History Is NOT A CLOSED BOOK: The View from IMF

``We'll tax and tax, spend and spend, elect and elect because the people are too damn dumb to know the difference." -Harry Hopkins, advisor to FDR

Our basic function is to profit from opportunities presented by market asymmetries. This by acting on perceived favorable probabilities presented by themes, be it momentum (technical) or fundamental (growth, value, economic or business cycles etc...). Yet as previously expounded, the marketplace is NO different from the economy as it is CLOSELY linked with the political trends. In the analogy of an Elementary song “Dry Bones”.... ``your toe bone is connected to your foot bone which is connected to your ankle bone which is connected to your leg bone which is connected to your knee bone...”

Yet, in discerning for themes we aim to EXTRICATE signals from noises, since noises could entrap us to false premises and lead to senseless losses.

On the same grounds, when we hear of camouflaged political noises veneered in the context of moral issues such as “Maid Exports” or “Flawed Culture” or “Rapid Population Growth” circulating to influence the mindsets of public, our response is to challenge the “wisdom of conventional thinking” founded on the popular but on highly specious grounds. Our viewpoint comes in the lexicon of “what we see depends on where we stand” framework.

Our recent series of “History is Not A Closed Book” aims to show of how macro dynamics are MASSIVELY TRANSFORMING both the global economic and political landscape, where domestic politics are likely to take the shape under its growing influences rather than the circulating political bunk masquerading as virtuous “moral” ascendancy.

Yes, while we understand that there are risks to such evolution as signs of rising tide of protectionism, where the recently imposed tariffs by US on China’s paper products could be a symptom of a possible snowballing trend in the US (a political and economic hara-kiri in my view) which may serve to impede on the present developments, we think that to some degree technological advances, economic and financial integration and demographic trends will eventually COMPEL the adaptation of political economies that would best fit into today’s rapidly evolving environment.

For instance, the massive productivity growths in emerging market economies have resulted to tremendous impacts to our lives today. While we have been witnessing a trend of decreasing prices in manufactured goods, as a result of expanded capacity, rapid technological advances on the pace of “Moore’s Law” and surplus labor, on the other hand, increasing price pressures on raw materials and commodities, which reflects the strain by rapidly expanding demand on the on the supply side, is an outgrowth mostly from rising per capita income of emerging market economies.

Since most of these countries have benefited from recent globalization trends, chances are that they won’t opt to spoil the party, and would even work further to improve on this preferred avenue for development.

As testament, China, one of the leading forces in today’s seismic shifts, recently undertook a landmark legislation to protect property rights of its constituents. In the same breadth, China will also undertake a programmed expansion of its financial markets to include financial futures contracts and options beginning April 15^th, and as well, plans to establish a sovereign wealth fund or the world’s largest investment company that would manage its excess reserves which has reached over US$ 1 TRILLION.

These measures serve as growing manifestations of the country’s RECOGNITION of allowing market forces to determine the efficiency of resource allocation for the political SURVIVORSHIP of its ruling class. It is a growing realization that unless wealth spreads, the preservation of their power is jeopardized.

I think it will be no different here, unless of course we decide to do the extremes ala Chavez of Venezuela.

While global investments have been on a general decline as a result of the IT bubble implosion but seen with cautious recovery at present, this has NOT been the case in the local arena as investments have been on a steady declining trend far more than our neighbors as shown in figure 4.

Figure 4 IMF: Rising Share of Services sector while Gross Fixed Capital Formation is on a decline.

According to Wikepedia.org, the concept of statistical aggregate of Gross Fixed Capital Formation (GFCF) which is a flow value, is the ``measure of the net new investment by enterprises in the domestic economy in fixed capital assets during an accounting period.” In other words, residents have not partaken into investing domestically, which shows of a declining trend. This has been rightly pointed out by some observers.

However, in contrast to the belief that investments withheld by domestic investors could represent some innate asymmetries, the IMF thinks that present trends could be indications of a transition shift from that of remittances based economy to services based one, also shown above in Figure 4.

According to the IMF (emphasis mine),

``However, the lack of response of investment could also be a transitory phenomenon. Over time, a rise in remittances can cause an endogenous change in consumption-investment decisions. The shifting skill and regional patterns could also have potentially powerful implications for the saving patterns of the dependents in the Philippines who are the end users of these funds. In 1991, nearly 60 percent of families in the Philippines who considered their main income source as coming from abroad came from the bottom two quartiles of the income distribution. By 2003, this share had dropped to just under 18 percent, implying that the share of families in the top two brackets counting income abroad as their main source of income rose from 40 percent to 82 percent. The most likely interpretation of this fact is that the skill set of remitters has shifted exogenously, and there are both “pull” and “push” factors taking higher skilled workers abroad. Given that some 80 percent of families that receive income from abroad as their main source are now middle and high income families, it is much more likely now than in 1991 that the uses for this income go beyond consumption and subsistence, and are put toward saving and investment. This suggests that the lack of a relationship between investment and remittances could indeed be transitory, and that going forward, one may see a pick up in investment in physical capital.”

Figure 5: Gavekal Research: Growing Signs of Massive Capital Investments Boom?

If the IMF thinks that a domestic investment recovery is underway, so did we since last year, as we wrote in Want a Stock Market tip? PGMA’s SONA was a Mouthful, or as early as 2004 [November 29 to December 3, 2004 see Domestic Investment to Help Drive the Phisix?].

Like us, the Gavekal Research team believes that a massive investment boom is imminent in Southeast Asia, where in their recently (February 28^th) issued handbook, Asset Allocation & Economic Research they wrote (emphasis mine),

``One of the key themes of research in 2006 was that Southeast Asia is currently going through a massive capital spending boom (thanks to cheap Chinese machines, higher exchange rates and lower real rates). And everything we look at continues to point towards an unprecedented capital spending boom in ASEAN countries.”

