In The US, New Businesses Surge in 2009!

In the US, the Kauffman Institute claims a record surge of new business activities in 2009.
Here is an excerpt of the press release "Despite Recession US Entrepreneurial activity Rate Rises In 2009 To Highest Rate in 14 years" (hat tip: Mark Perry)

"Rather than making history for its deep recession and record unemployment, 2009 might instead be remembered as the year business startups reached their highest level in 14 years – even exceeding the number of startups during the peak 1999-2000 technology boom.

"According to the Kauffman Index of Entrepreneurial Activity, a leading indicator of new-business creation in the United States, the number of new businesses created during the 2007–2009 recession years increased steadily year to year. In 2009, the 340 out of 100,000 adults who started businesses each month represent a 4 percent increase over 2008, or 27,000 more starts per month than in 2008 and 60,000 more starts per month than in 2007.

"Challenging economic times can serve as a motivational boost to individuals who have been laid-off to become their own employers and future job creators,"said Carl Schramm, president and CEO of the Kauffman Foundation. "Because entrepreneurs drive the economy, the growth in 2009 business startups is encouraging and hopefully points to a hopeful trend in terms of our economic recovery.”

Read the rest of Kauffman's press release here.

My comment: While the Kauffman institute does provide some details over geographical distribution of entrepreneurial activities (press releases naturally provides limited info), it doesn't make a breakdown on the industries where these activities have seen the surges.

My suspicion is that they'd probably be centered on technology or technology related activities.

But the point is, it's simply wrong to write off the elan of entrepreneurs, in spite of all the troubles (aftereffects of bubbles cycles, government intervention, bailouts, prospective high taxes, growth of government relative to the economy and etc..).

The ramifications of the deepening knowledge based economy is one of the x factors that can sustain free enterprise.

Plus Ca Change: President Aquino's Policy On Jueteng

It's been argued in this space that the new administration will unlikely provide a meaningful change in the way current things are being done.

For instance, the declaration of war against corruption will be unmasked as nothing more than demagoguery or posturing, for the simple reason that we cannot solve "corruption" by mere virtuosity because governance is about laws. And laws affect the way people conduct their business or individual actions. And in most occasions, official malfeasance function as a product of arbitrary laws.

Well, events are indeed turning out the way we see it.

President Aquino seems likely to begin his term by taking upon a populist stance.

This from the Inquirer,

``Presumptive president-elect Benigno “Noynoy” Aquino III has thumbed down a proposal by his uncle to legalize “jueteng,” a numbers racket that brings in millions of pesos in cash to operators and their protectors.

“Jueteng is against the law and we will enforce the law,” Aquino told reporters."

Nice.

Whether it is the church, media or politicians, the simpleminded solution to any social problem will always be the visible...in the case of jueteng, a numbers game used for grassroots gambling--by prohibition.

There has been nary an attempt by the domestic academe or by any institutions to study or analyze the impacts of these laws on society or how prohibitions can lead to corruption.

Incidentally, accepting jueteng money had been used as the main basis for the indictment of former President Joseph Estrada's plunder trial in 2001 to 2007.

For the mainstream, enforcement issues are merely a matter of virtue.

And it is why for the economically misinformed public, the solution is to change the people in charge, rather than to examine the net effects of the law. And it is also why eradicating corruption has been an ever elusive task.

And President Aquino's actions seem no better than his priors.


The fundamental problem with prohibition laws is that it does not deal with demand.

It mistakenly assumes that if you do away with supply, so will demand. That's where things go awry. Demand does not go away, but supply is now controlled by illegal elements through the backdoor with apparent blessings by those in charge. The huge profits from restricted supply and monopoly, thus, allows for mass payoffs along the layers of government's bureaucracy and to media.

Here is Professor Mark Thornton on the supply side impact of the Economics of Prohibition.

"Prohibition is a supply-reduction policy. Its effect is felt by making it more difficult for producers to supply a particular product to market. Prohibition has little impact on demand because it does not change tastes or incomes of the consumers directly. As supply is decreased, however, the price of the product will rise, the quantity demanded will fall, and demand will shift to close substitutes. For example, consumers of narcotics might shift their demand to alcohol and tranquilizers as their prices become lower in relation to narcotics as a result of prohibition."

