Economic Myth Busted: In the US, Savings from Lower Gas Prices was Spent on even More Gas!

Remember the popular mantra/incantation “low oil prices equals more consumer spending”? (this applies not only to the US but elsewhere including Philippines too)

Well, in the US, a study debunks the popular myth: savings from lower gas prices was spent on even more gas!

And bizarrely, media and ‘experts’ blame such unexpected course of development on human irrationality!

From the New York Times  (bold mine)

When gas prices fall, Americans reliably do two things that don’t make much sense.

They spend more of the windfall on gasoline than they would if the money came from somewhere else.

And they don’t just buy more gasoline. They switch from regular gas to high-octane.

A new report by the JPMorgan Chase Institute, looking at the impact of lower gas prices on consumer spending, finds the same pattern as earlier studies. The average American would have saved about $41 a month last winter by buying the same gallons and grades. Instead, Americans took home roughly $22 a month. People, in other words, used almost half of the windfall to buy more and fancier gas.

This is not rational behavior. Americans spent about 4 percent of pretax income on gas in 2014. One might expect them to spend about the same share of any windfall at the pump — maybe a little more because gas got cheaper. Instead they spent almost half.

Americans, in short, have not been behaving like the characters in economics textbooks…

The study, based on the spending patterns of about one million JPMorgan customers, does not track the kind of gas consumers purchased. It shows that people bought more gas as prices fell, and that the increase in consumption is not sufficient to explain the entirety of the increase in spending on gas.

Here is what the law of demand says “all else being equal…as the price of a product decreases, quantity demanded increases.” 

"People bought more gas as prices fell..."

Have consumers not been “behaving like the characters in economics textbooks”? Really? Or have consumers not been behaving in accordance to the fictitious outcomes generated from econometric models?

Of course, such econometric models have been constructed principally on the assumptions that humans DO NOT act based on ever changing preferences and values, in the face of an equally dynamic complex environment, that shapes incentives and consequently their actions. Or in short, for the math pedagogues, humans are NOT humans but automatons or robots whose actions are programmed.

But one may retort, they shifted from “regular gas to high-octane gas”.

So why not? Perhaps high octane gas could have been seen as more "energy efficient" (more fuel savings or longer driving mileage). If so then this reinforces, the law of demand.

But refuting the mythological gas-savings-equal-to-consumption-binge meme goes beyond the statistical technicalities.

Yet as I have noted here and many times elsewhere: the economics of spending is MAINLY a derivative of INCOME conditions—secondarily the utilization of savings and of credit—and NOT from the changes in spending patterns or the redistribution of spending from static income.

And as for the perspective of economic punditry versus real world phenomenon, the great Ludwig von Mises warned (Misapprehended Darwinism, Refutation of Fallacies, Omnipotent Government p.120)

Nothing could be more mistaken than the now fashionable attempt to apply the methods and concepts of the natural sciences to the solution of social problems. In the realm of nature we cannot know anything about final causes, by reference to which events can be explained. But in the field of human actions there is the finality of acting men. Men make choices. They aim at certain ends and they apply means in order to attain the ends sought.

Now whose behavior have not been rational…acting humans or ‘experts’ whose views have been shaped by rigid econometric models?

Quote of the Day: Economics isn’t, and will never be, a science

I wonder how Chetty would use those tools to provide compelling answers to the following questions:

1. What is the expected rate of economic growth in conjunction with a 4 percent federal funds rate?

2. What is the effect on inflation of a 300 percent increase in the monetary base?

3. What is the effect -- the multiplier -- of a $1 increase in government spending on output?

4. What is the nonaccelerating inflation rate of unemployment, or the jobless rate that triggers rising prices?

5. What is the wealth effect from a 20 percent increase in the major stock indexes? What about a 100 percent increase?

The answer to all five questions is, it depends. And that’s one of the main reasons that economics isn’t, and will never be, a science.

Isaac Newton, the English physicist, mathematician and philosopher, pretty much explained the fundamental difference between economics and the hard sciences more than 300 years ago. With the physical sciences, we observe what happens in nature. Then we try to quantify it. An apple falls from the tree to the ground with increasing velocity. Water boils at 100 degrees Celsius at sea level. Light travels faster than sound. Each observation yields the same result. It’s why mathematicians end their proofs with QED -- “quod erat demonstrandum,” or that which was to be demonstrated -- and economists don’t.

Or, to paraphrase Newton: The same results are always obtainable under the same conditions. It is the repetitive duplication of a result that defines what are called laws of nature.

A law of nature, when properly measured, will yield duplicate results. A law of economics, even if properly measured, will not.

This is from Bloomberg’s columnist Caroline Baum explaining the difference between science and economics.

Booming Phisix-ASEAN Equities Amidst More Signs of Global Distribution

I talked about swelling signs of distribution before my dsl connection cut me off.

