Example of Good Deflation: Productivity and Technology Improvements

If you read the economic news, you'd have this impression that falling prices or deflation is "bad" for the society. Really now?

Below is an example of "GOOD" deflation, where you get more value for your money; as seen through the evolution of computers-not just in terms of prices but importantly in the quality of the product!

From 4 Block world,
(hat tip: Professor Mark Perry)

Where Is Deflation?

``In reality, Britain has the worst of all possible worlds: a stagnant economy, a crippling budget deficit and rising prices. The Keynesian consensus is that things would have been far worse without the stimulus provided by government. And if the economy isn’t pumped up with inflated demand, it will collapse back into recession. If it’s not working, that just proves the stimulus should be even larger. It is the argument quacks always push: If the medicine isn’t working, increase the dosage. And yet, reality has to intrude into this debate at some point. The deficit can’t get much bigger, interest rates can’t be cut much lower, and sterling can’t lose much more value. Stimulating the economy isn’t working. In fact, it’s only making it worse. Consumers and businesses don’t want rising taxes. A falling currency pushes up the cost of everything the U.K. imports, stoking inflation. Savers get decimated, and yet the banks remain reluctant to lend because they rightly believe the economy is in the doldrums.” Matthew Lynn, Deathbed of Keynesian Economics Will Be in U.K.

When deflation advocates point to charts of bank loan activities, the money multiplier or Treasury Inflated Protected Securities (TIPS) and proclaim “where is inflation?” - they seem to be asking the wrong question.

Figure 1 St. Louis Fed/Northern Trust: M1 Money Multiplier and Consumer US CPI

For instance, while it is true that the US M1 money multiplier[1] is down, (as shown in the left window in figure 1 and recently used by a popular analyst as example), there seems hardly a grain of truth that the falling money multiplier equates to sustained deflation in US consumer prices (right window).

In other words, if they are correct then obviously CPI should be adrift in the negative territory- to reflect on deflationary pressures until the present. Yet the CPI, both in the ALL items and ALL items LESS Food and Energy remains in the positive zone, in spite of, or even in the face of these ‘deflation pressure’ statistics; falling money aggregates, subdued TIPS and or lackluster bank activities.

And CPI turned negative only at the height of the crisis, which makes it more of an aberration than the norm. Of course, this counterpoint extends to the validity of the accuracy of the US government’s measure of inflation, which I am a skeptic of.

However, here are more of our counterarguments to the sarcastic question of “where is inflation?”:

1. Reading current performance into the future.

Deflation exponents insist that “deflationary pressures” ought to collapse the markets as they did in 2008. They’ve been doing so for the entire 2009. But this hasn’t been happening. That’s because the reality is, we haven’t been operating under the same ‘Lehman’ conditions of 2008!

The US government’s actions to effect a cumulative network of local and international market patches, as seen in the various ‘alphabet soup’ of emergency programs plus a raft of guarantees to the tune of over $10 trillion, swaps and direct expenditures (quantitative easing), seems to ensure of such non-repetition, as we have repeatedly discussed.

So more banks could indeed fail, the FDIC upgraded its watchlist from 552 to 702 banks in danger, but the liquidity gridlock of 2008 isn’t likely to happen. That’s because the Fed has a morbid fear of ‘deflation’ than warranted, and is likely to engage in a “whack a mole”; pouring liquidity on every account of the emergence of deflation.

Let me clarify that the US banking system is a solvency issue, but this is not the case for Asia or for major emerging markets. Ergo, the contagion from the Lehman collapse of October 2008 emanated from a liquidity shortfall as US banks seized up. Since today’s scenario is different, then predicting the same contagion seems unlikely, so any arguments calling for a 2008 scenario is like calling a banana an apple.

Besides, the Fed’s manipulation or “nationalization” of key markets such as the US mortgage markets seems to have been designed to stave off the odds of having a domino effect collapse in their banking industry. This, by keeping the banking system’s balance sheets afloat, through “elevated” or inflated prices. In spite of babbles for so-called exit strategies, this isn’t likely to change.

On the contrary, a broader view of markets appears to be suggesting that inflation looks likely a future or prospective phenomenon.

To consider, if any of these “deflationary” stats begin to recover then they are likely add to ‘inflation expectations’ and thus eventually reverse the current state of “deflation subdued” CPI .

2. Misleading Interpretation of Hyperinflations.

Hyperinflations have never been caused by excessive consumer borrowings, never in history. To paint of such an impression is to egregiously mislead.

Hyperinflations have basically been caused by insatiable government spending, whose exponential growth had been financed by the printing press. On the other hand, a credit boom from consumer borrowing is most likely to result in bubble (boom-bust) cycles and not hyperinflation.

The fundamental difference is that of the political goal; in boom bust cycles, government’s role to inflate the system is largely indirect-with mostly the goal to perpetuate ‘quasi’ economic boom conditions by inflating money supply and by skewing the public’s incentives through regulation or taxation to favoured political sectors, as in the case of the recent real estate-mortgage bubble.

Whereas, in hyperinflations, the government’s role is more direct, usually deliberate or represents an act of desperation to meet a political goal for the incumbent leadership, such as perpetuation of power (e.g. Zimbabwe), or the addiction to inflationism compounded by policy errors based on theoretical misunderstandings[2], as Germany’s Weimar hyperinflation experience, and not from war reparations as others have suggested[3].

Of course one may argue that there is always a possibility of first time. Perhaps.

3. Selective Perception And Misguided Expectations

Many deflation proponents tend to argue from the perspective of the private sector’s performance in the economy. Their propensity to “tunnel” or fixate into the private sector leads them to erroneously omit the impact of the rapidly bulging share of the US government’s contribution to the economy, which presently accounts for nearly a third.[4]

Ignoring government’s contribution and policy impacts to the economy renders a handicapped analysis.

Nevertheless, looking at the global scale, we seem to be seeing more incidences of a ‘quickening’ of consumer price inflation, as in Malaysia and in Brazil, aside from previous accounts in China, India, Vietnam, and even to the real estate bubble-banking crisis afflicted UK which saw consumer price inflation rise to its highest level since November 2008 (see figure 2)-where debt deflation has been the generally expected outcome by the mainstream.

