A Bet Against The Hong Kong's Peg, The Rise of the Yuan

Hong Kong's currency, the Hong Kong dollar, appears to be trading below the band allowed for its currency.

And the Wall Street Journal suggests that this appears to be a bet against the Hong Kong peg to the US dollar.
This from Wall Street Journal, (bold emphasis mine)

``Hong Kong won't break its 26-year-old currency peg to the U.S. dollar.

``Wanna bet?

``Traders in the currency forwards market are doing just that. Forwards give investors the right to buy or sell a currency at a fixed price at a certain point in the future, and they're now being traded with a view that the Hong Kong dollar is going to appreciate against the greenback.

``It's a trade that ignores history and the consensus among economists. In the past, it has proven a losing proposition.

``But the speculation highlights new pressures on the Hong Kong Monetary Authority. Hong Kong remains the gateway for foreign investors to profit from China's economic recovery and general strength, even as the dollar's value erodes on international markets due to the U.S. fiscal blowout.

``The forwards market currently implies that the value will be $7.726 in a year's time. Further out, the market is signaling an appreciation of 9% in the Hong Kong dollar by 2019.

``In recent months, the Hong Kong dollar has been stuck at the bottom of its band, and the HKMA has been printing Hong Kong dollars to sell on foreign exchange markets -- some US$44 billion over the last nine months -- to defend that."

Traders are betting on the fear that all this new money will inflate asset bubbles -- the bogeyman du jour -- which could force the HKMA to let its currency appreciate."

My take:

Since the Hong Kong currency has been pegged to the US dollar it implies that Hong Kong has essentially been importing its monetary policy.

Yet, the inflationary path undertaken by the US government suggest that Hong Kong is equally importing inflation-hence the rapid monetary expansion that has been fueling booming property and stocks.

Equally, the conditions of the economy of Hong Kong and the US are distinct. Hong Kong's relatively lesser degree of leverage amplifies the inflation transmission.

Additionally, the China's policy to promote the Yuan as regional currency standard equally puts pressure to the Hong Kong dollar as the Yuan gains more use than the Hong Kong dollar in Hong Kong's economy.

Lastly I wouldn't bet on past performance.

In my view, the Hong Kong dollar's pegged days seems numbered. And so as its existence, as the Yuan could displace it sometime in the near future.

All these would depend on the fate of the US dollar.

Warren Buffett: From Value Investor To Political Entrepreneur?

Warren Buffett has been widely known for his VALUE investing approach, largely influenced by his mentor Ben Graham.

But, lately our icon's political liberal leaning views, wherein he strongly supports government intervention in markets, appears to have similarly exposed a shift in his investing strategy, where Mr. Buffett's model appears to have evolved into investing under "government umbrella" or capitalizing on opportunities provided by the recent government sponsored bailouts.

In short, the reason he supports government intervention has been because he and his Berkshire Hathaway directly benefits from these.

Here is an excerpt from the splendid article from Reuter's Rolf Winkler, (all bold highlights mine)

``Today, Buffett remains famous for investing The Right Way. He even has a television cartoon in the works, which will groom the next generation of acolytes.

``But it turns out much of the story is fiction. A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company’s stock holdings would have been wiped out.

``Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money. The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt.

``To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee...

``He even traded the bailout, seeking morally hazardous profits in preferred stock and warrants of Goldman and GE because he had “confidence in Congress to do the right thing” — to rescue shareholders in too-big-to-fail financials from the losses that were rightfully theirs to absorb...

More of the rest of Buffett's conflict of interest here.

Nonetheless Mr. Winkler, apparently dismayed with the clash in the purist market based imagery against Mr. Buffett's actual practice, concludes, ``What saddens me is that Buffett is uniquely positioned to lobby for better public policy, but he’s chosen to spend his considerable political capital protecting his own holdings."

``If we learn one lesson from this episode, it’s that banks should carry substantially more capital than may be necessary. You would think Buffett would agree. He has always emphasized investing with a “margin of safety” — so why shouldn’t banks lend with one?"

