Drug Decriminalization Caravan Gets Rollin'

In our earlier posts War on Drugs: Learning From Portugal's Drug Decriminalization and Nicolas Kristof: Why The War On Drugs Is A Failure, we opined that sentimentalism over "the war on drugs" has to give way to economic realities and a more humane oriented approach.

Resources uneconomically spent for prohibition and detention should instead be diverted into education, treatment and the protection of private property.

As New York Times' Nicolas Kristof in a recent highly articulate commentary, (bold highlight mine)

``Look, there’s no doubt that many people in prison are cold-blooded monsters who deserve to be there. But over all, in a time of limited resources, we’re overinvesting in prisons and underinvesting in schools.

``Indeed, education spending may reduce the need for incarceration. The evidence on this isn’t conclusive, but it’s noteworthy that graduates of the Perry Preschool program in Michigan, an intensive effort for disadvantaged children in the 1960s, were some 40 percent less likely to be arrested than those in a control group.

``Above all, it’s time for a rethink of our drug policy. The point is not to surrender to narcotics, but to learn from our approach to both tobacco and alcohol. Over time, we have developed public health strategies that have been quite successful in reducing the harm from smoking and drinking.

``If we want to try a public health approach to drugs, we could learn from Portugal. In 2001, it decriminalized the possession of all drugs for personal use. Ordinary drug users can still be required to participate in a treatment program, but they are no longer dispatched to jail.

``“Decriminalization has had no adverse effect on drug usage rates in Portugal,” notes a report this year from the Cato Institute. It notes that drug use appears to be lower in Portugal than in most other European countries, and that Portuguese public opinion is strongly behind this approach.

``A new United Nations study, World Drug Report 2009, commends the Portuguese experiment and urges countries to continue to pursue traffickers while largely avoiding imprisoning users. Instead, it suggests that users, particularly addicts, should get treatment."

Now, it appears that indeed several Latin American Countries have begun to assimilate the Portugal Experience; Mexico and Argentina has opened their doors for the less antagonistic option by decriminalizing drugs.

According to Juan Carlos Hidalgo of Cato, (bold highlights mine)

``Following in Mexico’s footsteps last week, the Supreme Court of Argentina has unanimously ruled today on decriminalizing the possession of drugs for personal consumption.

``For those who might be concerned with the idea of an “activist judiciary,” the Court’s decision was based on a case brought by a 19 year-old who was arrested in the street for possession of two grams of marijuana. He was convicted and sentenced to a month and a half in prison, but challenged the constitutionality of the drug law based on Article 19 of the Argentine Constitution:

``The private actions of men which in no way offend public order or morality, nor injure a third party, are only reserved to God and are exempted from the authority of judges. No inhabitant of the Nation shall be obliged to perform what the law does not demand nor deprived of what it does not prohibit.

``Today, the Supreme Court ruled that personal drug consumption is covered by that privacy clause stipulated in Article 19 of the Constitution since it doesn’t affect third parties. Questions still remain, though, on the extent of the ruling. However, the government of President Cristina Fernández has fully endorsed the Court’s decision and has vowed to promptly submit a bill to Congress that would define the details of the decriminalization policies.

``According to some reports, Brazil and Ecuador are considering similar steps. They would be wise to follow suit."

We, Filipinos, should learn from their experiences.

Short Seller Guru Jim Chanos Is Bearish On Big Pharma

One of the more popular short seller, the billionaire hedge fund manager and president of Kynikos (Greek for "cynic"), Jim Chanos, who had been polevaulted to fame with his critical "whistle blowing" short position on Enron (which became bankrupt in 2001 and was embroiled in a scandal that led to its demise) and who made a fortune betting against banks and brokers declared that he is targeting Big Pharma.

From the Australian News, ``Mr Chanos is estimated by Trader Monthly, an American trade magazine, to have made up to $US350 million ($418m) personally in 2007. He profited from the collapse of Enron and in April 2007 warned finance ministers of the Group of Eight leading economies that banks and brokerages were heading for a calamity."

From the Business Insider,

Recession Slams On Restaurant And Foodservice Industry

The deep global recession has affected the public's appetite for patronizing foodservice/restaurant outlets, especially in developed economies.


According to NPD.com, ``Feeling the sting of a bleak global economy, consumers around the world cut back on visiting foodservice outlets in the first quarter of the year, according to The NPD Group, a leading market research company. NPD’s CREST®, which tracks consumer usage of foodservice in Canada, France, Germany, Italy, Japan, Spain, United Kingdom, and United States, reports foodservice traffic declines in France, Germany, Italy, Japan, Spain, United Kingdom, and the United States. Traffic was essentially flat in Canada. Total spending at foodservice outlets fell in all of the reported countries with the exception of Canada and the United States.

