Showing posts with label money aggregates. Show all posts
Showing posts with label money aggregates. Show all posts

Monday, February 25, 2013

Has the Phisix has Gone Ballistic?!

14.66% in 8 straight weeks of unwavering ascent has truly been spectacular!!

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Whether parabolic or vertical, the Phisix seems to have gone ballistic.

February has already racked up 6.8% with this week’s 2.2% gains. Yet there are still four trading days to go.

As I said last week, should 7% return per month persist, then the Phisix 10,000 will be reached within the second semester of this year.

Again I am NOT saying it will, but we cannot discount the likelihood of such event, considering what appears to be the deepening of the manic phase in the Philippine Stock Exchange. 

Signs of Mania: Friday’s Marking the Close

I highlighted this week’s actions (via red ellipse) because of what appears to be a botched attempt by the Phisix to correct.

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In what appears to be a sympathy move with US markets which closed lower Thursday, on Friday, the Phisix has been down through most of the session, by about 1.5% (chart from technistock). That’s until the last few minutes before the closing bell window, where the losses had precipitately been wiped out to close the day almost unchanged (or a fraction lower)

Whether what seems as “marking the close” has been another attempt “manipulate” the Phisix for whatever ends (I would suggest political), or that bulls have taken the opportunity to conduct a massive counterstrike against the bears, such refusal to allow for a normal profit taking mode simply has been an expression of the intensifying du jour bullish frenzy.

Net foreign activity posted marginal selling last Friday (Php 36 million). Index heavyweights exhibited mixed performance in terms of foreign activity, which may suggest that local buying could have been mostly responsible for the last minute rebound.

To boost the Phisix means to bid up major blue chip issues. This requires heavy Peso firepower that can emanate mostly from institutions rather than from retail participants, regardless of nationality, whether foreign or local.

The scale of actions from Friday reflects on either hugely expanded risk appetite or the increasing symptoms of desperation to chase momentum from so-called professional money managers, or that parties responsible for Friday’s action could have been conducted by largely price insensitive taxpayer financed institutions.

Yet given the current election season and perhaps the desire to generate upgrades in the nation’s credit rating in order to justify political spending binges, one cannot discount on the potential influences played by public institutions in the stoking of today’s frenetic markets.

To elaborate, marking the close is the practice of buying a security at the very end of the trading day at a significantly higher price[1] is considered illegal by Philippine statutes[2]. Although personally speaking, I consider insider trading[3] and related rules and regulations as arbitrary, repressive, unequal and immoral form of laws.

For instance, the legality or illegality of what appears as “marking the close” could depend on the identity or of the class of executor/s. If public institutions may have been involved, then I doubt if such regulations will apply or will be enforced. Such rules get activated only when there has been a public outcry or when authorities want to be seen as doing something or when used for assorted political goals.

Either way, yield chasing or politically motivated actions to artificially prop markets arrive at a similar conclusion: a policy induced mania.

Mounting Publicity Hysteria

Of course, the manic phases are essentially reinforced through public’s psychology. The public has been made to believe that prices represent reality which tells of the perpetual extension of such boom. Such resonates on the mentality that “this time is different”: the four most dangerous words of investing, according to the late legendary investor John Templeton
Hysteria about the boom phase has been building up.

Proof?

This Bloomberg article entitled “Philippines Trounces Global Stocks in Aquino-Led Rally[4]”, even sees the current rally as “structural”.

I wonder how valid will the “structural” foundations of this bull market be when faced with significantly higher interest rates.

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Nevertheless it is a fact that the Philippines have “trounced” the world in terms of returns.

In my radar screen of the equity benchmarks of 83 nations, on a year-to-date basis Venezuela’s Caracas Index has been on the top of the list, with an astronomical 31% nominal currency gains which essentially compounds on 2012’s stratospheric 302%.

Yet as I have repeatedly been pointing out[5], what seem as rip-roaring stock market gains are in fact an illusion.

Venezuela has most likely been suffering from seminal stages of hyperinflation, where the stock market becomes a shock absorber or a lightning rod of a massively devalued or inflated currency. Venezuela’s recent official devaluation by 32% has only triggered a steeper fall in the unofficial rate of her currency, the bolivar.

The official rate has been recently readjusted to 6.3 bolivar per US dollar, but the black market for the bolivar trading has been trading at around 22 per US dollar[6] from 19 less than two weeks back[7]. As typical symptom of hyperinflationary episodes, Venezuela has been suffering from widespread shortages of goods.

Venezuela’s skyrocketing stock market from hyperinflation has been reminiscent of Zimbabwe in 2008. In 2008, as the world plumbed to the nadir as consequence to the contagion effects from the US housing bubble bust, Zimbabwe became the top performer, nominally speaking.

Yet Kyle Bass, a prominent hedge manager, captures the zeitgeist of such a boom[8] (italics added)
One of the best performing equity markets in the last decade has been Zimbabwe. But now your entire equity portfolio only buys you three eggs.
Yes, thousands of percent in returns buys you three eggs.

