Desperately Looking For Normal-In Pictures

Here is another demonstration of how massively disconnected the stock markets are with conventional fundamentalism (e.g. economy or earnings)-which is the reason why many "experts" have been utterly perplexed.

Russia's RTSI had been one of the top world performers for 2009 and produced 129% in local currency gains!


The conventional thought have been that stocks function as forward looking indicators for the economy with about a window of 4 to 6 months ahead.

Yet the Russian economy has wobbled ALL throughout last year as shown below from US Global Investors.


According to US Global Investors, ``Russian GDP contraction is estimated to decelerate to -5.3 percent in the fourth quarter compared to -9.8 percent in the third quarter. The beginning of economic recovery as well as the base effect means a substantial upside to 3-4 percent growth estimate in 2010."

The RTSI spiked by another astounding 8% this week!

More.

In our recent post, Venezuela's Path To Hyperinflation we noted that despite the recent crisis-massive devaluation and electricity rationing-Venezuela's stock market benchmark, the IBVC, soared by a whopping 10.85% this week!

Chart From Bloomberg

No, it isn't that Venezuela is immune or crisis proof.

Instead it is likely that we are witnessing accelerated signs of the demonetization process or the trajectory towards hyperinflation.

Bottom line: the common denominator appears to be massive inflationism and how these has mangled economic calculation and has thus resulted to unexpected volatility.

Venezuela's Path To Hyperinflation

My prime candidate for the next episode of hyperinflation (which I mentioned here) has long been Venezuela.

That's because accelerating socialism, espoused by the dictatorship regime translates to profligate spending which generates intractable financial claims and economic inefficiencies (which impedes the capacity to pay the incurred liabilities) that has resulted to ballooning deficits.

And this translates to massive printing of money in order to fill or cover such shortfalls for the preservation of power by the incumbent political leader. In short, using the printing press as political tool.

So while hyperinflation is technically about sustained excessive money printing, the underlying incentives that beckons it is political.

The end result: the demonetization of money.

According to Professor Ludwig von Mises from his Stabilization of the Monetary Unit? From the Viewpoint of Theory,

``If people are buying unnecessary commodities, or at least commodities not needed at the moment, because they do not want to hold on to their paper notes, then the process which forces the notes out of use as a generally acceptable medium of exchange has already begun. This is the beginning of the “demonetization” of the notes. The panicky quality inherent in the operation must speed up the process. It may be possible to calm the excited masses once, twice, perhaps even three or four times. However, matters must finally come to an end. Then there is no going back. Once the depreciation makes such rapid strides that sellers are fearful of suffering heavy losses, even if they buy again with the greatest possible speed, there is no longer any chance of rescuing the currency. In every country in which inflation has proceeded at a rapid pace, it has been discovered that the depreciation of the money has eventually proceeded faster than the increase in its quantity.” [all bold emphasis mine]

Seen in the context of Venezuela, which massively devalued its currency last week, this from Wall Street Journal account, (hat tip Douglas French and Mises Blog) [bold highlights mine]

``President Hugo Chávez's decision to devalue Venezuela's bolivar and impose a complicated new currency regime may paper over some growing cracks in the economy, but it is also setting the stage for bigger problems down the road for the country's oil-rich nation and its populist leader.

``Over the weekend, there were signs that Mr. Chávez's slashing of the "strong bolivar" currency could create as many problems as it solves in Venezuela's economy, provoking a wave of anxiety that sent Venezuelans scurrying to spend cash they feared could soon be worthless.

``At Caracas's middle-class Sambil shopping mall, lines at cashiers reached 50-deep. Carmen Blanco, a 28-year-old accountant, waited to buy a 42-inch flat-screen television she doesn't need because she already has one at home.

``"It doesn't make any sense to keep my savings," Ms. Blanco said Saturday. "I'd love to see how things work in a normal country."

``On Sunday, Mr. Chávez vowed to fight speculation and price increases that could result from the devaluation, which raises the price of imports.

