Ireland’s Bailout Will Be Financed By Monetary Inflation

``This is what the phrase "lender of last resort" really means: the creation of fiat money by the central bank. It means breaking the normal rules of the fiat money game. It means bailouts.”- Gary North

A short note on Ireland financial crisis.

This from the Bloomberg[1],

European finance ministers are racing to conclude an international rescue package for Ireland before markets open to stop the country’s financial crisis from spreading to the rest of the euro region.

Prime Minister Brian Cowen’s government is finalizing a bailout agreement that may amount to 85 billion euros ($113 billion) after more than 50,000 people took to the streets of Dublin yesterday to protest budget cuts. As Ireland’s crisis spreads to Portugal and Spain, investors are looking for details on the interest rate Ireland will pay on its loans and the fate of senior bondholders in the country’s banks.

It is quite nonsensical to believe that the Euro will be sacrificed for the misguided notion that austerity will compel for its disintegration as previously argued[2]. As shown in the said article, Eurozone governments have been using market actions to justify interventionism via bailouts.

I am reminded of the institutional incentives borne out of government’s control of the monetary and banking system, as the great Professor Ludwig von Mises wrote[3], (bold emphasis mine)

But today credit expansion is an exclusive prerogative of government. As far as private banks and bankers are instrumental in issuing fiduciary media, their role is merely ancillary and concerns only technicalities. The governments alone direct the course of affairs. They have attained full supremacy in all matters concerning the size of circulation credit. While the size of the credit expansion that private banks and bankers are able to engineer on an unhampered market is strictly limited, the governments aim at the greatest possible amount of credit expansion. Credit expansion is the government's foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make-everybody prosperous.

However this time we are dealing with the bailout on claims on sovereign assets, mostly for the benefit of the creditors or bondholders, which apparently are mostly held by the Euro banking system (see figure 3).

Figure 3 Bank of International Settlements: Exposures to PIIGS

According to the BIS[4], (bold highlights mine)

The integration of European bond markets after the advent of the euro has resulted in a much greater diversification of risk in the euro area. As of 31 December 2009, banks headquartered in the euro zone accounted for almost two thirds (62%) of all internationally active banks’ exposures to the residents of the euro area countries facing market pressures (Greece, Ireland, Portugal and Spain). Together, they had $727 billion of exposures to Spain, $402 billion to Ireland, $244 billion to Portugal and $206 billion to Greece.

French and German banks were particularly exposed to the residents of Greece, Ireland, Portugal, and Spain. At the end of the 2009, they had $958 billion of combined exposures ($493 billion and $465 billion, respectively) to the residents of these countries. This amounted to 61% of all reported euro area banks’ exposures to those economies.

As repeatedly argued here, redistributive policies have always been meant protect certain powerful interest groups. But they are camouflaged by the use of social welfare as cover and by the captured intelligentsia class in the provision of the technical rationalization.

Central banks, to quote Murray Rothbard[5], are ``governmentally created and sanctioned cartel device to enable the nation’s banks to inflate the money supply in a coordinated fashion, without suffering quick retribution from depositors or noteholders demanding cash. Recent researchers, however, have also highlighted the vital supporting role of the growing number of technocratic experts and academics, who were happy to lend the patina of their allegedly scientific expertise to the elite’s drive for a central bank. To achieve a regime of big government and government control, power elites cannot achieve their goal of privilege through statism without the vital legitimizing support of the supposedly disinterested experts and the professoriat. To achieve the Leviathan State, interests seeking special privilege, and intellectuals offering scholarship and ideology, must work hand in hand.”

The quote actually referred to the US Federal Reserve but can be applied universally.

Of course, the next question is how will these large scale sovereign bailouts be financed? The obvious answer by monetary inflation.

Again from Professor Rothbard[6], (bold highlights mine)

The Central Banks enjoy a monopoly on the printing of paper money, and through this money they control and encourage an inflationary fractional reserve banking system which pyramids deposits on top of a total of reserves determined by the Central Banks. Government fiat paper has replaced commodity money, and central banking has taken the place of free banking. Hence our chronic, permanent inflation problem, a problem which, if un checked, is bound to accelerate eventually into the fearful destruction of the currency known as runaway inflation.

So what we are basically seeing is a validation of the perspectives of these great Austrian economists which seem to be playing out or unfolding today in both the Euro and the US.

In short, what the mainstream mostly ignores is the political role played by the central banks on our global economy.

By the way, it would seem that I have been validated anew. I earlier said that the risks at the US housing markets could weigh on the balance sheets of the US banking system which has prompted the US Federal Reserve to pursue QE 2.0[7] despite tepid signs of economic recovery.

Figure 4: Federal Housing Finance Agency: Falling Home Prices

US home prices are reportedly falling anew[8].

