Why Crony Capitalism Pays: The Cojuangco-PCGG-San Miguel Case

If one must understand why the ‘politics of plunder’ remains and will constitute as an important driver of the Philippine political economy all you have to do is to turn to the front page of today’s major newspapers.

The message: Crony capitalism pays!

Key passage from the news.

From the Inquirer, (bold highlights mine)

In their ruling, the justices observed that the government failed to offer clear evidence to prove that Cojuangco amassed his wealth illegally.

For example, the court said the nullification of the writs of sequestration against Cojuangco was valid because in some instances, the PCGG had failed to determine prima facie basis for sequestration.

This is a patent manifestation of the failure of government. The bureaucracy is venal and, either deliberately or inherently, inefficient and inept. And the legal system has been possibly subjected to manipulation by the political class.

As in the acquittal of the alleged culprits of the Vizconde Massacre case, the same legal ploy seem to apply—the letter of the law (technicalities) dominate the spirit of the law (intent) in the adjudication of these cases.

Again I quote the Wikipedia,

The letter of the law versus the spirit of the law is an idiomatic antithesis. When one obeys the letter of the law but not the spirit, one is obeying the literal interpretation of the words (the "letter") of the law, but not the intent of those who wrote the law. Conversely, when one obeys the spirit of the law but not the letter, one is doing what the authors of the law intended, though not adhering to the literal wording.

"Law" originally referred to legislative statute, but in the idiom may refer to any kind of rule. Intentionally following the letter of the law but not the spirit may be accomplished through exploiting technicalities, loopholes, and ambiguous language. Following the letter of the law but not the spirit is also a tactic used by oppressive governments. (bold emphasis on this paragraph mine)

Two, more passage from the adjoining Inquirer article...(bold highlights mine)

In 1975, Marcos authorized the Philippine Coconut Authority, the agency tasked with developing the coconut industry and whose board included businessman Eduardo Cojuangco, to use the funds to buy a bank “for the benefit of the farmers.”

The bank was First United Bank, later renamed United Coconut Planters Bank (UCPB). Cojuangco became its president and chief executive officer.

With the PCA and UCPB in their control, Cojuangco and his associates were able to buy firms and mills placed under the Coconut Industry Investment Fund(CIIF), a group of 14 holding companies whose assets included 47 percent of San Miguel Corp. (SMC). These assets were held by UCPB, the CIIF administrator.

This is just an example of the nature of rent seeking activities that emanates from state ‘crony’ capitalism.

From Nobel laureate James Buchanan, (bold emphasis mine)

If the government is empowered to grant monopoly rights or tariff protection to one group, at the expense of the general public or to designated losers, then it follows that potential beneficiaries will compete for the prize, so to speak. And, since by construction, only one group can be rewarded, the resources invested by other groups is wasted. These resources could have been used to produce valued goods and services. Once this basic insight is incorporated into the mind-set of the observer, much of modern politics can only be interpreted as rent-seeking activity

Or as author Frank Chodorov explained (The Rise and Fall of Society p.84) (bold emphasis mine)

in every age political power has lent itself to purposes that are uneconomic and antisocial, that it has never hesitated to purchase support with confiscated property. For the ancients it may be said that they conducted the business in a forthright manner, unadorned with moralisms; the Caesars did not invoke an ideology to cover up the real objective of "bread and circuses/' Today, political preferment and the augmentation of political power are accomplished in the same way—with subsidies of all sorts, paid for by taxpayers—but the business is conducted under a panoply of rectitude. Our politicians do not purchase votes, they advocate "social" programs. It comes to the same thing.

In short, politicians use ‘social programs’ to supposedly deliver public goods (service) supposedly for society’s weal, but eventually end up ‘gaming’ the system for their own personal benefits. Yet people hardly see through such prestidigitation. Worst, local laws can't seem to identify and provide the necessary corrective mechanism (social justice) on this.

This is also working proof of the time consistency of political issues or the capriciousness of public sentiment.

Post EDSA I, the public had passionately been for the pursuit of regaining ill-gotten wealth from ex-President Marcos and his cronies, and that’s the reason for the recovery suit. Apparently time dampened this desire. Legal dilatory tactics thereafter paved way for the clearance of what looks very much like obtaining resources via (Franz Oppenheimer’s) political means.

And that’s why lobbying, backdoor dealing, anti-competitive laws, getting elected into political office (having a political career) and other political artifices in the name of public welfare will be a potent political force in the Philippine society—the political-legal system fundamentally incentivizes these socio-political imbalances.

As libertarian author Albert Jay Nock wrote,

every assumption of State power, whether by gift or seizure, leaves society with so much less power. There is never, nor can there be, any strengthening of State power without a corresponding and roughly equivalent depletion of social power.

Bottom line:

This only goes to show that it’s a fundamental illusion for anyone to believe that elections will change the nature of the government—by putting in place people with so-called ‘virtuousness’.

