Rampaging Global Equity And Commodity Markets Are Symptoms Of Rampant Inflationism!

Credit expansion not only brings about an inextricable tendency for commodity prices and wage rates to rise it also affects the market rate of interest. As it represents an additional quantity of money offered for loans, it generates a tendency for interest rates to drop below the height they would have reached on a loan market not manipulated by credit expansion. It owes its popularity with quacks and cranks not only to the inflationary rise in prices and wage rates which it engenders, but no less to its short-run effect of lowering interest rates. It is today the main tool of policies aiming at cheap or easy money. Ludwig von Mises

Global stock markets appear to be on a juggernaut!

Figure 1: Stockcharts.com: Where Is the Oil-Stockmarket Negative Correlation?

Figure 1 tells us that despite soaring oil prices, last traded at $113 per barrel as of Friday (WTIC), global equity markets have been exploding higher in near simultaneous fashion as demarcated by the blue horizontal line.

The Global Dow (GDOW)[1] an index created by Dow Jones Company that incorporates the world’s 150 largest corporations, the Emerging Markets (EEM) Index and the Dow Jones Asia Ex-Japan Index (P2DOW) have, like synchronized dancing, appear as acting in near unison.

We have been told earlier that rising oil prices extrapolated to falling stock markets (this happened during March—see red circles), now where is this supposed popular causal linkages peddled by mainstream media and contemporary establishment analysts-experts[2]?

Yet, the current actions in the global financial and commodity markets hardly represent evidence of economic growth or corporate fundamentals.

And any serious analyst will realize that nations have different socio-political and economic structures. And such distinction is even more amplified or pronounced by the uniqueness of the operating and financial structures of each corporation. So what then justifies such harmonized activities?

As we also pointed out last week[3], major ASEAN contemporaries along with the Phisix have shown similar ‘coordinated’ movements.

In addition, the massive broad based turnaround in major emerging markets bourses appear to vindicate my repeated assertions that the weakness experienced during the past five months had been temporary and signified only profit taking[4].

Yet if we are to interpret the price actions of local events as one of being an isolated circumstance, or seeing the Philippine Phisix as signify ‘superlative performance’ then this would account for a severe misjudgment.

Doing so means falling into the cognitive bias trap of focusing effect[5] —where one puts into emphasis select aspect/s or event/s at the expense of seeing the rest.

Ramifications of Rampant Inflationism

So how does one account for these concerted price increases? Or, what’s been driving all these?

We have been saying that there are two major factors affecting these trends:

One, artificially low interest rates that have driven an inflationary boom in credit.

That’s because simultaneous and general price increases would not be a reality if they have not been supplied by “money from thin air”.

As Austrian economist Fritz Machlup wrote[6],

If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, a boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and amortization current amortization allowances is fairly inelastic, and optimism about the development of security prices, inelastic would promptly lead to a "tightening" on the credit market, and the cessation of speculation "for the rise." There would thus be no chains of speculative transactions and the limited amount of credit available would pass into production without delay.

Some good anecdotal examples:

Credit booms are being manifested in several segments of the finance sector across the world, such as the US Collateralized Mortage Obligations (CMO)

From Bloomberg[7], (bold emphasis mine)

The biggest year since 2003 for the packaging of U.S. government-backed mortgage bonds into new securities has extended into 2011, bolstered by banks seeking investments protecting against rising interest rates.

Issuance of so-called agency collateralized mortgage obligations, or CMOs, reached $99 billion last quarter, following $451 billion in 2010, according to data compiled by Bloomberg. The creation of non-agency bonds, which force investors to assume homeowner-default risks, is down more than 90 percent from a peak with parts of the market still frozen.

Facing limited loan demand and flush with deposits on which they pay close to zero percent, banks are turning to agency CMOs to earn more than Treasuries and gird for when the Federal Reserve boosts funding rates. Insurers, hedge funds and mutual- fund managers such as Los Angeles-based DoubleLine Capital LP are seeking different pieces of CMOs, which slice up mortgage debt, creating new bonds that pay off faster or turn fixed-rate notes into floating rates.

Or in Europe, the leveraged buyout markets...

Again from the Bloomberg[8], (bold emphasis mine)

ING Groep NV, the top arranger of buyout loans in Europe this year, sees a “liquidity bubble” building as lenders forego protection and accept lower fees.

