Gary North On Why Asia Will Surpass The West

Here is Professor Gary North on Why Asia will Overtake the West,

``How is it that Asia has had a huge trade surplus with the United States? Because its people work long hours. They are finally getting access to capital. This capital increases their productivity. The tools they need to compete are made available through thrift. Then they put capital to use in a long work week. They have little time for leisure. They are at work many hours per day.

``In contrast, Americans are losing capital through consumer debt and withdrawal from the labor force. I don't mean unemployed people. I mean underemployed people. The person who watches TV for 4 hours a day is consuming his most precious capital: time.

``When we see a society committed to work, we see a society that has the basis for economic growth. If people work hard to get ahead, they will accumulate capital. Their work will become more efficient. If they work merely to buy spare time for play, then they will not experience economic growth.

``Asia is growing economically, because of the people's future-orientation. The United States is barely growing, because of its present-orientation. We see this in the waste of time associated with entertainment. This is a culture-wide phenomenon. It has been accelerating in the West for at least 85 years. The rise of radio and the movies marked the transition. World War II delayed the advent of the entertainment culture. The 1950s produced the first teenage subculture. It had its own movies, music, and entertainment. Why? Disposable income from parents and part-time jobs. The money went into our pockets. That was my generation. We spent as children spend, but we spent more money than children ever had spent in history. We got used to entertainment. The counter-culture, 1965–70, was even more committed to entertainment. It even turned cultural revolution into entertainment.

``This happened all over the West. It was not a uniquely American phenomenon. The student revolt in France in 1968 was worse than anywhere else.

``We now live in a nation that has suffered capital consumption. Foreigners are providing capital for us. Asians buy something like 40% of Treasury debt sold to the public. This will not go on indefinitely.

``When we learned to waste time and money in our youth, we developed bad habits. These bad habits are not easily broken. Asians never developed these bad habits. The youth of Asia headed for the cities to get jobs, not entertainment."

While it is true that attitude, behavior and time preference are key factors necessary to an Asian outperformance, I think these are insufficient.

Accumulation of capital can only come from a political and economic environment that permits it to do so. As Ludwig von Mises wrote, ``The masses, in their capacity as consumers, ultimately determine everybody's revenues and wealth. They entrust control of the capital goods to those who know how to employ them for their own, i.e., the masses', best satisfaction."

In other words, Asia will be able to surpass West only if Asians pursue and maintain a more capitalist society or an environment of greater economic freedom which allows her people save and accumulate capital, from competition and production of more goods and services to serve the masses, whom as Mr. von Mises said, determines the wealth of the society.

Asia And Emerging Markets Should Benefit From The 2010 Poker Bluff

``What gave the west the edge over the east over the past 500 years? My answer is six “killer apps”: the capitalist enterprise, the scientific method, a legal and political system based on private property rights and individual freedom, traditional imperialism, the consumer society and what Weber probably misnamed the “Protestant” ethic of work and capital accumulation as ends in themselves. Some of those things (numbers one and two) China has clearly replicated. Others it may be in the process of adopting with some “Confucian” modifications (imperialism, consumption and the work ethic). Only number three – the Western way of law and politics – shows little sign of emerging in the one-party state that is the People’s Republic. Niall Ferguson, The decade the world tilted east

So what does the Policymaker’s poker’s bluff mean for Asian and Philippine asset markets, aside from emerging markets?

Widening Interest Rate Spread and the Carry Trade Arbitrage.

If Asian and emerging economies begin to tighten as we expect them to, and if we are correct about the implied devaluation policies by major economies as the US, Japan and the UK, then currency carry trade arbitrages will not only likely expand, but balloon.

This means we can expect foreign money to flood into these markets possibly triggering an asset meltup, meaning outperformance in stocks, currency and bonds.

Naturally, this won’t go in a straight line, and possibly be intermittently forestalled by internal policies to stanch flows such as capital controls similar to one imposed by Brazil.

Great Growth Story.

Asia and major emerging markets as noted above, having learned from the recent past crisis and having to embrace more globalization friendly policies particularly in trade, investment, finance and labor, will likely lure more funds given the relative its advantages-which means low debt, higher productivity, urbanization, demographic dividends and lower cost of living will likely magnify in the growth story.

Figure 5: Bloomberg: Goldman’s Call of Decade-Buy BRICs

An example would be Goldman’s Buy of the decade as shown in figure 5.

Policy Response and the Bubble Cycle.

Low systemic leverage and the largely uncontaminated banking system have responded “positively” to present policies that rejuvenated the markets and the economy.

As a reminder, manipulation of interest rates work similar to price controls, it leads to false signals which brings about massive distortions of the production and capital structure and gets magnified by people irrationality or in responding to the “bandwagon effect”.

As Henry Hazlitt explains, ``The credit expansion does not raise all prices simultaneously and uniformly. Tempted by the deceptively low interest rates it initially brings about, the producers of capital goods borrow the money for new long-term projects. This leads to distortions in the economy. It leads to overexpansion in the production of capital goods, and to other malinvestments that are only recognized as such after the boom has been going on for a considerable time. When this malinvestment does become evident, the boom collapses. The whole economy and structure of production must undergo a painful readjustment accompanied by greatly increased unemployment.”

Excessively low interest rates are the seeds to any bubble cycle which means that central bank policies have been a serial bubble blowing phenomenon.

And for this cycle, Asia and emerging markets are ripe as prime candidates for the next bubble.

Commodity Theme.

While we have greatly focused on the monetary aspects of commodity demand, there is also the policy and real economy facets that boosts the commodity dynamics.