In Figure 5, courtesy of Gavekal Research, the chart of Philippine Imports of Capital Goods shows of a healthy uptrend. This indicates of a reversal from its previous decline following the Asian Crisis. Are we perhaps now witnessing the unfolding of our gradual BOOM scenario?

According to the Gavekal Team, ``As ASEAN starts to spend real money on infrastructure (for example, Mrs. Arroyo just announced a US $20 billion, 4-year infrastructure spending plan for the Philippines), there could be less money making its way to reserves.” Hmmm, sounds familiar?

In a similar plane, we have noted of how the seeds of the infrastructure boom have been sown in India last week, which to the extent reflects the booming Infrastructure theme in Global latitude, and how this should affect the political, economic and investment dimensions.

Now of course, if one would ask WHY the shift to the services industry instead of manufacturing industry? Asian Development Bank (ADB) during their latest development outlook shares with us their insight on the existing malaise of our much maligned industry (emphasis mine),

``In the 1950s, a sophisticated manufacturing sector emerged in the Philippines, supported by protection and a well-developed human capital base (Hill 2003). The problems for manufacturing began subsequently. A combination of factors appear to have played a part, including a period of costly and badly directed interventions, a tendency to focus on protecting rents rather than improving efficiency, poor physical infrastructure, and, to a lesser extent than in India, some problems with labor market regulation. High levels of corruption, disputed property rights and difficulties with contract enforcement have also played their part (ADB 2005). These facets of everyday economic life seem to reflect deeply embedded institutional difficulties including high concentration of wealth and a political system based on patron-client relations (World Bank 2005, p.3).”

So essentially what the ADB in its “Growth Amidst Change” outlook mean is that instead of allowing for market forces to determine the industry’s wellbeing, the country has been engaged in a slew of anti-market forces in forms of policies that cater to protectionism, costly interventions, protection of favored interests (rents), choking regulations, questionable implementations of property rights and contract enforcement.

In short, most politicians and their statist retinues have had a blighted “long-term” record of “saving the country” and in fact, as the ADB shows, have been responsible for compounding our self-inflicted miseries. As Julius Caesar once said, ``All bad precedents begin as justifiable measures.”

Where we always argue that stifling regulations lead to both massive inefficiencies, and imbedded corruption, and where economic opportunities are determined by politicians or by their factotums rather than the market itself (meritocracy; market efficiency determined by efficiency of resource allocation), the result has always been market distortions, little productive savings and investment and the lack of entrepreneurs and or of market opportunities. As been said before, our poverty is a result of dysfunctional and underdeveloped markets.

Here the IMF gives us a list of suggestions for our betterment (emphasis mine),

``Therefore, to move to a decisively stronger growth path, the Philippines needs to prioritize the following areas:

• First, improvements in infrastructure are necessary to support the emerging service sector. For the BPO industry, these include not only continuous upgrading of the technological hardware that has made the Philippines competitive thus far, but also access, in terms of roads and transportation to cities that are new emerging centers for these industries beyond Metro Manila.

• A renewed emphasis on the provision of stronger education, including across engineering and scientific disciplines, are essential if higher value-added overseas jobs, or high value offshore servicing industries are to make the Philippines their home.

• The need for education is further underscored, if the Philippines is to turn its relatively high population growth into a demographic advantage in an “aging” world. Otherwise, sustaining a growing population on income sources that emanate directly or indirectly from abroad with a stagnant set of labor skills could prove untenable.

• Finally, as the demographics of the end-users of income from service sector jobs (domestically and abroad) change, besides education, there is also a need for greater savings out of these incomes, and more productive investments being made using these savings. Absent this, the strong indirect effects from the growth of services which have been seen in other countries may not be realized.”

Except that these proposals come from the IMF itself, have we not dealt with most of these since?

Gavekal, Holy Week and Political Gibberish

My warmest thanks to Mr. Louis Gave and the remarkable GAVEKAL Research team for the compliments; where I was supposedly to purchase their latest publication, “The End is Nigh”, instead got a complimentary set of not one but FOUR books.

It is when the big players whom we’d like to emulate acknowledges our lowly efforts, we feel humbly delighted.

In the observance of Holy Week, our regular outlook will resume on the 15^th of April, although if events warrant, we may post some short insights at my blog.

Finally, heard recently from a newscaster covering the recent hostage taking, “....especially from a country that values most its children.”

Our take: HUH? Isn’t “value” supposedly a subjective word? Our sense of values differs in the context of personal definition. What you value may or may not be the same as mine although in a general sense they could seem or be alike. In the words of Ludwig von Mises, ``All judgments of value are personal and subjective. There are no judgments of value other than those asserting I prefer, I like better, I wish.”

Hence, to arrive at such GENERALIZATION is indeed an outlandish spectacle. One is tempted to ask, on what basis does one derive or attach “VALUE” to merit such assertion; is it because of population growth, educational attainment or educational spending, health, family kinship, cultural ethos or productivity growth or etc. or a combination thereof?

My hunch; statements like this reflect political gibberish on the platform of moralizing from those allegedly are “in the KNOW”. This serves as an example of how the cankers of “toxic noises” pervade media which in turn taint the mindsets of the gullible general public.

Watching the Tape: We’re Keynesians for the Moment

``The exit strategy is painfully simple: Ultimately, it is up to Ben Bernanke – and whether he has both the wisdom and the courage to break the daisy chain of the “Greenspan put.” If he doesn’t, I am convinced that this liquidity-driven era of excesses and imbalances will ultimately go down in history as the outgrowth of a huge failure for modern-day central banking. In the meantime, prepare for the downside – spillover risks are bound to intensify as yet another post-bubble shakeout unfolds.”-Stephen Roach, The Great Unravelling

Lord John Maynard Keynes once said, Markets can remain illogical far longer than you and I can remain solvent. The statement seems indisputably accurate, and when applied in a different context, it simply means we shouldn’t “fight the tape”.

