Behind Ukraine’s Bank Run

The emerging market Bank run has now spread to political crisis stricken Ukraine. 

From Bloomberg:

Ukraine’s deadly clashes prompted OAO Sberbank to stop offering loans to individuals in the country less than one year after it opened 50 branches there, Chief Executive Officer Herman Gref said.

Russia’s biggest bank, which closed three branches in downtown Kiev this week as violent clashes killed at least 77, has also witnessed a “run on” its automatic teller machines in the country, Gref told reporters in Moscow today. The hryvnia, which is managed by Ukraine’s central bank, plunged almost 8 percent against the dollar this year and non-deliverable forward rates show it will slump another 11 percent in three months….

Growing pressure on the currency could lead individuals to rush to pull money from Ukrainian bank accounts, Dmitri Barinov, a money manager overseeing $2.5 billion of debt at Frankfurt-based Union Investment Privatfonds, said Feb. 18.

Political instability has been blamed on the “bank run” while ignoring the fact that Ukraine has been in a recession even prior to the current political crisis. 

The World Bank during the 2nd quarter of 2013 outlook even notes of the Ukraine’s government’s spendthrift ways even during the recession. (bold mine)

Weak economic performance resulted in a significant budget shortfall in the second half of 2012. Actual revenue of the central budget was UAH 33 billion (2.5 percent GDP) lower than initial budget plan because both real GDP growth and inflation were lower than the forecast on which the budget was based. Meanwhile, expenditures remained inflated due to a hike in social spending (by over 2 percentage points of GDP) introduced in Spring 2012. Fiscal deficit (general government definition) reached 4.5 percent GDP in 2012. In addition, structural deficit of the state-owned company “Naftogaz” was not addressed.

I also pointed out that this has not just been the government, but the private sector sector has been engaged in a debt financed-borrowing spree.

Ukraine’s credit as % to gdp as of 2012 (based on World Bank Data)

Ukraine’s banking sector credit as % of gdp as of 2012.

As you can see Ukraine’s debt levels in both dimensions has more than doubled since 2005.

What the credit inflation has done? Well it has inflated two incredible stock market bubbles in a span of about 5-6 years (2007-12).

Like the first stock market bubble collapse, the second coincided with a recession. The imploding stock market bubbles has now segued into a currency meltdown.

The question unaddressed is how much of money has been lent by the banks to the private sector that had been funneled to inflate such stock market bubbles? How much had been borrowed in foreign currencies?

To what degree have Ukraine’s banks have been affected by deterioration in loan quality? 

So given Ukraine’s Wile E. Coyote moment, 'bank runs' would seem as natural consequence as bank assets deteriorate in the face of fractional reserve banking, a recession, escalating shortage of liquidity and debt deflation.

And banks can hardly rely on the public sector support because Ukraine government has been cash strapped, she desperately sealed a financing deal with Russia in December 2013

In short Ukraine’s economic crisis, primarily due to inflationism or bubble blowing policies, set stage for this political crisis. The likely ramification from the Ukraine's economic crisis is that more bank runs will occur.

I don’t deny that politics have become a factor. But this is a consequence rather than the cause. 

Ukraine’s economic crisis has only deepened the polarization of Ukraine’s fragmented society via partisan politics. Geopolitics may even have been involved here. Some have even alleged that the US has been operating behind the scenes in fomenting another Orange revolution

Because of Russia’s intensive exposure in Ukraine in terms of culture (Russian population in Ukraine) and embedded interests in the energy sector, aside from perceived threats from a supposed US ‘encirclement strategy’ of Russia, where a new US friendly government in Ukraine will be enticed to join NATO.…Russia has reportedly declared that she is “prepared to fight a war over the Ukrainian territory” using the Russian population as cover.

So Ukraine’s crisis can easily metastasize into a international geopolitical crisis. 

And while Ukraine has just signed a peace deal, this serves as no certainty that the political crisis has passed. Russia, a major influence to Ukraine's politics, didn’t join the accord.

What is likely to aggravate the political conditions will be sustained economic uncertainty brought about by Ukraine’s earlier bubble blowing policies amidst heated tensions from culture based politics inflamed by geopolitical interventions.

Anyway the above charts from the World Bank demonstrates why relative debt position seem irrelevant in the measuring of credit risks.

Ukraine’s debt in terms of nominal USD stock has been lower than many developing nations or emerging markets equivalent. This can also be seen in terms terms of % of gdp but at a much lesser scale. Yet Ukraine’s government recognized her near bankruptcy last year.

Debt tolerance has been always based on independent valuations from creditor’s perception of the capacity and willingness of debtors to settle indentures which differs from country to country. When a critical mass of creditors begin to call on the loans, the crisis becomes apparent--one symptom "bank runs".

Going back to the bank run, again if Ukraine’s economic crisis intensifies then more bank runs should be expected.

Yet increasing accounts of emerging market bank runs such as in Thailand, Kazakhstan and now Ukraine, aside from China’s continuing bailouts of delinquent financial institutions demonstrates why the EM crisis have not been over. And as reminder, all these has transpired in a span of two weeks.

And contra the bulls, this may just be the tip of the iceberg.

Phisix: Will Abenomics trigger a “Sell in May”?

"Reason obeys itself; and ignorance does whatever is dictated to it."- Thomas Paine

Does “Sell in May” Apply in the Era of Activist Central Banking?

“Sell in May and go away” has been a popular Wall Street axiom that has been premised on the seasonal, particularly semestral, effects of stock market performance. Some people use this as their portfolio management strategy. The idea is to avoid the sharp downside volatility which periodically besets the equity markets during September and October and to reposition back on November. So basically the strategy entails a semi-annual exposure on the stock markets. Such approach suites people who trade the market over the short-term. Besides given the short term nature of stockmarket investing this should benefit brokers more rather than real investors.

But like any patterns, they can be defective. Investopedia.com rightly notes of its supposed drawback[1], “market timing and seasonality strategies do not always work out, and the actual results may be very different from the theoretical ones.”

The answer to this is simple: history hardly functions as reliable indicators of the future.

