Ireland’s Woes Won’t Stop The Global Inflation Shindig

``When governments try to confer an advantage to their exporters through currency depreciation, they risk a war of debasement. In such a race to the bottom, none of the participants can gain a lasting competitive edge. The lasting result is simply weaker and weaker currencies against all goods and services — meaning higher and higher prices. Inflationary policies do not confer lasting advantages but instead make it more difficult to plan for the future. Stop-and-go inflationary policies actually reduce the benefits of using money in the first place.” Robert P. Murphy Currency Wars

For the mainstream, effects are usually confused with the cause to an event. And the misdiagnosis of the symptoms as the source of the disease frequently leads to the misreading of economic or financial picture which subsequently entails wrong policy prescriptions or erroneous predictions.

Yet many mainstream pundits, whom has had a poor batting average in predicting of the markets, have the impudence, premised on either their perceived moral high grounds or their technical knowledge, to prescribe reckless political policies that would have short term beneficial effects at the costs of long term pain with a much larger impact.

Take for instance currency values. Many pundits tend to draw upon “low” currency values as the principal means of attaining prosperity via the “export trade” route. As if low prices mechanically equates to strength in exports. And it is mainly this reason why these so called experts support government interventionism via currency devaluation.

Yet what is largely ignored is that in the real world most of the world’s largest exporters have currencies that are relatively “pricier”, and that most of the “cheap” currency economies tend to be laggards in trade—the latter mostly being closed economies.

In contrast to mainstream thinking, prosperity isn’t about the unwarranted fixation of currency values, but about societies that promotes competitiveness and capital accumulation.

As Ludwig von Mises once wrote[1], (bold emphasis mine)

The start that the peoples of the West have gained over the other peoples consists in the fact that they have long since created the political and institutional conditions required for a smooth and by and large uninterrupted progress of the process of larger-scale saving, capital accumulation, and investment.”

In other words, prosperity emanates from a society which respects the sanctity of property rights premised on the rule of law, which subsequently acts as the cornerstone or foundations of free trade and economic freedom that shapes the state of competitiveness of the economy.

The allure of the polemics of “cheap” currency is no less than “smoke and mirror” chicanery aimed at promoting the interests of a politically privileged class that does little or nothing to advance general welfare.

In short, what is being passed off or masqueraded as an expert economic opinion, is no less than a political propaganda.

Discipline As Basis For Bearishness?

And this applies as well to debt.

Many see the humongous debt load by developed nations as the kernel of the most recent economic crisis. They also use the debt argument as the main basis in projecting the path of economic and financial progress.

Yet debt serves NOT as the principal cause, but as a SYMPTOM of an underlying cause.

It is the collective monetary and administrative policies that have promoted debt financed consumption predicated on the presumed universal validity of AGGREGATE DEMAND that has been responsible for most of the present woes. This has largely been operating for the benefit the government-banking industry-central banking cartel worldwide[2]. Yet such irresponsible policies have spawned endless boom bust cycles and outsized government debts from repeated bailouts and various redistribution schemes which ultimately end in tears. Yet no lesson is enough to restrain these pundits from making nonsensical rationalizations of encouraging a repeat of the same mistakes.

The point is, redistribution has its limits, and we may be reaching the tipping point where the natural laws of economics will undo such false economic premises. And this would represent the grand failure of Keynesian economics from which today’s paper money standard has largely been anchored upon.

For instance the current woes in Ireland, which has not been about the imploding unwieldy social welfare programs yet, but has been about the BLANKET GUARANTEES issued by the Irish government to some of their major ‘too big to fail’ banks, have been used by perma bears to argue for the revival of the ‘deflation’ bogeyman.

While the Ireland debt crisis seem to share a similar characteristic to that of the experience of Iceland[3] in 2008, where the presumed ascendancy or infallibility of government “guarantees” crumbled in the face of economic laws, Ireland’s case is different in the sense that there appears to be political manoeuvring behind the pressure for the latter to comply with the proposed bailout.