This means that the traction generated by the recent policy actions could exacerbate a massive demand for commodity related investments and or speculation, following two decades of underinvestment.

Of course, the economic evolution where emerging markets outgrow advance nations would like spur heightened consumption.

Since commodity investments take time to materialize, the lag between the rapid growth in demand and availability of supply will be reflected on prices.

Redefining Markets And Asia’s Emerging Consumer Economy.

Since one the relative advantage of these economies have been scalability, whose rubric consist of more than half of the world’s population, what makes for the lost high value sales from the recession affected advance economies would probably be replaced by price sensitive massive volume based markets from Asian and the emerging economies.

Even Japanese exporters appear to be recognizing such reality [see Japan Exporters Rediscovers Evolving Market Realities].

In other words, global trade will likely be reconfigured, not because of mercantilist policies but of the shifting nature of consumer demands; this time brought about by the rapidly growing consumer dynamics of Asia and the emerging markets.

Leapfrogging The Industrial Age As A Candidate For Technology Ascendancy.

One of the major flaws by the mainstream is to ignore the tremendous contribution of technology in the form of increased information flows and enhanced efficiency of today’s marketplace.

Their outlook appears fixated on the industrial age paradigm even when they knowingly use the computers and the web to conduct exchanges and socially connect. Yet, ironically, they preach policies that would regress to medieval ages. These are the modern day Luddites.

Nevertheless, they are likely to be grossly mistaken. That’s because Asia has had a wide experience as an outsource agent for the western world, where it has learned to compete in the realm of technology.

Many Asian companies have recently embarked on technology value added ventures that today challenges the supremacy held by the West, see our post Asian Companies Go For Value Added Risk Ventures.

They appear to have taken advantage of the recent recession and utilized their inherent strengths or competitive advantages (access to capital, free cash flows, more liberal markets, etc.) to expand while the western peers reel from the recent setback. This is a dynamic we’ve discussed during the peak of the crisis [see Phisix and Asia: Watch The Fires Burning Across The River?]

J. Michael Oh of Matthews Asia describes of the Asia’s quest to leapfrog to the information age,

Figure 6 Matthews Asia: Fastest Growth In Internet Usage Is In Asia

``Over the years, Asia has given birth to many great technology companies but the region has also become its own dominant market for various consumer technology products including personal computers. Asia now boasts the world’s largest Internet user community, accounting for more than 40% of the world’s usage and last year, China surpassed the U.S. as the world’s largest Internet market, with more than 300 million users. Yet, China’s Internet penetration is only at approximately 22% compared to about 72% for the U.S. When China reaches the 70% penetration level, its Internet community will be larger than the combined population of all G7 countries.”

In short, technology based market competition will likely engender high productivity and generate wealth and would favor economies that would intervene less in discovering the fast evolving consumer desires.

Enhancing The State Of The Financial Markets.

One of the advantages of the West is that it has deep and sophisticated markets that allow her to efficiently channel savings into different investment needs.

This story appears to be changing.

While the recent crisis has led to more regulation, administrative control of employees (payroll), and the stifling of competition in the West, emerging markets appear to be drawing from their latest experience and trying to emulate Western market standards.

According to John Derrick of the US funds, ``Regulators in Beijing have approved a variety of investment products and strategies that are commonplace in mature stock markets: margin accounts for trading, stock index futures and short selling.

``A trial period will come first, so it’s not yet clear when the millions of investors in China will be able to execute a short sale or buy stocks on margin. But just the decision to move forward on this front indicates that the government recognizes that its highly liquid markets are ready for more sophisticated strategies.”

China, aside from trying to expand investment instruments for its retail sector has also opened its version of the Nasdaq board last year (New York Times).

In other parts of Asia, Hong Kong has positioned to compete for a Swiss-style trading hub for the gold bullion market (marketwatch), Singapore has opened a new commodity derivatives exchange the SMX (Financial Times) and likewise would offer its version of the dark pool (Asian Investor). The Philippines is reportedly considering a commodity exchange.

One must also consider the immense growth potentials for the pension, health and insurance industries, which is largely underdeveloped relative to the West, the overdependence on the banking system for corporate and business financing and the underutilization of the capital markets and the low penetration level of population engaged in financial institutions among emerging economies,

All these aspects- Widening Interest Rate Spread and the Carry Trade Arbitrage, Great Growth Story, Policy Response and the Bubble Cycle, Commodity Theme, Redefining Markets And Asia’s Consumer Economy, Leapfrogging The Industrial Age As A Candidate For Technology Ascendancy and Enhancing The State Of The Financial Markets-greatly depends on economic policies that allow for a greater freedom of commerce.

For as long as present dynamics continue in these directions we can remain confident over the long term investment prospects in Asia and in select emerging markets.

Short Word On Risks

Finally, speaking of risks, the character of the 2008 crisis had been vastly different than the next crisis, that’s simply because the drivers of the past bubble-Wall Street firms, Fannie Mae, Freddie Mac, the FHLB, the massive securitization marketplace, derivatives, and the hedge funds-haven’t been much into play, except for some, like the GSEs, dispensing their on support roles, while the bank as trader model appears to have given lift to the US financials.

But generally, the underperformance of the US markets signifies the changing composition of today’s reflation game which has obviously evolved from the core (advanced economies) to the periphery (emerging markets and commodity themes) amidst the backdrop of vastly inflating government liabilities (pls revert to figure 4-right pane).

In short, today’s central banks appear to attain a pyrrhic short term victory; it took huge amounts of deficits and money printing activities to achieve stabilization of credit flows see figure 4, left pane. This likely implies future risks ahead which means that anything that could spike interest rates of debt afflicted deficit laden nations- a sovereign bond Keynesian debt crisis or a currency crisis or a failed auction or spiraling inflation.

