Poker Bluff: The Exit Strategy Theme For 2010

Many have used the strong showing of 2009 to advert that 2010 would be the year of “exits”. I don't buy it.

As in the game of poker, I’d call this equivalent to a policymaker’s Poker bluff.

Clear Divergence: Periphery Versus Core

This ‘exit strategy’ may be probably ring true for many emerging markets whose economies have been more responsive to the hodgepodge of policies designed to cushion the economies from downside volatility.

Again, the wide variance of performances of emerging markets relative to advanced economies validates our theory since the peak of the crisis where each nations would respond differently to the near uniform set of policies adopted, leading to divergent market and economic results.

And such patent discrepancies have led to earlier tightening policies of some nations. According to the Businessweek, ``Since Nov. 30, the central banks of Australia, Vietnam, Norway and Israel have raised interest rates, and signs the global recession is ending have spurred speculation the U.S. Federal Reserve will follow this year.”

On Thursday, China joined the roster of countries engaged in a rollback of easy money policies, the Businessweek quotes the Bloomberg, ``China's move to raise the cost of three-month bills will probably lead to the nation's first interest-rate increase in almost three years by September, a survey of economists showed.”

Figure 2: Economist: Decoupling in Government Debt and Growth

The Economist says that a major source of this growth discrepancy will likely emanate from the PONZI scheme employed by major economies to substitute lost ‘aggregate’ demand with leverage incurred by government to spur this ‘demand’.

From the Economist, ``Advanced economies, which aggressively stimulated demand and are forecast to experience weak GDP growth next year, contrast starkly with the G20’s developing countries. After some gentle fiscal stimulus, these countries are on track for strong growth next year. The IMF forecasts that gross government debt among advanced economies will continue to rise until 2014, reaching 114% of GDP, compared to just 35% for developing nations. With governments struggling to rein in their finances, rating agencies are becoming increasingly twitchy; rich countries such as America and Britain are fearful of losing their hallowed triple-A status.” (all bold highlights mine)

Of course there are many other reasons to suggest why emerging markets seem to be on a secular trend to play catch up with advanced economies, particularly positive demographic trend, urbanization, high savings rate, low debt or systemic leverage, unimpaired banking system, rising middle class and most importantly a trend towards embracing economic freedom via more freer trade, investments, financial and migration flows [e.g. see Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone]

However the more important factor revealed by the Economist in the terse article above is that the debt onus for advanced economies implies low productivity, cost of crowding out private investments, larger tax burden, greater risks of escalating consumer prices, higher than average unemployment rate, greater cost of financing debt, heightened sovereign risk premia and fiscal austerity measures that may entail a higher degree of political volatility.

Harvard’s Carmen Reinhart and Kenneth Rogoff seconds this view in a recent study,

``Our main finding is that across both advanced countries and 23 emerging markets, high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes. In addition, for emerging markets, there appears to be a more stringent threshold for total external debt/GDP (60 percent), that is also associated with adverse outcomes for growth. Seldom do countries simply “grow” their way out of deep debt burdens.”

Alternatively, this also raises the risks of an implosion in the fast emerging government debt bubble, which we will call as the Keynesian Debt Crisis-(since most of these debts were acquired in the context of the Keynesian ideology), one of the risks that could spoil our fun in 2010.

Nearly 90% of the world’s bond markets have been denominated in these four major currencies (Ivy Global Bond): the US dollar, the Japanese yen, British pound, dollar, and the euro.

This means that even if many emerging markets will tighten, it is the policies from the advanced economies that will likely have a greater impact on global capital flows.

And it is why we hypothesize that even if global policymakers pay lip service to the so-called “exit strategies”, what truly matters will be the policy actions by authorities in the face of the evolving activities in the marketplace, the real and the political economy.

Hence, it would be an immense mistake to parse on a single variable, e.g. unemployment, when there would be sundry factors in determining political action.

In other words, this means deducing political and economic persuasions or ideology of the incumbent officials, interpreting their underlying cognitive biases based on their speeches, interviews or official pronouncements, analyzing their interpretation of events and lastly appraising on the political influences of certain interest groups that may determine the prospective actions of policymakers.

The Underlying Incentives Of The Poker Bluff

So what factors could likely determine the direction of policy actions?

Interest Rate Derivatives. One must realize of the extent of sensitivity of global asset values are to interest rates.

Figure 3: BIS: Composition Of Global Derivatives

Interest rate derivatives account about 72% or $437 trillion of the notional $605 trillion as of June of 2009 according to the Bank of International Settlements.

