On India’s Lost Government Revenues From ‘Corruption’

Columnist Megha Bahree of Forbes reports that a huge amount ($213 billion) of tax revenues had been lost to bribes, tax evasion and mispricing in India during 1948-2008.

These estimates were supposedly conservative because it may have excluded different forms of smuggling and missing data, aside from foregone interest charges.

Ms. Bahree writes, (bold highlights mine)

The flight of capital from the legal system accelerated once the Indian government eased its tight control with economic reforms that started in 1991, the report says. Part of the problem was that Indian’s economic liberalization wasn’t accompanied by better governance or more accountability in the system. So while this period started liberalization of trade, lowering of trade barriers, less control and less oversight, it also led to an increase in bribes (to get your goods out of customs more quickly, for instance) and higher tax evasion.

India’s underground economy has been estimated at 50% of the GDP, making it about $650 billion at the end of 2008. Of this, 72% is held abroad, estimates Dev Kar, the author of the report and a former senior economist at the International Monetary Fund.

My comments:

1. Bribes occur only when there are legal proscriptions.

Bribes are symptoms or representative of societal response to the existing maze of arbitrary regulations.

Absent these restrictions or obstacles, then there won’t be any incentive to bribe, or much less, commit to an act that would circumvent any laws.

In short, the economic liberalization isn’t to blame for the institutional inefficiencies but on the partiality or the tepidness of liberalization reforms.

The strength of any social institutions emanate from the respect for the rule of law.

2. Tax evasions, like bribes, are symptoms of circumvention to onerous statutes.

They represent as cost saving measures resorted to by many enterprises in the face of the high costs of doing business largely due to obstructive taxes and the cumbersome compliance costs from the incumbent regulatory regime.

In other words, in most instances, a regime of high taxes is likely to incentivize tax evasion. Thus, it would be inaccurate to link economic liberalization with tax evasion because the cause and effect does not square. Economic liberalization should translate to lower taxes predicated on less dependence on the government.

3. The 50% share of India’s underground economy is emblematic, not of economic liberalization, but of the bureaucratic morass and the oppressive regulatory structures that discourages half of the economy to participate in the legal framework.

Again they are symptoms of people shunning government regulations, which is tantamount to government failure.

Like any process there always will be a transition. This means that the current reforms made by India hasn’t been enough (but should be on path), and that people and the existing institutions, coming from a long rule of statism, has yet to fully assimilate on the benefits of economic freedom premised on the respect for private property and the adherence to the rule of law.

4. Lost government revenues can be seen both ways.

If it is pocketed by government officials then it is likely to be devoted to consumption activities thereby would be considered unproductive and thus have negative implications.

Whereas if lost government revenues gives private enterprises room to expand production or services then it could be seen as having positive effects. Yes, this is the positive aspect of corruption.

Of course one could argue that lost revenues deprives the government to spend for social projects.

But most of social spending itself is questionable.

Aside from the issues of wastage and corruption, most of these so called public goods can be handled better and more efficiently by the private sector.

More importantly, high dependence on social spending is likely to foster a culture of entitlement or parasitism that is unlikely to prompt people to engage in productive activities but in acrimonious partisan politics between political insiders and the outsiders, promote patron-client relations (or crony capitalism) and even nurture criminal or underground activities.

India’s corruption problems isn’t one that hails from economic liberalization but from the vestiges of statism.

Quote of the Day: You Can’t Eat QE 2.0!

From Professor Steve Landsburg,

You can’t make the world a richer place just by creating dollars. Dollars are claims on wealth, but they’re not wealth. You can’t eat them, you can’t drive them, you can’t live in them.

If printing money is all what it needs to solve the world’s economic ills then why pay taxes (picture form Gary North/lew rockwell.com), or more importantly, why even work at all?!

The Power of Slow Change: Transition To The Information Age Economy

Society evolves. Along with it the industry.

I have been saying that old paradigms always gives way to a new order. Nothing is ever static.

And in the context of the industry, where agriculture gave way to industry, today the transition to the information age seems to be deepening as we move away from the paradigm of the industrial era.

Even the stock market seems to be saying so.

The following charts are from Bespoke Invest

One would notice that the technology sector in the US has mostly led, or if not placed a very close second (except 2002) during the US mortgage bubble days, based on the market cap industry weightings since 1998.

The sustaining dominance of the technology sector has been echoing on such transition where the rapid advances in technology translates to more dispersion of knowledge, specialization and a more roundabout production process—all of which would only be sustained under free market conditions—a dynamic which globalization appears to have accommodated.

Of course, not the everybody benefits from any changes. The important thing is the NET benefit from creative destruction.

We should see more of this dynamic percolate across the world.

QE 2.0 Equals Capital Flight

We have been told that QE 2.0 has been designed to help the US economy grow its way out of the recession.

However evidence seem to show otherwise. Capital investments appear to be flowing out of the US as a result of present policies putting at risk a recovery in employment conditions.

This from Bloomberg, (bold highlights mine)

Southern Copper’s plans illustrate why the Fed’s second round of bond buying may not reduce unemployment, which has stalled near a 26-year high. Chairman Ben S. Bernanke and his colleagues appear to be fueling a foreign-investment surge, underscoring the difficulty of stimulating the economy through monetary policy with interest rates already near record lows.

“You’re seeing leakage from quantitative easing,” said Stephen Wood, chief market strategist for Russell Investments in New York, which has $140 billion under management. “That leakage is going into emerging markets, commodity-based economies, commodities themselves and non-U.S. opportunities.”

U.S. corporations have issued more than $1.07 trillion in debt so far this year, according to data compiled by Bloomberg. Foreign companies also are tapping U.S. markets for cheap cash, selling $605.9 billion in debt through Nov. 15 compared with $371.8 billion for all of 2007, before the Fed cut the overnight bank-lending rate to a range of zero to 0.25 percent.

