Asian Crisis Watch: Taiwan’s 3Q GDP Contracts, Government Launches Stimulus

Impact from a strong USD, China’s economic slump and domestic property bubble? 

From Focus Taiwan:

Taiwan's gross domestic product (GDP) recorded a negative year-on-year growth of 1.01 percent in the third quarter of the year, failing to meet a government forecast of 0.1 percent growth, according to government data released Friday.

The Directorate General of Budget, Accounting and Statistics (DGBAS) said that the third-quarter GDP figure was the lowest since the second quarter of 2009, when the country's economy fell 1.24 percent from a year earlier amid a global financial crisis.

The GDP data for the July-September period reflected a poor export performance resulting from weak global demand and worse-than-expected domestic demand, the DGBAS said. 

In August, the DGBAS predicted a year-on-year GDP growth of 0.1 percent for the three-month period.

After seasonal adjustments, the country's third-quarter GDP registered a 0.05 percent quarterly growth.

Exports Down…

In the third quarter, Taiwan's merchandise exports fell 13.86 percent from a year earlier in U.S. dollar terms, with outbound sales of electronics devices, the backbone of the country's exports, down 7.88 percent.

After inflationary adjustments, Taiwan's real goods and services exports in the July-September period dropped 2.85 percent year-on-year, missing an earlier projection of a 0.39 percent increase.

In the three month period, Taiwan's real merchandise and services imports fell 1.47 percent from a year earlier, missing the projected 1.64 percent increase by a wide mark. The DGBAS said the weaker exports and imports dragged down the entire GDP growth by 1.11 percentage points for the third quarter.

Slower outbound sales resulted in lower income, which affected private consumption in the third quarter, the DGBAS said. Private consumption in the third quarter grew only 0.89 percent year-on-year, far short of the estimated 2.94 percent increase, the government agency said.

And so with domestic investments…

It said capital formation, which includes public and private investments, fell 1.25 percent from a year earlier, missing an earlier government forecast of a 0.04 percent increase.

The firming USD relative to Taiwan's Dollar as seen in the US/TWD chart above from investing.com

Taiwan’s annual GDP crumbled during the past 2 Quarters

With exports down, manufacturing have also shrank in 4 months from May to August

Retail sales (year on year) have been in contraction from July to September

Loan growth has been in a cascade.

And with loan growth down, property inflation has turned the corner. The annual housing growth rates and the nominal index exhibits this downshift.

In fear of a bubble, part of the slowdown has been due to property curbs too imposed by the national government, according to Global Property Guide and  by DBS

 

Taiwan’s stock market, as measured by the TWSE, entered the bear market zone last August 2015 (down 25% peak to trough). 

The ‘bad news is good news’ rally which powered the TWSE away from the bear market still shows the index down by 14% from the August bottoms.

And so, Taiwan’s government have  been in a dilemma.

All these market and economic signals had earlier prompted Taiwan’s central bank to cut policy interest rate last September the first since 2011.

And like any conventional pious Keynesian abiding government, the response on the economic contraction has been to use politics: a NT $4 Billion (USD $123 million) stimulus. Political solution to economic problems.

From another Focus Taiwan article

The Cabinet on Friday announced a series of short-term stimulus measures, including subsidies for the purchase of energy-efficient home appliances and for domestic travel, in a bid to boost Taiwan's flagging economy.

The package, which will be effective Nov. 7 to Feb. 29, also includes a subsidy for buyers who replace their second-generation (2G) cell phone with a 4G smartphone.

The measures were announced by Premier Mao Chi-kuo at a press conference, which was attended by Vice Premier Chang San-cheng and other top officials.

It is estimated that the package will cost the government NT$4 billion and add NT$1.54 billion to the gross domestic product (GDP). Money needed for the measures will come from the Cabinet's special reserve fund so Legislative approval is not required.

The measures include a subsidy of NT$2,000 per person for the purchase of air conditioners, refrigerators, television sets or water heaters certified with Grade 1 or Grade 2 energy-efficiency performance.

And political response almost always fixates at the short term.

But if the political fixes fail, and the downturn is sustained, economic contraction will imply of the amplification of financial losses that would have ramifications on the credit channel. And increased credit woes will boomerang back on economic activities. The escalation of the feedback mechanism may lead to insolvencies. And snowballing insolvencies heighten the risks of a crisis.

Will economic contraction be limited  to Taiwan? Or will other nations within the region suffer the same dynamic wherein Taiwan leads the pack? Singapore barely escaped a technical 3Q GDP recession.

Interesting turn of events.

 

Photo of the Day: Asia's Deteriorating Economic Headlines

Today's Nikkei Asian Review presents a chain of articles from the "economy" section that has been quite revealing of what's been happening to the Asian region.

While Asia Central Bankers Need to Go Easy on Rate Cuts, They will Cut Rates Anyway

Frederic Neumann co-head of HSBC’s Asian economic research counsels Asian monetary authorities to go slow with interest rate cuts. Writing at the Nikkei Asia “Asia needs to go easy on rate cuts”, he provides three reasons: (bold mine)

The trouble is, it will prove only mildly effective and, in some cases, possibly counterproductive. That interest rate cuts help to ease the debt servicing burden of indebted consumers and companies is not in doubt. But, in most economies, it seems unlikely they will exert a lift through their second, more potent channel: faster credit growth. Take India. State banks, which dominate the financial system, are saddled with non-performing loans. Many large companies, too, are stuck with too much debt. Rate cuts alone, therefore, may not boost spending. Thailand, Malaysia and South Korea face similar challenges.

Translation: When company balance sheets have been hocked to the eyeballs with debt, borrowing will about debt rollovers rather than capex. And that's if there will be borrowings at all. You can lead the horse to the water, but you cannot make it drink.