Like in the US, inflating the monetary system have been designed to rescue the respective banking systems.

Austerity, hence, is a farce. US and European governments (and even Japan) will continue to inflate the system.

And like the US dollar, the Euro will be used as an instrument to achieve political goals but coursed through the central bank (ECB).

---

[1] Bloomberg, EU Ministers Meet to Find Agreement on Irish Bailout November 28, 2010

[2] See Ireland’s Woes Won’t Stop The Global Inflation Shindig, November 22, 2010

[3] Mises, Ludwig von Currency and Credit Manipulation, Chapter 31 Section 5 p.788

[4] Bank of International Settlements International banking and financial market developments BIS Quarterly Review June 2010

[5] Rothbard, Murray N The Origins of the Federal Reserve, Mises.org

[6] Rothbard, Murray N Central Banking: The Process of Bank Credit Expansion Chapter 11 Mystery of Banking p.176

[7] See The Possible Implications Of The Next Phase Of US Monetary Easing, October 17, 2010

[8] Bloomberg.com U.S. Home Prices Fell 3.2% in Third Quarter, FHFA Says, November 24, 2010

Marc Faber: Dollar Will Eventually Go to Value of Zero

Here is Dr. Marc Faber's interview at the Bloomberg...



Some quotes:

"Best is to have foreign currencies and commodities but also equities that protect you to some extent as they adjust upwards as the currency goes down."

"The fiscal position of the US is a complete disaster. Eventually in ten years time, in my opinion, about 50% of tax revenues will be used to just cover the interest payments on the government debt and that is unsustainable. Then you really are forced to print money"

"Stocks don`t have a big downside risk because of the Bernanke put. As soon as the S&P drops towards 900 or 800 Bernanke will print money again, he is a money printer, he is nothing else. But he does that well - he prints well; you have to give him a medal for that..."

Basically Dr. Marc Faber's perspectives epitomizes much of what the Austrian School of Economics have been saying.

Falling Global Trade Equals Rising World Hunger

The Economist recently published a chart depicting the rising incidence of hunger in the aftermath of last year's financial crisis.

According to The Economist, (all bold emphasis mine)

``THE economic crisis is having a big impact on those already struggling to survive. The number of chronically hungry people in the world will rise from 913m in 2008 to 1.02 billion this year, a sixth of the global population, says the UN's Food and Agriculture Organisation in its annual report on food insecurity. Food prices that are 17% higher than they were two years ago, and big falls in remittances and investment are contributing to growing hunger. The economic slump has meant a growing share of the world's population is going hungry, after a steady decline since 1970. And the FAO notes that global food output will have to increase by 70% to feed a population projected at 9.1 billion in 2050."


I think The Economist has painted only a minor part of the big picture.

It is true remittances are expected to decline to about $290 billion in 2009 from only $305 billion in 2008, according to Indiainfo.com., and possibly contribute to the hunger woes. The Chart of global remittance trend above from UNCTAD Trade and Development Report.


But remittances are puny compared to what matters more.

The Economist have significantly missed the most important aspect- the impact from the $32 trillion global trade. From this perspective remittances constitute only 9% of global trade.

Yet, the material improvement of world hunger has coincided with a surge in global trade similar to the impact on depressed gold prices in the 90s as explained in Gold: An Unreliable Inflation Hedge?

While investment matters too, this has likewise mostly been underpinned by globalization trends.

In short, global trade creates job opportunities, expands the global labor market and improves on per capita GDP as to reduce poverty and incidences of hunger.

On the other hand, food prices are largely determined by trade, investments incentivized or hindered by national administrative policies and importantly, current synchronized monetary policies to curb so called demand shock from last year's meltdown.

Policies aimed at resolving such demand shock, with an overdose of paper money with dead politicians printed on them, may spawn a "supply shock" or a food crisis.

Situational Attribution Is All About Policy Induced Inflation

``Believe nothing just because a so-called wise person said it. Believe nothing just because a belief is generally held. Believe nothing just because it's said in ancient books. Believe nothing just because it's said to be of divine origin. Believe nothing just because someone else believes it."- Buddha, Unconscious Beliefs

If fundamental attribution bias is the “undervaluing or failing to acknowledge the potentiality of situational attributions”, then that means people overlook or substantially underprices situational developments.

For instance, some have suggested that stock market prices today as having been “overvalued”.

Well in my view, prices are relative:

1. in terms of direction: low prices can go lower and high prices can go higher,

2. valuations are always subjective and

3. prices can be seen as higher/lower in a relative sense when compared to the specifics. In the psychological context this is known as the contrast principle/effect or judgments based on relative comparisons or simply higher compared to what or whom?

Importantly, the issue of prices or valuations would greatly depend on the situational attribution or developments.

Situational Directions

So what has been the “situational” course of events?

