Philippine Politics In the Prism of the Peso

``I'm in favor of achievements - degrees and wealth and that sort of thing. Still, those achievements convey formal authority but not always moral authority. The only way to acquire moral authority is through your character and contribution, to live in such a way as to merit the confidence and the trust of other people.”- Stephen Covey

Allergy to Politics and the Focusing Illusion

The most difficult position for one to take today is to be apolitical. To my experience, in almost every discussion which deals with current events seem to require the domestic political equation as an indispensable theme.

Worst, it would appear that our world has been reduced to an argument of tangibles or absolutes (sometimes known as the fallacy of the False Dilemma) - where one’s choice is confined to ONLY black or white, good or evil or pro or against.

Yet, the arguments as we presented last week is one of the abstract phenomenon. It deals with intangibles or theoretical suppositions or even metaphysical concepts- where judgments are mostly based on the perceived values of individuals or are very subjective in nature.

So when words such as “Honesty, Morality, Truth, Altruism, Compassion, Justice etc.” are used and floated in the political sphere, beyond the public’s comprehension these words basically become expediencies or “slogans” meant to achieve a goal. Unfortunately once these are met, we see the cycle repeat over and over again, hence the never ending issue of street politics.

In behavioral finance, such cognitive distortion or bias can be identified as the Focusing Effect or Focusing illusion which is, according to wikipedia.org, ``when people place too much importance on one aspect of an event, causing an error in accurately predicting the utility of a future outcome.” The underlying belief that a personality change in the present leadership will automatically result to national salvation exemplifies this premise. This represent as the “lotto” or "quick fix" mentality. Again, we said the same in 1986 and 2001 only to find ourselves repeating the same mantra.

Yet, without structural reforms in our defective system, which is based on a pork barrel rent seeking “culture” grounded on excessive dependence on government and a dysfunctional market system controlled by politicians and their associates, all this beliefs are likely to signify another illusion-as in the past, we are likely to see the same dynamics in the future (even under new leadership).

The Abstraction of Action Speaks Louder

Abstraction, seen in the present day developments in our local financial markets, can be related to one’s perception of reality.

Because of the onslaught of controversies encompassing media space, the atmosphere depicted is of a country teetering on a verge of chaos. Thus, we are told that the Philippines as having been mired in a deep crisis which requires “urgent solution to a desperate situation”. This reverberating clamor for “change” has today become a fashionable social theme. Unfortunately, this fad has yet to reach a “critical mass” or to the same level of political fervor that has successfully ousted incumbents in the past.

Nonetheless, as a market observer, we are aware of the distinction between what is bruited about in the media-conventional thinking and how the market responds to what is the perceived as the risk environment.

The normal or conventional behavior is; the general public is unlikely to invest in a marketplace whose environment is perceived as highly risky. For example in 2002-3, hardly any local investor wanted to even talk about investments in the Philippine Stock Exchange following its deep cyclical funk because it was perceived as “highly risky”. This signifies extreme levels of risk aversion, yet, the public’s “Focusing Effect” led them to miscalculate and miss out the greatest buying opportunity which marked the secular bottom of the Phisix for this cycle.

If I ask you to invest in the sub-Saharan African states, would you? How about in the previously war torn areas of Mindanao? The most likely response would be a NO, especially if one is not acquainted with the area or is not from the area. Because people tend to operate merely on impressions, the conventional perception of such risk environment is likely to be based on negative reports depicting anarchy or violence.

But can a perceived high risk environment receive ample investments? Yes, perhaps depending on the social mood and or on the risk appetites of investors. So when social mood is optimistic or rather risk appetite is more tolerant regardless of the stream of bad news, then markets may not exactly reflect today’s headline sentiments and vice versa. In other words, ACTION speaks LOUDER than words! Financial markets may translate to votes of actual money placements by the investing public than mere “verbal” sentiment.

The Weakest Link: The Phisix

The Phisix today seems most susceptible to the present political drama than in any part of the current cycle (since 2003) because foreign money which had underpinned the run up of the entire cycle has now turned to negative (since the late semester of 2007).

In contrast, the local participants apparently have traded places with their foreign counterparts, whereby the former have been providing the backbone to the Phisix during the recent market turmoil as the former drivers exited.

Yes, as you well know, external developments have dragged foreign sentiment away from local equities which is most likely due to the ongoing liquidation dynamics as a result to the implosion of the house of cards built from highly leveraged mortgage securities and other derivatives papers in the US and in some other parts of the world.

Since many institutions had been caught holding into these papers with unrecognized value, raising funds meant selling of the most liquid holdings of their portfolio, hence the contagion effect (selling across the globe). Some financial institutions and lenders have been estimated to shrink capital assets by about $2 trillion (Greg Ip- WSJ).

Aside, this also mean adjustments in the economic and asset valuation expectations from the perceived impact of a meaningful downshift from the US economy as an offshoot to the tightening credit environment- where the same estimates say that about 1.5% percentage points would be knocked off the US economy- brought upon by the ongoing global credit crisis and the contraction of leveraged securities markets.

So with hiatus of foreign money serving as principal support for the Phisix, this leaves local participants as its major drivers. True enough, we have seen SOME impact of the political drama manifest in the Phisix as shown in Figure 1.

Figure 1: stockcharts.com: Phisix “Decouples” on Political Drama

The vertical line represents the “short-term” bottom from which Emerging market Economies (lowest pane), the US S&P 500 (above pane) and the Dow Jones ex-Japan index (behind-center window) has indicated partial recoveries or consolidation. On the other hand, over a similar timeframe, the Phisix has missed the recovery train and remained sluggish. Hence, the Phisix has partially "decoupled" from world markets which implies clues of negative impact from domestic politics.

Notably, in spite of this the net foreign selling has been greatly reduced and in fact these turned positive last week, as our market belatedly recovered (see circle).

Of course, hefty fall by the major benchmarks in the US markets last Friday are likely to exacerbate the negative conditions in the Phisix at the outset of this week.

So yes, admittedly over the short period the lack of foreign support has exposed the Phisix to some degree of political risks.

The Peso As The Strongest Measure of Sentiment

But, this is not entirely the same tune we hear if measured relative to our currency.

The Philippine Peso is likely to be a more accurate pulse of investor sentiment since they reflect capital flows across asset classes within our domain, aside from other factors such as remittances or trade surpluses or deficits.

Figure 2: Philippine Peso: No Crisis so Far

As a reminder, net selling in the Phisix does not automatically reflect capital exodus as it may imply asset shifts (from stocks to bonds or short-term cds).

