Why Mainstream Economists Are Mostly Wrong

How could economists/experts get it (forecasting, policy prescriptions) so wrong?

This from Janus Lim of the World Bank (hat tip: Prof Antony Mueller) [bold emphasis mine, italics his]

It would seem that the current crop of modern macro models are not only ill-suited for prime-time policymaking in the developed world, they are also inadequate for the developing-country context. At some level, this is ironic. Developed economies are typically far more complex, with larger and more sophisticated product, financial, and labor markets. If anything, the relatively simple structure of DSGE models should be attractive to developing countries, since they are more likely to be successful in capturing the primary features of these economies.

Of course, it may well be the case that developing country policymakers are not quite ready for such sophisticated, state-of-the-art macro modeling tools. Perhaps so, but this seems to me to be a red herring. While ease of use is certainly relevant for capacity-constrained LDCs, the more important question to ask is whether such models can answer the questions foremost on the minds of developing country policymakers. If they can't, it matters much less that the developing world is not ready for them. It would be more that these models are not ready for the developing world.

For simplicity sake, the answer is because they substitute models for human action.

Prof Richard Ebeling writes,

The inability of the economics profession to grasp the mainsprings of human action has resulted from the adoption of economic models totally outside of reality. In the models put forth as explanations of market phenomena, equilibrium — that point at which all market activities come to rest and all market participants possess perfect knowledge with unchanging tastes and preferences — has become the cornerstone of most economic theory.

How Free Trade Saved The World From Depression

This from the Economist, (all bold highlights mine)

DURING the Great Depression, America’s protectionist Smoot-Hawley Act of 1930 raised tariffs on more than 900 goods. A series of retaliatory actions by other countries followed. The effect on global commerce was devastating. In the three years to June 1932, the volume of world trade shrank by over a quarter. No wonder, then, that the spectre of the worst recession since the Depression led many to fear another descent into protectionism and a similar decline in trade.

At first, the recession did hit trade hard. Global GDP fell by 0.6% in 2009 while the volume of world exports dropped by 12.2%. But whereas the Depression saw trade decline for at least four years, this time the rebound has been quick, and sharp. By May this year, emerging-economy members of the G20 were importing and exporting around 10% more than their pre-crisis peaks (see chart). Rich-world trade has recovered from the trough too, though it has not yet made up all the ground lost since the credit crunch began.

Trade has not been devastated by the raft of protectionist actions taken during the downturn. According to the World Bank, the rise in tariffs and anti-dumping duties explains less than one-fiftieth of the collapse in world trade during the recession. For the most part, the fall in trade reflected a drop in demand.

There is even some evidence that activity has rebalanced from the lopsided trade pattern that existed just before the crisis. Then, the share of emerging-world imports that came from rich countries had been on a steadily declining path. But now demand from emerging economies is helping to prop up rich-world exports to a larger degree than is commonly realised. According to IMF figures, of nine emerging markets in the G20, seven got a higher share of their imports from rich countries in 2009 than they did a year earlier. Just 59% of China’s imports came from rich countries in 2008, but this rose sharply to 66% in 2009. India obtained 42% of its imports from rich countries in 2008, but last year this rose to 47%.

That mutually beneficial pattern points to the importance of both rich and poor countries keeping their markets open, so that growth in one part of the world can help stimulate a recovery elsewhere.

Some observations:

People have learned from history (perhaps heeded George Santayana’s admonitions?)

Having sentiently benefited from the experience of trade, most of the world appear to embrace free-trade globalization as means of generating wealth. And as shown above, this is noteworthy especially in the emerging markets.

The proof of the pudding is in the eating. The best test of the conceptual assimilation of free trade is through a crisis, and free trade seems to have passed with flying colors.

The Economist doesn’t mention it, but the world’s growing acceptance of free trade, in my opinion, is largely aided by the shift to the information age. This seismic transition allows for real time communication, thereby reduce the instances of conflicts by open dialogue.

Like always, mercantilists have it wrong anew.

And with this we quote Mr. Ludwig von Mises in Liberalism,

To this question Ricardo's doctrine provided the answer. The branches of production distribute themselves among the individual countries in such a way that each country devotes its resources to those industries in which it possesses the greatest superiority over other countries. The mercantilists had feared that a country with unfavorable conditions for production would import more than it would export, so that it would ultimately find itself without any money; and they demanded that protective tariffs and prohibitions on imports be decreed in time to prevent such a deplorable situation from arising. The classical doctrine shows that these mercantilist fears were groundless. For even a country in which the conditions of production in every branch of industry are less favorable than they are in other countries need not fear that it will export less than it will import. The classical doctrine demonstrated, in a brilliant and incontrovertible way that has never been contested by anybody, that even countries with relatively favorable conditions of production must find it advantageous to import from countries with comparatively unfavorable conditions of production those commodities that they would, to be sure, be better fitted to produce, but not so much better fitted as they are to produce other commodities in whose production they then specialize.