“There is a liquidity bubble in the European leveraged loan market at the moment, driven by institutional fund liquidity,” said Gerrit Stoelinga, global head of structured acquisition finance at Amsterdam-based ING, which toppled Lloyds Banking Group Plc as no. 1 loan arranger to private-equity firms, underwriting 10 percent of deals in the first quarter.

Investors more than doubled loans to finance private-equity led takeovers in the first quarter to $6.7 billion as the economy shows signs of strengthening, reducing risk that the neediest borrowers will default. Inflows to funds dedicated to loans and floating-rate debt jumped to $8.5 billion this year, compared with $1.7 billion in the same period in 2010, data from Cambridge, Massachusetts-based EPFR Global show.

Second, it’s all about the dogmatic belief espoused by the mainstream and the bureaucracy where printing of money or the policy of inflationism is seen as an elixir to address social problems.

Figure 2: Swelling Central Bank Balance Sheets and Commodity Prices (Danske Bank[9] and Minyanville[10])

The balance sheets of developed economies central banks have massively been expanding (except the ECB, see figure 2 left window), as respective governments undertake domestic policies of money printing or Quantitative Easing (QE) programs, even as the global recession has passed.

Commodity prices have, thus, risen in conjunction with central banks QE programs (right window).

What this implies is that both inflationary credit and the ramifications of various QE programs appear to be mainly responsible for the rise in most commodity markets. This is a phenomenon known as reservation demand, which as I wrote in the past[11]

“commodities are not just meant to be consumed (real fundamentals) but also meant to be stored (reservation demand) if the public sees the need for a monetary safehaven.”

As the great Ludwig von Mises explained[12], (bold highlights mine)

with the progress of inflation more and more people become aware of the fall in purchasing power. For those not personally engaged in business and not familiar with the conditions of the stock market, the main vehicle of saving is the accumulation of savings deposits, the purchase of bonds and life insurance. All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to be indicated. The ultimate reaction of the public, the “flight into real values,” is a desperate attempt to salvage some debris from the ruinous breakdown. It is, viewed from the angle of capital preservation, not a remedy, but merely a poor emergency measure. It can, at best, rescue a fraction of the saver’s funds.

Ironically as I earlier pointed out, even the Bank of Japan (BoJ) has recognized the causal effects of money printing and high food prices[13], but they continue to ignore their own warnings by adding more to their own “lending” program using the recent disaster as a pretext [14]!

Yet despite increases of policy rates by some developed economy central banks as the European Central Bank (ECB) and the Denmark’s Nationalbank[15], not only as interest rates remain suppressed but the ECB pledged to continue with its large scale liquidity program[16].

To add, policy divergences will likely induce more incidences of leveraged carry trade or currency arbitrages.

Record Gold Prices and Poker Bluffing Exit Strategies

And it is of no doubt why gold hit new record nominal highs priced in US dollars last week (now above $1,470 per oz.)

Figure 3: Surging Gold prices versus G-5 currencies (gold.org)

It wouldn’t be fair to say that gold has been going ballistic only against the US dollar because gold has been in near record or in record territory against almost all major developed and emerging market currencies.

Gold, as shown in Figure 3, has been drifting near nominal record highs against G-5 currencies[17] (US dollar, euro, Yen, sterling and Canadian dollar).

Figure 4: Gold Underrepresented as an Asset Class (US Global Investors[18])

Gold, despite record nominal prices, appears to be vastly underrepresented as a financial asset class compared to other assets held by global finance, banking, investment, insurance and pension companies.

Should the scale of inflationism persists, which I think central bankers will[19], considering the plight of the foundering “too big to fail” sectors or nations e.g. in the US the real estate markets (see figure 5), in Europe the PIIGS, this will likely attract more of mainstream agnostics (see figure 4) to gold and commodity as an investment class overtime.

This only implies of the immense upside potential of gold prices especially when mainstream finance and investment corporations decide to load up on it or capitulate.

Figure 5: Tenuous Position of US Real Estate, Bank Index and Mortgage Finance

This brings us back anew to “Exit” strategies that is said to upend gold’s potentials.

The Fed can talk about exit strategies for all they want, but they are likely to signify another poker bluff similar to 2010[20].

The Fed’s inflationist programs which had been mostly directed at the US banking system seem to stand on tenuous grounds despite all the trillions of dollars in rescue efforts.

US real estate appears to stagger again[21] (left window), while the S & P Bank Index (BIX) and the Dow Jones Mortgage Finance (DJUSMF) appears to have been left out of the bullish mode seen in the S&P 500 Financials (SPF) and the Dow Jones US Consumer Finance (DJUSSF), possibly reflecting on the renewed weakness of the US real estate.

