The Euro Bailout And Market Pressures

``The problem is that the fundamentals of these economies are not right. People in those countries cannot maintain a decent standard of living because they are not producing enough in the private economy to keep the public-sector unions afloat. Unfortunately, these unions are so powerful that they can extort pay and work agreements that plunder the taxpayers, and now that the bailouts have arrived, look for the unions to be even more militant and violent. These countries don’t need more inflation, contra Keynesians. They need to stop feeding the monster of public-employee unions and permit business to operate without being smothered by rules and regulations. But after being bailed out, these governments will go back to doing things as they always have, and the malinvestment will continue.” William L. Anderson, Will the New Bailout Save Europe?

The ultimate question at present is whether the Greece crisis would escalate into a full-blown international sovereign debt crisis, in spite of the recent monster $1 trillion bailout[1] announced by an EU-IMF syndicate last Sunday or if the market stresses emanating from the Greece episode would lead to a cascading impact on the real economy. And for that matter the sequential question should be, what would be the attendant policy response if the markets continue to react negatively?

Bailouts Are Politically Motivated And Ballooning

It’s a silly notion to limit ourselves to only the economic aspects, when throughout the decade the policy response, when confronted with a crisis, has been mostly politically designed which eventually had political results, particularly boom bust cycles. And this is why political reactions[2] by global leaders have been like clockwork, which has seemingly validated us anew.

For instance, the nearly 10% plunge[3] in the US the other Friday, which was mostly pinned on computer error, has prompted authorities to conduct an investigation. Here is a very telling commentary, as quoted by the Financial Post[4], from a US lawmaker,

"We cannot allow a technological error to spook the markets and cause panic," Rep. Paul Kanjorski said late on Thursday. "This is unacceptable."

This only implies that US markets have been very much incorporated into the policy setting modules of US authorities, where falling stockmarkets for valid reasons or not, e.g. due to technological glitches, is like a taboo.

And there is little nuance when compared to the EU’s bailout of the Euro, where EU Commissioner Olli Rehn announced, ``We shall defend the euro whatever it takes”[5]

These are more than enough proofs that the guiding principle for global authorities is to shore up their markets as means to convey “confidence”. As we have been saying, the intuitive response by global governments has been to unceasingly throw money at the problem. And confidence in the market is likely to translate to financing for politicians running for elections, aside from a favourable image to the public.

And one would note that the cost of bailouts have been growing,

This from Bloomberg[6],

``The cost of saving the world from financial meltdown has been bloated by ‘hyperinflation’ since Long Term Capital Management LP’s rescue in 1998… rising price of bailouts since the $3.5 billion pledged to hedge fund LTCM after it was crushed by Russia’s default, and the almost $1 trillion committed to halt the European Union’s sovereign debt crisis this week. It cost just $29 billion to sooth markets in March 2008 when Bear Stearns Cos. was taken over, and $700 billion for the Federal Reserve to save the banking system with the Troubled Asset Relief Program in October that year. ‘We haven’t had any kind of normal inflation in the last decade, but we’ve had hyperinflation in writedowns and the magnitude of bailouts,’ said Jim Reid, head of fundamental strategy at Deutsche Bank… ‘You have to do more to get a similar effect every time.’”

As we earlier wrote[7], To paraphrase Senator Everett Dirksen ``A trillion here and a trillion there, and pretty soon you're talking real money; (gold as money)"

There seems to be no apparent end to the spate of bailouts.

QE In 4 Largest Economies And A Different Kind Of Carry Trade

Will global governments wake up to face reality recognizing the attendant risks by adapting policies that require stringent sacrifices to clear their respective markets of excesses or malinvestments? Or will they continue to flush the economic system by the massive use of their printing press as a short term fix or a nostrum?

For us, until they are faced with a crisis that forces their hands, the path dependency for authorities is for the latter.

Yet a genuine manifestation of an international sovereign crisis would be a surge in interest rates among nations afflicted by growing risks of debt default.

However this seems unlikely to occur yet, as governments would still be able to manipulate the bond markets for political expediency, particularly to finance existing deficit as incidences of inflation appear muted.

And part of such policies to suppress interest rates would be to buy government bonds from the financial markets or the banking system. And this apparently has been part of the measures that was packaged with the bailout of the Euro.

In essence, we have 4 of the world’s largest economies that have now engaged in “quantitative easing” (even if the ECB denies these, for the reasons that she would “sterilize” her purchases or offset bond purchases from banks/financial institutions with sale of EU bonds).

And these 4 economies constitute nearly 85% of the $83 trillion global bond markets as of 2009[8].

In short, world markets and the global economy would likely suffer from an unprecedented meltdown in a horrific scale, which would make 2008 a walk in the park, if any of the developed nation’s sovereign crisis transform into a full contagion.

However, I don’t believe that we have reached that point yet.

Figure 2: US Treasuries Index, EM Index, Yield Curve, US Dollar

The highly volatility in the markets have led a misimpression of a repeat scenario of carry trade circa 2008.

As we have pointed on last February, there is little evidence that a carry trade from the US dollar has been building among the global banking system[9].

Instead what the Euro crisis has been showing us is that the carry trade has been within the Eurozone system as seen by the interlocking[10] activities or the vastly intertwined network among private and national banks, EU member governments and the ECB. In short, it isn’t a foreign currency arbitrage, but a carry trade of government debts distributed among EU banks.

