Video: Mark Thornton on How Silver Money Kept Inflation in Check

From the Mises Blog

Much of the history of Philippine money has been in commodity: gold/silver. This is until the US Congress enacted the Philippine Coinage Act.

In the US, Food Prices have been Rising FAST

If you talk to members or read articles of the mainstream economic faith, they often imply to you that money printing does NOT lead to inflation. Aside, any discussion about consumer price inflation has mechanically been viewed as strictly a “supply side” issue.

Of course despite their rabid denials, price inflation has been very much present given that central banks around have been jointly blowing bubbles to ensure that bankrupt governments stay afloat.

The mainstream hardly recognizes that first we see monetary inflation expressed via booming asset prices, next we see the same dynamic eventually spillover to consumer inflation.

Since inflation is a political process and represents part of the grand political scheme of financial repression, the effects on the markets and the economy runs in different phases or stages too. Central bank manipulation of money and credit affect specific prices of assets and of goods and services in relative scale and time periods.

We are seeing such phenomenon at work even in the US

Cost of fresh produce are expected to move significantly higher according to a Wall Street Journal report. This supposedly has been  to a “three year drought in California” where the report adds that higher cost of fresh produce will lead to “overall food cost gains are expected to accelerate this year”

The Zero Hedge shows of spiraling prices beef, pork and shrimp. Note these are long term trends. But the recent rate of increases seem to have accelerated.

Another Wall Street Journal chart shows the spreading price inflation in basic commodities

In the US, food accounts for 14.9% of the CPI basket according to Doug Short.

The US Bureau of Labor reported last April 15th of the changes in US CPI stating that the “increases in the shelter and food indexes accounted for most of the seasonal adjusted all items increase. The food index increased 0.4 percent in March, with several major grocery store food groups increasing notably”

In early 2013 I predicted that rising home prices and rents will contribute to higher US CPI. So the US housing bubble is adding to CPI strains.

Finally rising food prices has not just been a US or Philippine phenomenon but a also global one. Again the mainstream blames this on the supply side particularly to weather and to deteriorating events in Ukraine

While this is not to deny that supply have contributed to rising prices, what has been a standard operation procedure for the mainstream has been to deliberately omit or obscure the demand side—which seems to operate in a vacuum—particularly demand that has been influenced by central bank policies 

For instance, as one would note from the FAO chart, dairy prices have been rising prior to the polar vortex or to the escalation of the Ukraine conflict.

The bottom line is that central bank inflationism has been increasingly spilling over to the real economy via rising food prices. And this is being aggravated by supply chain disruptions. This also means incidences of global hunger and poverty will rise. Such also implies of growing risks of a global food crisis.  

And importantly this signals why the era of asset inflation boom is bound to reverse soon as sustained pressures on consumer prices will eventually reflect on interest rates (whether in the US, Philippines or elsewhere).

Fed Officials Uttered Words of Taboo: Breakout of Inflation and Unsustainable Bubbles

At the recent convention “Meeting of the Federal Advisory Council and the Board of Governors”, Fed officials spoke of words that have been considered taboo by their standards (bold mine)

There are potential risks associated with current policy. The Fed’s securities purchases have reduced mortgage yields and, to a lesser extent, Treasury yields. Current low bond yields are disruptive to management of fixed-income portfolios, retirement funds, consumer savings, and retirement planning. They may encourage unsophisticated investors to take on undue risk to achieve better returns. MBS purchases account for over 70% of gross issuance, causing price distortion and volatility in the MBS market. Fixed-income investors worry that attractive mortgage-backed securities are in very tight supply. Higher premium coupons carry too much exposure to prepayments, potentially led by new government support programs for housing. Many are concerned about the Fed’s significant presence in the market. They have underweighted MBS in favor of corporate, municipal, and emerging-market bonds. There is also concern about the possibility of a breakout of inflation, although current inflation risk is not considered unmanageable, and of an unsustainable bubble in equity and fixed-income markets given current prices.

Fed officials finally admits to the growing risks of price inflation “the possibility of a breakout of inflation” and bubbles “unsustainable bubble in equity and fixed-income markets given current prices”.

But will they act? Or will the markets force them via the comeback of the bond vigilantes?