In addition, there is also the problem of financing the enormous US budget deficits. And there is also the excess banking reserves dilemma.

So in my view, the US Federal Reserve seems faced with the proverbial devil and the deep blue sea. Other major economies are also faced with their predicaments.

Going back to the stock markets, as Austrian economist Fritz Machlup explained[22],

if all of these indices show an upward (or downward) movement, the presumption is very strong that inflation (or deflation) in the sense defined is taking place, even if the level of commodity prices does not show the least upward (or downward) tendency.

Well some commodity prices have paralleled the actions in the stock markets if not more.

Bottom line: Rampaging stock markets and commodity markets are symptomatic of rampant inflationism.

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[1] Wikipedia.org The Global Dow

[2] See “I Told You So!” Moment: Being Right In Gold and Disproving False Causation, March 6, 2011

[3] See Phisix and ASEAN Equities: The Tide Has Turned To Favor The Bulls! April 3, 2011

[4] See I Told You So Moment: Emerging Markets Mounts A Broad Based Comeback! April, 8, 2011

[5] ChangingMinds.org, Focusing Effect

[6] Machlup, Fritz The Stock Market, Credit And Capital Formation Mises.org p.92

[7] Dailybusiness.com CMO sales at 7-year high as banks gird for Fed: credit markets, Bloomberg, April 5, 2011

[8] Bloomberg.com ING Sees ‘Liquidity Bubble’ in European LBO Financing Market, April 5, 2011

[9] Danske Bank Flash Comment Japan: BoJ upgrades its view on economy, April 7, 2011

[10] Minyanville.com When Will Fed-Created Melt-Up Turn Into a Meltdown?, April 8, 2011

[11] See Oil Markets: Inflation is Dead, Long Live Inflation November 4, 2010

[12] Mises, Ludwig von The Effects of Changes in the Money Relation Upon Originary Interest, Human Action, Chapter 20 Section 5 Mises.org

[13] See Correlation Isn't Causation: Food Prices and Global Riots, April 2, 2011

[14] Bloomberg, BOJ Offers Earthquake-Aid Loans, Downgrades Economic Assessment, April 7, 2011

[15] Reuters.com Danish c.bank raises lending rate by 25 bps, April 7, 2011

[16] See ECB Raises Rates, Global Monetary Policy Divergences Magnifies, April 8, 2011

[17] Gold.org, Daily gold price since 1998

[18] Holmes, Frank The Bedrock of the Gold Bull Rally, US Global Investors

[19] See The US Dollar’s Dependence On Quantitative Easing, March 20, 2011

[20] See Poker Bluff: The Exit Strategy Theme For 2010, January 11, 2010

[21] Economist.com Weather warning America's housing market is in the doldrums, March 30, 2011

[22] Machlup, Fritz Op.cit p.299

Symptoms of Crony Capitalism: Soaring US Financial Profits

This is exactly how crony capitalism looks like.

Following massive support from the US government, US financial firms posts huge profits.

From the Wall Street Journal, (bold highlights mine)

During the darkest days of the financial crisis, when Lehman Brothers and Washington Mutual went belly up and the U.S. government had to bail out other institutions, the finance sector reported an annualized loss of $65.2 billion in the fourth quarter of 2008. It was the only quarterly loss recorded in the government data.

Since then, the sector has come roaring back. The GDP report shows finance profits jumped to $426.5 billion. While profits haven’t returned to their high levels of 2006, the gain in finance profits last quarter more than offset a drop in profits posted by nonfinancial domestic industries.

After rising like the Phoenix, the financial industry now accounts for about 30% of all operating profits. That’s an amazing share given that the sector accounts for less than 10% of the value added in the economy.

Wall Street and banking critics have pointed out the finance industry enjoys government supports not given to other companies. That includes the low cost of funds from the Federal Reserve. As a result, critics say, the U.S. economy is overly skewed toward finance.

Aside from the bailouts and behest loans, the Federal Reserve’s QE programs have had a big influence on this swelling of corporate profits.

Writes Peter Schiff, (bold highlights mine)

But another very large chunk of Treasuries go to "primary dealers," the very large financial institutions that are designated middle men for Treasury bonds. In a late February auction, these dealers took down 46% of the entire $29 billion issue of seven year bonds. While this is hardly remarkable, it is shocking what happened next.