Any unexpected volatility from so-called monetary rollback could amplify the risks of unnerving the markets. Thereby, policymakers would likely remain supportive of unorthodox actions like Quantitative Easing.

Hence, we see the recent measures by the Bank of Japan to impose their version of Quantitative Easing last December has catapulted the Nikkei to outperform [see The US Federal Reserve Experiments On Unwinding Stimulus As Bank Of Japan Engages in QE]. In addition, the Bank Of England remains with on track with its ₤ 190 billion of asset purchases and which is likely to increase to ₤ 200 billion (Edmund Conway, Telegraph) and possibly more.

Expanding GSE Operations. In the US, a day before Christmas eve, as everyone had been partying, the US government via the US Treasury stealthily lifted its financing cap on the Government Sponsored Enterprise of Fannie Mae (FNM) and Freddie Mac (FRE) [Wall Street Journal].

Essentially, this places the GSE debt on the US balance sheets, which technically has been operating on “implied” guarantees. Some analysts see that the ambiguity of the US position has led to foreigners to become risk-averse and avoid purchases of these securities.

Hence, the US treasury hopes that by making “implicit” guarantees as “explicit”, it would reduce the pressure on US Fed to bolster the US housing market via Quantitative Easing, and make GSE assets more attractive.

Remember about 9 out of 10 mortgages transacted today have been consummated by these GSE entities, thereby by opening the checkbook to absorb more tainted assets and in the absence of the resumption of foreign interests, the alternative view is that the Fed could increase its scope of quantitative easing programs.

Of course by incorporating the aforementioned GSE debt on the US balance sheets, recorded US liabilities will rise and exert pressures on its sovereign credit ratings.

The point is, US housing market, even faced with some semblance of recovery, remains heavily sensitive to interest rates movement which will likely compel authorities to tweak with financial markets and remain policy easy.

Policymaker’s Economic Ideology. Ben Bernanke is known as an expert of the Great Depression from which his views on monetary policy has been oriented towards the Milton Friedman model, i.e. to provide generous liquidity during an economic recession. The illustrious Mr. Milton Friedman in an interview with Radio Australia said, ``So in our opinion, the Great Depression was not a sign of the failure of monetary policy or a result of the failure of the market system as was widely interpreted. It was instead a consequence of a very serious government failure, in particular a failure in the monetary authorities to do what they'd initially been set up to do.”

And it is likely that from this monetary paradigm he sees the risks of an economic relapse from premature tightening as that in 1937-38. Hence Mr. Bernanke is likely to pursue what he sees as a triumphant path dependency policy of money printing.

Analyst Mike Larson says it best, ``Look at Chairman Bernanke’s background. Massive money printing is at the heart of his entire philosophy. He literally wrote the book on this subject — the book that’s now essentially the Fed’s operating manual on precisely how to print enough money to overwhelm almost any economic collapse.

``Bernanke believes in his heart of hearts that the Fed prematurely hiked rates in 1937, prolonging the Great Depression into 1938 and beyond. He’s convinced that that single, momentous blunder of history is what doomed the world to a nasty “double dip.” (emphasis added)

It’s also the reason why Fed Chair Ben Bernanke recently put the blame squarely on the shoulders of belated regulatory response as having caused the crisis and exculpated the low interest regime (Bloomberg).

By keeping the political heat off low interest rates, he hopes and intends to divert the public’s attention away from his primary tool to manipulate markets.

Ironically and bizarrely too, Mr. Bernanke used the Taylor Rule model to justify the exoneration of role of low interest to the recent crisis.

However John Taylor, a Professor at Stanford University and a former Treasury undersecretary, the creator of the popular model challenged and issued a rejoinder on Bernanke’s interpretation saying ``The evidence is overwhelming that those low interest rates were not only unusually low but they logically were a factor in the housing boom and therefore ultimately the bust.” (Bloomberg).

This goes to show that the fudging, twisting and the manipulation of the means (model or data) in order to come up with the desired end signify as a symptom of economic dogmatism, which operates regardless of the veracity of the implied causality.

Record Debt Issuance, Rollover and Interest Payments. We have pointed out that the US economy, while indeed has been manifesting signs of recovery, hasn’t been entirely out of woods.

The next wave of mortgage resets, which we identified as Alt-A, Prime mortgages, and commercial real estate, which follows the original strain-the subprime mortgages, are still putting pressure on the US real estate industry [as discussed in Governments Will Opt For The Inflation Route].

Moreover, many US States have been staggering from bloated deficits stemming from falling tax revenues in the face of bubble day spending budgets, probably this year will mark a series of bailouts from the Federal government [see Federal Bailout For US States In 2010?]

