Japan’s Highly Protected Insurance Industry Has Taxpayers On The Hook

Japan’s Insurance industry isn’t only heavily distorted as a result of protectionism but likewise exposes taxpayers heavily to losses.

That’s according to Economic Policy Journal’s Robert Wenzel.

Mr. Wenzel writes, (bold emphasis mine)

First, the Japanese government protected domestic insurers by limiting foreign insurance companies from providing insurance. Then, the government wrote regulations that limit payouts from earthquake damage.

Because of all this, many in the region, where the earthquake just struck, don't even have earthquake insurance.

There's also a loss-sharing agreement that remains in place and if the damage stretches into the billions (which it will), the Japanese government (read: taxpayer) will be on the hook for much of the bill that rightly should be picked up by the insurance companies involved.

No wonder the subtle cries over a prospective fiscal crisis.

No wonder too why the BoJ was quick to resort to massive inflationism.

Despite The Disaster, Japan Reports Less Incidence Of Looting

Despite the horrible disaster, Professor William Easterly posits a very interesting observation and asks, why has there been no looting in Japan?

I quote Prof. Bill Easterly’s entire terse post... (bold highlight mine)

Amidst the heartbreaking devastation in Japan, many have noticed (especially this blog from the Telegraph) how much social solidarity — and little stealing — there has been. The Telegraph blogger Ed West notes vending machine owners giving out free drinks, in contrast to large-scale looting after Katrina.

Economists have been saying for a while that trust is a good candidate to be a major determinant of development. Think how much contract enforcement is critical to make trade and finance possible. Think how much easier contract enforcement is when nobody tries to cheat. This is supported by empirical studies correlating per capita income with a measure of trust, like that shown below, which is computed as …oh forget that, the current example is much more compelling.

Responding to tragedy, the Japanese have resources because they are rich, and it was their social solidarity that helped get them there.

While it may be argued that Japan’s homogenous society-a strong sense of group and national identity and little or no ethnic or racial diversity-could be attributed to such social cohesion, this idea of 'homogeneity' isn’t entirely true as such differences exists in Japan, like in all societies, as Harvard University professors Theodore Bestor (anthropology) and Helen Hardacre argues.

The economic development paradigm based on “Social solidarity that helped get them there” is perhaps what Henry Hazlitt explained in his The Foundations of Morality (quoted by Bettina Bien Greaves) as, (bold emphasis mine)

For each of us social cooperation is of course not the ultimate end but a means … But it is a means so central, so universal, so indispensable to the realization of practically all our other ends, that there is little harm in regarding it as an end in itself, and even in treating it as if it were the goal of ethics. In fact, precisely because none of us knows exactly what would give most satisfaction or happiness to others, the best test of our actions or rules of action is the extent to which they promote a social cooperation that best enables each of us to pursue his own ends.

Without social cooperation modern man could not achieve the barest fraction of the ends and satisfactions that he has achieved with it. The very subsistence of the immense majority of us depends upon it.

In short, a culture of (trust) social cooperation brought about by the interdependence of people founded on the division of labor, respect for private property and voluntary exchanges is what has mostly led to Japan's civil society that has greatly reduced the incidences of violence and theft even during bleak moments.

Is Japan At A Risk of Debt Default?

When tragic events hit, some people have the habit to resort to sensationalist babble.

They read one bad event as a trigger to even more untoward events.

Such thinking represents more of personal bias rather than a reflection of actual events.

For instance, some have argued that Japan faces a risk of a fiscal crisis following today’s catastrophic earthquake-tsunami.

While there may be some grain of truth to this, this view essentially ignores the option of having markets forces help in the recovery process and the role and the actions of Bank of Japan.

So far the markets have priced some concerns over Japan’s liabilities.

According to Bespoke Invest, (graphs and tables from Bespoke too)

At the moment, it costs $95 per year to insure $10,000 worth of Japanese sovereign debt for five years. As shown in the table of CDS prices below, Japan remains at the low end of default risk compared to other countries around the globe. With the resilient country fighting to get back on track, investors don't appear to be worried about Japan having financial problems.

Bottom line: There are concerns over Japan’s debt conditions alright, but this seems far far far away from real risks of default yet.

In other words, despite the uptick in Japan’s default risk, the Philippines still has higher CDS premium or that the Philippines is seen as more susceptible to a default than Japan.

I am not saying that Japan isn’t vulnerable. I am saying that concerns up to this moment represents more of exaggeration than what is being reflected on the marketplace.

Let me add that what appears to be hounding the markets are the uncertainty of the possible escalation of the meltdown of Japan’s nuclear reactors. Once news reveal of the containment of the problem, you can expect these string of bearish news to gradually get discounted.

Japan’s Solution To The Earthquake-Tsunami Problem: Inflate The System!

Central Bankers are almost so predictable.

For almost every social problem that crops up, the intuitive measures adapted appear to be always based on the path dependency of inflationism.

It’s no different with Japan.

From the Wall Street Journal, (bold emphasis mine)

The Bank of Japan jumped into action Monday to temper the economic blow from the earthquake, tsunami and nuclear emergency that hit northern Japan, doubling the size of its asset-purchase program and pouring a record 15 trillion yen ($183.17 billion) into money markets to ease liquidity concerns.

"What we were most concerned about was the possibility that increases in anxiety and risk-aversion moves would negatively affect the real economy, so we judged it appropriate to mainly boost purchases of risk assets," BOJ Gov. Masaaki Shirakawa said after the bank's policy board meeting, which was cut to one day from two because of the crisis.

The board boosted its purchases of riskier financial assets, such as corporate debt, exchange-traded funds and real-estate investment trusts, by a total of 3.5 trillion yen. It also will buy an additional 1.5 trillion yen of government debt.

That doubles the size of the central bank's asset-purchase facility—part of a temporary fund established on the bank's balance sheet—to 10 trillion yen. The BOJ also has a program under the fund to provide 30 trillion yen in three- and six-month loans at 0.1% interest.

To revise the popular quote of the late Senator Everett Dirksen, "A billion trillion here, a billion trillion there, and pretty soon you're talking real funny money."

Will Japan’s Earthquake-Tsunami Be Market Bearish Or Bullish?

The glazier's gain of business, in short, is merely the tailor's loss of business. No new "employment" has been added. The people in the crowd were thinking only of two parties to the transaction, the baker and the glazier. They had forgotten the potential third party involved, the tailor. They forgot him precisely because he will not now enter the scene. They will see the new window in the next day or two. They will never see the extra suit, precisely because it will never be made. They see only what is immediately visible to the eye.-Henry Hazlitt, The Broken Window, Economics in One Lesson

Next week’s front running issue will likely be the double whammy of the earthquake-tsunami that struck Japan.

There might be a third factor—risks of a nuclear meltdown[1] as consequence to the above.

Capital Accumulation As Life Preserver

The largest of the massive earthquakes had been one for the record books.