For the moment and perhaps for 2010, these risks don’t look imminent, yet.

Stephen Roach: Preparing For The Asian Century

McKinsey Quarterly Interviews Morgan Stanley's Stephen Roach on his latest book "The Next Asia".





Find below the transcript of the Interview from McKinsey Quarterly...(if video doesn't appear pls proceed to McKinsey's website


(all bold highlights mine)

Clay Chandler: We’re joined today by Steve Roach, the chairman of Morgan Stanley Asia. Steve, thank you for being with us. You’ve been watching and writing about the dynamism in this region for many decades now. In your new book, The Next Asia, you write about how the region in the next 20 years will be much different than in the past 20 years. What’s driving that change?

Stephen Roach: Well, Clay, I think the Asia of the past 30 years has done an extraordinary job—especially China, but, increasingly, the rest of the region—in lifting standards of living well beyond anything we’ve seen in the annals of economic development. But the drivers have been primarily export led. And there’s been a lot of investment in the export platform that has been required to get that export machine to the state that it’s at.

But this model is close to having outlived its usefulness. The next Asia will be more consumer led, will have a growth dynamic that places greater emphasis on the quality of the growth experience, especially in terms of environmental protection and pollution control.

Clay Chandler: If I’m the chief executive of a Fortune 500 company and I’m thinking about my global strategy, how do I need to be thinking differently about Asia than I might have been before the crisis?

Stephen Roach: I think global multinationals have, up until now, primarily viewed developing Asia—and China in particular—as an offshore-production platform. The offshore-efficiency solution is still an attractive option. But what really could be powerful would be a growing opportunity to tap the region’s 3.5 billion consumers. This has been the dream all along of the Asian potential. But the consumer dynamic has largely been missing in action. And now, as it comes online, this is an extraordinary bonanza for global multinationals as well.

Clay Chandler: In The Next Asia, you strike a very optimistic tone. You note that Asia has always embraced change and that that’s really been the secret of Asia’s dynamism in years past. But the same thing was said in the wake of the Asian financial crisis in 1997. And yet by and large, most Asian economies went right back to the model that worked so well for them before the Asian financial crisis, a model that was heavily focused on exports and government-led investments. What’s different about the economic scene today?

Stephen Roach: The external demands that underpin the export model are now in trouble. So even if Asia is the best and most efficient producer that anyone has ever seen, the external demand is not going to be there the way it was. So if Asia wants to keep growing, if Asia wants to keep developing, if it wants to keep raising the standard of living for its three-and-a-half-billion consumers, it’s got to depend more on its own internal demand. So it really boils down to the fact that Asia’s options have been narrowed in terms of economic development as never before. And it has no choice but to become more internally, rather than externally, dependent.

Clay Chandler: Let’s talk for a moment, if we could, about India, the other big, growing economy in the region.

Stephen Roach: I think the micro has always been very positive in India: a large population of world-class competitive companies; a well-educated, English-speaking, IT-competent workforce; pretty good market institutions; relatively stable financial institutions; rule of law; democracy. The micro has never been the problem.

What’s really been the problem for India has mainly been the macro—inadequate savings; relatively limited foreign direct investment, especially when compared with China; and, of course, the horrible infrastructure. The macro has actually gotten better. In the last three to four years, India’s savings rates have moved from the low 20s nationwide to the mid-to-high 30s, which is still short of China but a huge improvement for India.

Foreign direct investments accelerated dramatically—again, not up to Chinese standards, but a huge acceleration vis-à-vis where India has been historically.

And the third leg of the stool is politics. The mid-May election, by sweeping the Communist Party out of this new coalition, gives the reformers an opportunity to finally deliver on the promises they made five-and-a-half years ago, when they first took power. I think that India actually could be the real sleeper in Asia over the next few years. Just at a time when everybody is all lathered up and excited over a China-centric region.

Clay Chandler: You can’t really talk about Asia’s future without also considering the trajectory of its largest economy. That, of course, is Japan. The story there has been almost unrelentingly gloomy for years. But now we’ve got a new government.

Stephen Roach: Well, you know, Japan is an example of what happens when you take a very prosperous economy and allow it to experience the post-bubble aftershocks of a massive asset-led implosion.

But here Japan sits, 20 years into the post-bubble era, and it’s not clear that it has really awoken from its long slumber, as you aptly put it. This is an economy that remains very much export dependent. Its two largest export markets, the US and China, are not providing much sustenance. The Japanese consumer is very constrained by demography, by unfunded pension liabilities. It still has a very high predisposition toward saving. There has been some capital-spending impetus in recent years but, again, it has largely been driven by a new export linkage into China, and that’s on hold right now. And then finally, Japan has a horrific leadership problem. So the combination of structural problems, this long post-bubble hangover, leadership issues—it’s hard to be too constructive on the Japanese economy going forward, I’m afraid.

Clay Chandler: How about prospects for greater integration and cooperation in Asia as a whole? In your book, you talk about the emergence of what you call a pan-Asian economic framework. What will that framework look like?

Stephen Roach: Well, I think the building blocks of that framework are starting to fall into place. There’s been increased integration in a China-centric supply chain, with most of the large economies in the region—from Japan, to Korea, to Taiwan—now more dependent on exports to China than any of their other major trading partners, including Europe or the United States. So the logistics of an increasingly China-centric supply chain are starting to fall into place.

