Information Age: Individual Job Outsourcing

Outsourcing has been largely thought as mainly company based commercial operations. However in the real world, given today’s deepening of the digital economy or information age, the application of outsourcing has been broadening to include individual operations.

The oxymoronic account  of where a company caught an employee  outsourcing one’s job, from CNN.com, which led to his termination, seems like a manifestation of such snowballing dynamic

After a U.S.-based "critical infrastructure" company discovered in 2012 its computer systems were being accessed from China, its security personnel caught the culprit ultimately responsible: Not a hacker from the Middle Kingdom but one of the company's own employees sitting right at his desk in the United States.

The software developer is simply referred to as "Bob," according to a case study by the U.S. telecommunications firm Verizon Business.

Bob was an "inoffensive and quiet" programmer in his mid-40's, according to his employee profile, with "a relatively long tenure with the company" and "someone you wouldn't look at twice in an elevator."

Those innocuous traits led investigators to initially believe the computer access from China using Bob's credentials was unauthorized -- and that some form of malware was sidestepping strong two-factor authentication that included a token RSA key fob under Bob's name.

Investigators then discovered Bob had "physically FedExed his RSA token to China so that the third-party contractor could log-in under his credentials during the workday," wrote Andrew Valentine, a senior forensic investigator for Verizon.

Bob had hired a programming firm in the northeastern Chinese city of Shenyang to do his work. His helpers half a world away worked overnight on a schedule imitating an average 9-to-5 workday in the United States. He paid them one-fifth of his six-figure salary, according to Verizon.

Some thoughts

Programmer Bob’s offense has really not been about outsourcing but of the unauthorized disclosure of what has been internal corporate affairs to a third party.

In the digital economy or the information age, non-contiguous work requirements enable outsourcing on an international scale. The non-sensitivity to geographic confines means that work can be delegated to a specialty agent wherever access to connectivity is present. This translates to job  decentralization or semi-autonomous jobs or jobs that allows for “home based” work or telecommutation.  I may add that semi-autonomous work may not really be “home based” or static work location but about mobility.

Deepening decentralization of industries and jobs will translate to decentralization of living areas. Thus, the incompatibility of mainstream concept of industrial age “urbanization” with decentralization.

Outsourcing, which contributes to the informal economy, should continue to grow as the world’s economy gravitates towards technology inspired specialization.

Reasons for US Insourcing

Mercantilists previously argued that in order for the US to regain competitiveness expressed via investments outsourced to China, the US needs to devalue. How misguided this perspective had been.  

While the US has indeed by inflating (devaluing) everyone else has been doing the same including China’s PBoC.

From Mao Money, Mao Problems

The net effect has been to negate each other inflationist policies and instead such seemingly collaborative actions has spawned a global asset boom.

Recently, reports suggest that the US has now been experiencing greater degree of reverse outsourcing, or insourcing. In a verbose report, the Atlantic suggests the following reasons:

-Oil prices are three times what they were in 2000, making cargo-ship fuel much more expensive now than it was then.

-The natural-gas boom in the U.S. has dramatically lowered the cost for running something as energy-intensive as a factory here at home. (Natural gas now costs four times as much in Asia as it does in the U.S.)

-In dollars, wages in China are some five times what they were in 2000—and they are expected to keep rising 18 percent a year.

-American unions are changing their priorities. Appliance Park’s union was so fractious in the ’70s and ’80s that the place was known as “Strike City.” That same union agreed to a two-tier wage scale in 2005—and today, 70 percent of the jobs there are on the lower tier, which starts at just over $13.50 an hour, almost $8 less than what the starting wage used to be.

-U.S. labor productivity has continued its long march upward, meaning that labor costs have become a smaller and smaller proportion of the total cost of finished goods. You simply can’t save much money chasing wages anymore.

While the above may be true, this seems insufficient.

I may add that numerous wealthy Chinese have likewise been seemingly anxious about China’s political economic conditions, such that they have been looking elsewhere to shelter their capital.

