Philippine Competitiveness: Cut Capital Income Taxes

Duanjie Chen and Jack Mintz writes, (special thanks to Cato's Chris Edwards for this)

Many industrial and emerging countries have reduced their corporate tax rates over the last decade or so. The largest rate cuts were in Austria, Bulgaria, Canada, the Czech Republic, Germany, Greece, Iceland, Ireland, Italy, Netherlands, Poland, Slovakia, Turkey, Egypt, Georgia, Kazakhstan, Lesotho, Mauritius, and Singapore. America’s largest trading partner, Canada, cut its statutory corporate rate from 43 percent to 29 percent, which helped to bring down its effective rate from 44 percent to 21 percent, according to our calculations. Substantial cuts were also achieved in Australia, Belgium, China, Denmark, Finland, Korea, Luxembourg, Mexico, New Zealand, Taiwan, and the United Kingdom. Taiwan cut its statutory rate from 25 percent to 17 percent in 2010, and now has an effective rate of just 10.9 percent.

A number of countries are initiating or phasing-in further corporate tax-rate cuts in coming years, including Australia, Canada, Ecuador, Israel, Japan, New Zealand, and the United Kingdom. In some countries, such as Israel and Japan, these are straight rate cuts. In other countries, such as New Zealand and the United Kingdom, rate cuts are being paired with base-broadening measures. When these reforms are in place, the average effective tax rate in 2014 will be 18.0 percent in the OECD and 17.4 percent among all 83 countries.

Philippine corporate tax rate is at 32%.

It’s positive to note how the world has been trying to stay competitive by lowering tax rates. This has been consistent with the growth explosion of global trade.

I hope the trend continues in spite of the recent crisis. And it would certainly be positive if the Philippines joins this global bandwagon.

It’s one of the many things that can be done to incentivize capital formation, build on research and attract foreign direct investments that could lead to more jobs.

As a side note, I honestly detest the rubric “jobs”, but this has been the mainstream vernacular. I’d rather say “economic opportunities” which is where jobs come from anyway.

And I hope that politicians will stop diverting people’s attention over to education policies. Education hasn’t been the answer, a big number of unemployed have been college graduates. Instead, the Philippines need to be competitive.

Back to taxes, in the Philippines, on top of corporate taxes there are capital gains and final withholding taxes on dividends. So you have a double whammy on capital income. Is it not a wonder why investments are low? And the hurdle rate is high?

While my ideal scenario would be to abolish all these taxes, this isn’t likely to be politically palatable, so I would suggest to start with the reduction of corporate tax rate or get taxed once by abolishing either capital gains or the final withholding tax on dividends.

Of course, there are other many factors that could lead to competitiveness, such as repealing obstructive regulations and avoiding distortions from arbitrary interventions, but this would be a topic for another post.

Overall, competitiveness boils down to economic freedom.

Knowledge Revolution: Globalizing Education

Technology enhanced globalization forces are likewise enveloping the education industry.

This from Ben Wildavsky at the Foreign Policy (bold emphasis mine)

But over the long term, exactly where countries sit in the university hierarchy will be less and less relevant, as Americans' understanding of who is "us" and who is "them" gradually changes. Already, a historically unprecedented level of student and faculty mobility has become a defining characteristic of global higher education. Cross-border scientific collaboration, as measured by the volume of publications by co-authors from different countries, has more than doubled in two decades. Countries like Singapore and Saudi Arabia are jump-starting a culture of academic excellence at their universities by forging partnerships with elite Western institutions such as Duke, MIT, Stanford, and Yale.

The notion of just how much a university really has to be connected to a particular location is being rethought, too. Western universities, from Texas A&M to the Sorbonne, have garnered much attention by creating, admittedly with mixed results, some 160 branch campuses in Asia and the Middle East, many launched in the last decade. New York University recently went one step further by opening a full-fledged liberal arts campus in Abu Dhabi, part of what NYU President John Sexton envisions as a "global network university." One day, as University of Warwick Vice Chancellor Nigel Thrift suggests, we may see outright mergers between institutions -- and perhaps ultimately the university equivalent of multinational corporations.

In this coming era of globalized education, there is little place for the Sputnik alarms of the Cold War, the Shanghai panic of today, and the inevitable sequels lurking on the horizon. The international education race worth winning is the one to develop the intellectual capacity the United States and everyone else needs to meet the formidable challenges of the 21st century -- and who gets there first won't matter as much as we once feared.

Read the rest here

Two comments

In terms of education, people should focus on the general or macro trend more than just looking and interpreting localized developments. With the introduction of the internet, what used to be local has increasingly become global.

I’d also say that there is more to expect than just the above. We’re likely to see an explosion of web based education that would bring down the cost of education, which subsequently should increase demand for it. The vertical flow of knowledge and communication process will enhance the Hayekian Knowledge revolution, education will be part of it.

Moreover, the web will possibly rearrange or restructure many aspects in the education-job process such as decentralization and more diversification (curriculum), more specialized jobs, reconfigure recruitment and hiring process, adaption of new certification or recognition standards and etc….

Example Of How The Welfare State Destroys The Individual

This is a graphic example of how the welfare state destroys the individual or the intermporal effects (short term gain, long term costs) of welfarism.

