Despite Abenomics, Japan Still Mired in Recession

Despite the Bank of Japan’s (BoJ) ramping up of her balance sheet, statistical economic growth remains sluggish

From Bloomberg,

Japan’s economy unexpectedly shrank last quarter as falling exports and a business investment slump outweighed improved consumption, bolstering Prime Minister Shinzo Abe’s case for more monetary stimulus to end deflation.

Gross domestic product contracted an annualized 0.4 percent, following a revised 3.8 percent fall in the previous quarter, the Cabinet Office said in Tokyo today. The median forecast of 32 economists surveyed by Bloomberg News was for 0.4 percent growth. Nominal GDP shrank 0.4 percent on quarter.

An economy still mired in recession suggests a lag before Japan benefits from a weaker yen and rising stocks. Banks from Goldman Sachs Group Inc. to Nomura Holdings Inc. have raised their growth forecasts for this year on Abe’s plan to revive the economy through fiscal and monetary stimulus as central bank Governor Masaaki Shirakawa prepares to exit next month.

Let me be clear: I don’t deny that massive increases in monetary inflation could artificially boost the statistical economy. The issue is about intertemporal sustainability.

Yet one can’t help but notice that the despite the ballooning of the BoJ’s balance sheet from ¥ 10 Trillion in 2011 to a projected ¥ 80 Trillion or ¥ 40 Trillion realized (chart from Danske Bank), Japan’s statistical economic growth has been anemic or in a persistent state of stagnation. 

Chart from tradingeconomics.com

Add to this the recent recession update, which “experts” find excuse as having been a “pre-Abenomics” condition. PM Shinzo Abe regained the political stewardship as Prime Minister in December of 2012.

Whether Abenomics or pre-Abenomics, the solution has been all the same.  The difference has been in the magnitude applied. Politicians and their apologists expect magic from bigger doses of what has failed.

Such social policies can be characterized as “insanity”—doing the same thing over and over and expecting different results.

Rising stock markets in the face of sustained economic recession serve, not only as signs of parallel universe or of a distorted sense of reality, but importantly as symptoms of a deep seated monetary-economic disorder. They represent bubbles.

Japan’s economic minister even has the derring do to target the Nikkei at 13,000 as if inflationism can wish away structural political economic imbalances. Maybe Japan's officials have been covetous of Venezuela where the latter's stock market surged by 300% in 2012 but the people have been suffering from severe shortages of goods as consequence of shrinking supply of hard currencies due to inflationism.

To add, one would note how mainstream economists has wrongly forecasted Japan’s economy, most of them having been enthralled by the prospects of the supposed magic of inflationism.

The real reason for their optimism has been that the currency elixir via BoJ’s inflationism represents subsidies or transfers of wealth to the banking, insurance and finance industry at the expense of society.

Japan’s serial blowing of bubbles will surely end up in societal misery.

As the great Austrian economists and professor Ludwig von Mises warned,

It would be a serious blunder to neglect the fact that inflation also generates forces which tend toward capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of illusory or apparent profits. If the annual depreciation quotas are determined in such a way as not to pay full regard to the fact that the replacement of worn-out equipment will require higher costs than the amount for which it was purchased in the past, they are obviously insufficient. If in selling inventories and products the whole difference between the price spent for their acquisition and the price realized in the sale is entered in the books as a surplus, the error is the same. If the rise in the prices of stocks and real estate is considered as a gain, the illusion is no less manifest. What makes people believe that inflation results in general prosperity is precisely such illusory gains. They feel lucky and become openhanded in spending and enjoying life. They embellish their homes, they build new mansions and patronize the entertainment business. In spending apparent gains, the fanciful result of false reckoning, they are consuming capital. It does not matter who these spenders are. They may be businessmen or stock jobbers. They may be wage earners whose demand for higher pay is satisfied by the easygoing employers who think that they are getting richer from [p. 550] day to day. They may be people supported by taxes which usually absorb a great part of the apparent gains.

Finally, with the progress of inflation more and more people become aware of the fall in purchasing power. For those not personally engaged in business and not familiar with the conditions of the stock market, the main vehicle of saving is the accumulation of savings deposits, the purchase of bonds and life insurance. All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to be indicated. The ultimate reaction of the public, the "flight into real values," is a desperate attempt to salvage some debris from the ruinous breakdown. It is, viewed from the angle of capital preservation, not a remedy, but merely a poor emergency measure. It can, at best, rescue a fraction of the saver's funds.

The illusions of inflationism as a path to prosperity will likely be unmasked either by a debt crisis-debt default or by hyperinflation or even by war.

