QE 2.0 Equals Capital Flight

We have been told that QE 2.0 has been designed to help the US economy grow its way out of the recession.

However evidence seem to show otherwise. Capital investments appear to be flowing out of the US as a result of present policies putting at risk a recovery in employment conditions.

This from Bloomberg, (bold highlights mine)

Southern Copper’s plans illustrate why the Fed’s second round of bond buying may not reduce unemployment, which has stalled near a 26-year high. Chairman Ben S. Bernanke and his colleagues appear to be fueling a foreign-investment surge, underscoring the difficulty of stimulating the economy through monetary policy with interest rates already near record lows.

“You’re seeing leakage from quantitative easing,” said Stephen Wood, chief market strategist for Russell Investments in New York, which has $140 billion under management. “That leakage is going into emerging markets, commodity-based economies, commodities themselves and non-U.S. opportunities.”

U.S. corporations have issued more than $1.07 trillion in debt so far this year, according to data compiled by Bloomberg. Foreign companies also are tapping U.S. markets for cheap cash, selling $605.9 billion in debt through Nov. 15 compared with $371.8 billion for all of 2007, before the Fed cut the overnight bank-lending rate to a range of zero to 0.25 percent.

Instead of addressing issues which genuinely distorts the balance of the US economy mostly concerning (bubble) policy induced malinvestments, the left, as always, would most likely pin the blame of capital flight on “evil” China for having an artificially suppressed “manipulated” currency.

But again the “smoke and mirror” reasoning would not be substantiated by evidence, that’s because much of the ongoing outflows appear headed towards the relatively higher valued currency of the Eurozone.

From the same Bloomberg article,

U.S. corporations’ overseas investment in the first half of 2010 exceeded the amount that foreign firms spent in the U.S. on factories and acquisitions at an annual rate of almost $220 billion, according to the Commerce Department. In the first half of 2006, the last year before the financial crisis, the net flow favored the U.S. at an annual rate of about $30 billion.

More than half of outbound investment this year landed in Europe, Commerce data show. In April, Valmont Industries Inc., which manufactures light poles and communication towers, issued $300 million in 10-year notes. The Omaha-based company said it would use the proceeds to help fund its $439 million acquisition of Delta PLC, a London-based maker of similar products.

So again, the above circumstances only goes to show that the currency elixir (snake oil panacea) embraced by mercantilists, via QE 2.0, to solve the supposed global imbalances seems to be having an opposite effect.

Yet capital flows into the Europe has occurred in spite of the unresolved debt crisis in the periphery, the PIIGS.

So it seems another vindication for Friedrich von Hayek who once wrote

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Central planners seem to mostly get their designs backwards. It’s called the law of unintended consequences.

Tumult In Global Markets: It Is Just Profit Taking

``Experience is a dear school, but fools learn in no other”-Benjamin Franklin

It is very interesting to observe how the volatility in the marketplace can intensively sway the emotions of participants. Apparently, this is the reflexivity theory—the feedback loop mechanism between prices and expectations—at work.

On the one hand, there are those whose crowd driven sanguine expectations seems to have been dramatically fazed by an abrupt alteration in the actions of market prices, where the intuitive reaction is to frantically grope for explanations whether valid or not.

Nonetheless such instinctive reactions are understandable because it signifies our brain’s defensive mechanisms as seen through its pattern seeking nature, a trait inherited from our hunter gatherer ancestors for survival purposes, mostly in the avoidance to become a meal for stalking predators in the wildlife.

For this camp, the newly instilled fear variable has been construed as the next major trend.

On the other hand, there are those whose longstanding desire for a dreary outcome. They cheerfully gloat over the recent actions that would seem to have their perspectives momentarily validated.

Permabears, whom have lamentably misread the entire run, sees one day or one week of action as some sort of vindication. This pathetic view can be read as the proverbial “broken clock is right twice a day”.

This camp claims that the recent paroxysms in the marketplace would signify as a major inflection point.

I’d say that both views are likely misguided.

The Market Is Simply Looking For A Reason To Correct

It’s not that I have been pounding on the table saying that the global markets, including the Philippine Phisix, have largely been overextended[1] and that profit-taking activities should be expected anytime.

Albeit, considering that the global financial market’s frenzied upside momentum, the unprecedented application of monetary policies and its probable effects on the marketplace, and where overextensions are common fares on major trends (bull or bear), crystal-balling short term trends can be fuzzy[2].