Gerry Garibaldi writes [hat tip: Dan Mitchell] (bold emphasis mine)

Connecticut is among the most generous of the states to out-of-wedlock mothers. Teenage girls like Nicole qualify for a vast array of welfare benefits from the state and federal governments: medical coverage when they become pregnant (called “Healthy Start”); later, medical insurance for the family (“Husky”); child care (“Care 4 Kids”); Section 8 housing subsidies; the Supplemental Nutrition Assistance Program; cash assistance. If you need to get to an appointment, state-sponsored dial-a-ride is available. If that appointment is college-related, no sweat: education grants for single mothers are available, too. Nicole didn’t have to worry about finishing the school year; the state sent a $35-an-hour tutor directly to her home halfway into her final trimester and for six weeks after the baby arrived.

In theory, this provision of services is humane and defensible, an essential safety net for the most vulnerable—children who have children. What it amounts to in practice is a monolithic public endorsement of single motherhood—one that has turned our urban high schools into puppy mills. The safety net has become a hammock.

And this applies to the Philippines as well.

For instance, in terms of demographics and education, public schools relieve the personal responsibility of the “poor” to have children, since the entrenched impression is that the state provides “free” education. So family planning becomes less of a priority because of such skewed incentives. I have personally spoken to many ‘poor’ people whose brains appear hardwired to the state’s ‘free schooling’.

And this seems backed by statistics which shows that the highest fertility rate is seen among the poorest in the society.

And this also departs from the layman’s opinions who mostly see that the “poor people have less to do except make babies”.

Of course, I am quite sure that there are many other laws which contribute to the distortion of people’s behaviour. The essence of which are that these laws (welfare programs) essentially abdicate personal responsibility and are substituted for government dependence, with the provision that individual freedom is compromised or curtailed in return for “safety nets” and votes.

Furthermore, people hardly know that there is no free lunch and such law distorting behaviour will eventually lead to an entitlement crisis. Yet politicians and their apologists continue to sell promises which they don't intend to fulfill.

Free Trade As Unilateral Policy

A popular objection to free trade is when a nation's trading partner is perceived as having to apply mercantilist policies, then trade relations is seen as uneven. Thus the popular oversimplified political justification is to go tit-for-tat via "fair or managed trade" which is euphemism for implied protectionism.

This we say is wrong. Even under such conditions Free Trade should be a unilateral policy. Why?

As Professor Don Boudreaux lucidly explains, (bold highlights mine)

By erecting tariffs that dampen competition, mercantilism encourages home producers to become unresponsive and uncreative. By issuing subsidies paid for with higher taxes, government debt, or distortionary monetary policies, mercantilism helps exporters only by inflicting more-sizable damages on the nation’s economy writ large. By turning the national government into a bazaar for the buying and selling of monopoly privileges, mercantilism deflects entrepreneurial energies away from building better mousetraps and into building politically advantageous political connections. And by raising prices in the home market, mercantilism makes consumers poorer as well as makes producers who rely upon imported inputs less efficient.

Well said.

[update: Earlier what I thought as saving as in a draft, I mistakenly published-thus the garbled commentary]

Cognitive Dissonance: Associating MENA Political Crisis Or Oil Prices With Weak EM Equities

Listening to media and to their “experts” or to mainstream chitchats will give you a false impression of what’s been happening.

Some would claim the Middle East has been causing market turmoil.

On the other hand, others will claim rising oil prices has hurt the EM equity markets.

Let’s put into perspective the reality of the current situation as seen by the above chart. (pls pay close heed)

By the way, here is the time line of the MENA’s (Middle East and North Africa) revolt against autocracy.

The best view for this interactive chart is to go the Wall Street Journal here

The important point is to show you WHEN all these began—January 9^th. (you may want to include Algeria’s food riot 3 days earlier)

So what do all these tell us?

-The fall of emerging market equity prices began last December as OIL prices in general continued to climb. In fact, the initial downturn of EM equities coincided with the WEAKENING of oil prices. But oil reversed and rallied.

-Emerging equity markets has been on a decline WAY BEFORE the domino like political crisis in the Middle East and Africa (marked by the blue vertical line).

-Oil prices have been on the rise WAY BEFORE the MENA Political crisis

-The US S&P 500 has been on a winning streak and only materially declined yesterday.

So has rising oil prices and or the Middle East crisis has caused the decline in EEM? The answer is clearly NO!

The correlationship of the Middle East crisis, oil and Emerging markets appear to be tenuous, i.e. correlations have been starkly weak.

Yet to argue that Middle East or High Oil Prices equals WEAK global equities is no more than cognitive dissonance or in my terminology popular “superstitions” or in Taleb’s lingo, “Negative Knowledge”.

People are simply trying to grope for an explanation and would take any events to confirm or to read by the market’s action.

Instead the role played by the Middle East Crisis to the current EM equity infirmities has been as an AGGRAVATING CIRCUMSTANCE to an already existing condition.

Those who took action because of the alleged Tunisia-Oil-Equity relations are plain LUCKY, for the simple reason that to argue base on this premise has been simply false.

I’d like to further add that to my observation NO EXPERT PREDICTED this MENA political crisis to happen or unfold as it has today.

