Graphic: Dead Currencies

Below is a deck of pictures, courtesy of Casey Research, showing various currencies from different parts of the world that have expired or have been abandoned.

It is foolish or naïve, for some, to believe that political actors willed or deliberately engineered the demise of these currencies, or that these have been the responsibility of the private sector.

Instead, the spate of currency extinction overtime signifies as the outcome of a series of actions undertaken by political leaders which essentially collided with economic reality and failed.

In other words, hyperinflation or war, which had been mainly responsible for the demise of most of these currencies, represents as the unintended effects from the desire to preserve or expand of political power by incumbent political leaders during their era.

As the great Ludwig von Mises reminds us, (bold emphasis mine)

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 forever.

The Coming Global Government Debt Default Binge

From the Wall Street Journal blog:

The biggest risk, however, isn’t Greece per se. It is the prospect of other peripheral euro members — Ireland, Spain, and Portugal — following Greece down the default path. That cascade effect has to be avoided….

The global credit authorities and financial markets have been digesting this problem for more than a year. Some participants think a default is inevitable; Greece should just do it.

Then the world can move on to an even bigger worry: whether the U.S. government will soon default on its debt.

Yes, ballooning debt as a consequence of incessant government spending on the welfare state isn’t just an issue of Greece. It’s everywhere.

From the Bank of International Settlements

Sooner or later, something will occur to prevent debt from exploding: governments will adopt corrective measures on their own, or they will be forced to act as sovereign risk premia reach unbearable levels.

And this is only from the facet of government liabilities, which does not include the banking system

This bring us to the admonitions of the great Ludwig von Mises

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.

Governments will default, either by massive inflation or by the far better option-deflation.

And that’s why the events in Greece is a prelude to the next monumental chain of government-and-banking debt crisis.

We are approaching the Mises moment.

Minnesota a la Greece, Bill Gross says US Worst than Greece, PIIGS

If Greece has been one of Europe’s major headache, then the US has her counterpart, Minnesota.

From yahoo.com

Time is running out for Minnesota's parks, highway rest stops and public universities, not to mention 36,000 state employees.

If Gov. Mark Dayton and lawmakers don't agree on a budget by June 30, the state government is expected to shut down. The state moved one step closer to this outcome on Friday by sending layoff notices to much of the state workforce.

Should officials not resolve their differences in time, state parks and highway stops could be shuttered over the busy Fourth of July weekend. Forget about renewing a driver's license or taking classes at state colleges. Nonprofit agencies may have to suspend their social services if their state funding disappears.

As for the state workers, they'll have to wait to see who is deemed critical. The rest could lose their pay, and some their health benefits. The unions have already launched a campaign pressuring state officials to pass a budget.

At issue is whether to close a $3.6 billion budget shortfall by increasing taxes or making spending cuts. The decision must be made before the fiscal year ends on June 30.

I know Minnesota is small compared to Greece. But the point is both have been suffering from the same sin—profligate government spending—and now faces the consequences. Reality stares on them.

Yet seen from a relative standpoint, Pimco’s Bill Gross says that the US is in worst condition than Greece or the Eurozone.

Mr. Gross’ recent analysis or outlook squares with mine.

Incidentally Mr. Gross, formerly an apostle of Krugman, has reversed his position, since his uber-Keynesian partner Paul McCulley departed from (or kicked out of?) PIMCO in December 2010.

From CNBC, (bold emphasis mine)

When adding in all of the money owed to cover future liabilities in entitlement programs the US is actually in worse financial shape than Greece and other debt-laden European countries, Pimco's Bill Gross told CNBC Monday.

Much of the public focus is on the nation's public debt, which is $14.3 trillion. But that doesn't include money guaranteed for Medicare, Medicaid and Social Security, which comes to close to $50 trillion, according to government figures.

The government also is on the hook for other debts such as the programs related to the bailout of the financial system following the crisis of 2008 and 2009, government figures show.

Taken together, Gross puts the total at "nearly $100 trillion," that while perhaps a bit on the high side, places the country in a highly unenviable fiscal position that he said won't find a solution overnight.

"To think that we can reduce that within the space of a year or two is not a realistic assumption," Gross said in a live interview. "That's much more than Greece, that's much more than almost any other developed country. We've got a problem and we have to get after it quickly."