Breakfast Inflation

We’ve been repeatedly told by experts that inflation has been non-existent and is less of a threat compared to deflation which is seen as the major scourge.

This from the Economist,

SEVERE drought and wildfires in Russia, the world’s fourth largest wheat producer, have destroyed a fifth of the country’s crop and sent prices soaring. Since the end of June wheat prices have more than doubled. On Wednesday August 4th, the UN’s Food and Agriculture Organization cut its forecast for 2010 global wheat production by 5m tonnes, to 651m tonnes. Kazakhstan and Ukraine, both big wheat producers, have also been hit with dry weather. In Canada the problem is the reverse: unusually wet weather has prevented seeding and destroyed crops. But wheat is not alone. The price of orange juice has also risen recently, probably thanks to bets placed on the likelihood of tropical storms. Coffee prices, which hit a 13-year high, are a result of poor harvests. Taken together, the raw ingredients for breakfast in much of the rich world have increased in price by 25% since the beginning of June.

Some observations:

Inflation on your breakfast table poses only as short term quirk.

Inflation is beginning to pick up and your breakfast is first among the many diffusing signs.

Let me guess, mainstream analysis which see money has having a neutral effect is wrong.

What Exploding IPOs In Asia Means

There has been an explosion of IPOs in emerging markets, particularly in Asia.

According to Globe and Mail (graph included)

Globally, July IPOs totalled $30.5-billion (U.S.), according to Thomson Reuters, the highest value since November, 2007. The Asia-Pacific region benefited most from the boom, buoyed by Agricultural Bank of China Ltd.’s $20.8-billion IPO. Not only did AgBank garner strong demand, the offering was ultimately upsized.

Since January, the Asia-Pacific region, excluding Japan, has raised almost $136-billion (U.S.) in IPOs and follow-on offerings, according to Thomson Reuters, while the United States has raised $67-billion. Investors can only wonder why North America has been so tepid while Asia is so hot.

Exploding IPOs, for me, are symptoms of brewing euphoria, which are mostly in response to policies. The rate of increases provides significant clues to the transitioning phases of a bubble cycle. See earlier discussion What Agricultural Bank of China’s IPO Should Imply For Asian Financial Markets

The issue of concern here isn’t a liquidity drain. For every buyer there will always be a seller. Thus, liquidity (money) is transferred from buyer to seller.

The issue is here is euphoria, artificially bolstered demand from policy impetus that forces the public to (decrease savings) increase risk appetite and chase yields, thereby distorting relative price levels of financial securities, the fostering malinvestments (in the real economy) and the attendant speculative orgies.

The primary reasons why Asia outperforms or has gained significant traction from such policies as earlier stated here has been because of huge savings, less systemic leverage, and a largely unimpaired banking system.

Of course, many real economic reasons provide for the other “rationalization”. Think regionalization, urbanization, wealth transfer etc... But they are secondary forces.

Importantly, in a world of globalization, global funds tend to seek out the best performers, which is emblematic of the ‘bandwagon effect’, as Templeton’s Mark Mobius writes,

In general, institutional pension funds’ exposure to the emerging markets asset class averages around 3% to 8% of their portfolios. From a pure market capitalization perspective I think that they are severely underweight in the asset class, as emerging markets stocks account for more than 30% of the world’s total market capitalization. We anticipate seeing some shift of institutional allocations to this asset class. Consequently, we believe institutional investors could fuel further demand for emerging markets equities.

...and that there would be numerous carry trade or arbitrage opportunities, from the fast emerging divergent monetary policies which could be channelled from currencies to bonds and could find its way to these IPOs and fuel more of this bubble like phenomenon.

I don’t think that Asia’s IPOs has reached a scale of bubble proportions to the point of implosion. Not yet anyway. Perhaps we could still be far off. But these constitute one of the many signs that we are headed in that direction.

P.S. As per the Philippines an IPO boom has yet to materialize.

Revocation Of Midnight Appointments: It’s About Who YOU know

Perhaps you’ve heard the axiom “It’s not about what you know but WHO you know.”

In a market economy, this would be less relevant because consumers are reckoned as the empowered political-economic force.

But in a statist economy, where economic opportunities are mostly distributed according to whims or priorities of politicians then this becomes a very influential factor.

And it appears that the second executive order issued by the President Aquino is emblematic of the latter.

This from the Inquirer.net,

President Benigno Aquino III has issued Executive Order No. 2, revoking the “midnight appointments” former President Gloria Macapagal-Arroyo made on or after March 10, Malacañang has announced...