According to analysis that appeared in Zero Hedge, nearly 53% of those bonds were then sold to the Federal Reserve on March 8, under the rubric of the Fed's quantitative easing plan. While it's certainly hard to determine the profits that were made on this two week trade, it's virtually impossible to imagine that the private banks lost money. What's more, knowing that the Fed was sure to make a bid, the profits were made essentially risk free. It's good to be on the government's short list.

So what we essentially have is a redistribution of resources from the real economy to the financial sector.

This is rent-seeking.

The essence of which is, as explained by Alfred Nobel Prize winner Professor James M. Buchanan,

“it extends the idea of the profit motive from the economic sphere to the sphere of collective action. It presupposes that if there is value to be gained through politics, persons will invest resources in efforts to capture this value. It also demonstrates how this investment is wasteful in an aggregate-value sense.

Such is the essence of government interventions or the political distribution of resources via state capitalism. Winners are the politically endowed (concentrated) while losses are distributed throughout the system.

Falling US Home Sales Points To QE 3.0

The Reuters reports,

Sales of new U.S. homes sank to a record low in February and prices were the weakest since December 2003, showing the housing market slide was deepening.

The Commerce Department said on Wednesday sales of new single-family homes dropped 16.9 percent to a seasonally adjusted 250,000 unit annual rate, the lowest since records began in 1963, after a 301,000-unit pace in January.

The following charts from Northern Trust....

As I earlier wrote

Under enfeebled housing conditions, a failure to continue with the QE amplifies the risks of falling housing prices thereby jeopardizing the fragile state of the US banking system

Looks like Quantitative Easing (QE) 3.0 is underway

QE 2.0: It’s All About The US Banking System

``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.” Ludwig von Mises

It’s time for a little gloating.

Last week we noted how global financial markets would likely respond to two major events that just took place in the US this week.

Globalization Versus Inflationism

We noted that while the outcome of the US elections would matter, it would be subordinate to the US Federal Reserve’s formal announcement of the second phase of the Quantitative Easing or QE 2.0.

Nevertheless we mentioned that in terms of the US Midterm Elections, still the odds greatly favoured a rebalancing of power from a lopsided stranglehold by left leaning Democrats towards the conservative-libertarian right that could result to what mainstream calls as “political gridlock”.

Such stalemate would thereby reduce the chances of government interventionism, which should have positive implications for both the markets and the US economy[1].

Figure 1: The Drubbing Of Keynesian Policies (USA Today[2])

Of course, what the surveys earlier conveyed had been merely translated into actual votes-Americans largely repudiated the highhanded Keynesian spend and tax policies adapted by the Obama administration. This also signifies as a decisive defeat for President Obama’s illusory “Change we can believe in”.

Except for the Senate which had only 37 seats, out of the 100, contested, Republicans swept the House (239-188) and the Governorship position (29-18). Yet, even in the Senate, the chasm in the balance of power held by the Democrats had been significantly narrowed (from 57-41 to 51-46).

To rub salt into the wound, even President Obama’s former seat at Illinois was won by a GOP candidate[3], Mark Kirk.

The burgeoning revolt against interventionist Keynesian policies has likewise been an ongoing development in Europe[4].

And as we have repeatedly been pointing out, two major forces have been in a collision course: technology buttressed globalization (represented by dispersion of knowledge and the deepening specialization expressed through free trade) and inflationism (concentration of political power).

The rising tide against Keynesianism, which translates to a backlash from these two grinding forces, can be equally construed as a manifestation of an evolving institutional crisis or strains from traditional socio-political structures adjusting to a new reality.

As Alvin and Heidi Toffler presciently wrote[5],

``Bureaucracy, clogged courts, legislative myopia, regulatory gridlock and pathological incrementalism cannot but take their toll. Something, it would appear will have to give...

``All across the board –at the level of families firms industries national economies and the global system itself—we are now making the most sweeping transformation ever in the links between wealth creation and the deep fundamental of time itself. (italics mine)

For now, the forces of globalization appear to be the more influential trend.

Validated Anew: QE 2.0 Is About Asset Price Support

However, as we also noted, Keynesianism hasn’t entirely been vanquished[6]. They remain deeply embedded in most of the political institutions represented as unelected officials in the bureaucratic world. Importantly, they are personified as stewards of our monetary system.

Here is what I wrote last week[7],

``The QE 2.0, in my analysis, is NOT about ‘bolstering employment or exports’, via a weak dollar or the currency valve, from which mainstream insights have been built upon, but about inflating the balance sheets of the US banking system whose survival greatly depends on levitated asset prices.