Figure 3: Economist: World Largest Earthquake

According to the Economist[2],

ON Friday March 11th a huge earthquake of magnitude 8.9 struck off the north-east coast of Japan's main island, triggering a tsunami seven metres tall. The earthquake is thought to be the largest ever to hit Japan, and the fifth-largest since decent records began in 1900. According to the US Geological Survey, 15 of the 16 largest earthquakes occurred in and around the Pacific "Ring of Fire". Fortunately, many of the biggest, known as "megathrust" earthquakes, as one tectonic plate is forced under another, have occurred in sparsely populated areas.

While it may be true that megathrusters have occurred in sparse areas, the terrifying aspect is when the body counts begin to pile up. And the issue isn’t about the magnitudes of earthquakes but about how wealth from capital accumulation[3] has prepared society for such contingencies.

The 2010 earthquake in Haiti which only had a 7.0 magnitude took an estimated 92,000 to 220,000 lives[4]. However, the Philippines lost about 1,621 lives when a 7.8 tremblor struck in Northern Luzon on July 16^th 1990[5]. Strict building codes can’t be enforced if there is no wealth to fund it. That’s basic.

Earthquakes compounded by tsunamis increases the casualty rate. The 2004 Indian Ocean earthquake and tsunami took some estimated 227,000 lives across 15 countries and is considered as one of the ten worst earthquakes in recorded history[6]. Indonesians bore the brunt of the death toll (130,736) or about 70% of fatalities.

Outside the escalation of a nuclear radiation disaster, I am hopeful that Japan’s fatality will be fraction of Haiti and or the 2004 Indian Ocean earthquake and tsunami incident.

Framing The Impact of the Earthquake-Tsunami

Some say that the Japan tragedy is market bearish. Others see this as market bullish.

My position is that while the initial reaction could be negative, this woeful episode would be a neutral or a nonevent over the medium to the long term.

Basically it’s all about the issue of risk and uncertainty.

While it is true that such large scale devastation would likely impact the insurance industry the most, as insurance companies would have to indemnify insured claims, looking solely at the damage-indemnity framework wouldn’t be sufficient or won’t reveal market dynamics in action.

My presupposition is that these companies have factored in the Japan’s geographic risk profile, and naturally, the calamity risk that Japan is faced with, as Japan is situated in the Pacific ring of fire[7] where 10% of the most active volcanoes are.

In other words, most of them would have assumed on the risk-reward balance of actualizing insurance contracts. Otherwise failure to do so means the risk of bankruptcy.

And if there are any clues towards Japan’s earthquake risks, many geologists have spent so much time and money to predict the “big one” coming but apparently failed to do so[8]. The point is the Japanese or the insurers are most likely well aware of such risks.

Nor do I agree with the suggestion that such disaster would trigger a fiscal crisis in Japan. All Japan would need is to open its doors to rehabilation and reconstruction to domestic and international private investors, as well as, to liberalize labor.

The assumption that reconstruction should be undertaken solely by Japan’s government represents as analytical myopia.

What we should also look at instead is if Japan or Japan’s financial companies would repatriate funds from abroad, and how this might put pressure on the US dollar, as well as, US Treasuries.

To add, I think Japan will, from this event, be forced to import labor or liberalize migration given its declining population due to rapidly falling fertility rates[9].

Figure 4: Bespoke Invest[10]: Framing The Kobe Earthquake

Many charts will frame peoples thoughts as Figure 4. By looking at the Kobe incident also known as the Great Hanshin earthquake[11] without ascertaining the backround would possibly mislead people into thinking that the past performance equals the future.

The Nikkei has already been in a downtrend following the 1990 bubble bust. Thus, the Kobe Earthquake only became an aggravating circumstance rather than the key driver.

Figure 5: Jakarta Composite Index and Thailand’s SET Post 2004 Tsunami

To balance the perspective, the 2004 Indian Ocean earthquake hardly put a dent on the Indonesia’s (upper window) or even Thailand’s (lower window) stock markets, see figure 5. While both did suffer from a very short term decline they eventually proceeded higher.

Also economic data proved that the Kobe earthquake had been much less of an impact.

Figure 6: Kobe Earthquake had limited impact (Danske Bank)

According to Danske Bank[12]

From a macroeconomic point of view, the overall impact from the Kobe quake in January 1995 was limited. Industrial production dipped in February in the wake of the quake not least because of Kobe’s importance as a distribution centre, but recovered in the following two months as reconstruction started. It is harder to see any visible impact on GDP growth in 1995, but on balance we believe the impact will be positive because of the positive impact from reconstruction. Hence, the quake today is unlikely to derail the current recovery in Japan. If anything it will be a short-term boost to growth.

As you can see, when viewed from many comparisons, and from other angles, the source of “pessimism” fades.

Critical Analysis Matters

Eventually the issue boils down to uncertainty versus risk.

Event uncertainty, unless further worsened by more unseen untoward events (such as the risk of nuclear meltdown), will tend to get discounted. People learn to weigh in on the risk-reward balance as they see through the events unfold.

The diminishing returns of information or marginal value of information as I previously wrote[13],

Because the emergence of such unforeseen events are considered as uncertainty (immeasurable risk, and not possible to calculate), the markets work to reappraise of ‘uncertainty’s’ influence or impact, which gradually digests on them. So the influence of uncertainty depends mostly on the scale and the time value of influence...

Once the markets learned of and adjusted to such uncertainty, or to the new information, and subsequently established its cost-benefit expectations around it, uncertainty gets to be transformed into risks (measurable potential losses) via discounting. Discounting, thus, signifies as the diminishing returns of information or the marginal value theorem applied to information.”

And this is why critical analysis matters alot.

Broken Window Fallacy and Conclusion

On the other hand, I can’t see how such reconstruction can be positive overall.

Numerous people lost their precious lives which also mean lost human capital. Damaged property also equates to capital losses. And such capital losses are NOT captured by statistics on nominal GDP.

Capital meant for increasing productivity will now have to be redirected towards replacement. And replacement adds no value, and that’s why there’s no growth in the overall.

But what I wouldn’t deny is that there will be some sectors or entities who will profit from these. I think Filipino labourers will see an opportunity to grab. And yes, statistics could register a short term boost. But again statistics don’t capture the human experience.

On balance, the negative impact of disasters on the financial markets tends to be short term as effects of disasters get to be discounted overtime.

The underlying market trends will likely be determined by the general market direction overtime and not from a lasting impact of Japan’s earthquake-tsunami.