So what do you call entrepreneurs who profit from government intervention?

According to Wikipedia.org, `` a business entrepreneur who seeks to gain profit through subsidies, protectionism, government contracts, or other such favorable arrangements with government(s) through political influence (also known as corporate welfare)" is known as a political entrepreneur.

And an economy that thrives on political entrepreneurship is also pejoratively known as "crony capitalism"-an allegedly capitalist economy in which success in business depends on close relationships between businesspeople and government officials. It may be exhibited by favoritism in the distribution of legal permits, government grants, special tax breaks, and so forth (wikipedia.org).

And I mistakenly thought that political entrepreneurship only existed in "banana republics" characterized by mostly autocratic rulers (or even manipulated democracies) under unfree economies.

Has the political economy changed so much that has compelled our icon to shift strategies?

Or has Mr. Buffett's performance been a chronic "mythologizing a humble background"- typical of tycoons as Joe Studwell in Asian Godfathers observed-where reputation and reality do not match?

World's Largest Companies As Investing Roadmap?

Here is an interesting chart depicting the world's largest companies by market capitalization from the Economist.

According to the Economist, ``THE market capitalisation of PetroChina may have fallen by almost half in the past year, but it remains the world’s most valuable company. Chinese firms now occupy three of the top four slots. (The state’s large non-traded holdings are valued at market prices.) Seven of the 12 most valuable companies are either banks or oil producers. Wal-Mart, Johnson & Johnson and Procter & Gamble have all climbed the table in the past year; their industries tend to weather recessions better than others. Market capitalisation does not necessarily tally with other measures of size. Microsoft is worth more than Royal Dutch Shell, which has nearly eight times the revenue of the software company and 10,000 more employees." (emphasis added)

Given the sustainability of the present trends where Asia outperforms, the rankings will likely be skewed towards the inclusion of more Chinese or Asian companies, especially if the prediction of Templeton's Mark Mobius, where China's market value might overtake the US, would be anywhere accurate.

While past performance may not be indicative of the future, the evolution of global corporatism has been striking. The underlying themes being that of China-Asia, oil, global banking and consumer products and retailing.

Could this serve as our roadmap for investing?

Bubble Thoughts Over Meralco’s Bubble

``The lies the government and media tell are amplifications of the lies we tell ourselves. To stop being conned, stop conning yourself.”-James Wolcott, American Journalist

Meralco is in the spotlight anew.

The country’s premier utility firm, which holds the exclusive franchise for the electricity distribution for the National Capital Region (NCR), caught the public’s attention following a spectacular record romp by its share prices.

And last week’s parabolic vertiginous ride appears to have been playing out the blowoff phase of a conventional bubble cycle. (see Figure 1)

Figure 1: Bubble cycle (left) and Meralco (black candle right)

Importantly, like typical bubbles, the culmination of which can be identified by delusional rationalizations aided by experts exacerbated by media- Meralco’s skyrocketing price has been attributed to speculations on a prospective ‘tender offer’ (Bloomberg)!

Allegedly one of the titans involved [see King Kong Versus Godzilla at the PSE; Where Politics Trumps Markets] in the drama of the recent corporate joust has acquiesced to a purchase price of Php 300 per share which would require a mandated offering to minority stockholders!

Yet rising prices and some special trades (block sales and cross trades) have been used as signs to confirm on such myths.

Why do we think all these rationalizations seem ridiculous?

Simply said, because logical reasoning has been totally thrown out of the window!

As financial writer and investment speaker Joe Granville warned, ``the media is the biggest enemy of the small investor, mostly headlining the wrong news at the wrong times, playing on his misguided reliance on fundamentals and his normal fears and greeds.”

Putting A Perspective On Meralco’s Price And Corporate Disconnect

To put on some level headed perspective we will deal with some key issues.

First, on a year to date basis, despite the recent turbocharged upsurge, Meralco hasn’t been the only leader with 284.87% of gains (as of Friday’s close).

