Currency Wars And The Philippine Peso

``One cause for hope of an early agreement is that many of the illusions concerning the advantage of drifting currencies and competitive depreciation have been dissolving under the test of experience. Great increases in export trade have not followed depreciation; the usual result of anchorless currencies has been a shrinkage of both export and import trade. Again, the fallacy is beginning to be apparent of the idea that a currency allowed to drift would finally "seek its own natural level." It is becoming clear that the "natural" level of a currency is precisely what governmental policies in the long run tend to make it. There is no more a "natural value" for an irredeemable currency than there is for a promissory note of a person of uncertain intentions to pay an undisclosed sum at an unspecified date. Finally, it has been learned that competitive depreciation, unlike competitive armaments, is a game that no Government is too poor or too weak to play, and that it can lead to nothing but general demoralization.” Henry Hazlitt, From Bretton Woods To World Inflation

The Federal Reserve’s prospective Quantitative Easing 2.0 has now triggered an impassioned debate among international policymakers over the risks of currency wars.

Today, policy divergences among developed and emerging markets, which have been spurring capital flows that has boosted asset markets of emerging markets, has prompted for such worries.

Brazil’s minister Guido Mantega fired the first salvo[1] to accuse advanced economies of adapting “beggar-thy-neighbour” policies that could harm international trade.

Currency wars or competitive devaluation simply implies inflationism applied by governments in order to “boost jobs by bolstering exports”. This has been a long held mercantilist-protectionist approach, which had been debunked[2] by classical economist as Adam Smith, but seemingly being adapted by today’s leading authorities, perhaps out of desperation.

As the Wall Street Journal editorial writes[3],

``The growing danger today is currency protectionism—what students of the 1930s will remember as competitive devaluation or "beggar-thy-neighbor" policies. As economic historian Charles Kindleberger describes in his classic "The World in Depression," nations under domestic political pressure sought economic advantage by devaluing their national currency to improve their terms of trade.

``But that advantage came at the expense of everyone else. "As with exchange depreciation to raise domestic prices, the gain for one country was a loss for all," Kindleberger writes. "With tariff retaliation and competitive depreciation, mutual losses were certain."

Here is my take on the currency episode:

First, I don’t see the Federal Reserve as attempting to attain “export competitiveness” by taking on the currency devaluation path.

The Federal Reserve’s action, as well as the Bank of England, seems to be more directed at surviving the balance sheets of their respective banking systems which has been buoyed by earlier dosages of QE.

Therefore, as said above, dodgy assets that are still held by the banks would need further infusion of credit to maintain their subsidized price levels.

Second, it is political season in the US with mid-term elections coming this November. Hence, political talking points have been directed against free trade to signify attempts to shore up votes by appealing to nationalism and to economic illiterates, following the growing unpopularity with Obama administration and the Democratic Party.

This has been underscored by the recent passage of the China currency sanction bill[4] at the US House. Yet this bill isn’t certain to be passed by the Senate, which will most likely be after elections.

Third, while the currency bill has been seen as directed towards “forcing” China to revalue what most don’t know is that technicalities matters. As lawyer Scott Lincicome writes[5],

``But none of that changes the fact that, if it became law, this particular legislation probably won't have a big effect on things, at least in the near term.”

Why?

Because, according to Mr. Lincicome, ``The change in language... gives the administration 'a way to say no' to U.S. industries and could signal to China that Washington isn't looking to declare a trade war over currency practices."

In politics, it is usually a smoke and mirrors game.

Lastly, global policymakers appear to be cognizant of the dangers of applying protectionism and the nonsensical approach by mercantilist policies.

The IMF has cautioned against currency friction and has volunteered to act as a “referee”[6] to settle trade disputes emerging from such strains.

Importantly, emerging market authorities have been quite sensitive into maintaining open trade channels.

Poland’s central bank governor Marek Belka in an interview with Wall Street Journal[7] delivers a jarring statement against mercantilism.

From Mr. Belka, (bold emphasis mine)

``All those wars produce a lack of stability, and the warring parties forget the basic point. The bottom line is devaluations and appreciations change your competitive position temporarily but they don’t change your competitive position for good. If you want to strengthen your competitiveness by devaluing your currency, this is a sign of despair, this isn’t a policy. I am worried because this destabilizes the global economy and it does not lead to rebalancing, something we all long for.”

We just hope that global policymakers remain steadfast in support of freer trade than engage in inflationism which is no less than veiled protectionism.

Nonetheless, as far as the subtle competitive devaluation has been an ongoing concern, we should expect the local currency, the Philippine Peso to benefit from a far larger scale of interventionism from advanced economies as United Kingdom and Japan, whom like the US, has been engaged in “quantitative easing”.

Figure 5: Yahoo Finance: Philippine Peso Versus Quantitative Easing Economies (ex-US)

This means that the Peso is likely to appreciate against the British Pound and could likely reverse its long term decline against the Japanese Yen as Japan expands her battle against alleged deflation, which for me is no more than promoting the nation’s export sector at the expense of the rest.

Relatively speaking, the Peso is in a far better position than both of the above and most especially against the US dollar given the current conditions.

---

[1] BBC.co.uk Currency 'war' warning from Brazil's finance minister, September 28, 2010

[2] See Does Importation Drain The Wealth Of A Nation?, September 13, 2010

[3] Wall Street Journal, Beggar the World Monetary instability is a threat to the global recovery October 1, 2010.