It’s apparently not imputable to traditional or conventional specific metrics, because evidences haven’t been pointing to such direction, see Figure 2.

Figure 2: Stockcharts.com: Correlation: Phisix, Euro, Emerging Markets and Oil

The Euro which comprises 57.6% of the US dollar Index according to the ICE Futures, seems to be leading the way for Emerging Market Stocks (EEM), including the Philippine Phisix (PSEC) and commodities as represented by oil (WTIC).

The highs of the Euro (vertical blue lines) have been coincident with turning points of the specified markets above, but with a lag.

In short, over the interim the rising euro, or the inversely the falling US dollar index seems tantamount to higher financial asset prices.

As we have repeatedly argued, the global inflation dynamics are apparently being transmitted into equity, commodities and property markets (ex-developed economies) via the currency channel, as described in many past issues including the latest [see last week’s Warren Buffett’s Greenback Effect Weighs On Global Financial Markets].

Therefore, if markets haven’t been driven by conventional specific metrics, then why should we utilize conventional metrics as a gauge to determine our trade positions? That would be like using sonar to track airplane movements.

Inflation Dynamics In The Phisix And The World

The beauty of any theory would lie within its applicability or by the function of factual evidences… (see figure 3)

Figure 3: PSE Sectoral Indices: Rising Tide Lifts All Boat

The sectoral indices of the Philippine Stock Exchange (PSE) depicting synchronicity in motion.

Current market activities have strongly been demonstrative of the tidal ebbs and flows (or our Livermore-Machlup model see Are Stock Market Prices Driven By Earnings or Inflation? ) of the Philippine marketplace as we have long forecasted.

Our outstanding premise has been the lesser the efficient the markets the more prone to inflation driven dynamics.

Although domestic stock prices have risen in general, price levels have been nuanced, where some sectors have been outperforming the others [see Sectoral Performance In US, China And The Philippines].

The present pecking order of outperformance: Mining (green), Holding (red), the All Index (maroon), commercial (pink), property (blue), bank (black) and services (grey).

As you can see, the “rising tide lifts all boats” phenomena compounded by the relative price level actions have all been reinforcing the symptoms of an inflationary (liquidity) driven boom.

Such situational course of events hasn’t confined locally but to the world though.

As we pointed out in the latest Global Stock Market Performance Update: Despite China's Decline, Emerging Markets Dominate, 68 (83%) of the 82 issues monitored by Bespoke Invest (based on August 20^th) registered positive gains against 14 (17%) which accounted for losses.

Despite China’s Shanghai benchmark, which fumbled for the fourth consecutive week of losses (this week 3.38%) for an aggregate 4 week loss of 17.2%, China has been up 57% on year to date basis.

The Philippine Phisix as of Friday’s close seems to be closing the gap fast.

Nonetheless, the best performances have been among key emerging markets (many of which are situated from Asia), some having been beneficiaries of low systemic leverage and an unimpaired banking system, which has responded favorably to lower interest rates, while some have been reaping from rising commodity prices.

Although we expected some degree of differences relative to the US to emerge, this hasn’t been so yet.

The evolving activities in the US seem to reflect on more of the actions seen in most of the world.

According to Bespoke Invest, ``93% of stocks in the S&P 500 were trading above their 50-day moving averages. That number has come in slightly with today's declines, but it's still above 90%.” (emphasis added)

In short, macro thinkers, who fixate over the actions of the US, but negate the activities across the geographically diverse asset markets have been missing out on these developments.

The Validation Of Our Livermore-Machlup Model

More proof of more liquidity driven boom in the domestic market? (see Figure 4)

Figure 4: PSE: Daily Traded Issues (left) and Number of Daily Trades (right)

When the marketplace becomes reanimated, the speculative appetite expands.

This implies that transactions would cover issues that are less liquid (low market float), which can be found mostly among second or third tier securities.

As you can see in the left window, the daily traded issues have been broadening. This means that the advances in the Phisix are being seen in general terms, validating Jesse Livermore’s assertion.

Moreover, improving daily trades suggests of more people participating or engaging in churning activities.

Again another manifestation of a bullish breadth (right window).

It doesn’t stop here.

Figure 5: Advance Decline Spread: Broadening Gains

Another indicator would be the advance decline spread.

In the height of the selloff in 2008 (red ellipse), the advance decline spread has been obviously tilted towards huge broad based selloffs.

Today we see the opposite, since March of 2009, the internal activities in the Philippine Stock Exchange has largely been in favor of the advancing issues (light green ellipse).

To consider, local investors have usurped the role as the dominant pillar of the current state of the Phisix, a role which we presume should contribute to a sturdier trend and likewise could be deduced as having become less sensitive to the external developments, in contrast to the 2003-2007 cycle.

Added together, all these essentially have been validating our Livermore-Machlup inflation driven tidal dynamics thesis, where the collective inflationary policies by global governments will presumably take a major role in determining asset pricing conditions.

