Video: The Cost-Benefit Trade-off of Low Interest Rates

What are the cost-benefit trade-off of low interest rates?

At the LearnLiberty.org, Duquesne Professor Antony Davies discusses this very critical issue.

Here is a summary from LearnLiberty.org,

The cost of borrowing money is at a record low. Low interest rates and cheap credit encourage people to spend more, and to save less. Is this good or bad?

Many argue that we need low interest rates to encourage spending. But low interest rates don’t actually encourage people to spend more money. Low interest rates simply encourage people to spend more money now, and less in the future. The opposite is true for high interest rates.

So what interest rate is best overall? Professor Davies says the best interest rate is the one that comes about naturally, without government intervention. Individuals know better than the Federal Reserve how and when to spend their money. Decisions on whether to consume more or save more is best left to individuals, not government officials.

Since interest rates are essentially about time preferences of people to hold money, notice that the policies to artificially suppress interest rates, such as zero bound rates or the US Federal Reserve's Zero Interest Rate Policy (ZIRP), have been designed to promote spending NOW at the expense of spending in the FUTURE.

The consequent distortion of people's time preferences, and its corollary, the enticement to get hocked into unsustainable debt, thus produces boom bust cycles.

Also this reflects on the PRIORITIES of political agents who almost always take on measures which addresses the short term with hardly any regards or concern over the longer term impact from their actions.

Nevertheless low interest rate policies are attained through credit expansion, which fundamentally represents the hallowed creed of interventionists and inflationists, who think they can wish away the law of scarcity in order to achieve a statist or socialist utopia.

As the great Ludwig von Mises wrote,

Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.

Bullish Signal Confirmed as Phisix Sets New Record High

As I said last week, rising stock prices on a slew of internal and external bad news usually signifies as bullish indicators.

Here is what I wrote,

Foreign trades have also been sluggish with paltry changes over the last two weeks. Yet, despite the marginal actions by foreign investors, the Philippine Peso posted modest advances.

So essentially, last week’s action suggest of a rotation away from second and third tier issues back into the blue chips.

Yet I expect to see normalization of trading activities in terms of Peso volume which should undergird either the current consolidation phase or a fresh attempt to break away into new highs.

When the markets to defy the spate of bad news that signifies as a bullish signal.

Speaking of luck that’s exactly how it turned out the week!

First of all, the Phisix broke into fresh nominal record high even as the Scarborough issue has not been resolved.

As an aside, I would reiterate that for whatever innuendos about resources alluded by media, the Spratlys-Scarborough issue has not been about oil or commodities but more about unspecified political agenda which could be related to promoting arm exports or ploys to divert the public from festering real political issues or as justifications for inflationism.

I might add that the heated kerfuffle over territorial claims has expanded to cover the disputed Senkaku Islands, where Japanese authorities has jumped into the fray to announce of their acquisition of the island from the “owners”. This has resulted to a political backlash from Chinese authorities.

Given that politics in Japan seems to have been entangled with monetary policies, Japan’s recent provocative foreign policy posture could be portentous of Bank of Japan’s (BoJ) moves to expand its stimulus (via asset purchases), perhaps under the pretext of increasing military spending.

Going back to the Philippine stock market, given the record performance, we can’t discount the prospects of interim ‘profit taking’. But again I think momentum still favors the bulls.

Second, net foreign trade has turned significantly positive mostly bolstered by the GT Capital’s listing last Friday

Third market breadth also turned positive…

…as advancing issues took the driver’s seat anew.

If the positive momentum, which is likely to be reflected on the actions of the benchmark Phisix should persist, then we would see a broadening of gains over the broader market.

Most of the gains had been concentrated on the sectoral leaders since the start of the year, particularly, property, finance and holding companies or mother units of the former two.

I think that rotation will occur among the heavyweights as the current leaders may take a short reprieve.

Importantly the Peso volume DID normalize…

Daily traded Peso volume (averaged weekly) surged amidst as last week’s record breakout.

I see a continuity of the bullish or upside momentum of the financial markets which may last until the first semester of the year, where central bank steroids are due for expiration. While this may lead to an interim volatile phase perhaps backed by deteriorating economic or financial conditions in Europe or in China, we should expect downside volatility to be met by aggressive responses from central bankers. This feedback mechanism between markets and central bank interventions has not only been made to condition the markets, but has become the central bankers’ guiding policy of crisis management.

BSP’s Euthanasia of the Rentier

This dogmatic approach has been assimilated even by the local central bank, the Bangko Sentral ng Pilipinas (BSP).

Just last week, domestic interest rate policies have been kept at “historics” lows whose levels were justified as “sufficient to help boost economic activity and avoid potential spike in inflation amid volatile global oil prices”.

The BSP blames external factors as secondary variables of domestic inflation through a “likely rise in foreign portfolio investments and higher prices of electricity amid petitions for further power-rate increases.”

In reality, interest rates policies that has driven been to superficially “historic” lows that are financed by “money from thin” are the real cause of inflation

Austrian economist Dr. Frank Shostak explains,

The exchange of nothing for something that the expansion of money out of "thin air" sets in motion cannot be undone by an increase in the production of goods. The increase in money supply — i.e., the increase in inflation — is going to set in motion all the negative side effects that money printing does, including the menace of the boom-bust cycle, regardless of the increase in the production of goods.