This shows how stock markets, as surrogate or as representative of real assets, serve as refuge to monetary inflation. This has been especially elaborate at the extremes—hyperinflation.

This also implies that monetary inflation, which has been neglected by the mainstream, plays a very important role in establishing price levels of the equity markets.

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Outside Venezuela, the rest of the top ranked equity bellwethers have been far beyond their respective nominal record highs. This makes the local equity bellwether, the Phisix, the likely global crown holder or the current world champion. The Manny Pacquiao of international stock markets. The $64 trillion question is its sustainability.

From Friday’s close, the Phisix has been up 256% since the last trading day of 2008. This translates to around 35% CAGR.

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Even among the top ASEAN peers, from a 5-year perspective or from a starting point in mid-2008 from the Bloomberg chart, the Phisix [PCOMP: red orange] has outclassed by a widening margin, Thailand [SET: Green], Indonesia [JCI: orange] and Malaysia [FBMKLCI: red].

So the feedback loop between prices and media cheerleading entrenches the public’s belief and conviction of the flawed views of realty. Such perceptions translate to actions: more debt.

Bubble Mentality Leads to Bubble Actions

As I have pointed out last week, manias signify as the stage of the bubble cycle where the yield chasing phenomenon has become the prevailing bias. Manias are essentially underpinned by voguish themes unquestioningly embraced by the public and most importantly enabled, facilitated and financed by credit expansion.

I pointed out how the booming stock markets have reflected on the growing imbalances in the real economy of the Philippines

The stock market boom has similarly been reinforced by the expansion of credit at exactly where such imbalances have been progressing: property-finance-trade, or simply, the property-shopping mall-stock market bubble.

Such extraordinary growth in credit may have already percolated into the domestic money supply 

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The monetary aggregate, M3 or as per BSP definition[9], constitutes currency in circulation, peso demand deposits, peso savings and time deposits plus peso deposit substitutes, such as promissory notes and commercial papers, has jumped by 16.22% in 2012. From 2008 CAGR for M3 has been at 11.51%.

On the other hand, M0 or narrow money or as per tradingeconomics.com[10], the most liquid measure of the money supply including coins and notes in circulation and other assets that are easily convertible into cash, spiked by 24% in 2012, which on a 5 year basis grew by 13.2% CAGR.

Although there have been many intermittent instances of peculiar outgrowth, such outsized move appears to be the largest.

Moreover, it remains to be seen if this has been an anomaly.

If this has indeed been an aberration, then this implies that the coming figures should show a decline which should revert M3 and M0 back to the trend line. If not, recent breakout may establish an acceleration Philippine monetary aggregate trend line: an affirmation of the classic bubble.

Considering that both the private sector, lubricated by expansionary credit, and the domestic government, whom will undertaking $17 billion of public works spending, will be competing for the use of resources, we should expect that pressures to build on either relative input prices (wages, rents, and producers prices), particularly on resources used by capital intensive industries experiencing a boom, and or, but not necessarily price inflation.

Such dynamics would exert an upside pressure on interest rates that would eventually put marginal projects, including margin debts on financial assets operating on leverage, on financial strains which lay seeds to the upcoming bust.

Yet the idea that price inflation is a necessary outcome of an inflationary boom has been misplaced.

In the modern economy, many things such as productivity growth, e.g. informal economies and or technological innovation) or today’s financial quirks, e.g. as excess banking reserves held at the central banks, such as the US Federal Reserve, can serve to neutralize its effects.

As the great dean of Austrian school of economics Murray N. Rothard wrote[11],
Similarly, the designation of the 1920s as a period of inflationary boom may trouble those who think of inflation as a rise in prices. Prices generally remained stable and even fell slightly over the period. But we must realize that two great forces were at work on prices during the 1920s—the monetary inflation which propelled prices upward and the increase in productivity which lowered costs and prices. In a purely free-market society, increasing productivity will increase the supply of goods and lower costs and prices, spreading the fruits of a higher standard of living to all consumers. But this tendency was offset by the monetary inflation which served to stabilize prices. Such stabilization was and is a goal desired by many, but it (a) prevented the fruits of a higher standard of living from being diffused as widely as it would have been in a free market; and (b) generated the boom and depression of the business cycle. For a hallmark of the inflationary boom is that prices are higher than they would have been in a free and unhampered market. Once again, statistics cannot discover the causal process at work.
Nonetheless, while price inflation may not be the necessary and sufficient factor for upending a boom, the lack of its presence does not prevent business cycles from occurring.

Moreover, the yield chasing boom will likely spur greater demand for credit that will similarly put pressure on interest rates.

In addition, competition for resources by both the government and the private sector will likely increase demand for imports that subsequently leads to wider trade deficits. Eventually bigger trade deficits may impact the current account that could put pressure on foreign exchange reserves.

