Phisix: The Impact of Slowing Banking Loans

BSP Official on Property Bubbles: Move Along Nothing to See Here

Pressed to comment by the media on the ‘formation’ of a property bubble based on the recent rise of Non-performing loans (NPL) of the thrift banking industry, a BSP official brushed aside such statistical data as a “blip” and readily dismissed concerns over bubbles as non-problematic[1]. 

NPLs increased to 5.34% as of the end of 2012 compared to 4.97% period in June of last year.

The same BSP official cited that “real demand” and not speculation has been the main force driving the property sector and that current boom has not compromised the banking system’s underwriting standards for “the sake of growth”.

Here is the latest year-on-year bank lending growth for the each month during the first semester of 2013.

The BSP says that 80% of the banking system’s loan portfolio has been extended to production activities, where for the month June, overall banking lending growth slightly receded to 12.2% from 13.5% in May (revised data). 

Meanwhile loan growth to the domestic consumers eased slightly to 12.1% from 12.2% over the same period[2].

Since we understand that only 21.5 of every 100 households[3] have access to the banking system, growth in consumer loans can be seen as less of a systemic threat.

In addition, in contrast to the popular wisdom which sees the Philippines as being driven by consumer or household spending, the reality is that current exemplary performance by the statistical economy has mainly been powered by supply side and government spending bubble dynamics[4].

Yet if household demand have been growing at the range of 4-6%, while the rate of growth of supply side expenditures (particularly real estate and real estate related sectors) have been more than double the household rate, then to suggest that the current boom represents final demand or where there has hardly been any yield chasing going on, signifies as a bizarre or contradictory claim which practically ignores reality or substitutes reality with statistical data mining.

Yet how sustainable is the economic framework where supply side growth continually outpaces the demand side?

The mainstream often confuses statistical analysis as economic reasoning. Statistics without causal theory underpinning them tends to mislead. As the French classical liberal economist[5] Jean Baptiste Say wrote in A Treatise on Political Economy[6],

Hence, there is not an absurd theory, or an extravagant opinion that has not been supported by an appeal to facts; and it is by facts also that public authorities have been so often misled. But a knowledge of facts, without a knowledge of their mutual relations, without being able to show why the one is a cause, and the other a consequence, is really no better than the crude information of an office-clerk, of whom the most intelligent seldom becomes acquainted with more than one particular series, which only enables him to examine a question in a single point of view.

Of course, we understand that officials need to “toe the line” or be a part of the political PR campaign to promote the administration’s agenda.

Despite the declining year on year rate of bank lending growth by the supply side (production activities) and the steady growth of demand side (household), the current pace credit growth expansion remains largely above the previous years. 

Nevertheless the declining trend looks portentous.

For June, real estate renting and business services grew by 22.35% which has significantly been down from the peak at 28.53% in January.

The construction industry continues to sizzle with 48.7% growth in June albeit at the low side of the year’s growth. The massive rebound in the construction industry has been a belated effect since construction growth during the past few years has been negligible. For the year, construction growth has been at the 48-56% levels.

Meanwhile, offsetting the decline in the real estate loans has been the sterling growth of the wholesale and retail trade (which have been part of the shopping mall bubble) has been reaccelerating from a low of 10.02% in April to June’s 15.74% (or a 50% jump).

Also lending to Hotel and restaurant (casino bubble) remains brisk at a 19.55% y-o-y which is slightly off the mean growth of 20.385% for the year.

Despite the apparent slowdown, bank lending in support of supply side ‘interest rate-sensitive’ bubble blowing industries continues to overwhelm demand side growth. If such trend will be sustained then the outcome will be anything but pleasant.

Is the Financial Intermediation Sector the Canary in the Coal Mine?

A good example has been the ballooning shopping mall bubble in China. The race to expand shopping malls has led to a massive oversupply, where many developers and landlords resort not only to foregoing rents to attract tenants, but likewise to paying popular mass market based retail firms to have a presence in their malls[7].

In China’s second tier cities, mall vacancy rates are expected to surge to over 30% by next year! If these malls have been mainly financed by debt or leverage, then rising vacancies will extrapolate to mass insolvencies that will pressure China’s formal and informal (shadow) banking system which similarly will have a contractionary spillover effect on the economy.

China’s impending shopping mall bubble bust should serve as a crucial lesson to the Philippines[8].

And interestingly, one critical industry that has significantly contributed to the marginally declining trend of overall loan growth to production activities in the Philippines has been financial intermediation sector.

Coincidental to the bear market strike on the Phisix last May-June, the rate of growth on loans to the financial intermediation sector dramatically shrunk to a still positive but a measly 1.45% in June. In January, this sector grew by a stunning 39.25% y-o-y. In the onset of the financial market stress last May, the rate of growth has slumped by more than half the highs of January to 12.99%.

If a significant segment of the previous loan growth from this sector has been channeled to the domestic financial assets, such as the stock and bond markets, and if pressures on financial markets persist and or if domestic interest rates should rise in response to the ongoing bond market turmoil, then a call on these loans and or margin calls will likely be the response by the lending institutions or creditors.