And symptoms from BSP’s actions have been manifesting on the domestic credit markets. Notes the Inquirer.net

True enough, credit growth so far this year has been robust. As of February, data from the central bank showed that outstanding loans by universal and commercial banks grew by 18 percent year on year to P2.74 trillion. The BSP said the increase in bank lending benefited both individual and corporate borrowers.

A boost in bank lending is not “a one-size-fits-all” thing.

A boost in bank lending that has NOT been prompted by consumer preferences but from the skewing price signals due to political “money printing” policies designed to achieve quasi permanent booms leads to bubble cycles.

And what is deemed as “robust growth” by media are, in reality, signs of malinvestments and speculative diversion of productive capital. Some of these borrowed money will find their way to the local stock exchange, real estate properties, bond markets and much of which will be diverted into consumption spending or misallocated capital that leads to capital consumption.

And adding to the policies of the promotion of “aggregate demand” or “the euthanasia of the rentier” through “historic” low interest rates has been the announcement by the local version of the welfare state, the Social Security System (SSS), to lower interest rates and to increase loanable amount to members for housing loans.

Apparently, little has been learned by local political authorities of the lessons from the latest US centric political homeownership crisis that has diffused across the world and whose phantom continues to haunt the political economies of the developed world.

Noble intentions eventually get burned by politically instituted economically unfeasible projects.

Sell In May?

Fund manager David Kotok of Cumberland Advisors rightly points out the differences in the current environment from yesteryears, such that seasonal statistical patterns like Sell in May and Go Away may not be relevant to current conditions.

History shows that ‘Sell in May and go away’ has applied when the Federal Reserve was in a tightening mode during the six-month span from May to November. If the Fed was actively raising interest rates, withdrawing or constricting credit, imposing additional reserve requirements, or taking an action that was of a tightening mode, stock markets were usually punished in that six-month period.

When we did the study we examined what the Fed did, not what it said. We used actual changes in the Federal Funds rate to determine whether the Fed was tightening, easing, or neutral. Once the Fed took the interest rate to zero at the end of 2008, the historical data series lost its power for forecast purposes, since the Fed cannot take the rate below zero. However, we believe the concept is valid even if the present measurement problem exists.

It is human action and NOT charts (for example the failed death cross pattern of the S&P 500 of 2011) or seasonal patterns, based on either statistics or historical outcomes, that determines future outcomes.

The substantial impact of central bank policies on the markets has been through the manipulation of money. Since money is a medium of exchange which represents half of every transactions people make, tinkering with money has greater tendency to alter or reshape the incentives of people.

Manipulation of money through inflationism tend to narrow people’s time orientation or increases time preferences which has been and will be ventilated through several attendant actions, as higher inclination to take debt, misdirection of investments via distorted price signals, consumption based lifestyles or pejoratively known as “consumerism”, greater risk appetite or higher inclinations towards speculation.

So when major central banks combine to tamper with money, which among themselves account for about 85% of the capital markets of the world, we can expect participants of the marketplace to adjust accordingly to these newly implemented policies. Current policies have been engendering asset inflation, which in reality has been designed to keep the flagging banking system and the unsustainable welfare states afloat.

Even emerging market central banks, as the Philippines have employed the same policies which are often justified from “growth risk”. Yet despite the standardization of monetary policies, the differences in market outcomes have been resultant to variances of people’s actions relative to the idiosyncratic structural compositions of each political economy.

In addition, while monetary policies have significant effects on people’s incentives other policies also matters such as fiscal policies and tax regimes, rule of law and protection of property rights, trade and economic freedom, and regulatory policies.

The bottom line is all these policies would have a greater impact to people’s action than simply reading numbers and history as basis for predictions.

As the great Ludwig von Mises wrote in Theory and History

Historicism was right in stressing the fact that in order to know something in the field of human affairs one has to familiarize oneself with the way in which it developed. The historicists' fateful error consisted in the belief that this analysis of the past in itself conveys information about the course future action has to take. What the historical account provides is the description of the situation; the reaction depends on the meaning the actor gives it, on the ends he wants to attain, and on the means he chooses for their attainment...

The historical analysis gives a diagnosis. The reaction is determined, so far as the choice of ends is concerned, by judgments of value and, so far as the choice of means is concerned, by the whole body of teachings placed at man's disposal by praxeology and technology.

Along the lines of the Professor von Mises, my former idol the exemplary stock market guru but who now has been converted to a crony, Warren Buffett, once lashed out at the tendency of people to anchor or rely heavily on past performance. The ailing 81 year old billionaire Mr. Buffett said

If past history was all there was to the game, the richest people would be librarians.

China’s War against the Informal Economy or the Shadow Banks

From the Bloomberg, (bold emphasis added)

When a Chinese court sentenced 28- year-old Wu Ying, known as “Rich Sister,” to death for taking $55.7 million from investors without paying them back, it sparked an unexpected firestorm that has drawn in China’s top leadership.

Her crime involved a common, illegal practice in China: raising money from the public with promises to pay back high interest rates. Known as shadow banking, these underground lending and investing networks are estimated to total $1.3 trillion, according to Ren Xianfang, an economist with IHS Global Insight Ltd. (IHS) in Beijing. That’s the size of the 2011 U.S. government deficit.

Operating outside the banking system or government regulation, the informal networks provide an important source of economic growth, capital for private companies and return for investors seeking to beat inflation. Premier Wen Jiabao, in an unusual move, weighed in on the case at a March 14 news conference. His comments highlighted a public debate over the importance of shadow banking to the Chinese economy, government efforts to bring it under control -- and whether capital punishment is an effective means to do so.