Straight from the horse’s mouth, in a recent Op-Ed column[8] Federal Reserve Chair Bernanke justifies the Fed’s QE 2.0,

``This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion. (bold highlights mine)

Once again I have been validated.

The path dependency of Ben Bernanke’s policies has NOT been different[9] from his perspective as a professor at Princeton University in 2000 when he wrote along the same theme.

``There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse. (bold emphasis mine)

Figure 2: stockcharts.com: Global Equity Markets Explode!

The net effect of QE 2.0 has been almost surreal.

Global equity markets (DJW), as expected, skyrocketed to the upside from the higher than expected $600 billion or $75 billion a month (for 8 months) of US treasury long term security purchases that the Federal Reserve will be conducting with new digital dollars. Markets reportedly estimated the QE program at $500 billion[10].

And the Federal Reserve made sure in their announcement that $600 billion will not be a limiting condition. The FOMC said that they “will adjust the program as needed to best foster maximum employment and price stability”[11].

It’s simply amazing how the Fed’s QE 2.0 transmission mechanism has been worldwide. Whether in Asia (P1DOW-Dow Jones Asia), Europe (E1DOW-Dow Jones Europe) or Emerging markets (EEM-iShares MSCI Emerging Markets Index), the story has all been the same—markets breaking out to the upside.

I’d like to add that such bubble blowing policies has NOT been limited to the Federal Reserve.

Immediately after the Fed’s announcement, the Bank of Japan voted unanimously to support the domestic stock market by engaging on their own version of QE that would include “exchange-trade funds linked to the Topix index and Nikkei Stock Average, and Japanese real-estate investment trusts rated at least AA, the bank said. It said it would begin buying Japanese government bonds under its new program next week.[12]” (bold emphasis mine)

Add to these the inflation of global central banks international reserve position to the tune of $ 1.5 trillion over the past 12 months[13].

Hence the consequences of massive inflationism are likely to be fully felt yet in the markets.

The False Premise: Aggregate Demand Story

The substantiation of our analysis isn’t limited to Bernanke’s statements alone. Markets have likewise bidded up the major beneficiaries of the QE 2.0 program—the banks and the financial industry (see figure 3).

Figure 3: Financial Industry: From Laggards to Leaders (charts from US global Investors and stockcharts.com)

The mainstream wisdom goes this way: Money printing does not create inflation. With low inflation, printing money is, therefore, needed to generate demand that would spur inflation. This form of circular reasoning[14], which characterizes Keynesian economics, is what is sold to public as rationalization for the current policy. The mainstream sees it as an aggregate demand problem that can only be addressed by money printing.

The mainstream fails to see that there is NO such thing as a free lunch or that prosperity cannot be conjured or summoned by the magic wand of the printing presses.

All these so-called technocratic experts refuse to learn from history or deliberately distort its lessons, where debasing money has always been meant to accommodate for the political goals or interests of the ruling class.

Yet monetary inflation eventually crumbles to nature’s laws of scarcity for the simple reason that it is unsustainable. Printing of money does NOT equate anywhere to the same degree as producing goods and services. Printing of money can be limitless, while production of goods and services are limited to the available scarce resources.

Unknown to many, printing of money is subject to the law of diminishing returns (getting less for every extra output or a law affirming that to continue after a certain level of performance has been reached will result in a decline in effectiveness[15]) and law of diminishing marginal utility (general decrease in the utility of a product, as more units of it are consumed[16]).

And it is why repeated experiments with paper money throughout the ages of human affairs have repeatedly failed[17]. And I don’t see why the grand US dollar standard experiment today as likely to succeed either. The QE programs fundamentally reflect on the same symptoms of any degenerating or festering de facto money regime. We should expect more QE programs to happen.

Yet the aggregate demand story is basically premised on debt. To promote aggregate demand is to promote debt. Debts either incurred by the private sector or by governments in lieu of the private sector. While productive debt and consumption debt are hardly distinguished, consumption debt is promoted. Savings are disparaged as economically harmful. And the promotion of debt is the essential or critical element to fostering bubbles.

Figure 4: World Bank: Banking Crisis Since the 1970s

Hasn’t it been a wonder that since the closing of the Bretton Woods gold-dollar window in 1971, bubbles became a permanent fixture worldwide?