The second point is that rate cuts, to the extent that they spur lending, may fuel growing imbalances that could ultimately push economies deeper into a disinflationary, if not deflationary, trap. Leverage in Thailand, for example, is already high, especially among consumers. Cutting interest rates could provide a temporary boost to spending, but at the cost of driving debt ratios even higher. In Australia, too, further easing will add fuel to the booming housing market without curing the underlying problem: a deflating mining investment boom. China also comes to mind, with blanket easing doing little to correct imbalances.

Translation: When company balance sheets have been hocked to the eyeballs with debt, borrowing will about debt rollovers rather than capex. More companies will resort to Hyman Minsky’s Ponzi financing. With insufficient cash flows for debt servicing, companies become heavily reliant on using debt to service existing debt. Asset sales function as a compliment. In short, Ponzi finance=Debt IN debt OUT + asset sales. And this is why the need to spike asset values as they provide bridge financing for debt.

Unfortunately as Mr. Neumann rightly points out, increasing use of Ponzi finance signifies heightens the risk of ‘debt’ deflationary trap.

Third: Easing monetary policy exposes countries to greater financial volatility down the road. The Fed, of course, may raise rates only gradually in the coming years. But the dollar looks set to strengthen further. In itself, this may not be enough to drive capital out of the region. Still, if local central banks overplay their hand and ease too aggressively, especially with no improved growth prospects to show for it, investor jitters might return. The "taper tantrum" of 2013, when investors dumped risky assets, was a painful reminder of the vulnerability of emerging markets when the Fed starts to move. Indonesia, especially, looks exposed.

Translation: In a financial and economic landscape where asset sales become complimentary to debt IN debt OUT, today’s asset market pump have likely been about the use of inflation in asset markets to generate cash flows to service debt.

And because asset market inflation are unsustainable this leads to “greater financial volatility”. 

In addition, a general use of Ponzi financing can become a systemic issue. 

From Wikipedia (bold mine): If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.

So even mainstream can see what I am seeing.

While the advise to monetary authorities of the diminished use of zero bound rates has been commendable, I doubt if such will be heeded.

Reasons?

Political agenda will dictate on monetary policies. Incumbent political leaders would not want to see volatilities happen during their tenure, so they are likely to pressure monetary authorities to resort to actions that will kick the can down the road. Here is an example, Turkish central bank yielded to the Prime Minister’s repeated demand for interest rate cuts. The Turkish  central bank trimmed 25 basis points for both overnight lending and borrowing rates yesterday

In short, authorities are likely to be concerned with short term developments. And political agenda will most likely revolve around popularity ratings and or the next election—or simply preserving or expanding political power.

Next, there is the social desirability bias factor. Monetary authorities won’t also want to be seen as “responsible” for a volatile environment. They don’t like to be subject to public lynching from market volatilities.

Third, there is the appeal to majority and path dependency. Since every central banker has been doing it and have long been doing it, they think that they might as well do it and blame external factors for any untoward outcomes. Again the cuts of central banks of Turkey and the record low rates by Israel two days back brings a tally of 21 nations on an easing path in 2015. 25 actions if we consider the multiple actions by some countries (Romania and Denmark) as I noted last weekend.

Asian central bankers are likely to embrace the “sound banker” escape hatchet as propagated by their political economic icon—JM Keynes: 

A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.

So expect more rate cuts ahead.

As a side note: Indonesia "vulnerable"? Hasn't Indonesian stocks been at record upon record highs? Has record highs not been about a risk free environment? Of course, opposite record high stocks have been a milestone high USD-Indonesian rupiah.

Quote of the Day: Asian Elites

It’s estimated that in the Philippines, just 40 of the country’s richest famillies account for, control and enjoy the benefits of 76 per cent of annual production; in Thailand, the figure for the 40 wealthiest families is 34 per cent. However, wealth is spread much wider in other Asian nations. In Japan, the equivalent figure is less than 3 per cent.

This is from analyst Martin Spring from his On Target Newsletter (no link available).

Inclusive growth? Guess who benefits most from a central bank induced property and financial market boom?

Why Asia is in Trouble: Corporate Savings Under Assault

For the government and the mainstream, the only thing that matters for the political economy is spend, spend, spend to infinity and beyond, regardless of the quality and financing of such activities.

So they endorse almost any policies that assails on savings--which is seen as a scourge.

This Keynesian myth has practically been embraced by Asian governments to the point that some of have directly imposed penalties on corporate cash hoard.

From the Wall Street Journal Real Times Economics Blog

Investors have long criticized many of Asia’s corporate giants for hoarding billions of dollars. Now those cash piles are under attack from governments that want them put to better use driving economic growth.

Last month, Korea announced that as part of a $40 billion economic stimulus package, it would impose a tax on companies that keep piling up savings instead of paying them out to workers or shareholders.

In Japan, Prime Minister Shinzo Abe has pushed companies to raise payouts to shareholders and workers, and Beijing has ordered state-owned behemoths to boost their dividends to the government to help pay for expanded social-welfare programs.

The International Monetary Fund took aim at the issue this month in its latest report on Japan, calling on Friday for better corporate governance to help “unstash Japan’s corporate cash.” The IMF estimates Japanese companies are sitting on record amounts of cash, equivalent to more than 9% of gross domestic product.

The idea is that by unleashing these corporate cash lodes onto shareholders and employees, they will either invest it more profitably in other parts of the economy, or simply spend it – either of which is better for growth than having it sit in the bank.

While such policies may temporarily be a boost to shareholders and employees these will have nasty side effects over the long run that has been unseen or neglected by the consensus. 