From Reuters

In short, US insourcing relative to China may not have been entirely about economic issues but also about politics. 

The risk of an economic bust from China’s assimilation of Western Keynesian policies, that has ballooned a huge shadow banking industry and skyhigh debts, which have intensely increased the risks of a financial and economic bust. This implies that concerns over political instability may have been prompting China’s wealthy and capitalist class (along with cronies) to consider safehaven alternatives abroad. The increasing political risks may serve as a major reason for the US insourcing.

And political risks has also been manifested in China’s gunboat  diplomacy with Japan and Southeast Asia over territorial issues, which has been most likely a diversion from her brewing economic woes.

I might add advances in technology may be a factor too. For instance, advances in 3-D printing may eventually bring manufacturing to the household, which may reduce cross border FDIs relative to manufacturing.

The bottom line is looking at US insourcing relative to China may not signify as an accurate picture of global investment flows. That’s because there is a whole world of other options via many other capable emerging markets than China alone.

War on Outsourcing: The Specter of US Economic Nationalism (Protectionism)

The Malaya reports

President Aquino appears unfazed by US President Barack Obama’s endorsement of House Bill No. 3596 or "Call Center and Consumers Protection Bill" pending in the US Congress saying it may be an election-related statement.

"We have to take into account that this is an election year but at the end of the day, like any other country, the US would want to make their companies more effective, more competitive, etc. and outsourcing is one of the keys towards that," Aquino said in an ambush interview at the EXL Service Philippines Site at the Mall of Asia in Pasay City.

"At this present time, I was made to understand, that this was an issue that was brought up during the last elections in America and from that time which was four years ago and now, the situation has not changed. Perhaps there isn’t that much of a danger," Aquino said.

"I will assume that it (BPO) will continue, hopefully it will not change because that is one of our sunrise industries," he said.

Aquino said there are no plans at the moment to lobby against the passage of the bill and that he prefers to "cross the bridge" only when the bill is passed.

It’s good to know that Philippine President Noynoy Aquino recognizes what looks like an election ploy. It really takes one to know one.

But it’s unfortunate that President Aquino, beneficiary of the outsourcing boom, would remain passive on this issue. Never mind if America’s turn to protectionism might indeed harm the industry. It would seem better to be bullied into submission. Yet fawn over with plans by the US to expand military presence here.

President Aquino doesn’t seem to realize that the divide-and-conquer and class warfare strategies have been the hallmark of the Obama administration.

As Mike Brownfield of the conservative Heritage Foundation writes,

Obama enacted a purely progressive agenda with his expansion of the state under Obamacare, his trillion-dollar stimulus bill, the government takeover of the auto industry, the proliferation of regulations under the Dodd-Frank regulatory reform bill, the crony capitalism of the Solyndra scandal, and the illegal appointments to the unrestrained Consumer Financial Protection Agency and the National Labor Relations Board. The result: Some 13.1 million Americans remain unemployed, job creation has been abysmal for much of the past three years, and the President’s promise to turn around the U.S. economy has gone unfulfilled.

The difference is that Mr. Obama’s progressive agenda, during this election season, seems to have transitioned from a moderate to hard line stance.

Maybe’s this also part of the desperation to get re-elected considering the Mr. Obama’s near record low approval rating. (chart from Gallup)

Yet here is more proof of President Obama's protectionist urge.

From the Wall Street Journal,

China was dragged into the 2010 U.S. midterm elections, and President Obama is busy ensuring that it will be an even bigger political target during the 2012 campaign. In Tuesday night's State of the Union address, the President joined Republican candidate Mitt Romney in singling out China as a special trade violator.

In announcing that he will set up a new Trade Enforcement Unit to investigate "unfair trade practices in countries like China," Mr. Obama is promising to increase investigations against Chinese exporters. His Administration has so far brought five cases against China in the World Trade Organization (WTO). Late last year it began targeting China's solar industry, while last week it said it would investigate Chinese makers of wind energy towers.

