The Atlantic on Philippine Economic Boom: Looks Great on Paper

I spoke about unevenness of the Philippine boom last weekend

“Protectionist reflexes on sensitive sectors” represents as the “concentrated” segments of the economy that are controlled by the unholy alliance of political elites and their cronies. They are the key beneficiaries of today’s central bank asset market friendly policies. Many of them are into the yield chasing bubbles in the real economy. And so the unevenness of the much touted economic boom.

On the same issue, I also wrote about the discrepancy of today’s supposed economic boom in the lens of jobs or employment

Nonetheless what arouses my curiosity is that the much ballyhooed economic boom tagged as the “Rising Star of Asia” seems to have been “concentrated” on few sectors of the economy. And this is most likely the reason behind the supposed “boom” in joblessness, as pointed out by the survey.

Even the government’s statistics has not shown any material improvement in joblessness, despite Phisix at 7,200, the Peso at 40s or 6.6% GDP growth in 2012.

Today on the Bloomberg

Jeany Rose Callora left her home on the Philippine island of Negros last year to work at a soft- drinks factory in Manila, hoping to earn money for college. When her contract ended six months later, she said she couldn’t get another job in Southeast Asia’s fastest growing economy.

“I’ll do anything: saleslady, factory worker, waitress,” the 20-year-old high-school graduate said as she waited 11 hours for an interview in an employment agency in Manila, surrounded by dozens of other applicants.

Callora is one of 2.89 million unemployed Filipinos, swelling a jobless rate that climbed to 7.1 percent in January from 6.8 percent the previous month. About 660,000 positions have been lost since October 2011, even as the economy expanded 6.6 percent last year.

The nation is struggling to reconcile a lack of jobs for people like Callora, who have little training, with a shortage of skilled workers in industries such as information technology and shipbuilding. While the economy is being boosted by call centers and remittances from workers who moved abroad, the country’s poverty level hasn’t decreased since 2006.

Now the Atlantic on the Philippine paper tiger boom.

But that economic growth only looks great on paper. The slums of Manila and Cebu are as bleak as they always were, and on the ground, average Filipinos aren't feeling so optimistic. The economic boom appears to have only benefited a tiny minority of elite families; meanwhile, a huge segment of citizens remain vulnerable to poverty, malnutrition, and other grim development indicators that belie the country's apparent growth. Despite the stated goal of President Aquino's Philippine Development Plan to oversee a period of "inclusive growth," income inequality in the Philippines continues to stand out.

In 2012, Forbes Asia announced that the collective wealth of the 40 richest Filipino families grew $13 billion during the 2010-2011 year, to $47.4 billion--an increase of 37.9 percent. Filipino economist Cielito Habito calculated that the increased wealth of those families was equivalent in value to a staggering 76.5 percent of the country's overall increase in GDP at the time. This income disparity was far and away the highest in Asia: Habito found that the income of Thailand's 40 richest families increased by only 25 percent of the national income growth during that period, while that ratio was even lower in Malaysia and Japan, at 3.7 percent and 2.8 percent, respectively. (And although critics have pointed out that the remarkable wealth increase of the Philippines' so-called ".01 percent" is partially due to the performance of the Filipino stock market, the growth of the Philippine Composite Index during that period would not account for such a dramatic disparity from neighboring countries.) Even relative to its regional neighbors, the Philippines' income inequality and unbalanced concentrations of wealth are extreme.

This is obvious. We have an asset boom fueled by central bank policies. 

The major beneficiaries have been the politically connected elites whom has mainly benefited from government bubble policies, particularly from zero bound rates and the SDA.

As pointed out by Matthews Asia about 83% of the total market cap of publicly listed economies in the Philippines are held by a few families.

The Philippine stock market remains “concentrated”, which to paraphrase the Atlantic: The stock market boom has brought about an “increased wealth of those families was equivalent in value to a staggering 76.5 percent of the country's overall increase in GDP at the time”.

Given low penetration level of domestic stock market participants (1% or less) the boom has had residual effects on the economy. Retail participants are the poor folks lured by the easy money policies, who will bear the brunt of the losses, since many of these elites will eventually be rescued.

The other beneficiaries are foreign speculators who are also on a yield chasing mode due to their own easy money policies practiced by their respective central banks.

The failure of the Philippine Stock Exchange [PSE: PSE] to diffuse stock market ownership has also been one of the factors. For instance the refusal to hook up with the ASEAN trading link essentially means preserving the status quo of the high concentration of stock market ownership.

Equally asset boom means a boom in real estate. So rising asset markets also adds to the ballooning policy induced wealth inequality.  

Philippine Housing Prices has been in a bull market (tradingeconomics.com).

But one cannot look at housing alone as the Philippines has bubbles in shopping malls, vertical commercial or office and the casino.

And this is why today’s BSP’s engineered boom essentially means a redistribution program in favor of the elites and the banking system at the expense of the purchasing power of the members of society or the general economy. 

Political promises to deliver jobs will fail for the simple reason called interventionism and corporate protectionism or crony capitalism.

Today’s easy policies can be analogized as taking from the poor and giving to the rich. This is what media hails as the good governance economic model.

Look at the income statement by Philippine banking system as provided by the BSP.

The distribution of bank earnings from interest and non-interest as of December 2012 is 60-40. If you look at the non-interest portion of banking system’s income, they are mostly into fees and commissions, Gains/(Losses) on Financial Assets and Liabilities Held for Trading, Gains/(Losses) from Sale/Redemption/Derecognition of Non-Trading Financial Assets and Liabilities and Foreign Exchange Profit/(Loss)

In short, the non-interest income segment of the Philippine banking system largely relies on the continuation of an asset boom.  

The balance sheet of the Philippine banking system as provided by the BSP also demonstrates of the same story.