[Note: I exclude China's State Owned Enterprises in the discussion below]

One major reason why corporations hold cash is due to “uncertainty” (perhaps in reaction to social policies, to changes in the risk environment or to changes in profit opportunities) and or in relation this, the possible waiting for the right opportunities to deploy these surplus reserves. 

Yet by forcing companies to spend, such incentivize companies to wade into or speculate on unproductive ventures that risks financial losses. This would hardly be a boost to shareholders and employees. 

In addition, if many companies engage in politically induced 'forced' speculation such will lead to massive mis-allocation of capital, thus poses as a systemic risk. Combined with easy money policies, such will compound on bubble formation.

By forcing companies to pay employees more than what the company sees as their marginal productivity contribution to the company’s product/s, such increases business costs (decreases productivity) that could lead to a scrimp in profits or even to financial losses.

By forcing companies to shell out dividends, the opportunity cost of such actions will be investment opportunities when they emerge. These companies won’t have the resources to invest without recourse to debt. Subsequently, this also means that forcing companies to reduce cash reserves would increase balance sheet risks via debt accumulation.

This obsession with the crucifixion of savings and spending as panacea signals trouble ahead. 

As Austrian economist Gerald Jackson recently wrote: (bold mine)

Unfortunately economic thinking has now deteriorated to the point that one of the major economic fallacies the classical economists refuted is now presented on a daily basis in universities, colleges and the media as an irrefutable fact. The result is that governments the world over are implementing policies that direct economic activity to increased consumption at the expense of gross investment. As the Austrians are forever pointing out, it is gross investment, expenditure on all future-goods factors, that maintain the capital structure: not net investment or consumer spending

We are thus left with the conclusion that fighting a recession by encouraging consumption will prolong and perhaps even deepen it. One thing is certain from an Austrian perspective: if the critical point is reached where increased consumption spending continues to drive down gross investment then real wages must eventually fall if the phenomenon of permanent widespread unemployment is to be avoided.

Overall, the spending nostrum is all about temporary gratification at the expense of the future. This signifies what politics has been all about: Get votes today, voters be damned after.

More Signs of Asia’s Credit Bubble: Soaring Wages

I have pointed out that Thailand’s minimum wages surprisingly polevaulted by 89% in 2012. This led me to discover a massive build up in systemic debt, particularly weighted on the short term which makes the Thai’s economy highly sensitive or vulnerable to a spike in interest rates. 

Well soaring wages have not been limited to Thailand but a symptom evident throughout Asia.

From the Bloomberg,

Average pay in Asia almost doubled between 2000 and 2011, compared with a 5 percent increase in developed countries and about 23 percent worldwide, according to the International Labour Organization in Geneva. The gain was led by China, where average remuneration more than tripled during the period. Southeast Asia is catching up, with new minimum pay levels in at least five nations eroding companies’ ability to make cheap toys, clothes and furniture.

“Producers are no longer able to absorb rising wage costs and ultimately will have to jack up prices for consumers in the West,” said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc in Hong Kong and a former consultant on Asian economics and politics to the World Bank. “It’s the manufacturing hub of the world, and if prices rise here, then inevitably the global price level will have to rise as well.”

The threat of inflation prompted Pacific Investment Management Co., which runs the world’s biggest bond fund, to plan Asia’s first fund to protect against it. The investment will aim to return at least 2 percentage points more than the average consumer-price gains in Singapore and Hong Kong, Michael Thompson, head of Pimco’s wealth-management group for the region excluding Japan, said in a March 7 interview in Singapore.

Unfortunately this comes amidst falling labor productivity and deteriorating balance of payments.

More on Southeast Asia’s wage gains.

In Jakarta, the capital of Indonesia and home to 10 million people, Governor Joko Widodo last year approved a 44 percent increase in minimum pay for workers, to 2.2 million rupiah ($226) a month. The national government is considering extending the plan across the country, which has the world’s fourth-largest population, after China, India and the U.S.

Thailand raised its national daily minimum wage to 300 baht ($10) in January. Malaysia introduced a base salary last year, benefitting about 3.2 million workers before elections that must be held within three months. A similar tactic helped Taiwanese President Ma Ying-jeou, who won a second term in 2012 after increasing the lower limit on earnings by 5 percent.

Credit booms, which will be compounded by public works or government spending, will mean competition for scarce resources. Such dynamic will be expressed through higher costs of factors of production or input prices for industries experiencing such boom.

As I previously wrote,

we should expect that pressures to build on either relative input prices (wages, rents, and producers prices), particularly on resources used by capital intensive industries experiencing a boom, and or, but not necessarily price inflation.

Such dynamics would exert an upside pressure on interest rates that would eventually put marginal projects, including margin debts on financial assets operating on leverage, on financial strains which lay seeds to the upcoming bust.

The bottom line is that unless Asia’s central banks desist from her current engagement in accommodative policies, which signifies an attempt to align with policies of developed economies (yes central banks collaborate with each other), malinvestments will eventually unravel in the fullness of time. 

Yes, Asia’ bubble cycle is in progress.

RBS: Asia Has a Credit Bubble!

Like Thailand, Philippine officials will likely continue to stubbornly contradict publicly on the risks of bubbles, yet as I recently pointed out, recent events in Cyprus only reinforces the perspective of how regulators can hardly see or anticipate bubbles until fait accompli or until the ex-post materialization of the advent of a crisis[1].

And it would seem that more from the mainstream are becoming aware of elevated risks of Asia’s credit expansion. (yes, I am not alone)

The Royal Bank of Scotland (RBS) practically notices all the symptoms I have been elaborating as effects or symptoms of bubbles.