Figure 2 shows of the historical significance of political tensions to the Peso. Tremors from major scandals, which rocked the political landscape in the Estrada Impeachment to the culmination of the People Power 2001, caused a significant drop in the US dollar-Philippine Peso exchange rate (see red arrow leftmost side).

Following the Estrada ouster in 2001, the Peso appreciated over a short period but resumed its long-term downward path.

It is the same story in 2005. The Peso which has greatly lagged the region relative to currency appreciation found itself attempting to firm up during early 2005 [as explained at What Media Didn’t Tell About the Peso]. However, as the HELLO GARCI scandal erupted- where almost the same intensity for the quest of “truth” was advocated-the Peso lost its upside momentum and consequently fell back to the 56 level (middle red arrow).

Meanwhile, the Phisix lagged the world by trading sideways then. It must not be forgotten that operating underneath the dynamics of 2003 to 2007 had been sizable foreign portfolio flows. Such that even during the outbreak of the Garci Scandal, foreign funds accounted for “net buying” even at greatly reduced scale.

Essentially, the public’s impulse of scampering for cover in response to the political scandals has been demonstrated by a loss of value of the Peso relative to the US dollar-where political anxieties has even overwhelmed foreign money flows. Or simply said the resident public exited the Philippine Peso on political antsy and sought the US dollar as safehaven.

Today we see almost the same extent of political drama but under a different set of circumstances. Yet as opposed to the past - the Peso is seen breaking into NEW highs…in fact is in a fresh EIGHT year high! Nonetheless, this comes in the light of a streak of net foreign selling in the Phisix since the advent of 2008!

This development thus leads us to several intriguing questions:

1. If the Public is seen selling from the perceived “crisis” then who is on the other side of the trade…buying? This is a big curiosity. Yet, market reaction does not suggest of high volatility or wild gyrations (just look at the chart) to indicate strains of “panic” or “fear”, accompanied by a “forcible” containment (yet!).

2. Has the public been immune to the political risks such that all the brouhaha for change could possibly translate to an “All bark no bite” scenario?

The fragmented elite, many of whom have joined the caravan to the supposed “path of enlightenment”, seem to have been jaded by the political stress as they appear to remain calmly invested! There has been NO substantial evidence of panic selling from locals in the Phisix or in the Peso. In fact, the main support in the Phisix has been from the local participants since the July 2007 credit crisis exploded or even since the start of the year! Can we deduce their actions as merely rhetoric in a political sense?

3. Has the negative real rates impelled the local investors to turn a blindeye to political risks (despite the social chatters) given the opportunity cost of holding US dollar assets? The thinking goes, “I’d like to flee but where to go? The US dollar keeps falling! Besides, inflation is eating up my peso.” (Still this does not represent a sign of panic…since they’re still thinking!)

4. Or how about this naughty thought of mine…could it be that some political entities been “manipulating” public sentiment to do a “poop and scoop” or spread bad news in order to buy assets in the hope that they fall?

With Philippine trade account registering a deficit for 2007 of $5.04 billion (forbes.com), this leaves remittances and portfolio flows as possible major contenders for the vitality of the Peso.

Yes, remittances have remained strong- as they had been during the Estrada impeachment to the People power 2001 and during the 2005 outbreak of Garci Scandal…yet the Peso fell! But it would seem dubious if they signified as the sole variable responsible for the levitated state of the Peso.

This most likely posits that the combined forces of unseen portfolio flows, the “no panic” attitude (yet) among local investors (instead of capital flight maybe a capital repatriation!) compounded by continuing of remittances may have buoyed the Peso. (Of course, this has shadowed the region's performance).

Foreign Money Are Not Zombie Investors!

It is also awkward or a cockamamie to suggest that foreign money is inured to political risks.

Figure 3: Bloomberg: Thailand’s SETI

While there are still substantial signs of copious liquidity in the world’s financial system, the market tensions evident in the global credit markets as well as in the structured finance securities and derivatives markets spilling over to global equities signify traces of discriminatory flows of liquidity. Ostensibly, these “surpluses” have been flowing into the commodity markets. Hence, the attendant risk taking posture by international fund managers are likely to be more discerning than during the previous pre-July 2007 Credit crisis era.

Yet, even then, political risks did matter. When the military successfully unseated the incumbent Thaksin Government of Thailand via a coup d'état, a financial market carnage ensued in September 2006 as seen in Thailand’s premier benchmark, the SETI, in Figure 3 courtesy of Bloomberg.

This was further exacerbated when Thailand’s central bank instituted capital controls from which they have partially reversed following a fierce backlash from investors. Incidentally, Thai’s Central Bank has reportedly been scheduled to lift all controls this week (Reuters).

So, foreign investors are not zombie buyers who acquire assets regardless of risks. Since they are profit oriented enterprises (unless they are Sovereign Wealth Funds SWFs), their positions are based on estimates of a risk-reward tradeoff.

Likewise, foreign money have not been acquiring assets out of political considerations; again unlike central banks who continue to amass US dollar instruments (mostly agencies today) despite the steep losses of the US dollar or like select Sovereign Wealth Funds (e.g. China’s CIC or SAFE). So it would be a huge mistake to presume foreign money flows as entirely impervious to political risks.

Encore: Believing In Six Impossible Things Before Breakfast

All this goes to show that words can be different from actions. One can say a mouthful of things yet act on the contrary. Politicians are the ultimate practitioners of this, they are devout followers to Napoleon Bonaparte’s advice, ``If you want to be a success in the world, promise everything and deliver nothing.”

Such abstract disparities have been equally conspicuous under today’s setting; reality according to the Philippine financial markets is starkly different from the reality as limned by the media, the politicians and their followers.

In a perspective, yes there is a crisis- but this has been limited to the political spectrum, the media space, and to social circles.

No, there is no crisis (yet) in the financial sphere or the economic front as signified by performances of the Peso or other financial markets; for whatever reasons possibly higher risk tolerance, negative real yields or buoyant social mood.

To argue otherwise is to see our reasons BLINDED by extreme fixation on politics. Besides, the generalization that Philippines in a crisis falls under a logical fallacy- the fallacy of composition, which is, according to wikipedia.org, the inference of ``something is true of the whole from the fact that it is true of some part of the whole (or even of every proper part).” As you can see, sensationalism will bring us nowhere.

To paraphrase Mr. Warren Buffett in his latest Berkshire annual letter, many of those suggesting for a crisis seems to direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.”

So until we see this “crisis” rear its ugly head possibly through further deterioration in the political arena which may diffuse into the real economy and most likely felt first in the markets, like the global depression tales, they belong to the genre of horror movies.