As we earlier quoted[11] Philipp Bagus[12],

(bold emphasis mine)

``The banks buy the Greek bonds because they know that the ECB will accept these bonds as collateral for new loans. As the interest rate paid to the ECB is lower than the interest received from Greece, there is a demand for these Greek bonds. Without the acceptance of Greek bonds by the ECB as collateral for its loans, Greece would have to pay much higher interest rates than it does now. Greece is, therefore, already being bailed out.

``The other countries of the eurozone pay the bill. New euros are, effectively, created by the ECB accepting Greek government bonds as collateral. Greek debts are monetized, and the Greek government spends the money it receives from the bonds to secure support among its population.”

And the existing regulations which mandate the banking system to hold government debt as a risk-free reserve has equally contributed to the current mess by introducing the moral hazard problem effectively channelled into subsidies to the subprime EU member states as Greece.

So the pressure seen in the Euro markets of late isn’t due to the unwinding of US dollar carry trades but a perceived rise in the default risks and possibly the consequent impact to the real economy from a perceived slowdown due to compliance to fiscal adjustments, or of the question of the European Union ability to survive the crisis without getting dismembered.

As shown above, US interest rates markets and the US dollar have been chief beneficiaries from the troubled Euro. The Morgan Stanley US Government Morgan Stanley Fund (USGAX), a fund where 80% of its assets are invested in Treasury bills, notes and bonds, has surged. Moreover, the US dollar Index where the Euro has the largest share of the basket, has continually spiked.

This, in essence, looks more of a rotation away from EU assets into US assets than a looming full blown international sovereign crisis.

In addition, we are seeing parts of that rotation away from the EU into Emerging Market Bonds as shown by rise in the Salomon Bros. Emerging Market Debt Funds (XESDX).

Likewise, the spread between the 3 month Bills and 30-year Bonds remains steep in spite of a relatively higher 3 month rates since the start of the year.

In a full scale sovereign crisis we are likely to see a faster surge of short term bills rather than bonds. And this will likely be triggered by a spike in inflation which sets about a self feeding mechanism that would force up rates. At this point, governments will have to choose to bring down interest rest rates by printing more money or by totally renouncing inflationism.

This Isn’t Lehman Of 2008; China’s Role And Slumping Commodities

Well obviously this isn’t 2008, where the disruptions in the interbank funding markets forced a seizure or a rapid system-wide contagion in the banking system.

Yes, we are seeing some volatility but this has been nowhere near the post Lehman episode as shown in the credit markets or in the interest spreads (see figure 3).

Figure 3 Danske Bank: Credit Markets Isn’t Manifesting Signs Anywhere Near 2008

The yields in US cash indices for different corporate bonds (left window) have largely been unscathed in spite of the current selling pressures.

And the 3 month Libor-OIS spread considered as a measure of the health of the banking system (in the US and Europe), hasn’t been suffering from the same degree of stress during the zenith of the Lehman days (right window).

And that’s also why EU officials have been quick to institute “buying of government bonds” or “quantitative easing” in response to signs of growing stress in Europe’s banking system.

By making sure of the ample liquidity of markets, these actions which work to suppress interest rates are meant to allow markets and the banking system continually finance EU’s bailout. In other words, the bailout is not only meant to politically uphold the Euro as the region’s currency, but to also keep intact the carry trade, unless overhauled by reforms-which appears to be nowhere in sight.

Morgan Stanley’s Joachim Fels sees the same view,

(bold highlights mine)

``More generally, with the establishment of a potentially large stabilisation fund, fiscal policy in the euro area is being effectively socialised. No country will be allowed to fail, and it seems that no country will be too big to bail. Ultimately, this creates an incentive for governments to run a looser policy than otherwise. If markets then refuse to fund a profligate government, it could turn to the fund, borrow at below-market interest rates and domestically blame the required fiscal tightening on the ‘diktat' from the euro area partners and the IMF. So, our bottom line on the implications of the European fiscal emergency plan is that, while it addresses the near-term liquidity problems, it does little to solve the underlying problem of fiscal sustainability and may even make things worse on this front over the medium term.”

Moreover, I’d like to add that while some have argued that the EU’s actions will not violate the principle of Maastricht treaty, which disallows for direct bailouts, the Special Purpose Vehicle (SPV) created to extend loans to troubled nations, for me, signifies as EU’s act to go around their self-imposed rule, or regulatory arbitrage, but this time by the EU government.

If governments would work to circumvent their rules in order to accommodate political expediency and likewise save particular interest groups in the context of the meme of saving the economy or the Union, then how else would this politically privileged group react when they knowingly feel protected? They are likely to engage in more reckless behaviour.

This reminds us of Hyman Minsky[13] who warned that bubbles emanate from government intervention, ``It should be noted that this stabilizing effect of big government has destabilizing implications in that once borrowers and lenders recognize that the downside instability of profits has decreased there will be an increase in the willingness and ability of business and bankers to debt-finance. If the cash flows to validate debt are virtually guaranteed by the profit implications of big government then debt-financing of positions in capital assets is encouraged. An inflationary consequence follows from the way the downside variability of aggregate profits is constrained by deficits.”

So its more than just inflating, it’s also a burgeoning moral hazards problem.

In addition, considering that the US is directly and indirectly involved, through the Federal Reserve via the currency swap lines and the IMF respectively, this can’t be seen as “beggar thy neighbour” approach considering that the US Federal Reserve sees the spillover risks from a banking contagion as possibly harmful to the sensitive state of her counterparts. In other words, the Fed isn’t causing a higher a US dollar for trade purposes but to ring fence the US banking system from a Euro based contagion.

