Financial Populism Means Confirming Mainstream’s Biases

``Who do you listen to? Who are you trying to please? Which customers, relatives, bloggers, pundits, bosses, peers and passers by have influence over your choices? Should the Pulitzer judges decide what gets written, or the angry boss at the end of the hall so influence the products you pitch? Should the buyer at Walmart be the person you spend all your time trying to please? Your nosy neighbor? The angry trolls that write to the newspaper? The customer you never hear from? Just for a second, think about the influence, buying power, network and track record of the people you listen to the most. Have they earned the right?” Seth Godin The people you should listen to

Some experts will virtually say anything just to get to the limelight or promote ideology. Unfortunately, the public hardly understands the motives behind such actions.

For instance when mainstream experts obstinately hammer on a “remittance driven Peso”, even if they have hardly been directly correlated in terms of remittance growth trends relative to the Peso-US dollar value [see How The Surging Philippine Peso Reflects On Global Inflationism], would be analogous to religion, arguing against populism would appear like blasphemy.

This goes to show that it is never about evidences or direct proofs (ipse dixitism) or logical reasoning but about indoctrination- from what academic or institutional experts, as repeatedly quoted by media, thinks they should be.

It’s Isn’t About Adherents, It’s About Profitability

At the start of the year high profile local experts had been in near unison predicting that the Philippine Peso will fall in excess of the Php 50 to a US dollar level.

Yet, in spite of the repeated forays by the local central bank (Bangko Sentral ng Pilipinas) to keep the Peso from firming, the Philippine Peso has virtually been up (by about 1.8% as of Friday’s close on a year to date basis) blatantly defying the collective projections of these mainstream experts.

Media never elaborates on the motivations of the actuations of mainstream experts or their predisposition for more interventionist government via inflationism in an attempt to uphold the plight of OFWs.

Since OFWs have been glorified as economic heroes, populism dictates that socio-political policies have to be directed at alleviating the conditions of the 12% of the economy at the expense of the rest.

However, these experts, who pretend to know how resources ought to be allocated, have failed to see the unintended effects of the 40 years of devaluation, and importantly botched at predicting the Peso level for 2009.

Yet if they can’t predict the whereabouts of the financial markets how the heck should we expect them to know how to deal with an even more complex real economy?

Still, in order to devalue the Peso, the BSP will have to massively intervene by printing money and/or have government spend more in the economy.

Yet, hardly any of these experts dealt with the repercussions of such interventionists actions through flagrant distortions in the production structure of the domestic economy and the resultant higher consumer prices.

Nor have they expounded on the crowding out effect of private investments that would lead to higher unemployment and to greater incidences of corruption from an enlarged bureaucracy, aside from greater inefficiency in the system as a consequence of government’s politicization of the economy.

Also yet none appears to have ever discussed on how the Peso’s over 40 years of devaluation from Php 2 to a US dollar in 1960s to Php 55 in 2005 have NOT lead to a goods and service export economy but to an unintended consequence-labor or manpower exports.

So while we have been correct in predicting for a stronger Peso for 2009 and a meaningful recovery in the Phisix, it’s primarily because we focused on what we thought mattered most-the impact of global political inflationism to asset and consumer prices and its diversified impact to the idiosyncratic structures of national economies.

And maybe lady luck mattered too.

In other words, we didn’t mince words to go against the crowd and worked on the basis of facts operating on free market based economic theory.

So it really doesn’t matter if we don’t gain “adherents”, what we have purported to do is to offer an alternative “contrarian” point of view in spite of the risks of social ostracism. Most importantly, we aim to impart market profitability and not just entertainment value.

In adhering to Warren Buffett’s investment advice, ``Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success.''

Populism And Forecasting Accuracy

Does populism imply forecasting accuracy?

Perhaps for some, especially for those with a longer term horizon such as Warren Buffett, Dr. Marc Faber or Jim Rogers, but certainly not for all.

Especially NOT for celebrity gurus.

If it is not saying something radical, populism is always about declaring something outlier that connects with the mainstream ideology or short term views.