In the case of jueteng, or the poor man's gambling game, this represents as an alternative (substitute) to horse racing or casino or Jai Alai which are legalized.

Ironically, the disparity of application of laws makes it appear that the poor have no right to engage in the same activity as the rich or the middle class. Hence, in my view, such laws are not only arbitrary and unenforceable but also discriminatory.

So whether rich or poor, where some people are inclined to gamble, the choice of horse racing, jai-alai or jueteng becomes an issue of accessibility or as substitutes to the poor.

Jueteng, in short, is a niche market for grassroots gamblers.

Nevertheless another negative effect of prohibition laws: waste of resources.

Again Professor Thornton,

"Efficiency in economics is the search to equate the marginal cost of an activity with its marginal benefit. For the individual, this means that the number of apples consumed depends on each apple's being valued at more than its cost. In public policy the situation is more problematic.

"In simple terms, the marginal cost of prohibiting one unit of a product is the cost of the law enforcement necessary to bring about this result. Every dollar spent on prohibition enforcement means one less dollar that can be spent on alternative public policies such as national defense, shelters for the homeless, or Congressional postal privileges. If taxes are increased to fund prohibition enforcement, individuals will have less to spend on food, medical insurance, and lottery tickets. Initially, the declaration of prohibition, the use of excess law-enforcement capacity, and the existence of marginal users make expenditures on prohibition enforcement highly productive.

"Also, these resources can be diverted away from the least important policies or consumer expenditures and therefore can be obtained at a low cost. After these initial conditions, the price of additional enforcement increases, its productivity declines, and the cost of expended resources increases."

So resources that could be spent on worthier social programs are wasted on law enforcement which has little benefit to the society. In short, society suffers from a net loss/deadweight loss (cost greater than benefit) on jueteng prohibition.

And here is the corrupting influence of prohibition laws...

Again Professor Thornton,

``Another motive for enacting prohibition legislation is to reduce corruption of both public officials and the democratic process. People have sold their votes for money or drugs, and the alcohol industry tried to influence elections and public policy. Politicians could also be subject to corruption and blackmail because of alcohol and drugs, and drug use can have a corrupting influence on the actions of political leaders. For these reasons, prohibition was promoted as a means to maintain the integrity of democracy and government.

[my comment: same here, the only difference is that good intentions backfires]

``In general, however, prohibition results in more, not less, crime and corruption. The black markets that result from prohibitions represent institutionalized criminal exchanges. These criminal exchanges, or victimless crimes, often involve violent criminal acts.

``Prohibitions have also been associated with organized crime and gangs. Violence is used in black markets and criminal organizations to enforce contracts, maintain market share, and defend sales territory. The crime and violence that occurred during the late 1920s and early 1930s was a major reason for the repeal of Prohibition (Kyvig 1979, 123, 167). The nondrug criminal activity of heroin addicts has been associated with the economic effects of prohibition laws and is viewed by Erickson (1969) and others as a major cost of heroin prohibition.

``Corruption of law-enforcement officers and other public officials is also a familiar manifestation of prohibited markets. Experience with prohibition has shown it to be a major corrupting influence. The corruption of the Prohibition Bureau proved to be a major stumbling block to the effective enforcement of Prohibition and was also cited as a reason for repeal. Most important, this corruption penetrates beyond the enforcement bureaucracy to government in general. Recent experience has shown that worldwide multidrug prohibition is a major corrupting force in several national governments, such as Colombia and Mexico."

So whether it is about drugs, abortion or jueteng, these issues have fundamentally the same grounds: Prohibition induces corruption but does not stop or limit these activities or that the unintended effects are greater than the supposed benefits the law aims to achieve.

So President Aquino's first act demonstrates more of the same things, an administration that seeks popularity or desires to look and feel good (public choice theory again!) but seems tolerant of law induced corruption and wastage of government resources from feckless Prohibition laws.

More On "Are People Inherently Nihilistic?"

I stumbled upon this interesting interview with Yale Professor James C. Scott who teaches political science and anthropology.