The implication is that these will compound on the existing strains on the financial markets via the feedback loop between asset prices and collateral values. 

Debtors will be required to add collateral or creditors will require liquidation of soured loans. If the liquidations route dominates, then this would put additional downside pressure on financial asset prices. Lower asset prices would extrapolate to diminishing value of collateral which should prompt lending institutions to demand more collateral or for more liquidations.

In addition, what has been seen as a ‘blip’ and uncompromised underwriting standards will eventually extrapolate to a series of tightening of credit standards as asset quality deteriorates and as NPLs rise.

Such debt deflation dynamics ultimately will depend on the scale of exposure of financial intermediation loans on the domestic financial markets, which is something unspecified in BSP data. What is publicly known is that financial intermediation loans account for 9.4% of the overall loans to production activities in June. 

While this may seem small, it would be foolhardy to ignore the potential contagion effects on the highly leveraged real estate and allied industries which falling asset markets may spur or trigger.

Bubbles Operate as a Process

Bubbles don’t just appear from nowhere. Bubbles represent a process where people’s incentives are shaped by distortive social policies, which leads to a clustering of errors via discoordination or misallocation of resources. The eventual unwinding of such imbalances also undergoes a reversal process.

For instance the survival of shopping malls ultimately depends on mostly retail based tenants, whom are predominantly small and medium scale enterprises (SME).

The domestic shopping mall industry has been growing rapidly via the industry’s misperception or overestimation of the rate of growth of domestic consumers. They have been misled by the price signals brought about by zero bound rates or easy money policies and from the disinformation disseminated by mainstream media.

Popular wisdom holds that easy money represents a perpetual phenomenon. The reemergence of the bond vigilantes has placed the spotlight on viability of mainstream’s premises.

And like China, there has been a blitz of shopping mall expansion, mostly financed by debt, designed to capture profits from what seems as unlimited pockets by the consumer.

The Philippine consumers, if based on inflation adjusted GDP per capita growth, has been expanding by a top of the line 3.16% in 2006-2010[9]. If we estimate per capita growth for 2011-2013 at 7% (economic growth rate) per annum then per capita levels today would only be at about 3.87%. This would hardly be enough to finance all the double digit supply side spending boom. This is unless the informal economy has been far larger than estimated.

Yet if the profitability of the SME retail sector should come under pressure from a combination of factors: cut throat competition, oversupply, higher cost of capital via rising interest rates, and rising cost of business from non-regulation directly influenced factors such as rising input prices via rents, wages or producers goods and etc.., then loans from ensuing operational losses will most likely reflect on the lenders via impaired loans.

So any sustained amplification of the deterioration of NPLs from clients of thrift banks could signify as one of the possible symptoms of the periphery-to-core process of a bursting bubble.

To disregard them by comparing with the past when credit growth has not reached current levels would signify as imprudent anchoring bias or even apples to oranges comparison.

A Peak in Domestic M3?

The BSP also recently noted of a significant boost in domestic liquidity in June, where on a year on year basis growth ramped up by 20.3% to Php 5.7 trillion, which has risen faster than the 16.4% in May.

The surge in M3 has mostly been due to Net Domestic Assets (NDA) which jumped by 30.5% in June from 28.7% in May. Soaring NDAs, according to the BSP, reflected the sustained growth in bank lending to help finance economic activity[10].

Since 2004, M3[11] has been growing by a Compounded Annual Growth Rate (CAGR) of 11.05%. But this hasn’t been reflecting on the current state of affairs. One would note that M3 zoomed only during the end of 2012. Based on 2011, Philippine M3 CAGR soared by 13.815% from 2011, and from January 2012 until June 2013 CAGR catapulted by 14.53%. So we have a 2-3+% increase in money supply from the current administration.

Where has all these 13-14% money growth been flowing? The most probable answer: property, stock and bond market bubbles. Yes, the 13-14% money growth from sharp increases in bank loans been responsible for, or represents as the trade secret of the current administration’s ‘good governance’ ‘rising tiger’ statistical economy.

Unfortunately the recent declining trend on bank loans spearheaded by the financial intermediation sector will reduce the speed of rate of change of M3 overtime. Such decline may have already been signalled by the domestic stock market.

Similarly, should the rate of growth of bank loans continue to shrivel, then this would also be reflected on the rate of growth of the statistical economy.

The populist glorification of the so-called politically driven economic boom will face reality.

Philippine 10 year Bond: The Odd Man Out?

And speaking of asset bubbles, last week’s actions in ASEAN’s bond markets brought upon a huge surprise.

Yields of the Philippines 10 year bonds[12] has fallen nearly to the pre-Taper market seizure levels (upper left window) even as yields of our bigger and far richer ASEAN neighbors climbed. As of the actions of last week, the Philippines has decoupled from the region!

This implies the following:

One the Philippines doesn’t need a Moody’s upgrade or that the bond markets has been front running or pre-empting a Moody’s upgrade.

Two, current yields demonstrates the prevailing low interest rate environment.

Three, Philippine yields is just about 103 basis points away from the US counterpart as of Friday’s close, which if I am not mistaken accounts for as the narrowest spread between 10 year Philippine Peso and 10 US treasury note ever.