Other issues like Phisix component mining giant Lepanto Consolidate (+271.43%) and Business Process Outsourcing Paxys (+358.33%) have seen the similar or greater level of share price action as seen in the above chart represented by the green and red lines respectively.

As an aside, I wouldn’t suggest that the latter two would seem in a bubble considering the U-shaped recovery vis-à-vis Meralco’s actions which appear to have replicated the motions of a bubble paradigm as shown in the chart.

Although from a trough to peak basis, Meralco, hands down based from last year, does hold the tiara for market outperformance (700%).

Nonetheless, one must be reminded that past performances are not indicative of future outcomes.

Two, Meralco’s share in the Phisix has now jumped to 7.7% from less than 1%, as we similarly pointed out in Beware Of The Brewing Meralco Bubble!, and now holds the second spot after PLDT in terms of free floated market cap.

This for a company whose profits are constrained by political forces! (see below)

Meralco has effectively, leapfrogged over former heavyweights Ayala Corp, Bank of the Philippines, Globe Telecoms, Ayala Land and SM Investments.

With Meralco’s share of the Phisix gaining more weight, any ensuing volatility from its share prices will likely be reflective on the directions of the Philippine benchmark unless counterweighted by the lagging erstwhile behemoths.

Three, financial valuations, if any of these apply at all, have ENTIRELY been jettisoned for wanton speculations and nonsensical justifications.

As we discussed in Meralco’s Run Reflects On The Philippine Political Economy, the share price movements in the local markets hardly reflects on corporate fundamentals.

The first three factors cited above have clearly been validating our Livermore-Machlup model where Philippine equities move in tidal fashion underpinned by liquidity or loose monetary landscape.

This climate essentially begets a predominant horse racing outlook or mentality, where canards touted as facts mostly emanating from the foibles of cognitive biases.

In short, NO liquidity from loose monetary policies equals NO bubbles, and all the rest are simply footnotes.

As writer Peter McWilliams warned (bold highlights mine), ``The media tends to report rumors, speculations, and projections as facts... How does the media do this? By quoting some "expert"... you can always find some expert who will say something hopelessly hopeless about anything..” Indeed.

Fourth, common sense should dictate to us that perhaps none of these engaged (supposedly cunning and astute) Taipans, whom have built their wealth and “credibility” over the years, would likely pay for excessively or overpriced assets, unless they have other undeclared agenda in mind, which are exclusive of profits meant for the institutions which they represent.

Yet, any outrageous and reckless acquisitions, that would put at risk the interests of such institutions involved, could provoke a minority shareholder revolt. That’s assuming shareholder activism is alive here. Nevertheless, even in the absence of it, we should expect the minority foreign shareholders to vote with their feet.

In short, the supposed buyout, from the alleged stratospheric levels, signifies as tremendous costs to the interests of the company they represent from both the majority and minority stakeholders’ perspectives.

Needless to say, the present day hysteria from rising share prices is temporal in nature and subject to market cycles and does NOT represent the underlying fundamentals. Unless people think that these tycoons are dimwits, I would bet on the opposite…that the so called godfathers involved are cognizant of this!

Fifth, even if the so called buyout does occur, it is less likely that such deal would be consummated in transparency or reflective of market conditions.

These titans could have such transaction wrapped up much earlier than known by the public, or have done so with attendant compromises such as rebates et.al., and could use recent actions as a partial exit point to profit from today’s insanity.

Lastly, as we have been repeatedly arguing, the Meralco brouhaha is beyond the sphere of normal financial analysis because it is a POLITICAL SENSITIVE public listed company.

You can’t just attribute earnings without comprehending on the business model from which the company operates on.

Besides, here, the interests of the owners under the said platform are divergent from the interest of the minority shareholders.

Here is why.

Meralco’s Business Model: From RORB TO PBR

Lately, Meralco’s business model has shifted from Rate of Return Based (RORB) to Performance Based Rating (PBR).