Here is an interesting piece... (bold highlights mine)

``The state, or centralized political organization, has been with us for the last 4000 years. Even when this state was not all-pervasive or all-powerful everywhere, it was always there. So even if certain spaces or people were ‘outside’ the state—in the so-called state of nature—they always coexisted with the state and interacted with it dialectically. So saying that there are people living inside and with the state, and others outside and without it, and that supposedly they will behave completely different, is a difficult hypothetical.

``I have, for instance, the idea that life was not ‘brutish, nasty and short’ outside of the state as Hobbes argued, partly because the population levels were so low that the way of dealing with conflict was simply moving out of the way. A lot of the things people struggled and died over, were essentially commodities. So if by the state of nature we mean people living outside the state in a world in which states already exist so they are at the periphery of states, then this is a completely different thing.

``We know, for instance, that pastoralism is in fact always organized in order to trade with agrarian states; it is not some previous form of subsistence that is superseded by agriculture. Another example: in the 9th century the people in Borneo were considered to be very backward and they were a typical example of a hunting and gathering society. What were they gathering? Certain kinds of feathers and resins and the gall bladders of monkeys, all stuff hugely valuable in China at the time! So they were gathering these things for international trade with an already existing state; their hunting and gathering is a hunting and gathering performed in the shadow of states. So which ‘state of nature’ are we referring to? When Rousseau speaks of the savages he has met, he sees people that strategically respond to representatives of an organized state, pursuing their interests and behaving politically. So the concept, perhaps, hides more than it reveals."

read the rest of the interview here

my comment:

Professor Scott, who ironically is a "'Marxist' inclined towards anarchism by convictions", suggests that people operate in the same manner in and out of the state, aside from the groups at the periphery ("living outside the state") interacting with the state.

In other words, people instinctively operate on the basis of trade under a spontaneous political order, similar to what we pointed out in our earlier post, Are People Inherently Nihilistic.

Again, arguments that assert that people are endemically atavistic and self destructive beings that require government is simply not proven by facts.

Multiple Intelligence And Human Freedom

Marketing guru Seth Godin makes another fantastic insight about the multiple intelligence of the individual which he calls ironically calls multiple dumbness.

``About twenty five years ago, Howard Gardner taught us his theory of multiple intelligences. He described the fact that there's not just one kind of intelligence, in fact there are at least seven (1 Bodily-kinesthetic, 2 Interpersonal, 3 Verbal-linguistic, 4 Logical-mathematical, 5 Intrapersonal, 6 Visual-spatial, 7 Musical, 8 Naturalistic). This makes perfect sense—people are good at different things." (emphasis added)

In other words, dumbness or intelligence depends on the relative comparison of traits, as no person can claim a monopoly or absolute superiority in all traits.

And such uniqueness makes man superior and complimentary, which highlights the case for human freedom.

Quoting Murray N. Rothbard from Inequality,

``If men were like ants, there would be no interest in human freedom. If individual men, like ants, were uniform, interchangeable, devoid of specific personality traits of their own, then who would care whether they were free or not? Who, indeed, would care if they lived or died? The glory of the human race is the uniqueness of each individual, the fact that every person, though similar in many ways to others, possesses a completely individuated personality of his own. It is the fact of each person's uniqueness, the fact that no two people can be wholly interchangeable, that makes each and every man irreplaceable and that makes us care whether he lives or dies, whether he is happy or oppressed. And, finally, it is the fact that these unique personalities need freedom for their full development that constitutes one of the major arguments for a free society." (bold emphasis added)

Quote of the Day: Capitalism Ended Slavery

Another gem from Professor Don Boudreaux, (bold highlights mine)

"Slavery was common throughout history until the age of industrial capitalism. Only then did this heinous institution disappear. Slavery was killed by capitalism because that institution puts a premium on creativity, initiative, and good judgment (which even the mightiest slave-master’s whip cannot extract from its victims), and because the ethos that gives life to capitalism – free-market liberalism – is hostile to the ownership of man by man. That the first-to-industrialize English were the first abolitionists is no coincidence.

"In North America, pressure brought by capitalism to end slavery was countered by the very agency that you praise as slaves’ liberator: government. From 17th and 18th century slave codes to the Fugitive Slave Acts of 1793 and of 1850, government in America actively deployed force on behalf of slaveholders. Without this force, slavery would never have taken root as deeply as it did in the U.S. and would have died away sooner and with less bloodshed."

