Portugal Central Bank Bails Out Banco Espiritu Santo

I previously noted of the banking turmoil happening in Portugal: Add to Bulgaria’s woes has been the recent hubbub over Portugal’s largest listed lender the Banco Espiritu Santo (BES) which just filed for creditor protection following the company’s newly discovered financial irregularities and the failure to make payments to creditors. Following March highs, Portugal’s stock market  plummeted into the bear market as the BES saga unraveled. 

Well governments (like China) are back into a frantic bailout mode. The Portuguese Central Bank reportedly announced a $6.6 billion rescue of Banco Espiritu Santo (BES) 

From Bloomberg:

Portugal’s central bank took control of Banco Espirito Santo SA, once the country’s largest lender by market value, in a 4.9 billion-euro ($6.6 billion) bailout that will leave junior bondholders with losses.

The Bank of Portugal’s Resolution Fund will move Banco Espirito Santo’s deposit-taking operations and most of its assets to a new company, Novo Banco, which it will own outright. The fund will finance the rescue with a Treasury loan to be repaid by Novo Banco’s eventual sale. Espirito Santo shareholders and junior bondholders will be left with the most “problematic” assets, including loans to other parts of the Espirito Santo Group and the lender’s stake in its Angolan operation, according to a central bank statement yesterday.

“Shareholders, subordinated debt holders as well as board members or former board members directly involved in the more recent events, and not the taxpayers, will be called to shoulder the losses incurred by a banking business they failed to adequately oversee,” the Finance Ministry said in a statement.

Banco Espirito Santo has been forced to take public money after regulators uncovered potential losses on loans to other companies tied to Portugal’s Espirito Santo family and ordered the lender to raise capital. Bank of Portugal Governor Carlos Costa had sought to find private investors to inject the cash, and said government funds would only be a last resort. The Portuguese government has about 6.4 billion euros remaining from its European Union-led bailout in 2011 to fund the capital injection.

So the Portugal government’s BES bailout will leave little contingent funds for any other potential financial instability.

Chart from Reuters

The sustained meltdown in BES shares has prompted the Portuguese government to suspend trading.

The BES ruckus has even spilled over to Portugal’s major equity benchmark the P-20, which has been hammered, now back to a bear market 

Here is the timeline of the BES saga.

The BES episode is a reminder that, despite previously rising stocks and today’s bail out, all have not well in the Eurozone.

How Inflationism Propagated Singapore’s Riots

Sovereign Man’s Simon Black Singapore eloquently explains of the unexpected recent outbreak of riots in Singapore.

Like individual people, societies have their own breaking points. They build up anger and frustration for years… sometimes decades. Then all it takes is one spark. One catalyst. And it all becomes unglued.

Just yesterday, a 33-year old Indian man got hit by the proverbial bus in Singapore’s Little India neighborhood. That was the catalyst. What transpired for the next several hours was a full blown riot… the first of its kind since 1969.

Several hundred rioters stormed the streets. They started off smashing the up the bus that was still on the corner of Hampshire Road and Race Course Road. Then they started throwing objects at the ambulance staff who were unsuccessful in extracting the man in time to save his life.

By the end of the evening, an angry mob had lit five police vehicles on fire, plus the ambulance, leaving the streets in a towering inferno.

The government immediately went into damage control mode trying to explain what happened. But the explanation is really quite simple.

Singapore has had years of tensions building. The wealth gap is growing like crazy. Wealthy people are becoming ultra-wealthy, while the majority of folks see the cost of living rise at an alarming rate.

Strong ideological and ethnic differences are boiling over. And backlash against immigrants, especially from certain countries, is becoming an acute and obvious problem.

These issues are commonplace. Ideological differences. The wealth gap and economic uncertainty. Immigration challenges.

They’re the same issues, for example, that have plunged much of Europe into turmoil, including the rise of a blatantly fascist political party in Greece.

And these same issues exist, in abundance, in the Land of the Free… where a number of serious ideological divides are becoming obvious social chasms.

Printing money with wanton abandon. Racking up the greatest debt burden in the history of the world. Doling out wasteful and offensively incompetent social welfare programs at the expense of the middle class. Brazenly spying on your own citizens. These are not actions without consequences.

And if it can happen in Singapore– one of the safest, most stable countries on the planet, it can happen anywhere. Even in a sterile American suburb.

It is indeed disappointing to see upheavals erupt in what has been ‘successful’ economies. Singapore is one place I would prefer as residence.

But riots have indeed been a manifestation of tensions building overtime.

Growing politicization of the marketplace, e.g. latest labor protectionism, compounds only to social tensions

As I wrote about Singapore’s gradualist transformation to a welfare state in August of 2012

Once the ball gets rolling for the feedback loop of tax increase-government welfare spending then Singapore eventually ends up with the same plagues that has brought about the current string of crises, particularly loss of economic freedom, reduced competitiveness and productivity, lower standard of living, a culture of dependency and irresponsibility and of less charity and unsustainable debt conditions. The outcome from politically instituted parasitical relationship would not merely be a financial or economic crisis but social upheavals as well.

Be reminded that all these massive money printing measures and zero bound rates has only been driving a deeper wedge between the beneficiaries—which really are disguised bailouts of banks, the political elite and their cronies and of the bankrupt governments—and the main street (from whom the transfer to elites has been sourced)

Singapore is of no exception. 

Singapore’s loan to the private sector has been exploding, it began its upside acceleration in 2006, but then the ascent has intensified since 2011. Today this has turned nearly parabolic

Singapore’s massive credit bubble has been reflected on her money supply M3 growth (red rectangle)

The credit bubble has found its way largely to the property sector where Singapore’s property index has already eclipsed the pre-1997 Asian crisis highs.

Populist politics, which always looks at the superficial, the “visible” or the symptom, blame this largely on immigration rather than central bank policies led by the US Federal Reserve and Singapore’s counterpart Monetary Authority Singapore (MAS). The MAS has been resorting to "containing” the rise of the Singapore dollar vis-à-vis the US Dollar by pumping a domestic credit bubble.

Popular clamor has thus spurred more and more interventionism that has only been inciting social tensions which paved way for the recent riot.

So it should be no surprise when inflationism will continue to provoke riots worldwide, even in places deemed as ‘safe’ or stable.  We have seen a similar outbreak of public turmoil in Sweden last May.

Here in the Philippines, today the media announced of a massive jump in electricity prices in the metropolis. This will not only prick local bubbles but will also provoke a public uproar via demonstrations and possible riots.