So stubbornly insisting on the idea of conventional metrics as a gauge of the market’s parameters will only lead to wide off the mark appraisals and severe underperformance.

The Economic Disconnect And Domestic Mainstream Policies

So does a 54% year to date surge in the Phisix translate to a V-shape recovery in the Philippine economy?

The Economist gives as an answer, (bold highlights mine)

``Although the return to robust quarter-on-quarter growth of 2.4%—the highest in over two years, following a first-quarter contraction of 2.1%—fits the international pattern, the economy has not contracted at all in year-on-year terms during the current global crisis. Growth of 0.6% in the first quarter appears to have marked the low point in the current cycle. Still, the recovery is far from entrenched. At just 1.5% year on year, real GDP growth in the three months to June was far below the 2004-08 quarterly average of 5.5%.

``In output terms, the service sector was the main driver of economic growth in the second quarter. Services output rose by 3.1% year on year, up from 2% in the previous quarter. Government services rose by 7.7% in real terms, reflecting stimulus spending. Trade rose by 3% on the back of strong growth in retail activity. In contrast, agricultural growth slowed sharply due to weak production of rice and some other crops. And industry contracted for the second straight quarter, falling 0.3%. Although the government's fiscal measures boosted construction, which rose by 16.9%, and mining and quarrying also recorded a big gain, growth in these areas was more than offset by the decline in manufacturing. This underlines the weakness of demand for Philippine exports, which has hit manufacturers hard.”

So seen from mainstream’s “money is neutral” perspective, then today’s Phisix, if it were to reflect on the performance of the economy, has vastly been overbought.

But seen from a perspective where the economy has been detached from the stock market and where the latter have been propelled by circulation credit expansion from a combination of government spending, low interest rate regime and a raft of other Bangko Sentral ng Pilipinas (BSP) policy instruments [as expanded peso and US dollar based repurchasing (repo) agreement, Credit Security Fund (CSF) that guarantees funding access to small cooperatives from which provides financing to small business and the easing of accounting regulations such as reclassifying “financial assets from categories measured at fair value to those measured at amortized cost” and where banks were allowed “not to deduct unrealized mark-to-market losses in computing for the 100 percent asset cover for FCDUs, effective until 30 September 2009).” (Gov. Amando Tetangco Amcham Speech August 11)], all of which could snowball into a massive source of structural misallocation of resources in the local economy, prices will be determined by the scale of leverage that will be imbued by the domestic financial system.

Yet like all policymakers globally (except for Israel which has dumbfounded the marketplace by being the first central bank to raise interest rates), Philippine BSP Governor Amando Tetangco takes on the mainstream tack, (bold emphasis mine)

``This 200 basis-point cumulative reduction in the policy rate will help stimulate economic growth or help moderate the slowdown by bringing down the cost of borrowing and reduce the financial burdens on firms and households. This will help us avoid or at least mitigate the negative feedback loop from weakening economic conditions to the functioning of the financial sector. Lower policy rates would also have the effect of shoring up business and consumer confidence.”

Business Cycle, The Philippine Version

Artificially reduced rates will only send false signals of the true amount of real savings available for lending. This would unnecessarily increase the acceptable level of risk taking activities by shifting the time preferences for both the lender and the borrowers. This in turn induces investments in the durable capital goods and or investments in the longer term process of production at the same time where consumption demand will be expanding which thus would leads to serious economic distortions and competition for resources, or in short, malinvestments.

To quote Professor John Cochran and Noah Yetter in Capital in Disequilibrium: An Austrian Approach to Recession and Recovery, ``But with a credit expansion relative reduction in the interest rate, producers are attempting to lengthen the production structure while consumers are attempting to shorten it. Longterm investment is booming at the same time as demand is growing for final consumption. Available resources are not sufficient to sustain both processes— individual business plans made in response to the interest rate change and the new pattern of consumer spending set up the problem of the ‘dueling production structures’. Thus the expansion in the money supply brings about unsustainable growth, characterized by a pattern of over consumption and over investment accompanied by malinvestment, investment inconsistent with consumers’ time preferences.” (bold highlight added)

Moreover, such policies allows the public to take on more debt than warranted which leads to systemic overleverage similar to the Asian Crisis, US housing and dot.com bubbles, as Prof, Thorsten Polleit explains in Bad News for Our Money ``It allows borrowers to issue even more debt, refund maturing debt at artificially suppressed interest rates, and reduce their real debt burden at the expense of money holders. The downward manipulation of the interest rate drives a wedge between the (real) market interest rate and the societal time-preference rate, and therefore wreaks havoc with the economy's intertemporal production structure. It leads to economic impoverishment, as it would stimulate consumption at the expense of savings and encourage malinvestment of scarce resources. What is more, suppressing the interest rate does not provide a solution to the overindebtedness problem, which is a result of government-controlled fiat money produced by banks extending credit in excess of real savings.”