Philippine Election Aftermath: Goodbye Illusion, Welcome Reality!

``Their final objective toward which all their deceit is directed is to capture political power so that, using the power of the state and the power of the market simultaneously, they may keep the common man in eternal subjection.” -Henry A. Wallace

First of all I’m gratified that the Philippine elections are nearly over with, as we are just awaiting the formality of official proclamations. The Philippine elections according to the Business Mirror had been the “most peaceful” since 2004[1].

Naturally, I presume that the goals of the automated polling system has been to facilitate for a swift and accurate tabulation of results and reduce chances of manipulation and human error, all of which should diminish tensions that could spur violence as traditional methods has. And quite obviously, technology has been critically instrumental in this successful transformation.

Second, I am glad that the Filipinos appear to have accepted the results and would like to congratulate everyone for the success of the exercise.

Of course, I’d also like to extend this congratulatory note to the new President, President Noynoy Aquino, as well as all other newly elected officials in both national and public offices.

Third, contra to the many commentators who romanticize or glamorize on the results of the poll, e.g. People power victory, we’d like to put the current events into perspective.

Political Leadership Determined By A Significant Minority

With a 90.2% of the total votes tabulated[2], where candidate Noynoy Aquino holds a commanding lead with 13,841,583 votes, I estimate the final tally to reach 15.3-15.5 million. This should reflect a little over 40% share of total voter turnout.

By the way, total voter turnout of the recently concluded elections, at 38 million, represents 75% share of the total registered voters, which according to the Business Mirror, had been the highest since 1978[3].

Figure 1: NSCB: Philippine Voting Distribution

According to the NSCB[4], there are 50.7 million registered voters (see figure 1), and 56.21 million projected voting population.

This only means that Mr. Aquino’s share of votes would be reduced or extrapolated to only signify 30.5% and 27.56% of the population, respectively.

Yet, I am not sure how the NSCB arrived at 56.21 million, considering that the present count of the Philippine population stands 92.2 million with 35.2% of the population at ages 0-14[5]. Statistical errors can dramatically swing the size of potential voters.

What I am driving at is that the political leadership in the Philippines have been determined by only a third (or even less) of the eligible voting (registered and non registered) population.

So how can we adduce ‘people power’ when today’s Philippine political exercise represents a vote of the plural minority?

Remember 18 million (56.21 million minus 38 million) voters did not participate in this exercise, for one reason or the other, and that’s even more than the votes accrued by candidate Aquino [estimated at 15.5 million]!

18 million votes could have swung the election results either way, or yet pejoratively seen, 18 million could have represented disenchantment with the process [!] or have been thought as a non-bearing activity or of lesser import to their lives [!].

One possible anticipated objection from this is that- it is the fault of the 25% of the registered voters, as well as the other 6 million who didn’t register and similarly vote.

But this would be a non-sequitor, it doesn’t deal with the fact- why our representative government ‘represents’ only the voice of the significant minority and certainly not Vox Populi, Vox Dei.

The other possible rebuttal is that People Power represents symbolism of the winning candidate as legacy from the parents. Well, in this case, I would agree, elections function nothing more than as symbolism.

Think of it, in 2001 President Joseph Estrada was ousted by a second edition ‘People Power’ revolution yet in this election candidate Estrada has garnered a substantial 25.5% of the voting share among those who voted! Whatever happened to the so called principles of People Power 2?

Yet if one ponders at the polling trends prior to the filing of candidacy of the contenders until the culmination of elections, deducing the poll data would only reveal that the cornerstone of today’s elections have been the struggle between pro-Aquino and anti-Aquino camps[6].

Since candidate Aquino’s share of votes have been little changed from start to the end, most of the variability or fluctuations from poll figures came from among the opposition. This only implies that the unfortunate part for the anti-Aquino camp is that the votes had been split or divided into 8 aspirants!!

Had the Philippine electoral platform been structured on a two party system or if we had a run-off elections for the top spot, candidate Aquino’s victory won’t be anywhere near assured. Based on economist Kenneth Arrow’s Impossibility Theorem[7], and given the share distribution of election returns, there would have been a big chance for an upset!