De Mesa said Malacañang found 977 instances wherein the previous administration violated the constitutional ban on appointments two months before the presidential elections and 90 days before the end of Mrs. Arroyo’s term last June 30.

My comment:

1. After the Wang Wang, now political retribution. President Aquino’s thrust seems very much directed at populist politics, obviously aimed at sustaining his high popularity ratings.

Since former President GMA has been intensely unpopular, then piggybacking on vindictive sentiments seems the most apparent way to meet his personal goals (popularity ratings).

However, as we earlier wrote, ``Political gimmickry can only have a short term impact, thus he would need a bagful of other tricks to keep people entertained.”

2. Like any other politician, the President’s action reveals that political loyalty and affiliation have been the primary mechanism to effect ‘changes’.

This implies that preservation of power translates to rewarding supporters and will use such occasion (PGMAs unpopularity) to his advantage.

Hence, the vacated posts will most likely be used for election payback.

Yet, if President Aquino truly desires to seek the betterment of the Philippine society, then he should use this opportunity to trim the bureaucracy. But the latter option is wishful thinking on our part and isn’t likely the course of action.

3. While one may argue that midnight appointments are illegal, they could, technically speaking.

But these types of laws can be arbitrarily interpreted to the convenience of the powers-that-be.

Laws can be perverted to unjustly impose powers over certain groups or to the society for the attainment self-interested political agenda by political leaders.

As Frederic Bastiat wrote in the Law, “they turn to the law for this despotism, this absolutism, this omnipotence.”

And as we’ve been saying all along, we are seeing more and more proof of “the more things change the more they stay the same”.

Elusive dreams will remain ever elusive.

Rahn Curve: Defining The Optimum Level Of Societal Benefits From Government Spending

There is a limit to everything. And this applies to government spending as well.

Cato's Daniel Mitchell, in another great educational video, explores to identify the optimum state point of government spending [up to what level of government spending benefits a society?] via the Rahn Curve.

Demographic Nightmares 2

George Magnus writes,

``capitalism rewards scarcity, and as labour supply fades relative to the availability of capital, returns will shift towards the former...

Huh?

If capitalism rewards scarcity then why at all risk precious capital to invest in order to produce?

What could Mr. Magnus be smoking?

Capitalism is an economic or resource distribution system which operates on the platform of property rights, voluntary exchange, and the profit and loss system in a world of scarcity. And the reason capitalism exist is to satisfy the unease or the pain of consumers from scarcity, hence the incentive to invest to produce.

I am reminded that once we argue using false premises then the conclusion would obviously wrong.

Mr. Magnus is apparently anxious about the world’s demographic trends echoing Pimco’s Bill Gross [see William Gross’ Demographic Nightmare]

His concern is that a smaller labor force would result to reduced corporate earnings and a lower economic growth. Hence, he recommends numerous “policy levers” or interventions to solve these predicaments.

Yet how valid is this?

True, the global rate of population growth has been falling as shown above, but it is still mostly positive (ex- Japan).

However, what is not seen is that the crucial reason why the rate growth has been falling is due to the relatively high nominal levels of world population which has already reached 6.697 billion (!), in 2008, according to the World Bank.

Another important variable in the present global demographic trends is that while population growth rate has slowed in developed economies, the bulk of the growth now comes from emerging markets.

Chart from Oppenheimer Funds

The implication is that this puts to risk the cumbersome welfare system of developed economies, aside from crimping “aggregate demand” (we dealt with this earlier).

Although I would be agreeable to one of Mr. Magnus’ suggestion that changes be made in the welfare system, I’d take a more radical approach.

Since it is to my opinion that welfare systems signify as unsustainable political PONZI programs that had been designed to buy votes of the population and to keep people dependent on politicians, welfare systems should be phased out or trimmed to the essentials.

The reduction or elimination of which would entail diminished financial burdens for the future generations, which should allow our children more room to deploy resources to their interest or pleasure, thereby reduce the barriers to investments.

This should also instill the culture of savings and personal responsibility and importantly advance the cause of personal liberty—where lesser redistribution translates to more efficiency of resource allocation and freedom of choice.

And there is another possible solution which could compliment this: ease immigration barriers to allow for free movement of people or enhance social mobility.

So globalization shouldn’t be limited to trade and finance, but also to migration flows, which at present constitutes only an estimated 3.1% of the global population, according to the International Organization For Migration (IOM).

These two structural reforms will greatly ease the concerns over reduced economic and corporate earnings growth, thus, needing less government activist (boom-bust) policies which would only worsen whatever demographic nightmare envisaged by interventionists.

Quote Of The Day: No Scientific Understanding Of Human Society

From James Manzi, (hat tip Prof Arnold Kling)

``At the moment, it is certain that we do not have anything remotely approaching a scientific understanding of human society. And the methods of experimental social science are not close to providing one within the foreseeable future. Science may someday allow us to predict human behavior comprehensively and reliably. Until then, we need to keep stumbling forward with trial-and-error learning as best we can.”