Instead, such policy is more of a “beggar thy economy” genre where resources are being marshalled to save the banking system in the US and in Europe, at the expense of the real economy.

It’s not clear that the recent spate of falling oil or commodity prices are materially connected to the events in Greece or Europe, as they seem more correlated to the developments in China (figure 8).

Figure 4: China and commodities

As you can see the sharp drop in China’s Shanghai index (SSEC), which has been under constant assault from her government in an attempt to quash formative bubbles, has nearly been concurrent with the drop in oil (WTIC) and general commodities (CRB). Albeit the SSEC’s recent steep decline has also coincided with the fall of global markets from the Greece crisis the other week.

However, one bizarre development which seems moving in contrast to the current tide has been the Baltic Dry Index (BDI). The BDI appears headed towards the opposite direction almost as markets have been falling.

And with reports that consumer price inflation has been accelerating, it is quite likely that the Chinese yuan, could be expected to appreciate soon. And possibly, the rising BDI could possibly mean two things: one, a rising renmimbi means cheaper imports, which could reflect on the possibility of China’s positioning, and second, the falling prices could also be another factor for increased demand.

Unlikely Slump For Global Markets

So what does this tell us of the global markets?

First I am doubtful if this is the “inflection point” as expected by the permabears.

I see this more of a reprieve than a reversal. As said earlier, for as long as consumer price inflation rates are low, governments can continue to flood the economic system with newly printed money that may artificially contain interest rates levels.

Since money isn’t neutral, the impact from bailouts will have uneven effects to countries or specific sectors in particular economies. Even those expecting a deflation in Greece seem gravely mistaken[14].

Second, aside from the liquidity enhancement programs, policy rates by developed economy central banks are likely to stay at present levels for a longer period of time.

We even think that EM economies are likely to maintain rates at current levels, given the current conditions. In addition, rate increases enhances the risks of attracting more foreign capital in search of higher yields. Policymakers in EM nations will be in a fix.

Three, given the still steep yield curve, I have been expecting a pick-up in credit activities even in nations afflicted by over indebtedness. So far there have little signs of these (see figure 5)

Figure 5: St. Louis Federal Reserve: Consumer Loans at All Commercial Banks

Our basic premise has been that incentives provided for by the government to punish savers and reward debtors by suppressing rates will eventually force people to spend or speculate at the risk of blowing another bubble.

Besides, debt has been culturally ingrained in Western societies. It is an addiction problem[15] that will be hard to resist considering that the government itself is the main advocate of the use of addictive credit.

Fourth, economies of emerging markets have been performing strongly and are likely to maintain this momentum given the ultra loose liquidity backdrop.

Fifth, any slowdown or economic problems in any countries is likely to produce more bailouts from governments.

The trend has been set, therefore the chain of events are likely to follow. For instance, US participation in the bailout of Greece is likely to set a moral hazard precedent for financially troubled domestic states.

As Ganesh Rathnam argues[16], (bold highlights mine)

``The Federal Reserve's and IMF's participation in the eurozone bailout will not be lost on union members and politicians of heavily indebted US states such as California and Illinois. When the day of reckoning arrives for the US states who are unable to close their budget gaps and whose pension plans have huge funding gaps, they will be up in arms for their bailout as well. How could the US government politically defend its bailing out Greece via the IMF and the Federal Reserve and refusing the same for its own citizens? The idea that California would be allowed to default on its obligations when Greece wasn't is unthinkable. Therefore, the bailout of the PIIGS sets the stage for similar bailouts of bankrupt US states and cities.”

So governments worldwide will continuously pour freshly minted or digital money into the system. And yes this is going to be an ongoing battle between the markets and government armed with the printing presses.

Finally, Nassim Taleb in a recent interview[17] said, “No government wants solution to apply on themselves”.

And this only means that there will be even more government spending, bigger deficits and debts, higher inflation and missed fiscal targets or slippages from proposed austerity programs.

In the Eurozone, the EU circumvented existing rules to accommodate a bailout. These are signs that rules can flouted for political goals.

For the interim, this will all help. But at a heavy price in the future.

---

[1] see $1 Trillion Monster Bailout For The Euro!

[2] Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?

[3] See A Black Monday 1987 Redux?

[4] Financial Post, Obama says authorities probe cause of stock swoon

[5] see $1 Trillion Monster Bailout For The Euro!

[6] InvestorVillage/Bloomberg, Cost of Bailouts Keep on Rising

[7] See Are Record Gold Prices Signalling A Crack-Up Boom?

[8] The Asset Allocation Advisor, World Stock and Bond Markets and Portfolio Diversity; distribution share as follows US 37.9%, Euro 28.7%, Japan 13%, UK 4.9%

[9] See Does This Look Like A US Dollar Carry Bubble?

[10] See Was The Greece Bailout, A Bailout of The Euro System?

[11] See Why The Greece Episode Means More Inflationism

[12] Bagus, Philipp, The Bailout of Greece and the End of the Euro Mises.org

[13] Minsky, Hyman "Inflation, Recession and Economic Policy", 1982 (page 67) quoted earlier here More On Goldman Sachs: Moral Hazard And Regulatory Capture

[14] See Is Greece Suffering From Deflation?