Populist Symbolism And Celebrities

Moreover, all one has to do is to take a look at the composition of the winners of the Senate to determine the quality of votes or how Filipino voters chose.

The rosters of winners can be broken down into two categories, one, celebrities turned politicians, and second, the political class, incumbent or inherited. Apparently, no exceptions this time around.

In other words, Filipinos on a national level did NOT vote based on “relevant issues” as misleadingly propounded by some inebriated commentators, but mostly on familiarity and perceived symbolism.

The fact that the antagonists from past people power revolution versions 1 & 2, who were represented in the national levels in the Presidency and the Senate, reaped considerable votes only reveals how people have abridged memories or have very little sense of history.

One may argue that celebrities didn’t fare all that well in the current elections[8]. But this would be mistaking the forest from trees.

The contest for local positions, where celebrities have not fared as well relative to national positions, have more direct impact on voters, such as annual doleouts, transfers, ‘free’ health or hospital use, ‘free’ movie passes, various freebies for the elderly and etc... Hence, popularity may not work its magical wonders relative to magnified effects of redistribution through local social programs. In short, patronage politics is likely to overwhelm the celebrity status on a local level.

In the national levels, where the impact of redistribution has been perceived as indirect, thus the conspicuous the dominance of popularity based votes.

Besides, it would also be a mistake to assume celebrities have equal stardom effect to the populace, as this would be more of a local issue (level of perception of a celebrity’s popularity transformed into social programs), political associations or affiliations [since people think based on symbolism, associations matter] and the contrast effect principle relative to the other challengers, including the incumbents.

Moreover, another vital issue will always be that of financing (a.k.a. direct or indirect vote buying), which could be a chink in the armor of celebrities relative to the incumbents.

Such dynamics, while strong in the local levels, may have a little less significance relative to the national level. And this seems how the national elections took hold.

Political Reality Seeps In

What’s shaping up is that the Aquino presidency appears likely to be confronted by an opposition (GMA) appointed Supreme Court Chief Justice and possibly an opposition dominated Congress (both in the Senate and the House of Representatives).

For those who believe that Aquino’s regime will be founded on virtuosity that would lead to corruption free governance, this will be the first supreme test [yes, even before the official inauguration!].

For President Aquino to be able to put his programs at work, he would need the collaboration of the Congress. Yet he is caught in a dilemma. He would need to attract significant segment of the opposition to his side or forge an alliance or otherwise risk becoming ineffectual. It’s a battle between supposed “principle” versus political convenience, where a looming tradeoff in President Aquino’s political stance would reveal of the harsh reality of Philippine politics.

In essence, the next phase of the electoral process can be characterized by horse trading and vote buying in Congress (via Pork barrel)[9].

Can President Aquino resist the allure of annexing power or risks being rendered into a lameduck president? Here based on public choice theory, the answer will be no. Like all presidents before him, there will be much dirty politics in play. Maintaining popular appeal translates to high profile “president in action” regardless of the validity of the prop act.

Yet once President Aquino embarks on this process, as the 1980 song by the Fixx goes, “One Thing Leads To Another”!

This only means: Goodbye Illusion, Welcome Reality!

---

[1] Business Mirror, Polls ‘most peaceful’ since 2004

[2] ABS-CBN, Partial Results of votes for President; “official data from the Commission on Elections (Comelec) and the Parish Pastoral Council for Responsible Voting (PPCRV), which did a parallel vote count”

[3] Business Mirror, 38-million voter turnout highest since 1978

[4] National Statistical Coordination Board (NSCB) Did you know that … Region IV-A has the highest number of registered voters for the 2010 elections?

[5] Wikipedia.org, Demography of the Philippines

[6] See Philippine Post Election Analysis: 2010 Election Theme and The Runoff Theory

[7] See Philippine Elections: In A Hypothetical Runoff Elections, Will Noynoy Aquino Still Be The Winner?

[8] GMANews.tv, Celebrity winners and losers in May 2010 polls

[9] See Quote of the Day on Philippine Politics: Changing Parties To Get So Many Benefits Under A Sitting President

External Developments Are Prime Movers of Philippine Markets

``The key to making money in stocks is not to get scared out of them."-Peter Lynch

If there are any lessons learned from the events of last week, it is what we have earlier observed: markets are mostly externally driven and alternatively local ‘political’ activities have less an impact.