“Chinese companies, especially small ones, need access to funds,” Wen said when asked about Wu’s case. “Banks have yet to be able to meet those companies’ needs, and there is a massive amount of idle private capital. We need to bring private finance out into the open.”

This is just an example of the abominable repercussions from arbitrary laws or how arbitrary laws are used as instruments for oppression.

Here, the private sector, clearly acting in response to government’s policies as evidenced by “seeking to beat inflation”, have been driven to become “criminals”. Yet China’s “criminal” shadow banks, which is no more than regulatory arbitrage practiced by grassroots entrepreneurs, has grown to an “estimated to total $ 1.3 trillion” or about 1/5 of the economy.

The conviction of the “Rich Sister” looks like another futile exercise at political symbolism to project the illusions of “virtuous” government or “government in action”. Nevertheless exposes on how arbitrary laws are used as instruments for oppression.

Of course, shysters and manipulators will always exist in every society and deserve punishment for the violation of the property rights of their victims.

However, Ponzi schemes, which these scoundrels frequently employ, are magnified in an environment where money have been debauched as I earlier pointed out here.

That’s because the anti-savings policies by governments through central banks, encourages or incentivizes such behavior by narrowing the public’s time orientations or increasing the public’s time preferences.

So instead of savings, inflationism leads the public to chase for yields, speculate, gamble, increase debt loads and to consume at the expense of production. This policy induced shifts in people’s incentives make the public vulnerable to skullduggery and knavery.

And that’s why the biggest Ponzi schemers and ultimate insider traders are no more than central bankers and political authorities who use financial repression to plunder wealth from people.

In reality, the China’s informal economy has been emblematic of dynamic market forces at work, viz, filing the gap of the “need access to funds”, since state sanctioned or regulated private banks, as well as, state owned banks “have yet to be able to meet those companies’ needs”.

So Premier Wen’s statement and the actions of China’s government represents the proverbial “left hand doesn't know what the right hand is doing” or a patent self-contradiction.

The truth is that the Chinese government has virtually been exercising the same decorum as their Western counterparts—the promotion of the interests of politically privileged rent seekers or crony bankers who finances the activities of political authorities.

China’s war against informal economy serves as another indicator of the growing political fissures from a command and control political structure against the forces of decentralization or the “marginal revolutions”, as evidenced by the expanding political clout of entrepreneurs in and out of the ambit of China’s government.

China’s war against the informal economy or the shadow banks is bound for failure.

After 5,000: What’s Next for the Phisix?

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. Ludwig von Mises

Phisix breaks 5,000!

As I previously wrote[1], we should expect this soon. But this happened much sooner than I expected. I was looking at 2 weeks to a month as my window for this projection to materialize.

I am hardly indulgent towards crafting short term predictions, however the slew of events combined with momentum seemed too compelling, as the popular idiom goes, “The writing was on the wall”.

Nevertheless Friday’s breach of the psychological threshold signifies as another fulfilment or “I told you so moment”.

I even thought that I might be operating with overconfidence such that Monday turned sharply in the opposite direction from my expectations—the Phisix fell nearly 2%!

However with lady luck on my side, what I thought could be signs of falsification of my thesis turned out to be a springboard instead. The local benchmark expunged the one-day loss and carved a hefty 2.52% gain over the week to close at 5,016.3! That’s a full 4.5% swing.

Well, riding on a bullish momentum, market participants have palpably been looking for some events to nudge them into a buying spree. And they found one in BSP’s [Bangko Sentral ng Pilipinas] lowering of key policy rates, the second time this year.

Misleading Focus to Justify Low Policy Rates

Local central bank authorities justified their actions based on the crisis in the Eurozone.

From the Inquirer.net[2]

“Global economic conditions are expected to stay subdued as fiscal and banking sector headwinds in advanced economies affect global output growth and as market confidence remains fragile,” BSP Governor Amando Tetangco Jr. said in a statement Thursday.

The unfavorable global factors Tetangco was referring to included the prolonged debt crisis in the eurozone that would likely to continue dragging export earnings of the Philippines and other countries that have been exporting goods to the Western region. The crisis is also seen dampening outlook on the global economy, thereby dragging appetite for investments even in countries outside the eurozone.

Apparently many mainstream institutions also see events in the lens of political authorities as the chart above from Danske Bank showed[3]

But how valid has this view been?

The problem that haunts the mainstream is the same problem that plagues political authorities. In behavioural finance, this is called as the focusing effect. People tend to focus on some aspects which they construe as a generalized phenomenon. This is really a fallacy of composition.

Why?

Outside the Eurozone crisis, global events don’t support this view.

The CPB Netherlands Bureau for Economic Policy Analysis in its recent monthly report indicates that both world trade volume and world industrial output ended last year or December 2011 at record highs[4].

In reality, in spite of the Eurozone crisis, world industrial production and exports soared to new record highs which should hardly have been a drag on local exports or the local economy.

This means that whatever slowdown that has afflicted Philippine exports has little to do with global DEMAND but has been mostly about relative competitiveness and relative productivity.

As always what is available and visible will be used as cover, or in this case, the Eurocrisis has been used as scapegoat to justify the redistributionist policies via interest rates interventions.

Psychological Disorientation from Low Interest Policies

The local inquirer article continues

“Cut in interest rates is seen boosting demand for loans, which in turn support increase in consumption and investments. However, since lower rates spur demand, it has the tendency to accelerate inflation.”