As the above example show, arbitrary laws and a highly vulnerable and manipulable legal system will undo ‘virtue’. In essence, the problem isn’t about virtue, the laws signify the problem.

The current system rewards those who can effectively game the system via political-legal means. Such reward is an incentive to do more. And that’s why as I keep saying, the more things change, the more they remain the same….

Why Nuclear Power Became Japan’s Energy Priority

Eric Margolis, at the lewrockwell.com, traces Japan’s prioritization of nuclear power as its main source of energy to ‘energy independence’ and the stigma of World War II.

Mr. Margolis writes,

In Japan’s samurai code, an act of supreme bravery occurs when a fighter confronts impossible odds, or knows his death in battle is inevitable, yet still decides to fight for honor’s sake. In samurai lore, this is know as "the nobility of failure."

Japanese history and, of course, World war II, are replete with examples of self-sacrifice and boundless valor in the face of certain defeat.

Brave and resolute as Japanese are, the question remains, why did Japan only 15 years or so after the nuclear horrors of Hiroshima and Nagasaki decide to build nuclear power plants they knew could be potentially dangerous?

The answer lies in World War II. Japan has no resources, other than rock, wood, water and its industrious people. All raw material to this island nation had to be imported by sea...

After the war, Japan’s leadership concluded their nation had to have energy independence, even if it meant from potentially dangerous nuclear power. Japan must never again be left helpless. Oil was too precious to use for power generation. It had to be stockpiled for strategic use and transportation.

So Japan took a calculated risk with nuclear power in spite of the ingrained fears of its people.

Read the rest here

Restricting Social Mobility Equals Poverty

Economist Bill Easterly commenting on the incidences of ghost towns in the US makes a point where restriction of social mobility leads to impoverishment.

I quote Bill Easterly, (bold highlights mine)

What if we had a law that everybody had to stay in their home state? What if North Dakotans had to stay in North Dakota despite the collapsing economy there? Then wages would collapse and we would have very poor North Dakotans. Happily no one would dream of such a stupid law. Instead we have middle class North Dakotans moving to other places voluntarily, where employers want to hire them voluntarily. And so (former) North Dakotans stay middle class.

For states…but not for countries. We treat migration usually as a non-option if Zambia has an economic decline, so Zambians stay there and get even poorer as the economy declines.

This is the great point made by Lant Pritchett in a classic article and in a CGD book. Why can’t we start treating Zambians like North Dakotans? If their home economy is declining, let them move to other places voluntarily, where employers want to hire them voluntarily. Why do we recognize the right to live wherever you want for North Dakotans and not for Zambians?

I guess the Philippines should be a worthy example.

Had many of our countrymen (kababayan) been prohibited from finding greener pastures around the globe, then we’d be worst off economically considering the relatively unfree political and economic environment that continues to beleaguer us.

That’s why anyone who claims that the exodus of people results to “brain drain” is no less than prescribing poverty for us.

Regional share of Philippine remittances (ADB)

Bottom line:

Freedom should encompass people’s mobility or to move around or migrate in accordance with their perceived interests.

We should allow people to come in, in as much as to go out. Where free markets is about voting with money on products and services, freedom of movement is about voting with the feet.

As Ludwig von Mises wrote, (bold highlights mine)

The principles of freedom, which have gradually been gaining ground everywhere since the eighteenth century, gave people freedom of movement. The growing security of law facilitates capital movements, improvement of transportation facilities, and the location of production away from the points of consumption. That coincides, not by chance, with a great revolution in the entire technique of production and with drawing the entire earth's surface into world trade, The world is gradually approaching a condition of free movement of persons and capital goods. A great migration movement sets in. Many millions left Europe in the nineteenth century to find new homes in the New World, and sometimes in the Old World also. No less important is the migration of the means of production: capital export. Capital and labor move from territories of less favorable conditions of production to territories of more favorable conditions of production.

Policy Divergences: Structural Versus Relations Power

Deutsche Bank’s Emerging Market analyst, Markus Jaeger, explains what I think is a relevant nuance between the role of foreign currency reserve, and one of a national currency (or one that is not)-e.g. US dollar versus Philippine peso or China's yuan.

Mr. Jaeger writes, (bold emphasis mine)

Put differently, the US pursues an economic policy – namely a lax fiscal policy and quantitative easing – it deems to be in its interest and however the EM respond to it is of little consequence to the US. This is a prime example of continued US “structural power”. Structural power is the power of a state to indirectly influence others by controlling the structures within which they must operate – in this instance, the international monetary system. This differs from “relational power”, or the ability of one state to influence another state's behaviour directly in pursuit of specific outcomes. This describes the situation quite accurately, for Washington is not seeking to influence other countries’ policies. It is simply pursuing policies it deems to be in its interest. Meanwhile, the EM have no way of influencing US macro-policy and are therefore left to deal with the QE-driven capital inflows and the implications of rising US government debt.

Some thoughts:

I agree with the essence of the differentiation.