A Week of Milestones

``Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.”- Ludwig von Mises, from Lord Keynes and Say's Law, The Critics of Keynesian Economics, edited by Henry Hazlitt, University Press of America 1983

Figure 4: stockcharts.com: Milestone Highs in Commodities!

Last week was a week of milestones.

One, crude oil crossed the all important psychological threshold of $100 barrel (lowest pane), two, gold is only a breath away from another landmark $1,000 and copper nears its all time high at $3.95 a lb.

The CRB index too a composite featuring a basket of different commodities likewise is on a record run (pane below main window) as shown in Figure 4.

Of course, all this comes in the light of a US dollar index that has etched a lifetime low.

Meanwhile, Gold priced in the US dollar index (main window) - meaning against the Euro, Japanese yen, the Canadian Dollar, the British Pound, Swedish Krona and the Swiss Franc-which means not only has gold risen to a milestone high in US dollars terms but likewise against a basket of currencies represented by the US dollar index.

Of course, the burst of activities maybe interrupted by interim corrections.

Again others say that the next wave of credit derivatives implosion will sink these lofty gainers. This maybe true in the equities market but we aren’t convinced with regards to commodities. Others also say that inflation is a lagging indicator and would eventually fall as credit driven woes escalate. As we have noted before, monetary policies will have divergent impact to different countries. In addition, yes while demand maybe impacted by a slowdown but what of supplies?

Besides, as collective government attempts to socialize losses and increase interventions in the marketplace in the challenge to stabilize prices, we are likely to see even more distortions, more liquidity generation and more currency debasement activities—or your “moralistic” inflationary activities.

Figure 5: Comex Gold to the Philippine Mining Index: A clue of Future Prices?

In figure 5 we see the US comex gold shares take a spike, whereas local mining issues have not responded similarly. Is the COMEX gold sending us a signal of the prospective direction of our domestic Mining issues?

As a reminder, not all mining issues are cut from the same cloth.

Jessica Hagy's Indexed: Crony Capitalism and Oligarchy fits the "Gap"?

In Jessica Hagy's wonderful Blog called Indexed, she makes an eloquent depiction of how a "banana republic" seems caught between the influences of communism and capitalism...

where she describes "A" as represented by Fidel Castro while "B" as the "Gap"...

I'd like to fill in the "GAP"..."Crony Capitalism" and "Oligarchy" seems to fit the bill. (see preceding blogs)

P.S. We also don't have a shortage of "A" or "Castro" wannabees...I mean, here on this island. Just watch the local news headlines and you'll know what I mean.

Hat Tip Jessica Hagey

Philippine Politics: Systemic Defects of the Pork Barrel Political Economy

``We are taught, from a very early age, to believe in that which is unreal - known in street parlance as B.S. It becomes so ingrained in us that we jeer those who try to talk straight. Nothing can make a person more unpopular more quickly than daring to be truthful - especially when the truth threatens the instant gratification of others. "Woe to him," cautioned Will Durant, "who teaches men faster than they can learn.”-Robert Ringer

Personality based politics is once again the order of the day. Given today’s highly charged atmosphere, mainly juiced up by mainstream media, many people have been impassioned in the belief that we are in desperate times that requires drastic measures.

Amidst the hullabaloo of the unraveling episodes of scandals, exposés and titillating controversies, the basic premise has been this: The incumbent leadership is so morally BANKRUPT that the ONLY RECOURSE to the nation’s salvation is to UNSEAT THEM (by extra legal means).

While we do not disagree with initial premise, what seems to confuse the public is the distinction between the means to an end and the end itself, where a complex problem is reduced to simplicity with a corresponding “simplified” solution.

Hence, the conundrum of “People Power Fatigue” or the seeming irresponsiveness by the general public to calls from certain quarters to undertake the street politics of the past.

We Get What We Deserve

We have to understand we live in a “democracy”. The nation’s leadership did not pop up from nowhere, we PUT them where they are today (by both the extra legal and electoral process).

One may argue that the incumbent may have cheated themselves into the present position, but what is missed is that cheating comes in a tightly contested race (e.g. Erap’s landslide victory in 1998 did not give the FVR administration the opportunity to cheat-yet it was a political statement against FVR too) and next, the alternative or rival candidate was no guarantee of a “moral” leadership (yes, a highly popular but surrounded by traditional politicians, and political interest associated with the deposed president).

What I’d like to point out is that the Filipinos are simply reaping from the sets of leaders we chose from.

Take the 2007 senate elections. As we pointed out in our May 28 to June 1 2007 edition, [see Philippine Elections Determined by The Contrast Principle!], the outcome of the elections, where the opposition trumped the administration bets, was clearly based on sentiment meant to drive a political statement against the administration.

I wrote then ``As Franklin Pierce Adams (1881-1960) American Journalist wrote, ``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.” And Mr. Adams’ aphorism echoes loudly in today’s vote; it was a vote AGAINST somebody rather than for somebody (-ies).”

For as long as the candidates were deemed to be winnable and strongly biased against the administration, regardless of the past performance they were voted upon by the public into office. One even spearheaded the ouster of the previous president via congressional impeachment yet ironically had to seek the latter’s endorsement-it’s a curiosity how it seems like a norm for the public to simply accept political “turncoatism” or “butterflies”.

In the context of the contrast principle or (changingminds.com) the difference between “things” and not absolute measures, this means that the limited options reduce the chances of highly qualified set of leaders being voted into office. In politics it could mean a choice between the proverbial “pot” and the “kettle” where both have been calling each other black!

The lesson here is we do not elect our leaders based on integrity, ideology, platform, performance track record or other quality measures of meritocracy but on superficial traits as winnability, personal familiarity or association or network, sentiment, popularity, machinery or faddish themes, regardless of political baggages.

Thus, we get what we deserve.

This also means that for us to attain our desired “moral” leadership we need to RADICALLY IMPROVE THE MANNER FROM WHICH WE SELECT OUR LEADERS. Otherwise all this political exercise for “change” can easily be labeled as mere blarney.

Abstractions, Value Judgments and Getting Fooled Over and Over

This leads us to the next item. The public seems to have a short memory. Philosopher George Santayana’s famous axiom, ``Those who cannot remember the past are condemned to repeat it” seems so fitting. Or how about this anonymous quote ``Fool me once shame on you fool me twice shame on me.”

Many have been calling for another People Power. The underlying belief is a swift resolution in response to a “simplified” problem. The unfortunate part is that we keep on repeating what philosopher Santayana keeps warning us about: WE NEVER SEEM TO LEARN FROM THE PAST. Or applied to the present situation, we seem to keep on fooling ourselves over and over. The unanswered question is why?