In reality what the lowering of interest rates below market levels does is to increase people’s time preferences or magnifies people’s time orientation towards present consumption activities than of the future.

Again to quote Professor Roger W. Garrison[5],

Time preference is simply a summary term that refers to people's preferred pattern of consumption over time. A reduction in time preferences means an increased future-orientation. People willingly save more in the present to increase the level of future consumption. Their increased saving lowers the natural rate of interest and releases resources from the final and late stages of production. Simultaneously, the lower natural rate, which translates directly into reduced borrowing costs, makes early stage production activities more profitable. With the reallocation of resources from late to early stages of production, the preferred temporal pattern of consumption gets translated into an accommodating adjustment of the economy's structure of production.

This means, yes, consumption activities will increase, enhanced by more borrowings (credit cards, home, car chattel loans and personal loans etc…), but this will also reflect on a shift in the balance of people’s savings and investment patterns with a bias for consumption.

Borrowings accrued from artificially lowered interest rates does not distinguish between productive and consumption demand. They are seen as homogenous when they are not. This is misleading. That’s because consumption activities are not growth inducing for the simple reason that they are not productive.

As Dr. Frank Shostak explains[6],

We suggest that an individual's effective demand is constrained by his ability to produce goods. Demand cannot stand by itself and be independent — it is limited by production. Hence what drives the economy is not demand as such but the production of goods and services. The more goods an individual produces, the more of other goods he can secure for himself.

In short, an individual's effective demand is constrained by his production of goods. Demand, therefore, cannot stand by itself and be an independent driving force.

And as I earlier pointed out[7], bank lending growth in the Philippine has surged by 19% in 2011 according to the BSP. The BSP assumes the categorization of loan disbursement is accurate, I believe it is not. In many occasions loans can be redirected to other uses.

And since savings are penalized from such policies, people will be induced to take on high risks activities in order to generate profits (search for yield), such as intensive speculation and gambling, to sustain their consumption activities.

As I have repeatedly been pointing out[8], negative real rate environment has been instrumental for the record rise of the local stock market.

Local investors has lorded it over foreign investors for this cycle which incepted in 2009. The chart above shows that foreign investor’s share of total trade has been below 50% since 2011. This is in contrast to the 2003-2007 cycle, where foreigners were dominant. This should serve as evidence to the policy impact of a negative real rate environment to the stock market. While today’s actions look pleasant, we must keep in mind that the obverse side of a (inflation driven) boom phase is a (deflation driven) bust.

Euthanasia of the Rentier: The Greatest Ponzi Scheme

Since fixed incomes will also suffer from interest rate manipulations, many will fall victim or get seduced to dabble with Ponzi schemes marketed by scoundrels who would use the current policy induced environment as an opportunity to exploit a gullible public.

In the US, Ponzi schemes skyrocketed as the US Federal Reserve has taken on a zero bound interest rate environment in response to the recent crisis in 2008.

“Bad times” have been attributed as pretext to such incidences[9]. In reality, US Federal Chair Ben Bernanke’s zero bound rates have altered people’s value scales and time preferences such that they became vulnerable to high risks yield chasing actions as exemplified by large accounts of people being duped by fraudsters.

And despite declining incidences, Ponzi schemes remain outrageously high compared to the 2003-2007. Of course, the chart omits one major critical factor: 2003-2007 highlighted the property boom phase that morphed into a worldwide crisis where huge number of Americans (and foreign bankers and financial houses) got sucked into the bubble.

What this means is that Fed policies have transformed many Americans to become inveterate gamblers who jump from the proverbial frying pan to the fire by motivating them to plunge into every unsustainable booms in search of the elusive Holy Grail.

In other words, policies of the US Federal Reserve, which have been embraced or imbued by the central banking class all over the world—including the Philippines—seem to be the grandest Ponzi scheme ever hatched, except that central bank policies have been politically mandated.

Negative interest rate environment will also adversely affect financial companies dependent on fixed income such as life and non life insurance, pre-need, HMOs and pension companies. If their revenues (premiums, fixed income placements and investments) do not grow enough to match the increase in liabilities (where the latter will be affected by price inflation), then these companies will be tempted or motivated to undertake adventurous risk matching portfolios for survival, that may lead to future bankruptcies. So do exercise discretion in selecting your insurer.

Serial Bubble Blowing from Negative Real Rates Policies

Further, below market interest rates will encourage capital intensive “early stage production” ventures.

As I have been pointing out, even the activities in the domestic stock markets have been validating this concept.

This week, the property sector has dominated the field. Led by Ayala Land (+5.21%), the property indiex has risen above the weekly gains of the Phisix, which means that the breach of the 5,000 level has been mostly due to the property index.

Year to date, the property and the financial indices have running nose to nose for the leadership.

And in contrast to what the news article says, demand alone does not accelerate inflation, it is the bank-circulation credit (fiduciary media) and or direct central bank asset purchases which manifested through the expansion money supply that spawns inflation.

Yet the silence of media and political authorities in dealing with the truth has been tainted by political goals.

As the great Ludwig von Mises observed[10],

The hindrance that the monetary or circulation-credit theory had to overcome was not merely theoretical error but also political bias. Public opinion is prone to see in interest nothing but a merely institutional obstacle to the expansion of production. It does not realize that the discount of future goods as against present goods is a necessary and eternal category of human action and cannot be abolished by bank manipulation.