Bubbles just can’t last forever. Heed the prescient admonitions of the great Austrian economist Ludwig von Mises:

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

Riots serve as the proverbial writing on the wall.

Did the Fed bailout Emerging Markets?

Has Turkey been bailed out by the Fed, the Zero Hedge inquires? (bold original)

Following the Fed's decision to not Taper, Turkish stocks were the world's best performing asset overnight. Jumping almost 8% today, the main Turkish stock index is now up over 26% in the last 3 weeks, back above its 200DMA and in bull-market territory as BAML notes "the Fed decision amounts to a bailout for Turkey." While the fundamental adjustment in current account imbalances remains unfinished, in the near term gross bearish positioning and the dovish FOMC decision are likely to support Turkey bonds... once again removing any pressure for a politician to make any hard decision anywhere in the world. How do you say "thank-you, Ben" in Turkish? (or Indonesian, Indian, Malaysian, or Thai?)

In addition to Turkey, other EM bourses has been buoyed by the FED (including those of EM Asia as mentioned).

Brazil’s Bovespa

Russia’s MICEX

Indonesia’s JCI

Malaysia’s KLCI

Thailand’s SETI

The Philippine Phisix

And another biggest beneficiary from the Fed's actions seems to be India, whose BSE-SENSEX has reached a 2011 high! See no risks of a crisis. The Fed’s magic wand shooed them away.

The near sweeping bailout of emerging markets can be seen via the iShares Emerging Markets (EEM)

The bailout has not just been an EM affair, it has extended to developed Asia Pacific…

Such as Singapore’s STI

and Australia ASX 200 (at record highs)

The above equity markets began to rally in anticipation of a modest tapering by the FED. Besides with other assets down, equity markets became the only alternative or magnet for yield chasers. And the Fed's "UNtaper" served as the icing on the cake.

The only “fundamental” thing relevant to the current financial markets has been central banking bailouts.

Yet for every artificially generated boom there is eventually a corresponding...

Are Taxes and Regulations as Primary Business Obstacles a Myth?

The McKinsey Quarterly writes to supposedly debunk the myth where taxes and regulations poses as key obstacles to small businesses:

Many business leaders will tell you that taxes and regulation are the biggest barriers to starting up and enlarging small businesses. It’s true that some regulations and laws have inhibited the growth of small businesses; the Sarbanes–Oxley Act, for instance, had the unexpected consequence of discouraging some companies from making initial public offerings, a step typically followed by a burst of hiring. But taxes and government oversight are not the primary barriers to stimulating the growth of small businesses. In the latest recession, their owners pointed to a lack of market demand as the primary problem, as well as an inability to obtain financing

In reality, the alleged inadequacy of consumer demand are no less than symptoms of invisible but real underlying causes.

The perception of the lack of consumer demand as the main culprit to business or even economic deficiencies represents a populist Keynesian fallacy.  As the great Friedrich A. von Hayek explained  (Unemployment and Monetary policies, p.40; hat tip Professor Don Boudreaux) [bold mine]

The conquest of opinion by Keynesian economics is due mainly to the fact that its argument conformed to the age-old belief of the businessman that his prosperity depended on consumer demand.  This plausible but erroneous conclusion was derived from his individual experience in business, namely, that general prosperity could be maintained by keeping general demand high.  Economic theory had been rejecting this conclusion for generations, but it was suddenly made respectable by Keynes.  And since the 1930s it has been embraced as obvious good sense by a whole generation of economists brought up on the teaching of his school.  Thus for a quarter of a century we have systematically employed all available methods of increasing money expenditure, which in the short run creates additional employment but at the same time leads to a misdirection of labor that must ultimately result in extensive unemployment

The policies of inflationism, aimed at increasing “money expenditures”, that has prompted for the large scale or clusters of “misdirection of labor” and resources that “must ultimately result” in capital consumption which gets to be manifested as “extensive unemployment” and consequently, the dearth of consumer demand.

In short, boom bust cycles fosters what mainstream sees as lack of demand.

Additionally, regulations that prevent markets from “clearing” or allowing markets to coordinate resources and labor towards consumer preferences also poses as unseen but real hindrance to additional consumer demand.

High taxes divert resources from production to consumption, thereby decreasing capital investments that suppresses income and eventual demand.

 

Bailouts and subsidies too or the transference of resources from productive to politically preferred unproductive areas (e.g. Obama’s green energy projects) also results to wasted resources, high costs to taxpayers, crowding out, diminished capital investments and subsequently a paucity of demand

Lastly, arbitrary regulations have been the major obstacles to business creation or expansion.

Some real life examples: In Georgia, policemen shut down a child’s lemonade stand (due to lack of permit) and in Chattanooga City Tennessee, a pedicab project has been shelved simply because state officials didn’t like it. 

Of course, there are many more instances of economic repression from political agents. Deprivation of livelihood from political interference, signifies as a source of the lack of demand. No income, No spending.

Bottom line: The world does not operate on a vacuum. People just don’t act because they wake on one side of the bed and feel either confident or anxious. People’s actions are driven by incentives (and not by moods or by animal spirits). 

Lastly, effects must not mistaken as the cause.  

China Prepares For Massive Bailout!

China spent around $586 to shield itself from the global meltdown in 2008. The aftermath has been to engender bubble conditions as evidenced by the ballooning balance sheets of their banking system and the local government. Recognizing the risk of a bust, China mulls a massive bailout.

The following report from Reuters, (bold emphasis mine)

China's regulators plan to shift 2-3 trillion yuan ($308-463 billion) of debt off local governments, sources said, reducing the risk of a wave of defaults that would threaten the stability of the world's second-biggest economy.

As part of Beijing's overhaul of the finances of heavily-indebted local governments, the central government will pay off some of their loans and state banks including some of the "Big Four" will be forced to take some losses on the bad debt, said the sources, both of whom have direct knowledge of the plans.

Part of the debt will also be shifted to newly created companies, while private investors would be welcomed in projects previously off-limits to them, sources said.

Beijing will also lift a ban on provincial and municipal governments selling bonds, a step aimed at bolstering their finances with more transparent sources of funding.

Many analysts see China's pile of local government bad debt as a major risk to the economy, especially as the economy slows, but few see widespread banking fallout as they believe cash-rich Beijing can step in to soak up losses.

The clean-up plan could boost investor confidence in Chinese banks, which have provided many of their loans as part of the massive economic stimulus program launched by Beijing in late 2008 to counter the global financial crisis.

The program resulted in unfettered lending to local government financing vehicles, hybrid government-company bodies that governments used to get around official borrowing restrictions.