[15] See Influences Of The Yield Curve On The Equity And Commodity Markets

[16] Rantham, Ganesh A Greek Tragedy in the Making

[17] See Nassim Taleb: Waking Up One Day To Perceptional Hyperinflation

Phisix: The Philippine Presidential Honeymoon Cycle Is On

``Most of Southeast Asia is held back by corrupt relationships between politicians and businessmen. This results in too many monopolies and cartels, and a corporate sector that enriches a few powerful families at the expense of the overall economy. Under Marcos, crony capitalism plumbed new depths of larceny and incompetence. Still, the situation was bad in the Philippines even before then. This perhaps reflects two things. First, the key business families are also the key political families, rather than their associates, and so are even closer to the heart of government. Second, its history as a Spanish colony means its systems are closer to those of Latin America than the rest of Asia, which was mostly colonised by Britain, France and the Netherlands. So it shares many of that region’s governance problems.”- Cris Sholto Heaton Should you invest in the Philippines?

So how will the present turn of events impact Philippine markets?

Here is how the Wall Street Journal sees the effect of the Euro’s bailout on Asia[1], (bold highlights mine)

``While Asian markets welcomed the €750 billion ($955 billion) bailout plan, economists and analysts warned that the rescue package could end up bringing even more capital to Asian markets...

``Loose monetary policy in Europe and the U.S. has already helped to inflate assets prices in Asia, especially for emerging-market bonds and real estate. The European Union proposal telegraphs that easy money will continue for the time being. The Federal Reserve reinstalled currency-swap lines that will also make dollars more easily accessible to funding markets around the globe.

``Recent data confirm that Asia's economies are moving strongly despite the turmoil in Europe, and are at risk of inflation grabbing hold.

Why should foreign money come to us?

Aside from the tremendous liquidity, Asia’s finances are generally better positioned relative to developed economies (see figure 6)

Figure 6: Money Week Asia[2]: Why the eurozone crisis won't rattle Asia

In relative terms, Asia has higher savings, current account surpluses, low systemic private sector debt, lower national debt as % of GDP and better fiscal position.

I think the most important factor driving Asia today is the inclination towards more openness to trade and investment with the world today. This is aside from deepening trends towards regional integration.

Moreover, the other notable impact of the trade openness is the economies of scale from Asia’s huge population.

However, economic development and financial markets can disconnect as it did in 2008.

So I am not as confident of a decoupling until we see more elaborate evidences from this.

Nevertheless since markets as unlikely to crater from our perspective, the other potential impact could likely come from the optimism brought about by a Presidential honeymoon cycle.

As we noted in the past[3], the Presidential elections in the Philippines tend to coincide with the troughs in the interest rate cycle in the US.

This we think has fuelled the optimism that led to previous Presidential honeymoon cycles (see figure 6). And we seem to be in exactly the same position as before.

Figure 7 Phisix: The Phisix’s Presidential Honeymoon Cycle

The outperformance of the Phisix relative to global markets of late could already be a sign of liquidity driven Presidential honeymoon cycle.

But one week does not a trend a make.

Therefore we will have to observe how our markets will react to external pressures.

Nevertheless the odds appear to be greater for the domestic honeymoon cycle to playout as it has, possibly this time with a stronger impact.

However it’s mainly not because of the election winner, although the buoyant sentiment will indeed contribute, but it’s going to be because of the unprecedented scale of liquidity, given the current conditions.

---

[1] Wall Street Journal, Asia Fears Flood of Capital Risks More Overheating

[2] Money Week Asia Why the eurozone crisis won't rattle Asia

[3] See Why The Presidential Elections Will Have Little Impact On Philippine Markets

Does Falling Oil Prices Suggest A Drop In Real Economic Growth?

This chart says yes!

For biased opinion writers, data mining facts to support their point of view is a common folly.

The chart above from the Casey Research, who I usually agree with except for this, reveals on such vulnerability.

Unfortunately, while correlation isn't necessarily causation, the correlation shown above isn't even persuasive enough to suggest of a meaningful causal effect.

There are four periods (in blue numbers) indicated to exhibit the so-called 'strong' correlation between falling oil prices which allegedly leads to falling GDP.

Unfortunately the first two (early and late 70s) shows falling real GDP ahead of falling oil prices. It's only in 2001 and 2008 where falling prices seemingly coincided with falling GDP.

Moreover, in nearly two decades, i.e. 1981-1998 (that's one heck of a long period!), the oil-real GDP correlation was entirely absent!

I am not saying that their implications won't happen.

If it does, it 's more because of many other factors, which makes the oil-GDP correlations more serendipitous than from actual cause and effect relations.

What I am saying is that the suggested correlation isn't only infallible, it is rather inconsistent to be relied on.

But this certainly makes for a good presentation.

Is Greece Suffering From Deflation?

New York Times' Floyd Norris writes,

``Making Greece’s exporters competitive will be a very difficult task while the country remains in the euro zone. If it does, the likelihood is that there will be a prolonged period of deflation, with wages being reduced in an effort to cut costs." (bold highlights mine)

The mainstream impression is that because Greece is stuck with the rigidities of having a monetary system anchored on the Euro, where devaluation isn't an option, the attendant adjustments to the current debt problems intuitively leads to deflation.

But how true is this perception?

Greece has indeed been suffering from recession throughout most of 2009 until the present as shown in the above annual and quarterly charts from tradingeconomics.com.

Yet the inflation index registers a hefty jump (annual basis)!