In the eyes of cranks and demagogues, interest is a product of the sinister machinations of rugged exploiters. The age-old disapprobation of interest has been fully revived by modern interventionism. It clings to the dogma that it is one of the foremost duties of good government to lower the rate of interest as far as possible or to abolish it altogether.

All present-day governments are fanatically committed to an easy money policy.

Gosh, how relevant this has been today.

Said differently present day governments are fanatically committed to serially blowing bubbles.

So far, bank lending growth has not yet reached alarming levels in the Philippines and in the region.

So in spite the recent surge in bank lending, the low base of lending growth (relative to the past and relative to the ASEAN peers) seem to have provided BSP authorities the confidence to take the gambit of further lowering interest rates.

Despite the highly visible construction boom, which should serve as empirical evidence, growth in the loan category to the property sector as percentage of total loans has hardly improved over the last three years. Both charts from ADB[11]

We must understand that bubble cycles function as a process which means they develop overtime and undergo several stages.

Thus, it takes constant vigilance to identify or guess estimate on the whereabouts of which particular stage we could be in.

How the Credit Fuelled Boom Unfolds

What this implies is that the BSP’s move will fuel more upside to the Phisix where the prospective gains will be bankrolled mainly by the substantial expansion of domestic bank credit. Although auxiliary markets equities and bonds will tapped, most likely price expression of the bubbles will become apparent or ventilated in these markets too.

Importantly this credit boom will also filter into the real economy most likely to the property and the mining sector.

Such dynamics represents the business cycle at work.

The credit boom will be highlighted by a reflexive feedback mechanism between prices of securities and collateral values.

When people are eager to borrow, as George Soros writes in the Alchemy of Finance[12], and the banks are willing to lend, the value of the collateral rises in a self-reinforcing manner. High prices of securities extrapolate to higher collateral values which encourages more borrowings that eventually feed into higher prices which reinforces the feedback loop.

However the growth in lending based on artificial price signals through the interest markets, whether in the asset markets or in the real economy, will lead to the accretion of misdirected allocations of resources since artificial interest rates will skew the economic coordination process

As Professor Steve Horwitz[13] writes,

Once that bad interest rate signal is in place, intertemporal discoordination will result. The nature of money and the time-ladenness of production mean that we don't see that discoordination at first, as it is masked by the boom. The increased activity at both the higher orders of goods and the consumption level looks like growth until the fact that there is insufficient real savings to support the increased (now "mal") investment at the highest orders makes itself known.

Nonetheless, the phases of the bubble will run in conjunction with credit cycles (based from post Keynesian economist Hyman Minsky’s hypothesis[14]) which transitions from the current state of hedge financing (income flows will meet interest and principal liabilities) to speculative financing (income flows will meet interest payments only) and ultimately to Ponzi financing (income flows will not cover both interest and principal liabilities but will depend on asset prices which today has been very evident in the sovereign debts of western nations and which subsequent actions by central banks has been engineered to keep propping these up by zero interest rates, asset purchasing programs and direct interventions in the marketplace). Israel’s central bank buying into US stocks can be seen as direct intervention although cloaked as “investments”[15].

Actions in the external environment actions will substantially affect returns in the local markets too. As developed economies intensify their credit easing policies, these could lead to heightened capital inflows, partly through yield arbitrages or carry trades and partly through portfolio flows, into emerging markets as the Philippines which should amplify the domestic credit boom. Of course a credit boom will also occur in the international that would finance these carry trades and portfolio flows.

Given these interconnectedness of world markets, the Philippines will remain highly sensitive to the international risk environment.

The Ponzi dynamics of government debt markets, as well as the heavily politicized financial markets assures of outsized volatilities in both directions for financial markets.

The seeming epiphany of global stock markets on the side of the bulls have been underpinned by actions of major central banks who recently has jumpstarted the next wave of asset purchases such as Bank of Japan and Bank of England and indirectly through the ECB’s LTRO facilities which as predicted had an overwhelming reception[16].

The continuity of the current boom conditions has been principally dependent on liquidity conditions which emanates from feedback loop of market’s reactions to policy responses and vice versa.

For the recent past years, stock markets tend to experience amplified downside volatility when policy programs approached their maturity (such as in the US).

Yet given the rabid fear of another episode of recession or deflationary scare, the mechanistic response by central bankers has been to reflate the system with more credit easing programs. Thus we should expect mini-bubble cycles amidst a larger bubble framework.

Also, we cannot discount any upsurge in consumer price inflation given the scale of monetary injections. This will have repercussions on the market too. This is why markets will be volatile.

After 5,000: What’s Next for the Phisix?

Interim profit taking following the recent breakout of the Phisix from the 5,000 threshold level should be expected, given the partially overbought conditions.

But any retracements are likely to be minor and will not exhibit large scale broad market deterioration in the strict condition that the current domestic and international markets remains on a RISK ON mode.

Instead we should expect rotations among sectoral performances or issues within specific sectors.

The recent interest rate cut by the BSP will provide more fuel to the bulls. Given the relatively less leverage financial system, the booming Phisix will be augmented by a surge in domestic bank credit and possibly credit driven portfolio flows and carry trades from overseas investors.

Yet returns in the Phisix will be subject to the highly fluid conditions abroad.

Lastly the mercantilist goal of “promotion of exports” through low interest rate policies won’t work. What this will do is to foster an unsustainable domestic boom that will become evident in the stock market and in the real economy through specific sectors, that leads to an eventual bust in the fullness of time.

Moreover domestic inflation will undo any ephemeral cost advantage from policies that have been designed to undermine a currency’s purchasing power.