But I think this observation underrates the role played by external influence on US policies. For instance, has Federal Reserve’s QE been aimed solely at ‘jumpstarting aggregate demand’? Or has it been designed to protect the banking system? Or has it been engineered to promote exports? Or possibly all of the above?

Point is: Policymakers can read external goals combined or as part of internal or national interests too. In short, instead of a black and white, gray areas (mixture of internal and external interests) can be assumed to determine policy objectives (The Fed’s loan to Libya’s Gaddafi in 2009 should be an example).

Two, this appears to underscore the Triffin dilemma dynamics—conflicts of interests that may arise from international and domestic objectives from a country whose currency is considered as foreign currency reserve. For example, the US may be applying policies for its own interest but because of its currency reserve status, her policies affect other economies and consequently their policies.

Three, although the implication is that the US has a lopsided influence on the world with its internally driven policies, I think this perspective lacks the perspective of the feedback mechanism as consequence from US policies. Think currency arbitrages (carry trades) or real economic effects of QE-e.g. greater demand for food or oil or other commodities.

Nevertheless, the best evidence that proves or disproves such proposition is if the next bust emanates from Emerging Markets (such as China), then here we should see whether US policies will remain impervious and or unaffected or will adjust accordingly along with economies affected by the EM recession or crisis.

ASEAN Integration: Regional Stock Exchange Website Launched

The path towards the deepening of integration of ASEAN markets and economies has moved one step forward.

ASEAN has launched a website to promote the integration of ASEAN stock markets.

Reports the yahoo,

The www.aseanexchanges.org website launch was celebrated on the sidelines of the 15th ASEAN Finance Ministers Meeting at the Laguna Resort and was attended by the chairman of the meeting -- Indonesian Finance Minister Agus Martowardojo -- and seven chief executive officers (CEOs) of the member stock exchanges.

The ASEAN Exchanges website features a product called "ASEAN Stars", which provides 210 blue chips stocks ranked by "investability" in terms of market capitalization and liquidity and made up of a selection of 30 stocks from each exchange.

"The main focus will be ASEAN's key assets -- the strength and diversity of ASEAN's companies, some of which are the largest and most dynamic companies in the world, including leaders in the banking, finance, telecommunications, commodities and automotive industries," Indonesia Stock Exchange president director Ito Warsito said at the event.

The 30 Indonesian stocks included in the ASEAN Stars come from various sectors, including Astra International (ASII), Adaro Energy (ADRO) Indofood Sukses Makmur (INDF) and state-owned firms such as Bank Mandiri (BMRI), Jasa Marga (JSMR) and Telekomunikasi Indonesia (TLKM).

Shares of firms from other countries promoted through the ASEAN Stars include Malaysia's CIMB Group and Petronas, as well as Singapore's SingTel and Wilmar International.

"Each of these 30 stocks will represent the favor of a particular exchange. Review will be done on a six-month basis in terms of liquidity, size and market capitalization," Gan said, adding that Thomson Reuters, which has thousands of terminals worldwide, would provide market data for the website.

ASEAN had a combined market capitalization of about $1.8 trillion as of January 2011, the eighth highest in the world, with total listed firms numbering over 3,000 companies and a market of more than 538 million people.

This how the nascent website looks...

If the goal is to balance trade and investment flows by reducing dependence on the US—this incorporates the vendor cycling programs of buying US sovereign securities and the implied importation of US monetary policies—then the development of ASEAN financial markets have much more much much room for progress.

The share of some of the major ASEAN members in % to the world stock market capitalization [chart from safehaven.com] reveals of the lack of depth, sophistication and the penetration levels by the local populace in the domestic equity markets which has resulted to the inadequate channeling of savings to investments.

This can also be seen from the region’s share of global market capitalization (2007 chart from Leaps) where ASEAN’s role remain insignificant.

Yet ASEAN has huge foreign exchange reserves which it can use for its development.

(chart from Donghyun Park and Gemma Esther B. Estrada Asian Development Bank Foreign exchange reserve accumulation in the ASEAN-4: challenges, opportunities, and policy options)

Bottom line: This represents more indications that ASEAN (and Asia) have increasingly been adhering to free trade principles which should translate to more progress down the road.

China' Potemkin Cities and Malls

Here are two videos showing China's obsession towards Keynesian GDP spending which has resulted, so far, to 64 million vacant apartments from China's building of 10 new cities every year. (pointer to Israel Curtis, Mises Blog)

This obsession towards achieving statistical GDP from central planning reminds me of two John Maynard Keynes quotes,

The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi boom.

If the Treasury were to fill old bottles with bank-notes, bury them at suitable depths in disused coal-mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of repercussions, the real income of the community, and its capital wealth, would probably become a good deal greater than it actually is.

The obvious result has been an ongoing quasi-boom (as Keynes has predicted) but which ultimately will be faced with the restrains from natural the law of economics which equates to a prospective bust (from the Austrian perspective).