Aside from cash and loans portfolios, the banking system principal assets consist of Financial Assets, excluding Equity Investment in Subsidiaries/Associates/ Joint Ventures, net of amortization, Financial Assets, net of Allowance for Credit Losses and Equity Investment in Subsidiaries/Associates /Joint Ventures.

Again income and assets of the Philippine banking system principally depends on BSP’s easy money or bubble policies. This also shows how the banking system, or might I say a banking cartel, has been a politically preferred agency by the BSP.

People hardly realize that a bubble bust would effectively shrink both interest and non-interest earnings of the banking system that risks transforming a slowdown or a recession into a banking crisis.

So, the so-called “strength” or “boom” by the Philippine banking system and the economy are no more than a hype or a spin behind the scenes from the manipulations mostly through monetary policies. 

Again this wonderful reminder from the great Ludwig von Mises:

All governments, however, are firmly resolved not to relinquish inflation and credit expansion. They have all sold their souls to the devil of easy money. It is a great comfort to every administra­tion to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors. It is the typical policy of après nous le déluge. Lord Keynes, the champion of this policy, says: "In the long run we are all dead." But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years.

The days of the easy money orgy are numbered.

Paper Wall Street Gold: Has JP Morgan Engineered the Flash Crash?

Recent developments in the gold markets seem to have exposed, which partly validates my view (if the below report is accurate), that the flash crash in Wall Street-Government Paper gold had been contrived.

From CNBC:

J.P. Morgan accounts for nearly all of the physical gold sales that Comex in the last three months, blogger Mark McHugh wrote in a blog on Friday, which was reposted on ZeroHedge.

McHugh, who writes the “Across the Street” blog, cited a report on the CME Group web site that details metals issues and stops year to date for his findings.

In the report, “I” stands for issues, the number of contracts it sold, “S” stands for stops, meaning the firm took delivery of the gold, McHugh said. It shows that just one firm accounts for 99.3% of the physical gold sales at the Comex in the last three months, he said.

Doing the math on J.P. Morgan, McHugh says the brokerage “fumbled ownership” of 1,966,000 troy ounces of gold since Feb. 1 through the reporting date of April 25. (One gold futures contract is 100 troy ounces.)

That nearly 2 million ounces of gold is 74% more gold than the U.S. Mint delivered through the U.S. Mint’s American Eagle program in all of 2012, said McHugh.

“One thing’s very clear: When it comes to selling physical gold, J.P. Morgan is acting alone,” he said.

Gosh. 99.3% of gold sales contracts.

 

Two days ago, Zero Hedge questioned the steep fall on JP Morgan’s eligible inventories (bold and italics original)

What many may not know, is that while registered Comex gold has been flat, the amount of eligible gold in Comex warehouses (the distinction between eligible and registered gold can be found here) in the past several weeks has plunged from nearly 9 million ounces, to just 6.1 million ounces as of today- the lowest since mid-2009.

What nobody knows, is why virtually the entire move in warehoused eligible gold is driven exclusively by one firm: JPMorgan, whose eligible gold has collapse from just under 2 million ounces as of the end of 2012 to a nearly record low 402,374 ounces as of today, a drop of 20% in one day, though slightly higher compared to the recent record low hit on April 5 when JPM warehoused commercial gold touched a post-vault reopening low of just over 4 tons, or 142,700 ounces.

This happened just days ahead of the biggest ever one-day gold slam down in history.

Some questions we would like answers to:

1. What happened to the commercial gold vaulted with JPM, and what was the reason for the historic drawdown?
2. Gold, unlike fiat, is not created out of thin air, nor can it be shred or deleted. Where did the gold leaving the JPM warehouse end up (especially since registered JM and total Comex gold has been relatively flat over the same period)?
3. Did any of this gold make its way across the street, and end up at the vault of the building located at 33 Liberty street?
4. What happens if and/or when the JPM vault is empty of commercial gold, and JPM receives a delivery notice?

Inquiring minds want to know...

Adding up the pieces of the jigsaw puzzle.

Falling comex gold warehouse inventories—both from the registered (top) and eligible (bottom) categories—appears to be consistent with the record sales exhibited by retail physical “real” gold markets worldwide. Both charts are from 24gold.com.

A drawdown in the Comex inventories may have been channeled to the physical markets, which also means that Wall Street-Central banks may have lesser leeway to continue with their stealth suppression attempt.

But marked distinction between the withdrawal in “registered” gold which is reportedly the “physical” inventory relative to the eligible “gold” which is “some else’s inventories” seems like another puzzle. Add to this JP Morgan’s collapsing ‘someone else’s’ gold holdings, which partially matches the reported dominance 99.3% of selling contracts over the last 3 months. Has JP Morgan shorted gold deposits of their clients? Could the client/s be the New York Federal Reserve? Or the US Federal Reserve?

Such mysteries will likely be made public soon.

I share the conclusions of Alasdair Macleod from GoldMoney.com:

For the last 40 years gold bullion ownership has been migrating from West to elsewhere, mostly the Middle East and Asia, where it is more valued. The buyers are not investors, but hoarders less complacent about the future for paper currencies than the West’s banking and investment community. There was a shortage of physical metal in the major centres before the recent price fall, which has only become more acute, fully absorbing ETF and other liquidation, which is small in comparison to the demand created by lower prices. If the fall was engineered with the collusion of central banks it has backfired spectacularly.

The time when central banks will be unable to continue to manage bullion markets by intervention has probably been brought closer. They will face having to rescue the bullion banks from the crisis of rising gold and silver prices by other means, if only to maintain confidence in paper currencies.

A blowback may be in the process.

On the US Federal Reserve’s Information Leak

If the Fed had entirely been a private company, they will likely be charged with "insider trading", which based on Wikipedia’s definition, is "trading of a corporation's stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the company."

