5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

``The next bubble in asset markets will not be in the West but in emerging Asia, led by China. The irony is that the more anaemic the Western recovery proves to be, the longer it will take for Western interest rates to normalize and the bigger the resulting asset bubble in Asia. Emerging Asia, not the U.S. consumer, will be the prime beneficiary of the Fed's easy money policy.”- Christopher Wood, Is the U.S. Economy Turning Japanese?

In this issue:

5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

The Cost of Self Esteem

5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

1. Reflation Trade Has Been A Crowded Trade

2. No Trend Goes In A Straight Line

3. Markets Have Been Liquidity Driven

4. Tightening Trial Balloons Responsible For Recent Shakeup

5. Nothing But A Head Fake Signaling

In a recent commentary marketing guru Seth Godin asked ‘Why do people celebrate Halloween?’

His answer, ``Because everyone else does….Most of what we believe is not a result of direct experience (ever seen an electron?) but is rather part of our collection of truth because everyone (or at least the people we respect) around us seems to believe it as well.” (bold highlights mine)

Let me add, for many, there is that need to be seen as conforming to traditions (social status), aside from the need to use such opportunities for networking.

Mr. Godin concludes that “social constructs” drive people to behave in traditional ways. In behavioral finance or economics, such traditionalism represents as the “comfort of the crowds” or the Bandwagon Effect or the Herding instinct.

In other words, it isn’t much about rationality vis-à-vis irrationality or evidence against theory but social impulses predicated on assumed experiences that motivates people’s actions to observe traditions.

The Cost of Self Esteem

In the marketplace, mainstream behavior represents the same dynamics-traditionalism, where the underlying assumption is that the consensus mindset applies as the self-evident truth, regardless of proofs.

For instance, interventionists or inflationists or the left predominantly use industrial era metrics to justify government interventionism in a world evolving around the “information age” whose platform is principally structured upon the twin forces of globalization and competition inspired technological revolution.

By postulating that today’s economic landscape as dissimilar compared with the configurations of the past, they argue that markets have been failing and thereby justify more intervention by the government via inflation (fiscal deficits, centralization, price controls, devaluation and so forth…) or increased regulation.

Moreover, the same line of thinking pervades the mainstream mindset when traditionalist fundamental models appear to be ‘foisted upon’ the public in the hypothesis that markets have been operating under “normal” or basic law of scarcity conditions, when the reality is that governments have been the markets!

For instance, some has sternly argued that can’t consumer price inflation can’t occur when unemployment is high. Yet, Iceland seems to be a real life example debunking such unrealistic model [see Iceland's Devaluation Toll: McDonald's].

In other words, the conventional approach have been to read and interpret the market or the global economy as operating under assumed models with historically similar dynamics, when the reality is ‘this time is different’ or that we are operating under uncharted territory.

Mr. Doug Noland in his Credit Bubble Bulletin hits the nail on the head in arguing that today’s economic environment is starkly different from any previous conditions we have ever seen, ``the unfolding reflation will be altogether different than previous reflations. The old were primarily driven by Fed-induced expansions of U.S. mortgage finance and Wall Street Credit. Our mortgage industry, housing and securitization markets, and Bubble economy were at the epicenter of global reflationary dynamics. The new reflation is fueled by synchronized fiscal and monetary stimulus across the globe. China, Asia and the emerging markets/economies have supplanted the U.S. at the epicenter. U.S. housing is completely out of the mix. Those fixated on old reflationary dynamics look today at tepid U.S. housing markets, mortgage loan growth, consumer spending, and employment trends and see ongoing deflationary pressures. The Fed is wedded to the old and is positioned poorly to respond to new reflationary dynamics. A stable dollar used to work to restrain global finance – hence global inflationary forces. The breakdown in the dollar’s stabilizing role has unleashed altered inflationary dynamics – forces that the Federal Reserve disregards.” (bold emphasis mine)

So why is it difficult to change peoples’ thinking even when presented by strong evidences?

Based on social constructs, Professor Arnold Kling of EconoLog argues that change comes at the cost of “acknowledging a loss of status” or “loss of group identity”.

This implies that self esteem derived from social linkages account for as one of the basic human needs, which can be seen in the order of values as framed by Maslow’s hierarchy of needs (see figure 1)

Figure 1: Wikipedia.org: Maslow’s Hierarchy Of Needs

According to Wikipedia.org ``Maslow's hierarchy of needs is predetermined in order of importance. It is often depicted as a pyramid consisting of five levels: the lowest level is associated with physiological needs, while the uppermost level is associated with self-actualization needs, particularly those related to identity and purpose.”

In short, one of the major costs or barrier or resistance to change dynamics of changing people’s thinking is self esteem. Professor Kling suggests, ``On political issues, I think that it is harder to change the mind of someone who is highly educated than someone who is not. The highly-educated person is more likely to have his sense of status and identity tied up in his political beliefs. He is more likely to have a made a larger investment in finding facts and theories that confirm his beliefs.”

This applies not only to politics but likewise to other aspects such as economic or social dimensions.

So what has this got to do with today’s market actions or more particularly today’s market slump?

A whole lot.

The “desperately seeking normal” camp or those “fixated on old reflationary dynamics” as distinguished by analyst Doug Noland, has interpreted the recent plunge in global markets as a semblance of vindication of the “ongoing deflationary pressures”.

Where they have been mostly wrong throughout the recent episode, fleeting market signals that appear to validate their supposition may otherwise be construed as “even a broken clock is right twice a day”.

5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects

We see five factors why today’s market slump isn’t the scenario from which the desperately seeking normal camp expects.

1. Reflation Trade Has Been A Crowded Trade

There is a limit on how much a rubber band’s elasticity can be stretched before it snaps or the breakage of the so called “cross links”. The degree of elasticity depends on the basic dimensions and the quality composition of the rubber band.

Applied to the markets, there is also a limit on how markets can be manipulated or a maximum elasticity on how markets can accommodate extreme sentiment. This applies even across varying time dimensions, which means that even as fundamental imbalances of inflation are being built globally over the long term, strains from one sided or popular trades can be vented to reflect on an interim “breakage of cross links” or snap backs. Hence, long term or secular trends will always be spliced with intermittent countertrends.

In the context of the US dollar Index, which have been the foundation of today’s reflation dynamic, the recent rebound amidst the hefty decline in global markets epitomizes the interim crowded traded snap back (see figure 2).

Figure 2: US dollar Commitment of Traders and US dollar Index

The chart from futures.tradingcharts.com demonstrates on the crowded trade phenomenon where non-commercial positions (banks, hedge funds, or large speculators) have overwhelmingly shorted the US dollar, as shown by the blue vertical lines. Commercial positions (red lines) are the end users (as importers or exporters) who apply currency hedges.

In the most recent past, each time US dollar short contracts reached the -19,200 level, the US dollar “recoiled” (June and August). Today, large speculator short contracts have vastly broken below said levels. And this signifies the crowded trade.

Alternatively this means that as the US dollar rebounded, carry trades based on the US dollar may have all been closed which oppositely results to the steep drop in so-called risks assets.