Video Jon Stewart on the $1 Trillion Platinum Coin: It's a Stupid F*cking Idea

Hat tip: Mises Blog

The Daily Show with Jon Stewart
Get More: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

Let me add Cumberland Advisors' Bob Eisenbeis sensible remark on such outrageous proposition:

a tongue-in-cheek proposal that was getting traction in DC was that the Treasury (and thus the Administration) could solve its funding problems by simply exploiting a loophole in the law that would permit the Treasury to mint a trillion-dollar platinum coin, deposit it in the Treasury’s account with the Fed, and write checks on that account to cover operating costs. Shame on us that we are even talking about the possibility, and even Paul Krugman has weighed in on the issue. To mint the coin would be to print money, and we know from history that printing money doesn’t solve a debt problem. The Spanish found that out when they scoured the world for gold. The more of it you have in circulation, the less valuable it becomes. The Germans found it out during the Weimar Republic, and the Argentineans found it out in the latter half of last century. Krugman claims it isn’t printing money because the Fed would offset Treasury spending, which would put new money in the hands of the public, with asset purchases. But he is wrong, since he is assuming behavior by another governmental entity to offset the Treasury’s spending and hasn’t apparently looked recently at the Fed’s exploded balance sheet. As the result of its quantitative easing programs, there are no offsetting transactions and wouldn’t likely be such transactions. [italics added]

When experts resort to surrealistic ideas as space aliens and platinum coins as solutions to economic fragility, you know how debauched, not only the economic spectrum has been, but importantly, the public's moral standings by virtue of its popularity.

As the great Ludwig von Mises warned, (bold mine)

There are still teachers who tell their students that “an economy can lift itself by its own bootstraps” and that “we can spend our way into prosperity.” But the Keynesian miracle fails to materialize; the stones do not turn into bread...

There is no use in arguing with people who are driven by “an almost religious fervor” and believe that their master “had the Revelation.” It is one of the tasks of economics to analyze carefully each of the inflationist plans, those of Keynes and Gesell no less than those of their innumerable predecessors from John Law down to Major Douglas. Yet, no one should expect that any logical argument or any experience could ever shake the almost religious fervor of those who believe in salvation through spending and credit expansion.

More Magic from Abenomics: 10.3 Trillion Yen in Fiscal Stimulus

Not content that the Bank of Japan (BoJ) has increased monetary stimulus by 50 trillion yen ($595 billion), partly as a result of political pressures and mostly from ideology and peer pressure, the Shinzo Abe led Japanese government will expand fiscal stimulus from the earlier 1 trillion yen ($12.3 billion) to 10.3 trillion ($116 billion)

From Bloomberg,

The Japanese government will spend 10.3 trillion yen ($116 billion) to drive a recovery from a recession in Prime Minister Shinzo Abe’s first major policy initiative to end deflation and boost growth.

Around 3.8 trillion yen will be for disaster prevention and reconstruction, with 3.1 trillion yen directed to stimulating private investment and other measures, according to a statement released today by the Cabinet Office. Extra spending will increase gross domestic product by about 2 percentage points and create about 600,000 jobs, the government said.

PM Abe’s elixir of inflationism will achieve its goal of having price inflation. But as I explained earlier, the desperate attempts to try old ineffective ways but with more of it to achieve new effects is plain absurd.

Given Japan's government's huge debt levels (the world's largest), compounded by major factors as demographics (shrinking population or fertility rate), falling savings rate—which has been manifested through declining support by domestic investors on Japan’s sovereign bonds (JGBs) and where Japan's government has become increasingly reliant on the BoJ’s monetization—and the reversal of current account balance from surpluses to deficits, the ultimate outcome from all these short term nostrum will be one of debt crisis, sooner rather than later.

The initial effect of the combined aggressive interventions via inflationism has been to create a stock market boom…

…but such artificially constructed boom, as manifested by a falling yen, will have to rely on accelerated expansion or the infusions of credit and money which is unsustainable, and which should translate to a future bust—and this will be accompanied by a debt crisis.

Abenomics is really founded on the Philosopher's stone.

As the great Ludwig von Mises warned,

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

The real goal of the alleged radical "Abenomics" is the transfer of wealth from the average Japanese to the political class and their allies.

So aside from the bust, one of the expected consequence from such policies will be capital flight, incipient signs which we are already seeing today but masked as Portfolio flows or FDIs

Japan PM Abe’s Economic Elixir: Inflationism

How will the world not have price inflation when practically political leaders of every developed economies have seen inflationism as a philosopher’s stone and have been intensely pushing for it via monetary policies?

From Bloomberg,

Japan’s incoming Prime Minister Shinzo Abe backed the central bank when it raised interest rates in 2006, a move he now says was a mistake. His shift may signal less tolerance for deflation in the third-largest economy.

Abe, whose party swept to victory in elections for the lower house of Parliament two days ago, will have the chance to reshape the Bank of Japan (8301) next year, when the terms of its governor and two deputies expire. He reiterated yesterday he wants a 2 percent inflation target for the BOJ, which is forecast to boost its asset purchases as soon as Dec. 20…

Kasman’s colleague Masamichi Adachi in Tokyo said last week that the BOJ may this week adopt a “new style of open-ended asset purchases.”

Governments of the US, ECB, Japan and the UK whom has undertaken massive balance sheet expansions via QE, compounded by various forms of declarations for “unlimited” asset buying programs, accounts for over 95% of the $98.4 trillion global bond markets. 

The government’s share of total bond markets has been 45% and growing. (charts courtesy of climatebonds.com) 

This means that as government debt grows (chart above from McKinsey Quarterly), given either the lack of savings or private sector qualms of sustained financing of profligate governments, central bank support of domestic sovereign bonds will also expand through their respective QE or balance sheet expansion programs.

And central bank purchases of government securities are not only inflationary, but raises the risks of hyperinflation.