So together with huge fiscal spending slated for 2010 plus the rollover of maturing debts and the attendant interest payments, as previously discussed in Market Myths and Fallacies On The Dubai Debt Crisis, all these would translate to some $3.6 Trillion of financing required for the US for this year.

We said then,

``$1.9 trillion of debt required for refinancing + $1.5 trillion in additional deficits + $ .2 trillion in interest payments=$3.6 trillion of financing required for 2010! Since US and global savers (particularly Asia) are unlikely to finance this humungous amount, [other parts of the world will require debt financing too (!!)], the available alternative options appear to be narrowing-the Federal Reserve would have to act as the financer of last resort through the Bernanke’s printing press or declare a default. Of course, Bernanke could always pray for a “Dues ex machina” miracle.”

This means that to activate an “exit” mode by raising interest rates risks heightening the amount required for financing. That’s obviously is a NO CAN DO for the authorities.

Moreover, the US won’t likely take the risks of a “failed auction” during its record Treasury sales this year, since this would likely send the interest and bond markets into a tailspin or a mayhem.

This means that as contingent plans we expect that the US Federal Reserve will remain as THE buyer of the last resort for the US treasury markets.

Devaluation as an unofficial policy. We have stated in numerous occasions [e.g. see Changing The Rules Of The Game By Inflation] how Ben Bernanke champions the mainstream view of oversimplifying economic problems by reducing (yes reduction ad absurdum) them into few variables. Hence by focusing on a few variables such as global imbalances, he sets forth devaluation as the key instrument for economic salvation- via his Helicopter “nuclear” option.

Again Mr. Bernanke in his Helicopter speech, ``it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation.”

Yes it’s a supreme irony for government to promote debt, yet fear its consequence-deflation.

It’s also worth repeating that the only way to achieve devaluation is through inflationism which is what Bernanke’s Zero Interest Rate policy, quantitative easing and host of other interventionism-in the form alphabet soup of programs to the tune of Trillions of spending and guarantees, have all been about.

As Ludwig von Mises wrote in Stabilization of the Monetary Unit? From the Viewpoint of Theory ``The valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money.”

The same ideology afflicts other policymakers as seen in Japan, England and most of the central bankers of the world.

Remember, inflationism is a form of protectionism, since it supports or protects the interests of some politically favorite sectors at the expense of the rest of the society.

In the case of the US, such collective ‘devaluation’ policies appear aimed at alleviating the untenable debt levels held by the banking industry.

Although the public seem to have been grossly misled by political demagoguery and politically colored experts who try to make believe the tomfoolery that devaluation is about exports (only 11% of the economy see Dueling Keynesians Translates To Protectionism?) or about jobs.

Of course, another mechanism of devaluation is the transferring of the resources from the real economy to the banking and finance industry.

Unfortunately for the gullible adherents, who seem to have lost any semblance of critical thinking and common sense enough to swallow hook line and sinker the hogwash that such political propaganda as the “truth”, “candidness” of the messenger and meant as “best” for the social order.

Hardly in the understanding that such political actions represent as ruse for a political end. Again from Professor von Mises, ``By deceiving public opinion, it permits a system of government to continue which would have no hope of receiving the approval of the people if conditions were frankly explained to them.”

Hence, the so-called “exit” program would be antipodal to the policy thrust to devalue the currency.

Political Influences On Policy Making. One unstated reason why companies like General Motors or Chrysler have been nationalized or significantly buttressed by the government is due to the payback of favors to a political constituent, particularly in this case the labor union.

Considering that labor had been a big contributor to Obama’s election, where according to Heritage Foundation, ``Big Labor spent an estimated $450 million on the 2008 election, and the SEIU alone put $85 million into the political campaign — almost $30 million just for Obama’s election”, many of Obama’s major policies appears to have been designed as remuneration for political ties.

This can be seen with the recent tariffs slapped against China, the infrastructure stimulus spending which forces contractors to hire labor union members, the latest $154 billion round of stimulus passed in Congress last December targeted at reducing unemployment, proposed taxes on stock trades to fund labor projects, mass unionization of the US government which now constitutes more than half or 51.2% compared to 17.3% in 1973 and many more.

Of course the other vested interest group as stated above would be the banking sector.

The point is- a higher cost of financing from a series of interest rate increases and monetary policy rollback will vastly reduce the Obama administration’s capacity to fund the pet projects of his most favored allies.

And going into the election year for the US Senate in 2010, greatly reduces this incentive especially that the popularity of Democrats has been on a free fall, as shown by recent Gallup polls, WSJ-NBC News, and Ramussen Reports

Finally, the Question Of Having To Conduct Successful Policy Withdrawals. This would be technical in nature as it would involve the methodology of how excess reserves, the alphabet soup of market patches, guarantees and commitments will be successfully scaled down.