2. No Trend Goes In A Straight Line

When we say long term or secular trends will always be spliced with intermittent countertrends it simply means that markets don’t move in a linear fashion.

In other words, there is a distinction between secular trends and countertrends or a difference between the short-term and the long term.

Confusing one for the other could risk a disastrous portfolio.

Today’s massive asset speculations have resulted to overextended markets as in the case of the US (see figure 3)

Figure 3: Chartoftheday: Extraordinary Bear Market Rally

Chartoftheday.com sees an exceptional episode in today market action by the Dow Jones Industrials from whose chart ``illustrates the duration (calendar days) and magnitude (percent gain) of all significant Dow rallies that occurred during the 1929-1932 bear market (solid blue dots). For example, the bear market rally that began in November 1929 lasted 155 calendar days and resulted in a gain of 48%. As today's chart illustrates, the duration and magnitude of the current Dow rally (hollow blue dot labeled you are here) is greater than any that occurred during the 1929-1932 bear market.”

It is quite obvious that the referenced site is biased towards the “old reflation model” with their view predicated on a bear market rally, and perchance, expects the US markets as in a path towards the Great Depression levels.

Unfortunately, using the basic metrics of the monetary standards alone, where the Great Depression was anchored to gold while today operates on a pure paper ‘US dollar’ standard, comparing the Great Depression with today would fundamentally be immaterial.

Nevertheless today’s significant correction amidst the vastly overstretched or overbought market denotes of a “normal” corrective phase of market dynamics.

While we haven’t bullish with the US markets, we can’t also be equally bearish for the simple reason that we see the US government as supporting their asset markets as a priority over the other areas of concern. As 2008 meltdown has shown, the survivability of the US dollar standard depends on the Federal Reserve’s key agents, the US banking system.

This is a fundamental variable that can’t seem to be comprehended by the consensus.

3. Markets Have Been Liquidity Driven

As earlier noted, another outstanding fallacy utilized by the old reflation model or desperately seeking normal camp is to extrapolate conditions of the yesteryears through traditional metrics to project a preferred or biased scenario.

For instance we noted that the humongous profits reaped by ‘Too Big To Fail banks’ have been fundamentally derived from trading [as previously discussed in What Global Financial Markets Seem To Be Telling Us]

This seems to have confounded mainstream analysts like MSN’s Jim Jubak who recently wrote, ``What's really disturbing to me, however, is that the model is relatively new, even at Goldman Sachs, and current financial policy is pushing Goldman and JPMorgan Chase to even more extreme versions of the "bank as trader" model.” (bold emphasis mine)

But of course, the “bank as trader” represents as the du jour model.

That’s because the only significant alternative way to rehabilitate the US banking system’s balance sheet is to profit from trading. The industry has been hobbled by balance sheet impairments from the recent bubble bust and this has reduced their incentives to engage in the traditional model of lending.

And the only way to consistently profit from trading is to have an environment that will be conducive to this. And the only way to attain this is to create it. Hence, the US government has engaged in a decisive, massive, monumental and unprecedented scale of operations. The US government, according to Bloomberg, ``has lent, spent or guaranteed $11.6 trillion to bolster banks and fight the longest recession in 70 years, according to data compiled by Bloomberg. That’s a 9.4 percent decline since March 31, when Bloomberg last calculated the total at $12.8 trillion.” (bold highlight mine)

And this is why too the world appears to likewise adopt a seemingly complementary set of policies too.

This refusal to acknowledge the massive influence of government in today’s market system, results to this deep confusion between conventional models and evolving market realities.

Yet the ‘Bank As Trader’ model has been underpinned by the following sequence:

1. Taxpayers provide the Too Big To Fail banks with liquidity, loans, guarantees and equity.

2. Financial conditions has been stage managed by the US Federal Reserve via zero interest rate, quantitative easing, expansion of loan books of Fannie Mae, Freddie Mac and the FHLB, and through various programs where the US government acts as market maker (such as Term Discount Window Program, Term Auction Facility, Primary Dealer Credit Facility, Transitional Credit Extensions, Term Securities Lending Facility, ABCP Money Market Fund Liquidity Facility, Commercial Paper Funding Facility, Money Market Investing Funding Facility, Term Asset-Backed Securities Loan Facility, and Term Securities Lending Facility Options Program.)

3. Investment banks, hence, profit immensely from the spread generated by these manipulated markets.

4. The resultant handsome profits generated from these arbitrage opportunities prompts companies to deploy huge employee bonuses which prompts for an uproar from politicians and media over the ‘evils of greed’.

Incidentally, this brouhaha over greed is obviously a myopic distraction in the sense that pay and profits simply signify as symptoms of the main disease.

The underlying fundamental malaise is that the ‘bank as trader model’ has been a product of the collusion between the banking system and the US government to inflate the economy to the benefit of the elite bankers!

Nevertheless, the ‘Bank As Trader Model’ appear to synthesize with the overall the fundamental strategy employed by the US Federal Reserve to revitalize its banking system.

How?

1. By manipulating the mortgage markets and US treasury markets with the explicit goal of lowering interest rates, in order to ease the pressures on property values and to mitigate the losses in the balance sheets of the banking system,

2. By working to steepen the yield curve, which allows for conducive and favorable trading spreads for banks to profit and to enhance maturity transformation aimed at bolstering lending, and

3. By providing the implicit guarantees on ‘Too Big To Fail’ banks or financial institutions, this essentially encourages the revival of the ‘animal spirits’ by fueling a run in the stock markets. As we have noted in Investment Is Now A Gamble On Politics, 5 financial stocks otherwise known as the Phoenix stocks accounted for most of the trading volume last September.

In short, the recovery of the US banking and financial system has basically been entirely dependent on government actions via inflation.

One cannot simply read today’s markets without addressing the policy recourse or anticipating the prospective actions of the US government.

Figure 4: Liquidity Prompted Markets Equals Highly Correlated Trade

And the impact to the global marketplace has been the same dynamics: a high correlation of market activities.

The inverse correlation of US dollar vis-à-vis ‘risk’ asset markets (commodities and stocks) seems like a déjà vu. This should be music to the ears of the ‘desperately looking for normal’ camp.

However, this isn’t about traditional fundamental model, but about liquidity.

A rising US dollar signifies global liquidity contraction, as leverage in parts of the global financial system could have forcibly been unwinded. Moreover a spike in the VIX or volatility sentiment appears to be chiming with the underlying theme.

In addition, given the synchronous market actions brought about by a seeming reversal in liquidity dynamics, then the impact should be reflected on Asia over the coming sessions due to the recent strong correlation (Figure 5)

Figure 5: Money Week Asia: High Correlation Liquidity Driven Trade

According to Chris Sholto Heaton of Money Week Asia, ``the markets are generally highly correlated in terms of direction, with an R-squared value of 0.94 (the maximum is one, implying perfect correlation). In short, when Wall Street rises, Asia rises; and when Wall Street falls, Asia falls.”

