Massive Earth Hour (Blackouts) in India

Massive power outages in India has affected more than half of the population.

From the Bloomberg, (bold highlights mine)

India’s electricity grid collapsed for the second time in as many days, cutting off more than half the country’s 1.2 billion population in the nation’s worst power crisis on record.

Commuter trains in the capital stopped running, forcing the operator, Delhi Metro Rail Corp., to evacuate passengers, spokesman Anuj Dayal said. NTPC Ltd. (NTPC), the biggest generator, shut down 36 percent of its capacity as a precaution, Chairman Arup Roy Choudhury said by telephone. More than 100 inter-city trains were stranded, Northern Railway spokesman Neeraj Sharma said, as the blackout engulfed states in the north and east.

So what went wrong?

From the same article…

State-owned Power Grid Corp. of India Ltd., which operates the world’s largest transmission networks, manages power lines including in the northern and eastern regions. NTPC and billionaire Anil Ambani-controlled Reliance Power Ltd. (RPWR) operate power stations in north India that feed electricity into the national grid. The northern and eastern grids together account for about 40 percent of India’s total electricity generating capacity, according to the Central Electricity Authority.

The grids in the east, north, west and the northeast are interconnected, making them vulnerable, said Jayant Deo, managing director of the Indian Energy Exchange Ltd. The outage has also spread to seven additional states in the northeast, NDTV television channel reported.

“Without a definitive plan by the government to gradually bring the grids back online, this problem could absolutely get worse,” Deo said.

Singh is seeking to secure $400 billion of investment in the power industry in the next five years as he targets an additional 76,000 megawatts in generation by 2017. India has missed every annual target to add electricity production capacity since 1951.

Well in reality, the root of the problem hasn’t been about ‘definite plans’ by the Indian government, but rather largely due to India’s statist political economy.

Again from the same article…

Improving infrastructure, which the World Economic Forum says is a major obstacle to doing business in India, is among the toughest challenges facing Singh as he bids to revive expansion in Asia’s third-largest economy that slid to a nine- year low of 5.3 percent in the first quarter.

Tussles over policy making with allies in the ruling coalition, corruption allegations and defeats in regional elections have weakened Singh’s government since late 2010.

Must I forget, artificial electricity demand has partly been boosted by India’s central bank, the Reserve Bank of India (RBI), who passes the blame on others.

Again from the same article

The Reserve Bank of India, which has blamed infrastructure bottlenecks among others for contributing to the nation’s price pressures, today refrained from cutting interest rates even as growth in the $1.8 trillion economy cooled to a nine-year low in the first quarter.

Indian consumer-price inflation was 10.02 percent in June, the fastest among the Group of 20 major economies, while the benchmark wholesale-price measure is more than 7 percent.

The last time the northern grid collapsed was in 2001, leaving homes and businesses without electricity for 12 hours. The Confederation of Indian Industry, the country’s largest association of companies, estimated that blackout cost companies $107.5 million.

Chart above from global-rates.com and tradingeconomics.com

India’s bubble ‘easy money’ (upper window) policies in 2009-2010 fueled a stock market recovery (below window) in 2010.

On the other hand, the then negative interest rate regime also stoked local inflation (pane below policy interest rates).

This has prompted the Reserve Bank of India to repeatedly raise policy rates or tightened monetary policy. The result has been to put a brake on India’s economy and the stock market rebound.

Part of the Indian government’s attack on her twin deficits, which has been blamed for inflation through the decline of the currency, the rupee, has been to turn the heat on gold imports and bank gold sales.

Aside from demand from the monetary policies, electricity subsidies has also been a culprit. Farmers have been provided with subsidized electricity. Such subsidy has not only increased demand for power but also put pressure on water supplies.

Environmentalists would likely cheer this development as ‘Earth Hour’ environment conservation.

Yet India’s widespread blackouts are evidences and symptoms of government failure.

Rampant rolling blackouts extrapolate to severe economic dislocations which not only to means inconveniences but importantly prolonged economic hardship.

War on Gold: Indian Government Mulls Ban on Bank Gold Sales

From Mineweb.com,

The sale of gold coins in India by banks could be curbed with the Reserve Bank of India considering banning such sales. Partly, an attempt by the Reserve Bank to help curb rising gold imports, the Bank says it also believes such sales are not relevant to core banking operations.

The move, if implemented, could deal a major blow to banks that are estimated to make a clear profit of $26 million (Rs 1.5 billion) given the 3% margin from the sales of gold coins. Some 36 banks have been nominated by the apex bank to import gold into the country.

Gold is a regulated sector in India and the government allows state-run and private banks to trade in bullion at the wholesale and retail level. To profit from Indians love of gold, banks in India started vending gold coins four years ago, earning a small commission with each sale.

Though the practise did not catch the fancy of Indian customers in its early days, major discounts and monthly instalment programmes offered by banks during festivals and other auspicious days, including gold-buying days, have resulted in huge sales.