Figure 2: Finfacts.ie/stockcharts.com: Surging UK Inflation, Devaluing UK Pound

Reporting on the surprising resilience on UK’s inflation (left window), according to Finfacts.ie. ``The ONS said the CPI fell by 0.2% between December and January. Although negative, this is the strongest ever CPI growth between these two months (prices typically fall at a faster rate between December and January). This record monthly movement is mainly due to the increase in January 2010 in the standard rate of Value Added Tax (VAT) to 17.5% from 15% and, to a lesser extent, the continued increase in the price of crude oil. In the year to January, the all items retail prices index (RPI) rose by 3.7% up from 2.4% in December. Over the same period, the all items RPI excluding mortgage interest payments index (RPIX) rose by 4.6%, up from 3.8% in December.” (bold highlights mine)

Why should oil prices rise if demand has been declining as the Fisherian and Keynesian deflationists experts allege? From a “money is neutral” perspective, wouldn’t that be a paradox?

Also, why should higher taxes become inflationary, when all it does is to distort the economic structure by shifting investments from private to the public, as well as, to decrease the incentives for the private sector to participate?

Murray Rothbard provides the answer[5], ``If inflation has been under way, this “excess purchas­ing power” is precisely the result of previous governmental in­flation. In short, the government is supposed to burden the pub­lic twice: once in appropriating the resources of society by in­flating the money supply, and again, by taxing back the new money from the public. Rather than “checking inflationary pres­sure,” then, a tax surplus in a boom will simply place an addi­tional burden upon the public. If the taxes are used for further government spending, or for repaying debts to the public, then there is not even a deflationary effect. If the taxes are used to redeem government debt held by the banks, the deflationary ef­fect will not be a credit contraction and therefore will not cor­rect maladjustments brought about by the previous inflation. It will, indeed, create further dislocations and distortions of its own.” (bold highlights mine)

In short, what could easily be seen is that the inflationary effects of bailouts, subsidies and its domestic version of quantitative easing programs have gradually been manifesting on her devaluing currency first (right window), and next, to consumer prices. And the newly increased VAT in the UK only adds to the existing distortions already in place.

Of course this account of emerging inflation seems to have befuddled the mainstream anew.

Yet, this dynamic is likely to emerge in the US too...perhaps soon.

For us, another reason why inflation is still quiescent in the US; aside from the slack in the banking system out of the reluctance to lend due to balance sheet concerns, is because of the natural belated response to the record steepness in the yield curve.

The uncertainty arising from the abrupt market cleansing adjustments and the rediscovery phase of where resources are needed, implications of new regulatory regime, prospects of higher taxes to pay for the slew of stimulus programs, risks of more government interventions, impaired and unsettled balance sheets of banks and financial institutions mired in the bubbles have all conspired to inhibit investors from taking advantage of the steepness in the yield curve.

Yet the past has shown that eventually zero interest rates and a steep yield curves will likely artificially impact the credit process to jumpstart a new boom-bust cycle. Although we aren’t likely to believe that a boom phase of a bubble cycle could happen in sectors recently affected by a bust, any seminal bubbles will most likely diffuse into other sectors untainted by the recent bubble (technology or materials and energy?) or percolate outside of the US.

This implies that the ramifications from policies are likely to gain traction with a time lag, as had been in the past.[6]

Hence, expectations for the immediacy of the markets’ response from policies have not been only myopic but also constitutes as wishful thinking-anchoring on a belief that people don’t respond to incentives.

4. The Folly Of Excluding The Role of the US dollar And Other External Forces

In addition to the lagged response, it is likely that the US dollar, as the world’s de facto seignorage provider, has the privilege to extend its inflationism outside her shores hence, inflation becomes a precursory tailwind (see figure 3)

Figure 3: St. Louis Fed: CPI (red) versus US Trade Balance (blue)

Recessionary forces around the world, as exhibited in gray shaded areas in both the 2000 and the present crisis, required diminished US dollar financing for global trade. This led to an improvement of the US trade balance (red line), which none the less, dampened US CPI inflation (blue line).

As the world recovered from the recession or the crisis, trade deficits surged anew to reflect on the revitalization of global trade. And the US CPI eventually followed suit. One could observe that the CPI trailed trade deficits by a short interval in both accounts.

And also given that today’s situation is vastly different from the 2000-2007, where the slack in private expenditures have been replaced by monstrous government spending, the impact from the surging “twin” deficits will likely have a more meaningful impact. First, this will be reflected externally, as in the account of emerging inflation ex-US, and possibly channelled via the US dollar relative to other currencies or if not through commodities. Next, this gets manifested on the US domestic consumer price indices.

Therefore the interstice, where CPI inflation seems subdued, should be known as inflation’s “sweet spot”, perhaps where we are today.

Hence the idea that slow inflation today equals slow inflation tomorrow predicated on the money multiplier and an impaired credit process, seems to grossly underestimate on the repercussions of inflationary policies because, aside from the lagged impact from yield curve and the blatant disregard of the expanding share of the US government in the economy, such analysis discounts on the effects of exogenous forces, particularly the US dollar’s role as chief financier of global trade, and the underlying transmission mechanism from external ‘inflation’, such as competitive devaluations, impact on nations with pegged currencies-a core to periphery phenomenon. This is, aside from, misconstruing money’s role as having neutral effect on the economy.

In other words, markets and economic trends will depend on the directions of ensuing policy actions, by major economies most especially the US, to ‘reflate’ the system.

And given that Fed Chairman Ben Bernanke was again shown as seemingly in a cautious stance about the “halting” pace of economic recovery for the US from which he reassured Congress of an extended regime of low interest rates and where in addition to the apparent mounting clamour of adopting a philosopher’s stone as mainstream policy, as discussed last week[7], more professional entities seem to be joining the chorus for extended inflationism, such as the latest joint project by Goldman Sachs [Economists Jan Hatzius] Deutsche Bank [Peter Hooper], Columbia University [Frederic Mishkin], New York University [Kermit Schoenholtz] and Princeton University [Mark Watson] who arrived at the conclusion that current conditions remain tight despite the Fed’s efforts.

We don’t need to actually wish for it, but evidently, the pronounced lobbying to justify more inflationism is likely to be music in the ears for the current crops of political and technocratic overseers.

So the question of “where is inflation?”, should be substituted with the opposite, given the limited and sporadic accounts of ‘deflation statistics’, the question should be “Where is Deflation?”

As markets haven’t been collapsing and as the world have elicited signs of rising incidences of inflation, the onus of proof, is on them.

