The Symmetry Between Ponzi Scams and Ponzi Financed Global Financial Markets

Lessons from the Aman Ponzi Scam

A few months back I warned that the current negative real rates regime will foster and bring about accounts of fraudulent financial operations such as Ponzi and pyramiding schemes 

I wrote last March[1],

Since fixed incomes will also suffer from interest rate manipulations, many will fall victim or get seduced to dabble with Ponzi schemes marketed by scoundrels who would use the current policy induced environment as an opportunity to exploit a gullible public.

I even followed this up last week[2],

instead of locking money through interest rate dividends from savings account in the financial institutions, zero bound regime or negative real rates which are part of financial repression have been forcing people to chase on yields and gamble in order to generate returns. So the public have become more of a “risk taker” and take on “greedy” activities in response to such policies. Some would even fall or become victims to Ponzi schemes which I expect to mushroom.

Enormous losses from Ponzi operations of the Aman Futures Group[3] to a whopping tune of Php 12 billion (US 289 million at 41.5 to a USD) from over 15,000 victims coming from various sectors, largely from Southern Philippines, particularly in Visayas and Mindanao, has been a recent revelation.

The streak of large scale financial hoaxes continues to surface.

Today, another financial scam in Lanao, also in Mindanao, by an alleged Jachob “Coco” Rasuman group[4], whom preyed on a smaller number, specifically 29 Muslims investors by defrauding them of Php 300 million (USD 7.22 m) was reported by media. Ironically, these scumbags got gypped or suffered a dose of their own medicine, when they invested in Aman Futures. Talk about karma. 

Negative real rates, which in reality punishes savers and creditors, have been forcing many people to chase on yields in order to preserve on their savings. Such environment has encouraged the vulnerable public to take unnecessary risks and gamble which unscrupulous agents take advantage of.

While negative real rates necessarily do provide the incentives for many in the public to get financially duped or hoodwinked, this has not been a sufficient reason.

A big part has been a mélange the lack of financial alternatives, which has been tied or linked to the dearth of financial education, as well as, the paucity of critical thinking and self-discipline which has been associated with the welfare mentality.

All Ponzi operations have been anchored on “something for nothing” dynamic.

Typically astronomical returns on placements by early investors are paid for by the infusion of new money from new investors. Of course, sky high returns are dangled as compelling motivation for financial patsies to ensnare the bait. Yet, once the critical mass or where insufficient money from new investors to pay for existing ones has been reached, the whole bubble operations collapses like a house of cards.

It is quite obvious that a yield offer of something like 50% a month would translate to a nominal 600% returns a year. Yet nobody seems to have the common sense to ask “what kind of businesses or investments would return at least 600% a year”?

The apparent insufficiency of financial common sense can be traced to the underdeveloped conditions of the country’s financial markets. 

The development of financial markets has been associated with greater degree of economic development. According McKinsey Global Institute[5], most of the emerging markets’ financial depth has been between 50 and 250 percent of GDP compared to 300 to 600 percent of GDP for developed countries. In other words, increasing standards of living from the accretion of individual savings, which became the cornerstone of financial intermediation that led to the development of financial markets, has played a significant role in capital formation and the subsequent growth in the economy.

Financial depth has been conventionally measured[6] through:

-the traditional banking system,

-the non-banking financial institutions[7] which comprises risk pooling institutions (Insurance), contractual Savings Institutions (Pensions and Mutual funds), Market Makers (broker dealer), Specialized Sectoral Financiers (real estate, leasing companies, payday lending) and Financial Service Providers (security and mortgage brokers) and finally

-financial markets[8], particularly capital markets (stock and bonds), commodity markets, derivatives, money markets, futures markets, insurance markets and foreign exchange markets.

One would note of the severe deficiencies of the state of non-banking financial institutions as well as the financial markets. Example the Philippines remains as a laggard in the ASEAN regions commodity markets having no existing commodity markets. Another example is that specialized investment vehicles have been inaccessible to the public such as short sales (short sales exist but operating rules render them useless), derivatives (which have been limited to banks), and select futures (e.g. currency forwards also restricted to banks) among many others.

Thus the immature state of financial markets essentially restricts the transmission mechanism of savings to investments that has functioned as one key hurdle to economic growth and development.

Again, no less than the heavily politicization, taxation and overregulation of the industry or the political unwillingness to openly promote alternative savings and investment vehicles, as well as incentivize industry competition, has been responsible for the backward state of affairs.

Because many lack the access to such legitimate financial alternative options, there has been similarly less desire or motivation to imbue the necessary knowledge to protect oneself from financial knavery.

And while education may help, in reality, contextual education to establish the virtues of self-discipline or emotional intelligence is paramount.

Education per se (or education as a function of social signaling) has not deterred the infamous Bernard Madoff from having to cream, bamboozle and embezzle $50 billion off from a legion of supposedly professional finance managers representing top banks, insurers, hedge funds[9] with his Ponzi version which got busted in 2008.

Also, the public’s increased reliance on politicians to exercise the paternalist ethical plane of behavioral guidance for financial operators and for market participants has prompted for the substitution of self-responsibility and mutual respect for dependency: the welfare mentality. Plainly put, such victims outsourced self-responsibility to equally gullible local politicians, who in a bizarre twist of events, “openly endorsed” and likewise became victims of the grand Philippine Ponzi scam. This simply serves as another lucid example of the knowledge problem at work.

So while national political authorities swiftly use such crisis as opportunity to pontificate on the supposed paternalist virtues in seeking redress and the rightful justice deserving for the aggrieved parties, these politicians skirt the blame of the adverse effects from their policies. Out of ignorance or in collusion with the political establishment or both, mainstream media has been equally culpable for concealing the social effects of bubble policies.

Nonetheless, bubble policies promote bubble psychology, bubble attitudes and bubble actions.

As the late economic historian Charles P. Kindleberger wrote in Mania’s, Panics and Crashes (p.66 John Wiley)[10]

Commercial and financial crisis are intimately bound up with transactions that overstep the confines of law and morality shadowy though these confines be. The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom. Crash and panic, with their motto of sauve qui peut induce still more to cheat in order to save themselves. And the signal for panic is often the revelation of some swindle, theft embezzlement or fraud

The Addiction to Legalized Ponzi Financing

Think of it, if Ponzi schemes are considered illegitimate because they arise from financing investment operations by enticing new money[11] from new investors by offering surrealistic returns, how would one call today’s financial markets which operate on the deepening dependency on central banks to provide ever increasing “new” money to bolster or at least maintain elevated asset prices? 

Everyday we see signs of these.

A parallel universe represents an alternative reality. If doctrinal finance teaches that economic growth serves as indicator to corporate earnings which should get reflected on stock prices then Japan’s financial markets and her economy appear to operate on a parallel universe. That’s because economic growth and stock market pricing seems to move in diametrical directions which jettisons the conventional wisdom.

Ever since the 2011 triple whammy Earthquake-Tsunami-Fukushima Nuclear disaster, Japan’s economy continues to weaken. Japan has reportedly entered a mild recession in the 3^rd Quarter[12]. Yet since April’s bottom, the Japan’s major equity bellwether the Nikkei 225 continues to gain grounds.