However this also means that the vastly narrowing yield spread will likely work as a disincentive for US based investors who will likely look for bigger spreads as margin of safety.

Four, such record low spread or near record low yield means that the Philippines is seen as having lesser interest rate and credit risks relative to her bigger and wealthier neighbor. Said differently, the Philippines despite having a US dollar GDP nominal per capita of only US$ 2,617 (IMF 2012)[13] compared with Indonesia’s US$ 3,910 (IMF 2012), Thailand’s US$5,678 (IMF 2012) and Malaysia’s $10,304 (IMF 2012) has been valued by the markets as having been far more credit worthy or has higher credit standings.

The Philippines at $2,617 per capita seems now at par with Australia US $67,723 (IMF 2012).

Wow this time is different! Or has it?

As of July 25^th 5 year senior Credit Default Swaps (CDS)[14] of the Philippine has marginally been higher or exhibits the higher risk profile compared with Malaysia and Thailand (upper right window). It is unclear if the CDS markets have replicated the bond markets over the last few trading days.

But one thing is certain, during the last market seizure emanating from the return of the bond vigilantes in response to Bernanke’s Taper Talk, CDS prices of the four ASEAN majors surged concomitantly (lower window). While CDS prices have fallen from their peaks in June, they have been creeping higher during the last few days ending July 25^th. My guess is that they are above the July 25^th levels considering the recent actions in the bond-stock and currency markets.

And speaking of currency markets, the Philippine Peso continues to drop along with her regional peers. This reveals of the sharp divergences between actions of the 10 year bond yields and the Peso. 

Importantly, stock markets of the three of ASEAN majors appear to be substantially faltering. The decline in the Phisix along with the Peso appears to be departing from the signals emitted by the domestic bond market.

Such huge divergences and the record (US-Phil) spread exhibits of the enormous misperception, misappraisal, maladjusted and deeply mispriced markets.

Given what seem as the odd man out, Philippine 10-year bonds look like a great short opportunity.

The Philippine Government Spending Bubble

Apart from titles to capital goods (stocks and property), another aspect of the risk of bubbles, which the public can’t or refuses to see, has been the government’s spending budget.

The Philippine President has recently submitted to the Congress for approval a proposed Php 2.268 trillion (US $52 billion) budget for 2014 which is reportedly 13.1% higher than this year[15].

While the general public has been debating over who gets what, they hardly realize that the current trend of growth of the Philippine government’s spending is unsustainable and will lead to a debt or currency crisis.

According to the data from National Statistical Coordination Board or NSC[16], over the past 17 years CAGR for revenues has been at 8.07% (green) whereas the CAGR for expenditures has been at 9.1% (red). The Philippine budget has turned into deficit in 1998 and never looked backed. 

The CAGR for the budget deficit has been 11.1% over the past 17 years.

If the economy grows at 5-6% while growth trend of deficits remains at the current pace then we will see huge increases in taxes or higher inflation or exploding debt overtime.

The budget gap was almost closed or the elusive balancing of the budget was nearly a reality in 2007-2008. But a crisis exploded, whose epicenter was in the US, which rippled through the globe, and nearly caused a recession in the Philippines.

The effect of the near recession was felt a year later or in 2009, where the deficit swelled as revenues slumped amidst sustained increases in government expenditures.

Interestingly, the pattern where government revenues plummet in the aftermath of every banking crisis[17] affected the Philippines even in the absence of a domestic banking crisis.

Such transmission mechanism has apparently been an offshoot from today’s financial globalization.

Admittedly the incumbent administration has accomplished marginal improvements.

Revenues (CAGR 8.31%) grew more than expenditures (5.305%) in 2010-2012, but such has not been enough to push back deficits to the 1998-2007 levels.

But to consider, we supposedly are in the salad ‘economic boom’ days where budget gaps should narrow. Obviously this hasn’t been the case.

And yet if the current budget will be approved and spent accordingly, then this will signify as a big jump on the expenditure side. Of course, the hope is that these expenditures will transform into future revenues. This seems as wishful thinking. Aside from arguing that public works are unproductive, the public has obviously discounted risks even when the Philippines look vulnerable from both directions or from external (capital flows, remittances, merchandise trade, external debt) and internal (level of domestic debt).

Yes I know, the popular approach has been to use the above as ratio to GDP. But again, I don’t think that the conventional accounting GDP identity represents a useful indicator since I have been pointing out these have been puffed up and manifest on a credit driven asset bubble and unproductive government expenditures which may unravel and easily cause a swift deterioration on what seems solid ratios today.

My understanding of the theory of business ‘boom-bust’ cycles, backed by the history of banking, sovereign and currency crises tells me where and what aspects to monitor. I wouldn’t like to be subjected to a Black Swan event when the latter can be predicted.

Deficits will have to be financed by debt, taxes or inflation.

In terms of debt, the rate of increases in Philippine debt outstanding[18] both from domestic and from foreign lenders over the past 17 years have been at CAGR 9.49% and 9.62% respectively. Total debt has grown 9.59%. The growth rate during the past 17 years, if sustained, enhances sovereign credit risks.