And as noted last December[12],
And since the prolonging of the domestic boom requires foreign capital or that trade deficits would need to be offset by capital accounts or increasing foreign claims on local assets, either the BSP loosens up or keeps an eye closed on foreign money flows. Most of which will likely come from hot money inflows seeking refuge from inflationism and financial repression.
By then the Philippines could be vulnerable to “sudden stops” which may arise from a domestic or regional if not from a global event risks.

And as pointed out last week, today’s global pandemic of bubbles will most likely alter the character of the next crisis.

Instead of many nations offsetting bursting bubbles of some nations, the coming crisis would translate to a domino effect.

Wherever the source or origins of the crisis, the leash effect means cascading bubble implosions over many parts of the world. The escalation of bubble busts would prompt domestic political authorities to intuitively embark on domestic bailouts and fiscal expansions (or the so-called automatic stabilizers), and for central bankers to aggressively engage in monetary easing for domestic reasons—or a genuine “currency war”.

In contrast to what seems as phony “currency wars”, real currency wars have had broad based carryover effects from expansionist political controls. This usually includes price and wage controls, capital and currency controls, social mobility and border controls, trade controls or protectionism and other financial repression measures[13] (e.g. taxes, regulations on banks, nationalizations, caps on interest rates, deposits and etc…).

How inflationism leads to forex controls and the spate of other political controls, the great Ludwig von Mises explained[14]
But the government is resolved not to tolerate any rise in foreign exchange rates (in terms of the inflated domestic currency). Relying upon its magistrates and constables, it prohibits any dealings in foreign exchange on terms different from the ordained maximum price.

As the government and its satellites see it, the rise in foreign exchange rates was caused by an unfavorable balance of payments and by the purchases of speculators. In order to remove the evil, the government resorts to measures restricting the demand for foreign exchange. Only those people should henceforth have the right to buy foreign exchange who need it for transactions of which the government approves. Commodities the importation of which is superfluous in the opinion of the government should no longer be imported. Payment of interest and principal on debts due to foreigners is prohibited. Citizens must no longer travel abroad. The government does not realize that such measures can never "improve" the balance of payments. If imports drop, exports drop concomitantly. The citizens who are prevented from buying foreign goods, from paying back foreign debts, and from traveling abroad, will not keep the amount of domestic money thus left to them in their cash holdings. They will increase their buying either of consumers' or of producers' goods and thus bring about a further tendency for domestic prices to rise. But the more prices rise, the more will exports be checked.
In short, one form of interventionism breeds other forms interventionism.

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For now, the domestic yield chasing mania means an increasing pile up on winning trades.

And instead of the rotation to the mining sector as has been for the past years, the latter of which has been smacked by a double black eye from the Semirara landslide and from the recent blowup in metal prices, dampened appetite for the mines has shifted the public’s attention back to the last year’s biggest winners.

The trio: property, financial and banking and property weighted holding firms has reclaimed their leadership positions.

Thus the checklist for the manic phase of stock market bubble:

Deepening price or yield chasing dynamics √
Popular themes √
This time is Different mentality √
Expansionary credit √

Every Bubble is a Thumbprint

And it’s not just me.

One analyst from the S&P credit rating agency recently raised his concern over Asia’s growing appetite for debt where he says many Asia-Pacific countries have raised debt “well above the levels in the mid-2000s”, importantly, credit to GDP ratios of few nations has been “high relative to peers at similar income levels”
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S&P KimEng Tan at an interview with Finance Asia further adds[15],
Real estate downturns may be less of a threat to financial institutions in the key economies than they were in the worst-hit developed economies. Nevertheless, credit losses can still increase rapidly if general economic conditions weaken materially. The top concern is that China’s growth could slow sharply before the developed economies recover sufficiently to contribute to maintaining moderate growth. The slowdown is likely to have a material negative effect on economic activities across the Asia-Pacific.
Although the seemingly disinclined Mr. Tan downplays the imminence of the risks of a crisis by making apple-to-orange comparison with debt levels in Europe.

Let me improve by saying that each nation have their own unique characteristics or idiosyncrasies, therefore it may not be helpful to make comparisons with other nations or region. Moreover, while many crises may seem similar, each has their individual distinctions.

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For instance, one Bloomberg article I came about highlights the portentous troubles that lie ahead for Asia. The article[16] relates on the symptoms: South Korea’s household debt “rose to a record 959.4 trillion won last quarter”, and equally such debt has “reached 164 percent of disposable income in 2011, compared with 138 percent in the U.S. at the start of the housing crisis”.

South Korea’s domestic credit provided by the banking sector[17] (shown above), as well as, domestic credit to the private sector[18] as % of has reached over 100% GDP, although slightly below the recent peak.

China’s mounting debt problem and property bubble has also been daunting. Recent easing and government intervention via stealth spending programs[19] has prompted a recovery in housing prices. According to a Bloomberg report[20] (italics mine)
Average per-square-meter prices in 100 cities tracked by SouFun are five times average monthly disposable incomes.
In addition,
Home sales in China’s 10 biggest cities almost quadrupled to 8.5 million square meters in the first five weeks from last year, property data and consulting firm China Real Estate Information Corp. said in an e-mailed statement Feb. 19.
Either China and South Korea’s productivity growth has to catch up with the lofty levels of debt or that untenable debt dynamics will eventually lead to self-destruction whether triggered by an upsurge in interest rates or by weakening of the economic conditions or from a global contagion or simply unsustainable debt.

