Political Paralysis Paves Way to Bubble Bust Conditions

If politics continue to shackle central bankers, then the risks of a slowdown transitioning to a recession will get magnified.

The lucid example of political deadlock hounding the markets from the EU seems best captured by this Telegraph report[1]

The head of the European Central Bank hit out at the political paralysis gripping the region as he warned the eurozone's set-up was "unsustainable"

Mario Draghi said the central bank could not "fill the vacuum" left by member states' lack of action as it was claimed the zone is on the point of "disintegration".

Amid escalating talk of a potential bail-out for Spain, the president of the ECB said the central bank was powerless to stop the debt tornado. "It's not our duty, it's not in our mandate" to "fill the vacuum left by the lack of action by national governments on the fiscal front," he said.

Over at the worsening economic conditions in China, political debates over policy have once again been best illustrated by this comment from a former central banker turned representative for a think tank[2]

Americans and Europeans like it. Investors like it because they want to speculate on stocks. The whole world is hoping China will relax policy," Xia told Reuters.

"We will fall into a trap if we do. We will not be that stupid," Xia said, adding that the government should only stimulate economic growth in a "balanced and modest" way, while forging ahead with structural reforms to sustain growth over the longer term. China stimulus unnecessary, risks long-term damage

As a reminder, the current issue here has NOT been about a supposed “squeeze” on government spending and the supposed effects of low levels of capital from it.

The bank runs in the PIGS dismisses this false and self-contradictory logic, Spain experienced 100 billion capital flight during the first 3 months[3], as bank runs have been symptomatic of the fear of devaluations on the heightened prospects of a severance of EU ties.

The monumental capital flight has produced negative interest rates on the treasury yields of Switzerland[4] (see above) and also in Denmark.

Instead, the issue here has been the unwinding of MASSIVE malinvestments from EXCESSIVE government spending (welfare, bureaucracy, bailouts, and etc…) that has not only produced unsustainable loads of debt, but also resulted to the CROWDING out of the private sector investments. When government confiscates scarce private sector resources through taxation and spends it, the private sector losses ‘capital’ and opportunity from which to undertake productive activities. This is known as OPPORTUNITY costs; something which becomes a monumental blackhole to mainstream logic, whose ideas are premised on the laws of abundance.

Of course, add to this the misdirected resources from private the sector, particularly the real estate industry, whom had been induced by bubble ‘convergent interest rate’ policies.

The capital flight from crisis affected Euro nations has also been affecting the US where volatile money flows could exacerbate the current boom-bust dynamics. Add to this policy actions to address on such flows[5].

Yet the predicament of crisis afflicted EU nations has essentially been about vastly diminished competitiveness from asphyxiating bureaucracy and choking regulations, particularly in the labor markets[6].

Accounts of massive tax avoidance from current tax increases only debunk the supposed solution of increased government spending. Greeks have shown that they have not been amenable to paying NEWLY IMPOSED taxes[7].

If people truly believed that government spending is the solution then they would have volunteered payment for taxes. In reality, both the intensifying tax avoidance and capital flight defeats the silly statist illusory elixirs.

Even China today has been revealing signs of emergent bank runs[8] and such bank run seems to coincide with the recent depreciation of the yuan relative to the US dollar. This increases signs of uncertainty over China’s bubble economy.

Yet in general, current uncertainty has been aggravated by the political paralysis which has led central bankers to dither from pursuing further inflationist policies.

This Reuters article entitled “Central Banks to hold fire... for now[9]” nails it.

The intensifying euro zone crisis and uncertain global growth outlook have raised hopes for a policy response from major central banks but, while it could be a close call, they are likely to resist pressure to act in the coming week.

When central banks and the banking system stops or withholds from further inflating, the ensuing market reaction from a PREVIOUS inflationary Boom would be a Bubble Bust.

As the great dean of Austrian school of economics explained[10]

For the banks, after all, are obligated to redeem their liabilities in cash, and their cash is flowing out rapidly as their liabilities pile up. Hence, the banks will eventually lose their nerve, stop their credit expansion, and in order to save themselves, contract their bank loans outstanding. Often, this retreat is precipitated by bankrupting runs on the banks touched off by the public, who had also been getting increasingly nervous about the ever more shaky condition of the nation's banks.