``With the exception of Japan, traffic counts declined at quick service (fast food) restaurants in the monitored countries. Full service foodservice concepts posted virtually no growth around the world. Most foodservice daypart segments (i.e. morning meal, lunch, supper, and evening snack) declined in nearly every country. Supper was weak everywhere but France. Germany and the United States experienced some growth in the morning meal daypart. The evening snack daypart showed the most encouraging trend, with increases or flat results in three countries."(bold emphasis added)

The Wall Street Journal adds, ``Spending fared somewhat better: the average spent per check declined in Japan, the U.K., Italy and Spain, but rose slightly in the U.S., Canada, France and Germany.

``In dollar terms, the average check remains highest in France, at $8.11, followed by Japan at $7.87 and Germany at $7.55. Diners spent the least per meal on average in Italy, just $5.56. The U.S. fell roughly in the middle, with a $6.51 average check."

``The restaurant industry has suffered deep cuts amidt consumer pullbacks. In the U.S., restaurant traffic fell at the steepest pace since 1981 in the spring quarter ended May 2009, according to NPD.

``In response, many restaurants have been slashing prices in a bid to lure diners through the door - a strategy that has eaten into profits while not drawing as many customers as restaurants hoped".

Presently booming markets, which has apparently lifted sentiments, ought to bring on some improvements to this bleak picture.

Marketing Strategy: From Pickpockets To Putpockets

Putting some fun into the crisis, in London, as part of an advertising blitz, former pickpockets does a reverse- they put-pocket or put money into people's pockets in stealth. (hat tip: Mark Perry)

From Reuters, ``Visitors to London always have to be on the look out for pickpockets, but now there's another, more positive phenomenon on the loose -- putpockets.

``Aware that people are suffering in the economic crisis, 20 former pickpockets have turned over a new leaf and are now trawling London's tourist sites slipping money back into unsuspecting pockets.

``Anything from 5 pounds ($8) to 20 pound notes is being surreptitiously deposited in unguarded pockets or open handbags in Trafalgar Square, Covent Garden and other busy spots.

``The initiative, which runs until the end of August in London before being rolled out countrywide, is being funded by a broadbrand provider, which says it wants to brighten up people's lives in unusual ways.

"It feels good to give something back for a change -- and Britons certainly need it in the current economic climate," said Chris Fitch, a former pickpocket who now heads TalkTalk's putpocketing initiative."

Maybe if governments catches on to such an idea, they might incorporate this as part of their stimulus programs.

Where Yahoo Beats Google

This from Randall Stross (New York Times)

``Google has an outsize image as the deft master of information. Its superior technology seems to pitilessly grind up its rivals. But Google’s domination in search has proved hard for it to match in some information domains. When serving financial news and information, for example, Yahoo draws 17.5 times the traffic of Google, according to comScore Media Metrix.

``Yahoo Finance, which has occupied the top spot in the category for 19 consecutive months, drew 21.7 million unique United States visitors in July; Google Finance drew only 1.2 million unique visitors, placing it 17th in comScore’s rankings for the category, one slot above a site called FreePressRelease.com."

Gold As Our Seasonal Barometer (For Stocks) II

Many analyst appear to be giving weight to the seasonality factors.

That's because the scars from the horrid events of 2008 remains freshly imprinted, as we pointed out in Gold As Our Seasonal Barometer

For instance this from US Global Investors,

`` Even as the markets are moving higher and excitement builds, don’t get too carried away. Late-summer trading volumes are notoriously low and this year is no exception. On top of that, money supply data from the Fed indicates negative growth over the past four weeks and the past quarter, which is historically a negative indicator for the equity markets.

``The graph shows the average monthly returns of the S&P 500 since 1970, September is by far the worst performing month of the year with average losses of about 1 percent."

Or this from Early To Rise,

``Research from Georgia Tech: Over a 200-year period, 15 out of 18 stock markets studied posted negative returns in September. From 1970 to 2007, all 18 posted negative returns.

``Consider these facts:

-The last bear market for U.S. stocks began in September of 2000.

-That market hit its lows in September of 2002.

-The Lehman Brothers collapse happened in September.

-The crash of 1987 happened in October, but the decline began in September.

-And the worst month of the great depression? September 1931, when the market fell 30 percent."

Or this new crash alert from an expert who rightly predicted last year's crash. This from Telegraph's Ambrose Evans Pritchard (bold highlights mine)

``After predicting a torrid "relief rally" over the early summer, Bob Janjuah at Royal Bank of Scotland is advising clients to take profits in global equity and commodity markets and prepare for another storm as winter nears.