According to GMANews.tv, ``The new PBR scheme also replaces the return on rate base (RORB) formula, which charges customers for using Meralco assets — including posts and cables — in bringing electricity to its end-users.

``Under the RORB, public utilities such as Meralco are disallowed from charging rates exceeding 12 percent of the worth of its total assets.”

So what’s PBR?

According to the same article, ``The new scheme provides “rewards and penalties for performance and non-performance respectively, Jose de Jesus, Meralco president said.

``Under the said mechanism, Meralco may be required to pay fines should its performance — such as failing to immediately respond to a blackout — fall below certain standards.”

And why PBR?

According to the “quasi independent” regulator of Meralco the Energy Regulatory Commission (ERC),

``The ERC adopted the PBR for distribution utilities starting in 2005 pursuant to its authority under Section 43 (f) of Republic Act No. 9136 (EPIRA) to adopt internationally accepted rate making methodologies. PBR strives to achieve a balance between efficient price levels, allowing utilities efficient revenue to ensure their sustainability, and maintaining or improving network service performance levels. It provides strong incentives to improve operational efficiencies. International experience (Australia and United Kingdom) indicates that, over time, with its built-in mechanisms for incentives and fines depending on the utilities’ performance, PBR leads to reductions in the real price of electricity distribution while improving service levels.”

Aside, the ERC has required Meralco to implement a subsidized rates for the poor by the so-called “NEW LIFELINE program, where ``The ERC reiterated that customers consuming only 20 kWh and below shall continue to enjoy the 100% discount granted them and shall pay only the adjusted PhP5.30 per month metering charge, while the other lifeline customers shall enjoy a discount corresponding to the consumption level under the new lifeline program approved under the DTI case, including the PhP21.00/customer/month minimum charge.”

Implications Of The Business Model: Absolute Dependence On Political Discretion!

What ALL of these means:

1. Basically prices charged to the paying consumers of Meralco are solely determined by the ERC and NOT by the markets.

This means that Meralco’s profits are ultimately determined by fickle political winds.

As Ludwig von Mises described of Bureaucratic Management of Private Enterprises, ``But ours is an age of a general attack on the profit motive. Public opinion condemns it as highly immoral and extremely detrimental to the commonweal. Political parties and governments are anxious to remove it and to put in its place what they call the “service” point of view and what is in fact bureaucratic management.”

Think $100 oil. Rising energy prices are likely to stoke political discomfort among the society’s underprivileged from which would force politicians to focus on “windfall profits”.

Yet, in a world where profits will be deemed as inconsistent with political interests, the owners of Meralco will likely wring profits out through other mechanisms, e.g. off balance sheet transactions, loans or contracts to affiliated parties, transfer pricing and etc.

In short, where financial reports will unlikely be transparent, the interests of the owners of Meralco and the minority shareholders departs.

2. Meralco maintains a subsidy for the poor from which are tacitly charged to the account of the middle and high income consumers.

This exemplifies as a “private” company, functioning under stringent control of political interests, conducting the political redistribution aspect in behalf of the government. Hence Meralco acts as a subcontracted implementing agent under political behest.

This implies that economic rents or “profits” for Meralco’s owner managers will only be attained under the auspices of the political leadership for as long as the political interests are served.

3. Under the PBR, the ERC determines the “carrot and stick” for Meralco.

Basically, Meralco’s lifeline hangs on ERC’s dictate!

This implies that the ERC and Meralco will haggle over what comprises as sufficient or inadequate under the PBR guidelines and NOT the consumers.

And since rules are always technically subjective and subject to nonlinear or amorphous interpretations, they will be subject to compromises. Ask the lawyers.

Therefore this implies two things:

One absolute subservience to the political office, where to quote Ludwig von Mises in Bureaucracy, ``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.” (bold highlights mine)

Second, instead of looking after the welfare of its clients (Metro Manila consumers), the unlimited dependence on the discretion of the government bureaucracy means conflict of interests from parties involved abound.

Principally, the owner’s priorities will mostly be directed into the realm of public relations; of wheedling or currying favor with that of ‘The Powers That Be’. Satisfying the public will requirements will be subordinate to this.

