What Draghi’s Statement “The ECB is Ready to do Whatever it Takes to Preserve the Euro” Means

I pointed out that ECB President Mario Draghi delivered a magical statement last week which sent markets soaring (I think much had to do with the covering of short sales).

For Professor Gary North such statement has the following implications…

What he said was in fact a cry of desperation. He does not know what to do, other than to inflate. He knows he must break the Maastricht treaty that created the EU, but he does not have any choice. He has defined out of existence the treaty's limits on the ECB. He defines his mandate broadly. He knows that Spain is close to default. The ECB must buy Spain's bonds, or else provide funds for some other agencies to buy Spain's bonds. The weekend summit meeting less than a month ago has already broken down. Spain's ten-year bond rate went above the failsafe 7% figure.

The European banking system is being propped up by monetary inflation. There are signs that this cannot go on much longer, but the central bankers have enormous self-confidence. They believe that fiat money can delay any major crisis. They believe that fiat money is the ultimate ace in the hole. So do Keynesians. So do politicians. They really do believe that the exclusive government monopoly authority to supervise the creation of digits is the basis of prosperity.

Investors invest digits called money. They are convinced that the ability of central banks to create digits has created a failsafe for investors' digits. They believe that a prudent mixture of digit-generating investments will gain them a positive rate of return, as measured in digits, just so long as the total number of digits is always increasing. This is the key to every investment strategy that is tied to "digits invested now, more digits to invest later": an ever-increasing supply of digits.

You might think that investors would judge their success in investing by increased real income: stuff, not digits. But the vast majority of investors assume that stuff will inevitably take care of itself, if only the supply of digits is increasing. Here is the mantra of this generation: "The system of stuff production depends on a steady increase in the supply of digits."

This is why there is no resistance to central bank monetization. On the contrary, there is cheering. The journalists follow the economists. The economists have adopted the mantra of digits with the zealous commitment of any priesthood. Milton Friedman is their high priest.

Professor North sees depression or another crisis ahead, but this will either be through hyperinflation or through mass defaults. He thinks that defaults will be the most likely outcome because the incentives guiding the career of central bankers have been tied with large banks.

I think that the both scenario has a level 50-50 odds, as central bankers will most likely underestimate the impact of their actions.

Read the rest here

Emerging Markets Eye Insurance Against the US Dollar, Euro

Aside from the pledge to assist in the rescue of the EU, key emerging markets led by the BRICs and South Africa discussed insurance options that goes around the US dollar.

From the China Money Report,

The BRICS countries said on Monday that they’re considering setting up a foreign-exchange reserve pool and a currency-swap arrangement as financial problems threaten to spread across the global economy.Leaders of the five-member group —Brazil, Russia, India, China and South Africa— also said BRICS is “willing to make a contribution” to increase the International Monetary Fund’s ability to rescue troubled economies. President Hu Jintao joined his counterparts from other BRICS nations on Monday morning in the Mexican resort city Los Cabos ahead of the start of the G20 Summit.

According to the Chinese Foreign Ministry, the leaders discussed the currency swap and foreign-exchange reserve pool ideas and tasked their finance ministers and central bank chiefs to implement them, according to China’s Foreign Ministry.

Swap arrangements, which allow nations’ central banks to lend to each other money to keep markets liquid, and the pooling of foreign-exchange reserves are contingency measures aimed at containing crises such as the one roiling the eurozone, analysts said.

Zhang Yuyan, director of the Institute of World Economics and Politics affiliated with the Chinese Academy of Social Sciences, said the new mechanisms established by the emerging markets themselves, who “know their current conditions and demands
much better”.

Amid the global economic slowdown, the pooling of foreign-exchange reserves will help BRICS countries to fight the lack of market liquidity, beef up their immunity to financial crises and boost global confidence, Zhang said.

Contributions to this “virtual” bailout fund, as Brazil’s Finance Minister Guido Mantega put it, would be tied to the size of each BRICS member’s currency reserves, he said. The five leaders also discussed BRICS’ participation in replenishing the IMF’s lending capital. Hu said the G20 should encourage and support the eurozone countries’ adoption of fiscal controls and spending cuts as efforts to improve confidence in world markets. The leaders also urged the IMF to carry out promised reforms of its quota and governance systems. Mexico, which was hosting the G20 Summit on Monday and Tuesday, has said it will use the meeting to press the world’s largest economies to increase IMF resources and build the fund’s capacity to intervene in the European debt crisis.

While these may be constitute added signs that much of the world seem to be getting antsy with the unfolding events in the developed economies, swaps and foreign reserve pools won’t do much when the whole paper money system goes into flame.

The reason for this is that much of the world’s banking and financial system remains anchored on fiat currencies of the western world, where the US dollar and the euro constitute 90% of global reserve currencies (see chart from Wikipedia.org).

Besides, the monetary system of emerging markets operates from the same fractional reserve system as their developed peers, which means that like their developed peers, EM politicians will be seduced to used inflationism to achieve political goals.