But here again, I would say that the real challenge for a pan-regional economic integration would be to shift the structure increasingly away from one that’s externally led to one that’s internally led. When the Asian consumer starts to rise and is sourced increasingly by the Asian producer, that’ll be the real, powerful synergy that I think can take this region to the next place.

Clay Chandler: Is it fair, do you think, to say that the Asian Century has finally arrived?

Stephen Roach: The central premise of my book, The Next Asia, is that it’s a little early to crack out the champagne and declare the onset of the Asian Century. It’s the stuff of great headlines and possibly documentary films, but the next Asia—an Asia which is more balanced, one that brings the Asian consumer into the equation—that’s what the Asian Century needs. The Asian Century, in my view, is not a sustainable image if it’s an Asia of producers or exporters selling things to others. The Asian Century is one where Asia produces to its home markets, rather than just to markets around the world. And until we see that, I think, again, that champagne is going to have to stay on ice for awhile".

Asia's Economic Growth Engine: The Muslim Factor

This interesting chart/commentary from the Economist on world Muslim population.
From the Economist, (bold emphasis mine)

``THE total number of Muslims in the world is 1.57 billion, nearly a quarter of the global total, according to a new survey of the world's Muslim population by the Pew Research Center. Almost two-thirds of Muslims live in Asia, with Indonesia providing the biggest contingent (203m), followed by Pakistan (174m) and India (160m). One of the more surprising finds is that the European country with the highest Muslim population is not France or Germany, but Russia, where 16.5m adherents of Islam make up nearly 12% of the total national population. Compared with other studies, the report gives a lowish estimate for the number of Muslims in France (3.6m), as it does for the United States (2.5m); in both those countries, secular principles make it impossible to ask religious questions on a census."

Here is another chart from Pew Research...

To add some comments from Pew Research

``More than 300 million Muslims, or one-fifth of the world's Muslim population, live in countries where Islam is not the majority religion. These minority Muslim populations are often quite large. India, for example, has the third-largest population of Muslims worldwide. China has more Muslims than Syria, while Russia is home to more Muslims than Jordan and Libya combined.

``Of the total Muslim population, 10-13% are Shia Muslims and 87-90% are Sunni Muslims. Most Shias (between 68% and 80%) live in just four countries: Iran, Pakistan, India and Iraq....

``The Pew Forum's estimate of the Shia population (10-13%) is in keeping with previous estimates, which generally have been in the range of 10-15%. Some previous estimates, however, have placed the number of Shias at nearly 20% of the world's Muslim population.³ Readers should bear in mind that the figures given in this report for the Sunni and Shia populations are less precise than the figures for the overall Muslim population. Data on sectarian affiliation have been infrequently collected or, in many countries, not collected at all. Therefore, the Sunni and Shia numbers reported here are expressed as broad ranges and should be treated as approximate."

Why do I find this interesting?

Because if emerging markets or Asia will serve as the world's economic growth engine, then the economic framework will emanate from vastly diverse cultures, religions (as the Muslims) and the political regime that underpins this.

This is far from the Western models, which we have been accustomed with, which would also alter the approach to contemporary analysis.

Besides, another very important factor would the character of marketplace in both the real and financial aspects-such as the resurgent Islam bond markets (Shariah compliant).

So the emergence of Asia, which incorporates the biggest segment of the world's Muslim population, will come with challenging heterogeneity and complexity.

Asia: Policy Induced Decoupling, Currency Values Aren’t Everything

``The biggest lesson of the current crisis for Asian countries is that they can no longer depend on the West as a market for their exports, nor for reliable returns on their investment capital. To address the first issue, Asia has to cultivate its domestic consumer markets to sustain its growth. For the second, it faces a potentially more daunting challenge: to grow and strengthen its domestic capital markets, and stimulate Asian investment in Asia. Should Asia achieve these goals, it would mark a fundamental shift in the economic relationship between Asia and the West—and in particular between China and the U.S.” Matthews International Capital Management Asia Now, The Growth Issue

As we have been saying, inflationary policies are essentially vented on currencies which are instantaneously transmitted to the financial asset markets.

Besides, the impact of inflation has always been relative, since money enters the economy at specific points of the economy, and considering the distinct capital structure of national economies, the effects from these policies are likely to be divergent.

Take for instance, high savings, low systemic leverage, and an unimpaired banking system from the recent crisis [as we recently discussed in Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble] are likely to be more responsive to low interest rate policies regime implemented by domestic central banks. The massive outperformance of emerging markets relative to developed economies is a symptom of such response [see Global Stock Market Performance Update: Despite China's Decline, Emerging Markets Dominate]

It doesn’t stop here. This phenomenon has somewhat distilled also into national economies, see figure 5.

Figure 5: Divergent Impact On Industrial Production (Economist) and Car Sales (PIMCO)

Industrial production in the Emerging Asia has sharply been reinvigorated in contrast to the sluggish performance in the US.

The same divergent dynamics can also be seen in the comparative car sales between China and the US.

In short, what you are seeing is a clear manifestation of decoupling at work.

This from the Economist,

(bold highlights mine)

``Across the region, aggressive fiscal and monetary stimulus has helped revive domestic demand. Asia has had the biggest fiscal stimulus of any region of the world. China’s package grabbed the headlines, but South Korea, Singapore, Malaysia, Taiwan and Thailand have all had a government boost this year of at least 4% of GDP. Most Asian countries, with the notable exception of India, entered this downturn with sounder budget finances than their Western counterparts, so they had more room to spend. Bank of America Merrill Lynch forecasts that the region’s public debt will rise to a modest 45% of GDP at the end of 2009, only half of the average in OECD countries.