Again from Ludwig von Mises, ``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. Businessmen who have grown up under the conditions of a more liberal age have to leave and are replaced by adventurers.” (bold emphasis mine)

The sordid and unfortunate experience of the current managers in the besieged Lopez group (who appear to be outgoing****), having to oppose the PGMA administration politically, serves as fundamental and shining example of the consequences of political defiance.

So those nurturing the view that owner-managers of political enterprises will be looking for one dimensional financial bottom line growth are living in a world of fairy tales.

Thus, financial statements have little relevance to Meralco’s valuation as a financial security because economic rents accruing the owner-managers of Meralco may come in sundry forms, than simplistically “profits” as defined by textbooks.

Besides, as pointed out in Has Meralco’s Takeover Been A Good Sign?, the current managing owners of Meralco have to deal with socio-political, bureaucratic and political risks, which ultimately mean that they need to be in constant harmonious relations with the current and forthcoming political leaders.

These are things that are learned outside of traditional or mainstream school curriculums. And yet these signify as unorthodox or contrarian views that operate realistically.

4. The ERC’s leadership is appointed by the President of the Philippines.

This makes the agency hardly independent as purported to be, but instead beholden to the administration.

Again since political appointments are almost always based on political affiliates or interests and are hardly ever about virtues or meritocracy, the direction of regulatory implementation and compliance will likely be dependent on the caprices of the political leadership.

Conclusion/Additional Comments

All these imply that the rewards from the ownership of Meralco comes with the blessings of the ‘Powers That Be’ combined with a possible implied backstop (guarantee) in the case of failure or bankruptcy, provided that the interests of the company’s owner managers or political entrepreneurs operate along the lines of interests of the incumbent political leaders.

Therefore it would be foolhardy or naïve to believe that the tycoons that got engaged in Meralco with billions of pesos of investments, had been there to only leverage on the political misfortunes of the present owners and to speculate on share prices while at the same time ignoring the risks associated with the political aspects of having a stake in Meralco.

Also, this implies that the changing dynamics of the ownership structure of Meralco strongly alludes to the next president-the identity of which only the kingmakers or the chief Meralco proponents know.

****The prevailing notion is that there has been an ongoing power struggle in Meralco.

For me, this seems like an oversimplistic crock.

In my view, both protagonists appear like unheralded allies, only awaiting the appropriate opportunity for a graceful exit for the Lopezes, which I think should come after the elections.

As per Joe Studwell in Asian Godfathers, ``The reality is that tycoons are typically forced to invest together because of the environment in which they operate.” (emphasis mine)

Considering that Meralco’s destiny is fundamentally intertwined with the Presidency, this probably implies that both godfathers could be straddling in support of different candidates in the forthcoming Presidential elections where its outcome will decide who among the two groups will takeover.

Although it is most likely that a price agreement for the prospective exchange may have already been sealed but perhaps at prices much less than the rumors (my guess is anywhere Php 90-120).

Moreover, it has been my inclination to believe that the Meralco saga will unfold similar to the Philippine Airlines privatization, where former PLDT chair Antonio Cojuangco initially fronted for the bidding which ultimately landed in the laps of Taipan Lucio Tan, the current owner.

Finally, of course, both parties would want to see Meralco’s share prices remain elevated, hence through various associates or intermediaries, they might continue to float stories from which the public so eagerly yearns for, as appetizer for their innate speculative instincts operating under today’s loose monetary environs.

However, the idea is-once the political matters have been settled, excess shares could be sold through the markets or that if any contingency arises (such as a dark horse winner in the Presidential elections) both parties can avail of present lofty prices as an exit strategy.