They note that bank deposits have not kept the pace with rate of credit growth. They also noticed that the focus on domestic consumption coincides with rising credit levels and the loosening of credit conditions (left window). Savings have also been in a conspicuous decline.

Remember consumption is a function of income. Outside income, more consumption can only be attained by virtue of borrowing and by running down of savings. Borrowing represents the frontloading of consumption. Expanded consumption today eventually leads to lesser consumption tomorrow as the borrowers would have to pay back on the interest and principal of debts.

As I previously noted[2]

My explanation revolved around examining the 3 ways people to consume; productivity growth (which is the sound or sustainable way) and or by the running down of savings stock and or through acquiring debt (the latter two are unsustainable).

So the decline in deposits and savings as credit expands are signs of capital consumption.

The RBS also observed that the ballooning of credit have come amidst the backdrop of falling labor productivity while the region’s balance of payments had rapidly been deteriorating.

Declining savings and the diversion of household expenditure towards debt financed consumption goods leads to capital consumption, thus the decline in productivity.

Artificially suppressed interest rates, which penalizes savers and encourage speculation in the financial markets and other unproductive uses of capital, mainly through the concentration of speculative investments or gambles on capital intensive projects, e.g. property, shopping mall, casinos, are symptoms of malinvestments. So instead of promoting productive investments, low interest rates serve as another source of productivity losses.

The RBS equally notes that India, Indonesia and Thailand have become balance of payment ‘deficit’ countries whereas Malaysia’s surplus has been sharply declining. The regions banks’ loan-deposit ratios have likewise substantially increased to uncomfortable levels (right window).

When nations spend more than they produce, then such deficits occur. And deficits would then need to be financed by foreigners or as I previously noted “would need to be offset by capital accounts or increasing foreign claims on local assets”[3]. 

And with more countries posting deficits, then the increased competition for savings of other nations will translate to increased pressure for higher domestic interest rates. Yet greater dependence on foreigners increases the risks of a sudden stop or of a slowdown or reversal of capital flows.

On the same plane, when domestic spending is financed by domestic debt then deficits grow along with rising local debt levels.

The deterioration of real savings or wealth generating activities and the expansion of bubble activities only increases the risks of a disorderly adjustment (bubble bust) which may be triggered by high interest rates or by interventions to reverse the untenable policies or by sudden stops or by plain unsustainable arrangements or even a combination of these.

The RBS also comments that household debt ratios particularly in Hong Kong Malaysia and Singapore have increasingly transformed into a fragile state, accounting for over 65% of GDP. Worst is that household wealth has nearly been concentrated in property, which makes the region’s wealth highly vulnerable to higher interest rates and a decline in property prices.

Overreliance on debt which has been used for unproductive and consumption activities only increases people’s sensitivity and susceptibility towards upward changes in interest rates that are likely to affect asset prices and economic performance.

This is known as the bubble cycle.

The RBS as quoted by the Reuter’s Sujata Rao[4],

What is however worrying is the pace of credit growth. …The combination of rapid credit disbursals and more importantly, the on-going divergence between credit disbursals and GDP growth implies that the system is becoming more vulnerable to income and interest rate shocks.

Again while such imbalances may not have reached a tipping point or the critical mass yet and which may not likely impact the region over the interim, everything will depend on the “pace of credit growth”.

And a manic phase will likely goad more debt acquisition in order to chase yields.

---

[1] see The Anatomy of the Cyprus’ Bubble Cycle March 24, 2013

[2] see Shopping Mall Bubble: The Quibble Over Statistics January 29, 2013

[3] See E-Vat 15%: Possible Consequence from Current Quasi Boom Policies December 10, 2012

[4] Sujata Rao Asia’s credit explosion, Global Investing Reuters.com March 22, 2013

Quote of the Day: Wealth Drives Evertything

Wealth drives everything. Military might, scientific achievement, medical breakthroughs, and technological advancement are all possible in wealthy societies. 

Of course, nations don’t just become wealthy by accident. National prosperity is built on a foundation of savings, economic freedom, ingenuity, and hard work… all factors that are in terminal decline in the west today.

(bold original) 

This quote is from Sovereign Man's Simon Black discussing the economic power renascence of Asia. 

The Impact of Open Ended QEs on Asia: Bubbles or Stagflation

At least some foreign experts have an idea of the risks posed from inflationist policies, adapted by political authorities of developed economies, on Asia.

From CNBC-Finance.yahoo

The Federal Reserve's measures to revitalize the U.S. economy pose risky side effects half way across the world in Asia, warn experts, particularly in the form of asset bubbles driven by an inflow of speculative funds into the region.

Pumping cash into the U.S. financial system tends to have a spillover effect on other parts of the world and Asia, in the past, has been a big beneficiary of the extra cash looking for a home.

"The problem is that the Fed is simply not paying attention to Asia because they are so concerned about the internal economic dynamics in the U.S. and they are trying to resuscitate the U.S. labor market," Boris Schlossberg, Managing Director, BK Asset Management told CNBC Asia's "Squawk Box" on Friday.

"It is creating a bifurcated result where you (get) higher asset prices, but not necessarily quality growth," he added.

Hot money flows into the region are likely to return.

Currency debasement policies in the developed nations would motivate investors to move funds elsewhere. This has been widely known as “the search for yields” which in reality signifies as a capital flight dynamic where investors seek refuge for savings.

More from the same article:

The Fed announced on Thursday its third round of monetary stimulus, in which it pledged to buy mortgage related debt and other securities until the country's labor market showed sustained improvement.

The last two rounds of quantitative easing in 2009 and 2010 resulted in massive capital inflows into the region of $66 billion and $96 billion, respectively, according to data from the Asian Development Bank (ADB), some of which was withdrawn in 2011, contributing to a subsequent slump in markets.