For us, thinking that garbage would be bought back at the original “subsidized” price is no more than wishful thinking. Most of the so-called “plans: would be like having off balance sheet holdings.

Figure 4: BIS: Central Bank Balance Sheet and Spreads for the Crisis

Analyst Jim Bianco was spot on when quoted by Tyler Durden of Zero Hedge, ``We believe the proposal of this new tool signals the Federal Reserve is still flailing around trying to look busy so everyone is assured they have a plan.” (Bold highlight mine)

Bottom line: Interest Rate Derivatives, Expanding GSE Operations, Economic Ideology Record Debt Issuance, Rollover and Interest Payments, Devaluation as an unofficial policy, Political Influences On Policy Making and the Question Of Having To Conduct Successful Policy Withdrawals all poses as huge factors or incentives that would drive any material changes in the Federal Reserve and or the US government policies.

In knowing the above, I wouldn’t dare call on their bluffs.

Politics Ruled The Market In 2009

``Looking back, policymakers of all stripes missed their opportunities to make tough but necessary decisions in 2009. And now 2010 just doesn’t have the feel of a year that will witness a lot of decisive policymaking. In Washington, the focus will turn to the 2010 elections. The Fed will worry about its reputation and independence. Fearing for their jobs and fearful of mistakes, timid will win over bold. Bubbles treasure timid.”-Doug Noland, Issues 2010

At the start of the year, a friend asked, where I thought the local stock market is headed for in 2010. When my reply wasn’t in a definitive, I was asked instead where I FELT the market would go. Not satisfied in dealing with matters most- an analysis of the risk reward tradeoffs-I was expected to reply in the reductio ad absurdum or a confirmation of a preconceived bias.

And this is why Warren Buffett’s pejorative of stock forecasters becomes a reality, ``We have long felt that the only value of stock forecasters is to make fortune-tellers look good”. That’s because it has been a propensity for the public to reduce the role of financial market investments into intuitive based pulsating adrenalin based fortune telling “punts”, i.e. the euphemism for gambling.

Well, in dealing with markets most people deserve their fate.

Making New Year’s projection would have been evident from our notes of late last year. You can check out Following The Money Trail: Inflation A Key Theme For 2010, where we argued that inflation will be a concern for the year or How The Surging Philippine Peso Reflects On Global Inflationism where we argued for the case of a stronger Peso and a higher Phisix.

Nevertheless while it is easy to say or to get wedded to the notion or be overwhelmed by the bias that the Phisix will likely be significantly higher and that the Peso might be materially stronger, we might fall into a Pollyannaish trap without taking into consideration of what might preclude this from happening.

Market Extraordinaire

For starters, one must realize that last year, hardly anything that operated in the markets seemed traditional or conventional. Said differently, the market sailed in uncharted waters.

The fundamental distinction from the tradition market behavior had been the extent of concerted and coordinated inflationism engaged by global governments.

Data provider and research outfit Trim Tabs recently decomposed the buyers of the latest rally in the US markets and found little proof of mass public participation (see figure 1).

Figure 1: Fool.com/Trim Tabs: Who’s Buying This Rally?

This is why the “desperately seeking normal” camp has utilized myriad justifications for declaring the market’s unsustainable trend, such as a low volume or sponsorship (John Hussman), low cash levels of mutual funds (Claus Vogt), or even worst cycle for dividends (Floyd Norris) [But unlike the others, Mr. Norris makes a spin that a sharp plunge in dividends may translate to a sharp recovery] to many other issues mostly focused on valuations (e.g. Vitaliy Katsenelson).

Little have these experts noticed that government policies of printing colossal waves of digital and paper money would have an impact to the markets, had to go somewhere or find something to exchange for and would affect the markets and the economy unevenly. One analyst even called “inflation” as “secondary” concern.

In short, the basic flaw wasn’t only to underestimate on money’s neutrality but to greatly discount the incentives of the policymakers that prompted for such policy actions.

Value Scale Of Authorities: Banking Gets The Priority

Importantly, the obvious policy priorities of global authorities, especially in the US have been to rescue and ensure the survival of its banking system. The US and European governments have spent and guaranteed some $15 trillion (Bloomberg) of commitments or liabilities! This signifies as more than two fifths of the combined economy.

For anyone to argue that these governments have been devoting their efforts to mitigating economic woes (such as unemployment) have severely been misjudging the scale of values of those in power.