Yet much of these pronounced gains had been made last week, ironically when the Prime Minister Yoshihiko Noda dissolved the parliament and simultaneously called for a snap election on December 16^th[13].

His expected replacement, Shinzo Abe, leader of the once dominant Liberal Democratic Party (LDP) has been widely expected to pressure the Bank of Japan (BoJ) to aggressively stimulate the economy.

Thus like the Pavlovian conditioned stimulus, the smell of freshly minted or digitally created money sends the financial markets into a rapturous bliss

So amidst the announcement of a recession, the Nikkei 225 jumped 3.4% for this week. That’s effectively half of the modest year to date return of 6.73%. The reversal of the Nikkei’s year to date performance from loss to gains come at the heels of further weakening of major global equity bellwethers.

In other words, Japan’s politicians, media and the marketplace continue to carry unwavering faith and undying hope over the BoJ’s action, despite the series of QEs launched since. In short, all the money printing did has been to boost asset prices even as the economy tumbled. Such Pollyannaish belief is tantamount to “doing the same thing over and over again and expecting different results”. Someone once defined this as insanity.

Just last month, the BoJ announced a back to back QE 8^th[14] and QE 9^th[15] in a span of one week.

Yet despite all the easing polices by other major economies, previous gains continue to dissipate from the current string of losses.

Since the latest peak of the S&P 500 in mid-September 2012, the major US bellwether has lost in 6 out of 9 weeks, which as of Friday’s close, has been off about 7% from the zenith and has pared down year to date gains to just 6.42%. 

President Obama’s class warfare policies which will raise capital gains and dividend tax substantially, contradicts the US Federal Reserve’s easing policies, thus US equity markets remain plagued by political uncertainties[16]. US markets remain hostaged to politics. 

Yet what has been apparent is the volatile environment from the addiction to central bank Ponzi financing.

Financial analyst and fund manager Doug Noland of the Credit Bubble Bulletin[17] at the Prudent Bear neatly captures the soul of today’s policy based Ponzi-bubble dynamics

a Credit Bubble is sustained only through ever-increasing quantities of “money” and Credit.  The greater the Bubble, the greater the required policy response to sustain the inflation.  But, importantly, the greater the policy measures imposed the greater the market reaction – and the greater the market reaction the greater the necessity for even bigger policy interventions in the future.  

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[1] See After 5,000: What’s Next for the Phisix? March 5, 2012

[2] See The Phisix in the Shadow of the US Fiscal Cliff November 11, 2012

[3] Inquirer.net Thousands duped in P12-billion scam November 14, 2012

[4] Inquirer.net Bigger scam in Lanao Sur November 18, 2012

[5] McKinsey Global Institute Mapping global capital markets 2011 August 2011

[6] Financial Depth (Size) Rethinking the Role of the State in Finance WorldBank.org

[7] Wikipedia.org Non Bank Financial Institutions

[8] Wikipedia.org Financial market

[9] See Madoff Ponzi Scam and Boom-Bust cycles December 21, 2008

[10] Charles Kindleberger, Mania’s, Panics and Crashes A History of Financial Crisis, p.66 John Wiley

[11] Wikipedia.org Ponzi scheme

[12] Editorial Japan Times Nip the recession in the bud, November 17, 2012

[13] The Globe and Mail Election call puts spotlight on Bank of Japan, November 14, 2012

[14] See Bank of Japan Adds More Stimulus October 27, 2012

[15] See Bank of Japan’s Back to Back Stimulus November 1, 2012

[16] See Obama’s Fiscal Cliff: The Effects of Taxing Wealth November 13, 2012

[17] Doug Noland, When Money Dies, Prudent Bear November 16,2012

The Honor of Japan's 'Lonely Deaths’

From BBC.co.uk (bold emphasis mine)

The discovery of three bodies that lay unnoticed for up to two months in an apartment in Japan has raised concern over so-called "lonely deaths".

The three people, believed to be from the same family, were discovered on Tuesday in Saitama, north of Tokyo.

Electricity and gas to the house had been cut off, there was no food in the house and just a few one-yen coins.

Despite being the world's third richest country, Japan has seen a number of similar cases in recent years.

Such deaths are referred to as "kodokushi" - lonely deaths.

The BBC's Roland Buerk, in Tokyo, said when the police broke into the apartment in Saitama, they found the three bodies extremely thin.

It is believed they were a couple in their sixties and their son in his thirties who died of starvation. The alarm had been raised by the building's management company.

The Asahi Shimbun newspaper said that the family had asked a neighbour for help, but had been refused and instead advised to contact the welfare authorities.

The family did not do so, a move some local media outlets have put down to feelings of shame.

Asahi Shimbun quoted lawyer Takehiro Yoshida as saying: "Some people have a resistance to going on welfare and are reluctant to consult with authorities. Others are isolated in their communities."

Our correspondent says the case has prompted soul-searching in one of the most affluent societies on earth about whether the needy are falling through gaps in the welfare system.

The left points to this as an example of the lack of compassion of the system, which they use as an excuse to advocate for bigger welfare states.

Yet it is not true that Japan lacks safety net, in reality, the number of people enrolled in Japan’s welfare system has reached nearly reached the record set during post World War II.

According to the Japan Times

There were 2.02 million people receiving welfare as of March, close to the record 2.04 million in the aftermath of World War II, while the number of households on welfare in March hit an all-time high of 1.46 million, the government said

The total number of people was almost equivalent to the record monthly average of about 2.04 million logged in fiscal 1952, the Health, Labor and Welfare Ministry said Tuesday.

Moreover, not only has the welfare state increased dependency of many Japanese, which reduces their productivity (as well as of the nation), another adverse consequence has been to diminish community values.

As the above report shows, calls for assistance by the affected to seemingly desensitized neighbors “had been refused and instead advised to contact the welfare authorities.”

Already burdened by heavy taxes paid to the government, neighbors must have probably thought that such responsibility should be the cargo of the welfare state, thus the reluctance to extend aid.

To quote Professor Shawn Ritenour in a Biography of Economist Wilhelm Röpke

Compulsory aid "paralyzes people's willingness to take care of their own needs" and its financial burden makes people depend more on the state and expect more from it. "To let someone else foot the bill" is the "very essence" of the welfare state; moreover, the people who pay are "forced to do so by order of the state"--the opposite of charity. "In spite of its alluring name, the welfare state stands or falls by compulsion. It is compulsion imposed upon us with the state's power to punish noncompliance. Once this is clear, it is equally clear that the welfare state is an evil the same as every restriction of freedom."

Hence, the politics of coercive welfare redistribution reduces the zeitgeist of voluntary charity.

Finally, the few Japanese who endured the 'lonely deaths', who by their “resistance to going on welfare and are reluctant to consult with authorities”, willingly refused to become a liability to taxpayers, or wards of the state, which they perhaps deemed as stigma. They must have died out of principle, and thus should be honored as true patriots.

America’s Growing Dependency on the Welfare State

Proof that Americans have become less a representative of “the land of the free” has been the deepening trend of dependency on the welfare state.

From the Wall Street Journal Blog

The pool of Americans relying on government benefits rose to record highs last year as an increasing share of families tapped aid in a weak economy.

Some 48.6% of the population lived in a household receiving some type of government benefit in the second quarter of 2010, up a notch from 48.5% in the first quarter, according to Census data…

The largest chunk of benefits flowing to families came from means-tested programs. In the second quarter, 34.4% lived in a household benefiting from food stamps, subsidized housing or Medicaid, among others.

