A Deeply Embedded Inflation Psyche

``What deflationists always overlook is that, even in the unlikely event that banks could not stimulate further loans, they can always use their reserves to purchase securities, and thereby push money out into the economy. The key is whether or not the banks pile up excess reserves, failing to expand credit up to the limit allowed by legal reserves. The crucial point is that never have the banks done so, in 1990 or at any other time, apart from the single exception of the 1930s. (The difference was that not only were we in a severe depression in the 1930s, but that interest rates had been driven down to near zero, so that the banks were virtually losing nothing by not expanding credit up to their maximum limit.) The conclusion must be that the Fed pushes with a stick, not a string.” –Murray Rothbard, Making Economic Sense

Many have touted today’s action in the marketplace as a manifestation of success from government intervention.

Given public’s predisposition to focus on the short-term and interpret heavily on current information, especially after repeatedly being seduced from the incentives provided for by inflationary policies, today’s appearance of success equals tomorrow’s seismic crisis.

Betting The House On Too Big To Fail

In the US, the “Too Big To Fail” syndrome is becoming deeply entrenched in the heavily regulated banking industry.

An article by Peter Eavis at the Wall Street Journal entitled “Uncle Sam Bets the House on Mortgages” gives as a stirring depiction of the growing intensity of systemic concentration risks.

(bold highlights mine)

``It is a stunning change, but is it good for the housing market, and to what extent will it boost profits over the long term for this elite trio: Wells Fargo, Bank of America and J.P. Morgan Chase?”

Graph 1: Wall Street Journal: Too Big To Fail Getting Bigger

``Right now, housing remains on government life support. Treasury-backed entities are guaranteeing about 85% of new mortgages, while the Fed buys 80% of the securities into which these taxpayer-backed mortgages are packaged.”

``The optimistic take is that this support, though large, will shrink when market forces regain confidence. But there is a darker possible outcome: The emergency assistance is entrenching a system in which the taxpayer takes the default risk on most mortgages, while a small number of large banks get a larger share of the fee revenue from originating and servicing mortgages.

``That is what is happening now. While big banks are originating lots of mortgages, they are selling nearly all of them to Fannie Mae and Freddie Mac. Indeed, combined single-family mortgages held on the balance sheets at J.P. Morgan, BofA and Wells actually fell 3.5% in the first half. Before the bust, these banks sold large amounts of loans to Fannie or Freddie, but they also held on to products like jumbo mortgages. The volumes for those large loans now have tumbled.”

What you have here is essentially the politicization of the US banking industry, where the top 3 banks have cornered the meat of the “economic rent” from mortgage servicing and issuance which it deals with the US government.

And this concurrently, becomes an issue of moral hazard, where these highly privileged banks, which operates on implied guarantees from US government that they are “too big to fail”, may indulge on more aggressive risk taking activities at the expense of US taxpayers.

Moreover, the US government stands as THE market for home mortgages.

Alternatively, this also posits that since the US government is a political entity and is less constrained by economic pressures, the pricing structure for transacting these mortgage securities have been above what the market is willing to pay for. Thus, government intervention translates to massive tax payer subsidies to cover losses meant to keep the banking system afloat.

Analyst Doug Noland in his Credit Bubble Bulletin recently dissected the Federal Reserves 2^nd Quarter Flow of Fund and construed that instead of targeting stabilization for conventional mortgages, the Fed has been propping up private label Mortgage Backed Securities.

He says (all bold emphasis mine), ``So, the Fed is amassing quite a stockpile of “conventional” GSE MBS, but often these are “private-label” mortgages recently “refinanced” into GSE securities. And as the Fed buys the new GSE MBS, newly created funds become available to flow back to reliquefy the formerly illiquid ABS marketplace (along with agencies, Treasuries, corporates, and equities). To be sure, placing essentially federal government backing upon previously “private-label” mortgages dramatically changes the market’s perception of these securities’ worth (“moneyness”) – especially with fed funds pegged for an extended period at near zero and the Fed in the midst of a $25bn weekly purchase program in order to fulfill it commitment to purchase $1.25 TN of mortgage securities….”

``Not only is the vast majority of new mortgage Credit this year government-backed, Washington guarantees are being slapped on hundreds of billions of existing “nonconventional” mortgages. This intrusion and transfer of (Credit and interest rate) risk has terrible long-term ramifications. Although in the near-term this mechanism provides a powerful stabilizing force for both the Credit system and real economy.”

Here is an example of the “privatization of profits and socialization of losses” from which would most likely exact a heavy toll on US productivity and which would likewise be reflected on the economy, as the productive segments will be penalized dearly for the subsidies or the losses incurred by the US banking system.

Nevertheless all these accounts for the priorities of the incumbent officials and their penchant to salvage a preferred industry via the inflation route, as we discussed in Governments Will Opt For The Inflation Route.

Bernanke’s Fascism Risks An Inflation Crisis

One would have to wonder whether Fed Chair Ben Bernanke is a chronic prevaricator or has been captured by the industry he regulates or operates with a tacit vested interest on the industry or has been fanatically blinded by ideology to declare that the Fed won’t monetize debt and likewise yearn for expanded powers or control over more parts of the economy including the proposed regulation of banker’s pay. Mr. Bernanke failed to predict, was in denial of the crisis and panicked in front of Congress to ask for bailout money.