And this also has been evident with a shift in the model of the banking system from one providing traditional “loan services” to a “Banker as Trader” business model, where major banks have seen profit windfall from arbitraging financial markets that have been heavily massaged by the US government.

In 5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects, we have discussed why most of the financial markets have been dysfunctional to price market based risks.

We said that…

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.

Let me add that by implementing quantitative easing programs, the US government has fundamentally been subsidizing her banks by absorbing the toxic assets of the banking system allowing for the cosmetic enhancements of their balance sheets.

Next, by juicing up the equity markets, the US government has attempted to unleash the “animal spirits” in order for the market to abet on the financing of equity to the capital dispossessed banking and financial industry.

And like hitting two birds with a single stone, such unprecedented scale of market manipulations attempts to paint a picture of recovery and allow for the redeployment of stashed capital at the expense of savers.

In other words, the incentives to manipulate the financial markets to attain stabilization of the banking system appear commandingly superior to any other concerns.

Ergo, the markets of 2009 behaved in terms of the impact from political policies, as we correctly predicted in November of 2008 [see Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?], and believe that such dynamics will remain in operation for 2010, as we asserted in Investment Is Now A Gamble On Politics.

How does the US government manipulate the stock market? Perhaps through the Presidential Working Group On Financial Markets, an ad hoc group created in March 18, 1988 via Executive Order 12631 by President Ronald Reagan “established explicitly in response to events in the financial markets”, possibly channeled through the S & P futures.

As Zero Hedge’s Tyler Durden suggests, ``One way to manipulate the stock market would be for the Fed or the Treasury to buy $20 billion, plus or minus, of S&P 500 stock futures each month for a year. Depending on margin levels, $20 billion per month would translate into at least $100 billion in notional buying power. Given the hugely oversold market early in March, not only would a new $100 billion per month of buying power have stopped stock prices from plunging, but it would have encouraged huge amounts of sideline cash to flow into equities to absorb the $300 billion in newly printed shares that have been sold since the start of April.”

Of course, manipulation of the stock market would be speculation on our part. But the underlying incentive seems credible enough to suggest that such conjecture could be for real.

China And The Bubble Cycle In Pictures

Most of the time narratives haven't been convincing enough to present a strong case.

Hence I decided to put into pictures, some relevant data that may signal the whereabouts of China's bubble cycle.

In our earlier post [see Jim Chanos Goes From Micro To Macro With Bet Against China] we showcased the chart of a bubble cycle.

I am republishing it below for comparison purposes.


In the outset of the new millennium, the US dot.com bubble appears to have unraveled exactly as the dynamics shown above.

The Nasdaq chart (courtesy of bigchart.com) shown below went parabolic before collapsing.

Today, or nearly 10 years after, sadly the Nasdaq remains distant from its bubble highs.

And it's seems no different from the way the US real estate bubble unfolded in 2002-2006 (courtesy of the New York Times)...

...and as earlier stated bubble dynamics are manifested on asset prices via massive overvaluation and a manic 'euphoric' mood by the public.

China is alleged to be at a risk of an imploding bubble, which is deemed by some as a clear and present danger. Given such premise we should then expect some parallels with the bubble cycle template above to take shape.

In other words, China's asset markets should somewhat resemble the above dynamics.

So have these concerns been justified?

While it is true that there has been an unprecedented surge in credit expansion which has been the primary cause of concern of bears... (the following charts except indicated are sourced from World Bank China)

...these has not yet been apparent in property prices.(see below)

Even Bloomberg's own property index chart for China hasn't been frothy...yet.

We don't see the same phenomenon in China's stock markets too (unless one interprets the 2008 top as the main inflection from which today's rally accounts for merely a countertrend action)...
And so far the booming conditions experienced by China has emanated from government spending...
Although the massive credit expansion appears to be filtering into the domestic economy...
Bottom line: China's Bubble has yet to mature or transition into the mania phase. It's probably not the right time to bet against a bubble.

Yet if China is truly in a bubble but the timing of the bet is wrong, then a short position can be bloody or devastating (see bubble cycle template above) to a portfolio, since the manic phase has yet to emerge.

Mercantilism: Misunderstanding Trade And The Distrust Of Foreigners

One of goal is to expose on false doctrines peddled by mainstream media.

Here is another example of the fixation of the currency "magic wand" solution to global ills.

In a recent article by the Economist, the woes of Japan's diminishing share of world trade has unfairly been pinned to its firming currency.

From the Economist, ``Its 10% slice this year will equal that achieved by Japan at its peak in 1986, but Japan’s share has since fallen back to less than 5%. Its exporters were badly hurt by the sharp rise in the yen—by more than 100% against the dollar between 1985 and 1988—and many moved their factories abroad, some of them to China. The combined export-market share of the four Asian tigers (Hong Kong, Singapore, South Korea and Taiwan) also peaked at 10% before slipping back."