Politicians and their fanatic worshipers think that money printing measures will help solve such dilemma by kicking the proverbial can down the road. They’re dead wrong. [If they have strong enough convictions, they should put all their money in shorting gold]

If Mr. Gross analysis is accurate, then this only shows that socio-economic problem of the US is so remarkably huge. And that if the US obstinately pursues on the money printing path, the scale of such undertaking would equally be colossal. This brings to fore the risks of hyperinflation, which is what US presidential aspirant and candidate Ron Paul has recently warned of and which could also be read as his prediction.

This is also why I have been saying that the next crisis will be even more devastating than 2008, as both the banking system and governments have already been pushed wall. The next crisis will likely see what I call the Mises Moment: either massive defaults by governments and a possible collapse of the banking sector or the worst alternative—hyperinflation. I can't fathom yet how the technology driven globalization will be impacted.

Yet hyperinflation would likely mean the end of the de facto US dollar standard or even the closure of US Federal Reserve as Nassim Taleb predicts or even possibly the disintegration of the Euro too (if the Euro would hyperinflate along with the US).

Finally there are many speculations on the new terminology of money printing or currently known as Quantitative Easing.

Jim Rogers calls sarcastically his version as the ‘cupcake’. Bill Gross sees a price cap on 2-3 treasuries and David Rosenberg calls his the ‘Operation Twist’

At the end of the day, what faces the world is the risk of debt defaults or default by hyperinflation.

Ron Paul: Expect 50% Inflation

US Presidential candidate Ron Paul expects the US government to default via inflation

The unionleader.com writes, (hat tip lew rockwell political theatre)

Texas congressman Ron Paul on Friday predicted that inflation will hit 50 percent in the next couple of years, thanks to the massive debt the country has accumulated.

Paul, who spoke to admirers and Republican activists at a Manchester house party, said the inflation will act like default.

Social Security checks will still be cut and interest payments will still be made, but the inflated dollars will allow the government to repay borrowed dollars with devalued money, Paul said.

“They cannot pay the debt,” he said. “I don't think that means you shouldn't try and work things out, but with the size of this debt it never gets paid.”

The national debt is about $14.3 trillion.

Currently about 2/5 of the US CPI index accounts for housing which only means that for inflation to reach 50% that commodity prices will have to go vertical. There would be a flight to real assets. The inflation would have to be so devastating that even housing prices which currently has reverted to a declining price trend, would rise.

Thus Ron Paul sees that the US Federal Reserve will likely take, or experiment, on the path of hyperinflation rather than an outright default.

I would surmise that this is more of a warning than of a prediction.

Yet, this is one tail risk that the mainstream has continued to ignore which is why Ron Paul raises this concern. The obstinacy to maintain current path of government spending profligacy risks this outcome.

The next global financial crisis will likely signify what I call the Mises Moment—the critical moment where the set of choices of policymakers determines whether the entire paper money system collapses or major economies suffers from debt deflation.

Remember in 2008 the banking system nearly collapsed. Major economy governments assumed many of the banking system’s bad assets by flooding the world with money in the hope that these concerted rescue efforts can wish away the accrued malinvstements.

Today, both the banking system and governments have been disproportionately leveraged, and which continues to rely on further inflation (via serial bailouts) to maintain price levels that keeps the banking system afloat. The unfolding events in Europe, particularly the PIIGS, seem as appetizers to the next government-banking system crisis. The difference would be the intensity.

What is unsustainable can’t last.

Have a nice day.

A Crack-up Boom in Belarus

Belarus appear on the verge of experiencing hyperinflation.

Reports the Bloomberg, [bold emphasis mine]

Belarus is headed for an economic “meltdown” and the ruble will need to depreciate another 51 percent, VTB Capital said, as locals lay siege to shops and protest price increases after the central bank devalued the currency.

The Belarusian central bank let the managed ruble weaken by 36 percent versus the dollar on May 24 as demand for dollars and euros from importers and households threatened to derail an economy already laboring under a current-account deficit equal to 16 percent of gross domestic product. Russia and other former Soviet partners last week agreed to give Belarus a $3 billion loan and urged President Aleksandr Lukashenko’s government to sell $7.5 billion of assets to replenish the state’s coffers.

“A ‘91-style meltdown is almost inevitable,’’ said Alexei Moiseev, chief economist at VTB Capital, the investment-banking arm of Russia’s second-largest lender, referring to the country’s economic slump after the collapse of the Soviet Union. ‘‘Rapid privatization is the only way that can help avert complete disaster.”