The desire to uphold the Keynesian unemployment goals will backfire and result to China's version of today's MENA political crisis.

First video is from Dateline


Second video from AlJazeerah

To quote the great Ludwig von Mises,(bold highlights mine)

There are still teachers who tell their students that “an economy can lift itself by its own bootstraps” and that “we can spend our way into prosperity.” But the Keynesian miracle fails to materialize; the stones do not turn into bread. The panegyrics of the learned authors who cooperated in the production of the present volume merely confirm the editor’s introductory statement that “Keynes could awaken in his disciples an almost religious fervor for his economics, which could be affectively harnessed for the dissemination of the new economics.” And Professor Harris goes on to say, “Keynes indeed had the Revelation.”

There is no use in arguing with people who are driven by “an almost religious fervor” and believe that their master “had the Revelation.” It is one of the tasks of economics to analyze carefully each of the inflationist plans, those of Keynes and Gesell no less than those of their innumerable predecessors from John Law down to Major Douglas. Yet, no one should expect that any logical argument or any experience could ever shake the almost religious fervor of those who believe in salvation through spending and credit expansion.

Moral Grandstanding: The Dumbing Down of TV Viewers

I hardly watch TV (except occasionally for cable movies and international financial sites) and hardly read local newspapers, unless some events warrant for this.

Having to see some online discussions over an alleged impropriety by a local TV host, I was prompted to read today’s headlines.

To my horror, here is a primetime display of sanctimonious virtuousness!

A renowned Filipina international media artist along with a Solon lectured of the “dumbing down of the viewers”.

From the Inquirer,

“The debate is no longer whether it was child abuse or not,” Wilson said, referring to the widely criticized episode of Revillame’s “Willing Willie” show on TV5 that had a 6-year-old boy gyrating like a macho dancer while breaking into tears for a P10,000 cash prize.

“The facts are plain to see. No one with a sense of respect for another human being can dispute that,” Wilson said.

“The discourse now is how we, as Filipinos, as artists involved in the same industry that created Willie Revillame and shows like his, could have allowed this to go on for as long as it has.”

Acclaimed locally and internationally, Wilson has dozens of productions to her name as actress, director and producer, most famously her lead performance alternating with Lea Salonga in the original West End production of “Miss Saigon” in the late 1980s and early 1990s.

Wow, see that phrase...“could have allowed this to go on”!

The controversial video can be seen here.

Having seen the above, I am quite sure that this doesn’t represent an isolated incident and that there have been many more of these. It’s just that in the past, these alleged immoral acts may have either been downplayed or ignored.

Here is a movie trailer where children dance the OTSO-OTSO—dance steps plastered with “sexual” undertones. The video can be seen here. But where have the moral censures been then?

What’s my point?

The short of it is that all these reek of political miasma.

First, this looks like more of selective condemnation of what looks like a media norm. Many local songs and dance steps have sexual connotations. And they have been performed in various TV programs or movies by children (as the above).

Two, while one may argue that the controversial incident and the trailer are different, which is technically true, this should even expose what seems as even more duplicitous application morality...Trailers are qua advertisement, i.e. meant to promote or sell to the public goods or services (in this case the movie). In short, one could interpret selling amoral behaviour through comedy cum dance scenes to the public. Selling and providing service are two different functions.

So other media programs have the moral license to do this, while others don’t? Who determines which is moral and which isn’t, the Philippine government, the Solon or Ms. Wilson?

Three, this smacks of the extended legal battle between the TV host Willie Revillame and his former employer the ABS-CBN but this time coursed through the public arena, perhaps involving third parties, predicated on moral issues.

Fourth, dumbing down of audiences isn’t just the work of TV programs but of politicians and their accessories in media, as well as, the political cronies who benefit from the current and previous political economic climate.

Dumbing down translates to more political control, more votes and the political appeasement of the underprivileged masses.

History shows that ancient Roman emperors provided free entertainment via gladiator combats and chariot racing and even gave away free bread as a “good way to keep the people of Ancient Rome happy and content with the way the city was being governed.” Moreover Roman emperors used this as a strategy to “keep happy the many unemployed people in Rome.”

See, dumbing down represents an effective political strategy!

Fifth, we go back to Ms. Wilson’s statements.

Again from the Inquirer

Even news reports on TV, she noted, are now “horrifyingly biased and sensationalist,” while noontime variety shows “exploit women and insult our intelligence” and talk shows have become “intrusive, subjective and tasteless.”

When a wife of a politician and two former politicians perform the role as news anchors, who frames the public (through polls) that the only two policy recourse to high (food and oil prices) inflation is either higher minimum wages or price controls—then in this case, I would agree (hands down) with Ms. Wilson, that this represents as “horrifyingly biased and sensationalist”-dumbing down of the audience.

But in contrast to her I wouldn’t even dare imply to impose political control using my sense of morality, or lecture them for their flawed brand of economics, or castigate the gullible audience or voters for buying into them.