Tyler Durden of Zerohedge recently unmasked RealMoney columnist James Cramer “Citigroup” recommendation that prompted for a 14% drop in 3 days. The mercurial TV personality James Cramer appears to have a poor track record in calling the market right (Wall Street Cheat Street).

Another celebrity guru, Nouriel Roubini followed up on his debate with Jim Rogers [see Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble] and has repeatedly but incoherently been thrashing gold (projectsyndicate.org).

Mr. Roubini introduced the US dollar carry trade as a major risk “mother of all carry bubbles” last November, even when we had brought out this possibility last August [see The US Dollar Index’s Seasonality As Barometer For Stocks]- this means we have already reckoned the US dollar carry trade even prior to Mr. Roubini’s admonition.

Mr. Roubini’s derring-do concept has reflexively been embraced by the mainstream institutions like the IMF (Bloomberg), the World Bank (World Bank Blog) and other financial institutions.

Nevertheless we have argued against this [see Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble and Central Bank Policies: Action Speaks Louder Than Words, The Fallacies of US Dollar Carry Bubble] noting of:

-the confusion between the incentives of private purchases against government purchases of commodities and select financial securities,

-the ultimate tasks of (developed economies) governments appear to be securing the stability of its banking system via the manipulation of several key markets including the mortgage, treasury and equity markets coupled with the tacit aim to devalue their currencies (US dollar, UK pound, Japanese Yen),

-the variability of the impact from the recent recession on industries and nations,

-the inability by the old financial system to regenerate systemic leverage,

-expectations of money’s neutrality,

-comparing today’s economic model with that of the Great Depression and

-the tendency of experts, like Mr. Roubini, to anchor on the recent past events or from the success of recent ‘carry’ models.

Mother Of All Carry Trade Bubble, Where?

Yet the proof of the pudding is in the eating.

Figure 3: Stockcharts.com: What US Dollar Carry?

With the US dollar has been up 4.8% from its recent bottom over the last 2 weeks, surprise (!), we are hardly seeing any generalized financial market tumult similar to that of 2008 see figure 3)

Except for the recent weakness in China’s Shanghai index (not shown above), Asian ($DJP1), European ($STOX 50) and Emerging markets (EEM) equities appears to be generally resilient amidst a rising US dollar.

In addition, the infirmity of the gold market, which has reflected on its inverse correlation with that of the US dollar, has yet to spillover to other commodities.

Instead of weakening, it would appear that other commodities have been firming up such as the Dow Agricultural Index ($DJAAG), the Copper markets ($COPPER) and most importantly, rallying oil prices ($WTIC) again, in the face of the recent strength by the US dollar.

So unless we see further deterioration across global financial markets (amidst the Dubai debt Crisis and the recent credit rating downgrade of Greece), there hardly seem any traces of the unwinding of “mother of all carry bubbles”.

So, where o’ where is the US dollar carry?

Seasonal Oil Strength And Celebrity Guru Track Records

Figure 4: US Global Investors: Oil’s Seasonal Price Patterns

Moreover if we should see oil’s seasonal strength play out, as it had during the previous 15 years, similar to gold and US dollar index (which has proven to be quite effective see Gold and the September Stock Market Seasonality Syndrome and The US Dollar Index’s Seasonality As Barometer For Stocks), then we can probably expect oil prices to further rise from current levels (see figure 4) and possibly break above its recent high at $82 per barrel in the face of a rising US dollar.

As a caveat, the rising US dollar appears to be a technical bounce and is likely a short term event more than fundamentally driven inflection or reversal.

Perhaps the US dollar bounce could also be interpreted by markets as anticipating the end of the US QE program, while major trading partners as the UK and Japan proceed with their own versions. In addition, the downgrade of Greece which risks of a contagion may spur more policy easing from the ECB to contain the ripples of the shockwaves.

Nevertheless with 7 banks closed by US regulators this week (marketwatch.com), and with next wave of ALT-A and Prime mortgages (aside from Commercial Real Estate) threatening the US banking system anew [see 5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects], we shouldn’t expect any policy tightening or reversals of the QE program even if they expire in March. In fact, if things turns for the worst we should expect QE policies to intensify.