In addition, during the depth of the global crisis, Greece's inflation index shows that consumer prices had NOT fallen below zero or to the negative levels! So even if we stick by the mainstream's definition of deflation- of falling consumer prices and not shrinking money supply- deflation has been non-existent in Greece!

And the index has even yet to account for the recent massive bailout.

Bottom line: the mainstream perception, premised on the dominant economic ideology, of how the world operates seems far far far away from reality.

Before I forget, let me add that Greece seems to be suffering from 'stagflation' or a period of slow economic growth, high unemployment and rising prices, a scenario which mainstream has blatantly overlooked in the past (1970s) and seemingly appears to be the same source of vulnerability today.

Nassim Taleb: Waking Up One Day To Perceptional Hyperinflation

Here is Bloomberg's recent interview of Black Swan author Nassim Taleb.

Great stuff from Mr. Taleb...




Some notes:

-If you look at governments they typically underestimate deficits
-No government wants solution to apply on themselves
-I think we are going to have, at some point, a failed auction that’s gonna cause severe worries...here in Greece in US, something that’s gonna contage...
-We don’t have enough buyers for treasury bonds so the government may have to print them, and you know can what can happen when you start printing money
-Nothing happens early on and then suddenly you wake up one day and you have something called hyperinflation without having inflation-perceptional hyperinflation.
-Worried about government debt and rising interest rates
-Perceptional hyperinflation is going to penalize real estate in real terms, stock market and companies
-The problem was debt, you don’t cure debt with debt.
-I am going to give what I call as negative advise-what investors should not be doing
-I don’t recommend...treasury bonds as a repository of value...go very short term
-Euro and the US dollar will have the same ills
-If you have perceptional hyperinflation you should have hard assets...a good collection of metals would work or agricultural land
-I’d recommend not thinking about the stock market...
-If you go to business school today they teach you the wrong stuff, so I suggest not to go to business schools
-Don’t take any class that has equations in it. Learn accounting, computer science but not what they teach you...it’s all bogus

Emerging Asia Surpasses EU As Top US Export Destination

This should be a very interesting and promising development-Asia has surpassed the EU as the biggest US export market!

As reported by the Wall Street Journal Blog, (all bold highlights mine)

``Yet John Lonski, chief economist at Moody’s Investor Service, points out an interesting nugget within the March trade figures, released on Wednesday by the Commerce Department, in a note to clients today. March was “a watershed month,” he says, as “For the first time in recorded history, the moving 12-month sum of $227.6 billion of U.S. merchandise exports to Asia’s emerging market countries surpassed the… $223.7 billion of such exports to the European Union.”

``In the year through March, he notes, U.S. merchandise exports to emerging Asia — which includes China, India, Hong Kong, Taiwan, Korea plus a handful of smaller nations — rose by 3.7% while shipments to the EU dropped by 13.9%. In other words, U.S. exports to Europe have already been dwindling while Asia has become an increasingly important destination for U.S. goods. That should help U.S. companies avoid too much of a hit from euro zone woes.

``But the development carries risks of its own: Asian economies are growing so strongly at the moment that China in particular is scaling up efforts to damp inflation through tighter monetary policy. While a “soft landing” outcome in which the Chinese economy slows to say at 8% annualized growth rate would be ideal, a harder landing whereby higher interest rates slow demand precipitously can’t be ruled out. Indeed, it’s one of the top risks to the global growth outlook. Though much attention has been focused across the Atlantic lately, it’s actually the Pacific Rim which perhaps should merit closer scrutiny."

As we'd habitually point out, social actions are always dynamic, where people respond to ecological changes rather than being static-except in the eyes of retrogressive anti-development protectionists.

Moreover, the trade and competitive issues are not predicated solely on currency values (or the pixie dust economics for mercantilists), but on many many many factors such as the willingness or openness to trade, economic freedom, hurdle rate, market size and composition and relative costs in terms of tax and regulatory compliance costs, transaction costs, accessibility to finance, raw materials, technology, communication, labor and infrastructure, quality of communication and infrastructure platforms, accessibility to labor, relative labor costs, labor regulations, labor productivity and etc...

Otherwise this shifting trade development wouldn't be happening.

Moreover, this also goes to show of the broadening importance of Emerging Asia's role in global trade.

So yes the composition of world trade is changing, so will geopolitics.

Are Record Gold Prices Signalling A Crack-Up Boom?

Gold prices zoomed to nominal record highs based on the US dollar during the past two days. See chart below


While much of the recent actions have been imputed to the events in the Eurozone, e.g. 'currency fears', gold's rise hasn't been a one-off affair, but a long term trend.

Likewise rising gold prices hasn't been limited to the US dollar but against global currencies.

Put differently, this means gold prices has risen across paper money over the long term and where the current pace of increases seem to be accelerating.

Below are charts of gold prices relative to different currencies, courtesy of gold.org.

As reminder, these charts were updated last May 10th and doesn't include the spike of the previous two days.

Gold Prices in US dollar since 2000

Gold Prices in Japanese Yen

Gold Prices in British Pound

Gold Prices in South African Rand

Gold prices in Australian Dollar

Gold prices in Canadian Dollar

Gold Prices in India Rupee

Gold prices in G5 currency basket

There are two possible themes which record gold prices appear to be telling us:

One, since the symptoms of the monetary disorder (or inflationism) has been intensive and applied on a global scale, gold prices are seemingly being incorporated gradually as part of the global currency system.

And as Ludwig von Mises reminds us,

``The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system."