In other words, Asian Markets may indeed fall from a US dollar rally over the interim. But this should be a short-term countertrend or a buying opportunity more than a secular trend as liquidity dynamics favor Asia and emerging markets/

4. Tightening Trial Balloons Responsible For Recent Shakeup

High profile and prolific investment strategist of CLSA, Mr. Christopher Woods in a recent opinion column at the Wall Street Journal basically echoed my observation, Mr. Woods wrote, ``The reality of an increasingly command-driven economy in America means that government policy is likely to become the key determinant of where investors should place their money.”

If the recent hyperactivity of the markets had been based on government policy to reflate the system, then the easiest explanation should be to attribute the recent correction as a reversal of the liquidity flows.

However, what drives such motions? Could it be that monetary inflation hasn’t kept up with present price levels? Or has present price levels been too high for monetary inflation to support?

Or could it be that governments have suddenly rediscovered sound banking, where signs of bubbles may have prompted for active strategies to ‘exit’ from the today’s policy induced liquidity environment?

Aside from Israel and Australia, which had been the early birds in raising interest rates, Brazil followed suit with capital controls to stem foreign inflows, a week earlier.

Late this week, we find an eerie coincidence of central banks in a tightening mode.

Norway was the first European country to raise interest rates Friday, while India ordered its banks to keep more of its cash funds in government bonds, last Thursday.

In addition, four of the world’s biggest central banks signaled the end or the near end of their Quantitative Easing programs.

On Friday, the Bank of Japan announced that ``it will stop buying corporate debt at the end of the year, as central banks around the world phase out emergency measures taken at the height of the financial crisis” (Bloomberg).

Also last Friday, the US Federal announced that it has ``completed its $300 billion Treasury purchase program today amid signs the seven-month buying spree helped stabilize the housing market and limited increases in borrowing costs” (Bloomberg).

In addition, likewise on Friday, a former official of the Bank of England announced a prospective downscaling of their own Quantitative Easing program, ``Former Bank of England policy maker Charles Goodhart said the bank may scale back or pause its bond- purchase program next week as officials around the world start to pull back stimulus for their economies.” (Bloomberg).

The European Central Bank wouldn’t be left behind, again on Friday, ``European Central Bank council member Axel Weber signaled the bank may start to withdraw its emergency stimulus measures next year by scaling back its “very long- term” loans to banks.” (Bloomberg)

Articles like this also published last Friday (Financial Times) exacerbated on the uncertainty brought about by the changes in the direction in global central bank policies, ``As the Federal Reserve’s programme of buying mortgage debt edges towards $1,000bn this week, investors are starting to worry about what happens once the central bank starts to slow down and exit from this key plank of its monetary easing policy.”

Of course, Friday had been catastrophic for global equity and commodity markets. And perhaps, the ensuing selling pressure from these agitations may likely spillover to the coming sessions.

However, given the latest round of triumphalism from being able to pivot or manipulate markets higher enough to project an economic recovery, global governments seem to increasingly exude confidence over their actions, so as to embark on an audacious experiment to conjointly orchestrate an apparent end to the quantitative easing programs, in order to keep a rein on asset prices from spiraling higher.

Again this is new stuff for central banking: Concerted policies are seemingly aimed at nipping an asset bubble from its bud!

Nevertheless, this lamentably reflects on the artificial nature of today’s marketplace, as it has been primarily negotiated by global political and bureaucratic authorities.

This week’s violent reaction in the marketplace following the policy signaling ploy by key central bankers seems like trial balloons to test for market reactions.

It is likely that the corresponding events may prove to be knee jerk and temporary as the overall environment remains accommodative. Perhaps, central bankers have been heeding the PIMCO’s Paul McCulley advice when he recently wrote, ``that markets can stray quite far from “fundamentally justified” values, if there is a strong belief in a friendly convention, one with staying power. And right now, that convention is a strong belief in a very friendly Fed for an extended period. Thus, the strongest case for risk assets holding their ground is, ironically, that the big-V doesn’t unfold, because if it were to unfold, it would break the comforting conventional presumption of an extended friendly Fed.”

By trying to prevent a V-shape recovery as Central Bankers appears to have done, Mr. McCulley, banking on behavioral dynamics, suggests that markets can expect more of extended friendly policies from the Fed (and from other global central banks) which should prolong the rise in asset markets.

I wouldn’t share Mr. McCulley’s confidence though. His theory discounts the Ponzi dynamics required to maintain and improve on asset pricing.

What we seems certain is that volatility risks from bi-directional interventionist policies have been reintroduced and could be the dominant theme ahead of us.

However, it is my view that the upside risks as having more weight than the downside over the longer term, because the US government will likely sustain an implied “weak” US dollar policy.

Remember, with the goal to stabilize and promote interests of the banking system, as seen from Bernanke’s doctrines, the US will likely proceed with the devaluation path in order to reduce real liabilities via inflation.

Further, the Fed will likely work on normalizing its credit system by keeping the banking system’s balance sheets afloat with elevated asset prices from which the only recourse is to inflate the asset markets.

In the interim, markets can go anywhere.

5. Nothing But A Head Fake Signaling

In the US, the so-called exit from the Quantitative Easing seems likely a head fake move.

Figure 6: T2 Partners: Woes of Mortgage Markets Still Ahead

With the risks of the next wave of resets from the Alt-A, Prime Mortgages, Commercial Real Estate Mortgages, aside from the Jumbo and HELOC looming larger [as previously discussed in Governments Will Opt For The Inflation Route] (see figure 6), they are likely to exert more pressure on the banking system.

Resets of Alt-A mortgages will crescendo until the end of 2012. And as you can see the subprime is dwarfed by risk exposures from Alt-A, Commercial and the Prime Mortgage.

In addition, commercial mortgages which has a risk exposure of around $1 trillion, is more widely held by US financial institutions.

According to Wall Street Journal, ``In contrast to home loans – the majority of which were made by only 10 or so giant institutions – thousands of small and regional banks loaded up on commercial property debt. As a result, commercial real estate troubles would be even more widespread among the financial system than the housing woes. At the present, more than 3,000 banks and savings institutions have more than 300% of their risk-based capital in commercial real-estate loans.” (emphasis added)

So the Fed’s communiqué and the real risks appear to be antithetical. One will be proven wrong very soon.

In addition, the Fed has been actively trying to expand its power which at present is being heard by the US Congress.

Moreover, worries over the politicization of the Fed as a proposed law grants veto power to the Secretary of the Treasury over Section 13(3) emergency action by the Federal Reserve Board of Governors (David Kotok).

In short, there is little indication that the Fed has embraced a tinge of sound banking. Instead, all these could be read as growing signs of the politicization of the monetary policies.

As Murray N. Rothbard in Mystery of Banking wrote, ``When expectations tip decisively over from deflationary, or steady, to inflationary, the economy enters a danger zone. The crucial question is how the government and its monetary authorities are going to react to the new situation. When prices are going up faster than the money supply, the people begin to experience a severe shortage of money, for they now face a shortage of cash balances relative to the much higher price levels. Total cash balances are no longer sufficient to carry transactions at the higher price. The people will then clamor for the government to issue more money to catch up to the higher price. If the government tightens its own belt and stops printing (or otherwise creating) new money, then inflationary expectations will eventually be reversed, and prices will fall once more—thus relieving the money shortage by lowering prices. But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to “catch up” to prices, then the country is off to the races.”

