Financial Bubble: Shadow Banking System Soar to US $67 Trillion or 100% of World GDP

Each bubble carries with them their own individual or distinctive character. Bubbles are hardly identical, except for their monetary origins. 

Prudent Bear’s Doug Noland writes 

The current inflationary boom is unique.  It is global in nature unlike anything previously experienced.  The global Credit Bubble completely engulfed the “dollar reserve” global financial “system.”  The massive inflation of dollar financial claims fomented a corresponding historic inflation in various currency Credit systems worldwide.  Unprecedented global Credit inflation has been fueled by a globalized system of electronic “money” and Credit.  This prolonged cycle has been unique in terms of a global Credit expansion unconstrained by a monetary anchor, gold backing or even restraint imposed by bank reserve and capital requirements.  It’s been runaway non-productive debt growth on a scale never before seen.

Today’s unanchored US dollar standard system combined with the incumbent political economic architecture, which privileges the banking and financial sector, has brought upon the exploding growth of the Shadow Banking system

From Bloomberg,

The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight.

The size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector…

At $67 trillion this accounts for about 100% of the world GDP

The informal economy should not be seen as similar to the shadow banking system.

The former mostly signifies guerilla capitalism, while the latter has been the consequence of government protected banking and financial institutions taking advantage of legal loopholes (regulatory arbitrage) to financially “engineer” their balance sheets through innovative investment vehicles and accounting maneuvers.

From the same Bloomberg article:

Supervisors consider shadow banking activities to be those that allow banks to carry out business off balance sheets, as well as those which allow investors to bypass lenders and the functions they traditionally fulfill on the markets.

Once concentrated in the US, weak economic conditions and the recent financial crisis has prompted the Shadow Banking system to shift activities the worldwide.

Some highlights from the Financial Stability Board’s Global Shadow Banking Monitoring report 2012 (bold mine)

-Aggregating Flow of Funds data from 20 jurisdictions (Argentina, Australia, Brazil, Canada, Chile, China, Hong Kong, India, Indonesia, Japan, Korea, Mexico, Russia, Saudi Arabia, Singapore, South Africa, Switzerland, Turkey, UK and the US) and the euro area data from the European Central Bank (ECB), assets in the shadow banking system in a broad sense (or NBFIs, as conservatively proxied by financial assets of OFIs) grew rapidly before the crisis, rising from $26 trillion in 2002 to $62 trillion in 2007. The total declined slightly to $59 trillion in 2008 but increased subsequently to reach $67 trillion in 2011.

-Expanding the coverage of the monitoring exercise has increased the global estimate for the size of the shadow banking system by some $5 to 6 trillion in aggregate, bringing the 2011 estimate from $60 trillion with last year’s narrow coverage to $67 trillion with this year’s broader coverage. The newly included jurisdictions contributing most to this increase were Switzerland ($1.3 trillion), Hong Kong ($1.3 trillion), Brazil ($1.0 trillion) and China ($0.4 trillion).  

-The shadow banking system’s share of total financial intermediation has decreased since the onset of the crisis and has been recently stable at a level around 25% of the total financial system, after having peaked at  27% in 2007.  In aggregate, the size of the shadow banking system in a broad sense is around half the size of banking system assets. 

-The size of the shadow banking system (or NBFIs), as conservatively proxied by assets of OFIs, was equivalent to 111% of GDP in aggregate for 20 jurisdictions  and the euro area at end-2011 (Exhibit 2-3), after having peaked at 128% of GDP in 2007

-The US has the largest shadow banking system, with assets of  $23 trillion in 2011 on this proxy measure, followed by the euro area ($22 trillion) and the UK ($9 trillion).  However, its share of the total  shadow banking system  for  20 jurisdictions and the euro area has declined from 44% in 2005 to 35% in 2011. The decline of the US share has been mirrored by an increase in the shares of the UK and the euro area

This shows how deeply interconnected and intertwined the global banking and financial system is. 

This also underscores financial globalization, where the chain link of banking and finance amplifies contagion risks especially from from counterparty risks in the event of defaults.

This is also why central banks will likely keep on inflating as they will likely "move heaven and earth" to prevent the risks of cross-cascading defaults that would collapse the Shadow Banking system (and not to mention the collosal derivatives market which have reached $639 trillion as of June 2012 according to the BIS) and which would translate to a meltdown of the global banking industry and to sovereign defaults.

Current monetary inflation will require significantly more of the same monetary steroids to keep up the illusion of stability, which is why this inflationary boom has been no less different from the Ponzi operations, except that the central bank printing press has been the source of “something for nothing” operations.

Also the expanding depth of financial interdependency  poses limits to ‘decoupling’ or the idea that select national economies can move on a different path or become immune to a crisis.