From Zero Hedge

As always political goals such such as the desire to maintain hold on power by incumbent political leaders abetted by inflationist and socialist policies have contributed to this.

Again from the same Bloomberg article, [bold highlights mine]

Lukashenko reintroduced controls on prices and the currency and re-nationalized some companies and infrastructure after coming to power in July, 1994, on a platform of “market socialism.” The nation’s economy returned to growth in 1996, according to World Bank data.

At the Minsk Refrigerator Plant Co. shop in the capital today, about 20 people queued in drizzling rain to use their rubles to buy fridges. While the shop didn’t open on the day of the devaluation, most of the models in the store already had ‘Sold Out’ stickers on their doors.

“I came on Saturday and it was a nightmare, the store was stormed by people who wanted to spend their rubles because of rumors about the devaluation,” said Nikolay, a 74-year-old pensioner who declined to provide his last name. His entire savings of 6 million rubles now buy one fridge compared with three before the devaluation, he said.

The ruble traded at 5,019.75 per dollar at banks and currency kiosks around the country today, according to the median mid-price of six banks compiled by Bloomberg from the lenders’ websites. That’s 1.8 percent weaker than the official rate.

The devaluation lifted the local price of automobile fuels as much as 24 percent, according to Belneftekhim, an industry group for the country’s oil sector. Last night, about 50 people protested the price increase in the car park of a Minsk hypermarket.

“I can’t describe how I feel without using obscenities, this is all our government’s fault,” said Sergey, a 32-year old attending the protest who works for a computer importer. “The whole world tells them, guys, you have economic problems, you should do something, and all they did was live off getting more and more loans.”

Both the IMF and the EBRD have blamed Lukashenko’s spending before last year’s presidential election for much of the economy’s woes. Lending was increased by 38 percent last year and public-sector salaries rose by about 50 percent, the Washington-based IMF said in a March 9 report.

Belarus got a $3.5 billion bailout loan from the IMF during the global credit crisis and the country has more than $2 billion of ruble and dollar debt outstanding. Foreign-currency reserves hit a 1 1/2-year low in March...

The price of children’s diapers has “gone completely insane” in Minsk, said Natalia, a 24-year-old mother also queuing outside the refrigerator store. “I used to buy a pack for 69,000 rubles, now they cost 140,000,” or almost half the 343,260-ruble monthly child benefit paid by the government, she said.

“We have become paupers,” said Tatiana, a 70-year-old woman in the line who also declined to give her last name. “We have been squeezed into a corner by this devaluation.”

Belarus’ skyrocketing inflation from Danske Bank

The previous bailout of the IMF has introduced the moral hazard factor which seems to have compounded this process.

Yet the unfolding episode in Belarus seems like a good example of the phase of the inflation process known to the Austrian school as the crack-up boom

From 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

US Dollar’s Diminishing Role As Reserve Currency

The Wall Street Journal editorial highlights on the baneful effects of the Fed’s inflationist policies, which is being transmitted via the US dollar, to the world. Such paradox had partly been captured by the famous quote attributed to former US Treasury secretary John Connally “our currency, but your problem.

From the Wall Street Journal, (bold highlights mine)

The larger story is that the world is starting to protect, and perhaps ultimately free, itself from America's weak dollar standard. The European Central Bank recently raised interest rates and may do so again to prevent an inflation breakout. China is allowing more trade to be conducted in yuan, a first step toward making it a global currency. At a meeting of developing countries—the so-called BRICs—in China recently, leaders called for "a broad-based international reserve currency system providing stability and certainty." They weren't referring to the dollar.

Even in the U.S., Americans are buying commodities (oil per barrel: $111) and gold ($1,500 an ounce) as a dollar hedge, and the state of Utah recently took steps to make it easier for citizens to buy and sell gold as a de facto alternative currency. Whether or not these prove to be wise investments, they are certainly signals of mistrust in Washington's economic stewardship.

At an economic town hall this week, President Obama blamed "speculators" for rising oil prices. He should have mentioned the Fed and his own Treasury, which have encouraged the world to invest in hedges against the falling dollar. Chairman Ben Bernanke and Mr. Geithner have deliberately pursued a policy of unprecedented monetary and spending stimulus to reflate the economy and boost asset prices. The bill is coming due in a weak dollar, food and energy inflation, and the decline of U.S. economic credibility.