---

[1] See Aftermath of Japan’s Earthquake: Risk of A Nuclear Reactor Meltdown, March 12, 2011

[2] Economist Daily Charts, Terrifying tremors, March 11, 2011

[3] See Economic Freedom And Natural Disasters: Haiti's Tragic Earthquake, January 15, 2010

[4] Wikipedia.org 2010 Haiti earthquake

[5] Wikipedia.org 1990 Luzon earthquake

[6] Wikipedia.org 2004 Indian Ocean earthquake and tsunami death toll and casualties

[7] Wikipedia.org Pacific Ring of Fire Japan

[8] See Science Models Fail To Predict Japan’s Earthquake, March 12, 2011

[9] Japan Times, Population decline worsening January 15, 2010

[10] Bespoke Invest, Japan's Stock Market Post Kobe Earthquake in 1995, March 11, 2011

[11] Wikipedia.org Great Hanshin earthquake

[12] Danske Bank, Japan: Impact from quake should prove limited, March 11, 2011

[13] See “I Told You So!” Moment: Being Right In Gold and Disproving False Causations, March 6, 2011

Aftermath of Japan’s Earthquake: Risk of A Nuclear Reactor Meltdown

The aftermath of Japan’s horrible 1-2 earthquake-tsunami punch has brought to light another potential catastrophe: growing risk of an outbreak of radioactive contamination from a meltdown in one of the affected nuclear reactors.

From Marketwatch.com:

Japanese nuclear authorities warned of a meltdown Saturday of the core of a nuclear reactor at a plant in Fukushima operated by Tokyo Electric Power Corp., also known as Tepco, according to Kyodo News. Authorities said that there was a high possibility that nuclear fuel rods at the reactor of Tepco's Daiichi plant may be melting or have melted, Reuters reported, citing Jiji news. The Daiichi No. 1 nuclear reactor is about 240 kilometers (150 miles) north of Tokyo. Friday's 8.9-magnitude earthquake damaged the plant's cooling mechanism, leading to overheating that reportedly damaged the fuel rods in the reactor's core

Should this become a sad reality, expect a global political backlash on Nuclear energy. The debate have already began as this link shows.

A breakdown of Japan Energy Sources from Wikipedia.org and MutantFrog.com

Meanwhile, demand for traditional oil, natural gas and coal is expected to take up the slack from Japan’s debilitated nuclear energy (Bloomberg).

Science Models Fail To Predict Japan’s Earthquake

If you think man has acquired enough expertise to know the environment, think again.

From the Washington Post, (bold highlights mine)

They have long been ready for the Big One in Japan. But when it arrived Friday, it was still surprising, still utterly devastating, and it left scientists around the world humbled at how unpredictable the heaving and lurching earth can be.

Japanese geologists have long forecast a huge earthquake along a major plate boundary southwest of Tokyo, and have poured enormous resources into monitoring the faint traces of strain building in that portion of the earth's crust. They have predicted in great detail the amount of property damage and the number of landslides such a tremor would generate. They have even given the conjectured event a name: The Tokai Earthquake.

Lesson: Despite the massive advances in technology, there is a limit to the knowledge man can acquire from the innate complexity of nature.

As aptly pointed out by Friedrich von Hayek in his Nobel Prize speech ‘The Pretence of Knowledge’… (bold emphasis mine)

The chief point we must remember is that the great and rapid advance of the physical sciences took place in fields where it proved that explanation and prediction could be based on laws which accounted for the observed phenomena as functions of comparatively few variables - either particular facts or relative frequencies of events. This may even be the ultimate reason why we single out these realms as "physical" in contrast to those more highly organized structures which I have here called essentially complex phenomena. There is no reason why the position must be the same in the latter as in the former fields. The difficulties which we encounter in the latter are not, as one might at first suspect, difficulties about formulating theories for the explanation of the observed events - although they cause also special difficulties about testing proposed explanations and therefore about eliminating bad theories. They are due to the chief problem which arises when we apply our theories to any particular situation in the real world. A theory of essentially complex phenomena must refer to a large number of particular facts; and to derive a prediction from it, or to test it, we have to ascertain all these particular facts. Once we succeeded in this there should be no particular difficulty about deriving testable predictions - with the help of modern computers it should be easy enough to insert these data into the appropriate blanks of the theoretical formulae and to derive a prediction. The real difficulty, to the solution of which science has little to contribute, and which is sometimes indeed insoluble, consists in the ascertainment of the particular facts.

And this applies to sociology too.

Bottom line: We should be leery of anyone who peddle to us the reliability of predictions based on science or math models, especially those who advance the policy of interventionism.

And this applies to whether we deal with the financial markets and the economy or with environmental issues such as global warming.

Japan’s Earthquake-Tsunami In Pictures

Below is an awesome picture which virtually illustrates of how man is seemingly helpless against wrath of nature. (please spare me the climate change drivel)

It’s just one of the 40 incredible tragic images captured by the Boston’s The Big Picture from yesterday’s 1-2 punch of earthquakes compounded by tsunamis that struck Japan.

See the rest here (ht: Mark Perry)

Environmental Black Swan: ‘Doomsday’ Asteroid Could Slam Into Earth on 2036!

Since many people like to scare themselves with fictitious tales of environmental doom, this should represent as the ultimate environmental horror story or a black swan (low probability, high impact) event: earth could be hit by a ‘doomsday’ asteroid!

Scientists have even pegged a date for Armageddon: April 13, 2036!

From the Daily Mail, (emphasis added)

Warning comes days after another asteroid shot over the Pacific just 3,400 miles above the Earth’s surface

An asteroid travelling at 23,000mph could crash into Earth on April 13, 2036 killing millions and causing global chaos, scientists claim.

In a plotline taken straight from a science-fiction film, astronomers in Russia are predicting that the 300-yard-wide Apophis could slam into the planet in 25 years' time.

But don't panic just yet, as it is extremely unlikely to happen.

So unlikely, in fact, that Nasa has given the catastrophic event odds of 250,000-to-1 that it actually takes place.

Read the rest here.

Goodbye anthropogenic global warming!

How Socialism Aggravates Harm from Natural Disasters: The Venezuelan Experience

The destructive side effects of Socialism are amplified by national disasters. Venezuela is an example.

Wall Street Journal’s Mary O’Grady writes, (bold highlights mine)

Most of Venezuela's democratic institutions have been destroyed by Mr. Chávez. But Caracas is still not Pyongyang or Havana, and a groundswell of popular dissatisfaction could yet unseat him. His favored strategy to deal with this risk is spreading government funds around and redistributing private wealth. Yet even as hundreds of millions of dollars have been reallocated under chavismo in the past decade, life for Venezuela's poor has been growing more difficult. Mr. Chávez's popularity has been dropping, as evidenced by the opposition's gains in Congress.

Then came the late November rains.

An estimated 130,000 people were left homeless when the northern tier of the country was hit with torrential downpours that lasted well into December. Their plight has become a main theme in all the president's speeches, and he has been scrambling to find them shelter. They have been sent to live in government clinics and offices, more than 150 hotels and even Miraflores, the presidential palace. At one point Mr. Chávez offered to pitch a Bedouin tent—a gift from the Libyan Moammar Gadhafi—in the garden of the palace to make room for flood victims in his home.

All of this has elevated a structural problem of housing shortages that many of Mr. Chávez's constituents expected him to solve when he came to power. Instead the problem has gotten worse.