That number is up from 32.8% a year ago (when a total of 46.8% of the population lived in a home receiving benefits). The biggest increases came from an uptick in those turning to food stamps and Medicaid.

Nearly 15% of Americans lived in a household receiving food stamps in mid-2010; Almost 26% had access to Medicaid.

Only a small share of the population accessed cash welfare benefits as the 1990s overhaul made it more onerous in many cases to receive and maintain those payments. Some 1.9% of the population lived in a household that received welfare in the second quarter of 2010.

I previously had Robert Higgs perspicacious and highly relevant insight as my quote of the day. [bold emphasis added]

As the ranks of those dependent on the welfare state continue to grow, the need for the rulers to pay attention to the ruled population diminishes. The masters know full well that the sheep will not bolt the enclosure in which the shepherds are making it possible for them to survive. Every person who becomes dependent on the state simultaneously becomes one less person who might act in some way to oppose the existing regime. Thus have modern governments gone greatly beyond the bread and circuses with which the Roman Caesars purchased the common people’s allegiance. In these circumstances, it is hardly surprising that the only changes that occur in the makeup of the ruling elite resemble a shuffling of the occupants in the first-class cabins of a luxury liner. Never mind that this liner is the economic and moral equivalent of the Titanic and that its ultimate fate is no more propitious than was that of the “unsinkable” ship that went to the bottom a century ago.

Any wonder why US politicians has unflinchingly been pushing for many arbitrary laws?

20 Signs of the Unsustainable US Nanny State

From The Economic Collapse Blog

The following are 20 signs that the culture of government dependence has gotten completely and totally out of control....

#1 If you can believe it, 48.5% of all Americans now live in a household that receives some form of government benefits. Back in 1983, that number was less than 30 percent.

#2 Way too many Americans believe that the government should just swoop in and solve all of their problems. For example, the plight of a single mother named Angel Adams made national headlines recently. Over the years her relationships with three different men have produced 15 children, and she was recently found living in a single motel room with 12 of those children.

As you can see in the video below, Adams is looking for the government to come in and rescue her. The following is what Adams told one reporter....

“Somebody needs to pay for all my children and my – for all my suffering. Somebody needs to be held accountable, and they need to pay.”

#3 The amount of money paid out to individual citizens by the government today is absolutely staggering. In 1980, government transfer payments accounted for just 11.7% of all income. Today, government transfer payments account for 18.4% of all income.

#4 According to a recent ABC News report, suicides in rural America are spiking, and experts say that cuts to Medicaid are partly to blame....

“Kathie Garrett, co-chairman of the Idaho Council on Suicide Prevention, says the problem has gotten only worse since the recession. "The poor economy and unemployment—those put a lot of stress on people's lives," she explains. To save money, people skip doctor visits and cut back on taking prescribed medications. Cuts in Medicaid have reduced the services available to the mentally ill.

"I personally know people who lost Medicaid who've attempted suicide," says Garrett.

#5 By the end of 2011, approximately 55 million Americans will receive a total of 727 billion dollars in Social Security benefits. In future years, this dollar figure is projected to absolutely skyrocket.

#6 When you total it all up, American households are now receiving more money from the U.S. government than they are paying to the government in taxes.

#7 It is being projected that the federal government will account for more than 50 percent of all health care spending in 2012.

#8 Back in 1965, only one out of every 50 Americans was on Medicaid. Today,one out of every 6 Americans is on Medicaid.

#9 According to the Congressional Budget Office, the Social Security systempaid out more in benefits than it received in payroll taxes in 2010. That was not supposed to happen until at least 2016.

#10 The federal government is expected to "take care" of their workers far better than the private sector does. If you can believe it, the average federal employee in the Washington D.C. area brings in total compensation worth more than $126,000 a year.

#11 Last year, federal employees "earned" approximately 447 billion dollarsin total compensation.

#12 Spending by the federal government accounts for approximately one thirdof the GDP of the entire Washington D.C. region.

#13 The federal government spent more than 50 billion dollars on "housing assistance" in 2009.

#14 The U.S. government now says that the Medicare trust fund will run outfive years faster than they were projecting just last year.

#15 The total cost of just three federal government programs - the Department of Defense, Social Security and Medicare - exceeded the total amount of taxes brought in during fiscal 2010 by 10 billion dollars.

#16 Right now, there are more than 45 million Americans on food stamps. That means that approximately one out of every seven Americans is dependent on the federal government for food.

#17 The number of Americans on food stamps has increased 74% since 2007.

#18 Sadly, one out of every four American children is now on food stamps.

#19 In 2010, 42 percent of all single mothers in the United States were on food stamps.

#20 According to one study, "64.3 million Americans depended on the government (read: their fellow citizens) for their daily housing, food, and health care" during 2009.

The following chart from Heritage Foundation shows that by 2049, Medicare, Medicaid and Social Security will consume 100% of taxes.

This excerpt from Professor Higgs (previously at quote of the day) has been so relevant…

As the ranks of those dependent on the welfare state continue to grow, the need for the rulers to pay attention to the ruled population diminishes. The masters know full well that the sheep will not bolt the enclosure in which the shepherds are making it possible for them to survive. Every person who becomes dependent on the state simultaneously becomes one less person who might act in some way to oppose the existing regime. Thus have modern governments gone greatly beyond the bread and circuses with which the Roman Caesars purchased the common people’s allegiance. In these circumstances, it is hardly surprising that the only changes that occur in the makeup of the ruling elite resemble a shuffling of the occupants in the first-class cabins of a luxury liner. Never mind that this liner is the economic and moral equivalent of the Titanic and that its ultimate fate is no more propitious than was that of the “unsinkable” ship that went to the bottom a century ago.

The laws of economics will not allow for its persistence, whereas beneficiaries will revolt over any cuts.

The ultimate end of the welfare state extrapolates to chaos or dystopia.

Britain’s Riots: Symptoms of the Disease called Welfare State

The psychology of entitlement or dependency derived from the welfare state brings with it the propensity for violence once this privilege is seen as being taken away. The political beneficiaries think that there is an inexhaustible Santa Claus fund always there to serve them.

Add to the baneful effect of this dependency psychology is the lack of respect for the sanctity of private property rights.

And Britain’s riots appear to have been manifesting these symptoms.

Writes Allister Heath cityam.com (hat tip Dan Mitchell)

The cause of the riots is the looters; opportunistic, greedy, arrogant and amoral young criminals who believe that they have the right to steal, burn and destroy other people’s property. There were no extenuating circumstances, no excuses. The context was two-fold: first, decades of failed social, educational, family and microeconomic policies, which means that a large chunk of the UK has become alienated from mainstream society, culturally impoverished, bereft of role models, permanently workless and trapped and dependent on welfare or the shadow economy. For this the establishment and the dominant politically correct ideology are to blame: they deemed it acceptable to permanently chuck welfare money at sink estates, claiming victory over material poverty, regardless of the wider consequences, in return for acquiring a clean conscience. The second was a failure of policing and criminal justice, exacerbated by an ultra-soft reaction to riots over the past year involving attacks on banks, shops, the Tory party HQ and so on, as well as an official policy to shut prisons and reduce sentences. Criminals need to fear the possibility and consequence of arrest; if they do not, they suddenly realise that the emperor has no clothes. At some point, something was bound to happen to trigger both these forces and for consumerist thugs to let themselves loose on innocent bystanders.