By the way one looks at it, protectionism has been rearing its ugly head as politicians like President Obama and the mainstream Republican candidates appeal to the emotions of the uninformed via nationalism/patriotism to solicit for their votes.

Many are unaware that economic nationalism (or protectionism) fundamentally underpins the philosophy of war or of military conflicts. World War II, for instance has mainly been caused by rabid nationalism.

Again current events have been affirming the admonitions of the great Ludwig von Mises,

Economic nationalism is incompatible with durable peace. Yet economic nationalism is unavoidable where there is government interference with business. Protectionism is indispensable where there is no domestic free trade. Where there is government interference with business, free trade even in the short run would frustrate the aims sought by the various interventionist measures…

What generates war is the economic philosophy almost universally espoused today by governments and political parties. As this philosophy sees it, there prevail within the unhampered market economy irreconcilable conflicts between the interests of various nations. Free trade harms a nation; it brings about impoverishment. It is the duty of government to prevent the evils of free trade by trade barriers. We may, for the sake of argument, disregard the fact that protectionism also hurts the interests of the nations which resort to it. But there can be no doubt that protectionism aims at damaging the interests of foreign peoples and really does damage them. It is an illusion to assume that those injured will tolerate other nations' protectionism if they believe that they are strong enough to brush it away by the use of arms. The philosophy of protectionism is a philosophy of war.

In short the President Obama’s war on outsourcing constitutes part of what seems to be an overall protectionist agenda, which translates to a war on trade against every nationality (including the Philippines).

President Aquino should negotiate to retain and expand free markets and abide by such principles. Otherwise, perhaps Marc Faber’s prediction may come true.

China’s Urbanization: City Population Surpasses Rural Population

China’s urban population has surpassed the rural population for the first time.

The Economist writes,

FOR a nation whose culture and society have been shaped over millennia by its rice-farming traditions, and whose ruling party rose to power in 1949 by mobilising its put-upon peasantry, China has just passed a remarkable milestone: its city-dwellers now outnumber its rural residents. New data from the National Bureau of Statistics show that of China’s 1.35 billion people, 51.3% lived in urban areas at the end of 2011. In 1980 less than a fifth of China’s population lived in cities, a smaller proportion than in India. Over the next ten years the government remained wary of free movement, even as it made its peace with free enterprise. Touting a policy of “leaving the land but not the villages, entering the factories but not cities”, it sought industrialisation without urbanisation, only to discover it could not have one without the other. Even now, its ratio of city-dwellers is, if anything, low for an economy at its stage of development. America reached the 50% mark before 1920. Britain passed it in the 19th century. Go further back, however, and China’s cities dazzled the world. It is likely that one thousand years ago, the Song Dynasty capital of Kaifeng was the world’s most populous city. Marco Polo, who visited China in the 13th century, claimed that Hangzhou was “the most splendid city in the world” with 13,000 bridges—although later estimates suggest the true number was 347.

Count me as a skeptic of the continuity of urbanization trends, a phenomenon derivative of the industrial age.

Basically urbanization has been driven by economic opportunities, the economies of scale and centralization of facilities all of which may be changing.

The dynamics of urbanization, according to Wikipedia.org (bold emphasis mine)

People move into cities to seek economic opportunities. A major contributing factor is known as "rural flight". In rural areas, often on small family farms, it is difficult to improve one's standard of living beyond basic sustenance. Farm living is dependent on unpredictable environmental conditions, and in times of drought, flood or pestilence, survival becomes extremely problematic. In modern times, industrialization of agriculture has negatively affected the economy of small and middle-sized farms and strongly reduced the size of the rural labor market.

Cities, in contrast, are known to be places where money, services and wealth are centralized. Cities are where fortunes are made and where social mobility is possible. Businesses, which generate jobs and capital, are usually located in urban areas. Whether the source is trade or tourism, it is also through the cities that foreign money flows into a country. It is easy to see why someone living on a farm might wish to take their chance moving to the city and trying to make enough money to send back home to their struggling family.