The Booming Global Islamic Finance

From the Economist (bold emphasis added)

THE global market for Islamic finance at the end of last year was worth around $1.3 trillion, according to the UK Islamic Finance Secretariat, part of the CityUK lobby group. The total value of sharia-compliant assets has grown by 150% since 2006. Globally, banks hold over 90% of Islamic assets, and together with funds are big investors in sukuk, a type of bond. According to the latest quarterly report from Zawya, a business information firm, global sukuk issuance in the first quarter of this year was $43.3 billion, almost half the total for the whole of 2011. The withdrawal of European banks lending to the Gulf Co-operation Council (GCC) region is thought to have contributed to this rise. Total issuance could reach $126 billion this year, continuing the growth trend (aside from a brief decline in 2008 associated with the global economic slowdown). Malaysia, which dominates the global sukuk issuance market, is over 60% Muslim, and Islamic banking assets make up around a quarter of the country’s total. Globally, perhaps 12% of Muslims use Islamic financial products, but with other countries (predominately Muslim or with large Muslim populations) expressing interest in increasing services, the market seems likely to continue to grow.

My observations

The unfettered market always evolves according to the people’s demand. In today’s deepening of the information age, market trends have increasingly been based on niches or custom designed products and services. And this applies to the fast growing modern Islamic financing.

The terse article also shows how the world does not operate on a vacuum. The European crisis may have even bolstered the demand for sukuk issuance, as Muslim investors seek alternative options or safe havens.

Yet, Islamic finance has not been limited to the Muslims, as seen by the over 90% holding of Islamic assets by global banks, along with other countries “expressing interest in increasing services”. The point is that integration represents as natural consequences of free trade. In other words, the booming Islamic finance has been representative of the deepening of financial globalization.

Lastly, it is should also be pointed out that Malaysia being the largest sukuk issuer in 2011 has been a key proponent of the reintroduction of the Islamic gold standard, or the Islamic gold dinar since 2002.

While there seems hardly any traces of connection between sukuk issuance and the gold dinar yet, perhaps further inflationism by the developed nations may prompt for wider usage of the gold dinar in Muslim states as Malaysia, and also perhaps sukuk issuance could be backed by gold or denominated in the gold dinar. A combination of the two would likely incite greater demand for sukuk bonds and the dinar.

Video: World Bank Promotes Africa's Trade Liberalization

Something to cheer at: The World Bank, along with the African Union, promotes trade liberalization in Africa.

Dr Maxwell Mkwezalamba, Commissioner African Union Commission:

Trade is actually an engine of growth (2:24)

More signs of bullish prospects on Africa

China Aims For Global Financial Center, Plans To List Foreign Shares

China proposes to internationalize her stock exchanges.

From the Bloomberg,

China is “basically ready” to allow foreign companies to sell equity in the world’s second- biggest stock market, according to the Shanghai Stock Exchange official in charge of the so-called international stocks board.

The exchange has finished working on listing and trading rules, while the technological, regulatory, and system requirements are “basically ready,” Xu Ming, executive vice president of the Shanghai Stock Exchange, said in a Nov. 11 interview at the bourse. While there is no timetable for introducing the board, it should start “as soon as possible when the time is ripe,” he said.

“The internationalization of the securities market will benefit the whole nation and overseas companies are highly motivated,” Xu said.

Shanghai, home to one of China’s two stock exchanges, is luring overseas companies to list as part of the local government’s drive to make the city a global financial center by 2020. HSBC Holdings Plc, Coca-Cola Co. (KO) and NYSE Euronext are among the multinational companies that have expressed interest in selling shares to investors in China. Shanghai, the nation’s financial hub, has been contacted by foreign companies in the finance, telecommunications, consumer goods and manufacturing industries, Fang Xinghai, head of the city’s financial services office, said in a May 2010 interview.

Listing in China would let foreign companies benefit from higher valuations and give them access to Chinese currency to fund their expansion in the world’s second-biggest economy, Arjuna Mahendran, Singapore-based head of investment strategy for Asia at HSBC Private Bank, overseeing $460 billion globally, said in a June interview…

Xu said the Shanghai bourse has set no priority on which foreign companies can list first, refuting media reports that so-called red-chips, or overseas-incorporated Chinese businesses listed in Hong Kong, would be first. Hong Kong-listed Cnooc Ltd., China’s largest offshore energy producer, would sell stock if it received regulatory clearance, Chairman Fu Chengyu said in March.

Companies seeking to list on the international board should have a market value of more than 30 billion yuan ($4.7 billion) and combined three-year net income of more than 3 billion yuan, the 21st Century Business Herald reported in April, citing a draft plan. Ten companies may be allowed to sell shares initially, according to the report.

“We have no plan for the first batch of companies to be listed or how many there will be in the first batch,” Xu said. “We don’t give priority to whether foreign companies or red- chip companies should be listed first. Whoever is ripe will get listed first.”…

There are about 104 million investors in China, including mutual funds, institutional investors and 85 million individuals, the Shanghai exchange said.

“China and its capital markets don’t lack money,” Xu said. “Once the companies are listed, it will have a huge advertisement effect.”

Basically this means that China wants to local investors to diversify.