In spite of this week’s majestic breakaway run by the Phisix and a robust performance by ASEAN peers, there seems to be more evidence of global distribution in motion. Some would call this divergence or disconnect.

So far, ASEAN has been on the positive end and converging.

As of Friday’s close, the Philippine Phisix (Orange line) continues to provide leadership in the region up by .95% over the week or 19.69% nominal currency gains year-to-date.

Such remarkable advance accounts for an average monthly return of about 5.6%. At the current rate of gains, the Phisix 10,000 in 2013 is still very much in play. Of course that’s unless some exogenous event, such as the growing risks of a crisis in Japan, may prove to be an obstacle to the current manic phase.

Our regional counterparts have also been showing signs of buoyancy. Indonesia’s JCI (yellow) has been a distant second to the Phisix after this week’s 1.24% advance which accrues to a 15.79% return year-to-date. Thailand’s SET (red orange) has recaptured double digit gains up 1.19 for the week or 11.3% returns for 2013. Thailand’s SET, which earlier had been neck to neck with the Phisix, has been derailed by interventions from regulators who recently raised collateral requirements for margin trades. Malaysia’s KLCI (green) has officially popped to the positive side (charts from Bloomberg)

The Philippine Mania in Motion

In the Philippines, the manic phase seems in full motion.

The manic phase as aptly described by Harvard’s Carmen Reinhart and Kenneth Rogoff in chronicle of their 8 centuries of financial, banking and economic crises in This Time is Different[1]:

The essence of this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times; crises do not happen to us here and now. We are doing things better, we are smarter, we have learned from our past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many booms that preceded catastrophic collapses in the past (even in our country), is built on fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes

A good example is the embarrassing gaffe by one of the leading broadsheets for publishing in the headlines a bogus or spoof pictorial of Time magazine featuring the Philippine President[2]. While the Philippine president did land in the Time’s list of 100 most influential people, he failed to grace the magazine’s cover. 

But the booboo shows exactly how media has functioned as mouthpieces for the government. 

More than that, mainstream media has been quick to hype on the supposed economic boom from alleged “good policies”.

Yet local media hardly covered World Bank’s latest implicit admission of emerging Asia’s bubble in progress, where the World Bank supposedly warned of “demand-boosting measures may now be counterproductive” (euphemism for asset bubbles) and that capital flows “may amplify credit and asset price risks”. Thus the World Bank prescribes that emerging Asia should put a break on easing policies[3].

In addition, local central bank chief also got accolades for taking the Philippine economy to the “stars”. 

The Wall Street Journal Blog reports[4]

Philippine’s central bank chief Amando Tetangco has taken to star gazing, of a kind, to guide the nation’s economy and so far he likes what he sees.

“The star of strong GDP growth and the star of low inflation,” Mr. Tetangco says in an upbeat interview during the Spring meetings of the International Monetary Fund. “This alignment of the stars is further strengthened by a healthy balance of payments surplus,” he said.

But it’s not all about the cosmic. The central bank boss also likes to draw on physics to explain how the quick growing South East Asian economy is faring between surging inward capital flows and risks posed by a sluggish global economy.

“I am not an astrologer but sometimes it is better to describe things like this,’ he says. Physics tell it best.

Amazing hubris.

Mr. Tetangco didn’t say it explicitly but his implication is that “healthy balance of payments surplus” serves as shield against a crisis. 

Mr. Tetangco does not distinguish between the various types of crises. While it is true that most crises has had the character of balance of payments deficits functioning as triggers to imbalances earlier accumulated that led to balance of payment or currency or exchange rate crises[5], there are other forms of crises.

They fall under the categories of debt crises, banking crises and serial defaults[6] (Reinhart, Rogoff 2011).

The above are examples of non-balance of payment crises. Particularly they are examples of two banking crises and a sovereign debt crisis.

Japan’s domestic asset bubbles[7] in the 1980s had been forged amidst current account surpluses. The 1990 bust led to a banking and economic crisis that still lingers 3 decades after…today.

UK’s secondary banking crisis of 1974-1975 also emanated from a prior property boom or the “last hurrah of the post war property boom” as noted by Wikipedia[8], which likewise has had a current account surplus going into the crisis.

Russia’s 1998 debt crisis[9] from unwieldy fiscal deficits that led to a massive government debt build-up was exacerbated by crashing commodity prices that led to a sovereign debt default. Going into the crisis, Russia posted current account surpluses from oil and commodity export receipts.

False assumptions and illusions brought about by a credit boom will eventually be unmasked. 

Such basking in narcissistic self-attribution glory reminds me of the Bank of Cyprus[10], one of the largest financial institutions of the recently stricken Cyprus.