Yet, the public hardly can see through who the major beneficiaries from the debt based aggregate demand story. Obviously, it is the banking and the financial industry as they represent as the major funding intermediaries or financiers to both the private sector and importantly to the government.

And the banking system had been structurally incented to hold (or buy or finance) government debts into their balance sheets as they have been classified as less risky assets and thus requires less capital in accordance to the Basel Accord[18].

During the last crisis the unholy alliance of the central banking-banking industry cartel had been exposed as seen by the trillions worth of bailouts by the US Federal Reserve[19].

Yet the politicized nature of central banking (everywhere) obviously leads to cartel structured relationships, as survivability depends not on profitability based on market forces, but from the privileged conditions bestowed upon by the political strata.

And the QE 2.0, which I argued as having been unmoored from the prospects of the US or global economy, but rather aimed at safeguarding the balance sheets of the banking system has successfully boosted the prices of financial equity benchmarks, such as S&P Bank Index (BIX), the Dow Jones Mortgage Finance Index (DJUSMF), the S&P Insurance (IUX) and the Dow Jones US General Financial Index (DJUSGF), all along the lines of Bernanke’s design.

The industry that had miserably lagged[20] the recent stock market recovery in the US has in one week suddenly outclassed the rest.

Of course people who argue about the success or failure of policies frequently look at the effects depending on the time frame that support their bias.

For instance, policies that induce bubbles will benefit some participants, during its heydays. Hence, policy supporters will claim of its ‘success’ seen on a temporary basis as the bubble inflates. Yet overtime, an implosion of such bubbles would result to a net loss to the economy and to the markets. The overall picture is ignored.

And the same aspects would also apply to those arguing that the Fed’s rescue of the banking system has been worthwhile. They’re not. The benefits of a temporary reprieve from the recent crisis envisages greater risks of a monumental systemic blowup. If Fed policies had been successful, then why the need for QE 2.0?

So for biased people, the measure of success is seen from current activities than from the intertemporal tradeoffs between the short term and long term consequences of policies.

In other words, yes, the QE 2.0, which constitutes the continuing bailout of the US banking industry, seems to successfully inflate bubbles, mostly overseas. But at the end of the day, these bubbles will result to net capital consumption, if not the destruction of the concurrent monetary regime.

The next time a major bubble implodes there won’t likely be free lunch rescues as these will be limited by today’s massive debt overhang.

The Effects of QE 2.0: Promotes Poverty And A Shift To A New Monetary Order

Of course while the equity price performance of the US financial industry stole the limelight the next best performers have been the Energy and the Materials Index.

In other words, as I have long been predicting, the accelerating traction of the inflation transmission channels are presently being manifested in surging prices of commodities and commodity related equity assets aside from global equity markets.

While this should benefit equity owners and producers of commodity related enterprises, aside from the financial sector, those who claim that inflationism is justifiable and a moral policy response to the current conditions are just plain wrong. Such redistributive policies to the benefit of the banking sector come at the expense of the underprivileged.

What is hardly apparent or seen is that the current government structured inflation indices have been vastly underreporting inflation.

Yet surging agricultural and food prices would not only harm a significant percentage of financially underprivileged by reducing their money’s purchasing power but also promote poverty in the US and elsewhere.

Figure 5: Food Expenditures By Income Level

Tyler Durden of Zero Hedge quotes a JP Morgan study[21], (bold emphasis mine)

When the Fed considers the possible consequences of a falling dollar resulting from QE2, it should perhaps focus on food and energy prices as much as on traditionally computed core inflation. First, the food/energy exposures of the lower 2 income quintiles are quite high (see chart). Second, the core CPI has a massive weight to “owner’s equivalent rent”, which suggests that the imputed cost of home occupancy has gone down. Unfortunately, this is not true for families living in homes that are underwater, and cannot move to take advantage of it (unless they choose to default and bear the consequences of doing so). Due to the housing mess, there has perhaps never been a time when traditionally computed core inflation as a way of measuring changes in the cost of things means less than it does right now.

Figure 6: ADB[22] Asia’s Share of Food Expenditure to Total Expenditure

And as said above the effects are likely to hurt the underprivileged of the emerging markets more than the US.

So inflationism or QE 2.0 poses as a major risk to global poverty alleviation and prosperity, a blame that should be laid squarely on these policymakers and their supporters.

Of course as the ramifications of inflationary policies worsen, the subsequent scenario would be for political trends to shift towards holding the private sector responsible for elevated prices and for ‘greed’ in order to institute more government control and inflationism.