But boom days have cosmetically improved debt levels.

It is true that the current administration has reduced the rate of growth in total debt levels by almost half or 4.84% from 2010-2012, aside from changing the mix of the debt exposure in favor of domestic debt, where domestic debt grew by 8.46% while foreign debt contracted by .523%. Domestic debt now commands nearly 64% share of the total outstanding debt. The shift to tilt the balance of debt outstanding towards domestic debt from foreign debt deftly avoids external debt risks and at the same maximizes the Philippine government’s financial repression policies, through not only the stealth transfer of people’s savings in favor of the government (debtor) but importantly by keeping interest artificially rates low, such reduces the government’s interest expenditures which effectively operates as a covert deficit reduction mechanism.

But these again are boom days which can easily be reversed by a dramatic collapse of revenues and from potential bailout policies—should a crisis emerge from anywhere from the world.

And all it takes is a snap of a finger, from Professors Carmen Reinhart and Kenneth Rogoff[19];

Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence—especially in cases in which large short term debts need to be rolled over continuously—is the key factor that gives rise to the this-time is different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!—confidence collapses, lenders, disappear and a crisis hits.

The bang! actually represents a state of unpredictable time, where accumulated imbalances have reached a tipping point that radically overturns the positive perception of the critical mass of creditors against debtors.

---

[1] Inquirer.net Property ‘bubble’ a remote possibility August 3, 2013

[2] BSP.gov.ph Bank Lending Sustains Growth in June, July 31, 2013

[3] see The Flaws of BSP’s Real Estate Monitoring and Banking Stress Tests May 20, 2013

[4] see Phisix: The Myth of the Consumer ‘Dream’ Economy July 22, 2013

[5] Wikipedia.org Jean-Baptiste Say

[6] Jean Baptiste Say A Treatise on Political Economy, Library of Economics and Liberty

[7] see China’s Shopping Mall Bubble: Free Rents to Attract Tenants, July 2, 2013

[8] see Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux), January 13, 2013

[9] Wikipdia.org List of countries by GDP (real) per capita growth rate

[10] BSP Domestic Liquidity Growth Accelerates in June July 31, 2013

[11] Tradingeconomics.com PHILIPPINES MONEY SUPPLY M3

[12] Investing.com Philippines 10-Year Bond Yield

[13] Wikipedia.org List of countries by GDP (nominal) per capita

[14] AsianBondsOnline.org Credit Risk Watch

[15] ABS-CBNNews.com PNoy to submit P2.3T budget for 2014 July 23, 2013

[16] National Statistical Coordination Board, Statistics, Public Finance

[17] Carmen Reinhart and Kenneth Rogoff BANKING CRISES: AN EQUAL OPPORTUNITY MENACE December 2008 NBER Working Papers

[18] National Statistical Coordination Board Lubog na ba tayo sa Utang? May 9, 2012; Bureau of Treasury National Government Outstanding Debt

[19] Carmen Reinhart and Kenneth Rogoff, Preamble: Some Initial Intuitions… This Time is Different Princeton University

Quote of the Day: Most People Can’t Handle the Truth

I’ve written a great deal over the years about the subject of truth, which is why this particular line from A Few Good Men caught my attention.  The truth can often be harsh.  The truth can be scary.  The truth can be embarrassing.  The truth can be costly.  Yes, for all these reasons, and more, most people can’t handle the truth.

And because they can’t handle truth, they learn to hate it.  That’s right, instead of loving truth, most people try to make true that which they love.  They much prefer the comfort of self-delusion to the pain often associated with truth…

In politics, for example, any newcomer quickly discovers that if he is totally committed to truth, he will likely find himself on the outside looking in.  Because a majority of voters can’t handle the truth, politicians believe they have no choice but to lie.  And if they refuse to do so, they usually — and quickly — become ex-politicians.

This is from self development and libertarian author Robert Ringer

China’s Replica of Paris is a Ghost Town

China’s real estate industry has the propensity of imitating famous European architectures. 

From the Reuters:

Tianducheng, a gated community near Hangzhou, capital of coastal Zhejiang province, boasts its own Arc de Triomphe and rows of European-style villas to attract China's newly wealthy.

"(It) can house up to 100,000 people comfortably," said Lu Xiaotian, a director at the Zhejiang Guangsha Co. Ltd, the estate's developer.

Unfortunately, the European fashioned gated community has reportedly been a ghost town.

Some pictures courtesy of Business Insider

See more pictures here

The above is just one of the numerous ghost projects epitomizing the Chinese government’s assimilation of policies that promotes “abolishing slumps and thus keeping us permanently in a quasi-boom” grounded on the misinterpretation of Say’s law of “supply creates its own demand” or from a rigid adaptation from Kevin Costner’s Field of Dreams, “if you build they will come”. This also signifies as an example of wastage of capital from centrally planned projects.

Incidentally the developer, Zhejiang Guangsha Co Ltd is a publicly listed company at Shanghai, which represents a “province share holding system” or largely a local state owned owned enterprise (SoE) with private sector facet. 