That’s because I understand that these grandstanding political demagogues are mostly guided or incentivized by political ambitions (public choice) and the desire to generate self esteem (social signaling) rather than doing genuine social service (which is the work of entrepreneurs).

I would rather say that competition to provide information and knowledge should eventually help determine the truth and expose on the falsehood and pretentiousness from such media based demagoguery.

I would suggest that if Ms. Wilson so indeed desires to help, she ought to put money where her mouth is. And since she is a show producer, she could provide the necessary competition against these inferior, degenerate and manipulative shows rather than just pontificate.

The Filipino consumers, despite their dumbing down, will either eventually see the merits of her quixotic actions or punish her with financial losses.

Ms. Wilson’s comments represents a sweeping indictment not only of the industry but as well as the millions of patrons of the “horrifyingly biased and sensationalist”, “exploit women and insult our intelligence” and “intrusive, subjective and tasteless” shows. She had been unabashed to even say that these shows “insult our intelligence” which seems self-explanatory. (my household help watches some of these shows, so when I have lunch I happen to take a glimpse of these programs, especially the part where girls in skimpy outfits do their renditions--thus, I am partly guilty of Ms. Wilson's accusations)

So whether you agree with her or not, one thing is for sure, she grandstands on her ethical virtues as somewhat superior to the masses (yeah this includes me).

Finally, political grandstanding could be construed as a normal action for politicians.

So when we read from the same article where a Solon proposed that “top ad spenders should sponsor more quiz shows rather than song-and-dance programs that lure in millions of viewers with hefty cash prizes”, I would suggest that this Solon should put up her own private advertisement agency and try to see whether her idealism will be rewarded financially.

Otherwise forcing firms to adapt on what they see as moral, in contrast to opinion of the consumers, is similar to forcing them to close and tantamount to penalizing the economy just to impose their sense of idealism.

In short, restricting people to avail of the option to choose is a form of “slavery”.

The above events are best encapsulated by this poignant and pertinent quote from Michael Bakunin (1867) Power Corrupts The Best (bold highlights mine)

“Nothing is more dangerous for man's private morality than the habit of command. The best man, the most intelligent, disinterested, generous, pure, will infallibly and always be spoiled at this trade. Two sentiments inherent in power never fail to produce this demoralisation; they are: contempt for the masses and the overestimation of one's own merits.”

Rampaging Global Equity And Commodity Markets Are Symptoms Of Rampant Inflationism!

Credit expansion not only brings about an inextricable tendency for commodity prices and wage rates to rise it also affects the market rate of interest. As it represents an additional quantity of money offered for loans, it generates a tendency for interest rates to drop below the height they would have reached on a loan market not manipulated by credit expansion. It owes its popularity with quacks and cranks not only to the inflationary rise in prices and wage rates which it engenders, but no less to its short-run effect of lowering interest rates. It is today the main tool of policies aiming at cheap or easy money. Ludwig von Mises

Global stock markets appear to be on a juggernaut!

Figure 1: Stockcharts.com: Where Is the Oil-Stockmarket Negative Correlation?

Figure 1 tells us that despite soaring oil prices, last traded at $113 per barrel as of Friday (WTIC), global equity markets have been exploding higher in near simultaneous fashion as demarcated by the blue horizontal line.

The Global Dow (GDOW)[1] an index created by Dow Jones Company that incorporates the world’s 150 largest corporations, the Emerging Markets (EEM) Index and the Dow Jones Asia Ex-Japan Index (P2DOW) have, like synchronized dancing, appear as acting in near unison.

We have been told earlier that rising oil prices extrapolated to falling stock markets (this happened during March—see red circles), now where is this supposed popular causal linkages peddled by mainstream media and contemporary establishment analysts-experts[2]?

Yet, the current actions in the global financial and commodity markets hardly represent evidence of economic growth or corporate fundamentals.

And any serious analyst will realize that nations have different socio-political and economic structures. And such distinction is even more amplified or pronounced by the uniqueness of the operating and financial structures of each corporation. So what then justifies such harmonized activities?

As we also pointed out last week[3], major ASEAN contemporaries along with the Phisix have shown similar ‘coordinated’ movements.

In addition, the massive broad based turnaround in major emerging markets bourses appear to vindicate my repeated assertions that the weakness experienced during the past five months had been temporary and signified only profit taking[4].

Yet if we are to interpret the price actions of local events as one of being an isolated circumstance, or seeing the Philippine Phisix as signify ‘superlative performance’ then this would account for a severe misjudgment.

Doing so means falling into the cognitive bias trap of focusing effect[5] —where one puts into emphasis select aspect/s or event/s at the expense of seeing the rest.

Ramifications of Rampant Inflationism

So how does one account for these concerted price increases? Or, what’s been driving all these?

We have been saying that there are two major factors affecting these trends:

One, artificially low interest rates that have driven an inflationary boom in credit.

That’s because simultaneous and general price increases would not be a reality if they have not been supplied by “money from thin air”.