As the great Ludwig von Mises once wrote[23],

``They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying "catch the thief." The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices. While the [the government] is busy annoying sellers as well as consumers by a flood of decrees and regulations, the only effect of which is scarcity, the Treasury [and the Fed] go on with inflation”

Here free trade will likely give way to protectionism; that is if public remains ignorant of true causes of inflation and if the world would stubbornly stick by the US dollar as preferred global medium of exchange.

Of course Asian nations were hardly receptive to the unilateral actions by the Federal Reserve. The conventional recourse in dealing with QE 2.0 has been via currency appreciation, tightening of domestic liquidity by raising bank reserves or increase policy rates or lastly ‘temporary’ capital controls. So far some countries as South Korea have threatened to impose some variation of capital controls.

Yet we should expect the world to shift out of the US dollar regime once inflationism becomes rampant enough to pose as a meaningful hurdle to national economic development and global trade. The Bloomberg quotes China’s Central Bank adviser Xia Bin[24],

``China should counter the U.S. through regional currency alliances, speeding international use of the yuan and seeking stability in exchange rates through the Group of 20, which holds a summit next week”

A currency from a political economy that engages in significantly less inflationism, has deep and developed sophisticated markets, has a convertible currency and hefty geopolitical exposure is likely to challenge the US dollar hegemony, whether this would be the yuan (which for the moment is unlikely) or the Euro, only time will tell.

Of course, we can’t discount gold’s role in possibly being integrated anew in the reform of the monetary architectural system.

Figure 7: Virtual Metals[25]: Central Bank Gold Holdings and Sales

Global Central banks appears to be rediscovering gold as possibly reclaiming its role as money in a new monetary order. A new monetary order is not question about an if, but a when.

Once as net sellers, central banks seem to be transitioning into potential net buyers.

So again, our peripheral insight seems being validated with the ongoing process of shifting expectations by authorities on the functions of gold.

As I pointed out last year[26], gold is presently seen by an ECB official as a form of economic security, risk diversification, a confidence factor and an insurance against tail risks. Once these factors become well entrenched, a store of value role would likely be the next step. And more QE’s would only serve to push gold towards such a path.

Those who obstinately relish the bias that gold is nothing but a barbaric relic will likewise suffer from taking on the wrong positions. But they eventually will succumb to the shifting expectations as with many monetary authorities today. The reflexive process of having prices influence fundamentals has clearly been taking shape.

With gold prices at $1,390 mainstream economists like celebrity Nouriel Roubini[27], who last year debated savvy investor Jim Rogers and declared “Maybe it will reach $1,100 or so but $1,500 or $2,000 is nonsense”, must be squirming on his seat for the likelihood to be proven wrong once again.

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[1] See US Midterm Elections: Rebalancing Political Power And Possible Implications To The Financial Markets, October 31, 2010

[2] USA Today, 2010 Elections: Live Results

[3] Politico.com Roland Burris will serve in November, November 5, 2010

[4] See An Overextended Phisix, Keynesians On Retreat And Interest Rate Sensitive Bubbles, October 25, 2010

[5] Toffler, Alvin and Toffler, Heidi Revolutionary Wealth Random House p.40

[6] See Trick Or Treat: The Federal Reserve’s Expected QE Announcement, October 31, 2010

[7] Ibid

[8] Bernanke, Ben What the Fed did and why: supporting the recovery and sustaining price stability, Washington Post, November 4, 2010

[9] Bernanke, Ben A Crash Course for Central Bankers, Foreign Policy.com or wikiquote Ben Bernanke

[10] Macau Daily Times Asian markets rise, dollar falls, November 5, 2011

[11] Board of Governors of the Federal Reserve System, November 3, 2010 Press Release

[12] Marketwatch.com Bank of Japan holds steady, details asset plans, November 4, 2010

[13] Noland, Doug QE2 Credit Bubble Bulletin, Prudent Bear.com

[14] See Thought Of The Day: The Keynesian Circular Thought Process, June 22, 2010

[15] Wordnetweb.princeton.edu law of diminishing returns

[16] Wiktionary.org law of diminishing marginal utility

[17] See Surging Gold Prices Reveals Strain In The US Dollar Standard-Paper Money System, November 1, 2010

[18] See The Myth Of Risk Free Government Bonds, June 9, 2010

[19] See $23.7 Trillion Worth Of Bailouts?, July 29 2010

[20] See The Possible Implications Of The Next Phase Of US Monetary Easing, October 17, 2010