The ADB warned earlier this week that history could repeat itself should the region be hit by a surge in speculative fund inflows, adding that policymakers should brace for a scenario where money exits the region as quickly as they entered.

Vishnu Varathan, Market Economist at Mizuho Corporate Bank, says Asia could see an even higher level of capital inflows this time around, since the Federal Reserve is unlikely to be the only major central bank launching renewed quantitative easing - the European Central Bank, for instance, may also step in with asset purchases.

He says the region's property market is most vulnerable to sharp price increases, particularly in countries such as Singapore and Hong Kong - where the seeds were sown a few years ago from previous rounds of monetary stimulus - and nascent markets like Indonesia.

Earlier I postulated that intensifying inflationism in Japan and in western nations will drive savers (or the capital flight dynamic) into Asia. This should include the Philippines.

But since (inward) capital flows into ASEAN will reflect on global central bank activities, this dynamic would not be limited to Japan but would likely include western economies as well.

With the Fed and the ECB riding into the open ended-unlimited options, it’s not far fetched for central banks of Japan (BoJ), England (BoE) and others to join the club.

By putting a cap on the Euro-Swiss Franc, the central bank of Switzerland (SNB) have been the frontrunner of the open ended asset purchasing policy options where signs of internal bubbles have emerged.

Yet unlimited inflationism will likely to spur consumer price inflation that increases the risks of stagflation especially on emerging Asia.

Vasu Menon, Vice President, Wealth Management Singapore, adds that rising prices will pose a challenge for Asian central banks going forward.

"I think central bankers are worried about inflation - the Philippines for example held its rates steady because they are concerned about inflation," Menon said, referring to a decision by the Philippine central bank on Thursday to leave its benchmark interest rates steady at 3.75 percent.

As I recently wrote,

High commodity prices are likely to influence emerging markets consumer price inflation more. Food makes up a large segment of consumption basket for emerging Asia including the Philippines. This would prompt for their respective central banks to reluctantly tighten. Monetary tightening will put pressure on the stock market.

Stagflation, thus, also represents both a contagion and internal (political and market) risk for the Philippines and for emerging Asia.

Yes the risk ON environment has been re-triggered by massive inflationism by the Fed and the ECB.

And one of the above risks (a bubble or stagflation) will become a force to reckon with in Asia, possibly in 2014 or 2015. All these will essentially depend on the feedback mechanism between the dynamics at the marketplace and policy responses on them.

Will Soaring Agricultural Commodity Prices Bring about Stagflation to Asia?

Over the past few weeks, US dollar prices of key agricultural commodities have soared.

Prices of corn, wheat and grains have reached their highest levels in 3 years.

And this has alarmed economic experts from Africa.

From Reuters, (bold emphasis mine)

Rising food prices could hit commodity producers in Africa with a dangerous "double whammy" when combined with an economic slowdown in Europe and China reducing African exports of oil and raw materials, a leading African economist said on Tuesday.

Mthuli Ncube, Chief Economist and Vice President of the African Development Bank (AfDB), saw the threat of a food price spike casting a shadow over an otherwise positive growth outlook for Africa that will outpace much of the rest of the world.

"Certainly, there is a lot of reason to worry," Ncube told Reuters, recalling a food and fuel prices squeeze in 2008 that touched off social unrest and food riots in several African nations and also directly affected the continent's growth.

Global economic slowdown compounded by surging food prices would mean stagflation.

From the same Reuters article,

Despite Africa's comparatively strong economic expansion rates, the continent was experiencing "jobless growth", particularly in relation to its huge reservoir of unemployed youth, Ncube said.

Youth represented 60 percent of Africa's unemployed, and despite recording world-topping growth rates between 2000 and 2008, the continent was failing to create the number of jobs necessary to absorb the 10-12 million young and increasingly educated people entering the labor market each year.

Ncube said a major obstacle to more job creation was the persistence of what he called "one-sided economies" in Africa that exported oil and raw materials instead of moving decisively to diversify into job-multiplying manufacturing, commercial agriculture or agro-processing.

"It's a painful slog to diversify," he said.

"We need entrepreneurs to do it. We need to spend the time to build that business culture, the entrepreneurs," he added.

While Africa has taken important steps towards embracing liberalization, their hefty dependence on commodity exports remains an impediment to economic freedom which is the reason for the dearth of entrepreneurs.

This serves as more evidence where the supposed blessing from abundant resources can in fact translate to disadvantage—resource curse. Politicians and their cronies who benefit from commodities have little incentive to open their respective economies until forced by economic reality.

Although the bright side is that multilateral experts from Africa, who provide policy recommendations to political leaders, have exhibited increased recognition of the importance of entrepreneurship and of a political friendly business environment to economic development.

Yet while news tell us that drought in the US has mainly been the catalyst for the spike in prices of agri commodities, others share my insight that an integral element of these price surges has been because of central bank actions.

From yesterday’s Bloomberg article, (bold emphasis mine)

For the first time in more than two years, commodities, equities, bonds and the dollar posted gains, as the U.S. drought sent corn prices to a record and European Central Bank President Mario Draghi’s pledge to protect the euro buoyed stocks.

Raw materials led the increase as the Standard & Poor’s GSCI Total Return Index of 24 raw materials rose 6.4 percent in July, the most since October. The MSCI All-Country World Index of equities rallied at the end of the month for a 1.4 percent gain. The Dollar Index, a measure against six currencies, added 1.3 percent. Bonds of all types returned 1.4 percent on average, the most since December, Bank of America Merrill Lynch’s Global Broad Market Index shows.