While it may be true that Japan's share of world exports have fallen, blaming the strong yen is far from accurate. There may have been some companies or industries that may be affected, but this can't be applied in the general or macro sense.

What this implies is that the article has engaged in selective perception of its presentation of facts or has engaged in fact twisting in of support of a preconceived bias, i.e. inflationism via anti-market bias currency interventions.


As you will note from the chart above by Google's public data, exports as % of GDP has been rising for the world.

This means that for most of the world's major economies, exports have been improving. This includes the BRIC's or particularly China or even the 'burdened' strong yen of Japan.

Yet, to give a better perspective, the world's GDP has been in an uptrend going into the 2008 crisis, with most of the world's economies reflecting such improvement.

In other words, the impression that China has been stealing export market share, by manipulating her currency, at the expense of Japan who 'suffers' from a strong currency is far from the reality.

Instead, what has been happening is that as globalization gets entrenched, the pie of world output has been increasing with an increasing share of contributions from more nations nations participating in global trade, particularly, from emerging markets as China.

In short, the major fallacy of the mercantilist view is the perspective that trade is a zero sum game. It isn't. In fact globalization has generally benefited the world.

And currencies, the favorite snake oil nostrum, have hardly been the determinant of the share of exports or competitiveness or economic growth. [see previous discussion: Big Mac Index: The Fallacy of Blessed And Burdened Currencies]

In fairness to the Economist, they mentioned other factors that may have helped China's expanding exports amidst a falling share of her major trading partners during the recent recession.

``Lower incomes encouraged consumers to trade down to cheaper goods, and the elimination of global textile quotas in January 2009 allowed China to increase its slice of that market."

Nevertheless, article's underlying theme seems slanted towards 'Sino phobia' -which unnecessarily portrays her as arbitrarily benefiting from the recession.

Again the Economist, ``Strong growth in China’s spending and imports is unlikely to dampen protectionist pressures, however. China’s rising share of world exports will command much more attention. Foreign demands to revalue the yuan will intensify. A new year looks sure to entrench old resentments".

Well perhaps it is more than just a misperception of the role of trade but from an anti-foreign bias endemic in the public's mind.

According to Professor Bryan Caplan, ``The root error behind 18th-century mercantilism was an unreasonable distrust of foreigners. Otherwise, why would people focus on money draining out of “the nation” but not “the region,” “the city,” “the village,” or “the family”? Anyone who consistently equated money with wealth would fear all outflows of precious metals. In practice, human beings then and now commit the balance of trade fallacy only when other countries enter the picture. No one loses sleep about the trade balance between California and Nevada, or me and iTunes. The fallacy is not treating all purchases as a cost but treating foreign purchases as a cost." (emphasis added)

Bottomline: Mercantilist solution deals with symptoms and not the cause. This means that policymakers who follow mainstream prescriptions is likely to suffer from the law of unintended consequences.

Jim Chanos Goes From Micro To Macro With Bet Against China

Jim Chanos, one of the most successful and well respected investors, who specializes is short selling, has reportedly bet against China.

This from the New York Times,

``Now Mr. Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc.

``As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

``“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point." [emphasis added]

Credit excesses is a necessary but not a sufficient condition in the formation of bubbles. That's because valuation excesses have always been a manifestation of the collective actions of mass psychology filliped by excessive doses of credit.

And markets are primarily and basically psychology, which means people respond to incentives from which government policies have been a key instrument.

So yes, while we agree with Mr. Chanos that current policies in China, and the continued pursuit thereof may bring her towards a full bubble cycle, we don't agree that China has reached a manic phase of typical bubble cycle [as we have argued in China's Bubble And The Austrian Business Cycle.]

There will be more convincing and obvious signs where China would have reached its 'euphoric' or manic zone. Mr. Chanos may be betting too early and too soon which may be catastrophic (see below).
Here is the next chink in the armor for Mr. Chanos, again the same New York Times article,

``For all his record of prescience — in addition to predicting Enron’s demise, he also spotted the looming problems of Tyco International, the Boston Market restaurant chain and, more recently, home builders and some of the world’s biggest banks — his detractors say that he knows little or nothing about China or its economy and that his bearish calls should be ignored.

``“I find it interesting that people who couldn’t spell China 10 years ago are now experts on China,” said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. “China is not in a bubble.”

``Colleagues acknowledge that Mr. Chanos began studying China’s economy in earnest only last summer and sent out e-mail messages seeking expert opinion."