Moreover, such policies only borrow economic activities from the future.

Floyd Norris of the New York Times recently noted how US homes prices reflected on the degree of inflation, initially rising (boom) but falling back (bust) to the same inflation adjusted price levels where the cycle all began [see US Home Bubble Cycle: Upside Directly Proportional To Downside]. Of course, all these came at the expense of the society. Hence Mr. Tetangco’s anxiety over the negative feedback loop can only be deferred until sometime in the future when enough imbalances will force itself on the marketplace.

Figure 6: Washington Post: Banks 'Too Big to Fail' Have Grown Even Bigger

Of course, monetary inflation has moral consequences; it redistributes wealth in a way where the initial recipients would be major beneficiaries from such policies.

Similar to the US where taxpayers and small businesses and small banks today have been sacrificed for “too large to fail” institutions which has even expanded more today (see figure 6), in the Philippines, investors with liberal access to the domestic banking institutions are likely to be the capitalists benefiting from the economic rent or politically bestowed economic privileges (licenses, cartels, monopolies).

So the wealth redistribution from present economic policies is likely to benefit the political elite at the expense of rest of the society.

In addition, with the fast approaching political Presidential election season, we should expect the present expansionary monetary landscape to be sustained. Here is a clue, again from Governor Tetangco, “Lower policy rates would also have the effect of shoring up business and consumer confidence”.

Besides, government’s fiscal spending to are likely to rev up in order spruce the economic landscape and financial marketplace for a Potemkin Village effect [see previous discussion in Philippine Peso: Interesting Times Indeed].

Well, Governor Tetangco in terms of policymaking would likely seek the comfort of the mainstream crowd once such policies start to unravel.

Hence he is likely to take heed of the insights from the mainstream icon at heart, this from John Maynard Keynes, ``Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

Anyway, comfort of the crowd it is for Asian policymakers.

From China’s Premier Wen Jiabao (Reuters) ``Therefore, we must maintain continuity and consistency in macroeconomic policies, and maintaining stable and quite fast economic growth remains our top priority. This means we cannot afford the slightest relaxation or wavering."

Or From South Korea’s Finance Minister Yoon Jeung Hyun (Bloomberg/Credit Bubble Bulletin) ``There is a risk that the economy may fall into a double dip if the government shifts the stance of policy too fast…It’s premature to discuss the timing of an exit strategy.”

However, even if Asian authorities have qualms on tightening present policies, the interest rate markets suggest that they will be tightening soon.

According to the Wall Street Journal, ``Asia's central bankers say they have no timetable for raising interest rates. But some investors already are placing bets to the contrary, speculating that India will go first, followed by China and Korea.

``The money is being put down in the huge interest-rate-swaps market, where the yields on two-year maturities across much of Asia have risen sharply in the past few months.

``This market, which had $403 trillion of contracts outstanding at the end of 2008, draws a range of investors, from hedge-fund managers to companies looking to hedge against a change in monetary policy. About a quarter of its volume is traded in Asia.”

Nonetheless even if Asian authorities begin to tighten for as long the US maintains ultra loose rates, pump the prime (deficits expected to reach $9 trillion in 2019!) and flood the global system with greenback emissions (Warren Buffett), we should expect the continued stickiness from inflation to be reflected on financial asset prices.

While markets could indeed show episodes of outsized volatility, as in the case of China or in the past in Russia, the impact from the present policies, in support of the Ponzi based global economic system, which are likely to be stretched way into the future for political motivated reasons should cushion or even give a boost to the reflation in asset prices.

Timing markets won’t be a recommended approach given the swiftness of market action.

Bottom line: Situational Attribution is all about policy induced inflation.

Food Crisis Watch: Sugar On Fire- Writing On The Wall?

Sugar prices have been on fire.

According to the Economist, ``THE price of sugar is higher than at any point in 27 years, having risen much more than prices of other food in recent months. The cause appears to be a huge drop in sugar production in India, the world's second-largest producer. In the 2007-08 season India's output was 28.6m tonnes of sugar, but this year production is estimated to fall to 16m tonnes. Indian farmers planted less sugarcane last year after sugar prices fell, partly in response to a ban on exports. A weak monsoon also threatens this year's production. Indians are also the biggest consumers of the sweet stuff: in 2008, they used 24.3m tonnes, nearly 15% of global demand. A decline in Indian production means that it will import more, driving up international prices. India's government has lifted its export ban, but production is unlikely to meet demand before 2011."

So the unintended effects from government policies to curb exports and weather appears to be the "seen" culprit.

But as you would probably notice, the Economist food price index have likewise been creeping higher but at a much subdued clip relative to sugar prices.