To quote John H. Cochrane And Luigi Zingales who wrote on a Wall Street Op-ed on the Lehman anniversary, `` these speeches amounted to the financial system is about to collapse. We can't tell you why. We need $700 billion. We can't tell you what we're going to do with it." That's a pretty good way to start a financial crisis.”

Yet the justification to “help the agency act more decisively to reduce the chances of a recurrence” would only entrench the growing politicization, reduce the systemic efficiency and transition the US market economy into fascist state.

In the definition of Sheldon Richman, Fascism is ``where socialism nationalized property explicitly, fascism did so implicitly, by requiring owners to use their property in the “national interest”—that is, as the autocratic authority conceived it. (Nevertheless, a few industries were operated by the state.) Where socialism abolished all market relations outright, fascism left the appearance of market relations while planning all economic activities. Where socialism abolished money and prices, fascism controlled the monetary system and set all prices and wages politically. In doing all this, fascism denatured the marketplace.” (bold emphasis mine)

Yet, the diminishing role of institutional check and balances and an increasingly centralized flow of power would only amplify the systemic concentration risks that could spark a runaway inflation crisis (given Bernanke’s tendency to inflate).

One man’s error could lead to another global systemic mayhem.

The Fed didn’t monetize debt?

Again Doug Noland on the Fed Fund Flow, ``In total, Rest of World purchased $403bn SAAR of Treasuries during Q2, about a quarter of total issuance ($1.896 TN SAAR). Who were the other major purchasers? The Fed monetized $647bn SAAR, the Household Sector bought $343bn SAAR, and Broker/Dealers accumulated $404bn. And while it is positive that American households are buying Treasuries and saving more, this does not change the fact that this so called “savings” was bolstered by income effects from massive government spending increases.”

For us, the outcome of inflation or deflation is a result of a deliberate policy. It’s only the fat tails or the extreme outcomes that function as a form of unintended consequences, similar to the meltdown post Lehman bankruptcy in 2008.

Moreover we don’t believe that inflation can only occur via a revitalized US consumer.

Such view myopically underestimates the role of fiscal channels [Noland: “bolstered by income effects from massive government spending increases”] or an increasing concentration or centralization of power by central banking [Richman: “Where socialism abolished money and prices, fascism controlled the monetary system and set all prices and wages politically”].

In addition, given today’s increased globalization or deepened integration by global economies and financial system, there are transmission mechanisms or interlinkages from global governments undertaking the same inflationary tools [Noland: “Rest of World purchased $403bn SAAR of Treasuries during Q2, about a quarter of total issuance ($1.896 TN SAAR)”].

Hence while the risks of debt deflation seem a concern for some parts of the world, it does not apply to all. Yet if debt deflation is premised from a monetary phenomenon perspective, based on country specific issues, then the argument crumbles especially when applied to countries that have been least leveraged.

Not even a “ghost fleet of recession” or massive number of ships idly anchored in Asia in the absence of international trades arising from the recession would be enough to circumvent a steadfastly determined central bank to inflate a system.

A central bank can simply print a dollar per every dollar of liability, even if it means hundreds of trillions, if it deems it as beneficial.

Zimbabwe’s recent example should be a reminder that no amount of capacity utilization, unemployment rate, velocity of money [see last week’s Velocity Of Money: A Flawed Model], consumer spending or consumer debt and other traditional econometrics used by mainstream experts deterred a tyrant (operating on centralized power and a politicized economy) and an inflation obsessed central banker in Dr. Gideon Gono from fanning 89,700,000,000,000,000,000,000% hyperinflation in 2008.

While the US or UK may not be the same as Zimbabwe, an increasing centralization of power and politicization of the economy could neutralize any inherent advantages thereof. As former Fed Chief Alan Greenspan quoted in Bloomberg commented, ``It’s the politics in the United States that worries me, whether the Congress will basically feel comfortable” with the Fed withdrawing its stimulus, Greenspan said in a broadcast to Tokyo clients of Deutsche Bank Securities Inc. today. He later said that “if inflation rears its head, it will swamp long-term markets,” referring to bonds.”

In short, Mr. Greenspan appears sardonically worried about the US government’s addiction to inflation, a policy which incidentally, he applied extensively throughout his tenure. One might say that he inured the world with the “Greenspan Put” or Mr. Greenspan’s repeated policy of rescuing or providing support for the markets with artificially lowered interest rates during the 1987 stock market crash, the Gulf War, the Mexican Tequila crisis, the 1997 Asian crisis, the LTCM debacle, Y2K, the burst of the internet bubble, and the 9/11 terror attack.

Not until a significant part of the world becomes as deeply indebted as those afflicted by the recent bubble, will deflation become a meaningful threat to the global banking system or perhaps not until the destruction of the present currency system.

Yet deflation is a natural and rightful antidote to the excesses of inflation.