The last time all four measures rose for a month was in April 2010, when concerns about Greece were heating up and U.S. economic reports were improving. While corn rose the most last month in almost a quarter century and wheat reached a four-year high, financial assets gained as policy makers worked to boost global growth. Federal Reserve Chairman Ben S. Bernanke said he’s prepared to take more steps, and Draghi pledged to do “whatever it takes” to preserve the euro.

“A lot of the rally in everything is central-bank led,” said Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, New Mexico, which oversees $80 billion. “So now we have a world where central-bank actions are really what people are looking at, and those actions are really positive for all asset prices and negative for savers and folks who are looking to put money in at reasonable levels over a longer period of time.”

And Africa’s stagflation concerns should also haunt Asia, and the Philippines, whom have been major agricultural commodity importers

As Zero Hedge points out, (bold original)

The level of inventories were already low going in and as Bloomberg notes, consumers around the world will feel the effect of higher food prices as the worst drought in 50 years impact the world's largest exporter of corn and wheat (and 3rd largest of soymeal). Within Asia, Korea and Malaysia will be most adversely affected, considering direct effects referenced in per capita and GDP terms. Indonesia and Japan are Asia’s largest importers of wheat, both importing roughly 5.7 million metric tons on average. China is by a wide margin the region’s largest importer of soy, with average imports of 49.9 million in the last five years. The impact on headline inflation in Asia will be stronger for the economies with lower per capita incomes — Vietnam, India, the Philippines and Indonesia — where food and food products account for a larger share of the typical consumption basket. Even in places where incomes are high, such as Singapore, food accounts for 22 percent of the consumer price index.

This only means that high commodity prices will be transmitted to Asia, whom has been inflating too (mostly through negative real interest rates).

And that a prolonged environment of elevated prices in agricultural commodities will likely induce an adverse impact to the region’s domestic economies too. (chart from Financial Times)

Stagflation risks therefore represents as another potential source of contagion.

Yet the most likely political response from the risks of a food crisis will be protectionist in nature (couched through cries of “self sufficiency”) that will only exacerbate such conditions.

In the Philippines, the risks of global and local food crisis may have been amplified by the desire by the Philippine central bank, Bangko Sentral ng Pilipinas’ (BSP) to stoke inflation through the recent cut of policy interest rates to new lows.

As the Inquirer reported last week,

Lower interest rates are expected to spur demand for loans which, in turn, could help boost purchases of goods and services. Higher demand, if supply remains constant, will help accelerate inflation.

The BSP said preventing the consumer price index from falling below target was as important for the economy as avoiding a higher-than-target inflation. Depending on variables, a very low inflation rate can be just as bad for business as high inflation, according to economists.

The BSP shares the same demand side interventionist creed as her international contemporaries.

They believe that the stealth redistribution of resources from the society (which includes the poor) to the cronies and to the political class will ‘help the economy’. In reality, this functions no more than a political setup, where markets will eventually get the blame, and thus lays the groundwork for more interventionism.

The great Ludwig von Mises presciently warned of this in his Theory of Money and Credit (bold highlights mine)

The undesirable but inevitable consequence of inflation, the rise in prices, provides them with a welcome pretext to establish price control and thus step by step to realize their scheme of all-round planning. The illusory profits which the inflationary falsification of economic calculation makes appear are dealt with as if they were real profits; in taxing them away under the misleading label of excess profits, parts of the capital invested are confiscated. In spreading discontent and social unrest, inflation generates favourable conditions for the subversive propaganda of the self-styled champions of welfare and progress. The spectacle that the political scene of the last two decades has offered has been really amazing. Governments without any hesitation have embarked upon vast inflation and government economists have proclaimed deficit spending and 'expansionist' monetary and credit management as the surest way towards prosperity, steady progress, and economic improvement. But the same governments and their henchmen have indicted business for the inevitable consequences of inflation. While advocating high prices and wage rates as a panacea and praising the Administration for having raised the 'national income' (of course, expressed in terms of a depreciating currency) to an unprecedented height, they blamed private enterprise for charging outrageous prices and profiteering. While deliberately restricting the output of agricultural products in order to raise prices, statesmen have had the audacity to contend that capitalism creates scarcity and that but for the sinister machinations of big business there would be plenty of everything. And millions of voters have swallowed all this.

So the next time a food crisis erupts, you should know the real culprit.

Quote of the Day: Hubris has its Costs, the Decoupling that Never Was

The lesson from recent economic data and policy moves in Asia (MXAP) is this: Hubris still has its costs.

In recent years, Asia believed its own press a little too much. The way it steered around the financial crisis of 2008, the dizzying stock gains, the migration of bankers from New York to Hong Kong and the region’s mergers-and-acquisitions binge were all interpreted as immutable signs of Asia’s economic arrival.

Decoupling-from-the-West euphoria flooded emerging markets in general. The BRIC economies -- Brazil, Russia, India and China -- thought their rapid growth rates would pick up the slack as America and Europe reeled. Debt markets in developing nations reveled in their new roles as sanctuaries.

Disappointing data and interest-rate cuts in Beijing, Hanoi and Seoul last week show the extent to which Asia got ahead of itself. Asia isn’t re-coupling; it never decoupled much in the first place. That leaves us with two stark realities for the second half of 2012: Emerging markets aren’t ready for prime time globally, and Asian policy makers need to get more aggressive about finding new avenues for growth.

That’s from Bloomberg’s Asian columnist William Pesek.

And this why it is equally dangerous, if not a folly, to believe that ASEAN markets and economies will decouple.