Interventions can only delay the day of reckoning but worsen the longer term entropic impact.

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These are debt levels when “credit events” occurred via the Asian Crisis (left window) and of the other emerging market debt crisis (right window). Data from Harvard’s Carmen Reinhart as presented by Ricardo Cabral at the Voxeu.org[21]

First, there has been no definitive line in the sand for credit events. South Korea has for instance very low external debt when the crisis struck, although Argentina’s debt crises shared the same debt levels during 2 crises within 10 years.

Second, external debt may or may not function as an accurate gauge today. Many economies have resorted to amassing debts based on internal local currency units and from local currency bond markets which has been unorthodox relative to the past.

In addition, financial innovation may mean risks have spread to other potential channels as securitization and derivatives.

Nonetheless, external debts have indeed been swelling in Philippines, Thailand, Indonesia and even in South Korea with the exception of Malaysia.

The implication is that there are many potential sources of black swan events.

The Wile E Coyote Moment

Yet the current booming environment has been prompting policymakers of several economies to pull back on current easing programs. 

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The Chinese government has recently withdrawn funds from the financial system. In addition, the Chinese government has recently ordered more property curbs[22]. Such perception of tightening has prompted for a 4.86% plunge in the Shanghai Index (SSEC) over the week, which reverberated throughout the commodity markets (see CRB line behind SSEC).

Prior to February, Chinese authorities were loosening up on the monetary spigot, then all of a sudden the change of sentiment. As one would note, this is an example of how markets has been held hostage to the actions of authorities.

Of course it is also important to point out that the European Central Bank (ECB) has been draining funds from the system since October of 2012 which has coincided with the peak in gold prices. February’s dramatic shrivelling to March lows of the ECB’s balance sheet has mirrored the collapse in gold prices[23].

And it’s not only the ECB.

Swiss banks have been required only this month to up their capital reserves by 1%.

And in the face of credit fueled property boom in Europe’s richer nations as Switzerland, Sweden and Norway, Sweden’s regulators have warned that they are ready to tighten more given the recognition of a brewing debt bubble. “Swedish households today are among the most indebted in Europe” the Bloomberg quotes a Swede official[24].

Meanwhile, Hong Kong’s government has doubled sales tax[25] on high end real estate worth HK$2 million and above, as well as, commercial properties in her attempt to suppress bubbles that has spread from apartments to parking spaces, shops and hotels

As one would note, wherever one looks there have been blowing bubbles: a global pandemic of bubbles

So contradicting policy directions can became a headwind and increased volatility for financial markets, including the Phisix. Although domestic dynamics are likely to dictate on momentum.

Nonetheless bubbles eventually peak out regardless of interventions.

Again in Hong Kong, prior to the sales tax hike, bankruptcy petitions has risen to 2 year highs[26]

Things operate or evolve on the margins. And so with puffing bubbles. Deflating bubbles always commences from the periphery that eventually moves into the core.

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The US housing bubble cycle should serve as a noteworthy paradigm.

US home prices represented by the National Composite Home Price Index peaked (lower window blue line) at the close of 2005, as interest rates increased (red line). The Fed controlled Fed fund rate topped in 2007.

Notice that the mild descent of home prices in 2006 steepened or accelerated in 2007. The housing bear market fell into a trough only in 2011 and began showing signs of recovery in 2012.

Yet the US stock market (S&P 500 blue line top window) continued to ignore the developments in the housing markets in 2006-2007, as well as, the interest rate hikes. In fact, gains of the S&P seem to have accelerated when interest rates peaked. 

The stock market came to realize only of the flawed perception of reality when home prices affected the core, or when the banking and financial system began to implode. It was like cartoon character wile e coyote running off a cliff.

From hindsight, the divergence between housing and the stock market, the massive debt buildup on the housing, mortgage, banking and financial sectors, the denial by authorities of the existing problem, the transition of deflating bubbles from the periphery to the core and the public’s persistent yield or momentum chasing dynamics, all meets the criteria of a manic phase in motion.

But as I said last week, the next crisis may not be similar to the US housing crisis of 2008.

Then policymakers have been mostly reactive, today policymakers are pro-active, pre-emptive and considered as activists. The outcome isn’t likely to be the same.

Importantly, given that almost every nations have been serially blowing bubbles, a domino effect from a bubble bust would either mean the path to genuine reform (bankruptcies and liberalization) or more of the same troubles but in different templates (stagflation, protectionism, controls of varying strains and etc…). I am leaning onto the latter outcome, although I am hoping for the former.

Everything now depends on the Ping Pong feedback loop between markets and international policymakers.

Although from the lessons of US bubble, I believe that the Phisix in spite of several increases in interest rates may go higher.