There are better basic services as well as other specialist services that aren't found in rural areas. There are more job opportunities and a greater variety of jobs. Health is another major factor. People, especially the elderly are often forced to move to cities where there are doctors and hospitals that can cater for their health needs. Other factors include a greater variety of entertainment (restaurants, movie theaters, theme parks, etc.) and a better quality of education, namely universities. Due to their high populations, urban areas can also have much more diverse social communities allowing others to find people like them when they might not be able to in rural areas.

These conditions are heightened during times of change from a pre-industrial society to an industrial one. It is at this time that many new commercial enterprises are made possible, thus creating new jobs in cities.

The transition to the information age extrapolates to more specialization, as commerce will evolve along with improvements in technology. This means reduced cost advantages of centralized organizations which simultaneously has been accelerating and deepening the trends of business outsourcing.

Moreover real time connectivity should enhance this process, which again reduces the motivation for commerce to congregate in specific areas—or cities.

Also business focus will increasingly be directed to specific needs (niche marketing) rather than mass production and also on where the consumers and markets are.

In the Philippines, shopping malls have sprouted not only in major cities but also in capitals of provinces or secondary cities. Take for example the largest shopping mall chain the SM Group which has 43 malls nationwide and growing. This is a noteworthy example of the deepening dispersion trends, where facilities have been mushrooming outside of mega cities.

Also this serves as an example of the evolving location based markets—businesses locating and providing goods and services where the consumers are.

On the supply side, the call center industry, whose firms have been looking for agents to fill up outsourcing jobs, has been spreading outside the metropolis (Metro Manila). According to Wikipedia.org, there are 788 call centers in over 20 locations, where growing number firms are being established again in secondary cities and in the provinces.

All these suggest that the snowballing forces of decentralization should dampen urbanization trends--that depends on the dynamics of centralization--over the long run.

Proximity Based Manufacturing Supply Chains as Trend of the Future?

The Economist proposes that the current trend in global manufacturing could shift based on the following priorities, other than labor arbitrages.

-Proximity to customers

Many multinationals will continue to build most of their new factories in emerging markets, not to export stuff back home but because that is where demand is growing fastest.

-Inventory Management

Firms are also trying to reduce their inventory costs. Importing from China to the United States may require a company to hold 100 days of inventory. That burden can be handily reduced if the goods are made nearer home (though that could be in Mexico rather than in America).

Read the rest here

Ballooning inflation means not only rising wages in Emerging markets which erodes the opportunities for labor arbitrage, but may also extrapolate to substantial increases in transportation costs which could alter the cost benefits of outsourcing.

So perhaps proximity based supply chains could be a dynamic that could gain a larger role in the future.

Philippine Peso Wilts Under The Unwinding Short US Dollar Carry Trade!

``The world is changing and how we measure that change economically and financially is clearly a challenge and an opportunity. We have seen a re-weighting of risk around the world, but the world itself is being economically re-rated and so we need an index that allows investors to take advantage of these changes. Indian companies will obviously have a place in The Global Dow as will companies from other emerging countries where we have seen an unprecedented economic emancipation over the past two decades.” Rupert Murdoch, owner Dow Jones, on the Global Dow plan, in Mumbai, India.

So what ails the Philippine Peso?

After a fierce rally following the Philippine central Bank the (Bangko Sentral ng Pilipinas) BSP’s move to raise policy interest rates to quell “inflation”, the Philippine currency made a 180° turn and dived. The Peso lost 2.19% over the week to 45.13 to a US dollar see figure 1, Asia’s second biggest loser after India’s Rupee.

Figure 1: Yahoo.com: USDollar/Philippine Peso: Ailing Peso?

Local mainstream media ascribes the recent activities on several factors as foreign portfolio outflows “on jitters over rising inflation”, “heightened concerns over global economic growth”, “lower commodity prices”, “hedge against potential recovery in oil prices” and “low levels of liquidity” in the financial markets.

There seems to be some confusion about “rising inflation” and “lower commodity prices” (which is which? Isn’t rising inflation supposed to be represented by higher commodity prices?), aside from concerns about global economic growth as a causal factor to Peso’s steep loss (how does slower “global” economic growth translate to lower Peso?).