In the mistaken perception that Cyprus successfully eluded the Euro crisis, and that they had become “immune” or has “decoupled” from the Eurozone, the Bank of Cyprus became a recipient of as many as 9 prestigious awards from February 2011 until September 2012[11]. As the Cyprus crisis emerged in March of 2013 or 5 months after the last award, depositors of the Bank of Cyprus may lose up to 60% of their savings[12] to bail-in the banks. Yes this is an example of a bizarre twist of fate.

I may add that for the mainstream, bubbles are after the fact knowledge.

As author Philip Coggan, and Economist contributor under the pen name of Buttonwood notes[13],

Ireland and Spain looked OK on government debt-to-GDP before the crisis but then they didn't.

And one of the haughtiest allusions has been to attribute policy success as “physics”. Such are patent symptoms of bubble mentality.

Positivist policies shaped by mathematical models will hardly extrapolate to “good policy”.

The presumption that natural science as equivalent to social science is a mistake. This has been based on faith or dogma and ego rather than reality. One cannot build on policies based on simplistic assumptions and mathematical aggregates when the fact is that the world is highly complex and where knowledge is distinct, diffused and fragmented. And because of such complexity, econometrics and statistical equations cannot model individual preferences, knowledge, emotions and value scales, since there is nothing constant in human action, especially with people’s interaction with each other or with the environment. 

Statistics are historical artifacts, relying on them means to wrongly assume the same circumstances will take hold in the future. Statistics and math alone cannot precisely foretell of the future. And policies based on statistics and math will be met with unintended consequences.

As the great Austrian economist Ludwig von Mises explained[14]

The natural sciences too deal with past events. Every experience is an experience of something passed away; there is no experience of future happenings. But the experience to which the natural sciences owe all their success is the experience of the experiment in which the individual elements of change can be observed in isolation. The facts amassed in this way can be used for induction, a peculiar procedure of inference which has given pragmatic evidence of its expediency, although its satisfactory epistemological characterization is still an unsolved problem.

The experience with which the sciences of human action have to deal is always an experience of complex phenomena. No laboratory experiments can be performed with regard to human action. We are never in a position to observe the change in one element only, all other conditions of the event remaining unchanged. Historical experience as an experience of complex phenomena does not provide us with facts in the sense in which the natural sciences employ this term to signify isolated events tested in experiments. The information conveyed by historical experience cannot be used as building material for the construction of theories and the prediction of future events. Every historical experience is open to various interpretations, and is in fact interpreted in different ways.

The postulates of positivism and kindred schools of metaphysics are therefore illusory. It is impossible to reform the sciences of human action according to the pattern of physics and the other natural sciences. There is no means to establish an a posteriori theory of human conduct and social events. History can neither prove nor disprove any general statement in the manner in which the natural sciences accept or reject a hypothesis on the ground of laboratory experiments. Neither experimental verification nor experimental falsification of a general proposition is possible in its field.

Growing Distribution or Divergences

Finally signs are pointing to a growing dynamic of divergence dynamic among global asset markets.

Among major equities, US and Japan continues to post gains even as much of the world appears to turning over. Of course this is with the exception of ASEAN. 

Despite the material year to date 9.1% gains by the S&P 500, internally the sectoral performance has diverged. Health Care, Consumer staples, utilities cyclicals and financials have boosted the S&P while materials, technology energy and industrials have weighed on the index. Perfchart from stockcharts.com

While I believe that much of the world will likely endure more pangs from growing signs of financial market weakness, it is unclear whether this will also impact the ASEAN markets whose mania phase has been running in full throttle.

This is of course unless there would be a major external financial smash up that could trigger a domino effect.

Nonetheless as market weaknesses becomes more pronounced, we should expect global authorities to jettison their “exit” meme that was really never meant to be and shift their tones to “dovish” or advocate on more inflationism. 

The recent quasi crash of gold-commodities which has been used by the mainstream as pretext to clamor for more central bank inflationism partly validates my earlier views[15].

And in contrast to the common reaction where crashes would lead to a loss of confidence and a ripple effect or a panic contagion, the quasi crash in paper gold at Wall Street, prompted for a near simultaneous frenzied or panic buying of gold in the physical markets[16] across the globe which also attained a milestone. For instance one day sales of US gold mint reached a landmark high[17]. 

In short, gold-commodity markets have also been diverging.

Yet this is hardly about “deflation” under the context of “aggregate demand”, and “liquidity traps” but about the dynamics of bubble cycles.

Navigating today’s treacherous market requires prudence, as incessant interventions has rendered markets highly susceptible to magnified volatility and whose state of fragility raises the risks of bubble busts, whose trigger may emanate from anywhere.