For Indian investors, gold coins in smaller denominations are considered apt for corporate gifting and rewards for contests or for commemorative giveaways. Banks have also been incentivising their staff to sell gold coins as they earn a margin of $2.62 (Rs 150) per gram of gold. Special edition gold coins with images of deities or monuments have also helped to drive the overall coin sales in the country.

The Indian government has been desperately looking for a scapegoat. This attempt to ban bank sales of gold coin is a follow-up to the earlier tariffs imposed on gold imports

Unfortunately the problem isn’t gold (or the Indian people), the problem is the government as I pointed out before.

As Oil Prices Slump, China Imports Record Amount of Oil

China has not just been buying RECORD amounts of gold, it seems that China has also been gobbling up RECORD amounts of crude oil.

From Bloomberg,

China, the world’s second-biggest oil consumer, increased crude imports in May to a record high as refineries raised processing rates and oil prices declined.

The country bought a net 25.3 million metric tons, or 5.98 million barrels a day, more than it exported last month, according to data published today on the website of the Beijing- based General Administration of Customs. That compares with the previous high of 5.87 million barrels a day in February.

The jump in oil purchases helped spur a 12.7 percent gain for the nation’s imports last month, exceeding economists’ estimates. Refineries boosted processing rates last month as some facilities resumed operations after scheduled maintenance while Brent oil in London entered a so-called bear market on June 1 after sliding more than 20 percent from this year’s peak.

“International crude oil prices have been falling in the past two months, so more crude was probably shipped in to fill commercial and state emergency stockpiles” as prices could rise again, Gong Jinshuang, a Beijing-based senior engineer at China National Petroleum Corp., the nation’s biggest oil company, said by telephone.

Purchases cost an average $120 a barrel, compared with about $123 in April, Bloomberg calculations from the customs data showed. China’s imports of crude were 25.48 million tons in May, while exports were 180,000 tons

A chart of soaring oil imports from Zero Hedge who rightly points out that this means China seemingly has not been hoarding the USD

Gold and oil functions as benchmark commodities or as lead commodities.

And as I recently pointed out

It could also be possible that China’s quickening pace of gold hoarding could be as insurance against a potential cataclysmic currency crisis that could be unleashed from political responses by major central banks to avert a global recession.

Add oil to the insurance factor or “flight to real value” on the increasing risk of a crack-up boom (currency crisis)

As the great Ludwig von Mises explained

with the progress of inflation more and more people become aware of the fall in purchasing power. For those not personally engaged in business and not familiar with the conditions of the stock market, the main vehicle of saving is the accumulation of savings deposits, the purchase of bonds and life insurance. All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to be indicated. The ultimate reaction of the public, the "flight into real values," is a desperate attempt to salvage some debris from the ruinous breakdown. It is, viewed from the angle of capital preservation, not a remedy, but merely a poor emergency measure. It can, at best, rescue a fraction of the saver's funds.

By the way, I have been reiterating the point that financial markets will be faced with sharp volatilities in both direction but with a downside bias.

Yesterday oil spiked up on the news of Spain’s bailout, but got smashed at the end of the trading session.

Clearly boom bust dynamics at work.

Gold is Money: Turkey Edition

While Ben Bernanke and his ivory tower based cohorts do not treat gold as money, for the average Turks, gold is money.

From the Wall Street Journal,

The Turkish government, facing a bloated current-account deficit that threatens to derail the country's rapid expansion, is trying to persuade Turks to transfer their vast personal holdings of gold into the country's banking system.

The push to tap into the individual gold reserves—the traditional form of savings here—is part of Ankara's efforts to reduce a finance gap that is currently about 10% of gross domestic product.

Government officials say the banking regulator will soon publish a plan to boost incentives for consumers to park their household wealth inside the financial system. Banking executives said they are considering new interest-yielding gold-deposit accounts that would allow savers to withdraw gold bars from specially designed automated teller machines.

The moves come after the central bank in November announced that lenders could hold up to 10% of their local-currency reserves in gold, in part to tempt Turkey's gold hoarders to deposit their jewelry, coins or bullion at banks.

Economists say the policy shift is designed to change Turks' historic preference for storing a high percentage of personal wealth outside the banking system as a way to protect themselves against the economic volatility that has periodically hit Turkey in recent decades.

The effort is one front in a broader battle to encourage more savings while curbing the ballooning current-account deficit—a pressure point many investors fear could upend a fast-growing economy, estimated to have expanded more than 8% last year. Turkey's current-account gap has expanded faster than expected in recent weeks amid a surge in oil prices and data showing unexpectedly high consumer demand.

"Turkey has historically been hit by crises and inflation, so the tradition of holding gold outside the system could be hard to shift," said Murat Ucer, an economist at Global Source Partners, an Istanbul-based research consultancy.