At the end of the day, the policy path appears heavily skewed towards more inflation to insure against additional losses and to safeguard against renewed disruption in the banking system.

Ron Paul On Michael Moore: Corporatism Not Capitalism Is To Blame

Congress Ron Paul responds to Michael Moore's criticism of Capitalism. (Hat tip: Marcaeld)

some noteworthy quotes...

-"it's a fallacy to say that you have a right to someone else's services...

-"you've a responsibility to take care of yourself, but you don't have a right to get something from government because government has nothing and so government has to take it from somebody and give it you, so its a failed policy, it is a form of socialism...

-"But he is complaining about it being part of capitalism, but this has nothing to do with capitalism, this is corporatism. The corporations run things, the drug corporations lobbyist, insurer's lobbyist...We have a system where money and bigness influences the government, but that's corporatism not capitalism.

-example of free market-medical tourism

-"pumping money into the system doesn't improve quality it increases prices"

-you either have government intervention to mess up the markets or you don't. You either believe in freedom and believe voluntary choices...

-"when something is free and you don't have it, it is irrelevant"

William Gross On The New Normal

Pimco's Bill Gross explains the "New Normal" at a recent CNBC interview

Stratfor Video: A Crisis in the Kremlin

Russia seems caught between the clashing interest of political interest groups and the economy.

Stratfor: "A plan to remake Russia's economy threatens to unleash political infighting in Moscow -- upsetting a balance that Prime Minister Vladimir Putin has worked to maintain. If the plan goes through, the implications for industry and investors could be profound." (Hat tip: Stratfor & John Maudlin)

This is an example of the hazards from state capitalism...

Graphics: Are We Coming Out Of Recession?

Interesting graphics from mint.com.

Although this applies more to the US more than the world.


Mint.com Personal Finance Software

"The US stock market is soaring, commodity prices are on the rise, and there are signs that consumer confidence is growing. Ask the US government if the recession is ending and you’ll hear a resounding yes as the Obama administration rushes to claim an early victory. Naysayers however point to the massive US debt and the 10% unemployment rate as signs that, even with the economic stimulus package, we still have a long way to go. Our info-graphics displays some leading economic indicators on the road to recovery."

Decoupling In Foreign Direct Investments?

In the crest of the 2008 crisis, decoupling, for the mainstream, resonated as a fantasy or myth.

Well, for us the synchronization or "recoupling" then signified more of shock or an anomaly than of a secular trend.

Again we see another sign where emerging markets appear to be diverging from advanced economies in terms of Foreign Direct Investments.

According to the Economist, ``FOREIGN direct investment inflows will barely reach $1 trillion in 2009, a decline of more than half since 2007, predicts the Economist Intelligence Unit, a sister company to The Economist. And for the first time emerging economies will attract more than half of the global total. Flows to poorer economies, especially Asian ones, are proving more resilient than flows to rich economies which are suffering the worst recession in several decades." (bold emphasis mine)

In short, secular trends appear to be overpowering interim 'crisis based' dynamics.

Creative Destruction: Newspaper Industry Headed For The Dinosaur Age?

When one or several companies of an industry are in the red financially, the losses may be attributed to the developments within the companies themselves.

However, when losses are evident on an industry scale, then the core dynamics of the industry may be in question.

This predicament currently applies to America's newspaper industry, whose survival seems threatened by the growing use of the internet for acquiring news.

Yet developments in the US could be an ominous sign for the world.

According to the Economist, ``MORE bad news for America's newspaper industry. In the six months to the end of September, daily circulation fell by 10.1% to 30.4m compared with the same period in 2008. All of the top 20 papers have seen their circulation plunge, with the exception of the Wall Street Journal. The Journal now has the biggest circulation in the country, surpassing USA Today, which suffered an enormous 17.5% drop in readership over the same period. Paying readers are now turning to the internet to get the news free." (bold highlights mine)

First, in terms of internet penetration level rates, North America appears to be the leader.

The chart above is from internetworldstats.com. In other words, perhaps the best measure for the evolving shift in the way news is being acquired would be from the world's most connected.

Next, the trend towards the internet as a source for information appears to be validated by survey.


The chart above courtesy of Pew Research.

According to a Pew report issued last December, ``Currently, 40% say they get most of their news about national and international issues from the internet, up from just 24% in September 2007. For the first time in a Pew survey, more people say they rely mostly on the internet for news than cite newspapers (35%). Television continues to be cited most frequently as a main source for national and international news, at 70%." (emphasis added)

So empirical evidence connects the cost- financial losses and the flagging usage trend of the of the news industry- to the beneficiary- the burgeoning use of the internet as a source of news.

Why this appears to be so?

Mr. Scott Bradner of Network world gives a clue, ``The three most important observations to me are that power is shifting from institutions (like newspapers) to individual journalists; that people increasingly want news "on demand" rather than scheduled, like the evening news; and that there has been a raise in importance of "minute-by-minute judgment in political journalism." These trends greatly benefit the Internet and Internet-based journalists. The latter two trends also benefit the full-time cable news channels, but only when the cable is available. And, in the office, cable is not generally available." (bold emphasis mine)

In other words, the conspicuous shift marks of a market based redistribution of power and wealth to the industry that satisfies the consumer most.

Bottom line: This seems to be a manifestation of Joseph Schumpeter's "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one" or in short, the process known as "creative destruction" at work. This phenomenon largely emanates from the competitive nature brought about by capitalism.

Iceland's Devaluation Toll: McDonald's

Recently we dealt with The Evils Of Devaluation. And Iceland should be a good example.

Last year's meltdown heavily devastated Iceland, an erstwhile prosperous nation but whose banking system recklessly engaged in intensive leveraged based speculation [see last year's post Iceland, the Next Zimbabwe? A “Riches To Rags” Tale? ]

The consequent losses in the banking system prompted Iceland's government to intervene and provide support even when there had not been enough resources to do so. This eventually took toll on its currency, the Krona.

The Krona has devalued or collapsed from 60 to around 140 (chart courtesy of ino.com).

This fueled domestic inflation even amidst a spike in unemployment.

chart courtesy of tradingeconomics.com

Nevertheless Iceland's crisis has prompted one of the world's most prolific fast food chain, McDonald's (NYSE: MCD), to withdraw.

This from Financial Times

``Iceland edged further towards the margins of the global economy on Monday when McDonald's announced the closure of its three restaurants in the crisis-hit country and said that it had no plans to return.

``The move will see Iceland, one of the world's wealthiest nations per capita until the collapse of its banking sector last year, join Albania, Armenia and Bosnia and Herzegovina in a small band of European countries without a McDonald's.

``The loss of the Golden Arches highlights the extent of Iceland's economic demise since the pre-crisis boom years when its "Viking Raider" entrepreneurs turned Reykjavik into an international finance centre and launched a buying spree of high-profile European assets."

The reason...