The bank contraction reverses the economic picture; contraction and bust follow boom. The banks pull in their horns, and businesses suffer as the pressure mounts for debt repayment and contraction…

This, then, is the meaning of the depression phase of the business cycle. Note that it is a phase that comes out of, and inevitably comes out of, the preceding expansionary boom. It is the preceding inflation that makes the depression phase necessary.

Pieces of the jigsaw puzzles have been falling right in place into the boom bust picture.

And another thing, if there should be a global recession it is not certain that this will be deflationary, as this will depend on how central bankers react. The term deflation has been adulterated by deliberate semantical misrepresentations.

Not all recessions imply a monetary deflationary environment as alleged by a popular analyst. The US S&P 500 fell into TWO bear markets 1968-70 and 1974-1975 even as consumer price inflation soared (blue trend line).

If in case the same phenomenon should occur where stagflation becomes the dominant economic landscape, then a bear market in stocks will likely coincide with a bull market in commodities.

Yet for now everything remains highly fluid with everything dependent on the prospective actions by policymakers

As of this writing, reports say that the EU has been preparing for the $620 ESM Rescue fund for July[11]. If this is true then perhaps, this means the ECB will begin her next phase of massive monetization of debt.

Let me reiterate my opening statement of last week[12]

Like it or not, UNLESS there will be monumental moves from central bankers of major economies in the coming days, the global financial markets including the local Phisix will LIKELY endure more period of intense volatility on both directions but with a downside bias.

I am NOT saying that we are on an inflection phase in transit towards a bear market. Evidences have yet to establish such conditions, although I am NOT DISCOUNTING such eventuality given the current flow of developments.

What I am simply saying is that for as long as UNCERTAINTIES OVER MONETARY POLICIES AND POLITICAL ENVIRONMENTS PREVAIL, global equity markets will be sensitive to dramatic volatilities from an increasingly short term “RISK ON-RISK OFF” environment.

And where the RISK ON environment has been structurally reliant on central banking STEROIDS, ambiguities in political and monetary policy directions tilts the balance towards a RISK OFF environment.

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[1] Armistead Louise Eurozone is 'unsustainable' warns Mario Draghi, Telegraph.co.uk, May 31, 2012

[2] See HOT: China’s Manufacturing Activity Falls Sharply in May June 1, 2012

[3] CNBC.com Spain Reveals 100 Billion Euro Capital Flight, June 1, 2012

[4] Bloomberg.com Switzerland Govt Bonds 2 Year Note Generic Bid Yield

[5] See The Coming Colossal Bernanke Bubble Bust May 30, 2012

[6] See Germany’s Competitive Advantage over Spain: Freer Labor Markets, May 25, 2012

[7] See Is Greece Falling into a Failed State? May 28, 2012

[8] See Is China Suffering from Bank Runs too? June 2, 2012

[9] Reuters.com Central Banks to hold fire... for now, June 2, 2012

[10] Rothbard Murray N. Economic Depressions: Their Cause and Cure, Mises.org

[11] See HOT: EU Readies $620 ESM Rescue Fund for July, June 3, 2012

[12] See The RISK OFF Environment Has NOT Abated, May 27, 2012

Chart of the Day: America’s Fast Expanding Welfare State

From the Wall Street Journal Blog,

Families were more dependent on government programs than ever last year.

Nearly half, 48.5%, of the population lived in a household that received some type of government benefit in the first quarter of 2010, according to Census data. Those numbers have risen since the middle of the recession when 44.4% lived households receiving benefits in the third quarter of 2008.

The share of people relying on government benefits has reached a historic high, in large part from the deep recession and meager recovery, but also because of the expansion of government programs over the years. (See a timeline on the history of government benefits programs here.)

Means-tested programs, designed to help the needy, accounted for the largest share of recipients last year. Some 34.2% of Americans lived in a household that received benefits such as food stamps, subsidized housing, cash welfare or Medicaid (the federal-state health care program for the poor).

Another 14.5% lived in homes where someone was on Medicare (the health care program for the elderly). Nearly 16% lived in households receiving Social Security.

Aside from the bailout policies, this serves as one significant reason why prospective US economic growth, as manifested by the current elevated rate of unemployment and low output, will progressively become lethargic as scarce resources are diverted towards more non-productive, capital consuming activities.

Importantly, US politics will increasingly be sensitive to the maintenance and the advancement of the unsustainable system of the welfare state.

To wean away dependants from this system, which has become more entrenched, will be considerably difficult and destabilizing.

Perhaps it may come to a point where the markets will force a tragic resolution, partly similar to what’s been happening to Greece.

