``But the administration does not want to stop inflation. It does not want to endanger its popularity with the voters by collecting, through taxation, all it wants to spend. It prefers to mislead the people by resorting to the seemingly non-onerous method of increasing the supply of money and credit. Yet, whatever system of financing may be adopted, whether taxation, borrowing, or inflation, the full incidence of the government's expenditures must fall upon the public. With inflation as well as with taxation, it is the citizens who must foot the total bill. The distinguishing mark of inflation, when considered as a method of filling the vaults of the Treasury, is that it distributes the burden in a most unfair way, overcharging those who are least able to bear it.”-Ludwig von Mises The Truth About Inflation
The Dubai Bugaboo
The recommendations of most of the local institutional analysts quoted in the media at the start of this abbreviated week had mostly been bearish. And if anyone did heed on their calls they would have regrettably stampeded out of the market for the wrong reasons. That’s because these analysts have interpreted the initial shock waves from the Dubai Crisis as having a lasting impact. Their fundamental premise: Dubai’s adverse effect on the OFW market.
I find it peculiar to read highly paid analysts to babble on false causalities based on spurious evidence. I guess they are paid not to be “right” or “profitable” instead they are there to say what people would like to hear, or to confirm on other people’s biases. Well one doesn’t need to be an “expert” (CFA) to employ “available bias”- or the fallacy of attaching recent events to market actions.
As discussed in Why Dubai’s Debt Crisis Isn’t Likely THE Next Lehman, the Dubai Debt Crisis seems to validate our outlook, which we deduced as more influenced by politics than by plain vanilla economics.
“A political struggle going on” says this New York Times article, “Analysts say Abu Dhabi has long been unhappy with Dubai’s independent, free-spending ways — and its strong trade links with Iran, which sits just across the Persian Gulf but is considered an enemy by most Sunni Arab states.” (bold highlight mine)
This from Oxford Analytica as quoted by Research Recap, ``OxAn suggests payoffs for Abu Dhabi’s bailout might be on a political level rather than commercial via, for example, a stake in Emirates Airlines: -Abu Dhabi could demand a strengthening of federal authorities, while Dubai would need to relinquish certain sovereign rights, such as the control of customs, which so far remain at the level of individual emirates. -Hints at increased centralisation are already discernible, with Abu Dhabi and federal institutions playing a more visible role in national development policy and Sheikh Mohammed increasingly appearing in his role as prime minister of the United Arab Emirates (UAE) rather than as ruler of Dubai. -In particular, centralised control of customs — in exchange for financial help — would give Abu Dhabi a firmer grip on the implementation of sanctions policies against Iran, which has been repeatedly demanded by Washington in the past. Such a move would also serve its own tough stance with regard to the regional ambitions of Iran. Interestingly, despite the blow Dubai has taken as a financial center, OxAn thinks that more regulation of capital markets, and a unification of the stock markets in Dubai and Abu Dhabi, could strengthen the position of the UAE as a niche player in international capital markets.” (bold emphasis mine)
Moreover, in addition to last week’s argument, Dubai accounts for only 26% of the UAE’s GDP (2006) with Dubai’s share of gas revenues at only 2% (wikipedia.org).
Besides, even if we tally up the remittance data, the entire Middle East accounts for only 15% of the global share (see figure 2)
Figure 2: POEA: OFW Remittances By Origin
In addition, in contrast to conventional expectations, the UAE registered the largest growth in OFW deployment in terms of new hires and rehires, in spite of the crisis year of 2008 (60.6%). UAE is followed by Qatar 49.9% and Canada 40.5% according to the POEA.
This means that to lump the Dubai Debt woes to UAE or to other Middle East countries would be terribly shortsighted and account for sloppy analysis.
Philippine Peso A Manifestation Of Global Inflationism
Besides since mainstream associates the price direction of the Philippine Peso with that of remittances, this week’s fantastic 2.55% jump of the Peso to Php 46 vis-à-vis US dollar implies that the Dubai Credit Crisis has been a discounted factor.
If indeed the Peso has a strong correlation with that of remittances then the Peso should fall and not firm up. However, we don’t subscribe to the mainstream view that the Philippine Peso is entirely about remittances [as discussed in Claims Of The Peso’s Dutch Disease Is A Symptom Of Political Hysteria or in What Media Didn’t Tell About the Peso].