Yep, markets today have rebounded strongly from its recent shakeout lows last late February, and if one were to use the China’s Shanghai Index as barometer to future directional flows, then figure 1 tell us that what was said to have been the epicenter of the latest bout of volatility had been merely a blip.

Figure 1: Chartoftheday.com: Shanghai Composite Index: What Volatility?

The losses during last end-February had been completely erased and with this week’s 5% gain as the Shanghai Index trades at new record HIGHS!

And it is not just a picture of China; we see various markets in all parts of the world, appearing to have been injected with renewed adrenalin.

Figure 2: stockcharts.com: Carry Trade Still At Work?

In figure 2, courtesy of stockcharts.com, we note that the US benchmark, the Dow Jones Industrial Averages (candlestick) bouncing ferociously off its lows coincidental to the decline in the Japanese Yen.

The inflection points (red arrow) of the Japanese Yen seems to ran inversely parallel to the turning points of the Dow Jones (blue arrows) and the JP Morgan Emerging Debt Fund (lower panel-blue arrows).

What this probably implies is that the carry trade is “back in business” and that the declining yen could have provided for the necessary fodder or ammunitions to restore the risk taking activities as reflected by the bounce in emerging market stocks and bonds, as well as in the other asset markets.

While it is to my opinion that the present behavior of markets have been simply cyclical, undergoing a natural corrective phase, then signs are that the US markets following the break from its 50-day, may further advance. However, one noteworthy development is that the breakout came amidst tepid volume (shown above) which leads us to question on the strength or sustainability of the breakout.

The Phisix also has been at the trails of its counterparts rallying 3.52% over the week, with the Peso nearing its record milestone high to close at Php 48.16 per USD over the week. Since we noted that the Phisix and the Peso has shown some relative strength, I will have to change my neutral view on the Phisix, once the Peso breaks its recent high at Php 48.03 to a US Dollar, to a buy.

Of course, IF the Yen have been a crucial factor in determining liquidity conditions allowing for today’s worldwide rally, one must be reminded that the downtrodden Japanese currency in spite of its recent flagging conditions has been drifting near its all time lows relative to the US dollar and the Euro as discussed last March 5 to 9 edition (see US Markets: Risks of Ponzi and Speculative Finance). Hitting support levels usually generate violent reactions which may once again lead to heightened volatility.

The question is IF the Yen has indeed BEEN a pivotal factor in determining liquidity flows.

Figure 3: Stockcharts.com/The Rhodes Report: Yen Volatility has led to Financial Market upheavals

In Figure 3, Richard Rhodes of the Rhodes Report depicts of past financial market upheavals as a result of the Japanese Yen’s volatility. Again, a critically oversold Yen may lead to severe market swings which may affect global asset prices.

Of course, others may argue that the recent rebound by the global markets have been due to statement changes by the US Federal Reserve, indicative of a potential shift in FED policy.

Figure 4: Federal Bank of Saint Louis: Market prices in a RATE CUT?

The indicated changes in the recent FED outlook implies of a slightly weakening economy [from “somewhat firmer” to “mixed”], but still concerned over inflation represented by the price indices [“Recent readings on core inflation have been somewhat elevated” and “the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected”]. However, the most striking development in the word parsing game over the FED’s statement was the explicit EXCLUSION OF THE “ADDITIONAL FIRMING” clause.

The market seemed quick to interpret this as carte blanche omission of further rate hikes and instead tilted the outlook toward a RATE cut, as shown in Figure 4. ``Interest-rate futures show a 28 percent chance the Fed will lower its target overnight lending rate between banks a quarter- percentage point to 5 percent on June 28” from a Bloomberg report.

In my view, the shift in the statement represents as INSURANCE, where if the US markets would feel the pinch from the ripple effects of the unwinding subprime mortgage implosion towards a greater segment of economy, the FED has made available its “BERNANKE PUT” option or readiness to deploy its contingent “liquidity of last resorts” measures. So those contending that US FED will not intervene have now been given a preview of what comes next. On the other hand, it also marks the concern of the FED over the degree of landing.

In the event that the US economy decelerates more-than-what is-expected the Bernanke Put would likely be set in motion. Whether such actions will successfully reduce the impact of the deterioration has yet to be known although, I am in the camp of PIMCO’s Paul McCulley and Merrill Lynch’s David Rosenberg (March 5 to March 9 edition, see US Markets: Risks of Ponzi and Speculative Finance), who suggests that any forthcoming slowdown in the FED will be LESS determined by the price of credit, again to quote Paul McCulley ``It is also the case that once a speculative bubble bursts, reduced availability of credit will dominate the price of credit, even if markets and policy makers cut the price. The supply side of Ponzi credit is what matters, not the interest elasticity of demand.”

Yet, the bizarre part is how prices can persist to rise in view of an economic deceleration and declining trends in corporate profits. These shows of how distorted market pricing has been and how addicted the global financial economy have been to “low interest rates” and to the “massive creation and intermediation of credit, derivatives and digital money”.

Another timely reminder comes from, William Hester of the Hussman Funds, who warns that present expectations have been derived from conditions different from the past, ``In any case, investors should keep in mind that the stock market's reaction to Fed cuts has historically been dependent on other conditions such as valuations, economic expectations and the slope of the yield curve. The belief that rate cuts strongly benefit the stock market is based on conditions that don't match the present very well. It's possible that a Fed cut might help the stock market later this year. But given current conditions, history doesn't support much risk-taking based on that hope.”

Well, it’s hard to be overly optimistic knowing the possible risks of Damocles’ Sword hanging over the US and global markets via the Carry Trade or the degree of the impact by an imploding US real estate industry. However, Lord Keynes is right in terms of market’s irrationality, which means we shouldn’t fight the tape. Yet we can ACT on using the tape for our benefit.