In today’s environment where central bank policies increasingly determine the direction of asset prices, comparing with previous accounts would most likely be rendered inapplicable or irrelevant. That’s because in the past, markets has had more freedom or has significantly been less intervened with. Current direction has been towards more interventions, thereby more distortions.

Multiple accounts of Parallel universe or flagrant disconnect between financial markets and the real economies have been the hallmark of the era of activist central banking. Current global market conditions have been operating on uncharted territories.

The same operating principle applies to the Philippine financial markets too.

The Moody’s “No Property Bubble” Redux

The domestic markets have been seduced by easy money policies, particularly zero bound rates, which the consensus interprets as “sustainable”. The allure of easy money policies has also been reflected on current populist political dynamics.

Without looking under the hood, and by imbuing hook, line and sinker the blandishments by the mainstream media, the politicians and vested interest groups, the markets have unduly embraced the “This Time is Different” outlook.

New order thinking such as “The Rising Star of Asia” and the latest defense of “No Property Bubble” both of which emanates from the US credit rating agency Moody’s are wonderful examples.

Moody’s “No property bubble” defense has mainly been a narrative of the reclassification of the real estate loans (REL) statistics from the local central bank, Bangko Sentral ng Pilipinas’ (BSP) and an expression of steadfast faith on the same institution. The Moody’s expert who preaches on the use of economics then confuses statistics with economics[2]. 

Their analysis apparently fails to adhere to the lessons of history; an explosion of world banking crisis had been largely due to the inflationist policies by central banks undergirded by the paper money system. Incidences of banking crises ballooned after the closing of the Bretton Woods gold exchange standard in 1970 or the Nixon Shock.

Central banks and governments find inflationism as convenient instruments to promote political objectives which results to an eventual blowback. Hence the boom bust cycles.

Yet officials of the Moody’s hardly see the one of the most important factors in identifying bubbles: the trajectory.

At the current rate of growth, debt levels will proximate if not surpass the 1997 high by end of this year. The big bosses of the BSP discount or dismiss such risks because they use neighboring debt levels to compare with.

For instance it would be easy to dismiss the risks of debt when domestic debt can be seen as vastly smaller than the regional counterparts (see upper window[3], this chart will be used also in my discussion of Abenomics).

Yet such apples and oranges comparison has been predicated on the false assumption that the operating frameworks of the political economies of the region are similar. From culture, to political institutions, to degree of market environment, there are hardly any material similarities. And like individuals, each country has a distinctive thumbprint. So relative comparisons should only be based on accounts of high degrees of similarities which should be rare.

And as history has shown and previously discussed[4], there is no line in the sand for a credit event to happen (lower window). For instance, credit events occurred in India, Korea and Turkey (1978) even when the external debt ratio had been low by debt standards.

In short, all countries have unique levels of debt intolerance.

Aside from the trajectory, another very important pillar which has been overlooked is the incentives that drive the trajectory. Zero bound rates have increased appetite for debt accumulation from both the private sector and the government. Credit rating upgrades also reward debt. Thus zero bound rates which prompts for yield chasing speculations through debt accretion will be compounded by credit upgrades.

The feedback loop in the yield chasing dynamics from credit easing policies has been evident even in the US. Rising prices feeds into mounting debt and vice versa. In terms of margin debt, as of April this year, NYSE’s margin debt at $384,370 has eclipsed the 2007 July high of $381,370 as US equity markets reach a milestone[5].

Zero bound rates and credit upgrades will also serve as incentive for the government to spend more by borrowing more. So both the public and private sectors’ increasing debt exposure comes in the expectations that the regime of low interest rates have become a permanent feature.

Additionally, statistics can be distorted. For instance, today’s vigorous statistical economic growth has been magnified by a credit boom which effectively shrinks debt ratios. Unknown to most, once the boom reverse, such ratio will explode to the upside. This will be compounded by “automatic stabilizers” or technical gobbledygook for government rescues or bailouts which will be allegedly used to provide “cushion” to an economic downturn but in reality benefit the politically favored.

We don’t even have a crisis but current policies have already been calibrated towards a crisis fighting mode from both the fiscal and monetary policy fronts.

Aside from record low interest rates, on the fiscal front, the Philippine government’s budget deficit[6], according to a recent report, will more than double in the first half of this year (Php 84.66 billion) compared to the same period from last year or 2012 (Php 34.5 billion) as growth in expenditures (18.9%) outweighs the growth in revenue collection (13.16%).

So how will this be funded? Naturally, by debt. What the heck are low interest rates for???!!!

So Moody’s does not see or refuses to look or simply denies the causal link between the incentives from such policies and its effect on the markets. Yet we seem to be witnessing both the government and the private sector in a debt financed spending splurge.

No matter, denials will not wish away existing problems.

As an analogy, a man ignores the risks of having to swim in an open sea with a fresh wound. Somewhere he finds himself being encircled or surrounded by sharks. Experts from Moody’s would probably make a risk assessment by identifying the shark/s and cite statistics showing the world incidences of shark attacks[7] from such specie/s, as well as, the history of local occurrence, the time of the day, water temperatures and many more, to compute for the statistical odds. Using this information plus since the sharks have not made any aggressive move yet, Moody’s will likely declare “No Shark Attack risks”.

Meanwhile common sense should suggest that a shark attack seems imminent for one basic reason: sharks smell food from the blood emitted by the man’s wound, which is the reason they are sizing up the man through encirclement passes and awaits the opportunity to pounce on him. So the man has to act to immediately by finding a way how to defend himself or work to cover on his injury, rather than just float, relax and enjoy the presence of what seems as ambling water predators.

Such is the stark difference between the use of statistical logic which predominates on the consensus mindset and the causal realist[8] reasoning.

And such also reveals of how the bubble mentality works. The appeal to statistics functions like a mental opiate that reinforces the Panglossian view that artificial booms will everlastingly blossom. 

Global stock markets have been under pressure last week, mostly due to the tremors from “Abenomics”.

But for the Philippine markets, there seems to be no such thing as risks from “Abenomics” or anything in the horizon.

This comes from the marketplace whose convictions have become entrenched that there is no way but up, up and away! This applies to politically correct themes. On the other hand, politically incorrect themes have been seen as perpetually condemned.