Instead, what these economies should do would be to ramp on gold acquisition, and possibly consider a quasi-gold standard possibly through a gold based currency board (as proposed by Professor Steve Hanke) or a return to the gold standard or allow for currency competition with the private sector (free banking, free currency competition as proposed by Ron Paul and Professor Lawrence White).

Since any of the proposed monetary reforms would entail restriction in political actions and simultaneously require massive liberalization of respective economies, these won’t likely be palatable with incumbent political agents, who under such circumstances, lose much of their current privileges (Europe’s deepening crisis are manifestations of these).

Thus, it would likely take a deeper crisis (most likely a currency crisis) to force real reforms in the system.

Ben Bernanke Plays with the Inflation Fire

From Bloomberg,

Federal Reserve Chairman Ben S. Bernanke spent six years pushing for an inflation goal. Now that he has it, some investors are betting he’ll breach the 2 percent target in the short run to lower unemployment.

The Fed chairman told lawmakers last week that an increase in energy costs will boost inflation “temporarily while reducing consumers’ purchasing power.” He also said the central bank will adopt a “balanced approach” as it pursues its twin goals of price stability and full employment, which it defines as a jobless rate of between 5.2 percent and 6 percent.

Things that team Bernanke could be working on with the 'inflation goal': inflating away debt, boosting asset prices to give strength to balance sheets of the embattled banking and financial industry, the money illusion or the lowering real wages by inflation and currency devaluation.

I don’t think inflation targeting has been about competitive devaluation, as central bankers have collaborated in conducting current monetary policies. Neither has these been the money illusion.

I am sure Mr. Bernanke is aware that elevated inflation (upper window) and high unemployment (lower window) coexisted in the 1970s, known as the stagflation era. In short, Mr. Bernanke understands the risk of inflation, i.e. inflation does not solve the unemployment problem. In reality, in contrast to mainstream thinking, inflation even worsens economic performances by distorting economic calculation of entrepreneurs and businesses which impairs the market's functionality through the division of labor.

So by process of elimination this leads us to Bernanke’s primary goal of saving the banking system and the welfare state.

Yet Mr. Bernanke’s inflation goal is like playing with fire. Since the world's monetary system operates in a de facto US dollar standard, Bernanke's playing with fire translates to the risk that we all get burned.

Are Surging Oil Prices Symptoms of a Crack-up Boom?

Dr. Ed Yardeni thinks that there has been a mismatch between oil prices and oil demand

Dr. Yardeni writes

The price of Brent crude oil is up again this morning over $124 a barrel. It’s up from $107.65 at the end of last year as a result of increasing tensions with Iran following the imposition by the US and Europe of tough new sanctions on Iran. They are already reducing the ability of Iran to export crude oil. Last year, Iran exported about 2mbd. That is likely to get cut by half or more. That’s not enough to explain why oil prices are soaring given that global oil supply is around 88mbd. Of course, concerns are mounting that the diplomatic and economic confrontation with Iran could turn into a military conflict that would disrupt oil traffic coming out of the Persian Gulf. This certainly explains why oil prices are rising.

Global oil demand, on the other hand, is weakening and suggests that oil prices could fall sharply if the Iranian issue can be resolved without push coming to shove. As I’ve explained previously, I believe that the sanctions are rapidly crushing Iran’s economy and may force the Mullahs to give up their ambitions to build nuclear weapons. This may take some time, of course. Meanwhile, if oil and gasoline prices continue to rise, I expect that the Obama administration will coordinate a global release of supplies from the Strategic Petroleum Reserves, as occurred last summer in response to the drop in Libya’s exports.

While tensions over Iran partly contributes to the elevated state of oil prices, there are deeper factors involved as previously explained

Importantly when mainstream economists talk about demand they usually refer to consumption demand and ignore the second type of demand—reservation demand.

The distinguished dean of the Austrian school of Economics Murray N. Rothbard explained,

The amount that sellers will withhold on the market is termed their reservation demand. This is not, like the demand studied above, a demand for a good in exchange; this is a de­mand to hold stock. Thus, the concept of a “demand to hold a stock of goods” will always include both demand-factors; it will include the demand for the good in exchange by nonpossessors, plus the demand to hold the stock by the possessors. The demand for the good in exchange is also a demand to hold, since, regard­less of what the buyer intends to do with the good in the future, he must hold the good from the time it comes into his ownership and possession by means of exchange. We therefore arrive at the concept of a “total demand to hold” for a good, differing from the previous concept of exchange-demand, although including the latter in addition to the reservation demand by the sellers.

Yet what prompts for an increase in reservation demand?

Again Professor Rothbard

an in­crease in reservation demand for the stock may be due to either (a) an increase in the direct use-value of the good for the sellers; (b) greater opportunities for making exchanges for other purchase­-goods; or (c) a greater speculative anticipation of a higher price in the future

Speculative activities also drive the increased demand to hold a stock of goods. Or in the case of oil prices, increased speculation has also been responsible for the recent spike.

This means that monetary policies designed to ease credit via zero interest rates and quantitative easing have been responsible for encouraging, not only consumption but speculative activities too, by increasing people’s time preferences.