So from previous concerns over “inflation” to now “global economic growth”, media and the local experts appear to be lost on what truly is driving the Peso’s decline.

The Inflation Bogey Revealed

While it is true that foreign portfolio continued to account for outflows that have weighed on the Peso, we doubt if the premise is indeed ALL about “inflation”.

Proof? See Figure 2.

Figure 2: AsianBondsonline.com: What Inflation? Where?

ADB’s Asianbondsonline depicts of the Philippine Peso denominated sovereign instruments in 2 year (green line) and 10 year (red line) yields. As the chart shows, the sharp drop in the yields last month seems to be validating our arguments that inflation concerns have been abating as discussed in Philippine Economy: World Financial Markets Allude To Diminishing Risks of Inflation.

With LOWER food prices, which is our MAIN concern (over 45% of our Consumer Price Index basket is in food while energy is just about 3%), manifested by sharply falling broad based commodity prices, via moderating “global and local” demand compounded with supply side responses from market forces and from policy directives emanating from political pressures (subsidies, interest rate hikes, added investments and etc.), the falling yields reflected in Philippine debt papers have equally signified diminishing inflation risk over the interim.

Since government “inflation” figures represent past data, this accounts as a LAGGING indicator. So when you read of Philippine inflation rates nearing a 17 year high in July at 12.2% (xinhua.net), we should expect these figures to drop significantly in the coming months. In short, consumer goods and services inflation has peaked!

So from this angle, inflation as a risk variable hasn’t been the MAIN impetus for the Peso’s decline.

Slowing Global Economic Growth Weighs On The Peso? Not Likely

Now if the argument swings to one of global growth, economic data doesn’t seem to support such a premise either.

One must be reminded that the currency values are ALWAYS priced in pairs. That’s why currency markets function as a zero sum game because when one wins, the other loses.

This means that the conventional measure of the Philippine Peso is relative to the US dollar, since the US dollar represent as the de facto world currency reserve. This also means that if we allude to the world economic growth’s impact on the Philippines, then we must also account for how the same factors will affect the US.

Let us see how the downturn abroad has impacted the Philippine Economy…

According to the latest remittance trends, June’s money flows from overseas foreign workers set a NEW record in the face of a SLOWING global economy! (Yeah…“decoupling is a myth”??!!)

This from Bloomberg (highlight mine),

``Remittances from Philippine citizens working overseas rose at the fastest pace in 14 months in June as more people found jobs as nurses, seamen and engineers abroad.

``Money sent back to the Philippines jumped 30 percent from a year earlier to $1.5 billion, the highest since records began in 1989, the central bank said in a statement in Manila today. Remittances grew 15.6 percent in May.

``The number of Filipinos who got jobs overseas rose 33.5 percent to 640,401 in the first six months of the year, the central bank said today…

``Slowing global growth may limit jobs abroad as companies lay off workers and freeze expansion, reducing the amount of money expatriates can send home in the coming months. Half of the Philippines' remittances come from the U.S., where tumbling home prices, mounting job losses and credit restraints are threatening growth.

``Funds sent home by the more than 8 million Filipinos living abroad climbed 17.2 percent to $8.2 billion in the first half of 2008 from a year earlier.”

Remember, remittances account for about 10% of the local economy and have SUPPORTED consumption patterns in the Philippines. The fact that 3 of the 10 largest malls in the world are in the Philippines (see our blog post A Nation Of Shoppers??!!) could be seen as partly being propped up by these fund flows from our migrant workers. Thus as far as labor and financial links are concerned, the global economic slowdown hasn’t been reflected YET in these accounts.

Although it is true that the risks of a negative impact to remittances from a slowing global economy may have a lagging effect, as in the case of Mexico which reported a slight decline during the 2^nd quarter and the first semester of 2008 (Wall Street Journal), these would actually depend on the sectors from which our OFWs are exposed to.

