ASEAN to Join Credit Easing Cycle Bandwagon, Philippines Launch Stimulus

As pointed out in my earlier blog, global central banks are on path to an interest rate easing cycle anew. Asian-ASEAN central bankers will also be joining the bandwagon.

From Bloomberg,

Asian central banks from Thailand to the Philippines may be preparing to cut interest rates in coming weeks as an escalating impact from Europe’s debt crisis prompts economists to scale back growth forecasts for the region.

Thailand will cut its benchmark one-day bond repurchase rate tomorrow, all 16 economists surveyed by Bloomberg News predict. Pakistan’s central bank may add to its previous rate cuts or refrain from raising borrowing costs, a separate survey showed. Two analysts expect the Philippines to cut its key rate on Dec. 1, the first predictions for an easing since August 2009 based on Bloomberg surveys.

Morgan Stanley lowered its Asian economic estimates this week as the region that led the rebound from the 2009 global recession sees export demand impaired by Europe’s sovereign-debt turmoil. Asia’s currencies and stocks have fallen in the past month as investors shun emerging-market assets and the faltering growth outlook prompts companies including Philippine Long Distance Telephone Co. to cut profit forecasts….

The last time Asia went into an interest rate easing spree was during the immediate post Lehman crisis in the last quarter of 2008 until 1^st quarter 2011

And to reminisce on what had happened to ASEAN equity markets…. (chart from the World Bank)

…that cycle stoked the seeds of the boom phase in ASEAN equity markets (chart from Bloomberg).

The Philippine Phisix (red), Malaysia’s KLSE (yellow), Indonesia’s JCI (green) and Thailand’s SET (orange) have all been substantially up (only Malaysia has been up by less than 100%, Indonesia has more than doubled)

While I think that this may spark a similar boom…

…one must be reminded that this cycle will be different. ASEAN’s inflation rate has been substantially elevated compared to 2008 (chart from World Bank). This means that the easing cycle via the interest rate channel will be limited. And that any further easing may fuel the risks of accelerated inflation.

And because of the constrained latitude of interest rate maneuvering, governments will be resorting to other forms of stimulus such as fiscal spending.

From the same Bloomberg article,

Bangko Sentral ng Pilipinas may consider easing its policy rate, Economic Planning Secretary Cayetano Paderanga said after the report. Twelve of the 14 economists surveyed expect the central bank to keep the benchmark at 4.5 percent, with two predicting a cut to 4.25 percent.

President Benigno Aquino unveiled a 72 billion-peso ($1.6 billion) fiscal stimulus package in October, joining neighbors including Malaysia and Indonesia in seeking to protect growth. Bank Indonesia unexpectedly cut rates by half a percentage point to a record low this month to 6 percent.

Fiscal stimulus essentially represents a tradeoff between future growth and current growth, as government spending borrows from future to finance the present.

The goal is to boost Keynesian constructed (spending based) statistics rather than to generate long term jobs as determined by the market.

Think of the irony, if economic growth is generated by government spending why not make spending infinite. Yet spending will have to be financed by taxes (also borrowing) or inflation which leads to either default or hyperinflation and political upheavals.

In reality, government spending will be directed to non-market or political (mostly vote generating, e.g. infrastructure) activities which will signify as 72 billion peso worth of wastage and a 72 billion peso window for corruption.

Thus, the "protection of growth" should be seen in the light of protecting the growth of politicians, allies and cronies rather than the public, as taxpayer money will be diverted into non productive engagements. Also this implies higher taxes ahead which again will increase the burden for investments and competitiveness and more unemployed workers.

So even as the current administration prosecutes the former administration for alleged misconduct, the fiscal spending program signifies a huge room for the same set of malfeasant actions.

Thus, politics is about grabbing credit (to get ratings approval or generate votes) by stepping on someone else’s toes, but at the same time providing opportunities for the same set of inappropriate actions.

And the best way to do this is to divert public’s attention so as to camouflage their actions in the name of "protecting economic growth" and of "anti corruption" measures through public arraignment or trial-by-publicity of political adversaries. In this context, personality based politics in the shadow of welfare-pork barrel politics as explained by Professor Robert Higgs seems fitting.

Nonetheless all those credit creation and spending will have to flow somewhere.

Once the interest rate reductions and the stimulus are activated, the fuse to the next leg of the bubble cycle would have been lit.

Profit from folly.

Global Central Banks Ease the Most Since 2009

Here is what I wrote last night

Yet what sets the today’s markets apart from the 2008, Japan’s stagnation and or the Great Depression has been the central bank activism which as I have been reiterating has been navigating on uncharted treacherous waters.

Artificially manipulated interest rate together with money printing results to relative pricing of assets, which all comprises the inflation cycle.

For a little validation of my observations, here’s the latest Bloomberg article with the particulars, (bold emphasis mine)

Central banks across five continents are undertaking the broadest reduction in borrowing costs since 2009 to avert a global economic slump stemming from Europe’s sovereign-debt turmoil.

The U.S., the U.K. and nine other nations, along with the European Central Bank, have bolstered monetary stimulus in the past three months. Six more countries, including Mexico and Sweden, probably will cut benchmark interest rates by the end of March, JPMorgan Chase & Co. forecasts.