One would note that oil prices and stock market prices (S&P 500) have been ramping up. These are symptoms of an inflationary boom.

Of course, inflationary boom extrapolates to a boom bust cycle or to a crack-up boom.

As Professor Ludwig von Mises wrote

The boom could continue only as long as the banks were ready to grant freely all those credits which business needed for the execution of its excessive projects, utterly disagreeing with the real state of the supply of factors of production and the valuations of the consumers. These illusory plans, suggested by the falsification of business calculation as brought about by the cheap money policy, can be pushed forward only if new credits can be obtained at gross market rates which are artificially lowered below the height they would reach at an unhampered loan market. It is this margin that gives them the deceptive appearance of profitability. The change in the banks' conduct does not create the crisis. It merely makes visible the havoc spread by the faults which business has committed in the boom period.

Neither could the boom last endlessly if the banks were to cling stubbornly to their expansionist policies. Any attempt to substitute additional fiduciary media for nonexisting capital goods (namely, the quantities p3 and p4) is doomed to failure. If the credit expansion is not stopped in time, the boom turns into the crack-up boom; the flight into real values begins, and the whole monetary system founders. However, as a rule, the banks in the past have not pushed things to extremes. They have become alarmed at a date when the final catastrophe was still far away.

While a crack-up boom is not imminent, current monetary policies have brought us into this direction. The more governments engage in reckless policymaking in our monetary affairs, the greater risks of spiraling commodity prices.

Rising oil price, thus can be seen as symptoms of a chronic disorder in the current state of money.

New Record Highs for the Philippine Phisix; How to Deal with Tips

I worry less about small failures, more about large, potentially terminal ones. I worry far more about the "promising" stock market, particularly the "safe" blue chip stocks, than I do about speculative ventures-the former present invisible risks, the latter offer no surprises since you know how volatile they are and can limit your downside by investing smaller amount. I worry less about advertised and sensational risks, more about the more vicious hidden ones I worry less about terrorism than about diabetes, less about matters people usually worry about because they are obvious worries, and more about matters that lie outside our consciousness and common discourse (I also have to confess that I do not worry a lot - I try to worry about matters I can do something about) I worry less about embarrassment than about missing an opportunity. Nassim Nicholas Taleb The Black Swan The Impact of the Highly Improbable

Rampaging stock market bulls has propelled the local benchmark, the Phisix to another milestone record high!

Friday’s electrifying breakout anchored by a 2.4% advance, largely influenced by developments overseas, essentially pushed the Phsix farther away from the 13 month consolidation level (green channel). This seems to reinforce the new support level, which formerly was represented by the resistance level (upper green horizontal line).

Of course, price charts merely function as guides, as they are ultimately driven, not by patterns, but by the value-scale time preference exhibited by the marketplace or by market participants acting through the price mechanism.

The Global Boom Phase

It is important to keep in perspective what has been driving actions in the stock markets.

Where the mainstream associates today’s milestone feat to ‘economic growth’, ‘earnings growth’, ‘confidence’ to the political affairs or to some other bunk, it is worth accentuating that what has been happening in the Philippines has not been an insulated event but a global phenomenon.

The exemplary performance by the local bellwether has not even kept pace with the remarkable advances by many of the world’s bourses.

While the Phisix has assumed on the leader’s role relative to the performance of our nieghbors or the ASEAN-4, we even trail the returns of another ASEAN member particularly Vietnam’s 14.72% on a year-to-date basis.

The exceptional gains by Hong Kong and India as indicated in the above table as one of the top performers in the world, has also outclassed the Phisix.

Yet most of Asia has been up by over 10%, except for China, Indonesia, Malaysia, Australia and New Zealand. Only Sri Lanka, Bangladesh and Mongolia registered losses over the same period.

And of the 71 international bourses on my radar screen, 42% have posted gains of over 10%. Such broad based bullishness has simply been astounding.

Intensifying Local Boom

In the local markets, again, the bullmarket sentiment has not been limited to select issues, particularly to heavyweight components of the Phisix, but to the broader market.

While we should be expecting a natural profit taking process or a countertrend to occur anytime, overbought conditions in a bullmarket may remain extended.

Such dynamics may be taking place.

The recent decline in the advance-decline differentials (averaged weekly) seems to have augured for a retracement. However, Friday’s intense rally may have deferred anew what should have been a normal profit taking sequence.

The market’s sentiment can be measured by the trading activities or internal market actions.

The average daily traded issues, which has been ascendant since November of 2011, has also been exhibiting signs of exhaustion. Friday’s rally has not alleviated the weekly decline.

So far market breadth seems indicative of a coming salutary profit taking cycle.

This week’s rally has evidently been led by the service sector via gains of the major telecom issues. The property and the financial indices, took second and third spot, have similarly bolstered the gains of the Phisix.

On a year-to-date basis the property and the financial sector continues to widen their lead relative to their contemporaries, whose gains have mostly been responsible for the outstanding returns of the Phisix.