According to Aquiles Martini, the president of the Real Estate Chamber of Venezuela, who I interviewed by telephone from Caracas last week, the growing population requires 80,000-100,000 new homes per year. But during chavismo, he says, the country has added, on average, only 40,000 units annually. Venezuela now has a housing deficit of two million units. This explains why so many Venezuelans live in fragile, shanty-town housing and suffer so greatly during natural disasters.

Mr. Martini says 2009 was a good year, with 92,000 new units added to Venezuela's stock. But in 2010 the number dropped to 50,000, and the forecast for next year is still fewer new homes. One reason is the nationalization of companies that produce cement and steel. Venezuelan steel output dropped last year by 40% and cement output by 12%, and this provoked shortages in construction materials.

There are other deterrents. Builders have traditionally protected against inflation, now 30% annually, by indexing their contracts with buyers to cover rising costs during construction. But in 2009 the government outlawed this practice. Last year, accusations that some builders were still trying to hedge led the government to threaten harsh penalties and even jail some individuals. Many private developers have since disappeared. Investors who might like to build an apartment for rental income have also withdrawn from the market because, according to Mr. Martini, landlords no longer have the right to evict if their tenants don't pay.

Natural calamity + a cocktail mix of inflation and many other forms of interventionism= More social suffering.

What’s The Yield Curve Saying About Asia And The Bubble Cycle?

``What is being ignored is the more fundamental question of whether the Fed should be attempting to set or influence interest rates in the market. The presumption is that it is both legitimate and desirable for central banks to manipulate a market price, in this case the price of borrowing and lending. The only disagreements among the analysts and commentators are over whether the central banks should keep interest rates low or nudge them up and if so by how much.” Richard M. Ebeling, Market Interest Rates Need to Tell the Truth, or Why Federal Reserve Policy Tells Lies

What’s The Yield Curve Saying About Asia And The Bubble Cycle?

-The Ultimate Black Swan-Armageddon

-The Cyclical Nature Of Bubble Cycles

-Measuring Boom Bust Cycles Via The Yield Curve

-What’s The Yield Curve Saying?

-Bubble Cycles Do NOT Discriminate

The Ultimate Black Swan-Armageddon

WATCHING National Geographic’s ‘Apocalypse How’ made me realize how the world is so vulnerable to the exogenous forces of nature and how man could be completely helpless in the face of such overwhelming power.

Yes, you may forget the farcical anthropogenic climate change, because the forces of nature would be exponentially be way far far far far more powerful and potent than the outcome from any of our collective destructive actions.

Besides, as remarked by the scientists interviewed in the TV documentary program, like any part of nature, our world operates on its own cycle. This means that the “ice age” could be just around the corner in some thousands of years to come, while the sun will expire on its own, by running out of fuel to burn, in about 5 billion years, and that today’s “aging” earth, even without the sun’s demise, will likely meet its end on its own.

And the sad part is that there is nothing mortal man can do to stop it. Every species or anything else that is part of nature will cyclically become extinct.

While we have been made aware by media of these apocalyptic scenarios through a variety of science fiction movies that could or may occur; such as huge asteroid/s crashing on earth, super volcano eruptions, alien invasion, robot uprising and many more, there are other factors such as the black hole, gamma rays from an imploding star or the unleashing of a mighty wave of solar flares from our sun, that could send our world into oblivion, unpredictably and instantaneously.

This would be the ultimate black swan for us- a low probability high impact event- our Armageddon.

Even in nature we see the variances of applied risks:

-cyclical risks (demise of sun or earth)-which if we are lucky enough would allow the Homo sapiens species commodious time to prepare for such eventuality through technological innovations and applications that could enable our descendants to scour other parts of universe for relocation

- and the Black Swan risks, which I guess leaves us to get insured with the Almighty.

The good news is that cycles extrapolate that for every death means a new birth somewhere. It’s just that we won’t be appreciating it, since we can’t know everything even when we’re alive, and perhaps because it is least of our concerns- since it ain’t about us.

However, in the understanding of nature’s dynamics, as consolation, a new life is taking place…somewhere.

The Cyclical Nature Of Bubble Cycles

This brings us back to the markets.

The difference between dealing with the complex forces of nature and that with actions of human beings is that the cyclical risks factors appear much magnified in the latter than the randomness elicited from the former.

But in contrast to the presumptive fallacious assumptions of the self-righteous aggregatists, the less complexity of social science doesn’t translate to technocratic omniscience since social sciences remain fluid, dynamic and adaptive to the constantly changing environments. Importantly they aren’t mechanistic.

The reason is that human actions are based on incentives: People are guided by what they perceive as satisfying some ends by engaging in specific means as distinguished by the scale of values (marginal utility) and time preferences, which comes in two parts-a low and high preference. In the Austrian School, low time preference means long term while high time preference means short term.

Interest rates function as major incentives in ascertaining the allocative (savings, investment and speculation) decisions of economic agents. To quote Professor Ludwig von Mises on interest rates and its money relation, ``The final state of the market rate of interest is the same for all loans of the same character. Differences in the rate of interest are caused either by differences in the soundness and trustworthiness of the debtor or by differences in the terms of the contract. Differences in interest rates which are not brought about by these differences in conditions tend to disappear. The applicants for credits approach the lenders who ask a lower rate of interest. The lenders are eager to cater to people who are ready to pay higher interest rates. Things on the money market are the same as on all other markets.”

In other words, in a laissez faire environment, creditors and debtors have essentially the same incentives as with buyers and sellers- both parties compete with their own class to serve the other parties or to satisfy the market, whereby both seek the price levels which satisfy their interests. Therefore, the rates of interest are determined by the demand and supply of credit through time preferences.

Unfortunately we aren’t in laissez faire environments where central banking has usurped the function of free markets in an attempt to perpetuate boom cycles via interest rate manipulation.

In Making Economic Sense, Murray N. Rothbard describes the boom bust cycle from monetary expansion primarily from interest rate controls (bold highlights mine), ``Inflationary bank credit is artificial, created out of thin air; it does not reflect the underlying saving or consumption preferences of the public. Some earlier economists referred to this phenomenon as "forced" savings; more importantly, they are only temporary. As the increased money supply works its way through the system, prices and all values in money terms rise, and interest rates will then bounce back to something like their original level. Only a repeated injection of inflationary bank credit by the Fed will keep interest rates artificially low, and thereby keep the artificial and unsound economic boom going; and this is precisely the hallmark of the boom phase of the boom-bust business cycle.

``But something else happens, too. As prices rise, and as people begin to anticipate further price increases, an inflation premium is placed on interest rates. Creditors tack an inflation premium onto rates because they don't propose to continue being wiped out by a fall in the value of the dollar; and debtors will be willing to pay the premium because they too realize that they have been enjoying a windfall.”

So in contrast to the myopic mainstream, which sees the market as operating in some ‘randomesque animal spirits’, interest rates mold the public’s mindset (not just capitalists or speculators but also workers, housewives and everyone else) as to how money gets allocated.