With national leaders unable to increase spending or cut taxes, policy makers including Australia’s Glenn Stevens and Israel’s Stanley Fischer are seeking to cushion their economies from Europe’s crisis and U.S. unemployment stuck near 9 percent. Brazil and India are among countries where easing or forgoing higher interest rates runs the risk of exacerbating inflation already higher than desired levels.

“We’ve seen central banks that were hawkish begin to turn dovish” against a “backdrop of austerity” in fiscal policy, said Eric Stein, who co-manages the $6.6 billion Eaton Vance Global Macro Absolute Return Fund in Boston. “You could debate how bad it will be for growth, but it can’t be good,” he said of the challenges facing the world economy.

Global Rate

Monetary easing will push the average worldwide central bank interest rate, weighted for gross domestic product, to 1.79 percent by next June from 2.16 percent in September, the largest drop in two years, according to data and projections from JPMorgan, which tracks 31 central banks. The number of those banks loosening credit is the most since the third quarter of 2009, when 15 institutions cut rates, the data show…

While central banks in Australia and Indonesia have reduced borrowing costs and the Bank of Japan increased asset purchases in October, other countries in Asia may be slower to ease policy.

The People’s Bank of China has raised its main interest rate three times this year to fight inflation. India’s central bank lifted rates on Oct. 25 by a quarter of a percentage point, while signaling it was nearing the end of its record cycle of increases as the economy cooled.

“Most central banks will wait and see how the situation develops in Europe,” said Joseph Tan, Singapore-based chief economist for Asia at Credit Suisse Group AG’s private-banking division. “If we do have a continuation of the political impasse in Europe and that leads to a recession in Europe, and the U.S. economy starts to slow again, then Asian central banks will cut interest rates.”…

Europe’s turmoil has led Australia, Brazil, Denmark, Romania, Serbia, Israel, Indonesia, Georgia and Pakistan to reduce interest rates since late August. Chile, Mexico, Norway, Peru, Poland and Sweden are also forecast by JPMorgan Chase to lower borrowing costs by the end of the first quarter, while Australia, Brazil, Indonesia, Israel and Romania may cut rates further.

In the U.S., Federal Reserve Chairman Ben S. Bernanke is considering further actions to lower borrowing costs in the world’s biggest economy. He vowed in August to keep the benchmark interest rate close to zero through at least mid-2013. The central bank in September decided to replace $400 billion of short-term securities it holds with longer-term debt to reduce rates on extended-maturity debt.

The article doesn't say it but global central bank asset purchases have been unprecedented, although in terms of interest rate rates--yes, they are 2009 lows.

Yet given the above, there will be NO deflation coming as central banks continue to aggressively ease. I even expect more coming from the ECB

On the other hand, prepare for a boom bust cycle in parts of the global economy and nasty inflation ahead.

New Zealand’s John Key’s Victory, A Win for Free Markets

Despite all the troubles confronting the world today, forces of globalization and economic freedom appear to be getting some headway in the realm of politics.

From Bloomberg,

New Zealand Prime Minister John Key’s re-election with his party’s biggest mandate in 60 years will strengthen a government push for free-market policies as he pursues welfare cuts and asset sales to balance the budget.

Key’s National Party won 48 percent of the vote on Nov. 26, up from 45 percent three years ago, allowing him to form the next government with support from political allies in parliament. Electricity companies Mighty River Power Ltd. and Genesis Power Ltd. may be among the first considered for share sales, the prime minister signaled today, as his administration focuses on divesting some state assets.

A second term allows Key to expand policies aimed at reducing the economy’s reliance on government spending, an effort that was slowed in the past three years by the need to help the country recover from the global financial crisis and New Zealand’s deadliest earthquake in 80 years. The leader, whose popularity survived a credit-rating downgrade, has pledged to return the budget to surplus by 2014-15 or sooner as soaring borrowing costs imperil indebted European nations.

Information and education are the only means where free market/classical liberalism forces can generate political following. Nevertheless today’s technology enabled connectivity platforms (social media) should help facilitate the campaign for liberty.

John Key’s win plus the recent defeat of the Socialist government or a victory by Conservatives in Spain are refreshing examples of marginal changes in the political sphere that has been happening across the world.

Quote of the Day: Welfare State and Personality Based Politics

As the ranks of those dependent on the welfare state continue to grow, the need for the rulers to pay attention to the ruled population diminishes. The masters know full well that the sheep will not bolt the enclosure in which the shepherds are making it possible for them to survive. Every person who becomes dependent on the state simultaneously becomes one less person who might act in some way to oppose the existing regime. Thus have modern governments gone greatly beyond the bread and circuses with which the Roman Caesars purchased the common people’s allegiance. In these circumstances, it is hardly surprising that the only changes that occur in the makeup of the ruling elite resemble a shuffling of the occupants in the first-class cabins of a luxury liner. Never mind that this liner is the economic and moral equivalent of the Titanic and that its ultimate fate is no more propitious than was that of the “unsinkable” ship that went to the bottom a century ago.

From Professor Robert Higgs.