"We are now in the middle of a parabolic spike up," he said in his latest confidential note to clients.

``"I expect this risk rally to continue into – and maybe through – a large part of August. What happens after that? The next ugly leg of the bear market begins as we get into the July through September 'tipping zone', driven by the failure of the data to validate the V (shaped recovery) that is now fully priced into markets."

``The key indicators to watch are business spending on equipment (Capex), incomes, jobs, and profits. Only a "surge higher" in these gauges can justify current asset prices. Results that are merely "less bad" will not suffice.

``He expects global stock markets to test their March lows, and probably worse. The slide could last three months. "A move to new lows is highly likely," he said."

For all we know they could all be right.

But as we earlier wrote, the fundamental forces behind 2008 and today have been substantially different.

We don't see today's rally as a dynamic emanating from "economic recovery" but from inflationary dynamics.

Second given the acknowledgment by global authorities of the continued fragility of today's economic environment, they are likely to keep the monetary spigot open.

All those issued money from thin air from global governments compounded by the growth in circulation credit arising from the low interest rates worldwide has to go somewhere.

And that somewhere has been in stocks, commodities and Asian/EM properties.

In addition, instead of using the seasonal performances of stocks as the yardstick for predicting a major bear market for turbulent September-October period, I would offer a shift in perspective- the US dollar index as the locus point of a possible major selloff in September-October.

Hence, I would prefer to benchmark gold's seasonal factors as barometer for the stock market. See my earlier explanation here.

Finally we can't discount sharp volatility given the inflationary landscape, but it doesn't mean stocks would crash ala 2008.

Warren Buffett’s Greenback Effect Weighs On Global Financial Markets

``If it seems too good to be true, it probably is. Always look at how much the other guy is making when he is trying to sell you something. Stay away from leverage.” Warren Buffett, Three Rules for Average Investors

Hardly has the ink dried from the issues we dealt with last week when events unfolded almost exactly as anticipated, albeit in a fusion [see Will China’s Stock Market Correction Spread Globally?]

US Dollar Leads The Markets

Here is a summary of what we wrote:

1) We expected that China’s overextended markets to have some ripple or leash effect on global stock markets and the commodities markets.

2) The correction in the China’s markets would possibly trigger a correlation trade-where the US dollar would rise in conjunction with falling markets.

3) We also noted of a contingent provision-our suspicion that the US dollar’s rise wouldn’t find firm legs to stand on, ``if the US dollar fails to rally while global stocks weaken, then any correction, thus, will likely be mild and short.”

True enough during the early part of the week, global markets crumbled resonating China’s rapid fall. This initially prompted for a short rise in the US dollar index.

However, the US dollar index failed to maintain its bullish composure (can’t get to cross the 50-day moving averages) and eventually faltered steeply going into the close of the week.

Figure 1: Stockcharts.com: USD Dollar Index Leads The Markets

The result-global markets, especially in the US and Europe, came back with a vengeance. (see figure 1)

On the other hand, China’s market (SSEC down 2.83% week on week) appears to have hit our defined bottom range and has fiercely bounced back, while the commodities market caught fire- Oil (WTIC) sped back and drifts at its resistance levels!

And again we see some technical pictures failing to keep up with evolving market events.

All of these hyper volatile actions in just a span of one week! Amazing.

And when the US dollar leads the financial asset markets, it is no less than a symptom of inflation driving markets today.

Warren Buffett Warns On The Greenback Effect

Even the sage of Omaha Mr. Warren Buffett acknowledges the growing risk of inflation as the “greenback effect or greenback emissions”. Last week in the New York Times he wrote

(all bold highlights mine)

``Because of this gigantic deficit, our country’s “net debt” (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent. Admittedly, other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to G.D.P. at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out.

``An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually — and in combination.

``The current account deficit — dollars that we force-feed to the rest of the world and that must then be invested — will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients — China leads the list — to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.

``Then take the second element of the scenario — borrowing from our own citizens. Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

``Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington’s printing presses will need to work overtime.

``Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”

Here Mr Buffett makes an elementary calculation. I have to admit my admiration for Mr. Buffett’s ability to explain or relate circumstances in very simple “layman connecting” terms.

Essentially, US savers “borrowing from our own citizens” ($500 billion) + Foreign surpluses “borrowing from foreigners” ($400 billion)= $900 billion. US debt initially estimated at $1.8 trillion, which has been scaled down to $1.58 trillion equals a deficit of still at least $680 billion-that would have to be financed out of “a roundabout process, printing money” or central bank money from thin air!

The US treasury is slated to sell $197 billion next week (CNBC). This means that the US sovereign bond markets will likely be tested anew and the US dollar index will likely remain under siege or under pressure.

