only depend on a sustained low interest rate environment but will likewise depend on the greater rate of growth of income—via economic output from both formal and informal economy and from remittance transfers—relative to rate of growth of supply of malls. Debt will temporary augment spending, but has its limits.

Once supply of malls grows faster than the consumer’s capacity to spend (income and debt), then trouble lies ahead.

I don’t know yet how much of the banking industry’s loan portfolio are exposed to these malls. But given that the Philippine retail industry from which the shopping malls are categorized, accounts for approximately 15% of the domestic economy and 33% of the service sector and employs some 5.25 million people, representing 18% of the Philippines' workforce (according to Wikipedia.org), there is a possibility of significant exposure.

This also implies that shopping malls will be faced with stiff competition among themselves. While this should be a good thing since competition should mean lower rental prices and provide more quality services, unfortunately the policy induced boom has clouded the effects of competition—giving the incentive for both consumer and investors to jump on the debt bandwagon which magnifies on such errors.

It’s one thing to have bankruptcies as a result of failing to satisfy the consumers via competition, and it’s another thing when the public has been enticed to a cluster of business errors (malinvestments) which accrue from price signaling distortion brought upon by manipulated policy rates and from other forms of policy interventions.

Once the tipping point has been reached where an oversupply becomes apparent, and where markets begin to awaken to such economic reality, then we are likely to see an increase in bankruptcies at the margin. Smaller malls are likely to suffer first.

If such insolvencies are funded merely be cash flows from retained earnings or from equity, or from bond markets then this won’t be much of a problem because the impact would likely remain isolated. Those who will suffer the losses would be the shareholders of the malls or bondholder-non bank creditors.

However, it’s a vastly different story when these projects are bankrolled by debt from the banking system as repercussion to artificially low interest rate regime, and or, if bonds used to finance shopping mall expansions have used as collateral to acquire related or non-related loans, and or, if such liabilities have been acquired or held by banks in their balance sheets.

The likely consequences will be a contagion via an increase in the number of foreclosures, a tightening of lending standards, calling in of loans, negative feedback loop via sharp downside adjustments in prices of equities and collateral values and higher interests rates or a chain link of effects from a bursting bubble as accurately identified by the late economist Irving Fisher as debt deflation[14] (italics original)

(1) Debt liquidation leads to distress setting and to

(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes

(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be

(4) A still greater fall in the net worths of business, precipitating bankruptcies and

(5) A like fall in profits, which in a " capitalistic," that is, a private-profit society, leads the concerns which are running at a loss to make

(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to

(7) Pessimism and loss of confidence, which in turn lead to

(8) Hoarding and slowing down still more the velocity of circulation.

The above eight changes cause (9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.

And such ensuing bubble bust will likely hit the banks, malls and the property hardest, but the negative effects will spillover to consumer spending too, aside from the business channels, the transmission mechanism will be felt through labor via rising unemployment, falling wages and restrained access to credit.

However, instead of a swelling of the US dollar, as noted by Prof Fisher, we will likely encounter capital flight and a meltdown of the local currency, the Peso, ala the 1997 crisis.

Again, all these will depend on the degree of leverage by the industry, and or, of their exposure to the banking system.

Finally, shopping malls exist to serve the consumer, and thus, are subject to the market discipline of profits and losses.

This also implies that programs undertaken by malls to draw in crowd, signifies as means to an end—serving the consumer through sales of goods and services—where the social benefits of ‘assembly’ or ‘gathering’ are ancillary.

No shopping malls exist to provide free lunches unless these are subsidized from other more profitable lines of other businesses by the same company, or as redistribution from social policies via the taxpayer funding.

Let me be clear: This is NOT to say that the current inflation of the shopping mall bubble will extrapolate to a BUST tomorrow, perhaps not in 2013 yet.

Rather this is to say that IF the current trend (or growth rate) of the industry persists without substantial improvements in the demand side via real economic growth—and not statistical growth from government spending or zero bound rates or credit expansion, then economic imbalances will continue to mount or worsen which essentially increases the risk of a bubble bust sometime ahead.