We have seen this script before in 1986 and in 2001. While the difference maybe in the characters and circumstances involved or how these events played out, the patterns and the alleged sins have basically been the same: Abuse of authority and corruption.

For starters, the fanfare about political change is mostly anchored on abstraction. As self-development Robert Ringer defines (highlight mine),

``An abstraction is theoretical in nature - i.e., it is not a tangible reality. It has no form or substance. Examples of abstractions include such concepts as time, infinity, negative numbers, zero, gravity, motivation, resourcefulness, love, justice, fairness, dreams, intuition, common sense, conceptualization, and axioms…What I'm driving at here is that we live in an abstract world, a world filled with abstract thought, existence, and causality. A world where time, being, and substance are not provable. ”

Let me give you an example.

A terminally ill father is supported by his children. The eldest child gives out a portion of his income as contribution. The second child gives out all of his income, while the third child even borrows aside from shelling out his entire earnings to sustain their father. The youngest child does not contribute because he is unemployed. So which among the children serves best their father?

You see the problem here is one of opportunity costs. It is a problem based on a trade off between the available resources (by the children) and the life of their father. People are likely to have different responses with respect to this dilemma based on their perceived “value”. In other words, the above case represents a mundane abstraction based on value judgments.

Where value judgments, according to wikipedia.org, ``is a judgment of the rightness or wrongness of something, or of the usefulness of something, based on a narrow personal view. As a generalization, a value judgment can refer to a judgment based upon a particular set of values or on a particular value system. A related meaning of value judgment is an expedient evaluation based upon limited information at hand, an evaluation undertaken because a decision must be made.” (highlight mine)

The point is what you may define as “morality” or how you perceive the world (or government) should function maybe different from what I or others may perceive as “moral”. While we may share the same definition for a particular abstraction (e.g. altruism or honesty), the degree of application of value judgments is likely to vary according to the existing conditions when the problem is presented.

Example, if I decided to donate to some spare money to some street children of Mandaluyong, then what I give to them means that I don’t give to the street children of Manila, San Juan or to street children of other places or to orphans or to handicapped children or to delinquent juveniles or to abused children or other underprivileged class. Does that make me any less charitable?

Or if you happen to see a Php 1,000 bill on the floor right in front of the ATM, with nobody near the premises…do you ignore the bill or do you get the bill and give it to the bank branch manager or surrender it to the police headquarters or donate it to the beggar at the street corner or keep the money for yourself? If you decide on the latter, does it make you any less honest?

Yet the problem is, media portrays the present political predicament as something clear cut; a choice between black and white, or good or evil. Remember, wrong diagnosis leads to the wrong treatment.

In the same plane, in economics, a free market laissez faire advocate, a Keynesian, a Supply Sider, a monetarist or communist while exposed to a similar problem would apply different solutions according to their value judgments.

In politics, we see the same, where you see some leaders call for moral upheaval the unfortunate part is that many of those who were previously privileged have not shown satisfactory performances to validate their claims. Again English Author Samuel Johnson maxim is a perfect working example in Philippine politics ``Patriotism is the last refuge of a scoundrel." In essence morality is term conventionally used for political convenience.

Lets us change the equation from the above example.

Suppose the four children died and you would be asked to regularly give, donate or sustain the terminally ill man, would you do so?

Essentially you probably won’t, if you don’t know the person or his family. You probably would-only if it falls under certain circumstances, e.g. part of the project of your socio-civic group…but perhaps not regularly and perhaps under a limited sum in proportion to your surplus resources.

But this is how exactly government functions, it forces you to do so-it is a coercive redistribution of resources-by taxing you and me-and giving it to the “underprivileged”. It transfers resources from the productive sectors of the economy to the non-productive sources.

If the redistribution process grows more than the required rate of capital investment then the economy suffers. Government would resort to borrowing money (deficit spending), inflating the money supply which eventually leads to a litany of ills- higher taxes, high cost of doing business, a depreciating currency, reduced purchasing power via higher cost of living, capital flight, higher interest rates and social inequality.

Meanwhile, the social costs are deeply rooted sense of entitlement and the dependency culture. Yes, why work or take risks when government pays anyway.

The important point as elucidated by Ludwig von Mises in his magnum opus Human Action, `` There is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity.”

Figure 1 ADB: Comparison of Investment Rates as % of GDP

Yet, to attract capital investments you would need to have a competitive hurdle rate or (wikipedia.org) ``minimum rate of return that must be met for a company to undertake a particular project” relative to other investment alternatives as our neighbors. As you can see in Figure 1 from Asian Development Bank, the Philippines has the least investment rate among its neighbors.

ADB imputes this partially to hefty growth in service sector (which is not capital intensive), excess capacity and low domestic savings, and weighted towards infrastructure inefficiencies (e.g. expensive and unreliable electricity and transport networks), high taxes, cumbersome business procedure and overregulation, aside from fiscal deficits, poor governance and small and narrow industrial base. The reason for the highlight is to show you the congruence between my observation and that from ADB.

The Pork Barrel Political Economy

Come to think of it given the way “morality”-honesty, compassion and fairness is tossed about in the media, it would seem to allude of our poor as a “privileged class” since many politicians and experts seem to use them so often and throw in every interventionist “kitchen sink” solution to our problem of more than 45 years! Yet the paradox is while they (experts and politicos) have been in and out of power, the Poor unfortunately remain POOR!

As evidence, our “moralistic” political economy has seen the government intervene in almost every sector or industry such that many state owned enterprises (Government Owned Corporations or Controlled Corporations) are still being subsidized by national government which continues to be a drain and a drag to country’s fiscal conditions (thus constitutes a major growth constraint cited by ADB).

Or take a look at the Pork Barrel system as discussed in our November 12 to 16 edition, [see The Economics of Philippine Election Spending], the purpose of the Pork is to provide benefits and jobs to the local constituents. The idea is-since local elected officials should know more and are “sensitive” to the needs of its constituents, these taxpayer funds are meant to be “moralistically” reallocated according to the discretion of elected authority’s “value judgments”. The problem is where has all the money gone?

If our elected officials have been “efficient” in allocating or dispensing of such funds “productively” then probably ADB won’t be citing much of our infrastructure inefficiencies as another constraint to growth.

On the other hand, who among the elected officials have not encountered requests for special personal favors from one’s political jurisdiction?

Special personal favors such as burial expenses, to medicines, to jobs to tuition fee subsidizes, to loans, to basketball t-shirts to trophies, etc…, yet given the low and limited pay of our officials, they have allegedly been impelled to use the Pork Barrel projects as a source (via SOP – euphemism for kickbacks) for accommodating these personal requests.