As Austrian economist Fritz Machlup wrote[6],

If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, a boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and amortization current amortization allowances is fairly inelastic, and optimism about the development of security prices, inelastic would promptly lead to a "tightening" on the credit market, and the cessation of speculation "for the rise." There would thus be no chains of speculative transactions and the limited amount of credit available would pass into production without delay.

Some good anecdotal examples:

Credit booms are being manifested in several segments of the finance sector across the world, such as the US Collateralized Mortage Obligations (CMO)

From Bloomberg[7], (bold emphasis mine)

The biggest year since 2003 for the packaging of U.S. government-backed mortgage bonds into new securities has extended into 2011, bolstered by banks seeking investments protecting against rising interest rates.

Issuance of so-called agency collateralized mortgage obligations, or CMOs, reached $99 billion last quarter, following $451 billion in 2010, according to data compiled by Bloomberg. The creation of non-agency bonds, which force investors to assume homeowner-default risks, is down more than 90 percent from a peak with parts of the market still frozen.

Facing limited loan demand and flush with deposits on which they pay close to zero percent, banks are turning to agency CMOs to earn more than Treasuries and gird for when the Federal Reserve boosts funding rates. Insurers, hedge funds and mutual- fund managers such as Los Angeles-based DoubleLine Capital LP are seeking different pieces of CMOs, which slice up mortgage debt, creating new bonds that pay off faster or turn fixed-rate notes into floating rates.

Or in Europe, the leveraged buyout markets...

Again from the Bloomberg[8], (bold emphasis mine)

ING Groep NV, the top arranger of buyout loans in Europe this year, sees a “liquidity bubble” building as lenders forego protection and accept lower fees.

“There is a liquidity bubble in the European leveraged loan market at the moment, driven by institutional fund liquidity,” said Gerrit Stoelinga, global head of structured acquisition finance at Amsterdam-based ING, which toppled Lloyds Banking Group Plc as no. 1 loan arranger to private-equity firms, underwriting 10 percent of deals in the first quarter.

Investors more than doubled loans to finance private-equity led takeovers in the first quarter to $6.7 billion as the economy shows signs of strengthening, reducing risk that the neediest borrowers will default. Inflows to funds dedicated to loans and floating-rate debt jumped to $8.5 billion this year, compared with $1.7 billion in the same period in 2010, data from Cambridge, Massachusetts-based EPFR Global show.

Second, it’s all about the dogmatic belief espoused by the mainstream and the bureaucracy where printing of money or the policy of inflationism is seen as an elixir to address social problems.

Figure 2: Swelling Central Bank Balance Sheets and Commodity Prices (Danske Bank[9] and Minyanville[10])

The balance sheets of developed economies central banks have massively been expanding (except the ECB, see figure 2 left window), as respective governments undertake domestic policies of money printing or Quantitative Easing (QE) programs, even as the global recession has passed.

Commodity prices have, thus, risen in conjunction with central banks QE programs (right window).

What this implies is that both inflationary credit and the ramifications of various QE programs appear to be mainly responsible for the rise in most commodity markets. This is a phenomenon known as reservation demand, which as I wrote in the past[11]

“commodities are not just meant to be consumed (real fundamentals) but also meant to be stored (reservation demand) if the public sees the need for a monetary safehaven.”

As the great Ludwig von Mises explained[12], (bold highlights mine)

with the progress of inflation more and more people become aware of the fall in purchasing power. For those not personally engaged in business and not familiar with the conditions of the stock market, the main vehicle of saving is the accumulation of savings deposits, the purchase of bonds and life insurance. All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to be indicated. The ultimate reaction of the public, the “flight into real values,” is a desperate attempt to salvage some debris from the ruinous breakdown. It is, viewed from the angle of capital preservation, not a remedy, but merely a poor emergency measure. It can, at best, rescue a fraction of the saver’s funds.

Ironically as I earlier pointed out, even the Bank of Japan (BoJ) has recognized the causal effects of money printing and high food prices[13], but they continue to ignore their own warnings by adding more to their own “lending” program using the recent disaster as a pretext [14]!

Yet despite increases of policy rates by some developed economy central banks as the European Central Bank (ECB) and the Denmark’s Nationalbank[15], not only as interest rates remain suppressed but the ECB pledged to continue with its large scale liquidity program[16].

To add, policy divergences will likely induce more incidences of leveraged carry trade or currency arbitrages.

Record Gold Prices and Poker Bluffing Exit Strategies

And it is of no doubt why gold hit new record nominal highs priced in US dollars last week (now above $1,470 per oz.)

Figure 3: Surging Gold prices versus G-5 currencies (gold.org)

It wouldn’t be fair to say that gold has been going ballistic only against the US dollar because gold has been in near record or in record territory against almost all major developed and emerging market currencies.

Gold, as shown in Figure 3, has been drifting near nominal record highs against G-5 currencies[17] (US dollar, euro, Yen, sterling and Canadian dollar).