While the MENA crisis has been long overdue, and has been predictable, as current political structures and system are simply unsustainable, what has been unforeseen is the timing and the scale of contagion.

Take for instance, Dr. Marc Faber, as previously pointed out, rightly predicted on the weakening of the emerging market stocks in the end of 2010. But he didn’t foresee this political crisis unfold (although his prediction of an Israel-US air strike on Iran since has not materialized. Generally speaking, he’s been spot on).

So current conditions have only coincided or buttressed Dr. Marc Faber’s general perspective of the weakening of emerging market equities.

Bottom line: the MENA crisis serves only an aggravating circumstance, not the cause of weakening EM equities.

I’d like to add that MENA political crisis is an upheaval against dictatorship regimes whom had been US puppets.

Yet violence is likely to remain local, as the incumbent autocracy will stubbornly resist relinquishing power which they see as an endowed entitlement.

Nevertheless, it is a positive outlook to see people start to be appreciative of freedom or liberty, even if many have misplaced ideas about what constitutes genuine liberty.

In watching a live interview broadcast in Aljazzera, two Middle East experts seem to acquiesce on the root of the unrest: economics—where the current system has only channelled wealth redistribution to the privileged political class at the cost of the public.

However, in contrast to common impression about Islam Dr. Mark LeVine says that he’s been amazed by how Islam authorities have been urging people to revolt peacefully in spite of government actions.

So while there may be some risks of a militant Islam theocracy taking over, he thinks that this may be overrated.

I agree, people are starting to learn about the difference between top-down and bottom up political structures. Thus, this is no reason to be bearish.

Note: People believe whatever they want to, some to the point of deluding themselves.

I am interested in positive knowledge or what works. This means reading through all the facts rather than selectively taking in facts that only conforms to a preconceived conclusion.

Video: Repairing The Nation’s Balance Sheets By Limiting Growth of Government Spending

Cato’s Dan Mitchell has a nice video showing examples of the actual experiences of different nations in restraining government spending which has resulted to a reduction in budget deficits and likewise augmented their respective economic growths.

Says Mr. Mitchell,

These success stories from Canada, Ireland, Slovakia, and New Zealand share one common characteristic. By freezing or sharply constraining the growth of government outlays, nations were able to rapidly shrinking the economic burden of government, as measured by comparing the size of the budget to overall economic output.

Maria Lourdes Aragon: Another Celebrity Sensation From Globalization?

Just like Charice Pempengco and Journey’s Arnold Pineda before her, Canadian based 10 year old Filipina Maria Lourdes Aragon looks likely the next celebrity sensation as a result of the web enhanced globalization evolution.

This from OMG.yahoo

Lady Gaga was overcome with emotion after a video of a 10-year-old fan performing a flawless rendition of "Born This Way" hit the internet and Access caught up with Maria Lourdes Aragon to bring you all the details on this budding web sensation! …

Thanks to the wonders of modern technology, the Grammy Award-winning singer saw Maria's video tribute less than 24 hours after the young fan had posted it. Gaga then re-Tweeted the video to her followers early Thursday, writing, "Can't stop crying watching this. This is why I make music. She is the future."

The reason I have been pressing on this is to demonstrate how the web has virtually cut the geographical distance and directly connected people or increased social interactions without the traditional layers that would have limited discovery and access to required information.

And this isn’t just in seen in celebrities. Goods and services and most importantly ideas have likewise fluxed in such a horizontal manner where knowledge, which used to be localized, has now been globalized. In terms of knowledge, the world is now everyone’s oyster.

And this is why, in contrast to the obstinate views of top-down analysts and the ideological neo-luddites, the unprecedented spread of the People Power phenomenon in the Middle East and Africa, have caught almost everyone by surprise.

The internet, like the printing press, has and will serve as the most critical instrument for the spread of the Hayekian knowledge revolution or Alvin Toffler’s Third wave, as epitomized by the newly discovered celebrities bypassing traditional talent recruitment channels or as seen in the People Power near synchronous phenomenon in MENA.

These are structural changes occurring at the fringes which people hardly notices (yes they see the changes but they hardly understand its mechanics and implications).

Like it or not, these changes will inevitably shape our future (commerce, lifestyle, culture and politics).

The Middle Of The Road Policy Of A Local Free Market Group

I was delighted to learn about the existence of a “free market” group in the country, especially that it seemed to have several prominent members.

But when I read further and saw that the same group acclaimed or endorsed the leadership of the local central bank for “steering” the economy and for producing “low inflation”—my enthusiasm faded. I got turned off and dismayed.

Suggesting that central banks can “steer” the economy essentially destroys the free market principle. Doing so suggests that socialism is superior to the free markets. If central banks can steer the economy, then why the heck bloviate about free markets at all?

There are many aspects to quibble with central bank operations, but the most important facet is the manipulation of interest rates.

Tinkering with interest rates represents a form of price control that causes price distortions which subsequently produces bubble cycles. In addition, maneuvering interest rates impels for indirect redistribution: from savers and creditors to debtors.

So essentially a central bank that dabbles with interest rates does this to promote the local banking cartel, (banks are financial intermediaries so lowering of interest rates attracts borrowers or clients for the industry) at the expense of the other industries and the consumers.