Yet celebrity guru Mr. Roubini has had a poor track record, according to Wall Street Cheat Street, with only 1 out of 7 predictions being accurate over the last few years.

Mr. Roubini had earlier failed to see this year’s rally and vehemently denied of its persistence, and also predicted that oil will trade at the $40 for the rest of 2009 [see Wall St. Cheat Sheet: Nouriel Roubini Unmasked; Lessons].

Realizing his obvious mistake, Mr. Roubini has switched sides during the midyear and declared oil to rise “closer to $100” (CNBC), which apparently hasn’t likewise been valid unless oil explodes during the coming sessions.

With wrong predictions after wrong predictions, it’s a wonder how mainstream institutions and experts have been hasty to freely embrace such flimsy and specious macro theories based on archaic models without addressing the impact from the policy directives by global governments on the economy and markets aside from oversimplistically interpreting economics like some school laboratory experiment.

Perhaps the common denominator for publicity seeking gurus is the ideological likemindedness, where according to Richard Ebeling, ``a whole host of economists who crave popular approval and political influence have been propounding a whole series of quack medicines to "heal" the economy, with the promise of curing the recession through interventionist and monetary "elixirs." (bold highlights mine)

If it were a choice between 15 minutes of fame from quackery and profitability from accurately predicting markets, the latter would be my choice hands down.

The US Federal Reserve Experiments On Unwinding Stimulus As Bank Of Japan Engages in QE

``The basic cause of inflation, always and everywhere, lies in the field of money and credit." -Henry Hazlitt in Newsweek, December 22, 1947

The US Federal Reserve did the unexpected this week, aside from conducting a preliminary test to unwind current stimulus by selling $180 million of reverse repurchases Friday (Wall Street Journal), the Fed’s balance sheet recorded sales of $2.7 billion in Mortgage Backed Securities (MBS) which is the first decline in the Fed’s MBS holdings since the Quantitative Easing program begun. Incidentally, since MBS represent as the “toxic” securities, it would seem improbable for anyone to actually buy them.

Figure 1: stockcharts.com: An Anomalous Response To A US dollar Spike

Nevertheless, the Fed actions has apparently coincided with the spike in the US dollar index (see figure 1) which media attributes to improving economic jobs (marketwatch) and factory orders (Wall Street Journal) data.

To add, recent concerns over the strengthening yen [as discussed in Vietnam’s Inflation Control Measures And The Japanese Yen’s Record High], has prompted Japanese officials to deploy their own version of quantitative easing with the excuse to fight “deflation” by having the Bank of Japan (BOJ) inject one trillion ($11.5 billion) into money markets and likewise introduce a 10 trillion yen facility for banks-equivalent to 2% of GDP. The BOJ would accept everything from government bonds to corporate bonds as collateral (Wall Street Journal).

The Japanese Yen which constitutes about 13.6% of the US dollar index pie, second only to the Euro (57.6%) in terms of weighting, fell by 4.18% over the week. The Euro fell by only .71% which means the chunk of the US dollar’s gains came from the Yen’s fall.

Meanwhile, Japan’s equity benchmarks celebrated on the announced QE program, the Nikkei rocketed by 10.36% while the Topix index soared 9.69%.

In short, central bank actions of Japan and the US has prompted for the heightened volatility in the price movements of US dollar index. And one may even suspect that the combined actions may have been deliberately calibrated for unspecified reasons.

Yet, in contrast to the conventional inverse relationship between the US dollar (USD) and stocks (SPX), where a rising US dollar impacted equities negatively and vice versa, the actions last week saw an anomalous synchronism. Only gold (GOLD) and oil appears as having been negatively affected. Even copper (COPPER) shrugged off the surge in the US dollar.