[4] BBC.co.uk US House passes China currency sanctions bill, September 30, 2010

[5] Linicome Scott, House Passes Currency Legislation; Whoop-Dee-Freakin-Doo, September 29, 2010

[6] Marketwatch.com, IMF moves to referee currency debate, October 9, 2010

[7] Wall Street Journal, Poland’s Central Bank Governor Belka on Currency Wars, October 9, 2010

Interest Rates As Key To Stock Market Trends

``Credit expansion can bring about a temporary boom. But such a fictitious prosperity must end in a general depression of trade, a slump.” Ludwig von Mises

As we have long reiterated, the main driver of the financial assets isn’t economic growth nor is it about earnings but mainly about monetary inflation and credit.

Well it appears that the prominent mainstream research company McKinsey Quarterly somewhat shares our view (see figure 3)

Figure 3 McKinsey Quarterly[1]: Watch For Credit Conditions

Tim Koller of McKinsey writes that the stock markets are not reliable economic indicators of the economy (left window), ``While the equity markets may not predict economic trends well, their depth does provide investors with liquidity, so they generally continue to function smoothly even in difficult times.”

And importantly, Mr. Koller identifies credit conditions as the chief mover of the economy and of the financial markets: ``The credit markets are where crises develop—and then filter through to the real economy and drive downturns in the equity markets. Indeed, some sort of credit crisis has driven most major downturns over the past to 40 years.” (see right window of chart)

And four common patterns of credit crisis cycles can be observed: yield curve inversion and the freezing up of the debt markets, marketplace illiquidity, bandwagon effect on the industry participants and enlarged risk appetite out of the expectations that governments will provide support (moral hazard problem).

And naturally the common symptoms of a blossoming bubble would be loose lending standards, unusually high leverage and what Mr. Koller calls as “transactions without value” or euphemism for outrageous valuations, which are rationalized as the new paradigm.

Interest Rate Manipulation Fuels Imbalances

In reality, credit conditions are hardly shaped by free markets, otherwise boom bust conditions would largely be limited in scale and in duration. Instead, as a major policy tool used by central banks, interest rates are mainly used to perpetuate boom conditions, mostly based on political considerations.

As the great Professor Ludwig von Mises described of the Business or Trade cycle fostered by central bank manipulation of interest rates[2],

``The creation of these additional fiduciary media permits them to extend credit well beyond the limit set by their own assets and by the funds entrusted to them by their clients. They intervene on the market in this case as "suppliers" of additional credit, created by themselves, and they thus produce a lowering of the rate of interest, which falls below the level at which it would have been without their intervention. The lowering of the rate of interest stimulates economic activity. Projects which would not have been thought "profitable" if the rate of interest had not been influenced by the manipulations of the banks, and which, therefore, would not have been undertaken, are nevertheless found "profitable" and can be initiated.”

In short, artificially tampering of interest rates leads to an unnecessary pile up in systemic leverage along with massive malinvestments which also drives up valuations of securities or assets to extreme levels.

Of course the market psychology here is to rationalize such actions as being warranted to the prevailing conditions, when they genuinely account for “flaws in perception” as billionaire George Soros rightly identifies[3], or a false sense of reality brought about by distorted incentives.

Yet in order to maintain these lofty levels would require constant infusion of fresh credit at far larger scale than the former.

Figure 4: Economic Slowdown and Quantitative Easing (chart from Danske Bank[4])

We seem to be seeing this episode playout today with renewed clamor[5] and the growing expectations by the mainstream for the US Federal Reserve to implement Quantitative Easing 2.0 on escalating fears of a global economic relapse (see figure 4 right window) by further pushing down interest rates.

Market expectations of the realization of the Federal Reserve’s QE 2.0 have thrashed the US dollar (left window), even as US treasury yields fall!

Even the resurgence of Ireland’s debt woes have failed to bolster the US dollar relative to the Euro. The rising Euro seems to validate our earlier prediction in contrast to mainstream expectations, but appears to have overshot our target[6].

So we have now a phenomenon outside or opposite to what had occurred in 2008, where a rally in US treasuries coincided with a rally in the US dollar.

And this should be a prime example of how past performances or patterns do NOT repeat.

Unravelling Of The Business Cycle

However, artificial suppressed rates can last only for so long.

Since resources are scarce and where interest rate manipulation essentially diverts massive amount of resources and labor into unproductive speculative activities, the increased demand for resources are eventually reflected on the price levels.

The current run-up in most prices of commodities[7] seem to be manifesting symptoms of the Austrian business cycle theory at work.

Eventually the whole artifice unravels with a bubble bust or with a destruction of the currency system if central banks persist to inflate.

Again Professor von Mises,

``This upward movement could not, however, continue indefinitely. The material means of production and the labor available have not increased; all that has increased is the quantity of the fiduciary media which can play the same role as money in the circulation of goods. The means of production and labor which have been diverted to the new enterprises have had to be taken away from other enterprises. Society is not sufficiently rich to permit the creation of new enterprises without taking anything away from other enterprises. As long as the expansion of credit is continued this will not be noticed, but this extension cannot be pushed indefinitely. For if an attempt were made to prevent the sudden halt of the upward movement (and the collapse of prices which would result) by creating more and more credit, a continuous and even more rapid increase of prices would result. But the inflation and the boom can continue smoothly only as long as the public thinks that the upward movement of prices will stop in the near future. As soon as public opinion becomes aware that there is no reason to expect an end to the inflation, and that prices will continue to rise, panic sets in. No one wants to keep his money, because its possession implies greater and greater losses from one day to the next; everyone rushes to exchange money for goods, people buy things they have no considerable use for without even considering the price, just in order to get rid of the money....