But inflationism eventually will be everyone’s problem.

There will be feedback mechanisms from other nations. And this process is exactly what the Wall Street Journal article has been about. Other nations have been taking defensive maneuvers from a policy of sustained inflationism adapted by the US Federal Reserve.

And one consequence is that the US dollar will shed its pre-eminence as the world’s reserve currency.

Sustained inflationism means that the US dollar will diminish her role as the world’s reserve currency. The above chart shows how this process has been taking place.

The rise of the Euro came amidst the US Technology bust in 2000. Overtime, the Euro has grabbed a larger slice of the reserve currency pie. But it is unclear if the Euro will be a worthwhile substitute as the Euro suffers from the same malaise as the US. The difference is just a matter of degree.

Nevertheless, the great Ludwig von Mises described how the inflation process negates the role of money. (bold highlights mine)

The course of a progressing inflation is this: At the beginning the inflow of additional money makes the prices of some commodities and services rise; other prices rise later. The price rise affects the various commodities and services, as has been shown, at different dates and to a different extent.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services.

These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

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’s a process in motion.

The Phisix And The Boom Bust Cycle

``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 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.”- Fritz Machlup, The Stock Market, Credit and Capital Formation

At this time of the year, many institutions and experts will be issuing their projections. Some, like me[1], have already done so late last year.

Most of the forecasts will be positive as they will likely be anchored on the most recent past performance. And I would belong to this camp but for different reasons.

The Phisix Boom Bust Cycle At A Glance

While the mainstream interpret and analyse events mostly from the lens of economic performance, technical (chart) and corporate financial valuations, as many of you already know, I look at markets based boom bust (business) cycles as a consequence of incumbent government policies (see figure 1).

Figure 1: Stages of the Bubble and Phisix Bubble Cycle of 1980-2003

As one would note, the Phisix played out a full bubble cycle over a 23 year period in 1980-2003 (right window). The cycle also shows that in the interregnum, there had been mini-boom bust cycles (1987 and 1989).

A formative bubble cycle appears in the works since 2003, with the 2007-2008 bear market representing a similar mini countercycle similar to the previous period.

The lessons of the previous bubble cycle impart to me the confidence to predict that the Phisix will likely reach 10,000 or even more before the cycle reverses.

Although one can never precisely foretell when or how these stages would evolve, as past performance may not repeat exactly (yes but it may rhyme as Mark Twain would have it), the important point is to be cognizant of the whereabouts of the current phase of the bubble cycle.

And evidence seems to point out that we are in the awareness phase of the bubble cycle as demonstrated by the swelling interest for Philippine assets. The latest success of the $1.25 billion PESO 25-year bond offering[2] and the upgrade of the nation’s credit rating by Moody’s[3] serve as good indications.

In addition, local authorities audaciously and ingeniously tested the global market’s risk appetite for the first time ever with a substantial placement at a long tenor that passed with flying colours. With 160 investor subscriptions mostly from the US and Europe, the Peso bond offering further illustrates the mechanics of cross currency arbitrages or carry trades arising from monetary policy divergences.

Of course for the mainstream, this will be read and construed as signs of confidence. For me, these events highlight the yield chasing phenomenon in response to present policies.

Figure 2: McKinsey.com[4] Global Financial Assets

And considering that the global financial markets have immensely eclipsed economic output as measured by GDP (see figure 2), the yield chasing dynamic will likely be magnified, largely driven by the disparities in money policies and economic performance. Another apt phrase for this would be ‘rampant speculation’.

To reiterate for emphasis, anent the Phisix, we don’t exactly know if there would be another countercyclical phase or if the present bubble cycle will persist unobstructed until it reaches its zenith.

In addition, we can’t identify how the rate of acceleration of the cycle will unfold nor can we ascertain the exact timeframe for each of the stages in succession.

Instead we can measure the bubble cycle by empirical evidences such as conditions of systemic credit, rate of asset or consumer price inflation and mass sentiment.

The Growing Influence Of Negative Real Interest Rates

With interest rates artificially suppressed, which fundamentally distorts the price signals that account for the time preference of the public over money and the economic balance of the credit market, policy influenced interest rates and the interest rate markets that revolve around them will lag the rate of inflation.

In short, real interest rate will be negative for an extended period.

