Surging Gold Prices Reveals Strain In The US Dollar Standard-Paper Money System

Tocqueville Asset Management LP’s John Hathaway poignantly writes:

The world’s monetary system is in the process of melting down. We have entered the endgame for the dollar as the dominant reserve currency, but most investors and policy makers are unaware of the implications.

The only questions are how long the denouement of the dollar reserve system will last, and how much more damage will be inflicted by new rounds of quantitative easing or more radical monetary measures to prop up the system.

Whether prolonged or sudden, the transition to a stable monetary system will become possible only when the shortcomings of the status quo become unbearable. Such a transition is, by definition, nonlinear. So central-bank soothsaying based on the extrapolation of historical data and the repetition of conventional wisdom offers no guidance on what lies ahead.

History has shown that paper money system don’t last long.

The only exception is that of the medieval Chinese experience which reportedly lasted 600 years. But the historical account of this isn’t certain: wikipedia says it was during the Song Dynasty, the Buttonwood’s Blog at the Economist says it was during Emperor Tsung while Dollardaze.org’s Mike Hewitt says this was during the Tang dynasty.

Meanwhile Murray Rothbard argued that the first paper money in the US was issued by the colonial government of Massachusetts in 1690.

Nevertheless Dollardaze’s Mike Hewitt examined 775 world currencies which includes the 176 in circulation (as of 2009) and 599 not in circulation, and found that

-the “median age for all existing currencies in circulation is only 39 years” and

-that the extinction of currencies had primarily been through acts of war and hyperinflation.

Incidentally and ironically, the US dollar standard since 1971 is 39 years old and seems to feel the same strain from old political habits.

Yet the attraction of the paper money system is that it allows government to pursue its political agenda via unsustainable free lunch policies.

As Murray Rothbard wrote in Mystery of Banking,

The inventions of paper and printing gave enterprising governments, always looking for new sources of revenue, an “Open Sesame” to previously unimagined sources of wealth. The kings had long since granted to themselves the monopoly of minting coins in their kingdoms, calling such a monopoly crucial to their “sovereignty,” and then charging high seigniorage prices for coining gold or silver bullion. But this was piddling, and occasional debasements were not fast enough for the kings’ insatiable need for revenue. But if the kings could obtain a monopoly right to print paper tickets, and call them the equivalent of gold coins, then there was an unlimited potential for acquiring wealth. In short, if the king could become a legalized monopoly counterfeiter, and simply issue “gold coins” by printing paper tickets with the same names on them, the king could inflate the money supply
indefinitely and pay for his unlimited needs.

Eventually, as always, monetary debasement gets abused and suffers from rampant inflation or at worst hyperinflation. And this will require either massive reform or a new currency system.

The current US dollar standard paper money system seems to be in a no different path from its forbears, as free lunch and mercantilist policies are being subtly pursued through global currency debasement.

Some call this the “currency wars”. I call this cycle the Mises moment.

And rampaging gold prices priced in every major currency (US dollar, Euro, Yen, Pounds, Canadian Loonie, Aussie Dollar, Indian Rupee, South African Rand and Gold in G5 index) seems to be saying this for quite sometime—the endgame could be near.

Charts from Gold.org (as of October 25, 2010)

For the “gold is barbaric metal” camp, paper money will reign forever even when unsupported by history and economic laws for the simple reason of dogmatic belief over free lunch politics.

But as Professor Ludwig von Mises once wrote,

The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity.

Unfortunately, anything unsustainable won’t last. And Voltaire would be validated anew, paper money eventually returns to its intrinsic value—zero.

Ireland’s Fiscal Austerity Seen From The Big Picture

One of the popular rejoinders or justifications made by mainstream economists has been to refer to Ireland as an example of the perils of having to impose fiscal austerity.

The general idea is the lack of aggregate private demand as measured by a decline in private spending should be substituted for by the government, in order to boost the economy. This is premised on the assumption that every variable in the economy are homogenous and subject to the same sensitivity from interventionist policies.

Yet we understand Ireland as having an ongoing crisis with her banking industry such that her government has undertaken massive recapitalizations of Allied Irish Bank and Anglo Irish Bank to the tune of “some €50 billion ($68 billion) this year and will push Dublin's budget deficit to an estimated 32% of GDP” according to Wall Street Journal.

Ireland’s banking woes continues to be reflected on her sovereign spreads as with the other crisis affected Euro nations classified as the PIIGS. (chart courtesy of Danske)

If the focus is plainly on unemployment, then the mainstream is right, high unemployment continues to plague the country. (chart courtesy of tradingeconomics.com)

However, unemployment will always be a lagging indicator. In a market economy as Ireland, profitability will be the primary gauge for investments, which eventually will be reflected on the job market.

First of all, despite the selective nature of evidence brought by the mainstream, Ireland isn’t in all that deep funk.

Ireland appears to be emerging from a deep recession and is expected to continue to grow through 2011 in spite of the fiscal tightening measures.

According to Finfacts

IBEC, the business group, said today the economy will return to growth in 2011 despite the greater than anticipated scale of the fiscal adjustments needed over the coming four years. GNP (gross national product) will grow 1.2% in 2011 and 3.4% in 2012 while GDP (gross domestic product with no adjustment for the profits of multinational operating in Ireland) will grow 2.2% and 3.1%. The forecasts for 2012 can be only guesswork and the outturn depends on the robustness of the international recovery in rich countries.