Prudent investing means that we should scrutinize at potential risks instead of swallowing mainstream disinformation hook, line and sinker.

I end this article with a poignant warning from French social psychologist, sociologist and author[15] Gustave Le Bon on paying heed to the wisdom of the Crowd[16] 

The masses have never thirsted after truth. They turn aside from evidence that is not to their taste, preferring to deify error, if error seduce them. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusions is always their victim.

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[1] Wikipedia.org List of largest shopping malls in the world

[2] Wikipedia.org List of countries by GDP (PPP) per capita

[3] Wikipedia.org List of shopping malls in the Philippines

[4] Wikepedia.org Proof by assertion

[5] Daniel Kahneman Thinking, Fast and Slow Farrar Straus and Giroux p 263

[6] Tradingeconomics.com PHILIPPINES - NATIONAL STATISTICS

[7] SM Investment Corporation 3^rd Quarter Media and Analyst Briefing Presentation

[8] Teresita Sy-Coson Keynote Address Philippine Stock Exchange 06 May 2010

[9] Manila Standard Today SM Group allots P65b in 2013, November 9, 2012

[10] Manila Standard Today Ayala Land increases capex target to P70b November 12, 2012

[11] Robinson’s Land Corporation QUARTERLY INVESTORS’ BRIEFING August 15, 2012

[12] Philstar.com Robinsons Land sets P20-billion capex for 2 years, January 7, 2013

[13] See A Philippine Shopping Mall Bubble? January 7, 2013

[14] Irving Fisher THE DEBT-DEFLATION THEORY OF GREAT DEPRESSIONS St. Louis Federal Reserve

[15] Wikipedia.org Gustave Le Bon

[16] Gustave Le Bon The Crowd: A Study of the Popular Mind, Google Books Page 53

Contagion Risk: Watch for China’s Catastrophic Deleveraging

Dee Woo at the Business Insider has an insightful analysis on why we should continue to keep vigil on China’s banking and financial system. (bold emphasis mine)

China’s policy makers have been caught in a dangerous bind.

1. The frustrated and aggressive central bank

If one wants to know how bad the health of China's economy has gone, look no further than the PBOC's composure, which seems rather frustrated and aggressive as of late. On 5th July, the central bank cut benchmark interest rates for the 2nd time in less than a month. This happened right after the fact that in December 2011, PBOC cut the reserve requirement ratio(RRR) by a 50 bp to 21%, it followed up with another 50 bp in February and another 50 bp in May to 20% currently.

On top of all the rate cuts, PBOC also made its biggest injection of funds into the money market in nearly six months. The PBOC injected a net 225 billion yuan ($34.5 billion) through the reverse-repurchase operations(repo) on last Tuesday and Friday, following a combined injection of 291 billion yuan in the previous four weeks.

2. The systematic short-circuit of debt financing's in order

So why PBOC is in such an urge to open the floodgate of liquidity? This economist will spare you the boredom of looking at the diagrams of China's economic misery: HSBC PMI, etc, since you can find those eye candies everywhere else on the web. Let me cut to the chase: However high it aims, PBOC's action in practice merely work as the band aid to the bleeding economy. But it won't be able to fix it. The central bank's aggressive pro-liquidity maneuvers at best serve to sustain the over-leveraged economy and avoid the systematic short-circuit of debt financing. Now allow me to divulge:

The main drivers of China's debt financing,China's state-owned banks, are starving for cash. According to Citigroup estimates, in 2011 seven of the biggest Chinese banks raised 323.8 billion renminbi ($51.4 billion) of new fund. Several financial firms are expected to raise another $17.7 billion in the next few months, with China’s fifth-biggest lender, the Bank of Communications, accounting for $9 billion. The unprecedented lending binge encouraged by the central government,increasingly rigorous requirement of regulatory capital and excruciating maintenance of excessive dividend payouts have rendered the most-profitable banks in the world--Chinese banks--in a rather precarious position.