Momentum will initially mask the traps that have been set, until of course, economic reality prevails; eventually. Or going back to wile e coyote analogy, wile e coyote will continue to chase after Road Runner to the cliff until he realizes that there is no more ground underneath.

Again bubbles signify a market process.





[2] Republic of the Philippines Security Exchange Commission Chapter VII Prohibitions on Fraud, Manipulation and Insider Trading




[6] Wall Street Journal Ailing Chávez Returns to Caracas February 18, 2013


[8] Kyle Bass Why Inflation Could Eat Into Stock Gains: Kyle Bass Klye Bass Blog February 1, 2013


[10] Tradingeconomics.com PHILIPPINES MONEY SUPPLY M0

[11] Murray N. Rotbhard Part II The Inflationary Boom: 1921-1929 America’s Great Depression


[13] Wikipedia.org Financial repression

[14] Ludwig von Mises 6. Foreign Exchange Control and Bilateral Exchange Agreements XXXI. CURRENCY AND CREDIT MANIPULATION, Human Action Mises.org







[21] Ricardo Cabral The PIGS’ external debt problem, voxeu.org May 8, 2010





Sunday, July 03, 2011

Greece Crisis: Does Fiscal Austerity Mean a Deflationary Policy?

The same principle leads to the conclusion, that the encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone, furnishes those means. Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption.-Say, Jean-Baptiste

For some it is held the current actions by Eurozone government represent as “deflationary policies”.

Such notion has been premised from the economic ideology which sees the economy as driven by aggregate demand.

Demand side economics see spending as the ultimate driver of any economy. Where private spending has been reckoned as insufficient or inadequate, government has been prescribed to takeover the spending process or through “socialization of investment”; otherwise the lack of spending, which supposedly impairs the aggregate demand, would result to people hoarding money, an outcome which this camp morbidly dread most: deflation.

This is why this camp argues for the “euthanasia of the rentier” which is to keep interest rates at perpetually low levels (if only they can abolish interest rates!).

Also, because spending is seen as the only driver of the economy, it doesn’t matter if spending is financed by unsustainable debt loads or by money printing “parting with liquidity”[1]. For them, spending is spending period.

This is an example of what I would call as analysis blinded by the Nirvana fallacy or “the logical error of comparing actual things with unrealistic, idealized alternatives. It can also refer to the tendency to assume that there is a perfect solution to a particular problem[2]” where mathematical models based on aggregate assumptions have substituted for real life activities. Statistical aggregates assume that people think and act homogeneously.

This also serves as another example where this mainstream economic pedagogy leads to a lack of common sense and self-discipline[3] because this camp basically advocates that people should borrow and spend to prosperity even when reality says that this would be impossible (see Jean Baptiste Say quote above).

How true has deflation been the problem of the PIIGS or the crisis affected nations of peripheral Europe?

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At present, NONE of the PIIGS has shown DEFLATION as an economic condition as exhibited by the charts from tradingeconomics.com.

Instead, PIIGS have shown symptoms of mild stagflation (high unemployment and high inflation).

Of the five, only Ireland encountered consumer price deflation for over a year in 2009-2010.

Others like Spain and Portugal experienced very limited bouts of deflation in 2009.

Thus, little of what the demand side economics have feared has ever been true since the 2008 Lehman crisis began to unravel.

Theoretically, fiscal austerity means transferring of non-productive resources to productive resources.

Yet because of the dependency/entitlement culture which had been inbred from too much of “socialized investment”, as in the case of Greece, Greeks have taken to the streets[4]

As Takis Michas, staff writer for the Greek national daily, Eleftherotypia in a Cato Forum accounting for the seeds of the crisis[5]

The largest part of public expenditure was directed, not to public works or infrastructure, but to the wages of public service workers and civil servants.

The grounds for the rent-seeking struggles of the future were thus firmly laid.

As resources are freed for productive use, deflation then should be seen as positive because the productive private sector should be able to use these freed resources to produce goods and services, which would fuel a genuine recovery. With more output than than the growth of supply of money this is known “growth deflation” similar to the dynamics of falling prices of mobile phones, appliances and computers.

And that’s why a major part of Greece’s crisis ‘austerity plan’ resolution has been to undertake mass privatization[6].

However theoretical isn’t actual.

The unfolding Greece crisis isn’t being resolved entirely to free resources for productive means, instead the bailouts have been intended to use these resources to protect the banking system from a collapse[7]. Resources are merely being transferred from government welfare programs to the politically privileged banking sector.

Thus, the Greece bailout has been and will continue to be financed by European Central Bank’s inflationism.

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Since the end of 2009, just as the Greece Debt Crisis surfaced[8], ECB’s M3 annual growth rate continues to climb, as shown by the chart from Bloomberg[9] (upper window). Such rate of increase in the money supply has shadowed the growth rate of the Euro’s inflation (chart from trading economics.com[10]).

For as long as the ECB and EU governments will continue to finance these serial bailouts by inflationism, then we should see more inflation and not deflation.