The Inflation Cycle Accelerates; Asia As Chief Beneficiary

``Neither China nor the US can morph into more balanced economies overnight, and China can't tolerate a sharp RMB appreciation to speed up the process. So the adjustment scenario will be disappointing, involving slower US demand and Chinese export growth. And higher US rates will be a vehicle to reinforce that outcome. In fact, the ‘impossible trinity' may be hitting Asia in reverse. An Asian rebound would normally induce capital inflows, rising asset values, a stronger currency and a tighter policy. But no one wants currency strength, and it is too soon to tighten. So, the authorities can and will intervene in FX markets and will probably tolerate too-loose liquidity and rising asset prices. As global investors seek higher returns outside US markets, the accompanying decline in risk-aversion probably won't be good, either for the dollar or for US Treasuries.”-Richard Berner, Morgan Stanley, Challenges to Rebalancing the US Economy

US dollar bulls and deflation advocates wildly gloated over China’s 7% collapse in its stock market but closed down 5% last Wednesday.

One even paraded the prediction made by a team of quants [as we earlier featured in China In A Bubble, ASEAN Next Leg Up?] as rationalization for such activities.

What was thought to be an important inflection point, eventually turned out to be a short term “tryst” as China’s stock market robustly recovered and nearly expunged the losses going into the last 2 sessions of the week.

And this was met with a deafening silence from the US dollar bulls.

Figure 2: Asianbondsonline: China’s yield curve remains steep

As we earlier said we won’t bet on the ridiculous notion that bubbles would pop so soon because, as we wrote from our earlier article, ``bubbles normally take time to reach a climax. For instance, the US real estate bubble ballooned from 2002-2006, while global stock markets inflated from 2003-2007. True, today’s China bubble could risk being pricked hastily or abruptly, but in my view, this may seem too early.”

``It’s because normal bubble cycles need sustained massive infusions (we seem to be seeing the first phase) and the vast concentrations or clustering of resource misallocations that could either become huge enough to be extremely sensitive to interest rate hikes or would require continued exponential amplification of credit to maintain present price levels or a pyramiding dynamics…until the structure in itself can’t be sustained (usually interest rates from market or policy induced does the trick).”

If we look at the China’s yield curve (see figure 2), the persistent steepness signifies as continued ultra loose monetary landscape thereby potentially posing as additional fuel for more stock market conflagration to the upside.

Although of course, since no trend goes in a straight line, the clashing combination of severely overbought conditions and price “stickiness” from the power of monetary policies could translate into sharp volatility.

But then again, the bubble cycles can stretch much further than anyone can expect them to. As mainstream’s most favorite icon, John Maynard Keynes used to say, “the markets can remain irrational far longer than you and I can remain solvent”.

Speculation Or Eroding Store Of Value?

China’s bubble isn’t confined to China.

Most emerging and Asian markets including the Philippine Phisix have now exhibited manifestations of bubble like circumstances.

Even the conditions of the US markets appear emit the same signals. Commodities are likewise manifesting bubble symptoms.

Yet all of these appear to be in response to the trajectory of the US dollar index, which as of Friday’s close appear to be at the verge of breaking both the critical support levels etched in December 2008 and June 2009, as shown last week.

The implication of a breakdown of the US dollar index is that it could further reaccelerate the “speculative” frenzy as “stickiness” from policy induced inflation appears to be accelerating.

The obverse perspective from that of speculation is the question of the state of paper money’s store of value.

Business Cycles and Speculative Errors

Curiously too, it would seem bizarre how policymakers have been drudging and debating over identifying and controlling bubbles, when bubbles are the direct and indirect consequences of their policies and seem to be popping all over like mushrooms in a field.

Haven’t you noticed, as global central banks simultaneously coordinated a zero rate bound approach with some apply quantitative “money printing” easing (QE) measures combined with massive fiscal stimulus programs, the apparent consequence has been rising stocks and commodities?

Of course, suggestions that today’s risks may pose as something like a ‘car accident’ operate from the perspective of randomness, where “animal spirits” which have gone berserk would suddenly stop for unexplained reasons.

For us, while random shocks may indeed occur, the significant part of such observation is the crucial misunderstanding of the speculative process of the policy induced business cycle.