Many private companies are vehicles used by the local state to promote the political objectives of the national government, as well as, the career goals of local politicians. Thus as previously discussed, the interests of the private sector and the state has been complexly interwoven. Yet the same sectors have acquired huge debts from boondoggles as the above that has put the Chinese economy in jeopardy or has raised the risks of a China bubble bust with far reaching ramifications.

The sustainability or viability of these massive credit fueled “build and they will come” social projects have recently been under intense scrutiny by the national government and by the markets.

Interesting times indeed.

On Internet Searches: Big Brother is Watching You

George Orwell’s dystopian novel 1984 looks increasingly prescient as evidenced by the slippery slope transformation of the US into a police state.

From Simon Black of the Sovereign Man:

In any discussion about privacy, there’s invariably someone who says, “Well, if you have nothing to hide, you have nothing to fear.”

What a bunch of baloney. This may be one of the most ignorant statements ever uttered yet it’s held by a wide majority of people who still trust their governments.

Yesterday the Guardian newspaper published yet another example of why this thinking is completely fallacious.

On Wednesday of this week, Michele Catalano and her husband, both residents of Long Island, were greeted by a knock at the door by a counter-terrorism task force.

Apparently their Google searches had aroused intense suspicion. She was looking for pressure cookers online. Her husband was searching for backpacks.

Ordinarily those two items would seem completely harmless. But in such an absurd, security-conscious world where finger-nail clippers are considered deadly weapons, a pressure cooker and a backpack are viewed as vital tools in a terrorist’s toolkit… practically WMDs.

And so, Big Brother’s crew of six government agents arrived to the family’s home with weapons in holster, and their vehicles tactically positioned to block any exit from the premises.

The husband was questioned, and the agents searched the house looking for any other terrorist clues.

And in their conversation, the agents proclaimed that they do this “about 100 times a week.”

Apparently this is what passes as a free society these days, where even the most harmless online interactions end up being scrutinized by armed agents.

And thanks to a never-ending and expanding apparatus of online surveillance, governments have the means to monitor… almost everyone.

Of course, they want us to think that we have nothing to fear as long as we have nothing to hide. But a rational, thinking person has got to see the writing on the wall at this point and realize how out of control the police state has become.

Remember, there are a number of ways to safeguard your web browsing, search experience, email, and phone calls. And we’ve put a lot of great resources together for you in this free guide, something that we call ‘How to give the NSA the finger.’

In the 1984 novel, when asked by a skeptical Outer Party member (Winston Smith) to a Inner Party official (O'Brien) on how Power is used to control others, the latter's reply: (bold mine)  (quote from Thirdworldtraveler.com)

By making him suffer. Obedience is not enough. Unless he is suffering, how can you be sure that he is obeying your will and not his own? Power is in inflicting pain and humiliation. Power is in tearing human minds to pieces and putting them together again in new shapes of your own choosing. Do you begin to see, then, what kind of world we are creating? It is the exact opposite of the stupid hedonistic Utopias that the old reformers imagined. A world of fear and treachery and torment, a world of trampling and being trampled upon, a world which will grow not less but more merciless as it refines itself. Progress in our world will be progress toward more pain. The old civilizations claimed that they were founded on love and justice. Ours is founded upon hatred. In our world there will be no emotions except fear, rage, triumph, and self-abasement. Everything else we shall destroy- everything. Already we are breaking down the habits of thought which have survived from before the Revolution. We have cut the links between child and parent, and between man and man, and between man and woman. No one dares trust a wife or a child or a friend any longer. But in the future there will be no wives and no friends. Children will be taken from their mothers at birth, as one takes eggs from a hen. The sex instinct will be eradicated. Procreation will be an annual formality like the renewal of a ration card. We shall abolish the orgasm. Our neurologists are at work upon it now. There will be no loyalty, except loyalty toward the Party. There will be no love, except the love of Big Brother. There will be no laughter, except the laugh of triumph over a defeated enemy. There will be no art, no literature, no science. When we are omnipotent we shall have no more need of science. There will be no distinction between beauty and ugliness. There will be no curiosity, no enjoyment of the process of life. All competing pleasures will be destroyed. But always-do not forget this, Winston-always there will be the intoxication of power, constantly increasing and constantly growing subtler. Always, at every moment, there will be the thrill of victory, the sensation of trampling on an enemy who is helpless. If you want a picture of the future, imagine a boot stamping on a human face-forever." 

Big Brother is Watching You

War on Gold: Pakistan Temporarily Bans Gold Imports

Intervention begets intervention.

Such ratchet effect or mission creep applies not only within a state defined national boundary but could diffuse into the neighbors or the region as well.

The Indian government’s war on gold is an example. Such anti-tradition policies has incited massive smuggling across her borders. Pakistan responds by mimicking the Indian government albeit temporarily.

From Mineweb.com:

India's neighbour Pakistan has decided to temporarily ban the import of gold for one month, to save its foreign currency reserves and to curtail the rampant smuggling going on in the nation.

On Wednesday, July 31, Pakistan imposed a temporary ban on the import of gold.