The size of the gold haul stored outside Turkey's banking system is hard to quantify; no data reliably capture the scale of the informal economy. The Istanbul Gold Refinery estimates the figure at 5,000 metric tons, valued at $270 billion. Recent numbers show many consumers have boosted home-held deposits even as the country's tightly regulated banking system won plaudits for comfortably weathering the financial crisis.

Unlike India, whom recently announced plans to raise import duties on gold imports, Turkey’s government either has not yet reached a point of desperation to impose political controls over gold trades, or that they have come to realize of the futility of imposing antagonistic and oppressive policies. Instead, the Turkish government has, so far, resorted to wooing or appealing to the public to help the government.

However, I am inclined to the view that this as an initial or temporary step before any imposition of political controls. With institutional violence under their control (police or military power), the temptation to use force through tax or administrative policies will always be there.

It is also very important to note of how gold has served as insurance against political control via the banking system. It would appear that the average Turks, basically don’t trust the banking system, and thus keeps their savings in gold and stashed away from the prying eyes of political authorities. The average Turks, I presume, perhaps (culturally) understands that through the banking system, their savings or wealth could be faced with greater risks of confiscation through various political means as taxation.

Nevertheless this is a good remainder of the distinction between the world as seen by politicians and bureaucrats and of reality (which reflects on people’s sense of values.)

This quote, which I earlier blogged, attributed to Mr. Janos Feteke (who I think was the deputy governor of the National Bank of Hungary) seems very relevant

There are about three hundred economists in the world who are against gold, and they think that gold is a barbarous relic - and they might be right. Unfortunately, there are three billion inhabitants of the world who believe in gold

This is essentially why political actions that go against public’s desires eventually self-destructs.

War on Gold: India Raises Import Duties

So the Indian government will make good their threat to inhibit gold imports.

Writes the Mineweb,

Gold eased on Friday, caught up in its largest weekly decline in three months, after top consumer India said it would double import duties on bullion and upbeat U.S. data this week fed optimism over the global economy, boosting risk appetite.

The bullion market relies heavily on Indian jewellery demand. Last year, the country imported a record 969 tonnes of metal and in January, raised the import duty by 90 pecent. Finance Minister Pranab Mukherjee said the strong growth in imports had played a key role in widening India's current account deficit…

Investors hold a near-record amount of gold now in exchange-traded products and have stepped up their holdings of gold through U.S. futures so far in 2012, meaning the market could be subject to steeper sell-offs by disenchanted players, at least in the near term…

Gold imports to India, the world's top importer, are likely to fall significantly in 2012 as the government's decision to double import duty to four percent is seen squeezing local demand, especially for jewellery, industry officials said.

Gold imports as the cause of India’s trade deficit are in reality just an excuse for its true driver: insatiable government spending.

And the belief that people’s demand for gold will be curtailed, as governments around the world ramp up the printing press, is an illusion

The likely response as captured by the same Mineweb article,

Bombay Bullion Association President Prithviraj Kothari said the increase would prompt a rise in smuggled gold and impact the jewellery sector more than the investment sector.

Yes a gold black market in India will mushroom

Also politicization of markets translates to more corruption.

Nevertheless whatever price weakness gold has recently been faced with should be temporary.

Record Bank Borrowing from ECB’s Second Round LTRO

Here is what I wrote last Sunday,

Despite talks of ‘stigmatization’ or the reluctance to avail of European Central Bank facilities by several banks, I expect the reopening of the second three year Long-term Refinancing Operations (LTRO) facility will be utilized to the hilt.

Apparently there had been no signs of stigmatization as European banks flocked to the ECB to borrow in record numbers.

From the Bloomberg,

The number of financial institutions flocking to the European Central Bank’s three-year loans soared to 800 and borrowing rose to a record in an operation that may boost the euro-area economy.

The Frankfurt-based ECB said it will lend banks 529.5 billion euros ($712.2 billion) for 1,092 days, topping the 489 billion euros handed out to 523 institutions in the first three- year operation in December. Economists predicted an allotment of 470 billion euros in today’s tender, according to the median of 28 estimates in a Bloomberg News survey.

“The astonishing number this time is the number of banks participating, which signals that a lot more small banks looked for the money and it is likely they will pass it on to the economy,” said Laurent Fransolet, head of fixed income strategy at Barclays Capital in London. “So the impact may be bigger than with the first one.”

Two factors here:

This is about the preservation of the debt based welfare political system and thus the gargantuan subsidies to the banking system, the chief financiers of the welfare state.

Second, “who the heck would refuse free money???!!!” Certainly bankers will take them and did so.

As for yesterday’s 5% crash in gold prices, rumors have it that cartel operations could have been responsible for the bear raid for unspecified reasons. If true, my guess is that the manipulation gold-silver market must have probably been aimed at dampening the effect of the record ECB borrowings by Euro banks. Nothing to see here, move along.