Moreover, the US political spectrum will likely be dominated by class divisions, where welfare beneficiaries and their political patrons will call for more taxation in support of the pocket picking welfare policies.

The result of a recent poll exudes this political climate

From another Wall Street Blog,

Poll after poll shows that a majority of Americans support higher taxes on the wealthy, even when “wealthy” is defined as those making more than $250,000 a year.

Presumably, most of those polled don’t make the income cut-off, so it’s easy for them to demand that someone else pay for the nation’s debt.

Political divisions, from such class warfare, would only encourage instability and abet on violence.

In addition, the welfare state will continually be funded by debt that will ultimately lead to an outright default or will be inflated upon.

Ludwig Wilhelm Erhard, former economic minister and Chancellor, architect of Germany’s postwar economic reform and economic recovery popularly known as "Wirtschaftswunder" or "economic miracle", in his book Prosperity through Competition wrote a very apropos admonition on the dangers of the welfare state (p.187) [emphasis added]

if this mania increases we shall slide into a social order under which everyone has one hand in the pocket of another. The principle would then be: I provide for someone else and someone else provides for me.

The blindness and the intellectual inertia which are pushing us towards a Welfare State can only bring disaster. This, more than any other tendency, will serve slowly but surely to kill the real human virtues—joy in assuming responsibility, love for one’s fellow being, an urge to prove oneself, a readiness for oneself—and in the end there will probably ensue not a classless but a soulless mechanical society.

The Parallels Of The Philippine Con Ass And The Honduran Political Crisis

In a recent post on Philippine politics, particularly, the brouhaha over the CON ASS we wrote, ``We must remember, in politics, those in power will always work or attempt to preserve their political privileges, while those in the periphery will always work or attempt to usurp such privileges. Such is the vicious cycle of politics.’ [See Philippine Politics: "Con Ass" Much Ado About Nothing?]

Well, the ongoing political crisis in Honduras could be interpreted as a seeming parallel to the local Con Ass situation. Basically, it's about an attempt by the incumbent political leader to extend his stay in power.

Honduran President Jose Manual Zelaya wanted to force a referendum on his people to approve a new constitution to achieve this goal.

Sounds familiar?

This from Cato’s Juan Hidalgo,

``Zelaya, a close ally of Hugo Chávez, is barred from pursuing a second term in the general elections in November.

``Unfortunately for Zelaya, he doesn’t have the backing of his own party, much less any other major political group. So he has moved unilaterally to call for a referendum on the need for a new constitution. The vote, which is scheduled for this Sunday, has been declared illegal by the Supreme Court and the Electoral Tribunal, and condemned by the Honduran Congress and attorney general (whose office is not part of the cabinet in Honduras).

``Despite the widespread institutional opposition to his plans, Zelaya is pushing for the vote. On Wednesday he ordered the Honduran armed forces to start distributing the ballots and other electoral materials throughout the country. The army chief, complying with the Supreme Court ruling, refused to obey the order. Zelaya sacked him, which prompted the resignation of all other leading army officers and the defense minister.”

``The attorney general is asking Congress to impeach Zelaya for violating the institutional order and abusing his powers. Last night, the Congress discussed removing Zelaya from his office. The president is defiant and has accused the Congress of attempting a coup.``The attorney general is asking Congress to impeach Zelaya for violating the institutional order and abusing his powers. Last night, the Congress discussed removing Zelaya from his office. The president is defiant and has accused the Congress of attempting a coup.”

But events unfolded quite hastily out of desperation.

It didn’t take long for the Honduras military to mount a coup and successfully oust President Zelaya which sent him into exile in Costa Rica (CNN Blog).

The Honduran Congress swiftly responded by legally stripping Pres. Zelaya of the Presidency and appointed a provisional president in Roberto Micheletti (CNN Blog)

Meanwhile Zelaya’s ally Venezuela’s Hugo Chavez has threatened to intervene militarily-by invasion (guardian).

As of this writing, the Honduran political crisis still remains unresolved.

As in the earlier post, I think PGMA understands that the Honduran Crisis could be the most probable outcome if her followers insist to let her remain in office.

Given her unpopularity, its almost a no win probability for her if she adamantly opts for this route. And this is why I think, the Con Ass controversy, seems more of a diversionary tactic than an outright attempt to grab power.

Nonetheless all these reeks of what Lord Acton once warned of, ``Power corrupts; absolute power corrupts absolutely”