So essentially, the Pork Barrel culture reinforces the patron-client relations from which the Patron (politicos) delivers doleouts and subsidies, which is squeezed from the Pork Barrel projects, to the clients who deliver the votes and keeps the former in power. Hence, the Pork Barrel system is essentially a legitimized source of corruption and abuse of power seen from almost every level of the nation’s political structure, an oxymoron from its original “moralistic” intent (unintended consequences). As the saying goes “the road to hell is paved with good intentions”.

As we previously noted, ``Plainly said, when we demand for more social spending or welfare based programs to resolve our problems then we increase the funds allocated to politicians for their dispensation. Essentially, Pork Barrels signify our excessive dependence on government where the correlation of government spending and the price of getting elected are direct.”

Oligarchy, Crony Capitalism and Conflict of Interests

More proof? Look at the recent “oligarchic system” floated in the papers or in speeches by some officials. In my recent post It’s Less About Oligarchy and More About Bureaucratic Crony Capitalism, I demonstrated how the proffered “present ills” of the society is less about oligarchy but more about cronyism. Since the names of the alleged oligarchs seem relatively new (except for one) this does not qualify them under such definition. Oligarchs are those who command powerful economic means to allow them to shape the nation’s political structure to their auspices, hence they are likely to be longstanding well entrenched “oligarchs”.

Yet people look at the surface without parsing through the casual structures; both of these political structures operate on common grounds, Oligarchy and Cronyism essentially signifies overregulated economies.

Oligarchs thrive on regulations that keep away competition (hence, exerting control via “king makers” role) while cronyism makes use of high political connection which takes advantage of the "web" of regulations in order to benefit financially.

In a market economy, capital investment allocation is determined by market forces competing to win the consumer’s vote. Wealth is determined by satisfying the consumers. Regulation is kept at a minimum: mainly to uphold contracts and property rights. Taxpayer burden is thus, marginal.

In overregulated economies, the privileged class is sustained by a wall of regulation and close political ties and not by a level playing field. Wealth comes from getting the right political connections than risk undertakings.

So aside from the benefits of spending other peoples’ money (SPOM) through the Pork Barrel system, today’s struggle for power is also about economic dominance-consorting with the privileged class.

Finally is the issue of conflict of interest. Ex-US President Thomas Jefferson once said, ``The man who reads nothing at all is better educated than the man who reads nothing but newspapers."

In this case, I would agree with Ex-US President Thomas Jefferson, the obsession with political drama is derived from media’s propensity to paint the proverbial “mountains out of molehill” or to create a crisis of monumental proportions when the problem is all about “personality based” politics and the proclivity for drama and controversies.

Remember, media’s incentive is to sell news. And bad news sells; the more the controversial, the more the sensational, the more sales and advertising revenues for the media outfits. It is the incentive for media to sensationalize bad news. Yet, many believe media as some sort of “gospel wisdom”.

We see the same predicament with the church. The church appears to know how the government should be run and where the economy ought to be steered into. They should be allowed to turn this self-righteous attitude into real politics, let one of their representatives run for the top spot in 2010. Maybe they can clean the proverbial Aegean Stables.

Yet, the problem of the church is one of incentives and not of direct taxes. When the church advocates for more welfare spending to signify “compassionate governance”, it means more burden for the taxpayers. Again where do you get the money to spend for do goodies for the underprivileged (remember the example of the terminally ill father)? Unfortunately, it is us and not them.

Since they do not pay direct taxes (which according to them is not a privilege), taxpayers would shoulder any direct weight of additional social spending, so it is easy for them to tell us where to spend government money because the burden falls squarely on our shoulders.

As for the argument of indirect taxes, according to them while they don’t pay direct taxes they pay indirect taxes. Following such premise we get a double whammy: we pay both direct and indirect taxes. Woe again to us the taxpayers.

Conclusion

All these tells me that this is LESS of a problem about morality, but more of a SYSTEMIC DEFECT which skews on the incentives for the politicians, the investors/capitalists and the voting populace arising from TOO MUCH dependence on government sustained by a pork barrel culture and the defense of the privileged class.

It is my sincere hope that people would start looking at the roots of the problem, rather than deal with superficialities and learn by the lessons of the past as philosopher Santayana warns.

It is easy to make a prediction. 2-3 years after the assumption of a new administration, be it through extra legal change or via elections proper in 2010, we will most likely see similar scandals, but at a varying degree over and over again.

Why? For as long as we don’t change the way we choose our leaders, for as long we depend on the Pork Barrel system of governance and hide behind the walls of regulations to uphold the privileged class, the system remains greatly vulnerable to the abuse of power and its offshoot-corruption.

Moreover, our inherent penchant for melodrama as well as advances in technology-cellphones, the web, would allow us to witness and share more of such controversies.

But all is not without hope though. Happiness is not only measured by money, a recent study by Freakonomics’ Justin Wolfers (posted in our blog) indicates that the Philippines is probably the most conducive place for love. Maybe when we are not busy playing acrimonious politics we fall in love.

A Prospective Boom in Philippine Agriculture!

``Who controls the food supply controls the people; who controls the energy can control whole continents; who controls money can control the world.”-Henry Kissinger

Experts tell us that Philippine government needs to shore up our agricultural sector. While I think they are reading too much of the past to project it well right into the future, I likewise think that they have been underestimating the operating dynamics of today’s macro environment.

A Rush to Hard Assets

Let us look at what’s happening to the world first. While significant parts of the world is now constrained by debt contraction (deflation), consumer price indices continues to march upwards where many countries (especially emerging markets) have been experiencing a surge in food and energy price indices.

Figure 2: Danske Bank: Rising Consumer Prices in G4 Countries against a contracting manufacturing sector

Well it is not actually contained to emerging markets as shown in Figure 2, even G4 countries have seen a spike in consumer prices even as observed by Chief Economist Steen Bocian from Danske Bank ``The past week has brought more surprisingly high inflation figures. In the US, for example, inflation climbed to 4.3% y/y in January. The story is the same every-where: inflation has risen sharply while growth is either already falling or feared liable to fall in the wake of the weaker growth stateside.

``The increase in inflation is still due primarily to rising energy and food prices. Both oil and food prices have continued on upwards in February, and there is therefore a risk of inflation not dropping back as quickly as we anticipated. This could result in an even weaker growth scenario in the short term, as the expectation of gradually falling inflation, and so stronger growth in real incomes is key to stronger private consumption in countries like the US and Japan during the course of 2008.” (highlight mine)

You are probably aware that Crude Oil recently spiked to over $100 anew this week but fell back to $98.8 with a week-on-week gain of 3.52%. Much of the energy markets have likewise exhibited considerable advances too, as Natural gas, US ROB Gasoline and heating oil. Precious metals has also surged, as gold $944, silver $18 and even DR. Copper which now trades only a stone’s throw distance away from its all time high!