As analyst Sean Corrigan neatly describes the illusions from groupthink[9]

Even if the monetary fuel for this whirl of self-reinforcement is not lacking, the market still needs a narrative around which it can cluster psychologically. It needs a canon of shared myth about which the bard can weave a reassuringly familiar refrain so as to reinforce the sense of community when the members of the clan gather to listen to his warblings amid the flickering fires and guttering torchlight of the Great Hall at night

Nonetheless, this week has been a rerun of last week. Strong start, soft finish.

At the end of the day, the Phisix still closed at essentially record highs, off by only a fraction.

Deep convictions will only be undermined when a big unexpected event is enough to jolt back senses to reality.

Abenomics in Hot Water!

 

The bubble outlook has not just really been about the Philippines. Such manic character has assumed a global presence.

The intensifying use of “something for nothing” policies, promoted by media, vested interest groups, the political class and their allies, has surely been getting a lot of fans particularly from the short term oriented and yield chasing crowd as shown by buoyant markets.

One strong statistical growth data from “Abenomics” has been enough to merit a magazine cover from the Economist[10] depicting Japan’s Prime Minister Shinzo Abe more than a rock star but a superhero! And I’ve encountered studies and articles with headlines: “Abenomics Works!” or “Abenomics is the only thing!”.

Yet magazine covers can occasionally serve as useful indicators of extreme sentiments, a crowded trade or major inflection points of markets.

The ruckus over at Japan’s bond markets last Thursday which prompted for a one day crash in Japan’s stock market has been rationalized by media as having been spooked by US Fed Chair Ben Bernanke’s comments[11]. 

Thursday, the key Japanese benchmark Nikkei tanked by 7.3% (upper window) while the Topix dived by 6.9%.

But such imputation has hardly been accurate. Yields of Japanese Government Bonds (JGB) have surged since the Bank of Japan’s (BoJ) announcement of the doubling of her monetary base, during the first week of April. The BoJ will incorporate buying assets to the tune of ¥ 7.5 trillion ($78.6 billion) a month[12]. Later this has been revised to ¥7 trillion ($71.41 billion)[13].

One would note that despite the huge interventions by the Bank of Japan last Thursday and Friday which brought down the 10 year yield to 1% to .82%, yields across the curve[14] except the 2 year remains significantly up over the month.

This means that if there has been any influence from Bernanke’s threat to withdraw stimulus such served as aggravating circumstance.

Mainstream media immediately downplayed the role played by the marginal decline by US stocks in response to the Japan rout.

Media instead shifted the blame on China’s manufacturing contraction. Just look at the headlines on the day following the Japan crash: From Bloomberg “U.S. Stocks Retreat on China Data, Stimulus Speculation[15]” and from BBC “Global stocks markets hit after Chinese data and Fed comments[16]”.

Look at the earlier chart showing China’s PMI. Following a brief jump during the late 2012, the HSBC Purchasing Managers Index turned the corner late 2012 and has been on a DECLINE through this year. Thus the downshifting trend shouldn’t have been seen as a surprise. Falling commodity prices also has partly been reflecting on such dynamic.

The real shocker has been Japan’s twin stock market and bond market crash which clearly had been a “fat tail” event considering the parabolic surge of Japan’s equity markets. Importantly such dramatic ascent has been due to the cheer leading and heavy evangelism by media in support of Abenomics.

In short, for the consensus, Abenomics can take no blame. Japan’s financial market crash has essentially been whitewashed!

Nevertheless Abenomics is in hot water.

Abenomics: Digging Japan Deeper into the Hole

Deliberate disinformation or not, the current convulsions of the Japanese markets proves my earlier point[17]: 

Abenomics operates in a logical self-contradiction. While the politically and publicly stated desire has been to ignite some price inflation, Abenomics or aggressive credit and monetary expansion works in the principle that past performance will produce the same outcome or the that inflationism will unlikely have an adverse impact on interest rates, or that zero bound rates will always prevail.

The idea that unlimited money printing will hardly impact the bond markets is a sign of pretentiousness.

But there seems to be a more important reason behind Abenomics; specifically, the Bank of Japan’s increasing role as buyer of last resort through debt monetization in order to finance the increasingly insatiable and desperate government.

First of all considering a political economy whose debt is 24 times (see first chart) central government tax revenues[18], this makes Japan ultra-sensitive to interest rate risks and subsequently rollerover and credit risks.

Since inflationism represents a transfer from creditor to the borrower, or a subsidy to the borrower at the expense of the saver, the prospects of higher price inflation means creditors will demand for higher interest rates to compensate not only for assuming credit risks but also to cover for purchasing power losses from price inflation.

Should the credit transactions fail to consummate due to the dearth of agreement on interest rates between parties, the prospects of higher inflation would mean that savers will opt to spend their money, seek safehaven through hard assets or search for alternative assets or currency overseas which embodies capital flight.

The updated quarterly newsletter from Japan’s Ministry of Finance shows of the huge schedule of JGBs due for rollover this year ¥114.18 trillion and ¥79.04 trillion in 2014 (top window)[19].

The biggest owners of JGBs are the Japan’s financial sector particularly the banking system 42.7% life and Nonlife insurance 19.2% Public and private pension funds 7.1% and 3%, respectively. The financial sector accounts for 72% of the JGBs.

So considering the BoJ’s expressed inflation target of 2% these institutions will become natural sellers of bonds.

Banks have indeed become sellers, according to the Bloomberg[20]:

Japanese banks, which had been using their excess deposits to buy government bonds, have reduced their holdings as the central bank increases purchases. Lenders had 164 trillion yen of the securities in February, down from a record 171 trillion yen in March last year.

A sustained turmoil in the bond markets will jeopardize the refinancing of these maturing bonds, substantially raise the costs, may prompt for the accelerated selling by these institutions and increase the imminence of the risks of a default.