Besides it isn’t our role to tunnel in on the possible whereabouts of short term directions of the markets, a practise which I would call as financial astrology, to borrow Benoit Mandelbroit’s terminology.

Yet in vetting on the general conditions of the global marketplace in order to make our forecasts, we should look at the big picture.

Figure 1: Global Markets: Correction Not An Inflection Point

What is said as a ‘crowded trade’ is where the consensus has taken a position that leaves little room for expansion for the prevailing price trends. And in the paucity of further participation of ‘greater fools’, profit taking which starts as a trickle gradates into an avalanche, or the account of high volatility.

In looking at the charts of Gold (left upper window), the Dow Jones World Index (right upper window) and the Euro (left lower window) one would observe that the crowded trade phenomenon under current market conditions may have been in place since the run up began mainly from August.

I say ‘may’ because this will always be subjectively interpreted.

And for those who use the charts as guide, the intensifying degree of overextension have been evident from the departure or from the widening chasm of price actions from that of the moving averages, particularly the 50-day moving averages (blue lines).

Figure 2: Bloomberg: ASEAN Hotshots Likewise In A Corrective mode

And the same market motions seem to affect the ASEAN bourses, which of late has assumed the role as one of the world’s market leaders[3] or as one of the best performers. ASEAN benchmarks, last week, almost reacted synchronically with most emerging markets or with developed economy bourses. Decoupling, anyone?

The Philippines Phisix, which grabbed the top spot among ASEAN contemporaries, fell the most (6.26%) this week among all Asian bourses.

The last time the Phisix had a major one week slump at a near similar (but worst) degree was in the week that ended June 19, 2009. Like today, in tandem with our neighbours and global activities, the Phisix then lost 7.7% (see figure 2 blue ellipse: Thailand SET-red, Indonesia’s JKSE-yellow, Malaysia’s KLSE-green, Phisix-orange). Of course what followed was not a collapse but a febrile upside spiral from where the Phisix has not looked back.

So from the hindsight view, everything seems perfectly clear, the overheating or the overextensions, applied in current terms, may have peaked and thus has prompted for the market’s current ‘reversion to the mean’. Yet such regression should not imply a major trend reversal as it is likely to be a short term process.

And thus the current spasms seen in the marketplace is likely to account for mostly a normative profit-taking dynamic than from either a fear based regression or as a major inflection point.

I would thus carryover on my earlier advice[4],

I am not a seer who can give you the exactitudes of the potential retrenchment. Anyone who claims to do so would be a pretender. But anywhere from 5-15% from the recent highs should be reckoned as normal.

Yet, one cannot discount the potentials of a swift recovery following the corrective process. This is why trying to “market timing”, in this “growing conviction” phase of the bullmarket, could be a costly mistake.

Reflexivity and The Available Bias

The reflexive price-expectation-real events theory simply states that price actions may influence expectations which eventually reflect on real events. Consequently, developments in real events may also tend to reinforce such expectations through the pricing channel, hence the feedback loop.

Since this theory operates on a long term dimension, it plays out to account for as the shifting psychological or mental stages of a typical bubble cycle.

In other words, it would take sustained intensive price actions or major trends to trigger major psychological motions that eventually pan out as real events.

A simple illustration is that if the current market downside drift would be sustained, then the public may interpret the formative trend as an adverse development in the real world. Subsequently, people’s actions will be reflected on the economic sphere via a recession or another crisis. Hence, the price actions emanating from evolving negative events get to be reinforced in the stock markets-via a reversion to a bear market.

Unfortunately, there appears to be a problem in applying this theory in today setting; the reason is that the opinions from the marketplace seem to be tentative over what constitutes as the real cause and effect.

In short, the public’s pattern seeking character refuses to accept the profit taking countercyclical actions of the markets, and instead, looks for current events from which to pin the blame on or associate the causality nexus.

Again we understand this as the available bias.

Available Bias: China’s Battle With Inflation

There have been two dominant factors from which the mainstream has latched the recent stress in the global markets on (see figure 3): one is China’s war with inflation and the other is the political tumult over Ireland.

