China’s Richest Man: Capital Markets suck in China

When people’s options to invest have been restricted via financial repression measures such as taxes and capital and currency controls, and when people savings are being surreptitiously taxed via inflation for the benefit of the political class, and likewise given the above political conditions when people have been unwittingly drawn to yield chasing or inflation hedging dynamics via property bubbles which “perhaps is the largest in human history”, one can’t help but partly commiserate with this striking comment from the richest man in China

From the Wall Street Journal:

China’s richest man has a strong statement for those looking to invest: “The capital markets suck in China.”

Zong Qinghou climbed his way to the top of the list of China’s wealthiest by amassing a fortune of $12.6 billion through his privately listed beverage empire Hangzhou Wahaha Group Co. On Tuesday, he made clear he didn’t gain his wealth through the country’s stock market.

“When the ordinary people invest in it, the market should reward them with some benefits. But it does not,” Mr. Zong said on the sidelines of China’s annual parliamentary session, taking aim at speculators he says ruin the stock market for others. “The speculation has totally cheated ordinary investors of any benefits.”

The sentiment of the billionaire, who is also an NPC representative, speaks volumes about the state of the country’s capital markets, highlighting the monumental obstacles investors face in China as they look for places to park their money in hopes of a return.

Yet his comment does not say on what motivates people to speculate and by what mechanism such rampant speculation morphs into boom bust cycles. Instead he mistakes interpreting symptoms as “insider trading” as the disease.

Shifting culpability to the public seems typical of political agents. Mr. Zong hasn’t just been a “rich” businessman but a representative of China's legislative body, the National Public Congress, thus a likely political entrepreneur.

In reality, since no one knows the future, everyone speculates. Such knowledge problem includes, or most importantly, applies to politicians.

And Mr. Zong doesn't need conspiracy theorists, global central bankers have been the biggest manipulators (insider trading) of the marketplace.

In addition, in 2004 there had been 942 publicly listed state owned enterprises (SoE), 52 of which had been directly owned by local governments (OECD). Mr. Zong can start looking for his "insider" bogeyman from them.

Nonetheless, when capital markets, not limited to China, are being propped up, manipulated or subjected to political interventions, to borrow Mr. Zong's fitting comment, they "suck". 

Quote of the Day: The Virtues of Stock Market Speculation

But the speculator’s actions have conferred definite services to the community. He has smoothed out the jumps in Acme’s share price. By buying the undervalued stock, he has put upward pressure on the price. (Likewise, if he short sells an overvalued stock, he puts downward pressure on the price.) Rather than Acme’s stock jumping from $10 to $20 when war breaks out, it jumps only from $13 to $20, because (in our example) the speculator’s heavy buying had already closed 30% of the gap.

By reducing stock price volatility, speculators take some of the risk out of holding stocks. For example, it’s not necessarily true that the person who sold early to the speculator at $11 “lost” $9 to the wily profiteer. It’s entirely possible that the person needed to sell his holdings of Acme because he had lost his job or because his kid’s tuition went up again. Thus, the speculator has actually made this person — who had planned to sell even if Acme remained at $10 — richer.

More generally, by anticipating future changes in the “fundamentals” and translating them into current stock prices, speculators reward even long-term investors, the kind whom most people praise (as opposed to the short-term, quick-buck speculators). For example, if an institutional investor thinks she has found a solid company that will pay high dividends and will be around for at least 20 years, it is speculators who will help keep the day-to-day stock price from straying too far out of line with these long-term facts. If a financial panic sets in and shareholders are dumping stocks across the board, it is speculators who will staunch the bleeding and swoop in to pick up “deals” at fire-sale prices.

This shows that speculators provide liquidity to the stock market and make it more lucrative for other, long-term investors to do their homework and put some of their savings into corporations they believe have a solid future. A major risk of such an investment is illiquidity — that the investor may have to sell under duress and accept a much lower price than she could get if she only had more time — but speculators mitigate this risk. If the price gets well below “what the stock is really worth,” then that’s exactly when a speculator has an incentive to swoop in and buy.

[italics original]

 

This is from Austrian economics Professor Robert Murphy at the Laissez Faire Books.

Quote of the Day: The Ethics of Speculation and Natural Calamities

Many of the same people who today publicly encourage us to speculate (“Make sure your family has ample supplies of batteries!”) are among the loudest critics of speculation at other times and in other markets.

But in fact the oil speculator who, say, buys oil today in anticipation of oil becoming more scarce tomorrow does just what a consumer does today in a supermarket in anticipation of a disruptive storm: both persons usefully transfer resources across time.  They both stock up on resources that are today relatively abundant in order to preserve these resources for consumption at a time when they are relatively more scarce (and, hence, more precious).  Both persons transfer resources from today – when the consumption of any one bottle of water or gallon of gasoline provides relatively less benefit – to tomorrow when the consumption of that same bottle of water or gallon of gasoline will provide relatively more benefit.