``If, on the contrary, the banks decided to halt the expansion of credit in time to prevent the collapse of the currency and if a brake is thus put on the boom, it will quickly be seen that the false impression of "profitability" created by the credit expansion has led to unjustified investments. Many enterprises or business endeavors which had been launched thanks to the artificial lowering of the interest rate, and which had been sustained thanks to the equally artificial increase of prices, no longer appear profitable. Some enterprises cut back their scale of operation, others close down or fail. Prices collapse; crisis and depression follow the boom. The crisis and the ensuing period of depression are the culmination of the period of unjustified investment brought about by the extension of credit.

Therefore, it has been long contention of mine that the interest rates and market psychology working as a feedback loop mechanism ultimately sorts out the phases of the business cycle.

---

[1] Koller, Tim A better way to anticipate downturns, McKinsey Quarterly

[2] Mises, Ludwig von The Austrian Theory of the Trade Cycle

[3] Soros George, The Alchemy of Finance p.58

[4] Danske Bank, Currency Debate Heats Up, October 8, 2010

[5] Los Angeles Times Blog More Fed help for economy now just a matter of time October 8, 2010

[6] See Buy The Peso And The Phisix On Prospects Of A Euro Rally, June 14, 2010

[7] See Commodity Inflation, October 8, 2010

Political Spin On The Philippine Economy And An Overextended Phisix

``Now we see these qualities displayed by virtually all politicians in democracy: the constant need for status and recognition. The ends — compensating for an inferiority complex — justify whatever Machiavellian means. Because democracy is open to any and all who can get themselves elected, either through connections, personality, or personal wealth, it is a social system where leadership positions become a hotbed for sociopaths. Maslow's self-actualizing man won't have an interest in politics. But those stuck on the need for esteem are drawn to it like flies to cow pies.”- Doug French

The bullmarket has been relentless.

In the context of the Philippine Phisix, it has been a steamy 13.45% gains in 5 consecutive weeks that has produced a stupendous year-to-date return of 38.8%!

Economic Takeoff Mumbo Jumbo

Again this has nothing to do with the Philippines allegedly in an economic takeoff[1] emanating from the so-called public’s belief in the effective deliverance of the incumbent political leadership.

This messianic thinking is no more than political spin anchored on current events used to grab credit for popularity ratings (votes on issues or endorsements) and for self-esteem purposes[2].

Governments cannot generate wealth by picking on Juan’s pocket in order to give to Pedro. Shifting resources away from productive activities to non-productive activities diminishes wealth creation. There is little or no value added from coercive (tax based) reallocation of resources. In a world of scarcity, prosperity cannot emerge from “something out of nothing”.

Wealth is generated by capital accumulation, or the act or process of increasing the supply of capital goods, whereby capital can only be accumulated by producing more wealth than is consumed, i.e. savings[3]. And this can only occur when more risk-taking, profit-and-loss and market price sensitive entrepreneurial activities are allowed to legitimately flourish.

Political redistribution of scarce resources only leads to inefficiency, wastage, corruption, inflation and capital decumulation. So claims of economic takeoffs can only take place by an intensive reduction of politicization of the economy and by liberalizing economic activities in favour of the entrepreneurs.

The other way to say this it is that—in a world of tradeoffs, political power has to pave way to economic power for capital accumulation to progress. We can’t have both.

Applied to politics, you either expand political power via socialism or enhance economic power via capitalism or the market economy. And the latter is something political leaders won’t intuitively succumb to, unless forced at hand by the natural laws of economics.

Proof?

The proposed P 1.645 trillion National Budget for 2011 supposedly would include a doubling of the Pork Barrel[4], a bonanza for lawmakers.

This simply means more government spending on political pet projects, which are unproductive and not demanded by the markets (think basketball courts[5]), and whose implied effects translate to higher taxes, higher cost of doing business, rising cost of goods and services, high unemployment, and importantly increasing incidence of corruption from arbitrary dispensation of resources and further restrictions to civil liberty.

The election mantra of a corruption free government is gradually being revealed as no less than a drivel, despite the public’s current blind faith over the prospects by the incumbent administration.

So with these added obstacles to entrepreneurship growth, how does one expect the domestic economy to takeoff?

What we are certain of is that the personal economies of politicians and their affiliates or cronies will indeed takeoff. P1.645 (estimated $37 billion) or 22% of the $161 billion (nominal dollars[6]) Philippine economy is certainly alot of money being channelled or transferred from the private (productive) sector to unproductive institutions and to political agents. And surely, these massive diversion of resources, will NOT serve to the wellbeing of the general public. Instead, more will suffer from the unforeseen and indirect effects of these redistributive actions.

Applied globally, political redistribution has its limits, as recent crisis has evinced.

And this grand experiment of the paper money (US dollar) standard seems to push redistribution to its near limits as global government debt has reached over $39 trillion[7] or about 63% of the $61 trillion GDP[8].