This also implies that the global bond market represents a ballooning bubble.

And as I have recently pointed out, Japan’s demographics, declining savings, which has been expressed through the declining support by domestic investors on Japan government bonds (JGB) and the reversal of current account balance from surpluses to deficits, only aggravates her unsustainable fiscal conditions that would lead to a debt crisis, perhaps sooner than later.

In addition, the above debunks the myth about central banking independence.  As appointed agents, central bankers will most likely pursue policies preferred by the executive branch of government.

While the elixir of inflationism continues to revitalize the “animal spirits” for now, a crisis of monumental proportions has been building up.

Philosopher Karl Popper as recently quoted by Charles Gave of Gavekal Research strikes at the heart of today’s “free lunch” policies that favors the political elites and their cronies

In an economic system, if the goal of the authorities is to reduce some particular risks, then the sum of all these suppressed risks will reappear one day through a massive increase in the systemic risk and this will happen because the future is unknowable.

Signs of Dancing on the Grave of Keynesianism

Yesterday my quote of the day was about Austrian economist Gary North’s prediction of the twilight of the Keynesian political economy.

Today, Sovereign Man’s Simon Black enumerates of the 8 signs that reveals how the “system is broken”.

Apparently 6 of them represent symptoms of Mr. North’s prophesy.

The 6 signs from Simon Black:

3) Last month, a school district in California sold $164 million worth of bonds at 12.6% interest; this is more than Pakistan, Botswana, and Ecuador pay in the international bond market.

4) Based on the Treasury’s most recent statistics, US government interest payments to China will total at least $26.055 billion this year. The real figure may be much higher given that China has been purchased Treasuries for decades, back when interest rates were much higher. They’re still getting paid on those higher rates today.

Even still, this year’s interest payment to China totals more than ALL the silver that was mined in the world last year.

5) In August 2008, just before the Lehman Brothers collapse, the number of employed persons in the United States was 145.47 million persons. Over the subsequent years, the employment figure dipped to as low as 139.27 million. Today it stands at 142.1 million.

Even if this is considered recovery, to ‘rescue’ those 2.8 million jobs, it took the federal government an additional $6.421 trillion worth of debt ($2.3 million per job), and a $1.9 trillion (203%) expansion of the Federal Reserve balance sheet.

6) Meanwhile, despite trillions of euros in debt and bailouts, the unemployment rate in the eurozone just hit a record high of 11.4%… and a second Spanish bailout is now imminent.

7) Inflation in Zimbabwe (3.63%) is lower than inflation in the UK (3.66%, August 2011-July 2012).

8) Last week, the French government reached a ‘historic’ budget compromise, shooting for a budget deficit that’s ‘only’ 3% of GDP. This is based on an assumption that the economy will grow by 0.8%.

In other words, France’s official public debt (which is already at 91% of GDP) will increase by 2.2% of GDP next year amid flat growth. And this is what these people consider progress.

From Cato’s Dan Mitchell

To add, last month the French government approved of the 75% tax on those earning over one million euros a year — by holding public spending and not cutting government jobs (IBD). So the French class warfare policy essentially kills the proverbial goose that lays the golden eggs.

So by maintaining the unproductive segments of a society who entirely depends on the shrinking the productive sectors, French politicians believe that the Santa Claus Fund will never end and instead would bring about prosperity.

The populist measures undertaken by the French government essentially assures of the diffusion and the intensification of the Euro crisis which most likely serves as the death warrant for the euro.

Events in France will perhaps herald the coming global debt default that will engulf most of developed nations and emerging economies whose economies have been predicated on the Keynesian parasitical relationship welfare-warfare states.

In a world of politics, common sense is uncommon specially backed by obtuse theories moored on the belief of the Philosopher’s stone of turning lead into gold.

As the distinguished Ron Paul recently wrote,

It's because too many politicians believed that a free lunch was possible and a new economic paradigm had arrived. But we've heard that one before — like the philosopher's stone that could turn lead into gold. Prosperity without work is a dream of the ages.

The Coming Debt Default Binge: US Debt Surged $6,866,712,084,997.92 in 5 Years!

The policy of record debt financed spending in the US continues…

From CNSNews.com (hat tip Sovereign Man)

By the end of the third quarter of fiscal 2012, the new debt accumulated in this fiscal year by the federal government had already exceeded $1 trillion, making this fiscal year the fifth straight in which the federal government has increased its debt by more than a trillion dollars, according to official debt numbers published by the U.S. Treasury.

Prior to fiscal 2008, the federal government had never increased its debt by as much as $1 trillion in a single fiscal year. From fiscal 2008 onward, however, the federal government has increased its debt by at least $1 trillion each and every fiscal year.

The federal fiscal year begins on Oct. 1 and ends on Sept. 30. At the close of business on Sept. 30, 2011—the last day of fiscal 2011—the total debt of the federal government was $14,790,340,328,557.15. By June 29, the last business day of the third quarter of fiscal 2012, that debt had grown to $15,856,367,214,324.44—an increase for this fiscal year of $1,066,026,885,767.29.

In the fourth quarter of fiscal 2012, the federal debt has continued to accumulate, hitting $15,874,365,457,260.40 at the close of business on Thursday, July 19—marking a total increase so far in fiscal 2012 of $1,084,025,128,703.25.