As Jeremie T.A. Rostan fittingly explains,

``Speculative error can go on at no cost as long as that limit is not reached. In fact, there are two other limits. First, the rate of interest tends to rise to its real value, undermining the pseudoprofitability of the real assets underlying sensitive and risky assets. Thus, new credit has to be created constantly. Second, the injection of liquidity will have to be stopped at some point, or else hyperinflation will take place.”

Proof?

China has been warning its banks over the possibility of asset bubbles. And through fiat has directed ``banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets” reports the Financial Times.

When two banks reportedly responded to curb lending the result was Wednesday’s stock market crash.

This from Robert Flint of the Wall Street Journal (all bold highlights mine), ``On Tuesday, two of China's major lenders were quoted as saying they would sharply slow credit growth in the second half. This prompted fears of a sudden tightening of credit that could choke off the loans which have so far eased the effects of the world recession. Shanghai equity prices plunged as much as 7.7% at one point Wednesday and closed 5.0% down on the day.

``Later on Wednesday, the PBOC said it will emphasize market-based systems, rather than administrative controls, in guiding the appropriate growth of credit. PBOC Vice Governor Su Ning's comments appeared to signal the PBOC wasn't about to set loan curbs in the second half of this year to cool explosive lending growth, as it had done in 2008.

``Nevertheless, Mr. Su's comments were the most forceful yet from China's central bank in trying to talk down the lending spree put into motion by Beijing's massive stimulus program.”

So the Chinese government tried unsuccessfully to jawbone down the credit bacchanalia but the violent response from its credit addicted stock market, sent officials on an apparent U-turn.

Inflation Cycle and Price Controls

Has this been a surprise to us? The answer is NO.

We have been repeatedly saying all along that governments will persistently attempt to put a kibosh on the gamut of exploding surges of asset prices but the fear of recidivist recession or deflation will force them back into the same accommodative and expansionary stance.

That’s the legacy of government policy trends derived from the influences of central banking dogma.

And China’s official response has fallen precisely into the ambit of our expectations.

Moreover, policymakers are in a policy dilemma.

The appearance of short term gains from levitated asset prices has a reflexive feedback loop- it has successfully created the impression of an economic recovery, which subsequently has loosened up risk aversion thereby reducing demand for money but increasing the demand for holding assets.

Nevertheless these account for as footprints of inflation.

Policymakers are then on the hook to at least maintain present levels. Paradoxically, this requires even more credit creation.

As Ludwig von Mises wrote in Inflation and Price Controls (bold highlights mine),

``The problems the world must face today are those of runaway inflation. Such an inflation is always the outcome of a deliberate government policy. The government is on the one hand not prepared to restrict its expenditure. On the other hand it does not want to balance its budget by taxes levied or by loans from the public. It chooses inflation because it considers it as the minor evil. It goes on expanding credit and increasing the quantity of money in circulation because it does not see what the inevitable consequences of such a policy must be.”

And governments will attempt to conceal the adverse impact from their inflationary policies by diverting the public’s attention into scapegoating private enterprises and markets.

This extrapolates to the next measure-PRICE CONTROLS.

Again from Mr. von Mises from the same article, ``The real danger does not consist in what has happened already, but in the spurious doctrines from which these events have sprung. The superstition that it is possible for the government to eschew the inexorable consequences of inflation by price control is the main peril. For this doctrine diverts the public’s attention from the core of the problem. While the authorities are engaged in a useless fight against the attendant phenomena, only few people are attacking the source of the evil, the Treasury’s methods of providing for the enormous expenditures. While the bureaus make headlines with their activities, the statistical figures concerning the increase in the nation’s currency are relegated to an inconspicuous place in the newspapers’ financial pages.”

Evidence?

Each time oil prices went down during the last month they coincided with a barrage of fire from regulators whom have threatened to curb speculative trading (July 7, NYT) or impose additional regulations supposedly inspired from purported study that is due out soon, that pins the blame on speculators as “driving the wild swings in oil prices” (WSJ July 28)

Figure 3: Stockcharts.com: Oil Prices and Threats of Price controls

The blue arrows denotes of the dates where the threats of added scrutiny or imposition of price controls on oil trading had been broached.