After a months'-long investigation into local government liabilities, Beijing has determined that local governments have borrowed around 10 trillion yuan, said one of the sources.

Additional comments:

1. The previous bailout (stimulus spending) fostered a political economic environment of moral hazard whose consequence was to propagate massive misdirection of capital investments.

2 While lifting the ban on selling provincial and municipal governments seems good, as bond markets will supposedly reflect on the economic conditions, alternatively seen, this measure is meant to soak up private savings into government bailout programs. In short, this represents no more than China’s version of financial repression at work.

3. It is true that China has massive savings that perhaps may afford her to conduct another bailout, but as previously discussed, bailouts would only consume productive capital by diverting them into non-productive activities. Additionally part of the bailouts will surely be accommodated with inflationism.

4. The proposed bailout which accounts for as 20-30% of local government could be understated. Yet this seems like more evidence of the maturing phase of China’s bubble cycle.

5. If China applies the above bailouts before the bust then this could extend the boom but at the risk of that the next crisis will come with a greater intensity.

The Implication of Emerging Market Central Banks’ Buying of Gold

The revolt against the US dollar regime seems underway.

The Bloomberg reports, (bold highlights mine)

Central banks that were net sellers of gold a decade ago are buying the precious metal to reduce their reliance on the dollar as a reserve currency, signaling demand that may extend a record rally in prices....

In 2010, central banks became net buyers for the first time in two decades, adding 87 metric tons in official-sector purchases by countries including Bolivia, Sri Lanka and Mauritius, according to World Gold Council data. China, with more than $3 trillion in foreign-currency reserves, plans to set up new funds to invest in precious metals, Century Weekly reported this week. Russia purchased 8 tons of gold in the first quarter...

China, which has just 1.6 percent of its reserves in gold, may invest more than $1 trillion in bullion, Pento said. “China wants to be an international player, and they need to own more gold than they currently have.”...

As of April, China was the sixth-largest official holder of gold, with 1,054.1 tons, according to World Gold Council estimates. The U.S. has the most, with 8,133.5 tons, or 74.8 percent of the nation’s currency reserves, council data show.

Central-bank buying may have the same impact on gold as the introduction of exchange-traded funds, Cuggino said. Prices have more than tripled since the SPDR Gold Trust, the biggest ETF backed by bullion, was introduced in November 2004.

Central banks in emerging markets may aim to hold 2 percent to 8 percent of their foreign-currency reserves in gold, Francisco Blanch, the head of commodities research at Bank of America Merrill Lynch in New York, said in an interview.

If emerging market central banks sustain the shift of their dollar reserve stash for gold or other metals, then this means that US government will have to increasingly rely on their resident savings or on the US Federal Reserve to finance their fiscal deficits.

Otherwise, the US economy faces the risk of higher interest rates.

So far, while the nominal amount of US treasuries debt held by foreign central banks continue to climb; the annual rate of change has been falling since 2009. (chart courtesy of yardeni.com)

BRICs and East Asia are major holders ‘financiers’ of long term US debts. (charts above and below from Wikipedia)

Yet about 28% of US debts has been owned by foreigners. The gist of these debts has been held by the Federal Reserve and intragovernmental Holdings whose trend has risen steadily since 1997.

Higher interest rates go against the implied guiding dogma of the incumbent authorities of the US Federal Reserve which has been anchored on low interest rates (ZIRP) to perpetuate permanently ‘quasi booms’.

Also higher interest rates can severely affect the balance sheets of the overleveraged banking system which may again result to another turmoil.

According to Wikipedia,

The U.S. banking sector's short-term liabilities as of October 11, 2008 are 15% of the GDP of the United States or 43% of its national debt, and the average bank leverage ratio (assets divided by net worth) is 12 to 1.

And given that the US government has spent and exposed her taxpayers to trillions of dollars worth to protect the banking industry, I expect the Federal Reserve to see the interests of the banking sector as a continuing political priority.

So going by the elimination process, I see the conditionality as:

-if emerging market central banks continue to reduce their US dollar exposure

-if savings of US residents would turn out to be inadequate to finance government deficits

-given the path dependency and political interests (priorities) of US government and

-the US government’s refusal to pare down spending

then the US Fed seems backed into a corner with further QEs (this may not happen immediately right after QE 2.0 in June, but any signs of weakness or volatility will likely prompt the FED for the next set of QE)

And more QEs extrapolate to higher gold prices, lower dollar, possibly higher equity prices (depending on the degree of the impact of CPI inflation) and more CPI inflation...all these signifying a feedback mechanism of the inflation cycle until CPI inflation turns into a nightmare.

Alternatively, the US can cut government spending and reduce debt, but that would be an anathema or a seeming taboo for politicians.

US Federal Reserve Lent To (or Bailed Out?) Libya’s Qaddafi in 2009

Part of the US Federal Reserve’s post Lehman market stabilizing scheme included loans to Libya’s state owned bank, the Bloomberg reports, (bold emphasis mine)

Arab Banking Corp., the lender part- owned by the Central Bank of Libya, used a New York branch to get 73 loans from the U.S. Federal Reserve in the 18 months after Lehman Brothers Holdings Inc. collapsed.

The bank, then 29 percent-owned by the Libyan state, had aggregate borrowings in that period of $35 billion -- while the largest single loan amount outstanding was $1.2 billion in July 2009, according to Fed data released yesterday. In October 2008, when lending to financial institutions by the central bank’s so- called discount window peaked at $111 billion, Arab Banking took repeated loans totaling more than $2 billion.

Fed officials say all the discount window loans made during the worst financial crisis since the 1930s have been repaid with interest.

The U.S. government has frozen assets linked to the regime of Libyan ruler Muammar Qaddafi and engaged in air strikes against his military forces, which are battling a rebel uprising in the North African country. Arab Banking got an exemption that allows the firm to continue operating while barring it from engaging in any transactions with the Libyan government, according to the U.S. Treasury Department.

Some comments:

This represents as the continued the love-hate relationship between the US and Libya’s Qaddafi

The Federal Reserve has been bailing out the world, which included despots, and not just US banks.

No wonder the US Federal Reserve has been getting brickbats not only from Americans but also from some other authorities elsewhere in the world.

Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionism

Many of you may be familiar with the idiom to “fit a square peg to a round hole”. This simply means, according the Free dictionary, “trying to combine two things that do not belong or fit together.”

From Oftwominds.com

I think this expediently characterizes mainstream’s misplaced notion about Japan’s long held predicament: deflation.