But while all three main parties are responsible for flawed policies that have fuelled this growing underclass at a time of national prosperity – 5.5m-6m adults now on out of work benefits, a number that has been roughly constant for over two decades – the argument made by some that the riots were “caused” or “provoked” by cuts, university fees or unemployment is wrong-headed. Just because someone is in personal trouble doesn’t give them the right to rob, attacks or riot.

In any case, the state will spend 50.1 per cent of GDP this year; state spending has still been rising by 2 per cent year on year in cash terms. It has never been as high as it is today – in fact, it is squeezing out private sector growth and hence reducing opportunities and jobs. Many of the vandals were school children not yet in the labour market; unemployment is a tragedy that must be fought but 9, 10 or 14 year olds can’t be pillaging because of it. Equally tragically, most of the older rioters would never have any hope of going to university, regardless of cost, such is their educational poverty.

What they wanted is free money and free goods and so they helped themselves. They were driven by greed, a culture of entitlement, of rights without responsibility, combined with a complete detachment from traditional morality, generalised teenage anger and a sense that anything goes in the current climate. This wasn’t a political protest, it was thievery.

read the rest here

Example Of How The Welfare State Destroys The Individual

This is a graphic example of how the welfare state destroys the individual or the intermporal effects (short term gain, long term costs) of welfarism.

Gerry Garibaldi writes [hat tip: Dan Mitchell] (bold emphasis mine)

Connecticut is among the most generous of the states to out-of-wedlock mothers. Teenage girls like Nicole qualify for a vast array of welfare benefits from the state and federal governments: medical coverage when they become pregnant (called “Healthy Start”); later, medical insurance for the family (“Husky”); child care (“Care 4 Kids”); Section 8 housing subsidies; the Supplemental Nutrition Assistance Program; cash assistance. If you need to get to an appointment, state-sponsored dial-a-ride is available. If that appointment is college-related, no sweat: education grants for single mothers are available, too. Nicole didn’t have to worry about finishing the school year; the state sent a $35-an-hour tutor directly to her home halfway into her final trimester and for six weeks after the baby arrived.

In theory, this provision of services is humane and defensible, an essential safety net for the most vulnerable—children who have children. What it amounts to in practice is a monolithic public endorsement of single motherhood—one that has turned our urban high schools into puppy mills. The safety net has become a hammock.

And this applies to the Philippines as well.

For instance, in terms of demographics and education, public schools relieve the personal responsibility of the “poor” to have children, since the entrenched impression is that the state provides “free” education. So family planning becomes less of a priority because of such skewed incentives. I have personally spoken to many ‘poor’ people whose brains appear hardwired to the state’s ‘free schooling’.

And this seems backed by statistics which shows that the highest fertility rate is seen among the poorest in the society.

And this also departs from the layman’s opinions who mostly see that the “poor people have less to do except make babies”.

Of course, I am quite sure that there are many other laws which contribute to the distortion of people’s behaviour. The essence of which are that these laws (welfare programs) essentially abdicate personal responsibility and are substituted for government dependence, with the provision that individual freedom is compromised or curtailed in return for “safety nets” and votes.

Furthermore, people hardly know that there is no free lunch and such law distorting behaviour will eventually lead to an entitlement crisis. Yet politicians and their apologists continue to sell promises which they don't intend to fulfill.

The Myth Of Money Flows Into The Stock Markets

``To understand reality is not the same as to know about outward events. It is to perceive the essential nature of things. The best‐informed man is not necessarily the wisest. Indeed there is a danger that precisely in the multiplicity of his knowledge he will lose sight of what is essential. But on the other hand, knowledge of an apparently trivial detail quite often makes it possible to see into the depth of things. And so the wise man will seek to acquire the best possible knowledge about events, but always without becoming dependent upon this knowledge. To recognize the significant in the factual is wisdom.” Dietrich Bonhoeffer (1906-1945) German Lutheran Pastor

I recently picked up a short remark on the cyberspace about how the most recent febrile punts from “Meralco” could have caused a “rotation” in the general markets. The idea is that those who profited from the recent upside volatility in Meralco may have buoyed the general market by using profits earned from recent trades to shift into other issues.

This seems similar to the conventional thinking where occasions of huge IPOs or other security offerings (e.g. preferred shares, bonds) in the domestic financial system are deemed as having to adversely “suck the liquidity out” of the Philippine Stock Exchange.

The general idea for both assertions is that money flows “in” and “out” of the Philippine Stock Exchange .

The fact is that money DOES NOT flow in or out of the stock market.

Why?

On any given trading day unless a publicly listed company issues new or additional securities, shares available to the market are fixed.

This means that a transaction occurs only when buyers and sellers agrees to voluntarily exchange cash for a specified security at a particular price.

Let’s say Pedro has Php 100 in cash and agrees to buy Juan’s ownership of publicly listed XYZ company shares for Php 10 a share. The transaction would prompt for a shift in ownership: Pedro’s cash will be credited to Juan’s account while Juan’s XYZ shares will be transferred to Pedro’s account.

In short, in contrast to conventional thinking there is no money flows.

The price directions in the exchange merely reflect on the aggressiveness of the buyers in bidding up the price level of a security (hence, higher prices) or of the assertiveness of sellers in selling down a security at certain price levels (hence lower prices).

As we recently wrote at A Primer On Stock Markets-Why It Isn’t Generally A Gambling Casino, ``Yet prices are always set on the margins. What you read on the stock market section in the newspapers account for as prices determined by marginal investors, where daily traded volume represent only a fraction of total shares outstanding or market capitalization, and not the majority owners.”

As in the case of Meralco, there had been buyers and sellers at recently low prices as much as there had equally been buyers and sellers at the recent high prices. Thereby the suggested “rotation” from punts signifies as “rationalization”-probably holds true for some but not all (fallacy of composition)-than of reality.

In addition, the “sucking out of liquidity” from a monster $800 million record bond offering of San Miguel Brewery , which was reportedly oversubscribed by 16 times, to exclusively the domestic market hasn’t drained liquidity from the PSE, the fact is that despite the resurgence of broadmarket NET foreign selling, the Phisix is up by about 15% from the close of the SMB bond offering last March 16^th.

The SMB offering only suggests that there is a vast pool of non-equity market liquidity sloshing in the domestic financial system.

Importantly, the recent recovery in the Phisix likewise extrapolates to local liquidity substituting for the net foreign selling which has been accounted for in the market since the credit crisis erupted in 2007.

Figure 1: PSE: NET Foreign Selling (above), Transition from Foreign Dominance to Local Dominance

Figure 1 from the PSE gives an abbreviated view of the ongoing dynamics in the local exchange.

The chart manifests of the prevalent net foreign selling since last quarter of the 2008 and the shifting regime of trading ascendancy which was previously controlled by foreign investors (grey line) to presently local investors (maroon line) seen at the lower pane entitled ‘Total Value Traded By Investor Type’.