---

[1] Carmen M. Reinhart and Kenneth S. Rogoff This Time is Different p.15 Princeton Press 2009

[2] Rappler.com Inquirer: Fake Aquino Time cover ‘honest mistake’ but... April 20, 2013

[3] See World Bank: Developing Asia Should Put a Brake on Easing Policies April 16, 2013

[4] Wall Street Journal Blog Philippines Stars Line Up, Thailand Looks for a Lady’s Touch April 19, 2013

[5] Wikipedia.org Currency crisis

[6] Carmen M. Reinhart and Kenneth S. Rogoff From Financial Crash to Debt Crisis, Harvard University August 2011

[7] Wikipedia.org Japanese asset price bubble

[8] Wikipedia.org 1998 Russian financial crisis

[9] Wikipedia.org 1998 Russian financial crisis

[10] Wikipedia.org Bank of Cyprus

[11] See Example of the Mania Phase: Awards Received by the Bank of Cyprus March 27, 2013

[12] Bloomberg.com Bank of Cyprus Clients May Lose Up to 60% on Deposits April 2, 2013

[13] Philip Coggan Buttonwood Rotation schmotation April 18, 2013 Economist.com

[14] Ludwig von Mises 1. Praxeology and History Chapter II. The Epistemological Problems of the Sciences of Human Action Human Action Mises.org

[15] See I Told You So: Gold Slump Used as Justification for MORE QE April 17, 2013

[16] See Gold Price Crash Spurs Boom in Physical Gold Markets April 18 2013

[17] Frank Holmes Gold Buyers Get Physical As Coin and Jewelry Sales Surge US Global Investors April 19, 2013

Video: Peter Schiff Versus John Mauldin on US Dollar and Deficits

The following video exhibits the extemporaneous debate between Peter Schiff and the populist analyst John Mauldin on the US dollar and deficits. 

The Zero Hedge make this observation, (bold original)

Based on the coming 'oil revolution', John Mauldin makes the point that the US can run $300-400 billion deficits and the Fed "can print trillions" and the dollar will surge (since the rest of the world demands it). Peter Schiff begins quietly adding that "we don't have that much oil" then goes on to discuss the 'ifs' in Mauldin's thesis, beginning the wildcard that "we can't suppress interest rates indefinitely" as we await this supposed oil export boom to begin - and that somehow the US is expected to generate a budget surplus when even the perpetually optimistic CBO in its most recent forecast gave up on expecting a surplus in the future of America. Ever. The ensuing 3 minutes or so is worth the price of admission as Dollar bull meets Dollar bear in a nose-dripping, face-ripping trip into the future.

Note that Mr. Mauldin sees the world in the light of statistics or mathematical equations or "macro", while Mr. Schiff shreds on the contradictory logic behind them

Start at 5:25

Quote of the Day: The Ethics of Minimum Wage

The biggest problem I have with the standard analysis of the minimum wage–on either side of the ideological divide–is that it shows a certain lack of imagination. It presumes that market forces work only on quantity and price. So that when legislation artificially raises price, the debate is over the impact on quantity–how many jobs will be lost (or gained if you’re on the other side.)

But price and quantity are not the only way market forces work. And they are certainly not the only attributes of a job. There is how hard you have to work, how many breaks you get, how much training or mentoring or kindness. What amenities are in the workplace–snack bar, vending machine, nicely decorated walls and so on. When the government requires that wages be higher than what they would otherwise be, that creates an increase in the number of people who would like to work and reduces the number of opportunities available.

Ironically, the minimum wage creates a reserve army of the unemployed. That in turn allows employers to be less thoughtful, helpful, and kind. It destroys the civilizing effect of competition by muting it. That encourages exploitation. It reduces the cost to employers of racism or cruelty. Before the increase, being obnoxious or racist made it much harder to find employees. A minimum wage makes it easier to indulge in bad behavior. The costs are lower. Before the minimum wage, a cruel, selfish employer might have had to mentor his employees or train them or be nice to them despite his nature. Now he won’t have to. He can still get workers to work for him. Even more cruelly, the minimum wage encourages workers to exploit themselves.

This is from Standard University research fellow, author and blogger Russ Roberts at the Café Hayek.

Mr. Roberts captures the largely unseen human dimension in the impact, not just of minimum wages, but of the stereotyped debate on myriad regulations: the excessive focus on price and quantity via mathematical formalism or "scientism" which plagues mainstream analysis.

Applying Methodological Individualism to the Financial Markets

I recently received a suggestion for me ‘quantify’ the probabilities of my risk scenarios.

While this may represent the conventional practise by the mainstream, I see this as a foolish undertaking.

Putting numbers assumes that I KNOW the nitty gritty or the minutest details of the risk events that I have been investigating. It also means that I KNOW how people think and their corresponding responses to the changes in the economy, the environment or the financial marketplace. Otherwise, I would be making irresponsible assumptions that may be out of touch with reality.

Besides, I don’t see the need to ‘signal’ or project my expertise just to get plaudits from any institutions. All I aim to do is to excel at my current undertakings in order to survive.

Anyway the prediction markets such as Intrade.com exhibits the probabilities of specific events based on actual risk money or bets and not merely from mathematical models.

For instance, the odds of a US recession in 2012[1] has been quite volatile.