In the milieu where government here and abroad have been working to stimulate ‘aggregate demand’ via the interest rate channel and for developed economies who employ unconventional monetary operations in support of the banking sector and the burgeoning fiscal deficits, the impact on consumer price inflation will likely go beyond the targets of their respective authorities.

As an aside, some governments in the Europe, such as Hungary, Bulgaria, Poland, Ireland and France have begun to “seize” private pensions[5], but applied in diverse degrees, all of which have been aimed at funding unsustainable deficits accrued from welfare programs and the cost of bailouts.

This only serves as evidence that governments are getting to be more desperate and would unflinchingly resort to unorthodox means to keep the status quo.

Figure 3: Global Negative Real Interest Rates[6] and Record Food Prices (courtesy of US Global Funds and Bloomberg)

Real interest rates were at the negative zone for several countries (see figure 3 left window) even as 2010 had largely been benign.

But with the most recent explosion of food prices[7] to record levels on a global scale as measured by the Food and Agriculture Organization Index (FAO- right window), aside from surging energy prices, we should expect consumer price inflation rates to ramp up meaningfully.

Meanwhile, Federal Reserve Chairman Ben Bernanke imputes high oil prices to “strong demand from emerging markets”[8]. This would represent as a half truth as Mr. Bernanke eludes discussing the possibility of the negative ramifications from his policies.

In the Philippines, such broad based price increases in many politically sensitive products or commodities have even triggered alarmism of the local media. Similar to Fed chair Ben Bernanke, local authorities and the media seem to have conspired to sidetrack on the scrutiny of the real origins[9] of such price hikes.

Nonetheless, most governments will, as shown above, try to contain interest rates from advancing, as this would increase the cost of financing of many of their liabilities. But this will only signify a vain effort on their part as politics will never overcome the laws of scarcity.

For the public, the growing recognition of widening negative real interest rates will further spur the dynamics of reservation demand—call it speculation, hoarding or punting, or in the terminology of the Austrian economists the “crack-up boom” or the flight to commodities as the purchasing value of money erodes.

And that those who expect fixed income to deliver positive returns while underestimating on the impact of changes in the rate of inflation will suffer from underperformance.

Yet the same dynamics are likely to incite further “risk taking” episodes (note again: reservation demand and not consumption demand), one of the fundamental source of boom bust or bubble cycles.

As a caveat, I am not an astrologer-seer who will predict day-to-day movements, rather in taking the role of an entrepreneur we should see or parse the business or bubble cycle as an active process that is subject to falsification.

This also means market actions won’t be moving in a linear path.

Figure 4: Markets Drive Policies (source: Danske Bank and economagic.com)

And as earlier stated, policy interest rates trail inflation.

And where market based rates partly reflect on prevailing inflation conditions, one would observe that market rates almost always lead policy rates (see figure 4 right window). Despite the Fed’s QE program aimed at keeping interest rates low, markets have started pricing US treasuries higher. In other words, policy interest rates react to market developments than the other way around.

In a parallel context, the interest rate markets seem to also price aggressively[10] Fed fund rate futures (left window) contradicting the promulgated policy by the US Federal Reserve.

Bottom line: the surging consumer inflation signifies as unforeseen consequences to the current polices.

The Continuing Policy of Bailouts

Of course higher interest rates, at a certain level, will ultimately be detrimental to local or national economies, particularly to those in the hock.

But the risk of a high interest rate environment will depend on the leverage of policymaking. Debt in itself will not be the main source of the risk, prospective policy actions will.

Many government institutions (or even politicians) are aware of the risks of overstretched debt levels.

In the US, the Federal Reserve has its 220 PhDs and many more allied economists in the academia or in financial institutions[11] to apprise of the debt-economic conditions and the available policy options and their possible implications. The problem is that they are math model based and hardly representative of actual state of human affairs.

Besides, most of them are predicated on Keynesian paradigms whose fundamental premises are in itself structurally questionable. Thus, market and economic risks come with the methodology guiding the policy actions that are meant to address present concerns.

For instance, should the problem of debt be resolved by taking on more debt?

Applied to US states whom are in dire financial morass, will the US, through the US Federal Reserve, bail them out?

Ben Bernanke pressed by the Senate recently said no[12], but his statements can’t be relied upon as proverbially carved in the stone. That’s because this would largely depend on the degree of exposure of the banking system’s ownership of paper claims of distressed States on its balance sheets. A ‘no’ today can be a ‘yes’ tomorrow if market volatility worsens and if credit market conditions deteriorates based on the financial conditions of the banking system.