And if we are to look at the biggest companies within the Phisix basket, whose ranking are based on free float market cap, the actions of the heavyweight basically confirms the standings of the sectoral performances.

Property issues led by Ayala Land [ALI] have taken the commanding lead, along with SM Primeholdings [SMPH] at fourth spot.

Meanwhile, the financial sector has been powered by BPI and MBT at third and fifth spot respectively. Ayala Corp, the mother unit to ALI and BPI, at second place has also been buoyed by the gains of the sizzling hot subsidiaries.

And in evaluation of the above dynamics there are several things to keep in mind:

One, the gains of the Phisix hasn’t been limited to Phisix based heavyweight components but manifested on the overall markets. This means that market’s attention has been percolating into second or third tier issues.

Two, the rotational process has been in progress, where past laggards are today’s darling and yesterday’s favorites have become the du jour laggards. Such dynamics are being exhibited in the actions of the Phisix heavyweights, which have been confirming the sectoral rankings. The interchanging gains with the Mining industry[1] relative to the other capital intensive sectors of the property and telecoms, along with financial sector, which functions as the financial intermediaries of these industries, signify as symptoms of a mounting inflationary boom. In short, the real relative effects of monetary inflation[2] are being likewise being demonstrated in the actions in the stock markets, here and around the world.

Also the rotational process extrapolates to the shifting market’s attention from heavyweights to second or third tier issues and vice versa which can also be a dynamic found within specific sectors.

The bottom line is that for as long as the monetary inflationary push persists, the Phisix will continue to ascend, but the distribution of gains will vary in terms of degree and of timing seen from sector to sector and from heavyweights to tiered issues.

Inflationary Credit Fueling the Boom Phase

There is another very important aspect to remember in the environment where everybody is a genius.

To quote the legendary trader Jesse Livermore via Edwin Lefèvre in the must read classic Reminiscences of a Stock Operator[3], (emphasis added)

The public ought always to keep in mind the elementals of stock trading. When a stock is going up no elaborate explanation is needed as to why it is going up. It takes continuous buying to make a stock keep on going up. As long as it does so, with only small and natural reactions from time to time, it is a pretty safe proposition to trail along with it.

Sustained broad stock market gains will not occur if funded by savings alone. Since savings are limited or are scarce, market will then reflect on offsetting actions—i.e. gainers would be counterbalanced by losers, where net gains will only emerge from dividends. It is under such environment where earnings would truly matter.

Austrian economist Fritz Machlup provides the economic underpinnings to Mr. Livermore’s empirical observation[4] (emphasis added)

A factor which is capable of evoking expectations of a rise in security prices is a reduction of the interest rate. In so far as this reduction occurs merely as the result of an increased supply of intended new savings, the likelihood of a long-lasting upward movement of the market is rather meagre.

In addition, since stock markets operate on the principle of pricing, then any increase in the demand for stocks through higher prices would likewise entice more supply (more listings). This would again entail offsetting actions under a savings only financed milieu

Again from Mr. Machlup continuing from the same paragraph,

It is easy to see that if dividend prospects are unchanged increased and the rate of interest is reduced, security prices will rise, and it is more than probable that a sufficient amount of security sales from "final sellers' (unloading by temporary holders and new issues) will be quickly forthcoming: comparatively small offerings of securities will suffice to absorb the increased supply of new savings and to drain them off to other markets. For no matter how the supply of money capital derived from current new savings may fluctuate, it is scarcely conceivable that the total supply of money capital can ever rise to unexpected dimensions as the result of an increased flow from this source. If the public devotes only its new savings to the securities market, and the new demand at once causes some groups of securities to become "firmer," it will not be necessary for the purchasing power of the public to be withdrawn from the commodity market until it has "run through'* all the securities quoted on the exchange and has adjusted the prices of securities, one after the other, to the new market conditions.

In the present world, boom conditions spread from the markets to the real economy.

Yet the boom phase of the business cycle, as reflected in the actions of the stock markets requires continuous infusion of credit to facilitate an increase in demand for stocks.

Mr. Machlup further explained[5],

If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, a boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and amortization current amortization allowances is fairly inelastic, and optimism about the development of security prices, would promptly lead to a "tightening" on the credit market, and the cessation of speculation "for the rise." There would thus be no chains of speculative transactions and the limited amount of credit available would pass into production without delay.

And such a boom can only happen when interest rates have been tampered with to produce a negative real rate environment.

Today’s boom can easily be traced to seemingly coordinated policies by global central banks to allegedly fight economic downturn with an environment of negative real rates.

Zero interest rate policies (ZIRP) have become the conventional creed utilized by central bankers as shield against the publicized menace of recessions. In reality, these measures have been designed to buttress and preserve the beleaguered banking system from a collapse.

Interest rates today on a global scale have been approaching the 2009 levels[6], although policy rates directives of emerging markets have been less aggressive compared to crisis afflicted developed economies[7].

This week, we see the same patterns of credit easing policies in some of the major economies. Sweden cut interest rates[8], China pared down the banking sector’s reserve requirements for the second time in 3 months[9] and importantly, the Bank of Japan (BoJ) surprised the markets by aggressively expanding quantitative easing (QE) which according to them is slated to be completed by the end of 2012[10].