``McDonald's blamed the closures on the "very challenging economic climate" and the "unique operational complexity" of doing business in an island nation of just 300,000 people on the edge of the Arctic Circle.

``Most ingredients used by McDonald's in Iceland are imported from Germany - leading to a doubling in costs as the krona has collapsed while the euro has strengthened.

``Magnus Ogmundsson, managing director of Lyst, the McDonald's franchise holder in Iceland, said that price rises of at least 20 per cent were needed to produce an acceptable profit. That would have pushed the price of a Big Mac burger well above the $5.75 it costs to buy one in Switzerland, home to the world's most expensive McDonald's, according to the Big Mac index."

Of course somebody's else problem could serve as another person's solution:

It could be argued that this should be healthy as there would be less junk foods.

Or that Iceland will have to rely more on their own.

Again the FT, ``Mr Ogmundsson admitted that some customers were alarmed by the symbolism of such a recognisable brand abandoning Iceland but others have reacted positively. "People are pleased that we will be sourcing more goods locally," he says.

Overall, Icelanders would have lesser choice and diminished privileges from today's modern society. In short, Iceland's living standard has retrogressed.

Marc Faber: Dollar Will Eventually Go to Value of Zero

Here is Dr. Marc Faber's interview at the Bloomberg...



Some quotes:

"Best is to have foreign currencies and commodities but also equities that protect you to some extent as they adjust upwards as the currency goes down."

"The fiscal position of the US is a complete disaster. Eventually in ten years time, in my opinion, about 50% of tax revenues will be used to just cover the interest payments on the government debt and that is unsustainable. Then you really are forced to print money"

"Stocks don`t have a big downside risk because of the Bernanke put. As soon as the S&P drops towards 900 or 800 Bernanke will print money again, he is a money printer, he is nothing else. But he does that well - he prints well; you have to give him a medal for that..."

Basically Dr. Marc Faber's perspectives epitomizes much of what the Austrian School of Economics have been saying.

Drug Decriminalization: Regulation Versus Prohibition

Here is an interesting article on drug decriminalization from Peter Moskos at the Washington Post.

Some notes:

1. Regulation versus Prohibition

``The Dutch classify marijuana as a "soft drug," which means that, like alcohol and tobacco, it is best regulated through controlled distribution. "Hard drugs," such as cocaine and heroin, remain illegal. But personal drug use is more a health matter than an arrestable offense.

``Even the Amsterdam police want to keep the coffee shops open. "Why push drug use underground?" asked Christian Koers, the police chief responsible for Amesterdam's red-light district. "Then you cannot control it, and it becomes more popular and more dangerous. "

``This idea -- that drugs are both enjoyable and dangerous and thus better regulated than prohibited by government and sold by criminals -- seems common-sense enough, even in America. Until now, the main opposition to a state's right to legalize marijuana has been the federal government. But last week, in a major policy shift, the U.S. Justice Department instructed federal prosecutors not to focus on "individuals whose actions are in clear and unambiguous compliance with existing state laws providing for the medical use of marijuana."

2. Illegal Dealing Spawns Violence

``There is little violence surrounding the private drug trade between friends, coworkers and family members. The real drug problem, along with addictive heroin and crystal meth, is illegal public dealing. In public drug markets, signs of violence are everywhere: Intimidating groups of youths stand on corners under graffiti memorializing slain friends; addicts roam the streets and squat in vacant buildings; "decent" people stay inside when gunshots ring out in the night."

3. Addressing Crime Is Distinct From Controlling Vice

``In another neighborhood in Amsterdam, a man caught breaking into cars was released pending trial. The arresting officer returned to him, along with his shoelaces and personal property, his heroin and drug tools. I was amazed. The officer admitted he wasn't supposed to do that; heroin is illegal. But the officer had thought it through: "As soon as he runs out of his heroin, he'll break into another car to get money for his next hit."

``For the addict, the problem was drugs. But for the police officer, the problem was crime. It made no sense, the officer told me, to take the drugs and hasten the addict's next crime. The addict was not a criminal when he had drugs (beyond possessing them); he was a criminal when he didn't have drugs.

``I asked the officer if giving drugs to addicts sends the wrong message. He said his message was simple: "Stop breaking into cars!" With a subtle smirk in my direction, he added, "It is very strange that a country as violent as America is so obsessed with jailing drug addicts." Indeed, Dutch policymakers plan, regulate, fix and pragmatically debate harms and benefits. Police in the Netherlands are not involved in a drug war; they're too busy doing real police work."

4. Decriminalization Doesn't Promote Usage, Regulation Reduces Chaos

``The results are telling. In America, 37 percent of adults have tried marijuana; in the Netherlands the figure is 17 percent. Heroin usage rates are three times higher in the United States than in the Netherlands. Crystal meth, so destructive here, is almost nonexistent there. By any standard -- drug usage rates, addiction, homicides, incarceration and dollars spent -- America has lost the war on drugs.

``And just as escalating the drug war over the past three decades hasn't caused a decrease in supply and demand, there's no good reason to believe that regulating drugs instead of outlawing them would cause an increase. If it did, why are drug usage rates in the Netherlands lower? People start and stop taking drugs for many different reasons, but the law seems to be pretty low on the list. Ask yourself: Would you shoot up tomorrow if heroin were legal"

``Nobody wants a drug free-for-all; but in fact, that's what we already have in many communities. What we need is regulation. Distribution without regulation equals criminals and chaos -- what police see every day on some of our streets. People will buy drugs because they want to get high, and the question is only how and where they will buy them.

5. Learning From History

``History provides some lessons. The 21st Amendment ending Prohibition did not force anybody to drink or any city to license saloons. In 1933, after the failure to ban alcohol, the feds simply got out of the game. Today, they should do the same -- and last week the Justice Department took a very small step in the right direction."

Read the entire article here

Hat tip Mark Perry

Unintended Consequences From Europe's Agricultural Subsidy

This is another example of the unintended effects from market distorting regulations.

From the New York Times

(all bold highlights mine)

``Call it the mystery of the European sugar triangle.

``It began when Belgian customs officials examined shipping records for dozens of giant tanker trucks that outlined an odd, triangular journey across Europe. The trucks, each carrying 22 tons of liquid sugar, swung through eight nations and covered a driving distance of roughly 2,500 miles from a Belgian sugar refinery to Croatia and back — instead of taking the most direct, 900-mile route.

``Along the way the trucks made a brief stop in Kaliningrad, a grim and bustling Russian border checkpoint on the Baltic Sea.

``Suddenly the sugar triangle made sense to them. Because Russia, and not Croatia, was listed as the intended destination, the shipments qualified for valuable special payments known as export rebates from the European Union’s farm subsidy program.

``Some 200 shipments roared along this route over a three-year-period, investigators say, earning 3 million euros in refunds (about $4.5 million) for the Belgian sugar maker Beneo-Orafti. In the spring, dozens of Belgian and European investigators raided the company’s offices, freezing half of its refunds and initiating an investigation that could cost the company the remaining 1.5 million euros, and possibly more. In the sprawling European subsidy program — which lavishes more than 50 billion euros ($75 billion at current exchange rates) a year in agricultural aid — no commodity is more susceptible to fraud, chicanery and rule-bending, experts say, than simple household sugar."