At the end of day, false economics leads to misdiagnosis and wrong predictions/conclusions.


[1] what-when-how.com SOCIALIZATION OF INVESTMENT

[2] Wikipedia.org Nirvana Fallacy

[3] See Financial Success is a Function of Common Sense and Self Discipline June 23, 2011

[4] See The Anatomy of False Economics as Revealed by the Greece Crisis, June 28,2011

[5] Michas Takis , Policy Forum: A Greek Tragedy, Cato Policy Report Cato.org, July/August 2011

[6] ca.reuters.com Greek sovereignty to be massively limited: Juncker, July 3, 2011

[7] See Greece Crisis: The Lehman Moment Hobgoblin, June 19, 2011

[8] News.bbc.co.uk Greece timeline June 16, 2011

[9] Bloomberg.com ECB M3 Annual Growth Rate SA (ECMAM3YY:IND)

[10] Tradingeconomics.com Euro Area Inflation Rate

Monday, March 01, 2010

Where Is Deflation?

``In reality, Britain has the worst of all possible worlds: a stagnant economy, a crippling budget deficit and rising prices. The Keynesian consensus is that things would have been far worse without the stimulus provided by government. And if the economy isn’t pumped up with inflated demand, it will collapse back into recession. If it’s not working, that just proves the stimulus should be even larger. It is the argument quacks always push: If the medicine isn’t working, increase the dosage. And yet, reality has to intrude into this debate at some point. The deficit can’t get much bigger, interest rates can’t be cut much lower, and sterling can’t lose much more value. Stimulating the economy isn’t working. In fact, it’s only making it worse. Consumers and businesses don’t want rising taxes. A falling currency pushes up the cost of everything the U.K. imports, stoking inflation. Savers get decimated, and yet the banks remain reluctant to lend because they rightly believe the economy is in the doldrums.” Matthew Lynn, Deathbed of Keynesian Economics Will Be in U.K.

When deflation advocates point to charts of bank loan activities, the money multiplier or Treasury Inflated Protected Securities (TIPS) and proclaim “where is inflation?” - they seem to be asking the wrong question.


Figure 1 St. Louis Fed/Northern Trust: M1 Money Multiplier and Consumer US CPI

For instance, while it is true that the US M1 money multiplier[1] is down, (as shown in the left window in figure 1 and recently used by a popular analyst as example), there seems hardly a grain of truth that the falling money multiplier equates to sustained deflation in US consumer prices (right window).

In other words, if they are correct then obviously CPI should be adrift in the negative territory- to reflect on deflationary pressures until the present. Yet the CPI, both in the ALL items and ALL items LESS Food and Energy remains in the positive zone, in spite of, or even in the face of these ‘deflation pressure’ statistics; falling money aggregates, subdued TIPS and or lackluster bank activities.

And CPI turned negative only at the height of the crisis, which makes it more of an aberration than the norm. Of course, this counterpoint extends to the validity of the accuracy of the US government’s measure of inflation, which I am a skeptic of.

However, here are more of our counterarguments to the sarcastic question of “where is inflation?”:

1. Reading current performance into the future.

Deflation exponents insist that “deflationary pressures” ought to collapse the markets as they did in 2008. They’ve been doing so for the entire 2009. But this hasn’t been happening. That’s because the reality is, we haven’t been operating under the same ‘Lehman’ conditions of 2008!

The US government’s actions to effect a cumulative network of local and international market patches, as seen in the various ‘alphabet soup’ of emergency programs plus a raft of guarantees to the tune of over $10 trillion, swaps and direct expenditures (quantitative easing), seems to ensure of such non-repetition, as we have repeatedly discussed.

So more banks could indeed fail, the FDIC upgraded its watchlist from 552 to 702 banks in danger, but the liquidity gridlock of 2008 isn’t likely to happen. That’s because the Fed has a morbid fear of ‘deflation’ than warranted, and is likely to engage in a “whack a mole”; pouring liquidity on every account of the emergence of deflation.

Let me clarify that the US banking system is a solvency issue, but this is not the case for Asia or for major emerging markets. Ergo, the contagion from the Lehman collapse of October 2008 emanated from a liquidity shortfall as US banks seized up. Since today’s scenario is different, then predicting the same contagion seems unlikely, so any arguments calling for a 2008 scenario is like calling a banana an apple.

Besides, the Fed’s manipulation or “nationalization” of key markets such as the US mortgage markets seems to have been designed to stave off the odds of having a domino effect collapse in their banking industry. This, by keeping the banking system’s balance sheets afloat, through “elevated” or inflated prices. In spite of babbles for so-called exit strategies, this isn’t likely to change.

On the contrary, a broader view of markets appears to be suggesting that inflation looks likely a future or prospective phenomenon.

To consider, if any of these “deflationary” stats begin to recover then they are likely add to ‘inflation expectations’ and thus eventually reverse the current state of “deflation subdued” CPI .