``Harried by recession and sliding popularity, Mr. Chávez on Friday weakened the bolivar to 4.3 per dollar from 2.15 in a bid to shore up government finances, which have been hit by weaker oil prices, and to stimulate economic growth ahead of key elections."

And where does Mr. Chavez gets his ideas? Unfortunately from the stereotyped self-righteous protectionist mindset.

Again from the same WSJ article, (all bold highlights mine; comments added)

``In Mr. Chávez's favor, a weaker currency helps narrow a growing budget shortfall by instantly giving his oil-rich government more local currency to spend per barrel of oil exported by the state petroleum company, PDVSA. That is a key consideration with congressional elections looming in September.

[yes inflationism shifts spending power to the government and his allies at the cost of less spending power for the people-Benson]

``Mr. Chávez has watched his popularity slide amid corruption scandals, a shrinking economy, rising crime and shortages of food and electricity. Increased spending could boost Mr. Chávez's popularity.

[note: Venezuela is a major oil exporter-Benson]

``Mr. Chávez also predicted a weaker currency would breathe life into a domestic economy that depends on imports for everything from beef and milk to cars.

[this is an example of the currency magic wand mindset at work-Benson]

``The measure may buttress the banking system, which has been rocked by the closure of several institutions amid an embezzling scandal. Many Venezuelan banks head into the devaluation holding large stocks of dollars.

[governments almost always favors the banking system because it can help in the financing of its political goals-Benson]

``Holders of dollar-denominated bonds issued by Venezuela and PDVSA will be encouraged by the move. Devaluation narrows Venezuela's financing gap to around 3% of economic output from around 7%, said Boris Segura, a Royal Bank of Scotland economist."

``However, the devaluation does little to assuage the deeper problems plaguing the Venezuelan economy, economists say. Devaluation isn't enough to revive the domestic manufacturing base. Few investors are willing to brave Venezuela's maze of price caps, currency controls and the ever-present fear of nationalization."

[Here's the rub: the rubber finally meets the road, this is a vivid example where fallacious theories don't square with reality. The currency magic wand can't offset domestic policy distortions-Benson]

``Higher inflation from the move will also keep chipping away at the value of the bolivar, even at its new peg."

``What is more, by keeping a subsidized dollar rate for importing food, medicine and essential items, Mr. Chávez removes any incentive for Venezuelans to produce what they need most."

From Murray Rothbard in Mystery of Banking, ``But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to “catch up” to prices, then the country is off to the races. Money and prices will follow each other upward in an ever-accelerating spiral, until finally prices “run away,” doing something like tripling every hour. Chaos ensues, for now the psychology of the public is not merely inflationary, but hyperinflationary, and Phase III’s runaway psychology is as follows: “The value of money is disappearing even as I sit here and contemplate it. I must get rid of money right away, and buy anything, it matters not what, so long as it isn’t money.”

We seem to be witnessing unfolding chaos from the demonetization process.

Another observation: It's been a common fallacious notion that stock markets respond negatively to intensified inflation.

In Venezuela, this hasn't been the case.

Perhaps this could be true depending on the degree of inflation.

But in cases where the state of money swiftly deteriorates, where its store of value comes into question or comes under severe strain, stock markets become haven from the demonetization process.

Why?

Again from Professor von Mises, ``If the future prospects for a money are considered poor, its value in speculations, which anticipate its future purchasing power, will be lower than the actual demand and supply situation at the moment would indicate. Prices will be asked and paid which more nearly correspond to anticipated future conditions than to the present demand for, and quantity of, money in circulation. The frenzied purchases of customers who push and shove in the shops to get something, anything, race on ahead of this development; and so does the course of the panic on the Bourse where stock prices, which do not represent claims in fixed sums of money, and foreign exchange quotations are forced fitfully upward."

And this has been the case of Weimar Germany and just recently Zimbabwe.

If present political trends won't reverse, then Venezuela would be another real time example of paper money based system that will evaporate soon.

Global Inflationism: It's Not All About Gold

Many have argued that gold is in a bubble.