Because of the mammoth boom-bust cycle seen in Japan's property and stock markets, which led to Japan’s economic “lost decade”, the image of the Great Depression of the 1930s has frequently been conjured or extrapolated as the modern version for it.

Of course, there is a second major reason for this, and it has been ideologically rooted, i.e. the bubble bust has been used as an opportunity to justify the imposition of theoretical fixes by means of more interventionism.

Has a deflationary depression blighted Japan?

If the deflation is measured in what mainstream sees as changes in the price level of the consumer price index, then the answer is apparently a NO.

As you would notice from the graph from moneyandmarkets.com, deflation isn’t only episodic (or not sustained), but likewise Japan’s intermittent economic growth (blue bars) came amidst the backdrop of negative or almost negative CPI (red line)! In other words, economic growth picked up when prices where in deflation--this translates to real growth.

And if measured in terms of changes in monetary aggregates, then obviously given that the changes in Japan's M2 has been steadily positive, as shown by the chart above from Northern Trust, all throughout the lost decade, then we can rule out a "monetary deflation".

Of course, the next easiest thing for the mainstream to do is to pin the blame on credit growth.

chart from McKinsey Quarterly

While there is some grain of truth to this, this view isn’t complete. It doesn’t show whether the lack of credit growth has been mainly from demand or supply based. It doesn't even reveal why this came about.

We can even say that such generalizations signify as fallacy of division. Why? Because the problem with macro analysis is almost always predicated on heuristics-or the oversimplification of variables involved in the analytic process.

Banks have not been the sole source of Japan’s ‘credit’ market. In fact, there are many as shown below.

According to Promise.co.jp (bold emphasis mine)

``Providing credit to consumers is generally referred to as "consumer credit." This can be classified into two types. The first is providing credit to allow consumers to buy specific goods and services, which is called "sales on financing," and the second is providing credit in cash, which is called "consumer finance." There are many types of financial service companies that offer consumer finance, including banks, but compenies which specialize in providing small loans to consumers are referred to as "consumer finance companies."

Further promise.co.jp describes the function of consumer finance companies as providing credit

``including loans but, unlike banks, do not take deposits are referred to as "non-banks." Leasing companies, installment sales finance enterprises, credit card companies, and consumer finance enterprises belong to the non-bank category.”

So how has Japan’s alternative financing companies performed during the lost decade?

Promise provides as an especially noteworthy chart. It shows of the following:

1) During the lost decade or from 1989-2007, the share of consumer financing companies (yellow-orange bar) has exploded from 15.6% to 41.9%!

2) Other forms of credit (apple green bar) also jumped from 13.4% to 30.1% during the same period.

3) The bubble bust has patently shriveled the share of 'traditional bank' based lending or the share of lending from commercial financial institutions collapsed from 48% to 12.4%.

4) The sales financing companies likewise lost some ground from 22.4% to today’s 15.6%.

All these reveals that while it is true that nominal or gross lending has declined, there has been a structural shift in the concentration of lending activities mainly from the banking to consumer financing companies and "other" sources.

And importantly, it disproves the idea that Japanese consumers have “dropped dead” or that the decline in lending has been from the demand side.

Obviously banks were hampered by the losses stemming from the bubble bust. But this wasn’t all, government meddling in terms of bailouts were partly responsible, as we wrote in 2008 Short Lessons from the Fall of Japan

``One, affected companies or industries which seek shelter from the government are likely to underperform simply because like in the Japan experience, productive capital won’t be allowed to flow where it is needed.

``Thus, the unproductive use of capital in shoring up those affected by today's crisis will likely reduce any industry or company’s capacity to hurdle its cost of capital.

``Two, since capital always looks for net positive returns then obviously capital flows are likely to go into sectors that aren't hampered by cost of capital issues from government intervention.

``This probably means a NEW market leadership (sectoral) and or money flows OUTSIDE the US or from markets/economies heavily impacted by the crisis.”

Apparently, our observation was correct, the new leadership had shifted to the financing companies.

But there is more.

Because the banking system had been immobilized, which conspicuously tightened credit access, the explosive growth of the financing companies emerged as result of demand looking for alternative sources of supply.

In addition, financing companies, who saw these opportunities circumvented tight regulations or resorted to regulatory arbitrage, in order to fulfill this role.

According to the Federal Bank of San Franscisco, (bold emphasis mine)

``Prior to the passage of the new legislation, Japan had two laws restricting consumer loan interest rates. The Interest Rate Restriction Law of 1954 set lending rates based on the size of the loan, with a maximum rate of 20 percent. The Investment Deposit Interest Rate Law, last amended in 2000, capped interest rates on consumer loans at 29.2 percent on the condition that any rate exceeding 20 percent requires the written consent of the borrower. Most Japanese CFCs have been operating in this “gray zone” of interest rates, charging rates between 20 and 29.2 percent.

``Non-bank consumer finance companies in Japan comprise a ¥20 trillion industry, averaging 4 percent annual loan growth over the past decade while bank loan growth was negative. Most of the approximately 14,000 registered lenders are small, with the largest seven operators-which include the consumer finance arms of GE Capital and Citigroup- having a 70 percent market share. The significant growth in this industry can be traced directly to the collapse of the asset bubble in the early 1990s when consumers whose collateral had dwindled in value turned to CFCs offering uncollateralized loans. Adding to the success of the industry was the fact that CFCs were more service-oriented than the retail operations of Japanese banks, offering a wider network of loan offices, 24-hour loan ATMs, and faster credit approval.”

In short, banking regulations and policies proved to be an important obstacle to credit access.

Yet, the Japanese government worked to rehabilitate on these legal loop holes. This led to further restrictions to credit access.

According to Yuki Allyson Honjo, Senior Vice President, Fox-Pitt Kelton (Asia), [bold emphasis mine]

``The Supreme Court made a ruling in 2006 to make it easier for individuals to collect repayment of interest in excess of that allowed under the Interest Rate Restriction Law (grey zone interest). The court ruling called into question the legality of the grey zone. This prompted revisiting of the rules governing money lending and forced companies to create grey zone reserves. People were entitled to claim the "extra" interest they paid from their lenders.

``Revisions to the money lending laws were passed, and by June 2010, the maximum lending rate will be unified to rates specified under the Interest Rate Restriction Law, thereby eliminating the grey zone. Loans will be limited to a third of borrowers' annual income. For loans exceeding 1 million yen, moneylenders would be obligated to inquire about the applicant's annual income. Implementation is still ambiguous. Regulators are to have more power, such as the ability to issue business improvement orders.