``But he is tagging along with the bears, who see mounting evidence that China’s stimulus package and aggressive bank lending are creating artificial demand, raising the risk of a wave of nonperforming loans. [emphasis added]

Two noteworthy developments here:

One, in contrast to Mr. Jim Chanos' former exploits where he had been one of the originating or 'lead' contrarian, here we have the famous short seller cramming with a crowd of China bears or skeptics.

In other words, instead of relying on his convictions from self-analysis, he seems to be simply borrowing the unproven idea of others.

As Warren Buffett warned, "risks comes from not knowing what you are doing".

Two, Mr. Chanos appears to confuse interpreting actions of profit driven corporations as similar with that of an economy. The latter of which is more complex with multitude of working parts driven by distinct incentives, e.g. enterprises-profits, government leadership-politics, bureaucracy-technical guidelines provided by leadership, state owned enterprises- a mixture of both etc...

In addition he appears to be bewitched by mainstream's "aggregate-ism" or the flawed notion that the world operates in simplistic dynamics-so as to fall for inane sloganisms as China Inc.

In short, Mr. Chanos appears to have departed from his field of specialization (residual specific risk), and now dabbles with issues which he seems unfamiliar with, particularly by engaging in macro bets (systematic risks).

Considering that policy based imbalances have brought upon many opportunities to engage in specific risks globally, it a curious thing for Mr. Chanos to deviate from his expertise.

And this leads us to wonder, "Could Mr. Chanos have reached what is known as the Peter Principle or "Rising to one's level of incompetence"? Or could his actions reflect on overconfidence from his strings of successes?

Big Mac Index: The Fallacy of Blessed And Burdened Currencies

The Economist recently published its updated Big Mac Index aimed at demonstrating whether a currency is cheap or expensive relative to the US dollar, as benchmarked to the price of the a McDonald's Big Mac Burger in the US.


According to the Economist, (bold highlights mine)

``THE Big Mac index is based on the theory of purchasing-power parity (PPP)—exchange rates should equalise the price of a basket of goods in different countries. The exchange rate that leaves a Big Mac costing the same in dollars everywhere is our fair-value benchmark. So our light-hearted index shows which countries the foreign-exchange market has blessed with a cheap currency, and which has it burdened with a dear one. The most overvalued currency against the dollar is the Norwegian kroner, which is 96% above its PPP rate. In Oslo you can expect to pay around $7 for a Big Mac. At the other end of the scale is the Chinese yuan, which is undervalued by 49%. The euro comes in at 35% over its PPP rate, a little higher than half a year ago.

Looking at the chart above, 'expensive' nations hail mostly from the Euro zone except for Australia, Canada and Turkey.

On the other hand, emerging markets, especially our ASEAN neighbors Indonesia, Thailand and Malaysia have been classified along with China as "cheap".

So by virtue of association we assume that the Philippine Peso is likely to be in the 'cheap' category.

Yet reading through the article we observe that 'cheap' currencies have been reckoned as "blessed" whereas 'dear' currencies have been deemed as "burdened".

This is just an example of the perverted mainstream view [as recently discussed in Dueling Keynesians Translates To Protectionism?] which gives prominence to mercantilist ideology that the advocates "inflationism" and varied form of regulatory protectionism.

The oversimplistic idea is that 'cheapness' equals export strength and competitiveness which translates to economic growth.

Yet such preposterous prejudice is unfounded.


Based on the list of world's export giants from wikipedia.org estimates (left window), 8 nations from Europe plus Canada comprise the top 15 biggest international exporters belong to the "expensive" category. In short, a majority.

Meanwhile, only 3 of the ultra blessed 'cheapest' currency nations (Mexico, Russia and China) and marginally cheaper (South Korea and Japan) are part of the roster of elite exporters.

Moreover, in terms of competitiveness, except for Singapore, Japan and the US, 7 out of the 10 most competitive nations, according to the World Economic Forum, come from the 'burdened' expensive currency group.

In other words, the rationalization of 'cheap' as blessed and 'dear' as burdened greatly misleads because, as evidence reveals, cheapness doesn't guarantee competitiveness or export strength.

Why the mainstream's predisposition on such a view? Because of the fixation to parse on economic disequibrium predicated current account asymmetries.

Zachary Karabell writes in the Wall Street Journal that global imbalance is a myth because in no time in history has there been a global economic equilibrium.

From Mr. Karabell (bold highlights mine), ``The blunt fact is that at no point in the past century has there been anything resembling a global economic equilibrium.