Oh, this very much applies to the Philippine political setting. Think Pork Barrel politics and the 250 political dynasties. And that's why the search for the elusive efficacious leader who is supposed to deliver us from hardship will always be just that: a constant source of frustration. People don't realize that the much sought after miracle of effectiveness and justice from the nanny patriarch state will always be a mirage.

More Signs of the Coming Inflation Tsunami from the ECB

Desperate times call for desperate measures.

In politics, supposed principled stance frequently gives way to convenience, as I have been predicting here and here.

From Reuters

France and Germany are planning a quick new pact on budget discipline that might persuade the European Central Bank to ramp up its government bond purchases, Welt am Sonntag reported on Sunday.

Echoing a Reuters report on Friday from Brussels, the Sunday newspaper said the French and German leaders were prepared to back a deal with other euro countries that might induce the ECB to intervene more forcefully to calm the euro debt crisis.

The newspaper report quoted German government sources as saying that the crisis fighting plan could possibly be announced by German Chancellor Angela Merkel and French President Nicolas Sarkozy in the coming week.

In an advance release before publication, Welt am Sonntag said that because it would take too long to change existing European Union treaties,euro zone countries should just agree among themselves on a new Stability Pact to enforce budget discipline - possibly implemented at the start of 2012.

At the end of the day, this will all be about defending the political syndicate of the welfare state-central bank-banking cartel.

Watch gold fly.

UK Prepares for Euro Collapse

From the Telegraph

As the Italian government struggled to borrow and Spain considered seeking an international bail-out, British ministers privately warned that the break-up of the euro, once almost unthinkable, is now increasingly plausible.

Diplomats are preparing to help Britons abroad through a banking collapse and even riots arising from the debt crisis.

The Treasury confirmed earlier this month that contingency planning for a collapse is now under way.

A senior minister has now revealed the extent of the Government’s concern, saying that Britain is now planning on the basis that a euro collapse is now just a matter of time.

“It’s in our interests that they keep playing for time because that gives us more time to prepare,” the minister told the Daily Telegraph.

Recent Foreign and Commonwealth Office instructions to embassies and consulates request contingency planning for extreme scenarios including rioting and social unrest.

Greece has seen several outbreaks of civil disorder as its government struggles with its huge debts. British officials think similar scenes cannot be ruled out in other nations if the euro collapses.

Diplomats have also been told to prepare to help tens of thousands of British citizens in eurozone countries with the consequences of a financial collapse that would leave them unable to access bank accounts or even withdraw cash.

I don’t trust how politicians and bureaucrats assess and analyze events. Usually more planning extrapolates to the extension of political control over the citizenry under the guise of sundry crises.

In the memorable words of the great Libertarian H.L. Mencken

Civilization, in fact, grows more and more maudlin and hysterical; especially under democracy it tends to degenerate into a mere combat of crazes; the whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by an endless series of hobgoblins, most of them imaginary.

On the other hand, could this signify as more signs of a crowded trade?

Video: Andrew Napolitano: What If Freedom's Greatest Hour of Danger Is Now?

A rousing message of Freedom from Judge Andrew Napolitano.


(hat tip Bob Wenzel)

Steve Leuthold: ‘I’m Scared to Death of the Markets’, but He’s Buying

This stuff caught my eye. Star Tribune’s Kara MCGuire quotes the veteran investor Steve Leuthold:

I'm scared to death of the market.

Here’s why Mr. Leuthold is scared.

"I've been scared to death of the market before and it's been the time to buy," he said, pointing out that the hundreds of data points the Leuthold investment team use to make buy-and-sell decisions have turned positive. Their core portfolio is now half invested in stocks -- up from 30 percent earlier this year.

"You do have pretty good valuations here, and we do think the economy is OK. We're not expecting a double dip -- we're probably going to see 2.5 to 3 percent GDP growth next year." He also expects a "Band-Aid" solution in Europe to address the uncertainty coming from Greece, Italy and Spain.

But several alarming issues loom: gridlock in Washington, the U.S. deficit and concerns about the long-term value of the U.S. dollar, to name three on the top of Leuthold's mind.

He said the last time individuals faced an economic crisis of this magnitude was in the 1970s. But investors who lost faith in the market back then could invest in Treasury bills and earn 15 percent in interest.

"Now there is nowhere to go with safety where you can get a decent return on your money," said Leuthold, who thinks the policy of keeping interest rates low is really hurting average investors, who are in over their heads to begin with.

Not far from how I see current developments.

Yet he shares some tips: (bold original)

"Opinions are for show; numbers are for dough." In other words, don't make investment decisions based on emotions, news reports or cocktail talk. Do your research. If you have a tendency to make emotional decisions, consider an asset allocation fund made up of a mix of stocks and bonds with a manager paid to worry for you.

Be conservative. Save more, spend less because the idea that the future will always be better, well, "That's not necessarily true."

Don't follow the herd. Although being in the middle of the herd is the most comfortable place to be, consider getting out of your comfort zone. "When you see everybody go one way, look at why they may be wrong."