In fiscal 2007, according to the U.S. Treasury, the federal government’s debt increased $500,679,473,047.25. But that marked the last fiscal year in which the federal government's debt did not increase by at least $1 trillion.

In fiscal 2008, the debt increased $1,017,071,524,650.01. In fiscal 2009, it increased $1,885,104,106,599.26. In fiscal 2010, it increased $1,651,794,027,380.04. And in fiscal 2011, it increased $1,228,717,297,665.36.

So far this fiscal year (which is a leap year of 366 days), the Treasury has increased the net debt of the federal government at an average rate of $3,699,744,466.56 per day. If that average were to hold up for the 73 days that remained in the fiscal year after July 19, the debt would increase in fiscal 2012 by a total of $1,354,106,474,762.13—a greater increase than last year.

At the close of business on Sept. 30, 2007--which marked the beginning of fiscal 2008--the total debt of the federal government stood at $9,007,653,372,262.48. At the close of business on July 19, it stood at $15,874,365,457,260.40--an increase of $6,866,712,084,997.92 in less than five years.

I find the argument of a sustained low interest environment from the intensifying growth of the current level of indebtedness as specious reasoning.

Japan in the 90s or the Great Depression days of the 1930s signify as apples to orange comparison for the simple reason that current degree of indebtedness has been global and has been unprecedented.

Again one cannot count on history alone (e.g. Reinhart-Rogoff) as an accurate roadmap for the future as everything will depend on how such dynamics will be dealt with. Will the growth rate of debt based political spending continue? Who will finance these? And up to what extent? If funded by central banks up to what point before (consumer price) inflation surfaces and becomes an economic menace (stagflation, if not hyperinflation)? Will governments strangulate the economy with more repressive regulations or will governments undertake “shock liberalization” (J. Cochrane)?

The current scale of debt implies that these countries will be competing with each other for limited savings from residents and non-residents for financing. (chart from Zero Hedge)

This is why we are seeing a crisis in the Eurozone…

…a crisis that will likely spillover to the rest of the nations encumbered by huge liabilities.

For crisis affected PIIGS, obviously a low interest rate regime has gone pfffftt. This is the revenge of the bond vigilantes.

The (liberal) counterargument will say that the crisis stricken PIIGS doesn’t have the same ability as Japan or the US to print their own money. That’s unalloyed hogwash.

Any argument that sees printing money as a way to prosperity IS delusional. Eventually such craving for the philosopher’s stone will be exposed for what they truly are: a fraud.

As the great Ludwig von Mises warned,

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

Interest rates will eventually rise (everywhere) to reflect on either the disproportional distribution or imbalances between the level of savings and debt OR an inflationary surge (or perhaps even both). There is no such thing as a free lunch.

Bad News is Good News: US Manufacturing Activity Contracts

Signs of economic slowdown has percolated to the US, but global stock markets remain buoyant.

From Bloomberg,

Manufacturing in the U.S. unexpectedly shrank in June for the first time since the economy emerged from the recession three years ago, indicating a mainstay of the expansion may be faltering.

The Institute for Supply Management’s index fell to 49.7, worse than the most-pessimistic forecast in a Bloomberg News survey, from 53.5 in May, the Tempe, Arizona-based group’s report showed today. Figures less than 50 signal contraction. Measures of orders, production and export demand dropped to three-year lows.

Treasury yields fell on concern Europe’s debt crisis and a slowdown in Asia are taking a bigger toll on the world’s largest economy and hurting manufacturers like DuPont Co. (DD) and Steelcase Inc. (SCS) Assembly lines are at risk of slowing further as consumers temper purchases and companies cut back on investment…

The ISM index, which dropped to its lowest level since July 2009, was less than the median forecast of 52 in the Bloomberg survey. Estimates of 70 economists ranged from 50.5 to 53.5. The gauge averaged 55.2 in 2011 and 57.3 the prior year.

No Recession

Today’s reading is well above the 42.6 level that generally indicates the economy as a whole is expanding, according to ISM…

Manufacturing is also weaker in the rest of the world. The industry in the euro-area contracted for an 11th straight month in June as Europe’s debt crisis sapped demand. A measure of the region’s factories held at 45.1, London-based Markit Economics said.

No worry, bad news has never been a problem as central banks are expected to ride like the fabled knights to save the damsel in distress.

From another Bloomberg article,

Japanese and Australian stock futures rose on expectations that a contraction in U.S. manufacturing may encourage the Federal Reserve to ease monetary policy as the European Central Bank cuts interest rates to help contain the region’s sovereign-debt crisis.

Yet another article from Bloomberg,

Asian stocks climbed for a fifth day, the longest rising streak on the regional benchmark index since March, on expectations that central banks from Washington to Frankfurt may ease monetary policy to spur economic growth…

“The prospect for central banks easing policy gives us a good setup for equity markets globally,” said Mikio Kumada, a global strategist in Singapore at LGT Capital Management, which manages more than $20 billion globally…

The weakness in manufacturing may encourage more accommodative policies from the Federal Reserve, Princeton University economist Alan Blinder said in an interview on Bloomberg Television’s “Market Makers” with Erik Schatzker and Scarlet Fu.