Anticipating the future and taking actions to allocate goods and services from times of relative abundance to times of relatively greater scarcity is an immensely useful activity. And we all perform such speculation whether or not we are popularly identified as “speculators.”

This is from Professor Donald Boudreaux at the Café Hayek exposing the populist schizophrenic ‘moralistic’ concept of “speculation”.

Peddling “morality” through emotions has been popular even if they emanate from wrong premises and self contradictory logic. The fact is that speculation is all about acting in anticipation of the future. Different circumstances (emergency or not) under which people “speculate”  hardly does justify a moral color or distinction.

This applies to the stock markets as well.

Btw, my phone line and dsl got busted since yesterday. Internet access has been on-and-off, so I might be low on posting.

Will Frothy Bond Markets Drive the Phisix Higher?

The Philippine equity benchmark, the Phisix seems to be knocking on the gateway of another milestone high, as I noted two weeks back[1],

One must be reminded that bubbles come in stages. So far the Philippines seem to be at a benign phase of the bubble cycle.

Again bubbles will principally be manifested on capital intensive sectors (like real estate, mining, manufacturing) and possibly, but not necessarily, through the stock markets.

This means that for as long as the US does not fall into a recession or a crisis, ASEAN outperformance, fueled by a banking credit boom and foreign fund flows operating on a carry trade dynamic or interest rate and currency arbitrages (capital flight I might add), should be expected to continue.

And again I will maintain that ASEAN’s record breaking streak may be sustained at least until the end of the year 2012.

Friday’s substantial decline in the US stock markets may put a start-of-the-week dampener on the current momentum. However this seems unlikely a hurdle to the Bernanke-Draghi inspired Christmas or year-end rally particularly for the record setting ASEAN bourses as shown above [Philippine Phisix PCOMP orange, Indonesia JCI green, Thailand SET yellow, Malaysia FMKLCI red].

Emerging Market Bonds Outperform Equities

The price actions of the bonds of emerging market should give us a clue.

The zooming pace of the JP Morgan USD Emerging Market Bond Fund (EMB) appears to be accelerating.

In the bond fund, the Philippines and Indonesia have been among the major components of with 6.81% and 6.56% share of the pie in the total portfolio[2]. This implies that the ASEAN bond markets have been outperforming their respective equity peers.

A further clue can be seen in what appears as emerging bond markets (EMB) eclipsing the gains of emerging equity (EEM)[3] counterparts.

As caveat, the country based distribution of weightings of the bond and equity indices have been different. This means that we can’t entirely depend on its accuracy when making a comparison.

Nevertheless, for local bond currency market, the huge jump in the share distribution of the real estate (18% in June vis-à-vis 13% December 2011) and infrastructure-based industries (from insignificant to 6%) gives further evidence of the business cycle in progress.

As per the largest issuers by sector, banks and financials remain the largest but have lost 3% of the share of the pie. This is followed by the rapidly growing real estate sector and holding companies.

And for the share of the ownership of investors by type, based on % of local currency denominated government bonds issued, banks and financial institutions have been the largest, albeit on a steady marginal decline in terms of trend over the past 7 years.

Other major investors, according to the Asian Development Bond includes[4]

1) BTr-managed funds which account for Bond Sinking Fund (BSF) Securities Stabilization Fund (SSF), and the Special Guaranty Fund (SGF),

2) contractual savings and tax-exempt institutions (TEIs) which represent government pension and insurance funds (e.g., Government Service Insurance System [GSIS], Social Security System [SSS], and Philippine Health Insurance Corp. [PHIC]), private insurance companies, and tax exempt funds and corporations

3) custodians which are BSP-accredited securities custodians for investor-clients and lastly

4) other government entities such as government-owned and -controlled corporations (GOCCs), and various corporate and individual investors.

The apparent boom in emerging market bond markets may have been partly reflected on the sectoral returns in the equity markets.

The financial sector, property and holding companies—which have been heavy on both—have returned a whopping 42.54%, 40.95% and 33.32% respectively; on a year-to-date basis (see light maroon bars).

Except for the service sector, the nearly broad based weekly gains (dark maroon bars) for the rest of industry compounded on the outsized year-to-date returns (see light maroon bars).

Bonds are Less Risky or a Bubble?

The positive flows into the bond markets have not been limited to Asia, this has apparently been true even in the US, where fund flows have mostly been concentrated on fixed income related investments such as ETFs and “hybrid” balance funds with income orientation as retail investor flee equity markets[5].