My comment: Anyone audaciously claiming that they can use science or math or econometric models to influence changes in society signify no less than a huckster, a false messiah or a fraud.

China’s State Driven Bubble

Who is responsible for inflating China’s Bubble?

Her Government.

This from the New York Times, (bold emphasis mine)

All around the nation, giant state-owned oil, chemical, military, telecom and highway groups are bidding up prices on sprawling plots of land for big real estate projects unrelated to their core businesses.

“These are the ones that have the money to buy the land,” says Prof. Deng Yongheng at the National University in Singapore. “Because in China, it’s the government that controls the money supply and the spending.”

By driving up property prices, the state-owned companies, which are ultimately controlled by the national government, are working at cross-purposes with the central government’s effort to keep China’s real estate boom from becoming a debt-driven speculative bubble — like the one that devastated Western financial markets when it burst two years ago.

Land records show that 82 percent of land auctions in Beijing this year have been won by big state-owned companies outbidding private developers — up from 59 percent in 2008.

This is looking very much like the transitioning phases of the Austrian Business Cycle...

(all charts from World Bank China’s Quarterly report and IMF’s People’s Republic of China: 2010 Article IV Consultation)

From the rapid expansion of circulation credit….

to exploding money supply growth…

mostly directed at future oriented capital structure in this case, real estate.

Frothy real estate markets…

….the deepening exposure by the banking system to the property-real estate sector.

Add that to the Chinese government’s crowding out of the private sector by her state owned enterprises bidding up on land, which worsens the bubble conditions and fosters systemic malinvestments.

And most importantly, artificially suppressed interest rates have been crucial to these dynamic.

Well, since bubbles come in phases, muted inflation hasn’t YET been much of a factor in pressuring interest rates higher.

So perhaps the bubble will persist.

This reminds me of Ludwig von Mises who once wrote, (emphasis added)

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

In fullness of time, China’s policies of turning stone into bread (philosophers' stone) will end in tears.

For now, party on!

Inflation’s Sweetspot: Jitters Over Debt Crisis Subside

At the start of the year, financial markets, particularly in developed economies, had been jittery over the contagion effects of the debt crisis in the PIIGS area led by Greece.

Now, such concerns appears to have reversed, as highlighted by the table below from Bespoke Invest, which covers 5- year CDS swap prices and includes the ‘four problematic’ US states.

According to Bespoke,

European countries rank first through fifth in terms of decline since July 2nd. Belgium has seen default risk decline the most at 30.1%. Belgium is followed closely by Spain (-29.1%), Italy (-27.3%), and France (-26.2%). The four US states highlighted are Illinois, California, New York, and New Jersey. All four states declined roughly 20%, with California decline the most (-22.3%) and New Jersey declining the least (-18.6%).

In terms of default risk levels, Venezuela ranks highest, followed by Argentina, Greece, and Dubai. The four US states highlighted aren't too far from the top of the list and have higher default risk than countries like Spain and Italy. The US, Germany, Australia, the UK, and France currently have the lowest default risk.

Ah, behold the seductive ephemeral wonders of inflationism!

The New Trading Platform Of The Philippine Stock Exchange

``There’s a simple and elegant test of whether there is skill in an activity: ask whether you can lose on purpose. If you can’t lose on purpose, or if it’s really hard, luck likely dominates that activity. If it’s easy to lose on purpose, skill is more important.” Michael J. Mauboussin

Mayhem struck the Philippine Stock Exchange (PSE), this week. What was expected to be a smooth transition in the migration of the old MakTrade system to the New Trading System turned out to be quite messy.

Aside from the erroneous data feed which resulted to a whopping one day 14% jump in the Phisix on the first day of the new system, news reports say that it took more than three hours[1] to correct the figures in the benchmark index.

The glitch wasn’t just seen in the major benchmark figures. This extends all the way to the data, particularly on the daily quotes. Previous computations for foreign trade seem to have been altered, so as with the breadth (daily number of issues traded-formerly sum of advance, decline and unchanged issues), this I would have to clarify with the PSE.

So unless the PSE resolves to align this week’s quote with the past, the new system will render our previous data as invalid.

Though this is a technical issue which eventually should be resolved, I am not sure how the PSE will make good the right adjustments, considering that it could be costly to reprogram (if this is included in the package).

In addition, the posting of the daily quotes at the PSE website has been way delayed. The quote for July 30^th trading session had been uploaded only this morning, August 1^st.

The Unseen Cost Of Inefficiencies

Meanwhile, a PSE official, quoted by media, rushed to exculpate the disorderly transition by insensibly claiming that such transition represents as a mere “minor” issue and emblematic of normal “birth pains”. This is not only ridiculous, but is unwarranted.