Exploding Bond Markets, From Periphery To The Core

Moreover, while debt deflation advocates continue to tunnel onto the banking system as the key source for benchmarking credit market conditions, they seem to forget the existence of the bond market as an alternative venue for credit access.

However, the difference is that credit via the bond markets won’t trigger the fractional reserve nature of today’s banking platform that would expand monetary aggregates. Nonetheless it helps push up prices of securities.

This from the Financial Times, ``European bond issuance has hit $2,000bn so far this year, the fastest ever pace of issuance, as companies race to refinance in the bond markets and banks remain reluctant to lend.

``European sovereigns, agencies and companies have sold 38 per cent more than the $1,450bn issued in 2008 in the year to date, according to analysts at data provider Dealogic, who add that issuance has never previously stood at such a high level so early in the year.

``Non-financial companies accounted for a record $446.3bn so far this year, 55 per cent more than in all of 2008….

``Financial issuers have sold a record of $542.8bn year to date, 24 per cent more than issued in 2008.”

In Asia, a somewhat similar dynamics could be at work as bond market growth has also been robust see figure 2.

Figure 1: ADB Bond Monitor: Hefty Growth in Bond Markets

According Standard & Poors as quoted by Researchrecap ``Notwithstanding a near universal attempt by central banks to ease monetary conditions, bank lending—still the predominant source of funds in the emerging markets—has varied from country to country. China is a standout, having reportedly injected as much as $1.1 trillion in new lending during the first six months of 2009. For many other markets, however, credit growth is decelerating (and, in some cases, contracting) in comparison with a year ago. This suggests that banks, even those that were largely unscathed by the financial crisis, are remaining cautious to stave off a potential increase in nonperforming loans.” (bold highlights mine)

In short given the fresh memory of the 2008 setback, some banking system in the region has opted to remain conservative in their lending practice. Nonetheless, the other route has been through the debt markets.

According to the ADB’s Bond Monitor, (bold underscore mine)

``Emerging East Asia’s bond market grew by 12.8% year-on-year (y-o-y) on an local currency (LCY) basis to USD3.94 trillion in the first half of 2009. The market also expanded by 5.2% quarter-on-quarter (q-o-q) in 2Q09 as financial markets showed signs of stabilization and the region’s growth showed signs of recovery. This lifted the growth rate for outstanding LCY bonds for the first half of the year…

``The strongest improvements in y-o-y bond market growth rates on an LCY basis in the first half of 2009 were in Hong Kong, China (19.4%); the People’s Republic of China (PRC) (14.8%); Republic of Korea (Korea) (13.1%); Indonesia (12.3%); and the Philippines (8.2%).”

Anyway, one of the publicly listed companies in the Philippines, the SM Investments, successfully sold $500 million worth of bonds from which two-thirds of the placements had been made local investors (FinanceAsia). This is a testament of the immense liquidity of the domestic system which had been reinforced by a faster growth clip in July (BSP).

In addition, domestic bank credit growth has remained vigorous in terms of trade and production, household consumption and bank repo lending activities (BSP).

And the growth in both the banking and bond markets have been indications of inflationary policies gaining continued traction in Asia. This as we repeatedly been saying is simply due to low systemic leverage, high savings rate, unimpaired banking system, current account surpluses and an apparent trend towards a deepening regionalization, and likewise, integration with the world economic system.

And as discussed in The Growing Validity Of The Reflexivity Theory: More PTSD And Periphery, we proposed that growth dynamics would probably shift from the core (US consumers) to the periphery (emerging markets), ``money appears as being transmitted to support growth in the developing countries as part of the collaborative efforts to inflate the system.”

Morgan Stanley’s Joachim Fels, takes a parallel view in his recent outlook, ``near-zero interest rates in the US and Europe eased monetary conditions in those emerging market economies that peg to the dollar or the euro, adding to their domestic stimulus packages. Thus, it didn't come as a surprise that China was the first major economy to emerge from recession, given that it imports easy money from the US through the exchange rate link without having the US's financial sector problems.

``The point worth noting here is that we may all still be underestimating the effects of the stimulus that has already been put into place and is still playing out. If so, growth would not moderate from its current 4%+ global pace going into 2010 as in our base case, but accelerate further. The most plausible upside scenario, in our view, would be one where Asia keeps motoring ahead with domestic demand strengthening further in response to the stimulus, leading to a surprisingly strong revival of global trade.” (bold emphasis added)

Stages Of Inflation Redux

Instead of the deflation scenario, today’s sweet spot in inflation could actually signify as the initial phase of the three stages of inflation as also discussed in Warren Buffett’s Greenback Effect Weighs On Global Financial Markets.