Yet the idea that bonds are relatively “less risky” represents charade bestowed upon by global central bank’s tsunami of monetary inflation and financial and banking regulations that have biased towards incentivizing financial and bank institutions to hold bonds[6].

For instance, Japan’s central bank, the Bank of Japan (BoJ) recently warned the banking and financial industry of their high sensitivity to interest rate risks; where for every 1% increase of interest rates, large banks and regional banks could suffer losses of ¥ 3.7 trillion and ¥3.0 trillion respectively[7]

But the supreme irony has been that the BoJ themselves have been responsible for putting at risks the domestic banking system through their pronounced policy of supposedly fighting deflation through inflationism via asset purchases. The BoJ’s balance sheet[8] now accounts for about 30% of the IMF’s estimated economic growth rate.

Reports also suggest that the BoJ may even add to their monetary easing efforts[9] on October 30^th

Noticeably Japan’s outward investment flows, which are at near record levels[10], have supplanted China, despite the streak of failures where the batting average of outward FDIs have been unfavorable and the losses have been substantial.

About 26 trillion yen ($330 billion) have accounted for the lost market value from the 10 biggest overseas purchases by Japanese companies from 2000 to a year ago. Apparently the batting success average of Japan’s outward Foreign Direct Investments has been 1: 5 or 20%, where two posted gains while eight companies suffered losses during the said period.

And of the two winners, one is from Kirin Holdings whose acquisition of 48% of San Miguel Brewery [PSE:SMB] in 2009 has tripled in value[11].

I have been pointing out here that beyond the mainstream’s false notion of Japan’s deflation bogeyman, monetary policies, policy or regulatory (regime) uncertainties, interest rate risks and credit risks have all compounded to haunt Japan’s increasingly crony based political economy, prompting resident investors to take larger and unnecessary risks abroad for either survival or to seek out higher returns[12].

Going back to the fund flows in the US, ironically, despite the sustained outflows in the equity markets and last Friday’s slump, the US major bellwether the S&P 500 ended the week marginally on the positive note (dark violet bars).

Yet major global equity markets, led by the S&P 500, have mostly been significantly up on a year-to-date basis (light violet bars).

This fantastic but unsustainable run in the bond markets, which has exhibited symptoms of bubble dynamics, will unlikely persist.

We can either expect a shift out of bonds and into the stock markets or that the bond markets could be the trigger to the coming crisis.

In my view, the former is likely to happen first perhaps before the latter. To also add that triggers to crisis could come from exogenous forces.

Central Bank Actions Rule the Day

So far, steroids from central banks aimed at supporting the asset markets will continue to distort market price signals. And this time I am not alone saying this.

This recent commentary from Financial Times[13] seems highly relevant to the current state of affairs (bold emphasis mine)

Much of the blame for this tends to be attributed to the fact that markets now move to a drumbeat of statements from politicians and central bankers, such as the head of the US Federal Reserve. “All 500 S&P companies have the same chairman and his name is Ben Bernanke,” says Jurrien Timmer of the Fidelity Global Strategies Fund.

It is also true that securities within markets, as well as far-flung debt and equity markets have been trading more “in sync” with each other: the willingness of investors to take on risk being a common factor behind price moves.

The conditions of a parallel universe—where markets have become seemingly detached to economic reality—which I have been pounding on the table since, has even been recognized by the chief executive Mohamed El-Erian of PIMCO one of the largest fixed income firms.

At the Financial Times Mr. El-Erian writes[14] (bold mine)

Essentially, the Fed is inserting a sizeable policy wedge between market values and underlying fundamentals. And investors in virtually every market segment – including bonds, commodities, equities, foreign exchange and volatility – have benefited handsomely. In the process, many asset prices have been taken close to what would normally be regarded as bubble territory, with some already there. 

Central bank action, both real and perceived, rules the investment day, and will continue to do so for now. This is also the case in Europe.

And if central bank actions have truly become the rule for the investment world, then to what degree of relevance does traditional or conventional knowledge apply on pricing and valuing stock markets in the current setting?

Another commentary from the Lex Column of the Financial Times nails it[15],

Perhaps the most horrifying thing about the current combination of sales deceleration, margin contraction and high valuations is that it might not even be a sell signal.  The central banks of the US and Europe may well keep investors trapped in risky assets indefinitely. Those who look at the fundamentals and flee to cash had better be patient.

In reality market participants are being sucked into the vortex of speculative mania, which means another round of intensive build-up of misallocated resources or malinvestments and a future bust. We are in a boom phase of a bubble cycle.