Instead of addressing issues which genuinely distorts the balance of the US economy mostly concerning (bubble) policy induced malinvestments, the left, as always, would most likely pin the blame of capital flight on “evil” China for having an artificially suppressed “manipulated” currency.

But again the “smoke and mirror” reasoning would not be substantiated by evidence, that’s because much of the ongoing outflows appear headed towards the relatively higher valued currency of the Eurozone.

From the same Bloomberg article,

U.S. corporations’ overseas investment in the first half of 2010 exceeded the amount that foreign firms spent in the U.S. on factories and acquisitions at an annual rate of almost $220 billion, according to the Commerce Department. In the first half of 2006, the last year before the financial crisis, the net flow favored the U.S. at an annual rate of about $30 billion.

More than half of outbound investment this year landed in Europe, Commerce data show. In April, Valmont Industries Inc., which manufactures light poles and communication towers, issued $300 million in 10-year notes. The Omaha-based company said it would use the proceeds to help fund its $439 million acquisition of Delta PLC, a London-based maker of similar products.

So again, the above circumstances only goes to show that the currency elixir (snake oil panacea) embraced by mercantilists, via QE 2.0, to solve the supposed global imbalances seems to be having an opposite effect.

Yet capital flows into the Europe has occurred in spite of the unresolved debt crisis in the periphery, the PIIGS.

So it seems another vindication for Friedrich von Hayek who once wrote

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Central planners seem to mostly get their designs backwards. It’s called the law of unintended consequences.

More Regulations Equals More Politics

In an egroup message, several former schoolmates decried on the pervading corrupting influence of politics in the state of the Philippine educational system as seen through this plea or manifesto.

However, the expressed dissatisfaction had not been complete as this did not deal with the cause-and-effect, where regulations and politics basically go hand in hand.

To extrapolate: the greater the role of regulations in the economy, the deeper the involvement of politics as means to distribute resources.

Perhaps the state of Greece as described by Michael Lewis at the Vanity Fair could be emblematic of the corrupting influence of a collectivist and highly politicized society (hat tip Russ Roberts). [all bold emphasis mine]

The Greek state was not just corrupt but also corrupting. Once you saw how it worked you could understand a phenomenon which otherwise made no sense at all: the difficulty Greek people have saying a kind word about one another. Individual Greeks are delightful: funny, warm, smart, and good company. I left two dozen interviews saying to myself, “What great people!” They do not share the sentiment about one another: the hardest thing to do in Greece is to get one Greek to compliment another behind his back. No success of any kind is regarded without suspicion. Everyone is pretty sure everyone is cheating on his taxes, or bribing politicians, or taking bribes, or lying about the value of his real estate. And this total absence of faith in one another is self-reinforcing. The epidemic of lying and cheating and stealing makes any sort of civic life impossible; the collapse of civic life only encourages more lying, cheating, and stealing. Lacking faith in one another, they fall back on themselves and their families.

The structure of the Greek economy is collectivist, but the country, in spirit, is the opposite of a collective. Its real structure is every man for himself.

Tumult In Global Markets: It Is Just Profit Taking

``Experience is a dear school, but fools learn in no other”-Benjamin Franklin

It is very interesting to observe how the volatility in the marketplace can intensively sway the emotions of participants. Apparently, this is the reflexivity theory—the feedback loop mechanism between prices and expectations—at work.

On the one hand, there are those whose crowd driven sanguine expectations seems to have been dramatically fazed by an abrupt alteration in the actions of market prices, where the intuitive reaction is to frantically grope for explanations whether valid or not.

Nonetheless such instinctive reactions are understandable because it signifies our brain’s defensive mechanisms as seen through its pattern seeking nature, a trait inherited from our hunter gatherer ancestors for survival purposes, mostly in the avoidance to become a meal for stalking predators in the wildlife.

For this camp, the newly instilled fear variable has been construed as the next major trend.

On the other hand, there are those whose longstanding desire for a dreary outcome. They cheerfully gloat over the recent actions that would seem to have their perspectives momentarily validated.

Permabears, whom have lamentably misread the entire run, sees one day or one week of action as some sort of vindication. This pathetic view can be read as the proverbial “broken clock is right twice a day”.

This camp claims that the recent paroxysms in the marketplace would signify as a major inflection point.

I’d say that both views are likely misguided.

The Market Is Simply Looking For A Reason To Correct

It’s not that I have been pounding on the table saying that the global markets, including the Philippine Phisix, have largely been overextended[1] and that profit-taking activities should be expected anytime.

Albeit, considering that the global financial market’s frenzied upside momentum, the unprecedented application of monetary policies and its probable effects on the marketplace, and where overextensions are common fares on major trends (bull or bear), crystal-balling short term trends can be fuzzy[2].

Besides it isn’t our role to tunnel in on the possible whereabouts of short term directions of the markets, a practise which I would call as financial astrology, to borrow Benoit Mandelbroit’s terminology.

Yet in vetting on the general conditions of the global marketplace in order to make our forecasts, we should look at the big picture.

Figure 1: Global Markets: Correction Not An Inflection Point

What is said as a ‘crowded trade’ is where the consensus has taken a position that leaves little room for expansion for the prevailing price trends. And in the paucity of further participation of ‘greater fools’, profit taking which starts as a trickle gradates into an avalanche, or the account of high volatility.

In looking at the charts of Gold (left upper window), the Dow Jones World Index (right upper window) and the Euro (left lower window) one would observe that the crowded trade phenomenon under current market conditions may have been in place since the run up began mainly from August.