Rumors have been rife that the proposed bailout of Ireland have been meant to raise Ireland’s exceptionally low 12.5% corporate tax rates, which has been an object of contention by European policymakers, most especially by the European Central Bank (ECB)

According to the Wall Street Journal[4],

``Brussels has always resented that Ireland transformed its economic fortunes by cutting corporate income taxes and marginal tax rates. At various times, the EU has sued Ireland to raise its rates, accused it of "social dumping" for having a 12.5% corporate income tax, and threatened to cut off European subsidies unless it hiked taxes. None of it worked, but now, with Ireland's banks teetering and its economy in its worse shape in a generation, Europe is moving in for the kill.”

And what better way to compel Ireland to accede to the whims of the bureaucrats in Brussels than to force a crisis from which Ireland would need to accept political conditionalities in exchange for a rescue!

Of course, politicians such as French President Nicolas Sarkozy had been quick to deny the political blackmail[5], saying that “But that’s not a demand or a condition, just an opinion.”

However the important point is that what is being misread by the mainstream as an economic predicament is actually a self inflicted mayhem arising from the political ruse meant at achieving certain political goals.

And unelected politicians have used the markets, largely conditioned to the moral hazard of bailouts and inflationism, to advance their negotiating leverage.

Another point I wish to make is that Euro bears have emphasized that the decision by some Eurozone members to assimilate fiscal austerity has been interpreted as a reason to be bearish on the Euro.

For this camp, the alleged political angst from imposing fiscal discipline would allegedly force the disintegration of the currency union. This is plain AGGREGATE DEMAND based hogwash.

How can it be bearish for individuals or nations (which comprises a community of individuals within defined territorial or geographical boundaries) to act on cleaning up their balance sheets? The excuse is that the lack of AGGREGATE DEMAND will pose as a drag to the economy undergoing the process of “develeraging” from which the government should takeover. What works for the individuals does NOT work for the nation.

Of course the distinction of the paradox can viewed based on time preferences: short term negative and long term positive. People who emphasize on the long term see the positive effects of the structural adjustments even amidst the necessary process of accepting short term pain. Like any therapeutic process, it takes time, regimented diet and regular exercise to recover. There is no short cut, but to observe and diligently work by the process.

On the other hand, there are those who cannot accept any form suffering, or the entitlement mentality. And this mindset characterises the advocates of short term policy fixes.

For politicians who depend on the electoral process to remain in office, any form of suffering represents a taboo as this would signify as loss of votes and consequently the loss of office. Thus, politicians have used short term premised Keynesian economics to justify their actions mostly via the magic of turning bread into stones—printing money.

For unelected bureaucrats the incentives are almost similar, the consequences of any imbalances must be kicked down the road and burden the next officeholder.

For academic or professional supporters, whom are employed in the industries that have privileged ties with the government or whose institutions are funded directly or indirectly by the government, they serve as mouthpieces for these interest groups by embellishing propaganda with expert opinion covered by mathematical models.

The point is this that the AGGREGATE DEMAND paradigm from debt based consumption is not only unsustainable but unrealistic. Yet mainstream experts purposely confuse interpreting the effects as the cause to advance vested interest or for blind belief from dogmatism.

Remaining Bullish On The Euro

And having to confuse effects with the cause is one way to take the wrong side of the markets.

Figure 1: Ireland Government’s Spending Binge

As we pointed out above it is not debt but the incentive by politicians to spend taxpayer money to the point of accruing heavy debt loads that has aggravated the present woes.

As Cato’s Dan Mitchell[6] points out in the case of Ireland,

``When the financial crisis hit a couple of years ago, tax revenues suddenly plummeted. Unfortunately, politicians continued to spend like drunken sailors. It’s only in the last year that they finally stepped on the brakes and began to rein in the burden of government spending. But that may be a case of too little, too late.”

And contrary to the outlook of the Euro bears, the incumbent low corporate taxes seem likely to attract many investors into Ireland.

According to the Economist[7],

IDA Ireland, the agency that targets such investors, says FDI in 2010 will be the best for seven years. A new generation of firms, including computer-gaming outfits like Activision Blizzard and Zynga, are joining the established operations of Intel and Google. Ireland’s workforce is young, skilled and adaptable. Rents are coming down even faster than wages.

So not limited to low taxes, Ireland’s less activist government has resulted to more market based responses in the economy that seems to have also been generating incentives for investors to react positively in spite of the ongoing crisis.