Figure 3: Phisix-Peso Correlation
In spite of the 2008 crisis, the growth in OFW remittances accelerated by 13.7% (Inquirer.net), yet the Peso fell by a staggering 19% from around 40.5 to 50 (see figure 2 left scale, line chart)…so much for specious mainstream reasoning.
In contrast the Philippine Peso has mainly manifested the state of global liquidity flows during both the crisis and post crisis period. And this can clearly be seen in the Phisix-Peso chart.
The correlation between the Philippine Peso and the Phisix (black candlestick) may not be precise but the general trend is quite observable.
During the bear market of the Phisix from October 2007 to October 2008 (red descending line), the Peso likewise fell (red ascending line). Notice that the inflection point of the Peso (left blue arrow pointed up) lagged the Phisix (left blue arrow pointed down) by about 3 months.
We see the same motion during the last turning point.
As the Phisix bottomed in October of 2008, the Peso belatedly bottomed about a month after. From then, both the Phisix and the Peso has strengthened. The recent breakout of the Peso even came amidst repeated interventions by the Bangko Sentral ng Pilipinas (BSP) or the Philippine central bank to subdue the Peso’s rise aimed at promoting the mercantilist perspective of protecting exports and enhancing the purchasing power of the OFW.
Of course it is pretty naïve and myopic for our officials or mainstream “Keynesian” experts to oversimplistically associate weak currency with stronger exports or with expanded purchasing power for the OFWs. That’s because theory and experience tells us that this is NOT true.
Whatever the gains from inflating the system to weaken a currency will always be temporary, that’s because inflationism results to a lower standard of living, capital outflows and a lower purchasing power of the currency will offset any short term gains [as discussed in The Evils Of Devaluation].
Besides, inflationism only distorts a nation’s production structure that would benefit a few at the expense of the rest of society (see Joe Studwell exegesis below)
The Peso fell from Php 2 during the 60s to Php 55 in 2005 and still lags in terms of goods and service exports relative to its neighbors. Instead of goods exports, we became a major exporter of manpower, of course with the attendant social costs.
Why the Philippines failed to become an export giant? Primarily, because of the anti-market policies that protected the interests of the political and economic elite.
Joe Studwell in Asian Godfathers explains (all bold emphasis mine): ``The reaction of local business to the multinational exporters, welcomed back so soon after foreign enterprises that grew up in the colonial era had been kicked or bought out, is telling. Small firms found innumerable opportunities supplying parts and components and services to multinational investors. But their ability to move up the value chain was inhibited by a lack of scale that left them without resources for research and development. Tycoons, on the other hand, had scale and access to capital, but were rarely interested in working in the export sector. The reason is simple. Exporting is a globally competitive business. Where the godfathers outperformed was in trading on the inefficiencies of south-east Asia’s domestic economies, whether in the form of politicians’ willingness to disburse monopolistic concessions on the basis of personal relations or through the profits to be made when governments tried to micromanage industrial development. For tycoons, the benefit of EOI (Export Oriented Industrialization) was significant but indirect: the growth produced underwrote the continued relationship between political and economic elites and eased pressure for deregulation of domestic economies. Public work projects without tenders, and privatizations decided behind closed doors, where politically much more feasible when exports were driving the growth in the south-east Asian economy.”
In short, another evil promoted by inflationism is the economic fascism brought upon by complicit crony-state capitalism.
So while we can usher in a new popular president, unless the anti-market structures are dismantled, we ain’t gonna see much of an improvement on the political economic spectrum. Populist policies are likely to harm than aid the plight of Filipinos.
Instead of an organic growth, the Philippine economy will be dependent on the tidal flows that accrue to its neighbors and the impact of policies to imbue more debt.
Asian Outperformance and Path Dependency
It would also be fundamentally incorrect to suggest that the Asia can’t benefit from a policy based bubble cycle despite the slack from developed economies.
That would translate to “anchoring” or the reading past performances or interpreting past models as tomorrow’s dynamics.
Fundamentally Asia has led the world out of recession see figure 4. China and the rest of Asia have massively outperformed the developed country economies. As we wrote in Following The Money Trail: Inflation A Key Theme For 2010, ¾ of the economic losses of US, Europe and Japan in 2008 to the tune of $580 billion have been offset by China’s $450 billion growth. And we are seeing this outpeformance in Industrial production and domestic retail sales.