According to the BSP, ``Filipino workers continue to be in strong demand overseas due to the diversity and quality of skills they offer. The conduct of bilateral talks with host countries also continues to open up new employment opportunities abroad for Filipinos.” (emphasis mine)

Much to our knowledge, health (caregivers and nurses) and science based industries (engineers) aside from education (teachers) could be seen as defensive sectors that are least likely to be affected by the ongoing economic and financial slump in the US, thus the seeming resilience.

Aside, as the BSP has noted, bilateral agreements has effectively widened the opportunities for more of our labor/manpower exports.

Paradoxically, it appears that the so-called “Peso-driven-remittance” premise formerly touted by media and our experts has vanished altogether! Why? Just because the Peso is down and seems not to be supported by the remittance flows doesn’t mean this has no contribution. This goes to show how media and the highly paid institutional “experts” frequently resort to specious analysis based on AVAILABLE Bias.

Might as well abide by Nassim Taleb (author of the Black Swan) advise, ``Don’t read newspapers for the news (just for the gossip and, of course, profiles of authors). The best filter to know if the news matters is if you hear it in cafes, restaurants... or (again) parties.”

Going back to the local economy, if we look at the performances of publicly listed companies, we hardly notice any significant slowdown. Yes while earnings fell (from a jump in input costs or “inflation” and from mark down on equity investments), revenues from business operations jumped!

This from ABS-CBN (emphasis mine), ``Companies whose shares are listed on the local bourse saw their total earnings fell in the first quarter of the year due to rising inflation and lower trading gains, a new study by the Philippine Stock Exchange (PSE) showed.

``According to PSE data, the combined profits of listed firms amounted to P66.68 billion in the first three months, a 4.3-percent decrease over the previous year's P69.67 billion. The same study showed that their combined revenues expanded by 10.4 percent to P589.71 billion from P534.05 billion a year ago.

``The findings were based on the unaudited financial statements of 221 listed companies received by the PSE as of June 11.”

Of course past performance doesn’t imply the same prospective outcome, but the point is if the largest companies in the Philippines have been seeing strength in the revenue context, then a material slowdown (or even a recession) isn’t likely to be in the cards. So the world may go into a recession alright but we are unlikely to join the bandwagon.

Besides, except for the trade linkages seen via the export and export related manufacturing channels, which supposedly accounts for as the most sensitive or the weakest link to a global slowdown (ironically exports grew 8.3% in June year on year, and 4% from January to June over the same period last year), the rest of the other industries should remain resilient.

As evidence, we can get some clues from the latest export figures (Inquirer.net)…

``Exports of clothing and accessories, the second-biggest export item after electronics in June, were down 7.6 percent year-on-year at $172.33 million.”

``Other top exports in June were petroleum (down 1.0 percent at $138.71 million), cathodes of refined copper (up 97 percent at $122.16 million), and coconut oil (up 105 percent at $116.97 million).

So there…a downturn in global consumer spending is reflected through the decline in clothing and accessories exports. Meanwhile, agriculture (coconut oil) and mining and related (refined copper) industries should continue to experience robust growth. As reminder, agriculture accounts for a substantial-over one third of the Philippine employment profile.

Not only that…the ongoing economic slack in the OECD economies have been prompting more firms to consider the outsourcing avenue as a way of cost cutting.

In the US, investment banks suffering from the housing and mortgage backed securitization meltdown is seen accelerating the outsourcing of jobs or in the vernacular- “knowledge process outsourcing,” “off-shoring” or “high-value outsourcing-to emerging markets.

This from the New York Times (underscore mine),

``Cost-cutting in New York and London has already been brutal thus far this year, and there is more to come in the next few months. New York City financial firms expect to hand out some $18 billion less in pay and benefits this year than 2007, the largest one-year drop ever. Over all, United States banks will cut 200,000 employees by 2009, the banking consultancy Celent said in April.

``The work these bankers were doing is not necessarily going away, though. Instead, jobs are popping up in places like India and Eastern Europe, often where healthier local markets exist.