I say ‘may’ because this will always be subjectively interpreted.

And for those who use the charts as guide, the intensifying degree of overextension have been evident from the departure or from the widening chasm of price actions from that of the moving averages, particularly the 50-day moving averages (blue lines).

Figure 2: Bloomberg: ASEAN Hotshots Likewise In A Corrective mode

And the same market motions seem to affect the ASEAN bourses, which of late has assumed the role as one of the world’s market leaders[3] or as one of the best performers. ASEAN benchmarks, last week, almost reacted synchronically with most emerging markets or with developed economy bourses. Decoupling, anyone?

The Philippines Phisix, which grabbed the top spot among ASEAN contemporaries, fell the most (6.26%) this week among all Asian bourses.

The last time the Phisix had a major one week slump at a near similar (but worst) degree was in the week that ended June 19, 2009. Like today, in tandem with our neighbours and global activities, the Phisix then lost 7.7% (see figure 2 blue ellipse: Thailand SET-red, Indonesia’s JKSE-yellow, Malaysia’s KLSE-green, Phisix-orange). Of course what followed was not a collapse but a febrile upside spiral from where the Phisix has not looked back.

So from the hindsight view, everything seems perfectly clear, the overheating or the overextensions, applied in current terms, may have peaked and thus has prompted for the market’s current ‘reversion to the mean’. Yet such regression should not imply a major trend reversal as it is likely to be a short term process.

And thus the current spasms seen in the marketplace is likely to account for mostly a normative profit-taking dynamic than from either a fear based regression or as a major inflection point.

I would thus carryover on my earlier advice[4],

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.

Reflexivity and The Available Bias

The reflexive price-expectation-real events theory simply states that price actions may influence expectations which eventually reflect on real events. Consequently, developments in real events may also tend to reinforce such expectations through the pricing channel, hence the feedback loop.

Since this theory operates on a long term dimension, it plays out to account for as the shifting psychological or mental stages of a typical bubble cycle.

In other words, it would take sustained intensive price actions or major trends to trigger major psychological motions that eventually pan out as real events.

A simple illustration is that if the current market downside drift would be sustained, then the public may interpret the formative trend as an adverse development in the real world. Subsequently, people’s actions will be reflected on the economic sphere via a recession or another crisis. Hence, the price actions emanating from evolving negative events get to be reinforced in the stock markets-via a reversion to a bear market.

Unfortunately, there appears to be a problem in applying this theory in today setting; the reason is that the opinions from the marketplace seem to be tentative over what constitutes as the real cause and effect.

In short, the public’s pattern seeking character refuses to accept the profit taking countercyclical actions of the markets, and instead, looks for current events from which to pin the blame on or associate the causality nexus.

Again we understand this as the available bias.

Available Bias: China’s Battle With Inflation

There have been two dominant factors from which the mainstream has latched the recent stress in the global markets on (see figure 3): one is China’s war with inflation and the other is the political tumult over Ireland.

Figure 3: Available Bias: Ireland Debt Crisis and China’s Tightening (charts from Danske Bank[5])

Friday’s 5.2% dive in China’s Shanghai Composite Index has been ascribed to the unexpected surge in inflation data[6] that has prompted Chinese authorities to reportedly raise bank requirements[7] to stanch credit flows coupled with rumors over more interest rate increases.

The selloff percolated to the commodity markets and rippled through emerging markets which laid ground to the rationalization of the supposed contagion effects from a potential curtailment of global economic growth on a tightening monetary environment in China.

It’s funny how the mainstream repeatedly argues over a myriad of fundamental issues supposedly affecting the markets when all it seems to take is the prospects of a credit squeeze to bring about a fit in the markets. This only proves our case that global stock markets have been mainly driven by inflationism (artificially suppressed rates and the printing of money).

China has been no stranger to such interventionism where the stock markets have been repeatedly buffeted by her government’s struggle, over the past year, to contain the so-called inner demons or a progressing bubble cycle (see figure 4).

Figure 4: Shanghai Composite: Another Government Instigated Drubbing (from stockcharts.com)

If I am not mistaken these interventions were interspersed from sometime mid 2009 until the 1^st quarter of 2010. The net result over the past year has been a consolidation phase in the Shanghai Composite Index (SSEC) albeit a negative 8.9% return on a year to date basis.

Nonetheless, China isn’t likely to resort only to monetary tools but also through the currency mechanism. China would likely allow her currency to appreciate as part of the mix in her ongoing battle against bubble cycles.

And on the consumption based model, the appreciating the yuan is likely to spur internal demand that would further increase demands for commodities and trade flows with emerging markets. But this would be too simplistic, if not myopic.

Yet even if this is partly valid, then this only shows that the sell-off had been exaggerated which will likely be self corrected over the coming sessions.

The currency factor will not, by itself, likely do the trick, for the simple reason that the manifold parts of any economy have different costs sensitivity and that the distribution of costs for corporations are likewise varied in terms of ownership (private or state owned or mixed), per industry or per geographic boundaries and many other factors.

While the currency factor will partly help in the adjustment towards the acquisition of higher value added industries, a transition towards more convertibility of the yuan would allow international trade to be facilitated by China, instead of relying solely on the US dollar. Of course this could also function as one possible solution to China’s concern over the US Federal Reserve’s QE 2.0[8].

Thus more liberal trade and investment policies must compliment in the prospective adjustments in the yuan in order to have more impact.

Fixating on the currency elixir on the premise of “ceteris paribus” constants is all being out of touch with reality, applying models notwithstanding.

Available Bias: Political Kerfuffle Over Ireland

The second factor in the latest market stress, as shown in figure 3, is being imputed to the re-emergence of credit quality concerns over the periphery nations in the Euro zone, particularly that of Ireland which seems to be spreading to the other crisis stricken PIIGs.