This implies two things: One that the US dollar’s rise has merely been a knee jerk response to the recent Fed action, which may be deemed as synthetic or a bluff and likewise reflected on Japan’s thrust to devalue its currency. And second, concerns over the US dollar “carry trade” have been vastly exaggerated [see Central Bank Policies: Action Speaks Louder Than Words, The Fallacies of US Dollar Carry Bubble and Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble], as markets didn’t suffer from a chain of losses arising from a strong US dollar.

The coming sessions will reveal if these trends will be sustained.

Central Bank Policies: Action Speaks Louder Than Words, The Fallacies of US Dollar Carry Bubble

``The cause of waves of unemployment is not “capitalism” but governments denying enterprises the right to produce good money”-Friedrich August von Hayek

In last week’s outlook [5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects], we proposed that the recent market volatility had most likely been a government mounted attempt to put a rein on “animal spirits” having gone berserk. We also posited that markets, having been overstretched, may have likely reached a snap back point or analogous to the breakage of the crosslinks elasticity as seen in the dynamics of a Rubber band.

In short, we argued that the recent downside volatility could have embodied a “bear trap”- a bearish signal that turns out to be false or a trap.

Market performance, this week, appears to have validated us anew. While short term direction is less of a concern to us as markets can go or gyrate bi-directionally, what matters most is the strategic context of the risk-reward or market analytical framework fused with a tactical approach in portfolio management.

And strategical analysis should consist of objective interpretations of all available facts, underpinned by appropriate definitions and realistically functional theories, and not the selective collection of facts (data mining) that are designed to fit (usually ideological) biases and stamped as “analysis”.

And from this standpoint, we argued that government’s present pronouncements, which recently spooked markets, will eventually be unmasked in the face of grinding realities from the cumulative and prospective political actions and from the prevailing economic and financial conditions.

As we previously said, ``So the Fed’s communiqué and the real risks appear to be antithetical. One will be proven wrong very soon.”

It would seem that this vindication partly happened so soon.

Policy Statements And Actions Diverge

The Fed declared last October 29^th, the end of its Treasury purchase program, ``The Federal Reserve completed its $300 billion Treasury purchase program today amid signs the seven-month buying spree helped stabilize the housing market and limited increases in borrowing costs” (Bloomberg).

I don’t know what the Federal Reserve’s definition of today is, but to my understanding the self-imposed limits of $300 billion and October 2009 has been met yet the Treasury purchase program seems ongoing (see Figure 1).

Figure 1: Federal Reserve of Cleveland: Credit Easing Policy Tools

The Federal Reserve bought nearly $2.8 billion of US treasuries by November 4^th!

So if there is any short term validation, it is that the political actions of the US government have been to continually undertake quantitative easing or further inflationary activities regardless of its official pronouncements.

This only validates our postulation that the US banking system represents as the first order of priority among the many issues of concern by the incumbent US political and non-political leadership. Hence, the massive redistribution of wealth from the real economy to the financial sector and the corollary of accruing of structural imbalances in the pursuit of immediate resolution from short term oriented policies.

The same goes with the Bank of England, which recently declared a continuation of its own version of quantitative easing but at a “slower” pace (Telegraph).

Moreover one shouldn’t forget that equities have also been qualified as an eligible collateral as part of the TARP program.

To quote Mr. Practical of Minyanville (bold highlights mine), ``Under TARP, the fine print allows dealers to REPO stocks to the Fed as collateral (holy cow is right).

``What if there were an arrangement where large dealers buy stocks and stock futures through the day and REPO them to the Fed at the high closing prices? The dealer would book the profits derived from the difference at no risk.

``If you look at the trading patterns of the largest dealers, one in particular lost money trading in only one day last quarter. Statistically that's like finding a needle at the bottom of the ocean.”

What this implies is that the TARP program could be one of the many instruments used to prop up the equity markets.

As we have long been argued, markets today don’t act on the norm or as “traditional” forward indicators, which has essentially flummoxed the mainstream, but as policy instruments engineered primarily to keep the banking system afloat and secondarily to manage the “animal spirits” in order to jumpstart the economy.

As we noted last week, ``The underlying fundamental malaise is that the ‘bank as trader model’ has been a product of the collusion between the banking system and the US government to inflate the economy to the benefit of the elite bankers!”