``Moreover, pump-priming has been more effective in Asia than in America or Europe, because Asian households are not burdened with huge debts, so tax cuts or cash handouts are more likely to be spent than saved. It is also easier in a poorer country to find worthwhile infrastructure projects—from railways to power grids—to spend money on.”

Mainstream analysts, whom mostly have been deflation advocates, jeered and hectored on the decoupling theme following the climax of the US banking seizure last September and October. Unfortunately, it appears that the deflationary episode signified as a fleeting moment of glory and as developments deepen things has once again been turning out to refute their highly flawed assumptions.

Importantly, we described in our February article Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?, that creative destruction, the role of real savings, supply side responses, and the role of Asia’s middleclass could act as possible channels for decoupling.

Currency Values Aren’t Everything

The Economist highlights another point we’ve been making,

``The basic problem is that although the Asian economies have decoupled from America, their monetary policies have not. In a world of mobile capital, an economy cannot both manage its exchange rate and control domestic liquidity. By trying to hold their currencies down against the dollar Asian economies are, in effect, being forced to shadow the Fed’s monetary policy even though their economies are much stronger. Foreign-exchange intervention to hold down their currencies causes domestic liquidity to swell. Consumer-price inflation is not an imminent threat, because prices are falling in most Asian countries. Chinese consumer prices fell by 1.8% in the year to July. But asset prices look dangerously frothy. The obvious solution is to let exchange rates rise, but with exports still well below last year’s level, governments are reluctant to set their currencies free.” (bold emphasis mine)

What we are in agreement is here is that of the US Fed policy transmission to the Asian markets and economy.

Although it would be ideal that Asian currencies be allowed to rise to reflect some of these adjustments, the idea that currencies are the only major factor for adjustments represent as logical fallacies of hasty generalizations based on unfounded assumptions or Ipse Dixitism.

To consider, the Philippines saw its currency the Peso depreciate from Php 2 to a US dollar in 1960s to Php 55 pesos to a US dollar in 2005 (or 96% devaluation!).

Considering the macro assumptions that such magnitude of adjustments ought to reflect on its products, this implies that the Philippines should have been an export giant by now.

Unfortunately this hasn’t been the case. Instead, we became a giant of labor exports, as an aftereffect of a vastly lowered standard of living out of the inflationary policies accrued from present and the previous administrations.

Unfortunately, such simpleminded fallacy of composition by experts deals with the assumption of an economy producing a single good from a single type of labor funded by a single type of capital.

I’ll further the example; San Miguel Beer which cost Php 19 per bottle in a local sari sari store (informal retail outlet), costs Php 50 in local B rated bars, and Php 200 in 5-star hotels. This is known as Price Discrimination, which basically means the selling of identical products to different markets through market segmentation.

In other words, depending on the markets, some products are more price sensitive (price elastic) than the others. In practice, a product that caters to the lower income class of the society is more price sensitive compared to a product marketed to the high end income segment.

So markets, not only prices (through currencies), are the more important qualifying variables for any required economic adjustments.(yet, high profile local experts continue to call for inane Peso depreciation!)

The fundamental reason why the Philippines haven’t benefited from a depreciated currency is because the local political economy has a limited and underdeveloped market due to an unfree economic rent seeking crony capitalist structure which has remained in place until today.

Besides, if currency value is the sole determinant of economic growth then Zimbabwe should be the biggest exporter or the wealthiest nation today!!!

The Japan Experience

More example; if rising currency translates to “greater domestic demand” then why has the Japan’s economy remained an export dependent economy despite the huge (threefold) appreciation of the yen? (see figure 6)

Figure 6:Gold News: Soaring Japanese Yen

Nathan Lewis for the Daily Reckoning says that aside from the deflation in the banking system what mattered most had been the series of tax hikes that has kept Japan’s economy in the doldrums, 20 years from the bubble bust.

This from Mr. Lewis (bold highlights mine) , ``They began with a series of tax measures on January 1, 1990 - the first day of the bear market - which eliminated certain preferential capital gains tax treatments for property. To take a few of a great many such steps which followed: In 1992, the tax rate on short-term capital gains (under 2 years) on property was raised to 90%. Long-term gains were taxed at 60%. A 0.3% National property tax was introduced (this was several multiples greater than existing property taxes). A City Planning Tax of 0.3%. A Registration and License Tax of 5% of the sale value of a property. A Real Estate Acquisition Tax of 4%. An Office Tax of 0.25%. A Land Ownership Tax of 1.4%. Even the regular property tax, the Fixed Assets Tax, was effectively raised by several multiples. From 1990 to 1996, Japanese property values imploded by as much as 70%. However, the revenues from this tax rose by 46%. You can do the math…

``Already there is an annual rise in payroll taxes, scheduled for every year between 2004 and 2017, which will eventually take the payroll tax rate from 13.6% to 18.3%. (Employers match this, and there is no maximum income to which it applies.) And what about the increase in taxes on dividends from 10% to 20%? Or the introduction of a brand-new capital gains tax on equities of 20%, which had effectively been tax-free before? Or the effective 25% increase in personal income taxes, the result of the elimination of a 20% tax cut introduced in 1998? On top of all that, politicians are talking about increasing the consumption tax (similar to a sales tax) from 5% presently to 10% or higher. Until a 3% consumption tax was introduced in 1989, there was no consumption tax at all in Japan, not even at the prefectural or municipal level.”