The business group says the final national accounts data for 2009 show that the nominal size of the economy was much lower than the Department of Finance had originally estimated while the global economic recovery has lost steam in recent months and Government’s growth forecasts for the 2011 to 2014 period now appear too optimistic.

The full accounting of the banking costs means that the debt-to-GDP ratio will reach 100% this year and will peak at about 115% in 2014. While this represents a rapid escalation from the pre-crisis debt ratio it is not exceptional in international terms - - IBEC says it is just above the debt level of the Eurozone and the US, about the same as that in Belgium and below that in Italy.

Second, deflation hasn’t been a persistent scourge as the mainstream paints it to be.

True, the unravelling of the global crisis has brought about a bout of deflation, but this appears to be on the mend.

Third, for the mainstream to argue that politics always favours government intervention, this report from the BBC, (bold emphasis mine)

Despite public sector cuts averaging more than 15%, and a further huge bank bail-out, making Ireland the EU's most indebted nation, the popular backlash against the government's fiscal tightening has never really materialised.

Bottom line: All these add up to demolish the myth that adapting fiscal discipline will be a bane to the economy.

US Midterm Elections: Rebalancing Political Power And Possible Implications To The Financial Markets

``The most enthusiastic supporters of such unlimited powers of the majority are often those very administrators who know best that, once such powers are assumed, it will be they and not the majority who will in fact exercise them." Friedrich von Hayek, The Constitution of Liberty

Trick or treat.

The way we celebrate Halloween will similarly be parlayed into the political sphere next week.

One of which would have an important bearing in the global financial markets.

While everyone will likely be focused on the US Midterm elections, what would seem crucial would be the US Federal Reserves’ formal announcement of its next phase of ‘credit easing’ policies: Quantitative Easing 2.0.

But we will deal with both.

US Midterm Elections: A Rebalancing Act

We shouldn’t expect much from the US Midterm elections. From our perspective, what is likely to change will only be the redistribution of the political power, from a lopsided stranglehold of Congress by the Democratic party into a more balanced exposure with that of the Republicans, that should serve as a control from an abuse of political power.

As political analyst Stratfor’s George Friedman rightly describes[1],

The Democrats will lose their ability to impose cloture in the Senate and thereby shut off debate. Whether they lose the House or not, the Democrats will lose the ability to pass legislation at the will of the House Democratic leadership. The large majority held by the Democrats will be gone, and party discipline will not be strong enough (it never is) to prevent some defections.

In other words, Democrats would likely lose their capability to highhandedly ram down the throats, or railroad unpopular ‘socialist’ policies to the American public, similar to the Obamacare, where polls say that a majority, or 53% of the public, has favoured its repeal[2]. And obviously such a backlash is likely to get translated into votes.

Figure 1: Every Action Has A Consequence; A Likely Political Comeuppance (chart from Danske Bank)

Apparently, the Democrats haughtily put into motion President Obama’s former Chief of Staff Rahm Emmanuel inglorious advise[3],

``You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before”.

And since every action has consequences, the unintended ramifications from these unilateral political actions, perhaps construed as an abuse of power, could likely be a political comeuppance next week. Moreover, there are many signs where public sentiment appears to have shifted incrementally towards accepting more libertarianism[4].

And another very important setback for the incumbent party has been the failed effects of the cumulative stimulus programs in bolstering the US economy, which has been predicated on mainstream economics.

And one of the repercussions from this failure has been the spontaneous emergence of Tea Party Movement groups[5] in 2009, which amazingly has expanded swiftly and now accounts for anywhere 15-25% of the US population according to some estimates[6].

Tea Party groups basically protest on the burgeoning role of government interventionism in the US political economy.

Yet like anywhere else, under a democracy, people will likely be voting, not for idealism or ideology or platform, but against what they would perceive as either proponents of injustice or fear. In short, elections are mostly about symbolisms based on sentiment or voter emotions.

So whether it is the Philippines or in the US, journalist Franklin Pierce Adams (1881-1960) observations should resonate emphatically ``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.”

And one reason why I think there wouldn’t be much change even with a prospective rebalancing of political power, or political gridlock as many have labelled them, is that many who run for office only piggyback on so-called principles only when public sentiment supports them.

Eventually once elected into office, these principles usually get sloughed off when personal conveniences weigh in.

And recent history has shown this.

The passage of the Emergency Economic Stabilization Act of 2008[7] should serve as a good example. The bill was initially rebuffed at the first vote at the US House of Congress on September 29^th, but following the paroxysm in the financial markets possibly in response to this, the House reversed and ratified it, on October 3^rd, in a bipartisan support. Ironically, this law serves as one of the main anchors for today’s monumental swing in political sentiment.

Also, political competition represents mostly a zero sum game where one gains at the expense of another. As Henry Louis Mencken rightly pointed out ``Under democracy one party always devotes its chief energies to trying to prove that the other party is unfit to rule - and both commonly succeed, and are right.”

The implication is that a house divided could translate to more political horse trading and backroom dealing, where the administration may either lean towards more a centrist stance or risk a political impasse from maintaining the present hardcore path of left leaning policymaking.