Analyzing Inflation From A Political Dimension

While many have been saying that because of the deflationary pressures in bubble stricken economies inflation won’t take hold soon, for sundry mainstream reasons of money velocity, oversupply, output gap, excess capacity, liquidity trap, capital short banking systems, Federal Reserve paying interest rates on commercial bank reserves or a combination thereof, we aren’t sure of the interim impact.

We can’t be “timing” inflation because its impact has always been relative.

However we understand inflation to be an epochal problem of human society, which specifically constitutes a series of processes that makes up a cycle.

We can’t simply read through recent events and interpret them as the future.

Since inflation is a political process, it requires the understanding of the underlying motivations of the current crop of political leaders and their prospective actions. After all, politics revolve around economics.

And this has been a phenomenon that has haunted civilizations, kingdoms, governments or empires alike, which has always been expressed through the purchasing power of the underlying currencies.

Mises Institute President Douglas French in recommending cigarettes as an inflation hedge enumerates on such cycle, ``one of Ludwig von Mises's outline of the typical inflation process: prices aren't rising nearly as much as the money supply… phase two of Mises's inflation outline: instead of a rising demand for money moderating price increases, a falling demand for money will instead intensify price inflation. Finally, we come to phase three, where prices go up faster than money supply, the demand for money drops to zero, and government fiat currencies collapse.” (bold highlights mine)

Currently we seem to be drifting in between the phases of “prices aren't rising nearly as much as the money supply” and “falling demand for money”.

Eventually, we should see a transition deeper into “intensifying price inflation” and most probably segueing into “prices go up faster than money supply” depending on the incentives driving policymaking.

And if consumer prices don’t immediately reflect on the impact of the intermediate inflation process, then most of the present political actions will likely be felt or manifested in the financial asset markets.

And so a boom in asset markets is in the first order, as what we’ve been seeing today, and may likely continue as the US dollar index falls.

In short, asset markets are likely to continue functioning as the immediate absorbers of the inflation process.

As Morgan Stanley’s Manoj Pradhan observed of the difference between today’s cyclical patterns with the previous,

``During this cycle, however, interest rates that matter for borrowers have fallen only very slowly while the flow of credit to the private sector is likely to be weaker than usual due to financial sector deleveraging. Only risky asset prices have been roaring forward since the rally began in March. This imbalance between the various channels creates complications for the prospects of returning monetary policy to neutral. If central banks decide to tolerate higher asset prices in order to compensate for the weaker impact of both the interest rate and the credit channel, they risk inflating another asset bubble. If they respond to rapidly rising asset prices while the other transmission mechanisms have only played a weak role, they risk tightening policy into a weak economic recovery.” (bold highlights mine)

Politically, further inflation is required to sustain the elevation of asset prices, however economically, the risks is that these surges will result to a bubble. So maneuvers for an exit from policymakers seem to be getting trickier by the moment.

Will they take the booze away from the party and allow “normalization” or will they further supply more booze to enliven the atmosphere?

Here, we will bet on another major policy miscalculation.

Yet this boom in financial asset prices won’t translate to sustainable “green shoots” of economic recovery. Instead today’s inflation process will heighten misallocation of resources that would eventually culminate into another enormous bubble cycle.

As Murray N. Rothbard in Money Inflation and Price Inflation wrote, (bold highlights mine)

``Even if prices do not increase, this does not alleviate the coercive shift in income and wealth that takes place. As a matter of fact, some economists have interpreted price inflation as a desperate method by which the public, suffering from monetary inflation, tries to recoup its command of economic resources by raising prices at least as fast, if not faster, than the government prints new money…there is a relative underinvestment in consumer goods industries. And since stock prices and real estate prices are titles to capital goods, there tends as well to be an excessive boom. It is not necessary for consumer prices to go up, and therefore to register as price inflation. And this is precisely what happened in the 1920s, fooling economists and financiers unfamiliar with Austrian analysis, and lulling them into the belief that no great crash or recession would be possible. The rest is history. So, the fact that prices have remained stable recently does not mean that we will not reap the whirlwind of recession and crash.”

So while consumer price inflation may still be currently subdued, this doesn’t exempt us from a prospective bust from the fast evolving malinvestments.

More Inflation Equals Greater Risks

Despite the recent crisis, the fractional banking sponsored debt driven economy conjoint with government policies to rev up the credit cycle has reflected on Mr. Buffett’s admonition of debts reaching record unsustainable levels.

Figure 2: AIER: US DEBT AT RECORD LEVELS

According to Mr. Kerry A. Lynch senior fellow of the American Institute of Economic Research, `` The total debt owed by Americans increased to $51 trillion in the first quarter of 2009. One way to put such a mind-boggling number in perspective is to compare it to the value of what Americans produce. Gross domestic product is roughly $14 trillion per year. Thus, Americans now owe $3.62 for every dollar of GDP. As can be seen in the chart below, this is a record.