Now on the Fed’s prospective exit program:

Uncertainty exists about how markets will reestablish normal valuations when the Fed withdraws from the market. It will likely be difficult to unwind policy accommodation, and the end of monetary easing may be painful for consumers and businesses. Given the Fed’s balance sheet increase of approximately $2.5 trillion since 2008, the Fed may now be perceived as integral to the housing finance system

In short the Fed impliedly admits that a withdrawal of the easing environment would mean that the current boom will turn into a “painful for consumer and business” bust.

As the Zero Hedge quips “Uhm... wow.”

US Economic Growth Turns Negative Amidst US Stock Market and Property Boom

Have stock markets been about earnings or economic growth? 

Yesterday the US posted negative statistical economic growth

This from Bloomberg,

The economy in the U.S. unexpectedly came to a standstill in the fourth quarter as the biggest plunge in defense spending in 40 years swamped gains for consumers and businesses.

Gross domestic product dropped at a 0.1 percent annual rate, weaker than any economist forecast in a Bloomberg survey and the worst performance since the second quarter of 2009, when the world’s largest economy was still in the recession, Commerce Department figures showed today in Washington. A decline in government outlays and a smaller gain in stockpiles subtracted a combined 2.6 percentage points from growth.

Well a decline in government spending while statistically negative should be good news for the real economy. That’s because money not spent by government can be saved or productively used by the private sector.

But given the insatiable spending habits of the US government this is likely to be temporary.

Yesterday’s technical decline shows how anemic US statistical growth has been (chart from tradingeconomics)

This is the annualized economic growth rate for the US. (tradingeconomics.com)

Now for US companies beating earnings estimates...

The above chart from Bespoke Invest

Consensus expectations of strong earnings has been on a declining trend since 2006, this seems detached from the recent blitz in the US stock market.

Yet I previously explained how central bank actions can artificially boost earnings and how credit booms can mask statistical growth

The US is experiencing a resurgent real estate sector despite the sluggish economy, courtesy of the Ben Benanke’s QE infinity. (charts from Northern Trust). Money creation has to flow somewhere, and they seem channeled to the asset markets.

Rising property prices, which should spillover to rental prices, will likely increase statistical inflation. This puts to risks the current boom which could prompt the FED, whom in rabid fear of deflation, will likely resort to more inflationism in order to continue to suppress interest rates. And monetary expansion could feed through to the housing and housing bubble and or even consumer price inflation. The US asset economy has become greatly dependent on the Fed's doping policies. This means the US Federal Reserve has been trapped.

Yet, aside from the property sector and the spreading asset boom (via hedge funds, junk bonds, CDOs, etc…), stock market benchmarked by the S&P 500 has been attempting to carve new record highs (bigcharts.com)

Markets (and even the real economy) have essentially been distorted by monetary policies such that they don’t operate on conventional wisdom. Even the economic profession have been at a loss with their dysfunctional models.

Will Higher Rents lead to Higher US Consumer Inflation?

Rental markets appear to be the next phase of the broadening property inspired boom sponsored by the US Federal Reserve 

The Wall Street Journal reports

Apartment landlords continued to impose hefty rent increases as 2012 drew to a close, although there are some early indications they could be losing their leverage with tenants.

The average nationwide monthly apartment rent was $1,048 in the fourth quarter, up 0.6% from the third quarter and up 3.8% from a year earlier, according to a report set to be released Tuesday by real-estate research firm Reis Inc. The year-over-year increase was the largest since 2007 and a sign that landlords still have the upper hand they regained in 2010.

The nation's apartment vacancy rate, which has declined since hitting 8%in the aftermath of the financial crisis, fell to 4.5% from 4.7% in the third quarter. The rate is the lowest since 2001's third quarter.

Despite the team Bernanke's aggressive policies, US Consumer Price inflation (CPI) rates have been modest…until now.

Chart from Tradingeconomics.com

This is not to suggest of the absence of inflation, but rather that given today’s financialization (dominance of the financial industry over the real economy), most of the flows from central bank’s monetary inflation has been absorbed by the asset markets, which has brought about boom bust cycles, in spite of the moderate CPI figures.

The other factor is that much of the money created have stashed by the banking system with the US Federal Reserve

chart from St. Louis Federal Reserve

But all these may change soon. Rising rental prices will likely spillover to the US CPI basket considering that housing represents the largest share.