Apparently, the efficacy of such government sponsored communication signals to rein the oil markets appears to be diminishing.

In addition, because of the fear of further reemergence of falling prices from short selling, new rules are being imposed (WSJ, July 28)

Since regulators such as David Altig, senior vice president and research director at the Atlanta Fed, concede that ``Markets are, everywhere and always, one step (or more) ahead of regulators”, this implies that stifling regulation will only cause market inefficiencies by the circumvention of the regulation by arbitraging on different but related markets or financial innovation.

To quote the WSJ, ``The [CME group] exchange's chief executive, Craig Donohue, said: "We are deeply concerned that inappropriate regulation of these markets will cause market participants to move to dark pools and other unregulated markets, causing irrevocable harm to the entire U.S. economy." Dark pools are private markets where large orders are transacted.” (bold highlight mine)

In effect, adamant denials of the culpability of government inflationary policies will only result to the aggravation of the problem and only heighten volatility risks.

Too bad regulators can’t seem to accept God’s natural laws of supply and demand as having more power than their bloated egos.

Asia: More Room For Bubble Blowing

Going back to Asia this very interesting chart from Nomura Securities (see figure 4). (HT: Fullermoney) appear to support the legs for a continued bubble blowing.

Figure 4: Nomura Securities: Asia & West At Opposite Poles

In Nomura’s Mixo Das and Paul Shulte chart, they project that Asia will likely outperform for the following reasons:

One. Low banking system leverage.

As per Nomura’s Mr. Das and Shulte, ``Asia has NO forced sale of assets, so it gets free reflation. Under-performance by Asia mutual/hedge funds, cash piles everywhere.”

Two. Deleveraging in bubble bust economies are likely to cause divergent flows in asset pricing trends with the East outperforming (aha! Decoupling is a myth!).

Three, Corporate tax increases in response to government programs to shore up national economies are likely to translate to higher relative shift in income that would benefit Asia and

Lastly, central bank balance sheets seem likely to favor Asia, as asset components are mainly on “safer” US treasuries compared to “toxic” or high risk assets for US or UK.

In short, yes, the bubble dynamics in Asia seem to have ample room to run based on sustained expansionary monetary policies coupled with conducive economic stories that should underpin the relative advantage of Asia vis-à-vis the West.

Rebalancing The Chinese Economy

Below is a video from the Economist on its macroeconomic perspective of the structural imbalances of the Chinese economy. Along with it, is its "simplified" prescription for resolving the predicament.

Pls click on the link below:

Nonetheless, here is an excellent counterbalanced perspective from Robert Blumen (all bold highlights mine),

``A mercantilist policy of subsidizing export industries does not make a country more prosperous. Economic growth can only mean an increase in the ability of an economic system to produce more consumption goods. In the global economy, the system is the entire world, with each nation contributing some portion of a single integrated capital structure. Producing a lot of capital goods - factories, shipping terminals, etc. -- does not necessarily contribute to economic growth if the physical stuff is not economic capital. Economic capital means that it is integrated into the global structure of production through economic calculation.

``The purpose of exporting is not to create more factories per se, nor is it to "create jobs". The purpose of production is for the producers, is to gain the ability to afford to purchase more goods -- either capital goods or consumption goods. Producing things at a loss consumes capital and makes the producer poorer.

``Nor is there such a thing as consumer-driven economic growth. Consumption is the result of economic growth -- savings and investment drives it. The idea that a country can "switch" from "export-driven growth" to "consumer-driven growth" ignores the specific and heterogeneous nature of capital. The fact that people are talking about this so much only indicates that a lot of the physical infrastructure in China is not economic capital. If the existing capital structure in China was to be used to create a different mix of goods - say low-end consumer goods for Chinese consumers with lower incomes than Western consumers -- then the values of these factories under economic calculation would be marked down considerably, in many cases below their costs."