As part of the crisis resolution mechanism, reports say that Germany’s Chancellor Angela Merkel is requiring investors to take write-offs in sovereign rescues[9]. And on this account Germany has been pressing Ireland to seek aid from multilateral institutions such as the IMF and the EU commission in transition. A route so far downplayed by the government of Ireland.

And apparently the Merkel position has clashed with that of European Central Bank Jean Claude Trichet who said that having investors to suffer from losses under present conditions would ‘undermine confidence’.

To add, the ECB’s modest purchase of government bonds[10] have reportedly not helped in allaying concerns over such political impasse. Another way to see it is that the ECB could be using the markets as leverage to extract concessions in behalf of several interest groups.

This makes the debt problems over at the PIIGS a politically motivated one.

Of course in the understanding of the ethos of politicians, should the stalemate go out of hand, we should expect hardline positions to reach for a compromise or adapt a pacifist approach unless these politicians would be willing to put to risks the Euro’s survival.

So far what is being portrayed as an infectious credit crisis, similar to the Greek episode early this year, has been largely isolated as major credit market indicators appear to be unruffled yet by the political kerfuffle in the Eurozone (see figure 6).

Figure 6: Credit Markets Still Unaffected By The Ireland

There are hardly any signs of bedlam over at the credit markets if we measure the diversified corporate cash indices in the US (left window) and or the 3m LIBOR OIS spread (right window), both measured in the US (red line) and the Euro (blue line). The 3M LIBOR OIS spread is the interest rate at which banks borrow unsecured funds from other banks in the London wholesale money market for a period of 3 months[11] and is a widely watched barometer of distress in money markets.

In fact, these credit indicators have hardly manifested any signs of contagion, even if we are to take the Greece episode early this year as a yardstick.

Figure 6: PIGS Equities Not In Unison With Credit Markets (chart from Bloomberg)

In addition, considering the record spreads between the debts of Eurozone’s periphery with that of Germany, one should expect such strains to be vented hard on their respective equity markets.

Yet despite being significantly down on a year to date basis, equity markets appears to have been little affected, as shown by Ireland’s Irish Overall Index (green) Portugal’s PSI General Index (orange) Greece’s Athens Composite Share (yellow) and Spain’s MA Madrid Index (red), all of which seem to be in a consolidation phase.

One may observe that Spain and Portugal’s benchmark seem to be trending down of late, that’s because they have been moving higher from the 2^nd quarter, this, in contrast, to Greece and Ireland whose equity markets seem to be base forming.

Thus in summing up all these, I conclude that a potential major inflection point on the global equity markets emanating from the so-called contagion risks from the aftershocks in the PIIGS credit markets as largely unfounded.

One can add signs of resurfacing of some of the debt woes of Dubai[12], yet evidence suggests that today’s market actions is no more than an exercise of profit taking finding excuse in current events.

As a final note, I’d like to further emphasize that the Fed’s QE 2.0 seems to be failing in its mission to lower interest rates as US treasury yields have turned higher in spite of the recent market pressures (go back to figure 1 bottom right window). Of course, another way to look at it is that they seem to be succeeding in firing up inflation.

Moreover, the rally in the US dollar, despite the so-called return of risk aversion, likewise seems tepid.

So there seem little signs of a repetition of 2008 as many permabears have envisioned.

Overall the current market turbulence signifies as plain vanilla profit taking unless prices would be powerful enough to alter expectations that eventually would be reflected on real events.

---

[1] See An Overextended Phisix, Keynesians On Retreat And Interest Rate Sensitive Bubbles, October 25, 2010

[2] See Should We Chart Read Market Actions From QE 2.0?, November 7, 2010

[3] See Global Equity Markets Update: Peripheral Markets On Fire, Philippines Grabs Lead In ASEAN, November 4, 2010

[4] See Political Spin On The Philippine Economy And An Overextended Phisix, October 10, 2010

[5] Danske Bank, Focus turns from QE to debt crisis, Weekly Focus, November 12, 2010 p.1

[6] New York Times, China’s Inflation Rose to 4.4% in October, November 10, 2010

[7] Wall Street Journal, PBOC To Raise Major Bank's Reserve Ratio By Extra 50 BPs – Sources, November 11, 2012

[8] Businessweek/Bloomberg China Says Fed Stimulus Risks Hurting Global Recovery, November 5, 2010

[9] Bloomberg.com Germany Said to Press Ireland to Seek European Aid, November 14, 2010

[10] Danske Bank loc cit p.4

[11] St. Louis Federal Reserve The LIBOR-OIS Spread as a Summary Indicator, 2008

[12] Businessweek/Bloomberg Dubai ruler's firm talks with banks over debt load, November 11, 2010

Laurence Kotlikoff: The Scapegoating Of China

Author and Professor Laurence Kotlikoff argues, in a Bloomberg article, that the political heat applied to China, by certain political quarters, is not justified and represents the scapegoating of China.

Here is Mr. Kotlikoff,

Nothing could be further from the truth. But the truth is much harder to find these days than scapegoats. Fortunately, economics can move the debate beyond finger pointing.

Countries that run current account surpluses save more than they can fruitfully invest at home and invest the difference abroad. Countries with current account deficits do the opposite. They save less than their economy’s investment needs and attract investment from abroad.

Surplus countries take some of the seed corn they’ve saved and plant it in deficit countries. This physical movement of the seeds, or capital, is recorded as an export of the surplus country and an import by the deficit country.

Nations with current account surpluses are net exporters and have trade surpluses. Those with current account deficits are net importers and run trade deficits. Indeed, apart from the net income foreigners earn in the U.S. and invest here, their current account surplus equals their trade surplus, and their trade surplus is, apart from a minus sign, our trade deficit.