Chart from Doug Short’s Advisor Perspectives

As the US Bureau of Labor Statistics notes

Shelter, the service that housing units provide their occupants, is a major part of the CPI market basket—the goods and services that people need for day-to-day living.  Two CPI indexes, Owners’ equivalent rent of primary residence (OER) and Rent of primary residence (Rent), measure the change in the shelter cost consumers receive from their primary residences.  

Housing units are not in the CPI market basket.  Like most other economic series, the CPI views housing units as capital (or investment) goods and not as consumption items.  Spending to purchase and improve houses and other housing units is investment and not consumption.  Shelter, the service the housing units provide, is the relevant consumption item for the CPI.  The cost of shelter for renteroccupied housing is rent. For an owner-occupied unit, the cost of shelter is the implicit rent that owner occupants would have to pay if they were renting their homes.

In other words, if the US CPI index will begin to register higher CPI because of higher rents, then both Fed policies and the current environment of low interest rates may be jeopardized. This is assuming the constancy of the current methodology (or is premised on the assumption that US government won't change the way the CPI has been calculated)

US 10 year treasuries (TNX) appear to be signaling this.

Bernanke's FED seems boxed into a corner.

Food Crisis Watch: World Food Prices at 6 month High

For the mainstream’s view of the world, price inflation has hardly been a concern.

Yet in reality, price inflation appears to be seeping into the global economy mostly channeled through the commodity spectrum (one must add health, education costs among the other contributors).

A particular cause of concern has been rising international food prices which according to the FAO is at a 6 month high.

chart from FAO

From Businessweek/Bloomberg 

World food prices rose in September to the highest in six months as dairy and meat producers passed on higher feed costs to consumers, the United Nations’ Food & Agriculture Organization said.

An index of 55 food items tracked by the FAO rose to 215.8 points from a restated 212.8 points in August, the Rome-based agency reported on its website today. Dairy costs jumped the most in more than two years.

Livestock breeders and dairy farmers are passing on the higher cost of feed, after grain prices jumped in June and July, according to Abdolreza Abbassian, an economist at the FAO in the Italian capital. Higher prices don’t mean a food crisis is imminent, he said today by phone.

“Despite a very difficult market, the fundamentals that suggest a food crisis are just not there,” Abbassian said. “Market sentiment is now accepting high prices more as a rule than as an exception.”

Surging food crisis has been associated with social strife, particularly as one of the major trigger to the recent Arab Spring revolts. (chart from Sovereign Man)

While changes in weather patterns have proven to be a catalyst, many other policies such as tariffs, subsidies (agri and bioethanol) and others plays a role in exacerbating the supply side situation.

Importantly, massive inflationism by global central banks has been a key contributor to the demand side.

A continued ascent in food prices will amplify the risks of stagflation especially pronounced for emerging markets.

This is one very important dynamic to keep an eye on.

Have some steak today before they become pricey.

In Fantasyland Price Inflation has been Imaginary

One of the popular mainstream deceptions or mendacity employed by the apologists or lackeys of the state has been to repeatedly claim that there has been “no visible signs of inflation”.

Really?

Then how come even the OECD acknowledges that price inflation exists? 

From AFP,

Higher energy prices forced annual inflation in advanced economies to rise to 2.0 percent in August from 1.9 percent in July, the OECD said Tuesday.

"Energy price inflation accelerated sharply to 3.5 percent in August, up from 0.7 percent in July, while food price inflation slowed to 2.1 percent in August, compared with 2.3 percent in July," said the Organisation for Economic Cooperation and Development in a statement.

Excluding food and energy, the annual inflation rate slowed to 1.6 percent in August compared with 1.8 percent in July, according to the data for the 34-member OECD.

By individual countries, inflation gained pace in Germany, reaching 2.1 percent in August from 1.7 percent in July, while in the United States it advanced to 1.7 percent from 1.4 percent.

In Japan, however, consumer prices dipped 0.4 percent in August.

Outside the OECD area, annual inflation accelerated in India to 10.3 percent in August from 9.8 percent in July.

Inflation also rose in Russia to 5.9 percent from 5.6 percent and in China to 2.0 percent from 1.8 percent, the organisation said.

Annual inflation was stable in Brazil from July to August at 5.2 percent and Indonesia at 4.6 percent.