---

[1] coins, currency, checkable deposits demand deposits and travellers checks from wikipedia.org

[2] “The government and the Reichsbank both believe that monetary troubles arise from an unfavorable balance of payments, from speculation and from unpatriotic behavior of the capitalist class. They therefore attempt to fight the menace of depreciation of the Reichsmark by controlling dealings in foreign currency and by confiscating German holdings of foreign assets. They do not understand that the only safeguard against the fall of a currency's value is a policy of rigid restriction. But though the government and the professors have learned nothing, the people have. When the war inflation came nobody in Germany understood what a change in the value of the money unit meant. The business-man and the worker both believed that a rising income in Marks was a real rise of income. They continued to reckon in Marks without any regard to its falling value. The rise of commodity prices they attributed to the scarcity of goods due to the blockade. When the government issued additional notes it could buy with these notes commodities and pay salaries because there was a time lag between this issue and the corresponding rise of prices. The public was ready to accept notes and to keep them because they had not yet realized that they were constantly losing purchasing power.” Ludwig von Mises, The Great German Inflation, Money, Method, and the Market Process ch 7

Money, Method, and the Market Process

[3] See Wikipedia.org, Inflation in the Weimar Republic

[4] See previous post, It’s Not Deleveraging But Inflationism, Stupid!

[5] Murray N. Rothbard, Chapter 12—The Economics of Violent Intervention in the Market, Man Economy and the State

[6] See our previous discussion, What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?

[7] See Why The Hike In The Fed’s Discount Rate Is Another Policy Bluff

Emerging Local Currencies In The US Disproves The 'Liquidity Trap'

Deflation exponents tell us that deleveraging from overindebtedness will restrict demand for credit and cause a fall in consumption which leads to falling prices.

Further they allege that monetary policies will be ineffective to arrest this phenomenon which leads to a Keynesian "liquidity trap".

We say this is garbage.

Why? Empirical proof from the emergence of local currencies, which reportedly numbers nearly 100, is a manifestation that there hasn't been a fall in demand for goods or services or consumption.

This from Fox News, (all bold highlights mine)

``Today, there are close to 100 types of local currencies operating in the United States.

``While some currencies are true to their name and are backed by federal dollars, others are simply a record of hours worked by contributing “time bank” members. “Whenever you have a shortage of money, people look to invent their own medium of exchange,” said David Boyle, fellow of the New Economics Foundation and Author of "Money Matters."

``The earliest local payment system on record began in the 1930’s, which isn't surprising; historically, local currencies have been most popular during times of economic crisis, and the U.S. then was in the midst of the Great Depression."

``Today, the Community Exchange hours system has 450 members, though similar systems work with just 50 or more members. When one member does something for another, they get credit for the amount of time spent helping. Each member’s time is worth the same, whether they’re giving tax advice or cooking dinner.

``Because there is no set standard for what a local currency should be, many times the grassroots effort to start a program doesn’t gain the momentum it needs. The average success rate for local currency is around 20%, according to a study done by Professor Ed Collom at the University of Southern Maine, which looked at 82 such currencies.

So local currencies operate like an improved version of the barter system but is limited to the locality.

More from MSNBC, (all bold highlights mine)

``In most cases, these communities are simply looking to boost local commerce. The currency has to be spent in town, obviously, because it's worthless anywhere else. But a growing distrust of the U.S. dollar is also at work.

``When the Treasury prints billions to bail out banks and automakers, people look for alternatives. These folks may look nutty now, goes the quip, but wait till the dollar goes the way of the Argentine peso. Then you'll be exchanging a wheelbarrow of cash for a bay buck, local currency boosters say...

``At central Vermont's Onion River Exchange, services recently offered included basics such as haircuts but mostly oddities like puppet shows, trips to the dump and left-handed knitting. Among the service requests were a call for rawhide goat skins and a plea from someone named Pam, who "flushed a hair-catch thingy down the toilet and needs help getting it out."

Here's a list of community local currencies in the US.

So "shortage of money", "a growing distrust of the U.S. dollar" and "boost local commerce" hardly are signs of falling consumption, instead they reflect on the malaise plaguing the banking system.

GMU's Charles Rowley argues on the absurdity of the liquidity trap (hat tip: Cafe Hayek) [bold emphasis mine, italics his]

``The concept of the liquidity trap, as outlined by Keynes, and developed by his early disciples, is one aspect of the theory of liquidity preference. Liquidity preference is a theory of the demand for money. Individuals have a certain transactions and a certain precautionary preference for holding money over bonds, because of money’s property of liquidity. They have a speculative preference for holding money over bonds when their expectations are that interest rates are likely to rise, bringing down upon the holders of bonds significant reductions in the value of their bond portfolios.

``If this speculative fear is sufficiently high, the demand for money becomes infinite. In such circumstances, the monetary authority cannot lower interest rates on bonds by selling money in exchange for bonds on the open market. If this liquidity trap occurs under conditions of recession, the monetary authorities cannot stimulate the demand for investment by lowering bond rates of interest. In such circumstances, increasing government expenditures appears to be an attractive mechanism for returning the economy to full employment equilibrium. As Keynes emphasized, he knew of no such situation ever having occurred in the real world."

So has there been an extraordinary demand for money?

Again from Mr. Rowley,

``There is no evidence whatsoever that the demand for investment at current interest rates (incidentally Treasury notes with more than three years to maturity are nearer to 4 per cent than to zero in nominal terms, Mr. Krugman) is inadequate to move the economy to full employment equilibrium.

``Evidence suggests that small firms are desperate for loans from the banks at current interest rates, but cannot obtain them because the big banks will not lend. The big banks will not lend, not because they are are short of high-powered money (Bad Ben Bernanke has drenched the economy in high-powered money), but because their balance sheets are rock-bottom rotten and they are trying to use Bernanke money to bring their financial ratios back from insanely low levels."

Well, the reported shortages of money that has spurred the emergence of local community currencies seem to validate or corroborate this perspective. Moreover, inflationism could be another factor why people have indeed been looking for alternatives.

When Politics Ruled The Market: A Week Of Market Jitters

``The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” Thomas Sowell

As we have repeatedly argued, politics today more than the economy shapes market activities. That’s because boom-bust cycles are essentially politically oriented where inflationism is about the politics of redistribution.

Whether the source of this week’s troubles has been from China, Greece or the US, they have a common denominator, politics rule the day.

Bizarrely, there has been an apparent disorientation from media on who to blame or which among these nations have spawned major global markets to swoon!

Perhaps we can get some clues from the recent activities depicted in the charts (see figure 1)

Figure 1: stockcharts.com: What Caused The Meltdown?

The Dow Jones Stoxx 50 (main window-STOX50) or a benchmark of major European heavyweights collapsed only during the last three successive sessions of the week which also had been reflected on the US S & P 500 ($SPX).

Whereas China’s Shanghai Index ($SSEC), has peaked last August of 2009 and has repeatedly been underpressure since the start of the year.