On the other hand, this also allows foreign companies to tap on Chinese savings.

While this should be seen as substantially a positive development, this may not be enough as China ought to open more her stock markets to foreigners and not just to allow trading of foreign shares.

Cross listing with her neighbors may even seem better.

And another thing, Chinese equity investors represent about 8% of the population which is substantially more than the Philippines with about less than 1%.

Nevertheless, to wean dependence away from the banking system, capital markets in Asia will need, not only to grow, but to modernize, deepen and outperform the world.

Global Equity Markets Update: Deepening Losses

Global equity markets appear to be in a deepening funk.

Of last month's 10, now only four of the 78 global equity market indices monitored by Bespoke Invest posted gains, the Bespoke writes,

Just four countries are currently in the black this year -- Venezuela, Botswana, Jamaica and Ecuador. Greece and the Ukraine are the worst performers year-to-date with respective declines of -45.15% and -46.93%. The UK ranks second out of the G7 countries with a decline of 7.35%, followed by Canada (-10.13%) and Germany (-13.70%). Italy is the worst performing G7 country so far in 2011 with a decline of 19.25%. All of the BRICs are down more than 10% year to date.

And nearly a third of global benchmarks may be tipping into the bear market territory. Currently 8 or 14% of the total have losses of more than 20%

So far ASEAN markets continue to outperform the world but they have also been in the red.

The broadening of stock market declines reveal how interrelated today’s financial markets are and how global markets react in tidal flows as consequence to central banking boom bust policies.

US Banks are Exposed to the Euro Debt Crisis

Recently I wrote about how US banks have been dependent on Bernanke’s QEs, where the unfolding Euro debt crisis could heighten risks a contagion on the US banking industry.

Also given that US banks have substantial exposures to European banks, it isn't farfetched to perceive a potential contagion from any further deterioration in the latter's banking sector.

The Huffington Post gives some numbers (bold emphasis mine)

If European politicians are unable to contain their sovereign debt problems, Wall Street could be on the brink of another financial crisis, according to economists.

Although U.S. banks have limited their direct exposure to Greece, they have loaned hundreds of billions of dollars to European banks and governments that may not be able to pay them back, according to the Bank for International Settlements. If some European governments and banks are forced to default on at least part of their debt, American banks could lose a significant amount of money on that account alone.

The resulting panic from investors could compound the losses. Short-term borrowing costs would spike, bank stock prices would plummet and investors could demand their money from banks, several economists say. In a repeat of the liquidity crisis of 2008, some U.S. banks could run out of the money necessary to fund their day-to-day operations…

Some predict that a European financial crisis would spread quickly to U.S. shores. The pain would not come directly from government defaults; U.S. banks have loaned just $36.2 billion to the five European governments that are in danger of defaulting: Greece, Ireland, Portugal, Spain and Italy. But U.S. banks have also loaned $60.6 billion to banks in those five countries, and $275.8 billion to banks in Germany and France, according to data from the Bank for International Settlements.

A string of sovereign debt defaults would endanger the survival of major European banks, including those in France and Germany, which hold a large amount of troubled sovereign debt on their books, some economists note. According to Bryson, French banks' exposure to the five European countries that are in danger of defaulting amounts to 25 percent of France's gross domestic product, and the exposure of German banks to those countries is worth 15 percent of Germany's total output…

It remains largely unknown which U.S. banks are particularly exposed to the risks in Europe, so investors have drawn their own conclusions. The insurance market reveals that investors believe Morgan Stanley is most at risk, followed by Bank of America, Goldman Sachs and Citigroup, respectively, according to market data provider CMA. Bank of America's debt now is more than three times more expensive to insure than during the height of the financial crisis in October of 2008.

Morgan Stanley and Goldman Sachs are particularly vulnerable to the crisis in Europe because they rely largely on short-term borrowing from other banks and do not have a large deposit base, according to an economist who requested anonymity because he is not allowed to comment on specific banks. During a financial crisis, short-term borrowing costs could spike as banks cut back on short-term lending to protect themselves, putting banks such as Morgan Stanley and Goldman Sachs in danger of running out of money, the economist said.

The cartel like existence and the depth of interconnectedness of the banking system of major economies makes them highly vulnerable to any shocks which the current Euro crisis has been exhibiting.

And that’s why bailout policies will likely continue and may even become coordinated with increased participation from outsiders, particularly the IMF and some of the major emerging markets.

Asian Capital Markets Likely a Beneficiary of Europe’s High Taxes and Regulatory Maze

“If you tax something, you get less of it”, that’s Professor Mark Perry’s Economics 101

The following should be a great example, from Bloomberg, (bold highlights mine)

Banks in Europe are exploring ways to cut costs by routing more of their trades and other business through overseas subsidiaries, a plan that may shift tax revenue away from London and loosen European regulators’ influence over the lenders.