``In addition to moving some lower-level banking and research positions to support bankers and analysts in New York and London, firms are shipping some of their top bankers from those cities to faster-growing developing markets to handle clients there…

``After research, the next wave may include more sophisticated jobs like the creation of derivative products, quantitative trading models and even sales jobs from the trading floors.

``Proponents of the change say Wall Street’s wary embrace of the activity may signal the beginning of a profound shift in the way investment banks are structured, with everyone but the top deal makers, client representatives and the bank management permanently relocated to cheaper locales like India, the Philippines and Eastern Europe.”

We don’t like to sound like engaging in a schadenfraude but the article message is crystal clear-someone’s loss is somebody’s gain; very much like the tradeoff between the Peso and the US dollar.

So, in addition to the milestone remittance volume in June and the prospects of a lower “inflation”, plus a calibrated upswing in the rest of the other industries economic growth figures to the upside (Government expects the country to grow by 5.7% for the year (inquirer.net))!!!

Figure 3: San Francisco Federal Reserve: World Real Economic Growth and US Real GDP

So under the context of economic growth, we don’t expect the US to OUTPERFORM emerging markets including the Philippines, as shown in Figure 3 from the San Francisco Federal Reserve even under a very OPTIMISTIC scenario of a NO-recession economic recovery in the US (right pane), an outlook which seems as questionable for us.

Besides, even under a moderation in economic growth it is unlikely that emerging markets will undergo the same penance as those in the debt to the eyeballs OECD economies. Even during the Dot.com bust of 2000-2002, emerging markets contributed 75% to the world economic growth as seen on the left pane. Lately, the emerging countries or developing countries accounted for almost 70% of world real GDP and should remain as an important driver going forward.

Thus, the recent fall by the Peso isn’t also supported by the slow economic growth thesis.

The Unraveling Short US Dollar Carry Trade!

So if it is not inflation and it is not slowing global economic growth then what is?

The recent strength of the US dollar hasn’t been a Philippine Peso only phenomenon. It has been a broad based rally seen in Asia (except Indonesia) including the redoubtable Singapore or for much of the world as shown in Figure 3 as measured by the US dollar “trade weighted” Index.

Figure 4: stockcharts.com: US dollar rally

As shown in Figure 4 the US dollar (main window) has massively rallied against its major trading partners (except the Canadian Loonie) which apparently coincided with the collapse of commodity prices, CRB Index (pane below main window), Gold (pane below CRB) and Oil prices (lowest pane).

While others have imputed these to “deflationary” pressures which may be partly responsible for the recent events, but has been inconsistent with the activities seen in the equity markets, we think that today’s volatile actions in the currency market signify the rotating process of “deleveraging”.

Perma bears cheerfully claim that the breakdown of commodities signifies a collapse in EM demand-which we think is unproven yet- and not evident in the Philippines anyway.

While others may call it the “global margin call” we call it the unwinding “short US dollar carry trade”.

Said differently, the US dollar has almost functioned as a ONE WAY BET or one huge crowded trade where international investors have massively “borrowed” against (because of relative lower rates) or “shorted” the US dollar (in expectations of a lower US dollar because of the years of continued decline) to buy commodities or emerging market assets or ex-US currencies in the hunt for added yields.

When central banks intervened (as we pointed out in Global Markets: The End Of The World? Or Overestimating Global Consequences?) to put a floor on the US dollar, the entire short US dollar short phenomenon unraveled spectacularly!

The attendant margin calls from the US dollar carry spurred forced liquidations in the positions of the commodity trade or in emerging markets or even among the currencies of the major trading partners of the US which had morphed into a dysfunctional rout. Hence, the almost synchronous inverse actions of the US dollar relative to commodities and the rapid disorderly panic stricken selloffs involving many currencies including the Philippine Peso!

This has not been a new phenomenon. About a year earlier, the advent of the credit crisis resulted to a wallop in global equity assets as many financial institutions who were caught in the subprime mortgage shakeout were compelled to raise capital via forcible liquidations. Most of these were vented in the global equity markets including the Philippine Stock Exchange.