So what’s the essence of free market here? What you have instead is a banking cartel buttressed by state capitalism that essentially privatizes profits and socializes losses. (You will see this when a crisis surfaces)

As for low inflation, policies have intertemporal effects. Previous low interest regime was not due to central bank policies but due to many factors as globalization and technology aided productivity gains. Today’s rampaging food and energy prices are an offshoot to manipulated artificially suppressed interest rates, which promotes simulated unnatural demand, that will cause another global, if not, domestic crisis.

Thus, crediting central banks for current policies represents a naive and very narrow time oriented viewpoint.

It is of no wonder why free markets precepts in the Philippines have been denigrated.

They are founded on tenuous framework, which frequently gets obfuscated with the social democratic platforms.

In short, the free market principle is severely compromised and selectively and conveniently applied. This also means that the accommodation of the middle of the road policies such as the endorsement of central banking is a misguided way to promote free markets. It would seem like the devil who uses the Bible in order to mislead Christian devotees.

As the great Ludwig von Mises wrote,

The middle-of-the-road policy is not an economic system that can last. It is a method for the realization of socialism by installments.

Video: 10 Core Principles of Classical Liberalism

Dr. Nigel Ashford of Senior Program Officer at the Institute for Humane Studies (IHS) at George Mason University, explains the 10 core principles of the classical liberal & libertarian view of society and the proper role of government (via learnliberty.org):

1) Liberty as the primary political value
2) Individualism
3) Skepticism about power
4) Rule of Law
5) Civil Society
6) Spontaneous Order
7) Free Markets
8) Toleration
9) Peace
10) Limited Government

Update: Read in the following link Ralph Raico's magnificent article on "Austrian economics and Classical Liberalism"

Here is the intro:

Classical liberalism — which we shall call here simply liberalism — is based on the conception of civil society as, by and large, self-regulating when its members are free to act within very wide bounds of their individual rights. Among these the right to private property, including freedom of contract and free disposition of one's own labor, is given a very high priority. Historically, liberalism has manifested a hostility to state action, which, it insists, should be reduced to a minimum (Raico 1992, 1994).

Austrian economics is the name given to the school, or strand, of economic theory that began with Carl Menger (Kirzner 1987; Hayek 1968), and it has often been linked — both by adherents and opponents — to the liberal doctrine. The purpose of this paper is to examine some of the connections that exist, or have been held to exist, between Austrian economics and liberalism.

Quote of the Day: Rape is About Power

On the sexual assault and beating CBS reporter Lara Logan suffered during the Egyptian Riots, writes Amanda Taub of Wronging Rights…

“the idea that Lara Logan was "more at risk" of sexual assault because she was attractive is laughable. I'd be interested to know what fuckability threshold women should stay below in order to be safe from rape. Could Logan have just added some thick glasses? What if she had spinach in her teeth? How about if she gained 20 pounds - then would she be safe from the mob of 200 people who apparently decided to subject her to a prolonged beating and repeated sexual assaults because her delicate beauty stirred their romantic longings? Give me a break. Rape is about power, not how cute the victim is.”

Indeed.

People Adapt To Climates, Intervention Not Required

That’s the message of Matt Ridley and Indur Goklany, as they write against relying on climate models to argue for political interventionism. (bold emphasis mine)

Was this because we controlled the weather? No. It was because we adapted to it. So even if extreme downpours do increase, death rates as a result of them will continue to decline so long as we continue to get more people access to roads, telephones, houses and information. It’s like malaria: it retreated rapidly in the twentieth century despite rising temperatures, and it will retreat rapidly in the twenty-first century despite rising temperatures.

As the above figure shows, globally the average annual death toll from all extreme weather events is about 35,000. Compare this to the hundreds of thousands of excess winter deaths that occur annually. Perhaps we should try to control winter before we tackle climate change! Oddly enough, while we may not be able to control the weather, in the U.S., millions have done the next best thing—they have migrated from colder northeastern climes to the warmer southwestern states. This, according to a paper in MIT Press’s Review of Economics and Statistics by econometricians Deschênes and Moretti, is responsible for 8%–15% of the total gains in life expectancy in the U.S. population from 1970 to 2000.

Read more of their splendid article here

Emergent Signs Of People Power In China

The Web based People Power revolution appears to have diffused into China.

From AP/Yahoo,

Jittery Chinese authorities wary of any domestic dissent staged a show of force Sunday to squelch a mysterious online call for a "Jasmine Revolution," with only a handful of people joining protests apparently modeled on the pro-democracy demonstrations sweeping the Middle East.

Read the rest here

I’m not sure if any People Power movement would sell to the average Chinese today, if China is indeed experiencing an inflation based economic boom. The next crisis (bust) would look fertile for this.

However, Austrian economist Dr. Antony Mueller is right,

You can't stop a revolution once it's time has come. Repression does not work in China just as it did not work in the Middle East.

China’s top-down political system and her attempt to bottom-up the economic system looks rife for a head-on collision course.

And it’s just a matter of time.

Capitulating Deflationists: It’s John Mauldin’s Turn

Like Nouriel Roubini whom I pointed out earlier, we see another deflationist throwing in the proverbial ‘towel’.