And as previously noted[1], ``So I am not as confident of a decoupling until we see more elaborate evidences from this.”

As long as politics revolve around non-financial or market issues, they will likely have lesser influence than from developments in capital markets abroad.

So whether it is political tumult in Thailand where headlines scream “Bangkok Burns”[2] or from the recent electoral finis in the Philippines, it’s been little about local events.

Proof? (see figure 2)

Figure 2: Global Market Rout Spillover To The Phisix And The Peso

When local analysts and media babble about election failure jitters, and where the Peso continues to firm, that would seem like foisting one’s desired opinion as the aura of truth, even in the absence of evidences. This essentially begs the question. It is like observing in a horse race where horse X is ahead of horse Y even if in reality Y is way ahead of X with only a foot away from the tape.

Following the elections everyone seems optimistic about markets due to a change in leadership. In contrast, our upbeatness on the domestic markets emanate from different reasons.

Yet market reaction and political developments appear to be diverging.

Currency Markets Bears The Brunt As The Phisix Remains Resilient

The market rout in the Europe and Chinese markets appears as being transmitted into sundry market channels, most notably through the currency markets.

This week alone, the Philippine Peso fell by a whopping 3.8% (green line in the chart), which seems like a prayer answered to a local exporting group, whom has been calling for a 46 to a US dollar level!

Unfortunately for this myopic exporting group, if markets continue to stumble as reflected on the falling Peso, a lower peso won’t translate to ‘better business’ or added demand simply because markets appear to be suggesting exactly the opposite--a prospective fall in demand, hence reflected on the fall in the Peso.

In short, this may be called as the return of risk aversion—for the moment.

Mainstream must be wondering, with a newly elected “People Power” president why the sudden stampede away from the Peso? The answer is that elections have had little influence on the markets.

Yet this isn’t just a Peso phenomenon. Asian’s currencies were mostly in a swan dive; the Korean won crashed by 8.6%, the Malaysian ringgit 4%, New Zealand dollar and the Australian Dollar 4% and 6% respectively. And only the Thai baht seemed little changed this week in spite of the Bangkok burning event.

As you can see above, the S&P 500 (blue line) plummeted by 4.23% this week after the ugly plunge 3.8% last Thursday. From a peak to trough basis the S&P has lost some 10.7% based on Friday’s close.

Meanwhile, the Philippine Phisix lost 4.54% over the week. One peculiar behaviour has been that the Phisix fell by only 1% in reaction to the hefty over 3.5% decline in the US, last Thursday. Moreover, the Phisix is down 4.54%, following a newly established high or zenith the other week. This compared to the 10% decline, from the peak in the US markets, last end of April.

While one week doesn’t a trend make, the seeming resiliency seen in the local market relative to the Phisix can be traced to a shift in dominance in terms of transactions from foreign to the locals. This has been the case since 2009 (see figure 3)

Figure 3: PSE: % Share Of Foreign Trade

The red line marks the 50% threshold. In 2008, most transactions have been dominated by foreigners, this changed in 2009 where most transactions have been shown below the trend line.

So while we don’t believe that there will be a decoupling yet, continued marked improvements like this could function as a foundation.

Nevertheless, this implies that the state of international markets remain as key factors in ascertaining local trends or even individual local issues.

The idea that corporate fundamentals will defy general trends seems like a misconception. Even the deeper and more sophisticated US markets seem to be showing the same symptoms[3], where tidal fluxes shape psychology and affect individual issues which eventually determines the general state of the markets.

So unless we can establish that global markets are not headed for a free fall, only from then can we work on the significance of micro dynamics.

---

[1] See Phisix: The Philippine Presidential Honeymoon Cycle Is On

[2] See Politics And Markets: Bangkok Burns Edition

[3] See More Evidence On Liquidity Driven Markets

Global Markets Violently Reacts To Signs Of Political Panic

``Obviously the thing to do was to be bullish in a bull market and bearish in a bear market.”-Jesse Livermore

We don’t share the view with the Perma bears that this is the return of the bear market.