That’s basically because of low systemic leverage, high savings rate, unimpaired banking system, current account surpluses, a trend towards deepening regionalization and integration with the world economy.
Moreover, because of these inherent advantages, aside from fundamentally pegged currencies (by varying degrees) on the US dollar, monetary policies of the US are being transmitted to Asia.
As David Malpass rightly argues against zero interest rates in an article at the Wall Street Journal,
(all bold underscore mine),
``The irony of the zero-rate policy, coupled with Washington's preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home. For gold and oil, the low-rate policy works, weakening the dollar so commodity prices go up and providing traders with ample funds to buy into the expanding bubble. Those markets are almost daring the Fed to try to break out of its zero-rate box….
``According to International Monetary Fund data, U.S. GDP has fallen to 24% of world GDP from 32% in 2001. And as U.S. capital escapes the weak dollar and high tax rates, the U.S. share of world equity market capitalization has fallen to 30% from 45%. This leaves the U.S. alone with Japan at the bottom of the monetary heap, with rate expectations so low they repel investment.”
Hence, US policies combined with local policies have generated significant traction. This we believe is the trigger for the policy induced Asian-emerging markets business cycle or boom-bust cycle.
Proof?
In the Philippines, the following are headlines from our Bangko Sentral ng Pilipinas: Automobile Loans Up by 5.1 Percent From Last Quarter, Credit Card Receivables Up By 4.6 Percent From Year Ago, Residential Real Estate Loans Stand at P162.5 Billion in Q3 (down 1.4% over the quarter but up 13.1% from last year), Other Consumer Loans Stood at P36.7 Billion in Q3 (down 2.6% from last quarter but up 12.8% from a year ago) and November Inflation at 2.8 Percent.
In short, systemic leverage has gradually been picking up in response to these policies.
True, markets may not move linearly but policies to reflate the system has clearly shown divergent impact on individual economies and in the marketplace. This implies that trying to read economic dynamics as one size fits all is virtually flawed.
What ailed the US in the Bear Stearns-Lehman episode in 2008 isn’t likely to be repeated soon. That’s because policy makers are likely to engage in path dependency as guiding principle for their decisions.
Path Dependence according to wikipedia.org is a ``set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant”. Bank Of Japan’s decision to implement a new QE program is a testament of this- due to the alleged fear of systemic deflation, the applied solution stems from the apparent triumphalism from the recent money printing nostrum utilized by their peers.
In other words, policy approach has all been directed to combat another Stearns Lehman episode at a future unseen cost. That’s why tunneling on a deflation scenario won’t be advisable.
This also means we should understand the political incentives guiding the actions of the political and bureaucratic leaders to address financial and economic issues than simply analyzing economics exclusive of political goals. For instance, as discussed in 5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects, we identified why the US banking system has been in a US government guided therapy known as the ``bank as trader” model.
Conclusion
To recap, the Dubai debt crisis as an issue to be bearish would be a mistake. There are larger factors that affect the markets or even the Philippine Peso such as the cocktail mix of the US government monetary policies, local policies and intrinsic idiosyncratic traits for each economy.
Moreover, in contrast to conventional wisdom, remittances essentially have not been the prime factor that drives the direction of the Peso’s pricing levels. Instead the Peso has reflected on the policy induced decline in the US dollar, which is a manifestation of global liquidity. That’s the reason the Peso and the Phisix has had a strong correlation.
Although the Peso has been mostly a lagging indicator relative to the Phisix, the recent breakout of the Peso should augur well for the Phisix.
Finally, path dependency will likely guide the actions of policymakers. That’s why we view a Bear Sterns-Lehman episode of 2008, which caused a seizure in the US banking system, as lesser risks in contrast to a spike in inflation. In other words, governments are likely to engage in sustained inflationism.
The effect of inflationism will ultimately be unraveled but like all business cycles, this takes time and massive “clustering” misallocation of resources. Eventually, in spite of government actions, the marketplace will manifest on such strains.
For the meantime, inflationism appears to be in a sweetspot.
The Peso and the Phisix is likely to resume its ascent in 2010, with the latter likely to breach its old highs and may even attempt to reach the 5,000 level.