FED policies have begun to diffuse into the US property markets which have shown significant broad based recovery[16]: particularly in existing home sales, housing starts, new home sales, building permits, builder confidence, to even a decline in shadow inventories, and signs of the inflection point of real estate loans at ALL commercial banks.

The assumption that FED policies have been successful would signify as presumptive or short sightedness or even blind belief of the capabilities of bureaucrats.

People forget that costs are not benefits. What seems as a boom today will ultimately end in tears. And bubbles, which have been growing in scale and frequency, once pricked will lead to massive capital destruction that would take years to recover especially when interventions delay them and or even make them worse.

General destruction of wealth and wealth generating activities can never be a benefit even from the Pareto optimal perspective. 

The recovering US real estate industry is being buttressed by the improving state of credit as seen by the annual % change in consumer loans and commercial industrial loans at ALL commercial banks. (Source St. Louis Fed)

Yet once the colossal excess reserves by depositary institutions held at the US Federal Reserve flows into the system, the US and the rest of the world will be faced with the risks of price inflation.

And price inflation or the market’s recognition of the unsustainability of the fiscal positions of US will likely serve as the proverbial the pin that would perforate and end the inflating bubble.

For now, the US asset bubble will likely be sustained.

Miniature Stock Bubble: Alcorn Petroleum

At the local markets, as pointed out last week, inflationary booms titillates the gambling ticks and speculative adrenalin of many participants. Punters and tyros will be seduced to the allure of easy money based on dramatic price surges, and eventually, fall prey to gruesome price collapses.

And the imprudent and those bearing the entitlement mentality will pass the blame on ‘manipulation’ or ‘fraud’ to the markets and call for regulations without accounting for the incentives brought about by bubble policies on people’s behavior.

Let me quote anew the great libertarian economist, journalist Henry Hazlitt[17]

Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.

More regulations will not solve the behavioral imbalances caused and rewarded by antecedent immoral policies.

Over the past two weeks Alcorn Petroleum [PSE: APM] has skyrocketed to close on Friday by an eye-popping 600+%!

The company officially disclosed that they “cannot confirm” the rumored backdoor listing by allegedly the other “retailing” businesses owned by the same of owners, although the firm “appointed a financial adviser” to submit recommendations[18]. If the rumor involved different parties then such denial would seem sensible as negotiations involve the risks of transaction failure. But in this case, the parties supposedly are the same owners.

The company also referred the excessive price fluctuations or movements to a possible “oil exploration play”. Alcorn Petroleum has a 9.32% participating interests at the Service Contract 51- covering the East Visayas Basin.

Yet since the other partners in the same service contract[19] have had mixed performance this week, particularly, Trans Asia (+5.79%) [PSE: TA] and PetroEnergy [PSE: PERC] (-.84%) one can hardly impute an oil exploration play to the astronomical price surge of APM.

Whatever the reasons behind the price spike, prudence dictates that such huge series of price surges characterizes bubble dynamics which overtime typically ends up with huge frustrations for those left holding the proverbial bag.

Property giant Century Property Group [PSE: CPG], which got listed through the backdoor from the buyout of East Asia Power Resources in August[20] of last year, had seen a similar stratospheric surge as many jumped in on the rumored backdoor play.

However when the rumor became fact, CPG retrenched most of its accrued bottom-to-peak gains. As of Friday, CPG’s prices have been down about 62% from its zenith closing price.

Today’s bullmarket, and partly CPG’s financial heft, have essentially provided support to her current price levels. 

CPG’s tale is unlike the sordid experience of another stock bubble in 2000, which again involved another backdoor listing play, particularly Philweb [PSE: WEB] through formerly listed South Seas Oil[21]. Not to mention the BW Resources scandal in 1999.

In the backdrop of a bear market and upon the realization of the deal, WEB virtually gave back all its 1,000++% gains or returned whence it came from. And many punters who took part in the play had about a decade or more to recoup part of their losses (that’s for those who can’t accept their mistakes).

WEB’s experience seems to parallel the Thailand episode during the Asian Crisis as previously discussed[22]. Bubbles take time to heal whether seen from a macro or micro level.

The bottom line is to apply the Duck Test[23] for suspected stock bubbles: if it walks like duck, swims like a duck and quacks like a duck, it must be a duck.

These are the issues to avoid and to ignore.

This wisdom quote from author C Joybell C should apply to stock picking as well

Choose your battles wisely. After all, life isn't measured by how many times you stood up to fight. It's not winning battles that makes you happy, but it's how many times you turned away and chose to look into a better direction. Life is too short to spend it on warring. Fight only the most, most, most important ones, let the rest go.