So if market response this week appears favorable, that’s basically because money isn’t neutral- or money from these governments actions have filtered into equity and commodity assets-regardless of what has been happening in the real economy.

The Fallacies Of The US dollar As The Mother Of All Bubbles

This similarly shows that the allegations that the US dollar carry trade is now the “mother of bubble” isn’t generally true.

That’s because it hasn’t been the carry trade, but direct government liability accumulation via the quantitative easing aside from other government programs designed to reinforce the banking system that has kept the global financial markets at hyper-animated conditions.

Moreover, we take on the cudgels for investment guru Jim Rogers, in his debate with celebrity guru Mr. Roubini over the latter’s thesis that the US dollar signifies as the “Mother of ALL Bubbles” [see Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble].

We argue that the fundamental premise behind the falling US dollar hasn’t been the arbitrage leverage amassing within the private sector financial system especially in the US, which continues to reel from the lackadaisical credit growth amidst signs of surging reserves, but from global governments’ balance sheets.

Mr. Roubini oversimplistically attaches every asset class to the currency leverage, which he extrapolates as having an inverse direct causal relationship: a prospective bust in global assets as a result of delevaraging which should propel for massive rebound in the US dollar. This view has been anchored on (anchoring bias) virtually the same dynamics which made his celebrity “rock and roll star” status during the 2008 meltdown-(letting go of a success identity seems so hard to do!)

Moreover, the surge in commodity prices hasn’t just been a private sector dynamic, instead emerging market governments have played a pivotal role in the elevated state of commodity prices.

India’s recent surprise $6.7 billion purchase of half IMF’s gold’s reserves for sale serve as a major proof.

Figure 2: US Global Investors: China’s Impact On Metals

As one can observe in Figure 2, Chinese imports of metals and steel have exploded!

In addition, in 2009 China’s predominantly state owned enterprises has acquired $21.9 billion of privately owned resourced based companies (80% of which have been oil or energy while 20% have been in metals). Three more acquisitions are still in the process- Nigeria (offshore oil fields), Russia (stake at UC Rusal) and Norway’s Statoil (20 of the 451 drilling leases) [World Bank].

Emerging markets governments’ acquisition of commodities hasn’t entirely been for economic and monetary interests, but likewise has geopolitical dimensions into it. In short, the incentives that drives governments are likely political more than economical.

So it would be plain naïve to lump private sector speculation with government purchases and make a generalized conclusion based on unfounded one size fits all hypothesis.

I would like to further add that the degree of state buying advances our view that markets have been severely distorted by government interventions.

Moreover, unless one views the world as falling into an abyss from globalized deflation (which seems as a near impossibility given the fundamental nature of the paper money standard from today’s central banking and the diversified capital structure of each nation), today’s risk takers including that of governments/ government enterprises seem widely apprised of the risks from high inflation and the accompanying high interest rate regime, which could destabilize or cause heightened volatility in such arbitrages.

These have been evident from

-the numerous and growing clamor (including the United Nations) to replace the US dollar as reserve currency possibly with the Special Drawing Rights-SDR (a controversial rumor was recently publicized by the Independent which alleged that several key emerging markets and developed economies could have been attempting to a form coalition to conduct trade in oil in a basket of currencies outside the US dollar),

-increasing arrangements to conduct bilateral trade away from the US dollar (Argentina-Brazil, Russia-China, a Latin American Bloc),

-expanded currency swap arrangements in Asia, and

-importantly the proposed expanded use of the Chinese remimbi or the Yuan as the ASEAN’s currency standard [see The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency].

Ergo, the accumulation of commodities by emerging markets could function as an insurance against currency volatility, in view of a heightened inflationary environment, as consequence to spendthrift and reckless US national policies that could incite systemic global instability. Effectively, this demolishes the core premise of the “US dollar carry trade mother of all bubble”.

True, there are maybe some parts of the marketplace that has engaged in the carry trade but the overall climate departs from the 2008 environment depicted upon by Mr. Roubini.