To quote Henry Hazlitt, ``What we commonly find, in going through the histories of substantial or prolonged inflations in various countries, is that, in the early stages, prices rise by less than the increase in the quantity of money; that in the middle stages they may rise in rough proportion to the increase in the quantity of money (after making due allowance for changes that may also occur in the supply of goods); but that, when an inflation has been prolonged beyond a certain point, or has shown signs of acceleration, prices rise by more than the increase in the quantity of money. Putting the matter another way, the value of the monetary unit, at the beginning of an inflation, commonly does not fall by as much as the increase in the quantity of money, whereas, in the late stage of inflation, the value of the monetary unit falls much faster than the increase in the quantity of money. As a result, the larger supply of money actually has a smaller total purchasing power than the previous lower supply of money. There are, therefore, paradoxically, complaints of a "shortage of money." (bold emphasis mine)

What could be seen as some pockets of deflation today, could actually be the initial phases of inflation. And a continued rise in the commodities space even if it signifies as a currency “pass through” from the sagging US dollar would likely intensify the inflation expectations.

Then when the late stage of inflation have been reached, where the value of monetary unit falls faster (or consumer prices are rising faster) than the increase in the quantity of money which leads to the perception of “a shortage of money”, the central bank under the auspices of the government would either elect to print money at an ever accelerating “exponential” rate to meet such shortages-ergo the hyperinflation scenario, or opt to withhold feeding the boom (or by declaring a default) -the deflation scenario.

Again this will all be a result of policy choices.

So simply reading conventional metrics when governments have taken a lead role in the marketplace will lead to misdiagnosis and mass confusions on the disconnection between the market from economic reality. Analyzing how political trends will shape policy decision making will likely be a better alternative [see Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?]

Anyway, a hyperinflation episode would also lead to deflation once the hyperinflated currency have been eschewed and replaced by another currency. The recent case of Zimbabwe which has abrogated its currency, the Zimbabwean Dollar, for the US dollar and South African Rand is a prime example.

At the end of the day, global policymakers will continue to bask on the triumphalism from present day policies and will most likely continue to keep the booze flowing.

Hence even if markets don’t move in a straight line they will likely respond positively to policy sustained policy accommodations over this early phase of the inflation cycle.

Debating The Fate Of The US Dollar, A Gold Linked Currency And China’s Yuan

In view of the falling US dollar, many articles have emerged to defend the US dollar as being either irreplaceable or will become substitutable only after a defined period of years or the Chinese yuan may follow the unsuccessful attempt of the Japan yen to emulate the US dollar as reserve currency or of inapplicability of a gold linked currency in today’s paper money standard.

While they maybe correct, I inclined to think many of these have been relying heavily on past performances and projecting these into the future.

Debating The Fate of the US dollar

For me the issue of the continued privilege of the US dollar as reserve currency will depend on the extent of inflationary policies imposed by its government, and secondly, from the responses of the world to such policies.

Next, the US dollar hasn’t been stable relative to its purchasing power. The fact that it has declined by 95% since 1913, makes it “stable” in terms of the rate of purchasing power lost over the years.

Perhaps the US dollar could be seen as “stable” in relative terms, or against other currencies, as paper currencies in general continue to collectively suffer from eroding purchasing power based on the continued abuse of the elastic currency due to sundry political goals.

Moreover, given mercantilist tinge by many of the world’s central bankers who continue to embrace “cheap currencies for exports” mindset via the imposition of varying degree of exchange rate pegs, assorted subsidies and tariffs and other proscriptions, a global campaign for “competitive devaluation” could lead to a currency war.

To quote, Murray N. Rothbard, in Making Economic Sense, ``The whole world would then be able to inflate together, and therefore not suffer the inconvenience of inflationary countries losing either gold or income to sound-money countries. All the countries could inflate in a centrally- coordinated fashion, and we could suffer manipulation and inflation by a world government-banking elite without check or hindrance. At the end of the road would be a horrendous world-wide hyper-inflation, with no way of escaping into sounder or less inflated currencies.” (bold emphasis mine).

So again we shouldn’t see this as analyzing against a constant but of an action-reaction dynamics to evolving policies. Say for instance if the US will see an upsurge in inflation will global governments continue with the current setup?

My guess is no.

A Gold Link Currency In Today’s Fiat System?

Another, currency volatility has been due to too much distortion brought about by government interventions in the economic system.

A country which adopts a gold standard may indeed be destined to see its currency’s price swings based on gold’s price performance.

However, what must be understood is that the accompanying fiscal restraint brought about by adapting a gold-linked currency system will probably lead to an appreciation based on significantly less politicization of the nation’s political economy that could lead to a productivity spike.

Nonetheless currency values will always fall under natural law of demand and supply, as Ludwig von Mises in Theory of Money and Credit wrote, ``the valuation of the monetary unit depends not upon the wealth of the country, but upon the ratio between the quantity of money and the demand for it, so that even the richest country may have a bad currency and the poorest country a good one. (emphasis added)

This leads us to international trade, currency values aren’t everything; weak currencies don’t necessarily imply export strength, for instance Philippine exports plunged by 25% in July in spite of the underperforming Peso (Inquirer), whereas strong currencies don’t automatically translate to feebleness in exports, for example Europe registered a surplus on “strong exports” in July in spite of the steep appreciation of the Euro (google).

What would crucially matter is the market from which a producer of goods or services sells into, the capital structure of an economy and importantly policies that underpin the trade structure, as discussed in Asia: Policy Induced Decoupling, Currency Values Aren’t Everything.