It’s a ticking time bomb that has been camouflaged by today’s concerted efforts by central banks to flood the world with liquidity. Eventually, the pressure valve will give way. It has been this way throughout history, which means that this is a cycle which we must pay heed to.

As George Santayana who once admonished, ``Those who do not learn from history are doomed to repeat it”. We certainly cannot stop history from repeating but we can take steps to protect ourselves.

Expect Normal Profit Taking From Overextended Markets

Of course, seen the political standpoint, but looking at the bigger picture, it’s not only us whom are on a takeoff.

It’s the ASEAN or Asian emerging markets (see figure 1) aside from many emerging markets outside Asia that has been booming.

Figure 1: Bloomberg: ASEAN Bourses Takeoff

The Philippines (green line), Indonesia (yellow) and Thailand (orange) have been in a tight race for the top after successfully breaking past their most recent highs. Only Malaysia has lagged but remains on the positive.

On a year to date basis the gains of these bourses have been spectacular, with the three frontrunners posting over 30% returns.

Nevertheless, there appear to be signs of exhaustion strains from the recent breathtaking run.

And it would be ridiculous to expect the ongoing boom to streak endlessly as any overstretched gains are likely to result to the opposite action-a crash. We must remember that even in the financial markets Newton’s third law of motion[9] somewhat applies, where “To every action there is always an equal and opposite reaction”.

While I do not expect a major retrenchment in the global equity markets, a correction has long been overdue especially for the turbocharged emerging markets as ours.

And if there are any supposed signs of providence, last week’s market actions in Indonesia and Thailand could signify as pacesetters.

But any correction shouldn’t be construed as justification to raise cash balances. Rather, they should be used as entry point for those who have missed the ride or for those hoping to capitalize on the opportunities of the ASEAN-Phisix bullmarket.

What we can expect of is that any correction may unlikely be a broadmarket dynamic as last seen in the bearmarkets of 2007-2008. Instead, we should expect rotational of activities from outperformers to the laggards during the countercyclical phase.

I am not a seer who can give you the exactitudes of the potential retrenchment. Anyone who claims to do so would be a pretender. But anywhere from 5-15% from the recent highs should be reckoned as normal.

Yet, one cannot discount the potentials of a swift recovery following the corrective process. This is why trying to “market timing”, in this “growing conviction” phase of the bullmarket, could be a costly mistake.

From our standpoint, profit taking should be expected over the interim, but the main drivers of the current rally seem well entrenched enough to seemingly ensure that our markets (and those of our neighbours) are eventually headed higher in spite of the illusory political attribution and rhetoric.

---

[1] Philstar.net Noy: RP ready for takeoff, October 8, 2010

[2] See The Corrupting Influence of Political Power, October 9, 2010

[3] Greaves, Percy Jr. Mises Made Easier, Mises.org

[4] Inquirer.net, ‘Pork’ in budget doubled, October 9, 2010

[5] See Philippine Sports: The Craze For Basketball And The Lack Of Interest In The World Cup, June 12, 2010

[6] Wikipedia.org Economy of the Philippines

[7] See Global Debt Time Bomb, October 8, 2010

[8] Google Public Data, World GDP

[9] Wikipedia.org Newton's laws of motion

The Corrupting Influence of Political Power

Remember J. J. Tolkien’s The Lord of the Rings where “One Ring to rule the other Rings of Power” changed the behaviour of those who got hold of the powerful exotic ring by making them addicted to power.

Well, this has empirical basis.

According to Cato’s Julian Sanchez, (bold highlights mine)

The humor site Cracked rounds up some serious social science on the psychological effects of power and authority. The results are sobering—if not entirely surprising. When people in experimental environments were made to feel as though they were powerful—either by recalling actual instances for their lives or by being placed in simulated positions of power for a few hours—researchers found that they became less compassionate, less prone to take the perspective of others, more able to lie without feeling guilty about it, and more prone to consider themselves exempt from the rules and standards they righteously insist apply to others. What’s striking is how quickly and easily the experimenters elicited dramatic behavioral differences given that (unlike people who actively seek power) their “powerful” and control groups were randomly chosen.

Simply said, entities who acquire political power would most likely see a shift in perspectives and in attitudes. In short, ideology or platform becomes a secondary issue to ego.

And this is one reason why public image seems to be a foremost concern for politcos. Aside from the need to get re-elected they see popularity as feeding on their bloated self-esteem.

And applied to politics, this seems like a prominent reason why the public’s romanticized expectations of “changes” from new leadership usually ends up in frustration—the public fails to account for the risks of individual character shifts of the political leaders when assuming power.

Again Mr. Sanchez,

It’s useful to keep this in mind because, while the overwhelming lesson of the last half century of social psychology is that situational influences can easily swamp the effect of individual differences in character, our political rhetoric takes scant account of this. Political campaigns focus heavily on questions of “character”—which especially in the case of “outsider” campaigns should be of limited predictive value....The remedy is, invariably, to replace them in positions of power with better people from the other team. These social science results suggest that this is unlikely to work: The problem is power itself.

Lord Acton was right, "Power tends to corrupt, and absolute power corrupts absolutely.”

Global Debt Time Bomb

Here is a nice interactive counter of the world’s cumulative debt from the Economist.

According to the Economist (bold emphasis mine)

The clock is ticking. Every second, it seems, someone in the world takes on more debt. The idea of a debt clock for an individual nation is familiar to anyone who has been to Times Square in New York, where the American public shortfall is revealed. Our clock shows the global figure for all (or almost all) government debts in dollar terms.