Following the Indian government’s decision to discourage gold import by imposing 8% duties, buyers have reportedly shifted to Pakistan where the precious metal is allowed to be imported duty free since 2001.

(below charts from tradingeconomics.com)

Pakistan’s government passes the blame on her faltering currency, the rupee, on gold imports. USD-Rupee has been on an uptrend since 2008.

But the reality is that, gold imports has hardly been responsible for Pakistan’s predicaments.

Pakistan’s government continues to run a deficit. (I don’t know why a vacuum exist in the graph above)

Never the less, Pakistan’s government spending has been growing at a rate of 18.33% in 10 years, even when the GDP annual growth rate averaged of 4.73% over the same period. Since 1952, Pakistan’s annual gdp growth rate has been 4.94% according to Trading Economics

Pakistan have also been posting negative balance of trade since 2003 which has prompted for serial current account deficits over the same period

These twin deficits have been financed partly by external debt. 

Pakistan’s external debt nearly doubled since 2008, but has marginal declined in 2012

A big portion of the twin deficits have been financed via monetary inflation where M3 has grown by CAGR of 14.74% which is nearly double the average annual rate of growth her statistical economy. 

This has essentially been responsible for the weakness in her currency which her government scapegoats on gold.

Nonetheless Pakistan’s perfervid monetary activities has pumped up her stock markets.

The Karachi 100 has been one of the best performers in 2013 up by 36.29% in nominal currency terms. Chart from Bloomberg.

The Karachi appears to have hardly been jolted by Bernanke’s “taper” as frontier markets have been in vogue.

If the attack against tradition reach a critical point in a society’s tolerance level, the current passive resistance expressed via smuggling, may transform into social unrest, again Egypt, Brazil, and Turkey are du jour examples.

All these concerted anti-tradition policies are bound for failure.

Quote of the Day: Government Price Fixing of Markets

The government makes prices by buying certain assets but also by compelling you to buy them too. The whole point of QE is to make debt less valuable and to force you into equities. The point of asset purchases is to compel you to buy bonds even though you know it's not smart.

The strategy goes far beyond the equity and bond markets. More and more governments are also forcing businesses to spend money on things that serve the public interest.

Health care is one such issue. In the US now, 'Obamacare' is becoming so expensive to employers that they are starting to encourage workers to hold two part-time jobs in different firms so that neither employer is obliged to pay the full health care cost of a full-time employee.

This has the added advantage of keeping unemployment higher for longer, thus permitting governments to continuously justify their ever increasing role in setting market prices.

In the UK, pension funds are told by the regulators that they should put more capital into investments that are associated with public goals such as social housing and the building of schools or domestic infrastructure.

This is from Dr. Pippa Malmgren who is a  policy expert, (Wikipedia.org) former Special Assistant to the President of the United States for Economic Policy on the National Economic Council and former member of the U.S. President's Working Group on Financial Markets and serves as adviser to many firms, at her website.  A political insider talks about how 'gamed' or rigged the system is.

Is Indonesia ASEAN’s Canary in the Coal Mine?

Tight money may have begun to take its toll on Indonesia's economy

From Bloomberg

Indonesia’s economy grew less than 6 percent last quarter, adding to risks for the Southeast Asian nation as investments ease, inflation accelerates and the currency slumps.

Gross domestic product increased 5.81 percent in the three months ended June 30 from a year earlier, the Central Bureau of Statistics said in Jakarta today. That compares with a 6.02 percent pace reported previously for the first quarter and the median estimate of 5.9 percent in a Bloomberg News survey of 19 economists.

Indonesian policy makers are contending with easing growth at a time when higher fuel costs spurred the fastest price gains in more than four years and the rupiah trades near the weakest since the global financial crisis. The central bank has raised interest rates at the past two meetings in an effort to temper prices and reduce capital outflows, actions that may hurt domestic spending and compound the slowdown in Southeast Asia’s largest economy.

As I previously noted, Indonesia has her own credit boom fueled stock market-property bubble. 

And monetary tightening expressed via the bond vigilantes may have commenced to negatively impact on the accumulated imbalances on the real economy.

Indonesia’s bubble conditions has led to the deterioration of her trade balance since 2012.

Sustained government budget deficits has also compounded on her weakening external conditions.  (charts from tradingeconomics.com)

Indonesia's vulnerable external conditions has been reflected by the accelerating decline of her currency, the rupiah, or the rise of the US-IDR as shown in the chart from xe.com. These dynamics has prompted their government to cut fuel subsidies which sparked riots. 

Yet these deficits will need to be funded by more borrowing or higher taxes or by covert inflation. This also means a prospective cut on government expenditures.

So far the recourse has been via debt.

While Indonesia’s external debt level has been low relative to the past (30+% against 60+% in the pre-Asian crisis), it has been rising at an accelerating pace.

In July, Indonesia successfully raised US$ 1 billion from the debt markets but at significantly higher rates.

But these deficits have also been addressed via the monetary inflation route, hence the depreciation of the currency.

Indonesia’s 10 year bond spiked just a few months back when the Fed’s 'taper' talk became a fashion (chart from investing,.com).