Early last year, Ben Bernanke spoke about ‘exit strategies’[13] when at the end of the year exit strategies transmogrified into QE 2.0 and where talk of QE 3.0[14] has even been floated. Talk about flimflams.

In short, since the banking system is considered as the most strategic economic sector by the present political authorities, enough for them to expose tens of trillions worth of taxpayer money[15], then the path dependence by the Fed would be to intuitively bailout sectors that could weigh on their survival.

The fact that the US has had an indirect hand in the bailout of Europe[16], via the IMF and through the activation of the Fed swap lines hammers the point of Bernanke’s preferred route.

And of course, we shouldn’t be surprised if the Fed collaborated anew with European governments to any new bailout schemes in case of any further escalation in the financial woes of European banks and or governments.

So the US has been in a bailout spree: the US banking system, the Federal government, Europe and the rest of the world (through Fed swaps and through the transmission mechanism of low interest rates), so why stop at US states?

Hence given the policy preference, we should expect a policy of bailouts as likely to continue and should hallmark a Bernanke-led Federal Reserve.

And the policy of bailouts is likely to also continue in developed economies affected by the last crisis.

All these cheap money will have an impact on the relative prices of assets and commodities worldwide.

Thus, we see these internal and external forces affecting the Philippine assets--equities, real estate and corporate bonds.

What Would Stop Bailouts?

The preference for bailout option would only be stymied by natural (market) forces—higher interest rates from heightened inflation expectations (through broad based price signals-we seem to be seeing deepening signs of this)—which reduces the policy tools leverage available to the authorities, the resurrection of bond vigilantes as seen in the deterioration of the credit quality of sovereign papers, or a Ron Paul.

Of course the Ron Paul option, I would see as most unlikely given that a one man maverick is up against very well entrenched institutionalized vested interest groups which have been intensely associated with the government.

As Murray N. Rothbard exposited[17], (bold highlights mine)

But bankers are inherently inclined toward statism. Commercial bankers, engaged as they are in unsound fractional reserve credit, are, in the free market, always teetering on the edge of bankruptcy. Hence they are always reaching for government aid and bailout. Investment bankers do much of their business underwriting government bonds, in the United States and abroad. Therefore, they have a vested interest in promoting deficits and in forcing taxpayers to redeem government debt. Both sets of bankers, then, tend to be tied in with government policy, and try to influence and control government actions in domestic and foreign affairs.

This leaves us with inflation and credit quality which I think are tightly linked underpinned by a feedback mechanism.

A bubble bust elsewhere in the world from high interest rates would drain capital, but if inflation remains high this will reduce authorities leverage to conduct further bailouts. Think the stagflation days of 1970s (the difference is the degree of overindebtedness today and in the 70s).

In addition, high interest rates at a certain point will puncture global governments liquidity bubble which will expose nations propped up by the liquidity mask to deteriorating credit quality.

And at this point, crisis affected governments, including the US, are likely to choose between the diametrically opposed extreme options of continuing to inflate that may lead to hyperinflation or to declare a debt default (Mises Moment).

As a side note, under such scenario, people who argue that the US dollar’s premier status as international reserve won’t be jeopardized would be proven wrong, if, for instance, the policy route would be to inflate.

The health of any currency greatly depends on society’s perception of the store of value function. Once the public recognizes that debasement of the currency has been a deliberate policy and likely a process that would persist overtime, the perception of the store of value function corrodes significantly. And the public will likely look for an alternative.

In finding little option among the available choices, society may choose to revert to a commodity linked currency as default currency, as it always has.

Albeit the worst alternative would be that debasement of the currency or inflationism will lead to totalitarianism.

As Friedrich von Hayek warned[18],

At present the prospects are really only a choice between two alternatives: either continuing an accelerating open inflation, which is, as you all know, absolutely destructive of an economic system or a market order; but I think much more likely is an even worse alternative: government will not cease inflating, but will, as it has been doing, try to suppress the open effects of this inflation; it will be driven by continual inflation into price controls, into increasing direction of the whole economic system. It is therefore now not merely a question of giving us better money, under which the market system will function infinitely better than it has ever done before, but of warding off the gradual decline into a totalitarian, planned system, which will, at least in this country, not come because anybody wants to introduce it, but will come step by step in an effort to suppress the effects of the inflation which is going on.