GaveKal's data will illustrate this is no exaggeration: In 2010, China’s five biggest banks — the Big Four plus the Bank of Communications — paid more than 144 billion yuan in dividends while raising more than 199 billion yuan on the capital markets. The ballooning balance sheet caused by the loan frenzy and strict capital requirement make China's banks' cash-craving burning at both ends:this march, China’s big four— Industrial and Commercial Bank of China, the Bank of China, China Construction Bank and Agricultural Bank of China — have a combined 14 percent increase in total assets, to 51.3 trillion yuan, which is roughly the size of the German, French and British economies combined.

Meanwhile, under a new set of rules, the country’s biggest banks will need to increase their capital levels to 11.5 percent of assets by the end of 2013.Their core Tier 1 capital ratio will need to be at least 9.5 percent. These requirements are more stringent than the rules that apply to American and European banks. Hereby, we shouldn't be surprised why the world's most profitable banks are in the dire need of cash. It has to be PBOC who comes to the rescue.

Diminishing returns of China’s inflationism…

According to the great Ray Dalio's principles, the credit-fueled China's economy is so over-leveraged that a great de-leveraging is going to be the only way out. The pyramid of debt/credit is cracking and will collapse since the conditions of underlying economic agents are deteriorating.There's no mount of monetary band aids that can alter that destiny.

According to Fitch’s data, the ratio of total financing/GDP in China rose from 124% at end‐2007 to 174% at end‐2010, and rose by another 5pp to 179% in 2011.In 2012 the growth of broad credit will slightly decelerate but still outpace GDP. Clearly China is not suffering a liquidity crisis but the diminishing economic return on credit. According to Fitch, in 2012, each CNY1 in new financing will yield ￥0.39 yuan in new GDP versus ￥0.73 yuan pre-crisis.Returns would have to rise above ￥0.5 yuan for domestic credit/GDP to stabilize at 2011’s 179%.

The dilemma is that business entities will need more and more credit to achieve the same economic result, therefore will be more and more leveraged, less and less able to service the debt, more and more prone to insolvency and bankruptcy. It will reach a turning point when the increasing number of insolvencies and bankruptcies initiate an accelerating downward spiral for underling assets prices and drive up the non-performing loan ratio for the banks.

And then the over-stretched banking system will implode. A full blown economic crisis will come in full force. The chain of reaction is clearly set in the motion now. The question is when we will reach that turning point. What PBOC has done is only adding fuel to the fire because it is unable to tackle the root causes of China's economic ills.

Again interventionism will require more interventionism. Yet interventionism via inflation is a policy that will not and cannot last. Has China reached that moment?

More, insufficient savings to tap for bank recapitalizations…

Let's examine the structural reasons that China's domestic demand will have its work cut out to refill the tank space of the economic growth left out by collapsing investment and export:

1st, Contrary to what many choose to believe, China's trade surplus is not caused by Chinese consumers' high saving rate, but has much to do with their deteriorating disposable incomes which far lag behind GDP growth and inflation. According to the All China Federation of Trade Unions (ACFTU), workers' wages/GDP ratio have gone down for 22 consecutive years since 1983. It goes without saying that the consumption/GDP ratio is shrinking all the while.

Meanwhile, Aggregate Savings Rate has increased by 51% from 36% in 1996 to 51% in 2007. Don't jump to your conclusion yet that Chinese consumers has been over-tightening their purse strings. The truth is far away from conventional perceptions: according to Development Research Center of the State Council's report, that increase is mainly driven by the government and corporations and not by the household. For the past 11 years, Household Saving Rate has only increased from 19% to 22%. Even India's Household Saving Rate of 24% is higher than China's right now.