From Bloomberg:

Citigroup Inc. (C), Goldman Sachs Group Inc. and JPMorgan Chase & Co. were among at least 15 financial companies that received potentially market-moving Federal Reserve information 19 hours before the public in a release the central bank called a mistake.

Brian Gross, a member of the Fed’s congressional liaison staff, distributed the March 19-20 minutes of the Federal Open Market Committee meeting at 2 p.m. Washington time on April 9, according to an e-mail obtained by Bloomberg News. The list also included congressional staff members and trade groups. Gross referred questions to Fed spokeswoman Michelle Smith.

FOMC minutes, which include comments on the committee’s discussions about the direction of monetary policy and its outlook for the economy, are among the most closely scrutinized Fed documents as the panel debates when to stop its third round of bond purchases. The inadvertent release raised questions about the central bank’s internal controls among attorneys and disclosure experts.

The US Federal Reserve has partly been owned by the private sector or by “US member banks”, although Fed isn’t a publicly listed central bank, unlike the Bank of Japan (Jasdaq 8301). 

Importantly unlike private companies, the Fed functioning as a central bank, operates as a mandated monopoly which “derives its authority from the Congress of the United States” In other words, Fed policies, which are politically determined, greatly influence the markets, the domestic economy, as well as international economies (given the US dollar standard). 

Such distinction magnifies the importance between privileged access to information via firms operating in a market environment and firms benefiting from political institutions such as the FED.

While I don’t believe in market based “insider trading”, privileged access on political institutions serves as “picking winners and losers”. In short, access to badges and guns serves as a moat against competition.

Thus, special insider access to the FED tilts the balance of market resource allocation (both in financial markets and the market economy) towards those whom the political gods favor, particularly in today’s highly volatile conditions caused by financial repression. This represents the ultimate insider trading.

This also demonstrates of the insider-outsider, cartelized and crony relationships operating within the corridors of the US Federal Reserves.

Video: Iceland's President: Let Banks Go Bankrupt

In the following video, Mr. Olafur Ragnar Grimsson Iceland’s president calls for banks to go bankrupt. (hat tip Mises Blog)

Interesting quips:

On the worship of the banking sector:

1:24 Why do you consider banks to be the holy churches of the modern economy?

On crony capitalism 

1:37 The theory that you have to bailout banks is the theory about bankers enjoying their own profit of success and let the ordinary people be the failure...

On how political redistribution from bailouts impacts the real economy

2:31 If you want your economy to be competitive in the innovative sector of the 21th century, a strong financial sector that takes the talent from these sectors, even a successful financial sector is in fact bad news, if you want your economy to be competitive in the areas which really are the 21st century areas Innovation Technology IT 

While virtues of bankruptcy is something to extol, I think Iceland bubble experience is unique, considering her rather small 300,000+ population. 

A smaller population could mean that vested interest groups may have lesser political influence, or perhaps, are easier to deal with compared to the more complex and hugely populated social democratic welfare states as Europe, Japan or the US where power blocs have been deeply entrenched and have significant following in the populace. 

But yes, let the banks fail.

Banking Cartel Pressures ECB to Expand QE

The banking cartel lobbies the European Central Bank [ECB] to engage in more Quantitative Easing [QE] or asset purchases by central banks funded by “money from thin air”

Here is the Wall Street Journal Blog,

The banking sector’s international lobbying group on Wednesday joined the campaign to boost the European Central Bank‘s role in the euro-zone rescue, calling for the ECB to backstop struggling bond markets while the currency bloc implements its latest debt deal.

The comments by the Washington-based Institute of International Finance, which represents more than 450 financial institutions in 70 countries, add another major voice for a heightened ECB role despite concerns from some European officials — particularly in Germany — about the central bank’s bond purchases.

As Europe develops details around its new debt deal, “it is essential that all parties come together behind the continued active role of the ECB in the secondary government bond market,” IIF Managing Director Charles Dallara wrote in a letter to officials from the Group of 20 industrial and developing economies meeting in Cannes, France, this week. “This will allow time for national authorities’ adjustment efforts to take hold, and help stabilize markets at this crucial juncture.”

The ECB’s new president, Mario Draghi, who took his post Tuesday, faces the question of whether to continue or increase ECB purchases of Italian government debt to push yields lower. The ECB has bought an estimated 70 billion euros in Italian debt since August, but that hasn’t been enough to keep the 10-year yield on Italian debt below 6%.

Direct lobbying might not be enough though. A wider range of publicity tools would be required to justify these actions to the public, especially given the du jour populist demonstrations

So the politically embattled banking and finance sector would have to employ the same set of tools used by central banks to manipulate the public’s expectations—signaling channel (a.k.a propaganda).

And a lot of these will come from the academe or from the mainstream media.

An example of which is an excerpt from a recent article of Telegraph’s Ambrose Pritchard Evans, who uses the stereotyped deflation bogeyman to argue for more of ECB’s QE.

The two halves are locked together in a broken marriage. To pretend otherwise is no longer responsible. The structural gap cannot be closed by debt-deflation in the South – the current default setting of EU policy. It could arguably be closed if Germany were to let the European Central Bank reflate the whole eurozone system.

Instead, the ECB has done the opposite, opting to blight the chances that Spain might just be able to claw its way back to viability within the constraints of EMU.

Paradoxically, Mr. Evans is a popular columnist whose opinions easily flip-flops, i.e. from mainstream views towards espousing the contrarian [end the Fed] and backsliding again to the mainstream.

Nevertheless I am reminded by the great Murray N. Rothbard who presciently wrote [modifications mine]

An "impartial" Central Bank, on the other hand, driven as it is by the public interest, could and would restrain the banks from their natural narrow and selfish tendency to make profits at the expense of the public weal. The stark fact that it was bankers themselves who were making this argument was supposed to attest to their nobility and altruism.