Again Mr. Kotlikoff shows how mercantilists have been selective in applying evidence to argue for their case..

So what ails the US?

Like Morgan Stanley’s Stephen Roach, Professor Kotlikoff refers to inadequate savings. Albeit with a different twist, savings that had been squandered from excessive redistribution programs from the US welfare state.

The key question is why we aren’t saving enough to fulfill our own investment needs. The answer is a decades-long fiscal policy that has been taking more resources from young savers and giving them to old spenders. This has driven our national savings rate down the tubes.

In 1965, Americans saved 14 percent of their national income. Last year the figure was negative 1.5 percent. What’s worse, our domestic investment rate -- the ratio of domestic investment to national income -- was only 1.8 percent.

Professor Kotlikoff asks for evidences to support the currency manipulation case.

Where’s the proof the yuan is undervalued? You won’t read studies claiming our real terms of trade with China are out of whack or find a black market in yuan. Instead, you’ll see studies that measure how much China would have to revalue to dramatically lower its current account surplus. But these studies ignore that such a revaluation would lower Chinese domestic prices for toasters, leaving the net cost of Chinese products to Americans unchanged.

Too many economists seem to disregard the basics of international trade when they equate China’s trade surplus with currency manipulation. One prominent economist recently described China as “engaged in currency manipulation on a scale unprecedented in world history.”

Let’s get a grip. China is a poor country. The fact that it holds some of its wealth in dollar-denominated assets is not proof of currency manipulation. Moreover, as China’s economy grows, the amount of its overseas investment will increase too. We need to get used to the Chinese investing in our country because that is tomorrow’s natural economic order.

So why the unwarranted fixation with currency fixes?

U.S. officials should also stop accusing the Chinese of manipulating their currency. Yes, China is pegging its currency to the dollar. But this isn’t evidence, per se, of currency manipulation. As a result of the 1944 Bretton Woods agreement, the U.S. spent decades fixing its currency to those of other nations. No one accused it of unfair trade practices.

A fixed exchange rate is fully compatible with free trade because the dollar price Chinese exporters charge for their goods is the result of two things: the exchange rate and the cost, in yuan, to produce the good.

Getting the Chinese to make their currency more expensive (forcing us to pay more dollars for one yuan) won’t make Chinese exports more expensive to American consumers since the internal cost in China of producing these products will fall. The Chinese restrict their supply of yuan to make the currency appreciate relative to the U.S. dollar. When fewer yuan circulate in China, prices there fall.

As we long and repeatedly argued, the accusations of China as currency manipulator signifies as a diversion from the real culprit to the loss of US competitiveness: inflationary policies.

And the scapegoating of the China, similar to the Japan episode in the 80s, signifies as the entitlement outlook parlayed into free lunch policies.

At the end of the day, it’s never about economic reality but about political propaganda that benefits the elite minority.

The Aquino Government’s View of Free Trade

Is the incumbent Philippine political regime pro-growth via free trade?

Clues to this answer from the Japan Times, (bold emphasis mine)

A senior Philippine trade official said Wednesday his government has to study the U.S.-backed trans-Pacific free-trade initiative carefully before joining it because his country, like Japan, has sensitive sectors like agriculture to protect.

"We are also just exploring the TPP (Trans-Pacific Partnership Agreement) and studying it, because the TPP agreement is quite an ambitious agreement," Undersecretary for Trade Adrian Cristobal said in an interview on the sidelines of the Asia-Pacific Economic Cooperation forum meeting in Yokohama…

"So these are some of the real constraints that the Philippines has, and other countries have similar constraints," Cristobal said. "We have to look at our own legal and regulatory structure, even our own constitution . . . as part of our own evaluation. From there we need to do some stocktaking also of our own sensitive products, our own industries. Of course we have to consult our own people, business sectors and economic sectors of what their views are."

Blunt interpretation or euphemism from the political lingo: We have to look at the interests of our cronies first.

Is it a wonder why the Philippine economy continues to lag?

Uncertainty And Pessimism Bias

Popular blogger and lawyer Barry Ritholtz has a great piece on uncertainty at the Bloomberg.

Mr. Ritholtz writes, (bold highlights mine)

Wall Street has a sweet tooth for such investing maxims. They infect the trading community like influenza in December. Repeat mindless dictums ad nauseam, and they soon become the accepted wisdom.

The problem with these supposed truisms is they are no more accurate than the flip of a coin. A closer look at this uncertainty meme reveals it to be a false-ism -- one of those emotionally appealing phrases that ping around trading desks. The lack of evidence supporting their premise seems to matter very little.

To recognize how meaningless these statements are, consider the opposite: Could markets function without uncertainty? It takes only a little thought to realize that markets actually thrive on doubt, imperfect information and a lack of consensus.

Uncertainty drives the market’s price-discovery mechanism. Investing requires there to be differences of opinion. When there is broad agreement as to an asset’s fair value, trading volume falls. Without any uncertainty, who would take the opposite side of your trade?

History teaches that whenever the opposite occurs -- when certainty overwhelms uncertainty -- the herd tends to be wrong. In rare instances, when there is a near-total lack of uncertainty in the market, the outcome is usually a spectacular disaster.

Should the prospects of uncertainty prompt us to hide in our proverbial shells?

The answer is NO. What matters is the understanding of the risk-reward tradeoff.

Here is Mr. Ritholtz again,

When we discuss uncertainty, what we are really discussing is risk. All unknown outcomes contain risk, and therein lies the possibility of loss. Risk is inherent in the concept of uncertainty. However, anyone looking for performance must embrace risk, for without it, there can be no reward...