Go global. Investors should work toward having 50 percent of their portfolio based outside the United States, particularly in Asia. "The U.S. was the economic king of the world after World War II," Leuthold explained. "We had this huge wave behind the U.S. that gave us superior growth for 30 years. Then all of a sudden [other countries] started catching up. ... We go along like we're still the kings and can afford deficits as far as the eye can see and something is going to happen magically to support all these retired people with Social Security and Medicare. And it's a pipe dream."

Remember that investing isn't about the warm fuzzies. It can be downright unnerving. One short-term, tactical play is to consider investing in European stocks with global earnings. He mentioned Nestlé, Siemens and Unilever.

In short, use your common sense and don’t follow your confidence fairy or ‘animal spirits’.

Phisix-ASEAN Bourses Diverge from Global Market Turmoil

Markets have been exposing the farcical nature of politics—the popular belief that the fundamental laws of economics can sustainably be controlled or manipulated by edicts or by fiats or by legal mandates. Thus, I don’t see any validity to the expression which says that “markets are being forced to come to grips with a distressing reality” in describing what’s been happening today. Europe’s debt crisis has been manifesting on the dynamics where markets have been compelling politicians to act. It isn’t the markets that have been detached from reality; instead it has been the vastly skewing influence of politics in the marketplace.

And it would be serious mistake to simply gloss over the motives of politicians and presume that, along with their allies, they would docilely submit to market forces. The political class along with their economic clients have benefited immensely from the incumbent political institutions, organized along the 20^th century vertical top-bottom framework, will likely continue to fight to maintain their entitlements through the preservation of the system.

And such transition would be surrounded by intense volatilities in the marketplace and in the political realm as evidenced today.

It’s not a question of simply reading past performance (current economic figures) and projecting them into the future as the mainstream does. Many who see the world as operating in a prism of the 2008 paradigm or the Japan stagnation or the Great Depression of the 1930s will most likely be mistaken, as consistently proven in the recent past.

Instead, it is the question of how politicians along with their respective bureaucratic leaders will react in the face of the continuing unfolding crisis and the possible ramifications thereof that would matter most in forecasting the path of price trends in financial markets.

Divergences as Emerging Theme

Divergence seems to be an emerging theme.

One would need just to see how equity markets have been reflecting on the emerging signs of divergences, instead of a contemporaneous convergence during periods of market stresses such as in the crisis of 2008.

Below is the weekly performance of the select major equity markets.

While reflecting signs of weakness, Asian equity markets have not been as buffeted in the scale of her Western counterparts.

To consider, globalization has been increasing the correlations of equity markets.

Asian equity markets (ex-Japan) since 1995 has been exhibiting growing interdependence with global markets[1].

Given today’s deepening of globalization trend, Asian equity markets have become more sensitive to developments of the world. And this is why the argument for a decoupling may not be persuasive.

However my thesis has been that—market divergences or relative asset pricing may likely persists for as long as the world doesn’t succumb to a vortex of liquidity contraction or from a global recession which may also manifest the same symptom.

Yet signs of seminal diversity in equity market performance seem even more apparent from a wider timeframe.

The year-to-date performance of select global benchmarks as seen below.

While the European debt crisis has substantially battered the region’s equity markets where the current bear markets—shown by Germany and France could exhibit signs of forthcoming recession, the expected ripple or ‘contagion’ effects from this crisis seems to have been limited, thus far.

Again the ASEAN-4 and the US S&P 500 appear to sizably deviate from the Eurozone. Japan’s gloomy performance may partly be attributed to dour global sentiment but mostly to the first quarter triple whammy natural disaster. Meanwhile, the weak state of China’s equity markets could be a manifestation of either a cyclical slowdown or a bubble bust, which so far has yet to be established.

It is important to note that we cannot discount a shock from happening given the current circumstances. However as I have repeatedly been pointing out, the fundamental difference of the market’s outcome (from that of 2008 or from Japan’s lost decade) will be determined by prospective policy actions.

Monetization and Debt Profiling

Part of the aberration in market pricing can be attributed to the market’s differentiation of credit risks by specific nations.

The fascinating table above from Bespoke Invest[2] signifies an updated tale of the tape of credit risks, where the cost to insure debt of 44 nations via credit default swaps (CDS) has materially surged in the Eurozone led by Greece and Portugal (see bottom portion of the table) whom has surpassed the former laggard socialist Venezuela.

The Eurozone’s crisis has even dragged AAA credit rating France whose costs of insurance have skyrocketed by 142% year-to-date and which has even topped the ASEAN-4. France has now been ‘riskier’ than the Philippines and the ASEAN.

Meanwhile the US continues to exhibit strength or outperformance amidst rising concerns over global credit risks, which has hardly dented on her CDS premiums. This comes in spite of the recent S&P downgrade.

But the above table doesn’t tell the entire story though.

The reason for the current Euro crisis and the relative ‘safe US credit standing’ has largely been due to the debt maturity profile.

Much of the refinancing needs of Italy and the rest of the crisis affected PIIGS have been current or due in near term (top chart[3]).

Meanwhile US debt maturity profile has been farther out of the curve[4].

Nevertheless, sovereign liabilities of the US continue to balloon.

This November, US debts have soared passed 100% of GDP[5] which adds the US in the company[6] of prospective deadbeats.