The mantra of money printing as the Holy Grail have always been popular. As the great Professor Ludwig von Mises observed

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last

Yet 5 years of sustained inflationism have only worsened the crisis.

Inflationism is like religion, it is based on faith.

Absent real actions, until when can stock markets rise on mere ‘talk therapy’ or on expectations that central banks will deliver the ‘Bernanke PUT’? When will reality collide with hope?

Be careful out there.

Video: The Spend Your Way to Prosperity Drug

This LOL (laugh out loud) video from the Concerned Women for America Legislative Action Committee on the new miracle drug (hat tip Cato's Dan Mitchell)



Spending your way to prosperity signifies a snake oil remedy peddled by politicians and ever knowing self righteous socialist adherents everywhere.

China' Potemkin Cities and Malls

Here are two videos showing China's obsession towards Keynesian GDP spending which has resulted, so far, to 64 million vacant apartments from China's building of 10 new cities every year. (pointer to Israel Curtis, Mises Blog)

This obsession towards achieving statistical GDP from central planning reminds me of two John Maynard Keynes quotes,

The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi boom.

If the Treasury were to fill old bottles with bank-notes, bury them at suitable depths in disused coal-mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of repercussions, the real income of the community, and its capital wealth, would probably become a good deal greater than it actually is.

The obvious result has been an ongoing quasi-boom (as Keynes has predicted) but which ultimately will be faced with the restrains from natural the law of economics which equates to a prospective bust (from the Austrian perspective).

The desire to uphold the Keynesian unemployment goals will backfire and result to China's version of today's MENA political crisis.

First video is from Dateline


Second video from AlJazeerah

To quote the great Ludwig von Mises,(bold highlights mine)

There are still teachers who tell their students that “an economy can lift itself by its own bootstraps” and that “we can spend our way into prosperity.” But the Keynesian miracle fails to materialize; the stones do not turn into bread. The panegyrics of the learned authors who cooperated in the production of the present volume merely confirm the editor’s introductory statement that “Keynes could awaken in his disciples an almost religious fervor for his economics, which could be affectively harnessed for the dissemination of the new economics.” And Professor Harris goes on to say, “Keynes indeed had the Revelation.”

There is no use in arguing with people who are driven by “an almost religious fervor” and believe that their master “had the Revelation.” It is one of the tasks of economics to analyze carefully each of the inflationist plans, those of Keynes and Gesell no less than those of their innumerable predecessors from John Law down to Major Douglas. Yet, no one should expect that any logical argument or any experience could ever shake the almost religious fervor of those who believe in salvation through spending and credit expansion.

China’s State Driven Bubble

Who is responsible for inflating China’s Bubble?

Her Government.

This from the New York Times, (bold emphasis mine)

All around the nation, giant state-owned oil, chemical, military, telecom and highway groups are bidding up prices on sprawling plots of land for big real estate projects unrelated to their core businesses.

“These are the ones that have the money to buy the land,” says Prof. Deng Yongheng at the National University in Singapore. “Because in China, it’s the government that controls the money supply and the spending.”

By driving up property prices, the state-owned companies, which are ultimately controlled by the national government, are working at cross-purposes with the central government’s effort to keep China’s real estate boom from becoming a debt-driven speculative bubble — like the one that devastated Western financial markets when it burst two years ago.

Land records show that 82 percent of land auctions in Beijing this year have been won by big state-owned companies outbidding private developers — up from 59 percent in 2008.

This is looking very much like the transitioning phases of the Austrian Business Cycle...

(all charts from World Bank China’s Quarterly report and IMF’s People’s Republic of China: 2010 Article IV Consultation)

From the rapid expansion of circulation credit….

to exploding money supply growth…

mostly directed at future oriented capital structure in this case, real estate.

Frothy real estate markets…

….the deepening exposure by the banking system to the property-real estate sector.

Add that to the Chinese government’s crowding out of the private sector by her state owned enterprises bidding up on land, which worsens the bubble conditions and fosters systemic malinvestments.

And most importantly, artificially suppressed interest rates have been crucial to these dynamic.

Well, since bubbles come in phases, muted inflation hasn’t YET been much of a factor in pressuring interest rates higher.

So perhaps the bubble will persist.

This reminds me of Ludwig von Mises who once wrote, (emphasis added)

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

In fullness of time, China’s policies of turning stone into bread (philosophers' stone) will end in tears.

For now, party on!

The Zombie-fication Of Financial Markets

World markets appear to be increasingly transmogrifying into zombie markets.

This from the New York Times,

``A week after rattling global bourses and annoying allies with a unilateral ban on some forms of financial market speculation, Germany went much further Tuesday, proposing a law that would greatly broaden restrictions on several instruments that investors use to bet against stocks, bonds and currencies.

``Despite criticism that market regulation will be toothless unless it is enacted globally, the German finance minister, Wolfgang Schäuble, on Tuesday proposed extending a ban on what the draft legislation called “certain transactions that amplify the crisis.”

``There is broad support for such measures among leaders on both sides of the Atlantic, and some of the proposed rules are already in effect in the United States. Other European nations, however, have complained about Germany’s decision to act alone.