Nomura Holdings Inc., HSBC Holdings Plc (HSBA) and UBS AG (UBSN) are among lenders preparing plans to book as much business as possible through legal entities in jurisdictions where tax rates are lower and rules on capital and liquidity are less onerous, the banks and lawyers and accountants working with them say.

“Every bank is trying to work out the best way to be structured under the new rules,” Chris Matten, a partner at PricewaterhouseCoopers LLP in Singapore, said in a telephone interview. “It’s not just a question of what activities banks are in. It’s about which entities they put that business through and in which jurisdictions.”

Banks could record as much as 30 percent of the value of their trades through Hong Kong, Singapore and other jurisdictions instead of hubs such as London and New York without running into trouble with regulators, Matten said. Such a move would hurt traditional hubs such as London because assets are treated for tax and regulatory purposes in the country where they are booked. It would also allow banks to sidestep the U.K. bank levy, introduced last year to raise 2.5 billion pounds ($4.1 billion) from lenders operating in Britain, as well as any financial transaction tax imposed by the European Union.

This is one major lesson politicians and their followers can’t seem to digest, absorb or learn.

Nevertheless, this is also one major factor that could drive funds and the banking business to Asia.

Their loss could be our gain, that’s if we heed of the fundamental truism shown above.

Graphic: Distribution Share of World Market Cap

…of select countries.

Below is another deck of wonderful and telling charts from Bespoke Invest

Basically, the above charts say that the % share of developed economy equity markets has been declining overtime as Asian and emerging markets have been increasing.

What we are seeing is simply a deepening of the convergence trend and a rebalancing of roles which previously had been dominated by the former.

Of course there are many factors driving this, one of the principal factor would be globalization. But the point is: market dynamics, which essentially is about acting humans, has been about constant changes.

China Takes Steps to Relax Currency Controls

Amidst the political demand for higher taxes, more government spending, bailouts and centralization schemes by the US and Europe, China seems going on the opposite way and appears to be making a step in the right direction: by relaxing currency controls

From Bloomberg,

Chinese Vice Premier Li Keqiang unveiled the biggest package of measures supporting Hong Kong’s economy since the 2003 SARS epidemic, allowing more two-way investment in shares and sparking a rally in brokerage stocks.

China will start an exchange-traded fund based on Hong Kong equities, Li, the front-runner to replace Wen Jiabao as premier in 2013, said at a forum in the city today. He also pledged a 20 billion yuan ($3.1 billion) quota for qualified companies to invest in domestic Chinese securities and said sales of yuan bonds in the city will be expanded.

The plans relax restrictions on investment flows, bolstering the city’s role as a financial hub and aiding an economy that shrank in the second quarter for the first time since 2009…

Making the announcements in person, with the heads of the central bank and commerce ministry, was “a symbolic demonstration of Beijing’s commitment to Hong Kong,” said Kwok. The quota for qualified foreign institutional investors is a yuan-settled version of an existing program settled in dollars, she said.

China will expand its companies’ offshore bond sales and support the use of yuan for foreign direct investment in the nation, Li said. The city’s status as a financial center “is crucial for Hong Kong’s development,” he said.

I hope to see more of this not only for China but for the rest of Asia, including the Philippines.

Competition Fueled Global Stock Exchange Automation

Transition to electronic trading in global stock exchanges only gained traction after the derivatives exchanges gave them a challenge

Professor Michael Gorham of the Illinois Institute of Technology narrates (World Federation of Stock Exchanges) [bold emphasis mine]

As we have seen, the early pioneers of electronic derivatives trading created brand new exchanges starting in the mid 1980s. It took almost another decade before existing floor-based exchanges began fully converting to screens. Aside from the fact that conversions from floors to screens met stiff resistance from member-owners whose livelihoods were threatened, derivatives trading, especially in financial products, was still in its infancy and many countries did not yet have derivatives exchanges. New Zealand, Sweden, Switzerland, Germany, South Africa and China all had no derivatives exchanges. So during the mid 1980s and early 1990s, all these countries created new derivatives exchanges, and they were all electronic right out of the box.

Stock exchanges, on the other hand, were relatively mature institutions, and most countries of any size already had one or more stock exchanges and were not generally building new ones. And given the natural resistance of member-owners, the existing stock exchanges, just like the existing derivatives exchanges, were not likely to quickly convert to screens. Consequently, early electronic activity on the securities side was carried out on an experimental basis, typically only for stocks that were relatively inactive. So in figure 6.2, we see that except for the isolated event of the Cincinnati Stock Exchange becoming electronic in 1980, it was not until 1989 that stock exchanges began to start converting to electronic trading in earnest

Some observations;

Most stock exchanges being monopolies or oligopolies have been slow to adapt to changes.

It took the introduction of derivative markets which threatened to compete with these traditional exchanges to prompt the latter to automate.

Nevertheless automation revolutionized trading. It facilitated increases in transparency, enabled outsourcing of traditional functions such as trading floor operations, product development, marketing, legal, regulatory and often clearing and settlement, which has contributed to the precipitous decline in the cost of trading, promoted direct access to exchange matching engines, introduced new order types, and fuelled a leap in merger and acquisitions activities.