And unlike the past, where both the Congress and the Executive branch had been controlled by a single party, which seem to have made the Democrats think that they had a blanket mandate to foist laws as they see fit, the reconfiguration of power will likely make prospective policies more public sentiment sensitive.

And I’d like add that those who think that political ‘pragmatism’ equates to politics as operating in a fixed state will likely be been proven wrong again, if current polls will be actualized into votes, this Tuesday.

People’s dependence on government isn’t a constant for the simple reason that economic laws ultimately shape politics.

And where redistributive policies or programs would have reached its limits or to paraphrase Milton Friedman, there is no such thing as a free lunch, politics will have to come home to roost to face the new reality.

The recent lifting of the legal retirement age in France, in spite of the crippling protests and riots[8], should serve as a vivid example of the unsoundness of the welfare state system. Eventually, unsustainable systems crumble under their own weight, regardless of what people think.

Pragmatism isn’t about the false belief of sustained public’s acceptability of free lunch policies, on the contrary, pragmatism is about understanding the limits of redistribution operating under the ambit of the natural laws of economics.

Political Gridlock And The Financial Markets

And how should a divided government fare for the financial markets?

Based on past performance, they would seem favourable.

According to Danske Bank research team writes[9], (bold emphasis mine)

Interestingly, periods with the White House controlled by a Democrat and Congress controlled by the Republicans – a situation that is likely to be in place from 20 January 2011 - have seen the best average equity market performance. One important caveat is, however, that this result is heavily influenced by the fact that the period 1995-99, during which President Clinton faced a Republican-controlled Congress, coincided with the technology equity market boom.

When looking solely at the party controlling Congress, equities have performed better during periods of Republican control than in periods of Democratic Congress majority. This could indicate that from the point of view of investors, a Republican-controlled Congress is generally seen as less likely to put through legislation that is hostile to business, both in terms of tax policies, but also in terms of regulation issues. In the current situation, with financial sector regulation issues likely to remain high on the agenda in 2011-12, a Republican-controlled Congress could be seen as less likely to enact further measures to tighten regulation.

We can only conclude that the financial market conditions and the economic environment will likely be dependent on the kind of relationship that would emerge and cultivated from political diversity.

Nevertheless our caveat remains, past performance are not reliable indicators of the future, and that many other factors may influence the hue of US politics.

But if the chances of reduced government intervention in the economy are increased from a political gridlock, then the new political arrangement would likely boost business confidence, and thus becomes a positive influence, rather than undermine it.

And only the politically blind and those addicted to unsustainable inflationary big government would see this as some fictitious horror tale.

And as before, they will always miss out being right.

---

[1] Friedman, George U.S. Midterm Elections, Obama and Iran Stratfor.com October 26, 2010

[2] Rasmussen Reports, Health Care Law, October 25, 2010;

thehill.com POLL: Dislike of healthcare law crosses party lines, 1 in 4 Dems want repeal, October 6, 2010

[3] Wall Street Journal OpEd, A 40-Year Wish List, January 28, 2009

[4] See US Politics: A Libertarian Renascence?, October 29, 2010

[5] Wikipedia.org Tea Party Movement

[6] Examiner.com Video: Tea Party struggling in its efforts to find leadership, April 12, 2010

[7] Wikipedia.org Emergency Economic Stabilization Act of 2008

[8] Wall Street Journal Editorial, Dissecting French Schizophrenia, October 29, 2010

[9] Danske Bank, Much ado in the week ahead, Weekly Focus October 29, 2010

Trick Or Treat: The Federal Reserve’s Expected QE Announcement

``But on the other hand inflation cannot continue indefinitely. As soon as the public realizes that the government does not intend to stop inflation, that the quantity of money will continue to increase with no end in sight, and that consequently the money prices of all goods and services will continue to soar with no possibility of stopping them, everybody will tend to buy as much as possible and to keep his ready cash at a minimum. The keeping of cash under such conditions involves not only the costs usually called interest, but also considerable losses due to the decrease in the money’s purchasing power. The advantages of holding cash must be bought at sacrifices which appear so high that everybody restricts more and more his ready cash. During the great inflations of World War I, this development was termed “a flight to commodities” and the “crack-up boom.” The monetary system is then bound to collapse; a panic ensues; it ends in a complete devaluation of money Barter is substituted or a new kind of money is resorted to. Examples are the Continental Currency in 1781, the French Assignats in 1796, and the German Mark in 1923.-Ludwig von Mises, Interventionism: An Economic Analysis, Inflation and Credit Expansion

What I think would be the most important driver for the global financial markets over the coming weeks would be the prospective announcement by the US Federal Reserve’s Quantitative Easing version 2.0 on Wednesday.

The Gist of QE 2.0

I do NOT share the view that QE has been FULLY factored IN on the financial markets for the simple reason that estimates of the scale and duration and or terms have been widely fragmented. And there hardly appears to be any consensus on this.

The QE 2.0, in my analysis, is NOT about ‘bolstering employment or exports’, via a weak dollar or the currency valve, from which mainstream insights have been built upon, but about inflating the balance sheets of the US banking system whose survival greatly depends on levitated asset prices.

And all talks about currency wars, global imbalances and others are most likely to be diversionary ‘squid’ tactics to avoid the public from scrutinizing on the Fed’s arbitrary actions.