``“What the Germans are doing would be all the more effective if it were done at a coordinated European level,” Chantal Hughes, a spokeswoman for Michel Barnier, the European Union internal markets commissioner, said Tuesday.

``The draft law, released Tuesday by the German Finance Ministry, expands a ban on so-called naked short-selling to all stocks that have their primary listing in Germany, as well as on government bonds issued by euro countries.

``The law, which will take at least until September to win passage in Parliament, would also ban naked short-selling of the euro, and enshrine a ban on use of so-called credit default swaps to bet against European government bonds."

What the news reveals is how mainstream politicians think. They believe they can:

1.control or manipulate the markets at will, with no unintended effects. (yes, they seem to think that as deified entities, they are far superior to market forces and above the laws of scarcity)

2. prevent markets from revealing their natural state by controlling price signals. Thus, a market collapse markets isn't in their books. (yet the markets have been collapsing)

3. paper over solvency issues with massive liquidity injections and price control measures.

More demand for zombification...

From BCA Research,

``History shows that whenever authorities limit the commitment to a particular value, it encourages investors to quantify their worst case scenario (which during times of financial sector strains can be horrific), leading to a panic and meltdown. It is only once policymakers provide a credible unconditional commitment to put an end to the turmoil that investors’ fears calm, allowing financial markets to stabilize. Unfortunately, the “open-ended” nature of European policmakers’ commitment has come into question: German authorities moved to prevent speculative attacks by banning naked short selling for 10 German bank stocks as well as for CDS on regional government debt. Similarly, the ECB continues to reiterate their intent to sterilize purchases of public and private debt securities, i.e. not quantitative easing. The decision on short selling should not be a large surprise given that the primary motive of German politicians to participate in any rescue package has been to protect their domestic banks. The only good news is that German lawmakers have approved its country’s share of the $1 trillion bailout package. Still, the ECB will need to be much more forceful in its reflationary efforts. Bottom line: The ECB should reassure markets that any expansion of its balance sheet will be unwound in an orderly fashion once the economy is on a stable footing. In the meantime, substantial quantitative easing must be undertaken."

First of all, the claim of "history" as reference is dubious. That's because all these debt binges, rescue efforts and reflationary measures, have been unprecedented in scale and in scope, so there is basically no basis for comparison.

Besides in our own Asian crisis, an open-ended rescue was not an option, instead we were prescribed to adapt "austerity" programs via structural adjustment programs (SAP).

Only today, do we see the "need" for massive or aggressive substantial quantitative easing. In short, money printing as a policy is selective and conveniently applied, where it involves the developed nations. It becomes not only a fashion but a false sense of entitlement.

Yet as we keep pointing out, even Keynesian Hyman Minsky believes that massive government intervention leads to systemic bubbles by engendering the moral hazard conditions that sow the seeds of a bubble.

And likewise, as noted above, substantial QE's or money printing won't solve the solvency issues. They merely "kick the can" or defer and even aggravate the day of reckoning. Yet, history has never been quite digested, but misrepresented.

In the words of Thomas Paine, ``I remember a German farmer expressing as much in a few words as the whole subject requires; "money is money, and paper is paper."

``All the invention of man cannot make them otherwise. The alchemist may cease his labors, and the hunter after the philosopher's stone go to rest, if paper can be metamorphosed into gold and silver, or made to answer the same purpose in all cases."

If printing money is, indeed, the elixir to the world's problem, then Zimbabwe should have been the most prosperous and the world's largest exporter.

Besides, based on this line of reasoning, why do we or anyone need to work, if, at all, money printing can solve the issue of scarcity? Why do we even need the markets?

Why The Hike In The Fed’s Discount Rate Is Another Policy Bluff

``Certainly not without justification, the markets came to the recognition that yesterday’s increase in the discount rate did not signal any imminent tightening of financial conditions. It will be interesting to see if the markets eventually end up calling a bluff on Fed “exit” policies more generally.”-Doug Noland, The Beginning of Tightening?

The US Federal Reserve surprisingly raised its discount rate or its overnight lending rates to banks!

However, it maintained the Fed Fund rates, or the interest rates banks charge to each other, while it also shortened the maturity for primary credit on the discount window.

The widening of the spread of the Discount rate and the Fed Fund rate, according to the Federal Reserve Board, ``will encourage depository institutions to rely on private funding markets for short-term credit and to use the Federal Reserve's primary credit facility only as a backup source of funds.”

Figure 1: FT Advisors and Northern Trust: Spread of Discount and Fed Rates and Reserve Bank Credit

The fact of the matter is that the Federal Reserve has been reacting to the meaningful current improvements of market conditions, where access to the emergency credit window of the Federal Reserve has apparently been on a decline (see figure 1 right window).

The Federal Reserve has also been in the process of withdrawing other emergency programs prior to this week’s surprise. According to the Businessweek, the central bank has ``closed its emergency aid programs to money markets, bond dealers and foreign central banks.”

Since the cost of borrowing from using the Federal Reserve’s discount window would be higher than the interest rates of banks charge to each other, then the present policy adjustments incentivizes the banking system to wean from dependence on the central bank funding.

Nonetheless, the Fed’s action could be read as ex-post reaction of the little used programs which Asha Banglore of Northern Trust aptly labels as programs “dying a natural death”.