The same article notes that the Japanese authorities have been circumspect of risks posed by surging yields, from the same article:

Japan’s debt-servicing costs will rise 100 billion yen for each 10 basis-point increase in yields, Finance Minister Taro Aso said May 16

In a 2012 paper the IMF adds that higher rates will undermine capital from Japan’s banking and financial system[21]

Interest rate risk sensitivity is especially prevalent in regional banks and insurance companies (JGBs representing about 70 percent of life insurers' securities holdings and 90 percent of insurance cooperatives’ securities holdings). In addition, the main public pension scheme, as well as Japan Post and Norinchukin bank, also have large JGB exposures…

According to BOJ estimates, a 100 basis point (parallel) rise in market yields would lead to mark-to-market (MTM) losses of 20 percent of Tier-1 capital for regional banks (not taking into account net unrealized gains on securities), against 10 percent for the major banks.

Soaring interest rates will also weigh heavily on interest payments. Former controversial Morgan Stanley analyst, Andy Xie, now an independent economist, expects that at 2% interest rates, “the interest expense would surpass the total expected tax revenue (this year) of 42.3 trillion yen.[22]" Hedge fund manager Kyle Bass also sings almost the same tune noting that at 2% interest rate interest expense would comprise 80% of tax revenues[23].

In short, PM Abe and BoJ’s Kuroda have been now caught between the proverbial devil of supporting financial markets and the deep blue sea-the possible overshooting inflation target.

This also shows how authorities, despite the knowledge of risks, prefer short term solutions that come with a greater cost in the long run. Abenomics represents a political gambit whose consequence the Japanese citizens will have to bear.

Even before the last week’s turbulence, the BoJ’s bond buying according to the Wall Street Journal “will be equal in size to 70% of all new JGB issuance each month”[24]. Wow.

And given the burgeoning fiscal deficits[25] by the Japanese government which hedge fund manager Kyle Bass estimates at around ¥50 trillion a year[26], the BoJ’s programme of ¥60 trillion to ¥ 70 trillion ($683 billion) a year in asset purchases[27] will leave little room (¥10-20 trillion) for the BoJ to wiggle to institute financial stability measures.

The riot in Thursday’s bond markets prompted the BoJ to inject ¥2 trillion ($19.4 billion) which according to an article from the Bloomberg[28] signifies as the “second such market-calming infusion this month”. In other words, at the current rate and scale of stabilization measures, it will take only 5-10 “market-calming” sessions to wipe out the contingent ¥10-20 trillion fund.

This only means that the BoJ would need to substantially expand the current program in order to buy time.

But the Abenomics trend seems terminal and or irreversible.

The BoJ would need to expand more asset purchases in order to stabilize the market. On the other hand, expanding BoJ’s balance sheets would feed into the public’s inflation expectations. So this becomes an accelerating feedback mechanism that may lead to an eventual hyperinflation, if BoJ officials persist with such policies, or if they stop, a debt default.

We seem to be witnessing the culmination of one of the boldest experiment in modern day monetary system.

Abenomics has only been digging the Japanese economy swiftly deeper into the hole.

Will Japan’s Turmoil Signal the End of Easy Money Days?

The twin crash in Japan’s financial markets may be more than meets the eye.

The current financial markets boom has been prompting interest rates to climb higher for many nations.

10 year yields have begun to creep higher for crisis affected Eurozone sovereign papers (top window: Greece GGGB10-red orange, Portugal GSPT10Yr-green, Spain GSPG10YR orange and Italy GBTGR10-red). These nations has recently benefited from the Risk ON environment, prompted for by “do whatever it takes” policies and guarantees from the ECB as well as bank-pension funds related politically directed buying on such bonds.

And they seem to follow the footsteps of the developed market peers (lower window: Japan GJGB10-red orange, US USGG10YR-Green, Germany GDBR10 orange, and France GFRN10 red) whose interest rates have been moving higher earlier than the crisis stricken contemporaries.

But again interest rates affect each nation differently. Given the extremely high level of Japan’s debt, which makes them extremely interest rate sensitive, marginal increases has already jolted their markets

So far the twin crash has hardly put a squeeze on Japan’s Credit Default Swaps[29].

But again, the succeeding days will be very crucial. The coming sessions will establish whether the BoJ’s stabilization measures will delay the day of reckoning.

If not we should expect the mayhem in Japan’s bond markets to ripple across the world, which perhaps could be magnified by the derivatives markets.

Global OTC derivatives as of December 2012 totaled $633 trillion slightly lower than $ 639 trillion in June of the same year.

Interest rate derivatives account for $490 trillion or 77.4% of the overall derivative markets according to the Bank of International Settlements[30] (BIS). The bulk of which has been into interest rate swaps ($370 trillion) or about 75.5% of the interest rate derivative markets the rest have been forward rate agreements (FRA) and options. Yen denominated interest rate derivatives account for $ 54.812 trillion or 11.2% of the interest rate contracts.

The immense exposure by the derivative markets on interest rates extrapolates to heightened uncertainty as Japan’s bond markets draw fire.

While the direction of positions from such derivatives have not been disclosed, what should be understood is that a disorderly return of the bond market vigilantes would imply heightened counterparty risks that is likely to impact principally the financial and banking sector and diffuse into leverage sectors connected to them.

And given the extent of massive debt buildup around the world in the chase for yields, a Japan debt or currency crisis could easily be transmitted to highly leveraged economies. The result would be cascading implosion of bubbles.

There will hardly be any regional rescues as most nations will be hobbled by their respective busts.

However, central bankers of most nations will likely do a Ben Bernanke and this might change the scenario we have seen through or became accustomed to during the last decade.

Bottom line: Japan’s twin market crash for me serves as warning signal to the epoch of easy money.

Yet it is not clear if the actions of the BoJ will succeed in tempering down the smoldering bond markets, whom has been responding to policies designed to combust inflation.

If in the coming days the BoJ’s manages to calm the markets, then the good times will roll until the next convulsion resurfaces.

The BoJ will likely exhaust its program far earlier than expected and has to further expand soon to keep the party going.

However, if the bond vigilantes continue to reassert their presence and spread, then this should put increasing pressure on risk assets around the world.

Essentially, the risk environment looks to be worsening. If interest rates continue with their uptrend then global bubbles may soon reach their maximum point of elasticity.

We are navigating in treacherous waters.