Contagion Risk: More Signs of Asian Economic Slowdown

As I noted last night, the nasty repercussions of bubble bust conditions have been percolating into the global economy from different directions. [Good luck to the stock market bulls]

Here are more evidences of the escalation of the transmission… (from Bloomberg)

Hong Kong and Vietnam signaled growth may fall short of government forecasts this year as Asian policy makers stepped up efforts to protect their economies and currency markets from the worsening global outlook.

Hong Kong may revise its 2012 economic forecast next month, Financial Secretary John Tsangsaid on July 7. In Vietnam, Deputy Prime Minister Vu Van Ninh said the country may miss its growth target and the central bank told lenders to cut borrowing costs on existing loans to help businesses. The Philippines unveiled plans to contain currency gains that may hurt exports.

The Philippine central bank, the Bangko Sentral ng Pilipinas (BSP) reveals of their mercantilist leanings where destruction of the Peso is seen as the elixir to prosperity. History and theory serves no lesson to political agents who uses mercantilists policies to promote the interest of cronies and the political class in the name of exports (or remittances). Good governance? Duh!

The economic growth slowdown also slams Japan hard (from another Bloomberg article)

Japan’s current-account surplus was the smallest in May since at least 1985 and machinery orders fell the most in more than five years, adding to signs a slump in demand is threatening the nation’s rebound.

The excess in the widest measure of the nation’s trade shrank 63 percent from a year earlier to 215.1 billion yen ($2.7 billion), the Ministry of Finance said in Tokyo today. The median estimate of 24 economists surveyed by Bloomberg News was for a surplus of 493.1 billion yen. Machinery orders, an indicator of capital spending, fell 14.8 percent in May from the previous month, the Cabinet Office said, the biggest drop since comparable data were made available in 2005.

Japan’s trade position has weakened due to growing energy imports after last year’s earthquake and nuclear meltdown and also the yen’s gain of 4.9 percent against the dollar since mid- March. Prime Minister Yoshihiko Noda gave approval for a restart of reactors at the Ohi nuclear plant, which resumed power generation last week, to avoid power shortages and rolling blackouts over the summer.

“Today’s machinery order drop is very large, and it may be a signal that Japanese companies are becoming cautious about investment” amid concern about a global economic slowdown, said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management in Tokyo. “Though exports have been slumping, we don’t expect Japan to have any major trade deficit.”

Given that the economic slowdown emanates from multiple fronts, which amplifies the global contagion risks, for any interventions to have short term palliative effect, they must be really huge, coordinated or in collaboration with central banks of major economies from both BRIC and G-7.

Yet if they do so, expect a major train wreck that would make the 2007-2008 episode a picnic ahead.

Marc Faber: Asia to Benefit from Imploding Welfare States of the West

Dr. Marc Faber has been an indirect mentor of mine. It has been through his writings which has led me to learn of Austrian Economics, the major pillar of my analytical methodology.

Nevertheless, recently he says that imploding welfare states of the West should be positive for Asia.

The Asian Investor quotes Dr. Faber, (bold emphasis mine)

“Asia should send a thank-you letter to [Federal Reserve chairman Ben] Bernanke” for stimulus policies that have been an “utter failure” for the US but beneficial to Asia.

"We had, essentially, a bank failure in 2008 and the financial system in the Western world went bankrupt. Then it was bailed out by governments and the banks have learned nothing. “

Government intervention in private finance will have a damaging effect to the US and European economies over the long run, he predicts. “In 2008, the financial sector [went] bust, and in the future, the [Western] governments will go bust.”

In contrast, “the Asian banks are in a good shape”, says Faber. “Asia reacted well in the 1997-1998 crisis. A period of deleveraging followed. Businessmen became conservative. They paid down debts and the banks became very cautious in terms of their lending.”

As a result, he has more confidence in Asian banks than their Western counterparts. “I would deposit money with a Thai bank, no problem. They will pay me back. They don’t know what derivatives [are], because the derivatives salesmen never get through the traffic in Bangkok,” he quipped.

“I would rather stick to emerging economies than Europe and the US.”

For as long as Asia resists the siren song of the welfare based political economy and shun protectionism, the policy divergences between the West and the East should imply for a wealth convergence, where Asia’s potential higher returns on investments emanating from the declining relative trend of interference from the region’s governments should attract more of the savings from the West.

The above would compliment domestic growth dynamics for as long as Asian governments continue to ease on economic restrictions or regulations.

This also implies that the current contagion based financial market meltdown in Asia—mainly transmitted from the boom bust cycle policies of Western governments which have been aimed at the preservation of the unsustainable state of incumbent political institutions—is likely a temporary event.

And given the right conditions (not yet today) would present as ‘buy’.

The Window Is Closing For A Double Dip Recession In 2010

``The charm of history and its enigmatic lesson consist in the fact that, from age to age, nothing changes and yet everything is completely different.” -Aldous Huxley

Markets make opinion, as a Wall Street axiom goes. This means that people tend to rationalize or provide, rightly or wrongly, oversimplistic explanations for current market actions.

A good example of this is that during the first half of the year, the prevalent opinion was that the Euro was headed for its early demise and that this likewise entailed the political disintegration of the European Union.

Considering that the Euro has massively rallied and had already touched or is within spitting distance of our yearend target (1.30-1.32)[1], the du jour opinion has now shifted to the prospects of a US led global double dip recession following signs of weaknesses in the global equity markets (see figure 3).

Figure 3: stockcharts.com: Euro and Global Equity Markets

While equity markets in Europe (STOX50) and the US (SPX) seem lethargic, this has had little effect on Asian markets ex-Japan (DJP2) so far.

One important thing that I have learned about dealing with financial markets is not to get emotionally swayed by popular opinions, especially the half-truths espoused and expressed by the highly articulate mainstream experts.