Does it matter? After all, world governments owe the money to their own citizens, not to the Martians. But the rising total is important for two reasons. First, when debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future. Second, debt must be rolled over at regular intervals. This creates a recurring popularity test for individual governments, rather as reality TV show contestants face a public phone vote every week. Fail that vote, as the Greek government did in early 2010, and the country can be plunged into imminent crisis. So the higher the global government debt total, the greater the risk of fiscal crisis, and the bigger the economic impact such crises will have.

The global debt time bomb is no more than a symptom of the fundamental flaws of the fiat based money system which has been anchored on policies predicated on mainstream economics. As the Economist rightly points out, the larger the debt, the riskier the economic environment. Yet, there are two possible outcomes to these unsustainable conditions: massive inflation or default (restructuring).

Presently, policymakers are taking on the inflation path.

Commodity Inflation

The mainstream says there is LITTLE inflation to worry about.

However, evidence seems to go against this view.

Aside from the vibrant actions in the emerging market’s financial asset markets, where we seem to be witnessing ‘asset inflation’, we also seem to be seeing a broadening of rising price level activities in the commodity spectrum.

Below are nice charts from Bespoke Invest.

The Bespoke team comments

Most but not all have been on strong runs higher lately. In the charts, the green shading represents between two standard deviations above and below the 50-day moving average. Moves above or below the green zone are considered overbought or oversold. As shown, the two most widely followed commodities -- oil and gold -- are both trading outside of their trading ranges into extreme overbought territory. Silver, platinum, and copper are all at overbought levels as well. Wheat has pulled back to the bottom of its trading range recently, while coffee and orange juice have been heading lower as well. Corn pulled back from overbought territory a couple weeks ago, but it has bounced back some. Finally, natural gas remains in an epic downtrend.

These are symptoms of the relative effects of inflation.

Like in the domestic stock market, the rising tide tends to lift all boats but not simultaneously and not in the same degree. But overall, the general price level increments higher overtime as real purchasing power of currencies fall.

Well, even the US Treasury Inflated Protected Securities (TIPS) seem to be manifesting the same progressing expectations of inflation.

Bottom line: We seem to be experiencing the spreading effects of inflation.

Video: Best Way To Maintain Fiscal Discipline Is To Cut Government Spending

How to balance the budget? Simple, cut government spending.

Dan Mitchell of the CATO institute explains how...

Trigger To The Inflation Time Bomb

Will the trigger to the inflation time bomb be setoff soon?

According to Dr. Antony Mueller

Look at these two curves as if they were electrical wire all it takes a little twiggle of the money multiplier to surge and the bomb will explode. While it would be hard and enduring task for the central bank to reduce the monetary base, it only takes a whiff for expectations that determine the multiplier to shoot up. The bomb that will be ignited has already a name. It's name is "hyperinflation".

Mainstream have long been fixated about deflation.

But like Waiting for Godot, this has not occurred yet, and will unlikely happen unless the Fed accedes to the environment of shrinking liquidity at the risk of the implosion of the US banking system.

Ironically, this would defeat all their trillions of rescue efforts to the politically privileged industry. (As we long have been saying---bailouts were directed NOT primarily to save the economy but the political-economic class that depended on the benefits of seignorage from the US dollar standard.)

Also as we have long spelled out, the US yield curve cycle has a 2-3 year lag period from which we should expect it to generate “traction” by the last quarter of 2010.

And given the recent marked improvements in the credit markets of the US as shown below...

From St. Louis Federal Reserve...

From Northern Trust...

Not only is the yield curve cycle being validated, as US banks become more “open” to issue loans rather than seek safety in securities, but this also heightens the risk of the proverbial "pulling of the trigger" to the inflation time bomb.

When The Rubber Meets The Road: Political Controversies Hound The Aquino Administration

``The most important benefit of population size and growth is the increase it brings to the stock of useful knowledge. Minds matter economically as much as, or more than, hands or mouths.”- Julian Simon, More People, Greater Wealth, More Resources, Healthier Environment

Our projections are not only getting validated in the financial markets but also in the political front.

Many have come to fallaciously believe that the election of a new leadership would prompt for an overhaul in the management of the Philippine government. Now grinding reality has gradually been unmasking the mirage of “change”.

The Aquino administration is being rocked by several controversies. One is the hostage drama which has turned out to be a foreign policy relations disaster and has put into question the competence of the fledging administration.

Next is the allegation that the people close to the Aquino administration have been on the take[1], where the immaculacy of graft and corruption free image is evidently being chaffed.

As we have earlier argued[2], regulations that ignore the fundamental law of economics will only backfire.

Prohibition laws only foster and nurture violence, corruption and criminality and would not eliminate demand for the outlawed products or services, whether it is about drugs, abortion, prostitution or gambling.

Prohibition only worsens the situation by bringing these activities underground which undermines social institutions.

Apparently hardly anyone seems to have learned from history or from recent experience (President Estrada’s downfall was due to jueteng).

This is the fundamental pitfall of converting political “moral” issues into legal statutes without discerning on the responses of the individual.

Population Bill Controversy: Looking At The Wrong Picture

Another controversy hounding the Aquino administration is the religious uproar over the population control bill being sponsored by the administration.