Yet the inflationism (currency debasement policies) seen above represents a fundamental reason to remain bullish on gold.

War On Gold: China Applies Selective Ban

China has flipped flopped over gold. Over the past years, China has openly urged her citizenry to load up on gold and silver, and even installed their first gold ATMs; now a selective ban will be applied.

Reports the CNBC (hat tip: Bob Wenzel)

Gold exchanges in China outside of two in Shanghai are to be banned, authorities said in a statement released on Tuesday…

The notice — published on the central bank website (www.pbc.gov.cn) — said the Shanghai Gold Exchange and the Shanghai Futures Exchange are enough to meet domestic investor demand for spot gold and futures trading.

Existing exchanges or "platforms" were told to stop offering new services.

The PBOC cited lax management, irregular activities and evidence of illegality which were causing risks to emerge, as the reasons for taking the decision.

The assault on gold trading could be interpreted as an attempt to suppress the public’s growing interest over gold, which alternatively means that China’s inflation figures—4.2% as of December—has been materially underreported.

Also such response are manifestations of China’s boom bust cycles.

Policies are made in the interest of the government and of the political class, and hardly about the public.

Eventually, unsustainable political economic systems will be exposed.

MF Global Fallout Haunts the Metal Markets

The MF Global mess continues to haunt the commodity markets. Reports suggest that MF Global could have engaged in rehypothecation or illicitly pledged collateral by their clients as collateral for its own borrowing (Wikipedia.org). And ownership issue over collateral has given way to numerous lawsuits and liquidations.

Writes Zero Hedge (bold emphasis mine)

That paper gold, in the form of electronic ones and zeros, typically used by various gold ETFs, or anything really that is a stock certificate owned by the ubiquitous Cede & Co (read about the DTCC here), is in a worst case scenario immediately null and void as it is, as noted, nothing but ones and zeros on some hard disk that can be formatted with a keystroke, has long been known, and has been the reason why the so called gold bugs have always advocated keeping ultimate wealth safeguards away from any form of counterparty risk. Which in our day and age of infinite monetary interconnections, means virtually every financial entity. After all, just ask Gerald Celente what happened to his so-called gold held at MF Global, or as it is better known now: "General Unsecured Claim", which may or may not receive a pennies on the dollar equitable treatment post liquidation. What, however, was less known is that physical gold in the hands of the very same insolvent financial syndicate of daisy-chained underfunded organizations, where the premature (or overdue) end of one now means the end of all, is also just as unsafe, if not more. Which is why we read with great distress a just broken story by Bloomberg according to which HSBC, that other great gold "depository" after JP Morgan (and the custodian of none other than GLD) is suing MG Global "to establish whether he or another person is the rightful owner of gold worth about $850,000 and silver bars underlying contracts between the brokerage and a client." The notional amount is irrelevant: it could have been $0.01 or $1 trillion: what is very much relevant however, is whether or not MF Global was rehypothecating (there is that word again), or lending, or repoing, or whatever you want to call it, that one physical asset that it should not have been transferring ownership rights to under any circumstances. Essentially, this is at the heart of the whole commingling situation: was MF Global using rehypothecated client gold to satisfy liabilities? The thought alone should send shivers up the spine of all those gold "bugs" who have been warning about precisely this for years. Because the implications could be staggering.

Probably the core primary consequence of this discovery, which obviously has a factual basis, or else it would not lead to an actual lawsuit between two "reputable" firms (aka ponzi participants), is whether gold in the GLD warehouse, supervised by HSBC, is truly theirs, or has it all been hypothecated from some other broker who never really had the asset or the liquidity, and so on in what effectively can be an infinite chain of repledging one asset to countless counterparties. Because if there is on cockroach...

Suffice to say, expect either a prompt settlement in this lawsuit, or a fervent denial by all parties involved that any gold was misplaced. Because here is the punchline: each physical gold or silver bar has a unique deisgnator that should never be replicated, yet this is precisely what happened to lead to the lawsuit! In a non-banana world, there should never be any debate over who owns a given physical asset, as replicated ownership (note - not liens) effectively means someone stole the gold (or there was counterfeiting involved) and was never caught... until MF Global finally expired of course.

Read the rest here

Investing in the PSE: Will Negative Real Rates Generate Positive Real Returns?

Easy money also helps the fiscal position of the government. Lower borrowing costs mean lower deficits. In effect, negative real interest rates are indirect debt monetization. Allowing borrowers including the government to get addicted to unsustainably low rates creates enormous solvency risks when rates eventually rise. I believe that the Japanese government has already reached the point where a normalization of rates would create a fiscal crisis. David Einhorn

We are living in interesting times.

Negative Real Interest Rate as Stock Market Driver

In the Philippines, interest rates have considerably been below inflation rates.

Banks like the BPI[1], offers yields anywhere 2-2.75% for 364 days on their regular time deposit account, depending on the size of the account (as of November 15 to 21), whereas statistical Consumer Price Inflation rate has reached 5.2% last October[2].