Meanwhile the US dollar index bottomed during the start of December, and has, from then substantially ascended.

So gleaned from the first mover advantage perhaps it could have been China. But correlations appear rather unconvincing. Possibly a time lag effect? Maybe.

Greek Mythology And Market Divergences

This brings us first to the Greece.

The Greek episode as we earlier discussed in Poker Bluffing Booby Traps: PIMCO And The PIIGS seems more like a political poker bluff. That’s because European authorities won’t likely afford to put at risk the Union’s credibility that could easily escalate and eventually result to its disintegration.

Moreover, it wouldn’t also seem in the interest of Greece to take radical actions that would result to its leaving the Union. Since most of her debts have been denominated in the Euro, any devaluation would only expand her outstanding liabilities and result to more painstaking adjustments.

The team from the Danske Bank, Frank Øland Hansen and Gustav Smidth, puts it nicely, ``Greece could also choose to leave the euro and devalue. This is seen as a 'quick-fix' by some market participants. The Greek Central Bank Governor, George Provopoulus, has however emphasised today in the Financial Times, that this is not an option. Referring to Greek mythology, he said that "The future of its economy is unwaveringly tied to the mast provided by the euro". If Greece were to leave the euro and devalue, the new currency would lack credibility and there would be expectations of further devaluations. The outcome would be higher inflation and higher rates. In addition, existing eurodenominated debt would become foreign-currency debt. Any devaluation of the new domestic currency against the euro would thus increase the debt burden. We think that this 'quick-fix' is a highly unlikely scenario too.”

In other words, Greece will have to embrace austerity with or without the Union. But to disengage with the Union will likely result to greater hardship (larger debt, lesser access to financing, lose the privilege of integrated markets) and could present as “lose-lose” scenario for both parties. Hence assuming reform under the EU’s auspices would likely result to enhanced collaborative efforts to resolve her problems.

So unless there would be other unidentified incentives that implicitly serve the political parties involved, the most likely option would possibly be either for a broad European based rescue or with an IMF assisted bailout for Greece.

Figure 2: Danske Bank: Credit Markets Amidst The Market Turmoil

True, while the recent market volatility has triggered considerable anxieties in the credit sphere, as premiums on Credit Default Swaps-or cost to insure bonds- have spiked, it’s been largely a Greek problem (see figure 2 left window-lime green trend line).

Although Italy (gray) and Spain (blue) have likewise accounted for substantial upside movements, it hasn’t been as steep as Greece.

On the other hand, Ireland’s CDS (red) has improved in spite of the recent trembler.

In addition, the index of high yield spreads of the European (right window-blue trend) and US corporations (red trend) appears somewhat little shaken by the turmoil.

Let me add that Greece’s equity bellwether, the Greece [Athens] General Share index, has fallen by 31% since mid October. This brings her back her down 61% off its 2007 highs which has been reflective of the market’s apprehensions over her default risks. The Greece index lost over 70% during the market meltdown of 2007-2008 on a peak-to-trough basis.

Now if the ECB’s forthcoming actions will, as we expect, likely focus on market calming measures then we should see some semblance of rebound for Europe’s market.

To give us a clue, former crisis affected economies of emerging Eastern Europe such as Estonia, Latvia, Lithuania, Ukraine appears to have even shrugged off the recent antsy to stage massive rallies. Estonia is up 30% (!!!) on a year to date or 3 weeks basis after falling by about 75% from the 2007 peak. The current rally has only recovered 50% of the losses [see Scorecard From This Week's Global Equity Bloodbath].

So unlike in the 2008 episode where there had been a generalized fear, which resulted to a flight to safety, the apparent market based dissonance gives some credence to the decoupling theory.

And this has two important implications:

One. If markets deteriorate further, then the current inter-market divergences (Euro credit spreads, emerging markets versus G-7 equities and bond performances) would appear as belated responses to the lead actions of the core group, particularly the G-7 and BRICs which recently suffered from heavy losses.

In short, the losses will spread and close any gap that would lead to a convergence-partially resembling the 2007-2008 episode. I say partially because policymakers given will likely react in the same magnitude and swiftness to arrest any signs of a repeat of a 2008-esque meltdown.

Two. If major markets do find some stabilization or a base in the coming sessions from the recent mayhem, then we should expect inter-market divergences to materially widen. This implies that major emerging markets will likely recover earlier or ahead of its developed country peers and that those that has recently outperformed as emerging Eastern Europe could increase its outperformances. Emerging Eastern Europe looks likely on a catch up mode.

So the perma bears, whom have mostly anchored on a 2008 meltdown or a Japan crash scenario, will possibly be met anew by another setback-failed predictions.

I think this is the most likely outcome given the significant evidences of market divergences (credit, equity and bond markets) in the face of this week’s intense selling pressure.

Gold Tracing Euro’s Path

Another aspect that I’d like to dispel is the nonsensical view that gold is behaving like a bursting bubble or reflecting on deflationary forces.

Figure 3: stockcharts.com: Nonsensical Views About Gold

One should realize that gold’s action has NOT been exhibiting deflation or inflation but instead has moved mainly in consonance with the Euro, or inversely, but to a lesser degree, against the US dollar index where the Euro constitutes a hefty 57.6% of the index (see figure 3).

Notice that the contours of both gold (candlestick) and the Euro ($xeu-black line behind gold) have been nearly the same for the past 6 months. Thereby any variances lie within the degree of the changes.

A rising Euro does NOT translate to “inflation” nor does a falling Euro imply “deflation”. That would be another sign of clustering illusions.

As the earlier divergences discussed, this seems UNLIKE the AFTER LEHMAN Syndrome of October 2008. It hasn’t been the case where liquidity is being sucked out of the system that has resulted to a banking gridlock. The problems such as Greece, China or the US Volker fund appear to be more political than economic.

In short, the Euro and gold has had a strong correlation of late. But as caveat, the high correlation doesn’t imply any semblance of causation, that’s because gold’s relevance is as nemesis of any paper based currency and that’s why even central bankers tacitly revere it as “insurance” [see Is Gold In A Bubble?].

More signs of divergences? Just look at copper ($copper). Even as gold and oil has flailed along with major equity benchmarks over the last few sessions, copper prices remains vibrant and even rose.

In addition, if one should argue about prices being representative of less speculation and more real demand for commodities, then the Baltic Dry Index seems to be another sign of deviation. It has been in consolidation.

In short, unless markets will prove us wrong, signs have been saying that the recent meltdown is likely a bear trap.