Yet when market opinion seems to grope for explanations to project a deeply-held belief rather than to objectively appraise the current conditions, our inclination is to think in the opposite direction.

While it is true that equity benchmarks in developed markets have been sluggish, they are likely to account for a liquidity driven slowdown more than a double-dip recession.

Yet it would be misguided to look solely at economic variables and assume its independence from political actions because since both politics and economics account for social actions they are all systematically interconnected and interdependent on each other.

As Ludwig von Mises wrote[2], (bold emphasis mine)

``Economics does not allow any breaking up into special branches. It invariably deals with the interconnectedness of all phenomena of acting and economizing. All economic facts mutually condition one another. Each of the various economic problems must be dealt with in the frame of a comprehensive system assigning its due place and weight to every aspect of human wants and desires. All monographs remain fragmentary if not integrated into a systematic treatment of the whole body of social and economic relations.”

Hence given the current conditions, combined with the prevailing orientation and dogma espoused by policymakers, we expect any reemergent signs of sustained economic weakness in the US to be met with the reopening and the reactivation of the monetary spigot. This is simply what is known as the “path dependency”.

Working amidst the deepening trends of globalization, the transmission effects of the de facto monetary policies in developed economies will likely impact distinctly emerging economies due to the inherent structural idiosyncrasies.

Thus, as we previously pointed out[3], policy divergences will likely result to diversified market actions, for as long as there won’t be any liquidity seizure similar to 2008 post Lehman syndrome.

More proof of policy divergence?

According to Morgan Stanley’s Manoj Pradhan[4],

``Compared to the early part of 2010 when the roaring recoveries in the AXJ region were accompanied by monetary silence, the normalisation of the monetary policy stance that is well underway now is much more consistent with a sensible exit sequence for monetary policy globally. The beginning of tightening in Latin America initiated by the central bank of Brazil and echoed by the central bank of Peru highlights the game of catch-up that LatAm economies and central banks seem to be playing with their AXJ counterparts. And finally, the G10 economies which house the epicentre of sovereign risks and the CEEMEA economies with their close links to the euro area are at the back of the tightening pack. The AAA liquidity regime in the major economies is thus set to stay in place for longer, with growing risks that an eventual reversal of that regime may need to be stronger.”

In other words, while many in the west are having anxiety over the prospects of double dipping (sounds like ice cream), policymakers in emerging markets and in Asia have already engaged in policy tightening in fear of economic overheating.

Besides, I find it a bizarre reasoning for people to argue for another recession if indeed Asia and emerging markets have been responsible for the recent “cyclical recovery” (see figure 4). My idea is that the flow should depend on the leadership unless any shock would be deep enough to unsettle the current dynamics.

Figure 4 DBS Bank: Asia Drives Global Demand Growth

As the DBS Economic Research team boldly argues[5],

``So what is driving the global recovery then? Who is putting money on the table? The answer is Asia. Asia is where the world’s new demand is being generated-demand that is the very measure of growth. This is the real bailout of the global economy and it is being financed in Asia.”

While I agree that Asia has been a significant driver of growth, I disagree that the true measure of growth is about demand. Instead real growth is where capital is being accumulated, and where increased demand is merely a symptom of these actions.

Demand growth financed by unproductive debt is no less than a putting lipstick on a pig as evidenced by the recent bubble bust, therefore is not a “genuine measure of growth”.

Nevertheless the DBS Research team lends proof to these demand growth...

``In Asia it is 17% higher. This isn’t government spending on factories and roads. It’s private consumption-household purchases of pots and pans and bread and butter and shoes and rent and gadgets and gas and movies and music and…-and it has grown by 17 percent in Asia since the crisis began. In the G3, on average, consumption hasn’t grown one iota.

``That’s not what people said would happen. Most said that when the US stopped buying, Asia would too. Because Asia didn’t produce any final demand of its own or not “enough” anyway. Asia depended on US demand for its growth. Thankfully-for the US and the EU and Japan as much as for Asia-that turned out not to be true.”

Well the DBS team is correct to say that mainstream expectations have failed to anticipate this rebound since the mainstream’s insights had been weighted towards the sins of aggregatism, which had been mostly deduced from a US centric trade and investment flows to the detrimental exclusion of the other important variables.

While I would also tend to agree that Asia is likely to lead the global economy along with many emerging markets for many reasons such as deepening trend of free trade (or trade integration) in contrast to the west, high savings rate, less systemic leverage, and etc…, I’d say also say that aside from economic matters, my bias tells me that the business cycle could also be shifting from the West to the East.

And that DBS’ optimism could also signify as an endowment effect where “People often demand much more to sell an object than they would be willing to pay to buy it”[6] or what I call as “ownership premium”.

From the above premises I’d suggest that any signs of weakness should be considered as a buying window for Asian stocks particularly the Phisix and her Asean neighbors.

Some of those prominent experts whom has hollered for “deflation” and or “double dip from the start of the year, seem to be seeing the windows have been gradually close as we have entered the second semester. That’s why some of them have now shifted their time frames to 2011.

Having missed one and a half years is bad record enough. Though eventually they’ll be right that would be tantamount to missing the entire upside cycle. In essence, a broken clock can be right twice a day.

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[1] See Three More Reasons Why The Euro Rally Should Continue

[2] Mises, Ludwig von Human Action Scholar’s Edition

[3] See Why The Sell-Offs In Global Markets Are Unlikely Signs Of A Double Dip Recession

[4] Pradhan, Manoj Appetite for Restriction, Morgan Stanley, July 16, 2010

[5] DBS Group Research, Economics Markets Strategy

[6] Wikipedia.org Endowment effect