Figure 3: Available Bias: Ireland Debt Crisis and China’s Tightening (charts from Danske Bank[5])

Friday’s 5.2% dive in China’s Shanghai Composite Index has been ascribed to the unexpected surge in inflation data[6] that has prompted Chinese authorities to reportedly raise bank requirements[7] to stanch credit flows coupled with rumors over more interest rate increases.

The selloff percolated to the commodity markets and rippled through emerging markets which laid ground to the rationalization of the supposed contagion effects from a potential curtailment of global economic growth on a tightening monetary environment in China.

It’s funny how the mainstream repeatedly argues over a myriad of fundamental issues supposedly affecting the markets when all it seems to take is the prospects of a credit squeeze to bring about a fit in the markets. This only proves our case that global stock markets have been mainly driven by inflationism (artificially suppressed rates and the printing of money).

China has been no stranger to such interventionism where the stock markets have been repeatedly buffeted by her government’s struggle, over the past year, to contain the so-called inner demons or a progressing bubble cycle (see figure 4).

Figure 4: Shanghai Composite: Another Government Instigated Drubbing (from stockcharts.com)

If I am not mistaken these interventions were interspersed from sometime mid 2009 until the 1^st quarter of 2010. The net result over the past year has been a consolidation phase in the Shanghai Composite Index (SSEC) albeit a negative 8.9% return on a year to date basis.

Nonetheless, China isn’t likely to resort only to monetary tools but also through the currency mechanism. China would likely allow her currency to appreciate as part of the mix in her ongoing battle against bubble cycles.

And on the consumption based model, the appreciating the yuan is likely to spur internal demand that would further increase demands for commodities and trade flows with emerging markets. But this would be too simplistic, if not myopic.

Yet even if this is partly valid, then this only shows that the sell-off had been exaggerated which will likely be self corrected over the coming sessions.

The currency factor will not, by itself, likely do the trick, for the simple reason that the manifold parts of any economy have different costs sensitivity and that the distribution of costs for corporations are likewise varied in terms of ownership (private or state owned or mixed), per industry or per geographic boundaries and many other factors.

While the currency factor will partly help in the adjustment towards the acquisition of higher value added industries, a transition towards more convertibility of the yuan would allow international trade to be facilitated by China, instead of relying solely on the US dollar. Of course this could also function as one possible solution to China’s concern over the US Federal Reserve’s QE 2.0[8].

Thus more liberal trade and investment policies must compliment in the prospective adjustments in the yuan in order to have more impact.

Fixating on the currency elixir on the premise of “ceteris paribus” constants is all being out of touch with reality, applying models notwithstanding.

Available Bias: Political Kerfuffle Over Ireland

The second factor in the latest market stress, as shown in figure 3, is being imputed to the re-emergence of credit quality concerns over the periphery nations in the Euro zone, particularly that of Ireland which seems to be spreading to the other crisis stricken PIIGs.

As part of the crisis resolution mechanism, reports say that Germany’s Chancellor Angela Merkel is requiring investors to take write-offs in sovereign rescues[9]. And on this account Germany has been pressing Ireland to seek aid from multilateral institutions such as the IMF and the EU commission in transition. A route so far downplayed by the government of Ireland.

And apparently the Merkel position has clashed with that of European Central Bank Jean Claude Trichet who said that having investors to suffer from losses under present conditions would ‘undermine confidence’.

To add, the ECB’s modest purchase of government bonds[10] have reportedly not helped in allaying concerns over such political impasse. Another way to see it is that the ECB could be using the markets as leverage to extract concessions in behalf of several interest groups.

This makes the debt problems over at the PIIGS a politically motivated one.

Of course in the understanding of the ethos of politicians, should the stalemate go out of hand, we should expect hardline positions to reach for a compromise or adapt a pacifist approach unless these politicians would be willing to put to risks the Euro’s survival.

So far what is being portrayed as an infectious credit crisis, similar to the Greek episode early this year, has been largely isolated as major credit market indicators appear to be unruffled yet by the political kerfuffle in the Eurozone (see figure 6).

Figure 6: Credit Markets Still Unaffected By The Ireland

There are hardly any signs of bedlam over at the credit markets if we measure the diversified corporate cash indices in the US (left window) and or the 3m LIBOR OIS spread (right window), both measured in the US (red line) and the Euro (blue line). The 3M LIBOR OIS spread is the interest rate at which banks borrow unsecured funds from other banks in the London wholesale money market for a period of 3 months[11] and is a widely watched barometer of distress in money markets.