2. Misleading Interpretation of Hyperinflations.

Hyperinflations have never been caused by excessive consumer borrowings, never in history. To paint of such an impression is to egregiously mislead.

Hyperinflations have basically been caused by insatiable government spending, whose exponential growth had been financed by the printing press. On the other hand, a credit boom from consumer borrowing is most likely to result in bubble (boom-bust) cycles and not hyperinflation.

The fundamental difference is that of the political goal; in boom bust cycles, government’s role to inflate the system is largely indirect-with mostly the goal to perpetuate ‘quasi’ economic boom conditions by inflating money supply and by skewing the public’s incentives through regulation or taxation to favoured political sectors, as in the case of the recent real estate-mortgage bubble.

Whereas, in hyperinflations, the government’s role is more direct, usually deliberate or represents an act of desperation to meet a political goal for the incumbent leadership, such as perpetuation of power (e.g. Zimbabwe), or the addiction to inflationism compounded by policy errors based on theoretical misunderstandings[2], as Germany’s Weimar hyperinflation experience, and not from war reparations as others have suggested[3].

Of course one may argue that there is always a possibility of first time. Perhaps.

3. Selective Perception And Misguided Expectations

Many deflation proponents tend to argue from the perspective of the private sector’s performance in the economy. Their propensity to “tunnel” or fixate into the private sector leads them to erroneously omit the impact of the rapidly bulging share of the US government’s contribution to the economy, which presently accounts for nearly a third.[4]

Ignoring government’s contribution and policy impacts to the economy renders a handicapped analysis.

Nevertheless, looking at the global scale, we seem to be seeing more incidences of a ‘quickening’ of consumer price inflation, as in Malaysia and in Brazil, aside from previous accounts in China, India, Vietnam, and even to the real estate bubble-banking crisis afflicted UK which saw consumer price inflation rise to its highest level since November 2008 (see figure 2)-where debt deflation has been the generally expected outcome by the mainstream.


Figure 2: Finfacts.ie/stockcharts.com: Surging UK Inflation, Devaluing UK Pound

Reporting on the surprising resilience on UK’s inflation (left window), according to Finfacts.ie. ``The ONS said the CPI fell by 0.2% between December and January. Although negative, this is the strongest ever CPI growth between these two months (prices typically fall at a faster rate between December and January). This record monthly movement is mainly due to the increase in January 2010 in the standard rate of Value Added Tax (VAT) to 17.5% from 15% and, to a lesser extent, the continued increase in the price of crude oil. In the year to January, the all items retail prices index (RPI) rose by 3.7% up from 2.4% in December. Over the same period, the all items RPI excluding mortgage interest payments index (RPIX) rose by 4.6%, up from 3.8% in December.” (bold highlights mine)

Why should oil prices rise if demand has been declining as the Fisherian and Keynesian deflationists experts allege? From a “money is neutral” perspective, wouldn’t that be a paradox?

Also, why should higher taxes become inflationary, when all it does is to distort the economic structure by shifting investments from private to the public, as well as, to decrease the incentives for the private sector to participate?

Murray Rothbard provides the answer[5], ``If inflation has been under way, this “excess purchas­ing power” is precisely the result of previous governmental in­flation. In short, the government is supposed to burden the pub­lic twice: once in appropriating the resources of society by in­flating the money supply, and again, by taxing back the new money from the public. Rather than “checking inflationary pres­sure,” then, a tax surplus in a boom will simply place an addi­tional burden upon the public. If the taxes are used for further government spending, or for repaying debts to the public, then there is not even a deflationary effect. If the taxes are used to redeem government debt held by the banks, the deflationary ef­fect will not be a credit contraction and therefore will not cor­rect maladjustments brought about by the previous inflation. It will, indeed, create further dislocations and distortions of its own.” (bold highlights mine)

In short, what could easily be seen is that the inflationary effects of bailouts, subsidies and its domestic version of quantitative easing programs have gradually been manifesting on her devaluing currency first (right window), and next, to consumer prices. And the newly increased VAT in the UK only adds to the existing distortions already in place.

Of course this account of emerging inflation seems to have befuddled the mainstream anew.

Yet, this dynamic is likely to emerge in the US too...perhaps soon.

For us, another reason why inflation is still quiescent in the US; aside from the slack in the banking system out of the reluctance to lend due to balance sheet concerns, is because of the natural belated response to the record steepness in the yield curve.

The uncertainty arising from the abrupt market cleansing adjustments and the rediscovery phase of where resources are needed, implications of new regulatory regime, prospects of higher taxes to pay for the slew of stimulus programs, risks of more government interventions, impaired and unsettled balance sheets of banks and financial institutions mired in the bubbles have all conspired to inhibit investors from taking advantage of the steepness in the yield curve.

Yet the past has shown that eventually zero interest rates and a steep yield curves will likely artificially impact the credit process to jumpstart a new boom-bust cycle. Although we aren’t likely to believe that a boom phase of a bubble cycle could happen in sectors recently affected by a bust, any seminal bubbles will most likely diffuse into other sectors untainted by the recent bubble (technology or materials and energy?) or percolate outside of the US.