But of course, a gold linked currency given today’s political setting and economic ideological framework isn’t likely to be in the cards for policymakers, simply because it is not politically appealing. A gold backed currency would restrain politicians from taking advantage of the easiest, least understood and most discreet form of wealth redistribution.

China’s Remimbi As International Reserve?

Finally past performances don’t equate to future outcome.

Figure 2: Wall Street Journal: Yen Denominated Trade Transactions

The Yen’s failure to emulate the US dollar as a reserve currency, see figure 2, doesn’t necessarily extrapolate to the destiny of the Chinese Yuan. The circumstances behind the Yen’s unsuccessful attempt are not exactly the same forces faced by the Chinese today.

Becoming an international reserve standard would depend on many factors that would make a currency accepted as an international store of value, unit of account and medium of exchange, such as convertibility, market economy, depth and sophistication of the financial markets, transparency, low transaction costs, military might and etc…

Nevertheless, one good starting ground is by way of marketability.

Again Murray Rothbard in What Has Government Done To Our Money, ``Now just as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc. Eventually, one or two commodities are used as general media--in almost all exchanges--and these are called money.” (bold highlights mine)

The degree with which China would assimilate a market economy will serve as the pivotal fundamental steps towards achieving such a goal.

Nonetheless, again it will also depend on the underlying policies that China would be undertaking aside from the policies by the US government as the de facto currency reserve and of the world relative to China.

It’s a complex and a highly fluid issue to speculate on.

Wonders of Market Innovation: Text-to-Speech Technology Reaches an Inflection Point

This is just one of the numerous examples of the miracles borne out of the marketplace mainly through technological innovation.

This from Ashlee Vance of the New York Times, (bold emphasis mine)

``Moore’s Law is a funny thing. Computing gear ticks along, getting faster and often cheaper at a steady rate. But, every now and then, we hit an inflection point where things change in a drastic fashion. Such is the case with the iPhone from Apple and with netbooks -– products that nailed the right recipe of horsepower, size and cost at the right time.

``In an article published Tuesday, I took a look at how iPhones and netbooks have disrupted not only the consumer electronics market but also health care. People with speech-impairing conditions like A.L.S., autism, Down syndrome and strokes have started to discover that general-purpose devices, equipped with downloadable text-to-speech software, can in many cases help them communicate better and more cheaply than the proprietary speech devices covered by Medicare and private health insurance.

Read the rest here
The S-Curve as shown above depicts of the technology breakthrough cycle or where "an inflection point where things change in a drastic fashion" as applied to the text-to-speech technology.

As explained by AVG Aerospace, ``The S-Curve figure illustrates both the evolution of a given technology, and the breakthrough event when a new, superior technology becomes viable. For a given technology, the evolution is as follows: Initial efforts result in little advancement and then the technology becomes successful. This success point, at the lower knee of the curve, is where the technology has finally demonstrated its utility. After this point significant progress and improvements are made as several embodiments are produced and the technology becomes widely established. Eventually, however, the physical limits of the technology are reached, and continued effort results in little additional advancement. This evolution (effort expended versus performance gains) takes the form of an S-Curve. To go beyond the limits of the top of a predecessor's S-Curve, a new alternative must be created. This new alternative will have its own S-curve and will eventually require yet another new approach to surpass its performance limits. The breakthrough event, is when the new method demonstrates its viability to exceed past the limits of its predecessor." (emphasis added)

The Changing Role Of Stock Markets: From Market Signal To Policy Instrument

3 charts to explain what has been happening today.

First is that stock markets have been vigorously rallying across the globe. This means that OECD markets have surged but has underperformed emerging markets.


From the Economist, ``STOCKMARKETS in many countries have risen steeply in recent days, buoyed by signals from central bankers in America and Britain that their economies may now be out of recession. Retail sales and industrial production data released this week appeared to support the sunnier outlook for America, helping the Dow Jones Industrial Average to a peak for the year of 9,791 on Wednesday September 16th. On the same day the FTSE 100 reached 5,140, its highest point since the collapse of Lehman Brothers a year ago. The Nikkei is also climbing mostly upwards. However, most stockmarkets have a long way to go to regain their pre-recession levels." (emphasis added)

Next is that while stock markets have traditionally functioned as a forward indicator of the economy, they appear to have been detached from economic reality.

Despite some signs of improvements, some major economic indicators such as foreign direct investments (FDI) have deteriorated in the face of rising stock markets.


According to the Economist, ``FOREIGN direct investment has fallen sharply since the start of the financial crisis, according to the latest World Investment Report from UNCTAD. The purchase of factories, buildings and other assets by foreign firms was hardest hit in rich countries. At its recent peak in the last quarter of 2007, 80% of the world’s FDI went to developed economies, but by the first quarter of this year FDI into rich countries accounted for less than two-thirds of the total. FDI to Flows to emerging economies has held up better.Africa rose to a new record of $88 billion last year, much of it going to countries rich in natural resources. Foreign investment in China and India also surged, as companies sought footholds in resilient economies. (bold emphasis added)

The falling FDI and rising stock market prices suggest that the stock market hasn't been dispensing with its traditional role as forward indicator.