Automation has been a significant part of financial globalization which means that the trend for stock exchanges here (in the Philippines) and abroad will likely incorporate new trading platforms/services.

For instance, the Philippine Stock Exchange has derivatives on the pipeline (via Red Hat) and has seen participation in new Exchange Traded Funds (ETFs) traded offshore, e.g. for ASEAN, the FTSE ASEAN Index Series and iShares MSCI Philippines Investable Market Index Fund (EPHE)

Deep and sophisticated capital markets are prerequisites to progressing market economies.

Global Foreign Exchange Market Now at $4.71 Trillion

Average daily global foreign-exchange turnover has grown to $4.71 trillion according to a Dow Jones Newswires analysis, underscoring how currencies continue attracting liquidity and growing as an asset class despite the uncertain state of the economy.

The Dow Jones estimate, which is higher than the $3.98 trillion daily foreign-exchange number published in the Bank for International Settlements' 2010 report, takes into account official information compiled from Australia, Japan, Singapore, North America and the U.K.--all of which released updated figures Monday.

The Dow Jones numbers also include estimates for trading data from the rest of the world, based on previous BIS annual data. Taken together, the data illustrate how currency flows expanded across the globe over the last year.

That’s according to the Wall Street Journal.

The news didn’t specify the breakdown or the contribution share of the currencies traded.

Nonetheless to me these are:

-Signs of the deepening and growing sophistication of financial markets (growth led by high frequency and retail traders)

-Evidences of growing interconnectedness of financial markets or technology enabled financial globalization

-Symptoms the profusion of liquidity from inflationism (bailouts, QEs and circulation credit)

Capital Flows, Financial Liberalization and Bubble Cycles

Professor Arnold Kling excerpted the latest edition from the classic Charles Kindleberger book, “Manias, Panics, and Crashes”

One of the themes of this book is that the bubbles in real estate and stocks in Japan in the second half of the 1980s, the similar bubbles...in the nearby Asian countries in the mid-1990s, and the bubble in U.S. stock prices in the second half of the 1990s were systematically related. The implosion of the bubble in Japan led to an increase in the flow of money from Japan; some of this money went to Thailand and Malaysia and Indonesia and some went to the United States....When the bubbles in the countries in Southeast Asia implode, there was another surge in the flow of money to the United States...

The increase in the flow of money to a country from abroad almost always led to increases in the prices of securities traded in that country as the domestic sellers of the securities to foreigners used a very high proportion of their receipts from these sales to buy other securities from domestic residents...It's as if the cash from the sale of securities to foreigners was the proverbial 'hot potato' that was rapidly passed from one group of investors to others, at ever-increasing prices.

Harvard economists Carmen Reinhart and Kenneth Rogoff places the culpability of the global banking crises on financial liberalization

They write

Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically.

There are vast dissimilarities between political economic conditions of today and the yesteryears to simplistically impute the causal relationship of capital mobility and banking crises.

For instance, the pre-20^th century had mostly operated from precious metal based monetary system and had largely been without central banks compared to the 20^th century. Also today’s era can be characterized as having assimilated the Bismarckian welfare structured state than the pre-20^th century, which implies of a starkly different operating political system.

The economic environment had also been different. The pre-20^th century hallmarked the transition of the agricultural epoch to the industrial age. The 20^th century was the culmination of the industrial era which currently has been transitioning to the information age. There are so many many many more variables to consider.

For me, correlations like this should be meticulously scrutinized rather than just taken as “given”.

Although I won’t deny that liberalization could have been one of the many factors which may have contributed to historical episodes of banking crisis, perhaps this has not been the principal one.

However going back to the chart, one can note of the huge concentration in the incidences of banking crises (green circle) during the post-Bretton Woods; the de facto US dollar standard system of today. This comes after the Nixon Shock, a monumental event eponymous to President Nixon’s closing of gold convertibility in 1971.

The degree of concentration of banking crisis has been unprecedented when compared the cumulative interspersed banking crises of 1800-1970.

This lends credence to the “hot potato” dynamic as narrated by Robert Aliber co-author of the Charles Kindleberger’s classic.

As I have been saying here, the gamut of modern day or contemporary global bubble cycles represent as mainly the consequences of the central banking induced business cycles, the welfare state and the intensifying frictions or strains from the Triffin Dilemma that continues to plague the global fiat money system founded on the US dollar.

This “deficit without tears” paper money system which has privileged the US for the past 40 years has been unsustainable and won’t likely last (unless there would be drastic reforms on the political system).

The trend of gold prices has been showing the way.

How External Forces Influence Activities of the Phisix

There are secrets to our world that only practice can reveal.-Nassim Nicolas Taleb, Anti Fragility, Chapter 4 How (Not) To Be A Profit

We definitely live in interesting times.