From ‘Fisherian’ John Mauldin,

It takes at least 12 months (or longer) for monetary policy to work its way into the economy. The current small rise in inflation is not due to QE2. That will show up later. It appears to me the deflation war, at least for the time being, is won (the next recession will bring that worry back). But now, it is time for the adults at the FOMC to stand up and say stop the printing presses.

More and more celebrity gurus appear to be capitulating.

Usury Prohibition: Medieval Crony Capitalism

During medieval Europe, the Roman Catholic Church via Pope Benedict XIV promulgated usury prohibition or Vix Pervenit: On Usury and Other Dishonest Profit—where charging interest rates on loans were condemned as a sin.

Guess who profited from the prohibition throughout those years?

From Mark Koyama* (hat tip: Café Hayek) [bold emphasis mine]

The usury prohibition created monopoly rents which made it possible for the Church, the state and international merchant–bankers to benefit from the suppression of usury. It was this shared interest that made the usury prohibition a self enforcing institution. It cemented a partnership between the leading merchant–bankers, secular rulers, and the Church, and because it shaped the beliefs and expectations of medieval society as a whole, it generated behavior that reinforced and perpetuated its own existence.

So the church integrated the role of the ‘baptist and the bootlegger’ which essentially converted her moral positions into laws that generated economic windfall for them. Of course, this was not restricted to the church , who acted as a political patron, but had to be backed by a vested economic client seen in “international merchant bankers”-manifestations of patron client relations.

In short, the usury prohibition laws engendered crony capitalism-the medieval ‘church’ edition.

Then and today, the nature of economic rent hardly makes any difference. Only the participants has changed.

*Evading the ‘Taint of Usury’: The usury prohibition as a barrier to entry

MENA Revolutions Are Not People Power!

That’s according to some pundits who claim that unfolding events in the Middle East and Africa have not accounted for as People’s Power.

They allege that these upheavals are politically organized aimed at destabilizing the existing regime for the benefit of some scheming insiders.

How valid are their assertions?

From today’s New York Times, [bold highlights mine]

In Bahrain, the day started out with a lull, as both sides appeared to have been rattled by the violence of the past week, in which at least seven people were killed. The leaders of the major opposition parties called off the protests for Saturday, telling the public to stay home in an effort to lower the temperature.

But in what appeared to be a measure of who controls the movement now, the people ignored their ostensible leaders. Marchers set out from villages and the city center and by midday converged on Pearl Square.

The police met them with tear gas and rubber bullets. Young men collapsed in the road and others ran for cover, but people kept coming.

The police fired again.

Then the government blinked, perhaps sensing that the only way to calm a spiral of violence that claimed more lives with each passing day was to cede the square to the protesters.

I guess the main concept of people power revolution to these pundits is one of outright bloodshed modeled after the early 20th century (highlighted by centralized political philosophies).

From the above account, nevertheless, they seem totally out of touch with present reality.

So much for top-down thinking.

Resurgent Gold Equals Resurgent Emerging Market Bourses?

By the way, full employment was one of the main justifications for the Reichsbank's inflationist monetary policies. So nothing has changed. Central bankers still believe that monetary policy can lower the unemployment rate. Patrick Barron The Nightmare of 1923 and Its Cause

Don’t look now, but gold is surging right back! (I have to wait for a successful test of 1,430 before I could blurt out ‘I told you so’[1])

If gold is surging right back, then it is likely that global equity markets will follow gold’s path. And this includes the Philippine Phisix.

Figure 1: Stockcharts.com: Phisix-Gold

We’ve been saying that gold has been a reliable barometer of the equity markets.

As you can see in figure 1, gold (black line main window) seems highly correlated with the actions of the Phisix (candle chart main window), as well as with the movements of key emerging markets as the BRIC (Brazil, Russia, India and China via BKF) as well as ASEAN equities (via FSEAX).

However such correlation doesn’t imply causation. The link between gold and emerging markets can be traced to concerted monetary inflationism by global central banks most especially by the Fed’s QE programs.

And places which were said to suffer from the risks of deflation, as the US[2], UK[3] or Euro[4], have actually been experiencing the opposite—inflation has begun to seep in and has even been accelerating.

Earlier, mainstream had been telling us that inflation wouldn’t be a factor. How consistently ‘spectacularly’ wrong they have been[5].

Inflation hasn’t just been manifested in the asset markets but has also been spreading throughout the commodity space (see figure 2).

Figure 2: Price Shocks in Food and $100 Brent Crude (sources: Danske Bank[6] and tradingeconomics[7])

Some in mainstream media has pointed to the soaring food and energy prices[8] as representing effects of the unfolding political events in the Middle East and Africa.

However the causation has, in fact, been the opposite—the unintended effects of the cocktail mix of monetary, fiscal and administrative policies of global governments has caused a widespread boom (signs of crack up boom) in commodity prices that has partly added to the public’s political discontent which have led to the spate of unrest in many countries. While rising food and energy prices has functioned as trigger, there are deeper underlying problems from which has caused the public to vent their dissatisfaction.

Concerns of the risks of supply shocks represent as only ‘secondary’ effects or as a feedback mechanism from the main cause—government inflationist policies.

The False Allure Of Negative Knowledge

This reminds me of Nassim Nicolas Taleb’s “Subtractive Prophecy” knowledge theory where the knowledge of the consensus can be characterized as generally “negative”.