Such statement exemplifies on what we call as the stakeholder’s problem—where the urgency to know and act is fundamentally based on the perceived stake by the agent involved.

In this case, because the officer’s stake isn’t in the trading business, but as an employee of the PSE, his sentiment reveals of the seeming paucity in the urgency to patch up the system, as well as, the undeserved insensate remarks.

One should realize that distortions in the price signals engender imbalances in the capital markets.

This includes an increase in the perception of operational uncertainty which could result to heightened volatility, the expanded risk premium of holding local equities relative to other local and foreign assets, higher cost of transactions and a higher hurdle rate required by both local and foreign institutional investors for them to consider allocating their funds to Philippine equities.

In short, uncertainty translates to the risks of lesser investments!

Proof of this is that even if the Phisix bellwether did register a marginal gain this week, the average volume fell by 13% (Php 2.9 billion) and the average number of daily trades fell by 23%!

So when we are talking of billions of pesos per day (estimated at Php 3 billion or US $66 million), “minor” problems and “birth pangs” translate to Php 100 millions+ (US $2.2 million) lost in daily transactions. Think of all the multiplier effect from the lost transactions applied to the participants and to the PSE itself.

Figure 1: Bloomberg: Year To Date Performance Of The ASEAN 4

I would even suggest that the underperformance of the Phisix relative to our ASEAN neighbours amidst a seemingly sprightly market backdrop (see figure 1) could signify as the unseen ‘negative’ ramifications from the “birth pains” (see blue circle).

Except for Malaysia (orange), all three major ASEAN bourses have broken above the 2010 resistance levels, and this includes the Philippine Phisix (green). However the rally in the Phisix appears to have stalled while the others persisted.

So the lost opportunities in terms of trading volume and a higher Phisix level could have been the side effect of the unwieldy migration to the new system.

New Trading System Positioned For Derivatives Markets

The New Trading System (NTS) reportedly cost a staggering Php 197.39 million[2] (US $4.32 million-current exchange rate) whose trading platform is supposedly designed from one of the world’s largest stock market companies. According to the Inquirer.net[3],

``trading software product developed by NYSE Technologies SAS, the commercial technology unit of NYSE Euronext, which in turn operates the largest exchanges around the world including the New York Stock Exchange and Euronext.”

By concept, the NTS or the new platform seems promising, primarily because it is supposedly a system that would also service “cash, debt and derivative instruments”.

Among the major ASEAN bourses, the Philippines is a laggard in the derivatives markets as we have yet to implement one through the local stock exchange. Hence, the understandable shift to incorporate a trading platform that would allow for this expansion.

In other words, the New Trading System (NTS) is meant to position for a derivatives exchange market and not just the stock exchange.

By allowing investors the instrument to hedge, which is the main function of derivatives, this facility could enhance investor returns, which should ultimately attract more public participation.

Figure 2: Manila Bulletin: NTS Revised Ticker and Board Lot

There are many salient trading enhancements in the new program. This includes the adoption of a reduced tick size (price fluctuation) and board lot[4] (see figure 2); real-time monitoring of foreign ownership; new order and validity types; and the standardization of the account code[5].

I think some of the most noteworthy, among the many supposed new functions[6], that could be widely used are the following:

-stop order which consists of the stop-loss [order that is queued as a must be filled as soon as the trigger price is reached] and the stop limit [order that is queued as a limit order as soon as the trigger limit price is reached]

-market order [order that is filled irrespective of the price whereby the unfilled quantity will be queued into the order book.]

-market to limit order [order executed at the best opposite price for shares whatever is available; remaining unfilled quantity will be put in the order book at the execution price]

-good till date [order remains valid until the date specified by the user]

So in my view, the transition towards NTS, given the specified features, should extrapolate to a medium to long term advantage, if the PSE would use this platform to expand into financial derivatives, and most importantly, to the much needed commodity futures market.

As a side note, because of the dire lack of capital in the Philippines, despite being a relatively low wage low export country, a large part of the Philippine economy remains mired in the agricultural age. Thus, a commodity futures market should enhance pricing, logistics and distributional efficiency that should positively impact our farmers, as I have long been arguing[7] for.

In short, since I am not a Luddite (political zombies who are afraid of technological adaption), but one who embraces innovation, the NTS, based on its current features, looks enticingly positive.

How Competition Can Improve On The PSE

However, what I have cavilled about is the executional inefficiencies and the lack of sensitivity by the PSE in the migration process.

The PSE should have backtested the new platform with the MakTrade system into near precision first before formally replacing the latter that would have resulted to an orderly transition.