The odds of a recession began to recede since the last quarter of 2010 and began to bottom out in the first quarter of 2011. But this trend reversed to the upside and currently stands at the highest level since the last quarter of 2009.

As of this writing, the odds of a recession by the betting public is at 43.6% and constantly changes depending on the risk perception of the betting public.

The above simply shows that there is NO constancy in people’s actions or that the only thing constant in the real world is change.

Therefore to apply probabilities based on math or econometric constructed ‘models’ from faulty and flawed assumptions would not be only ridiculous but dangerous, especially to our management of portfolio.

Class and Case Probabilities

A better option would be to apply what the Austrian School of economics calls as Class and Case Probabilities.

Class probability, as the great professor Ludwig von Mises defined is[2]

We know or assume to know, with regard to the problem concerned, everything about the behavior of a whole class of events or phenomena; but about the actual singular events or phenomena we know nothing but that they are elements of this class.

We know, for instance, that there are ninety tickets in a lottery and that five of them will be drawn. Thus we know all about the behavior of the whole class of tickets. But with regard to the singular tickets we do not know anything but that they are elements of this class of tickets.

On the other hand, Case probability according again to Professor Mises means:

We know, with regard to a particular event, some of the factors which determine its outcome; but there are other determining factors about which we know nothing.

Case probability has nothing in common with class probability but the incompleteness of our knowledge. In every other regard the two are entirely different.

Let me apply these probabilities to the recent typhoon that hit Metro Manila. [As a caveat I don’t know exactly the details of the typhoon but am comparing the major hits from a typhoon in the metropolis.]

Class probability means that we know some generalized information of the risk event.

-Typhoons can result to loss of lives, injuries or damage to properties as a result of flooding, strong winds and other related or ancilliary consequences (landslide, health hazards as leptospirosis, snake bites, E. coli and etc..).

-We can predict the path of typhoons using satellites.

-We know for instance that around 19 cyclones or tropical storms enter the Philippine area of responsibility every year[3].

From the above, we can even parallel class probabilities or “the behavior of a whole class of events or phenomena” to former US secretary of defense Donald Rumsfeld theory of uncertainty called ‘known knowns’[4]

Yet if there are ‘known knowns’ then the antipode would be the ‘unknown unknowns’.

This would represent as the Case probabilities or fragmented, dispersed and localized information on specific risk events.

Back to typhoons, we don’t know the exactitude and the variability of the typhoon’s strength (only estimates) and or its impact to particular affected localities.

While the Typhoon Nesat[5] [code name: Pedring] recently hit Northern Luzon’s Aurora and Isabela provinces the hardest, in Metro Manila, the famous Manila district of Roxas Boulevard got slammed by a barrage of extremely high storm surges that caused flooding at a public hospital, a five-star hotel and the US embassy.

This is in contrast to Typhoon Ketsana[6] [code name: Ondoy] in 2009 where strong continuous rains basically submerged Metro Manila’s Marikina City that led to many fatalities.

Think of it, about 19 typhoons hit the Philippines every year, yet we hardly know much about the prospective destruction or the scale of calamity these typhoons would bring about and where they will hit for us to apply precautionary measures.

But if you listen to the self-righteous blarneys of prominent media broadcasters, who base their comments on ex post analysis of ‘case’ events, you’d bear the impression that if the government only does as they propose the next typhoon won’t have an impact to the nation at all. Duh!

Yet fallacies from such presumptive omniscient gibberish can be applied to the most recent triple whammy calamity of Japan: the 2011 Tohoku earthquake, tsunami and the nuclear reactor meltdown[7].

Japan’s geographical location[8] makes her exceedingly vulnerable or prone to earthquakes. Thus Japan has lavished in putting up scientific prediction models, which only has proven to be a massive failure in predicting the latest catastrophe[9].

The moral: While it would seem as intellectually comforting to be guided by math based models in predicting the probabilities of the markets or the economy or of any people based risk events, unfortunately, they almost always fail to achieve their goals. The problem is that the social science isn’t physics or natural sciences that are quantifiable and work on some constants.

As Professor Mises wrote[10],

People would like to find in an economics book knowledge that perfectly fits into their preconceived image of what economics ought to be, viz., a discipline shaped according to the logical structure of physics or of biology. They are bewildered and desist from seriously grappling with problems the analysis of which requires an unwonted mental exertion.

Another notable example would be how the 2008 crisis exposed the travesty of quant[11] models[12]. UK’s Queen Elizabeth even questioned the economic profession[13] on why they haven’t seen the crisis coming.

To insist on applying something that doesn’t work is an exercise of self-deception or delusion.

Using Methodological Individualism on Uncertainty

The best methodology will always be to apply the understanding of human action or methodological individualism on social problems

Again from Professor Ludwig von Mises, (bold highlights mine)

Praxeological knowledge makes it possible to predict with apodictic certainty the outcome of various modes of action. But, of course, such prediction can never imply anything regarding quantitative matters. Quantitative problems are in the field of human action open to no other elucidation than that by understanding.