In short, boom bust episodes don’t come by haphazard chance; they function like nature, they are cyclical. Importantly, inflationism also reflects on the conditions of money.

Measuring Boom Bust Cycles Via The Yield Curve

Figure 1: Steve Hanke, stockcharts.com: Austrian Trade Cycle And The 2003-2008 Bubble Cycle

Where interest rates have been distorted to create a false impression of the abundance of savings via central bank injected money from thin air, the allure to invest in long term projects becomes relatively more compelling (see figure 1, left window).

That’s the reason why Americans and many bubble economies of the world had been seduced into the real estate bubble trap in various degrees.

Cato’s Steve Hanke describes how the process evolved (all bold underscore mine), ``An artificially low interest rate alters the evaluation of projects – with longer-term, more capital-intensive projects becoming more attractive relative to shorter-term, less capital-intensive ones.

``Austrian theory played out to perfection during the most recent boom-bust cycle. By July 2003, the Federal Reserve had pushed the federal funds interest rate down to what was then a record low of 1%, where it stayed for a full year.

``During that period, the natural (or neutral) rate of interest was in the 3-4% range. With the fed funds rate well below the natural rate, a credit boom was off and running. And as night follows day, a bust was just around the corner.”

As you can see in the right window of figure 1, during the dot.com bust, the US Federal Reserve hastily pared interest rates that pushed up or sharply steepened the yield curve (spread between 10- year and 2- year spreads-blue trend line).

Since interest rates always impact the markets with a time lag, the S & P responded and began to rise in 2003, or about 2-3 years after.

Then the US Federal Reserve began to lift policy rates in June 2004, thereby reversing the monetary easing as shown by the flattening trend of the yield curve.

The flattening of the yield curve subsequently led to the peak of the US real estate industry in 2005 (more than a year after), again with a time lag, as shown in our charts in China And The Bubble Cycle In Pictures, and eventually crashed in 2006 (see here for Case Shiller update).

The aftermath similarly had the US and global stockmarkets belatedly react by gradually unraveling in 2007. The culmination of which was manifested by a spectacular collapse that had been heralded by the infamous Lehman spectacle of September 2008. The crash proved to be the capitulation or the turning point for the markets.

What’s The Yield Curve Saying?

So where’s the yield curve now?

Figure 2: stockcharts.com: Skyrocketing Yield Curve

This noteworthy observation from moneyandmarkets.com’s Mike Larson, ``We just saw the spread between 2-year Treasury Note yields and 30-year Treasury Bond yields widen to 379 points. That’s the highest in almost three decades of record-keeping. And the 10-year TIPS spread I’ve highlighted on multiple occasions blew out to yet another 18-month high of 246 basis points earlier this week.” (emphasis his)

This means that the incentives to profit from the yield curve arbitrage have never been as compelling as before. Investors will likely be tempted to borrow short and invest long.

Meanwhile, for financial intermediaries they will be incented to enhance their maturity transformation or conversion of short term liabilities (deposits) to long term assets (loans).

So both the demand and supply variables will likely be responding positively to the incentives provided by the gaping interest rate spreads as a result of policy distortions.

As you can see in the chart above, like in the past, world markets ($DJW) have belatedly responded to the steepening of the yield curve, albeit faster than in the previous cycle- the recent reaction had 1½ years lag compared to previous 2-3 years lag.

The faster response appears to have been abetted by the Quantitative Easing (QE) program, aside from other guarantees and other Federal Reserve as the “last resort functionaries” seen in diversified alphabet soup to the tune of TRILLIONS of dollars.

Moreover, gold ($gold) appears to be resonating the current undulations of the yield curve.

As caveat, correlation isn’t causation. This isn’t to suggest that gold has been driven by the yield curve arbitrage. What can be casually observed is gold’s apparent rhythmic symmetry with the curve during the past 3 years.

It must be remembered that Gold has risen in spite of the current and previous easing-tightening policy cycles, which experienced two boom-bust episodes during the last decade. Gold has been up for 9 straight years with an average of 17.1% returns denominated in US dollars (James Turk)!

Bubble Cycles Do NOT Discriminate

SUBSIDIZED interest rates are likely to generate borrowing traction for institutions or industries or countries which had been LEAST blemished by the recent bubble.

This had been elaborated by both Professor von Mises- where credit take up is ``caused either by differences in the soundness and trustworthiness of the debtor or by differences in the terms of the contract”- and by Professor Rothbard’s description of the impact of such policies- ``As the increased money supply works its way through the system, prices and all values in money terms rise, and interest rates will then bounce back to something like their original level”-as duly noted above.

China’s recent response to increase bank reserves, aside from last week’s higher T-bill sales, is on path to this as discussed in Asia And Emerging Markets Should Benefit From The 2010 Poker Bluff.

Figure 3: McKinsey Global Institute: Leverage of Financial Institutions

It is also the major and fundamental reason why major emerging markets and Asia have fundamentally outclassed and significantly outsprinted developed economies in 2009 and why it would likely do a similar rendition in 2010.

Again, specifically because low systemic debt, high savings rate, least affected banking system (see figure 3) and importantly the increasing adoption of economic freedom among other variables have allowed policy impelled circulation credit to percolate more within the national borders and within the region in a relative scale compared with other parts of the globe.

And this is why many have been aback by the sudden surge or the rampant improvement in Asian and major emerging markets financial markets, which have prompted some skeptics to call a “top”.

Figure 4: Bloomberg Chart of the Day: Asian Outperformance

For instance, the combined European sovereign Credit Default Swaps (CDS) or a gauge of default risks of the PIIGS (Portugal, Italy, Ireland, Greece and Spain) have spiked more than those of their emerging Asian counterparts (see figure 4-upper window) for the first time in history as measured by the CDS. This implies that Asian debts have been inferred as less risky than its European peers.

By using non sequiturs or the implication of political risks such as “nuclear armed neighbour”, “number of political coups”, “unstable neighbour” or “imposed currency controls”, an analyst calls for a “top” for emerging markets based on what he thinks as unrealistic valuations and euphoric sentiment that replicates 1994.

The analyst appears to have forgotten about the ``differences in the soundness and trustworthiness of the debtor or by differences in the terms of the contract”, which serves as the essence of what default risks is about.

Where the PIIGS have taken on debt more than they can afford to pay for, they were ultimately found swimming naked when the tide receded, to paraphrase Warren Buffett.

The markets have, in essence, justifiably priced such debt laden PIIGS as relatively more likely to default than the Asian peers, because the latter have learned, endured and painfully adjusted from the excesses of the Asian crisis (twelve years past) and have engaged in a more circumspect borrowing and lending activities and eluded emulating the West’s risky behavior during the last bubble cycle. [Although eventually persistent bubble policies will likely force us to embrace extravagance]

In the same context, we see a parallel in the default risks dynamics manifested on corporate debt ratings via VIX indices (figure 4-lower window). Americans have been perceived as having the most relative risks, the UK second and lastly China (go back to figure 3 to answer any whys).