In 2009, Stocks Over Bonds Means Inflation Over Deflation

This should be an interesting chart from Bloomberg's chart of the day.

According to Bloomberg,

``U.S. stocks beat 30-year Treasury bonds by a record 36 percentage points in 2009 as investors bet on a recovering economy and the government sold a record $2.11 trillion in debt.

``The CHART OF THE DAY shows the performance of 30-year bonds versus the Standard & Poor’s 500 Index since 1978, according to data compiled by Bloomberg and Bank of America Merrill Lynch. Last year, the debt lost about 13 percent, while the benchmark index for U.S. stocks surged 23 percent. Gold futures added 24 percent in New York.

``Stocks trailed bonds in 2008 as the worst financial crisis since the Great Depression drove investors to the relative safety of Treasuries. They switched places in 2009 as the yearlong contraction in U.S. gross domestic product ended and President Barack Obama raised money to fund economic stimulus programs."

I'd like to add to the perspective where 2009's outperformance of stocks over bonds essentially validates the camp of those who argued for inflation to prevail over the camp of those who advocated for deflation. And the difference hasn't been marginal.

Yet this serves as an example where a misread would have been devastating to the real returns of a portfolio.

We should see the same dynamics for the 2010.

Prices, Statistics and Lies

Here is an interesting table that compares prices of select items in the US in 1999 (before) and in 2009 (after) or over a period of ten years.

courtesy of walletpop.com (tip of the hat to Jeffrey Tucker of the Mises Blog)

The table shows that prices don't move up or down uniformly and are relative (some prices move more than the others).

Over the decade, most of the prices of goods or services had been higher although some were lower.

Prices reflect an amalgam of factors: government policies, supply demand or market dynamics, productivity, globalization, innovation, competition, demographics, cultural and others.

Would it not be a puzzle as to how these widely variant figures can be cobbled or aggregated as simplified statistical measures that are deemed by the officialdom and the public as accurately representing "inflation"?

Nevertheless these are the same tools used by central planners to determine and effect political and economic policies. No wonder the laws of unintended consequences exist.

As Mark Twain once observed, "There are three kinds of lies: lies, damned lies and statistics."

Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble

The celebrity guru strikes again!

Mr. Nouriel Roubini, whose shot to fame and stardom came after accurately predicting last year's crisis and has been media's du jour favorite gloom spinmeister or otherwise known as "Dr. Doom", recently predicted that every assets, including commodities and emerging markets stocks are in a bubble!

Mr. Roubini's captivating 'one size fits all' theory for this forecast is based on the US dollar as the "mother" of all carry trade.

In a recent column at the Financial Times Mr. Roubini wrote, ``Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions."

Portraits from Bloomberg

Hence he predicts a massive recovery of the US dollar, as every asset class anchored to the carry trade collapses.

It would seem that the 2008 financial crash functions as Mr. Roubini's operating paragon from which this call has been predicated (Anchoring bias?).

Bloomberg recently interviewed commodity king Jim Rogers, who dismissed Mr. Roubini's prediction.

According to Bloomberg,

``Many commodities are still down from record highs and equity markets aren’t on the brink of collapse, Rogers, chairman of Singapore-based Rogers Holdings, said in an interview on Bloomberg Television today. The price of gold will double to at least $2,000 an ounce in the next decade, he said.

“What bubble?” Rogers said, when asked if he agreed with Roubini’s view. “It’s clear Mr. Roubini hasn’t done his homework, yet again.”

``Rogers countered Roubini’s arguments by saying that Chinese stocks and sugar, silver, coffee and cotton have all dropped from their historical highs by at least 50 percent.

A sample of commodities (sugar and cotton) cited by Mr. Rogers are far from their all highs, as seen from the chart above courtesy of Moore Research Center.

One must note that the above charts exhibits nominal and not inflation adjusted prices.

Again from Bloomberg, ``When asked if gains made this year pointed to a bubble, he said: “It’s not a bubble if something is up 100 percent this year, but down 70 percent from its high. That’s not a bubble, that’s a good year. That’s a great year. Maybe it’s too high for this year, but that’s not a bubble.”

``“I suspect it’s going to go over $2000 some time in the bull market, but depending on what happens in the world it could go much, much higher,” Rogers said. “The old high, back in 1980 adjusted for inflation, would be over $2000 now, just to get back to the old high. So we’ll certainly get there some time in the next decade.”

``“I don’t know any emerging market stock markets that are so high I’d call them a bubble,” Rogers said. “They’re certainly all up a lot, maybe they’re too high, but being too high is not a bubble for anyone who knows financial markets.”...

``In contrast to Roubini, Rogers said the only bubble he sees in the Western world now is in U.S. bonds."

You can watch the video of Jim Roger's interview here

Meanwhile Mr. Roubini countered Mr. Rogers' objection by saying that gold at $2,000 is "utter nonsense".

According to Bloomberg, ``There is no inflation or “near-depression” to drive gold prices that high, Roubini said today at the Inside Commodities Conference in New York. If a severe depression came to pass, with investors buying canned goods and hiding out in log cabins, “maybe you want some gold in that scenario,” Roubini said.

``“Maybe it will reach $1,100 or so but $1,500 or $2,000 is nonsense,” Roubini said. Gold rose to a record $1,098.50 today in New York on speculation that central banks and investors will purchase the metal to hedge against a declining dollar...

``“It is very hard to justify oil going from $30 to above $80 based only on the fundamentals of supply and demand,” Roubini said. Prices are “in part” a bubble, Roubini said.

``Roubini predicted in 2006 the financial crisis that spurred more than $1.6 trillion of credit losses and asset writedowns at global financial companies".

As you would note, media highlights on Mr. Roubini's favorable call but ignores his glitches and miscalls.

Earlier this year Mr. Roubini predicted stagdeflation, a continuing rout in asset markets including oil. According to Bloomberg (Jan 20th), ``Nouriel Roubini, the New York University professor who predicted last year’s economic and stock market meltdowns, said oil prices will trade between $30 and $40 a barrel this year.

“I see oil remaining throughout 2009 in the range of $30 to $40” a barrel, Roubini said in Dubai today."

In an earlier post we noted how Mr. Roubini hit only one out of several calls,see earlier post Wall St. Cheat Sheet: Nouriel Roubini Unmasked; Lessons, yet managed to harvest media's attention.

Going back to Mr. Roubini's theme of the US Dollar Carry. Here is why we are in the camp of Jim Rogers.