Euro bears are wrong for interpreting discipline and responsible housekeeping as a bearish sign, and equally mistaken for prescribing unsustainable policies that play by the book of mercantilists.

We must be reminded of Professor von Mises’ advise on assessing currency values where ``valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money”[8]

This means that in terms of relative policies between the US and the Eurozone, the policy of inflationism as administered by the US monetary authorities, seem to tilt the relationship between the quantity (via Euro austerity) and demand, in favour the Euro, whose rally we have rightly predicted[9] in mid of this year.

Alternatively this means that any dip should be considered as a short term countercyclical trend or must be considered a buying window.

Misunderstanding Deflation

Finally, those who continually obsess over the prospects of a deflation environment similar to that of the Great Depression are bound to be incorrigibly wrong.

The Great Depression wasn’t not only a result of contraction of money supply via collapsing banks, but likewise the curtailment of trade from rampant protectionism (Smoot Hawley) and obstructionist policies (regime uncertainty) that inhibited the incentive of the public to invest.

Left to its own devise and unobstructed by government, the marketplace would result to an optimal supply of money. This means for as long as globalization remains operational there won’t be “deflation”.

As another great Austrian Economist, Murray N. Rothbard explained[10],

But money is uniquely different. For money is never used up, in consumption or production, despite the fact that it is indispensable to the production and exchange of goods. Money is simply transferred from one person’s assets to another. Unlike consumer or capital goods, we cannot say that the more money in circulation the better. In fact, since money only performs an exchange function, we can assert with the Ricardians and with Ludwig von Mises that any supply of money will be equally optimal with any other. In short, it doesn’t matter what the money supply may be; every M will be just as good as any other for performing its cash balance exchange function.

If there is any deflation it won’t be from what the mainstream expects, because price deflation would emanate from productivity growth instead of debt deflation, Think mobile phones or computers.

And that’s the reason why perma bears have gotten it miserably wrong, even all the credit indicators previously paraded to argue their case based on the flawed AGGREGATE DEMAND have NOT materialized[11] and worked to their directions.

Now that these indicators either have bottomed out or have manifested signs of improvements, they have NOT been brandished as examples.

So perma bears have been desperately looking for scant real world evidence to support their views.

Bond Markets Reveal Upsurge In Inflation Expectations

IF there would be any ONE thing that would crush the ongoing liquidity party it would be a chain of interest rates increases that eventually would reach levels that would trigger many projects or speculative positions financed by leverage or debt as unprofitable. This would be the credit cycle as narrated by Hyman Minsky.

This means that a bubble fuelled by systemic leverage would be pricked by the proverbial interest rate pin that would unleash a cascade of asset unwinding. This has been a common feature of our paper money system which only shifts from certain asset markets to another.

The motion of rising interest rates would surface from a pick-up in credit demand, which may reflect on policy induced illusory economic growth, broad based consumer inflation as a consequence to sustained monetary inflation or a dearth of capital, which may be prompted for by a surge of protectionism, a collapse in the banking system or snowballing questions over the credit quality on major institutions, if not on claims on sovereign liabilities.

Figure 2: Municipal Bonds by Rising Yields Over The Long End

Despite the recent statistical reports of muted consumer price inflation which marked “the smallest increase since records started in 1957”[12], one must be reminded that consumer price indices represent a basket of goods, services and assets based on the construct of the US government. And these hardly reflect on the accuracy of the real rate of consumer price inflation because they are determined based on the interpretation of government technocrats on what they perceive constitutes as a meaningful measure of “inflation” based on the aggregate assumptions.

So even if food and oil prices have been rising (CCI index in figure 2) it appears that these increases have hardly filtered into the government’s statistical data.

Yet the contradiction appears to have been vented on the bond markets as US treasury yields surge across the long end of the curve as seen in the US 1 year yield (UST1Y) and the 10 year yields (TNX).

As we have been echoing the view of Austrian economists, the inflation which signifies as a political process, would have uneven effects on the economy.