With Indonesia's financial markets tightening by its own, the Indonesian central bank, the Bank Indonesia, raised interest twice in a span of a few days last July or just a month back.

Since, the Indonesia’s major stock market benchmark, the JCI, hasn’t been as buoyant as the past (chart from Bloomberg). 

While the JCI has not touched the bear market levels during the market tapering incited spasm in the late May-June, the JCI appears to be weakening as evidenced by a series of lower highs.

Don’t forget that Indonesia used to be the darling of the credit rating agencies. 

For instance the Fitch Ratings has had a series of upgrades on Indonesia’s credit standing since 2002.

Tightening monetary conditions will put Indonesia’s economy to a critical test. The jury is out whether the Indonesian economy will be able to sustain growth or if tightening conditions will expose on the fragility of Indonesia’s systemic leverage that might bring the largest ASEAN nation into a recession--should the bond vigilantes continue to impose their presence around the world.

If Indonesia caves in to the latter, will the rest of the region follow?

And so far, the bond vigilantes have been disproving the outlook of credit rating agencies as in the past.

Are US Stocks Markets in a Wile E. Coyote Moment?

US stocks soared to fresh record highs! Again mostly based on the market’s Pavlovian response to central bank stimulus and partly to selective focus on economic data

 

Markets tend to rise during central bank meetings (see New York Fed Study here) as a conditioned response to central bank guarantees.

This euphoria ironically comes amidst soaring yields of 30 year UST bonds which is at a two year high

Yields of 10 year notes also spiked approximating the recent highs which are also at 2 year highs.

In the recent past, US stocks have risen in the backdrop of DECLINING yields of US Treasuries

And rising stocks and rising yields seem as a replay of 2006-2007.

The market’s Pavlovian response to central banking steroids signifies as expectations of extended zero bound rates or prolonged low interest environment.

But the bond markets has been saying otherwise.

Will this time be different?

Another headwind. Oil prices has also surged and is now at $107+ per bbl (WTIC). 

As I recently pointed out, each time WTIC passed the $100 mark, US stocks eventually succumbed to substantial corrections (green oval). Another this time is different?

Rising bond yields, oil prices, producers prices and stock markets are manifestation of the advanced (maturity ) phase of the US inflationary boom.

The incompatibility of the forces behind rising stocks and high oil/bond yields also means one of these two has been wrong…unless this time is different, where water flows uphill.

The impact of rising yields is on leverage. Rising yields which means higher interest rate extrapolates to higher cost of debt servicing.

The build up margin debt in the US stock markets seem to also mimic record stocks and replicates the 2000 and 2007 episode.

This means that the rate of increase of stock market returns should be greater than the rate of increase in interest rates, otherwise the wheels come off.

So yield chasing in the stock market has now transformed into a Minsky’s Ponzi finance—which relies on continued ascent of asset prices to maintain unsustainable debt levels.

Wile Coyote continues to chase the elusive Road Runner and he may just be running off the cliff.

And another thing, how do you think rising yields or higher interest rates will affect government debt of developed economies?  This time is different?

Don’t worry, be happy

US GDP Revision: Boost the Statistical Economy by Changing Methodology

The US statistical GDP has undergone major methodological revisions. The likely effect will be to temporarily 'boost' the economy.

The Zero Hedge quotes Bloomberg's Joseph Brusuelas on the changes made by the Bureau of Economic Analysis (BEA)  

Changes to the national income and product accounts data will be released at the same time as the second quarter estimate of gross domestic product. The revisions go back to 1929 and include the current business cycle. They will probably show a deeper recession and modest increases in the level of growth in the current cycle that may add as much as 3 percent to the level of GDP.

While growth may look more impressive, the growth path and rate of overall economic activity in recent years isn’t likely to change.

Policy Implications

Higher GDP may support those on the Fed pushing to start tapering. While the numbers are likely to shift noticeably, the change won’t merit a surprise announcement of tapering later today.

With increased data on receipts, expenditures and cash flow with respect to pensions, regulators and investors should have a better sense of what public entities have severely underfunded pensions programs. Investors should expect the potential crisis in the U.S. public pension system to play a greater role in the national economic narrative given the recent municipal bankruptcy in Detroit that includes $11.9 billion in unsecured obligations to lenders and retirees.

The biggest methodological change will be the reclassification of Research and Development Expenditures as well as Intellectual Property – entertainment, literary, and artistic originals. Where previously treated as an expense, these areas will now be categorized as investments and  included in the measure of GDP.

The other highlights from the revision, according to the Wall Street Journal economic blog will include:

-Dating back to 1929, the U.S. economy grew at a 3.3% annual pace, which is one-tenth of a percentage point higher than previously published estimates. From 2002 to 2012, the growth rate was 1.8%, up from a previously reported 1.6% pace.

-Intellectual property, which includes research and development, entertainment and the arts, and software, grew by 13% in 1997 from the prior year, as the Internet bubble began. But by 2001 growth had slowed and only rose 0.5% from a year earlier. By 2012, the categories’ contributions to overall growth were negligible.