Moreover while depressionists insist that the world is recoupling via credit deflation, it looks the opposite is happening-inflation is one factor that appears to be surfacing in most economies. So they look partially right, there is a recoupling-but it is via inflation.

We don’t like to argue against depressionists simply because they could be right, but so far they have yet to be proven accurate. Some of them went on saying that the appearance of stagflation (which generated quite a reaction following the publication of New York Times of “That ’70s Look: Stagflation”), is simply a transition from inflation to deflation and others say that there is not enough meaningful shortages to sustain this dynamic as inflation is a lagging indicator. We beg to differ, as we presented last week, relative to oil prices-if demand slows but supply slows faster then oil prices will spike. It’s not all about demand.

True enough, the high inflation period which marked the 1970s era was followed by an era of a “disinflationary” environment in the 80s until the new millennium. But it was not a global depression though, because boom bust cycles were seen shifting from Japan to Latin America to Asia and Russia then to the US.

We think it is the same dynamic at work; loose liquidity is looking for assets to park into as major global central banks work to debase their currencies to cushion the world economy from a material slowdown. Yes, with socialization gaining momentum, this means a flood of money into the global system. We just hope that protectionism don’t gather momentum.

Some say US monetary aggregates have shown signs of compression (meaning deflation) and thus reinforcing the view of more deflation to come. From the appearance of movements in asset markets, US monetary aggregates seem as an inadequate measure of global liquidity. It looks as if the growth rate of emerging market foreign currency reserves is a better indicator.

Hence, while there is credit deflation in some parts of the world, many parts of the world which have been least affected by the derivatives-securities-mortgage implosion are finding shelter in hard assets as opportunity costs of holding cash or as an alternative store of value.

It is noteworthy too that some equity markets, have already climbed to new record highs mostly found in GCC and African region, such as Kuwait, Nigeria, Oman, Morocco and Tunisia, with a good number knocking on the door of new record highs as Brazil, UAE, Qatar, Egypt, Jordan and Namibia. So what was once touted to as a “recoupling” has not happened so far except during the January 21 meltdown aside from the October decline. Present dynamics suggests of a financial markets “decoupling” or divergence from the US.

Booming Global Agriculture Prices Should Spillover to Philippine Agriculture!

Figure 3: Economagic: Wholesale Price Index, Food and Energy

And the most important development right now is the price surge in agriculture products! In figure 3 courtesy by economagic, shows of the wholesale price (blue) in the US which has been accompanied a broad market surge of soft commodities which includes livestock (red), foodstuffs (green), grains (yellow green) and energy (fuschia pink).

This implies that there is a massive imbalance between the supply and demand dynamics. Since this is a global phenomenon then it means many parts of the world are facing the same conditions. It also tells us that there is a great shortage which means that investors will continue to shift to agriculture investments for as long as price dynamics warrant this.

So in contrast to the opinion of our domestic experts, the Philippines don’t need direct government intervention except to disentangle the restrictions on investments by cutting red tape and facilitate for this upcoming surge of investments.

Philippine agriculture is an underrated but important contributor the Philippine economy. It is one of our ace against global depression. Agriculture accounts for about 16% to the nation’s GDP but employs nearly 35.8% of employed people in 2006. Agriculture exports likewise, contributed 24.54% of total exports during the first half of last year with coconut, banana, and pineapple being top export products. With the soaring prices of agriculture products expect a surge in this sector to support our economic growth.

We have been bullish in Philippine Agriculture as early as 2006, and even devoted an entire article last June 4 to June 8 [see Bond Markets Rout; Signs of Rising Inflation? Bullish on Philippine Agriculture].

There is only one oddity from which our academic experts have long been suspiciously reticent about…among our neighbors, we are the only country that doesn’t have a commodity futures market to support our farmers. Indonesia has Jakarta Futures Exchange, Malaysia has Kuala Lumpur Commodity Exchange and Thailand’s Thailand’s Future Exchange and the Agricultural Futures Exchange of Thailand.

As an agricultural country, future markets will help our farmers hedge their produce from price volatility. Not only that, it allows for savings to be channeled into investments, generates liquidity with the participation of speculators and arbitrageurs and subsequently pricing efficiency, aside from diminished transaction cost.

Of course, not everyone benefits, the role of middlemen will be reduced. But overall, greater profits for the farmers could translate to a lowering of social inequality. All that needs to be done is to set up the infrastructure and teach our farmers the modern way to do farming with financing. The diffusion of technology is a very important factor in addressing this.

Surge of Food Prices Presage Armed Conflicts!

``Anyone who thinks this decade’s problems start and end with credit, in other words, may yet receive a rude shock; sadly, we live in a world where soybeans may yet pack as painful a punch as subprime.”-Gillian Tett, The Next Crisis will be over Food

Rising commodity prices, especially food prices have in the past contributed to rising tensions and belligerence which may lead to more incidences of wars or civil wars.

Figure 4: Marc Faber GBD: War Time Distortion 1830-1950

As we have mentioned, the urbanization and growing wealth in emerging market economies have led to dietary changes on the demand side while climate changes, water shortages, desertification, industrialization, long underinvestments in agriculture, and the unintended effects of biofuel subsidies and other regulations have all contributed to the supply side shortages.

However surging food prices will mean lesser food for those living on the margins, this means increased political pressure or heightened risks for armed conflicts. Surging wholesale prices as shown in Figure 4, courtesy of our favorite Dr. Marc Faber’s Gloom Boom and Doom, has coincided with martial activities.

This from Dr. Faber (highlight mine), ``In his book Cycles (New York: 1971), Edward Dewey devotes a chapter to “The Patterns of Wars”. His research was inspired by an Index of International War Battles and Civil War Battles, which had been created by Raymond Wheeler in the 1930s. (Wheeler had been a professor of psychology at the University of Kansas and president of the Kansas Academy of Sciences, and became well known for his studies into climate cycles.) According to Dewey,

“… the War Index was used by Professor Wheeler to show a relationship between shifting temperatures in the earth’s climate and man’s proclivity for war. Warm periods, he noted, were the time of dictators and international wars, while cold periods produced civil unrest and democracy. His compilations were made without any preconceived notions of cycles, but he did note that there were recurrences of drought and civil war at approximately 170 years intervals and that every third of these drought–civil war periods was more pronounced, thus creating a longer cycle of 510 years. He also observed shorter rhythms, especially one of approximately 23 years.”