``A fiat-money inflation can be carried on only as long as the masses do not become aware of the fact that the government is committed to such a policy. Once the common man finds out that the quantity of circulating money will be increased more and more, and that consequently its purchasing power will continually drop and prices will rise to ever higher peaks, he begins to realize that the money in his pocket is melting away. Then he adopts the conduct previously practiced only by those smeared as profiteers; he "flees into real values." He buys commodities, not for the sake of enjoying them, but in order to avoid the losses involved in holding cash. The knell of the inflated monetary system sounds” admonished Ludwig von Mises. (bold underscore mine)

Put differently, as the public loses trust of the functionality of the prevailing money standard they either look for substitute/s (in the past-resort to barter or a foreign currency-but in this case a new currency standard) or a return to basics…commodities.

Fancy But Unrealistic Models

Of course, one can’t help but point out on the foibles of the highly mechanical traits of analyzing markets from presumptive models utilized by the mainstream that frequently leads to severe misdiagnosis and the subsequent maligned therapeutical prescriptions or perversely flawed actions in managing a portfolio.

Figure 3: Wall Street Journal: U.S. Factories Are ‘Grossly Underutilized’

Low capacity utilization is one of the most frequently used justifications by the mainstream to argue for “low” inflation which is blamed on the deficiency in demand as responsible for “idle” resources. The fundamentally flawed premise of mainstream’s concept of inflation is due to its definition-inflation is seen as rising prices instead of as emanating from money supply growth. Secondly, capacity is viewed in the context where capital is homogeneous.

In the Wall Street Journal article we note of such differences (bold highlights mine),

``Looking beyond the headline number points to another sobering reality: Some industries were hit much harder than others — and therefore have further to go to get back to more normal utilization. Capacity utilization in primary metals plunged from 86% in December 2007 to 55% currently, mainly because of collapsing demand for some types of steel, while the utilization rate in the computer and peripherals industry fell to 58%, down from 83% in December 2007.

``Each industry got hammered by its own mix of headwinds. Computer sales suffered as businesses postponed information technology upgrades and laid off white-collar workers, while makers of big ticket items such as furniture and cars suffered because consumer financing dried up even for those still eager to buy.

``Only a few industries avoided going off the cliff. Capacity usage in the petroleum refining and coal industries fell only 1 percentage point over the last 21 months, while in the food industry, usage declined only 2 percentage points.”

The performances of capacity utilization vary across industries. This extrapolates that the current monetary policies will likely influence relative “overinvestment/s” on specificity basis on a relative circumstances or that over investments will happen in some areas more than the others.

For instance, the implosion of the dot.com bubble in 2000 didn’t put a check on the 2003-2007 US housing bubble cycle from inflating. Moreover, in the recent case of Iceland, both rising unemployment and falling output didn’t forestall inflation, which had been a consequence of the currency’s or the krona’s devaluation [see Iceland's Devaluation Toll: McDonald's].

As Brookesnew’s Gerard Jackson explains, ``Sufficient monetary growth reduces excess capacity by raising the value of the product relative to production costs. (It should be noted that this does not always mean a general increase in prices). However, where inflation is already a force and there is a great deal misallocated capital then a loose monetary policy can bring about accelerating inflation before full operating capacity has been reached and full employment restored.”

Not to mention that the massive interventions put forth by the US Federal Reserve on the banking system combined with fiscal policies aimed at propping up select industries at the expense of the rest of society or as Mr. Jackson avers, ``inflation is already a force and there is a great deal misallocated capital then a loose monetary policy can bring about accelerating inflation”, ergo, the seeds of inflation has been planted, hence inflation is what we will be harvesting.

It’s just the “degree” of inflation that will likely be debated.

In short, mainstream can’t fathom the prospects of a stagflationary environment (at the very least) because of the continued reliance on popular but fallacious models.

Overall, for as long as global political and bureaucratic authorities continue to mount a massive campaign to fillip their respective economies with reflation steroids, we should expect the “Frankenstein” market to respond accordingly. So far the favorable responses will arise from Asia and emerging markets, until the systemic leverage renders them unsustainable.