It has long been my position that gold and global equity markets including the Philippine Phisix have been strongly correlated where the price actions of the gold market frequently leads equity markets.

Look at the beauty of such correlationship.

The above 2- year chart represents the price actions of the Phisix (PSEC red-black candlesticks) and gold prices in US dollar (black line). The relationship even looks like a 5-wave Elliott Wave count.

One would note that the oscillations may not be in exactitude, but clearly a symmetric cadence has been in motion.

The implication is: for as long as the trend of gold prices remains to the upside, the Phisix will likely follow unless domestic factors become powerful enough to impel a disconnect.

Prices of gold have served as reliable barometer so far.

Alternatively, this also means that accrued corporate earnings or micro economics or mainstream’s macro views can hardly explain this phenomenon.

Consumption demand, which has been the popular perspective, can hardly explain the broad based increases in commodity prices along with equity prices.

Of course correlation does not imply causation or that there presents no causal relationship between gold and the Phisix.

The point is: both gold and the Phisix account for as symptoms of an underlying pathology, which has largely been an unseen factor.

The Phisix-gold phenomenon has not been isolated.

This can also be observed elsewhere.

This relationship appears evident also in the global equity markets: commodities (represented by the CCI) have strongly been correlated with the S&P 500 and the Dow Jones World (DJW).

Financial Repression and Inflationism

Anyone can say what they want but it can’t be denied that the price actions in the commodity markets have been tightly connected with actions in the global equity markets.

Meanwhile the divergences in bond markets can be explained. Bond markets have essentially been rigged, have been heavily distorted and used as main instruments by governments to conduct financial repression[1]. They hardly account for as signs of deflation as deflation exponents argue.

Government interventions have been rampant almost everywhere: in the commodity markets[2] by the precipitate doubling of credit margins over a very short time frame, on the bond markets by banning short sales[3] and even seizing of private pensions such as in Argentina, Hungary, Ireland and demanding partial control of private savings in Bulgaria and Poland[4].

Even the construction of Consumer Price statistics [CPI] in the US has been severely contorted[5] which has largely been skewed towards housing.

The general incentive appears to be to keep CPI low so as to continually justify the policy of inflationism, which benefits the banking sector and the bureaucracy most.

Furthermore, the ongoing problems in the Eurozone (fiscal reforms), in China (inflation), in Japan (aftermath of the triple whammy calamity) and in the US (fiscal reforms) will likely prompt US authorities to avoid the risk of a bond market auction failure and similarly the potential risk posed by a further downslide in the housing industry which could destabilize the balance sheets of the highly protected banking industry[6]. This suggests of the likelihood of more Quantitative Easing (QE) programs to come.

Yet clamor for more QE from the mainstream has grown louder[7] which I think is part of the mind conditioning of the public meant for its acceptance.

Incidentally, the US Federal Reserve has been the largest buyer of US treasury [8]. This implies that without the QE, and with lower purchases from foreign entities, interest rates in the US will rise.

Hence, the overall direction of policies by global governments has been to expropriate private sector savings via printing money, keeping interest rates artificially down and outright confiscation (taxation or nationalization of pensions).

The leakages from these activities have percolated into commodity and stock markets.

Yet stock markets have also served as a target[9] of government policies considering their predominant guiding policy of the “wealth effect” doctrine.

So the traditional metrics to evaluate stock markets investments has been eclipsed by the direction of government policies as I have been predicting since 2008[10].

The Currency-Equity Link

If you should doubt such transmission mechanism, there are more proofs that the Phisix has been driven mainly by external forces.

It has also been a position of mine that the Philippine Peso and the Phisix have long had a symbiotic relationship.

Such actions are apparently being reinforced anew.

On the upper window, the recent feebleness in the Phisix (black candle stick) seems also reflected on the USD-Peso (green line).

In the past, a rising Peso would mirror a buoyant Phisix and vice versa. Recently both the Phisix and Peso seems to have hit the wall simultaneously (red trend lines) at the start of May (violet vertical line)!

And this has NOT been confined to a Peso-Phisix relationship. The same equity-currency collegial relationship pervades in Asia (see lower window).

The rally in the JP Morgan-Bloomberg Asian Dollar basket (ADXY- yellow line) and the MSCI Asia Pacific (MXAP:IND) has also been foiled at the start of May! So the rallies in both Asian currencies and Asian equity markets have been thwarted also on the first week of May.

Globalization Decoupling and Political Tea Leaves

The above only exhibits the depth of the interdependence of the global financial markets.

Those who extrapolate ‘decoupling’ on this highly globalized environment, will get the analysing and predicting the directions of the markets all wrong.

Globalization should not be seen only as a function of trade, labor, investment and capital flows but also on the transmission effects of global monetary policies (financial globalization) where the US as the world’s de facto currency reserve has the most influence.

Also the above price weaknesses share a common denominator: the early days of May 2011.

It is during this period where administrative interventions against the markets transpired, such as the war on commodity markets.