And what to do with people who always preach ‘uncertainty’?

Once more Mr. Ritholtz,

The future, by definition, is unknowable. Investing involves making our best guesses about the value of an asset at some point after this moment in time. There will always be an element of uncertainty involved. We can discount various outcomes, engage in probabilistic analysis, but no one knows for certain what tomorrow will bring.

Those who claim to know fail to understand the most basic workings of markets. We need only consider the track record of Wall Street’s prognosticators to know the truth in this statement. As much as the future is uncertain, the most likely outcomes are well understood.

Exactly. Many who preach doom and gloom hardly managed to predict the markets accurately, yet they stubbornly insist that the world is headed for the gutters.

Uncertainty is NOT a valid reason to be maintain a bias on pessimism. A bias that largely emanates from:

-resistance to accepting critical changes, e.g. industrial age to information age

-undue fixation on several variables as harbinger for gloom or to quote Professor Bryan Caplan,

a tendency to overestimate the severity of economic problems and underestimate the (recent) past, present, and future performance of the economy.

-and finally, a bias which is predisposed at the attainment of a desired political and or economic outcome.

Again the brilliant Professor Caplan,

a general-interest prop to political demagoguery of all kinds. It creates a presumption that matters, left uncontrolled, are spiraling to destruction, and that something has to be done, no matter how costly or ultimately counterproductive to wealth or freedom. This mind-set plays a role in almost every modern political controversy, from downsizing to immigration to global warming.

Like Mr. Ritholtz, the implications of misunderstanding uncertainty imbued as a bias often leads to misdiagnosis of the risk-reward tradeoffs that leads to wrong conclusions and subsequently a poor or dismal track record in investment decisions.

A Video on Tax Cuts: Myths Versus Reality

Expiring tax cuts will be the next agenda of the incoming gridlocked US Congress.

And in this instructive video, Cato's Dan Mitchell debunks the propaganda used by the White House to justify higher tax rates on investors, entrepreneurs and the so-called wealthy class.

While this may be considered a domestic issue for Americans, this has geopolitical and international economic ramifications. For instance higher taxes rates may exacerbate capital outflows already impelled by the current monetary policies such as the QE 2.0.

Besides, Filipinos can learn about the fundamental ills of excessive government spending, the negative effects of taxation and the smoke and mirror propaganda employed by the 'powers that be' and their political cohorts, just to able sell the programs, that would unjustly inhibit property rights and curtail civil liberty, for the benefit of politicians.

Watch the video below.

Dr. Marc Faber: Party Now, Hangover Tomorrow

One of my favorite guru Dr. Marc Faber says that Asians should be thankful for QE 2.0.

In a way, I would agree with him

From Newsmax

"U.S. monetary policies have been very good for Asia, specifically for China because it fostered industrial-production growth in China, employment growth, wage increases, domestic consumption, increased demand for raw materials," Faber tells CNBC.

"That then lifted commodities prices. For that, actually the developing world, the emerging economies including China, Vietnam, Brazil and so forth should all send a 'Thank You' note to Mr. Bernanke."

But of course, we know Dr. Faber as being sarcastic.

That’s because he knows that bubble policies have intertemporal diametric effects: namely immediate (boom) and distant (bust).

Newsmax further quotes Dr Faber..

Excessive liquidity and dropping dollar bills from helicopters like Mr. Bernanke suggested — the problem with that is he doesn't know where the money will flow," Faber says.

"In this case, the excess liquidity flows into emerging economies and precious metals, and new bubbles are building up that at some point will burst.”

The bubble cycle in Asia appears to be flourishing as seen by the surging property prices in many Asian countries (of that’s aside from stock markets).

The Asian Investor reports a booming real estate market (above chart also from Asian Investor)

[bold emphasis added]

Transaction volumes in the Asia-Pacific increased 44% to $20.8 billion during the quarter as the region resumed its upward trend. It follows a second-quarter blip blamed on domestic cooling measures brought in by Beijing.

Global transaction volumes also returned, rising 15% quarter-on-quarter to total $303 billion for the past 12 months – a 47% increase year-on-year.

Asia-Pacific accounted for 26% of global volumes in the third quarter, up from 21% in Q2 but down on 29% in the first three months, finds a report by the Asia-Pacific Real Estate Association (Aprea) and Real Capital Analytics (RCA).

“The general trend is a rising one in terms of global transaction volumes and that has been mirrored in Asia,” says Lok So, Aprea’s operations director based in Singapore. “Do we see transactions in Asia continuing to rise? You would expect so. In terms of investible real estate in the world, it is almost a no-brainer that Asia will get the lion’s share of that, driven by China.”

So yes, it still seems like party time.

But no, parties don’t last forever and the hangover will haunt us in the fullness of time.

Apples-To-Oranges Comparison: SM Group Versus Ayala

A friend recently forwarded an article from a local analyst analogizing the supposed “tale of the tape” in the coming boxing match between world champion and local politician Manny Pacquiao and challenger Antonio Margarito with that of Henry Sy companies vis-a-vis the Ayala Group.

Here is my edited/revised comment to my friend:

I'd say that Sy and Ayala is an apples to oranges comparison whether seen from property, banking or as holding company.

The Sy Group for instance owns the distinction of having 3 out 10 largest malls in the world (Forbes magazine) [11th is also from SM], that's because his malls cater to mostly mid-class markets, whereas Ayala's malls cater to higher end markets.

Besides Ayala doesn't compete in the mass production of malls.

This applies with banking too. BDO seems to be anchored on mall based clients, whereas BPI has been more traditional way of banking.

Even in management they differ too. Mr. Sy’s companies appear to be more family managed/oriented, in spite of the recently acquired financial heft, while the Ayala group seems to be more professionally or reliant on ex-family based managers.