In fact, these credit indicators have hardly manifested any signs of contagion, even if we are to take the Greece episode early this year as a yardstick.

Figure 6: PIGS Equities Not In Unison With Credit Markets (chart from Bloomberg)

In addition, considering the record spreads between the debts of Eurozone’s periphery with that of Germany, one should expect such strains to be vented hard on their respective equity markets.

Yet despite being significantly down on a year to date basis, equity markets appears to have been little affected, as shown by Ireland’s Irish Overall Index (green) Portugal’s PSI General Index (orange) Greece’s Athens Composite Share (yellow) and Spain’s MA Madrid Index (red), all of which seem to be in a consolidation phase.

One may observe that Spain and Portugal’s benchmark seem to be trending down of late, that’s because they have been moving higher from the 2^nd quarter, this, in contrast, to Greece and Ireland whose equity markets seem to be base forming.

Thus in summing up all these, I conclude that a potential major inflection point on the global equity markets emanating from the so-called contagion risks from the aftershocks in the PIIGS credit markets as largely unfounded.

One can add signs of resurfacing of some of the debt woes of Dubai[12], yet evidence suggests that today’s market actions is no more than an exercise of profit taking finding excuse in current events.

As a final note, I’d like to further emphasize that the Fed’s QE 2.0 seems to be failing in its mission to lower interest rates as US treasury yields have turned higher in spite of the recent market pressures (go back to figure 1 bottom right window). Of course, another way to look at it is that they seem to be succeeding in firing up inflation.

Moreover, the rally in the US dollar, despite the so-called return of risk aversion, likewise seems tepid.

So there seem little signs of a repetition of 2008 as many permabears have envisioned.

Overall the current market turbulence signifies as plain vanilla profit taking unless prices would be powerful enough to alter expectations that eventually would be reflected on real events.

---

[1] See An Overextended Phisix, Keynesians On Retreat And Interest Rate Sensitive Bubbles, October 25, 2010

[2] See Should We Chart Read Market Actions From QE 2.0?, November 7, 2010

[3] See Global Equity Markets Update: Peripheral Markets On Fire, Philippines Grabs Lead In ASEAN, November 4, 2010

[4] See Political Spin On The Philippine Economy And An Overextended Phisix, October 10, 2010

[5] Danske Bank, Focus turns from QE to debt crisis, Weekly Focus, November 12, 2010 p.1

[6] New York Times, China’s Inflation Rose to 4.4% in October, November 10, 2010

[7] Wall Street Journal, PBOC To Raise Major Bank's Reserve Ratio By Extra 50 BPs – Sources, November 11, 2012

[8] Businessweek/Bloomberg China Says Fed Stimulus Risks Hurting Global Recovery, November 5, 2010

[9] Bloomberg.com Germany Said to Press Ireland to Seek European Aid, November 14, 2010

[10] Danske Bank loc cit p.4

[11] St. Louis Federal Reserve The LIBOR-OIS Spread as a Summary Indicator, 2008

[12] Businessweek/Bloomberg Dubai ruler's firm talks with banks over debt load, November 11, 2010

Laurence Kotlikoff: The Scapegoating Of China

Author and Professor Laurence Kotlikoff argues, in a Bloomberg article, that the political heat applied to China, by certain political quarters, is not justified and represents the scapegoating of China.

Here is Mr. Kotlikoff,

Nothing could be further from the truth. But the truth is much harder to find these days than scapegoats. Fortunately, economics can move the debate beyond finger pointing.

Countries that run current account surpluses save more than they can fruitfully invest at home and invest the difference abroad. Countries with current account deficits do the opposite. They save less than their economy’s investment needs and attract investment from abroad.

Surplus countries take some of the seed corn they’ve saved and plant it in deficit countries. This physical movement of the seeds, or capital, is recorded as an export of the surplus country and an import by the deficit country.

Nations with current account surpluses are net exporters and have trade surpluses. Those with current account deficits are net importers and run trade deficits. Indeed, apart from the net income foreigners earn in the U.S. and invest here, their current account surplus equals their trade surplus, and their trade surplus is, apart from a minus sign, our trade deficit.

Again Mr. Kotlikoff shows how mercantilists have been selective in applying evidence to argue for their case..

So what ails the US?