In early April precious metals and commodities felt the heat. Last week that role has been assumed by Japan’s financial markets. Which asset class or whose markets will be next?

Trade with utmost caution.

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[1] Investopedia.com Sell In May And Go Away

[2] See Moody’s on the Philippines: No Property Bubble, Move along Nothing to see here May23, 2013

[3] Zero Hedge UBS On Japan - Are You 'Abe'liever? May 23, 2013

[4] See Has the Phisix has Gone Ballistic?! February 25, 2013

[5] New York Stock Exchange Securities market credit ($ in mils.), 2007, Securities market credit ($ in mils.), 2013

[6] Philstar.com Budget deficit seen to reach P84.66 B in H1 May 14, 2013

[7] Wikipedia.org Shark attack

[8] Wiki Mises Causal-realist economics

[9] Sean Corrigan What The Bulls Must Believe Zero Hedge May 25, 2013

[10] See Graphics: Here Comes Super-Abenomics! May 20 2013

[11] See Super Abenomics: Japan’s Nikkei Crashes on Rioting Japanese Government Bonds May 23, 2013

[12] See BoJ’s Kuroda’s Opening Salvo: 7 trillion yen ($74 billion) of Bond Purchases a Month April 4, 2013

[13] Wall Street Journal BOJ Revises Bond-Buying Plan April 18, 2013

[14] Bloomberg, Japanese Government Bonds

[15] Bloomberg.com U.S. Stocks Retreat on China Data, Stimulus Speculation May 23, 2013

[16] BBC.co.uk Global stocks markets hit after Chinese data and Fed comments May 23, 2013

[17] See Kuroda’s Abenomics May Trigger Global Financial Market Earthquake April 22, 2013

[18] CNBC.com Japan’s Debt Time Bomb Is Ticking: Kyle Bass January 18, 2013

[19] Quarterly Newsletter of the Ministry of Finance, Japan Quantitative and Qualitative Monetary Easing" of BOJ and trends of JGB Market April 2013

[20] Bloomberg.com Bass Sees BOJ Bond Purchases Overwhelmed as Investors Dump Debt May 23, 2013

[21] IMF Japan: Financial Sector Stability Assessment Update p.11 August 2012

[22] Yahoo.com Japan's Debt Addiction Creating 'Mother of All Bubbles' June 28, 2012

[23] John Mauldin The Mother of All Painted-In Corners May 25, 2013 Goldseek.com

[24] Wall Street Journal JGBs Rise After BOJ Bond-Buying May 2, 2013

[25] Tradingeconomics.com JAPAN GOVERNMENT BUDGET

[26] See Kyle Bass: BOJ will have to make buying bonds bigger May 24, 2013

[27] Bloomberg.com BOJ Prepared to Adjust Bond Purchases After Yield Jump: Economy May 22, 2013

[28] Bloomberg.com Kuroda Struggles With Communication as Japan Rates Rise: Economy May 24, 2013

[29] Tokyo Stock Exchange Benchmark for CDS (Credit Risk)

[30] BIS Statistical release: OTC derivatives statistics at end-December 2012 May 2013

Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania

7,000. The Phisix has finally breached the psychological 7,000 level. This represents an amazing 20.86% gain year to date. This accrues to an average of about 5.2% a month since the start of the year. At the rate at of such gains, 10,000 will be reached by the end of the year which should translate to over 40% nominal currency peso returns.

Up, Up and Away!

Financial markets are supposed to represent as discounting mechanisms. Considering the heavy expectation built on “credit rating” upgrades, after an earlier upgrade by Fitch Rating[1], last week’s upgrade by Moody’s should have been a yawner.

But no, the local stock markets used such events instead to furiously bid up on the markets. The Phisix zoomed by 2.32% on Monday on rumors of the upgrade (left window, chart from technistock.com).

The following day, the local benchmark retrenched 80% of the Monday gains or fell by 1.94% day on day on supposedly on “valuation” issues.

Analysts, foreign and local, had been quoted as saying the local equities were “beyond the correct valuation” and therefore “expensive”[2]. But again no one explained or was quoted to elucidate on how and why local stocks “have gone up and become expensive”. 

Contrary to such ‘expert’ rationalization, the public evidently liked “expensive”. They pushed the markets beyond the 7,000 levels. Whoever said market traded on valuations[3]?

The Phisix was up .98% over the week, along with ASEAN peers with the exception of Indonesia’s JCE. Suddenly there had been a marked rebound on global equity markets, in what appears to be a sign of the resumption of a “risk ON” environment.

US markets have also been exhibiting signs of a parallel universe where earnings expectations and stock prices have gone in opposite directions[4].

As one would note, the recycling of supposedly good news means that bulls have been steadfastly refusing for the need to correct or for normal cycles to prevail, and this only means that the mania phase has deepened.

There is no way but, to borrow from Superman, up, up and away!  

The Secret of Asia’s Rising Star: Credit Bubble

Moody’s upgrade has been justified as the Philippines representing “Asia’s Rising Star”. Glenn Levine Moody’s analyst responsible for the publication of the upgrade was quoted by FinanceAsia.com as “Investors are bullish on the Philippines, and so are we”[5].

So has “appeal to the popular” replaced economic analysis as basis for upgrades? Or is it that Moody’s simply wants to jump on the bandwagon like everyone else?

Another article says that the other reasons for Moody’s bullishness have been due to construction and business process outsourcing sectors and domestic demand[6].

However the upgrade on the Philippines didn’t come with enough scrutiny, again FinanceAsia quotes the Moody’s analyst

“A stock market bubble would affect relatively few, but the Philippines’ real estate market is a concern, since housing investment is more widespread,” says Levine. “The scant available data on the Philippines’ real estate, alongside anecdotal evidence, suggest that prices and construction may be rising ahead of fundamentals. This bears watching.”

The above represents the changes of loans from the banking sector to the supply side and the demand side. Data from BSP.

Since 2010 financials, real estate and trade, which accounts for more than 40% of total banking loans, have been running past 20% and rapidly increasing. I didn’t include construction loans despite its monstrous jump 57% year on year jump last February due to time constraints.