History Is Not a Closed Book: Signals from Noises, Seeing Opportunities in Problems

``All political thinking for years past has been vitiated in the same way. People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome."-George Orwell

FINANCIAL markets thrive on dissenting opinions. An exchange occurs when a buyer, who buys on the general premise that the price of the financial security will rise in the future; in contrast to a seller, who sells on usually the belief that price of the same financial product will fall, agrees to consummate a deal on an agreed price. And because markets are mostly about psychology and human action, subjective convictions are parlayed into actual risk-taking activities. Curtly said, differences in outlook make trades possible.

Since we write about the financial markets, being that “what we see depends on where we stand”, our opinions are usually subjected to validity test by MEASURE of PERFORMANCES. Markets continually give us a HUMBLING experience where we are often reminded of our vulnerabilities to countless errors from actual SUFFERING or losses. Hence, we try to avoid losses or the angst of suffering by LEARNING from our past mistakes. And in doing so, we countenance the possibility of such shortcomings by keeping an open mind or by accepting views in contradiction to our biases. Therefore, an imperative quality of a successful investor’s mindset is one’s ability to DISTINGUISH the requisite SIGNALS from the confounding NOISES. Some information matters while others don’t.

So in trying to winnow signals from noises, we go back to our assertion that Japan’s aging population will be forced to alter the construct of their “homogenous” society, the latest news from Japan Times shows us some telltale signs ``The Japan Business Federation (Nippon Keidanren) has proposed that skilled foreign workers be allowed to get temporary full-time working positions at Japanese companies in areas where Japanese workers are scarce....The federation said those foreign workers should be accepted from countries that have signed economic partnership agreements with Japan and should be limited to those with skills in areas where Japanese workers are scarce.”

Of course, this is aside from the recent FTA agreement concluded by Japan and the Philippines to test the waters of accepting nurses and caregivers to compliment their declining labor force. In short, demographic trends are gradually shaping the political and economic framework of Japan. What used to be will NOT be.

We see a similar case but from a different angle in India, whose economy seems to resemble our own, allow me to quote at length another favorite columnist of mine, MSNBC Jim Jubak. Please bear in mind that this article is imbued with political, economic and investing dimensions (emphasis mine),

``Somewhere between 30% and 40% of the country's crops rot in the fields or spoil in transit because of the country's creaky infrastructure. There simply isn't any way to get the food to market in time. What does make it through the supply chain is subject to huge markups at each stage of the process, because getting food from warehouse to distribution center to retail store to consumer is so time consuming and cumbersome. Consumers pay twice as much for wheat, for example, than do wholesale buyers. That adds another layer of inflation to food prices at a time when food inflation doesn't need any help in running wild: Wholesale wheat prices jumped 54% between April and November 2006.

``Agriculture isn't the only sector of the economy paying the price. On overcrowded highways, speeds average less than 20 mph. Major cities in some Indian states cut power to factories one day a week. Ships have to be unloaded manually and cargo manually loaded onto trucks. Getting cars the 900 miles from the factory to the port at Mumbai takes one automaker 10 days.

``India spends just 4% of its gross domestic product on infrastructure in comparison to the 9% spent in China. That disparity has existed for more than a decade. As a result, while China has 25,000 miles of expressways, India has just 3,700 miles.

``Facing what amounts to a rebellion by the rural poor over soaring food costs that is likely to cost the ruling Congress Party power in New Delhi, the government budget released in March promises to tackle the infrastructure part of the problem by raising spending on roads, bridges, airports, etc., by 40%. But the government isn't stopping there: It is promoting public-private partnerships on infrastructure projects that are projected to invest $300 billion to $500 billion over the next five years.”

Our take: The political survivorship of its ruling class DEPENDS on delivering affordable basic services to its constituents, where infrastructure bottlenecks in the face of rising demand has resulted to pressures of rising consumer prices which has affected its rural poor.

Hence, the political elite seeks to undertake projects which would facilitate MARKET FORCES by increasing ACCESSIBILITY, promoting COMPETITION and permitting FOREIGN CAPITAL to finance these in order to accomplish such goals. So what you have here is NOT your moral “virtuous” order at work but of allowing market forces to solve its economic and political problems.

On the investing dimension, it goes to show that the infrastructure boom is in GLOBAL LATITUDE which should continue to provide underlying support to the global commodity cycle.

Essentially you have been presented with TWO outstanding complementary themes, INFRASTRUCTURE and COMMODITIES. Notwithstanding, the rapid growth in key emerging markets with SIGNIFICANT POPULATION offers various LATERAL opportunities in many aspects of a rapidly changing world where a ``TRIPLE CONVERGENCE – of NEW players, on a new PLAYING Field, developing NEW processes and habits for HORIZONTAL collaboration”, to quote Thomas Friedman in his marvelous book the WORLD is FLAT, could likely be the important forces that would shape politics and economics in the 21st century.

India and Japan’s present evolutionary experience can best be observed by the following prescient quote lifted from John Maudlin’s equally magnificent book “Just One Thing” on James Dale Davidson and Lord William Rees-Mogg in the Sovereign Individual in 1997...

``In short, the future is likely to confound the expectations of those who absorbed the civic myths of 20^th century industrial society. Among them are the illusions of social-democracy that once thrilled and motivated the most gifted minds. They presuppose that societies evolve in whatever way governments wished them to-preferably in response to opinion polls of scrupulously counted votes. This was never true as it seemed 50 years ago. Now it is an anachronism, as much artifact of industrialism as a rusting smokestack. The civic myths reflect not only a mindset that sees society’s problems as susceptible to engineering solutions; they also reflect a false confidence that resources and individuals will remain as vulnerable to political compulsion in the future as they have been in the 20^th century. We doubt it. Market forces, not political majorities, will compel societies to reconfigure themselves in ways that public opinion will neither comprehend nor welcome.”