While the markets were palpably surprised by BoJ’s announcement, to the contrary we had expected this, as I wrote last week[11]

…politicians have been pressuring the Bank of Japan (BoJ) to ease further or face a revision of the BoJ law in order to “give the government more room to intervene in monetary policy”. This is an example of the sham in the so-called central banking independence.

Central banks are politically influenced directly or indirectly. The BoJ will be stepping on the QE gas pedal. Yet, if Japan’s government manages to remold on the BoJ law which gives Japanese politicians the space to intervene directly, then the yen will be faced with greater risk of hyperinflation.

This serves a reminder that central banks are politically influenced and that any talks of the completion of QE should be taken with a grain of salt. Political agents change their statements almost as fast as they change their underwear.

So credit easing measures will continue, with pretext of economic doom as cover for their actions.

And yet the actions of central bankers have been percolating into to the real economy, through the commodity sphere. Oil has broken out of the consolidation- quasi cup and handle formation while Natural gas which has been on a decline, largely influenced by the Shale gas revolution has suddenly surged. If the uptick in natural gas prices continues in spite of the expansion of the Shale gas output, then we could be seeing seminal signs of what Ludwig von Mises calls as the “crack up” boom or the intensifying symptoms of monetary disorder.

Jesse Livermore’s Investing Tip: Don’t Listen to Tips!

In a bullmarket, everyone’s a genius. That’s because ascendant prices will varnish many mistakes used in the evaluation stock price trends. Tersely put, many will be right for the wrong reasons. And the natural ramifications from easy money made from a bull run will be overconfidence, embedding of wrong analytical methodology (where many analyses are really just heuristics) and greater risk appetite.

Since broad market gains are the character of the typical bullmarkets, issues which are commonly deemed as ‘speculative’ or ‘third’ tier or in local colloquial terminology known as ‘basura’ issues will be imbued with magnificent gains symptoms of which we are seeing today.

The common conventional attribution for spectacularly performing speculative issues are that they are being spurred by undisclosed or yet to be disclosed insider activities which have been channeled as rumors, gossips or insider tips.

In reality while there may be some truth to such insider based plans and developments, the causal linkage between price actions and insider activities have not been straight forward. Such rumor based price action relationship hardly exists during bear markets.

Insider tips usually signify as available bias or looking at current events or scouring for any “available” seemingly plausible information to explain the market’s actions or the post hoc fallacy.

And insider tips are ultimately dependent on general market sentiment.

In short, negative real rates or the increase in people’s time preference have impelled market participants to look for all sorts of justifications to buy into the markets.

Another important factor is that insider tips can be subject to the machinations of stock market operators.

Again from the profound wisdom of the celebrated trader Mr. Jesse Livermore via Mr. Lefèvre[12] (bold emphasis added)

Tips! How people want tips! They crave not only to get them but to give them. There is greed involved, and vanity. It is very amusing, at times, to watch really intelligent people fish for them. And the tip-giver need not hesitate about the quality, for the tipseeker is not really after good tips, but after any tip. If it makes good, fine! If it doesn't, better luck with the next. I am thinking of the average customer of the average commission house. There is a type of promoter or manipulator that believes in tips first, last and all the time. A good flow of tips is considered by him as a sort of sublimated publicity work, the best merchandising dope in the world, for, since tip-seekers and tiptakers are invariably tip-passers, tip-broadcasting becomes a sort of endless-chain advertising. The tipster-promoter labours under the delusion that no human being breathes who can resist a tip if properly delivered. He studies the art of handing them out artistically

And relying on tips to goad for a buying action equally requires dependence on tips on how to close the transaction. More from Mr. Livermore[13].

A man must believe in himself and his judgment if he expects to make a living at this game. That is why I don't believe in tips. If I buy stocks on Smith's tip I must sell those same stocks on Smith's tip. I am depending on him.

Also relying on tips would seem like depending on the advice of quack doctors on your health. Yet again Mr. Livermore[14],

I have said many times and cannot say it too often that the experience of years as a stock operator has convinced me that no man can consistently and continuously beat the stock market though he may make money in individual stocks on certain occasions. No matter how experienced a trader is the possibility of his making losing plays is always present because speculation cannot be made 100 per cent safe. Wall Street professionals know that acting on "inside" tips will break a man more quickly than famine, pestilence, crop failures, political readjustments or what might be called normal accidents.

These seem like common sense and easy to observe advise that has been hardly practised by most participants. And the reason for this is due to our intuitive attachment to emotions which embodies our human frailty[15].

There are many thousands of people who buy and sell stocks speculatively but the number of those who speculate profitably is small. As the public always is "in" the market to some extent, it follows that there are losses by the public all the time. The speculator's deadly enemies are: Ignorance, greed, fear and hope. All the statute books in the world and all the rules of all the Exchanges on earth cannot eliminate these from the human animal. Accidents which knock carefully conceived plans skyhigh also are beyond regulation by bodies of coldblooded economists or warm-hearted philanthropists. There remains another source of loss and that is, deliberate misinformation as distinguished from straight tips. And because it is apt to come to a stock trader variously disguised and camouflaged, it is the more insidious and dangerous

Despite enrolling in the school of hard knocks, many fail to heed on such fundamental lessons.