Does the analyst from Moody’s know how much of the 20% increase year-to-date increase in the Phisix, aside from last year’s 32% returns, has been based on borrowed money from banks? From the above statement they are clueless.

Yet lending in financial intermediaries has jumped by over 30% in 2011-2012 and 27% this February (year on year).

So if a lot of money loaned from the banks has been channelled into the stock market, then despite the stock market’s small penetration level, a stock market hit will also extrapolate to a hit on loans and the banking system and other creditors. Thailand, may not be the Philippines, but the recent increase imposed by regulators in collateral requirements for margin trades jolted the SET[7], whom at the start of the year had been running neck to neck with the Phisix.

What’s the point? Thailand’s booming stock market has likewise been founded on a credit boom.

So, to conclude that the impact will be “relatively few” seems groundless and signifies a reckless conclusion.

On the demand side, household credit has risen to the mid-teen levels or more than double the statistical growth of the local economy.

This represents the robust domestic demand?

People have been confusing credit intoxication with productivity. Credit does not, in most occasions, translate to productive growth.

Yet ironically, the mainstream can’t seem to fathom the difference between statistical growth and real growth. Statistical GDP numbers has been computed based on the growth rate pumped up by such underlying credit growth.

This means that the statistical growth has been much puffed up. Without the credit boom statistical GDP will reflect on significantly lower numbers.

I have not enough data for BPOs to make any comments.

Are credit bubbles sustainable?

Bank credit growth has been running amuck, close to 30% (year on year; blue line, left window) and nearly 20% (4 quarter rolling GDP, red line)! This is according to the chart from the latest IMF 2013 ARTICLE IV CONSULTATION[8].

Domestic credit to the private sector as percentage of the GDP has spiked to 50.4% by the end of 2012 according to the BSP chief (right window). I previously quoted his speech on my last comment on this[9], now the same figure has been splashed over at media[10]. In 2011 the data was only at 31.78%. This means that in 2012, debt as % to GDP rocketed by 18.62%!

And given the rate of acceleration, which will be compounded by all these upgrades, we can expect that, regardless of the price levels of the Phisix (10,000 or not) at the end of the year, domestic debt to the private sector in % will likely balloon to anywhere around 60-70% or even more!

The BSP chief has the public routine of comparing Philippine debt levels with that of our regional peers. According to him, local debt levels are “low” given the 100%+ levels of our neighbors.

But again this really represents the fallacious apples to oranges comparison. Political money authorities feel like having attained a state of celestial bliss. This time is different. This is the new order.

In their chronicles of global financial crises over the eight centuries, Harvard Professor’s Carmen Reinhart and Kenneth Rogoff in their book points out, that debt intolerance or the “extreme duress” of debt levels which “involves a vicious cycle of loss of confidence, spiralling interest rates on external government debt and political resistance to paying foreign creditors”[11], have had “very different thresholds for various individual countries”.

Furthermore they state that “the worst the history, the less the capacity to tolerate debt”[12].

In the past, the Philippines fell into a recession or a crisis when debt levels reached 51.59% in 1983 and 62.2% in the pre-Asian crisis of 1997. While the level of debt intolerance may increase, expectations of 100% levels similar to our peers signifies as sheer fantasy.

A famous quote from Karl Marx in his book the Eighteenth Brumaire of Louis Napoleon[13] "History repeats ... first as tragedy, then as farce" seems very applicable today.

And given the dramatic deluge of debt, confidence can evaporate with a snap of a finger, where “rising star” may became a wayward meteor, especially when creditors become increasingly sceptical of the debtor’s ability to settle on their liabilities

In short, while I expect the mania may go on through the year, anytime the Philippines reaches or even surpasses the 1997 debt levels then she will become increasingly fragile or vulnerable to a recession or a crisis that may be triggered internally or externally.

BSP Officials on Bubbles: Yes and No

This week other BSP officials have offered mixed signals.

Some reportedly acknowledged the existence of bubbles, but like Thai authorities, deny of their risks, since they presume to have the tools to rein them.

But Deputy Governor Nestor Espenilla issued the strongest statement on bubbles so far, as quoted by Bloomberg[14]

“Our source of concern is the rapid growth of credit,” Espenilla said in his office on April 24. “The central bank is very mindful of seeing the foundation of an asset bubble that can burst and create dislocations in the economy.

Now we are talking.

A major market participant mentioned in the same article seems in a state of denial

“Demand is still growing,” Henry Sy Jr., chief executive officer of SM Development Corp. (SMDC), said in an April 24 interview. “But there’s danger in some areas because good days don’t last forever.”

But the Bloomberg reports that the SM group plans to invest up to 71 billion pesos on expansion up until 2015. Such magnitude of spending doesn’t seem to suggest that “good days don’t last forever”, because these implies of an investment payoff from 2015 and beyond!

Yet demand continues to grow, because of the acceleration of the credit boom.

And it gets more interesting. From the same article

“There could be some surplus in the upper end of the market,” central bank Deputy Governor Diwa Guinigundo told reporters yesterday. “On the more significant parts of the market like the low-cost, socialized and medium-cost, there are no signs of a bubble formation.”

Some very noteworthy aspects from the comment.

The good Deputy Governor Diwa Guinigundo resorts to the fallacy of substitution and composition. The allusion to areas supposedly unaffected by bubbles or the absence of bubbles doesn’t validate or invalidate the presence of bubbles elsewhere. Such represents an ambiguous statement designed to evade the question or that the good governor has poor grasp of bubbles.

Bubbles are concentrated on capital intensive popular themes that reflect on the cluster of entrepreneurial errors as incentivized by policies.

As the great dean of the Austrian school of economics, Murray N. Rothbard explained[15].

But the regular, systematic distortion that invariably ends in a cluster of business errors and depression—characteristic phenomena of the "business cycle"—can only flow from intervention of the banking system in the market

Yet Mr. Guinigundo seems to echo US Federal Reserve Chairman Ben Bernanke, who denied of a housing bubble and of the 2007 crisis until it blew up on the face of the US Federal Reserve

In a 2010 speech, Mr. Bernanke admitted to his failure to act on a national housing bubble[16].