-The BEA also tweaked how it calculates pension contributions. The agency will now consider compensation to reflect the value of the pension promises made by the employer, rather than the employer’s cash contributions to the pension fund. The new method better reflects the retirement benefits a worker earns while working and is consistent with business accounting standards, BEA said. As a result, the personal savings rate averaged 4.7%, an upward revision of one percentage point, for the period between 2002 and 2012.

-In 2012, the economy expanded at a 2.8% pace versus a previous estimate of 2.2%. But that performance was wildly uneven over the course of the year, with a strong 3.7% annualized pace in the first quarter after a big upward revision, followed by two middling quarters and finally an abysmal 0.1% growth rate in the final quarter of the year. In current dollar figures the revisions added nearly $560 billion to the overall figure 2012 GDP figure of $16.2 trillion.

-The great recession was less severe than previously thought, with the economy shrinking at an average annual pace of 2.9%, revised from a 3.2% contraction. The recession stretched, officially, from December 2007 through June 2009, according to the National Bureau of Economic Research, which determines the widely accepted benchmarks for U.S. business cycles.

-The current recovery, while revised to show stronger growth, is still the weakest since World War II. The economy expanded at an average 2.3% annual pace between the second quarter of 2009 and the fourth quarter of 2012, compared with a previously published 2.1% pace.

The US GDP reportedly grew at a rate better than the expected during the 2nd quarter, according to Time.com

But accounting changes may have played a big part in it.

 

The Zero Hedge notes

Think the pick up in Q2 GDP was due to the desired increase in end consumption? Think again. Following the full data revision, Personal Consumption as a component of GDP dropped from 1.54% in Q1 to 1.22% in Q2, offset however by an increase in fixed investment which rose from -0.23% to 0.93%. In fact, aside for Q3 and Q4 of last year, Personal consumption in the just completed quarter was the lowest goin back to Q2 2011 when PCE was 1.03%.

That's why I'd be leery of statistics since governments may manipulate them to suit their ends.

Federal Reserve Watching has become a Practice of Semiotics

Will the Fed be "Tapering"? Not from the latest announcement by the FOMC which reveals of the continued dovish non-tapering stance.

From Bloomberg: 

The Federal Reserve said persistently low inflation could hamper the economic expansion and pledged to keep buying $85 billion in bonds every month.

“The committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term,” the Federal Open Market Committee said today after a two-day meeting in Washington. Growth will “pick up from its recent pace.”

The Fed continues to use evasive language which has led the markets to second guess their prospective policy actions. Such seem as signs of the Fed’s deepening confusion (or looking to justify further easing)

Fed officials seem to acknowledge how the financial markets have become acutely or deeply dependent on them. 

During the recent selloffs which had the markets focusing on the ‘taper’ aspect of the Fed communiqué (while ignoring the dovish part), central bankers immediately acted to rectify what seems as a policy communications blunder.  

Such has even prompted concerted actions by ex-US central bankers as the BoE’s Mark Carney and the ECB’s Mario Draghi to introduce “forward guidance” policies which assures of the lower levels of interest rates “for an period of time extended period of time”, as part of the damage control on the Fed's communications. 

Just a week back Dr. Bernanke laid the cards with “If we were to tighten policy, the economy would tank.”

Still the consensus position has been that the Fed will taper in September. 

So central bank assurances has once again fired up the Pavlovian or the stimulus addicted equity markets. Most of Asian markets have been in green, as of this writing (Bloomberg).

The odd thing is that despite the FOMC’s dovishness, these has hardly made a significant dent on the US 10 year UST note yields. Yes, last night yields of 10 year UST fell from a high of 27 and closed the session down by .38%, yet the interim trend has been a rising one.

Assurances of central bankers of low interest rate environment may have partly stabilized bond markets of major economies such as 10 year UK bonds, 10 year German bonds, 10 year French bonds or 10 year Japanese Government Bonds, but they remain elevated. Immediate trend of these bond yields, like the US counterpart, have even been creeping upwards during the last week.

So the bond markets seem hardly convinced of the efficacy of the Fed’s or other central banker's position of maintaining an extended low interest rate environment.

And as I have been saying, the Fed has only repackaged “exit” communication strategies since 2010 as du jour “tapering”. This for me looks like the Fed's serial ‘Poker Bluffs’. And should there be any possible realization of “tapering” such will signify as tokenism, as these would partially be designed to realign monetary policy direction with actions in the bond markets in order to safeguard the central bank’s “credibility”. QE will continue and may even be broadened when financial markets suffer another bout of convulsion.

Fed watching has become a practice of semiotics or (dictionary.com) “study of signs and symbols as elements of communicative behavior”. 

Unfortunately, such dependency on the Fed and central banks, reveals of how broken financial markets have been.

Quote of the Day: Deutungshoheit or Interpretative Superiority

So here’s an important German word, which we could well import into English:Deutungshoheit. This translates literally as “interpretative superiority” and is analogous to “air superiority”. Deutungshoheit is what politicians and their spin doctors attempt to win by putting forward their interpretations and framings of the semirandom events that constitute the “news”.

This is from telecom research analyst Alex Harrowell at the Fistful of Euro. (hat tip Arnold Kling)