The other vital point to consider is that the transactions in the PSE represents for as a continuing flux of the character of ownership than one of technical “money flows”. As cited above, one of the current tangible alterations in the ownership has been that of local money replacing foreign money.

Fundamentally, it would rather be irrelevant if the issue of ownership transfers will be just from speculators to market punters or scalpers whom are looking to profit from minor price fluctuations.

But it would be materially relevant if the conveyance reflects a shift from major stockholders to a wider spectrum of public shareholder ownership because a larger breadth of public participation should entail a broader cognizance of the basic functions of capital markets.

And since capital markets operate as non-banking alternative option to raise, access, avail or price in or value investment capital, it has an economically vital function of channeling society’s savings into productive investments.

Moreover, when we argue about the low penetration rates of domestic investors in the local equity markets, which according to the PSE is estimated at less than half of 1% of the population even at the peak of the market, we are thinking along the premise of concentrated degree of ownership or of the limited float on the supply side (of listed companies) and or the lack of widespread market participation from the local public savers on the demand side. Of course, here the PSE looks at only direct investments, but glosses over the indirect investments through Unit Investment Trust Funds and mutual funds-where we estimate market exposure increases to somewhere at 1%.

The point is that these glaring deficiencies essentially reflect on the severe underdeveloped nature of the local equity markets.

And these are further compounded by the dearth of sophisticated instruments to hedge on “naked” positions, the “gambling” or overtrading culture disseminated as “education” by conventional brokers and the high cost structures from regulatory compliance that serve as material barriers to entice additional listing from privately owned unlisted enterprises into tradeable or investable publicly listed financial instruments.

Market Ignorance and Political Serfdom

Let me add that it doesn’t help or do justice to the public or to society to induce “trading” assimilation programs because it “tunnels” vulnerable neophytes to believe that the stockmarket is merely a gaming platform to play with, based on a very narrow time frame expectations regardless of prevailing risk conditions.

Ironically, what is the use to study the risk reward nature of markets (or even to obtain course certificates as Chartered Financial Analyst-CFA) if only markets operate in the analogy of games played in the casino or the racetrack?

People who get burned from wrong expectations tend to shy away from a bad experience. It is out of such adverse outcome that the “casino” imprint gets etched into mainstream psyche. And worst, a tarnished image has viral (word of mouth) repercussions. So short term gain always come at the expense of long term losses (in the form of monetary loss and mental anguish) which equally poses as a considerable obstacle to economic development.

On the philosophical aspect, the paucity of exposure to the capital markets is one substantial reason for the “overdependence” of Filipinos to the government as the ever elusive elixir for societal ills.

The problem is that government as the solution has served as perpetual illusion. The problem isn’t due to the “bad” attitudes by the Filipinos, as repeatedly floated in emails, but attitudes fostered by an entitlement and welfare privileged class or the “dependency culture” which is a common trait to a society highly dependent on government.

Yet the eternal search for virtuousness can’t be reconciled with political realities, where each incidence of hope from a new beginning eventually turns out as a mass frustration.

Mr. Robert LeFevre in his The Nature of Man and His Government tells us why, ``Government is a tool. The nature of the tool is that of a weapon…government, designed for protection, always ends up by attacking the very persons it was intended to protect…Government begins by protecting some against others and ends up protecting itself against everyone."

Notwithstanding, we Filipinos have not yet to realize that entrepreneurship and its quintessential feature of risk taking serve as fundamental conditions for economic and financial progress.

The Law Of Demand And Supply Applied To Equities

Going back on how the law of demand-and-supply of equities impact pricing, two charts from Northern Trust reveals of the basic laws of economics at work in the recent collapse of the US equity markets…

Figure 2: Northern Trust: How Demand and Supply Impacts Stock Prices During the Recent Crisis

Last year’s meltdown came in conjunction with a record amount of net equity issuance which totaled $986 billion during the fourth quarter of last year, or at a seasonally-adjusted annual rate or equivalent to 6.9% to nominal GDP.

And who was doing the record issuance?

Northern Trust Chief Economist Mr. Paul Kasriel makes as an astute observation, ``it was the financial system, desperate for new capital to replace a huge amount of old “depreciated” capital, that was doing all the issuing. At a seasonally-adjusted annual rate, financial institutions were net issuers of equity to the tune of $1.4 trillion in the last year’s fourth quarter while nonfinancial corporations were net “retirers” of $450 billion of equity.

``At the same time the financial institutions were issuing record absolute and relative amounts of new equity, I think it is safe to say that investors’ demand for financial institutions’ equities was somewhat inhibited…”

So as the US financial institutions had been undertaking intense balance sheet deleveraging by selling off liquid assets worldwide to raise capital, which further crimped on general market sentiment and which similarly contained demand interests for equity assets, we also saw financial institutions flooding the equity markets with new issuance or simply supply overwhelmed demand which prompted for a meltdown.

Mr. Kasriel rightly concludes, ``In sum, there is no mystery as to why the broad U.S. stock indexes took a dive in the fourth quarter of last year. It simply was a matter of an increase in supply accompanied a decrease in demand.”

The equity demand supply dynamics in the US hasn’t been the case in the Philippine equity markets as the latter has suffered mainly from the contagion impacts, as the exposure to “toxic” assets had been inconsequential that didn’t require equity issuance to plug losses.

The Myth Of Cash On The Sidelines

To further expand the thought about the misguided “money flows” in and out of the stockmarket, this should include the misimpressions about sitting “cash on the sidelines” as potential drivers of the market.

Dr. John Hussman rightly and eloquently argues (bold highlight mine), ``savings equals investment, and new savings can finance new investment. But what investors often point to and call “cash on the sidelines” is really saving that has already been deployed and used either to offset the dissavings of government or to finance investments made by other companies. Once those savings have been spent, you can't, in aggregate, use the IOUs (in the form of money market securities) to do it again.

``In other words, the amount of cash that investors hold “on the sidelines” is determined by the amount of borrowing that has occurred in the form of money market securities like T-bills and commercial paper. It's a lapse of proper thinking to believe that investors, as a group, can move their “cash on the sidelines” into the stock market, or that companies, taken together, can turn their “cash on the sidelines” into new investment and capital spending.”

Technically speaking, money invested in corporate or government bonds account for as money having been already spent and thus a shift into the equity markets does not account for as “money flows” into “new” capital investment.

So what is commonly perceived as drivers for equity prices in terms of “cash in the sidelines” isn’t accurate. Equity prices again are driven by the aggressiveness of either buyer or seller in the marketplace.

Other than that the exercise of paper shuffling, the switching of assets simply can be construed as realignment or rebalancing of portfolio holdings.

Applied to the Philippines, this implies that a genuine measure of money flow into the equity market should translate to savings financing a new equity issuance in the form of an IPO, which generally flourishes during boom days or is pro-cyclical [see The Prudent Way To Profit From IPOs!], and or secondary listings which are meant to finance fresh projects or company expansions.

Summary and Conclusion

The point of this article is to refute the fallacious mainstream notion that daily transactions signify as some mystic form of money flowing in and out of the equity markets.

Money flows into the equity markets only occur when savings are utilized to finance new capital spending projects by virtue of new corporate equity issuances in the form of IPO or secondary listing.

Instead, the directions of equity prices are driven by the aggressiveness of buyer or seller, where daily transactions only reflect on the dynamics of changing of ownership of mostly marginal investors.