This leads us to the second theme, the growing risks of global hyperinflation.

As global governments continue to inflate the system to delay the day of reckoning, the rate of financing bailouts through money printing and through suppressed interest rates appear to be swelling. And all these appear to be enhancing the case of a crack-up boom or our Mises moment.

The original bailout for Greece at $146 billion (110 billion euros) didn't calm the markets. And it took a "shock and awe" or a Hank Paulson's bazooka approach of nearly $1 trillion (750 billion euro) to achieve some semblance of stabilization.

To paraphrase Senator Everett Dirksen ``A trillion here and a trillion there, and pretty soon you're talking real money; (gold as money)"

For now, every leakage that could bring about a global bust, would be fiercely met by the policies revolving around the printing press as solution, until the critical point where policymakers would have to decide whether to embrace market reality (declare a default or restructure) or let the printing presses rip. The latter would put an end to the current paper money system.

And we hope the world will come to their senses enough to realize the lunacy of inflationism, before it is too late.

Has Quitting Facebook Been Gaining Steam?

There are some permabears who believe that moods drive people's action. According to this school, negative mood prompts people to cloister or become less open.

And in spotting few instances of people deactivating their Facebook accounts, such permabears declare a generalized trend towards social insulation.


Unfortunately this is simply not true or could be discerned as a fallacy of composition (making mountain of an anthill).

The chart from Nielsen/Marketingcharts.com shows that Facebook has been generating most of the recent gains among social media outfit in the US last March. In addition, the gains of Facebook has surged (and not collapsed) in spite of the 2008 crisis.

Where Facebook has reached more than 400 million members worldwide, see Facebook's statistics here, it would be natural for some among the huge number of people to become discontented enough to prompt them to quit for one reason or another.

But the point is to see whether trends in membership are NET positive or negative. The generalized net positive gains, so far, debunks the negative social mood outlook.

Anyway ABC News has an interesting article about Quitting Facebook.

Italy's Government Owned Cars And The Debt Crisis

This is one manifestation or symptom of why the PIIGS (Portugal, Italy, Ireland, and Greece) are in a crisis.

From the Economist, (bold highlights mine)

``RECKLESS, flashy and chaotic sums up the general view of Italian governments as well as the popular image of the country's drivers. It is hardly surprising that the two are so similar according to Renato Brunetta, Italy's minister for public administration. He reckons that the country runs a fleet of 629,000 official cars, ten times the number in similar European countries and 50,000 more than just a couple of years ago. The official fleet includes top-of-the-range Maseratis to ferry senior officials around Rome. Italy's domestic carmakers, which are starting to recover after a tough time, will be hoping that this particular government-efficiency drive goes no further."



Markets have been revealing the cracks from the unsustainable lavish spending by governments of mostly developed nations. Yet, as shown by the recent spate of bailouts, governments will fight to retain these privileges.

As an old saw goes, What are we in power for?

Philippine Elections: So Where Is The Election Failure?

Since the start of the year, we’ve been repeatedly told by mainstream media that that domestic markets had been affected by jitters arising out of a 'general election failure'.

Yet, over the months, the markets steadily climbed and signalled the opposite to what was being reported.

And we argued in Why The Presidential Elections Will Have Little Impact On Philippine Markets and Philippine Markets And Elections: What People Do Against What People Say, there is simply little incentives for the outgoing administration to destablize elections given the balance of risk-reward tradeoffs.

And any aspiring political groups are also unlikely to desire a tumultuous outcome, except probably for those who are on the extreme ends and are not in active in the present political process. But the latter would have a different version of troublemaking than the peddled automation based failure.

In short, media and the politically obsessed crowd had been forcing a causal relationship even when there was little evidence for it, a behavioural fallacy known as the available bias.

Last week, this so called election jitters had even been more pronounced [see Has Election Jitters "Caused" Falling Philippine Peso and Stocks?]. Yet media and 'experts' ignored or downplayed the role of external evidences, even if domestic markets were indeed tracking external developments more than domestic politics.

With over 50% of votes tallied, it safe to ask, where is all the brouhaha over election jitters? Apparently only in the imaginative minds of the politically frenzied crowd.

Today, we will see the same biased reporting.

Following a massive rally in the Phisix 3.85% which likely reflects on the rally in Wall Street (3%+) and in Europe (+5%) last night, aside from a rebounding Peso, in response to the monster bailout of the Euro currency, news reports will focus on associating the current gains with domestic politics-a vote for the new administration!

Of course local markets will likely have a "presidential honeymoon cycle" as with the previous, but this will be more of a rationalization fueled by a global zero bound interest rate regime and worldwide inflationism.

Bottom line: a culture obsessed with politics is likely to misread and gloss over the genuine factors driving the markets or the economy.

Mark Mobius On The Chinese Yuan (Renmimbi)

Here is Templeton's Mark Mobius view on the Yuan, (bold highlights mine)

``We look at all currencies on the basis of purchasing power parity (i.e. comparisons of different inflation rates) and, of course, any controls and influences imposed by the central bank of each country. We then try to asses whether a currency is over or undervalued, how devaluation or revaluation may impact a specific currency, and then gauge the potential impact of such currency characteristics on the business of each company. For example, for an export-oriented company, a devaluation of its operating currency could be positive because it may be able to export more aggressively and more profitably, while the opposite could be true for an import-oriented company.