I see the ongoing QE 2.0 as heavily correlated with the legal issues surrounding the ownership[1] of many mortgage securities that has plagued the industry over the past few weeks.

Of course, it is also possible that Federal Reserve Chairman Ben Bernanke and company maybe pre-empting the results of the midterm elections, which they might think, could upset the current policy directions directed at providing subsidies to the banking system. The possibility of Cong. Ron Paul taking over the banking committee in Congress, they might see as a potential risk that could disrupt the viability of the banking system.

More Evidence Of Inflation

Yet there is hardly any convincing evidence that the US will likely succumb to another recession even without QE 2.0.

Even the credit markets have been saying so as we earlier pointed out[2].

Figure 2: Improvement On US Credit Markets (charts from St. Louis Fed)

For an update (see figure 2): Bank Credit of All Commercial Loans seem to be picking up momentum anew (top window), even Individual loans at ALL commercial which have recently skyrocketed, seem to be in a short pause but still looking vibrant (bottom pane) while Commercial and Industrial Loans of ALL Commercial banks seem to be bottoming out (mid window).

Figure 3: US Monetary Aggregates Points To Inflation (St. Louis Fed)

And even US monetary aggregates[3] appear to be saying the same story: MZM (upper window) and M2 (mid window) have recently been exploding skywards, while the M1 multiplier, a former favourite tool of permabears which tries to measure velocity of money, appears to be emerging fast from a bottom. And this is even prior to the Fed’s supposed renewed engagement with QE.

What all these seem to be pointing out isn’t what the mainstream and the officialdom has been looking at: we seem to be seeing are convergent signs of emergent inflation!

You have seen the actions US credit markets and US monetary aggregates, now the actions of the financial markets.

Figure 3: EM Equities, US Bonds and Commodities In A Chorus

We have argued that the convergence between rallying US bonds and a bullmarket in gold and or commodity markets would seem incompatible, from which the incoherence the markets would eventually resolve.

We seem to be seeing clues of this happening now, of course, going into our direction.

And deflationistas, whom have adamantly argued that bonds will likely benefit from a so-called liquidity trap, and have used the deflation bogeyman as justification for more inflationism, appear to be on the wrong the trade anew.

As one would note in Figure 3, emerging market equities (MSEMF or the MSCI Emerging Market Free Index), the CRB or a major commodity benchmark, a bellwether of Treasury Inflation Protection Securities or TIPS (iShares Barclays TIPS Bond Fund) and 10 year US Treasury Yields appear to be in a chorus.

What all these (credit market, monetary aggregates, financial markets) seem to be indicating isn’t what the mainstream and the officialdom have been looking at. (They’ve been fixated with employment figures).

Instead, what we seem to be seeing is a convergence of surging inflation worldwide!

And this is even prior to the Fed’s coming actions.

Not only that.

Last week, the US government sold $10 billion of 5 year Treasury Inflated Securities (TIPS) at minus .55% or negative interest rates for the first time in US history[4]!

TIPS investors don’t just earn from coupon yields, they earn from the adjustment of the securities’ par value[5] along with that of the consumer price index (CPI) thus giving protection against inflation as measured by CPI (which I think is vastly underreported).

This only means that the aggressive bid up of TIPS, which has led to a milestone of negative interest rates, represents a monumental swing in investor sentiment towards a deepening recognition of our transition to an inflationary environment which over the recent past had only been a fringe idea!

And this, in essence, would validate our 2009 prediction that inflation will be a key theme for 2010[6]!

And this also means that the premises of deflationistas are being demolished or dismantled as inflation expectations emanating from central bank policies deepens.

What To Expect

So how does QE 2.0 translate to the actions in the Financial markets?

If the Fed announcement should fall substantially below market expectations (perhaps $ 1 trillion or less) then we are likely to see some downside volatility which should prove to be our much awaited correction.

Yet any substantial volatility in the financial markets would translate to the Fed likely upping the ante on the QE 2.0. Remember falling asset prices would pressure the balance sheets of the banking system, and thus, would prompt for the Fed to make additional injections.

However, given the penchant of the Fed to resort to shock and awe, I wouldn’t be surprised if the FED would equal or go over the previous $1.75 trillion[7] monetization of treasury and mortgage related securities in 2009.

Of course, the other important aspect would be how other central banks would react to the Fed’s actions. We cannot take the Fed’s action as isolated.

If Bank of Japan and Bank of England would augment the Fed’s QE 2.0 by increasing its exposure on its current programs, then we should expect money flows into emerging markets to expand significantly. And this should go along with commodity prices and commodity currencies.

From the current market actions, we seem to be witnessing the early stages of a crack-up boom.

I remain bullish on equity markets, which I see as protection or serving as insurance against the currency debasement programs being undertaken by central banks to promote covert political agendas.

For Emerging Markets and Philippine stocks, we should remain exposed to commodities, energy and property issues.

[1] See The Possible Implications Of The Next Phase Of US Monetary Easing October 17, 2010

[2] See The Road To Inflation, August 29, 2010

[3] M1: The sum of currency held outside the vaults of depository institutions, Federal Reserve Banks, and the U.S. Treasury; travelers checks; and demand and other checkable deposits issued by financial institutions (except demand deposits due to the Treasury and depository institutions), minus cash items in process of collection and Federal Reserve float.