In addition, the fundamental laws of demand and supply applied to equity distribution have been shown to have a material impact on its price values. Thus it is important not only to look at the elements encompassing macro or micro environment dynamics and its impact to earnings or to the national economy but likewise on the variables that may directly influence the demand and supply allocation of equities.

Finally the population penetration level of equity investors can be reflective of the nature of a society’s understanding of how capitalism works. The small diffusion of domestic public investors seems highly correlated to the statist biases of the local populace. Since the capital markets function as an important conduit of capital accumulation through the development of the country’s production structure, the corollary of the underdevelopment of the capital markets is manifested by the nation’s suboptimal economic growth.

Hence, until the local population can materially increase their comprehension over how markets fundamentally work or how their savings can be recycled into productive investments, the local markets will remain underutilized and underinvested if the misperception that markets are simply “games” to dabble with remains.

We hope that our industry colleagues will authentically “educate” the public that sets aside short term gains in exchange for long term economic progress.

US Presidential Elections: The Realisms of Proposed “Changes”

``The facts: We have a $10.5 trillion national debt; $53 trillion of unfunded liabilities; a military empire that has US troops in 117 countries and has spent $700 billion on a pre-emptive war that has killed over 4,000 Americans; a $60 billion trade deficit; an annual budget deficit that will exceed $1 trillion in the next year; a crumbling infrastructure with 156,000 structurally deficient bridges; almost total dependence on foreign oil; and an educational system that is failing miserably. We can’t fund guns, butter, banks and now car companies without collapsing our system.” –James Quinn, “Baby Boomers Led Us Into Fiscal, Moral Bankruptcy”, Minyanville

In "The Decline and Fall of the Athenian Republic" 1776.", Alexander Fraser Tytler poignantly wrote, ``A democracy cannot exist as a permanent form of government. It can only exist until the voters discover they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising them the most benefits from the public treasury, with the result that a democracy always collapses over a loss of fiscal responsibility, always followed by a dictatorship. The average of the world's great civilizations before they decline has been 200 years. These nations have progressed in this sequence: From bondage to spiritual faith; from spiritual faith to great courage; from courage to liberty; from liberty to abundance; from abundance to selfishness; from selfishness to complacency; from complacency to apathy; from apathy to dependency; from dependency back again to bondage."

It will be the denouement of the US presidential elections this week. And most likely, the popular, based on polls and prediction markets, will prevail.

The Realisms and Illusions of Change

While “change” has been the key theme for both aspirants to the White House, considering the present economic and financial conditions, the only real change we are going to see seems to be what most of Mr. Tytler’s prediction 3 centuries ago.

And what “changes” would that be?

More debt, more government spending, more government intervention, more future taxes, more running down of present assets and more bondage. In short, the road to bankruptcy.

The popular idea is if people get the government to spend more, this should lift us out of the rut. And if Americans get to redistribute more wealth (see Spreading the Wealth? Market IS Doing It!), this should lead to even more progress.

Yet, if the same idea is correct, then Zimbabwe would have been the most prosperous among the all nations for unabated printing of money for its government to liberally spend and redistribute wealth. Unfortunately, Zimbabwe has been mired in a hyperinflation depression (some reports say 231,000,000% others at 531,000,000% inflation) that is continually felt by its countrymen through the apparent interminable loss of its currency by the millisecond to the point that some its citizenry has resorted to Barter (see The Origin of Money and Today's Mackarel and Animal Farm Currencies).

Or how could one easily forget the redistribution strategies of China’s Mao Tse Tung “great leap forward” or USSR’s Joseph Stalin “egalitarian” regimes whose only achievement is the combined death toll “democide” of 79 million citizens (Hawaii.edu) and a decrepit “everybody-is-poor-except-the-leadership” economy.

Many would argue that the US cannot be compared to Zimbabwe in the sense that America has institutions, markets, and a labor force that is more intelligent, flexible, effective and sophisticated. Maybe the recent Iceland experience should be a wake up reminder of how countries can suddenly go “richest-to-rags” story (see Iceland, the Next Zimbabwe? A “Riches To Rags” Tale?) on major policy blunders. Here, the market idiom also applies, “Past performance does not guarantee future results”.

The fact that markets are meaningfully suppressed and substituted for government intervention effectively transfers resources from the economy’s productive sector to the non-productive sector. When people’s incentives to generate profits are reduced then they are likely to invest less. And reduced investments translate to lower standards of living.

As James Quinn in a recent article at Minyanville wrote, ``In our heyday in the 1950s, manufacturing accounted for 25% of GDP. In 1980, it was still 22% of GDP. Today it’s 12% of GDP. By 2010, it will be under 10%. Our government bureaucracy now commands a larger portion of GDP than manufacturing. Services such as banking, retail sales, transportation and health care now account for two-thirds of the value of the US GDP.

``Past US generations invented the airplane; invented the automobile; discovered penicillin; and built the interstate highway system. The Baby Boom generation has invented credit default swaps; mortgage-backed securities; the fast food drive-through window; discovered the cure for erectile dysfunction; and built bridges to nowhere. No wonder we’re in so much trouble.”

Yet while Americans seem to drool over future welfare spending (a.k.a. free lunch), nobody seems to ask who is going to pay for these or how will it be paid or funded?

The Emerging American Bailout Culture

It is my assumption that most of the Americans are aware of the current crisis, such that the US Congress rapidly passed a fiscal bailout package called the Emergency Economic Act of 2008.

In November of 2006, William Poole, president of the Federal Reserve Bank of St. Louis presciently noted in a panel discussion, “Everyone knows that a policy of bailouts will increase their number.”

How true it is today. Proof?

AIG, which had been originally been accorded a loan of $85 billion in exchange for a government guarantee on its liabilities and a management takeover, has now ballooned to $123 billion (New York Times).

Next are the Bond insurers currently seeking shelter under the current TARF program. According to the Wall Street Journal, ``Bond insurers are urging the government to reinsure their battered portfolios, the latest push by the industry to seek relief under the Treasury's $700 billion financial rescue.”

The US government bailout has expanded its reach outside the banking sector to include credit card issuer Capital One Financial (Australian News) which implies that as a precedent, the next step will probably be an industry wide approach.

Then you have a hodgepodge of interest groups vying for the next bailout. Excerpts from the Hill.com

-A diverse collection of interests — from city transit officials to labor unions to “clean tech” advocates — are clamoring to be added to the second stimulus package Congress may consider after the election.

-Labor groups, meanwhile, want the stimulus bill to pay for new road and bridge construction to put people to work.

-The National Governors Association and the National League of Cities among others on Tuesday wrote to House and Senate leadership, asking them to raise the federal matching rate for Medicaid payments and to increase the money spent on infrastructure projects.

-Lobbyists for these groups argue that more federal spending would help minimize the job losses from a recession. In a white paper being circulated on Capitol Hill, the American Shore & Beach Preservation Association, for example, says $5 billion for water resource projects would create 140,000 new jobs.

Then you have the US government indicating more guarantees for troubled mortgages. This from Bloomberg, ``The U.S. Treasury and the Federal Deposit Insurance Corp. are considering a program that may offer about $500 billion in guarantees for troubled mortgages to stem record foreclosures, people familiar with the matter said.