This has placed incumbent leadership in direct confrontation with the largest religious cum political lobby group—the Catholic Church, which has even threatened President Aquino with excommunication[3]. The Church reportedly backtracked[4] on this.

While I agree that people should be given a free choice on what to do with their lives, the population control issue is fundamentally a deflection of the genuine pathology surrounding the Philippine political economy—the lack of capital and the dependency culture.

Figure 1: Google Public Data[5]: Population versus Wealth Creation

It’s basically false to impute population growth as the cause of poverty.

As figure 1 from the World Bank (Google Public Data) shows, world population growth (upper window) has more than doubled from 3 billion in 1960 to 6.7 billion in 2008. Yet global GDP per capita leapt from $445 to $9045 or some 19 times!

One would note that the gist of the improvement of global GDP per capita occurred when China opened her “to get rich is glorious[6]” doors to international trade in 1980 and when India likewise joined the global community which gave rise to globalization.

Globalization, which anchored China’s economic reforms, led to a massive decline in poverty rates “from 64% at the beginning of reform to 16% in 2004”[7].

The same holds true for India whose poverty rate declined sharply: According to the criterion used by the Planning Commission of India 27.5% of the population was living below the poverty line in 2004–2005, down from 51.3% in 1977–1978, and 36% in 1993-1994[8].

So in contrast to popular wisdom, two of the most populous nations saw a massive improvement in wealth creation as trade diffused into their economies.

In other words, contra neo-Malthusians, population growth is a positively associated with wealth creation because having more people enhances the division of labor and specialization as well as the broadening of the diversity of knowledge which increases the chances of innovative ideas. Thus, the essence to economic growth is the coordination of these attributes, channelled through voluntary exchange, which would allow more products and services or economic goods to be offered for exchange.

Here is Jean Baptiste Say’s* rejoinder to Thomas Malthus[9] who believed that population growth would adversely affect the distribution of resources (bold emphasis mine)

When men are once provided with the means of producing, they appropriate their productions to their wants, for the production itself is an exchange in which the productive means are supplied, and in which the article we most want is demanded in return. To create a thing, the want of which does not exist, is to create a thing without value: this would not be production. Now from the moment it has a value, the producer can find means to exchange it for those articles he wants.

As we earlier pointed out it is the lack of capital and the culture of dependency that hampers economic development which policymakers erroneously pinpoint to population growth. And the starting point of the lack of capital is the inadequate protection of property rights.

As Murray N. Rothbard explains[10],

The Third World suffers from a lack of economic development due to its lack of rights of private property, its government-imposed production controls, and its acceptance of government foreign aid that squeezes out private investment. The result is too little productive savings, investment, entrepreneurship, and market opportunity. What they desperately need is not more UN controls, whether of population or of anything else, but for international and domestic government to let them alone. Population will adjust on its own. But, of course, economic freedom is the one thing that neither the UN nor any other bureaucratic outfit will bring them.

In other words, persistent government intervention serves as a major hurdle to promoting productive activities of trade and free exchange and significantly hampers the development of “the political and institutional conditions required for a smooth and by and large uninterrupted progress of the process of larger-scale saving, capital accumulation, and investment.[11]”

And by culture of dependency, we refer to the welfare state, whereby population growth is impliedly encouraged by institutional policies such as public education.

The fundamental premise is if people are not held liable for their actions, or when the cost of committing errors are low, then the incentive to repeat such mistakes are high. For instance, since the cost of public education is borne by the taxpayers, the underprivileged will exercise little restraint on sexual reproduction knowing that education is “free”.

So while it would seem “compassionate” on the surface to finance the education of the poor, what is not seen is the cost of redistribution or the transfer of resources away from productive activities to non-productive activities. Such transfers not only reduce productivity or lower the standards of living but likewise encourage irresponsible behaviour. In short, or irresponsible actions are rewarded while productive actions are punished. Thus, the negative aspects of population growth as portrayed by media.

One should add that more government control over our lives chafes at our freedom.

Of course the chief beneficiaries of these have NOT been the recipients of redistribution but the administrators of the government. For they not only financially benefit from such transfers, they benefit by the inequality of distribution of power or that they exercise undue control over our lives.

And it is why despite the high penetration levels of education in the Philippines, we end up exporting labor as a consequence of a cauldron of interventionist policies, the symptoms of which are: mass production of low quality of education (industrial age mentality), the glaring mismatch of required skills for the available jobs relative to the output (graduates) of public education [e.g. Business Process Outsourcing], skyrocketing cost of private education[12], the heavily politicized education sector, high levels of unemployment, combined with the lack of property rights, underdeveloped and politicized markets and social institutions, the lack of savings and investments, and etc...

Political Talking Points: Do As I Say, But Not As I Do

Finally, the battle between the religious cum political lobby group (the Catholic Church) and the population bill proponents reveal the nature of Philippine politics—the struggle to promote their versions of statist doctrines reinforced by economic and political (religion) biases.

Like loose cannons, many shout out nonsensical “moral” arguments or politically correct sounding talking points which they either don’t understand or don’t practise at all. The essence of their opinions has been founded on blind faith[13] rather than reality.

For instance, the Catholic Church as a political lobby group hardly seem to practice on what they preach.

They have been allegedly staunch pro-environment (anti-mining) advocates by rhetoric, but actions appear to speak louder than words (see figure 2)

Figure 2: Philippine Stock Exchange: Catholic Church: Do As I Say Not What I Do?