In addition, John Hempton of Bronte Capital says the legacy of zombie corporations has consumed capital resources which was otherwise meant for other productive investments, ``the problem in Japan was their ability to keep zombie corporations (not zombie banks) alive for decades. Japan has a “Rip-Van-Winkle” industrial legacy to go along with its absolutely brilliant modern technology industries. This old industry sucks resources which would better be used by the modern industry.” (emphasis added)

In short, like the Philippines, domestic policies have been responsible for restricting the required adjustments to expand the marketplace in spite of the currency adjustments. So calling for adjustments of imbalances via the currency route is no less than a fantasy.

Therefore, I’d avoid listening to “expert” economists who would reason along logical fallacies and prescribe snake oil medicines.

What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis

``The most popular method of deprecating capitalism is to make it responsible for every condition which is considered unsatisfactory. Tuberculosis and, until a few years ago, syphilis, were called diseases of capitalism. The destitution of scores of millions in countries like India, which did not adopt capitalism, is blamed on capitalism. It is a sad fact that people become debilitated in old age and finally die. But this happens not only to salesmen but also to employers, and it was no less tragic in the precapitalistic ages than it is under capitalism. Prostitution, dipsomania, and drug addiction are all called capitalist vices. Ludwig von Mises Economic Teaching at the Universities

Lessons from Nassim Taleb

There are two important things I’ve learned from my favorite iconoclast Nassim Taleb, the chief proponent of the Black Swan Theory.

One is that he cautions the public to indulge in the study of markets or economies centered upon highly flawed but popular econometric models which are nothing but algorithms designed to operate on sterilized environments similar to classroom or laboratory conditions.

Since these computer models unrealistically operate on the assumption that every factor can be anticipated, examined and evaluated, risks are therefore assumed to be under control. Yet, the complex nature of our world can lead to manifold variables which can’t be read, evaluated or anticipated. The impact of which is known as randomness or the BLACK SWAN, a low probability but HIGH impact event, and is the nemesis of these ‘quant’ models. For instance the humongous losses in today’s financial crisis have been be partially blamed on the failure of quant models to anticipate risks from statistical fat tails.

Second, the other lesson taught by our unorthodox savant is to avoid getting trapped with cognitive biases such as projecting past connections and outcomes into the future.

The Sanctity of Delusion

Today we are told that the world is going to the sewer.

That is because the US, which has functioned as the only major ‘aggregate demand’ of the world, can’t live up to its role as it is undergoing a deep recession. In corollary, these experts further assert that the world won’t be able won’t replace the US as the provider of demand because of its sheer size. In other words, past performance guarantees tomorrow’s outcome.

Based on their economic premise, where supply exists only as a function of demand, then with today’s imploding private sector credit bubble, which has deeply dented the demand equation, must be replaced and absorbed by the government. Therefore, the government’s role MUST be to create artificial demand by printing up as much money in order to sustain the bursting bubble structure.

Tersely said, from the private sector, the credit bubble now is being reconfigured to one known as a government credit bubble. And this seems to be what we are seeing all around the world. From nationalization, “bad bank” or other means of government interventions, the idea is to transfer the leverage and the attendant losses to the government.

The same logic says that if Bernard Madoff was a fraud, and had operated on an unsustainable platform which didn’t last, the government’s insistence of operating on the same an unsustainable platform, but charged to the taxpayers and meant for the “good of the citizenry”, MUST SUCCEED. The difference was that Madoff was a felon, while governments sustaining bubbles for chimerical prosperity, are deemed as legitimate and for a good cause.

Unfortunately for Madoff, he was an individual and not privileged to conduct the same scheme which is equally being thrown to the public by governments. But the underlying principle of both Madoff and the governments is the same: to get something from nothing!

In other words, you resolve the problem of drug addiction by providing more drugs. If you are Madoff you get charged with drug pushing. But if you are the government, you receive plaudits for a fighting for a good cause.

In a reality check, unsustainable trends which can’t last, won’t! NO amount of the printing press nostrums will make illusions a reality.

Reality has finally landed in Zimbabwe. The Mugabe-Gono government finally capitulated to the marketplace realities by allowing the depressed African economy to trade in foreign currencies which in effect jettisoned the local currency, the Zimbabwe dollar. This also means the Mugabe-Gono government will fall soon. And in the same vein, all nationalizations or government guarantees are only as good as the real capital standing behind these.

Does the words of Karl Marx in Das Kapita in 1867…``Owners of capital will stimulate the working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism"…ring a bell?

Fairy Tales Cures and Self Righteousness

Yet popular opinion believes in fairytale cures.

To call for market forces to rectify the situation, one risks being labeled as insane, inhuman or bloodless.

Nevertheless just look at level of desperation policymakers are into so as to consider ridiculous ideas to restore an unsustainable structure of economic growth:

-In déjà vu to the hog reduction program of the Great Depression of the 1930s, US policy makers are considering to boosts car sales via a program known as "cash for clunkers". (CNNmoney) Yes, the US government plans to buy and junk old cars so as to motivate its populace to buy new ones. If the policy gets enacted, this is going to be a waste of productive resources.

-Moreover, they are considering “to renegotiate mortgages it owns that might otherwise enter foreclosure” (Washington Post) or allow “bankruptcy judges to modify the mortgages of troubled homeowners” (Washington Post) all at the expense of the property rights of American people.

To add, not content with plans to impose tons of regulations on the national level, the statists have been contemplating on to expand impositions abroad. Signs of protectionism, which had greatly contributed to the Great Depression of the 1929, are surfacing in the political arena. At the confirmation hearing, Treasury Secretary Tim Geither unleashed what he “believes that China is manipulating its currency” (Wall Street Journal). In addition, the stimulus bill which was recently passed by Congress contained a “Buy America” rider (Washington Post).

All these actions seem to agitate for a mutually devastating global trade war.