[21] Durden Tyler, How Ben Bernanke Sentenced The Poorest 20% Of The Population To A Cold, Hungry Winter, Zerohedge.com November 5, 2010

[22] Asian Development Bank: Food Prices and Inflation in Developing Asia: Is Poverty Reduction Coming to an End? April 2008

[23] Mises, Ludwig von The Truth About Inflation

[24] Bloomberg.com Asians Gird for Bubble Threat, Criticize Fed Move November 4, 2010

[25] Virtualmetals.co.uk The Yellow Book September 2010

[26] See Is Gold In A Bubble? November 22, 2009

[27] See Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble, November 5, 2009

Should We Chart Read Market Actions From QE 2.0?

``We can chart our future clearly and wisely only when we know the path which has led to the present." - Adlai E. Stevenson

Now we know that no trend moves in a linear fashion.

Yet we cannot be heavily reliant on chart actions to determine the “overbought or oversold” conditions from which to base our positions.

In any major trend (bear or bull cycles), overstretched markets or securities can last for an extended period.

Besides, chart actions greatly depend on patterns from past performances in the probabilistic assumption of a recurrence. The operating word is here probability.

But charting does NOT incorporate the prospective stimulus-response and action-reaction by the public to the ever fast evolving highly fluid environment nor does charting impute exactly similar conditionalities from which decisions had been shaped. This is despite some successful repetition of patterns.

For instance can charting say to what degree the markets will react to a sustained QE? The answer is NO.

And it is from such dimensions that I accurately debunked earlier claims by perma bears of the supposed repetition of the Great Depression, through the alleged similarities in the unfolding of chart patterns[1].

For most of the perma bears, whom have been influenced by some form of (political or economic or cultural) bias rather than sound analysis, they can characterized by the frequent use of post hoc fallacy and data mining to support their desired outcome.

This is why I also correctly disproved earlier notions of chart based bearish patterns which ALL failed to pan out.

I earlier wrote[2],

``They never seem to run out of materials to throw in, after the earlier “death cross” and the ERCI leading indicator, whose effects remain to be seen, now they point to the Hindenburg Omen as a reason to take flight.”

Now that the actions have been reversed and that all former bearish patterns have evaporated, chartists have been talking about the bullish “Golden cross”. Duh!

Yet even if one looks at the charts, the synchronous breakouts in global markets imply a tailwind effect or “momentum” in favour of continuity going forward. As charts have yet to signify distribution or exhaustion.

Also the assumption that charts impute all the necessary information is similar to the flawed premises of the Efficient Market Hypothesis (EMH) which ignores the role of the individual entrepreneurial activities that generate variable outcomes and the erroneous implication that all participants have the same homogenous ‘rational’ expectations[3].

And in learning from the recently departed Benoit Mandlebroit, the father of fractal geometry, on why not to trust charts, Mr. Mandlebroit wrote[4],

``And in the fun-house mirror of logic of markets, the chartists can at times be correct...But this is a confidence trick: Everybody knows that everyone else knows about the support points, so they place their bets accordingly. It beggars belief that vast sums can change hands on the basis of financial astrology. It may work at times, but it is not a foundation on which to build a global risk-management system.” (bold emphasis mine)

In other words, Mr. Mandlebroit shares the analysis disputing the homogeneity of rational expectations incorporated in charting, such that everyone employing the same pattern recognition techniques would render charting to be impractical and an undependable tool for investment or trade.

For me, chart patterns have higher probability of repetitions only when it treads on major trends.

Yet I find more value in identifying the stages of the trend or the cycle, where charts only serve as supplemental role or a guidepost for entry and exit points rather than for main reasons to anchor on a major investment or trading decision.

Hence, given the current market actions and fundamental based developments brought about by QE 2.0, I am unlikely to recommend any position that would fight the major trend.

Remember, QE 2.0 represents uncharted waters in modern central banking, unless we’d include Zimbabwe Gideon Gono’s approach as part of this.

So why use traditional or conventional tools to engage in something unprecedented?

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[1] See Seeing Patterns Where None Exist, February 17, 2010

[2] See The Importance of Peripheral Vision, August 23, 2010

[3] Shostak Frank, In Defense of Fundamental Analysis: A Critique of the Efficient Market Hypothesis

[4] Mandlebroit, Benoit B and Hudson Richard, The (Mis) Behaviour of Markets, Profile Books p .8