1. Past Performance don't guarantee future results.

Last year's carry trade paradigm had been based on financial institutions, such as the shadow banking system, and foreign banks (as Iceland and parts of Europe) which leveraged on the currency arbitrage.

Today, hardly the same parties or sector appear to be engaged in the said arbitrage activities considering their debilitated conditions.

Next, it isn't the carry trade that brought down the house in 2008, it was the US housing bubble. The carry trade only exacerbated on the downturn.

2. Barking At the Wrong Tree.

It isn't just private sector speculation as Mr. Roubini sees it, but governments' "speculating" as well.

The recent sale of half of IMF's gold stash to India (Bloomberg) came as surprise to the market whom expected China to do the bidding.

To add China has been engaged in a buying spree of commodity assets globally as seen by the World Bank table above.

In short, the governments of emerging markets have in themselves been "speculating".

Of course we'd like to add that these speculative activities isn't myopically based on "animal spirits", because there are underlying geopolitical and monetary dimensions in these.

3. US dollar carry isn't likely to be a major factor.

Given the massive deficits and the monetary inflation engaged by the US, it would be naive or blind allegiance on the side of professional investors to discard the risks of higher interest rates by taking large positions for such arbitrage.

4. Money is neutral.

Mainstream always view money as a seeming constant where additional inputs of money are deemed as not to have an impact on the supply and demand balances. This is evident on Mr. Roubini remarks "very hard to justify oil going from $30 to above $80 based only on the fundamentals of supply and demand"

Mr. Roubini underestimates the impact of the global reflation efforts by collective governments on global economies. Moreover, Mr. Roubini reflects on the mainstream view which have been moored upon the US as still the key engine of global growth.

Yet apparently Mr. Roubini sees today's higher commodity prices as having little impact on inflation, he says, there ``is no inflation or “near-depression” to drive gold prices that high"


On the other hand, Bespoke Invest sees inflation on the horizon, ``Over the last ten years, trends in the CS have often preceded moves in the CPI. So when the net reading in the CS rises, increases in the CPI are typically not far off. Therefore, given that the net number of commodities rising in price is currently at +10 from a low of -15 in February, don't be surprised if upcoming inflation reports come in on the high side of expectations."

5. Wrong Models/Apples And Oranges

Gold isn't likely to rise during a deflationary depression (a view which Mr. Roubini leans on).

To argue for gold's strength on a Great Depression paragon misses the point that the US dollar then operated under a quasi gold standard. Thereby the rush to the US dollar equaled the rush to gold. That would be comparing apples to oranges today.

Gold doesn't serve as a medium of exchange for the consuming public today, but is still used as reserves by central banks. So gold's strength will be magnified by an inflationary depression and not during deflation.

In contrast to Jim Rogers who says Mr Roubini hasn't done his homework, Mr. Roubini's call would seem like an attention generating act.

An oversimplified theme which connects to the prevailing bias, appeals to the public. Publicity matters more than the content.

Technology's Early Adoptor Disproves Deflation

I'd like to rephrase the theme of Jessica Hagy's Shiny Object! Must Get! graphic in economic context: technology assimilation refutes the deflation bugbear in the absolute sense.

How?

This wonderful quote from Bloomberg's Matthew Lynn (Deflation Theory Is Lemon We Have All Been Sold), [bold emphasis mine]

``Everyone knows that a computer or an iPod will be both better and cheaper in six months. And people really want one right now. Torn between those two impulses, plenty of shoppers go out and buy computers and music players. It is true in the electronics industry, and, once they get used to falling prices, it will be true for other industries as well."

Moral: Prices are valued subjectively and relatively.

Not Just A Bear Market Rally For Philippine Phisix or Asia

``Key question then: why do smart people engage in negative thinking? Are they actually stupid? The reason, I think, is that negative thinking feels good. In its own way, we believe that negative thinking works. Negative thinking feels realistic, or soothes our pain, or eases our embarrassment. Negative thinking protects us and lowers expectations. In many ways, negative thinking is a lot more fun than positive thinking. So we do it. If positive thinking was easy, we'd do it all the time. Compounding this difficulty is our belief that the easy thing (negative thinking) is actually appropriate, it actually works for us. The data is irrelevant. We're the exception, so we say. Positive thinking is hard. Worth it, though.”- Seth Godin The problem with positive thinking

For many, the basic premise for today’s global market rebound has due to a “bear market rally”.

Dem Dry Bones

This especially holds true for the advocates of the global ‘deflation’ outcome and for those who interpret markets based on conventional methodology.

Nevertheless, predictions have underlying analytical foundations.

The basic pillar for such sponsorship is that the US will remain as the irreplaceable source of demand for the world. But laden with too much debt and hamstrung by a vastly impaired banking system, US consumers will be unable to take up the slack emerging from the recent bust, while the world will unlikely find a worthy substitute, and as consequence, suffer from the excruciating adjustments from the structural excesses built around them during the boom days.

Hence, the Dem Dry bones deduction-Toe bone connected to the foot bone, Foot bone connected to the leg bone, Leg bone connected to the knee bone. BOOO! We are faced with a Global Deflation menace.

We have spilled too much ink arguing against the seemingly plausible but fallacious argument simply because all these oversimplifies human action without taking into account how people will respond to altering conditions (creative destruction), overemphasis on the rear view mirror and importantly, such arguments tremendously underestimates the role money plays in a society (inflationary policies).

Moreover, the assumption that the world has been scourged with its arrant dependence on the US seems downright exaggerated as today’s market actions have shown.

In other words, yes while increased globalization trends has indeed integrated or has deepened the interlinkages of a large segment of global economies, particularly financial and labor markets and investment flows, it hasn’t entirely converged every aspect of the marketplace or the economy.

That’s because nations have their own cultural, religious and geographical traits that are unique to themselves that function as natural barriers.

Yet all these have significant impact on the motional profile of a country’s political economy. So every country (in terms of government and its constituents) will have to deal with its inherent domestic forces as much as it has to deal with fluctuating external factors, and all these dynamics will result to different or divergent responses.

Hence, national idiosyncrasies (or decoupling dynamics) will be retained and will continue to do so because of such intrinsic barriers. This, in spite of a prospective deepening globalization trends.

So individual values and actions will significantly matter more than perceived macro assumptions advanced by sanctimonious ivory tower experts.

This also means that the assumption that markets or economies will be totally convergent or “coupled” to each other is another false concept.

Four Stages of Bear Markets

Figure 1: US Global Funds: 4 Stages Of The Typical Secular Bear Market

Many have used this chart, the “four stages in the typical secular bear market”, which has floated around in the cyberspace, to justify the significance that today’s rising markets account for as a bear market rally (see figure1).