Finally, for investment success, the proof of the proverbial pudding is in the eating. Mr. Livermore’s priceless counsel[16],

Nobody can catch all the fluctuations. In a bull market your game is to buy and hold until you believe that the bull market is near its end. To do this you must study general conditions and not tips or special factors affecting individual stocks. Then get out of all your stocks; get out for keeps! Wait until you see or if you prefer, until you think you see the turn of the market; the beginning of a reversal of general conditions. You have to use your brains and your vision to do this; otherwise my advice would be as idiotic as to tell you to buy cheap and sell dear. One of the most helpful things that anybody can learn is to give up trying to catch the last eighth or the first. These two are the most expensive eighths in the world. They have cost stock traders, in the aggregate, enough millions of dollars to build a concrete highway across the continent.

Mr. Livermore’s line of thinking emanates from an empirical or pragmatic point of view which unknowingly to him, his ideas have been backed by sound economic theory.

Mr. Livermore’s emphasis on gains comes in form of capturing magnitude and not on the frequency. And this is the opportunity that buy-and-hold in a conditional bull market or the boom phase of the bubble cycle offers.

Prudent investing means to manage one’s portfolio under such direction.

---

[1] See Graphic of the PSE’s Sectoral Performance: Mining Sector and the Rotational Process, July 10, 2011

[2] See Phisix and the Rotational Dynamics, January 30, 2012

[3] Lefèvre, Edwin Reminiscences of a Stock Operator p.255 os24.org

[4] Machlup Fritz The Stock Market, Credit And Capital Formation, p.90 Mises.org

[5] Machlup, op. cit. p.92

[6] See Global Central Banks Ease the Most Since 2009, November 28, 2011

[7] Centralbanknews.info Emerging Markets Monetary Policy Rate Indicator, February 18, 2012

[8] Bloomberg.com, Sweden Abandons Rate Rises as Euro Crisis Hits Nordics: Economy February 16, 2012

[9] Bloomberg.com China Cuts Bank Reserve Reqs; Exports ’Grim’, February 19,2012

[10] Danske Research Nerves on edge, but brighter outlook Weekly Focus, February 17, 2012

[11] See Global Equity Market’s Inflationary Boom: Divergent Returns On Convergent Actions, February 13, 2012

[12] Lefèvre op.cit. p.166

[13] Lefèvre op.cit. p.27

[14] Lefèvre op.cit. p.256

[15] Lefèvre op.cit p.245

[16] Lefèvre op.cit p.55

US Debt Ceiling Breached, President Obama to Seek Increase

From the International Business Times,

President Barack Obama will ask Congress to raise the federal debt limit in "a matter of days," White House Press Secretary Jay Carney said on Tuesday.

Although the president was scheduled to ask for $1.2 trillion in additional borrowing authority on Dec. 30, the action was delayed because Congress has only been holding pro forma sessions, meaning no formal business has been conducted. Still, Carney told reporters the White House will request the third and final increase, as determined by the debt-ceiling deal reached by Congress last August.

"I'm confident it will be executed in a matter of days, not weeks," Carney said.

The vote could come as early as Tuesday Jan. 17, after lawmakers officially begin the second session of the 112th Congress.

The U.S. reached the current $15.2 trillion debt limit on Wednesday Jan. 4, The Hill reported. Since then, the federal government has reportedly tapped into its Exchange Stabilization Fund in order to avoid exceeding the limit. The U.S. Treasury Department Web site states the fund consists of three types of assets: U.S. dollars, foreign currencies and Special Drawing Rights.

More signs of the Obama administration’s insatiable appetite for spending… (the following charts from Heritage budget chart book)

…a trend where mounting deficits continue to drive US debt levels vertically

…which if sustained would eventually reach crisis levels.

Yet if other countries desist from funding skyrocketing debt, and with lack of internal savings, this means either default or the Fed’s monetization of debt, that risks an inflation spiral.

It appears that President Obama is on track to take the US to a tipping point or what I call the Mises moment.

Paul Volker Swings at Ben Bernanke on Inflationism

Writing at the New York Times former Federal Reserve Chairman Paul A. Volcker takes a swing at Ben Bernanke over the latter’s inflationist policies (bold emphasis mine)

IN all the commentary about Ben S. Bernanke’s recent speech in Jackson Hole, Wyo., little attention has been paid to six crucial words: “in a context of price stability.” Those words concluded a discussion by Mr. Bernanke, the Federal Reserve chairman, of what tools the central bank could consider appropriate to promote a stronger economic recovery.

Ordinarily, a central banker’s affirming the importance of price stability is not headline news. But consider the setting. There is great and understandable disappointment about high unemployment and the absence of a robust economy, and even concern about the possibility of a renewed downturn. There is also a sense of desperation that both monetary and fiscal policy have almost exhausted their potential, given the size of the fiscal deficits and the already extremely low level of interest rates.