Like Morgan Stanley’s Stephen Roach, Professor Kotlikoff refers to inadequate savings. Albeit with a different twist, savings that had been squandered from excessive redistribution programs from the US welfare state.

The key question is why we aren’t saving enough to fulfill our own investment needs. The answer is a decades-long fiscal policy that has been taking more resources from young savers and giving them to old spenders. This has driven our national savings rate down the tubes.

In 1965, Americans saved 14 percent of their national income. Last year the figure was negative 1.5 percent. What’s worse, our domestic investment rate -- the ratio of domestic investment to national income -- was only 1.8 percent.

Professor Kotlikoff asks for evidences to support the currency manipulation case.

Where’s the proof the yuan is undervalued? You won’t read studies claiming our real terms of trade with China are out of whack or find a black market in yuan. Instead, you’ll see studies that measure how much China would have to revalue to dramatically lower its current account surplus. But these studies ignore that such a revaluation would lower Chinese domestic prices for toasters, leaving the net cost of Chinese products to Americans unchanged.

Too many economists seem to disregard the basics of international trade when they equate China’s trade surplus with currency manipulation. One prominent economist recently described China as “engaged in currency manipulation on a scale unprecedented in world history.”

Let’s get a grip. China is a poor country. The fact that it holds some of its wealth in dollar-denominated assets is not proof of currency manipulation. Moreover, as China’s economy grows, the amount of its overseas investment will increase too. We need to get used to the Chinese investing in our country because that is tomorrow’s natural economic order.

So why the unwarranted fixation with currency fixes?

U.S. officials should also stop accusing the Chinese of manipulating their currency. Yes, China is pegging its currency to the dollar. But this isn’t evidence, per se, of currency manipulation. As a result of the 1944 Bretton Woods agreement, the U.S. spent decades fixing its currency to those of other nations. No one accused it of unfair trade practices.

A fixed exchange rate is fully compatible with free trade because the dollar price Chinese exporters charge for their goods is the result of two things: the exchange rate and the cost, in yuan, to produce the good.

Getting the Chinese to make their currency more expensive (forcing us to pay more dollars for one yuan) won’t make Chinese exports more expensive to American consumers since the internal cost in China of producing these products will fall. The Chinese restrict their supply of yuan to make the currency appreciate relative to the U.S. dollar. When fewer yuan circulate in China, prices there fall.

As we long and repeatedly argued, the accusations of China as currency manipulator signifies as a diversion from the real culprit to the loss of US competitiveness: inflationary policies.

And the scapegoating of the China, similar to the Japan episode in the 80s, signifies as the entitlement outlook parlayed into free lunch policies.

At the end of the day, it’s never about economic reality but about political propaganda that benefits the elite minority.

Why Mercantilists Are Wrong (Again)

The Chinese yuan may not be as undervalued as expected by present day mercantilists.

According to the Economist, (bold highlights mine)

The yuan may well still be undervalued but our index suggests American manufacturing should have less to fear from Chinese competition than it did five years ago. Until June 2009 appreciation was largely because of the stronger yuan. Since then it is largely because China’s unit labour costs have grown much faster than America’s. Employers in China’s coastal factories have suffered labour shortages and strikes. America’s factories have reported strong productivity gains as they have wrung more out of the workers that survived the recession (although those gains will be hard to repeat).

Of course, China and America do not trade only with each other. China’s big surpluses and America’s big deficits depend on the real exchange rate between them and all of their trading partners. But calculating that would require timely estimates of unit labour costs for all of China’s trading partners. That is a bit too laborious.

The Economist is correct to point out implicitly how wrong present day mercantilists unduly fixate on China’s currency as the main mechanism for global trade.

These mercantilists allude to trade imbalances as the root of all economic problems and thus recommend policies grounded on ‘restoring balance’ via curtailing trade or applying protectionism (tariff, and controls) or inflationism (currency wars)

Yet the mercantilist perspective deliberately neglects or disregards all other variables or factors which mistakenly presume that the world operates in a “ceteris paribus” or an imaginary two nation world of US and China. Yes, they love to fantasize a world beyond or outside of reality.

Contrary to the mercantilist orthodoxy, trades imbalances are NOT the problem. Instead trade imbalances account for as symptoms of evolving geopolitical and world economic conditions and patterns which had been brought upon by present policies.