So whether it is the commodity markets or Asian currencies and Asian equities the coordinated reaction from interventions has been quite evident.

The chart also suggests that a seeming reprieve in the interventions has palpably led to a bounce.

Whether this rally is a function of a dead cat’s bounce (a natural counter reaction to a previously extended action) or simply a reversion to the major trend has yet to be established. Of course governments may use such occasion to further intrude on the marketplace that may add to market’s instability.

It’s not in my crystal ball to go for short term trends. Although in the understanding that politics drives the markets today, governments could use market volatility to justify prospective money printing programs. So markets could go either way from here.

Of course, it is true that seasonal factors (such as “Sell on May and Go Away”[11]) can affect the market’s activities. These signify as statistical metrics that are subject to margins of error.

In other words, there would likely be more significant variables that may influence the markets than plain seasonality. And as said above, a major force will be politics.

Bottom line:

The actions in the Phisix reflect on its tight connection with the global financial markets. And these activities have likewise echoed the actions of commodity markets.

These conjoint motions represent as symptoms or signs of major forces operating beyond the superficial understanding of the consensus on what propel the actions in the marketplace. Such force is the policy induced boom bust cycles.

Because of this tight correlations, any extrapolations or predictions of decoupling will likely be falsified when the markets undergoes another episode of spasms. Decoupling under today’s US Dollar based system will prove to be a charade.

For now, the stalled rally in the Phisix has coincided with the weakness of global equity markets and commodity prices. Such infirmities appear to have been orchestrated, perhaps specifically designed to achieve unannounced political goals.

Yet a rally in the commodity sphere, which should manifest mostly a decline of the US dollar, will translate to a rally in the Phisix and the Peso.

This rally could happen anytime.

---

[1] See Financial Repression Drives The Bond Markets, May 23, 2011

[2] See War on Commodities: Intervention Phase Worsens and Spreads With More Credit Margin Hikes!, May 14, 2011

[3] See War on Speculators: Restricting Short Sales on Sovereign Debt and Equities, May 18, 2011

[4] nation.foxnews.com Watch Out! Feds Could Seize Your Private Retirement Savings, May 23, 2011

[5] See US CPI Inflation’s Smoke and Mirror Statistics, May 18, 2011

[6] See The US Dollar’s Dependence On Quantitative Easing, March 20, 2011

[7] See Mainstream Calls For More Quantitative Easing, May 24, 2011

[8] Wood, Christopher The new bond conundrum, Greed & Fear, CLSA May 6, 2011 scribd.com

[9] See The US Stock Markets As Target of US Federal Reserve Policies, May 12, 2011

[10] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?, November 30, 2008

[11] See Global Equity Markets: Sell in May and Go Away?, May 16, 2011

The Philippine Stock Exchange and Financial Globalization

Last week’s spike in the prices of the Philippine Stock Exchange [PSE], the publicly listed monopoly franchise that operates the domestic stock exchange and allied services, brought to light some of the ongoing developments of the world stock markets.

The PSE Makes A Big Move

First, I’ll deal with the Philippine Stock Exchange.

The PSE flew on the account of the 1:1 stock dividend[1] which the company declared last week. (Disclosure: I have long been a shareholder of PSE)

The chart formations presage many bullish signs in the PSE price actions.

One, there is the bullish reverse head and shoulders pattern by the blue descending line which signify as the neckline. And secondly, an uptrend channel (marked by the green lines) over the past two years, signifying a mid term trend.

The recent breakout only highlights of the fulfilment to these patterns (of course subject to the buoyancy of the overall market sentiment)

In addition, the PSE reached over php 700 per share when the Phisix topped at 3,800 in 2007. Today, the Phisix trades at over 4,200.

Aside from being a monopoly, the kismet of PSE depends on the general actions of the Phisix and of the broader domestic market. Thus, higher Phisix should equally be reflected on the share values of the PSE.

So for me, the PSE functions like an index fund or the equivalent of an Exchange Traded Fund (ETF) representative of the Phisix. Thus, for as long as the Phisix is headed higher so should the PSE. It’s almost like a no-brainer investment theme.

And that’s the domestic perspective.

Mergers & Acquisition, Collaboration and IPOs

Next, I have written about the prospects of consolidation or integration of global stock markets.

In 2007 I wrote[2],

With the revolutionary advances in the field of communications and information technology-the advent of on-line electronic trading platforms makes it possible for real-time electronic transactions regardless of the geographical distance.

Grounded on this premise, the major exchanges appears to be in a rush to integrate financial services, to diversify and expand their market coverage, reduce transaction (bookkeeping, clearing and settlement) costs by achieving the economies of scale, to eliminate further inefficiencies by way of human intervention, provide for financial depth by attracting global investors (to augment the demand side), traders and listing companies (to increase supply side), to improve on liquidity by easily matching buyers and sellers, and finally, adapt to the ongoing changes in marketplace by being accessible to the growing significance of institutional investors [pension funds, hedge funds, mutual funds and insurance companies] as compared to retail investors in the past.