So now we are beginning to hear murmurings about the possible invigorating effects of “just a little inflation.” Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the “animal spirits” of business, or so the argument goes.

It’s not yet a full-throated chorus. But remarkably, at least one member of the Fed’s policy making committee recently departed from the price-stability script.

The siren song is both alluring and predictable. Economic circumstances and the limitations on orthodox policies are indeed frustrating. After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? Let’s try to get business to jump the gun and invest now in the expectation of higher prices later, and raise housing prices (presumably commodities and gold, too) and maybe wages will follow. If the dollar is weakened, that’s a good thing; it might even help close the trade deficit. And of course, as soon as the economy expands sufficiently, we will promptly return to price stability.

Well, good luck.

Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with “stability,” but invokes inflation as a policy, it becomes very difficult to eliminate.

It is precisely the common experience with this inflation dynamic that has led central banks around the world to place prime importance on price stability. They do so not at the expense of a strong productive economy. They do it because experience confirms that price stability — and the expectation of that stability — is a key element in keeping interest rates low and sustaining a strong, expanding, fully employed economy.

At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.

Mr. Paul Volker appears to live up by his “inflation fighting” reputation

And with special emphasis, Mr. Volker criticism highlights Mr. Bernanke’s excessive reliance on models.

Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way.

Mr. Volker’s stinging rebuke reminds me that inflation is not a policy that will last.

From the great Ludwig von Mises,

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German Mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.

Hot: Major Central Banks to Jointly Offer US Dollar Liquidity

From Marketwatch.com,

Along with other central banks, the European Central Bank will undertake new operations to provide U.S. dollar liquidity. The operations will be conducted in coordination with the U.S. Federal Reserve, the Bank of England, Bank of Japan, and the Swiss National Bank. The operations will be conducted in addition to the ECB's ongoing weekly seven-day dollar operations announced in May 2010. The move comes amid worries about dollar-funding tensions in market amid the turmoil related to the euro zone's sovereign debt crisis

Here is what I wrote a few days back

And it wouldn’t signify a farfetched idea that a grand coordinated QE project or credit easing measures by major central banks something similar to the Plaza Accord as predicted by Morgan Stanley’s analysts could be in the works too. The Plaza Accord was a joint intervention in the currency markets by major economies to depreciate the US dollar in 1985. This time, perhaps, the biggest economies will all act in concert to devalue their currencies impliedly against commodities.

Global central banks and politicians have, in increasing signs of desperation, been intensifying the use of the nuclear option. Such concerted move is likely one of the many to come. Expect to see amplified market gyrations as consequence to the boom-bust policies of global central banks.

I told you so.

The Coming Global Debt Default Binge: Moody’s Downgrades Japan

The global debt default binge is in process with credit rating downgrades signifying as the initial symptoms.

US credit rating agency Moody’s today downgraded Japan.

From Bloomberg, (bold emphasis mine)

Japan’s debt rating was lowered by Moody’s Investors Service, which cited “weak” prospects for economic growth that will make it difficult for the government to rein in the world’s largest public debt burden.

Moody’s cut the grade one step to Aa3, with a stable outlook, it said in a statement today. Rebuilding costs from the March 11 earthquake and tsunami, along with continuing efforts to contain the Fukushima nuclear crisis, may make it hard for officials to meet their borrowing target this year, it said.

The first Japan downgrade by Moody’s since 2002 reflects deteriorating credit quality across developed nations from Italy to the U.S., which lost its AAA status at Standard & Poor’s this month. While the move adds to the challenges of the next Japanese prime minister, scheduled to be picked next week, the impact on bond yields may be limited by what Moody’s described as domestic investors’ preference for government debt.

The rerating has also been felt in the CDS markets…

The cost of insuring corporate and sovereign bonds in Japan against default increased, according to traders of credit- default swaps. The Markit iTraxx Japan index rose 7 basis points to 153 basis points as of 12:09 p.m. in Tokyo, on course for its highest level since June 10, 2010, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market…

Today’s rating move brings Japan to the same level as China, showing the diverging paths of Asia’s two biggest economies. China replaced Japan as the world’s No. 2 last year and Moody’s has a positive outlook on its ranking

But debt acquisition won’t be curtailed despite the downgrade…

Moody’s said today’s decision was “prompted by large budget deficits and the build-up in Japanese government debt since the 2009 global recession.”

Japan’s public debt is projected to reach 219 percent of gross domestic product next year even before accounting for borrowing to fund reconstruction after the March 11 earthquake, according to the Organization for Economic Cooperation and Development.

The government has amassed a debt of 943.8 trillion yen, according to the Finance Ministry, after two decades of fiscal spending to energize an economy hobbled by the collapse of an asset bubble in 1990 and lingering deflation that’s sapped private demand. The yen’s advance to a post World War II high this year also threatens exports, a main driver of the nation’s economic growth…

The government has pledged to raise the sales tax to 10 percent by the middle of the decade, a rate that would still be below the IMF’s recommendations. The additional revenue is intended to pay for social welfare for the aging population.