All the while, government and corporations' saving rate has increased from 17% to 22%, which accounts for nearly 80% of the increase on Aggregate Savings Rate. For the past decade, Government's fiscal income is growing faster than GDP or Household Income. In 2009, the fiscal income was 687.71 billion yuan, and achieved an annual growth of 11.7% while GDP growth was 8.7%, Urban household disposable income growth was 8.8% and agriculture household disposable income growth was 8.2%. It is obvious that the state and corporations has taken too much out of national income and hence they continue to weaken the consumers rather than empower them.

All inflationism is deceptively about self-serving politics…

The biggest problem for China is the state, central enterprises and crony capitalists wield too much power over national economy, have too much monopoly power over wealth creation and income distribution, and much of the GDP growth and vested interest groups' economic progress are made on the expanse of average consumers stuck in deteriorating relative poverty. If these problems aren't solved, the faster the Chinese GDP growth, the less Chinese consumers will be able to support the over-capacity expansion, the more export momentum China will need to sustain its growth. This is a vicious circle of global imbalance. Even the revaluation of RMB can't break it.

Read the rest here

To recall the admonitions of the great Professor Ludwig von Mises against Keynesian policies…

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.

Will China's policymakers ease on bank capital regulations? Or will China's authorities opt to finance these through PBoC's money printing that increases the risk of hyperinflation? Or will China be forced to deleverage? Many questions that has yet to be answered.

Be careful out there.

Is China Suffering from Bank Runs too?

Writes the Zero Hedge, (bold highlights original)

The balance sheet recession that seems to have correctly diagnosed the problem facing Japan (and now Europe and the US) - explicitly causing debt minimzation as opposed to profit maximization - seems to be taking hold. However, it appears this death-knell for credit-created growth is now being seen in China - as AlsoSprachAnalyst interprets "people are not borrowing, but selling assets to pay down debts, and/or holding cash". What is most worrisome is that while the focus of the world has been on European bank runs (for fear of bank failure and redenomination risk), 21st Century Business Herald now notes that these bank runs have spread to China's industrial and construction-heavy city of Wuyishan. Queues were seen on various branches of China Construction Bank, Agricultural Bank of China, and Industrial and Commercial Bank of China.

Bank runs represent as symptoms of a deflating fractional reserve banking inflated bubble. If the above account is true and escalates further, then serious challenges lie ahead, not only for China, but for the world.

Risk OFF Environment: Surging US Dollar

The Bloomberg reports

The dollar is proving scarce, even after the Federal Reserve flooded the financial system with an extra $2.3 trillion, as the amount of the highest-quality assets available worldwide shrinks.

From last year’s low on July 27, the greenback has risen against all 16 of its major peers. Intercontinental Exchange Inc.’s Dollar Index surged 12 percent, higher now than when the Fed began creating dollars to buy bonds under its extraordinary stimulus measures at the end of 2008.

International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The U.S. is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category, data compiled by Bloomberg show.

“The pool of high-rated assets has been shrinking, not just in the euro zone but elsewhere as well,” Ian Stannard, Morgan Stanley’s head of Europe currency strategy, said in a May 22 telephone interview. “With the core of Europe shrinking, and the available assets for reserve purposes shrinking, it makes the euro zone less attractive.”

In a world where debt has been the elephant in the room, especially for major economies then it would be obvious that once there will be pressure on the claims to debts then this would mean an increased demand for the US dollar. This is because debts have been denominated in fiat currencies mostly on the US dollar. Some people may have forgotten that the world still operates on a US dollar standard.

For instance, intra-region bank run in the Eurozone will likely extrapolate to higher demand for the ex-euro currencies, mainly the US dollar

From Kyle Bass/Business Insider

This means that anxieties over a shrinking pool of “high-rated assets” has also been misguided, because much of these so-called high-rated assets revolve around the problems which we are seeing today: DEBT!!!

In short, what has been discerned by the mainstream as risk-free or safe assets epitomizes nothing short of a grand myth, founded on the belief that government edicts can defeat or are superior to the laws of economics.