I would add that sugar's accelerated price movement came about as stock markets globally surged. This implies of some correlation-loose monetary environment plus fiscal policies may have likely been principal factors too.

Nonetheless here is Jim Roger's take on sugar.(emphasis added)

``Sugar –even though it is at a 28 year highs, you would probably know it is down 70% from its all time high. So sugar is still very depressed on any kind of historic basis and I suspect it will go higher. The last time we had a bull market in sugar in 70s, if you would remember there was no biofuel - that is a huge new element of demand now and most of Asia was not involved in the sugar market in any big way back in the 70s. But now Asia is prospering and there are 3 billion people trying to have a better life and most people when they get more prosperous, use more sweets. So you have big elements of demand in sugar now that you did not have in the last bull market. I wouldn’t sell sugar, I don’t know if it is going to go up in the next week or the next month but I am certainly expecting sugar to go much higher during the course of the bull market over the next several years.

It won't be just sugar though...

Jim Rogers anew, ``food inventories are at the lowest they have been in decades – not lowest in months or years but in decades. There is a very good chance that we are going very serious explosions in the price of food because we may have no food at any price if we continue to have weather problems. Yes you are having some monsoon problems in India but the rest of the world still hasn’t had bad weather. If we start having serious weather problems around the world as we have had many times in history, the price of food is going to skyrocket because there are no inventories and there is no productive capacity."

Ergo, The price spike in sugar could be the proverbial "shot across the bow".

As we noted in Chart: Global Food Price Inflation

``Many factors that gives rise to these disparities, aside from monetary and fiscal policies (taxes, tariffs, subsidies, etc...), there are considerations of the conditions of infrastructure, capital structure, logistics/distribution, markets, arable lands, water, soil fertility, technology, productivity, economic structure and etc.

``Our concern is given the present "benign state of inflation", some developing countries have already been experiencing high food prices, what more if inflation gets a deeper traction globally? Could this be an ominous sign of food crisis perhaps?"

The Asian-Emerging Market Momentous Historical Bubble?

``When a long-term trend loses momentum, short-term volatility tends to rise, it is easy to see why that should be so: the trend-following crowd is disoriented.”- George Soros

Excess volatility is the name of today’s game.

Global equity markets have been in a wild rollercoaster ride of late.

While US and European markets continue to sag following last week’s sharp decline, many of key Asian markets rallied hard recovering substantial segments of losses from the previous week.

So we seem to be witnessing another round of divergences at play, see figure 2.

Figure 2: stockcharts.com: Asia and EM stocks OUTPERFORM anew

The Dow Jones Asian Index which includes Japan appears to be testing for a new high, along with the less robust Emerging Market index (EEM) and the US S&P 500 (SPX). The weakest link seems to be European Stocks (STOXX).

Momentous Historical Bubble, Elixir Trade Model

The same friend, who commented earlier about the temptations of falling captive to gravity pulled “knives” in a bearmarket, likewise remarked of his friend who earlier paid for a series of monthly subscriptions to a local analyst, who is on the business of issuing regular technical charting outlook.

His friend came to realize that chart reading can be variable, vacillating and couldn’t be relied on, and hence, after a few months desisted from extending this “privilege”.

It’s simply amazing how people can be so captivated or bedazzled by the allure of short horizon Holy Grail type of market approaches, such that they have been shelling out substantial amounts to pay for guidance that dwell mostly on momentum driven or support-resistance trades or simply confirming biases of market participants through the technical picture. It seems like an incredible business model, I might add.

Yes, although this has been an opportunity cost for me in terms of the newsletter business paradigm, nonetheless, we’d rather stick by our principles to deal with prudent investing.

So aside from illustrating the possible dynamics of how the retail market works and how the some local subscription model business had profited immensely from the need for elixir based trades, the point of this article is to prove that today’s market can truly confound mechanical technicians or even macroeconomic fundamentalists.

Why is this so?

To put on our Ivory Tower thinking cap, we quote Prof. Steve Horwitz in The Microeconomic Foundations of Macroeconomic Disorder: An Austrian Perspective on the Great Recession of 2008, ``The Austrian approach to macroeconomics can already be seen as being fundamentally microeconomic. What matters for growth is the degree to which microeconomic intertemporal coordination is achieved by producers using price signals, especially the interest rate, to coordinate their production plans with the preferences of consumers. However, this coordination process can be undermined through economy-wide events that might well be called “macroeconomic.” In particular, the very universality of money that makes possible the coordination that characterizes the market process can also be the source of severe discoordination. If there is something wrong with money, the fact that it touches everything in the economy will ensure that systemic “macroeconomic” problems will result. When money is in excess or deficient supply, interest rates lose their connection to people’s underlying time preferences and individual prices become less accurate reflectors of the underlying variables of tastes, technology, and resources. Monetary disequilibria undermine the communicative functions of prices and interest rates and hamper the learning processes that comprise the market.” (emphasis added)

In short, too much of monetary inflation distorts the function of price signals which essentially increases speculative activities, massively misallocates capital away from consumer preferences and engenders excessive market volatility.