Mr. Taleb’s proposition holds that (from his forthcoming “must buy” book-AntiFragility[9]): [bold emphasis mine]

we know a lot more what is wrong than what is right, or, phrased according to the fragile/robust classification, negative knowledge (what is wrong, what does not work) is more robust to error than positive knowledge (what is right, what works). So knowledge grows by subtraction, a lot more than addition —given that what we know today might turn out to be wrong but what we know to be wrong cannot turn out to be right, at least not easily.

Mr. Taleb’s negative knowledge theory melds with my own when I alluded to why many celebrity gurus remain highly popular[10] despite being constantly ‘spectacularly’ wrong on their predictions—the public may not all be concerned with what really works but espouses on what may seem as the traditionally or conventionally accepted wisdom. Peer pressure, or the informational bandwagon, seems to be the single most influential factor in disseminating ‘negative knowledge’.

In addition, a secondary factor could one of projecting the acquisition of ‘positive knowledge’ built around empiricism modelled through scientism or as Professor Russ Roberts writes[11], “the use of the language and tools of science to reach a conclusion that is not merited”.

In short, scientism could signify a form of social signalling aimed at exhibiting one’s intellectual prowess through math based models.

Or simply said, the desire to build self esteem or social capital by projecting themselves as intellectuals. Thus, much of mainstream’s actions have hardly been about the quest to achieve positive knowledge, instead they are focused on sprucing up image or reputation for the intent of social interactions.

As prudent investors our main concern should not be about what is conventionally accepted, but about being right, and importantly, what works. That’s because return of investments depend on ‘positive knowledge’ rather than the false allure or the wishful thinking from a top-down engineered social utopianism.

Soaring Gold Investment ‘Reservation’ Demand

It is important to also point out that as we have been predicting[12], the demand composition for gold has been shifting from a typical commodity to one of money, and this has been represented by the substantial expansion of ‘investment’ demand (figure 3).

Figure 3: US Global Investors[13]: Changing Composition of Gold’s Demand

Investment demand for gold leapt 70% in 2011 with China as a big factor in the demand growth.

According to this Bloomberg report[14],

Investment demand in 2010 jumped 70 percent and consumption by the jewelery sector gained to a record, it said. Investment was 179.9 metric tons, surpassing Germany and the U.S., as buyers sought out gold bars and coins, according the London- based industry group. Demand from the jewelry sector was 400 tons, it said....

Chinese investors have shown great enthusiasm amid lack of other alternative investments,” Wang Lixin, China representative for the council, said today in Beijing. Wang said the forecast was a “conservative estimate.”

As for the supposed reasons for such growth in demand, the same Bloomberg article quotes a report from the World Gold Council...

“The main motivation behind this demand has been concern over domestic inflation pressure and poor performance of alternative investments, combined with expectations of further gold price gains,” the council said in a report released today.

Again the report only further confirms what we have repeatedly been talking about—a shift of gold’s demand dynamics to one of ‘reservation demand’. As I previously wrote[15],

“money’s “store of value” is increasingly being factored into gold prices (unit of account). Hence, relative to gold pricing, this implies that reservation dynamics or the reservation model (and not consumption model) determines gold valuations or that the exchange ratio or monetary valuations relative to fiat currency applies-- where valuations are determined by the expected changes in relationship between the relative quantity of, and the demand for, gold as money vis-a-vis paper currencies.”

So while jewellery still accounts for as the largest demand for gold, the gist would likely shift towards investments. Nevertheless, statistics can’t assimilate on what people actions represent.

Applied to gold, people can buy jewellery not only for aesthetics or for ornamental purposes, but also as investments.

Official Buying And Monetary Stablization

Figure 4: WGC: Official Purchases First Time in 21 Years

It hasn’t been only the man on streets and the financial markets whom has contributed to a surge in the demand for gold. Governments, perhaps, may have equally been afraid of their own shadows and have begun to stockpile.

In 2010, the official sector, writes the World Gold Council[16], became a net buyer of gold for the first time in 21 years. (see figure 4)

Two factors seem to bear this out, one emerging markets became significant net buyers and secondly, Europe, with significant gold holdings, has greatly reduced their traditional sales activities.

The end in the streak of official selling, should serve as a pellucid and practical example of the error prone predictive value of rigidly relying on statistics and or on the anchoring effect (linear expectations) of past performances. Numbers cannot and will not substitute for people’s actions (this includes the government, who are also comprised of individuals).

As to whether the shift in the attitudes of some governments as reflected by their gold buying patterns would parlay into prospective policies would be another matter.

Yet unless governments act in the way a gold standard is in place (which is to severely downsize on the welfare state and various forms of political economic interventionism), or that government democratizes the banking system to allow for mass competition (by dismantling the banking cartel structure), we are not likely to see governments stabilize the monetary system soon. Adjustments will likely happen at the brink of or during a crisis or what I would call the Mises Moment.

That’s because central banks can always surreptitiously work for the state’s political agenda camouflaged by the esoteric nature of the operations of central banking.

In the fitting and resonant words of Henry Ford,

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

So while the fiscal side of governments may be scrutinized by a vigilant public over the perceived profligacy of a government, central banks actions can and will likely substitute for such a loss.

In the US the Federal Reserve’s recent actions appear to reflect on this.