As Professor von Mises wrote, (bold highlights mine)

``Changes in money prices never reach all commodities at the same time, and they do not affect the prices of the various goods to the same extent. Shifts in relationships between the demand for, and the quantity of, money for cash holdings generated by changes in the value of money from the money side do not appear simultaneously and uniformly throughout the entire economy. They must necessarily appear on the market at some definite point, affecting only one group in the economy at first, influencing only their judgments of value in the beginning and, as a result, only the prices of commodities these particular persons are demanding. Only gradually does the change in the purchasing power of the monetary unit make its way throughout the entire economy.

So yes the ‘definite point’ where the symptoms of inflation appear to emerge can be seen in emerging markets, commodities and commodity related industries, with the succession of growing inflation expectations permeating presently into the bond markets.

Remember, recently investors bought into US Treasury Inflation Protected Securities (TIPs) at negative interest rates[13] indicative of mounting expectations of the resurgence of inflation.

So pundits sarcastically questioning “inflation where” are misreading the gradualist dynamics of deepening and spreading inflation. They will instead show you employment data and output gap to argue for “no” inflation regardless of what the bond, stockmarket and commodity markets have been saying.

The other sins of omission by the mainstream has been to read present trends as tomorrow’s dynamics.

Now the tax free US municipal bond markets had likewise been slammed by the surging treasury yields (despite the Fed’s QE 2.0 aimed at keeping interest rates at artificially low levels). As long term US treasury yields have soared, so has these tax free yields.

Other reasons attributed[14] to the recent collapse in muni bond markets have been the expectations of more issuance from many revenue strained states and the potential abbreviation of issuance of Build American Bonds (BABs) given a gridlocked in the US House of Congress, which may have prompted for a deluge of offering in order beat the deadline.

In my view, all these other excuses appear to be secondary to the deepening trend of inflation expectations.

Of course rising interest rates would also put more pressure on the already strained recovery in the US housing markets which I believe has been the object of QE 2.0.

Yet earlier this year we have debunked claims by the government officials and the mainstream pundits supporting the notion of “exit strategies” which I labelled as Poker bluff[15]. (Yes we are once again validated)

And this means that further stress into the housing markets which would translate into balance sheet problems for the US banking system will be perceived by officialdom as requiring more QE’s. So you can expect the Federal Reserve to feed on more QEs as strains on the housing sector remain unresolved.

Another beneficiary of the QE has been the US Federal government. While government spending may be curtailed under the new US Congress, concerns by emerging markets over “currency wars” may lead to less appetite in financing of US debts. This implies that the US will likely resort to the age old ways of financing deficits-debase of the currency. In short, more QEs to come.

So what all these imply for the markets?

It’s still an inflation shindig ahead.

Of course considering the inflation process distorts the market mechanism, we should expect sharp swings in the upside as well as the downside, but with the upside trend becoming more dominant as US monetary authorities resort to more QEs which will be transmitted globally.

Nevertheless, the so-called “crack up boom” or the flight from paper money appears to be taking place worldwide as gold has been fervently rising against all currencies.

With markets expectations over inflation getting more widespread, stay long commodity or commodity related investments.

Lastly, avoid the confusion trap of misreading effects as causes.

---

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

[2] See QE 2.0: It’s All About The US Banking System, November 8, 2010

[3] See Iceland, the Next Zimbabwe? A “Riches To Rags” Tale?, October 14, 2008

[4] Wall Street Journal Editorial Target: Ireland, October 5, 2010

[5] Bloomberg.com Ireland Aid From EU Won’t Require Tax Increase, Sarkozy Says, November 21, 2010

[6] Mitchell, Daniel J. Don’t Blame Ireland’s Mess on Low Corporate Tax Rates, November 18, 2010

[7] The Economist, Saving the euro, November 18, 2010

[8] Mises, Ludwig von Monetary Stabilization And Cyclical Policy (1928) The Causes Of The Economic Crisis, p.18

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

[10] Rothbard, Murray N. Mystery of Banking, p. 34

[11] See Trick Or Treat: The Federal Reserve’s Expected QE Announcement, October 31, 2010

[12] Reuters.com Dollar hampered by tame U.S. inflation data November 17, 2010

[13] See Trick Or Treat: The Federal Reserve’s Expected QE Announcement, October 31, 2010

[14] Mousseau, John The Spike in Muni Yields - an Opportunity, cumber.com November 16, 2010

[15] See Poker Bluff: The Exit Strategy Theme For 2010, January 11, 2011

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.