Although the house price bubble appears obvious in retrospect--all bubbles appear obvious in retrospect--in its earlier stages, economists differed considerably about whether the increase in house prices was sustainable; or, if it was a bubble, whether the bubble was national or confined to a few local markets.

Also it would signify as an obvious mistake to presume bubbles as merely a “upper higher end of the market” phenomenon. 

Shopping malls[17] and the casino industry, whom are part of the property sector, have been acquiring substantial amounts of banking loans in support their rapid growth. The rate of which has gone far beyond the growth rates of their respective demand side of the markets, particularly domestic consumers and regional bettors, respectively.

In other words, property projects for different classes of customers that have not been limited to the upper scale.

Shopping malls have catered largely to the general local population depending on the malls, whereas the coming casino complex has likely been targeted at regional or foreign clienteles.

Casino Bubble Redux

One of the four grand casino projects by the incumbent regime has reportedly obtained 14 billion pesos of debt from 3 banks for expansion. Three more grand casinos have been slated to open within 3 years[18].

Melco Crown (Philippines) Resorts Corp has reportedly raised $377 billion from follow on IPO offering[19]. My guess is that the next phase of fund raising will be on debt, whether from bonds or banking loans, perhaps similar to the path of the newly opened Solaire Manila which is owned and controlled by Enrique Razon led Bloombery Resorts [PSE BLOOM].

These marquee casinos are essentially competing with the regional casinos for the regions bettors rather than dependent on local peers. So the fate of these companies are essentially anchored or leveraged on regional growth.

Mainstream observers also say that such elaborate projects should help the tourism industry seems largely misunderstood. Many foreign based high rollers hardly go around the country as regular tourists. Their itinerary consists of the sojourn between casino and the airports. So while the casino, select hotels, and allied services and the airports benefits, they are hardly considered tourism in the conventional context.

Nevertheless, as discussed before, the gaming industry is said to grow at 28% CAGR from 2012-2018, when the average regional growth will be about the growth rate of the Philippines.

Yet these casinos appear to be political “pet” projects. These companies will operate on the government owned 8 hectare property envisioned as a Las Vegas entertainment complex known Entertainment City[20] and under the auspices or supervision of the Philippine Gaming and Amusement Board (PAGCOR)[21].

This also means that to obtain such privileges one has to be considered favorably within the circles of the incumbent political elite. And this is why one of the four major license holder whom is a Japanese mogul had been accused of bribery because such license had been acquired during the previous administration[22].

But political “pet” projects are unlikely good bets. They barely exists to serve customers. Instead these politically privileged agents use government “licensing” as economic moats from competition in order to extract financial rent, which they share with government directly and indirectly.

If the successes of political pet projects are to be measured, US President Barack Obama green energy “pet” projects could be used as paradigm. Obama’s green energy embodies a roster of failures[23]. Recently another supposed hybrid electric car company that got $200 million from the US government has been on the verge of bankruptcy[24].

I know, green energy projects are not casinos and Philippine politics haven’t been the same as American politics. But the hoopla of supposed gains where according to a study quoted by Finance Asia[25] “gaming revenues to more than double to $3.2 billion in 2015 from an estimated $1.4 billion in 2012, and reach $4.1 billion by 2016 as the supply increases” conspicuously ignores the risks from a severe regional economic slowdown, or a bursting bubble.

Such studies, which the political class relies on, overlook why global central banks need to keep interest rates at zero bound, and why central banks of developed economies need to expand balance sheets.

Nonetheless these big 4 casino operators will likely get bailed out once financial conditions turn against their expectations, which seems as why such aggressive risk taking behavior. 

 

Early Signs of the Periphery to the Core?

Of course the most important kernel of wisdom from Mr. Guinigundo’s quip looks like a revelation of what I call “periphery to the core” dynamics developing in the property sector.

He notes that there are “some surplus in the upper end of the market” without explaining the ramifications.

Well, allow me.

Surpluses may lead to cash flow problems for highly leveraged firms that may prompt for foreclosures.

If the incidences of surpluses multiply, then this could put to risk the entire bubble structure.

An overleveraged sector amplifies the risks of insolvencies that would undermine creditors, particularly the banking system which has been the source of much of the financing as shown above[26].

Bond creditors will also get hurt. And the impairment of assets of the banking industry would mean a general tightening of credit conditions.

Such contraction in bank assets would also translate to debt deflation or a bubble bust which also implies the race to liquidate or to raise cash, capital or margin calls at depressed price levels.

Thank you for the clues, Deputy Governor Mr. Guinigundo.

For shopping malls, the “periphery to the core” would start from the mall areas with the least traffic and from marginal malls or arcades.

Surpluses amidst a boom which implies high rents, high cost of operations such as wages, electricity and other inputs prices, would place pressure on profits of retail tenants competing for consumers with limited purchasing capacity.

Periphery to the core would mean initially fast turnover from retail tenants on stalls of lesser traffic areas and of marginal malls. Then the length of vacancy extends and the number of vacancy spreads.

Leveraged malls and arcades thus will suffer from the same vicious cycle of cash flow problems and eventual insolvencies that will impair creditors and will spread to many sectors of the economy.

Why has the Philippine Bond Yield Curve been Flattening?

The slope of the Philippine yield curve has dramatically been flattening (red arrow) since the start of the year. This week (red line) the 10 year revealed of a strong move. This compares with the previous week (green) or end of March (blue). Also see table on the right from Asianbondsonline.com[27]

This has been in stark contrast with our neighbors whose curves have registered marginal changes.

Rates from the longer end of the curve, particularly the 10 year bonds, have materially declined, which has been down by 137.5 bps year-to-date as of Thursday.

Why are investors stampeding into the Peso based government 10 year bonds? Are they discounting price inflation amidst the so-called ‘Rising Star of Asia’ boom?

Has this been merely yield chasing? Particularly by foreigners? Or has this been an anomaly? Why lock into 2.775% for 10 years, if so-called boom could lead to the risks of inflation or “ overheating” pressures?

Yet if such slope flattening continues, where the short end begins to rise while the longer end continues to fall then we may segue into an inverted yield curve: a harbinger of recession as a liquidity squeeze from malinvestment gets reflected on diametric moves of coupon yields across the maturity curve.