``Consider the heyday of the "American century" after World War II, when Western European nations were ravaged by war, and the Soviet Union and its new satellites slowly rebuilding. In 1945, the U.S. accounted for more than 40% of global GDP and the preponderance of global manufacturing. The country was so dominant it was able to spend the equivalent of hundreds of billions of dollars to regenerate the economies of Western Europe via the Marshall Plan, and also of Japan during a seven year military occupation. By the late 1950s, 43 of the world's 50 largest companies were American.

``The 1970s were hardly balanced—not with the end of the gold standard, the oil shocks and the 1973 Arab oil embargo, inflation and stagflation, which spread from the U.S. through Latin America and into Europe.

``The 1990s were equally unbalanced. The U.S. consumed and absorbed much of the available global capital in its red-hot equity market. And with the collapse of the Soviet Union and the economic doldrums of Germany and Japan, the American consumer assumed an ever-more central position in the world. The innovations of the New Economy also gave rise to a stock-market mania and overshadowed the debt crises of South America and the currency implosion of South Asia—all of which were aggravated by the concentration of capital in the U.S. and the paucity of it in the developing world. When the tech bubble burst in 2000, it had little to do with these global dynamics and everything to do with a glut of telecommunication equipment in the U.S., and stock-market exuberance gone wild."

In looking at the US current account chart from globalpolicy.org one would note that deficits began to explode during the 80s.

This probably implies that, aside from the above assertion by Mr. Karabell, as the China and emerging markets got into the globalization game, the US deficits soared. This bolsters the Triffin Dilemma theory as vastly contributing to such phenomenon.

Moreover, mainstream experts seem mixed up on the participating identities of those involved in current account and trade deficits with that of budget deficits.

With budget or fiscal balancing it is the government that accrues the surpluses or deficits. In contrast with trade balances, individuals through enterprises and not nations engage in commerce.

Professor Mark Perry makes a lucid explanation, (all bold underscore mine)

``It might be a subtle point, but it's important to realize that countries don't trade with each other as countries - rather it's individual consumers and individual companies that are doing the buying and selling. The confusion gets reinforced when we constantly hear about the "U.S. trade deficit with Japan" or China, which might again imply that the "unit of analysis" for international trade is the country, when in fact the unit of analysis is the individual U.S. company that engages in trade with other individual companies on the other side of an imaginary line called a national border.

``It's possible that some of the confusion about international trade can be traced to confusion about the "trade deficit" and the "budget deficit." The relevant unit of analysis for the budget deficit is indeed the country, since it's the entire country via elected officials that is responsible for the "budget deficit." By conflating these two distinctly different deficits, it's then easy to assume that the relevant unit of analysis for both is the "country" when in fact that only applies to the "budget deficit" and not the "trade deficit."

``Once one understands that it's individual companies, not countries, that are doing the trading, then it's not so easy to get fooled by statements or headlines like "Punitive tariffs are being imposed on China," or "Obama to hit China with tough tariff on tires." Since China doesn't actually trade with the United States at the national level, tariffs cannot be imposed on the country of China - it's not like the United States government sends a tax bill to the Chinese government.

``Rather, since it is companies that are trading, it's companies that have to pay the taxes (tariffs) TO their OWN government. In the case of U.S. tariffs on Chinese tires or steel, the tariffs (taxes) are being imposed not on the Chinese government or even the Chinese steel-producers, but on American companies who now are taxed for buying tires or steel from China, and then those taxes are ultimately passed along to the individual Americans who purchase the tires and purchase the consumer products like automobiles that contain Chinese steel."

In addition, it would seem similarly incoherent and ironic to think that manipulating currencies to subsidize "exporters" would generally benefit the country engaged in such policies.

That's because as a general rule for every subsidy someone has to pay for the "subsidized" cost. In short, subsidies redistribute rather than generate wealth.

Professor Donald Boudreaux debunks the favorite fixation of the mainstream: the US-China imbalances,

``The real costs of the resources and outputs exported by the Chinese people are not lowered simply because Beijing keeps the price of the yuan artificially low. And the resources spent to supply the extra American demand that results from an artificially low price of yuan—even though they are unseen by the untrained eye—represent a huge cost that harms the Chinese economy."(emphasis added)

So not only have mercantilists been barking up at the wrong tree, they have been brazenly promoting policies that focuses on short term fixes, which favors a select political group, and importantly, raise the risks of provoking a mutuality destructive trade war.

In closing this apt quote from John Chamberlain, ``when nations begin worrying about the "balance of trade," they are saying, in effect, that the price of a currency expressed in an exchange rate is more important than bananas, or automobiles, or whatever. This is a perversion that sacrifices the consumer to an abstraction; better let the currency seek its own level in the world's money markets."