Let us put this way, if central banks were to acknowledge that price inflation exists then what justifies their current policies of inflationism?

Here is an example. The Bloomberg Businessweek quotes Fed Chairman Ben Bernanke

Five years of low interest-rate policies “have not led to increased inflation,” and the public’s expectations for price gains “remain quite stable,” Bernanke told the Economic Club of Indiana.

In reality, the policy of inflationism has been justified based on the supposed non-existence or non-threat of price inflation. Should inflation become a menace, central banks might be forced to resort to tighten or to exit from the current accommodation phase which will spoil Bernanke-global central banks support for their cronies. 

And may I also reiterate that Ben Bernanke’s explicit goal has been to support the asset markets.

I quoted Mr. Bernanke in my last stock market outlook  

The tools we have involve affecting financial asset prices. Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other rates, I mentioned corporate bond rates. Also the prices of various assets. For example, the prices of homes. To the extent that the prices of homes begin to rise, consumers will feel wealthier, they’ll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they’ll make a better return on that purchase. So house prices is one vehicle. Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend. One of the main concerns that firms have is that there is not enough demand…if people feel their financial position is better they’ll be more likely to spend….

 So are we not seeing asset price inflation?

The post Bernanke’s QE forever or infinity has brought back the Risk ON environment as I earlier noted

This has been back led by US Stocks (SPX).

Risk ON means that world equities (MSWORLD), commodities (CCI) and even the euro (XEU) have risen in tandem.

Junk bonds have been booming too.

Inflationism does not necessarily translate to price inflation but to boom-bust cycles. But given the concerted efforts by all major central bankers to reflate (manipulate) the system, not only just boom bust cycles, but price inflation poses as clear and present danger.

Yet like incantation, the political pious repeatedly mumbles of the supposed NO price inflation environment. 

Go figure.

The following charts are all from tradingeconomics.com.

Euroland

United States

United Kingdom

Japan (the only exception)

China

Brazil

Russia 

India

And all these considers the accuracy of the respective statistics. As stated above, governments are likely to under declare inflation rates for political reasons.

One thing the above suggests is that the world is headed initially for stagflation. 

Updated to add: 

Ironically, the New York Fed's economic model predicts of "explosive inflation" 

From Zero Hedge:

Carlstrom et al. show that the Smets and Wouters model would predict an explosive inflation and output if the short-term interest rate were pegged at the ZLB (Zero Lower Bound) between eight and nine quarters. This is an unsettling fi nding given that the current horizon of forward guidance by the FOMC is of at least eight quarters

ASEAN’s Interest Rate Swap Markets Signals Stagflation Risks

Mainstream "experts" continue to dish out bromides about forthcoming rate cuts for the Philippines and her ASEAN peers without recognizing that impact of the FED-ECB-BoJ-SNB-BoE inflationists policies will heighten the risks of stagflation for the region.

Yet current market signals seems pointing to such direction.

From Bloomberg (bold emphasis added) 

Interest-rate swaps in Malaysia and Thailand are signaling central banks will start to tighten monetary policy next year for the first time since 2011, as fighting inflation takes precedence over economic growth.

Malaysian and Thai contracts in which investors exchange a fixed payment for a floating rate for two years climbed to four- month highs of 3.18 percent and 3.08 percent, respectively, in September. Societe Generale SA recommends clients pay the swaps in Malaysia targeting an increase to 3.35 percent. Goldman Sachs Group Inc. raised its forecasts for five-year rates in both countries on Sept. 19.

Southeast Asian nations are expanding at a faster pace than economists predicted this year, even as Europe’s debt crisis and unemployment in the U.S. reduce export orders. Analysts including Societe Generale’s Wee-Khoon Chong and central banks are starting to flag inflation risks for next year, driven by rising domestic demand and funds pumped into the European and U.S. financial systems.

What the mainstream imputes as ASEAN’s “growth dynamic” represents no less than a concealed credit driven boom.

Indonesia (IMF)

ASEAN M3 and Claims on private sector credit (IMF)

Thailand (US Global Investors)

These dynamics seem in the process of validating my prognostications

Capital inflows coupled with domestic negative real rates regime will likely translate into serial bubble blowing dynamics.

So yes, the risks of bubbles in Asia will become more enhanced. Even the local central bank or the Bangko Sentral ng Pilipinas (BSP) has recently acknowledged of such risks which they arrogantly claim they can control.