One of which is the Triffin Dilemma, which according to the Wikipedia.org, is the paradox by which “the country issuing the global reserve currency must be willing to run large trade deficits in order to supply the world with enough of its currency to fulfill world demand for foreign exchange reserves”.

Another is globalization.

Importantly, trade imbalancess signify as outcomes from voluntary action and not of government mechanistically engaged in trade for no apparent reason at all.

It is individuals who buy or sell services even if it is done with other individuals abroad.

Yet the mercantilist logic goes:

If I frequent my favorite pizza parlor, whose food I savor, which means I repeatedly incur a deficit with the pizza parlor, then the pizza parlor should be forced by edict to obtain my services (as a stock market agent) even if they refuse to get involved in the stock markets in order to balance our trade. By doing so, my favorite Pizza Parlor would only serve to people who they are willing to balance out which alternatively means going out of business. This circular reasoning by the mercantilists is all patent nonsense.

Individuals conduct trade to fulfil specific needs. And the division of labor and comparative advantages channelled via voluntary exchange is what allows our needs to be met. Territorial or geographic boundaries does not change this perspective.

And forcing people to balance trade would result to REDUCED trades, which ultimately leads to impoverishment via higher prices, shortages, diminished of choice of available products, inferior qualities and etc.

Besides, contrary to conventional mercantilists expectations, exports ALONE do NOT make a country prosperous. This mercantilist perspective, which aims to increase ‘surpluses’ by fiat or protectionism, actually confuses wealth with money and have long been demolished by Adam Smith (bold highlights mine)

I thought it necessary, though at the hazard of being tedious, to examine at full length this popular notion that wealth consists in money, or in gold and silver. Money in common language, as I have already observed, frequently signifies wealth, and this ambiguity of expression has rendered this popular notion so familiar to us that even they who are convinced of its absurdity are very apt to forget their own principles, and in the course of their reasonings to take it for granted as a certain and undeniable truth. Some of the best English writers upon commerce set out with observing that the wealth of a country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds. In the course of their reasonings, however, the lands, houses, and consumable goods seem to slip out of their memory, and the strain of their argument frequently supposes that all wealth consists in gold and silver, and that to multiply those metals is the great object of national industry and commerce.

The two principles being established, however, that wealth consisted in gold and silver, and that those metals could be brought into a country which had no mines only by the balance of trade, or by exporting to a greater value than it imported, it necessarily became the great object of political economy to diminish as much as possible the importation of foreign goods for home consumption, and to increase as much as possible the exportation of the produce of domestic industry. Its two great engines for enriching the country, therefore, were restraints upon importation, and encouragements to exportation.

In short, wealth is acquired through capital accumulation via savings and investment and expressed through voluntary exchange.

In truth, the undeserved obsession towards trade imbalances represent as selective perception and data mining applied by modern day mercantilists in order to justify all sorts of interventionism. They apply fallacious ‘cart before the horse’ reasoning.

Seen from the bigger picture trade deficits are part of the international transactions that can be seen from Balance of Payment (BOP) data where trade deficits are fundamentally offset by capital flows.

Professor Mark J. Perry points out that under double-entry accounting, debits have to equal credits, which applies to BOP accounting:

BOP = CURRENT ACCOUNT + CAPITAL ACCOUNT = CREDITS - DEBITS = 0

Professor Perry additionally writes,

The current account and capital account are the two main components of the U.S. Balance of Payments (BOP), which is a record of all international transactions for both: a) trade flows and b) capital flows in a given period. Every international transaction (e.g. export, import, U.S. investment abroad, foreign investment in the U.S.) is recorded on a double-entry accounting basis, so that each transaction involves both a debit and credit.

Professor Perry further notes that alarmism over deficits are unwarranted for the following reasons: (bold highlights mine)

1. There are no BOP deficits once we account for all international transactions, both for: a) goods and services, and b) financial transactions. For all of the one-sided coverage in the press about the "trade deficit," you would almost never even know that there is an offsetting "capital surplus" or "capital inflow." It's important for the general public to understand that trade deficits are offset by capital inflows on almost a 1:1 basis, resulting in a "balance of payments" for international transactions. When the public constantly hears about "trade deficits" without any understanding of the offsetting surplus, that economic ignorance allows politicians and special interest groups to exploit the general public, by advancing and promoting protectionist trade policies aimed to reduce the "trade deficit," or by refusing to approve trade agreements between Chile, Panama and Korea, etc.