In fact, as we have seen, the banks desperately desired a Central Bank, not to place fetters on their own natural tendency to inflate, but, on the contrary, to enable them to inflate and expand together without incurring the penalties of market competition. As a lender of last resort, the Central Bank could permit and encourage them to inflate when they would ordinarily have to contract their loans in order to save themselves. In short, the real reason for the adoption of the Federal Reserve European Central Bank [strike through and italic insertion mine], and its promotion by the large banks, was the exact opposite of their loudly trumpeted motivations. Rather than create an institution to curb their own profits on behalf of the public interest, the banks sought a Central Bank to enhance their profits by permitting them to inflate far beyond the bounds set by free-market competition. [bold mine]

Seems like a case of sleeping with the enemy

The Phisix And The Boom Bust Cycle

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

At this time of the year, many institutions and experts will be issuing their projections. Some, like me[1], have already done so late last year.

Most of the forecasts will be positive as they will likely be anchored on the most recent past performance. And I would belong to this camp but for different reasons.

The Phisix Boom Bust Cycle At A Glance

While the mainstream interpret and analyse events mostly from the lens of economic performance, technical (chart) and corporate financial valuations, as many of you already know, I look at markets based boom bust (business) cycles as a consequence of incumbent government policies (see figure 1).

Figure 1: Stages of the Bubble and Phisix Bubble Cycle of 1980-2003

As one would note, the Phisix played out a full bubble cycle over a 23 year period in 1980-2003 (right window). The cycle also shows that in the interregnum, there had been mini-boom bust cycles (1987 and 1989).

A formative bubble cycle appears in the works since 2003, with the 2007-2008 bear market representing a similar mini countercycle similar to the previous period.

The lessons of the previous bubble cycle impart to me the confidence to predict that the Phisix will likely reach 10,000 or even more before the cycle reverses.

Although one can never precisely foretell when or how these stages would evolve, as past performance may not repeat exactly (yes but it may rhyme as Mark Twain would have it), the important point is to be cognizant of the whereabouts of the current phase of the bubble cycle.

And evidence seems to point out that we are in the awareness phase of the bubble cycle as demonstrated by the swelling interest for Philippine assets. The latest success of the $1.25 billion PESO 25-year bond offering[2] and the upgrade of the nation’s credit rating by Moody’s[3] serve as good indications.

In addition, local authorities audaciously and ingeniously tested the global market’s risk appetite for the first time ever with a substantial placement at a long tenor that passed with flying colours. With 160 investor subscriptions mostly from the US and Europe, the Peso bond offering further illustrates the mechanics of cross currency arbitrages or carry trades arising from monetary policy divergences.

Of course for the mainstream, this will be read and construed as signs of confidence. For me, these events highlight the yield chasing phenomenon in response to present policies.

Figure 2: McKinsey.com[4] Global Financial Assets

And considering that the global financial markets have immensely eclipsed economic output as measured by GDP (see figure 2), the yield chasing dynamic will likely be magnified, largely driven by the disparities in money policies and economic performance. Another apt phrase for this would be ‘rampant speculation’.

To reiterate for emphasis, anent the Phisix, we don’t exactly know if there would be another countercyclical phase or if the present bubble cycle will persist unobstructed until it reaches its zenith.

In addition, we can’t identify how the rate of acceleration of the cycle will unfold nor can we ascertain the exact timeframe for each of the stages in succession.

Instead we can measure the bubble cycle by empirical evidences such as conditions of systemic credit, rate of asset or consumer price inflation and mass sentiment.

The Growing Influence Of Negative Real Interest Rates

With interest rates artificially suppressed, which fundamentally distorts the price signals that account for the time preference of the public over money and the economic balance of the credit market, policy influenced interest rates and the interest rate markets that revolve around them will lag the rate of inflation.

In short, real interest rate will be negative for an extended period.

In the milieu where government here and abroad have been working to stimulate ‘aggregate demand’ via the interest rate channel and for developed economies who employ unconventional monetary operations in support of the banking sector and the burgeoning fiscal deficits, the impact on consumer price inflation will likely go beyond the targets of their respective authorities.

As an aside, some governments in the Europe, such as Hungary, Bulgaria, Poland, Ireland and France have begun to “seize” private pensions[5], but applied in diverse degrees, all of which have been aimed at funding unsustainable deficits accrued from welfare programs and the cost of bailouts.

This only serves as evidence that governments are getting to be more desperate and would unflinchingly resort to unorthodox means to keep the status quo.

Figure 3: Global Negative Real Interest Rates[6] and Record Food Prices (courtesy of US Global Funds and Bloomberg)

Real interest rates were at the negative zone for several countries (see figure 3 left window) even as 2010 had largely been benign.

But with the most recent explosion of food prices[7] to record levels on a global scale as measured by the Food and Agriculture Organization Index (FAO- right window), aside from surging energy prices, we should expect consumer price inflation rates to ramp up meaningfully.

Meanwhile, Federal Reserve Chairman Ben Bernanke imputes high oil prices to “strong demand from emerging markets”[8]. This would represent as a half truth as Mr. Bernanke eludes discussing the possibility of the negative ramifications from his policies.

In the Philippines, such broad based price increases in many politically sensitive products or commodities have even triggered alarmism of the local media. Similar to Fed chair Ben Bernanke, local authorities and the media seem to have conspired to sidetrack on the scrutiny of the real origins[9] of such price hikes.

Nonetheless, most governments will, as shown above, try to contain interest rates from advancing, as this would increase the cost of financing of many of their liabilities. But this will only signify a vain effort on their part as politics will never overcome the laws of scarcity.

For the public, the growing recognition of widening negative real interest rates will further spur the dynamics of reservation demand—call it speculation, hoarding or punting, or in the terminology of the Austrian economists the “crack-up boom” or the flight to commodities as the purchasing value of money erodes.