Birth pains serve as no justification in today’s transition towards the information age. Yet if such reasoning holds true, then technology ‘birth pangs’ should translate into catastrophic crashes for the new airplane models as the Boeing’s 787 Dreamliner and the Airbus 380. Such rationalization is effectively a non-sequitur.

Instead, what these shortcomings manifest are symptoms of companies operating, outside of the discipline of consumers (or shareholders in this setting) in a monopolistic environment, which technically is what the Philippine Stock Exchange is.

As Professor Murray N Rothbard explained[8] (bold emphasis added, italics- Professor Rothbard)

``One form of partial product prohibition is to forbid all but certain selected firms from selling a particular product. Such partial exclusion means that these firms are granted a special privilege by the government. If such a grant is given to one person or firm, we may call it a monopoly grant; if to several persons or firms, it is a quasi-monopoly grant. Both types of grant may be called monopolistic. An example of this type of grant is licensing, where all those to whom the government refuses to give or sell a license are prevented from pursuing the trade or business.

``It is obvious that a monopolistic grant directly and immediately benefits the monopolist or quasi monopolist, whose competitors are debarred by violence from entering the field. It is also evident that would-be competitors are injured and are forced to accept lower remuneration in less efficient and value-productive fields. It is also patently clear that the consumers are injured, for they are prevented from purchasing products from competitors whom they would freely prefer. And this injury takes place, it should be noted, apart from any effect of the grant on prices.”

And according to former PSE President Jose Yulo Jr.[9]

``On March 4, 1994 the Securities and Exchange Commission granted the Philippine Stock Exchange, Inc. its license to operate as a securities exchange in the country stating that “a unified Stock Exchange is vital in developing a strong capital market and a sustainable economic growth.” It simultaneously canceled the licenses of the MSE and the MKSE.

``The Philippine Stock Exchange is currently the only organized exchange in the Philippines licensed for trading stocks and warrants.” (emphasis added)

So while it is true that stock exchanges of Thailand, Malaysia, Taiwan and Korea are monopolies in a sense (all others have multiple stock exchanges[10] including Pakistan), we see these organizations as more sensitive to the interest of the shareholders due to a deeper penetration level which make them a lot more efficient than the local contemporary.

That’s because shareholders exert pressure on listed companies as well as through the stock exchanges in terms of participation and through shareholder activism—or the use of equity stake to influence corporate management.

And a deep penetration level of shareholder’s base would naturally impact the way the exchange business are operated.

Besides, since the Philippines has a minute shareholder base[11] (less than 1% of the population direct and indirect) and whose listed companies are mostly companies owned by local tycoons, the lack of minority shareholder activism is one of the contributing factor that accentuates the negative dynamics of the monopolistic structure.

Figure 3: ADB[12]: Average Foreign Holdings of Equity—2003 to 2007 and 2008 (as % of market capitalization)

Another possible variable is the competition to attract foreign investors (see figure 3).

As one would note, except for Malaysia, the other monopolist Korea, Taipei and Thailand comprise the largest in terms of the average share of foreign participation as a percentage of the market capitalization.

This means that the respective markets are seen as highly liquid or has deep public participation levels, are considered sophisticated and shareholder friendly enough to generate large following from foreign funds.

Thus, inefficient management of the trading platform will curtail the interest of foreign investors to the detriment of the economy (lack of avenues to intermediate savings and investment) and to the investment public (returns relative risks).

So the PSE management should not only look slough off the monopolistic attitude, and on the competitive side work to attract investors by having more efficient implementation and a stable upkeep of the trading platform, but likewise have a PR communiqué that won’t be seen as snooty.

As a long time shareholder of the company, which is my expression of optimism for the Phisix and for the domestic capital markets, I hope that this critique would be deemed as constructive enough to make the PSE a more shareholder (market) friendly institution.

---

[1] Inquirer.net, New system throws Philippine bourse into disarray, July 27, 2010

[2] Philippine Stock Exchange, Security Exchange Commission Form 17-A, May 17, 2010

[3] Inquirer.net, loc. sit.

[4] Manila Bulletin, PSE implements new trading system, July 25, 2010

[5] Business Mirror, SEC approves PSE shift to new trading system, April 26, 2010

[6] Philippine Stock Exchange, NTS Update Session 1, October 2008

[7] See A Prospective Boom in Philippine Agriculture! and see Rice Crisis: The Superman Effect And Modern Agriculture

[8] Rothbard, Murray N. Triangular Intervention: Product Control, Man Economy & State Chapter 12

[9] Yulo, Jose Luis U. Jr. Knowing The Philippine Stock Exchange A guide for Investors

[10] tdd.lt Stock Exchanges Worldwide Links

[11] Philippine Stock Exchange, Less than half of 1% of Filipinos invest in stock market, PSE study confirms, June 16, 2008

[12] Asian Development Bank, Asia Capital Markets, May 2010

US and Global Economy: Pieces Of The Jigsaw Puzzles All Falling In Place

``Deflationary credit contraction is, necessarily, severely limited. Whereas credit can expand (barring various economic limits to be discussed below) virtually to infinity, circulating credit can contract only as far down as the total amount of specie in circulation. In short, its maximum possible limit is the eradication of all previous credit expansion.” Murray N. Rothbard

Mainstream expert analyses are mostly hinged on heuristics (mental shortcuts), except that they often argue from the context of technical gobbledygook which appeals and overwhelms the naive public to assume such abstraction as universal reality.