``The rate decline held various consequences for the industry. Margins were lowered as lenders were forced to lower their lending rates. There was a reduction in volume, with loans to current borrowers no longer being profitable, some customers were deemed too high-risk to borrow at the lower rates. Customers could borrow less due to new legislation restricting total loans as a percentage of income. Also, there has been a rise in write-offs.

``The result of all of this is that the number of registered money lenders has dropped precipitously since regulation began in 1984. The loan market is an oligopoly with 60% of the total loan balance with the Big Four, and 90% percent with the top 25 firms. This oligopoly was created in reaction to regulation.

``Stock prices for money lending companies began to drop steadily in 2006, predating the current economic crisis. The necessity for grey zone reserves has caused problems in money lenders' balance sheets. In March 2007, there are many large negative numbers visible in the balance sheets of Aiful, Takefuji, Acom and Promise. Loans approval rates crashed around 2006, with Aiful only accepting 7% of loans recently, down from over 50% before the 2006 Supreme Court rulings. Every month, 25-30 billion yen is paid out by money lenders to customers in grey zone claims, increasing steadily since 2006. Grey zone refunds have begun to pick up recently as a result of the recent economic crisis.

``The consequences of the court ruling and the re-regulation are that the Big Four companies found direct funding difficult. Credit default swaps have increased dramatically for Takefuji and Aiful, who are now essentially priced to fail. Bond yields also increased and going to market is difficult for these companies.

``From the regulator's perspective, re-regulation has been largely a success, given their aims. The size of the industry and the number of players have been reduced. The government has greater control on the industry and over-borrowing has been reduced. In regard to this last goal, its success is unclear as black market statistics are not reliable. In fact, anecdotes suggest that black market lending demand has increased.”

So aside the aftermath bubble bust, the bailouts of zombie institutions and taxes we discovered that government diktat have been the instrumental cause of supply-side impairments in Japan's credit industry.

Moreover, the other consequences has been to restrain competition by limiting the number of firms which led to the persistence of high unemployment rates, and fostered too-big-to-fail "oligopolies" institutions.

So we can conclude two things:

1. Japan’s economic malaise hasn’t been about deflation but about stagnation from wrong policies.

2. The weakness in Japan’s credit growth essentially has also not been about liquidity preference and the attendant liquidity trap, or the contest between capital and labor, or about subdued aggregate demand, but these has been mostly about the manifestations of the unintended consequences of the Japanese government's excessive interventionism.

As Ludwig von Mises wrote,

``The various measures, by which interventionism tries to direct business, cannot achieve the aims its honest advocates are seeking by their application. Interventionist measures lead to conditions which, from the standpoint of those who recommend them, are actually less desirable than those they are designed to alleviate. They create unemployment, depression, monopoly, distress. They may make a few people richer, but they make all others poorer and less satisfied.”

And it is here that we see how the mainstream can't seem to fit the square peg (deflation) to the round hole (stagnation).

US Taxpayers Could Be On The Hook For $23.7 Trillion!

A US official says that the US government has placed as much as $23,000,000,000,000 (trillion) of taxpayers money in support of the US financial system.

This from Bloomberg (bold highlights mine), ``U.S. taxpayers may be on the hook for as much as $23.7 trillion to bolster the economy and bail out financial companies, said Neil Barofsky, special inspector general for the Treasury’s Troubled Asset Relief Program.

``The Treasury’s $700 billion bank-investment program represents a fraction of all federal support to resuscitate the U.S. financial system, including $6.8 trillion in aid offered by the Federal Reserve, Barofsky said in a report released today.

“TARP has evolved into a program of unprecedented scope, scale and complexity,” Barofsky said in testimony prepared for a hearing tomorrow before the House Committee on Oversight and Government Reform.

``Treasury spokesman Andrew Williams said the U.S. has spent less than $2 trillion so far and that Barofsky’s estimates are flawed because they don’t take into account assets that back those programs or fees charged to recoup some costs shouldered by taxpayers.

``“These estimates of potential exposures do not provide a useful framework for evaluating the potential cost of these programs,” Williams said. “This estimate includes programs at their hypothetical maximum size, and it was never likely that the programs would be maxed out at the same time.”

``Barofsky’s estimates include $2.3 trillion in programs offered by the Federal Deposit Insurance Corp., $7.4 trillion in TARP and other aid from the Treasury and $7.2 trillion in federal money for Fannie Mae, Freddie Mac, credit unions, Veterans Affairs and other federal programs."

Table From WSJ

WSJ's Matt Philips also rushes into the defense noting that, ``It’s important to keep in mind the $23.7 trillion doesn’t really represent “spending.”

``It takes into account run-of-the-mill TARP programs such as loans to industries — the $79.3 billion lent to troubled auto giants for example — as well as exposure in the form of backstops to loans, such as the projected $1 trillion worth of backing for loans available through the TALF program. Also, we should point out that the mega-figure referenced above also includes a projected $500 billion to $1 trillion for to help banks shed their balance sheets of those toxic — oh, right, sorry … legacy assets through the Public Private Investment Program, or PPIP."

``Beyond that, the $23.7 trillion figure also includes total forecast exposure of the Fed, the FDIC, the Treasury — outside the TARP program — as well as the cost of swallowing up Fannie Mae and Freddie Mac, not too mention the potential cost of the enlarged guarantees tied to agencies such as Ginnie Mae. (For the full rundown on everything thrown into the number check out this section of the watchdog agency’s quarterly report.)

``The thing is, not all of the funding tied to financial crisis programs is going to get used. For instance, The Journal had a story on how the Fed’s lending has ebbed since the worst of the financial crisis, which suggests that the Fed won’t have to use all the ammo it set aside to combat the financial collapse."

Defenders of the faith are looking at an optimistic outcome. We don't share the same enthusiasm.

Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy

``The danger from all forms of paper money controlled and regulated by governments or their appointed central banks is that they remain creatures of the political process, and dependent upon the knowledge and policy preferences of those who have the power over the monetary printing press. The history of paper monies is a sorry story of inflations, currency depreciations, and resulting social and economic disorder.”-Richard M. Ebeling, IMF Special Drawing Right "Paper Gold" vs. a Real Gold Standard

The recent weakness in gold prices has prompted some mainstream commentaries to suggest “fear” as the main driving force behind this.

The underlying premise is that since gold competes with every other asset class for the investor’s money, the recent surge in global stock markets may have revived “risk” taking appetite or the Keynesian “animal spirits”. And since gold has been seen as less attractive alternative, investors may have possibly sold gold and subsequently bought into the stock markets. Hence the recent selloff has had “fear” imputed on gold prices.