``By comparison, in 1980 Americans owed just $1.55 per dollar of GDP. The ratio began to rise sharply in the 1980s, leveled off in the early 1990s, and surged again in the late ‘90s, continuing to do so through the past decade.”

While the recent crisis should have pruned down debt levels to the capacity where the economy may be able to handle it, however, the inherent fear by US and global governments of “deflation”, aside from the implied goal to sustain previous boom days, and the addiction towards inflation has prompted such continued accumulation of systemic imbalances.

As we said in the The Fallacies of Inflating Away Debt, the misleading notion of inflating away such debt levels would make the stagflation era of the 70s a virtual “walk in the park”.

Yet, Mr. Buffett seems quite optimistic on the resolve of the present administration to work this out, which we think could be attributable to the special political influenced privileges acquired from the administration, during the latest crisis, for his personal benefit [see Warren Buffett: From Value Investor To Political Entrepreneur?].

However, Mr. Buffett seems to seriously underestimate the political nature of the inflation process.

The expanded cash for clunkers, the administration’s foisting of its socialized version of health reform (which means another $1.3 trillion through 2019), cap and trade policies and the potential bailouts from the next wave of mortgage resets, the prospective support on FDIC’s eroding funding base as more banks suffer from closure, and the Obama administration’s consideration of future stimulus programs are simply symptoms of MORE (NOT LESS) government addiction towards consolidating power by debt and inflation based solutions.

As Ludwig von Mises on The Truth About Inflation presciently wrote, ``But the administration does not want to stop inflation. It does not want to endanger its popularity with the voters by collecting, through taxation, all it wants to spend. It prefers to mislead the people by resorting to the seemingly non-onerous method of increasing the supply of money and credit. Yet, whatever system of financing may be adopted, whether taxation, borrowing, or inflation, the full incidence of the government's expenditures must fall upon the public.” (emphasis added)

Hence, the current political leadership adheres to the typical path of leaders opting for the profligate inflation route. Inflation is what they want, then inflation is what we get.

So in contrast to the mainstream who thinks inflation isn’t in the near horizon, we join the outliers who have been warning of the risks of a potential disorderly unwind.

The Newsmax quotes Nobel Prize economist Joseph Stiglitz, ``The "dollar now is yielding almost zero return," Stiglitz said in a speech at the United Nations regional headquarters in Bangkok. "The current global reserve system is fraying. It's falling apart. The issue isn't whether we go to a new system. The question is do we do so in an orderly or disorderly way.” (emphasis added)

Meanwhile, PIMCO’s CEO Mohamed El-Erian says the policy divergence or “disjointed approach” between the US and other global central bankers could risk leading “to volatile financial markets, a damaging drop of the dollar and slower global growth.”

The Bloomberg quotes Mr. El-Erian ``The question is not whether the dollar will weaken over time, but how it will weaken,” said El-Erian, a former deputy director of the International Monetary Fund whose firm runs the world’s largest bond fund. “The real risk is that you will get a disorderly decline.” (emphasis added)

Thus, we won’t underestimate or discount the odds of the growing risks of an inflationary pass through by a lower (or a possible meltdown of the) US dollar on asset, commodity or consumer prices.

Remember inflation isn’t only generated through the credit system but also through fiscal expenditures.

In Zimbabwe, where consumer credit is virtually inexistent, an output gap of -99% (Marc Faber) and unemployment of 94% didn’t stop hyperinflation (89,700,000,000,000,000,000,000% year on year basis in 2008 or a doubling of prices daily)!!!

So the obsession with all sorts of perverse math models by mainstream economics vividly manifest that they don’t have a clue on reality.

That’s the reason why they haven’t rightly predicted last year’s crisis and why they are unlikely to be dependable forecasters.

Gold As Our Seasonal Barometer

``If our present inflation, as seems likely, continues and accelerates, and if the future purchasing power of the paper dollar becomes less and less predictable, it also seems probable that gold will be more and more widely used as a medium of exchange. If this happens, there will then arise a dual system of prices — prices expressed in paper dollars and prices expressed in a weight of gold. And the latter may finally supplant the former. This will be all the more likely if private individuals or banks are legally allowed to mint gold coins and to issue gold certificates.” Henry Hazlitt (1894–1993) Gold versus Fractional Reserves

I wouldn’t be in denial that seasonal factors could weigh on asset pricing as we mentioned last week.

This Ain’t 2008

But many analysts seem to have taken a rear view mirror (anchoring) of the seasonal factors on the possible performances of the global stock markets.