For instance, many go at length to argue that low interest levels in US Treasury exhibit signs of deflation. Heck, as if deflation or falling prices in the mainstream definition means the end of world. Well, falling prices also means greater purchasing power, which from the fundamental standpoint of demand and supply, it means more goods that one can acquire. So the end of the world, it is not.

For us, deflation isn’t a one size fits all dynamic. We see this market force as operating from different previous actions; one that deals with productivity growth or one that deals with government property confiscation, or bank credit contraction or cash building. So the social impact won’t be the same. Yet when the mainstream hears or reads of deflation they seem to develop a reflexive revulsion to the word.

What the mainstream actually refers to is of the credit contraction order- which according to them has a feedback mechanism which forces liquidation, reduces collateral values, curbs aggregate demand, which leads to excess supplies and subsequently falling prices which gets exacerbated by expectations of people to hoard cash and back to the loop.

It’s a story long been told even during the days of my Dad, but this has hardly occurred. Not even with Japan, which the mainstream has arrantly mislabelled[1].

Although deflation had an instance of reality in 2008, our rebuttal has been that in a world central banking, governments have the incentive and the tools to temporarily offset credit contraction by serially blowing up new bubbles. How? By keeping interest rates excessively low and by printing an ocean of money.

Yet mainstream insist that this is a demand problem and that government actions won’t have an impact.

On the contrary we persist to argue that this is mostly a supply dilemma—one where banks have been stuffed with questionable assets and that reluctance to lend is a function of some distrust.

And the disruption from the near seizure in the US banking system, which prompted for a short episode of deflation, as consequence to the Lehman bankruptcy is why the US government put to risk some $23.7 Trillion worth of taxpayer money[2], according to a US official.

In short, US officials have been acting on the current financial quandary predicated on a liquidity issue.

It’s funny how many gawk at the actions of the marketplace only to put meaning into them based on their bias or economic religion.

The mainstream refuses to acknowledge that government are people too and are driven by incentives. They see government in a paradox. On one aspect, they believe government operates like supermen whom would act on every single social problem that emerges. Yet on another aspect, particularly on the financial markets, they treat governments as passive onlookers!

From our perspective, the abnormally low yields in the US treasury markets may not be due to the fear of lending or the lack of demand to borrow, but rather from government intervention.

With the US budget deficit expected to hit $1.56 trillion in 2010[3], what better way to attract cheap private financing and create an environment of marketplace confidence (animal spirits) than by manipulating interest rates down!

Since there have been little signs of inflation in the past, then the US government can simply use its covert dealers to conduct interest rate manipulation operations.

And it may not be limited to stealth actions; it may even be reported.

In three weeks since June 30, the Federal Reserve balance sheet has registered consecutive additions to its US treasury positions by $45 billion, according to the data provided by the Federal Reserve Bank of Cleveland[4].

This seems consistent with some signs of unease from select Federal Reserve officials, such as James Bullard, president of the Federal Reserve Bank of St. Louis, who called for renewed buying of treasury securities or the resumption of quantitative easing[5].

Yet these guys seem to be looking at the wrong picture.

First of all, the banking system doesn’t represent the entire US capital markets.

Figure 4: St. Louis Fed: Consumer and Bank Credit at ALL Commercial Banks

But even if we deal with the banking system we are seeing not widespread signs of contraction but signs of credit expansion (see figure 4)!

True business and industrial loans are still down, but nominal lending in US dollars by consumers at all commercial banks have recently skyrocketed (upper window). And we seem to be seeing material improvement in credit activities of bank credit of all commercial banks, perhaps directed at consumers.

Figure 5: Yardeni.com[6]: Flow of Funds

We predicted[7] that the influence of the yield curve lags by about 2-3 year period, which if we are right we could see an acceleration in the activities in the US credit markets by this yearend, could we be seeing the seeds of this turnaround (see figure 5)? Oops....

Now as we earlier said, banks aren’t the sole source of funding for the US economy, which the mainstream loves to fixate on. And I think signs have saying they’re dead wrong.

Why? Because the corporate bond market is likewise booming!