Today’s bullmarket should come with a lot of opportunities without having to expose oneself to enormous risk. And all it takes is emotional intelligence[24] and self-discipline[25]

---

[1] See Phisix-ASEAN Bellwethers at Fresh Record Highs, October 8, 2012

[2] iShares.com J.P. Morgan USD Emerging Markets Bond Fund us.iShares.com

[3] iShares.com MSCI Emerging Markets Index Fund us.iShares.com

[4] ADB, Asia Bond Monitor, Asianbondsonline.org September 2012

[5] Zero Hedge R(osenberg) & B(ernstein): Two Ex-Merrill Colleagues, Two Opposing Outlooks, One Permabull Rebuttal, October 19, 2012

[6] See How Capital Regulations Contributed to the Current Crisis December 5, 2011

[7] Wall Street Journal Japanese Banks Face Huge Rate Rise Risk, Warns BOJ, October 19, 2012

[8] Pedro Da Costa Central bank balance sheets: Battle of the bulge Reuters Blog April 12, 2012

[9] Asahi Shimbun BOJ mulls further monetary easing, October 18, 2012

[10] Zero Hedge Forget China; Japan Is 'Taking Over' The World Again October 15, 2012

[11] Bloomberg.com Softbank’s Son Seeks to Skirt Cross-Border Failure History, October 17, 2012

[12] See Will Japan’s Investments Drive the Phisix to the 10,000 levels? March 19, 2012

[13] Dan McCrum End to ‘alpha’ spells trouble for fund managers Financial Times September 10, 2012

[14] Mohamed El Erian Beware the ‘central bank put’ bubble Financial Times, October 10, 2012

[15] Dave Glen Markets Remain Bid Despite Weakish Fundamentals September 18, 2012

[16] See US Federal Reserve Policies Re-Inflate US Property Bubble October 20, 2012

[17] Henry Hazlitt What You Should Know About Inflation p.18 Mises.org

[18] Alcorn Petroleum Re: Comment on Inquirer.net News Article PSE.com.ph October 16, 2012

[19] Business Inquirer.net Drillers settle dispute on farm-in deal August 10, 2012

[20]Business Inquirer.net Century Properties sets backdoor listing on Philippine Stock Exchange, August 18, 2012

[21] Newsflash.org BOI OKAYS REGISTRATION OF PHILWEB AS NEW I.T. FIRM January 29, 2001

[22] See FED-ECB’s Nuclear Policies: Risk ON is Back! September 17, 2012

[23] Wikipedia.org Duck test

[24] See Applying Emotional Intelligence to the Boom Bust Cycle August 21, 2011

[25] See Self-Discipline and Understanding Market Drivers as Key to Risk Management April 2, 2012

The Philippine SEC’s Phantasm of “Trading Gangs”

Below is an example of Hayek's Fatal Conceit applied to the Philippines

From the Business Mirror,

The Securities and Exchange Commission (SEC) is studying new surveillance initiatives that may see the establishment of a special division to monitor online chatter targeting so-called trading gangs, SEC Commissioner Juanita Cueto said on Thursday.

Trading gangs, according to Cueto are loosely defined as short-term trader syndicates who have both the resources and numbers to drive market prices and volumes.

She added that the trading rings that “play” the market are nothing new in the country or even abroad, but she noted that their influence had been growing in recent years, aided by the anonymity offered by the Internet and the influx of new and relatively inexperienced investors who may fall prey to these groups.

“They have pseudo names on the Internet. The scary part is they buy and sell in unison. Some of their analyses are inaccurate and can hurt issuers,” Cueto told the BusinessMirror. “It is a concern of legitimate brokers and issuers.”

She said the surveillance measures could involve closer scrutiny of Internet-based stock-market forums.

Some people cheer at this development WITHOUT an inkling of understanding HOW the SEC will be able to define and enforce surveillance of the so called "short term trader syndicates" that “have both the resources and numbers to drive market prices and volumes” from so-called trading gangs.

At what criterion will groups of people (syndicates) who shares “beliefs” in certain stocks, even in the short term, whom they are or could be exposed to, culpable of “driving” market prices and volumes? What if the stocks they promote indeed goes up? 

If a prediction fails, does this mechanically imply fraud?

In bear markets, does allegations of “pump and dump” proliferate or even exist at all?

Importantly what delineates “belief” and “analysis” from the intent to “defraud” through manipulation?

So the implication is that such regulations will be arbitrarily defined or established according to the whims of the political masters.

People who espouse political intrusions have a strange mystic adulation for the supposed omniscience of authorities and of the platonic ethics of regulators.

Yet if this logic holds true, then markets DO NOT need to exist at all.

Áll such ruckus essentially boils down to the definition of prices and values.