In addition, domestic and global bubbles will increase the risks of a global stagflation which is likely slam emerging markets harder.

The risks of ballooning bubble or stagflation will likely become evident in 2013-2014.

Remember that emerging Asia (ASEAN) is highly vulnerable to inflation risks, as I also wrote earlier, 

High commodity prices are likely to influence emerging markets consumer price inflation more. Food makes up a large segment of consumption basket for emerging Asia including the Philippines. This would prompt for their respective central banks to reluctantly tighten. Monetary tightening will put pressure on the stock market.

Stagflation, thus, also represents both a contagion and internal (political and market) risk for the Philippines and for emerging Asia.

A stagflationary environment will prove to be a spoiler for stock market bulls.

But the effects of monetary inflation via stagflation will not be the same, there will select sectors that may surf the stagflation tide.

For now, these incipient signs of price inflation won’t be much of a headwind for central bank sponsored stock market and financial asset boom...until next year.

Inflation Watch: World Food Prices Jump Most in 11 Months

And speaking of markets forcing the hands of central bankers, current developments in the commodity markets seem to be providing us some clues.

From the Bloomberg,

Global food prices rose 1.9 percent in January, the biggest gain in 11 months as the cost of oilseeds, dairy and grains increased, the United Nations Food and Agriculture Organization said.

An index of 55 food items climbed to 214.3 points from a restated 210.3 points in December, the Rome-based FAO said on its website today. All commodity groups in the index advanced, according to the UN agency.

Costlier food is driving up living costs in China, home to about a fifth of the world population. Chinese inflation unexpectedly accelerated in January on the back of food prices, which rose 10.5 percent last month compared with a year earlier, up from 9.1 percent in December, the country’s National Bureau of Statistics reported today.

“International prices of all major cereals with the exception of rice rose in January,” the FAO wrote. “Prices of all the commodity groups that compose the index registered gains, with oils increasing the most.”

Despite the 2008 crisis which has proven to be a reprieve and the temporary hiatus from last year’s slowdown, FAO’s food index (chart from Bloomberg) has resumed its ascent as global central banks embark on a negative real rate environment while central banks of major economies rev up on quantitative easing measures.

And it is not just in food, in the pump prices in the US has also began to inch higher.

(From Wall Street Journal Blog)

Consumer price inflation has already been staring in the faces of the mainstream experts and authorities, mostly of the Keynesian-Fisherian 'deflation' persuasion, who remain in deep denial……perhaps until CPI index goes berserk.

Censorship as Price Controls

The problem of inflation has usually been met by policy responses of price controls. This basically signifies deflection of culpability from government policies to the private sector.

But when reality becomes too hard to contain, the next step would be for government to impose censorship on media so as not to upset the political environment.

Argentina seems to be applying this recourse.

Reports the Wall Street Journal, (hat tip: Douglas French of Mises Blog)

Argentina's government has filed criminal charges against the managers of an economic consulting firm, escalating its persecution of independent economists.

A federal court official said Friday that a judge is evaluating the charges but has yet to decide if it is appropriate to begin investigating them.

The government is charging MyS Consultores with "publishing false information about inflation data" to benefit themselves and their clients. The criminal complaint alleges that MyS's data also lead to speculative behavior in Argentina's bond market.

MyS Managing Partner Rodolfo Santangelo described the charges as "ridiculous" and said the firm's inflation data do not affect financial markets.

Consumer prices rose 9.7% in May from a year ago, according to the national statistics agency, Indec. But virtually all economists say annual inflation surpasses 20%—one of the world's highest rates—angering government officials who dismiss inflation as a problem.

It won’t be long when such machination will be applied elsewhere including the Philippines.

Rising Inflation Expectations: Why Macro Economists Can’t See It Coming

This is an example why macro-models used by mainstream experts don’t get it.

From the Wall Street Journal Blog (bold emphasis mine)

The Federal Reserve expects higher price pressures to be “transitory.” But other economic players aren’t so sure.

A new survey of finance professionals done by J.P. Morgan shows core inflation expectations are rising around the world.

In the U.S. specifically, the mean response is that core inflation, as measured by the consumer price index excluding food and energy, will be running 1.8% a year from now. That is up from 1.4% when the survey was last done in November and up from February’s actual reading of 1.1%. The survey polled about 750 respondents, with about 40% from North America.