Finally we argued that the main reason why the Philippine economy has been sluggish is due to its dysfunctional markets, prompted by various forces. Although we have dealt with this in the past, our aim is to show how inadequate our financial sector has been in providing the necessary savings and investment channels for our domestic capital investments and the corresponding support for the consumer sector.

Figure 5: Barry Ritholz/Wall Street Journal: Banking on Consumers

As shown in Figure courtesy of another favorite analyst Barry Ritholtz, the Philippine banking sector represents only 55% of our GDP considering that the banking sector has been the traditional, if not the dominant source of financing for our enterprises in contrast to developed countries or to some of our neighbors.

Although the chart INTENDS to show of a probable shift from an export-driven paradigm to a consumer driven growth engine by heavyweight emerging markets as India and China, the insufficiency of their financial infrastructure and the narrow breadth and depth of its banking system makes such transition to be graduated. Even so, the massive ongoing wealth transfer from the West to Asia makes such direction almost inevitable.

In the investing spectrum, if you share the conviction that emerging market economies will advance to a level near the developed worlds then investing in the FINANCIAL INFRASTRUCTURE and its BANKING system, which may enhance the breadth and depth of its markets in support of its economic goals are the way to go, aside from the earlier themes I mentioned.

Cloaked beneath every problem are opportunities, seeing it is a matter of choice.

Additions to History Is not a Closed Book

In reply to a comment from a reader, I'd like to make additional clarifications.

Age of Derivatives.

According to BIS, derivatives turnover has reached $431 trillion in October to December alone. According to Financial Week, the notional amount of outstanding OTC (over the counter) was $370 trillion for the first half of 2006 alone. OTC means these are private contracts and are unregulated by authorities.

In addition derivatives is a financial instrument “derived” from some other underlying securities.

Our global economy is only about $45 trillion, while estimated global capital stock is $143 trillion which means derivatives are about 7 times global economy or three times global capital stock.

Since derivative contracts should "derive" from collaterals of other securities this means that the world is 3 times as much leveraged than existing global capital stock.

As Lord Rees Mogg says “Now we have a fashion for high leverage – in derivatives, in private equity and in hedge funds. The global financial system has spread its sails. The momentum is awe-inspiring. There is less transparency than there used to be – investors do not understand derivatives; hedge funds are less transparent than old fashioned investment businesses; private equity is less transparent than public companies.”

While derivative products are meant to reduce risk by diffusion, they do not imply a risk free environment, to quote Kevin Warch, member of the board of Governors of the FED in his speech on Market Liquidity Definitions and implications, ``Even the most sophisticated financial products are not immune to the physical Law of Conservation of Matter – the risk must rest somewhere.”

Well, Warren Buffett, from his personal experience, thinks that Derivatives are a menace and even labels them as Financial Weapons of Mass Destruction.

Keynesians and inflationary policies.

When we say no country wants a strong currency, it means that in order to preserve or gain from the market’s export share, countries’ tend produce or “manipulate” far more money relative to that which is required for economic growth.

For example, if EU’s GDP growth is at 2.5% and money growth is 9.8%, effectively you are seeing a greater supply of money relative to demand. And when supply is larger than demand effectively you reduce the value of the goods or services which is in surplus, such is Economics 101.

The problem here is that all countries are engaged in mass money production and such is the reason why Gold, which is neutral currency, has progressed relative to ALL major currencies and such is the reason why you also see rising consumer prices all over the world.

Best explained by Paul Van Eeden ``When we understand that monetary inflation means an increase in money supply and that an increase in money in money supply causes a devaluation of all the money outstanding we can make sense of the world even as economists, journalists and politicians attempt to obscure the truth.”

You can read more of about this through his link.
http://www.paulvaneeden.com/pebble.asp?relid=506

Even John Maynard Keynes, in his The Economic Consequences of the Peace (1919) piece acknowledges the dangers of monetary inflation or “no country wants a strong currency” phenomenon, ``There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

Yet practicing Keynesians (or government interventionists) believe that savings is not an applicable function today simply because they think they are fungible (transferable to assets) and governments will always be the buyers or liquidity providers of last resorts.

As evidence we cite Wharton’s famous Jeremy Siegel, ``Could they precipitate a crisis? Not with the Fed on top of it. The Fed can diffuse any crisis. If everyone gets on one side of the market and things are out of control, the Fed is the ultimate source of liquidity. I think that they can prevent that from spinning out of control.”

Oh, am not Keynesian, as I mentioned, I lean on the Austrian School of Economics persuasion, where real savings matter.

Moreover into currencies, while one may think that the world is trying to “stabilize fluctuations”, what appears to be is not what is. Do you know that Warren Buffett, Bill Gates and George Soros have all bet against “stability” such that they understand the risks of a potential US Dollar Crisis? All the imbalances chatters seem to stem from one source, today’s US Dollar Standard system or Fiat/Paper money system.

Japan and Selective Arguments

The reason I made a comparison on Japan is that self-righteous arguments present only one side of the coin, as earlier explained as cognitive biases. For a balanced view, I injected a broader dimension which considered the suicide rates, credit rating and more importantly demographic trends. The intent is to show a BIGGER picture.

Yes, while I agree that Japan is a homogenous society, investors look to the FUTURE to position for returns. And we understand that economies will NOT thrive under a population that is NOT growing, NOT increasing its TAX base and ECONOMIC base to quote analyst John Maudlin. Therefore, demographic trends will mean a CHANGE in the societal structure of the Japanese in order to maintain their economic weal. What used to be will not be.

As I earlier argued CHANGE is the defining structure of today’s economic landscape from which investors should pay heed to. You may read more about demographic trends in UN’s Replacement Migration.

With regards to India, I’ve said my case.

On Rapid Population Growth

The problem of rapid population growth is not the growth per se. It is the inability of investments to keep up with the pace of its growth, which leads to productivity loss.