Who determines what appropriate prices and values are? The SEC? From what basis?

For starters, market prices are ALWAYS subjectively determined

To quote the great Ludwig von Mises,

It is ultimately always the subjective value judgments of individuals that determine the formation of prices. Catallactics in conceiving the pricing process necessarily reverts to the fundamental category of action, the preference given to a over b. In view of popular errors it is expedient to emphasize that catallactics deals with the real prices as they are paid in definite transactions and not with imaginary prices. The concept of final prices is merely a mental tool for the grasp of a particular problem, the emergence of entrepreneurial profit and loss.

Prices, which are subjective expressions of people’s value scales and time preferences, are principally used for economic calculations from where trades (of all kinds including stock markets) emerge, again Professor Mises

In the market society there are money prices. Economic calculation is calculation in terms of money prices. The various quantities of goods and services enter into this calculation with the amount of money for which they are bought and sold on the market or for which they could prospectively be bought and sold. It is a fictitious assumption that an isolated self-sufficient individual or the general manager of a socialist system, i.e., a system in which there is no market for means of production, could calculate. There is no way which could lead one from the money computation of a market economy to any kind of computation in a nonmarket system.

So if prices are subjectively determined, how then does the "gods" of the SEC know each and every individuals order of priorities?

And at what levels are prices to be considered “fair”?

Again Professor Mises,

The concept of a "just" or "fair" price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. Market prices are entirely determined by the value judgments of men as they really act.

So supposed fraud will be substituted for propaganda and the curtailment of civil liberties.

This comment by a market practitioner from the same article “It could be really hard to prove wrongdoing this way,” is half correct, but has been obscured by the misleading reference of “noting how identities can be masked online”.

“Anonymity” does not automatically make stock promotions unethical. What makes unethical is the deliberate act to defraud or bamboozle people, e.g. a breach of contract or deprivation of property rights, which based on the above seems very difficult to prove.

This would be analogical to say that advertising is a fraud.

To which government providing “truth” in advertising is likewise delusional, Professor Ludwig von Mises writes,

But whoever is ready to grant to the government this power would be inconsistent if he objected to the demand to submit the statements of churches and sects to the same examination. Freedom is indivisible. As soon as one starts to restrict it, one enters upon a decline on which it is difficult to stop. If one assigns to the government the task of making truth prevail in the advertising of perfumes and toothpaste, one cannot contest it the right to look after truth in the more important matters of religion, philosophy, and social ideology.

And government interventions DO NOT make transactions ethical too, on the contrary, they make them worst.

Bruce L Benson in “The Enterprise of Law: Justice Without the State” writes, (bold emphasis mine) 

When government becomes involved in the enterprise of law, both the rules of conduct and the institutions for enforcement are likely to change. The primary functions of governments are to act as a mechanism to take wealth from some and transfer it to others, and to discriminate among groups on the basis of their relative power in order to determine who gains and who loses.

Yes most people don’t seem to realize that in an inflationary boom, the guiding incentives provided by manipulation of interest rates promote rampant gambling and irresponsible actions which are always blamed on market actors.

From the great Henry Hazlitt

Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.

Non-Austrian Charles Kindleberger author of Mania’s Panics and Crashes also notes how swindles emerge during bubble cycles. (Previously I quoted him here)

Commercial and financial crisis are intimately bound up with transactions that overstep the confines of law and morality shadowy though these confines be. The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom. Crash and panic, with their motto of sauve qui peut induce still more to cheat in order to save themselves. And the signal for panic is often the revelation of some swindle, theft embezzlement or fraud

And as proof, I cited instances of Ponzi schemes in the US has had meaningful correlations with the FED’s credit easing policies.

When political gods determine winners and losers, contrary to popular brainwashed expectations, the outcome is not one of optimism. According to author, philosopher and individualist Ayn Rand on her classic novel Atlas Shrugged,

Money is the barometer of a society's virtue. When you see that trading is done, not by consent, but by compulsion--when you see that in order to produce, you need to obtain permission from men who produce nothing--when you see that money is flowing to those who deal, not in goods, but in favors--when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you--when you see corruption being rewarded and honesty becoming a self-sacrifice--you may know that your society is doomed. Money is so noble a medium that is does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot.

Such interventionism also leads to a suppression of freedom of expression.

Nonetheless, sorry to say but regulations will not solve or protect people form their silliness or foolishness, their reckless behavior and the entitlement mentality which most likely has been a result of existing policies…instead these would only do worse.

And in contrast, as I previously noted, successful investing requires Self discipline.

David Stockman: The US Federal Reserve is Destroying the Capital Markets

David Stockman, former Republican U.S. Congressman and director of the Office of Management and Budget, founding partner of Heartland Industrial Partners and the author of The Triumph of Politics: Why Reagan's Revolution Failed and the soon-to-be released The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy in an interview at the Gold Report has this biting message. [bold emphasis mine]

The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. The very idea of "Operation Twist" is an abomination.

Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing when it is broke. Wall Street is arbitraging the Fed's monetary policy by borrowing overnight money at 10 basis points and investing it in 10-year treasuries at a yield of 200 basis points, capturing the profit and laughing all the way to the bank. The Fed has become a captive of the traders and robots on Wall Street…

I think the likely catalyst is a breakdown of the U.S. government bond market. It is the heart of the fixed income market and, therefore, the world's financial market.

Because of Fed management and interest-rate pegging, the market is artificially medicated. All of the rates and spreads are unreal. The yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors – none of these free market forces matter. The price of money is dictated by the Fed, and Wall Street merely attempts to front-run its next move.

As long as the hedge fund traders and fast-money boys believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades.

On the margin, nobody owns the Treasury bond; you rent it. Trillions of treasury paper is funded on repo: You buy $100 million (M) in Treasuries and immediately put them up as collateral for overnight borrowings of $98M. Traders can capture the spread as long as the price of the bond is stable or rising, as it has been for the last year or two. If the bond drops 2%, the spread has been wiped out.

If that happens, the massive repo structures – that is, debt owned by still more debt – will start to unwind and create a panic in the Treasury market. People will realize the emperor is naked.

Read the rest here.

Many people believe that the numerous incidences of irregularities seen in financial markets emanate from unscrupulous behavior by some market agents, little has been understood that central bank policies, together policies that cater to crony capitalism, have been incentivizing or fostering such behavioral anomalies.

And importantly, the nature of capital markets have been intensely distorted to the point where conventional wisdom of its mechanics has nearly been rendered obsolete.

Either we face up to such evolving realities or suffer from our recalcitrance to adjust when the day of reckoning arrives.

How US Federal Reserve Policies Stimulates the Public’s Speculative Behavior

In a book review, Douglas French, president of the Mises Institute, explains the physiological and psychological dimensions of how US Federal Reserve policies whets people’s appetite for speculation and gambling.

For the average Joe, the mere idea of making money fires the dopamine neurons in his brain, and because (crazy) people tend to herd, this leads investors to pile into the same investments at the same time, which happen to be investments that have done well in the past. Or in other words, investors gravitate en masse to investments that are overpriced. Merely watching the green arrows on CNBC stimulates dopamine.

So when the Fed hit the monetary gas in 2001, interest rates plunged and the lumpen investoriate collectively plunged into housing only to be massacred by the end of the decade. Before that, Greenspan's Fed lubricated the financial system thinking all kinds of things would go wrong at Y2K. The money sloshed into Internet stocks and investors piled in just in time to lose their shirts.

Dopamine neurons are stimulated only if the rewards exceed the expectation. If investments work as planned, even if the result is good, there will be no rush at reward. And when results are less than expected, dopamine neurons are depressed — creating immense regret.

As a real-estate developer told me in the early 2000s, "interest rates are so low, I have to do something." His brain was already feeling the dopamine tingle of anticipated profits by hearing of the lower rates. As Pavlov's dogs salivate at a bell that reliably signals food, low interest rates transformed investors into Greenspan's and now Bernanke's dogs.

Bernanke's zero-interest-rate policy has investors lunging for yield, buying junk bonds and junk houses. "The rally in junk bonds extends an advance that began in early 2009 and can be traced largely to the Federal Reserve's policy of keeping benchmark interest rates near zero," writes the Wall Street Journal's Matt Wirz. "A pretty robust cottage industry has developed and is absorbing [single family homes] at an incredibly fast pace," Richard Smith, chief executive of Realogy Corp., tells the WSJ.

To add insult to injury, Burnham points out that people are "systematically overconfident. We are bad at doing the calculations required to analyze investments, and simultaneously we are unaware of our shortcomings." And if this isn't bad enough, Burnham points out that numerous studies show that people "reveal themselves to be proud. They are willing to lose money to retain their self-esteem."

Of course this all flies in the face of the efficient-market hypothesis, which claims all market participants are rational, and therefore all news is priced into particular investments at any one time, and there is no such thing as a speculative bubble.

As he wound up his Atlanta speech, Burnham had some sobering thoughts. "Financial markets are the watering hole of society," he quipped. Like thirsty animals on the African Savannah, humans are attracted to the speculative gains that financial markets promise. But, stopping for a drink is likely hazardous to our financial health.

Incentives drives people’s actions. Yet policies plays a substantial role in influencing people’s incentives. What some see as inappropriate behavior (such as “speculation”) driven by individual character flaws, is in reality, mostly a reflection of people’s responses to such policies.

This simply shows that inflationism is immoral.

In Defense of Speculation

Riding to the defense of speculators, Terry Duffy, the executive chairman of exchange operator CME Group Inc. recently said, (hat tip Professor Mark Perry)

When the Dow goes above 13000, Google goes above $600 per share and everybody celebrates, who do you think did that? The U.S. equity market is 100% speculators

Rightly so.

Speculation happens not only when prices go up, but speculation also occurs when prices go down or stay stagnant.

As I previously wrote, Because we are uncertain of the future, all of us speculate.

Let me further quote the great Ludwig von Mises, (The Ultimate Foundation of Economic Science, p.50-51) [bold emphasis mine]

The term "speculate" was originally employed to signify any kind of meditation and forming of an opinion. Today it is employed with an opprobrious connotation to disparage those men who, in the capitalistic market economy, excel in better anticipating the future reactions of their fellow men than the average man does. The rationale of this semantic usage is to be seen in the inability of shortsighted people to notice the uncertainty of the future. These people fail to realize that all production activities aim at satisfying the most urgent future wants and that today no certainty about future conditions is available. They are not aware of the fact that there is a qualitative problem in providing for the future. In all the writings of the socialist authors there is not the slightest allusion to be found to the fact that one of the main problems of the conduct of production activities is to anticipate the future demands of the consumers.

Every action is a speculation, i.e., guided by a definite opinion concerning the uncertain conditions of the future. Even in short run activities this uncertainty prevails. Nobody can know whether some unexpected fact will not render vain all that he has provided for the next day or the next hour.

Politically controlling markets doesn’t solve the knowledge problem based on the issue of scarcity and human action or the “anticipation of the demands of the consumers”. Instead, interventions worsen them.

Proof?

Venezuela should be a vivid example the abject failure of price controls

From the New York Times

Venezuela is one of the world’s top oil producers at a time of soaring energy prices, yet shortages of staples like milk, meat and toilet paper are a chronic part of life here, often turning grocery shopping into a hit or miss proposition.

Some residents arrange their calendars around the once-a-week deliveries made to government-subsidized stores like this one, lining up before dawn to buy a single frozen chicken before the stock runs out. Or a couple of bags of flour. Or a bottle of cooking oil.

The shortages affect both the poor and the well-off, in surprising ways. A supermarket in the upscale La Castellana neighborhood recently had plenty of chicken and cheese — even quail eggs — but not a single roll of toilet paper. Only a few bags of coffee remained on a bottom shelf.

Asked where a shopper could get milk on a day when that, too, was out of stock, a manager said with sarcasm, “At Chávez’s house.”

At the heart of the debate is President Hugo Chávez’s socialist-inspired government, which imposes strict price controls that are intended to make a range of foods and other goods more affordable for the poor. They are often the very products that are the hardest to find.

“Venezuela is too rich a country to have this,” Nery Reyes, 55, a restaurant worker, said outside a government-subsidized store in the working-class Santa Rosalía neighborhood. “I’m wasting my day here standing in line to buy one chicken and some rice.”

Venezuela was long one of the most prosperous countries in the region, with sophisticated manufacturing, vibrant agriculture and strong businesses, making it hard for many residents to accept such widespread scarcities. But amid the prosperity, the gap between rich and poor was extreme, a problem that Mr. Chávez and his ministers say they are trying to eliminate.

They blame unfettered capitalism for the country’s economic ills and argue that controls are needed to keep prices in check in a country where inflation rose to 27.6 percent last year, one of the highest rates in the world. They say companies cause shortages on purpose, holding products off the market to push up prices. This month, the government required price cuts on fruit juice, toothpaste, disposable diapers and more than a dozen other products.

“We are not asking them to lose money, just that they make money in a rational way, that they don’t rob the people,” Mr. Chávez said recently.

But many economists call it a classic case of a government causing a problem rather than solving it. Prices are set so low, they say, that companies and producers cannot make a profit. So farmers grow less food, manufacturers cut back production and retailers stock less inventory. Moreover, some of the shortages are in industries, like dairy and coffee, where the government has seized private companies and is now running them, saying it is in the national interest.

Again, the knowledge problem or the failure to anticipate consumer demands in the absence of market based prices, due to suppression of capitalist speculations through political edicts, has led to shortages, black markets and worsened standard of living.

This is another classic example of how noble intentions (or feel good political biases) clashes with economic realities.

Or as an old saw goes, the path to hell is paved with good intentions.