We are seeing it happen today again, but this time involving ex-US assets. Hence the rotating disorder of delevaraging from a system that greatly relies on leveraging.

In May of 2006, the Gavekal Team wrote about the parallelism of a short US dollar phenomenon which had contributed to the imbalances or bubble formation that became what is known as the Asian Crisis (emphasis ours)…

``We had an echo of this very same phenomenon in Asia in the period 1995 to 2000. In 1995, everyone was convinced that the THB, MYR, KRW were massively undervalued and due a large revaluation. Everyone borrowed US$ (since rates were cheaper than local rates) to finance local projects (usually real estate). As money continued to plow in, returns on capital weakened. Soon the returns on capital moved below its cost and Asian currencies were forced to devalue. Asian banks, and the OECD banks that had lent to them, found themselves de facto “short the US$”. As Asia repaid its US$ borrowing in the period 1997-2000, the US$ rose higher than anyone expected (including ourselves) and central bank reserves barely grew (despite large current account deficits).”

Deleveraging and Probable Policy Goals Behind Interventions

The process of forcible liquidations almost always involves indiscriminate selling regardless of the fundamentals of an asset. This is because the antecedent of deleveraging is overleveraging which constitutes inflation, excessive speculation and reckless risk taking.

And deleveraging of overvalued or overextended markets means raising capital to fund margin deficits by closing out positions which usually is directed at the most liquid or most profitable positions. Hence deleveraging is commonly seen within a universe of a specified asset class. In today’s case: currencies and commodities.

Even gold, which traditionally functioned as hedge against volatility, inflation or financial or economic distress, became a downright victim to the latest market carnage.

An added view is our suspicion of the coordinated Central Bank-government efforts to prop the US dollar to force down commodity prices so as to reflect a peak in “inflation”, thereby relieving them of the political pressures from the responsibilities of policy errors (e.g. Biofuel subsidies).

Also we suspect that the same political forces could be conditioning markets for further policy easing measures (more rate cuts) in view of the still recalcitrant gridlock in the credit markets whose adverse impact has begun to spread into the real economy.

Finally in understanding of the guiding principles of US Federal Reserve Chairman Ben Bernanke policymaking, it is likely that such actions could have been designed to bolster or cushion equity markets especially under the seasonal conditions of August to October which have been prone to “crashes”!

In 2000, Chairman Ben Bernanke wrote a treatise entitled “A Crash Course for Central Bankers” which we quote Mr. Bernanke…

``There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.”

Figure 5: BBC US Market Crashes Through Ages

Figure 5 which we featured almost at the same time last year (see A “Normal” Correction in the FACE of Massive Government Interventions? No Can Do!) exhibits the worst crashes and bear markets in the US.

Given the cognizance of the unfolding weaknesses in the economy, US markets could be deemed as sensitive or vulnerable to a stock market crash, hence Mr. Bernanke alongside with other central banks could be attempting to create conditions that could avoid a similar situational risk.

Conclusion

In finale, we don’t share the mainstream view that the Philippine Peso’s recent downside jolt emanates from either the popular premises of being “inflation” impacted or as corollary to a global economic slowdown, both of which seems to have inadequate evidences and rests on tenuous logic in support such claims.

Much of the inter-market activities reflect on the process of deleveraging from an overextended-ONE way bet market (US DOLLAR) that has led to unruly forcible liquidations involving cross volatilities in the currency and commodity markets.

We suspect that political entities have had a hand in the present market actions were aimed at mitigating the political cost owing to adverse impacts of policy errors or US policymakers could be conditioning global financial markets for further policy easing measures (more rate cuts) or that alleged market intervention had been designed to bolster or cushion equity markets especially under the seasonal conditions of August to October which have been prone to “crashes”!

We further suspect that the unfounded serial bouts of forced selling should also translate to opportunities similar to that seen in the Phisix-that the Philippine Peso should rebound after the smoke from the battle clears.