What I believe is that the real goal by the BSP has not been to promote export growth (which is in itself is a very bad mercantilist-protectionist idea). The economy has always been used as a veneer to promote certain unstated or unpublicized political agenda.

I believe that the BSP has been working in conjunction or in collaboration with other global central banks to enforce the Keynesian doctrine of “the euthanasia of the rentier” or to keep interest rates permanently low, not just to promote permanent quasi-booms, but also to assist in the rehabilitation of an unsustainable welfare based political, which plagues many developed economies today, along with their banking cronies.

Yet we can expect a blowback from such actions overtime.

For now profit from folly.

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[1] See Phisix: Expect A Breakout from the 5,000 level Soon, February 26, 2012

[2] Inquirer.net BSP cuts interest rates to 4% for overnight borrowing, 6% for lending, March 1, 2012

[3] Emerging Market Weekly Global monetary easing is helping sentiment, February 22, 2012 Danske Bank

[4] Perry Mark, Dec. 2011 Sets Record for the Highest-Ever Volume of Global Trade and Global Output in History mjperry.blogspot.com February 28, 2012

[5] Garrison Roger W. Natural and Neutral Rates of Interest in Theory and Policy Formulation April 21, 2007 Mises.org

[6] Shostak Frank, It's Not Really about the Debt, March 1, 2012 Mises.org

[7] See Global Equity Market’s Inflationary Boom: Divergent Returns On Convergent Actions February 13, 2011

[8] See Investing in the PSE: Will Negative Real Rates Generate Positive Real Returns?, November 20, 2011

[9] Economist.com, Fleecing the flock, January 28, 2012

[10] Mises, Ludwig von The Monetary or Circulation-Credit Theory of the Trade Cycle, June 11, 2010 Mises.org

[11] ADB.org Asia Economic Monitor December 2011

[12] Soros George The alchemy of finance, p 23 John Wiley & Sons

[13] Horwitz Steve Austrian Cycle Theory is Not a Morality Play, March 3, 2011 CoordinationProblem.org

[14] Wikipedia.org Understanding Minsky's financial instability hypothesis, Hyman Minsky

[15] See Applying Bernanke’s Doctrine: Central Banks ‘Invests’ in Stock Markets, March 2, 2012

[16] See Record Bank Borrowing from ECB’s Second Round LTRO, March 1, 2012

Are Surging Oil Prices Symptoms of a Crack-up Boom?

Dr. Ed Yardeni thinks that there has been a mismatch between oil prices and oil demand

Dr. Yardeni writes

The price of Brent crude oil is up again this morning over $124 a barrel. It’s up from $107.65 at the end of last year as a result of increasing tensions with Iran following the imposition by the US and Europe of tough new sanctions on Iran. They are already reducing the ability of Iran to export crude oil. Last year, Iran exported about 2mbd. That is likely to get cut by half or more. That’s not enough to explain why oil prices are soaring given that global oil supply is around 88mbd. Of course, concerns are mounting that the diplomatic and economic confrontation with Iran could turn into a military conflict that would disrupt oil traffic coming out of the Persian Gulf. This certainly explains why oil prices are rising.

Global oil demand, on the other hand, is weakening and suggests that oil prices could fall sharply if the Iranian issue can be resolved without push coming to shove. As I’ve explained previously, I believe that the sanctions are rapidly crushing Iran’s economy and may force the Mullahs to give up their ambitions to build nuclear weapons. This may take some time, of course. Meanwhile, if oil and gasoline prices continue to rise, I expect that the Obama administration will coordinate a global release of supplies from the Strategic Petroleum Reserves, as occurred last summer in response to the drop in Libya’s exports.

While tensions over Iran partly contributes to the elevated state of oil prices, there are deeper factors involved as previously explained

Importantly when mainstream economists talk about demand they usually refer to consumption demand and ignore the second type of demand—reservation demand.

The distinguished dean of the Austrian school of Economics Murray N. Rothbard explained,

The amount that sellers will withhold on the market is termed their reservation demand. This is not, like the demand studied above, a demand for a good in exchange; this is a de­mand to hold stock. Thus, the concept of a “demand to hold a stock of goods” will always include both demand-factors; it will include the demand for the good in exchange by nonpossessors, plus the demand to hold the stock by the possessors. The demand for the good in exchange is also a demand to hold, since, regard­less of what the buyer intends to do with the good in the future, he must hold the good from the time it comes into his ownership and possession by means of exchange. We therefore arrive at the concept of a “total demand to hold” for a good, differing from the previous concept of exchange-demand, although including the latter in addition to the reservation demand by the sellers.

Yet what prompts for an increase in reservation demand?

Again Professor Rothbard

an in­crease in reservation demand for the stock may be due to either (a) an increase in the direct use-value of the good for the sellers; (b) greater opportunities for making exchanges for other purchase­-goods; or (c) a greater speculative anticipation of a higher price in the future

Speculative activities also drive the increased demand to hold a stock of goods. Or in the case of oil prices, increased speculation has also been responsible for the recent spike.

This means that monetary policies designed to ease credit via zero interest rates and quantitative easing have been responsible for encouraging, not only consumption but speculative activities too, by increasing people’s time preferences.

One would note that oil prices and stock market prices (S&P 500) have been ramping up. These are symptoms of an inflationary boom.

Of course, inflationary boom extrapolates to a boom bust cycle or to a crack-up boom.