Moreover, flattening of the slope will theoretically reduce the banking system’s net interest margins[28].

Although today’s banking system has been more sophisticated since they don’t rely on net interest income alone.

But the Philippine banking’s income statement shows that as of June 2012 net interest income is at 122.543 billion pesos relative to 73.876 billion pesos of non interest income according to BSP data[29]. So the banking system will have to rely on non-loan markets, otherwise there will be pressure on profits.

Developments in the Philippine bond markets appear to be a conundrum to the Rising Star of Asia meme. 

 

The “Controlled Deficits” Travesty

Another supposed bullish reason with Moody’s on the Philippines is the so-called “controlling fiscal deficits”.

One would wonder, if the Philippines has indeed been booming, why the tremendous pressure to raise taxes on the public?

Why does the Aquino regime resort to an implicit class warfare campaign of “ostracization” against the Chinese community[30] and on Forbes billionaires over taxes[31]?

Current fiscal conditions offers as some clues.

Cash operation on National government continues to operate on deficits, where expenditures have been more than revenues, as shown by the 2012 BSP Annual Report[32], since the advent of the Aquino presidency.

The same changes in deficits can be seen in % year-on-year and as % of GDP changes from the IMF’s paper.

Since 2009, tax revenues has been blossoming alright, but this represents less than 10% y-o-y growth, which should reflect on economic performance, or that tax revenues fluctates from about 4-8% GDP. But the government’s spending at 20% y-o-y, 8-12% of GDP has ballooned by even more!

Some controlling deficits eh?

The reason statistical debt-to-gdp or deficit-to-gdp ratio continues to exhibit signs of resilience has been mainly because of accounting treatment. Statistical gdp, which has been bolstered by a credit boom, has reduced the increases of government liabilities.

Moreover, government expenditures have been growing in a straight line (green arrow). But taxes mainly depend on, and are entirely sensitive to economic performance. So the revenue side of the government’s accounting book are variable while the expenditure side are at a fixed trend growth. Such asymmetry is a recipe for instability.

Should an economic slowdown occur, or worst, if a recession happens, those deficits will balloon as tax revenues collapse. Thus “controlled deficits” are really a charade.

While one can argue about from collection efficiencies, taxes essentially crowds out productive investments, so I would counter that tax collection inefficiencies are a good thing or adds to economic efficiency. As the great Ludwig von Mises would say “Capitalism breathes through those loopholes.[33]”

The US crisis of 2007-2008 was felt only in 2009, where a massive decline in tax revenue led to a jump in fiscal deficits. This transpired even when the Philippines didn’t fall into a recession.

Yet given that government spending continues to swell, now at far more than the 2009 levels, any regression of tax revenues to the 2009 levels would amplify deficits. The 2009 event is a clue to what will happen in the future…but magnified.

Moody’s will be exposed for another flawed call.

Moody’s and the false acclaim of political ascendancy along with all the rest are symptoms of the credit bubble in full motion.

As the great Ludwig von Mises warned[34],

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

---

[1] See Fitch Credit Upgrade: Phisix Mania Phase in Full Throttle March 28, 2013

[2] Bloomberg.com Philippine Stock Trading Drops as Valuations Surge to Record April 24, 2013

[3] See Are Stock Market Prices Driven By Earnings or Inflation? January 25, 2009

[4] See Parallel Universe: Record US Stock Markets and Falling Estimates of Corporate Earnings April 25, 2013

[5] FinanceAsia.com Bullish on the Philippines April 25, 2013

[6] GMANews Online Moody's Analytics says PHL is 'Asia's rising star' April 24, 2013

[7] See Thailand’s Officials Flexes Muscles on Domestic Stock Market Bubbles March 25, 2013

[8] IMF Country Report Philippines 2013 ARTICLE IV CONSULTATION p.25 IMF.org

[9] See Phisix and the BSP: This Time is Different? March 17, 2013

[10] Inquirer.net SDA amount remains huge; BSP considers more rate cuts March 21, 2013

[11] Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different Eight Centuries of Financial Folly, Princeton University Press p.21

[12] Reinhart and Rogoff Op. cit p.25

[13] Wikipedia.org The Eighteenth Brumaire of Louis Napoleon

[14] Bloomberg.com Philippines Ready to Act on Property Loan Surge: Southeast Asia April 26, 2013

[15] Murray N. Rothbard The Positive Theory of the Cycle Business Cycle Theory Mises.org

[16] Ben S. Bernanke Monetary Policy and the Housing Bubble At the Annual Meeting of the American Economic Association, Atlanta, Georgia January 3, 2010

[17] see Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux) January 13, 2013

[18] see The Philippine Casino Bubble April 11, 2013

[19] Inquirer.net Gaming firm MCP raises $377M from equity placement deal April 25, 2013

[20] Wikipedia.org Entertainment City

[21] Wikipedia.org Philippine Amusement and Gaming Corporation

[22] Bloomberg.com Kazuo Okada Under Criminal Investigation, U.S. Says April 10, 2013

[23] See US President Obama’s Green Energy List of Failures October 26, 012

[24] Judicialwatch.com Another Obama Green Project Folds after Getting Millions from Taxpayers April 24, 2013

[25] Finance Asia Melco Crown Philippines prices follow-on at the top April 24, 2013

[26] IMF Country Report Philippines Op cit p.19

[27] Asian Bonds Online Philippines ADB

[28] Federal Deposit Insurance Corporation What the Yield Curve Does (and Doesn’t) Tell Us February 22,2006

[29] BSP.gov Income Statement and Key Ratios Philippine Banking System

[30] Rappler.com 'Filipino-Chinese tax evaders will be prosecuted', March 25, 2013

[31] Editorial Inquirer.net BIR’s misleading list April 22, 2013

[32] BSP.gov Annual Report Volume I 2012

[33] Murray N. Rothbard Long Live the Loophole December 13 2012

[34] Ludwig von Mises Section 6 Monetary Planning Chapter 11 THE DELUSIONS OF WORLD PLANNING Omnipotent Government p 252