2. The "trade deficit" generates so much negative coverage, that the significant advantages of capital inflows from abroad get frequently overlooked. Since 1980, the U.S. has attracted almost $8 trillion of foreign investment, which has provided much-needed equity capital that has allowed U.S. companies to start or expand, has provided much-needed debt capital that has also funded the expansion of American companies, along with providing debt capital for U.S. consumers in the form of mortgages, student loans, and car loans. Some of the $8 trillion of investment includes billions of dollars of Foreign Direct Investment, which has funded thousands of new projects in the U.S. (Toyota factories for example) and created hundreds of thousands of jobs.

This goes to show that “imbalances” serve more as political talking points meant to promote dogmatism than of observing factual operating circumstances.

Moreover what matters most is what mercantilists refuse to bring up in the imbalance debate: what seems to ail the US, isn’t China, but the entitlement mentality effected by the political leadership through inflationary policies (such as the recent housing bubble).

The negative effects of inflationism can be broken down into the following

-diverts resources to one that is not desired by the markets.

-crowds out the private sector

-generates systemic malinvestments.

-causes overvaluation in assets or the currency.

-misallocates the distribution of economic weighting towards areas preferred by government at the expense of the consumers.

-raises the costs of living.

-distorts corporate profitability and income streams

-raises the cost of doing business which translates to reduced competitiveness

-destabilizes the economy from the boom bust cycle which eventually leads to a consumption of capital.

The mercantalism-inflationist agenda does the opposite of what it intends to accomplish.

Applying real life examples, if the mercantilists-inflationists school is correct then Zimbabwe, North Korea, Cuba and Burma should have been the most prosperous countries (having been closed economies).

Ironically, the opposite is true, nations that have been economically free, are those whom have been prosperous.

Unfortunately reality isn’t what mercantilists are concerned with. Political religion is.

Quote Of The Day: Germany’s Export Strength Comes From Competitiveness And Not Surpluses

My quote of the day comes from Germany’s Finance Minister Wolfgang Schäuble (Wall Street Journal)

Germany's exporting success is based on the increased competitiveness of our companies, not on some sort of currency sleight-of-hand. The American growth model, by comparison, is stuck in a deep crisis…The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base. There are many reasons for America's problems—German export surpluses aren't one of them.

Some public officials get it right.

Emerging Asia Surpasses EU As Top US Export Destination

This should be a very interesting and promising development-Asia has surpassed the EU as the biggest US export market!

As reported by the Wall Street Journal Blog, (all bold highlights mine)

``Yet John Lonski, chief economist at Moody’s Investor Service, points out an interesting nugget within the March trade figures, released on Wednesday by the Commerce Department, in a note to clients today. March was “a watershed month,” he says, as “For the first time in recorded history, the moving 12-month sum of $227.6 billion of U.S. merchandise exports to Asia’s emerging market countries surpassed the… $223.7 billion of such exports to the European Union.”

``In the year through March, he notes, U.S. merchandise exports to emerging Asia — which includes China, India, Hong Kong, Taiwan, Korea plus a handful of smaller nations — rose by 3.7% while shipments to the EU dropped by 13.9%. In other words, U.S. exports to Europe have already been dwindling while Asia has become an increasingly important destination for U.S. goods. That should help U.S. companies avoid too much of a hit from euro zone woes.

``But the development carries risks of its own: Asian economies are growing so strongly at the moment that China in particular is scaling up efforts to damp inflation through tighter monetary policy. While a “soft landing” outcome in which the Chinese economy slows to say at 8% annualized growth rate would be ideal, a harder landing whereby higher interest rates slow demand precipitously can’t be ruled out. Indeed, it’s one of the top risks to the global growth outlook. Though much attention has been focused across the Atlantic lately, it’s actually the Pacific Rim which perhaps should merit closer scrutiny."

As we'd habitually point out, social actions are always dynamic, where people respond to ecological changes rather than being static-except in the eyes of retrogressive anti-development protectionists.

Moreover, the trade and competitive issues are not predicated solely on currency values (or the pixie dust economics for mercantilists), but on many many many factors such as the willingness or openness to trade, economic freedom, hurdle rate, market size and composition and relative costs in terms of tax and regulatory compliance costs, transaction costs, accessibility to finance, raw materials, technology, communication, labor and infrastructure, quality of communication and infrastructure platforms, accessibility to labor, relative labor costs, labor regulations, labor productivity and etc...