Regulatory arbitrage according to wikipedia.org is "where a regulated institution takes advantage of the difference between its real (or economic) risk and the regulatory position".

Simply put, where some people try to profit from regulatory loopholes. The New York Times call this "cookie jar waiting to be pilfered"

Additional notes from the article:

-impact of price control via subsidies...

``Critics have long said that Europe’s subsidy system distorts the market, skewing competition and driving up prices. That is especially true for sugar, which in Europe has traded at roughly double the world market rate for almost two decades. European sugar prices are the highest per capita of any region in the world and about 20 percent higher than in the United States.

-failed goals

``But investigators say that fraud and rule-bending also contribute significantly to higher costs, because of the millions lost in uncollected revenue and in the payment of undeserved subsidies."

-spawns illegal activities...

``In addition, there are continuing investigations in Germany, Hungary and Belgium into cartel activity aimed at fixing prices and dividing up customers and territory."

``Perhaps the most common scheme used to game the system is to mix in cheap cane sugar from abroad with European beet sugar, which lowers production costs and increases volume. Companies doing this often falsely declare the country of origin for the sugar, which is illegal.

-producers confused with the bureaucratic maze...

``Sugar companies claim their activities are misinterpreted because they are governed by a byzantine European Union system that invites confusion. “It’s very complicated” and difficult for anyone to understand, said Dominik Risser, a spokesman for the Südzucker Group, a German company that is the industry giant in Europe and owns 40 factories in 10 nations, including those of Beneo-Orafti.

-producers or traders devise schemes to evade or circumvent regulations and taxes

``The mixing schemes extend into exotic hybrids — sugar mixed with dashes of tea and cocoa. By doing this, exporters can declare their products processed foods, and thus pay lower customs fees or avoid them altogether."

All these translates to a failure of policy or regulations.

Let me add that such distortive regulations will further put a strain on the global food supply chain as monetary stimulus from global central banks gains more traction, heightening the risks of a food crisis.

It's time to abolish such subsidies.

Graphic: World's Resources By Country

Mint.com provides a pleasant graphic on the distribution of the world's resources per country

Debating Climate Change Over Bed Time Stories

Here is the Thesis (Government advert implying deaths of family pets received many complaints from viewers-Protector1973)


Here is the Anti-Thesis (revised version Maggie's Farm)



Hat Tip: Russ Roberts Cafe Hayek

Niall Ferguson: Excessive Debt Predictor Of US Decline, China's Transitioning Role As A Rival

This interesting interview with Professor Niall Ferguson by Yahoo Tech Ticker

From Yahoo

``The U.S. is an empire in decline, according to Niall Ferguson, Harvard professor and author of The Ascent of Money.

"People have predicted the end of America in the past and been wrong," Ferguson concedes. "But let's face it: If you're trying to borrow $9 trillion to save your financial system...and already half your public debt held by foreigners, it's not really the conduct of rising empires, is it?"

Given its massive deficits and overseas military adventures, America today is similar to the Spanish Empire in the 17th century and Britain's in the 20th, he says. "Excessive debt is usually a predictor of subsequent trouble."

Putting a finer point on it, Ferguson says America today is comparable to Britain circa 1900: a dominant empire underestimating the rise of a new power. In Britain's case back then it was Germany; in America's case today, it's China.

"When China's economy is equal in size to that of the U.S., which could come as early as 2027...it means China becomes not only a major economic competitor - it's that already, it then becomes a diplomatic competitor and a military competitor," the history professor declares.

The most obvious sign of this is China's major naval construction program, featuring next generation submarines and up to three aircraft carriers, Ferguson says. "There's no other way of interpreting this than as a challenge to the hegemony of the U.S. in the Asia-Pacific region."

As to analysts like Stratfor's George Friedman, who downplay China's naval ambitions, Ferguson notes British experts - including Winston Churchill - were similarly complacent about Germany at the dawn of the 20th century.

"I'm not predicting World War III but we have to recognize...China is becoming more assertive, a rival not a partner," he says, adding that China's navy doesn't have to be as large as America's to pose a problem. "They don't have to have an equally large navy, just big enough to pose a strategic threat [and] cause trouble" for the U.S. Navy."

Additional noteworthy quotes:

“Excessive debt is usually a predictor of subsequent trouble”

“The more debt you have the more interest payments you have to make especially if interest rates move up”

On military: “They [China-mine] don’t have to catch up… they just have to have a big enough…to pose a strategic threat… can you handle two major challenges [debt and geopolitics-mine] simultaneously?”

My notes and comments:

-Interest payment burdens alone can translate to a self fulfilling prophecy for the US empire's decline

-Professor Ferguson comments that as China’s economy grows to reach parity with US, the character of relationship will transition from today's partnership to one of rivalry, i.e. from economic, to diplomatic, to military and to the naval sphere.

-The Soviet Union never rose to the occasion to challenge the US in terms of matching economic growth and military power.

-China's military doesn't have to reach the scalability of the US, it only needs to reach a critical mass to pose a serious threat.

-Besides, the US will be challenged by fighting its inner demons aside from coping with evolving realities of geopolitics.

The Evils Of Devaluation

``The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation's welfare.”-Ludwig von Mises, The Objectives of Currency Devaluation, Human Action, Chapter 31

Policies can be said to be socially beneficial if gains exceed the costs.

By such measure we can say that devaluation, as seen by some as a necessary evil, is nothing but an illusion.

How? Because devaluation:

1. Undermines the role of the US dollar as international currency reserve.

The role of the US dollar as the world’s currency reserve is to provide the medium of exchange function not only for national use but for the global economy. This means that the main channel of providing liquidity for international exchange is to have strong (overvalued) currency that imports more than it exports. By expanding current account deficits, the US finances global transactions mostly invoiced in US dollars.

However once the US dollar reaches a point where deficits would be vented on the currency, the role of the US dollar as the sole international currency reserve may be in danger.

The global central bank holdings of US dollar have reportedly been down to about 62% from over 70% during the past years. Moreover, as discussed in What Global Financial Markets Seem To Be Telling Us, the clamor to replace the US dollar standard has been getting strident.

Last week, a Latin American trade bloc of 9 members, the Bolivarian Alternative for the Americas (ALBA) declared that it would cease using the US dollar for regional commerce next year (Chosun English).

All these means that if the US continues to devalue its dollar, to point of losing its privileges from international seignorage [net revenue derived from issuing currency], or its international currency reserve status, this would translate to diminished access to global finance to fund domestic (trade or fiscal) deficits, reduced access to more goods and services worldwide, and a diluted leverage on the geopolitical sphere.

In short, the cost of devaluation greatly overwhelms the alleged benefits.

2. Overestimates the role of international trade as the share of the US economy.

One of the mainstream reductio ad absurdum is to overemphasize or, on the other hand understate, the role of global trade in the US economy, depending on the bias of the commentator.

For instance, some deflation proponents use 13% of import share to the US economy as rationale to downplay the transmission mechanism of global inflation to the US economy.