Philex Mining, one of the top mining companies in the Philippines, in its disclosure of the top 100 shareholders of June 2010[14], reveals that some entities of the Catholic Church have significant shareholdings in the company, which ironically practices what they allege as engaging in a morally wrong act of environmental degradation.

I would wonder if their self-contradictory stance is about defeating competition more than ‘well meaning’ pronouncements.

Bottom line: I’d advise you to be very careful about heeding the specious arguments of sanctimonious statists.

*in my newsletter mailing list, I erroneously placed John Stuart Mill for Jean Baptiste Say

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[1] Inquirer.net Aquino won’t ax Puno yet, September 24, 2010,

GMAnews.tv Bishop links moves to oust Robredo to jueteng, September 12, 2010

[2] See Plus Ca Change: President Aquino's Policy On Jueteng, May 24, 2010

[3]Inquirer.net Aquino faces threat of excommunication, October 1, 2010

[4]Inquirer.net CBCP: No threat vs Aquino, October 2, 2010

[5] Google Public Data Explorer, World Bank: Population and GDP per capita

[6] Wikipedia.org, Deng Xiao Peng Quote commonly attributed to Deng Xia Peng but has NOT been sourced

[7] Wikipedia.org, Poverty In China

[8] Wikipedia.org, Poverty In India

[9] Say Jean Baptiste Second letter to Malthus 1821 (The Pamphleteer)

[10] Rothbard, Murray N. Population Control Chapter 41, Making Economic Sense

[11] Mises, Ludwig von Period of Production, Waiting Time, and Period of Provision, Chapter 18 Section 4, Human Action

[12] See Is There A Brewing Bubble In The Philippine Education System? August 11, 2010

[13] See Blind Faith Analysis, October 1, 2010

[14] Philippine Stock Exchange, Philex Mining Corporation Top 100 Stockholders As Of 06/30/2010

Stock Market Investing: The Search For The Mythical Holy Grail

“A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply.” -Fritz Machlup, The Stock Market, Credit And Capital Formation

If you think that the bullmarket in the Philippine Phisix is an isolated ‘special’ affair and has been exhibiting signs of economic or corporate (micro fundamental) improvements or political endorsements, then you would be wrong (see Figure 3).

The same applies to the mainstream permabears who can’t seem to get their focus away from the debt problem angle or the supposed “lack of aggregate demand” in major economies.

The US Dollar Story

Figure 3 Bloomberg: Exploding MSCI Emerging Market and Asian Currencies

As one would note, emerging markets stocks, as represented by the MSCI Emerging Market index (upper window), have been exploding of late. But still has some distance from reaching the 2008 highs.

And this has not just been a dynamic in the Emerging market stock markets, but also in the currencies of Emerging markets and their Asian contemporaries.

This is best represented by the Asian currency index, the Bloomberg-JPMorgan Asia Dollar Index (ADXY) which have similarly spiked (lower window)!

With Asian currencies surging, I would assume that in spite of the recent appreciation of the Philippine Peso, the relative performance of the Peso has been lagging, considering that foreign money flows have been quite active. Nevertheless, despite my suspicion of the repeated intervention by the local central bank, the Bangko Sentral ng Pilipinas (BSP), the Peso should follow her neighbours and appreciate going into the yearend.

So domestic assets are evidently being juiced up by foreign and local money flows.

And as further proof that past performance can’t serve as reliable indicator of the future, even the ongoing troubles in Ireland hasn’t prevented the Euro from appreciating against the US dollar.

And more on more mainstream analysts appear to be getting it.

This from the BCA Research[1], (bold emphasis mine)

``Four currencies – dollar, euro, sterling and yen – currently account for the vast majority of reserve holdings. All of these four major reserve currencies have their own fundamental weaknesses. At the margin, this will force reserve managers to look for alternatives. Indeed, according to the IMF, there is already a sharp spike in holdings of “other” currencies, to 3.6% of total reserves...

``Bottom line: Reserve diversification away from the U.S. dollar remains an ongoing structural theme in the foreign exchange market and commodity currencies will be a main beneficiary.”

It has been an open theme for us here that the so-called policy divergences between the major economies led by the US and emerging market economies, which can be likewise as the called the US dollar carry trade, has underpinned the actions in today’s financial markets.

And the telegraphed actions by the US Federal Reserve in support of a weaker dollar have been causing a flood of liquidity flowing into emerging markets, gold and other commodities.

The Holy Grail Is The Rising Tide

However in the domestic front, I sense alot of psychological changes as some people seem to get aggressive over their expectations of stock market returns.

Some seem to think that the role of the analysts is to provide them optimal returns by capturing the trajectory of price actions via market timing of every issue.

They desire to be in every security that are rapidly going up and expect analysts to be able to identify and predict them.

Yet they read momentum as a way to generate outsized returns and seek all sorts of information (earnings, economic growth and etc...) to confirm on such biases in order to justify their participation. They seem to be seeking the elusive Holy Grail of investing. Unfortunately, either they are being misled or are being overwhelmed by emotions.

Let me reiterate, this isn’t about special events surrounding particular issues. This is about the rising tide lifting all, if not most boats. (see figure 4)

Figure 4: PSE: Number of Traded Issues (Daily)

It’s been happening across emerging markets, where many EM bourses appear to be reacting “positively” to the “leash effects” of the falling dollar-policy divergence trade.