Yet the US dollar has not been immune to debt, except that current instances reveal that the locus of market distresses have mainly been from ex-US dollar assets or economies, particularly the EU and China.

And since current predicament has been about debt deleveraging where central bankers have been fire fighting these with intensive money printing, then the pendulum of volatility swings from either asset deflation to asset inflation—or the boom bust cycles.

As one would note, gold has mostly moved in the opposite direction of the US dollar index. The euro has the largest weighting (about 58%) in the US dollar basket.

This simply debunks the flawed idea that gold is a deflation hedge under a paper currency system.

And as Professor Lawrence H. White aptly points out on an essay over monetary reforms,

We should not expect a spontaneous mass switchover to gold, or to Swiss francs, as long as dollar inflation remains low. The dollar has an incumbency advantage due to the network property of a monetary standard. The greater the number of people who are plugged into the dollar network, ready to buy or sell using dollars, the more useful using dollars is to you.

Where the US dollar continues to surge amidst staggering gold prices, then this only means central banking actions have been momentarily overwhelmed by apprehensions over debt mostly via political stalemates, whether in the EU or in China.

Yet we should not discount that central bankers to likely step on the inflation gas to save the current political institutions based on welfare-warfare state, central banking and the political clients—the banking sector.

Prices of commodities will now serve as crucial indicators as to the conditions of monetary inflation-debt deflation tug of war.

The Risk ON Risk OFF conditions may not last, we may morph into a stagflationary landscape.

Could Gold Prices be Signaling a Reprieve in Selloffs or a Bottom?

Over at the commodity markets, gold’s and silver’s recent bounce could yet signal a reprieve to the market’s selloff.

On the one hand, this bounce could signify a reaction to extremely oversold levels but may not be indicative of a bottom yet.

On the other hand, if gold and silver have found a bottom then they could likely be signaling the coming tsunami of inflationism, where the tendency is that gold leads other assets in a recovery, perhaps like 2008.

Also, the recent bounce came amidst Greek polls exhibiting improvements of the standings of pro-austerity camp, perhaps indicative of reduced odds of a Greece exit. A victory by pro-bailout camp government would allow the ECB to orchestrate the same operations that it has been conducting at the start of the year.

For most of the past 3 years prices of gold and the US S&P 500 have been correlated but with a time lag. Since March an anomalous divergence occurred, the S&P rose as the gold fell. For most of the past two weeks both gold and the S&P fumbled which seem to have closed the divergence gap.

But over the two days gold rose as stocks fell. Such anomaly will be resolved soon.

Again, gold cannot be seen as a standalone commodity and should be seen in the context of both the general commodity sphere and of other financial assets.

Focusing on gold alone misses the point that gold represents one of the contemporary assets that competes for an investor’s money. Such that changes in the gold prices would likewise affect prices of other relative assets.

Prices are all interconnected, the great Henry Hazlitt explained[1]

No single price, therefore, can be considered an isolated object in itself. It is interrelated with all other prices. It is precisely through these interrelationships that society is able to solve the immensely difficult and always changing problem of how to allocate production among thousands of different commodities and services so that each may be supplied as nearly as possible in relation to the comparative urgency of the need or desire for it.

To fixate only on gold without examining the actions of other assets would risk the misreading of the gold and other asset markets.

Let me further add that a Greece exit or a collapse of the Euro doesn’t automatically mean higher gold prices. This entirely depends on the actions of central banks.

Since gold is not yet money today, based on the incumbent legal tender laws, it would be totally absurd to argue that under today’s fiat money system—where financial contracts have been underwritten on paper currencies mostly denominated in US dollars or the foreign currency alternatives, European euro, British pound, Swiss franc, Japanese yen or even China’s renminbi—all debt liquidations, be it ‘calling in of loans’ or ‘margin calls’ will be consummated in paper money currency and not in gold.

This means that a genuine debt deflation would translate to greater demand for cash balance (based on Irving Fisher’s account of debt deflation[2]) which means more demand for the US dollar and other currencies of ex-euro trade counterparties.