The M1 multiplier is the ratio of M1 to the St. Louis Adjusted Monetary Base.

MZM (money, zero maturity): M2 minus small-denomination time deposits, plus institutional money market mutual funds (that is, those included in M3 but excluded from M2). The label MZM was coined by William Poole (1991); the aggregate itself was proposed earlier by Motley (1988).

M2: M1 plus savings deposits (including money market deposit accounts) and small-denomination (under $100,000) time deposits issued by financial institutions; and shares in retail money market mutual funds (funds with initial investments under $50,000), net of retirement accounts.

St. Louis Federal Reserve, Notes on Monetary Trends

[4] Financial Times, US Treasury sells negative-rate bonds, October 26, 2010

[5] Investopedia.com Treasury Inflation Protected Securities - TIPS

[6] See Following The Money Trail: Inflation A Key Theme For 2010, November 15, 2009

[7] The Economist, A roadmap for more Fed easing, December 4, 2009

Example of Government Wastage

This is a good example how government fritter away taxpayer money.

From the Wall Street Journal Blog, (bold highlights mine)

The U.S. Internal Revenue Service had difficulty implementing new tax benefits in 2010, paying $111 million in erroneous benefits related to the stimulus law, a Treasury Dept. report said.

The IRS didn’t have controls in place to stop people who weren’t eligible from claiming the $8,000 first-time homebuyer tax credit, and tax credits for plug-in vehicles, among others. The findings were released Thursday by the Treasury Inspector General for Tax Administration.

To put the errors in perspective, IRS processed more than $81 billion in claims for stimulus-related tax benefits in 2010, involving upwards of 90 million returns.

About 126,000 of those returns were flagged by TIGTA as including erroneous claims that weren’t caught by the IRS before they were processed. In some cases, the IRS put compliance controls in place during the tax-filing season to catch the errors.

The underlying message is that the stimulus programs has led to undue wastage.

And the sad part is that no one seems accountable for such errors. And I don’t think that this is limited to the “stimulus programs”.

To consider, the stimulus is just one aspect of the variable bureaucratic operations, which means there would be many more leakages elsewhere.

And applied to the Philippines where social institutions are weaker than the US, the losses would be magnified.

US Politics: A Libertarian Renascence?

In the Cato Blog, David Boaz posits that in the US, current political trends seem to evolve towards the re-emergence of libertarianism.

Mr. Boaz writes,

This chart, prepared for me by Garrett Reim, shows recent trends in public opinion polls on several issues — support for smaller government, marriage equality, and marijuana legalization along with opposition to President Obama’s health care plan and to the job the president is doing. The latter two have moved more sharply, but all five lines move at least marginally in a libertarian direction:

Read the rest here.

What was popular then may not be popular now.

As we have long been saying—the world doesn’t not operate in a stasis. And this applies to politics too, where public sentiment continuously changes depending on the prevailing conditions.

Vietnam’s Relative Policy Success Is Mostly Premised On Less Interventionism

In a recent comment at a social web platform, a local politician commented that the reason for the marginal improvements in Vietnam relative to the Philippines had been due to the “effective implementation of their policy”.

While it is true that political policies serve as fundamental framework to social activities, the question that needs to be identified is the kind of policies involved and to what extent the so-called ‘effective implementation’ which results to positive externalities.

For instance, the politician further noted that domestic agricultural issues had signified as a seemingly timeless unresolved imbroglio which needs to be addressed. Unfortunately, he didn’t say how.

Yet in citing Vietnam, what was not elaborated was that the so-called the ‘effective policies’ in agriculture had been the decollectivization or privatization of agricultural lands which served as a crucial step in the transition to a market economy.

As World Bank’s Martin Ravallion and Dominique van de Wallel wrote,

Vietnam's land reform of 1988 abandoned the collective farming system that had been introduced in the 1960s. The 1988 Land Law and its key implementation directive-"Resolution 10"-gave individual households long-term use rights over the collectives' land and other resources. Four million hectares of land were thus scheduled for effective privatization.

Opaque generalized political statements frequently leads to confusion. Statements like this would seem mellifluous to hear for the economic ignorant, yet lack the teeth in terms of specific actions.

Essentially, the fundamental reason for the apparent relative policy success of Vietnam is because of the thrust towards trade liberalization or economic freedom, which implies less government interventionism or political meddling in distributing scarce resources. And this runs contrary to the intone of the local politician.

This from McKinsey Quarterly,

Vietnam began to liberalize its economy in the 1980s, when the country’s leaders launched doi moi (or “renovation”). It was only after President Clinton lifted the US trade embargo in 1994, though, that multinationals began to pile in. Since then, Vietnam has taken off. In 2007, it joined the World Trade Organization (WTO)—just in time for the global financial crisis. The country weathered the storm well, posting 5 percent growth in 2009.

The remarkable embrace of globalization by Vietnam has prompted for a sharp recovery from a once war ravaged economy.

The following chart from the KOF Index of Globalization

Vietnam has undertaken substantial steps to reduce bureaucratic red tape.

The following chart from World Bank’s Doing Business presentation

Vietnam has also reduced and streamlined taxes.