And that those who expect fixed income to deliver positive returns while underestimating on the impact of changes in the rate of inflation will suffer from underperformance.

Yet the same dynamics are likely to incite further “risk taking” episodes (note again: reservation demand and not consumption demand), one of the fundamental source of boom bust or bubble cycles.

As a caveat, I am not an astrologer-seer who will predict day-to-day movements, rather in taking the role of an entrepreneur we should see or parse the business or bubble cycle as an active process that is subject to falsification.

This also means market actions won’t be moving in a linear path.

Figure 4: Markets Drive Policies (source: Danske Bank and economagic.com)

And as earlier stated, policy interest rates trail inflation.

And where market based rates partly reflect on prevailing inflation conditions, one would observe that market rates almost always lead policy rates (see figure 4 right window). Despite the Fed’s QE program aimed at keeping interest rates low, markets have started pricing US treasuries higher. In other words, policy interest rates react to market developments than the other way around.

In a parallel context, the interest rate markets seem to also price aggressively[10] Fed fund rate futures (left window) contradicting the promulgated policy by the US Federal Reserve.

Bottom line: the surging consumer inflation signifies as unforeseen consequences to the current polices.

The Continuing Policy of Bailouts

Of course higher interest rates, at a certain level, will ultimately be detrimental to local or national economies, particularly to those in the hock.

But the risk of a high interest rate environment will depend on the leverage of policymaking. Debt in itself will not be the main source of the risk, prospective policy actions will.

Many government institutions (or even politicians) are aware of the risks of overstretched debt levels.

In the US, the Federal Reserve has its 220 PhDs and many more allied economists in the academia or in financial institutions[11] to apprise of the debt-economic conditions and the available policy options and their possible implications. The problem is that they are math model based and hardly representative of actual state of human affairs.

Besides, most of them are predicated on Keynesian paradigms whose fundamental premises are in itself structurally questionable. Thus, market and economic risks come with the methodology guiding the policy actions that are meant to address present concerns.

For instance, should the problem of debt be resolved by taking on more debt?

Applied to US states whom are in dire financial morass, will the US, through the US Federal Reserve, bail them out?

Ben Bernanke pressed by the Senate recently said no[12], but his statements can’t be relied upon as proverbially carved in the stone. That’s because this would largely depend on the degree of exposure of the banking system’s ownership of paper claims of distressed States on its balance sheets. A ‘no’ today can be a ‘yes’ tomorrow if market volatility worsens and if credit market conditions deteriorates based on the financial conditions of the banking system.

Early last year, Ben Bernanke spoke about ‘exit strategies’[13] when at the end of the year exit strategies transmogrified into QE 2.0 and where talk of QE 3.0[14] has even been floated. Talk about flimflams.

In short, since the banking system is considered as the most strategic economic sector by the present political authorities, enough for them to expose tens of trillions worth of taxpayer money[15], then the path dependence by the Fed would be to intuitively bailout sectors that could weigh on their survival.

The fact that the US has had an indirect hand in the bailout of Europe[16], via the IMF and through the activation of the Fed swap lines hammers the point of Bernanke’s preferred route.

And of course, we shouldn’t be surprised if the Fed collaborated anew with European governments to any new bailout schemes in case of any further escalation in the financial woes of European banks and or governments.

So the US has been in a bailout spree: the US banking system, the Federal government, Europe and the rest of the world (through Fed swaps and through the transmission mechanism of low interest rates), so why stop at US states?

Hence given the policy preference, we should expect a policy of bailouts as likely to continue and should hallmark a Bernanke-led Federal Reserve.

And the policy of bailouts is likely to also continue in developed economies affected by the last crisis.

All these cheap money will have an impact on the relative prices of assets and commodities worldwide.

Thus, we see these internal and external forces affecting the Philippine assets--equities, real estate and corporate bonds.

What Would Stop Bailouts?

The preference for bailout option would only be stymied by natural (market) forces—higher interest rates from heightened inflation expectations (through broad based price signals-we seem to be seeing deepening signs of this)—which reduces the policy tools leverage available to the authorities, the resurrection of bond vigilantes as seen in the deterioration of the credit quality of sovereign papers, or a Ron Paul.

Of course the Ron Paul option, I would see as most unlikely given that a one man maverick is up against very well entrenched institutionalized vested interest groups which have been intensely associated with the government.

As Murray N. Rothbard exposited[17], (bold highlights mine)

But bankers are inherently inclined toward statism. Commercial bankers, engaged as they are in unsound fractional reserve credit, are, in the free market, always teetering on the edge of bankruptcy. Hence they are always reaching for government aid and bailout. Investment bankers do much of their business underwriting government bonds, in the United States and abroad. Therefore, they have a vested interest in promoting deficits and in forcing taxpayers to redeem government debt. Both sets of bankers, then, tend to be tied in with government policy, and try to influence and control government actions in domestic and foreign affairs.

This leaves us with inflation and credit quality which I think are tightly linked underpinned by a feedback mechanism.

A bubble bust elsewhere in the world from high interest rates would drain capital, but if inflation remains high this will reduce authorities leverage to conduct further bailouts. Think the stagflation days of 1970s (the difference is the degree of overindebtedness today and in the 70s).

In addition, high interest rates at a certain point will puncture global governments liquidity bubble which will expose nations propped up by the liquidity mask to deteriorating credit quality.

And at this point, crisis affected governments, including the US, are likely to choose between the diametrically opposed extreme options of continuing to inflate that may lead to hyperinflation or to declare a debt default (Mises Moment).

As a side note, under such scenario, people who argue that the US dollar’s premier status as international reserve won’t be jeopardized would be proven wrong, if, for instance, the policy route would be to inflate.

The health of any currency greatly depends on society’s perception of the store of value function. Once the public recognizes that debasement of the currency has been a deliberate policy and likely a process that would persist overtime, the perception of the store of value function corrodes significantly. And the public will likely look for an alternative.