Besides it would signify as spurious analysis to anchor on past performance. Who would have ever thought that Iceland, once belonging to the world’s elite, has fumbled? [see Iceland's Devaluation Toll: McDonald's and Iceland, the Next Zimbabwe? A “Riches To Rags” Tale?]

In short, bubble cycles have effectively sanctioned credit extravagance with no palpable discriminations; because it is a market imposed discipline.

Once it had been the Asians and now it is the turn of the Europeans and the Americans. That’s how the cycle, under the laws of scarcity, operates.

So the general rule is whoever inflates eventually suffers from the consequences of such political actions (yes inflation is fundamentally a political decision), irrespective of the identity (nationality) or present and past financial or economic standings or political or culture framework.

For now, markets appear to have been rewarding the prudent.

And like the forces nature, there are cyclical risks that one can insure against and there are black swan risks.

Economic Freedom And Natural Disasters: Haiti's Tragic Earthquake

Professor Don Boudreaux nails it.

While media have been fixated with the devastation of the recent earthquake in Haiti, which up to this writing has now tallied some 50,000 deaths, many have attributed the destructive loss of lives to many other peripheral causes, including the absurd ("pact with the devil").

What has hardly been mentioned is WHY Haiti's impoverishment had made her disproportionately vulnerable to human life losses in such natural calamities.

From Professor Boudreaux of Cafe Hayek says it best: [all bold emphasis mine]

``The ultimate tragedy in Haiti isn’t the earthquake; it’s that country’s lack of economic freedom.

``Registering 7.0 on the Richter scale, the Haitian earthquake killed tens of thousands of people. But the quake that hit California’s Bay Area in 1989 was also of magnitude 7.0. It killed only 63 people.

``This difference is due chiefly to Americans’ greater wealth. With one of the freest economies in the world, Americans build stronger homes and buildings, and have better health-care and better search and rescue equipment. In contrast, burdened by one of the world’s least-free economies, Haitians cannot afford to build sturdy structures. Nor can they afford the health-care and emergency equipment that we take for granted here in the U.S.

``These stark facts should be a lesson for those who insist that human habitats are made more dangerous, and human lives put in greater peril, by freedom of commerce and industry."

Let me add that the Philippines should be a more worthwhile in comparison.

We suffered from an even more destructive quake in July 16, 1990 which according to wikipedia.org registered 7.8 and resulted to an estimated 1,621 deaths

The Philippines has a per capita of $920.19 (ranked 106th according to nationmaster.com) almost double that of Haiti $480.52 (ranked 126th).

And by economic freedom, the Philippines is way up the list at 104th according to Heritage Foundation, compared to Haiti's 147th spot.

In short, capital or wealth generated from economic freedom has indeed been a key factor in reducing the risks of higher casualty toll from natural calamities.

As Ludwig von Mises wrote, ``It is fashionable nowadays to pass over in silence the fact that all economic betterment depends on saving and the accumulation of capital. None of the marvelous achievements of science and technology could have been practically utilized if the capital required had not previously been made available. What prevents the economically backward nations from taking full advantage of all the Western methods of production and thereby keeps their masses poor, is not unfamiliarity with the teachings of technology but the insufficiency of their capital."

Typhoon Ondoy: Market Fallacies and Risks

``The controls are deeply and inherently immoral. By substituting the rule of men for the rule of law and for voluntary cooperation in the marketplace, the controls threaten the very foundations of a free society. By encouraging to spy and report on one another, by making it in the private interest of large numbers of citizens to evade the controls, and by making actions illegal that are in the public interest, the controls undermine individual morality.”-Milton Friedman, An Economist’s Protest

Nothing captures the human mind more than the huge events.

And huge events frequently spawn oversimplistic explanations on everything that accompanies this.

For instance in the realm of the stock market, natural catastrophe or disasters have often been equated to lower prices, for the simple reason that such dislocations are deemed to “hurt” earnings or the domestic economy.

Plausible as it seems, however this exemplifies our populist “ipse dixitism”.

Fallacy of Natural Disaster Equals Lower Stock Prices

The Philippines is home to typhoons or tropical cyclones or “Bagyo” in local vernacular, where about an average 6-7 of them lay scourge to the country annually.

The table above from wikipedia.org enumerates on the deadliest and the most destructive of the typhoons that had afflicted the country in terms of deaths and estimated damages in Peso (albeit the estimates of Peso damage doesn’t specify whether prices are reckoned from current or constant “real” terms).

However this interesting trivia from wikipedia.org, (bold highlights mine)

``The most active season, since 1945, for tropical cyclone strikes on the island archipelago was 1993 when seventeen tropical cyclones moved through the country. There was only one tropical cyclone which moved through the Philippines in 1958. The most frequently impacted areas of the Philippines by tropical cyclones are northern Luzon and eastern Visayas. A ten year average of satellite determined precipitation showed that at least 30 percent of the annual rainfall in the northern Philippines could be traced to tropical cyclones, while the southern islands receive less than 10 percent of their annual rainfall from tropical cyclones.”

So how did the top 3 worst typhoons, which occurred mostly during the early 90s, impact the domestic stock market?

The worst in terms of fatalities would be Typhoon Thelma or codenamed Uring, which slammed the country in November 1991 with an estimated 5,000-8,000 death.

However in terms of estimated property damages, Typhoon Mike or codenamed Ruping (November 1990) and Typhoon Angela codenamed Rosing (November 1995) had been recorded as the largest, with over Php 10.8 billion each (with a marginal spread between the two).

Three noteworthy observations from these typhoons on the Phsix:

One, over the short term, the impact from these typhoons had generally been a carryover of the interim trend.

Typhoon Mike and Thelma traded sideways reflecting on the trends prior to their occurrences, while Typhoon Angela traded downhill also reflecting on the prior trend.

Second, in the wake of the three worst catastrophic typhoons, in the medium term (1-2 years) the Phisix surged!

A Pollyanna could even make a misleading conclusion that typhoons are ‘beneficial’ to the stock market! However, as a word of caution: correlation doesn’t imply causation.

And lastly, over the longer term, these typhoons merely reflected on the secular trend of the market.

Since all three typhoons were at that time operating under the secular bull market cycle from 1986-1997, hence the general trend was up.

In short, in contrast to the popular “available bias” of equating “calamity equals poor stock market”, the typhoon’s impact to the stock market has largely been immaterial over all timeframes considered and tends to reflect on the major trends from which undergirds the stock market cycle.

Typhoon Milenyo And 2004 Indian Ocean Earthquake As Added Exhibits

More proof.

Conditions of the 90s have been significantly less similar than today in the age of the iPod, twitter, facebook or the internet and the epoch of globalization (in spite of the recent crisis).

So we’d make two recent comparisons: one local and an international event.

The latest typhoon that appears to have an almost parallel degree of havoc to last week’s fateful Typhoon Ketsana or codename Ondoy, to the National Capital Region of the Philippines was Typhoon Xangsane or codenamed Milenyo in late September of 2006.