Given the fresh traumatic experience from the 2008 meltdown, it is understandable that many have written words of caution about navigating the turbulent periods of September and October.

But unless we are going to see another seizure in the banking system, the 2008 episode seems unlikely to be the appropriate model.

True, we could see some heightened volatility, as a result of the variable fluxes in inflation (as in the recent case of China).

But for us, the focus should be on how the US dollar index would be responding to the stickiness of inflation on the financial markets in the current environment, instead of one dimensionally looking at the stock markets vis-à-vis the seasonal forces.

In my view, gold’s strong performance during this period could be a fitting a precursor see figure 3.

Figure 3: Uncommon Wisdom/Sean Brodrick: Entering Gold’s Seasonal Strengths

If gold functions its traditional role as the archrival or nemesis to paper money, then simplistically a weaker dollar should translate to higher gold prices.

In Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy we pointed out that one of the major reasons why the mainstream has been wrong in attributing “fear” in gold prices was because of the massive distortions by governments in almost every market.

Hence, gold or the oil markets, which represents as the major benchmarks to commodity indices, hasn’t been on free markets to reflect on pricing efficiency enough to attribute fear.

Instead, over the short term, government interventions working through different channels such as the signaling, an example would be the previous announcements of IMF gold sales [which eventually got discounted], or other forms of direct or indirect manipulation, has been used as a stick to control gold prices.

This, plus the seasonal weakness has indeed brought gold prices to a tight trading range, instead of collapse as predicted by the mainstream, thereby validating our thesis and utterly disproving the “fear” thesis.

Nevertheless, governments appear to have retreated from selling their reserves under the Central Bank Gold agreement which expires on September. Central Bank’s selling during the first 6 months of the year are down 73% at 39 tonnes (commodityonline). Although as the calendar year closes, central bank selling could step up, but this would likely be met by the seasonal strength and won’

Investment Taking Over Traditional Demand

Also, as we also pointed out in February’s Do Governments View Rising Gold Prices As An Ally Against Deflation?, the dynamics of gold pricing has rightly been changing.

Then we said, ``The implication of which is a shift in the public’s outlook of gold as merely a “commodity” (jewelry, and industrial usage) towards gold’s restitution as “store of value” function or as “money”. The greater the investment demand, the stronger the bullmarket for gold.” (see Figure 4)

Figure 4: World Gold Council: Investment Leads Gold Demand

It would seem like another vindication for us, this from the Financial Times, (bold emphasis ours)

``Total identifiable gold demand, at 719.5 tonnes in the second quarter, was down 8.6 per cent compared with same period in 2008, with jewellery consumption down 22 per cent to 404.1 tonnes.

``Investment demand, which includes buying of bars and coins as well as inflows into exchange-traded funds, reached 222.4 tonnes in the second quarter, a rise of 46.4 per cent from the same period a year ago.

``However, the second quarter was the weakest three-month period for investment demand since before the implosion of Lehman Brothers in September 2008…

``Mr Shishmanian [Aram Shishmanian, chief executive of the World Gold Council-my comment] said that although total demand had failed to match the exceptional levels seen when the economic and financial crisis was at its peak, investment demand had enjoyed a strong quarter, underlining a growing recognition of gold as an important and independent asset class.”

In short, yes, investment demand has materially been taking over the dominant role in gold demand over jewelry and industry and will continue to do so as global central banks inflate the system.

China’s Role And The Reservation Price Model

Moreover, China’s government recently loosened up on its investment rules for gold and silver and even encourages the public to participate [see China Opens Silver Bullion For Investment To Public].

On a gold [in ounces] per capita basis, China has only .028 ounces of gold for every citizen, against the US which has .9436 ounces of gold in its reserves for every Americans (Gold World). That’s alot of gold for the Chinese with its huge savings and humongous foreign currency reserves to buy. And that’s equally alot of room for gold prices to move up.

This means that if the inflation process will continue to be reflected on the financial asset prices, then the likelihood is that gold will pick up much steam going to the yearend on deepening investment demand from global investors, perhaps more from Asia and augmented by the seasonal strength.

Moreover, gold will likely serve as a better barometer for the liquidity driven stock markets, in spite intermittent volatility, than from traditional seasonal forces.

Finally, Mises Institute’s Robert Blumen gives a good account of why evaluating the price dynamics of gold shouldn’t be from the conventional consumption model but from reservation prices model.

Since gold prices are not consumed by destruction and where above ground supply remains after being processed or used, the ``owners of the existing stocks own much more of the commodity than the producers bring to market.”