And the same phenomenon seems underway in the local stock exchange where the massive liquidity spillover has been generating a broader interest on publicly listed issues.

The underlying bullmarket has drawn market participants to trade on more issues, where an increasing number of formerly illiquid issues have now become “liquid”. The search for yield has been expanding and lifting prices across the most issues.

This only goes to show how an inflation driven bullmarket has relative effects on prices of securities even when the general level is likewise being lifted overtime.

The other way to say it is that rotational price actions of publicly listed issues is a general feature of a blossoming boom-bust cycle. As for which issues becomes tomorrow’s darling is a phenomenon that can be divined by Lady Luck and not any mortal analysts. Yet to narrow one’s timeframe is to unnecessarily increase risk tolerance and very dicey gambit.

So those who pin their analysis on a variety of non-essentials will certainly get the surprise of their lives when such dynamics reverses. For the meantime, as price levels go up, everyone’s a genius.

Interest Rates As Key

And it is equally important to remember that should there be any pin that may pop this liquidity driven activities (bubble) in the marketplace, it would be due to rising interest rates.

Figure 5: Casey Research[2]: Inflation Is The Biggest Driver of Interest Rate

And the benign levels of interest rates, which have been mainly due to manipulations by the governments will eventually succumb to one of the following factors:

-greater demand for credit or

-deterioration in the expectations of governments’ ability to settle existing liabilities, or

-most importantly, rising consumer price inflation which in the past have been the most pivotal factor in the determining interest rate levels (see figure 5).

As a final note, let me add to Warren Buffett’s advise, “The dumbest reason in the world to buy a stock is because it's going up”, and use all sorts of justifications to do so.

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[1] BCA Research, Prospects For FX Diversification September 28, 2010

[2] CaseyResearch.com Debtflation, September 13, 2010

Facebook’s Genesis: A Sensually Inspired Success?

This looks like an interesting trivia about the origins of Facebook.

From Naresh Vissa of Minyanville

Facebook founder Mark Zuckerberg started the site in his Harvard dorm room, though not to make money or get famous. Zuckerberg built several programs while attending high school at Phillips Exeter Academy in New Hampshire. He even had a seven-figure offer from Microsoft (MSFT) upon his high school graduation, but turned it down.

Ben Mezrich chronicled Zuckerberg’s journey in his best-selling novel, The Accidental Billionaires: The Founding of Facebook -- A tale of sex, money, genius, and betrayal. To Zuckerberg, it was never about money, rather his passions. More than anything else, he wished to get laid.

Zuckerberg should have thousands of friends, but social-networking’s father is far from social. After the woman of his dreams rejected him during his sophomore year, Zuckerberg sought revenge. He stole pictures from Harvard’s database and created Facemash, a site for users to rate girls against farm animals. Within a day, his server crashed due to high traffic, so then-Harvard President and President Obama’s former top economic advisor Lawrence Summers placed him on probation and even threatened expulsion. Zuckerberg’s dopamine levels rising through the roof, Facebook’s genesis was established.

It’s one of the unique moments were sensuality seem to have inspired a monumental productive idea.

Blind Faith Analysis

Arguing political or economic issues based on biases, in my view, seems similar to layman’s argument in the context of religion.

They are hardly grounded from reasoning but from ‘blind’ faith.

Well, it’s interesting to know that in surveys, a vast number adherents of world religions fundamentally know less about their ‘beliefs’.

This from Pew Research

More than four-in-ten Catholics in the United States (45%) do not know that their church teaches that the bread and wine used in Communion do not merely symbolize but actually become the body and blood of Christ. About half of Protestants (53%) cannot correctly identify Martin Luther as the person whose writings and actions inspired the Protestant Reformation, which made their religion a separate branch of Christianity. Roughly four-in-ten Jews (43%) do not recognize that Maimonides, one of the most venerated rabbis in history, was Jewish.

In addition, fewer than half of Americans (47%) know that the Dalai Lama is Buddhist. Fewer than four-in-ten (38%) correctly associate Vishnu and Shiva with Hinduism. And only about a quarter of all Americans (27%) correctly answer that most people in Indonesia – the country with the world’s largest Muslim population – are Muslims.

Professor Bryan Caplan adds a brain twister to what he calls rationally ignorant,

Now consider: If people sincerely believed that their eternal fates hinged on their knowledge of religion, their ignorance wouldn't be rational. If you could save your soul with 40 hours of your time, you'd be mad to watch t.v. instead. Unfortunately for religious believers, this leaves them with two unpalatable options:

1. Option #1: Deep-down, most religious believers believe that death is the end. (This is consistent with the fact that even the pious mourn their loved ones at funerals, instead of celebrating the good fortune of the deceased). Even if this covert atheism is mistaken, the idea that most of the people in church aren't true believers seems threatening.

2. Option #2: Most religious believers are so stupid and/or impulsive that they'll knowingly give up eternal bliss for trivial mortal pleasures. But why then do so many believers show intelligence and self-control in other areas of life?

Strange or self contradictory as this is, rational ignorance only goes to show that what most people believe in runs in contrast to their actions.

And applied to economic and political analysis, blind faith analysis is simply cart before the horse logic; of which the common characteristics are: they are full of factual errors, the frequent use of logical fallacies, deliberately misinterpretation of theories, ambiguous definitions and data mining or selective application of evidence.