Using the data from wikipedia.com, we note that exports account for only 9% ($1.283 2008) of the US economy ($14.441 trillion 2008) while imports account for 15% ($2.115 trillion). The point is international trade accounts only one fourth of the US economy.

Yet common sense tells us that policies that allegedly promote 9% (exports) of the US economy at the expense of 91%, which is deemed by some as being net beneficial to the economy, is deceiving oneself or is consumed by political or economic ideological blindness, or is totally ignorant of the tradeoffs of the cost and benefits from said policies or is extending the intoxicating influence of political propaganda.

3. Creates Systemic Inflation Which Overwhelms Advantages From Currency Depreciation

When governments decide to devalue, it embarks on credit expansion or conduct fiscal spending or other monetary tools or a combination of these policies, in support of special interest groups, as in the case of the US, the banking system (for media, the exporters) for a specific goal (debt repudiation or promotion of exports/tourism).

This in essence would lead to a redirection of investments or a diversion of real resources from other activities.

If the currency depreciates as a result of the government actions but the impact of which does not reflect on domestic prices, then the interest groups supported by such policies or those that engage in foreign currency exchange or trade will likely incur large profits.

However, once prices adjust to manifest the impact of the currency depreciation on imports and to producer and consumer goods, then the short term advantage erodes.

According to Dr. Frank Shostak, ``the so-called improved competitiveness on account of currency depreciation means that the citizens of a country are now getting less real imports for a given amount of real exports. In short, while the country is getting rich in terms of foreign currency, it is getting poor in terms of real wealth, i.e., in terms of the goods and services required for maintaining peoples' life and well-beings. As time goes by however, the effects of loose monetary policy filters through a broad spectrum of prices of goods and services and ultimately undermine exporters profits. In short, a rise in prices puts to an end the illusory attempt to create economic prosperity out of thin air.” (bold emphasis added)

In short, the beneficial impact of devaluation to certain groups will likely be short term and will eventually be offset by inflation.

4. Neglects The Role of Division Of Labor In Terms Of Imports and Exports

Adding to the fallaciously oversimplistic methodology by which mainstream seem to look at the world as operating from a homogeneous form of capital, whose product is produced by a single type of labor and sold as one dimensional product to an indiscriminate market affected by the same degree of price sensitivity, they also seem to think that exports have little correlation to imports, whereby final product sold abroad are all locally designed or processed- raw material sourcing, assembly, manufacturing, packaging, testing and etc...

The mainstream forgets about re-exports or imports of semi assembled products, parts or components that make up another product to be re-exported.

Applied to Asia, global parts and component trades have increasingly made up manufacturing output (see figure 3)

Figure 3: ADB: Emerging Asian Regionalism

To quote the ADB, ``In Integrating Asia, the share of parts and components trade (PCT) in manufacturing trade shot up from 24.3% in 1996 to 29.4% in 2006. That is a remarkable rise, not least since worldwide its share has scarcely increased, edging up from 19.6% to 20.2% over the same period.

``As a share of GDP, PCT is among the highest in the world in the ASEAN (especially in Malaysia, the Philippines, Singapore, and Thailand) and in Taipei,China, perhaps because the relatively small size of their economies makes specializing in small niches of comparative advantage particularly important. Broadly speaking, the success of these economies is based on policies that welcome foreign companies, encourage technological upgrading, and build strong connections with world markets, as well as on their proximity to Asian neighbors following similar strategies. PCT is particularly significant among ASEAN countries: it rose from an average of 35% of manufacturing trade in 1996 to 43% in 2006. The PCT share in the PRC nearly doubled over the same period, from 12.5% to 24.0%, while in India it remained at around 10.0%.” (bold emphasis mine)

In short, in a world where the integration of the global economy has been deepening to reflect on the specialization or division of labor, imports has significantly contributed to manufactured products which are eventually re-exported. Such trade specialization constitutes as the lengthening of the economic structure.

Figure 4: ADB: How A Typical Hard Drive Is Produced

As an example, the ADB shows how Asia’s parts and component trade (PCT) for a hard disk drive, assembled in Thailand, is networked within Asia and partly outside the region. And that’s merely for a hard disk, which also is only a component for a computer set.

So currency prices haven’t been the only factor that shapes production, but importantly trade openness, comparative advantages, division of labor and variability of markets as the ADB points out.

Here, globalization reveals that the division of labor and comparative advantage has been more than just “ideal” or “theoretical”. Instead, these economic forces depict of its pervasiveness in the global economic capital construct. They have even proven to be a more potent force than simply acquiring market share via currency price adjustments.

Talk about a genuine multiplier effect from free trade!

5. Overlooks On The Role of Societal Transition

One of the reasons why many support the government’s devaluation policies has been underpinned by concerns that US manufacturing output as a share of GDP has been declining.

The misimpression is that jobs have been exported out to third world countries.

Again, mainstream myopia which only looks at the surface sees jobs as one dimensional in nature. Their highly mechanistic viewpoint can’t seem to distinguish between low-scale low-value highly-commoditized jobs vis-à-vis high value specialized jobs or can’t seem to comprehend or digest the role of comparative advantage and specialization or division of labor in a world which practices globalization or freer trade.

The US supposedly is the premiere representative of the world’s democratic capitalism which implies that she has once been the world’s freest economy. Yet it is when an economy is economically free or open to trade that the advantages of comparative advantage and specialization can be seen and felt most.

For instance: in the 2008 capital goods accounted for the top US exports, according to US Department of Commerce, International Trade Administration, ``Capital goods represent the largest goods export category (end-use) for the U.S. with $469.5 billion worth of exports in 2008. The U.S. trade surplus in capital goods rose $12.8 billion to reach $15.7 billion in 2008, up from a surplus of $2.9 billion in 2007.”

On the other hand, top imports for 2008 crude oil, passenger cars, medicinal preparation, automotive accessories, other household goods, computer accessories, petroleum products, cotton apparel, telecom and video equipments (world’s richest countries). This means that aside from final consumption goods, the US imports parts and components for assembly or re-exports as well as raw materials.

The other way to look at this is that the US sells goods or services which reflect on its advance “technology age” state (capital goods) while buying input goods for reprocessing or commoditized goods for the end user.

Simply said, if the world has evolved from the agricultural era (agricultural economy) to the industrial era (manufacturing economy), then we are presently in a transition towards the information age or the post industrial society as identified by Alvin Toffler in his Third Wave Theory.

This means that the lengthening or expanding phase of an economy’s capital structure in an information age extrapolates to a bigger share of contribution from information and technology based goods and services relative to the overall economy.

As much as the share of output in agriculture shrank relative to the overall economy during the industrial era, today’s modern economy should see a smaller or declining contribution from the vestiges of the agricultural and the industrial output relative to economy.

Figure 5: Carpe Diem: Manufacturing Output and Productivity at Record Highs

Nevertheless, contrary to mainstream’s fanatical obduracy, US manufacturing in terms of productivity is at a record high (left window).