For me, this represents sloppy reasoning unbacked by evidence which has been “framed” in very short term horizon, the anchoring bias or the ``tendency to rely too heavily, or "anchor," on a past reference or on one trait or piece of information” in their analysis and an innate prejudice against the “barbaric metal”.

Such flawed analysis omits the following perspective:

1. Prices Are Relative.

As we discussed in Expect A Different Inflationary Environment, inflation moves in stages and would likely impact asset classes in a dissimilar mode.

From our perspective the stock markets and commodities have initially been the primary the absorber of government induced “reflationary” measures.

In other words, yes, a rotation will likely be the case, but this doesn’t imply “fear”. It simply means a pause in the trend because NO trend moves in a straight line. It is that elementary.

The same analogy can be ascribed to last year’s dreadful financial markets collapse, where many left leaning analysts have imputed “capitalism is dead”. The truism is that markets aren’t fated to move in one direction, because they always reflect on the fluid pricing dynamics by the different participants in response to perpetual changes in the flow of information as reflected by the changes in the environment.

But when markets are tweaked by governments to achieve a perennial boom, they attain the opposite outcome- a short-term euphoric boom and an equally devastating bust or the bubble cycle.

Mr. Bill Bonner in U.S. Banks Overrun by Dirty, Rotten Scoundrels eloquently describes this phenomenon, ``Capitalism is not a collection of nuts and bolts, gears and switches. Instead, it is a moral 'system.' 'Do unto others as you would have them do unto you,' is all you need to know about it. And like any moral 'system,' it rarely gives the capitalists what they hope for...or what they want. It gives them what they deserve. And right now, it's giving it to them good and hard.” (bold emphasis mine)

In short, losses are inherent features of the marketplace. Hence, they are reflected in trends or in cycles see figure 1.

Figure 1: stockcharts.com: Gold: Where’s The Fear?

Over the past three years we see some correlations among different markets, yet these correlations haven’t retained a fixed balance but instead have been continually evolving in a seemingly divergent fashion.

In 2006-2007 Gold (main window) soared along with the global stock markets (DJW), as the US Dollar index (USD) had been on a decline (see blue trend lines). So from this perspective alone, the premise that gold falls on higher stock markets simply DOESN’T HOLD. One could easily make the oversimplified case where the inflationary ramifications of a falling US dollar had fueled a frenzy over gold and global stock markets until this culminated.

But the past dynamics have been reconfigured.

Late last year, the spike in the VIX or the “Fear” index coincided with a surge in the US dollar as a majority of global stock markets went into a tailspin. Gold similarly melted. But in contrast to the stock markets, gold found an early bottom which corresponded with a peak in the US dollar and the VIX index. This apparently marked the end of an INVERSE or NEGATIVE correlation between gold and the US dollar.

In this landscape marked by FEAR, one can infer that the US dollar functioned as the sole “safehaven” from the banking meltdown triggered investor exodus in global stock markets and in gold. But apparently this dynamic appears to be a short term affair and may have signified as a ‘one-time’ event that marked the extraordinary market distress or dislocation-our Posttraumatic Stress Disorder PTSD.

In 2009, these dynamics have been rejiggered anew. From the start of the year, Gold strongly rallied but “peaked” alongside the US dollar index (see red arrows) concurrent to the decline in the fear index and a revival in global stock markets.

The falling US dollar and declining gold prices have reversed the NEGATIVE correlation to a POSITIVE correlation where both have moved in the same direction. The implication is that the US dollar, the VIX “fear” index and Gold encapsulated the investor’s negative sentiment, all of which have recently declined. And subsequently, the stock market rally has been “fueled” by the revival of the animal spirits, according to the fear believers.

Hence, the swift “rationalization” that investor’s negative sentiment has reversed course and has passed on the “fear factor” burden to “gold”.

Yet, this ignores the fact that both the US dollar index and gold are still on an UPTREND from the basis of the simultaneous lows last October. To reiterate, from their lows both had been positively correlated.

Stretching the picture, gold remains entrenched in a bullmarket since 2001, while the US dollar’s newfound virility could signify as either a cyclical rally within long term bear market or as a fledging bull.

But since gold represents as the nemesis of the paper money system (as seen by Keynesians-ergo “barbaric” metal) epitomized by the US dollar hence price action should reveal an inverse correlation. But this hasn’t been the case today, or as it had similarly been in 2005, where both the US and gold rose even amidst a milieu of rising stock markets.

Yet such positive correlation between gold and the US dollar may account for many variable reasons for the aberration. Since the US dollar index is significantly weighted towards the Euro this could mean a frailer European economy than the US, investor’s perception of Europe’s banking system as relatively more vulnerable, the deleveraging process continues to manifests of sporadic US dollar shortages in the global financial system, and etc.., but this seems likely to be temporary.

Nonetheless given that gold has been in a longer and a more solid trend of 8 years, combined with the fundamentals of the growing risks of unintended consequences by the collective money printing financed spending spree by governments, our money is on gold.

2. Governments Have Been Distorting Every Market Including Gold.

It’s quite naïve for anyone to docilely believe that the gold markets have been efficiently reflective of the genuine market based fundamentals, when almost every financial markets have seen massive scale of interventions from global governments.

To consider, the gold markets despite its relative smaller breadth (estimated at $4 trillion of above gold stocks and $150 billion gold mining stocks measured in market capitalization) has been a benchmark closely monitored by Central Bankers. For example the speech of Federal Reserve Chairman Ben Bernanke entitled as Money Gold and the Great Depression reinforces this view.

It is because gold has functioned as money for most of the years since humanity existed. So it isn’t just your ordinary or contemporary commodity.

In fact, this has been the 38^th year where our monetary system has operated outside the anchors of gold or other commodities. Alternatively, this represents as the boldest and grandest experiment of all time [see our earlier article Government Guarantees And the US Dollar Standard]. Remember, all experimentations of paper money system that has ever existed perished due to “inflationary” abuses by governments.

In other words, government distortions may cloud interim activities in the gold market, but this doesn’t suggest of a reversal of its long term trend. Thus, this isn’t fear.

The unstated overall goal of collective governments today is to revive the status quo ante environment predicated on the paradigm of borrow-spend-speculate policies. Thus an all out effort is being waged.