In finding little option among the available choices, society may choose to revert to a commodity linked currency as default currency, as it always has.

Albeit the worst alternative would be that debasement of the currency or inflationism will lead to totalitarianism.

As Friedrich von Hayek warned[18],

At present the prospects are really only a choice between two alternatives: either continuing an accelerating open inflation, which is, as you all know, absolutely destructive of an economic system or a market order; but I think much more likely is an even worse alternative: government will not cease inflating, but will, as it has been doing, try to suppress the open effects of this inflation; it will be driven by continual inflation into price controls, into increasing direction of the whole economic system. It is therefore now not merely a question of giving us better money, under which the market system will function infinitely better than it has ever done before, but of warding off the gradual decline into a totalitarian, planned system, which will, at least in this country, not come because anybody wants to introduce it, but will come step by step in an effort to suppress the effects of the inflation which is going on.

So the policy tethers will depend on the conditions of several factors such as the rate of commodity and consumer price inflation, real and nominal interest rates, falling bond prices or rising yields, currency volatility and administrative policies choices of protectionism or globalization/economic freedom and capital and price controls vis-a-vis the status quo.

Profiting From Folly: The Inflationary Boom And Cyclical Banking Crisis

For now, the incipient signs of commodity inflation and rising rates have yet to diffuse into alarming levels.

Thus, I perceive that much of the applied inflationism will likely get assimilated into financial assets, thereby projecting an inflationary boom.

So going back to assembling of the pieces of the jigsaw puzzles, the Philippine bubble cycle will merely represent as one of the symptoms of the escalating woes wrought by the paper money system.

Figure 5: World Bank[19]: Surging Banking Crisis Post 1970s

The Philippine markets like other emerging markets have been the one of the main beneficiaries of the transmission mechanisms of the monetary policies of developed economies aside from the impact from the domestic low interest rate policies.

This favourite chart of mine (see figure 5) reveals of the manifold banking crisis post the Bretton Woods dollar-gold exchange convertibility standard.

While many in the mainstream blame the spate of crisis on capital account liberalization and international capital mobility, this misleads because it is the capacity to inflate (or expansion of circulation credit) rather than capital flows that causes malinvestments. Capital flows merely represent as transmission channels for inflating economies. Like in most account, the mainstream misreads effects as the cause. The repeated banking crisis suggests of a continuing cycle which implies of more crisis to come in the future, despite new regulations introduced meant to curb future crisis.

So while the mainstream will continue to blabber about economic growth, corporate valuations or chart technicals, what truly drives asset prices will be no less than the policies of inflationism here and abroad that leads to cyclical boom and bust in parts of the world including the Philippines.

And that would be the most relevant big picture to behold. Yet relevance seems not a measure of importance for most.

Nevertheless, we’ll heed Warren Buffett’s sage advice,

Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.

Get it? Our objective then is to profit from folly by playing with the cycle rather than against it.

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[1] What To Expect In 2011, December 20, 2010

[2] FinanceAsia.com Philippines and Stats ChipPac usher in new year with style, January 7, 2011

[3] Inquirer.net Moody’s upgrades PH outlook to ‘positive’, January 6, 2011

[4] McKinsey.com Mapping global capital markets: Fourth annual report, January 2008

[5] csmonitor.com European nations begin seizing private pensions, January 2, 2011

[6] US Global Investors Investor Alert, December 31, 2010

[7] Bloomberg.com World Food Prices Jump to Record on Sugar, Oilseeds, January 5, 2011

[8] WSJ Blog, Bernanke on Munis, Oil and Fed’s Mandate, January 7, 2011

[9] The Code of Silence On Philippine Inflation, January 6, 2011

[10] Danske Bank, 2011 off to a good start, Weekly Focus, January 7, 2011

[11] Grim Ryan Priceless: How The Federal Reserve Bought The Economics Profession, Huffington Post, September 7, 2009

[12] Reuters.com Bernanke balks at bailout for states, January 7, 2011

[13] Testimony of Chairman Ben S. Bernanke on the Federal Reserve's exit strategy Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. February 10, 2010

[14] QE 3.0: How Does Ben Bernanke Define Change, December 6, 2010

[15] $23.7 Trillion Worth Of Bailouts?, July 29, 2010

[16] Reuters.com U.S. plays 2 roles in European bailout plan, May 11, 2010

[17] Rothbard, Murray N. Wall Street, Banks, and American Foreign Policy, 2005 lewrockwell.com

[18] Hayek, F. A. A Free-Market Monetary System, p. 23

[19] World Bank Data Statistics Worldview 2009 p.9

OPEC 50th Birthday: 50 Years of Oil Price Manipulation

It’s been 50 years since governments around the world have been manipulating the oil price market.

This from the Economist,

OPEC, the cartel of oil producers, celebrates its 50th anniversary on September 14th. The organisation was founded in 1960 with the explicit purpose of manipulating oil prices by controlling supplies. It has generally proved successful. OPEC controls around 80% of the world's proven reserves and over 40% of the world's production among its 12 member states. The Gulf states that dominate OPEC have the biggest reserves and lowest costs, so can most easily turn the taps on and off when required to keep prices high. Despite the slow return to health of a sickly world economy, oil fetches a lofty $75 a barrel, which Saudi Arabia, OPEC's most influential member reckons is "ideal".

One should note that the cartel, which has been responsible for 40% of the world’s production, holds also 4/5 of the proven reserves. This means that the cartel isn’t limited only to oil production but also in the access to oil reserves for production. Limiting access to production means restricting available supplies.

Of course, the production cartel (OPEC) hasn’t been the only factor. Otherwise the prices of oil would have steadily trekked upwards over the last 50 years.

That’s because there is another cartel involved: the US Federal Reserve, whom represents today’s de facto US dollar standard system.