The major reason why US the hasn’t suffered the same fate as that of the European PIIGS is that the US Federal Reserve has been monetizing her US debts, something which the Keynesians and the Chartalists have been raving about. The implication is that the US, as the world’s premier foreign currency reserve, is virtually immune to laws of economics. For them, money printing allows the US government to spend at will, which hardly will stoke any risks of inflation. Thus, the aversion to discuss any hyperinflation parallels of Weimar Germany or of Zimbabwe.

Yet the seeds towards the destruction of the US dollar have already been sown, the US Federal Reserve has reportedly outpaced China as the largest owner of US debt[7]. This means that the US has principally been relying on money printing by the Fed to finance her present liabilities.

This also shows the absurdity of the idea that the US Federal Reserve won’t commit to additional quantitative easing (QE) measures, as argued by some.

The US is faced with extremely challenging circumstances of pronounced weakness in many parts of the global economy that could intensify the risks of another recession, in an environment where national (US) saving rates has on a deepening slump[8], the worsening insolvency crisis at the Eurozone area that will extrapolate to reduced access to private financing and a possible contagion from a distressed banking sector[9].

True, US bond yields have been drifting in near record lows. However this hasn’t been a sign of systemic deflation (yes oil prices is just under $100, gold at under $1,700), instead low yields have been representative of policies targeted at manipulating the yield curve and of the temporal haven currency reserve status of the US dollar[10].

To add US CPI inflation has been climbing which in October was at the 3.5% rate and has been above the 1914-2010 average at 3.38%[11]. To consider, US CPI construct has vastly been skewed towards housing[12] which doesn’t accurately signal the real rates.

Yet the shortfall of financing US debts will be reinforced by the ongoing ‘slowdown’ in China whom has been resorting to her own whack-a-mole or piecemeal approach in applying bailouts[13]. And this also should apply to other emerging markets as well.

So far, the appetite to finance US debts by foreign central banks has been drying up[14].

Also the current crisis in the Euro area will postulate an environment of an even tighter competition with the US, the EU and other governments, as well as, other private entities wanting to access to savings from private sector.

Of course a no QE scenario for the FED will only happen if Bernanke and the rest of the FOMC will experience the epiphany of letting the markets clear.

But I would say that the odds for such an event to happen will proximate ZERO.

Central Bank Activism

For as long as the rates of inflation remains suppressed, politicians and their bureaucrats will use the current opportunities to test the limits of controlling and manipulating of the markets.

Thus any proclamations to impose self-discipline should be seen with cynicism.

For instance, the once defiant Germans, who have strongly been opposing the European Central Bank’s (ECB) role as ‘lender of last resort’, appear to be gradually acceding to pressures[15] for the ECB to aggressively backstop the Euro in the name of fiscal integration or union.

In reality, today’s signs of divergences seem to be driven by idiosyncratic liquidity conditions of each nation—where asset prices appear to be priced depending on relative systemic exposure on debt combined with the prospective impact of loose monetary conditions to their respective markets and the economy. These, aside from the transmission effects from policies set by the US Federal Reserve.

Thus in considering the above, the low leverage of ASEAN 4 makes them more receptive to the present boom bust policies.

Yet what sets the today’s markets apart from the 2008, Japan’s stagnation and or the Great Depression has been the central bank activism which as I have been reiterating has been navigating on uncharted treacherous waters.

Artificially manipulated interest rate together with money printing results to relative pricing of assets, which all comprises the inflation cycle.

Bottom line: I think the boom phase for the Phisix ASEAN markets, despite the turbulence in the EU, remains intact, barring any unforeseen events.

---

[1] Worldbank.org Navigating Turbulence, Sustaining Growth WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE 2011, VOLUME 2

[2] Bespokeinvest.com Global Sovereign Credit Default Swap Prices, November 25, 2011

[3] Macleod Alasdair Watch out for maturing debt, November 19, 2011

[4] Merk Axel, Operation Twist a Primer for QE3? , Merk Funds, October 4, 2011

[5] See US Debt Passes $15 Trillion or Over 100% of GDP, November 17, 2011

[6] Galland David Monetary Madness – Is the US Monetary System on the Verge of Collapse? , October 18, 2011, Daily Reckoning

[7] CNSNews.com Fed Now Largest Owner of U.S. Gov’t Debt—Surpassing China, November 16, 2011

[8] Bloomberg.com U.S. Economy Grew Less Than Forecast on Inventories, November 22, 2011 SFGate.com

[9] See The US Banking Sector’s Dependence on Bernanke’s QEs, October 5, 2011

[10] See Market Crash Confirms Some of My Thesis on Gold and Decoupling, October 2, 2011

[11] Tradingeconomics.com United States Inflation Rate

[12] See US CPI Inflation’s Smoke and Mirror Statistics May 18, 2011

[13] See China Expands Bailout Measures, Reduces Reserve Requirements for Select Financial Firms, November 24, 2011

[14] Vuk, Vedran Are Foreign Banks Losing Confidence in US Treasuries? October 17, 2011 Casey Research

[15] See Will the European Central Bank Relent to Political Pressures to Increase Debt Monetization? November 26, 2011

Euro Debt Crisis: The Confidence Fairy Tale and Devaluation Delusion

The Confidence Fairy (Fear and Greed) Fable

Suggestions have been made that Euro crisis has been an issue of confidence or “animal spirits” as alleged by the mainstream analysts.