Again according to wikipedia.org, ``In all, Milenyo was responsible for 197 deaths and 5.9 billion Philippine pesos ($118 million, 2006 USD) in damage, mostly to personal property and agriculture.”

The difference is that most of the destruction and loss from today’s tempest had emanated from intensive rainfall that had induced massive instantaneous flooding than from Milenyo’s calamitous winds.

In addition, the death toll from Ondoy has now reached 280 as of October 1, according to the Inquirer. This would be larger than the Milenyo experience, but would still account as vastly lower than 9 out of 10 of the list in the top 10 of the most devastating typhoons to slam the Philippines.

Typhoon Ondoy seems closing in on Typhoon Babs or codenamed Loleng during October 1998 which ranked 6^th which tallied 303 deaths.

Typhoon Milenyo had basically the same traits as cited above from the “worst” predecessors as reflected in the Phisix.

The precursor trend determined the short term actions. The medium term move was a significant advance and the long term manifested the secular trend-up.

Incidentally, Typhoon Loleng of 1998 had the same short and medium term impact albeit the long term reflected anew on the major trend-down (that’s because 1997-2002 was the bear market cycle).

And fundamentally the same dynamics would even apply to one of the worst or deadliest natural disasters in recorded history over the world: December 2004 Indian Ocean earthquake.

Fatalities in the 2004 Indian Ocean Earthquake approximated 443,929, according to the wikipedia.org, which makes it the fifth worst.

The pecking order of the 5 worst disasters ever to hit human history ahead of the Indian Ocean Earthquake are: China’s 1931 Floods which took some 1-4 million lives, China’s 1887 Yellow River Floods which had some 900k-2 million deaths, 1556 Shaanxi earthquake again in China which tallied 830k of lives lost, and the 1970 Bhola Cyclone in Bangladesh which claimed 500k lives.

Indonesia took the brunt of the casualties from the December 2004 Indian Ocean earthquake which had been propelled by the secondary effect of the earthquake-a destructive tsunami.

According to wikipedia.org, ``The Sumatran province of Aceh was severely damaged by the earthquake and resulting tsunami. An estimated 167,736 Indonesians were killed and 25% of Achenese lost their source of livelihood. Banda Aceh, Aceh's capital, was the closest major city to the earthquake's epicenter, and many of its major libraries suffered extensive damage.” (bold emphasis mine)

[I would like to further disclose that wikipedia’s account of statistical figures varies: the list of natural disasters by death toll page indicates an estimated 443,929, while 2004 Indian earthquake page lists 230,000]

Nevertheless the important point is, while the impact of catastrophes is real which has significant economic implications, stock markets seem to have discounted the effects from such human losses and property destruction.

Jakarta’s major bellwether, the JKSE, even immediately rose in the aftermath of the disaster but traded sideways for most of 2005 until it eventually took off by the end of 2005.

Moreover, the devastating earthquake in Indonesia last Thursday which has exacted 1,100 as of this writing left JKSE virtually unchanged as of Friday’s close.

So whether it is typhoon Thelma, Mike, Angela, Xangsane or today’s Ketsana (Ondoy) or the tsunamis from the December 2004 Indian Ocean Earthquake or even the Spanish Flu in 1918-1919 [as discussed in Swine Flu: The Black Swan That Wasn’t], these tragedies have had minor impact to the price movements of the stock markets.

Human Action And Monetary Policies Matter

So why would stock markets seem to overrule the popular impression that “calamity equals lower stock prices”?

We offer two explanations:

One is that this signifies the dynamics of human action.

It is natural for people to speedily work for the restoration of the economic structure.

John Stuart Mill has a magnificent explanation:

``This perpetual consumption and reproduction of capital affords the explanation of what has so often excited wonder, the great rapidity with which countries recover from a state of devastation; the disappearance, in a short time, of all traces of the mischiefs done by earthquakes, floods, hurricanes, and the ravages of war. An enemy lays waste a country by fire and sword, and destroys or carries away nearly all the moveable wealth existing in it: all the inhabitants are ruined, and yet in a few years after, everything is much as it was before.” (bold emphasis added)

While restitution from the natural disasters in rich countries can be financed by medical or insurance coverage on properties affected or on lives harmed or lost, in the poor nations, people rely mostly on social network for aid.

As in the wake of Typhoon Ondoy, it is why tremendous amounts of “private” sector charity (here and abroad) have poured into those afflicted areas.

It is also why there has been a large participation from the wide spectrum of the society to assist in the distribution of relief goods.

Unseen by most, these acts of social cooperation dynamics or the “bayanihan” spirit in local lingo is more than just a manifestation of self esteem or social work goals.

It represents exhaustive efforts towards swift societal rehabilitation for the economic interest of the community [as we explained in Typhoon Onyok's Aftermath: Charity Is The Province of the Marketplace]. It is in the interest of almost everyone to see the reversion to a semblance of ‘normalization’ of the community.

In other words, marketplace charity signifies as complimentary function to the recovery of capital impaired by the calamity.

Again John Stuart Mill, ``The possibility of a rapid repair of their disasters mainly depends on whether the country has been depopulated. If its effective population have not been extirpated at the time, and are not starved afterwards; then, with the same skill and knowledge which they had before, with their land and its permanent improvements undestroyed, and the more durable buildings probably unimpaired, or only partially injured, they have nearly all the requisites for their former amount of production.” (bold emphasis added)

Hence, markets could have discounted the adverse impact from these disasters as possibly representing an anomaly than from a permanent structural impairment in the economy.

In addition, markets may also have anticipated a relatively quick recovery from the collective rehabilitation efforts to restore the economy as reasons for valuation insouciance.

Another important unseen factor, which has always and seemingly intentionally been glossed over by the mainstream, is the impact of monetary policies on asset prices.

This appears true even amidst the turmoil brought about by natural disasters.

The red arrows in the chart courtesy of the economagic shows of the “Greenspan Put” policies instituted in response by the US Federal Reserve in the face of specific global crisis or to combat US recessions, such as the 1990-91 US Recession (left most shade) and Japan’s Bubble Bust (1990), the Mexican Tequila Crisis (1995), the Asian Crisis (1997), the LTCM (1998) and Millennium Bug scare (1999).

In other words, the easing of the monetary policies in the US which had been indirectly transmitted to Philippine equity assets by way of a secular boom cycle phase. Portfolio flows, which underpinned most of the secular trend, may have offset or cushioned the large scale of losses in the real economy exacted by the natural disaster shocks.

As one would note: The rallies in the Phisix, in spite of the calamity shocks, came in conjunction with the easing cycle of the US Federal Reserve.

It is likely that today’s market environment will trigger the same response as in the past, most especially that monetary easing isn’t just a conduct exclusive of the US Federal Reserve but from global central banks which means this includes the local central bank, the Bangko Sentral ng Pilipinas (BSP).