Monetary inflation by the US Federal Reserve has produced boom bust cycles in oil prices. The US Fed’s loose money policies has been instrumental in the huge price swings in the price of oil by artificially stimulating demand during the boom days, which subsequently resulted to the ensuing busts.

Bottom line: Unseen by the public has been the 50 years of manipulation by different government sponsored cartels that has vastly eroded our purchasing power and has prompted for intensive volatility in the world’s economic trends.

50 years of government “greed” at the expense of the people.

Ironically, the public sees things the opposite way.

The Road To Inflation

``The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptising it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.”-Ludwig von Mises

As expected, like the dogs in Pavlov’s experiment, US markets passionately cheered on the assurances provided by the US Federal Reserve to provide support to her economy even by possibly resorting to unconventional means or by taking the nuclear option to the table.

In a speech last Friday, Chairman Ben Bernanke[1] said that the Federal Reserve ``is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly”. (emphasis added)

US markets, of late, has been reeling from successive weekly losses giving rise to intensifying anxieties over a re-emergence of another recession or what many calls as “double dip recession”.

And for the mainstream, the prospect of another bout of ‘deflation’ has provided them with the ammunition to demand for more intervention from her government.

Unfortunately, as we have been repeatedly saying, inflationism is simply unsustainable. Like narcotics, it will always have soothing effects that are ephemeral in nature, but whose repercussions would always be nasty, adverse and baneful that would result to capital consumption or a lowered standard of living emanating from the unravelling of malinvestments or the misdirection of resources and on relative overconsumption. And at worst, persistent efforts to inflate could lead to a breakdown of the monetary system (hyperinflation). The 2007 US mortgage crisis had been a lucid example of the boom bust cycles from inflationism yet the public refuses to learn.

And since the time preferences of the masses are mostly directed towards the short term, the elixir of inflationism always sells. The illusion of free lunch policies is just too beguiling to reject.

As Ludwig von Mises once wrote[2], ``The favour of the masses and of the writers and politicians eager for applause goes to inflation.”

And such dynamics is exactly how the present environment operates.

Economic Hypochondria

Figure 1: Danske Bank[3]: Worries Are Intensifying

And as we previously noted[4],

For the mainstream, anything that goes down is DEFLATION. There never seems to be within the context of their vocabulary the terms as moderation, slowdown and reprieve. Everything has got to go like Superman, up up up and away!

The weakening of some economic indicators such as the manufacturing index has led many to envision the same scenario as in 2008 (see figure 1). But this seems more like an economic hypochondria, where the apparent infirmities today seems more like a manifestation of the countercyclical or reactive forces following a V-shape spike in 2009 (right window). The point is NO trend goes in a straight line.

And also this seems to be an extension of the Posttraumatic Stress Distorder (PTSD) which we accurately exposed on the mainstream’s false attribution on the crisis as being prompted by the lack of aggregate demand in 2009[5].

The follies from the same cognitive biases have reared their ugly heads, or perhaps have merely been used to justify government’s actions.

The main mistake of the mainstream is to ignore the interplay of relationships, in terms of stimulus-response action-reaction, between markets or the economy on the one hand and the policy actions from the government on the other.

The mainstream believes that ALL human actions are uniform and consequently discern linearly from such premises. They disregard the diversity of human actions which encapsulates the markets/economy and the political leadership, as well as the bureaucracy which incidentally government is basically run by human beings too. The difference lies in the incentives which drive their respective actions.

Inflationism To Protect The Banking Cartel and Gold’s Status

True, the US housing sector reveals renewed feebleness (left window). But this again is a manifestation of the failure of inflationism or the waning temporal positive effects, where the US government has tried to keep prices from reflecting the natural ‘market’ levels by using manifold interventions such as the manipulation or artificial suppression of the interest rates, quantitative easing (or printing of money), the tweaking of the accounting standards (Financial Standards Accounting Board reversed itself on FAS 157[6]), and the substantial exposure of GSE (Government Sponsored Enterprises) as Fannie Mae and Freddie Mac which currently accounts for $5.7 trillion of the $11 trillion market and provides 75% of the funds in the mortgage market[7].

In my view, whereas the official declaration (propaganda) has always been about the economy (social good), this conceals the true intent, which is to provide support and redistribute taxpayers resources to the banking cartel, whose balance sheets have been stuffed with toxic assets and thus the seeming stagnation in credit conditions.

True, the Federal Reserve has absorbed considerable part of questionable assets via the massive expansion of her balance sheets, but without the sustained redistribution from the US taxpayers to the cartel via more inflationism, this would extrapolate to the collapse of the fractional reserve banking system. Hence, the underlying economic moderation in the economy is sold to the public as requiring more inflationism.

As Murray N. Rothbard wrote[8],

It should be clear that modern fractional reserve banking is a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts

And the market seems to be validating such an outlook (see Figure 2)

Figure 2: Deflation? Recession? Not Quite (from stockcharts.com)

First of all, as said above we don’t believe that the US is anywhere near a recession. The gold market seems to be saying so.

We don’t believe gold is a deflation hedge. The recession of 2008 clearly indicates this phenomenon as gold’s prices materially fell along with the bear market in the S&P 500 and the strength in the US dollar or the obverse weakness of the Euro (green circles).

So gold does not elude the forces of recession, much more the forces of deflation as signified by the collapse of prices of gold along with all the other markets as the effect of the Lehman bankruptcy rippled in October of 2008.

And those making a comparison of gold’s performance during the depression days of the 1930s have only been looking at patterns without noting of the differences in the underlying conditions.

Gold during those days had been part of the monetary system. It was a gold standard then until its temporary suspension following the enactment of the Gold Reserve Act of 1933[9]. Today gold is only part of the assets of central bank reserves. It is only now where gold has seen increasing recognition as ‘store of value’ among global central bankers as gold prices continue with its winning streak[10]. So in accordance to the reflexivity theory, prices changes have been influencing the fundamental factors surrounding gold.