A technical trend break in chart trends does NOT automatically translate to a bear market. Besides charts are a menagerie of past information which does not suggest any infallible concept about the future outcomes.

And neither was last week about world credits being repriced nor about the adverse debt developments in the US.

Figure 4: Danske Bank: German short-sell ban rattles markets

To the contrary, sovereign debt papers of the US, Germany and Denmark were chief beneficiaries of last week’s turmoil (see figure 4 right window). So while we are seeing some emerging tensions in money markets via interbank funding rates (left window), they are yet substantially distant from the cataclysmic heights in post Lehman episodes of 2008.

Of course the $64 billion question is, are we headed there? My reply is a likely no.

Why?

Because most of adherents to this school sees markets as being immobilized by debt, which is simply not true.

To quote Murray Rothbard[1], (bold highlights mine)

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

UNLESS this time is different I simply can’t see how Zero interest rates combined with suppressed inflation will prompt for catastrophic markets.

Throughout Japan’s lost decade, as we previously discussed[2], we haven’t seen her market’s crash when interest drifts at the zero level.

While it may be true that government actions in solving today’s predicaments may be reaching diminishing returns, zero interest rates and dampened inflation provides government extended leeway to conduct activities as noted by Mr. Rothbard above.

And while Eurozone[3] and the UK[4] have been witnessing accounts of rising consumer price inflation to a 16 and 17 month highs respectively, they haven’t reached levels that could stymie government actions.

Moreover, as previously noted[5], the premise of diminishing returns is exactly the main reason why the scale of rescues have been constantly swelling. Unless we see global governments willing condescend to market forces, and accept the limits of central banking, this isn’t likely to happen yet.

But recent events only prove that this is exactly in the opposite direction.

Germany’s Signs Of Desperation

Just last week, the arrogance of trying to prevent markets from revealing the true nature of balance sheet impairments of subprime Europe prompted Germany’s chancellor, Angela Merkel, to slap a ban on naked short selling on credit derivatives, euro bonds and select financial equities[6].

European authorities similar to Filipino voters have little incentives to learn from past experiences. Never mind that the US tried the same approach in the wake of the Lehman bankruptcy that exacerbated if not helped triggered the October 2008 crash.

And we seem to be seeing the same market response.

According to the Danske Research Team[7], ``The reason for introducing the ban on naked short-selling is that BaFin wants to reduce the extraordinary volatility that has been witnessed but the immediate market reaction suggests that the contrary has been accomplished and the euro has weakened further against the dollar. In the credit market, sovereign CDS tightened dramatically (short covering) whereas the corporate indices widened – the reason probably being the uncertainty that has been created in the playing field.” (bold highlights mine)

So regulatory risks has been exacerbating the market’s meltdown.

To wit, there have been accounts of massive capital flight[8] from Germany to Switzerland, which according to some reports, prompted heavy foreign exchange intervention[9] by the Swiss National Bank (SNB).

Moreover, there have also been emerging signs of political schism in the Eurozone, the surprise ban on short sales, which had purportedly been meant to shore up political support for Germany’s approval of the Euro’s bailout, hasn’t been well received by France[10], while other EU nations remain undecided. The following day the Germany approved of the bailout[11].

Earlier much of EU’s actions have been tilted in favour of France; where Germany argued for Greece to solve her own problems while France favoured a bailout and where Germany was initially in favour of marginal support while France’s Sarkozy wanted a “shock and awe”.

According to Gordon Long[12], ``It's in Sarkozy’s interest to fight for a US-like Keynesian solution with excess money printing. This would "kick the can down the road" and avoid an impossible "austerity cuts" war with French unions and workers.”

Obviously we seem to be witnessing public choice theory at work anew, where political self-interest interests among policymakers continue to trump the markets.

So political risks from the discordant and unilateral policies seem to be worsening the uncertainties in the marketplace. And this has led to last week’s market carnage.

Moreover, one can infer that these actions signify as signs of panic and act of desperation by EU authorities. So while governments in panic can be indicative of a bottom or present itself as buying opportunities, the obverse side is that desperate actions can lead to reckless policies that could backfire. The ban in naked short selling is an example.

But as we have long been pointing out[13], politics will be the order of the day. And to this point we are being validated anew.