Yet, given the bigger picture, gold's recent spike pales in comparison to other commodities.
According to Bespoke Invest, ``While gold is currently grabbing the headlines, it's actually up the least out of the seven major commodities that are in the black this year. As shown, Copper is up the most with a gain of 126.7%. Orange juice is up the second most with a gain of 83.3%, while oil, silver, and platinum are all up more than 50%. Coffee and gold are both up about 30%. Three commodities are down in price in 2009 -- wheat (-20.27%), corn (-17%), and natural gas (-11.6%)."

However while momentum appears to have fizzled out for gold, the other precious metals and energy commodities, according anew to Bespoke, ``the breakfast drink commodities -- coffee and orange juice -- are both in strong uptrends and are trading right at overbought territory at the moment." For us, while we expect commodities to generally benefit from the loss of purchasing power of paper money or rising inflation, the rate of advances are likely to be divergent.

However, if indeed the US dollar system is suffering from what we deem as the initial symptoms of "demonetization", precious metals are likely to be the prime beneficiaries or 'leaders', from which should spillover to the general commodities sphere.

As Ludwig von Mises explained,

``The divorce of a money, which is proving increasingly useless, from trade begins when it starts coming out of hoarding. If people want marketable goods available to meet unanticipated future needs, they start to accumulate other moneys, for instance, metallic (gold and silver) moneys, foreign notes, and occasionally also domestic notes which are valued more highly because their quantity cannot be increased by the government, such as the Romanov ruble of Russia or the "blue" money of Communist Hungary. Then too, for the same purpose, people begin to acquire metal bars, precious stones and pearls, even pictures, other art objects and postage stamps. An additional step in displacing a no-longer-useful money is the shift to making credit transactions in foreign currencies or metallic commodity money which, for all practical purposes, means only gold." (bold highlights mine)

Put differently, gold's rise while symptomatic of a monetary disorder hasn't reached the level where rampant demonetization is taking hold yet.

Albeit, the symptoms can hardly be ignored as seen from the chart above from goldmoney.com where gold is even outperforming against the Euro. To quote James Turk of gold money,

``When viewed against gold, the time-tested numéraire of all national currencies, we can see that the euro is collapsing almost as fast as the dollar, which is not too surprising. The dollar and the euro have both caught the fatal disease that inevitably inflicts and eventually kills all fiat currencies – central bank mismanagement."

Vietnam’s Inflation Control Measures And The Japanese Yen’s Record High

``If most of us remain ignorant of ourselves, it is because self-knowledge is painful and we prefer the pleasures of illusion.” Aldous Huxley

There are other issues that appear to have been eclipsed by the Dubai Debt Crisis.

Vietnam’s Inflation Control Measures

First, Vietnam announced a sharp hike in its interest rate to allegedly combat inflation. According to Finance Asia, ``The State Bank of Vietnam will increase its benchmark interest rate to 8% from 7% as of December 1”

In addition, Vietnam likewise devalued its currency the Dong by 5.2%. According anew to Finance Asia, [bold emphasis mine] ``The State Bank of Vietnam also reset the US dollar reference rate to 17,961 dong from its current level of 17,034 dong, in its third devaluation of the currency in two years. The central bank will also narrow the trading band of the dollar against the dong to 3% from 5%.

``This is an effort not only to bring confidence to the currency, but also to correct the difference versus where the dong is trading on the black market, which has been at about 19,700 per US dollar in recent weeks.”

Figure 6: Wall Street Journal: Vietnam’s Devaluation

In other words, currency controls have widened the spread between the black market rate of the Vietnam Dong relative to the US dollar and the official devaluation merely is an attempt to close the chasm. The Vietnamese economy has been suffering from a huge current account deficit to the tune of almost 8% of its GDP.

However, in spite of the fresh monetary actions (see figure 6) the black market rate for the Dong and the official rate remain far apart.

And because of the spike in interest rates, the Vietnam equity benchmark fell by 11.73% over the week.