Right at the nadir of the market meltdown, triggered by the institutional bank run in the US [see October 26^th Phisix: Approaching Typical Bear Market Traits], we described how the Philippine Phisix reached the typical bear market levels in terms of depth or degree of losses and the timeframe covered, ``We are presently 15 months into the present bear market which begun in July of 2007. The last time the Phisix shadowed the US markets it took 28 months for the market to hit a bottom. I am not suggesting the same dynamics although, seen in terms of the US markets, the recent crash seems different from the slomo decline in 2000.”

From a hindsight view, we have been validated anew- we did not match the longest “slomo” decline of 28 months during the 1999-2001 cycle, but nevertheless clocked in as an extended cyclical bear market (15 months peak-to-trough), in terms of duration compared to 1987 (13 months) and 1989 (11 months).

Nonetheless the above chart of the 4 stages of a bear market has indeed traced out the bear market dynamics of the Phisix over the 1999-2002 period (see figure 2) but on a different timeframe scale relative to the US.

Figure 2: PSE Phisix: 4 Stages of Phisix Bearmarket

The Philippine market appears to have a slightly shorter cycle than its US counterpart if we are to base it on the first 3 stages (59 months US vis-à-vis 56 months). That is to repeat, in the context of a SECULAR bear market cycle.

But, I would caution you from interpreting the same operating dynamics today as that with 2001.

Besides, I would admonish any tautology that actions in the US markets should correlate with the Philippine markets-they shouldn’t. Not because of exports and not because of remittances.

Secular Bull-Cyclical Bear, Where The Rubber Meets The Road

The Philippines (Phisix and the economy) has essentially had some mixed blessings from its less globalized economy and market; she didn’t outperform during the boom days and conversely, didn’t fare as badly during the global recession.

But overall I don’t see this as being net beneficial for the country since trade openness and economic freedom is the source of capital accumulation. The semblance of any of today’s success could be attributed to more on luck than from any policy induced measures.

However, because boom bust or business cycles are fundamentally credit driven, then our eyes must focus on where the rubber meets the road.

The Philippine economy and its banking system have currently been operating from significantly reduced systemic leverage (in fact the private sector debt has been one of the lowest in Asia see Will Deglobalization Lead To Decoupling?).

Another, the crisis adjustment pressures or the market clearing process coming off the excesses from the pre-Asian crisis boom have had most of its imbalances ventilated during the 1997-2003 cycle. That’s the essence of bear markets-sanitizing excesses and balancing imbalances.

In addition, the Philippine banking system has been extremely liquid, where total resources in the banking system as of April 2009 at Php 5.8 trillion (BSP Tetangco speech August 11^th).

Domestic banking system’s Non Performing Loans (NPL) has returned to pre-Asian Crisis levels of around 4%, which serves as evidence of the market clearing process (BSP Tetangco).

Besides, because the domestic banking system’s balance sheets have been least impaired due to largely missing out on the highly levered securitization shindig, the Philippine banking system remains adequately capitalized, well above the risk ratios as per BSP regulations (10%) and Bank of International Settlement (8%) standards (BSP Tetangco).

This low systemic leverage reflects, as well as, on our emerging Asian market peers, in contrast to the US and European counterparts.

Thus, Philippine economy and its financial markets appear to be coming off on a clean slate, enough to imbue additional leverage in the system to power the Philippine Phisix and the economy to another bubble.

Sorry to say, but central bankers, being legalized cartels, are innately enamored to blowing bubbles, due to the unlimited potentials to issue credits via the fractional reserve banking platform (or issuing of money more than bank holds in reserve) from which all global central banks operate on.

Lastly, the recent bear market cycle emanated from contagion effects than from internal adjustments from massive structural misallocations, which is what the US economy has presently been undergoing. This means that adjustments from the bust are likely to be minor.

So, distinctions matter.

In short, the last bear market cycle that the Philippine Phisix suffered WAS NOT a secular bear market but a cyclical one.

Inflation: Keys To Future Investment Returns

The same reasons are behind why the historically low interest rate regime pursued by the Bangko Sentral ng Pilipinas (BSP) has generated significant traction in the economy, as we have been anticipating.

Proof?

According to the BSP, Real estate loans have been picking up as of June 2009, so as with Automobile loans, credit card receivables and other consumer loans (appliance and other consumer durables and educational loans) over the same period.

And all these have likewise been reflected on the Phisix, which as of Friday’s close has been up 51.16% on a year to date basis, driven by local investors [as discussed in last week’s Situational Attribution Is All About Policy Induced Inflation].

This compared to the 2003-2007 cycle which had been foreign dominated. That’s another key point to reckon with.

Moreover, from a chartist viewpoint, not all the bearmarkets have the same patterns, (see figure 3)

Figure 3: Philippine PSE: 18 year Cycle

At over the 23 years from where the Philippine Phisix has undergone a full cycle (secular bull and secular bear market 1985-2003 or 18 years), the ‘cyclical’ bear market in 1987 (45% loss in 13 months) did show a short resemblance to the 4 stage bears, but the 1989 market had been a V-shaped recovery (62% loss in 11 months) [pls see blue ellipses].

The point is that there is a material difference in the performance of bear markets during secular and in cyclical trends.

In cyclical markets, while bear markets can be deep, they are likely to recover rapidly compared to secular bear markets, whose correction process takes awhile, for structural reasons stated above.

Apparently, the action in today’s market appears to account for such cyclical trend dynamics.

Because no trend moves linearly, we should expect bouts of interim weaknesses. However, this should serve, instead, as buying opportunities.

Moreover, I’d like to bring to your perspective the long term cycle of the Phisix as exhibited by the pink channels. You’d notice that the long term channel isn’t sideways or down BUT UP!!!

While other observers, especially those colored by political bias, could impute economic fortunes on this, my thesis is that the nominal long term price improvements reflect more on “inflation” than real output growth.

This is why the Phisix seems so highly sensitive to monetary fluxes. The lesser the efficient the market, the more sensitive to inflationary ebbs and flows.

And this long term chart has likewise been giving us a clue to where the Phisix is likely headed for-10,000, as emerging markets and Asia takes the centerstage of the bubble cycle.

But this inflation driven pricing isn’t relegated to the Phisix alone, but has been accelerating its influence over the world and even in the US markets.

Proof?