So yes, while surging agriculture prices may underpin an investment boom in the Philippines the unseen risks is that this can lead to armed conflicts here or abroad.

Joann Muller of Forbes: Thank You, Asia

The survival of General Motors presently depends on the growth of overseas market, particularly of Asia’s market, as the chart below shows. That’s what Ms. Joann Muller of Forbes recently pointed out…

From Ms. Muller (emphasis mine),

``Well, at least they love General Motors (nyse: GM - news - people ) overseas. While the automaker's North American sales have dropped hard in the last three years, they've been soaring abroad, particularly in developing markets like China, India and parts of Latin America. Last year 60% of the vehicles it sold (9.4 million) were bought abroad, up from half just two years ago.

``For now, the global operations are carrying the company. GM made $2.1 billion in pretax operating profit last year, almost enough to offset the $2.7 billion it lost selling cars and home mortgages in North America. It's a revolution, just not an American Revolution.”

Of course yesterday’s sales composition may not be the same for tomorrow. But it would seem that GM’s overseas sales could serve as an important indicator of how today turbulent credit markets will likely impact Asian consumption as well as the other emerging markets.

All this goes to show how the world has been changing from a unipolar US centric growth dynamic to that of a multipolar one.

(hat tip forbes.com)

It’s Less About Oligarchy and More About Bureaucratic Crony Capitalism

It is held by some parties that the “web or ecosystem of corruption” in the Philippines stems from the oligarchic structure encompassing the Presidential seat of power. The following opinion is based on the assumption that such claims has merits.

According to wikipedia.org, ``Oligarchy (Greek Ὀλιγαρχία, Oligarkhía) is a form of government where political power effectively rests with a small elite (emphasis mine) segment of society (whether distinguished by wealth, family or military powers).”

Now ADB’s Critical Development Constraints says that ``In 2003, the richest 20% (highlight mine) of the Philippine families received more than half of the national income, while the poorest 20% accounted for only one twentieth.” This means that over 50% of national income rests on some 3.3 million of the 16.48 million families (businessworld).

By definition 3.3 million families controlling the entire economy may partially be true but is not a sufficient condition by which to categorize of an oligarchic political economy. 3.3 million is not a small segment. It may be true to some industries but probably not to all.

Further among the persons allegedly cited as oligarchs benefiting from the present administration only one appears to be a valid “oligarch”. Although as a caveat, the magnate has been a known “oligarch” since the Marcos administration. All the rest seem to be new names which mostly belong to the “old rich” families.

What seems to be a more adequate description under the alleged circumstances in our present political economy is "Crony Capitalism".

From Wikipedia.org, (highlight mine) ``Crony capitalism is a pejorative term describing an allegedly capitalist economy in which success in business depends on close relationships between businessmen and government officials. It may be exhibited by favoritism in the distribution of legal permits, government grants, special tax breaks, and so forth.”

The common characteristics of a crony capitalist society again from wikipedia.org ``Crony capitalism is generally associated with more virulent government intervention, however. Intentionally ambiguous laws and regulations are common in such systems. Taken strictly, such laws would greatly impede practically all business; in practice, they are only erratically enforced. The specter of having such laws suddenly brought down upon a business provides incentive to stay in the good graces of political officials.”

As Ludwig von Mises always reminds us "corruption is a regular event of interventionism", a complex web of bureaucracy is the ultimate design that allows for such perverted actuations,

From Ludwig von Mises in his Bureaucracy (highlight mine),

``Under this system the government has unlimited power to ruin every enterprise or to lavish favors upon it. The success or failure of every business depends entirely upon the free discretion of those in office. If the businessman does not happen to be a citizen of a powerful foreign nation whose diplomatic and consular agents grant him protection, he is at the mercy of the administration and the ruling party. They can take away all his property and imprison him. On the other hand, they can make him rich.

``The government determines the height of tariffs and freight rates. It grants or denies import and export licenses. Every citizen or resident is bound to sell all his proceeds in foreign exchange to the government at a price fixed by the government. On the other hand, the government is the only seller of foreign exchange; it is free to refuse ad libitum applications for foreign exchange. In Europe where almost every kind of production depends upon the importation of equipment, machinery, raw materials, and half-finished goods from abroad, such a refusal is tantamount to a closing of the factory. The final determination of taxes due is practically left to the unlimited discretion of the authorities. The government can use any pretext for the seizure of any plant or shop. Parliament is a puppet in the hands of the rulers; the courts are packed.

``In such an environment the entrepreneur must resort to two means: diplomacy and bribery. He must use these methods not only with regard to the ruling party, but no less with regard to the outlawed and persecuted opposition groups which one day may seize the reins. It is a dangerous kind of double-dealing; only men devoid of fear and inhibitions can last in this rotten milieu.”

So if this is true then at the end of the day it all boils down to a systematic backfire on our excessive dependence on government. From which special interest groups has taken advantage of the intricate webs of laws to economically profit using its political connections with the center of power.

As we quoted Ron Paul last Sunday, ``The only effective way to address corruption is to change the system itself, by radically down sizing the power of the federal government in the first place. Take away the politicians' power and you take away the very currency of corruption.”

Philippines: The Most Interesting Place for Love?

Amidst the hysteria of obnoxious domestic politics, Justin Wolfers of Freaknomics offers us some relief. In a study to gather insights of how love relates to the economy covering many countries, he identifies the Philippines as the most interesting place to search for love as seen in the chart below….

Mr. Wolfers, “It turns out that love is incredibly democratic, and is as common in poor countries as it is in rich countries. And, encouragingly, about 70 percent of us report feeling a lot of love on any given day. This isn’t as obvious as it may sound, as love’s enemy, anger, is significantly more prevalent in poor countries than in rich.

“The data suggest some interesting places to look for love: the Philippines, Rwanda, and Puerto Rico top the “love tables.” Meanwhile those in Armenia, Uzbekistan, and Tajikistan are feeling the least love. (Unfortunately, the love question wasn’t asked in the United States.)

Wow. The Philippines-the land of “Romeo and Juliet”?

Or could it be that that the Filipinos’ fixation for love is the obverse side to our obsession for domestic politics? If we cannot love then we can do politics.