We can predict, as will be shown later, that — other things being equal — a fall in the demand for a will result in a drop in the price of a. But we cannot predict the extent of this drop. This question can be answered only by understanding.

The fundamental deficiency implied in every quantitative approach to economic problems consists in the neglect of the fact that there are no constant relations between what are called economic dimensions. There is neither constancy nor continuity in the valuations and in the formation of exchange ratios between various commodities. Every new datum brings about a reshuffling of the whole price structure. Understanding, by trying to grasp what is going on in the minds of the men concerned, can approach the problem of forecasting future conditions. We may call its methods unsatisfactory and the positivists may arrogantly scorn it. But such arbitrary judgments must not and cannot obscure the fact that understanding is the only appropriate method of dealing with the uncertainty of future conditions.

Understanding of how individuals interact with one another and with the environment should give us a better insight than sloppy thinking based on hypothetical numerical aggregates which attempts to substitute for people’s choices.

---

[1] Intrade.com The US Economy will go into Recession during 2012

[2] Mises Ludwig von Uncertainty Mises.org

[3] Wikipedia.org Typhoons in the Philippines

[4] Wikipedia.org There are known knowns

[5] Wikipedia.org Typhoon Nesat (2011), Philippines

[6] Wikipedia.org Typhoon Ketsana

[7] Wikipedia.org 2011 Tōhoku earthquake and tsunami

[8] Wikipedia.org Seismicity in Japan

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

[10] Mises Ludwig von Blue-Collar Anticapitalism, Mises.org

[11] See How Math Models Can Lead To Disaster, February 25, 2009

[12] See Beware Of Economists Bearing Predictions From Models, May 27 2009

[13] The Telegraph The Queen asks why no one saw the credit crunch coming, November 5, 2008

Quote of the Day: Sargent-Sims knees the groin of Hayek

From Professor Arnold Kling on the 2011 Nobel Prize winners Thomas J. Sargent and Christopher A. Sims, (bold emphasis mine)

Rational expectations in the Sargent-Sims tradition treats everyone as having the same model with which to form expectations. As Frydman and Goldberg point out in Imperfect Knowledge Economics, this assumes away the local knowledge and tacit knowledge that Hayek correctly identified as being very important in the economy.

Indeed, if Sargent and Sims represent a slap in the face to Keynes, they must be regarded as a knee to the groin of Hayek. Hayek coined the term "scientism" to describe the pretentious pose that economists strike when they equate mathematics with rigor. If scientism is a germ that infects economics, then Sargent and Sims were responsible for unleashing some of the most virulent strains.

Resurgent Gold Equals Resurgent Emerging Market Bourses?

By the way, full employment was one of the main justifications for the Reichsbank's inflationist monetary policies. So nothing has changed. Central bankers still believe that monetary policy can lower the unemployment rate. Patrick Barron The Nightmare of 1923 and Its Cause

Don’t look now, but gold is surging right back! (I have to wait for a successful test of 1,430 before I could blurt out ‘I told you so’[1])

If gold is surging right back, then it is likely that global equity markets will follow gold’s path. And this includes the Philippine Phisix.

Figure 1: Stockcharts.com: Phisix-Gold

We’ve been saying that gold has been a reliable barometer of the equity markets.

As you can see in figure 1, gold (black line main window) seems highly correlated with the actions of the Phisix (candle chart main window), as well as with the movements of key emerging markets as the BRIC (Brazil, Russia, India and China via BKF) as well as ASEAN equities (via FSEAX).

However such correlation doesn’t imply causation. The link between gold and emerging markets can be traced to concerted monetary inflationism by global central banks most especially by the Fed’s QE programs.

And places which were said to suffer from the risks of deflation, as the US[2], UK[3] or Euro[4], have actually been experiencing the opposite—inflation has begun to seep in and has even been accelerating.

Earlier, mainstream had been telling us that inflation wouldn’t be a factor. How consistently ‘spectacularly’ wrong they have been[5].

Inflation hasn’t just been manifested in the asset markets but has also been spreading throughout the commodity space (see figure 2).

Figure 2: Price Shocks in Food and $100 Brent Crude (sources: Danske Bank[6] and tradingeconomics[7])

Some in mainstream media has pointed to the soaring food and energy prices[8] as representing effects of the unfolding political events in the Middle East and Africa.

However the causation has, in fact, been the opposite—the unintended effects of the cocktail mix of monetary, fiscal and administrative policies of global governments has caused a widespread boom (signs of crack up boom) in commodity prices that has partly added to the public’s political discontent which have led to the spate of unrest in many countries. While rising food and energy prices has functioned as trigger, there are deeper underlying problems from which has caused the public to vent their dissatisfaction.