According to World Bank’s Doing Business 2010

Vietnam cut the corporate income tax rate from 28 percent to 25 percent and eliminated the surtax on income from the transfer of land. It also adopted a new enterprise income tax law and value added tax law. In addition, increasing competition in the logistics industry and the application of new customs administration procedures as part of the World Trade Organization (WTO) membership reform program have reduced trade delays.

So overall, the marginal edge Vietnam has over the Philippines isn’t because of more politics but because of MORE TRADE.

As one would note from the above illustration, Vietnam has surpassed the Philippines in attracting investments by reducing hurdles to investments or has made the political and legal environment more conducive to trade and investments.

And the following chart from Google’s Public data seems to corroborate this.

Vietnam’s external trade (% to GDP) has sharply surpassed the Philippines. (Caution: currency values appear less of an influence compared to ease of business environment)

Economics shapes politics.

It is true that Vietnam remains politically a one party authoritarian regime, where according to the Heritage Index of Economic Freedom, “political repression and the lack of respect for basic human rights remain serious concerns.”

Chart above from KOF Index of Globalization

Nevertheless if economic trends should continue to influence politics, political trends may also gradate towards more openness or democracy. But this isn’t certain, specially not over the near term, as Vietnam may be following China ‘dualistic’ model.

Meanwhile, economic freedom is also reflected on social freedom.

Again from KOF Index of Globalization

And here is more proof that Vietnam’s society have been integrating with the world, this from McKinsey Quarterly,

In 2009, the General Statistics Office estimated that Vietnam had 5 million Internet subscribers and 18 million Internet users. Those figures are impressive for a country at a relatively early stage of digital development, and other estimates suggest the number is even higher. In Hanoi and Ho Chi Minh City, for instance, up to half of the population is now online, spending more than two hours a day, on average. Expenditures on digital marketing for the country as a whole, however, are still very low: only $15 million, according to Cimigo, a market research firm. As Mai Huong Hoang, the chairwoman of one of Vietnam’s leading advertising agencies, the local branch of Saatchi & Saatchi, noted, “TV is still king in Vietnam, because women are the decision makers in the family and they spend a lot of time watching TV.” However, recent McKinsey research in other emerging markets, such as China, India, and Malaysia, suggests that the pace of digital change can be rapid, especially with younger people. Therefore, businesses—particularly consumer goods companies—shouldn’t ignore digital media in their marketing plans.

Bottom line: “Effective policy implementation” means less political interventionism, where people will be incented to harness their innate talents and skills in an environment fertile for business growth.

In other words, Vietnam’s success formula has been the relatively more aggressive adaption of economic freedom compared to the Philippines.

And more politics won’t serve as the elixir to the Philippines’ dismal and lagging performance.

Power of Slow Change: Dying Mass Media, Endangered Traditional Politicians

Another marvelous stuff from marketing guru Seth Godin (all bold highlights mine)

Now, though...When attention is scarce and there are many choices, media costs something other than money. It costs interesting. If you are angry or remarkable or an outlier, you're interesting, and your idea can spread. People who are dull and merely aligned with powerful interests have a harder time earning attention, because money isn't sufficient.

Thus, as media moves from TV-driven to attention-driven, we're going to see more outliers, more renegades and more angry people driving agendas and getting elected. I figure this will continue until other voices earn enough permission from the electorate to coordinate getting out the vote, communicating through private channels like email and creating tribes of people to spread the word. (And they need to learn not to waste this permission hassling their supporters for money).

Mass media is dying, and it appears that mass politicians are endangered as well.

As the information based economy deepens, knowledge will likely be more dispersed, aided by the web. And that the power of traditional influences will get diminished, as the public’s attention gravitate towards niche based interest groups, founded on fragmented and specialized knowledge.

And as we long been saying, politics is NEVER static, they always evolve. The reshaping or the ‘digitalization’ of the economy will likewise reconfigure politics. Perhaps, seen in the line of niche marketing which could likewise evolve into realm of niche politics.

The Silent Revolution: Election Boycotts

In reading Frank Chodorov’s fantastic article, it dawned upon me that I have been an unwitting 6-year practitioner of Mr. Chodorov’s ‘silent revolution’: I haven’t exercised my rights to suffrage in protest to what I perceive as the current farcical ‘social democracy’ which hallmarks the Philippines’ political system.

Here are some rudimentary reasons how and why election boycotts could be utilized as one avenue to institute political change.

These great excerpts from Mr. Chodorov: (all bold highlights mine):

Why should a self-respecting citizen endorse an institution grounded in thievery? For that is what one does when one votes.

In the quiet of his conscience each citizen pledges himself, to himself, not to give moral support to an unmoral institution, and on election day he remains at home.

the fact that every election is a seizure of power. The balloting system has been defined as a battle between opposing forces, each armed with proposals for the public good, for a grant of power to put these proposals into practice. As far as it goes, this definition is correct; but when the successful contestant acquires the grant of power toward what end does he use it — not theoretically but practically? Does he not, with an eye to the next campaign, and with the citizens' money, go in for purchasing support from pressure groups? Whether it is by catering to a monopoly interest whose campaign contribution is necessary to his purpose, or to a privilege-seeking labor group, or to a hungry army of unemployed or of veterans, the over-the-barrel method of seizing and maintaining political power is standard practice

Remember that the proposal to quit voting is basically revolutionary; it amounts to a shifting of power from one group to another, which is the essence of revolution.