Hence to quote Mr. Blumen, ``The offered price of each ounce is distinct from that of each other ounce, because each gold owner has a minimum selling price, or "reservation price," for each one of their ounces. The demand for gold comes from holders of fiat money who demand gold by offering some quantity of money for it. In the same way that every ounce of gold is for sale at some price, every dollar would be sold if a sufficient volume of goods were offered in exchange.”

Read the rest here.

Asia: Policy Induced Decoupling, Currency Values Aren’t Everything

``The biggest lesson of the current crisis for Asian countries is that they can no longer depend on the West as a market for their exports, nor for reliable returns on their investment capital. To address the first issue, Asia has to cultivate its domestic consumer markets to sustain its growth. For the second, it faces a potentially more daunting challenge: to grow and strengthen its domestic capital markets, and stimulate Asian investment in Asia. Should Asia achieve these goals, it would mark a fundamental shift in the economic relationship between Asia and the West—and in particular between China and the U.S.” Matthews International Capital Management Asia Now, The Growth Issue

As we have been saying, inflationary policies are essentially vented on currencies which are instantaneously transmitted to the financial asset markets.

Besides, the impact of inflation has always been relative, since money enters the economy at specific points of the economy, and considering the distinct capital structure of national economies, the effects from these policies are likely to be divergent.

Take for instance, high savings, low systemic leverage, and an unimpaired banking system from the recent crisis [as we recently discussed in Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble] are likely to be more responsive to low interest rate policies regime implemented by domestic central banks. The massive outperformance of emerging markets relative to developed economies is a symptom of such response [see Global Stock Market Performance Update: Despite China's Decline, Emerging Markets Dominate]

It doesn’t stop here. This phenomenon has somewhat distilled also into national economies, see figure 5.

Figure 5: Divergent Impact On Industrial Production (Economist) and Car Sales (PIMCO)

Industrial production in the Emerging Asia has sharply been reinvigorated in contrast to the sluggish performance in the US.

The same divergent dynamics can also be seen in the comparative car sales between China and the US.

In short, what you are seeing is a clear manifestation of decoupling at work.

This from the Economist,

(bold highlights mine)

``Across the region, aggressive fiscal and monetary stimulus has helped revive domestic demand. Asia has had the biggest fiscal stimulus of any region of the world. China’s package grabbed the headlines, but South Korea, Singapore, Malaysia, Taiwan and Thailand have all had a government boost this year of at least 4% of GDP. Most Asian countries, with the notable exception of India, entered this downturn with sounder budget finances than their Western counterparts, so they had more room to spend. Bank of America Merrill Lynch forecasts that the region’s public debt will rise to a modest 45% of GDP at the end of 2009, only half of the average in OECD countries.

``Moreover, pump-priming has been more effective in Asia than in America or Europe, because Asian households are not burdened with huge debts, so tax cuts or cash handouts are more likely to be spent than saved. It is also easier in a poorer country to find worthwhile infrastructure projects—from railways to power grids—to spend money on.”

Mainstream analysts, whom mostly have been deflation advocates, jeered and hectored on the decoupling theme following the climax of the US banking seizure last September and October. Unfortunately, it appears that the deflationary episode signified as a fleeting moment of glory and as developments deepen things has once again been turning out to refute their highly flawed assumptions.

Importantly, we described in our February article Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?, that creative destruction, the role of real savings, supply side responses, and the role of Asia’s middleclass could act as possible channels for decoupling.

Currency Values Aren’t Everything

The Economist highlights another point we’ve been making,

``The basic problem is that although the Asian economies have decoupled from America, their monetary policies have not. In a world of mobile capital, an economy cannot both manage its exchange rate and control domestic liquidity. By trying to hold their currencies down against the dollar Asian economies are, in effect, being forced to shadow the Fed’s monetary policy even though their economies are much stronger. Foreign-exchange intervention to hold down their currencies causes domestic liquidity to swell. Consumer-price inflation is not an imminent threat, because prices are falling in most Asian countries. Chinese consumer prices fell by 1.8% in the year to July. But asset prices look dangerously frothy. The obvious solution is to let exchange rates rise, but with exports still well below last year’s level, governments are reluctant to set their currencies free.” (bold emphasis mine)

What we are in agreement is here is that of the US Fed policy transmission to the Asian markets and economy.

Although it would be ideal that Asian currencies be allowed to rise to reflect some of these adjustments, the idea that currencies are the only major factor for adjustments represent as logical fallacies of hasty generalizations based on unfounded assumptions or Ipse Dixitism.

To consider, the Philippines saw its currency the Peso depreciate from Php 2 to a US dollar in 1960s to Php 55 pesos to a US dollar in 2005 (or 96% devaluation!).

Considering the macro assumptions that such magnitude of adjustments ought to reflect on its products, this implies that the Philippines should have been an export giant by now.