``The plan, which might put as many as 3 million homeowners into affordable loans, would require lenders to restructure mortgages based on a borrower's ability to repay. Under one option, the industry would keep lower monthly payments for five years before raising interest rates, the people said.”

The government gives in a finger, now everybody wants the arm. From one industry to another, from one interest group to another, everybody seems to be clamoring for a bailout. So who’s gonna pay for all these? When will this culture towards accelerated dependency stop?

Throwing Pack Of Meat To The Wolves

This reminds us of self development author Robert Ringer who, in his recent article, cites Nathaniel Branden quoting staunch liberal Bennett Cerf in his book Judgment Day: My Years With Ayn Rand, ``You have to throw welfare programs at people — like throwing meat to a pack of wolves — even if the programs don't accomplish their alleged purpose and even if they're morally wrong… Because otherwise they'll kill you. The masses. They hate intelligence. They're envious of ability. They resent wealth. You've got to throw them something, so they'll let us live."

In a political season, pandering to the masses is the surest route to seize power. But of course, the hoi polloi can’t distinguish between the real thing and the varied interests behind those propping the candidates or even welfare economics behind all the programs being tossed to the people (or its unintended effects).

Some officials in the US government are actually aware of the perils of too much government intervention. This noteworthy excerpt from the testimony of South Carolina Governor Mark Sanford before House Committee on Ways and Means (all highlights mine)…

``Simply throwing money into the marketplace in the hope that something positive will happen ignores the fact that the government has already put over $2 trillion into the system this year using various bailouts and stimulus packages: including $168 million in direct taxpayer rebates this past spring; an $850 billion bailout last month that cost more than we spend on defense or Social Security or Medicaid and Medicare annually; and myriad loans and partial nationalizations of institutions like Freddie Mac and Fannie Mae, JPMorgan Chase, Bear Sterns and AIG. This doesn’t even include the arguably most effective form of stimulus the country has seen over the past year, a market-based infusion of over $125 billion into the economy and taxpayers’ wallets caused by falling oil prices and subsequently lower prices at the pump.

``This year’s $2 trillion plus in bailouts and handouts seems that much more momentous when you consider that federal tax revenues last year were only $2.57 trillion. Simple math demands we ask ourselves if $2 trillion did not ward off the crisis in confidence we’re currently experiencing, then how much can $150 billion more help? Especially since we’re dealing with a $14 trillion economy and a larger $67 trillion world economy, meaning that this shot in the arm represents merely one-fifth of one percent of the world economy…

``Essentially, you’d be transferring taxpayer dollars out of the frying pan – the federal government – and into the fire – the states themselves. I think this stimulus would exacerbate the clearly unsustainable spending trends of states, which has gone up 124 percent over the past 10 years versus federal government spending growth of 83 percent. It would also dangerously encourage even more growth in governmental programs like Medicaid, which in state budgets across the nation already grew 9.5 percent per year over the last decade – certainly unsustainable in our state. Moreover, the United States Department of Health and Human Services just last week projected that spending on Medicaid will grow at an average annual rate of 7.9 percent over the next 10 years – and possibly faster if this stimulus package passes. State debt across the country has also increased by 95 percent over the past decade. In fact, on average every American citizen is on the hook for $1,200 more in state debt than we were 10 years ago. So if government gives in WHO pays for these?”

Soaring US Fiscal Deficits; Can The World Fund It?

Figure 1: Casey Research: US Fiscal Deficit could top $1trillion!

Remember, global trade as a result from today’s crisis seems likely to diminish, as the US, Europe and most OECD economies meaningfully compress from a recession.

This implies that any improvement from the US current account deficit may be offset by a surge in fiscal deficit which is already at a record $455 billion (Bloomberg) to over $1 trillion in 2009, see figure 1.

Yet improving current account deficits for the US translates to almost the same degree of reduction of current account surpluses for Emerging Markets, Asia and other current account surplus nations, which equally means less foreign exchange surplus.

The point is with diminishing accretion of foreign exchange surpluses; such raises the question of funding for US programs, which in the past had been financed by the world, mostly by Asia and EM through acquisition of US financial claims.

Back to basics tells us that governments can only raise revenues in 3 major ways: by borrowing money (issuing debts), by printing money (inflation) or via taxation.

But if global taxpayers can’t fund US programs, and if the world’s capacity to lend and borrow seems limited by the degree of improving current account imbalances, then this leaves one option for the US government; the printing press. And it is a not surprise to see US authorities recognize this option, as it has revved up its monetary printing presses of last resort (see US Federal Reserve: Accelerator to the Floor!).

So while it is true that in the present conditions nation states maybe able to take over the slack or imbue the leverage from the private sector, this isn’t without limits. Unless the world would take upon further risks of the extreme ends of either global depression or hyperinflation as the Austrian School have long warned it to be.

The Coming Super Subprime or Entitlement Crisis

And it doesn’t stop here; today’s crisis has been centered on the credit bubble largely as a function of the US financial sector. What hasn’t been spoken about is the risks of the Baby Boomer or Entitlement Spending Crisis from which David M. Walker, former U.S. Comptroller General, tagged as “super subprime crisis” as even more deadlier than the crisis we face today. (We earlier spoke about this in Tale of The Tape: The Philippine Peso Versus The US Dollar)

This excerpt (Hat tip: Craig McCarty) from David Walker’s article published at CNN/Fortune (all highlights mine),

``The entitlements due from Social Security and Medicare present us with that frightening abyss. The costs of these current programs, along with other health-care costs, could bankrupt our country. The abyss offers no assets, troubled or otherwise, to help us cross it…

``In fact, the deteriorating financial condition of our federal government in the face of skyrocketing health-care costs and the baby-boom retirement could fairly be described as a super-subprime crisis. It would certainly dwarf what we're seeing now.

``The U.S. Government Accountability Office (GAO), noting that the federal balance sheet does not reflect the government's huge unfunded promises in our nation's social-insurance programs, estimated last year that the unfunded obligations for Medicare and Social Security alone totaled almost $41 trillion. That sum, equivalent to $352,000 per U.S. household, is the present-value shortfall between the growing cost of entitlements and the dedicated revenues intended to pay for them over the next 75 years.

Figure 2: GAO: David Walker Fiscal Wake Up Tour in 2006

``Today we are headed toward debt levels that far exceed the all-time record as a percentage of our economy. In fact, by 2040 we are projected to see debt as a percentage of our economy that is double the record set at the end of World War II. Based on GAO data, balancing the budget in 2040 could require us to cut federal spending by 60% or raise overall federal tax burdens to twice today's levels.

``Medicare, Medicaid, and Social Security already account for more than 40% of the total federal budget. And their portion of the budget is expected to grow so fast that their cost, and the cost of servicing our debt, will soon crowd out vital programs, including research and development, critical infrastructure, education, and even national defense.

``The crisis we face is one of numbers and demographics but also of attitudes. Promises were made in an earlier time, when they seemed more affordable. Like homeowners borrowing against the value of their homes in the expectation that the values would go up forever, the American government borrowed against the future and assumed that the economy would grow fast enough to make that debt affordable.

``But our national debt is not limitless, and our foreign lenders are not fools. If we persist on our current "do nothing" path, our future will be jeopardized. Americans need to reconcile the government we want with the taxes we're willing to pay for it.