All this would change if we quit voting. Such abstinence would be tantamount to this notice to politicians: since we as individuals have decided to look after our affairs, your services are no longer needed. Having assumed social power we must, as individuals, assume social responsibility — provided, of course, the politicians accept their discharge.

Revolutions starts with the individual.

By refusing to exercise our rights to suffrage we should put notice to the everyone, especially to the power hungry politicians, that we expect genuine “change” by fundamentally allowing individuals to assume greater social power and not some pretentious cycles of ‘personality based welfare-free goodies based politics’.

All it takes is to stay home.

Will A Weak US Dollar Boost The US Economy?

Conventional thinking says that a weak currency should boost the economy via promoting exports.

But the Wall Street Journal Blog argues otherwise. (bold highlights mine)

The financial markets are focused on how nations, including the U.S., would prefer weaker currencies in order to make their exports cheaper on global markets. Indeed, multinational companies Caterpillar and McDonald’s reported Thursday that their bottom lines benefited from stronger international sales.

The flip side of that weak-currency strategy, however, is that imports into the U.S. become more expensive. If so, that will be a problem for millions of companies that don’t have an export presence. These companies, especially small and medium-sized firms, will see their profit margins squeezed because of higher costs…

Michael Trebing, senior economist who oversees the survey at the Philly Fed, says that in the past, respondents have said the prices-received index is weak because of competition and the inability of businesses to pass along cost increases. As a result, profitability is under attack.

“Accounting 101 tells us that if a company’s input costs go up, and they are unable or unwilling to pass those costs on to the consumer, their margins get squeezed,” says Dan Greenhaus, chief economic strategist at Miller Tabak.

The squeeze could get worse as import prices adjust to a weaker dollar because U.S. business depends on imported supplies. Excluding energy commodities, industrial materials and supplies account for 14% of all U.S. imports. In the first eight months of 2010, nominal shipments of these imports increased 30% compared with the same period in 2009.

To be sure, many global contracts are priced in U.S. dollars. But as the dollar weakens, foreign producers themselves will soon come under margin pressure when the dollars are translated into local currency. Over time, new contracts will carry higher prices for the components and materials that are important inputs for U.S. manufacturers and service-providers.

In one respect, higher import prices would please the Fed because bank officials want to see overall U.S. inflation head higher.

Some quick stats: (all charts from Google's public data explorer)

Exports make up only 12% of the US economy (above chart) compared to imports at 17% (below chart)

Overall, US merchandise trade constitutes only 24% of the US economy.

A weak dollar policy not only punishes imports, which ironically represents a much larger component of the US economy, importantly, it would hurt domestic trade which comprises 76% of the GDP.

So when Fed officials say they would like to see higher inflation through a weaker currency, they are simply implying that exporters should be subsidized, shouldered by the rest of the economy, at the cost of vastly lowered standard of living through higher consumer prices.

Of course, as mentioned above, instead of adding jobs, a profit squeeze on domestic non-export enterprises, through higher prices of inputs, would translate to high unemployment.

And an environment of high prices and stagnating economy is called stagflation, a dynamic the US had encountered during the 70s to the 80s.

Yet that’s how ‘subtle’ protectionism works, the rhetoric and ‘noble’ intentions depart from real events, where a few politically handpicked winners would emerge at the cost of everyone else.

Update: I forgot to add: There is another unstated beneficiary here, i.e. holders of financial assets. And the sector that requires an asset boost is no more than the banking sector, which have been severely distressed by the recent crisis. And this is why I think that a weak dollar isn't directed mainly at bolstering exports but to keep the banking system afloat.

Profits And Social Responsibility

In a book review, the Economist hits the nail on the head.

``In poor countries the problem is not that businesses are unethical but that there are too few of them.”

More from the Economist, (bold highlights mine)

Ann Bernstein, the head of a South African think-tank called the Centre for Development and Enterprise, thinks that advocates of corporate social responsibility (CSR) tend to miss this point. In her new book, “The Case for Business in Developing Economies”, she stresses the ways companies benefit society simply by going about their normal business. In a free and competitive market, firms profit by selling goods or services to willing customers. To stay in business, they must offer lower prices or higher quality than their competitors. Those that fail disappear. Those that succeed spread prosperity. Shareholders receive dividends. Employees earn wages. Suppliers win contracts. Ordinary people gain access to luxuries that would have made Cecil Rhodes gasp, such as television, air-conditioning and antibiotics.

These are not new arguments, but Ms Bernstein makes them fresh by writing from an African perspective. Citizens of rich countries often fret about the occasional harm that corporations do, yet take for granted the prosperity they create. People in developing countries do not have that luxury.

If you pay heed to the mainstream, you’d have the impression that “labor costs” ultimately determines economic activities. Hence, the undeserved fixation towards currency values.

Of course in real life this is only fractionally true.

Economic activities are mainly about business enterprises seeking to serve consumers in return for the prospects of profits, where labor costs signify as one of the many factors or inputs necessary to produce a service or a good.

What ultimately determines profitability are respect for property rights and the rule of law which serves as the cornerstone for free trade to exist.