I am now really finding some “comfort with the crowds” (pardon me, I am also vulnerable to cognitive biases, but at least one that I am aware of) among big investing savants. Aside from Warren Buffett whom we featured in Warren Buffett’s Greenback Effect Weighs On Global Financial Markets, the world’s Bond King PIMCO’s top honcho, Mr. William Gross recently wrote about how asset pricing dynamics will be fueled by inflation.

These are the strategic scenarios which he enumerated as having a high probability of playing out:

(bold/underline highlights mine)

-Global policy rates will remain low for extended periods of time.

-The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.

-Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.

-Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.

-The dollar is vulnerable on a long-term basis.

In other words, US dollar vulnerability, QE and other monetary ‘bridge financing’ non interest rate tools, aside from fiscal policies and low interest rates are all inflationary policies that are “keys to future investment returns”.

Whereas Asia and Asian-connected economies, given their edge of low systemic leverage, unimpaired banking system and the thrust towards trade and financial integration with the world commerce, are likely to assimilate most of the circulation credit “inflation”, hence their likely dominance in terms of attaining the highest global economic “growth”.

I’m not suggesting that credit expansion equals sound economic growth. Instead what I am saying is that economic growth in Asia and emerging markets will be based on the public’s response to the incentives set forth by policies to sop up credit.

In short, conventional analysis will continue to find enormous disconnect as inflationary policies amalgamates its presence on the markets.

But at least Mr. Gross have been candid enough to unabashedly admit looking for opportunities to strike lucrative deals with the government based on special ‘privileges’, “shake hands with government policies, utilizing leverage and/or guarantees to their benefit”…or euphemistically this is called political entrepreneurship or economic rent seeking from the US government!

Well, more signs of the Philippinization of the America.

The Applause Goes To Inflation

I wouldn’t shudder at the thought of policy tightening given the near unison of voices from the global authorities to extend the party.

Since inflation is a political process, then let us tune in to the statements of the political authorities to get a feel on their pulse and the possible directions of the markets.

From Caijingonline, ``China's economy is at a crucial juncture in its recovery and the government will not change its policy direction, Premier Wen Jiabao was cited as saying by Xinhua news agency September 1”…``China will stick to its moderately loose monetary policy as it strives to meet economic goals, Wen said during a meeting with visiting World Bank President Robert Zoellick.” (emphasis added)

From Bloomberg, ``China’s banking regulator said it will take years to implement stricter capital requirements for banks, seeking to assuage concerns the rules will cause a plunge in new lending.”

From Wall Street Journal, ``World Bank President Robert Zoellick said Wednesday it is too early for China to roll back its stimulus measures as the country's economic recovery could still falter.”

From Bloomberg, ``European Central Bank President Jean-Claude Trichet said the bank won’t necessarily raise interest rates when the time comes for it to start withdrawing other emergency stimulus measures. The term ‘exit strategy’ should be understood as the framework and set of principles guiding our approach to unwinding the various non-standard measures,” Trichet said at an event in Frankfurt today. “It does not include considerations about interest policy.”

From Wall Street Journal, ``Dominique Strauss-Kahn, managing director of the International Monetary Fund, warned world governments against “premature exits from monetary and fiscal policies” despite signs that “the global economy appears to be emerging at last from the worst economic downturn in our lifetimes.”

From Bloomberg, ``Federal Reserve officials in their August meeting discussed extending the end-date for purchases of mortgage bonds to minimize any market disruptions, and expressed concern about the pace of a likely economic recovery.”

As presciently predicted by Ludwig von Mises in Human Action, ``The favor of the masses and of the writers and politicians eager for applause goes to inflation.”

The global political leadership sensing short term triumph from current policies will continue to exercise the same “success formula” to limn on the illusion of prosperity.

Their actuations are so predictable.

The Deflation Bogeyman

I wouldn’t be a buyer of the global deflation thesis especially under the context that deflation is a monetary phenomenon.

That’s because the only transmission mechanism from so-called deflationary pressures, via the recession channel, would be from remittances and exports, which isn’t deflationary in terms of the potential to wreak havoc on the domestic banking system or even on the 40% informal cash based economy.

Said differently: Slower or negative exports or remittances will NOT contract the money supply and won’t be a hurdle from a Central Bank determined to inflate the system!

In the US, the fact that tuition fees from Ivy League Schools have been exploding to the upside, in spite of today’s crisis, dismisses the deflationary nature in the absolute sense for the US economy [see Black Swan Problem: Deflation? Not In Ivy League Schools].

What the US has been undergoing is a statistical deflation- a price based measure from the preferred numbers by the establishment.

In terms of political dimensions, scare tactics (deflation bogeyman) has been repeatedly used by authorities to justify inflationary policies to wangle out concessions aimed at rescuing select (political interest groups) entities or industries at the expense of the society.

And I think that the ultra low inflation (BSP) in the Philippines reflects on the same statistical mirage.

Just this week my favorite neighborhood sari-sari store (retail) hiked beer prices by 5%! While beer may not be everything (it may even be a store specific issue, which I have yet to investigate), looking at oil prices at $68 today from less than $40 per barrel in March signifies a price increase of 70%!

Seen from a lesser oil efficient use economy, the transmission mechanism, whose effect may have lagged, could be more elaborate than reflected on government based statistical figures.

To consider both the US and the Philippines will have national elections in 2010, senatorial and Presidential-senatorial respectively. So it wouldn’t be far fetched that the incentive for incumbent authorities from both countries to intervene (directly or indirectly) in order to create the impression of a strong economic recovery for the sole purpose of generating votes.

The fact the Philippine Peso continues to slide against the US dollar in the face of stronger regional currencies seems so politically suspicious.

The Peso’s woes can’t be about deficits (US has bigger deficits-nominally or as a % to GDP), or economic growth (we didn’t fall into recession, the US did), remittances (still net positive) or current account balances (forex reserves have topped $40 billion historic highs) or interest rates differentials (Philippines has higher rates).

In sum, when you factor in all the major variables that could influence the Phisix- local politics (national elections), geopolitics (such US elections), the “anxiety” from global central bankers which should translate to prolonged or extended monetary inflation, continued loose domestic monetary policies, long term technical trends, inflation sensitive fundamental issues (as systemic leverage, banking system) and the potential response from the public to loose monetary policies-it would seem highly probable that the domestic stock market is likely to continue with its long term ascent.

So I would NOT reckon this to be a bear market rally especially not from the flimsy excuse of global deflation.

Figure 4: Bloomberg: Possible Bear Market Rally

Bear market rally could be a US phenomenon (see figure 4), but is unlikely for Asia and Asian Emerging Markets.

Nevertheless, I would use the US dollar index, gold and oil as my main barometers for measuring liquidity conditions.