And why would authorities engage in such potentially calamitous actions? We understand 3 possible things: economic ignorance, messianic complexity or plain political rhetoric.

Realities say that the US doesn’t produce enough, that’s why it incurs trade deficit. And a trade war would mean massive catastrophic shortages. Think oil. The US imports 60% of its oil requirements (CNNmoney). If world trade shuts, the economic implication would be a collapse in the US economy with a geopolitical implication of a possible World War 3.

And also considering that the US is the largest debtor nation in the world, it wouldn’t be far where a trade war would also extrapolate to an equally internecine debt default. And what’s to stop these interventionists fools from inciting a war economy or the misguided belief that only war, after everything else fails, can stimulate the economy?

Now we turn the tables and wonder who is insane, inhuman or bloodless? Does provoking a trade war which has dire consequences similar or worst in scale than the Great Depression a humane and charitable option? How altruistic is it, if the world goes into war out of the desire to stimulate the economy? How does hyperinflation as in the case of Zimbabwe lead to progress? How charitable can it be to live a world of self delusion?

Does the 2008 Global Trade and Production Collapse Signify Posttraumatic Stress Disorder?

If a bubble structure can be characterized by unrestrained credit creation, speculative excess seen in asset inflation and unparalleled concentration of financial wealth and power, then in as much as the massive wage or income disparities or “Shameful bonuses” in Wall Street relative to the average Americans had been a function of a bubble structure, the world’s production-supply chain structure have also been partly been built around the same bubble environment.

And today’s bursting bubble which has prompted for “demand destruction” has been met by more “supply destruction”.

Yet what seems to be remarkable has been the sharp collapse in global production and trade.

Figure 3: IMF World Economic Outlook: Collapse of Global Industrial Production and Merchandise Trade

The chart IMF’s World Economic Outlook demonstrates the seeming peculiarity of the last quarter’s world trade and production activities.

If you are to compare with the dot.com days or the previous bubble bust and its ensuing recession, you’d notice that the same trends went into a steady decline over a period of time (years). But this hasn’t been the case last year. The outright collapse in just ONE MONTH by both economic variables suggests that world suddenly stopped doing anything and merely watched in shock and awe!

And why would the world do that? The obvious answer is the shock emanating from the near meltdown of the US banking system subsequent to the Lehman debacle. This has been prompted for by the institutional bank run in the US banking system as discussed in last October’s Has The Global Banking Stress Been a Manifestation of Declining Confidence In The Paper Money System?

So contrary to mainstream views which ANCHORS upon this collapse as their basis for prediction, we suggest instead that this could be a function of a Posttraumatic stress disorder (PTSD) where according to Wikipedia.org, ``is an anxiety disorder that can develop after exposure to one or more terrifying events that threatened or caused grave physical harm.”

As an example, the 9/11 terrorist attack on the World Trade Center was graphically captured in living color by media. The repeated airing of the deplorable terrorist event heightened the fear of air travel which thereby caused a shift or substitution in some of the public’s traveling patterns.

And the shift emanating from the fear, resulted to more casualties from the higher risk land transportation.

According to a study The Impact of 9/11 on Driving Fatalities: The Other Lives Lost to Terrorism by Garrick Blalock, Vrinda Kadiyali, Daniel H. Simon, ``We find that driving fatalities increased significantly following the terrorist attacks of September 11, 2001, an event which prompted many travelers to substitute less-safe surface transportation for safer air transportation. After controlling for time trends, weather, road conditions, and other factors, we attribute an increase of 242 driving fatalities per month to additional road travel undertaken in response to 9/11. In total, our results suggest that about 1,200 driving deaths are attributable to the effect of 9/11. We also provide evidence that is consistent with the 9/11 effect on driving fatalities weakening over time as drivers return to flying. Our results show that the public response to terrorist threats can create unintended consequences that rival the attacks themselves in severity.”

Why is this so? According to Trevor Butterworth, ``Because fear strengthens memory, catastrophes such as earthquakes, plane crashes, and terrorist incidents completely capture our attention. As a result, we overestimate the odds of dreadful but infrequent events and underestimate how risky ordinary events are. The drama and excitement of improbable events make them appear to be more common.”

So given Mr. Butterworth’s tread, could we be “overestimating the odds of dreadful but infrequent events and underestimating how risky ordinary events are”?

Evidences of PTSD

Some evidences show we are.

One, global barter trade has been picking up. [see Does Growing World Barter Trade Suggests Of Bigger Cracks In Today's Monetary Order?]

According to the Financial Times, ``Officials estimated that they ranged from $5m for smaller contracts to more than $500m for the biggest.” It could be more. There have been accounts of barter since this episode has unraveled.

And the reported cause? ``Failure to secure trade financing as bank lending has dried up.”

The fact that governments have traded OUTSIDE the financial system, means demand and supply seems intact for basic necessities for them to conduct trade. The fundamental problem lies within the traditional means of facilitating payment and settlement via the banking system.

Two possible reasons why governments have been undertaking barter, which is a primitive method of trade:

One, the banking system remains dysfunctional despite the heavy interventions by global governments and

Two, there is a growing distrust for the present medium of exchange. The second finds a voice in Russian Prime Minister Vladimir Putin’s speech in Davos, ``Excessive dependence on a single reserve currency is dangerous for the global economy. Consequently, it would be sensible to encourage the objective process of creating several strong reserve currencies in the future. It is high time we launched a detailed discussion of methods to facilitate a smooth and irreversible switchover to the new model.”

The next evidence could be seen via the surging Baltic Dry Index see figure 4.

Figure 4: stockcharts.com: Rising Baltic Index=Rising Oil and Copper?