While the Economist article assails the issue of corporate social responsibility, the implied message is that poor countries have not sufficiently been exposed to competition for the anti-business environment reasons mostly out of the prevailing political or legal regime.

On the other hand, what needs to be understood is that profits are not necessarily “selfish”.

Since businesses are mostly established towards achieving long term relationships, profits have inherent social responsibility aspects such as maintaining or enhancing social relationships via charitable actions (donations and charities) or even addressing environmental concerns.

As Murray N. Rothbard wrote, (bold emphasis mine)

Whereas the opportunity for voluntary charity acts as a spur to production by the able, coerced charity acts as a drain and a burden upon production. In fact, in the long run, the greatest “charity” is precisely not what we know by that name, but rather simple, “selfish” capital investment and the search for technological innovations. Poverty has been tamed by the enterprise and the capital investment of our ancestors, most of which was undoubtedly done for “selfish” motives. This is a fundamental illustration of the truth enunciated by Adam Smith that we generally help others most in those very activities in which we help ourselves.

Hence, capitalism equates to mutually beneficial actions.

Integrating Asia: Japan-India Trade Pact

More signs that Asia continues to deepen her trade ties with each other.

This from the Japan Times

Prime Minister Naoto Kan and visiting Indian leader Manmohan Singh officially agreed Monday in Tokyo to activate an economic partnership agreement as soon as possible and to speed up talks on civilian nuclear cooperation.

The deal to strengthen economic ties between Japan and India, a fast-growing democratic nation with a population of 1.2 billion, comes at a time when Asian nations are becoming increasingly concerned about China's activities in the East China and South China seas….

The two countries will continue working-level preparations for signing the EPA. Tokyo aims to sign it around the end of the year so it can be submitted to the Diet early next year for ratification, Japanese officials said.

Under the EPA, the two countries will abolish a wide range of tariffs on products ranging from car components and electronic goods to bonsai plants. Broader than a free-trade agreement, the EPA is a more comprehensive pact on economic and trade cooperation that also includes promoting investments.

"This is a historic achievement that signals the economic alignment of two of the largest economies in Asia," Singh said. "It will open up new business opportunities and lead to a quantum increase in trade and investment flows between our two countries."

Japan and India began discussing the possibility of a civilian nuclear energy deal in June that would allow Tokyo to export its nuclear power technology to New Delhi. But India is not a signatory member of the Nuclear Non-Proliferation Treaty, and it is unclear how soon the two nations can conclude a deal, given the strong antinuclear sentiment here…

The EPA will eliminate tariffs on 94 percent of two-way trade in 10 years after the pact takes effect. The tariffs to be abolished include those on Indian exports of car components, DVD players, video cameras, peaches and strawberries to Japan, while Japan would improve access to most industrial products, as well as durian, curry, tea leaves and shrimp.

If there is anything to be bullish about, it is that the direction of geopolitics seems headed towards embracing broader ‘free’ trade.

Popular Sentiment Over Deflation Recedes

Aside from failed effects of the fiscal stimulus, one of the factors that could have been swaying political sentiment against Keynesian economics is the inordinate focus on “deflation”.

Yet for all the supposed threats that deflation would bring, there has been little signs of the emergence of the bogeyman since the culmination of the crisis.

This popular sentiment may have reached a "tipping point".

This from the Wall Street Journal Blog,

Deflation anxieties may be about to spur the Federal Reserve to do more to help the economy, but for bond traders, fears of a downward spiral in prices appear to be pretty low.

A paper published Monday by the Federal Reserve Bank of San Francisco said that based on pricing levels in the inflation indexed government bond market — the securities are commonly called TIPS — investors are sanguine the economy can escape a crippling bought of falling prices…

Fed officials fear that while growth remains positive, it is not powerful enough to overcome the ground lost over the course of the recession, leaving inflation at dangerously low levels, and unemployment unacceptably high. They want to act to help get growth levels higher, even though many economists and some in the Fed wonder if the institution can be effective in boosting activity, given that borrowing rates are already near historic lows and the financial system is flush with liquidity.

The TIPS market has long been one of the ways policymakers, economists and market participants could get a handle on the outlook for inflation. That said, the use of TIPS to tell a broader story is a complicated task.

The rap against the TIPS market goes like this: It is a relatively new market sector, and it has less liquidity than other parts of the Treasury trading world. That means price movements can be signaling something other than a shift in investors’ inflation outlook. In the market’s favor, however, is the fact that it at least represents a real money bet on something — an investor can lose cash if they predicted the pricing outlook incorrectly. In any case, Christensen argued his model compensates for these factors.

The gold market has been saying this ever since.

And as we long been saying here, false premises will eventually be unmasked.

Consumption-Led Growth Is A Myth

Even experts from the World Bank seem to be getting it, this from Ivailo Izvorski, (East Asia & Pacific On The Rise) [bold highlights mine]

“Consumption-led” growth is a myth. Output growth results from the accumulation of factors of production – capital, labor, land and others – and from technological progress. Consumption is not a factor that drives growth, it is the residual. And at early stages of development, rapid consumption growth – as we have observed in East Asia – is possible only with rapid investment growth. Cut down on investment to boost consumption and given the low level of capital in the region, output growth will plummet, and with it consumption growth.

Read the rest here

More signs that the mainstream appears to be moving away from Keynesian economics.