The report notes the recent jump in oil prices and the longer-running increase in commodity prices may be skewing responses. But the report notes core inflation rates have already been rising in the U.S. and the U.K.

Duh?!

Core inflation expectations have long been rising around the world! Don’t these experts see that the REVOLTS in the Middle East have partly been triggered by record food prices??!!!

Chart from Business Insider

Next, price pressures are “transitory”???!!!

The IMF even says that people should get used to high food prices for all other reasons except macroeconomic government policies. The IMF is part of mainstream macro.

From the Bloomberg,

Consumers should get used to paying more for food, after prices rose to a record, because farmers will take years to expand production enough to meet demand and drive down costs, the International Monetary Fund said.

People in developing countries are becoming richer and eating more meat and dairy, meaning more grain for livestock feed and land for grazing animals, Thomas Helbling, an adviser for the IMF’s research department, and economist Shaun Roache wrote in an article. Rising demand for biofuels and bad weather also tightened supply, they said.

“Rising food prices may be here to stay,” Helbling and Roache wrote in the article published in the agency’s Finance & Development magazine. “The main reasons for rising demand for food reflect structural changes in the global economy that will not be reversed.”

True, food prices signify a minor component in the household expenditure pie for developed economies. But that doesn’t mean that rising oil, food and commodity prices won’t spillover to the rest of the economy. Eventually they will!

Chart from Northern Trust

When models try to isolate variables from people’s action (like isolating food and energy from inflation index as shown above-right window), then experts tend to underestimate real social activities, like inflation.

People do not act based on one or two or select variables. Our actions are bundled, as I previously wrote

We cannot isolate one variable from the other. People’s actions are responses to an ever dynamic “bundled” environment shaped by laws, markets, culture, environment, etc...

Bottom line: macroeconomics tends to deal with superficial issues that are bottled up in laboratory environment models rather than lay blame on what truly causes CPI inflation—inflationism (low interest rates and money printing) and interventionism (price controls, subsidies and etc..).

ASEAN Bourses Undergoing Interim Correction

Since the advent of 2011, the Philippine Phisix has been on a losing streak.

In four out of the five weeks into the year so far or a string 4 consecutive weeks in the red, the Philippine benchmark has accrued a year-to- date decline of 10.76%

Regional Event and Seasonality

Before jumping to conclude about what’s been ailing the Phisix, we should take note of the following:

Figure 1: Bloomberg: Correcting ASEAN Bourses

One, this has been a regional phenomenon.

As the above chart reveals, our ASEAN contemporaries (Thailand-green, Indonesia-orange) have been synchronically on a downside path since November of 2010 (with the exception of Malaysia (red).

To extrapolate, there seems no internal dynamic that has been causing the current weakness—not the Rabusa expose nor the Angelo Reyes incident. And I don’t think that local or regional consumer price inflation has reached critical levels yet to incite political hysteria.

The Philippines just posted a record economic growth during the last quarter of 2010[1], and so with Indonesia[2], whose economic growth hit a 6 year high.

One may suggest that these events account for as past performances that does not serve as a good indicator of the future, from which the markets could be be pricing in. This could be true.

And that perhaps the market could be portending of a possible downshift following a turbocharged upside momentum. This could likely be a factor, too. But I would refrain from fixating on this premise as the main causation to the current market action.

The other thing is that the current correction could signify a cyclical motion.

The white arrows on figure 1 points to general market infirmities at the onset of 2009 and 2010.

The first quarter of 2009 marked the trough of the 2007-2008 bear market which culminated with the post Lehman bankruptcy global market collapse in October 2008.

In 2010, the first quarter weakness was then attributed to the Greece Debt Crisis, where the mainstream had insisted that deflation would return, the financial market would collapse and that the Euro dies along with this. All of which we had set out to debunk[3] and had been validated or proven correct.

So it appears that we have a normal countercyclical trend unfolding before our eyes.

No Egypt and Middle East Domino Contagion

Next, no this isn’t about Egypt nor is it about Tunisia’s Jasmine revolution or the falling dominos of autocratic regimes in the Middle East.

Figure 2: Bespoke Invest: Flight To Safety, Where?