Instead, what appears to be occurring is that global governments and central bankers, especially in OECD economies, have implicitly been using the stock market as an instrument for signal channeling. [see earlier discussion in Governments Will Opt For The Inflation Route]

By tweaking up prices of equity securities, the officialdom hopes to redeem the confidence lost or the "animal spirits" during last year's crisis and stoke an investment recovery.

What we have been getting instead has been rampant speculation and massive misallocation of resources or another bubble cycle.

In short the stock market has transformed from being a market signal to a policy instrument. Hence, traditional metrics under such environment won't operate effectively.

Moreover, another message from the FDI performance is that emerging markets such China, India and Africa have been diverging from OECD economies. In short, the decoupling phenomenon clearly in motion.

Of course all these comes with a cost.

For instance, as the chart above from Bloomberg's chart of the day suggests, rising stock markets from implicit policies to revive the animal spirits translates to a heavy onus on US taxpayers.

This is the result of inflationary policies, aimed at fixing short term predicaments and which benefits certain segments of the society but is paid for dearly by the productive sectors of the economy and by society in general, through the loss of purchasing power or higher prices over the long term.

As Henry Hazlitt once wrote, ``Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals."

Daniel Mitchell: The Case Against Big Government

From Daniel Mitchell of Cato.org

Graphic on Patents

Here is an interesting interactive graphics on patents from JSOnline. (Hat Tip Paul Kedrosky)





From Murray Rothbard in Man, Economy, and State (ch. 10, sec. 7)

``It is by no means self-evident that patents encourage an increased absolute quantity of research expenditures. But certainly patents distort the type of research expenditure being conducted. . . . Research expenditures are therefore overstimulated in the early stages before anyone has a patent, and they are unduly restricted in the period after the patent is received. In addition, some inventions are considered patentable, while others are not. The patent system then has the further effect of artificially stimulating research expenditures in the patentable areas, while artificially restricting research in the nonpatentable areas."

OECD on World Unemployment: Return To Normal Could Take Years

The OECD suggests that unemployment rate could take years to normalize.

This from Researchrecap,

``More evidence of the seriousness of the unemployment problem can be found in the OECD’s Employment Outlook 2009. The OECD compares the the trajectory of the current rise in unemployment with that seen in the 1973 recession. In that case, the unemployment rate flattened out approximately two years after the start of the recession. If the current recession followed the same pattern, it would be topping out around now. However, the OECD’s projection suggests the rate will continue to rise until the end of the third year before starting to level out. That would be toward the end of 2010, when the rate is projected at around 10%, or 57 million people in the OECD countries.

``The risk is that much of this large hike in unemployment becomes structural in nature as many of the unemployed drift into long- term unemployment or drop out of the labour force."

Read the rest here

My comment: serial bubble blowing policies ensures that unemployment rates will remain high.

Microfinancing Goes Facebook

Microfinancing goes Facebook....but a different version; it's a Facebook for farmers, says James Davison of the World Bank.

Technology has been introducing innovative ways of connecting capital and people. This should lead to more productivity and progress.

From Mr. Davison, (accompanying video likewise from the World Bank)

``Wokai has been dubbed by some as a “Facebook for farmers,” yet it may be more comparable to well-known microfinance sites like Kiva, which allow people with an Internet connection to give loans directly to entrepreneurs in developing countries. Wokai, however, focuses solely on impoverished people living in rural China.

``The site has been around for about two years and says it has raised $45,000 from about 500 contributors. The money has gone to more than 160 rural Chinese entrepreneurs, who put loans to a variety of uses, such as pig farming, furniture making and starting a restaurant.

``The comparison to Facebook is made because individual donors and borrowers have profiles on the site, and contributors can read about (and watch the progress of) the people their loans go to. Casey Wilson, one of the site’s founders, explains more about the organization in this video shot by a reporter based in China." (emphasis added)

Facebook for Farmers from grubbylens on Vimeo.

Warren Buffett On Recession: No Bounce but No Deterioration

Warren Buffett interviewed at the CNN.

Ron Paul Explains The Austrian Business "Boom Bust" Cycle

Great stuff from Congressman Ron Paul.

[Hat Tip: Jeff Tucker]

Graphic: Global Debt Time Bomb

A quaint interactive graphic from the Buttonwood of the Economist.

It actually is labeled "Global Debt Comparison", where one can see how much debt had been accrued by different countries.

Pls click on the image to redirect to the site's link.
So far, as of this writing global debt has reached over $35 trillion or around 65% of the global economy (2008, currency)

But my interpretation is one of the risk of budding debt bubble which is being compounded as global governments continue to undertake "stimulus" efforts.

Lessons From Atlas Shrugged: Senator Lacson Versus ex-President Estrada

This very interesting development from yesterday’s Philippine news headlines.

In a privileged speech, an incumbent Philippine senator, makes an exposition (accusation) against his old boss and erstwhile very close or dear friend, the former president, of some alleged malfeasances perpetrated when the latter had been in power.