And that’s what has been happening lately to the marketplace, the US dollar (USD) and US Treasuries 10 year prices (UST) has risen opposite to falling gold prices and other financial assets.

This means part of the global system has been enduring stresses from debt liquidations, which again bolsters the relative effects of money and boom bust cycles.

As pointed out before[3], it would be mistake to equate the 1930 eras (gold bullion standard) or the 1940 eras (Bretton Woods standard) with today’s digital and fiat money system. That would be reading trees for forest when gold was officially money then.

And given that gold has long been branded a “barbaric relic” and has practically been taken off the consciousness of the general public in Western nations, gold has hardly been appreciated as money, perhaps until a disaster happens.

It has only been recently and due to sustained gains of gold prices where gold’s importance has begun to percolate into the American public[4].

Yet the Americans see gold more of an investment than as money

But of course, this is different with many Asians who still values gold as money. For example, many Vietnam banks are even paying gold owners fee for storage[5] in defiance of government edict.

Gold’s rise would be premised from central banking inflationism designed to protect the certain political interests, which today have represented the banking institutions and the Federal and national governments.

As proof, the latest quasi bank run in Greece, which I pointed out above, has reportedly been due to concerns over devaluation of the drachma, should Greece exit from the EU and NOT from deflation.

While I remain long term bullish gold, short term I remain neutral and would like see further improvements in gold’s price trend and subsequently the relative trends of other “risk ON” assets.

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[1] Hazlitt Henry How Should Prices Be Determined? , May 18, 2012

[2] Wikipedia.org Fisher's formulation, Debt Deflation

[3] See Gold Unlikely A Deflation Hedge June 28, 2012

[4] Gallup.com Gold Still Americans' Top Pick Among Long-Term Investments, April 27, 2012

[5] See Vietnam Banks Pay Gold Owners for Storage, April 12, 2012

The Coming Global Debt Default Binge: Moody’s Downgrades Japan

The global debt default binge is in process with credit rating downgrades signifying as the initial symptoms.

US credit rating agency Moody’s today downgraded Japan.

From Bloomberg, (bold emphasis mine)

Japan’s debt rating was lowered by Moody’s Investors Service, which cited “weak” prospects for economic growth that will make it difficult for the government to rein in the world’s largest public debt burden.

Moody’s cut the grade one step to Aa3, with a stable outlook, it said in a statement today. Rebuilding costs from the March 11 earthquake and tsunami, along with continuing efforts to contain the Fukushima nuclear crisis, may make it hard for officials to meet their borrowing target this year, it said.

The first Japan downgrade by Moody’s since 2002 reflects deteriorating credit quality across developed nations from Italy to the U.S., which lost its AAA status at Standard & Poor’s this month. While the move adds to the challenges of the next Japanese prime minister, scheduled to be picked next week, the impact on bond yields may be limited by what Moody’s described as domestic investors’ preference for government debt.

The rerating has also been felt in the CDS markets…

The cost of insuring corporate and sovereign bonds in Japan against default increased, according to traders of credit- default swaps. The Markit iTraxx Japan index rose 7 basis points to 153 basis points as of 12:09 p.m. in Tokyo, on course for its highest level since June 10, 2010, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market…

Today’s rating move brings Japan to the same level as China, showing the diverging paths of Asia’s two biggest economies. China replaced Japan as the world’s No. 2 last year and Moody’s has a positive outlook on its ranking

But debt acquisition won’t be curtailed despite the downgrade…

Moody’s said today’s decision was “prompted by large budget deficits and the build-up in Japanese government debt since the 2009 global recession.”

Japan’s public debt is projected to reach 219 percent of gross domestic product next year even before accounting for borrowing to fund reconstruction after the March 11 earthquake, according to the Organization for Economic Cooperation and Development.