``Our purchasing power parity studies indicate that China’s currency, the renminbi, is actually close to fair value against the U.S. dollar at this stage. Judging from past experience, we believe that China is unlikely to act quickly on currency adjustments because they are afraid of the consequences of such volatility.

``The Chinese Central Bank Governor, Zhou Xiaochuan, hinted in March that the renminbi might be allowed to rise once the global economy recovered. However, the Commerce Ministry and others protective of Chinese exporters expressed opposition to a rise in the renminbi, as exporters saw shipments fall early in 2009 for the first time since China began opening trade in the late 1970s.

``As we see it, Chinese exporters have plenty of orders and Chinese companies are even stockpiling commodities such as crude oil, various metals, and grains, as a hedge against what appears to be rising inflation. Wages are moving up – in the export provinces of coastal China, for example, wages were raised by about 20% recently in an attempt to attract more workers from the interior.

``If the renminbi appreciates, that could mean losses in China’s vast foreign reserves, which would fall in renminbi terms. Meanwhile, the Chinese are addressing the depreciation of the U.S. dollar with a diversification of their foreign reserves into other currencies and a move to higher interest rate securities compared to low-interest U.S. Treasuries.

``The purchasing and storing of commodities is another way for China to conserve its value of foreign exchange reserves in an environment of a depreciating U.S. dollar. While statistics on commodity inventory levels in China may not be reliable or fully disclosed, our current information indicates that China’s commodity inventory levels are high. The Chinese favor commodities knowing that they will eventually be used, and also because they are concerned, given high and increasing demand, that commodity prices could rise further. A possible course of action could be to revalue the renminbi upwards so commodities would be cheaper in renminbi terms and wage demands could more easily be met. But with nationalist emotions rising, that course is probably closed."

Based on Mr. Mobius' account of China's forex management, China seems to be acting on her perceived changes in the exchange value of money of her currency relative to other currencies by diversification through higher yields of ex-US dollar instruments and importantly through massive stockpiling of commodities.

In the words of Ludwig von Mises,

``He who believes that the prices of the goods in which he takes an interest will rise, buys more of them than he would have bought in the absence of this belief: accordingly he restricts his cash holding. He who believes that prices will drop, restricts his purchases and thus enlarges his cash holding. As long as such speculative anticipations are limited to some commodities, they do not bring about a general tendency toward changes in cash holding. But it is different if people believe that they are on the eve of big cash-induced changes in purchasing power. When they expect that the money prices of all goods will rise or fall, they expand or restrict their purchases. These attitudes strengthen and accelerate the expected tendencies considerably. This goes on until the point is reached beyond which no further changes in the purchasing power of money are expected. Only then does this inclination to buy or to sell stop and do people begin again to increase or to decrease their cash holdings."

So it's not just the public acting to safeguard money as a store of value, even China seems aware of the endemic propensity by her trading partners to engage in inflationism thereby seek alternative havens.

In short, these are simply manifestations of the ongoing global monetary disorders, which I expect to worsen overtime.

Political Talk (Demagoguery) And Their Meanings

Economist Bob Higgs translates conventional politico-speak into their intended messages, in an article which he calls "When a Congressman Says X, He Is Thinking Y"

Some samples (includes my comments)

X : I will serve the people of this district to the best of my ability.

Y: I intend to look out for my own interest every step of the way, so unless you’re the highest bidder for my services, you’d better start saying your prayers now.

(my comment: corruption free government? That's utter nonsense. The more dependent people are on governments the greater the risks of corruption)

***

X: The people have spoken, and they have chosen me.

Y: The rich guys and well-heeled organizations that backed my candidacy picked me to run, and they coughed up enough dough to buy or steal this election for me. I’d be a damned fool to forget who put me in office.

(my comment: it's a political quid pro quo. That's if you grasp the reality that politics is an affair of people and not some delusional divine rights of political "masters")

***

X: America [or country X-additional remarks mine] needs A, B, and C.

Y: My critical electoral coalition stands to make a shipload of money off of A, B, and C. If I want to keep my sorry ass in office, I’d better do everything in my power to see that the government carries out A, B, and C.

(my comment: simply throw money at social problems to make politicians look good to win elections)

***

X: Thank you very much, ladies and gentlemen. Just let me assure you that I will continue to do my very best to prove that I deserve your continued trust and support.

Y: Money talks, bullshit walks.

(my comment: this is self explanatory)

Read more here

$1 Trillion Monster Bailout For The Euro!

I'm back!

And am vindicated anew!

Coming back from my self imposed exile away from the miasma of domestic politics, I picked this up from media on my way home; this from the Associated Press,

"We shall defend the euro whatever it takes," EU Commissioner Olli Rehn said after an 11 hour-meeting of EU finance ministers that capped a hectic week of chaotic sparring between panicked governments and aggressive markets." (bold emphasis mine)

It's been long argued on this space that policymakers have the innate proclivity to act towards inflationism. That's because of the following factors: inherent addiction to the printing press (or government spending), policy "triumphalism" (recent gains from interim policies), prevailing economic ideology and short term or "career" oriented policy based decisions.

And the political reaction to last week's meltdown was as clinically precise as we had anticipated.

Whether it is the US, China or the EU, the policy approach have all been similar-throw money at the problem- regardless of the long term consequences of their actions.

And it will be no different even for the newly elected authorities in the Philippines.

More from the AP,

(bold emphasis mine)

"The European Union spearheaded a $1 trillion plan Monday to contain Europe's spreading debt crisis and keep it from tearing the euro currency apart and derailing the global economic recovery.