So the policy tethers will depend on the conditions of several factors such as the rate of commodity and consumer price inflation, real and nominal interest rates, falling bond prices or rising yields, currency volatility and administrative policies choices of protectionism or globalization/economic freedom and capital and price controls vis-a-vis the status quo.

Profiting From Folly: The Inflationary Boom And Cyclical Banking Crisis

For now, the incipient signs of commodity inflation and rising rates have yet to diffuse into alarming levels.

Thus, I perceive that much of the applied inflationism will likely get assimilated into financial assets, thereby projecting an inflationary boom.

So going back to assembling of the pieces of the jigsaw puzzles, the Philippine bubble cycle will merely represent as one of the symptoms of the escalating woes wrought by the paper money system.

Figure 5: World Bank[19]: Surging Banking Crisis Post 1970s

The Philippine markets like other emerging markets have been the one of the main beneficiaries of the transmission mechanisms of the monetary policies of developed economies aside from the impact from the domestic low interest rate policies.

This favourite chart of mine (see figure 5) reveals of the manifold banking crisis post the Bretton Woods dollar-gold exchange convertibility standard.

While many in the mainstream blame the spate of crisis on capital account liberalization and international capital mobility, this misleads because it is the capacity to inflate (or expansion of circulation credit) rather than capital flows that causes malinvestments. Capital flows merely represent as transmission channels for inflating economies. Like in most account, the mainstream misreads effects as the cause. The repeated banking crisis suggests of a continuing cycle which implies of more crisis to come in the future, despite new regulations introduced meant to curb future crisis.

So while the mainstream will continue to blabber about economic growth, corporate valuations or chart technicals, what truly drives asset prices will be no less than the policies of inflationism here and abroad that leads to cyclical boom and bust in parts of the world including the Philippines.

And that would be the most relevant big picture to behold. Yet relevance seems not a measure of importance for most.

Nevertheless, we’ll heed Warren Buffett’s sage advice,

Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.

Get it? Our objective then is to profit from folly by playing with the cycle rather than against it.

---

[1] What To Expect In 2011, December 20, 2010

[2] FinanceAsia.com Philippines and Stats ChipPac usher in new year with style, January 7, 2011

[3] Inquirer.net Moody’s upgrades PH outlook to ‘positive’, January 6, 2011

[4] McKinsey.com Mapping global capital markets: Fourth annual report, January 2008

[5] csmonitor.com European nations begin seizing private pensions, January 2, 2011

[6] US Global Investors Investor Alert, December 31, 2010

[7] Bloomberg.com World Food Prices Jump to Record on Sugar, Oilseeds, January 5, 2011

[8] WSJ Blog, Bernanke on Munis, Oil and Fed’s Mandate, January 7, 2011

[9] The Code of Silence On Philippine Inflation, January 6, 2011

[10] Danske Bank, 2011 off to a good start, Weekly Focus, January 7, 2011

[11] Grim Ryan Priceless: How The Federal Reserve Bought The Economics Profession, Huffington Post, September 7, 2009

[12] Reuters.com Bernanke balks at bailout for states, January 7, 2011

[13] Testimony of Chairman Ben S. Bernanke on the Federal Reserve's exit strategy Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. February 10, 2010

[14] QE 3.0: How Does Ben Bernanke Define Change, December 6, 2010

[15] $23.7 Trillion Worth Of Bailouts?, July 29, 2010

[16] Reuters.com U.S. plays 2 roles in European bailout plan, May 11, 2010

[17] Rothbard, Murray N. Wall Street, Banks, and American Foreign Policy, 2005 lewrockwell.com

[18] Hayek, F. A. A Free-Market Monetary System, p. 23

[19] World Bank Data Statistics Worldview 2009 p.9

Surging Gold Prices Reveals Strain In The US Dollar Standard-Paper Money System

Tocqueville Asset Management LP’s John Hathaway poignantly writes:

The world’s monetary system is in the process of melting down. We have entered the endgame for the dollar as the dominant reserve currency, but most investors and policy makers are unaware of the implications.

The only questions are how long the denouement of the dollar reserve system will last, and how much more damage will be inflicted by new rounds of quantitative easing or more radical monetary measures to prop up the system.