The government has amassed a debt of 943.8 trillion yen, according to the Finance Ministry, after two decades of fiscal spending to energize an economy hobbled by the collapse of an asset bubble in 1990 and lingering deflation that’s sapped private demand. The yen’s advance to a post World War II high this year also threatens exports, a main driver of the nation’s economic growth…

The government has pledged to raise the sales tax to 10 percent by the middle of the decade, a rate that would still be below the IMF’s recommendations. The additional revenue is intended to pay for social welfare for the aging population.

Japan’s government plans total spending of 19 trillion yen over five years to rebuild after the magnitude-9 temblor and tsunami that devastated the northeast coast of Japan and triggered the worst nuclear crisis since Chernobyl.

Politicians won’t learn until forced upon by economic realities.

So the initial preemptive response to the anticipated downgrade has been to inflate the system using the recent triple whammy calamity as pretext.

Finally, it certainly is not true that current developments recognized as “fiscal austerity” have been about getting off the welfare state-big government-deficit spending path.

What has been happening instead is the political process where massive amount of resources are being transferred from the welfare state to the banking sector.

Global political leaders are hopeful that by rescuing the politically privileged interconnected banks, they can bring 'normalcy' back to the 20th century designed politically entwined institutions of the welfare state-banking system-central banking system.

Proof?

Just look how the Japanese government (and other developed governments) addresses their dilemma—mostly by raising taxes!

As the illustrious Milton Friedman once said,

In the long run government will spend whatever the tax system will raise, plus as much more as it can get away with. That’s what history tells us. So my view has always been: cut taxes on any occasion, for any reason, in any way, that’s politically feasible. That’s the only way to keep down the size of government.

So tax increases equates to the preservation of the welfare state or big government.

Unfortunately, the system has already been foundering from under its own weight. And importantly, politicians apparently blase to these risks, continue to impose measures that would only increase the system's fragility. What is unsustainable won't last.

The Coming Global Government Debt Default Binge

From the Wall Street Journal blog:

The biggest risk, however, isn’t Greece per se. It is the prospect of other peripheral euro members — Ireland, Spain, and Portugal — following Greece down the default path. That cascade effect has to be avoided….

The global credit authorities and financial markets have been digesting this problem for more than a year. Some participants think a default is inevitable; Greece should just do it.

Then the world can move on to an even bigger worry: whether the U.S. government will soon default on its debt.

Yes, ballooning debt as a consequence of incessant government spending on the welfare state isn’t just an issue of Greece. It’s everywhere.

From the Bank of International Settlements

Sooner or later, something will occur to prevent debt from exploding: governments will adopt corrective measures on their own, or they will be forced to act as sovereign risk premia reach unbearable levels.

And this is only from the facet of government liabilities, which does not include the banking system

This bring us to the admonitions of the great Ludwig von Mises

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.

Governments will default, either by massive inflation or by the far better option-deflation.

And that’s why the events in Greece is a prelude to the next monumental chain of government-and-banking debt crisis.

We are approaching the Mises moment.

Quantitative Easing and Shadow Banking Liabilities

I have repeatedly been arguing that the US banking system cannot last in an environment without inflationism or money printing or Quantitative Easing or “cupcakes” (as Jim Rogers would call it) unless the US government would allow for a violent deflationary unwind (yes another crisis of greater proportion compared to 2008).

The latter seem as a NO OPTION—for ideological and political reasons—or a Hobson’s choice.

Zero Hedge’s Tyler Durden points out that the collapsing liabilities of the shadow banking system have essentially been offset by the recent US Federal Reserve’s QE programs. In short, to stave off a continuing meltdown that would negatively affect the US banking system requires continued rounds of QEs.

Mr. Durden writes, (bold highlights mine)

And the most important chart: consolidated financial liabilities (total credit money) and the sequential change. Note that in Q1, courtesy of QE2, we have just experienced a jump in this series of a whopping $343 billion. Absent this jump the economy would have plunged into a deflationary collapse... And Ben Bernanke knows this...