We ARE NOT here to imply that such accusations are valid.

Instead, the point of our exercise is to demonstrate on how government interventionism begets crony capitalism or political entrepreneurship, which has been a common blight to the Philippine political economy, nevertheless applied to different levels of the state heavy economy.

And this could be an example of why the Philippines has fared badly in global competitiveness, thereby the lack of investments and the shortage of employment [see 2009 Global Competitiveness Report And The Philippines]

There have been two of three allegations raised in the expose that we'd like to deal with: Corporate arm twisting and dispensing of political favors by circumvention of the law.

All excerpts from the Philippine Daily Inquirer,

A. Corporate Arm Twisting (bold emphasis mine)

PDI: ``He [Senator Panfilo Lacson] said [President Joseph] Estrada had arm-twisted Yuchengco into selling his PLDT shares in August 1998 to Pangilinan’s group, the Hong Kong-based First Pacific Co., which eventually gained control of the telecommunications firm.

``The transaction showed Estrada’s “other sinister behavioral patterns” that Lacson said “must be told to the Filipino people.”

``“In August 2008, in the early part of Mr. Estrada’s abbreviated presidency, Mr. Alfonso Yuchengco was pressured to sign the conveyance of his 7.75 percent PTIC (Philippine Telecommunications Investment Corp.) holdings, equivalent to 18,720 shares to Metro Pacific, represented by Manuel Pangilinan,” Lacson said.

``He said these PTIC holdings corresponded to 2,017,650 PLDT common shares. PTIC at the time holds the biggest single block at 21 percent of the telephone giant. [Before the deal with Yuchengco, First Pacific had finalized the sales agreement on only 47 percent of PTIC—44 percent from the Cojuangco family and 3 percent from Antonio Meer. First Pacific could not touch the balance of 46 percent of PTIC shares because these were owned by the formerly sequestered Prime Holdings Inc., a shell company owned by the Marcoses, which was being recovered by the government.]

``Lacson said he learned later that Yuchengco was “pressed to sign a waiver of his right of first refusal over the PTIC shares of the Cojuangco-Meer group.”

``The senator said he learned years later that Estrada, then two months into his administration, had used the PNP to harass Yuchengco’s son Tito “with threat of arrest on some trumped-up drug charges to force his father, Mr. Yuchengco, to sell.”

``Lacson said he learned that the Yuchengcos were angry at him in the mistaken belief that Estrada had ordered him to harass them so that the patriarch would sell his shares.

``The senator said he was not aware of what had happened until later. “And if for example, Mr. Estrada would order me to do such thing, I am certain I will not follow him,” Lacson said.

``“The bigger and more important question remains—What was the deal in pesos and centavos between Mr. Estrada and Mr. Pangilinan, if any? Or should we rather ask, ‘How much was involved?”’ he said.

``Estrada’s friend Mark Jimenez reportedly brokered the $750-million PLDT takeover and got a $50-million commission for it. Jimenez denied getting such amount.

B. Political Favors (all bold emphasis mine)

``Lacson also claimed that Estrada had intervened in the release of smuggled shipments of dressed chicken parts from China and the United States as well as smuggled rice in Cebu.

``He said Estrada had told him to pull out his men, who were staking out a shipment of dressed chicken parts coming from near the Manila Hotel, after telling him his men were harassing people there.

``The shipment was eventually released. Lacson said he pointed this out to Estrada who in turn told him that he should have not pulled out his men.

``He said he got dismayed by this because he realized that Estrada’s order for him to fight crime and corruption was just a “moro-moro” (just for show).

The reply (rebuttal) of the former president here

All these indications are what Ayn Rand presciently warned in her monumental novel, the Atlas Shrugged...(bold highlights mine)

``When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing – when you see money flowing to those who deal, not in goods, but in favors – when you see that men get richer by graft and pull than by work, and your laws don't protect you against them, but protect them against you – when you see corruption being rewarded and honesty becoming a self-sacrifice – you may know that your society is doomed.”

Again, the populist notion of "virtuous" big government isn't the answer (this is nothing but a big self-contradiction). Instead, a free market under a limited government is.

All the rest are mere delusions.

Farewell To The Father Of Green Revolution

One of the world’s most unheralded heroes has recently passed away.

Norman E. Borlaug, 95, known as the father of the "green revolution", was credited for saving and uplifting hundreds of millions of lives around the world and is deserving of “Fawning Eulogies” compared to recently deceased politicians.

This from the New York Times, (bold emphasis added)

`` He was widely described as the father of the broad agricultural movement called the Green Revolution, though decidedly reluctant to accept the title. “A miserable term,” he said, characteristically shrugging off any air of self-importance.

``Yet his work had a far-reaching impact on the lives of millions of people in developing countries. His breeding of high-yielding crop varieties helped to avert mass famines that were widely predicted in the 1960s, altering the course of history.

``Largely because of his work, countries that had been food deficient, like Mexico and India, became self-sufficient in producing cereal grains.

``More than any other single person of this age, he has helped provide bread for a hungry world,” the Nobel committee said in presenting him with the Peace Prize. “We have made this choice in the hope that providing bread will also give the world peace.”