Japan’s government plans total spending of 19 trillion yen over five years to rebuild after the magnitude-9 temblor and tsunami that devastated the northeast coast of Japan and triggered the worst nuclear crisis since Chernobyl.

Politicians won’t learn until forced upon by economic realities.

So the initial preemptive response to the anticipated downgrade has been to inflate the system using the recent triple whammy calamity as pretext.

Finally, it certainly is not true that current developments recognized as “fiscal austerity” have been about getting off the welfare state-big government-deficit spending path.

What has been happening instead is the political process where massive amount of resources are being transferred from the welfare state to the banking sector.

Global political leaders are hopeful that by rescuing the politically privileged interconnected banks, they can bring 'normalcy' back to the 20th century designed politically entwined institutions of the welfare state-banking system-central banking system.

Proof?

Just look how the Japanese government (and other developed governments) addresses their dilemma—mostly by raising taxes!

As the illustrious Milton Friedman once said,

In the long run government will spend whatever the tax system will raise, plus as much more as it can get away with. That’s what history tells us. So my view has always been: cut taxes on any occasion, for any reason, in any way, that’s politically feasible. That’s the only way to keep down the size of government.

So tax increases equates to the preservation of the welfare state or big government.

Unfortunately, the system has already been foundering from under its own weight. And importantly, politicians apparently blase to these risks, continue to impose measures that would only increase the system's fragility. What is unsustainable won't last.

Hot: BSP’s Amando Tetangco says Philippines Open to Currency Intervention

Given the recent fad of currency interventions initiated by the SNB and the BoJ, the Philippine central bank, the Bangko Sentral ng Pilipinas (BSP) has threatened to join the bandwagon

From Bloomberg,

The Philippines is prepared to impose controls to cap volatility in the peso after its currency rose to a three-year high this week, central bank Governor Amando Tetangco said in an e-mail late yesterday. The bank “will not go against the fundamental currency trend but will not hesitate to use tools, including imposing prudential limits on certain transactions of banks,” he said.

Gadzooks. This guy speaks as if he has been bestowed with supernatural powers to control the marketplace, like the fabled King Canute who commanded the sea waves to halt.

The Philippines has already been engaged in subtle currency interventions, but because of the political correctness, which are meant to advance the remittance and export based interest groups, the BSP honcho has announced his willingness to do much further actions at the risks of unintended consequences

These people are hardly accountable for their actions, and would boldly take any measures at our expense.

Well, if competitive devaluation becomes widespread or the predominant measure worldwide, then expect inflation to accelerate.

Global hyperinflation could turn into a real risk.

James Grant on Faith based Paper Money and the Gold Standard

Wall Street Journal’s Holman W Jenkins Jr. interviews James Grant (hat tip Laird Smith) [bold emphasis mine]

The gold standard, he says, citing the "late, great" libertarian economist Murray Rothbard, was the "people's system. If you didn't like the currency, you could exchange your paper for gold and that sent a message."

More from Mr. Jenkins interview of James Grant

The "fiat" dollar, he adds ruefully, "is one of the world's astounding monetary creations. That a currency of no intrinsic value is accepted as money the world over is an achievement that no monetary economist up until not so many decades ago could have imagined. It'll be 40 years next month that the dollar has been purely faith-based. I don't believe for a moment it's destined to go on much longer. I think the existing monetary arrangements are so precarious, so ill-founded and so destructive of the economic activity they are supposed to support and nurture, that they will be replaced by something better."

How exactly the transition to a new gold standard might take place is a puzzle, but Mr. Grant says he's seen many "impossible" things come to pass in his career. A certain "social spontaneity" might take a hand. He points to GLD—the ticker symbol for an exchange-traded fund whose gold holdings now make it equivalent to the world's 10th largest central bank. "At the margin," he says, "people are registering dissent from the judgment of our central bankers by bidding up the price of gold."

Read the rest here

Chart from Sharelynx/goldchartrus.com

Anyone who thinks that today’s economic climate poses little risk for dramatic transitions in today’s monetary architecture should look at my post below on Dead Currencies.

They are likely to be overestimating the strength of today’s system which have increasingly been based on serial bailout policies, especially in developed economies.

Once the tipping point from the accretion of political mistakes have been reached, we are likely to see a hastening of the implosion of today’s money system.

And as a popular Wall Street maxim goes:

Past performance does not guarantee future results.

As for the return of the gold standard, that’s something unclear for now. But as history has shown, economic forces could compel us to drastically embrace this option once the motion of monetary collapse becomes entrenched and accelerates.

Gold and the precious metal group, based on the price trends relative to the incumbent 'faith based' currencies of major economies, seem to be showing their revitalized role as man's default currency or the public's dissent over the judgment of central bankers as Mr. Grant rightly observes.

Ultimately, the fate of our currency system depends on the direction of monetary politics which constitutes a substantial tail risk that the mainstream continues to ignore.