Further in the wake of the tragedy, I expect local monetary policies to further extend their easing cycle to politically justify on lending to the disaster victims.

Price Controls As Backdoor Entry To Tyranny

The real risks to the market arise NOT from the disaster itself, but from policies assumed by the incumbent government in the face of the calamity.

Considering that the stretch of the damage of Typhoon Ondoy has been significantly less than the damage from similar typhoons in the past, it would normally be a puzzle why a nationwide “state of calamity” had been promulgated by the government.

One of the alleged reasons for the nationwide scope of the state of calamity is because earlier impositions of price controls at selected typhoon affected areas haven’t worked. Producers or traders naturally opted to sell in places which had been free of regulatory controls.

Hence, a nationwide price control policy has been instituted, all aimed at controlling the “greed” of traders. Duh!

Given that our president hails from a respected economic professional background, such reactions wouldn’t be a stranger to her.

In addition, we wouldn’t question her familiarity with the hazards of employing the repeated historical precedents of the failure of price controls.

But alas! Political season is before us. And political expediency has taken precedence over economic priorities, thereby heightening the risks of exacerbating today’s crisis.

Yet mainstream media has virtually been stultified by discounting such government act as being connected to some other tangential electoral issues [see No To Price Controls! No To Despotism!]

Mainstream media have basically neglected the implication that a national price control implicitly “seizes” control of the factors of production.

This means that if such policies further get entrenched, we could be transitioning into etatism or a different flavor of “state” socialism.

In etatism, the largest industries will risk nationalization, especially those producing political goods or services. While the small and medium industries will probably retain their private identity, they will, in effect, eventually become extensions of government operations, whereby the amount of production and prices will all be ascertained by the government.

Further, the failure to control prices from nationwide price fixing would lead next to widespread rationing, universal price fixing (This means expanding the coverage of price controls from politically sensitive goods to general goods. Since shortages will force the public to consume substitutes outside of government controls which will likewise cause price increases, these will be areas which government will expand controls) and massive subsidies, all of which, I repeat, would only substantially aggravate today’s crisis.

Yet, any further signs of these occurring in the political theater, over the coming days, will be foreboding.

Media and the academic economic experts seemed to have forgotten that one way for a prospective tyrant to emerge is through the extensive use of price control instruments as political tool to grab power!

In short, price controls could serve as a backdoor entry into tyranny. Will we risk relapsing into a dictatorship or will we assimilate the socialist models of Latin America?

As Robert Shuettinger, Eamon Butler, Forty Centuries of Wage and Price Controls, ``In Egypt, government controls over the grain crop led gradually to ownership of all the land by the state. In Babylon, in Sumeria, in China, in India, in Greece and in Rome various kinds of regulations over the economy were tried and usually either failed completely or produced harmful effects. One of the most well-known cases of wage and price controls in the ancient world occurred in the time of the Emperor Diocletian. Thousands of people throughout the Empire were put to death before these futile laws were finally repealed.” (bold emphasis added)

And by taking over the reins of the major segments of the economy from the control of the “greedy” private sectors, our political leaders will then require extended police powers for the pervasive enforcement of such political objectives.

And the feedback mechanism between more price controls and more police power would accelerate to cover more and more economic areas and eventually snowball into martial law powers as the whole economy falls into the ramparts of government control.

Considering the twilight of the incumbent political regime, emergency powers aimed to addressing calamity woes could function as fitting rationalization to short-circuit the electoral process.

Effects From Price Controls, Hoping Over Hope

Besides, we should realize that there is no getting around the natural law of economics which principally operates on the world of scarcity.

Eventually, out of the façade of short term fixes will surface the strains from the imbalances built upon superficial structures-the unintended consequences. And this could be vented through a political upheaval.

Moreover, increased used of price controls would eventually translate to heightened risks of inflation-where the real economy will suffer from specific and relative real good shortages combined with mass subsidies and an upsurge in fiscal expenditures for the expanded imposition and enforcement of regulations.

All these would also be expressed in the financial markets.

Although widespread use of said policies would naturally imply for a weaker currency or a weak peso, the Peso’s fate would greatly depend on the relative dimension, or which of the country will do least worst in the race to the bottom. In the Philippines, the conventional exchange rate pair is the US dollar-Philippine Peso.

In addition, we should expect to see below par economic growth, spikes in unemployment, political restiveness and perhaps a lagging stock market-in view of nationalization risks, as investors turn risk averse.

We can only hope that forthright “sensibilities” will sink into consciousness of our political leadership.

And that the temptations of egotistically extending political tenures, by means of maneuvering economic policies as political instruments, would immediately be abandoned.

Aside from lifting price controls, the only way to rebalance the calamity distorted prices is by the liberalization of local trade barriers so that interim shortages will met by a barrage of supplies in response to temporary surges in price signals, which would bring back prices to normal levels.

Hence, the risks of wastage will all be borne by “greedy” entrepreneurs.

And for the genuinely concerned political leadership, these measures would mitigate the burdens of taxpayers by minimizing extravagant and unproductive redistribution and ultimately shield society from the ravages of inflation.

Politics Dictating The Affairs Of The Market, Outlook

For market observers and participants, while many continue to look for entertainment value instead of the real drivers of the marketplace, the role of politics has increasingly deepened its entanglement here and abroad, thereby generating more marketplace distortions that affect both the real and financial dimensions.

Hence we suggest that policy actions will continue to strongly determine the fate of the local and global markets, the local and global economy and even our society’s agility to recover from the recent disaster.

Traditional way of thinking has been loaded with theoretical lapses (e.g. devaluations doesn’t solve disequilibrium simply because currency values are not everything, instead inflationary actions aggravates them), confused definitions (e.g. macro thinking sees the world as operating from one kind of good or product, labor and capital, hence prescribe on simplistic set of solutions cloaked with technical jargon) and selective facts to confirm on tenuously held biases (e.g. rising US unemployment is deflationary to the Philippines!!?? Excuse me).

Domestic political uncertainty, as clearly shown above, and not the deflation menace is the risk for the local financial markets. A move towards a Honduras (political turmoil) or Venezuela (deepening socialism) risks upending present gains.

While Venezuela’s IBVC appears to be up over the past 5 years as seen from the chart above from Bloomberg, the tragedy is that stock market gains are wiped out by the huge spikes of inflation as seen from the chart below from tradingeconomics.com.

This should serve as a basic example on how inflationary policies from socialism will harm investors and the rest of the population or the economy alike than to enable them to achieve fraudulent “noble” social goals.

And political risks equally apply to the international marketplace than from the premises of traditional valuation. (e.g. growing murmurs of a military strike on Iran)

While we still remain net positive on asset prices mostly from the transmission effects from global and local monetary policies, we will have to keep a close vigil over the direction of the present political winds where the risk towards a recidivist dictatorship could constitute as political shock and rattle local markets regardless of exogenous developments, or if present actions have been cosmetically designed at embellishing the highly unpopular political credibility over the interim.