Whether prolonged or sudden, the transition to a stable monetary system will become possible only when the shortcomings of the status quo become unbearable. Such a transition is, by definition, nonlinear. So central-bank soothsaying based on the extrapolation of historical data and the repetition of conventional wisdom offers no guidance on what lies ahead.

History has shown that paper money system don’t last long.

The only exception is that of the medieval Chinese experience which reportedly lasted 600 years. But the historical account of this isn’t certain: wikipedia says it was during the Song Dynasty, the Buttonwood’s Blog at the Economist says it was during Emperor Tsung while Dollardaze.org’s Mike Hewitt says this was during the Tang dynasty.

Meanwhile Murray Rothbard argued that the first paper money in the US was issued by the colonial government of Massachusetts in 1690.

Nevertheless Dollardaze’s Mike Hewitt examined 775 world currencies which includes the 176 in circulation (as of 2009) and 599 not in circulation, and found that

-the “median age for all existing currencies in circulation is only 39 years” and

-that the extinction of currencies had primarily been through acts of war and hyperinflation.

Incidentally and ironically, the US dollar standard since 1971 is 39 years old and seems to feel the same strain from old political habits.

Yet the attraction of the paper money system is that it allows government to pursue its political agenda via unsustainable free lunch policies.

As Murray Rothbard wrote in Mystery of Banking,

The inventions of paper and printing gave enterprising governments, always looking for new sources of revenue, an “Open Sesame” to previously unimagined sources of wealth. The kings had long since granted to themselves the monopoly of minting coins in their kingdoms, calling such a monopoly crucial to their “sovereignty,” and then charging high seigniorage prices for coining gold or silver bullion. But this was piddling, and occasional debasements were not fast enough for the kings’ insatiable need for revenue. But if the kings could obtain a monopoly right to print paper tickets, and call them the equivalent of gold coins, then there was an unlimited potential for acquiring wealth. In short, if the king could become a legalized monopoly counterfeiter, and simply issue “gold coins” by printing paper tickets with the same names on them, the king could inflate the money supply
indefinitely and pay for his unlimited needs.

Eventually, as always, monetary debasement gets abused and suffers from rampant inflation or at worst hyperinflation. And this will require either massive reform or a new currency system.

The current US dollar standard paper money system seems to be in a no different path from its forbears, as free lunch and mercantilist policies are being subtly pursued through global currency debasement.

Some call this the “currency wars”. I call this cycle the Mises moment.

And rampaging gold prices priced in every major currency (US dollar, Euro, Yen, Pounds, Canadian Loonie, Aussie Dollar, Indian Rupee, South African Rand and Gold in G5 index) seems to be saying this for quite sometime—the endgame could be near.

Charts from Gold.org (as of October 25, 2010)

For the “gold is barbaric metal” camp, paper money will reign forever even when unsupported by history and economic laws for the simple reason of dogmatic belief over free lunch politics.

But as Professor Ludwig von Mises once wrote,

The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity.

Unfortunately, anything unsustainable won’t last. And Voltaire would be validated anew, paper money eventually returns to its intrinsic value—zero.

Trigger To The Inflation Time Bomb

Will the trigger to the inflation time bomb be setoff soon?

According to Dr. Antony Mueller

Look at these two curves as if they were electrical wire all it takes a little twiggle of the money multiplier to surge and the bomb will explode. While it would be hard and enduring task for the central bank to reduce the monetary base, it only takes a whiff for expectations that determine the multiplier to shoot up. The bomb that will be ignited has already a name. It's name is "hyperinflation".

Mainstream have long been fixated about deflation.

But like Waiting for Godot, this has not occurred yet, and will unlikely happen unless the Fed accedes to the environment of shrinking liquidity at the risk of the implosion of the US banking system.

Ironically, this would defeat all their trillions of rescue efforts to the politically privileged industry. (As we long have been saying---bailouts were directed NOT primarily to save the economy but the political-economic class that depended on the benefits of seignorage from the US dollar standard.)

Also as we have long spelled out, the US yield curve cycle has a 2-3 year lag period from which we should expect it to generate “traction” by the last quarter of 2010.

And given the recent marked improvements in the credit markets of the US as shown below...

From St. Louis Federal Reserve...

From Northern Trust...

Not only is the yield curve cycle being validated, as US banks become more “open” to issue loans rather than seek safety in securities, but this also heightens the risk of the proverbial "pulling of the trigger" to the inflation time bomb.