This from Businessweek/Bloomberg[8],

``U.S. corporate bond sales soared 31 percent to $85.7 billion this month, the busiest July on record, as yields fell to the lowest in more than six years on growing investor confidence in the economic recovery. The London interbank offered rate, or Libor, which banks say they can borrow at for three months in dollars, fell the most today in almost 11 months, dropping to the least since May 14.”

And the boom in the bond markets aren’t restricted to the US markets but around the world!

According to the Wall Street Journal[9], (bold emphasis mine)

``The global corporate-bond boom is gathering steam as companies rush to take advantage of some of the lowest borrowing costs in history....

``This month has been the busiest July on record for sales by U.S. companies with junk-credit ratings. Asia's debt market is on pace for a record year, and European companies are also raising money apace.

``The low borrowing costs are the culmination of an unprecedented bond-market rally that began in the depths of the credit crisis in late 2008 and early 2009 and has defied every prediction that it would soon run out of steam. But individual and professional investors continue to plow money into the bond market, giving companies a constant source of funds to tap.”

Defied every prediction? Not for us, as we have been predicting this all along!

And in terms of bank lending guess where the gist of the activities has been? (see figure 6)

Figure 6: Yardeni.com Lending by International Banks

If you guessed the Emerging Markets and Asia, then you are absolutely correct!

Now if we examine the contribution of economic growth in the US by sector, the mainstream seems caught somewhat surprised. Growth expectations didn’t come from the sectors they’d expected them to be (see figure 7).

Figure 7: Northern Trust: Sectoral Contribution To Growth Rates

According to Asha Banglore of Northern Trust[10], (bold highlights mine)

``In the second quarter of 2010, equipment and software spending (+1.36%) made the largest positive contribution to real GDP, followed by exports (1.22%), consumer spending (1.15%), inventories (1.1%), and residential investment expenditures (0.6%).

``In terms of growth rates, equipment and software spending posted a hefty increase of 21.9% after an upwardly revised 20.4% gain in the first quarter. Consumer spending moved up 1.6% in the second quarter after a downwardly revised 1.9% gain in the first quarter.

So technology and the world economy appear to be heavy lifting the growth momentum of the US economy.

As per the technology sector, here is what I wrote last February[11],

``What I am trying to say is that the contribution of the technology sector to the real economy could perhaps be more accurately reflected on the performance of S&P, however, such contribution may have been underrepresented by conventional statistical metrics.”

Not anymore.

For us, the current developments postulates to the following:

-US economic growth dynamics seem to be shifting from the housing to the technology and export sector.

-Investment in the US and the job growth will likely gravitate into these sectors.

-The pattern of growth in the US seem to confirm the boom in the global bond markets and the bank lending patterns of international banks

-Since technology is partly tied to exports, wealth accumulation in emerging markets is likely to fuel increasing demand for tech savvy products

-the global economy should be expected to sustain momentum as globalization deepens, and this will be in stark contrast to the prediction of deglobalization advocated by PIMCO’s Bill Gross.

-Of course, this is another bubble cycle. The next bubble will likely emanate from the emerging markets or the US technology industry[12], or the US treasury. But the risk of bubble implosion would only surface as inflation accelerates and hamstrings government efforts to intervene.

Speaking of which, where inflation is thought to be non-existent, here is a little surprise (see figure 8)...

Figure 8: stockcharts.com: Commodity Laggards

Oops, even the commodity laggards seem to be generating some reanimated activities!

We seem to seeing resurgence in agricultural products (DBA-Powershares DB Multisector Commodity Trust Agricultural Fund), as well as in Natural gas (NATGAS), the Industrial metals (Dow Jones UBS Industrial Metals-DJAIN) and the broad based commodity index (Reuters-CRB).

So far, pieces of the grand jigsaw puzzle seem to be falling in their rightful place, as we have seen it.

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[1] See Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionism, July 6, 2010

[2] See $23.7 Trillion Worth Of Bailouts?

[3] CNN Money U.S. deficit streak at 20 months, June 20 2010

[4] Federal Reserve Bank of Cleveland, Credit Easing Policy Tools

[5] New York Times, Fed Member’s Deflation Warning Hints at Policy Shift, July 29, 2010

[6] Yardeni.com: Flow of Funds, July 7, 2010

[7] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010

[8] Businessweek, Bloomberg: U.S. 10-Year Swap Negative for Fourth Day as Debt Sales Rise, July 30, 2010

[9] Wall Street Journal, Bonds Soar to Rare Heights, July 29, 2010

[10] Northern Trust, U.S. Economy – Q2 GDP Contained a Few Surprises Although Headline Was Close to Forecast, July 30, 2010

[11] See Statistics Don't Reveal Extent Of The Evolution To The Information Age, February 15, 2010

[12] See ASEAN Markets Surge, Where will The Next Bubble Emerge?, July 11, 2010