So until we see signs of restoration of order and confidence in terms of policymaking, the likelihood is for continued volatility in global markets.

But I’d like to reiterate that that this isn’t the 2008 meltdown, where most of the actions from last week seem to emanate from regulatory risks and from political risks rather than from a seizure in the banking system caused by quasi ‘electronic’ bank runs and the subsequent drying up of trade finance.

In short, the nature of market stress has been entirely a different animal.

Even the Federal Reserve’s swap facilities which it has recently reopened, has had less takers, if not entirely “no new demand”[14]. This hardly implies of credit stress but again most likely from political and regulatory oriented strains.

Furthermore, there is a chasm of a difference between administrative politics and the politics in the financial-economic sphere. The latter is where markets have been greatly influenced as the drama in the Eurozone has exhibited.

Contrasting China And EU’s Predicament

Finally I’d like to point out that there’s a big difference between the developments in China and the Eurozone.

In China, governments have been fighting a brewing bubble by attempting to contain surging asset prices, particularly property prices, from credit expansion. (see figure 5)

Figure 5: US Global[15]/ Danske Bank[16]: Money Supply and Inflation

In Europe, governments have been trying to contain the debt crisis by inflating the system.

In other words, you have two (set of) governments fighting different monsters with slightly opposite measures.

As you can see in the left chart, China’s money supply appears to be shrinking. And this may have prompted for the recent collapse in Shanghai Stock Exchange (SSEC) and a possible easing of her property markets.

And as pointed above, the bubble strains isn’t just being manifested in surging property prices but also in consumer price inflation (right chart).

Hence in my view, the odds of a bust look greater in China than in Europe at the present moment, considering that rising consumer price inflation and asset bubbles are likely to retrain the hand of the authorities. Although markets appear to be saying that both are in a bust now, I wouldn’t bet on it.

As noted above, governments coordinating to pump massive amounts of money into the system will have to go somewhere.

Moreover, austerity measures that should affect economies such as Greece is only a sliver to the economic recovery being seen in most of the Euroland, Spain and Italy included (see figure 6)

Figure 6: Danske Bank[17]: Euroland: Between robust data and political risk

Europe’s manufacturing indices PMI appears to be at an upside momentum while business surveys IFO remain positive, in spite of the unravelling crisis.

So unless you expect the markets to suffer from more convulsions out of concerted shrinking of supply of money, which will be the only way for a coordinated meltdown, possibly through simultaneous collapses in the banking system, I highly doubt this scenario would occur.

Especially not with governments putting implicit, if not explicit guarantees, in the banking system, and especially not with governments frantically throwing money at every known social problem.

Of course, the other major risk would be to severely impede or even restrict movements in the capital markets, but that would be opposing the interests of the banking system from which global governments have toiled so hard to save.

As previously shown, governments can put them to public trial for theatrics, but at the end of the day, they’d scamper to rescue once signs of distress emerge.

The recently passed new financial regulation bill in the US will hardly change the politics of banking cartels and the central banking system.

And as the EU drama shows, rules will be bent for political conveniences.

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[1] Rothbard, Murray N. Lessons of the Recession Making Economic Sense p.220

[2] See What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?

[3] Bloomberg, European Inflation Accelerates, Exports Increase

[4] BBC.co.uk, UK inflation hits 17-month high

[5] See The Euro Bailout And Market Pressures

[6] See Germany Bans Short Selling, Another Scapegoating The Markets

[7] Danske Bank, German ban on short−selling dampens the mood

[8] Pritchard, Ambrose Evans Germany's 'desperate' short ban triggers capital flight to Switzerland

[9] Alloway, Tracy, Swiss franc intervention cost a billion a day in April, FT Alphaville

[10] Wall Street Journal, Taking the Naked Ban to a New Level

[11] BBC.co.uk, Germans approve euro rescue plan

[12] Long, Gordon T., What Will Come of the Euro Experiment?

[13] See Why The Greece Episode Means More Inflationism

[14] Wall Street Journal, Lack Of Demand For Fed Currency Swaps Plus For Markets

[15] US Global Investors, Investor Alert, May 14, 2010

[16] Danske Bank, China: Solid growth and higher inflation clear the way for revaluation

[17] Danske Bank: Euroland: Between robust data and political risk