In today’s world, aggregate investments are low compared to the past, according to the IMF. And we simply see an upswell of financial markets relative to global GDP which means people are deploying capital derived from thin air to outright speculations rather of direct “productive” investments, hence the global imbalances.

In addition, the context of rapid population growth straining resources has been a longstanding Malthusian argument. To quote Elliot Gue, of the Energy Letters, ``Nevertheless, Malthus’ prediction has proven spectacularly incorrect in the two centuries since his Essay on Population was published. While the global population has continued to grow at the geometric, accelerated pace that Malthus projected, food production also rapidly accelerated after 1750 to more than keep up with that growth. The UK’s population exceeded 17.5 million by 1850 and topped 60 million by the latter part of the 20th century. More importantly, the total world population is at least six times what it was when Malthus penned Essay on Population. Not only has the population increased but so, too, has the consumption of food per capita.”

In other words, today’s commodity cycle has not been solely driven by the dynamics of growing population but of the dynamics of RISING purchasing power from a BROADER base of population. Again Elliott Gue says it best (emphasis mine),

``The United Nations predicts that by 2050 the global population will rise from the current six billion to exceed nine billion, with 5.2 billion living in Asia. Clearly, a growing population spells more demand for all sorts of food. But population growth in Asia plays only a tiny role in the boom in demand for food already apparent in the region. A far more important factor is rapidly rising Asian incomes and the emergence of a middle class. As nations develop and consumers become wealthier, food consumption patterns change. Not only do consumers eat more food, they tend to eat more meat and greater quantities of packaged and processed foods. Income is not the only determinant in these shifts--local tastes, religious practices and regional supplies certainly have an effect--but it is the primary factor behind differences in food consumption between countries and shifts in diets over time.”

I hope this helps.

Filipinos’ “Flawed” Culture? History Is Not A Closed Book

``It’s one thing to talk about ethics, but quite another to adhere to them. An ethical person consistently acts in accordance with his code of moral values. By contrast, a hypocritical person preaches a high standard of morality, but acts otherwise.” –Robert Ringer, A Wisdom-Filled Self-Eulogy, Part II

Price is a function of exchange subjectively valued by multivariate economic actors. And exchange is a function of markets, whose output (aggregate of production distribution, services, remittances, investments et. al) determines what is known in economics as your statistical GDP or GNI.

While academic textbook defines economics as a study of how forces of supply and demand allocate scarce resources, calculations to determine such resource allocations can ONLY BE done through the concept of pricing. The failure of the political paradigm known as “communism” was primarily an UNRESOLVED problem of economic calculation under centralized planned authorities or the inability to do away with pricing or with money. Who needs money in a Utopian society, anyway?

Financial markets or capital markets, serve as a mechanism of exchange for financial products; hence they operate under the same principle. Needless to say, today’s global economic environment have been dominated by so-called “paper shufflers” where financial assets overwhelm the real value of aggregate exchange of goods and services by about 3 to 1. As evidence we cite, McKinsey Quarterly’s estimate of the total global capital stock is $143 trillion whereas global output as about $44 trillion in 2005. In short, finance dominates today’s global economy.

Since value is determined by individual minds, then markets are basically psychologically driven. Having said so, in the realm of financial markets the psychological or emotional attributes of GREED, FEAR and HOPE serve as universal variables in determining value. So, whether you are long term investor, trader or a scalper, and REGARDLESS of color of the skin, culture, religious beliefs, political convictions and etc, such attributes accompanies the way decisions are made.

So whether we buy San Miguel Corp shares in the stock exchange or we buy a bottle of San Miguel Beer in a Bar, grocery or in the neighborhood Sari-sari store (as I did last night), (The difference being that of the platform of where the exchange is conducted.), essentially you are looking at the same operating principle; MARKETS AT WORK. My simple message is that MARKETS are the economy.

In the lay context, what is all so often labeled as “economic deprivation” translates effectively to AN INADEQUATE EXCHANGE MECHANISM that result to negative ramifications of poverty, inequality or low quality of living or simply said, DYSFUNCTIONAL markets (caused by distortion or underdevelopment).

For instance, how does our agricultural worker, representing the largest workforce in the Philippine labor pie, improve on their share of income when they continue to rely on the traditional channel (market), or in particular the “traders” (who gets a big chunk of their profits), for the exchange of their produce? In other countries, including our peers, they get not only full value of their produce (by bypassing middlemen) but have the ability to HEDGE their products from variable risks factors such as weather, seasonality and etc.

Therefore, the key question is HOW to resolve on what INHIBITS our markets from functioning at the optimum for the benefit of, what politicians and their factotums by nature call as the “common good”. Yet, media and celebrity pundits frequently tackle on tangential issues to becloud the perception of the public while politicians eagerly jump on controversies to use such opportunity to impose more “controls”. Again this reminds me of one popular quote by Dr. Samuel Johnson, one of England’s greatest literary figures, ``Patriotism is the last refuge of a scoundrel."

Since psychology drives capital deployment decision making, whether motivated on grounds of political (e.g. public institutions) or economic goals, we are inherently subject to heuristics (mental short cuts) or inherent biases. After all, we are merely humans, where our ancestors have basically shaped the functionality of our minds and biases operating under survivorship conditions then. As an example, fear leads to our natural defensive reaction (against predators) such as running!

We easily succumb to oversimplifying events based on our present knowledge giving us the “illusion of knowledge”. And because we think that we know the problem, hence we usually give out our “one-size-fit-all” remedies/panaceas out of the “illusion of control” on our perceived woes.

As examples, the recent circulating email describes of our “Flawed culture” (or “national inferiority complex”), which is no other than a recycled, resurrected makeover of the James Fallows’ Atlantic Monthly’s 1987 controversial piece “Damaged Culture”, or of common polemics on overpopulation, lack of education, cultural diversity, fragmented society, pervasive “corruption”, lack of “safety nets”, patronage politics, inadequate social spending, “unsophisticated” voters and others, all of which contribute to the lack of productivity or have been cited by different quarters as responsible to the present state of our depressed society.