Markets Reaction To The Federal Reserve Policy Changes

We said that the Fed’s action had been a surprise, that’s because while everyone knew it was coming, no one exactly knew of the timing.

Nevertheless, Fed officials immediately rushed into “calming” of the markets such as Federal Reserve Bank of Atlanta President Dennis Lockhart who was quoted by Bloomberg, “I would not interpret this action as a tightening of monetary policy or even a sign that a tightening is imminent,” Lockhart said. “Rather, this action should be viewed as a normalization step.” (italics mine)

It’s the same with Federal Reserve Bank of New York President William Dudley who called the adjustment “technical” in nature. The Wall Street Journal blog quotes Mr. Dudley, “We made a very small technical change” by raising the discount rate, Dudley said. “The action yesterday was really an action about the improvement in banks,” and reflected the fact these institutions no longer need this emergency source of cheap funding the way they did during the depths of the financial crisis, the official said.

``The discount rate increase “is not at all a signal of any imminent tightening” in monetary policy, and the Fed’s commitment to keep rates very low for an extended period “is still very much in place,” Dudley said.” (italics mine)

First Trust’s Brian Wesbury and Robert Stein noted that Ben Bernanke appeared to have telegraphed this action during his congressional testimony last week.

Mr. Wesbury and Mr. Stein quotes Mr. Bernanke: ``(B)efore long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate. These changes…should be viewed as further normalization of the Federal Reserve's lending facilities, in light of the improving conditions in financial markets; they…should not be interpreted as signaling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC.” (italics mine)

But of course not everyone is pleased.

David Kotok of Cumber Advisors thinks that the “surprise” factor more than the policy action itself constituted as uncertainty.

He sardonically writes, ``By using this surprise the Fed has introduced some confusion into markets. It doesn’t mean rates are going up tomorrow or next month or by mid-summer. But it does mean that an additional uncertainty has been introduced into market pricing. Interest rates will now reflect this uncertainty. The dollar strengthened immediately as one would expect it to do. Currency exchange rates are now the first thing to react to changes in policy. And this was a change in policy event though the Fed says it is not so…

``But the Fed has now added an uncertainty premium and markets are adjusting to it. That means somewhere, some mortgage will not get refinanced. And somewhere, some bond financing will cost more to accomplish. And somewhere, some US manufacturer who exports will face a headwind because the dollar is stronger and his foreign competitor can sell more cheaply than yesterday. And somewhere, some person is not going to get hired because this uncertainty has raised the risk of hiring to the employer. That, friends, is a tightening.”

In my view, the market’s reaction to unexpected information matters most. It’s simply people reacting by voting with their wallets!

Figure 2: stockcharts.com: Financial Markets Shrugs Off Discount Rate Hike

While the US dollar had an intraday spike following the “surprise” announcement, which subsequently faltered, the rising US dollar or the new policy action failed to contain the gains of the US broad based equity index the S & P 500, which incidentally rose 3% over the week! (I heard somebody uttered the US dollar carry trade?? Where???)

Importantly, major commodities as gold (+3.8%), silver (+4.96%), copper (+8.9%), oil (WTIC-7.5%) and the CRB (3.7%) index soared!

The advances of gold prices had even been subdued due to the IMF announcement of its second batch of on-market phase gold sales program, which amounted to 191.3 metric tons out of the original 403.3 metric tons, a day ahead of the Fed action.

What the markets appear to be saying is that the newly adapted policies by the Fed could likely be even more inflationary!

Are the markets suggesting that US interbank lending is likely to improve thereby venting its effect currently on the markets which would extrapolate to a spillover effect into the real economy?

In other words, markets appear to have reacted in stark defiance to mainstream expectations.

Yet despite the Fed’s purported efforts to rollback its influences, in my opinion, they still contribute immensely to the direction of the marketplace.

Figure 3: Federal Reserve Bank of Atlanta: Federal Reserve Assets

The Fed continues to balloon its balance sheet with purchases of agency debt and agency backed mortgaged back securities (MBS) which according to the Federal Reserve of Atlanta has reached 96% and 95% of respective Quantitative Easing (QE) quotas (see figure 3).

So while some mischievous minds could be entertaining the thought of the Fed or the US government could have been tweaking the markets, a generalized manipulation of sundry markets seems improbable.

Of course a day or a week doesn’t a trend make, which means we are likely to ascertain the sustainability of the market’s reaction over the coming sessions.

Although if the present momentum continues at its present pace then deflation advocates are likely in for a big a surprise!

The Philosopher’s Stone As The Dominant Policy

Notice further that the Fed’s campaign to pacify the markets had been directed at the assurance that the said adjustments in policies had not been aimed at tightening. Said differently, the promise is that the environment of cheap funding will remain intact.

In addition, the gingerly approach by Fed officials simply reveals what we’ve been saying all along…policymakers are so highly sensitive to the direction of asset prices as to concentrate their verbal signaling on maintaining current monetary conditions.

From these premises, should we believe that the Federal Reserve will meaningfully withdraw, even factoring in its present actuations?

My answer is NO.

Why?

Because aside from the entrenched economic ideology that has been institutionalized in the technocratic bureaucracy [as discussed in Getting Ahead Of The Curve], the path of the Fed’s policies are seemingly being telegraphed in terms of ‘political pressure’ from what is projected as ‘political consensus’.