That’s why global central banks have geared policy interest rates towards ZERO-in the name of providing liquidity. That’s why global central banks have resorted to the printing press or in technical terms “quantitative easing” and absorbed various junks from the banking system-in the name of “normalizing” the credit process. And that’s why governments have thrown or indiscriminately spent enormous sums of money into the global financial and economic system-in the name of sustaining aggregate demand.

In essence, they want everybody to stop saving and indulge in a binge of borrowing, spending or speculating in order to drum up the “animal spirits”.

For those with common sense, we understand that these policies are simply unsustainable. And unsustainable policies eventually will unravel.

Yet why are these being practiced? Because of sundry political reasons-primarily to expand the presence of government in the system.

When gold defied the “deflationary outlook” which infected almost all asset classes, we argued that governments could have wanted a higher gold prices as signs of reviving inflation [see Do Governments View Rising Gold Prices As An Ally Against Deflation?]. With the present developments, this has changed.

Since the overall goal of governments is to revive the “animal spirits”, then rising stock markets serves as a vital instrument to project these reinvigorated investor sentiment. Now that stock markets have been sensing signs of emergent inflation, gold markets are being targeted as the traditional adversary.

Proof?

Take the publicized plan by the G-20 to sell part of IMF’s gold stash of 403 tons out of the 3,200 tons it holds which is the third largest after the US and Germany.

You’d be wondering why the efforts by the G-20 to broadcast sales, considering the substantial size, would have a negative short term impact on gold prices even prior to the actual sales.

A normal seller in the marketplace would have the incentive to get the best possible price in exchange for the goods or services being sold. Hence if the IMF aims to achieve optimum prices from its sales it should conduct its program discreetly. But this isn’t so. Obviously the announcement of proposed gold sales would result to depressed prices even prior to the action itself. Therefore, this wouldn’t account for an “economically rational” seller but one shrouded by political motivations.

Factually, this is just one of the psychological tools employed by central bankers when manipulating the currency market. They call this the “signaling channel”.

According to IMF’s Division Chief of the Research Department, in his article Turning Currencies Around, ``Through the signaling channel, the central bank communicates to the markets its policy intentions or private information it may have concerning the future supply of or demand for the currency (or, equivalently, the path of interest rates). A virtuous expectational cycle can emerge: for instance, if the central bank credibly communicates its belief that the exchange rate is too strong—and would be willing to change policy interest rates if necessary—then market expectations will lead to sales of the currency, weakening it as intended.” (bold underscore mine)

In short, G 20 policymakers have been using conventional currency manipulation tactics to put a kibosh on the gold market.

Moreover, the same article on the G 20 gold sales from CBS Marketwatch reports that the European Central bank had “completed the sale of 35.5 tons of gold” late March.

Another, there have been discussions in cyberspace on the unverified interventions by the European Central Bank to save Deutsche Bank from its short positions.

The point is you can’t ascribe fear when knowingly such markets are being cooked up for some political purposes, although the superficial nature of market manipulations ensures that the impact will be felt on a short term basis.

But even as the G-20 has been attempting to maneuver the gold markets, actions by one party appear to be offset by the actions of another.

Apparently China has been doing the opposite of the G-20. Instead of publicly airing its intent to increase gold reserves, it has tacitly been amassing gold from its domestic producers and from the domestic market (mineweb.com) to see a 75% surge in gold reserve holdings to 1,054 tonnes in 2008 from the 600 tonnes in 2003. (AFP)

While other analysts downplay the significance of this reported gold hoarding citing that China has been buying up almost everything from US treasuries, US equities to other commodities, we believe that China seems to be positioning its currency, the yuan, as a candidate to replace the US dollar as the world’s reserve currency as discussed in Phisix: The Case For A Bull Run or possibly working to provide an insurance cover on its currency against the growing risks of hyperinflation, which would translate to massive losses in its US dollar holdings on its portfolio [see Has China Begun Preparing For The Crack-Up Boom?].

In presaging for times of trouble, commodities essentially could function as the yuan’s potential “anchor”.

It makes no fundamental sense to excessively store up on gold, other metals, oil and other commodities unless severe shortages have been perceived as a potential problem.

As a political institution, China won’t be much concerned with the “convenience yield” or “the benefit or premium associated with holding an underlying product or physical good, rather than the contract or derivative product” (answers.com), even as commodities don’t generate interest income which is offered by financial assets.

Besides what’s the point of disclosing the sharp increase in gold reserves by China after 5 years of covert accumulation operations?

Thus, China’s actions can be construed as essentially more politically motivated (timed with its bleating over the increased risks of the US dollar) with economic and financial ramifications.

The other point is NOT to look at China’s holdings of US dollar assets on an absolute level but from a relative standpoint: where has China’s concentration of US assets been-in long term or short term securities? Remember although China may continue to buy US securities in order to hold its currency down, if it does so by accumulating assets in mostly short term duration, then this may be extrapolated as an attempt too reduce its currency risks exposure.

Finally, despite the ongoing official manipulations gold market isn’t just an issue for central banks as private institutions have been feverishly accumulating on gold holdings as seen in Figure 2.

Figure 2: Casey Research: Gold ETFs are rapidly catching up with top Central Banks

According to Casey Research, ``SPDR Gold Shares (GLD), an exchange-traded fund, first hit the market in November 2004 with 260,000 ounces of gold. Today, GLD is the world’s 6th largest holder of physical gold with over 35 million troy ounces in the vault. In fact, since the general market meltdown last fall, the ETF has added over 16 million ounces and ended 2008 with a 5% gain – not many investments can make that claim. Investors worldwide are sending a clear message: Gold is the safest asset in which to store wealth, not the product of the printing press.”

So even when official institutions have been attempting to control the gold markets, the interest from private investors have been strongly accelerating to possibly offset any substantial sales by top gold holders.

As Professor Gary North notes, ``Eventually, governments will run out of gold to sell, and so will the IMF. They will run out of gold to lease. While I do not think the politicians will ever catch on to the fact that their nations' gold is gone, leaving only IOUs for gold written by bullion banks that are on the verge of bankruptcy anyway, I do think that at some point the central banks will stop leasing gold.”

In short, once a substantial segment of gold from official institutions has been transferred to the investing public, governments will lose their power to manipulate gold prices.

Moreover, the relative variances in the holdings of the gold reserves among central banks underpins a possible realignment of gold distribution from crisis affected US and European nations with present heavy gold holdings to the savings and foreign currency reserve rich emerging economies.

So the potential shift likewise favors rising gold prices.

3. Ignores Seasonality Effects of Gold

Those bewailing fear have likewise been guilty of the omission of the seasonality patterns of gold see figure 3.