This represents half-truth.

The idea that people are driven by sheer optimism or pessimism dumbs down the people’s ability to look after their self-interest. Of course those peddling such rubbish assume that they are above the rest of mankind.

Yet in a bizarre way of thinking, they use assorted and complex economic analysis when at the end of the day, everything for them, essentially boils down to random optimism or pessimism.

The assumption that psychological factors as purely driving the marketplace ignores the truism of the collective individual’s ability to calculate on the elemental tradeoffs of cost relative to benefits or of risk relative to rewards.

People don’t buy financial securities because they wake up in the morning feeling ‘optimistic’ or sell when they feel ‘pessimistic’. People buy or sell because they see, rightly or wrongly, beneficial aspects from the execution of such actions. Whether psychic or monetary, the assumed rewards are subjectively determined by the person taking action.

The supposed confidence fairy of fear and greed are essentially driven by an underlying event stimulus or incentive and not by mere impulse.

For instance, a market crash doesn’t happen because of fear itself. Instead a crash happens when people discover that the issues they own have not been priced accordingly or has substantially been worth below the most recent value as a result of some chain of causes.

Like those stampeding out of a theater (effect) because of a sudden discovery of fire (cause), the simultaneous act by many to exit ownership of financial securities fuels impulses or emotions to go along with the crowd (bandwagon effect). Thus fear signifies a symptom of an underlying cause rather than a cause in itself.

Yet fear and greed are prominent symptoms of bubble cycles.

During market euphoria usually at the acme of a bubble cycle, people pile up on ascendant prices because of the thought of the perpetuity of such price trends.

Of course, this can be only made possible by the loosening of extensions of credit (circulation credit) where the credit-collateral feedback loop mechanism gets rolling—where rising collateral values prompts for more lending, and more lending increases collateral values.

Thus, circulation credit (which are consequences of artificially suppressed interest rates and from policy directives, e.g. credit subsidies, bailouts) fuels bubble cycles which impels contortions in people’s economic calculations and subsequently results to the emotive price chasing phenomenon—Greed.

The opposite phenomenon holds true during bubble busts. The credit-collateral feedback loop mechanism goes into a reverse operation—falling collateral values prompts for margin calls and the calling in of bank loans both of which decreases collateral values. The simultaneous acts of exodus essentially signify—Fear.

In truth the confidence fairy has nothing been more than a pretext for more government intervention.

As the great Murray Rothbard once wrote[1]

Keynesian doctrine is, despite its algebraic and geometric jargon, breathtakingly simple at its core: recessions are caused by underspending in the economy, inflation is caused by overspending. Of the two major categories of spending, consumption is passive and determined, almost robotically, by income; hopes for the proper amount of spending, therefore, rest on investment, but private investors, while active and decidedly non-robotic, are erratic and volatile, unreliably dependent on fluctuations in what Keynes called their "animal spirits."

Fortunately for all of us, there is another group in the economy that is just as active and decisive as investors, but who are also--if guided by Keynesian economists--scientific and rational, able to act in the interests of all: Big Daddy government. When investors and consumers underspend, government can and should step in and increase social spending via deficits, thereby lifting the economy out of recession. When private animal spirits get too wild, government is supposed to step in and reduce private spending by what the Keynesians revealingly call "sopping up excess purchasing power" (that's ours).

The Euro crisis has hardly been founded from the issue of greed and fear, but of boom bust cycles.

Following massive imbalances acquired from the antecedent boom, market prices have been prevented from clearing or from seeking to adjust to the required levels that would allow resources to be transferred from unproductive to productive use. The discoordination and coordination mechanism of the marketplace have been impeded.

Yet the constant interventions that has sustained the current artificial price levels have led to mass distortions and market participants astray. So once the effect of interventions subsides or once markets discover the artificiality of such price levels, volatility ensues. Emotional transactions follow.

Hence, the distributive outcomes from a significantly politicized marketplace suggest of massive price distortions from repeated government interventions. This has been mistakenly construed or touted as fear. Those saying so have been misreading effects as the cause.

Political Insanity and the Devaluation Elixir

The mainstream has also been suggesting that the gold standard effect from the Eurozone Union, which prohibits internal devaluation of member states, has been a cause to this crisis. For me this represents as unalloyed hogwash[2].

While I agree that the EU needs to be dissolved because of the latent intention to politically centralize Euro economies such as the supposed need to fiscally integrate the EU, I oppose the idea of nationalizing currency for the sole purpose of inflationism via devaluation.

I will not elaborate on the evils of inflationism[3], but rather point out how ridiculous the assertion of supposedly allowing Greece, for instance, to devalue to become ‘competitive’.

Based on the average hourly labour costs in the business economy in 2009[4], Greece has been one of the cheapest among the peripheral EU states. Italy, Spain and Portugal are just within the range of Greece.

The cheaper labor costs (on the right) belong to those of emerging Europe.

And labor costs signify as part of labor market efficiency[5]

The crisis affected PIIGS also belong to the least competitive rankings[6] in terms of labor efficiency.