Concerns of the risks of supply shocks represent as only ‘secondary’ effects or as a feedback mechanism from the main cause—government inflationist policies.

The False Allure Of Negative Knowledge

This reminds me of Nassim Nicolas Taleb’s “Subtractive Prophecy” knowledge theory where the knowledge of the consensus can be characterized as generally “negative”.

Mr. Taleb’s proposition holds that (from his forthcoming “must buy” book-AntiFragility[9]): [bold emphasis mine]

we know a lot more what is wrong than what is right, or, phrased according to the fragile/robust classification, negative knowledge (what is wrong, what does not work) is more robust to error than positive knowledge (what is right, what works). So knowledge grows by subtraction, a lot more than addition —given that what we know today might turn out to be wrong but what we know to be wrong cannot turn out to be right, at least not easily.

Mr. Taleb’s negative knowledge theory melds with my own when I alluded to why many celebrity gurus remain highly popular[10] despite being constantly ‘spectacularly’ wrong on their predictions—the public may not all be concerned with what really works but espouses on what may seem as the traditionally or conventionally accepted wisdom. Peer pressure, or the informational bandwagon, seems to be the single most influential factor in disseminating ‘negative knowledge’.

In addition, a secondary factor could one of projecting the acquisition of ‘positive knowledge’ built around empiricism modelled through scientism or as Professor Russ Roberts writes[11], “the use of the language and tools of science to reach a conclusion that is not merited”.

In short, scientism could signify a form of social signalling aimed at exhibiting one’s intellectual prowess through math based models.

Or simply said, the desire to build self esteem or social capital by projecting themselves as intellectuals. Thus, much of mainstream’s actions have hardly been about the quest to achieve positive knowledge, instead they are focused on sprucing up image or reputation for the intent of social interactions.

As prudent investors our main concern should not be about what is conventionally accepted, but about being right, and importantly, what works. That’s because return of investments depend on ‘positive knowledge’ rather than the false allure or the wishful thinking from a top-down engineered social utopianism.

Soaring Gold Investment ‘Reservation’ Demand

It is important to also point out that as we have been predicting[12], the demand composition for gold has been shifting from a typical commodity to one of money, and this has been represented by the substantial expansion of ‘investment’ demand (figure 3).

Figure 3: US Global Investors[13]: Changing Composition of Gold’s Demand

Investment demand for gold leapt 70% in 2011 with China as a big factor in the demand growth.

According to this Bloomberg report[14],

Investment demand in 2010 jumped 70 percent and consumption by the jewelery sector gained to a record, it said. Investment was 179.9 metric tons, surpassing Germany and the U.S., as buyers sought out gold bars and coins, according the London- based industry group. Demand from the jewelry sector was 400 tons, it said....

Chinese investors have shown great enthusiasm amid lack of other alternative investments,” Wang Lixin, China representative for the council, said today in Beijing. Wang said the forecast was a “conservative estimate.”

As for the supposed reasons for such growth in demand, the same Bloomberg article quotes a report from the World Gold Council...

“The main motivation behind this demand has been concern over domestic inflation pressure and poor performance of alternative investments, combined with expectations of further gold price gains,” the council said in a report released today.

Again the report only further confirms what we have repeatedly been talking about—a shift of gold’s demand dynamics to one of ‘reservation demand’. As I previously wrote[15],

“money’s “store of value” is increasingly being factored into gold prices (unit of account). Hence, relative to gold pricing, this implies that reservation dynamics or the reservation model (and not consumption model) determines gold valuations or that the exchange ratio or monetary valuations relative to fiat currency applies-- where valuations are determined by the expected changes in relationship between the relative quantity of, and the demand for, gold as money vis-a-vis paper currencies.”

So while jewellery still accounts for as the largest demand for gold, the gist would likely shift towards investments. Nevertheless, statistics can’t assimilate on what people actions represent.

Applied to gold, people can buy jewellery not only for aesthetics or for ornamental purposes, but also as investments.

Official Buying And Monetary Stablization

Figure 4: WGC: Official Purchases First Time in 21 Years

It hasn’t been only the man on streets and the financial markets whom has contributed to a surge in the demand for gold. Governments, perhaps, may have equally been afraid of their own shadows and have begun to stockpile.

In 2010, the official sector, writes the World Gold Council[16], became a net buyer of gold for the first time in 21 years. (see figure 4)

Two factors seem to bear this out, one emerging markets became significant net buyers and secondly, Europe, with significant gold holdings, has greatly reduced their traditional sales activities.

The end in the streak of official selling, should serve as a pellucid and practical example of the error prone predictive value of rigidly relying on statistics and or on the anchoring effect (linear expectations) of past performances. Numbers cannot and will not substitute for people’s actions (this includes the government, who are also comprised of individuals).

As to whether the shift in the attitudes of some governments as reflected by their gold buying patterns would parlay into prospective policies would be another matter.