Fund manager Axel Merk glibly explains[17],

Many of the Fed’s policies since the onset of the financial crisis have not been traditional monetary policies: a central bank usually applies a very broad brush in managing economic growth by controlling levers such as interest rates or money supply. However, when the Fed, for example, bought mortgage-backed securities (MBS), it steered money to a specific sector of the economy. That’s fiscal, not monetary policy, traditionally reserved for elected policy makers in Congress. Just like the MBS program, many of the Fed’s policies continue to appear to be attempts at addressing the “shortcomings” of Congress.

In short, what the Congress cannot do, the central bank can.

So any talk of monetary stability should translate to the reining of the actions of central banks or to a more radical extent—abolishing the central banking platform.

Alternatively this also means that given the absence of popular discontent with central banking, the monetary skulduggery can and will likely go on, in spite of globalization or the internet.

Thus, like all price trends, gold will not go up on a straight line but will sporadically encounter severe headwinds, as seen in the previous months.

Nevertheless, the general trend for gold is that it will continually move higher, and most importantly, increasingly assimilate more of money’s characteristics in the face of the persistent central bank manipulation of the monetary system coupled with competitive debasement for political goals.

Even in the political front we seem to be seeing the evolution of gold as money gain significant ground.

I mentioned earlier the World Bank Chief Robert Zoellig[18] has called for the inclusion of gold in monetary reforms. This seems to be shared too by Kansas Federal Reserve President Thomas Hoenig[19] whereby Mr. Hoenig says gold standard is "legitimate”. And so with 10 US states which had “introduced bills in the past few years to allow state commerce to be conducted with gold and silver.[20]”

Moreover, there has been NO fear factor or fear premium in gold[21] as the vicissitudes (rise and fall) of gold prices has been along with risk assets.

To stubbornly insist on this is to put misplaced belief rather than acting on the basis of evidence required for any serious examination.

Having said so, with the momentum of gold seemingly regaining the upside path, we are likely to see a similar price inflation on equity assets as gold and equity prices have shown strong correlations.

This is most likely to be seen on many emerging market bourses that has started the year on the wrong side of the fence.

The Philippine Phisix included.

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[1] See Gold Fundamentals Remain Positive, January 31, 2011

[2] Wall Street Journal, Deja Deflation Fear, February 18, 2011

[3] bbc.co.uk UK inflation rate rises ‘hitting savers’, February 15, 2011

[4] Bloomberg.com Trichet Says ECB Doesn’t Exclude Possibility of Inflation Risks, February 19, 2011

[5] See Inflation Expectations: The Widening Chasm Between Households And Experts, February 12, 2011

[6] Danske Bank, Inflation so far not a risk to growth February 17, 2011

[7] Tradingeconomics.com, Brent Crude

[8] Bloomberg.com Brent Crude Trades Near Two-Year High on Mideast Supply Concern, February 17, 2010

[9] Taleb Nassim Nicolas Anti Fragility, How To Live In A World We Don’t Understand, Chapter 5, How (NOT) To Be A Prophet fooledbyrandomenss.com

[10] See Explaining Popularity In Terms of Predictions: Dr. Nouriel Roubini’s Case, February 17, 2011

[11] Roberts Russ Scientism, Cafe Hayek, January 10, 2011

[12] See Is Gold In A Bubble?, November 22, 2009

[13] US Global Investors, Investor Alert - February 18, 2011

[14] Bloomberg.com China 2011 Gold Investment May Jump 50%, Council Says, February 17, 2010

[15] See What Gold’s Latest Record Prices Mean, June 21, 2011

[16] World Gold Council, Gold Demand Trends Full year 2010

[17] Merk Axel, Politics of Inflation, safehaven.com February 16, 2011

[18] See World Bank Chief Robert Zoellig: Bring Gold Back As Part Of The New Monetary Order, November 9, 2010

[19] Reuters.com Fed's Hoenig says gold standard "legitimate", January 5, 2011

[20] TPMDC, At Least 10 States Have Introduced Gold Coins-As-Currency Bills, January 5, 2011

[21] See Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy, April 26, 2009

Phisix: What Market Internals Are Saying

A short comment on the market breadth of the Phisix.

The Phisix registered its first official weekly gain for 2011.

In 6 weeks through this year, the Phisix suffered 4 successive weekly losses and a nearly neutral week during the first trading week of the year.

So the bears have dominated.

I think that this will change quite soon.

Even if we set aside the argument of gold’s correlation and dissect on the market internals there are signs to suggest that the Phisix may have hit the bottom.

True, the rally last week had slim volume which usually demarcates a dead cat’s bounce.

However in furtherance of our earlier argument[1] where the extreme actions of retail participants represent as an opportunity to profit by doing the opposite, such signs seem to be reverberating.

One must realize that retail participants act mostly on the orientation of a very narrow timeframe, assess markets based on ticker based movements (linear thinking), and most importantly, are driven by emotions that are enveloped by mental biases and logical fallicies as rationalization.

That’s the reason why they are frequently referred to in Wall Street as the proverbial Pigs, who always get slaughtered by either the bulls or bears.

Figure 5 PSE: More Signs of Retail Selling

I have been saying that there have been signs of emergent market dissonance[2] which only proves that today’s falling Phisix signifies just a hiatus.