Figure 4: Gold Underrepresented as an Asset Class (US Global Investors[18])

Gold, despite record nominal prices, appears to be vastly underrepresented as a financial asset class compared to other assets held by global finance, banking, investment, insurance and pension companies.

Should the scale of inflationism persists, which I think central bankers will[19], considering the plight of the foundering “too big to fail” sectors or nations e.g. in the US the real estate markets (see figure 5), in Europe the PIIGS, this will likely attract more of mainstream agnostics (see figure 4) to gold and commodity as an investment class overtime.

This only implies of the immense upside potential of gold prices especially when mainstream finance and investment corporations decide to load up on it or capitulate.

Figure 5: Tenuous Position of US Real Estate, Bank Index and Mortgage Finance

This brings us back anew to “Exit” strategies that is said to upend gold’s potentials.

The Fed can talk about exit strategies for all they want, but they are likely to signify another poker bluff similar to 2010[20].

The Fed’s inflationist programs which had been mostly directed at the US banking system seem to stand on tenuous grounds despite all the trillions of dollars in rescue efforts.

US real estate appears to stagger again[21] (left window), while the S & P Bank Index (BIX) and the Dow Jones Mortgage Finance (DJUSMF) appears to have been left out of the bullish mode seen in the S&P 500 Financials (SPF) and the Dow Jones US Consumer Finance (DJUSSF), possibly reflecting on the renewed weakness of the US real estate.

In addition, there is also the problem of financing the enormous US budget deficits. And there is also the excess banking reserves dilemma.

So in my view, the US Federal Reserve seems faced with the proverbial devil and the deep blue sea. Other major economies are also faced with their predicaments.

Going back to the stock markets, as Austrian economist Fritz Machlup explained[22],

if all of these indices show an upward (or downward) movement, the presumption is very strong that inflation (or deflation) in the sense defined is taking place, even if the level of commodity prices does not show the least upward (or downward) tendency.

Well some commodity prices have paralleled the actions in the stock markets if not more.

Bottom line: Rampaging stock markets and commodity markets are symptomatic of rampant inflationism.

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[1] Wikipedia.org The Global Dow

[2] See “I Told You So!” Moment: Being Right In Gold and Disproving False Causation, March 6, 2011

[3] See Phisix and ASEAN Equities: The Tide Has Turned To Favor The Bulls! April 3, 2011

[4] See I Told You So Moment: Emerging Markets Mounts A Broad Based Comeback! April, 8, 2011

[5] ChangingMinds.org, Focusing Effect

[6] Machlup, Fritz The Stock Market, Credit And Capital Formation Mises.org p.92

[7] Dailybusiness.com CMO sales at 7-year high as banks gird for Fed: credit markets, Bloomberg, April 5, 2011

[8] Bloomberg.com ING Sees ‘Liquidity Bubble’ in European LBO Financing Market, April 5, 2011

[9] Danske Bank Flash Comment Japan: BoJ upgrades its view on economy, April 7, 2011

[10] Minyanville.com When Will Fed-Created Melt-Up Turn Into a Meltdown?, April 8, 2011

[11] See Oil Markets: Inflation is Dead, Long Live Inflation November 4, 2010

[12] Mises, Ludwig von The Effects of Changes in the Money Relation Upon Originary Interest, Human Action, Chapter 20 Section 5 Mises.org

[13] See Correlation Isn't Causation: Food Prices and Global Riots, April 2, 2011

[14] Bloomberg, BOJ Offers Earthquake-Aid Loans, Downgrades Economic Assessment, April 7, 2011

[15] Reuters.com Danish c.bank raises lending rate by 25 bps, April 7, 2011

[16] See ECB Raises Rates, Global Monetary Policy Divergences Magnifies, April 8, 2011

[17] Gold.org, Daily gold price since 1998

[18] Holmes, Frank The Bedrock of the Gold Bull Rally, US Global Investors

[19] See The US Dollar’s Dependence On Quantitative Easing, March 20, 2011

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

[21] Economist.com Weather warning America's housing market is in the doldrums, March 30, 2011

[22] Machlup, Fritz Op.cit p.299

Phisix-Philippine Peso Back In Rhythm

Upon examining the curves developed by institutes using the Harvard method, it becomes apparent that the movement of the money market curve (C Curve) in relation to the stock market curve (A Curve) and the commodity market curve (B Curve) corresponds exactly to what the Circulation Credit Theory asserts. The fact that the movements of A Curve generally anticipate those of B Curve is explained by the greater sensitivity of stock, as opposed to commodity, speculation. The stock market reacts more promptly than does the commodity market. It sees more and it sees farther. It is quicker to draw coming events (in this case, the changes in the interest rate) into the sphere of its conjectures. Ludwig von Mises

The Philippine Phisix made another substantial rally this week (+2.7%) to finally move up to the positive column.