However, a curious and notable observation is that Vietnam’s present policies seems like responding to a market symptom which can be characterized as our Mises Moment,

This from Thanhnien.com, ``Vietnamese lenders are facing a shortage of funds to meet rising demand for loans because gains in gold and the dollar are deterring people from putting money in the bank, according to a government statement. Commercial banks have had to raise deposit interest rates to as high as 9.99 percent over the past week and offered gifts and bonuses to depositors to lure them back, the statement on the government’s website said.” [bold emphasis original]

In other words, the Vietnamese people have been hoarding gold and foreign currency (US Dollar) and have shunned the banking system in response to Vietnam’s government repeated debasement of its currency. It’s seems like an early symptom of demonetization.

As we have previously quoted Professor Ludwig von Mises from his Stabilization of the Monetary Unit? From the Viewpoint of Theory,

``If people are buying unnecessary commodities, or at least commodities not needed at the moment, because they do not want to hold on to their paper notes, then the process which forces the notes out of use as a generally acceptable medium of exchange has already begun. This is the beginning of the “demonetization” of the notes. The panicky quality inherent in the operation must speed up the process. It may be possible to calm the excited masses once, twice, perhaps even three or four times. However, matters must finally come to an end. Then there is no going back. Once the depreciation makes such rapid strides that sellers are fearful of suffering heavy losses, even if they buy again with the greatest possible speed, there is no longer any chance of rescuing the currency. In every country in which inflation has proceeded at a rapid pace, it has been discovered that the depreciation of the money has eventually proceeded faster than the increase in its quantity.” [bold emphasis mine]

Will Vietnam follow the path of the most recently concluded Zimbabwean monetary disease?

I was thinking of Venezuela as next likely candidate but here we have a next door neighbor exhibiting the same symptoms that ails every government that attempts to control or manipulate the marketplace.

The Japanese Yen On A 14 Year High

The second issue overshadowed by the Dubai Debt Crisis is that the Japanese Yen soared to its highest level against the US dollar in 14 years.

According to a Bloomberg report, ``The dollar dropped to the lowest level versus the yen since July 1995 and fell against the euro as the Federal Reserve’s signal it will tolerate a weaker greenback encouraged investors to buy higher-yielding assets outside the U.S.”

The strength of the Japanese yen had been broad based against other major currencies but gains were marginal.

The news blamed the Yen’s rise on the carry trade ``delay debt repayments spurred investors to sell higher-yielding assets funded with the currencies.”

Such oversimplification is not convincing or backed by evidence.

As noted earlier, the US dollar fell to new lows on the Dubai incident before rallying back Friday but eventually giving back most of its gains.

Besides, not all markets had been severely hit. In Latin America, Brazil, Columbia, Chile, Mexico and Venezuela all registered weekly gains. Emerging markets are expected to take it to the chin when carry trades unravel. This hasn’t been the general case.

In Europe, Germany, Italy, Norway, Sweden, Switzerland and Italy survived the week on positive grounds. So even if the Dubai debt crisis exposed Europe more than the others, the selling pressure wasn’t the same. UK home to RBS suffered marginal losses (.11%).

Again none of these accounts for as any solid or concrete signs of an unwinding of carry trade.

Figure 7: stockcharts/google: Nikkei-Yen and Japan exports

While the rising Japanese Yen has so far coincided with a lethargic Nikkei since August (see figure 7 left window), it’s not clear that such correlation has causation linkages.

Although the Japanese government thinks it has.

Again from the same Bloomberg article, ``Finance Minister Hirohisa Fujii said he will contact U.S. and European officials about exchange rates if needed, signaling his growing concern that the yen’s ascent will hurt the economy. The Bank of Japan checked rates at commercial banks in Tokyo, seen as a type of verbal intervention, Kyodo News Service reported.

``Japan hasn’t sold its currency since March 16, 2004, when it traded around 109 per dollar. The Bank of Japan sold 14.8 trillion yen ($172 billion) in the first three months of 2004, after record sales of 20.4 trillion yen in 2003. Japan last bought the currency in 1998, purchasing 3.05 trillion yen as the rate fell as low as 147.66.”