Mr. Walker’s concern is that unfunded entitlement liabilities will continually mount and take up a significant share of the expenditures relative to the GDP, which can’t be afforded by the US over the coming years. Compound this with the bills from the present programs to bailout the US economy.

Much of the incumbent and aspiring US politicians have had little to say on these matters.

Yet any resolution to this predicament will require vastly unpopular and stringent political decisions. Think of it, rising taxes in general and or cutting retirement benefits or a combination of both will be politically acceptable? Will the next president turn against his supporter to implement the much needed reform?

But like typical politicians the likelihood is that the desire to avoid pain is politically paramount. Because a politician’s political capital or career will be at stake.

Thus, it is likely that the leadership will, once again, adopt a reactionary approach, because it is far more beneficial to game the present rules than to find a solution and enforce them.

Critical Policy Actions Will Draw The Fate Of The World

Steering the US political economy at this very sensitive and fragile stage will be very crucial.

Policies based on populism can set off a very dangerous chain of events. The great depression of the 30s was a result of a series of market stifling government policies that setoff massive waves of unintended consequences.

As analyst John Maudlin aptly points out in his latest outlook on the role of the new US president,

``One is a tax cut for 95% of Americans. The problem is that 47% of Americans do not pay taxes, so what you are really talking about it a massive expansion of welfare. But if you use that tax increase on the "rich" to pay for your "tax cuts" to other Americans, you have no money to pay for other programs, let alone get anywhere close to a balanced budget.

``And of course, as each year passes there is less net Social Security income to the government. If you use your tax increase to fund more expenses today, you will not have that to fund Social Security in 2017 when the program goes into a cash-flow deficit. Or, taxes will really have to rise later in the decade. But then again, that will be another president's problem.

``How do you offer the increased medical programs you propose if you use the tax increase for tax cuts for 95% of Americans (read: welfare for 50%) without really busting the budget? Or any of the $600 billion in programs that you want to see?

``And your serious economic advisors are going to point out (at least in private) that raising taxes on the 5% of wealthiest Americans is eerily similar to what Herbert Hoover did in his administration, along with legislation to restrict free trade and increase tariffs, which you have also advocated. Look where that got him and the country.

``75% of those "rich" you are targeting are actually small businesses that account for 50-75% (depending on how you measure growth) of the net new job growth in the US. When you tax them, you limit their ability to grow their businesses. Further, you reduce their ability to consume at a time when consumer spending is already negative.

``Reduced consumer spending will be reducing corporate profits and thus corporate tax revenues. Just when you need more revenues.

``A tax hike in 2010 of the magnitude you currently propose, in a weak economy, is almost guaranteed to create a double-dip recession. That will not be good for your mid-term elections. Given that the recovery from a second recession is likely to be long and drawn out, it would also make it difficult to get re-elected, as the economy would be the first and foremost issue.”

In short, policy actions will differentiate between the realization of an economic recovery or a fall to the great depression version 2.0.

As we have noted in the past, the 5 cardinal sins in policymaking that may lead to severe bear markets or economic hardships are; protectionism (nationalism, high tariffs, capital controls), regulatory overkill (high cost from added bureaucracy), monetary policy mistakes (bubble forming policies as negative real rates), excess taxation or war (political instability).

Populist policies without the consideration of unintended effects may result to an eventual backlash. Highly burdensome taxes to the productive sectors may lead to lost future revenues which will be inadequate to fund any present redistribution or welfare programs. Inflation will be the next likely path.

In addition, since the US is heavily dependent on the world for both trade (remember little manufacturing) and financing (selling of financial claims), any modern day form of resurrecting the Smoot-Hawley act will equally be disastrous for the US and for the world.

So we hope and pray that the next US President won’t be overwhelmed with hubris enough to send the world into a tailspin by attempting to shape the world in accordance to an unworkable paradigm or ideology or hastily taking upon policy actions without assessing the economic repercussions. After all, financial and economic problems today require financial and economic and hardly political solutions.

US Elections and the Philippines; Final Thoughts

We noted earlier (see Gallup Polls: Filipinos Say US Election Matters, McCain Slightly Favored) that Filipinos and Georgians have acted as the only TWO contrarians nations that has favored the underdog Senator John McCain in a world heavily tilted by 4-1 in favor of the leading candidate Senator Barack Obama.

There is nothing wrong with such contrarianism.

There are many reasons why various nations or even individuals favor certain candidates. Perhaps this could be because the candidate/s and or party aligns with their social-economic-financial political interest, has shared history or culture, agrees with proposed policies, have ties or association with the party or the candidates, shares similar ideology, influenced by the “bandwagon effect” or the desire to be “in” the crowd or captivated to the “charisma” of the candidate or just plain revulsion to the present system or the incumbent.

The latest Philippine senatorial elections (see Philippine Elections Determined by The Contrast Principle!) was an embodiment of the latter’s case from which we even quoted the precept of Franklin Pierce Adams, ``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.”

It looks the same for the US.

The worsening bear market in stocks and real estate which seems reflective of the prevailing economic conditions appears to be a key driving force which appears to have driven the US public into the open arms of the opposition. Also, the rash of the present bailout schemes appears to be feverishly fueling the “bailout culture” from which has boosted the opposition’s welfare based platform.

Whether or not this would seem as a right choice is called opportunity cost. A George Bush Presidency means a lost Sen. John Kerry leadership in the 2004 elections. We will never know what a Kerry Presidency would have been. But from hindsight we know what a Bush presidency is-“the Biggest Spending President since Lyndon Johnson” (McClatchy.com)-unbecoming of an ideal GOP conservative. Put differently, President Bush was more of a Democrat than a Republican in action or a Democrat in Republican robes.

Besides, Vox Populi Vox Dei –“voice of the people is the voice of God” isn’t always true. Just ask Alexander Fraser Tytler “promising them the most benefits from the public treasury” or Bennett Cerf “You have to throw welfare programs at people — like throwing meat to a pack of wolves”. Or assess the Bush administration or any of the previous Philippine administrations.

Reading into the politician’s actions today is like reading tea leaves during the George Bush versus Al Gore elections in 2000 or a George Bush versus John Kerry in 2004.

Yet, projecting present actions from the candidates’ appearances, slogans, sponsorships, endorsements, proposed platforms and speeches as tomorrow’s policies is a mirage! Many of what both candidates had been saying today, in order to get one’s votes, will probably be reversed once they get elected! Like almost all politicians, voters will eventually get duped.

But elections are atmospheres of entertainment. And people love to be amused by demagoguery to the point of fanatically “believing”. Or to quote Bill Bonner of Agora’s Daily Reckoning, ``People come to believe what they must believe when they must believe it.”

Understand that there will be many painful tough calls which will be politically unpalatable. Think super-sub prime crisis, think the deepening bailout culture. All these are unsustainable over the long run. Combined, they are lethal enough to prompt for a global economic and financial nuclear winter from either a US dollar crash (hyperinflation-yes a Zimbabwe model applied on a world scale!) or a global depression. And all these will need some painful reform or adjustments in American lifestyles sometime in the near future. By then, it wouldn’t matter whether one’s vote would count unless it is time for reelections.

Alas, to believe in purported “change” from today’s imagery is nothing but an unfortunate self-delusion.