The Baltic Dry index according to the wikipedia.org is ``a number issued daily by the London-based Baltic Exchange. The index provides "an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers Handymax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore and grain.”

Plainly put, the Baltic Index is the cost of freight to move raw materials or basic commodities. It could be seen as a leading indicator.

So far the Baltic Index has risen by 60%, whereas oil and copper appears to be consolidating or “bottoming” even as the US dollar index has been going up. To recall, during the October-November collapse, the US dollar has inversely accompanied the rapid declines of the Baltic index as with the oil and copper.

The seeming divergence could be added signs of the diminishing influences of debt deflation.

Furthermore, even in the US, there are signs that production and inventory or supply destruction have been catching up with its counterpart demand destruction see figure 5.

Figure 5: Danske Bank: Is the US Manufacturing Sector Beginning to Recover?

These observations from the Danske Team (bold emphasis mine),

``First, prior to the recession the US manufacturing industry ran very lean inventories. Second, the liquidity squeeze from the credit crisis has led to an unusually fast alignment of production to demand fundamentals.

``Consequently, the pace of production is now undershooting the slowdown in demand. Hence, it will merely take stabilisation in demand growth to spark an industrial recovery.

The Danske team suggests that the first signs of recovery will be manifested over the ISM index which may stabilize and recover over the coming 3-6 months. In addition, a recovery in the ISM index will most likely add pressure to long US bond yields and signal stabilization in corporate earnings.

While I don’t necessarily share the optimism of the Danske team, the point is that the recent collapse have meaningfully adjusted both the demand and supply equation possibly enough to generate some market based (and not government instituted) revival.

So from growing world barter activities, buttressed by the rising Baltic Dry index, and a potential run down of inventories and similar downside adjustments in the supply side production could mean a semblance of restoration of global trade.

And if indeed the Danske Team is right about their forecast about the manufacturing recovery in the US, then this could signal a potential trough or nearing close of the US recession.

But then again, as a reminder, the cardinal sins in policymaking that could lead to prolonged bear markets: protectionism (nationalism, high tariffs, capital controls), regulatory overkill (high cost from added bureaucracy), monetary policy mistakes (bubble forming policies as negative real rates), excess taxation or war (political instability). Except for the last threat, the 4 seems likely a clear and present danger.

Will An Easing PTSD Lead To A Resurgent Asia?

Nonetheless, if the US supply side has adjusted to counterbalance the sharp fall in demand, then it is likely that the spate of sharp declines in the economic activities in most of Asia can be construed as the same degree of supply/production side adjustments.

Figure 6: DBS Bank: Asia’s Industrial Production Recovered earlier during the .com recession

Like in 2001, Asia’s heavy exposure to the technology sector hit exporters. Today, the sharp decline in US consumer spending has equally affected Asia’s exports as much as it also affected production. However, the sharp drop late last year could likely be explained by the Posttraumatic stress disorder (PTSD) emanating from the distress in the banking system.

But unlike in 2001, which saw Asia as floundering from the nasty side effects of the Asian Crisis, where there essentially had been no domestic demand, this isn’t the case today. Asia has simply grown bigger and more dynamic and with ample shield from its high savings enough to potentially generate its own demand.

The recent DBS bank outlook says it best, ``Asia now generates almost as much new demand every year as the US- and it is that fresh demand that’s the very definition of global growth. The US is still a key driver and will remain so for a long time. But it is not the driver it used to be.” (bold emphasis mine)

And the Economist seems to agree, ``The question is, might domestic demand now take up some of the slack? There are reasons to think so. Falling commodity prices are boosting consumers’ purchasing power, just as they squeezed it last year. More important is the impact of monetary and fiscal expansion…(bold emphasis mine)

And the Economist sings to be singing a tune similar to ours, ``Asia has never before deployed its monetary and fiscal weapons with such force. Every country across the region has cut interest rates and announced a fiscal stimulus. In previous downturns, Asian governments were often constrained by dire public finances or the need to support currencies. But most countries entered this downturn with small budget deficits or even surpluses. All the main Asian emerging economies apart from India have relatively low ratios of public debt to GDP.” (bold emphasis mine)

In our Will “Divergences” Be A Theme for 2009?, we brought up the Austrian economics explanation that ``market rate of interest means different things to different segments of the structure of production.”

In essence we believe that convergent actions by global central banks will ultimately lead to divergent responses based on the capital and production structure of every economy.

Where the same amount of rain is applied to a desert land, forest land or grass land, the output will obviously be different. And to complement the DBS and Economist outlook, we recently said ``this crisis should serve as Asia’s window of opportunity to amass economic, financial and geopolitical clout amidst its staggering competitors. But this will probably come gradually and develop overtime and possibly be manifested initially in the activities of the marketplace.”

So to refrain from overestimating the odds of dreadful but infrequent events and underestimate how risky ordinary events are, we revert to the study of Garrick Blalock, Vrinda Kadiyali, Daniel H. Simon who concludes, ``Although we are unable to identify precisely reasons for either the 9/11 effect or its weakening, the existence of the effect is consistent with theoretical models in behavioral economics and psychology of inaccurate assessment of risks by consumers and exaggerated adjustments to risk assessments. The fortunate weakening of the 9/11 effect may be attributable to consumer learning over time in response to environmental changes. For example, the perceived risk of flying may have declined with the absence of any further terrorist incidents since 9/11, or travelers may have become accustomed to the increased inconvenience of flying.”

No we don’t just read past data and project them to the future like most of the experts. Instead, we try to understand that human action, to quote Ludwig von Mises, is a purposeful behavior!