Well it came to my surprise that after all the political gibberish about Japan’s so-called export economy or export dependency, we realized that Japan’s economy is hardly about global trade.

According to ADB data, Japan’s trade in 2006 only accounted for 28.2% of the nation’s GDP, where export (right window) is only 16% of the GDP pie (yes this stunned me as I had the impression all along that Japan’s trade was at the levels of Hong Kong and Singapore and I had to check on official or government data).

The Philippines has even a higher share of trade (84.7%) and exports (36.9%)!

In addition, Japan’s industry, as a share of GDP pie registered for only 26.3%, according to the CIA factbook in 2008.

So a policy for a weaker yen is likely to benefit a small but strong lobbying segment of the society at the expense of the consumers (via cheaper products) or the society.

All these are strong evidences on why the world is facing a greater degree of risks from a hyperinflation episode.

The fallacious Mercantilist-Keynesian paradigm wants a race to devalue currency values, based on a simplistic one product, single price sensitivity, one labor, homogenous capital model which presumes global trade is a zero sum game. They hardly think of money in terms of purchasing power but from political interests based on “aggregate demand”.

Finally, Finance Minister Hirohisa Fujii isn’t likely to succeed in convincing his peers to collaborate to prevent the yen from strengthening. That’s because all of them share the same line of thinking or ideology. And Fed Chairman Bernanke has been on a helicopter mission that will likely to persist until imbalances unravel to haunt the global markets anew.

Lost On Oil: False Reality Or Inflation Dynamics In Play?

This is another evidence on how regulators and the public seems lost on what has been happening in the markets and the real economy.


According to the Economist, ``THE oil market is behaving like a bucking bronco again, and politicians are once more blaming speculators for careening prices. It is difficult to assemble a definitive explanation for the rally: a weak dollar helps oil prices, but evidence for improving supply and demand remains thin. Positions held on NYMEX, the New York commodities exchange, have indeed soared. In 2008 America’s Commodity Futures Trading Commission (CFTC), which regulates NYMEX, examined how the changing positions of hedge funds affect prices. It found correlation, not causation, but its investigations were hampered by the fact that it could not examine intra-day trades. Nor could it monitor certain derivatives, such as those traded via London’s InterContinental Exchange (ICE), in which Wall Street dealers are particularly prominent. But in a sign of things to come in the oil market, on June 12th the CFTC said it had launched a public investigation to see whether the biggest natural-gas contract traded on ICE was moving prices around in the more regulated futures markets." (bold highlight mine)

Essentially regulators as much as the mainstream can't find sufficient answers to the conundrum of rising oil prices and weak fundamentals.

Instinctively, regulators always blame such predicament on speculators, when in the contrary, "speculation" has signified as direct responses to the policies imposed.

We have been saying repeatedly that this has been mostly monetary forces dominating both the financial markets and the real economy or inflationary dynamics in motion.

As we earlier quoted Ludwig von Mises in his Stabilization of the Monetary Unit? From the Viewpoint of Theory, at an earlier post, Our Mises Moment Answers Mainstream’s Conundrum of Market-Fundamental Disconnect

``If people are buying unnecessary commodities, or at least commodities not needed at the moment, because they do not want to hold on to their paper notes, then the process which forces the notes out of use as a generally acceptable medium of exchange has already begun. This is the beginning of the “demonetization” of the notes. The panicky quality inherent in the operation must speed up the process. It may be possible to calm the excited masses once, twice, perhaps even three or four times. However, matters must finally come to an end. Then there is no going back. Once the depreciation makes such rapid strides that sellers are fearful of suffering heavy losses, even if they buy again with the greatest possible speed, there is no longer any chance of rescuing the currency. In every country in which inflation has proceeded at a rapid pace, it has been discovered that the depreciation of the money has eventually proceeded faster than the increase in its quantity.”

All these constitute an evolving process known "demonetization". Where sooner or later a seemingly "benign" environment may turn into mayhem, if the inflationary process isn't halted.

And additional regulations won't be enough to curtail this process as the public has virtually been responding only to inflationary policies being effected.