Yet unless governments act in the way a gold standard is in place (which is to severely downsize on the welfare state and various forms of political economic interventionism), or that government democratizes the banking system to allow for mass competition (by dismantling the banking cartel structure), we are not likely to see governments stabilize the monetary system soon. Adjustments will likely happen at the brink of or during a crisis or what I would call the Mises Moment.

That’s because central banks can always surreptitiously work for the state’s political agenda camouflaged by the esoteric nature of the operations of central banking.

In the fitting and resonant words of Henry Ford,

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

So while the fiscal side of governments may be scrutinized by a vigilant public over the perceived profligacy of a government, central banks actions can and will likely substitute for such a loss.

In the US the Federal Reserve’s recent actions appear to reflect on this.

Fund manager Axel Merk glibly explains[17],

Many of the Fed’s policies since the onset of the financial crisis have not been traditional monetary policies: a central bank usually applies a very broad brush in managing economic growth by controlling levers such as interest rates or money supply. However, when the Fed, for example, bought mortgage-backed securities (MBS), it steered money to a specific sector of the economy. That’s fiscal, not monetary policy, traditionally reserved for elected policy makers in Congress. Just like the MBS program, many of the Fed’s policies continue to appear to be attempts at addressing the “shortcomings” of Congress.

In short, what the Congress cannot do, the central bank can.

So any talk of monetary stability should translate to the reining of the actions of central banks or to a more radical extent—abolishing the central banking platform.

Alternatively this also means that given the absence of popular discontent with central banking, the monetary skulduggery can and will likely go on, in spite of globalization or the internet.

Thus, like all price trends, gold will not go up on a straight line but will sporadically encounter severe headwinds, as seen in the previous months.

Nevertheless, the general trend for gold is that it will continually move higher, and most importantly, increasingly assimilate more of money’s characteristics in the face of the persistent central bank manipulation of the monetary system coupled with competitive debasement for political goals.

Even in the political front we seem to be seeing the evolution of gold as money gain significant ground.

I mentioned earlier the World Bank Chief Robert Zoellig[18] has called for the inclusion of gold in monetary reforms. This seems to be shared too by Kansas Federal Reserve President Thomas Hoenig[19] whereby Mr. Hoenig says gold standard is "legitimate”. And so with 10 US states which had “introduced bills in the past few years to allow state commerce to be conducted with gold and silver.[20]”

Moreover, there has been NO fear factor or fear premium in gold[21] as the vicissitudes (rise and fall) of gold prices has been along with risk assets.

To stubbornly insist on this is to put misplaced belief rather than acting on the basis of evidence required for any serious examination.

Having said so, with the momentum of gold seemingly regaining the upside path, we are likely to see a similar price inflation on equity assets as gold and equity prices have shown strong correlations.

This is most likely to be seen on many emerging market bourses that has started the year on the wrong side of the fence.

The Philippine Phisix included.

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[1] See Gold Fundamentals Remain Positive, January 31, 2011

[2] Wall Street Journal, Deja Deflation Fear, February 18, 2011

[3] bbc.co.uk UK inflation rate rises ‘hitting savers’, February 15, 2011

[4] Bloomberg.com Trichet Says ECB Doesn’t Exclude Possibility of Inflation Risks, February 19, 2011

[5] See Inflation Expectations: The Widening Chasm Between Households And Experts, February 12, 2011

[6] Danske Bank, Inflation so far not a risk to growth February 17, 2011

[7] Tradingeconomics.com, Brent Crude

[8] Bloomberg.com Brent Crude Trades Near Two-Year High on Mideast Supply Concern, February 17, 2010

[9] Taleb Nassim Nicolas Anti Fragility, How To Live In A World We Don’t Understand, Chapter 5, How (NOT) To Be A Prophet fooledbyrandomenss.com

[10] See Explaining Popularity In Terms of Predictions: Dr. Nouriel Roubini’s Case, February 17, 2011

[11] Roberts Russ Scientism, Cafe Hayek, January 10, 2011

[12] See Is Gold In A Bubble?, November 22, 2009

[13] US Global Investors, Investor Alert - February 18, 2011

[14] Bloomberg.com China 2011 Gold Investment May Jump 50%, Council Says, February 17, 2010

[15] See What Gold’s Latest Record Prices Mean, June 21, 2011

[16] World Gold Council, Gold Demand Trends Full year 2010

[17] Merk Axel, Politics of Inflation, safehaven.com February 16, 2011

[18] See World Bank Chief Robert Zoellig: Bring Gold Back As Part Of The New Monetary Order, November 9, 2010

[19] Reuters.com Fed's Hoenig says gold standard "legitimate", January 5, 2011

[20] TPMDC, At Least 10 States Have Introduced Gold Coins-As-Currency Bills, January 5, 2011

[21] See Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy, April 26, 2009