As an analyst I don't see Sy and Ayala as worthy comparisons.

In our lingo, we call them specialization. Each of these companies specializes on what serves them best.

Of course another important misleading analogy is the comparison of business and sports.

Sports has a specific outcomes (win or loss at a given time frame or period) while businesses signify as a continuing process.

Besides businesses provide good or services that adds value to the company’s respective customers, which alternatively means businesses are NOT zero sum games, where one wins at the expense of the other.

Whereas only one protagonist will emerge as winner in the coming Pacquiao-Margarito match.

JETRO: Rapid Globalization To Spur Emerging Asia’s Outperformance

In the latest monthly outlook “Japan Looks for Economic Growth in Emerging Asia” by Japan External Trade Organization (JETRO), a Japan government owned trade organization, JETRO cites Emerging Asia’s economic prospects as very promising. (hat tip: Keith Rabin of KWR International)

The reason: (bold emphasis mine)

The dynamics of the global economy are changing. During the past century, global economic growth was primarily driven by activity in the “the three locomotives,” the US, EU and Japan.

Rapid globalization, however, is leading to new innovations, such as the proliferation of highspeed telecommunications and enhanced logistical infrastructure. This is resulting in a more connected, multi-faceted world. Economically, these changes allow companies to coordinate over long distances to optimize their supply chains and reduce their cost structure by moving production to developing economies. Building from a lower income baseline, stronger growth is helping to raise living standards and turn these developing economies into markets in their own right. As a result, they are now becoming the primary incremental drivers of global consumption and production.

And Emerging Asia's thrust towards deeper globalization have been anchored on manifold Free Trade Agreements (FTA) which would not only integrate Asia but foster more free trade with the world.

Why Mercantilists Are Wrong (Again)

The Chinese yuan may not be as undervalued as expected by present day mercantilists.

According to the Economist, (bold highlights mine)

The yuan may well still be undervalued but our index suggests American manufacturing should have less to fear from Chinese competition than it did five years ago. Until June 2009 appreciation was largely because of the stronger yuan. Since then it is largely because China’s unit labour costs have grown much faster than America’s. Employers in China’s coastal factories have suffered labour shortages and strikes. America’s factories have reported strong productivity gains as they have wrung more out of the workers that survived the recession (although those gains will be hard to repeat).

Of course, China and America do not trade only with each other. China’s big surpluses and America’s big deficits depend on the real exchange rate between them and all of their trading partners. But calculating that would require timely estimates of unit labour costs for all of China’s trading partners. That is a bit too laborious.

The Economist is correct to point out implicitly how wrong present day mercantilists unduly fixate on China’s currency as the main mechanism for global trade.

These mercantilists allude to trade imbalances as the root of all economic problems and thus recommend policies grounded on ‘restoring balance’ via curtailing trade or applying protectionism (tariff, and controls) or inflationism (currency wars)

Yet the mercantilist perspective deliberately neglects or disregards all other variables or factors which mistakenly presume that the world operates in a “ceteris paribus” or an imaginary two nation world of US and China. Yes, they love to fantasize a world beyond or outside of reality.

Contrary to the mercantilist orthodoxy, trades imbalances are NOT the problem. Instead trade imbalances account for as symptoms of evolving geopolitical and world economic conditions and patterns which had been brought upon by present policies.

One of which is the Triffin Dilemma, which according to the Wikipedia.org, is the paradox by which “the country issuing the global reserve currency must be willing to run large trade deficits in order to supply the world with enough of its currency to fulfill world demand for foreign exchange reserves”.

Another is globalization.

Importantly, trade imbalancess signify as outcomes from voluntary action and not of government mechanistically engaged in trade for no apparent reason at all.

It is individuals who buy or sell services even if it is done with other individuals abroad.

Yet the mercantilist logic goes:

If I frequent my favorite pizza parlor, whose food I savor, which means I repeatedly incur a deficit with the pizza parlor, then the pizza parlor should be forced by edict to obtain my services (as a stock market agent) even if they refuse to get involved in the stock markets in order to balance our trade. By doing so, my favorite Pizza Parlor would only serve to people who they are willing to balance out which alternatively means going out of business. This circular reasoning by the mercantilists is all patent nonsense.

Individuals conduct trade to fulfil specific needs. And the division of labor and comparative advantages channelled via voluntary exchange is what allows our needs to be met. Territorial or geographic boundaries does not change this perspective.

And forcing people to balance trade would result to REDUCED trades, which ultimately leads to impoverishment via higher prices, shortages, diminished of choice of available products, inferior qualities and etc.

Besides, contrary to conventional mercantilists expectations, exports ALONE do NOT make a country prosperous. This mercantilist perspective, which aims to increase ‘surpluses’ by fiat or protectionism, actually confuses wealth with money and have long been demolished by Adam Smith (bold highlights mine)

I thought it necessary, though at the hazard of being tedious, to examine at full length this popular notion that wealth consists in money, or in gold and silver. Money in common language, as I have already observed, frequently signifies wealth, and this ambiguity of expression has rendered this popular notion so familiar to us that even they who are convinced of its absurdity are very apt to forget their own principles, and in the course of their reasonings to take it for granted as a certain and undeniable truth. Some of the best English writers upon commerce set out with observing that the wealth of a country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds. In the course of their reasonings, however, the lands, houses, and consumable goods seem to slip out of their memory, and the strain of their argument frequently supposes that all wealth consists in gold and silver, and that to multiply those metals is the great object of national industry and commerce.