And also today, we have a fiat money standard backed by nothing but empty promises of government to settle.

The Function of Market Prices

Second, those “tunnelling” or obsessively fixated at the treasury markets who scream “deflation” have been misinterpreting markets.

The treasury markets have been the one of key targets of interventionism. The other way to say it is that the prices of US treasury do NOT reflect activities of free markets in relative terms as compared with gold (main window), the Euro (XEU) and the S&P 500. This means prices represent distorted or highly skewed or artificial information.

This seems apparent with indications that small or retail investors have been fleeing the US stock markets and have been gravitating into the bond markets[11]. Yet these are likely symptoms equivalent to the Pied Piper of Hamelin[12] leading the rats to their perdition as they interpret erroneously current price signals to represent reality.

We are reminded of the unwisdom of the crowds[13] which we recently wrote about, and would quote anew Gustave Le Bon who wrote[14] ``The Masses have never thirsted after truth. They turn aside from evidence that is not to their taste, preferring to deify error, if error seduce them. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusion is always their victim.”

The crowd has been seduced by the siren song of government propaganda called “deflation”.

Remember prices serve not only as information to account for the relative balance of demand and supply, prices are the most essential tool for economic calculation.

According to Gerard Jackson[15],

``Without market prices it is impossible to engage in economic calculation and thus have a rational allocation of resources. Now the market is a coordinating process that assembles fragments of continuously changing information from millions of people; information that can only be known to them personally and expressed as preferences. The market transforms these preferences into prices which then act as signals to producers and consumers. It is this process that enables consumers to achieve the best possible outcome. If a socialist had invented the market it would have been hailed as one of man's greatest achievements. At any time there is always a configuration of prices determined by market data each price is closely interrelated with the others. No price is independent or exists in isolation. It therefore follows that to interfere with one price means interfering with others. Another fact the significance of which ardent price controllers and their supporters cannot seem to grasp. (bold emphasis mine)

Importantly, prices represent property rights which allows for voluntary exchanges between parties to happen that leads to social cooperation.

Bettina Bien Greaves says it best[16],

``Without private property, there would be no private owners bidding for goods and services, and no exchanges among real owners. Without private owners, each guided by the desire for profits and the fear of losses, there would be no market prices to indicate what people wanted and how much they were willing to pay for it. Without market prices, there would be no competition and no profit-and-loss system. And without a profit-and-loss system, there would be no network of interrelated, consumer-directed, independent producers. Without private property, competition, market prices, and a profit-and-loss system, the planners would not know what to produce, how much to produce, or how to produce it.” (emphasis added)

Thus, marginal utility (the cardinal order of want satisfaction or the scale of values), time preferences, rationing, coordination, the dynamic process of spontaneous order in the marketplace and property rights are all jeopardized when government undertakes interventionism or inflationism.

At worst, interventionism represents an assault on private property, which consequently means an attack against civil liberty.

In addition, it is important to recognize that ALL bubbles (boom-bust) cycles have been engendered by the illusion of perpetually rising prices which mainly accounts for the massive systemic distortions built from a variation mix of interventionism channelled via interest rates or monetary policies, tax policies, administrative and legislative policies all of which may combine to encourage irrational behaviour fuelled by credit expansion.

Figure 3: St. Louis Fed: Loan Conditions of US Commercial Banks

Another, I’d be careful to listen to pay heed to experts who claim that the US credit system remains totally dysfunctional (see figure 3).

At this time when the mainstream has been audibly shouting “deflation!”, bank credit of all commercial banks (upper window) seems to be ramping up.

Moreover, while commercial and industrial loans remain depressed, on an annual rate of change basis, we seem to be seeing a bottoming phase (middle window). To add, consumer loans at all commercial banks remain buoyant (lower window).

So in my view, industrial loans still remains problematic or has been the laggard, but may have already bottomed out which could likely see some improvement over the coming months.

Now if all these credit activities advances as I had long expected them to, mainly as a function of the belated effects of the yield curve[17], all the monster excess reserves held by the commercial banks at the Federal Reserve could simply turn into massive inflation. And this would be the rude awakening for the mainstream.

Therefore, deflation, for me, is no more than political propaganda, made by the major beneficiaries—the government and their clique of institutional and academic “experts”, in order to justify inflationism or extend more government control over our lives.

It would be foolish for people to simply read through economics without comprehending the indirect implications of the actions by the incumbent political leaders.

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[1] Bernanke, Ben The Economic Outlook and Monetary Policy, Speech Given At the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 27, 2010

[2] Mises, Ludwig von The Import of the Money Relation, Human Action Chapter 17 Section 10

[3] Danske Bank, Weekly Focus, August 27, 2010

[4] See Why Deflationists Are Most Likely Wrong Again, August 15, 2010

[5] See What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis, February 1, 2009

[6] North, Gary Translation of Bernanke's Jackson Hole Speech, marketoracle.co.uk August 28, 2010

[7] Laing, Jonathan What's Ahead for Fannie and Fred? Barron’s online, August 28, 2010

[8] Rothbard, Murray N. Mystery of Banking p. 97

[9] Wikipedia.org History of the United States dollar

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

[11] See US Markets: What Small Investors Fleeing Stocks Means, August 23, 2010

[12] Wikipedia.org Pied Piper of Hamelin

[13] See The UNwisdom Of The Crowds, August 15, 2010

[14] Le Bon, Gustave Le Bon, The Crowd The Study of the Popular Mind, p.64 McMaster University

[15] Jackson, Gerard Are price controls on the way? Brookesnews.com December 29, 2008

[16] Greaves, Bettina Bien A Prophet Without Honor in His Own Land, Mises.org

[17] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010