Otherwise this shifting trade development wouldn't be happening.

Moreover, this also goes to show of the broadening importance of Emerging Asia's role in global trade.

So yes the composition of world trade is changing, so will geopolitics.

Asia Needs Investments More Than Consumption

The Economist NAILS IT this time (well conceptually speaking).

Asia needs more investments more than consumption.

According to The Economist, (bold highlights mine-and comments added)

``ASIA’S current-account surpluses have been widely (if unfairly) blamed for causing the global financial crisis. Large inflows of foreign money helped inflate America’s housing bubble, the argument runs. Many Western economists say that Asians should squirrel away less of their income and consume much more. But a more rigorous analysis suggests that in most Asian economies it is investment, not consumption, that is too low.

[I would add that experts proposing a currency elixir to resolve so-called global imbalances, are those living in NEVERLAND ignoring the fact that every economy operates on different structures, e.g. market, capital or production, regulatory and etc., would mean more than just a single dimensional approach. The implication, say for example, for China to expand domestic demand is to generate a credit bubble, similar to the Japan in the 80s]

``Even economists who believe that most of the blame for the crisis lies in Washington, DC, argue that Asian economies need to shift from exports and investment to consumption as their new engine of growth. In “The Next Asia”, a recently published book, Stephen Roach, chairman of Morgan Stanley in Asia, calculates that consumption in emerging Asian economies fell from 65% of GDP in 1980 to 47% in 2008. American consumer spending, by contrast, accounts for more than 70% of GDP. “Until export-led growth gives way to increased support from private consumption,” he argues, “the dream of an Asian century is likely to remain just that.” His prescription certainly applies to China, where private consumption fell to only 35% of GDP in 2008. But what about the rest of Asia?

``A country’s current-account surplus is, by definition, equal to its domestic saving minus its domestic investment. So Asian economies can reduce their surpluses by saving less (ie, consuming more) or by investing more. Which route is appropriate depends in part on why their current-account surpluses widened during the past decade. In China the blame lies entirely with saving, which rose faster than its investment rate. (India’s saving rate climbed just as steeply, but it was matched by an even bigger jump in investment, which kept its current account in deficit.)

As we tackled in Dueling Keynesians Translates To Protectionism? the principal goal is to produce so as to be able consume, as Adam Smith argued centuries ago, ``Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce."

Hence any arguments based on heuristics (mental shortcuts) and or oversimplification of facts and theories, particularly on the currency magic wand, would be fallacious.

Besides, for experts to argue for imposing on other countries is to engage in reckless overweening presumptions- this risks provoking antagonism that would undermine or worsen the present conditions that would likely result to the opposite goals.

chart from SocGen's Albert Edward/Tyler Durden of Zero Hedge

Moreover, the liberals' proclivity to immerse in fingerpointing fundamentally shifts domestic policy failure accountability to other parties. As in the above, global investments has been MORE than savings which implies that the world, specifically the G-7 countries, has engaged in inflationism. Therefore, theories such as the "global savings glut" is nothing but an attempt to divert policy failures to others and at the same time justify inflationism.

Finally back to the Economist, ``A report by the Asian economics team at Barclays Capital concludes that to reduce their excess saving, most Asian economies need to invest more rather than consume more. Higher investment, especially in infrastructure, they argue, would not only reduce current-account surpluses but also boost growth and living standards. Better roads and railways would help farmers get their produce to cities and enable manufacturers to export their goods abroad. Clean water and sanitation could raise the quality of human capital, thereby lifting labour productivity."

Here we depart with the Economist or with Barclays Capital.

As seen in the earlier chart, Asia has engaged in massive spending during the early 90s but this didn't translate to the desired outcome. Yet the article didn't touch on why higher spending didn't engender domestic demand.

Well it's because investments then hasn't been directed at WHAT the market wants or needs, but instead had been fostered by bubble policies and profligate government spending which eventually led to the Asian Financial Crisis of 1997.

Moreover, as we previously argued, the protectionist-state capitalism model adapted by many Asian nations, e.g. ASEAN states, severely impeded market based investments.

Nevertheless, ASEAN and East Asia's thrust to integrate regionally and globally can be read as a major positive development going forward. [see Asia Goes For Free Trade]