While all of them may have SOME influence to the country’s downtrodden state, the weightings or relevance applied are different and will continue to shift as the landscape evolves.

Because these are ALSO elements to our living and breathing network of exchanges or markets, they are predominantly multi-dimensional variable based and NOT singular factor determined operating under the evolution of dynamic environments. When we say dynamic we mean changing micro and macro dynamics, such as new regulatory environments, shifting consumer/voter preferences, demographic and migratory trends, wealth changes, climate changes, capital flows, technologically and scientifically driven advances, inflationary driven psychology, et. al..

In other words, some problems contribute more than the others while some factors may nonetheless be rendered insignificant over the passage of time.

On the other hand, external factors have likewise been shown to have grown more in influence to the structural changes in our environment. For instance, how does one reckon with the so called “lack of national identity” dilemma operating in the FACE OF EXPLODING MIGRATORY TRENDS (UN says-about 191 million migrants in 2005 and growing) under the auspices of deepening trends of globalization?

No, the migratory trends today, which used to be driven mainly by seeking for “greener pasture” have now seen other sources of impetus; global demographic requirements, “ethnic reconsolidation” to quote the Economist, taxation, politics and et. al., have not been directed merely on labor skills (although they constitute the significant majority) but to growing trends even among the investor class. Hence, could we be at the cusp of the emergence of global citizenship?

Daniel Altman who writes for the International Herald Tribune and YaleGlobal (emphasis mine) says it best, ``...citizenship is becoming less and less about patriotism. In obtaining a second or even third nationality, earning a living is often a higher priority than confirming a sense of identity and belonging. Seeking a better deal from society can also be a prime motivation.”

The issue here is that market and economic environments are highly complex in nature and continually operate under fluid circumstances, where nothing is definitive except for change.

We also read of proposed simplistic solutions to our miseries, as being “Attitude” in nature, specifically, Ethics, Integrity, Responsibility, Respect to the laws & rules, Respect to the rights of other citizens, Work loving, Strive for saving & investment, Will-accompanied by super action, Punctuality and Community service, citing nations which have openly espoused such virtues as “progressive”. While I do not contest the INTENT of the message, as it is indeed IDEAL, the truth is HOW I WISH it were APPLICABLE or REAL.

For instance, while I would agree that Respect for Property rights and Personal Responsibility are key ingredients to functioning markets, the need for savings for instance would be an arguable topic. The others look like political gimcrackery.

Of course, through the Austrian persuasion I have learned that real savings are indispensable because they represent real wealth. However, practicing Keynesians would argue, “Huh? Who needs savings in the age of derivatives? With the combination of “money created from thin air” and the dawn of “digital money”, why save or produce when we can simply speculate? Have not savings today been represented by rising asset values?”

As we earlier mentioned today’s world is more of finance, ergo a Keynesian world. No country wants a STRONG currency and thus every country works to destroy or debase the value of their currency. These are manifestations of the inflationary proclivities. Nonetheless, beyond the knowledge of the public, inflationary policies serve to benefit special interest groups associated with the powers that be (for preservation). Yet, is it not a wonder why the widening worldwide inequality gap has been a consequence of collective INFLATIONARY POLICIES adopted by Keynesian protégés ensconced in central banks and in government bureaucracies?

One should also remember that today’s leaders maybe tomorrow’s mediocre performers or that Empires operate on their own CYCLES too. Have we not been colonized by Spain for over 300 years when they were yet at the helm of the world? Whereas the 19^th century belonged to the England, the United States took over the mantle in the 20^th century following the World War I.

One can have a short glimpse of the time intervals of shifting empires since Man’s civilization began, as illustrated by mapsofwar.com, as shown in the link below:

http://www.mapsofwar.com/ind/imperial-history.html

Do you think that history ends today?

To wit, such assertion of a simplified Utopian solution have been grounded on cognitive biases such as “framing” [wikipedia.org-cognitive heuristic in which people tend to reach conclusions based on the 'framework' within which a situation was presented], “representativeness” [James Montier of Dresdner Kleinwort--the judging of events by how they appear than they likely are] and “fallacy of composition” [wikipedia.org-one infers that something is true of the whole from the fact that it is true of some (or even every) part of the whole].

For instance Japan having been mentioned as one of such virtuous examples/practitioners. If they have been so puritanical, why have Yakuza’s (Japanese Mafias) thrived in such environment?

Or consider the suicide rates; among developed countries Japan has the most incidence of suicide statistics according to WHO, 36.5 for males and 14.5 for females for every 100,000. Compared to the Philippines, 2.5 and 1.7, or India 12.2 and 9.1, respectively. Should this imply that they are richer but we are happier (reword: appreciate life)? So which among these qualities should be highly valued? Or which should determine a nation’s success, a higher per capita GDP or lower suicide rates? (Now I pose to you a counter-FRAMING question.)

You might want to know that Japan’s credit rating is at the level of Botswana, an African nation, considering its about 160% public debt to GDP. Or of its declining or shrinking population from which if present trends persists, NO Japanese will be left standing by the next century (!), to paraphrase an official.

Who then pays for all of the debts incurred by them UNLESS they radically change, in terms of culture, i.e. to accept immigrants as part of society, empower female to close the gender gap and to increase fertility rates, and in politics, i.e. allow further ingress of immigrants? [Faced with Hobson’s choice, the inevitable reform path makes me bullish on Japan].

Morality, argues Steven Levitt and Stephen Dubner, ``represents the way that people would like the world to work-whereas economics how it actually does work.”

If history were likewise determined by such idealistic virtues, then John Lennon’s world of “Imagine” would possibly be realized on a pragmatist level and we would all be living in harmony with reduced conflicts. Yet as shown above history belies such utopian setting.