(Hat tip to Freakonomics)

Contingent Causes and Consequences of Human Action Should Underpin Decoupling Theme

``The only effective way to address corruption is to change the system itself, by radically down sizing the power of the federal government in the first place. Take away the politicians' power and you take away the very currency of corruption.”-Congressman Ron Paul

What was previously pronounced as the hottest emerging trend easily became an orphan overnight following the synchronous Jan 21^st global equity markets meltdown. Even some of the most revered advocates of the so-called Asian “century” went on air to debunk the so-called “Decoupling theory” as a myth or as the emperor with no clothes.

Ironically, it seems like logical fuzziness to claim that Asia will be the next economic powerhouse when supposedly its fate has been declared as being foreordained towards the growth trajectory of western nations due to its trade, economic and financial links.

In a positively correlated economic and financial sphere, does it imply that Asia would outperform only when global economies and markets are accelerating upwards?

Maybe, the difference lies in the definition from timeframe dimensions (not today but tomorrow or sometime in the future perhaps?). Maybe also, too much emphasis has been devoted to a singular event or analysis based on the rear view mirror or recency bias or past performance as guide to future events.

Again as a reminder, we do not deny that under globalization trends which means more heightened interconnectedness, linkages (trade, financial, labor) have been tightening and is likely to get tighter. And such dynamics are likely to be reflected on the markets as had been the case since 2000. But again the caveat is that there is no pure globalization or integration.

We argued the case of positive interrelationships since 2003, and in fact took on the prisms of a bear (last week) to show that under selective dimensions; particularly the induction premised from exports and remittances, a severe US slowdown will negatively impact the Philippine economy.

But unlike then, our idea today is that markets and economies could possibly be rediscovering its individualities due the different dimensions of exposures to what has weighed in on some economies or markets. Besides, under diverse conditions people, societies or even nations react divergently to changing conditions.

To quote Jörg Guido Hülsmann in his article “The Epistemological Case for Capitalism” published at the mises.org (highlight mine), ``The causal analysis of individual human behavior must take account of the fact that any human action has certain invariant consequences — that is, consequences that result from like action at any place and any time. For example, an increase of the quantity of money tends to entail an increase of the price level above the level it would otherwise have reached, irrespective of when and where the money supply is increased. The study of such consequences is the task of praxeology and economic science.

``But human action also has contingent causes and consequences. The very same action — increasing the quantity of money — can be inspired by very different ideas and value judgments. And the objective consequences resulting from any action can provoke very different individual reactions at different times and places. In other words, the causal chains through which ideas and value judgments are connected with human action are contingent. The elucidation of these contingent causal chains is the task of historical research.”

Recent examples, in the recent G7 finance ministers meeting, media asked if global central banks would concertedly lower interest rates to help stave off a world recession, here is the reply of Finance Minister Fukushiro Nukaga, ``Each country needs to take a step, and it is important to push that move based on its own economic and fiscal situation”. (highlight mine)

The interview best described by Japan Times, ``…the G7 had dashed any hopes of concerted international action, such as coordinated interest rate cuts and fiscal stimulus packages, because economic and fiscal conditions differ from country to country.” (emphasis mine)

So while global central banks would work to coordinate with each other, policy stimulus would have to be applied distinctly.

Oh, speaking of surprises, just when mainstream experts had been almost unanimously bearish brought upon by the “contagion” effects from the US mortgage crisis saga, Japan’s last quarter GDP unexpectedly soared.

From Bloomberg (highlight mine), ``Japan's economy grew 3.7 percent last quarter, twice the pace economists forecast, as business investment rose and exports to Asia helped companies weather the U.S. slowdown.” So contrary to most expectations capital expenditures (based on rising demand from Asia, Russia and the Middle East according to Bloomberg) and exports have remained resilient in the face of a US downturn during the last quarter of 2007.

We don’t like to read too much from a single event. Yet this imparts an important message- analysis based on “sterilized” conditions exhibits vulnerability. While some analysts call this a “blip”, one said that Japan’s GDP was not the appropriate indicator. A seeming case of denial?

Since a quarter does not imply a reinforced trend, it could be that the mainstream will be proven correct; as the downdraft in the US economy intensifies these positive variables could reverse. In the meantime some even assert that Japan will be the next country where the next wave of Pandora’s Box of toxic papers will surface, as measured by the recent spike in iTraxx Japan (a measure of default risks of Japan’s top 50 companies). So the global credit crisis is popularly expected to further curtail its economic activities. But on the other hand, again they could be wrong.

We read that Japan’s economic problems have been mostly about the unintended effects as a consequent to the recently imposed policies more than the ramifications from a global contagion, this from Takehiro Sato of Morgan Stanley (highlight mine),

``Japan’s “errant policy-induced slump” is already widely acknowledged among investors as “Kansei Fukyo”. The three main components are 1) heightened liquidity concerns for SMEs with de facto volume restrictions and caps on the loan interest rate for consumer financing and a shared responsibility program launched by the Credit Guarantee Corporations (CGCs) in October 2007, 2) a sharp downturn in residential investment under the revised Building Standards Law, and 3) diminished investment in risk assets following implementation of the Financial Products Transaction Law…”

``We think that liquidity restrictions from cutbacks in consumer credit and loans guaranteed by the CGCs, though for very different reasons than in the US and Europe, might be interfering with corporate activity in Japan as well. The scaled-back credit guarantee program is not having a major impact yet since the changes were accompanied by transition measures to cushion the blow.”

Of course, Mr. Sato like most of the mainstream believes that external conditions combined with internal forces are making Japan’s situation ``increasingly difficult to envision a convincing upside scenario for Japan.”

Figure 1 stockcharts.com: Japan’s Nikkei 225

We don’t know much about Japan except through the reports we read. So our outlook depends on the accuracy of the information we gather. From our perspective, many analysts have deduced Japan’s present woes as having been more internally generated, whereas the impact from external factors has yet to be actualized or has yet to surface on the economic data.

This means that if economic data continues to prove that the contagion impact from the US may have been exaggerated then Japan’s dramatic swan dive (a peak-to-trough decline of about 32%-see figure 1) could have been an overshoot.

In other words, Japan’s decline appears to have priced in more of the expected “global contagion related” bad news than is otherwise reflected in the present economic data. The major benchmark the Nikkei 225 is down about 11% year to date.

This implies for two scenario, one market is wrong (overshoot) and the Nikkei should start bottoming out 13,000-14,000 before recovering. Or two, Japan’s economic conditions will likely deteriorate further and may fall into a recession (from which the Nikkei could decline somewhere into 11,000 to 12,000).

We can’t say if the Nikkei has reached its bottom, time will make the cycle apparent but for the moment it looks like the major Japanese benchmark is poised to test its resistance level.

From the above examples (G7 and Japan), we can conclude that the battle between a globalized and a divergent outcome has yet to be resolved decisively.