Rotation, Improving Market Breadth and Bull Market Rules

And as we have been saying we see lots of ongoing rotational dynamics in place.

Figure 6: PSE Weekly Performance

Where last week we saw the telecom sectors take the center stage, this week it had been a story of the Property, Industrial and the Mining sector which has elevated the gains of the Phisix.

Last week’s front runner, the service sector led by the telecoms, had a lackluster but still posted a positive performance. The drab performance of this sector could have signified a natural reprieve following the other week’s sizzling performance.

This week’s broad market gains basically lifted most of the sectoral performance which left only the finance and service sector in the red on a year to date basis.

If the bullish momentum should continue over the medium term, which I expect it would, then I expect to see these laggard sectors to do some catching up which should equally lend a boost to the Phisix.

In addition, we see material progress in the market breadth.

Aside from a huge jump in net foreign buying which mostly came from block sales last April 5, we see broader gains through more trades and number of issues traded. Importantly the advance-decline spread has been tilted in favor of the bulls (see figure 7).

Figure 7: Advance-Decline Spread Shows Bullish Breadth

Thus, the rotational dynamics plus several progress in the market internal activities appear to highlight the Philippine Stock Exchange’s current intrinsic bullishness.

Of course mechanical chartists may argue that given the overbought conditions we may see some profit taking. That’s possible. Resolving short term movements, for me, is a matter of luck (noise) than of (signals) skills.

Nevertheless, major trends of bull and bear markets have some shared characteristics which could be translated into one of the many guideposts for market participants.

As prominent US chartist Carl Swelin notes[1], (bold emphasis mine) writes,

In a bull market oversold conditions are seen as a buying opportunity and will usually result in a rally to relieve the condition. When a bull market becomes overbought, it is not usually cause for concern, because corrections from these conditions are often small, and sometimes the market will continue to rally, while the overbought conditions are relieved internally.

In other words, even if the Phisix does correct, it is likely to be short, and it is likely to see internal rotations that would relieve issue specific conditions (not all issues will go down).

The Phisix-Peso Symmetry

Of course the rising Phisix has also been in conjunction with the firming Peso whose dissonance appears to have been finally resolved.

As I earlier wrote[2],

I can see a paradox—a strong Peso and equity outflows—or a meaningful divergence...

These variables appear to imply that the negative foreign trade in the PSE had NOT been repatriated abroad, but possibly rotated into other local assets.

And this perhaps explains the continued strenght of the Peso despite a weak equity market environment. Again, a divergence that is likely to be resolved soon

Figure 8: Phisix-Peso Back in Rhythm

Given the realities of the Philippine financial markets, the Phisix can’t go on a full downswing cycle on a firming Peso. It’s either a bear market that goes with a falling peso or the weakness in the Phisix represents an anomaly relative to the Peso. And that’s the essence of the recent paradox.

Obviously, the asymmetry appears as being resolved in the way have seen it.

Figure 9: Yardeni.com[3]: Non Gold Philippine Foreign International Reserves Surge Anew

Nevertheless with the country’s foreign international reserves on a new milestone high, and with the BSP’s reluctance to see the Philippine Peso appreciate meaningfully for political reasons, this only means lots of liquidity[4] will be sloshing throughout the domestic financial system.

This together with artificially suppressed interest rates should also imply that much these money will find their way into various Peso based assets such as those listed in the Philippine stock exchange, real estate or local bonds.

Of course, after financial markets, we get higher (CPI) inflation in the mainstream definition and subsequently public unrest.

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[1] Swenlin, Carl, Bull/Bear Market Rules Apply Decisiopoint.com

[2] See Are The Current External Event Risks Signals or Noise?, March 13, 2011

[3] Yardeni.com, (subscription required) Global Liquidity, April 7, 2011

[4] See Questions and Answers on Philippine Monetary and Fiscal Issues, April 8, 2011

Earth’s Possible Close Encounter With An Asteroid This November

Earth might have a close encounter with a huge asteroid this November, that’s according to Space.com [bold emphasis mine]

Mark your calendars for an impressive and upcoming flyby of an asteroid that’s one of the larger potentially perilous space rocks in the heavens – in terms of smacking the Earth in the future.

It’s the case of asteroid 2005 YU55, a round mini-world that is about 1,300 feet (400 meters) in diameter. In early November, this asteroid will approach Earth within a scant 0.85 lunar distances.

Due the object’s size and whisking by so close to Earth, an extensive campaign of radar, visual and infrared observations are being planned.

Asteroid 2005 YU55 was discovered by Spacewatch at the University of Arizona, Tucson’s Lunar and Planetary Laboratory on Dec. 28, 2005. En route and headed our way, the cosmic wanderer is another reminder about life here on our sitting duck of a planet

Read the rest here

This article hasn’t been meant to scare anyone, but as Space.com says our planet looks like a sitting duck.

And gloomy environmental stories about climate change seem to pale against the prospects of a wayward asteroid hitting us-the ultimate Black Swan.