As the excellent Bespoke Invest[4] charts shown in Figure 2, there hardly has been material signs of widespread anxiety as seen in the US dollar (left window) or Gold (right window). In short many of so-called market stress attributed to Egypt has been predicated on available bias.

Going back to the ASEAN equity markets, the interim bullmarket reversals began in November 2010, way before such Middle East “People Power” movements or political events that had long been predicted by French judge, political philosopher and anarchist, Étienne de la Boétie[5], during the 16^th century who once wrote[6], (bold emphasis mine)

``Resolve to serve no more, and you are at once freed. I do not ask that you place hands upon the tyrant to topple him over, but simply that you support him no longer; then you will behold him, like a great Colossus whose pedestal has been pulled away, fall of his own weight and break in pieces.”

In addition, people always tend to fall prey to mainstream media’s soundbites, yet the media blitz over Egypt has eclipsed the Thailand-Cambodia border military skirmishes that has also accounted for as negative news[7] this week. The risk of military escalation between our neighbors has apparently been eluded mainstream analysts.

Yet, such bellicostic incident should have prompted for a collapse in Thailand’s stocks, if we go by the mainstream’s logic. But this has not been so. Thailand SET lost 3.6% over the week was even less than Korea’s Kospi 4.6% or even nearly at par with the declines registered by the Philippine Phisix 3.18%.

I’d also like to point out that the bloody street riots[8] in Bangkok, Thailand’s capital, in May of 2010, didn’t trigger a collapse in Thai stocks, in the same way as the latest political crisis in Egypt.

In other words, political events do not necessarily or automatically create volatility in stock market pricing.

Inflation Led Slowdown? Not So Fast....

Some may argue that rising inflation could be a factor.

Theoretically, inflation will not be good for equities in general because from the corporate earnings perspective—earnings get squeezed or crimped out of rising real cost of capital and losses on the net asset position that are fixed in nominal terms.

Most importantly, the biggest threat to shareholder value, writes McKinsey Quarterly[9], lies in the inability of most companies to pass on cost increases to their customers fully without losing sales volumes. When they don’t pass on all of their rising costs, they fail to maintain their cash flows in real terms.

But I would argue that the impact to equities from an inflationary environment greatly depends on the underlying state or conditions. That’s because equities have proven to be hedges during episodes of hyperinflations, such as in 1920 Weimar Germany hyperinflation[10] or most recently the Zimbabwe hyperinflation.

I quoted an All African article[11] in 2008

``The feat continued into 2008 with industrials posting a year-to-date growth of 960 quadrillion percent, which is 4,15 billion times as much as July's annual inflation of 231 million percent.

``The resource index is up 444 quadrillion percent since January. And so, from the look of things, ZSE investors may have indeed managed to hedge their assets against the effects of high inflation but some have been at a loss in US dollar terms."

A great living example of the stock market as an inflation “hedge” would be Venezuela (see Figure 3)

Figure 3 Tradingeconomics.com[12]: Venezuela Stock Market Driven By Rampant Inflation

Notice as the rate of annual change in consumer price inflation ramps up, the stock market, on a time lag, follows. As the inflation rate declines, the Venezuela’s stock market bellwether also, on a time lag, declines.

I’d like to further point out that Venezuela’s inflation rate has been at high double digits (25-35%) and appears to nearly tip over to the hyperinflation level or where inflation exceeds 50% a month[13].

The fundamental premise why stocks can function as a hedge doesn’t tag along the lines of earnings but rather on the public’s perception of the changes in the role of money—a deterioration in the “store of value” function.

As Adam Fergusson wrote about the disastrous Weimar Hyperinflation in When Money Dies[14],

October 1922, however, was the nadir for shareholders. From then on not only did money find its way back into shares, but people who could obtain cheap credit, or were unable to send their money abroad, began to realise the advantages of buying up their own country's industrial and other assets at a fraction of their true value. Although in real terms the stock market began to go up, the mark's purchasing power continued to go down.

Said differently under the state of high inflation, even if the values of shares go up, in real terms share values lose money because the money’s value erodes faster than the increase in share prices.

And those who argue on the premise where ‘company earnings determine share prices’ have found current movements in the global stock markets baffling and inexplicable. That’s because these experts have basically been focusing on the wrong aspects and has been ignoring the fast expanding role of monetary inflation’s impact on share prices[15].