The vast tentacles of the US Federal Reserve in the academia, Wall Street and related political institutions could be working to paint the impression that there is a popular clamor to use inflation as the most effective tool to resolve the current economic predicaments.

Proof?

In a morbid fear of deflation, these networks of experts have been pushing hard for policies that would inflate away the debt in the system which they believe could simultaneously buoy nominal economic growth rates.

For instance, IMF’s chief economist Oliver Blanchard recently asked central banks to consider a higher rate of inflation. Basing his recommendations from a study by his IMF economist underlings, Mr. Blanchard recommends an annualized target of 4% to deal with the present predicament.

According to the Wall Street Journal, ``In a new paper with two other IMF economists, Giovanni Dell'Ariccia and Paolo Mauro, Mr. Blanchard says policy makers need to consider radically different approaches to deal with major banking crises, pandemics or terrorist attacks. In particular, the IMF paper suggests shooting for a higher-level inflation in "normal time in order to increase the room for monetary policy to react to such shocks." Central banks may want to target 4% inflation, rather than the 2% target that most central banks now try to achieve, the IMF paper says.

``At a 4% inflation rate, Mr. Blanchard says, short-term interest rates in placid economies likely would be around 6% to 7%, giving central bankers far more room to cut rates before they get near zero, after which it is nearly impossible to cut short-term rates further.”

Morgan Stanley’s Spyros Andreopoulos sees an average inflation rate of 4-6% to stabilize public debt.

Bloomberg’s Caroline Baum cites Harvard luminaries asking for nearly the same levels of inflation, ``Last May Harvard University economists Ken Rogoff and Greg Mankiw joined a chorus advocating higher inflation. Rogoff lobbied “for at least 6 percent for a couple of years” to help the deleveraging process while Mankiw saw inflation as a better alternative to more stimulus packages and higher national debt.”

One must be reminded that Ken Rogoff was the chief economist for the IMF (2001-2004) and Greg Mankiw was chairman of the Council of Economic Advisers for ex-President George Bush.

But why stop at 4-6%?

Ms. Baum mockingly remarks, ``if 4 percent is good, 8 percent should be better and 10 percent better yet!”

As Ludwig von Mises had warned, `` In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.” All these are simply manifestations of the political elite chronic addiction to inflationism.

Yet for the mainstream what matters is a band-aid approach in dealing with structural problems, with little concerns on the long term repercussions. As Cato’s Jerry O'Driscoll comments on an article, ``A little bit of inflation is like being a little bit pregnant. Once the process has begun, it is ended at only great cost.”

To consider, with the Fed’s quantitative easing program nearing completion and considering that the US mortgage market has been dependent on [where 9 out of 10 mortgages have been estimated to have been owned or guaranteed by], the US government, an abrupt retreat from the markets is a scenario that would likely be unacceptable to politicians and the bureaucrats. Besides, whatever short term political gains accrued today could be perceived as being negated by a sudden withdrawal.

Hence, the support for the housing market via the mortgage markets will likely be sustained, although the difference would be in the manner of how funding will be obtained. Most possibly this will be through the extension of quantitative easing by the Federal Reserve or through the US treasury by issuing sovereign liabilities (the latter could also be tacitly financed by the Fed) to cover the deficits or losses.

At the end of the day, mortgage investors are likely to be subsidized by the US government at the cost of the US taxpayers [Dr. John Hussman calls this “How to spend (up to) $1.5 trillion without Congressional approval”]. These are the kind of redistributive policies that will eventually erode the comparative advantages of the US relative to the world.

To add, as mentioned in Poker Bluffing Booby Traps: PIMCO And The PIIGS, there are many prominent personalities who superficially use “economic” analysis to masquerade as political propaganda.

The typical or identifiable approach by political propagandists would be for them to issue “analysis” that limns on a dire environment, where the helplessness of the situation would necessitate for more government intervention, via inflationism, as the only feasible solution.

As Professor Bryan Caplan aptly conveys, ``This pessimistic bias is a general-interest prop to political demagoguery of all kinds. It creates a presumption that matters, left uncontrolled, are spiraling to destruction, and that something has to be done, no matter how costly or ultimately counterproductive to wealth or freedom. This mind-set plays a role in almost every modern political controversy, from downsizing to immigration to global warming.” (bold highlight mine)

So I’d be leery of heeding ‘doomsday’ analysis from the progressive camp. They signify no less than self fulfilling propaganda predicated on the addiction to inflationism.

The bizarre part is that even if these experts know how baneful the after effects of inflation can be, they refuse to acknowledge that the path of any form of addiction is self-destruction.

They are inclined to believe in the alchemy of the philosopher’s stone where they can turn lead into gold or attain the elixir of life by the miracle of converting stones into bread.

Meanwhile, markets are likely to continue manifesting incremental signs of inflation, which will persist to seep through markets, consumer prices and into the economic system, both in the US and around the world.

This is not only because of the impact of past policies but also of the direction of prospective political policies.

As we said at the start of the year, Poker Bluff: The Exit Strategy Theme For 2010, we are likely to be faced with policy bluffs until authorities are faced with the true menace.