This implies that the ramifications from policies are likely to gain traction with a time lag, as had been in the past.[6]

Hence, expectations for the immediacy of the markets’ response from policies have not been only myopic but also constitutes as wishful thinking-anchoring on a belief that people don’t respond to incentives.

4. The Folly Of Excluding The Role of the US dollar And Other External Forces

In addition to the lagged response, it is likely that the US dollar, as the world’s de facto seignorage provider, has the privilege to extend its inflationism outside her shores hence, inflation becomes a precursory tailwind (see figure 3)


Figure 3: St. Louis Fed: CPI (red) versus US Trade Balance (blue)

Recessionary forces around the world, as exhibited in gray shaded areas in both the 2000 and the present crisis, required diminished US dollar financing for global trade. This led to an improvement of the US trade balance (red line), which none the less, dampened US CPI inflation (blue line).

As the world recovered from the recession or the crisis, trade deficits surged anew to reflect on the revitalization of global trade. And the US CPI eventually followed suit. One could observe that the CPI trailed trade deficits by a short interval in both accounts.

And also given that today’s situation is vastly different from the 2000-2007, where the slack in private expenditures have been replaced by monstrous government spending, the impact from the surging “twin” deficits will likely have a more meaningful impact. First, this will be reflected externally, as in the account of emerging inflation ex-US, and possibly channelled via the US dollar relative to other currencies or if not through commodities. Next, this gets manifested on the US domestic consumer price indices.

Therefore the interstice, where CPI inflation seems subdued, should be known as inflation’s “sweet spot”, perhaps where we are today.

Hence the idea that slow inflation today equals slow inflation tomorrow predicated on the money multiplier and an impaired credit process, seems to grossly underestimate on the repercussions of inflationary policies because, aside from the lagged impact from yield curve and the blatant disregard of the expanding share of the US government in the economy, such analysis discounts on the effects of exogenous forces, particularly the US dollar’s role as chief financier of global trade, and the underlying transmission mechanism from external ‘inflation’, such as competitive devaluations, impact on nations with pegged currencies-a core to periphery phenomenon. This is, aside from, misconstruing money’s role as having neutral effect on the economy.

In other words, markets and economic trends will depend on the directions of ensuing policy actions, by major economies most especially the US, to ‘reflate’ the system.

And given that Fed Chairman Ben Bernanke was again shown as seemingly in a cautious stance about the “halting” pace of economic recovery for the US from which he reassured Congress of an extended regime of low interest rates and where in addition to the apparent mounting clamour of adopting a philosopher’s stone as mainstream policy, as discussed last week[7], more professional entities seem to be joining the chorus for extended inflationism, such as the latest joint project by Goldman Sachs [Economists Jan Hatzius] Deutsche Bank [Peter Hooper], Columbia University [Frederic Mishkin], New York University [Kermit Schoenholtz] and Princeton University [Mark Watson] who arrived at the conclusion that current conditions remain tight despite the Fed’s efforts.

We don’t need to actually wish for it, but evidently, the pronounced lobbying to justify more inflationism is likely to be music in the ears for the current crops of political and technocratic overseers.

So the question of “where is inflation?”, should be substituted with the opposite, given the limited and sporadic accounts of ‘deflation statistics’, the question should be “Where is Deflation?”

As markets haven’t been collapsing and as the world have elicited signs of rising incidences of inflation, the onus of proof, is on them.



[1] coins, currency, checkable deposits demand deposits and travellers checks from wikipedia.org

[2] “The government and the Reichsbank both believe that monetary troubles arise from an unfavorable balance of payments, from speculation and from unpatriotic behavior of the capitalist class. They therefore attempt to fight the menace of depreciation of the Reichsmark by controlling dealings in foreign currency and by confiscating German holdings of foreign assets. They do not understand that the only safeguard against the fall of a currency's value is a policy of rigid restriction. But though the government and the professors have learned nothing, the people have. When the war inflation came nobody in Germany understood what a change in the value of the money unit meant. The business-man and the worker both believed that a rising income in Marks was a real rise of income. They continued to reckon in Marks without any regard to its falling value. The rise of commodity prices they attributed to the scarcity of goods due to the blockade. When the government issued additional notes it could buy with these notes commodities and pay salaries because there was a time lag between this issue and the corresponding rise of prices. The public was ready to accept notes and to keep them because they had not yet realized that they were constantly losing purchasing power.” Ludwig von Mises, The Great German Inflation, Money, Method, and the Market Process ch 7

Money, Method, and the Market Process

[3] See Wikipedia.org, Inflation in the Weimar Republic

[4] See previous post, It’s Not Deleveraging But Inflationism, Stupid!

[5] Murray N. Rothbard, Chapter 12—The Economics of Violent Intervention in the Market, Man Economy and the State

[6] See our previous discussion, What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?

[7] See Why The Hike In The Fed’s Discount Rate Is Another Policy Bluff