Yet the problem with moral solutions lies in its DEFINABILITY. The broad coverage makes them seem like motherhood statements mouthed by political demagogues. Another, moral solutions usually serve as cloak for more regulations or Spending Other People’s money (SPOM), which in most part have been the ROOT cause of the market asymmetries here or elsewhere.

In addition, we can argue about Switzerland’s success (specialization) or of Canada and Australia (market and commodity driven economies) or of Vietnam (China modeled-liberalization), but moralizers make the same predictive fallacies as that with typical market analysts; projecting past performances into the future.

For example, to argue that India is poor and imply to remain so (Oh yeah?), simply because they do not follow the said virtues, is predicated on the analogy that mechanical rotary telephones will never change.

Figure 1: Goldman Sachs: BRICs on the Run

The emerging markets phenomenon known as the Brazil, Russia, India and China or BRICs as labeled by Goldman Sachs shows if the present clip of growth rates were to persist, your unvirtuous paragon will SURPASS the virtuous ones as shown in Figure 1. Says the Goldman Sachs study in 2005 (emphasis mine),

``They suggest that if things go right, the BRICs could become a very important source of new global spending in the not too distant future. The chart below shows that India’s economy, for instance, could be larger than Japan’s by 2032, and China’s larger than the US by 2041 (and larger than everyone else as early as 2016). The BRICs economies taken together could be larger than the G6 by 2039.” The assumption here is for present conditions to maintain its pace which is a big IF going forward.

Yes, the meaningful transition in support of these evolving trends are becoming more apparent, this latest account on the convergence of global pay for managers, according to Financial Times (emphasis mine), ``Forecasts of wage increases in more than 50 countries, published by consultants Hay Group, reveal that real pay is predicted to race ahead in Asia and eastern Europe this year compared with the "developed old economies". Faster wage growth reflects "the wealth creation being generated by rapid economic acceleration in China, India, the former eastern bloc and the Baltic states," says Hay.”

Again, if such trend persists, the income levels for managers in today’s developing “POOR unvirtuous” countries (Philippines, India, Vietnam Egypt or others) and the developed world could reach near PARITY sometime in the distant future!

Nor is it limited to wages, Forbes list of billionaires shows of a growing trend of successful entrepreneurs from your unvirtuous countries, quoting William Pesek of Bloomberg (emphasis mine), ``Yet Forbes's latest tally says even more about what's happening within Asia. India wrestled the top spot in Asia from Japan, which held the title for two decades. India has 36 billionaires with a total of $191 billion; Japan has 24, with a total net worth of $64 billion....Following the money offers insights on the changing of the guard in world's most-vibrant economic region. Japan once dominated Asia, yet developing powers like India and China are moving to center stage. Expect more of the same in the years ahead.”

Before bringing this to a close, I’d like to show you another “human” cycle phenomenon which should affect the global markets, economies and or politics alike over the next few years or so.

Figure 2: Puru Saxena/ Barry Bannister, Stifel Nicolaus: Commodity Cycle

It’s called the commodity cycle. And the upturns of commodity cycles have been in the past associated with wars, simply because supply shortages create intense competition which eventually spillovers to the political arena, as shown in Figure 2.

As Dr. Marc Faber explains (emphasis mine), ``But it’s not only the commodity-importing nations that become more belligerent when shortages drive prices higher. The commodity producers themselves find they are in a sweet spot and become more aggressive in their relationship with their clients — the resource-importing nations. So, whereas we have seen that in the 1980s the balance of power in the world began to shift towards the industrialised nations as commodity prices fell, today it would appear that the balance of power has already shifted back to the resource producers — especially the oil producers. This shift of power to the resource producers is particularly pronounced when new countries and regions become involved in the “trade network”, as Kondratieff observed, because the demand from the traditional sources is, as a result of the entry of new countries into the global economy, gradually displaced by the incremental demand of nontraditional and new sources.”

Today’s upturn in the commodity cycle once again reveals of patterns of bellicosity as seen in the geopolitical developments of the Middle East (Iran, Iraq et. al.) and the rising tide of “nationalism” in Russia, Venezuela, Bolivia and others which are potential sources of future conflicts.

As historian Niall Ferguson warns in his War of the World: History’s Age of Hatred (emphasis mine), ``We shall avoid another century of conflict only if we understand the forces that caused the last one-dark forces that conjure up ethnic and imperial rivalry out of economic crisis, and in doing so negate our common humanity. They are the forces that stir within us still.”

In finale, since economies are the aggregates of functioning networks of exchanges or of markets, psychological underpinnings dictates on its cycles, most commonly characterized by greed, fear and hope.

Division of Labor enhances the exchange mechanism and allows for more social cooperation which leads to the so-called ATTITUDE “moral” solution. The successes or failures of economies have been ascertained by multi-dimensional variables which influence on the degree of the operativity of the markets.

In essence, the FUNCTIONALITY OF MARKETS ESSENTIALLY DETERMINES THE WEALTH TRANSMISSION. The so-called success formula has ONE coincident denominator, a market based economy.

Critiques or analysis of perceived inadequacies accompanied by “moral” solutions based on “selective” information reveal of MENTAL DISHONESTY and or the lack of understanding of the dynamics of market based cycles and evolutionary shifts in the global economic landscape to pass “undeserving” judgments.

The risk is such that we fall into the cognitive traps obviously laid by vested “political” interest or their functionaries to promote regressive policies camouflaged in the name of “common good”. Worst of all, is to repeat the same mistakes of our forebears.

Remember, today’s commodity cycle tell us that shortages and rising prices have tendencies for hawkish attitudes that may lead to undue “belligerency” or aggressiveness. It would be better for us to promote social cooperation via increased trade and work on to improve on our markets than to undergo violent upheavals brought about by the order of closed societies “nationalism” or “myopic” populism.

With regards to the Philippines being a “Damaged or Flawed” culture, history is not a closed book. Believing so, only imprisons one to corridors of the past.