This includes the rising trend of local and regional currencies, divergences between developed economy and EM bourses, steepening of the yield curve, economic growth disparities, aside from net foreign trade.

As for the last aspect we can see some signs of diminished degree of selling (right window figure 5).

While it is true that advance decline spread has been deteriorating (left window), I think we have reached a point of climax where panicking retail participants appear to have capitulated during the previous week (not last week).

And with a significant number of Phisix composite issues now showing signs of stabilization, in terms of price action through the charts, my hunch is that today’s hiatus is bound for closure.

Go take advantage of this. Thank me later.

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[1] See Phisix: Panicking Retail Investors Equals Buying Opportunity, January 31, 2011

[2] See ASEAN Bourses Undergoing Interim Correction, February 14, 2011

Knowledge Revolution: Creators and Servers

The transition towards Toffler’s Third Wave or the Hayekian knowledge revolution isn’t just my outlook. It is likewise shared by some, who like me, sees things evolving from the fringes.

Author Andy Kessler predicts that people will play starkly different roles from that of the past, and where technology (and not the Yuan) will eat alot of jobs.

In promoting his latest book Eat People, Andy Kessler writes at the Wall Street Journal, (bold highlights mine, italics his) [my comments]

There are two types of workers in our economy: creators and servers.

Creators are the ones driving productivity—writing code, designing chips, creating drugs, running search engines. Servers, on the other hand, service these creators (and other servers) by building homes, providing food, offering legal advice, and working at the Department of Motor Vehicles. Many servers will be replaced by machines, by computers and by changes in how business operates. It's no coincidence that Google announced it plans to hire 6,000 workers in 2011.

But even the label "servers" is too vague. So I've broken down the service economy further, as a guide to figure out the next set of unproductive jobs that will disappear. (Don't blame me if your job is listed here; technology spares no one, not even writers.)

• Sloppers are those that move things—from one side of a store or factory to another. Amazon is displacing thousands of retail workers. DMV employees and so many other government workers move information from one side of a counter to another without adding any value. Such sloppers are easy to purge with clever code.

• Sponges are those who earned their jobs by passing a test meant to limit supply. According to this newspaper, 23% of U.S. workers now need a state license. The Series 7 exam is required for stock brokers. Cosmetologists, real estate brokers, doctors and lawyers all need government certification. All this does is legally bar others from doing the same job, so existing workers can charge more and sponge off the rest of us.

But eDiscovery is the hottest thing right now in corporate legal departments. The software scans documents and looks for important keywords and phrases, displacing lawyers and paralegals who charge hundreds of dollars per hour to read the often millions of litigation documents. Lawyers, understandably, hate eDiscovery. [Yes, this should diminish the brains for interventionists-Prudentinvestor]

Doctors are under fire as well, from computer imaging that looks inside of us and from Computer Aided Diagnosis, which looks for patterns in X-rays to identify breast cancer and other diseases more cheaply and effectively than radiologists do. Other than barbers, no sponges are safe. [According to Marketingcharts.com ‘8 in 10 Web Users Look for Online Health Data’-Prudentinvestor]

• Supersloppers mark up prices based on some marketing or branding gimmick, not true economic value. That Rolex Oyster Perpetual Submariner Two-Tone Date for $9,200 doesn't tell time as well as the free clock on my iPhone, but supersloppers will convince you to buy it. Markups don't generate wealth, except for those marking up. These products and services provide a huge price umbrella for something better to sell under.

• Slimers are those that work in finance and on Wall Street. They provide the grease that lubricates the gears of the economy. Financial firms provide access to capital, shielding companies from the volatility of the stock and bond and derivative markets. For that, they charge hefty fees. But electronic trading has cut into their profits, and corporations are negotiating lower fees for mergers and financings. Wall Street will always exist, but with many fewer workers.

• Thieves have a government mandate to make good money and a franchise that could disappear with the stroke of a pen. You know many of them: phone companies, cable operators and cellular companies are the obvious ones. But there are more annoying ones—asbestos testing and removal, plus all the regulatory inspectors who don't add value beyond making sure everyone pays them. Technologies like Skype have picked off phone companies by lowering international rates. And consumers are cutting expensive cable TV services in favor of Web-streamed video. [crony capitalism under pressure-prudentinvestor]

Like it or not, we are at the beginning of a decades-long trend. Beyond the demise of toll takers and stock traders, watch enrollment dwindle in law schools and medical schools. Watch the divergence in stock performance between companies that actually create and those that are in transition—just look at Apple, Netflix and Google over the last five years as compared to retailers and media.

Two things:

One, this makes investments in the technology sector very compelling, despite the applied inflationism by global central banks.

Proof of this has been the steady ‘top’ ranking of the technology sector in the distribution of the sectoral weightings in the US S&P 500 over the years. And the technology sector remains a solid outperformer today.

Two, political opposition would likely emanate not only from anti trade/mercantilists but likewise from neo-Luddites.

Frederic Bastiat in his magnificent classic That Which is Seen, and That Which is Not Seen rebutted a similar objection as seen through this: "A curse on machines! Every year, their increasing power devotes millions of workmen to pauperism, by depriving them of work, and therefore of wages and bread. A curse on machines!"