Figure 3: US Global Investors: Seasonal Patterns

The chart from US Global Investors manifests of the 15 and 30 year pattern of gold.

Basically, the annual trend can be identified starting with Gold’s summit during the first quarter which effectively goes downhill until the early third quarter where it bottoms, strengthens and ascends.

Even if we were to compare the movements over the last 3 years in Figure 1, the seasonality effects almost seem like clockwork but not in exactitude.

So if I were a gold trader, I’d start accumulating the benchmark precious metal during the lowest seasonal risk months of July to September and be a seller at the start of the year. Although in the interim, I should expect gold to firm up going into May where I should expect a summit and weaken into July or August.

Of course the seasonality factors have divergent depth or heights in terms of losses and gains mostly depending on the underlying long term trend. However in the present bullmarket, instead of correcting during the seasonal low months gold could simply consolidate (similar to 2007).

The point is if we understand and become cognizant of gold’s seasonality patterns, we won’t be lulled to the oversimplified anchoring of ascribing “fear” on gold prices.

Although as a caveat, considering that in the past 15-30 years gold’s annual cycle has been predicated on the demand configuration centered on mainly Jewelry (as I have shown in a chart last February), the accelerating interests on identifiable investments could diminish the seasonality effect variable.

4. Neglects the Risks of Accelerated Inflation Due To Flawed Economic Principles

Most believers of the “Fear” in gold see the risks of deflation more than the risks of inflation. That’s because they live in a simple world of known variables such as “liquidity traps”, “aggregate demands”, “animal spirits”, “current account imbalances” and “overcapacity”. On the same plane, they believe in the “neutrality” of money.

Let me remind you that the fundamental reason global governments are inflating have been due to the perceived risks of deflation, or said differently, for as long as the perceived risks of deflation is in the horizon, governments will continue to inflate, as they have been practicing what can be described as their ideology or textbook orientation-where policymaking or the decisions of a few is reckoned as better than the decisions of the billions of people operating in the marketplace.

As you can see, the irony here is that governments essentially FEAR falling prices in everything. Where falling prices are good for the individual (as it translates to more purchasing power), they are deemed bad for the society, so it is held.

And the same applies to savings; “savings” defeat consumption, so it is held, as reduced consumption equates to diminished “demand” which is equally bad for the society. Hence, to counter falling prices, means that governments and their coterie of mainstream supporters exalt on the furtherance of borrowing, spending and speculative inducing policies, the very policies that brought us this crisis.

Unfortunately the US and European banking system remains fragile as governments have kept alive institutions that needs to expire. The losses have now escalated to a sink hole-some $4.1 trillion of toxic assets, according to the revised estimates of the IMF. This means more redistributive processes is in the offing given this ideological framework, where more money especially from crisis affected nations will be used to prop up zombie institutions. The US has pledged or guaranteed a stupendous $12.8 trillion and growing (as of March 31), while UK’s support for its financial industry has already surged to a remarkable $2 trillion and counting.

Apart, every nation have been urged to do their role of printing money, borrowing and spending from which global policymakers have gladly obliged. The local crocs have been jumping with glee as Philippine stimulus spending of Php 330 billion or ($7 billion) translates to a surge in “S.O.P” (Standard Operating Procedure or other term for kickbacks).

The unfortunate part is that not every country or region has been affected by an impaired banking system. Emerging markets have primarily been affected by the transmission mechanism of the US epicenter crisis via external linkages of trade (falling exports), labor (reduced remittances) and investments. Hence, the deflationary pressures seen in nations which presently endure from busted credit bubbles and emerging markets suffering from sharp external adjustments or two distinct diseases have been administered with similar medication but in varying dosages.

Apparently, since money, for us, has relative impact on prices, these concerted government sponsored programs has begun to ‘leak out’ to the marketplace-through stock markets first then commodities next, as expected.

The recently published World Economic Outlook from the IMF gave me an eye popping jolt over the very compelling fundamentals of food!

Thus, we’d deviate from gold and discuss about food. See figure 4.

Figure 4: IMF’s WEO: Supply side dynamics for select Food

According to the WEO (p.55) , ``In the face of weaker demand from emerging economies, reduced biofuel production with declining gasoline demand, falling energy prices, and insufficient financing amid tightened credit conditions, farmers across the globe have reportedly reduced acreage and fertilizer use. For example, the U.S. Department of Agriculture projects that the combined area planted for the country’s eight major crops will decline by 2.8 percent (year over year) during the 2009–10 crop year. At the same time, stocks of key food staples, including wheat, are still at relatively low levels. These supply factors should partly offset downward pressure from weak demand during the downturn.” (bold underscore mine)

Did you see spot the fun part in the chart? Notice that the inventory cover for the world’s major Food crops (middle) has been nearly at the lowest levels since 1989!

Despite the surge in Food prices in early 2007 these hasn’t translated to a boom in the production side. Now that the crisis has been the underlying theme which has also impacted the food industry, production has further been impeded by “tightened credit conditions” which has “reduced acreage and fertilizer use”. Whereas consumption demand is expected by the WEO to be maintained at present levels (yellow line middle chart).

Remember the shelf life for food is short. Hence, surpluses are likely to be minimal.

Moreover, we have a looming structural long term demand-supply imbalance.

According to Earth Policy, ``Demand side trends include the addition of more than 70 million people to the global population each year, 4 billion people moving up the food chain--consuming more grain-intensive meat, milk, and eggs--and the massive diversion of U.S. grain to fuel ethanol distilleries. On the supply side, the trends include falling water tables, eroding soils, and rising temperatures. Higher temperatures lower grain yields. They also melt the glaciers in the Himalayas and on the Tibetan plateau whose ice melt sustains the major rivers and irrigation systems of China and India during the dry seasons.”

What is this implies is that this episode of intensive money printing on a global scale will have a tremendous impact on food prices!!! If the boom in financial markets in emerging markets does extrapolate to “reflation” then there will be a tidal wave of demand to be met by insufficient supplies!! The next crisis may even be a food crisis!

In addition, the inelasticity or poor or lagged response from the price action, possibly due to overregulation, subsidies, import tariffs, etc… , suggests of a prolonged supply side response; as I earlier noted -the boom in food prices in 2007 didn’t translate to a meaningful supply side adjustment.

So those obsessing over the “deflation” bogeyman will most likely be surprised by a sudden surge of Consumer Price Index especially when food prices hit the ceiling.

This is equally bullish for gold.

Moreover, for governments and those fearing deflation who are in support of policies operated by the printing press, it seems to be a case of “be careful of what you wish for!”