As Professor Ludwig von Mises wrote

The boom could continue only as long as the banks were ready to grant freely all those credits which business needed for the execution of its excessive projects, utterly disagreeing with the real state of the supply of factors of production and the valuations of the consumers. These illusory plans, suggested by the falsification of business calculation as brought about by the cheap money policy, can be pushed forward only if new credits can be obtained at gross market rates which are artificially lowered below the height they would reach at an unhampered loan market. It is this margin that gives them the deceptive appearance of profitability. The change in the banks' conduct does not create the crisis. It merely makes visible the havoc spread by the faults which business has committed in the boom period.

Neither could the boom last endlessly if the banks were to cling stubbornly to their expansionist policies. Any attempt to substitute additional fiduciary media for nonexisting capital goods (namely, the quantities p3 and p4) is doomed to failure. If the credit expansion is not stopped in time, the boom turns into the crack-up boom; the flight into real values begins, and the whole monetary system founders. However, as a rule, the banks in the past have not pushed things to extremes. They have become alarmed at a date when the final catastrophe was still far away.

While a crack-up boom is not imminent, current monetary policies have brought us into this direction. The more governments engage in reckless policymaking in our monetary affairs, the greater risks of spiraling commodity prices.

Rising oil price, thus can be seen as symptoms of a chronic disorder in the current state of money.

Understanding America’s Debt Culture

Writes The End of the American Dream

When most people think about America's debt problem, they think of the debt of the federal government. But that is only part of the story. The sad truth is that debt slavery has become a way of life for tens of millions of American families. Over the past several decades, most Americans have willingly allowed themselves to become enslaved to debt. These days, most of us are busy either going into even more debt or paying off the debt that we have accumulated in the past. When your finances are dominated by debt, it makes it really hard to ever get ahead. Incredibly, 43 percent of all American families spend more than they earn each year. Even while median household income continues to decline (now less than $50,000 a year), median household debt continues to go up. According to the Federal Reserve, median household debt in America has risen to $75,600. Many Americans spend decades caught in the trap of debt slavery. Large numbers of them never even escape at all and die in debt. It can be a lot of fun to spend lots of money and go into lots of debt, but it can be absolutely soul crushing to toil and labor for years paying off those debts while making others wealthy in the process. Hopefully this article will inspire many people to try to escape the chains of debt slavery once and for all.

Because the truth is that the American people need a wake up call. Consumer borrowing rose by another $19.3 billion in December. Right now it is sitting at a grand total of $2.5 trillion according to the Federal Reserve.

Overall, consumer debt in America has increased by a whopping 1700% since 1971.

We always criticize the federal government for going into so much debt, but we rarely criticize ourselves for our own addiction to debt.

Debt slavery is destroying millions of lives all across this country, and it is imperative that we educate the American people about the dangers of all this debt.

The following are 30 facts about debt in America that will absolutely blow your mind....

Credit Card Debt

#1 Today, 46% of all Americans carry a credit card balance from month to month.

#2 Overall, Americans are carrying a grand total of $798 billion in credit card debt.

#3 If you were alive when Jesus was born and you spent a million dollars every single day since then, you still would not have spent $798 billion by now.

#4 Right now, there are more than 600 million active credit cards in the United States.

#5 For households that have credit card debt, the average amount of credit card debt is an astounding $15,799.

#6 If you can believe it, one out of every seven Americans has at least 10 credit cards.

#7 The average interest rate on a credit card that is carrying a balance is now up to 13.10 percent.

#8 According to the credit card calculator on the Federal Reserve website, if you have a $10,000 credit card balance and you are being charged a rate of 13.10 percent and you only make the minimum payment each time, it will take you 27 years to pay it off and you will end up paying back a total of $21,271.

#9 There is one credit card company out there, First Premier, that charges interest rates of up to 49.9 percent. Amazingly, First Premier has 2.6 million customers.

Auto Loan Debt

#10 The length of auto loans in America just keeps getting longer and longer. If you can believe it, 45 percent of all new car loans being made today are for more than 6 years.

#11 Approximately 70 percent of all car purchases in the United States involve an auto loan.

#12 A subprime auto loan bubble is steadily building. Today, 45 percent of all auto loans are made to subprime borrowers. At some point that is going to be a massive problem.

Mortgage Debt

#13 Total home mortgage debt in the United States is now about 5 times larger than it was just 20 years ago.

#14 Mortgage debt as a percentage of GDP has more than tripled since 1955.

#15 According to the Mortgage Bankers Association, approximately 8 million Americans are at least one month behind on their mortgage payments.

#16 Historically, the percentage of residential mortgages in foreclosure in the United States has tended to hover between 1 and 1.5 percent. Today, it is up around 4.5 percent.

#17 According to Dylan Ratigan, 46 percent of all mortgaged properties in Florida are underwater, 50 percent of all mortgaged properties in Arizona are underwater and 63 percent of all mortgaged properties in Nevada are underwater.

#18 Overall, nearly 29 percent of all homes with a mortgage in the United States are underwater.

#19 If you can believe it, the mortgage lenders now have more equity in U.S. homes than the American people do.

Medical Debt

#20 Medical debt is a major problem for a growing number of Americans. One study discovered that approximately 41 percent of all working age Americans either have medical bill problems or are currently paying off medical debt.

#21 Sadly, the number of Americans that are protected by health insurance continues to decline. An all-time record 49.9 million Americans do not have any health insurance at all right now, and the percentage of Americans covered by employer-based health plans has fallen for 11 years in a row.