And if we go by the market savant George Soros’ perspective of the market, ``Many momentous historical developments occur without the participants fully realizing what is happening.”

Incidentally we’ll be quoting much of George Soros’ market wisdom for this article.

And such “momentous historical development” could essentially be a seminal formation of the next bubble, in Asia and in Emerging Markets, see figure 3.

Figure 3 US Global Investors: Excess Liquidity Drives Up Asian Markets

According to the US Global Funds, ``U.S. Federal Reserve’s reluctance to withdraw from quantitative easing programs should bode well for Asian asset prices going forward. The past 25 years suggest that when money supply expansion outpaced GDP growth in the U.S., excess liquidity would typically drive equity prices higher the following two years in emerging Asia.” (bold emphasis added)

Oops, let me repeat… “excess liquidity would typically drive equity prices higher the following two years in emerging Asia”!!!

We are hardly into the first year of liquidity driven boom, which subsequently means more upside ahead.

So while markets can go anywhere over the interim, and that infirmities may follow the recent strength due to numerous variables: such as technical corrective patterns in the US [see INO's Adam Hewison On The S&P 500: Market Tenor Has Changed, Emphasis On The Negative-this is assuming the Phisix will track the US] or in the Phisix itself, seasonality weakness (July to September statistically is the weakest quarter for stocks), volatility brought about by next wave of US mortgage resets [see US Financial Crisis: It Ain’t Over Until The Fat Lady Sings!] and plain vanilla momentum- the sheer might of the combined stimulus package from Emerging Markets, (see figure 4) aside from those applied in OECD economies, could translate to an awesome impact for the markets in Asia and the Emerging markets to behold.

Figure 4: Deutsche Bank: EM-Anti Crisis Measures

The Philippines relative to other Emerging Market contemporaries seems hardly one of the most lavish spenders for government stimulus. Think about it, if deficit spending equates to weak currencies as discussed last week in Philippine Peso: Interesting Times Indeed, then it follows that China, Russia, Hong Kong, Brazil, South Africa, Vietnam, Thailand would all have weak currencies relative to the US dollar due to their larger deficit spending. Unfortunately this hasn’t been the case.

Nonetheless, ``Asian and Latin American banks, notes the Deutsche Bank, “seem to have learnt from their past crisis episodes. In general, they have restricted foreign-currency exposures and funded credit expansion with domestic deposits. Thus, most banking systems have suffered from tighter liquidity conditions but only a few have needed recapitalisation (Korea, India and Hong Kong). On the fiscal side, government packages seek to neutralise the effect of shrinking domestic demand as well as supporting local companies unable to roll over their foreign debt obligations.” (emphasis added)

As we have long been saying, an unimpaired banking system in the region and in Emerging markets coupled with substantial savings has the potential to take up the credit slack from the bubble bust plagued OECD economies to shore up domestic demand. And this alone is a massive force to reckon with.

Another empirical example, just this week, it’s like I received numerous calls or text messages from different banks on daily basis, offering me bank loans mostly based on the unused portion of my credit cards. I’d assume that this applies to their entire customer base.

As the Deutsche Bank concludes, ``The crisis is not over yet and we do not rule out additional bumps in the road. However, it is fair to state that in a more globalised world characterised by stronger linkages among economies, emerging markets are proving to be better prepared to face external shocks than in the past.”

Well “proving to be better prepared to face external shocks than in the past”, can be interpreted in a relative sense and applicable only when compared today against the recent past.

But if the bubble cycle is brewing from within, then such conclusion won’t hold when the bubble pops.

Inflation Analytics Over Technical And Fundamental Approach

Remember in a highly globalized world, the transmission mechanism from inflationary policies could be very substantial and has far reaching consequences.

And that is why in spite of the most recent global meltdown, out of the 77 countries monitored by Bespoke Investments [see our earlier article Inflation or Deflation? The Global Perspective], 59 nations experienced consumer price inflation against 14 nations that saw consumer price declines (consumer price deflation) while 4 nations saw flat CPI rates. This translates to a ratio of 4:1 in favor of inflation with an average inflation rate at 4%! And that includes the peak of the meltdown!

For all the claptrap about the global deflation bogeyman, this should have disproved such an assertion.

Figure 5: Danske Weekly Focus: The tide is turning

And the credit boom appears to be filtering into the real economy as Industrial production in key Asian regions has sharply picked up, shown in Figure 5.

Nonetheless, aside from disoriented chart technicians, we also have conflicting predictions from multilateral agencies.