Most people don’t realize that real money returns for the Peso has been negative or that savers have been losing money in terms of reduced purchasing power.

Curiously, inflation rates are even higher than the yields of domestic government bonds, from 1 to 10 years in maturity. This implies that bondholders of 10 years maturity and below are also getting squeezed from the current negative real interest rate regime (chart from Asian Bonds Online[3]).

Aside, the steep yield curve likewise induces borrow-short lend-long activities or maturity transformation which implies of higher future CPI rates as banks are incentivized to expand lending.

And since the yield curve has been steep even from last year, we are seeing credit activities ramping up.

From the BSP[4], (bold emphasis mine)

Growth in outstanding loans of commercial banks, net of banks’ reverse repurchase (RRP) placements with the BSP, accelerated in September to 21.7 percent from the previous month’s expansion of 19.8 percent. Meanwhile, the growth of bank lending inclusive of RRPs slowed down to 18.9 percent from 24.8 percent in August. Commercial banks’ loans have been growing steadily at double-digit growth rates since January 2011. On a month-on-month seasonally-adjusted basis, commercial banks’ lending in September grew by 1.0 percent for loans net of RRPs, while loans inclusive of RRPs fell by 2.0 percent.

Loans for production activities—which comprised 84.2 percent of commercial banks’ total loan portfolio—grew steadily by 22.9 percent in September from 21.5 percent a month earlier. Growth in consumer loans likewise accelerated to 17.9 percent from 13.4 percent in August, reflecting the rapid growth in lending across all types of household loans.

The expansion in production loans continued to be driven largely by higher lending to electricity, gas and water (which grew by 56.3 percent); manufacturing (24.2 percent); real estate, renting and business services (26.1 percent); wholesale and retail trade (29.8 percent); financial intermediation (32.8 percent); transportation, storage and communication (19.3 percent); and construction (17.6 percent). Moreover, with strong global demand driving growth in the mining and quarrying industry, loans to mining and quarrying more than tripled in September from a year ago, sustaining the three-digit growth rate since May 2011. Meanwhile, contractions were posted in lending to three production sectors, namely, health and social work (-4.9 percent), education (-10.0 percent), and agriculture, hunting and forestry (-3.5 percent).

From a mainstream economic viewpoint this will be seen as a good sign.

Theoretically low interest rate should reflect on the time preferences of individuals, where the preference to consume goods later rather than now (lower time preference) means that there should be an abundance of savings available for investments.

According to Mises.wiki[5]

The act of saving is a means through which man can achieve his ultimate goal, which is bettering his situation. Saving implies giving up some benefits at present - this is the price paid for the attainment of the end sought. The value of the price paid is called cost, and costs are equal to the value of the satisfaction which one must forego to attain the end aimed at.

The return on savings must be in excess of the cost of savings. If the costs are too high - if savings can’t better an individual’s life and well being - then saving will not be undertaken.

Consequently, the return on savings must be above the premium for man to agree to save. A positive time preference (i.e., the existence of a premium) precludes the natural emergence of a zero interest rate. Should a zero interest rate be imposed, this will abort all savings and lead to the destruction of the production structure. The premium of having goods now versus having them in the future is getting smaller with the increase in their stock. This, in turn, means that the required return on savings will be lower. An increase in the pool of funding sets the platform for lower interest rates.

Apart from time preferences, the purchasing power of money and business risk are important elements in the formation of interest. However, their importance is assessed in reference to the fundamental factor, which is time preference.

However as pointed out above a policy induced boom from manipulated interest rates distorts the production structure which will be misdirected towards investments in capital goods (higher stages of production) that leads to a bubble cycle (Austrian Business Cycle Theory—ABCT).

As I wrote last week[6],

Although I am not sure which sector should give the best returns over the short term, I am predisposed towards what Austrian economics calls as the higher order stages of production or the capital goods industries, which are likely the beneficiaries of the business cycle, specifically, mining, property-construction and energy, as well as financials whom are likely to serve as funding intermediaries for these projects.

Interestingly, even the relative performances by different sectors in the PSE seem to coincide or reflect on the distribution of credit growth as noted by the BSP.

For this week, except for Financial-Banking sector, the best gainers have been the mining index, followed by the industrial (mostly weighted on energy and utility companies) and the property sector. Here I am comparing apples to oranges because of the variances of time considerations between the PSE sectoral activities and loan portfolio growth in the real economy.

Yet the outperformance of the mining sector in the PSE can likewise be accounted for in the tripling of loans to the mining and quarrying industry.

Overall, the point is that the accelerating credit growth in capital good industries such as in mining, real estate and construction, power and financial intermediation appears to corroborate the boom bust process.

Another fascinating observation is that negative real interest rates may have altered the composition of trading activities seen during the current cycle in the Philippine Stock Exchange (PSE).

In the 2003-2007 boom cycle, foreign investors had largely been the dominant force in the daily trading activities at the PSE. Today, local participants appear to have wrested that role.

And the ascendancy of local investors seems to have provided resiliency to the Phisix during the recent shakeout.

The implication is that negative real interest rates may have driven many savers to speculate on the stock market to eke out positive real returns.

Yet if holding cash and near term bonds generates negative real returns then where to put one’s resources?

Every investment competes for your money. There will always be a tradeoff for any choices we make. Investments would mean a trade-off in terms of risk-reward and on relative assets.

Market Risk: Debating The Role of the ECB

There is no such thing as a risk free investment as inculcated to us by media, the academe or by mainstream institutions.

The concept of “risk-free” has been impressed upon us to justify the institutional rechanneling of private savings via the banking system into funding pet programs of politicians. And part of the process has been enabled by banking regulations such as the Basel Accord.

Yet such masquerade is presently being exposed by the markets. The bond spread of Italy and France (relative to the German Bund) has soared to record highs[7] as shown in the above chart (chartoftheday.com).

To add, the cost to insure liabilities of AAA credit rating France is now higher than the Philippines or compared to ASEAN-4[8]. This means that the credit standings applied by the government licensed or accredited credit rating agency cartel does not accurately reflect on the credit risks by developed economies plagued by the unsustainable welfare state.

And because financial markets have been defying whatever the EU governments has been imposing such as credit margin hikes[9] on Italian bonds and ban on short selling of Italian stocks[10], credit rating agencies appear as being pressured to downgrade the AAA credit rating of France[11].

The economics of the marketplace has been reasserting her ascendancy against welfare based politics.

Yet political impasse over the role of the European Central Bank as the “lender of last resort” has proven to be a seething issue that continues to unsettled financial markets.

While some key officials such as German Chancellor Angela Merkel[12], ECB’s Mario Draghi[13] and IMF’s John Lipsky[14] were allegedly against the carte blanche backstop role for the ECB, there has been a growing clarion clamor for the ECB to aggressively support the bond markets from France and from political personalities such as former German Chancellor Gerhard Schroeder[15], Portuguese President Anibal Cavaco Silva[16] and many more.

One popular analyst have even called the ECB’s role as either to “Print or Perish” for the Euro, which resonates with the popular call to inflate. Little do these inflation advocates realize that historical accounts of currency destruction have hardly been about the “deflationary spiral” but more about serial episodes of hyperinflations and or wars[17].

For the ECB to rapidly and intensify inflationism would be to “Print and Perish”.

Nonetheless, print and perish has been the name of the game for global central bankers.

But the supposed political stalemate over the ECB’s role appears as “smoke and mirrors” for me.

That’s because in reality, the ECB along with rest of major Central Banks except the US Federal Reserve has been scaling up their asset purchases as shown by the above chart[18].

Since 2008, major central banks have been ramping up asset purchases which makes today’s developments as unprecedented or entirely unique in modern history. So there hardly can be merit to claims that we are bound for “deflationary spiral” for as long as central banks continue to inundate the world with the liquidity approach to contain what truly are insolvency issues.

The ECB has reportedly an undeclared €20 billion weekly limit of bond purchases[19]. I would conjecture that rules, laws, regulations, policies or self-imposed limits change according to the convenience and the interests of politicians.

And recent reports suggest that European banks have been unloading heaps of sovereign debt issues.

So EU banks have been taking the opportunity to transfer their supposed “risk free” securities to the ECB in order to rehabilitate their balance sheets.

And the desire for the ECB to take on a more aggressive role can be seen through the implied missives from this New York Times article[20],

The dynamic of falling bond prices also undermines the capital position of the banks, since they are among the biggest holders of government bonds in many countries. As those assets plunge in value, banks cut back on lending and hoard capital, increasing the likelihood of a recession.

All these money printing won’t be sucked into a financial black hole, as they will have to flow somewhere.

Yet despite the current turbulence, I think that the current volatility may be ignoring such dynamic.

As a final note, if events in the Eurozone should turn out for the worst, the local and ASEAN economies may not be immune from such disruption, which may affect the region’s stock markets.

As Gerald Hwang of the Matthews Asian Fund writes[21],

Asian fixed income markets can have heavy foreign participation in both bonds and bank loans. The amount of participation from European banks is noteworthy in light of their exposure to European debt and the probability of shrinking balance sheets in the near future. European bank lending into Asia is greater than U.S. bank lending in the region; therefore, weakness in European bank balance sheets may tighten the financing environment for Asia’s borrowers more so than similar weakness in U.S. banks.

While European banks do have material exposure on Asia, I wouldn’t call less than 25% as substantial enough to possibly rock the boat. But again this depends on general market sentiment. Also, any tightening of credit conditions by Euro banks may be used as an opportunity by non-European banks to expand their market share.

Market Risk: US ‘Sequester’ Spending Cuts Will Be a Nonevent

The Philippine Stock Exchange’s Phisix has been up 2.41% on a year-to-date basis and has outperformed the majors and other Emerging Market contemporaries. But it is important to point out that such outperformance has still been dependent on the ebbs and flows of global markets, particularly the US (SPX).

Over the past weeks, we seem to be seeing renewed weakness in Europe (STOX50), China (SSEC) and US S&P 500 (SPX).

So far the stock markets of the Eurozone has, I think, already priced in an economic recession given the current bear market status. The Stoxx50 is still 19% down from the February 2011 high. Yet should the ECB intensify the asset purchases or inflationism we should see European stocks pick up.

Further, I think that US stock markets will likely steer the global markets rather than that of the EU. This means that an ascendant US markets should likely bolster the bullish case of the Phisix and of the ASEAN-4 and vice versa.

Yet another worry being promoted by some of the bears is the brewing gridlock by Congressional super committee over spending cuts that would result to sequester rules or automatic spending cut.

The Wall Street Journal editorial says that such concerns are exaggerated[22],

Under the sequester rules, roughly half of the spending cuts would come from defense and homeland security, and the other half from domestic programs such as roads, education, energy and housing. An automatic cut from every federal agency is far from an ideal way to write a budget, because it sets no priorities and largely exempts the major entitlements like Medicare and Medicaid.

But the sequester does have the virtue of imposing reductions in spending that Congress rarely agrees to on its own. The Congressional Budget Office estimates domestic programs would take a 7.8% cut, while defense programs would get sliced by 10%. Medicare spending, mostly payments to providers, would fall by 2%. This would yield $68 billion in savings in 2013, and more savings in future years by ratcheting down the baseline level of spending.

Given the spending increases of recent years, those cuts are hardly excessive. Domestic programs received a nearly $300 billion windfall under the 2009 stimulus, so a sequester would take back a little more than one-fifth in 2013. Total domestic discretionary spending doubled to $614 billion in 2010 from $298 billion in 2000. Even if there were a 10-year $1.2 trillion "cut," total discretionary spending would still rise by $83 billion by 2021 because those cuts are calculated from inflated "current services" projections.

Essentially, the $1.2 trillion sequester spending cuts will be spread over 10 years, and as mentioned above will be apportioned mostly towards defense, homeland security and domestic programs which hardly tackles on welfare entitlement programs.

The sequester or automatic spending cuts extrapolates to a cut on the rate of growth spending rather than real or actual cuts as shown above[23].

This only means that risks from the supposed political gridlock won’t be anywhere as disastrous as portrayed by political fanatics.

For the US markets, the reaccelerating growth of money supply should filter into and continue to provide support to her stock markets and the economy.

This week, the US economy posted strong growth which apparently surprised the mainstream[24]. Of course we understand this to be inflation boosted growth.

Barring any unforeseen events, I think this momentum should continue.

A Short Note On Commodities

Commodity markets experienced intensified downside volatility last week which many blamed on the Euro crisis.

While the Euro crisis may have aggravated sentiment, my guess is that these have been largely related to the liquidation process being undertaken by the trustee committee handling bankruptcy of MF Global Holdings who incidentally filed papers to set up the required accelerated filing of claims a day before the selloff[25].

Gold oil and copper simultaneously fell the following day.

I earlier noted that this should be expected[26] last week but apparently has been deferred until this week.

And I think that once the proceedings culminate, the upside trend for the commodity markets should resume.

Bottom line: Negative real interest rates and expanding balance sheets of major global central banks will impact asset prices differently. Nevertheless such dynamic will continue to provide support to the Phisix-ASEAN equity markets and the commodity markets.

On the other hand, unless a massive collapse occurs, political developments particularly in the Eurozone should spice up market actions.

So my guess is that the current domestic environment of negative real interest rates should bode well for investors of the PSE.

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[1] BPI Expressonline Regular Time Deposit (Peso) November 15 to November 21, 2011

[2] Tradingeconomics.com Philippine Inflation rate

[3] AsianBondsOnline Philippine Government Bond Yields

[4] bsp.gov.ph Bank Lending Growth Expands Further in September, November 11, 2011

[5] Wiki.mises.org Saving and the Interest rate

[6] See Phisix-ASEAN Equities: Awaiting for the Confirmation of the Bullmarket, November 13, 2011

[7] Telegraph.co.uk Spread between French and German bonds hits record, November 9, 2011

[8] See Chart of the Day: France ‘Riskier’ than the Philippines, ASEAN, November 17, 2011

[9] Reuters.com MONEY MARKETS-Italian banks risk becoming dependent on ECB, November 10, 2011

[10] Reuters.com Italy to ban naked short-selling on stocks, November 11, 2011

[11] Guardian.co.uk Debts in France threaten top credit rating, November 15, 2011

[12] Bloomberg.com Merkel Rejects ECB as Crisis Backstop in Clash With France, November 17, 2011

[13] Washington Post, ECB leader Mario Draghi rebuffs calls for greater central bank role, November 19, 2011

[14] CNBC.com IMF’s Lipsky Backs Merkel Over ECB Powers November 18, 2011

[15] Reuters.com German ex-chancellor sees ECB steps in "last resort", November 18, 2011

[16] Bloomberg.com ECB as Lender of Last Resort Will Resolve Debt Crisis for Portugal’s Silva, November 12, 2011

[17] Hewitt Mike The Fate of Paper Money, January 5, 2009 DollarDaze.org

[18] Danske Bank, Bank of Japan on hold, still sees substantial downside risks November 16, 2011

[19] Reuters.com ECB has secret 20 billion euro bond-buying limit: report November 18, 2011

[20] New York Times Europe Fears a Credit Squeeze as Investors Sell Bond Holdings, November 18, 2011

[21] Hwang Gerald Capital Flows: Asia's Quiet Revolution Asia Insight November 2011 Matthews International Capital Management, LLC

[22] Wall Street Journal Editorial The Sequester Option, November 18, 2011

[23] Mitchell Daniel What Matters More to Republicans, Defending Taxpayers or Expanding Government?, November 18, 2011

[24] See Strong Performance of the US Economy Surprises the Mainstream November 19, 2011

[25] See MF Global Holding’s Liquidations and the November 17th Commodity Prices Rout, November 19, 2011

[26] See Client Accounts Transfer from MF Global Holdings may trigger Market Volatility Next Week, November 5, 2011

MF Global Holding’s Liquidations and the November 17th Commodity Prices Rout

Aside from China’s proposed increase on credit margins for Silver, I think that the unwinding of mostly commodity assets of bankrupt MF Global Holdings has had much to do with the rout in the commodity markets last Thursday (November 17).

The above chart from stockcharts.com, is the weekly charts for gold, silver and CRB indices which exhibits the steep decline last Thursday.

From Businessweek-Bloomberg dated November 16th, (bold emphasis mine)

The trustee liquidating commodities broker MF Global Inc. filed papers yesterday setting up an emergency hearing tomorrow for approval to require the accelerated filing of claims.

Six customers filed a motion asking the bankruptcy judge to overrule the trustee and allow customers to take out 90 percent or more of their collateral.

In papers filed yesterday referring to his “vigorous efforts,” the trustee said the “precise size of and the reasons for the shortfall in segregated accounts are not yet known by the trustee, law enforcement, and other officials and regulators conducting investigations.”

If the trustee has his way, there will be a two-track process where commodities and securities customers must file claims by Jan. 27 to receive the maximum distribution of so- called customer property. General creditors must submit claims by May 28.

James W. Giddens, the trustee for the MF Global broker, said he has already distributed about 3 million commodities contracts in 17,000 customer accounts, together with $1.55 billion in collateral, to 12 or more other brokers. Accounts that weren't transferred by Nov. 11 are undergoing an “orderly liquidation,” Giddens said.

Giddens also said he's looking for other brokers to accept bulk transfers of 450 customer accounts for securities. He also asked a judge to let him transfer about $520 million in collateral to commodity customers whose accounts consisted solely of cash on Oct. 31.

The trustee said he will review customer claims on a “rolling basis” as they are filed. Given what he called the “relatively poor state” of the books, the trustee said he hopes to make additional requests to the court for further distributions of so-called customer property.

Giddens was unable to transfer accounts immediately because about $600 million of customers' collateral is missing. Consequently, open contracts transferred to other brokers weren't accompanied by all the collateral customers had on account with MF Global.

Six customers in their motion filed yesterday contend the trustee should be giving them at least 90 percent of the collateral. They arrive at the figure saying that the $600 million in missing cash is about 10 percent of the $5.5 billion supposedly held for customers.

Missing cash, accelerated filing (November 15th) of claims and orderly liquidations for accounts that have not been transferred seem to coincide with November 17’s rout in commodity prices.

I expected this liquidation induced volatility from MF Global Holdings to happen a week ago. Apparently legal obstacles may have delayed the process from taking place until late this week.

While it is unclear if the procedural liquidations has culminated, the likely effect from this should be temporary which means current weakness in commodity prices may prove to be a great buying opportunity.

War on Commodities: China will Raise Credit Margins on Silver

From Reuters

The Shanghai Gold Exchange said it will raise margins on silver forwards to 18 percent from 15 percent from Monday if the silver contract hits its daily trade limit on settlement on Friday.

The exchange said it would lift daily trade limits on silver forward contracts to 15 percent from 12 percent if the contract hits limit up or down on settlement on Friday.

Last week’s steep drop in commodity prices may have been influenced by the above. As I have been tirelessly pointing out, global governments has repeatedly been attempting to rein and control prices for political motivations (e.g. manage inflation expectations).