"Central banks around the world joined the coordinated effort to prop up the euro and repel speculative attacks against Europe's weakest countries. The European Central Bank used what analysts called its "nuclear option" — buying public and private debt to shore up liquidity in "dysfunctional" markets and lower borrowing costs.The U.S. Federal Reserve separately reopened a currency "swap" program to ship billions of dollars overseas, pumping more short-term cash into the financial system...

"Under the three-year plan, the European Commission — the EU's governing body — will make euro60 billion ($75 billion) available while countries from the 16-nation eurozone would promise backing for euro440 billion ($570 billion). The IMF would contribute an additional sum of at least half of the EU's total contribution, or euro250 billion."

So the massive bailout is essentially another redistribution from the real economy to the banking system, and to bank related creditors, as well as governments -the Euro version!

But this time with much of the world participating in the monster bailout via the IMF.

Rest assured that inflationary pressures are not limited to one country or region, but a concerted global action. So while the Fed inflates to protect her domestic banking system, the ECB, EU and the IMF along with everyone else are doing the same. We expect any further problems, say in China, to be met by the same response.

It's good to be back and proven right!

Blogging Hiatus On The Election Weekend

This weekend will culminate with the national elections in the Philippines, where Filipinos will go to the polling booth on Monday. The holiday on Monday means an extended weekend.

While most of the people here will be devoting their precious time to elect a set of new leaders under the perpetual promise of elusive 'change', I will be doing what most won't be doing- I'll take this opportunity to spend my time with my growing children, hopefully away from what I consider as an exercise of illusion.

This also means that I will be totally away from access to the computer until the post elections, which is on Tuesday.

So enjoy your weekend.

Central and Eastern Europe's Minsky Based Economic Recovery ?

Professor Arnold Kling writes,

``In a Garett Jones economy, hiring is discretionary. It is not tied automatically to output. Instead, it is a form of investment. In a Minsky economy, when the economy is in a "hedge finance" stage, businesses are reluctant to borrow and instead finance investment out of profits."

In Deutsche Bank's study on Central and Eastern Europe (CEE), they note that Eastern Europe's economic recovery has been credit less.

"Although Eastern Europe is lagging other EM regions in terms of recovery, most countries have left recession and and will record modestly positive growth rates this year. Only the worst or latest hit countries (Latvia, Lithuania, Hungary, Romania and Bulgaria) were still in recession in Q4 2009 or Q1 2010. But the recovery has been credit-less so far. Credit is still declining in most countries (see charts) and will only pick up slowly."


This means that for the CEE region, savings has served as the template of the recovery, not credit. In the Minksy model, savings leads to profit.

Hence, perhaps we are seeing a seeming Minsky model of profit -based economic recovery in the CEE region.

Nevertheless, some signs of renewed appetite for credit lending has emerged. Here is the New York Times, (bold highlights mine)

``No other region of the world suffered more grievous economic damage from the financial crisis last year than Eastern Europe, and a main cause was extensive borrowing in euros and other foreign currencies.

``When the currencies of countries like Hungary and Romania plunged last year, thousands of businesses and homeowners there found themselves stuck with some of the most extreme variable-interest-rate loans on the planet. Monthly payments soared, raising the threat of defaults and bank failures that was averted only with a joint rescue last year by the European Union and the International Monetary Fund — at a cost of €52 billion, or about $66 billion.

``So it may come as a surprise that Austrian, Italian and other West European institutions that dominate the regional banking market are once again offering Eastern Europeans the same kind of credit that nearly derailed their economies only a few months ago."

Of course, going forward, its going to be a question of how the fallout from the Greece crisis will impact this ongoing transition towards more accommodation to the credit process.

My point is, the mainstream idea that credit serves as the backbone for any recovery is just false.

A Black Monday 1987 Redux?

Was the plunge in the US markets, which allegedly had been due to "unusual trading activity" or from a rumored Citigroup Trader instigated 'quant' program selling, reminiscent of Black Monday October 19th 1987?
Intraday, the US markets fell by about 9% before recovering much of the losses but still suffered from a huge decline, a 3.2% for both the Dow Jones Industrials and the S&P 500. (chart from Bloomberg)

Well opposite to the rising tide, we have most issues suffering, with only 28% of S&P 500 companies trading above their 50-day moving averages (courtesy of Bespoke)

Of course, perhaps one major difference is that as the market fell out of "fear" (VIX index spiked beyond the February high) along with a crumbling Euro (XEU), gold surged! And its also hardly about a sovereign contagion when US treasuries (TNX) were among the biggest gainers, via falling yields!

Anyway this was how October 19, 1987 played out. Could we see a rhyme or could this be a start of the the perma-bear scenarios?

Has Election Jitters "Caused" Falling Philippine Peso and Stocks?

Media says yes!

It's funny but elections have long been a known issue and that markets has continually trekked higher in spite of the so-called jitters.

Yet media ought to explain this....

As you can see, the Philippine Phisix, the S&P 500, (SPX) Asia's Dow Jones ex-Japan (DJP2), and the European index (Stox5E) have near simultaneously fallen.

And this has been equally reflected on Asian Currencies as shown by Bloomberg-JP Morgan Asian Currency Index

Perhaps a more fitting rephrase of media's reasoning should have been:

"Global markets, ex-US dollar currencies fall on Philippine election jitters!!"

@#$%!!!