Moreover, while manufacturing jobs have been on a decline to reflect on productivity gains (right window), it is only during the last year’s recession where a drop of manufacturing output from record highs occurred. Still yet, all these, signify the advancement and not retrenchment of US manufacturing at the present state.

As University of Michigan’s Professor Mark Perry recently observed, ``More and more manufacturing output with fewer and fewer workers should be considered a positive trend for the U.S. economy, not a negative development. We should think of it the same way as the trend in farming over the last 150 years - we're much better off as a country, with a much higher standard of living, with 3% of Americans working on farms compared to 150 years ago when about 65% of Americans toiled on farms. If we can continue to produce more manufacturing output with fewer workers, we'll be better off as a country, not worse off.” (bold highlights mine)

So anyone who expects a return of the conditions of the industrial manufacturing age in today’s post industrial society simply suggest of the curtailment of progress or a throwback in time similar to Argentina in the 1930s or is against human progress.

And to adopt a protectionist economy combined with massive devaluation, which likewise signifies fear of competition, is a sure route towards decadence.

6. Promotes Capital Flight

Mainstream outlook seem to discern people as irresponsive to the incentives provided for by the governing circumstances. They haughtily presume of better intelligence than most of the society. While they could be somewhat correct, in terms of information (and not knowledge), we know that macro thinking is a poor substitute to the knowledge of F.A. Hayek’s “man-on-spot”.

This implies that when major policies which tend to have a momentous impact on society are undertaken, people consequently will respond in accordance to how such policies are transmitted into their respective fields or industries. In other words, in the marketplace a micro outlook is fundamentally superior than a presumptive model based macro analysis.

And devaluation policies would likely have an unintended effect: capital flight!

While there will be some sectors or interest groups that would benefit from a reconfiguration of investment flows, the alternative bet would be for capital to flow out of the country which have been engaged in policy devaluation and flow into assets of foreign currencies which have not or to real assets.

Economist David Malpass, a columnist at Forbes magazine, recently wrote an incisive article articulating how capital flight will subdue any tinge of benefits from devaluation.

Mr. Malpass wrote, ``Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin's Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs. The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity. China is doing the same now. It watches in chagrin as the U.S. pleads with it to strengthen the yuan, adding productivity fast with the dollars rushing its way in search of currency stability” (bold emphasis mine)

Figure 6: Casey Research: Drumbeats For The US Dollar

Systemic inflation aggravated by capital flight is likely to overwhelm any purported gains from devaluation.

Currently, foreign flows into the US by both private and official sectors appear to be in a swan dive as the interest to own US securities have evaporated (see figure 6).

If capital flight from US residents and foreigners snowball into a tsunami, then the risks of exchange controls could be in the horizon.

This would be different from the recent capital controls imposed by Brazil, which uncannily slapped a 2% tax on foreign capital flows into fixed income and the stock market (Bloomberg). Such unorthodox move was meant to stem the tide of capital inflows where the Brazilian government deems the recent surge of the real and its stock market as indications of a seminal bubble.

Conventionally, capital controls are instituted to curb capital from stampeding out of a national economy or from the region.

Applied to the Asian financial crisis of 1997 which had been largely blamed by the domestic officialdom on speculative hedge funds, Joe Studwell in Asian Godfathers, Money and Power in Hong Kong and Southeast Asia argue that local tycoons were more culpable, ``An enquiry after the crisis found little evidence that hedge funds and other leverage investors played a significant role. There was widespread in the region of massive capital flight orchestrated by local tycoons; but Singaporean and Hong Kong banking secrecy is such that this is impossible to quantify.”

Exchange controls only serve to appropriate the properties of its constituents and of foreigners. By adopting a close door policy in finance and trade, the impact would be to dramatically increase the risk profile of a country. This should translate to a reduction of wealth via a markdown on assets as investors will pay less to own income flows or property or demand higher premium than where there is full convertibility of the currency.

The bottom line is present policies aimed at attenuating the US dollar risks not only capital flight from foreigners but also from local residents.

7. Raises The Risks Of Global Currency War

The perils of using models for prediction would be the assumption that conditions of the past have similar dynamics today. For instance, when Fed Chair Ben Bernanke used the Great Depression as paradigm for measuring the success of devaluation, he probably assumes that the US dollar today can devalue against other currencies without much resistance or would be cordially tolerated by other central bankers.

This would be highly presumptuous.

During the Great Depression, the US managed to devalue because it operated under a gold standard. President Franklin D. Roosevelt’s EO 6102 basically confiscated gold from every Americans in 1933 from which gold’s role as the public’s medium of exchange had been indefinitely suspended.

Since President Richard Nixon closed the Bretton Woods standard in 1971, otherwise known as the Nixon shock, the US dollar has assumed the role of gold as transaction currency for international exchange and as anchor reserve currency for global central banks.

Compared to gold based notes whose rate of issuance would depend on the rate of output from extracting gold from the ground, which is vastly limited due to the high cost and the attendant risks from mining, should the US decide to massively devalue, it could easily facilitate these using the Federal Reserve’s printing press or the technology enhanced digital press. Yet this would impact fundamentally all currencies, given its role as the world’s foreign reserve currency.

To consider according to wikipedia.org, 14 countries are unofficial users of the US dollar or has a dollarized economy. In addition, 23 countries are pegged to the US dollar. If the US dollar continues with its descent in response to the prevailing policy actions, then basically all 37 countries will be importing inflation from the US. Yet, their economies haven’t been afflicted by the same debt woes.

This may lead to a supply shock, where massive waves of money will be chasing after scarce supply of real goods or property.

Moreover, one can’t discount that the other central bankers may not be as cordial or as permissive as Ben Bernanke expects them to be and might attempt to counteract the US devaluation policies by arbitrarily conducting their own currency weakening process.

At the end of the day, if more and more government hops into the devaluation bandwagon then we could countenance a global currency war. And a global currency war risks a horrendous hyperinflation on a worldwide scale.

Ludwig von Mises has admonished us on the possibility of such risks, ``If one looks at devaluation not with the eyes of an apologist of government and union policies, but with the eyes of an economist, one must first of all stress the point that all its alleged blessings are temporary only. Moreover, they depend on the condition that only one country devalues while the other countries abstain from devaluing their own currencies. If the other countries devalue in the same proportion, no changes in foreign trade appear. If they devalue to a greater extent, all these transitory blessings, whatever they may be, favor them exclusively. A general acceptance of the principles of the flexible standard must therefore result in a race between the nations to outbid one another. At the end of this competition is the complete destruction of all nations' monetary systems.” (bold emphasis mine)

Devaluation is a risk endeavor which US policymakers appear likely to undertake (or in my view “gamble on”) in order to neutralize the impact from an unmanageable debt burden plaguing its system.

And this has been cheered upon by their exponents. Yet given the above, it would seem that policymakers and their cheerleaders don’t truly have the necessary understanding or comprehension of the risks involved or has vastly underestimated them.

Devaluation isn’t a necessary evil. Devaluation can take the form of the inflation demon, from which having emerged from the inferno, may wreak more systemic havoc than expected. After all, in the context of history, devaluations have been the seeds to the extinction of currencies. This time may not be different.