#22 But even if you do have health insurance, there is still a good chance that you could end up with huge medical debt problems. According to a report published in The American Journal of Medicine, medical bills are a major factor in more than 60 percent of the personal bankruptcies in the United States. Of those bankruptcies that were caused by medical bills, approximately 75 percent of them involved individuals that actually did have health insurance.

Student Loan Debt

#23 Total student loan debt in the United States is rapidly approaching 1 trillion dollars.

#24 If you went out right now and starting spending one dollar every single second, it would take you more than 31,000 years to spend one trillion dollars.

#25 In America today, approximately two-thirds of all college students graduate with student loan debt.

#26 The average student loan debt load is now approximately $25,000.

#27 After adjusting for inflation, U.S. college students are borrowing about twice as much money as they did a decade ago.

#28 One survey found that 23 percent of all college students actually use credit cards to pay for tuition or fees.

#29 The student loan default rate has nearly doubled since 2005.

#30 Student loans made to directly to parents have increased by 75 percentsince the 2005-2006 academic year.

At this point, most Americans are up to their eyeballs in debt. According to a recent study conducted by the BlackRock Investment Institute, the ratio of household debt to personal income in the United States is now 154 percent.

Our entire economy has become based on credit.

Read the rest here

You’d hear or read of many adverse or negative imputations as “consumerism”, “not producing enough”, “spendthrift behavior”, “squanderville” and etc… from the mainstream, as if it has been the nature of Americans to be prodigal.

Lost on the real causation for the present circumstances, the politically popular theme has been to shift the blame on China for “currency manipulation” and or for financing US “profligacy”. In short, China bashing has served as a convenient political scapegoat for politicians and their allies.

Yet there have hardly been significant mainstream inquiries on what forces or variables may have influenced or motivated Americans to adapt on such consumption debt-financed based lifestyles.

In terms of government policies, a black hole emerges from mainstream thinking.

While the mainstream fixates on the moral aspects of the debt-consumption dynamics, they gloss over the effects of government policies that have vastly skewed people’s behavior to take on debts at the expense of savings and equity.

For instance, the credit fueled 2008 housing bubble has largely been policy driven. The speculative environment was entwined with debt based consumption activities.

Tax deductions on interest for corporations, and similarly for individuals—tax deductibility on mortgage interest and government subsidies on mortgages—encouraged debt take up and over-leveraging.

Another, capital regulations discouraged traditional mortgage lending and incentivized securitization, which has been abetted by the conflict of interest role played by credit rating agencies, whom ironically have been tightly regulated by the US government.

Also, public policy to promote housing or homeownership provided the moral hazard aspects via commitment by government to various housing subsidies. Thus, American’s penchant for McMansions. (My source Professor Arnold Kling: THE FINANCIAL CRISIS: MORAL FAILURE OR COGNITIVE FAILURE?)

Importantly, the zero bound interest rate policies, or formerly known as the Greenspan Put, favored debtors at the expense of savers. The Greenspan Put had also functioned as a conventional tool used against past crisis which has successfully kicked the proverbial can down the road.

Policies implemented by team Bernanke today have been NO different from the past, ergo the eponymous Bernanke Put.

Artificially suppressed interest rates thereby increases people’s time preference to consume at the expense production.

As the illustrious Ludwig von Mises explained,

The very act of gratifying a desire implies that gratification at the present instant is preferred to that at a later instant. He who consumes a nonperishable good instead of postponing consumption for an indefinite later moment thereby reveals a higher valuation of present satisfaction as compared with later satisfaction. If he were not to prefer satisfaction in a nearer period of the future to that in a remoter period, he would never consume and so satisfy wants. He would always accumulate, he would never consume and enjoy. He would not consume today, but he would not consume tomorrow either, as the morrow would confront him with the same alternative.

Thus, alternative to consumption activities from boom bust policies would be to entice short term speculation; ergo today’s speculative inflationary boom.

The ‘innovative’ and unparalleled Quantitative Easing (QE) approach also shields the banking system from having to face the harsh reality of the required market adjustments, from the massive malinvestments accumulated, brought upon by past policies.

QEs labeled as credit easing by central banks, have likewise been designed to promote debt by alleviating the conditions of the accounting books of the banking and financial industry.

In addition, America’s debt culture signifies a product of mainstream ideology

I previously wrote,

The culture of debt signifies symptoms of accrued policies shaped by the dominant economic ideology which sees spending as the key force for promoting prosperity or keeping society “permanently in a quasi-boom”.

The war against savings, which is being channeled through policy-based low interest rates (“The remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the boom to last”-General Theory) punishes savers and rewards speculative activities which benefits the wards of central banks—added profits for the banking industry cartel and expanded government spending for politicians.

Never mind the law of diminishing returns on debt to an economy

Past ephemeral successes [plus sustaining a debt based political economy] will lead global authorities towards path dependent policy choices (which is why I think that global QEs will continue)

Besides, politicians and the bureaucracy sees such policies as even more beneficial to them even if the markets suffer from the convulsions of debt overdose: people will be more captive to them which expands their control over the society.

Put differently, the cartelized political institutions made up of the triumvirate of the central bank, the welfare state and the politically privileged “too big to fail” banks represents as the major beneficiaries of a debt driven society, and thus, the incumbent political agents will continue to focus on maintaining the status quo founded on policies, laws and regulations that rewarded debts.

Sad to say, the laws of economics has been catching up with the artificiality of such political arrangement.