Unfortunately this hasn’t been the case. Instead, we became a giant of labor exports, as an aftereffect of a vastly lowered standard of living out of the inflationary policies accrued from present and the previous administrations.

Unfortunately, such simpleminded fallacy of composition by experts deals with the assumption of an economy producing a single good from a single type of labor funded by a single type of capital.

I’ll further the example; San Miguel Beer which cost Php 19 per bottle in a local sari sari store (informal retail outlet), costs Php 50 in local B rated bars, and Php 200 in 5-star hotels. This is known as Price Discrimination, which basically means the selling of identical products to different markets through market segmentation.

In other words, depending on the markets, some products are more price sensitive (price elastic) than the others. In practice, a product that caters to the lower income class of the society is more price sensitive compared to a product marketed to the high end income segment.

So markets, not only prices (through currencies), are the more important qualifying variables for any required economic adjustments.(yet, high profile local experts continue to call for inane Peso depreciation!)

The fundamental reason why the Philippines haven’t benefited from a depreciated currency is because the local political economy has a limited and underdeveloped market due to an unfree economic rent seeking crony capitalist structure which has remained in place until today.

Besides, if currency value is the sole determinant of economic growth then Zimbabwe should be the biggest exporter or the wealthiest nation today!!!

The Japan Experience

More example; if rising currency translates to “greater domestic demand” then why has the Japan’s economy remained an export dependent economy despite the huge (threefold) appreciation of the yen? (see figure 6)

Figure 6:Gold News: Soaring Japanese Yen

Nathan Lewis for the Daily Reckoning says that aside from the deflation in the banking system what mattered most had been the series of tax hikes that has kept Japan’s economy in the doldrums, 20 years from the bubble bust.

This from Mr. Lewis (bold highlights mine) , ``They began with a series of tax measures on January 1, 1990 - the first day of the bear market - which eliminated certain preferential capital gains tax treatments for property. To take a few of a great many such steps which followed: In 1992, the tax rate on short-term capital gains (under 2 years) on property was raised to 90%. Long-term gains were taxed at 60%. A 0.3% National property tax was introduced (this was several multiples greater than existing property taxes). A City Planning Tax of 0.3%. A Registration and License Tax of 5% of the sale value of a property. A Real Estate Acquisition Tax of 4%. An Office Tax of 0.25%. A Land Ownership Tax of 1.4%. Even the regular property tax, the Fixed Assets Tax, was effectively raised by several multiples. From 1990 to 1996, Japanese property values imploded by as much as 70%. However, the revenues from this tax rose by 46%. You can do the math…

``Already there is an annual rise in payroll taxes, scheduled for every year between 2004 and 2017, which will eventually take the payroll tax rate from 13.6% to 18.3%. (Employers match this, and there is no maximum income to which it applies.) And what about the increase in taxes on dividends from 10% to 20%? Or the introduction of a brand-new capital gains tax on equities of 20%, which had effectively been tax-free before? Or the effective 25% increase in personal income taxes, the result of the elimination of a 20% tax cut introduced in 1998? On top of all that, politicians are talking about increasing the consumption tax (similar to a sales tax) from 5% presently to 10% or higher. Until a 3% consumption tax was introduced in 1989, there was no consumption tax at all in Japan, not even at the prefectural or municipal level.”

In addition, John Hempton of Bronte Capital says the legacy of zombie corporations has consumed capital resources which was otherwise meant for other productive investments, ``the problem in Japan was their ability to keep zombie corporations (not zombie banks) alive for decades. Japan has a “Rip-Van-Winkle” industrial legacy to go along with its absolutely brilliant modern technology industries. This old industry sucks resources which would better be used by the modern industry.” (emphasis added)

In short, like the Philippines, domestic policies have been responsible for restricting the required adjustments to expand the marketplace in spite of the currency adjustments. So calling for adjustments of imbalances via the currency route is no less than a fantasy.

Therefore, I’d avoid listening to “expert” economists who would reason along logical fallacies and prescribe snake oil medicines.

Stephen Roach On China's Consumers

McKinsey Quarterly's Clay Chandler interviews Morgan Stanley's Stephen Roach on Unlocking the Power of China's consumers.






Here is Mr. Roach's end quote,

``I think China has the potential to become a major engine of global growth. But I think it’s unrealistic to expect China to step into that role immediately in this post-crisis era. I think it’ll take three years, more likely five to ten years, for China to really have the type of balance and scale of its economy that can fill the void that’s about to be left—or that is now being left—by the demise of what heretofore has been the biggest and most dynamic and powerful consumer in the world: the American consumer." (emphasis added)

Read the transcript here