In other words, cheap labor did not translate to export greatness.

Thus, devaluation will hardly impact the competitiveness of the labor market because this does not treat the disease.

The disease which plagues the PIIGS are highlighted by the unfriendly business enviroment[7] caused by too much regulations and bureaucratic hurdles.

And importantly, by the intractable government expenditures[8] mostly from the welfare state as measured by the Fiscal Imbalances (FI)[9].

At the end of the day, those who yearn for a Zimbabwe solution to the Euro don’t have the intention of resolving the crisis but to promote the same ills that has blighted them.

No wonder Albert Einstein called—doing the same thing and expecting different results—insanity.

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[1] Rothbard Murray N. Keynesianism Redux, Chapter 12, Making Economic Sense

[2] See Quote of the Day: A Very Expensive Education in Basic Economics, November 10, 2011

[3] See Vatican Banker Endorses ECB’s Inflationism November 24, 2011

[4] Euro Commission Wages and labour costs, Eurostat

[5] Financial-lib.com Labor efficiency variance: the number of hours actually worked minus the standard hours allowed for the production achieved multiplied by the standard rate to establish a value for efficiency (favorable) or inefficiency(unfavorable) of the work force

[6] Infectiousgreed.com Reforming Labor Markets, November 14, 2011

[7] Danske Research Euro Area Macro Handbook, November 2011

[8] Gokhale Jagadeesh Measuring the Unfunded Obligations of European Countries January 2009

[9] The fiscal imbalance (FI) measures the size of the total imbalance built into current fiscal policies, including future changes already scheduled by law. It is a country’s unfounded liability, looking indefinitely into the future. It is the difference between the present cost of continuing current government spending programs, including entitlement promises, present public debt, net of expected tax revenues. It is the amount of additional resources the government must have on hand today, invested and earning interest, in order to continue policies forever. Alternatively, it equals the additional net revenue or cost savings required from future policy adjustments to close the budeget gap embedded in current fiscal policies.

The FI is similar to outstanding public debt in one important way: It grows larger over time because of accruing interest costs. In addition fiscal policies that imply a positive FI are unsustainable: Because the ratio of FI to the present value of future GDP also grows larger over time, the implied annual service payments would eventually become larger than annual GDP

Will the European Central Bank Relent to Political Pressures to Increase Debt Monetization?

Here is what I said last week

I would conjecture that rules, laws, regulations, policies or self-imposed limits change according to the convenience and the interests of politicians.

This seems to be happening. A dithering European Central Bank (ECB) may be “softening” their stance as pressures for her to backstop the Eurozone mounts.

The Euro crisis has been rapidly spreading like a wildfire.

Even Germany’s bonds are being dragged by the crisis. (chart from Bespoke Invest).

Last night, Belgium’s credit rating had been lowered by the S&P. Belgium follows Slovenia, Spain, Italy, Ireland, Portugal, Cyprus and Greece as euro-area countries having their credit rating cut this year. The country of 10.8 million people, whose capital, Brussels, is home to the European Commission and the North Atlantic Treaty Organization, last had its credit standing lowered in December 1998 by Fitch Ratings. (Bloomberg)

The following report from Bloomberg shows us how political interests will likely lead to a change in the rules of the game in dealing with the Euro Crisis, (bold emphasis mine)

European governments may ease provisions in a planned permanent rescue fund requiring bondholders to share losses in sovereign bailouts, German Finance Minister Wolfgang Schaeuble suggested.

Schaeuble signaled that Germany may retreat from demands that private creditors contribute to rescues in exchange for European treaty amendments toughening rules on budget oversight.

European efforts to speed the setup of the 500 billion-euro ($662 billion) European Stability Mechanism from its planned mid-2013 debut have lost momentum as Germany and the Netherlands resisted pleas by France, Spain, Portugal and Ireland to drop its bondholder-loss provisions.

“Basically, we agreed on the principle for the ESM already in July,” Schaeuble told reporters in Berlin after talks with his Dutch and Finnish counterparts today. “If we now manage to move toward a stability union, we’ll see how one might possibly adjust the treaty.”

The debt crisis rattled Germany, Europe’s biggest economy, with the failure of a bund auction two days ago. Bond yields in Spain and Italy surged today, with Spain dropping a plan to auction a three-year benchmark next week and Italy being forced to pay more to borrow for two years than for 10. Belgium's credit rating was cut today to AA from AA+ by Standard and Poor's.

While there “may be discussions in Brussels” next week on sector involvement under the ESM, the aim of a finance ministers’ meeting will be to flesh out details of the agreement by EU leaders last month to write down Greek debt, recapitalize banks and strengthen the existing rescue fund, the European Financial Stability Facility, Schaeuble said.

ECB Pressure

As the crisis worsens, the European Central Bank is coming under pressure to step up its response. While France yesterday agreed to stop pressuring the ECB to print money, policy makers today signaled they are willing to offer cash-strapped banks more liquidity if needed.

Pieces of the jigsaw puzzle seems falling into place.

The probable reason why France has “agreed to stop pressuring the ECB” is because Benoit Coeure, chief economist at the country’s finance ministry has reportedly been nominated to the ECB to replace Lorenzo Bini Smagh, which appears to be part of the horse trading on the political appointments happening at the European Central Bank.