And this from the Wall Street Journal,

``Borlaug solved that challenge by developing genetically unique strains of "semidwarf" wheat, and later rice, that raised food yields as much as sixfold. The result was that a country like India was able to feed its own people as its population grew from 500 million in the mid-1960s, when Borlaug's "Green Revolution" began to take effect, to the current 1.16 billion. Today, famines—whether in Zimbabwe, Darfur or North Korea—are politically induced events, not true natural disasters.

``In later life, Borlaug was criticized by self-described "greens" whose hostility to technology put them athwart the revolution he had set in motion. Borlaug fired back, warning in these pages that fear-mongering by environmental extremists against synthetic pesticides, inorganic fertilizers and genetically modified foods would again put millions at risk of starvation while damaging the very biodiversity those extremists claimed to protect. In saving so many, Borlaug showed that a genuine green movement doesn't pit man against the Earth, but rather applies human intelligence to exploit the Earth's resources to improve life for everyone.”

It is unfortunate that there had been no public pandemonium or mass rallies over his death even when he has served to the benefit of much of mankind’s recent progress. Very much unlike politicians, whom have even been labeled as patriots or heroes, when the latter's accomplishments pale in comparison to Mr. Borlaug's.

As Café Hayek’s Professor Donald Boudreaux rightly laments,

``It’s distressing, I can’t help adding, that dead politicians are often canonized in the popular press while most of humanity will go to their graves never hearing the names of, or learning of the contributions of, genuine heroes of humanity such as Norman Borlaug.”

Norman Borlaug, R.I.P.

The US Dollar Meltdown Validates Our Version Of The September Syndrome!

``A good trader has to have three things: a chronic inability to accept things at face value, to feel continuously unsettled, and to have humility.” -Michael H. Steinhardt, American investor and philanthropist

The September “syndrome” struck again!

But this time it hadn’t been what the mainstream had expected. Instead, it had been what we had been expecting.

Coming into September we pounded on the table that 2009 won’t be 2008; where US banking system went apoplectic from which the world endured a consequent “sudden stop” and where global economic activities went into a freeze-frame or a virtual standstill-our Posttraumatic Stress Disorder (PTSD).

2009 will most likely produce a different seasonal pattern, we asserted.

It would probably center on the US dollar’s weakness and gold’s strength which should also provide support to stock markets especially in Asia and Emerging Markets, as we suggested in The US Dollar Index’s Seasonality As Barometer For Stocks, Gold As Our Seasonal Barometer, Gold As Our Seasonal Barometer (For Stocks) II and Gold and the September Stock Market Seasonality Syndrome.

Well, all these have been captured in Figure 1.

Figure 1: A US Dollar Meltdown Equals Rising Gold And Stock Markets

The US dollar Index’s meltdown has had a mirror or inverse effect on Gold (surged to close at record highs), global stock markets (DJW) and Emerging Market stocks (EEM).

So far this has only shown how the mainstream had been looking at the wrong angle and had been very much fixated with traditional metrics but has significantly been caught disoriented by overlooking the genuine dynamics of the market.

Worst, they have relied on cognitive biases, such as the hindsight bias (rear view mirror syndrome), the focusing effect and anchoring, as foundations for their analysis.

For instance, deflation advocates have used China’s recent crash as evidence to advance their cause (a case of selective perception).

However we averred that the directions of the US dollar will likely determine the degree of the correction in China’s Shanghai index (SSEC), as we wrote in Will China’s Stock Market Correction Spread Globally?, ``if the US dollar fails to rally while global stocks weaken, then any correction, thus, will likely be mild and short.”

The Shanghai Index has advanced by 4.5% this week and will most likely follow the path of Russia’s RTSI, see figure 2.

Figure 2: Bulls Recapture Russia RTSI, Shanghai To Follow

Earlier Russia’s RTSI had corrected by 30% but has now entirely reclaimed the losses.

With a bullish reverse head and shoulder (chart) pattern along with a sustained feebleness in the US dollar, the likelihood is that the RTSI will make a significant breakthrough soon (if not by next week).

Moreover, many have called for a major correction due emerging markets attributing overvaluation levels.

For example this news from Bloomberg underscores on such extravagance, ``Developing-nation stocks rose, driving the MSCI Emerging Markets Index to its most expensive level in nine years, as Indian software makers rallied and higher oil prices boosted the revenue potential of economies sustained by exports.

``The MSCI Emerging Markets Index increased 0.8 percent to 887.05 at 5:01 p.m. in New York, pushing valuations to 20 times reported earnings for the first time since June 29, 2000, according to data compiled by Bloomberg”

While we basically agree with the concept that “markets have risen too fast and too soon”, that would be interpreted as looking at the markets from the lens of the mainstream.

Again, excessive dependence on conventional metrics will likely persist to befuddle mainstream analysis.

In addition, they seem to forget that in major trends, whether in bullmarkets or in bearmarkets, momentum can lead to trend overextensions.

Of course the principal error has been that the mainstream has all underestimated the impact of government printing press on the financial and economic sphere.