Which leaves just one option: the Federal Reserve... Whose ongoing boost in excess reserves (its Liability) for the pendancy of any monetary easing episode, results in an increase in Reserve assets at Commercial Banks (their asset), but more importantly, a boost in Commercial bank liabilities, be they US (which is not the case) or (foreign) which we have now proven twice is what is happening. Simply said, absent the ongoing transfer of credit money liabilities, so critical to keep the economy growing, from the Fed to private institutions, there will be no marginal growth in the consolidate financial system's liabilities. Which in turn means outright deflation.

And you can bet your bottom fiat piece of linen and cotton that Ben Bernanke knows this all too well.

With QE2 ending just as Q2 ends, we are convinced that the next Z.1 report, due out in early September, will show another massive jump in liabilities... And that's it. It's all downhill from there. Unless, of course, the Fed comes up with another Fed to Commercial Bank liability transfer program, which the Fed can call it whatever it wants. The point is: it is critical for it to materialize soon or else, the economy, without a marginal source of new debt, will plunge in the deflationary abyss that the $5.1 trillion plunge in shadow liabilities would have created had it not been for Ben Bernanke.

Take away the money printing or the “cupcakes” and the entire house of cards collapses.

Ben Bernanke seems trapped from his own actions. And that’s unless one believes that a Deus ex machina (god out of the machine) would emerge to save the day.

Is Hungary Suffering From Debt Deflation?

For the experts at BCA Research, the answer is yes...debt deflation plagues Hungary.

According to the US Global Investors,

``Bank Credit Analyst research highlights that Hungary has been in a classic debt deflation, as its nominal GDP has been contracting while government borrowing costs have held above 6 percent. Hungary’s domestic demand has been contracting for three years and the current government is planning to reflate via massive interest rate cuts, fiscal spending, and a weaker currency."

However, we see Hungary's condition in a different light, if not the opposite circumstance.

While it is true that Hungary has been in a deep recession, as manifested by the steep decline in GDP as measured in both annual and quarterly changes, (chart courtesy of tradingeconomics.com), inflation as measured by price changes in consumer price index has been in positive zone and rising!

And it is not just in Hungary, but positive inflation is true for most of Europe, as shown in the above chart courtesy of Financial Times Blog on Money Supply, as of March. The only exception is in the Baltic states (but this has already reversed based on updated statistics).

The following is an updated chart on Hungary courtesy of tradingeconomics.com.

Fundamentally, we see the same dynamics unfolding; while Hungary's recession has been accompanied by RISING joblessness (upper window), inflation has also been RISING (lower window)!

And Hungary's currency has been falling against both the US dollar (upper window) and the Euro (lower window).

The next chart courtesy of yahoo finance.

This is in sharp contrast to the peak of the crisis in 2008, where the forint surged against both major currencies!

Then, the rising forint was symptomatic of debt deflation. Now it seems an entirely different story.

To add, while Hungary's equity bellwether the Budapest Stock Exchange fell by 3% this week on an apparent "gaffe" by the newly sworn administration, on a year to date basis, the Budapest index is still marginally up (by about 2%), and is still about 100% up or double compared to the March 2009 lows.

So all these hardly resembles a Fisherian debt deflation environment. Low bond yields in a recession doesn't automatically account for debt deflation.

Besides, Hungary has managed to turn her streak of current account deficits into surpluses.

So this should hardly make Hungary's conditions parallel to Greece's predicament. Yet Greece, like Hungary, hasn't also been suffering from debt deflation but from 'stagflation' as we have previously shown.

In November 2008, the hard hit crisis stricken Hungary received $20 billion in rescue money from the IMF, EU and the World Bank.

Meanwhile, IMF officials are set to meet with Hungarian officials early next week. The country still has an open credit line of about $2 billion dollars, according to the AP.

Bottomline: Hungary's conditions doesn't seem anywhere like debt deflation or resembles little of Greece's debt crisis. However, unless present trends make a volte-face, both Hungary and Greece appear to be in a mild stagflation.