Perhaps even Warren Buffett’s dramatic shift to political lobbying-crony capitalism[16] based investment approach could, in reality, be reflective of such changes.

To add, since inflation is basically a redistribution process, some industries are likely to benefit more than the others. Thus, a generalized or broadmarket decline is definitely not a characteristic of the supposed inflation based anxieties.

So all these point to an unsubstantiated premise where the decline in the values of ASEAN bourses has been imputed on the risks of inflation.

More On Growing Divergences

Here’s more: earlier we have pointed to several divergences[17] in the global market such as surging commodities, developed economy share prices and a firming Peso.

I’d like to add that one of the serious manifestations of a market meltdown/breakdown could be seen in the price actions of the local currency.

Figure 4: Bloomberg: JP Morgan Asia Dollar Index

That’s because market meltdowns tend to instigate a “flight to safety” dynamic where investors both local and foreign flee domestic capital markets and seek safehaven elsewhere abroad. In two words: capital flight.

This was demonstrably the case during the 2008 Lehman episode in 2008, (as shown by the white down arrow in the above chart) where the bellwether basket of Asian currencies represented by Bloomberg-JP Morgan Asia Dollar Index cratered.

Today, despite the quarter long weakness envisaged by the region’s stock market, Asian currencies values have remained buoyant.

Yet it is important to point out that Asian currencies tanked only during the latter half of 2008 or nearly at the pinnacle of the crisis. The Philippine Peso likewise began its descent 3 months after the peak in the local stock market.

This only means that as lagging indicators currency values can’t be used as a standalone metric to assess the state of the markets. It has to be combined with other indicators.

Finally here’s another important divergence as noted by Bespoke Invest (see figure 5)

Figure 5: Divergences in Global Markets (Bespoke Invest)

Figure 5 shows that the Exchange Traded Funds (ETF) of various emerging markets, the natural gas, various treasuries funds and gold mining issues have failed to live up to the animated performances by their contemporaries.

As Bespoke Invest[18] notes,

It's not the emerging markets in one region of the world that are struggling either. ETFs that track Brazil, Latin America, China, India, and Asia Pacific are all below their 50-days. Typically when the US market is rallying, emerging markets are rallying even more. Bulls looking to outperform the S&P 500 have been using emerging market securities to do so for multiple years now. Recently, however, this strategy has been a performance killer.

As duly noted by Bespoke, past performance can’t be expected to deliver similar results.

And it should apply opposite ways.

Although such divergences may be construed or seen by some as decoupling, it isn’t. Asian and most of emerging markets have vastly outperformed in 2010, thus given that no trend goes in a straight line, today’s relative underperformance signify as a pause or natural correction process and is likely a temporary event.

Bottom line: Current developments represent as buying opportunities.

---

[1] Inquirer.net, Philippines posts record economic growth at 7.3%, January 31, 2011

[2] Financial Times Asia, Indonesian growth hits six-year high, February 7, 2011

[3] See Why The Greece Episode Means More Inflationism, February 15, 2010

[4] Bespoke Invest Where's the Flight to Safety? February 11, 2011

[5] Wikipedia.org, Étienne de la Boétie

[6] de la Boétie, Étienne The Politics Of Obedience: The Discourse Of Voluntary Servitude, Mises.org, p.47

[7] Telegraph.co.uk Ancient temple damaged by shell fire in Cambodia, February 7, 2011

[8] See Politics And Markets: Bangkok Burns Edition, May 20, 2010

[9] McKinsey Quarterly How inflation can destroy shareholder value, Winter 2010

[10] Wikipedia.org Inflation in Weimar Germany

[11] See Black Swan Problem: Not All Markets Are Down! November 11, 2008

[12] Tradingeconomics.com, Venezuela Indicators

[13] Wikipedia.org, Hyperinflation

[14] Fergusson Adam, When Money Dies: The Nightmare of the Weimar Collapse, p.78

[15] See Stock Market Prices: Inflation versus Corporate Fundamentals, February 8, 2011

[16] See Warren Buffett: Embracing Crony Capitalism, February 12, 2011

[17] See Phisix: Panicking Retail Investors Equals Buying Opportunity, January 31, 2010

[18] Bespoke Invest Emerging Markets Not Participating in Global Rally, February 10, 2011