The two principles being established, however, that wealth consisted in gold and silver, and that those metals could be brought into a country which had no mines only by the balance of trade, or by exporting to a greater value than it imported, it necessarily became the great object of political economy to diminish as much as possible the importation of foreign goods for home consumption, and to increase as much as possible the exportation of the produce of domestic industry. Its two great engines for enriching the country, therefore, were restraints upon importation, and encouragements to exportation.

In short, wealth is acquired through capital accumulation via savings and investment and expressed through voluntary exchange.

In truth, the undeserved obsession towards trade imbalances represent as selective perception and data mining applied by modern day mercantilists in order to justify all sorts of interventionism. They apply fallacious ‘cart before the horse’ reasoning.

Seen from the bigger picture trade deficits are part of the international transactions that can be seen from Balance of Payment (BOP) data where trade deficits are fundamentally offset by capital flows.

Professor Mark J. Perry points out that under double-entry accounting, debits have to equal credits, which applies to BOP accounting:

BOP = CURRENT ACCOUNT + CAPITAL ACCOUNT = CREDITS - DEBITS = 0

Professor Perry additionally writes,

The current account and capital account are the two main components of the U.S. Balance of Payments (BOP), which is a record of all international transactions for both: a) trade flows and b) capital flows in a given period. Every international transaction (e.g. export, import, U.S. investment abroad, foreign investment in the U.S.) is recorded on a double-entry accounting basis, so that each transaction involves both a debit and credit.

Professor Perry further notes that alarmism over deficits are unwarranted for the following reasons: (bold highlights mine)

1. There are no BOP deficits once we account for all international transactions, both for: a) goods and services, and b) financial transactions. For all of the one-sided coverage in the press about the "trade deficit," you would almost never even know that there is an offsetting "capital surplus" or "capital inflow." It's important for the general public to understand that trade deficits are offset by capital inflows on almost a 1:1 basis, resulting in a "balance of payments" for international transactions. When the public constantly hears about "trade deficits" without any understanding of the offsetting surplus, that economic ignorance allows politicians and special interest groups to exploit the general public, by advancing and promoting protectionist trade policies aimed to reduce the "trade deficit," or by refusing to approve trade agreements between Chile, Panama and Korea, etc.

2. The "trade deficit" generates so much negative coverage, that the significant advantages of capital inflows from abroad get frequently overlooked. Since 1980, the U.S. has attracted almost $8 trillion of foreign investment, which has provided much-needed equity capital that has allowed U.S. companies to start or expand, has provided much-needed debt capital that has also funded the expansion of American companies, along with providing debt capital for U.S. consumers in the form of mortgages, student loans, and car loans. Some of the $8 trillion of investment includes billions of dollars of Foreign Direct Investment, which has funded thousands of new projects in the U.S. (Toyota factories for example) and created hundreds of thousands of jobs.

This goes to show that “imbalances” serve more as political talking points meant to promote dogmatism than of observing factual operating circumstances.

Moreover what matters most is what mercantilists refuse to bring up in the imbalance debate: what seems to ail the US, isn’t China, but the entitlement mentality effected by the political leadership through inflationary policies (such as the recent housing bubble).

The negative effects of inflationism can be broken down into the following

-diverts resources to one that is not desired by the markets.

-crowds out the private sector

-generates systemic malinvestments.

-causes overvaluation in assets or the currency.

-misallocates the distribution of economic weighting towards areas preferred by government at the expense of the consumers.

-raises the costs of living.

-distorts corporate profitability and income streams

-raises the cost of doing business which translates to reduced competitiveness

-destabilizes the economy from the boom bust cycle which eventually leads to a consumption of capital.

The mercantalism-inflationist agenda does the opposite of what it intends to accomplish.

Applying real life examples, if the mercantilists-inflationists school is correct then Zimbabwe, North Korea, Cuba and Burma should have been the most prosperous countries (having been closed economies).

Ironically, the opposite is true, nations that have been economically free, are those whom have been prosperous.

Unfortunately reality isn’t what mercantilists are concerned with. Political religion is.

World Bank Chief Robert Zoellig: Bring Gold Back As Part Of The New Monetary Order

I never imagined how quickly developments have been shaping in the direction of my perspectives.

Here is what I wrote last Sunday

Global Central banks appears to be rediscovering gold as possibly reclaiming its role as money in a new monetary order. A new monetary order is not question about an if, but a when…

Those who obstinately relish the bias that gold is nothing but a barbaric relic will likewise suffer from taking on the wrong positions. But they eventually will succumb to the shifting expectations as with many monetary authorities today. The reflexive process of having prices influence fundamentals has clearly been taking shape.

Here is from Monday’s news (Reuters)… [bold highlights mine]

The world's largest economies should consider gold as an indicator to help set foreign exchange rates, the head of the World Bank said on Monday in a proposal that threw open the acrimonious currency debate days before a summit of G20 nations.

Writing in the Financial Times, World Bank President Robert Zoellick called for a new monetary system to replace the floating rates adopted in 1971 known as Bretton Woods II…

The former U.S. trade representative, who served in several Republican administrations including Treasury, said the new system "is likely to need to involve the dollar, the euro, the yen, the pound and (a Chinese yuan) that moves towards internationalisation and then an open capital account".

"The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values," he added.

The geopolitical pressure for a monetary reform possibly anchored on gold appears to be mounting.

Quote Of The Day: Germany’s Export Strength Comes From Competitiveness And Not Surpluses

My quote of the day comes from Germany’s Finance Minister Wolfgang Schäuble (Wall Street Journal)

Germany's exporting success is based on the increased competitiveness of our companies, not on some sort of currency sleight-of-hand. The American growth model, by comparison, is stuck in a deep crisis…The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base. There are many reasons for America's problems—German export surpluses aren't one of them.

Some public officials get it right.