The growing clamor for the EU to have a "fiscal union" has served as veneer for the ECB to go on the path similar to the US Federal Reserve in pursuing an aggressive monetary policy stance.

Looks like we may be headed there pretty soon.

Quote of the Day: Perversion of the Law

The law perverted! And the police powers of the state perverted along with it! The law, I say, not only turned from its proper purpose but made to follow an entirely contrary purpose! The law become the weapon of every kind of greed! Instead of checking crime, the law itself guilty of the evils it is supposed to punish! If this is true, it is a serious fact, and moral duty requires me to call the attention of my fellow-citizens to it.

A very time relevant quote from the great Frédéric Bastiat, The Law (hat tip Professor Art Carden)

War on Drugs: Misplaced ‘Follow the Money’ Priorities by Cops Results to More Crimes

You think the war on drugs make society peaceful? Think again.

Police officers, like any human being, also follow the money. But unlike us, since they are armed by mandate, they may use the law for their self-interest or benefit at our expense.

From Radley Balko of the Huffington Post (bold emphasis added) [hat tip Don Boudreaux]

As Jessica Shaver and I chat at a coffee shop in Chicago's north-side Andersonville neighborhood, a police car pulls into the parking lot across the street. Then another. Two cops get out, lean up against their cars, and appear to gaze across traffic into the store. At times, they seem to be looking directly at us. Shaver, who works as an eyebrow waxer at a nearby spa, appears nervous.

"See what I mean? They follow me," says Shaver, 30. During several phone conversations Shaver told me that she thinks a small group of Chicago police officers are trying to intimidate her. These particular cops likely aren't following her; the barista tells me Chicago cops regularly stop in that particular parking lot to chat. But if Shaver is a bit paranoid, it's hard to blame her.

A year and a half ago she was beaten by a neighborhood thug outside of a city bar. It took months of do-it-yourself sleuthing, a meeting with a city alderman and a public shaming in a community newspaper before the Chicago Police Department would pay any attention to her. About a year later, Shaver got more attention from cops than she ever could have wanted: A team of Chicago cops took down her door with a battering ram and raided her apartment, searching for drugs.

Shaver has no evidence that the two incidents are related, and they likely aren't in any direct way. But they provide a striking example of how the drug war perverts the priorities of America's police departments. Federal anti-drug grants, asset forfeiture policies and a generation of battlefield rhetoric from politicians have made pursuing low-level drug dealers and drug users a top priority for police departments across the country. There's only so much time in the day, and the focus on drugs often comes at the expense of investigating violent crimes with victims like Jessica Shaver. In the span of about a year, she experienced both problems firsthand….

In other words priority has been skewed towards milking out drug felons at the expense of other peacekeeping tasks. All because of following the money

Again from Huffington Post…

Arresting people for assaults, beatings and robberies doesn't bring money back to police departments, but drug cases do in a couple of ways. First, police departments across the country compete for a pool of federal anti-drug grants. The more arrests and drug seizures a department can claim, the stronger its application for those grants.

"The availability of huge federal anti-drug grants incentivizes departments to pay for SWAT team armor and weapons, and leads our police officers to abandon real crime victims in our communities in favor of ratcheting up their drug arrest stats," said former Los Angeles Deputy Chief of Police Stephen Downing. Downing is now a member of Law Enforcement Against Prohibition, an advocacy group of cops and prosecutors who are calling for an end to the drug war…

At the same time, there's increasing evidence that the NYPD is paying less attention to violent crime. In an explosive Village Voice series last year, current and former NYPD officers told the publication that supervising officers encouraged them to either downgrade or not even bother to file reports for assault, robbery and even sexual assault. The theory is that the department faces political pressure to produce statistics showing that violent crime continues to drop. Since then, other New Yorkers have told the Voice that they have been rebuffed by NYPD when trying to report a crime.

The most perverse policy may be asset forfeiture. Under civil asset forfeiture, police can seize property from people merely suspected of drug crimes. So long as police can show even the slightest link of drug activity to a car, some cash, or even a home, they can seize it. In the majority of cases, most or all of the seized cash goes back to the police department. In some cases, the department has taken possession of cars as well, but generally non-cash property is auctioned off, with the proceeds then going back to the department. An innocent person who has property seized must go to court and prove his property was earned legitimately, even if he was never charged with a crime. The process of going to court can often be more expensive than the value of the property itself.

Asset forfeiture not only encourages police agencies to use resources and manpower on drug crimes at the expense of violent crimes, it also provides an incentive for police agencies to actually wait until drugs are on the streets before making a bust. In a 1994 study reported in Justice Quarterly, criminologists J. Mitchell Miller and Lance H. Selva watched several police agencies delay busts of suspected drug dealers in order to maximize the cash the department could seize. A stash of illegal drugs isn't of much value to a police department. Letting the dealers sell the drugs first is more lucrative.

Read the rest here

Again like all human beings, the police resorts to actions based on priorities or on personal value scales. And arbitrary laws affect their underlying incentives to act as public officials. Apparently the war on drugs tend to misplace their priorities, all at the expense of society.