With the global trade and economic structure presently favoring Asia, as evidenced by its exploding foreign exchange reserves and rapidly rising per capita and middle class, its largely fragmented and underdeveloped financial markets makes it a potential ground for an explosive expansion.

Apparently events are validating my earlier observations anew as many stock markets around the world are in the process of consolidation.

One channel is by mergers & acquisitions.

Though much to my dismay, the Australian government recently blocked Singapore’s Stock Exchange (SGX; SIN: S68) takeover bid of the Australia Stock Exchange (ASX:ASX) on absurd nationalist grounds[3].

If the objective is to reduce transaction costs, maximize on the economies of scale, expand market access and supply, and increase market efficiency by globalizing the channels of savings and investments then upholding “national interests” essentially defeats such ideals.

If the ASX rejects SGX out of financial or economic reasons, then there won’t be any opposition from me, but for politicians to pretend to know better of the interests of the stockholders or of the nation represents repression.

Besides, despite the setback, there has been a raft of ongoing mergers in the pipeline.

There has been an ongoing deal for a merger of the New York Stock Exchange (NYSE) with Deutsche Börse of Germany, where U.S.-based Nasdaq OMX Group Inc. and IntercontinentalExchange Inc. have also been waiting on the wings and have been interested to buy into the NYSE[4].

In addition, the London Stock Exchange Group PLC's have also proposed a takeover of TMX Group Inc owner of Toronto Stock Exchange.

And as world markets continue to recover, we should expect mergers & acquisitions deals to pick up steam.

Chart from Allen & Overy[5]

And such deals will include stock market M & A.

Well the integration process doesn’t stop with mergers.

Stock exchanges have also been rushing to push for alliances and collaboration.

One good example is the recent ASEAN deal which promotes the regional equity markets. The aim here is to provide link gateways to the region’s exchanges[6] in line with plan to promote free capital movements within the region, or the 2015 ASEAN Economic Community.

Individual bourses have been in play too.

The London Stock Exchange is likewise reported to be negotiating with Bursa Malaysia for a partnership[7]. Hong Kong has reportedly been open to accept partnerships. And so with Taiwan, who seeks regional alliances via Exchange Traded Funds[8].

And as global stock markets respond to inflationism and financial globalization, we should expect more Initial Public Offerings (IPO) to surge too.

Asia has so far led IPO deals into the recovery.

In the 2011 Global IPO trends outlook, financial services company Ernst & Young observes[9], (chart by Ernst & Young) [bold highlights mine]

In 2011, global IPO markets continue to recover and gain momentum. Global investors seeking to capitalize on the emerging markets growth story have been fueling stock market rallies and new listings world-wide. The lack of exit routes, shortage of capital-raising opportunities, and numerous IPO postponements since 2007 have led to a growing IPO pipeline worldwide. Many key drivers of 2011 global IPO markets reflect a continuation of 2010’s key trends including emerging markets growth, state privatizations, multinational company spin-offs, and fast-growth companies in the energy, industrial, materials and technology sectors.

Despite market volatility exacerbated by the Eurozone sovereign debt crisis, in 2010, global IPO fundraising gradually recovered to pre-crisis levels, buoyed in particular by a record-breaking fourth quarter. In 2010, emerging market issuers, particularly in China, maintained their fundraising leadership, driven by rapid economic growth, market liquidity, and foreign fund inflows.

Again we see a feedback mechanism where rising stock values have fuelled global IPOs and where IPOs tend to magnify gains in global equity markets.

As stock markets continue to advance these should be reflected in IPOs and in mergers & acquisition activities, as well as deals for free capital movement via alliances and other forms of collaboration.

All these simply represent the deepening thrust towards financial globalization.

And it’s quite obvious that the PSE will be a part of this deal making process, as already evidenced by the ASEAN collaboration.

I think more deals will come in the future that should involve the PSE. But all these are anchored upon the whereabouts of the current state of the bubble cycle.

So yes for as long as the boom phase of this cycle persists, I remain mostly bullish on global equity platform providers. And this includes the PSE.

---

[1] pse.com.ph Philippine Stock Exchange: Declaration of 100% Stock Dividends April 13, 2011 AN092-002557

[2] See Unifying Global Stock Markets; Asia Looks Next!, January 14, 2007

[3] BBC.co.uk Australia rejects Singapore's bid for stock exchange, April 8, 2011

[4] Wall Street Journal Asia, Stock-Exchange Mergers Fan Nationalism, April 15, 2011

[5] Allen & Overy, The Allen & Overy M&A Index Q1 2011

[6] See ASEAN Integration: Regional Stock Exchange Website Launched, April 12, 2011

[7] Dailymail.co.uk TAKING STOCK: LSE in scramble for partners as mergers boost competition, April 16, 2011

[8] Reuters.com, Taiwan exchange aims alliances, no M&A plans, April 16, 2011

[9] Ernst & Young Global IPO trends 2011