The readjusted outlooks saw the World Bank projecting a downgrade, whereas the IMF has raised its forecasts for world economic growth. On the other hand, OECD has joined IMF to forecast a modest increase in global growth.

2 out of 3 doesn’t mean that the majority is right.

Nonetheless, to put this anew in the context of George Soros’ reflexivity, `` The greater the uncertainty, the more people are influenced by the market trends; and the greater the influence of trend following speculation, the more uncertain the situation becomes.”

So yes, more reflexive actions are unfolding in the marketplace. As the market prices continue to move higher, the public will likely interpret market performance as indicative of the real economy.

Again from Mr. Soros, ``People are groping to anticipate the future with the help of whatever guideposts they can establish. The outcome tends to diverge from expectations, leading to constantly changing expectations and constantly changing outcomes. The process is reflexive.”

So not only do we speak of excess liquidity, but of excess liquidity translated into a secular weak dollar trend see Figure 6.

Figure 6: US Global Investors: Inverse Correlation Weak US Dollar, Strong Asian Markets vice versa

The weak dollar has had a strong inverse correlation with the performance of Asian stock markets, where a strong US dollar trend translates to weak equity markets and weak US dollar equals strong Asian markets trends.

With the US dollar trade weighted index expected to suffer from a secular decline as a consequence to its massive deficit spending, the continuity of these correlation suggests of the persistence of a revitalized or reenergized Asian markets.

Moreover, the prospective weaknesses in the respective bubble bust scourged economies combined with the appearances of the “right” and “effective” remedy measures ensures that present policy directions will be sustained.

Proof?

The ECB recently announced that it will be lending a historic €442 billion ($621 billion) over the next 12 months to backstop liquidity within the region.

The US Federal Reserves’ FOMC meeting recently announced that it would be extending most of its liquidity facility programs specifically, the Board of Governors approved an extension to 1 February 2010 of the following: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), Commercial Paper Funding Facility (CPFF), Primary Dealer Credit Facility (PDCF) Term Securities Lending Facility (TSLF).

The expiration date for the Term Asset-Backed Securities Loan Facility (TALF) remains set at December 31, 2009. The Term Auction Facility (TAF) does not have a fixed expiration date. In addition, the temporary reciprocal currency arrangements (swap lines) between the Federal Reserve and other central banks have been extended to February 1. (Danske Bank)

The Swiss National Bank conducted a series of intervention in the currency markets last week to keep the Franc from rising amidst a deflationary environment and shrinking economic growth (WSJ).

And this hasn’t been confined to the Swiss Franc, market chatters speculated on possible government interventions in the currency market in the Kiwi (New Zealand Dollar), the Loonie (Canadian Dollar) and the Aussie (Australian Dollar). (Bloomberg)

Moreover, the issuance of the new Won 50,000 banknotes in South Korea, after 35 years (the largest had been Won 10,000), further fueled speculations that the South Korean government could be expecting higher inflation from current policies undertaken (Financial Times).

As you can see, global governments have been conducting mercantilist “race to bottom” policies for their respective currencies to maintain their “export” latitude.

And as Steve Horwitz, echoing the Austrian school perspective, says that, ``If there is something wrong with money, the fact that it touches everything in the economy will ensure that systemic “macroeconomic” problems will result.”

And the continuation of these developments will only compound on the growing risks of a global inflation crisis.

So in my view, globally coordinated policy based programs to ensure excess liquidity through zero bound rates, quantitative easing and intensive stimulus fiscal spending programs, which has been manifested in the steepening of the global yield curve [see Steepening Global Yield Curve Reflects Thriving Bubble Cycle], a floundering US dollar, currency interventions or the implicit currency war, the reflexive market action which has been diffusing into the real economy and rising risk appetites based on credit boom outside the bubble plagued economies- all conspire to pose as more powerful or potent forces to deal with than simply technical or seasonal factors over the next “two years” at least.

Since market timing isn’t likely to be anyone’s expertise especially in the context of short term trades, we’d rather focus on the major trend as defined by George Soros.

The Boom Bust Cycle Of George Soros

This brings us to the boom bust stage cycle as defined by George Soros which we last mentioned in 2006:

1) The unrecognized trend,

2) The beginning of a self-reinforcing process,

3) The successful test,

4) The growing conviction, resulting in a widening divergence between reality and expectations,

5) The flaw in perceptions,

6) The climax and finally

7) A self-reinforcing process in the opposite direction.

In my assessment, present developments are highly indicative of the transition from 1) the unrecognized trend-as manifested by the substantial skepticism over the present market cycle and 2) the beginning of a self-reinforcing process.

In other words, the bubble cycle has much to accomplish yet.

Since this article has been a George Soros quotefest, the last statement belongs to Mr. Soros, ``Economic history is a never-ending series of episodes based on falsehood and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited"