Volatility of China’s Food Prices Largely Due to Policies

In China, rising food prices have been blamed on speculators. Now that select food prices have slumped, particularly vegetables, the culpability has been assigned to speculators anew.

From Business China,

Farmers across China are suffering from unmarketable vegetables since the arrival of spring, hurt by an increase in output following speculation last year’s surge in demand would continue in 2011.

Last week, the average price of 19 kinds of vegetables in 286 wholesale markets nationwide was RMB 2.66 per kilogram, down 11.4% from the previous week, according to data from the Ministry of Agriculture.

Many farmers blamed oversupply as the main reason for the poor market. Due to climate factors, leaf vegetables from northern and southern China came onto the market almost at the same time, making the supply much higher than last year.

Speculators also played a major role in the price collapse, as they dumped vegetables that they had been hoarding onto the market.

Since the markets have always been the villains then obviously the government, as hero, would come to the rescue.

From the same article,

Chinese government authorities have stepped in to help the farmers and deal with the vegetable oversupply.

Some supermarkets, schools and company canteens are on a buying spree in east China's Shandong province as the government urged them to help relieve farmers from a glut of vegetables.

Municipal authorities should take immediate action to "help farmers tackle difficulties in selling their produce and maintain a stable market," said a notice from Shandong's commerce department released on April 22.

The Ministry of Commerce (MOFCOM) and the Ministry of Agriculture have also issued a notice to ask local authorities to take immediate action to "help farmers tackle difficulties in selling their produce and maintain a stable market".

Of course, the article has not been that candid.

A better explanation from the World Bank’s quarterly report on China comes with the supply side perspective, (bold emphasis mine)

In addition to normalizing the overall macro policy stance it took some measures to boost food supply and reduce the cost of production and logistics, including releasing grain from China’s large reserves, increasing subsidies to farmers, exempting transport of vegetables from road toll, and boosting food imports. More recently, this was followed by limiting the increase in domestic fuel prices arising from higher oil prices and applying moral suasion on manufacturers of food and consumer products.

So a combination of price controls, import liberalization, targeted subsidies and tax reliefs has been applied.

In essence, massive interventions has been employed to control inflation, from which the effects could likely be temporary, and could further add to the imbalances from the previous actions of China’s government to blow bubbles.

Importantly, if inflation is a monetary phenomenon as Milton Friedman would have it, then the bust in the vegetable market in China could be a symptom of the prevailing monetary policies...

Again from the World Bank, (bold emphasis mine)

Since October 2010 the government has raised benchmark interest rates 4 times and RRRs 7 times. Most importantly, quantitative guidance on bank credit, traditionally the backbone of monetary policy tightening, began to be reinforced, especially in early 2011. As a result, M2 growth came down from 19.5% in the fourth quarter to 16.6% on average in the first quarter, close to the target for the end of 2011, with a similar slowdown in bank lending. In recent years, total bank credit extention has been significantly larger than headline data suggests as banks expanded the use of credit instruments such as designated loans, trust loans and corporate paper, financed in part by trust and wealth management products that are not counted as deposits and are not part of M2, in order to evade lending quotas, capital requirements and RRRs.

China’s equity markets, specifically the Shanghai index appears to have recoiled after hitting the resistance levels as earlier discussed.

This is the interim price action of the Shanghai Composite bellwether. (chart from Bloomberg)

In my view, the current retracement of the Shanghai index could also be reflecting on the current monetary tightening environment.

If there should be a broader weakening of consumer and financial market prices then this would possibly prompt Chinese authorities to unleash their main Keynesian weapon--inflation.

I’d posit that since the stage of China’s inflation cycle looks more advanced than the rest of the world, then the ongoing developments in China’s financial markets needs to be closely monitored.

Video: Fight of the Century: Keynes vs. Hayek Round Two

Below is the sequel to the marvelous 'Fear The Boom And Bust- Keynes versus Hayek Rap Video' produced by John Papola and Professor Russ Roberts.

The 'Fight of the Century: Keynes vs. Hayek Round Two' is themed on Keynes-Hayek debate over government spending (source: Cafe Hayek)

Price Controls Equals Russia’s Looming Gasoline Shortages

Basic laws of economics always prevail over ‘noble’ political edicts.

That’s how events are turning out in Russia.

From the Wall Street Journal, (bold highlights mine)

The world's biggest oil producer Russia is facing gasoline shortages in some parts of the country, as prices are kept artificially low, leading producers to cash in on higher fuel prices abroad.

Russian car-owners are seeing petrol stations halt operations across the country, following an order by Prime Minister Vladimir Putin in February to investigate steep increases in gasoline prices, which led producers to ship more fuel for exports.

Russia consumes about half of the 10 million barrels it produces a day domestically, but prices on oil products, including gasoline, are kept artificially low. The government's attempt to control gasoline prices is just one of several measures aimed at curbing inflation—a key political issue with elections less than a year away, as higher gasoline prices could hurt Mr. Putin's popularity.

Russia's antimonopoly agency has repeatedly accused the country's top oil producers such as OAO Rosneft, OAO Lukoil Holdings and TNK-BP Ltd. of increasing prices for diesel and jet fuel.

After gasoline prices rose at the end of last year and another 4% in January, Prime Minister Vladimir Putin in February warned the country's top oil executives against price fixing. Mr. Putin accused them of trying to "crudely exact maximum gains" and vowed more oversight of the fuel business, effectively capping prices. As a result, prices declined both in February and March, despite the continued surge in global crude prices.

"The domestic prices are being held artificially low due to pressure from regulatory authorities," TNK-BP's Chief Financial Officer Jonathan Muir said Wednesday.

As we earlier pointed out, the inflation cycle appears to be gradually playing out around the world.

The cycle goes: Government first engages in inflationism. Then government blames these (called as price gouging) on the ‘greed’ of speculators and market players. Finally the government imposes price controls. The effect: Price controls fuel more distortions (via shortages) which translates to more higher prices.

Governments essentially adapts the fallacy of “two wrongs make a right”, when denial only worsens the problem.

It’s vicious cycle practiced over 4 centuries that has always failed, yet political leaders everywhere never ever seem to learn. They are so predictable.

US Homeownership Shows The Bust Has Been Greater Than The Boom

Boom bust cycles are a net negative to a society.

The Wall Street Journal Blog narrates on the state of US Homeownership. (bold emphasis mine)

The release also showed that the housing bust has undone all of the gains in ownership rates that were much ballyhooed in the early and mid-2000s. The nation’s home ownership rate, at 66.4% in the first quarter, was down from 66.5% in the last three months of 2010 — the lowest level since 1998.

US homeownership fell more than the levels when the policy induced boom had been accelerated (meant to combat the dotcom bust during the advent of the new millennium). Thus, the damage incurred from the ensuing bust has been far greater than 'illusory' benefits of the boom.

As for China phobes: China played an insignificant role in the US housing bubble cycle engineered by the US government.

All these show that governments' penchant for blowing serial bubbles signify a path to a lower standard of living (poverty). As the great Murray N. Rothbard wrote,

“inflation reduces saving and investment, thus lowering society’s standard of living. It may even cause large-scale capital consumption”

Mainstream Media’s Increasing Attention To The Gold Standard

Below is an interesting perspective on gold from the Economist,

THE creditworthiness of a country used to be judged by the level of its gold reserves. Under the gold standard, a fall in reserves would lead to the central bank taking crisis measures. The country with the biggest reserves in the world is, not surprisingly, America, with 8,134 tonnes. But expressed in terms of reserves per person, the picture looks very different. It is no surprise to see Switzerland at the top of the list, but why is Lebanon in second place? Its reserves were purchased when the country was the Middle East’s financial centre in the 1960s and 1970s and safeguarded through the civil war years by legal restrictions and by central-bank governor Edmond Naim, who according to legend slept in the bank to protect the hoard. China does not feature in the list at all; but gold bugs fantasise about what might happen if the people’s republic were to swap just some of its mountain of Treasury bonds for bullion.

What’s interesting is that with gold prices over $1,500, there has been increasing instances of mainstream media’s reference to the gold standard.

Google Trends reveal of the upward trend in searches made on the “gold standard” (green trend line above window).

And at the bottom pane, in 2010-2011 (red circle) news reference volume has significantly improved compared with 2004-2007 and in 2008-2009.

Signs of things to come? Hmmmmm

Social Media Is Hayek’s Knowledge Theory At Work

Anyone who says or writes about social media and claims that today’s digital age is NOT about or related to Hayek’s Knowledge theory is dead wrong. They are either misrepresenting Hayek or have not read Hayek but has the chutzpah to make unfounded derogatory remarks.

The information age (third wave) is very much about the growing realization of Hayek’s Knowledge theory.

Proof?

Friedrich von Hayek wrote, (bold emphasis mine)

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.

Well here is how technology enabled information gathering has been benefiting businesses, according to the New York Times, (bold highlights mine)

INFORMATION overload is a headache for individuals and a huge challenge for businesses. Companies are swimming, if not drowning, in wave after wave of data — from increasingly sophisticated computer tracking of shipments, sales, suppliers and customers, as well as e-mail, Web traffic and social-network comments. These Internet-era technologies, by one estimate, are doubling the quantity of business data every 1.2 years.

Yet the data explosion is also an enormous opportunity. In a modern economy, information should be the prime asset — the raw material of new products and services, smarter decisions, competitive advantage for companies, and greater growth and productivity.

Is there any real evidence of a “data payoff” across the corporate world? It has taken a while, but new research led by Erik Brynjolfsson, an economist at the Sloan School of Management at the Massachusetts Institute of Technology, suggests that the beginnings are now visible.

Mr. Brynjolfsson and his colleagues, Lorin Hitt, a professor at the Wharton School of the University of Pennsylvania, and Heekyung Kim, a graduate student at M.I.T., studied 179 large companies. Those that adopted “data-driven decision making” achieved productivity that was 5 to 6 percent higher than could be explained by other factors, including how much the companies invested in technology, the researchers said.

In the study, based on a survey and follow-up interviews, data-driven decision making was defined not only by collecting data, but also by how it is used — or not — in making crucial decisions, like whether to create a new product or service. The central distinction, according to Mr. Brynjolfsson, is between decisions based mainly on “data and analysis” and on the traditional management arts of “experience and intuition.”

Essentially this means that businesses don’t rely on top down flow of information. Instead, supported by the rapidly advancing computing capacity of the current generation of computers, data gathering has been decentralized—“increasingly sophisticated computer tracking of shipments, sales, suppliers and customers, as well as e-mail, Web traffic and social-network comments”—which operates on real time basis that allows the businesses to rapidly store and process data “how it is used” and thus employ a “data-driven decision making”

Not Hayek?

More from the late great Hayek,

If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. We cannot expect that this problem will be solved by first communicating all this knowledge to a central board which, after integrating all knowledge, issues its orders. We must solve it by some form of decentralization. But this answers only part of our problem. We need decentralization because only thus can we insure that the knowledge of the particular circumstances of time and place will be promptly used. But the "man on the spot" cannot decide solely on the basis of his limited but intimate knowledge of the facts of his immediate surroundings. There still remains the problem of communicating to him such further information as he needs to fit his decisions into the whole pattern of changes of the larger economic system.

Again Hayek’s Knowledge Theory extrapolated in today’s social media setting, from the New York Times anew (bold emphasis mine)

STILL, the software industry is making a big bet that the data-driven decision making described in Mr. Brynjolfsson’s research is the wave of the future. The drive to help companies find meaningful patterns in the data that engulfs them has created a fast-growing industry in what is known as “business intelligence” or “analytics” software and services. Major technology companies — I.B.M., Oracle, SAP and Microsoft — have collectively spent more than $25 billion buying up specialist companies in the field.

Well when Hayek said “further information as he needs to fit his decisions into the whole pattern of changes”, applied in today’s lingo they are called “business intelligence” or “analytics” software and services.

Get it? This is very much Hayek’s theory at work.

Experts who pretend that they know, don’t really know.

The presume superior knowledge out of self importance and deceptive conceit by relying on false theories and flawed models from which they extrapolate as foundations for their preferred political theory. (Let them bet on markets and see how they can predict them with consistency. I'll bet they'll be consistently wrong)

Again as Hayek once wrote,

All political theories assume, of course, that most individuals are very ignorant. Those who plead for liberty differ from the rest in that they include among the ignorant themselves as well as the wisest.

And that’s where the Hayek and statists camp differ. It’s in the admission of the knowledge problem.

Will Ron Paul Run For President in 2012?

I hope he does. Signs point to this though...

From the Bloomberg,

U.S. Representative Ron Paul of Texas announced today in Iowa that he is forming an exploratory committee for a third presidential campaign.

Paul, a longshot 2008 Republican presidential candidate whose anti-tax, anti-government politics struck a chord with a swath of voters and fueled fundraising, will make a decision on whether to run by the middle of next month, said Jesse Benton, his political director.

“There’s a lot of enthusiasm,” Benton said. Paul plans to participate in a Republican primary debate May 5 in South Carolina.

Before his 2008 bid, Paul ran for president in 1988 on the Libertarian Party ticket.

Paul, who heads the House Financial Services subcommittee that oversees the Federal Reserve and wrote a 2009 book “End the Fed,” has long pushed for legislation to increase scrutiny of the central bank. He joined with his son, Rand, who was elected as a Republican senator from Kentucky in November, to introduce legislation this year to require an audit of the Fed by the Government Accountability Office.

Of course I don’t expect Congressman Paul to win. I don’t even think that this could even be the primary goal for Mr. Paul.

As Jacob Huebert aptly points out in this great talk (above), Ron Paul could simply be raising the level of awareness of classical liberalism or libertarianism to the public as he has successfully done so in the past by running for the top post.

The US is hardly a libertarian society (the youthful Mr. Huebert points to some 14% of the population as libertarians) which essentially makes Mr. Paul’s winning the Presidency seemingly against the odds.

However bringing the libertarianism platform to the political arena gradually opens the eyes of the public to the essence of liberty.

Aside, Mr. Huebert cites the internet as another complimentary driving force to Ron Paul as increasing the public’s interest on libertarianism.

One would note that since it is innate for people to look for role models, many libertarians may have seen Ron Paul as having assumed this function.

Besides classical liberalism or libertarianism requires some serious ruminations on economics and philosophy, something which most people appear averse at.

Great minds discuss ideas; Average minds discuss events; Small minds discuss people, said former US First Lady Eleanor Roosevelt.

Yet ideas are hardly the favored topic of mainstream media. Where ideas mattered, it could be seen in the context of social compassion but whose application implies compulsion to achieve this goal. (of course this would be embellished by math models)

Nevertheless the last word from hopefully Presidential candidate Ron Paul, (bold highlights mine)

To believe in liberty is not to believe in any particular social and economic outcome. It is to trust in the spontaneous order that emerges when the state does not intervene in human volition and human cooperation. It permits people to work out their problems for themselves, build lives for themselves, take risks and accept responsibility for the results, and make their own decisions.

Why I Would Not Subscribe To San Miguel’s Offering

I generally do not subscribe to IPOs or secondary listings because I am not a fan of it. As I pointed out here (July 2007) and here, their successes mostly depend on the performances of the broader market where new share listings basically reflect on market sentiment.

Since new listings are sentiment based, they frequently signify faddishness, and in fact, serve as dependable indicators of the whereabouts of the phases of the bubble cycle.

On that note, the fund raising campaign by San Miguel via equity and the exchange bond seems to have raised a buzz. I sense a bandwagon type of enthusiasm especially from short term traders or punters.

Nevertheless here is Finance Asia’s splendid take (or may I say takedown) of the San Miguel Corporation [SMC] offering, (bold highlights mine)

San Miguel Corp, the Philippine conglomerate whose businesses range from beer and food to oil, power and infrastructure, is set to raise $880 million from a concurrent sale of shares and exchangeable bonds. The fundraising is slightly larger than the $850 million indicated by the company earlier this month and could increase to $970 million if the $20 million greenshoe on the international tranche of the equity portion, and the upsize option on the domestic tranche, are both exercised in full.

Even at the base size, this is the largest follow-on capital raising in the Philippines ever. It is also the first ever combined equity and equity-linked deal in this market.

However, in return for the larger size, the company and its controlling shareholder, Top Frontier, had to compromise on price, as most of the investors who came into the equity portion of the deal were highly price sensitive. Having initially set a price range of Ps140 to Ps160 before the international bookbuilding kicked off on April 14, the indicative price was lowered to Ps110 to Ps140 two days before the close and eventually fixed at Ps110. This translated into a 28.1% discount to the latest market price of Ps153.

The final deal also falls well short of vice-chairman Ramon Ang’s talk of a sale of 1 billion shares back in December. Based on the share price at the time, that suggested a deal size of about $3 billion.

The exchangeable bonds did price at the issuer-friendly end with a 2% coupon and yield and a 25% exchange premium, but because it used the same Ps110 as the reference price, it was viewed as generous relative to other recent equity-linked deals. Indeed, investors were much keener on the bonds, which attracted a final order book of $2.8 billion. By comparison, the demand for the equity portion reached only $500 million, which clearly shows that the deal would have failed had it not been for the concurrent EB. Or seen the other way, the bookrunners were able to turn a difficult situation into a successful capital-raising by using the EB to draw in investors.

The deal was marketed as a way to invest into the broader Philippine economy, but evidently investors were not that comfortable with San Miguel’s aggressive expansion into new industries such as power, mining, energy, infrastructure telecommunications and banking, during the past few years. For one, it makes the stock more difficult to value, and there may also be concerns that it is spreading itself too thin.

San Miguel’s precipitate corporate makeover occurred prior to the Philippine presidential elections, which for me, put to question the motives behind such actions by the controlling interests, as I pointed out earlier.

Then the timing of the Supreme Court’s validation of Danding Cojuangco’s ownership may also have some influence on this.

To get some clue...

Again from Finance Asia...

Some 75% of the equity portion consisted of existing shares that were sold by Top Frontier, which owned 67.2% of San Miguel before the transaction and controlled 88.4% of the votes. San Miguel also owns a 49% stake in Top Frontier, making this a classic cross-shareholding situation. The EB was sold by San Miguel itself.

Cross (interlocking) holdings like SMCs’ smacks of corporate legal maneuverings similar to Japan Inc which investopedia.com describes as a “high degree of collusion between Japan's corporate and political sectors led to corruption throughout the system and contributed to the downfall of the overvalued Nikkei.”

Whether applied to Korea’s Chaebol or Japan’s Kiretsu such ownership structure types have functioned as traditional havens for the aforementioned collusion.

So in my view, yes the marketing has purportedly been about returns from equity ownership (well like all politics everything is about everyone else’s benefit) but behind the scenes the incentives, for this offering, could be political more than financial.

I’d further say that the San Miguel’s business model turnabout from beverage and consumer goods to industries as energy, infrastructure and mining seems like a manifestation of the socio-standings and the philosophy of the company’s top honchos.

Beverage and consumer goods dealt with market based competition whereas the latter industries mostly represents political concessions. In short, political operators would intuitively elect for political business platforms; because these are not subject to competition but acquired through privileges from political alliances or networks.

Earlier, I negatively weighed on San Miguel’s shift in its business model (outside the political context).

More clues from Finance Asia,

Aside from raising funds that can be invested into the company’s emerging infrastructure business, a key purpose of the deal was to increase the free-float and put the San Miguel stock back on the radar screens of international institutions. According to the Philippine Stock Exchange, the free-float was only 8% before the offering, which meant the deal had to be marketed pretty much as an initial public offering with an extensive roadshow, pre-deal research and a discount to other Philippine conglomerates. Investors also looked at the equity on an absolute valuation basis, rather than as a discount versus the current market price.

To get the maximum effect on the free-float, San Miguel initially planned to sell only shares. However, this turned out to be too much of a challenge, and so the plan was revised to include the exchangeable bonds at attractive terms as well. To ensure the company would still achieve its free-float objective, the EB was designed to be equity-like and to maximise the possibility of conversion. Hence the favourable premium.

At the end of the day, much ado about San Miguel's offering, unknown to many, falls short of the owners’ expectations, which is another reason why I should not get one.

Besides, in looking at the SMC’s chart...

...it would seem easy to get enchanted on something that has already massively exploded. That’s reading past performance into the future (in behavioral finance-this is called as anchoring).

The above shows where the offering has been made (red horizontal line). Needless to say for chartist SMC chart would translate to a breakdown.

Nevertheless, the sellers (Top Frontier) obviously made quick buck here: buying at php 75 per share and selling at 110 per share or about 46% returns [gross maybe 40% net] (after a big push in SMC's price- their push?) on a holding period of 1 year and a quarter—Not bad for the “largest follow on capital raising” billion peso deal!

Of course, as I earlier stated, San Miguel’s price direction will flow with the overall market.

So SMC can sell you the meme about exposure to the Philippine economy, but at the end of the day SMC's price actions will reflect on the phases of bubble cycle than the company's so-called fundamentals.

And part of the typified trait of bubble cycles is political money hyping up stock prices...Japan Inc. and the US mortgage bubble should be great reminders.

That said, investing in stocks or in financial markets has the greater fool theory always in play.

[As a side note: I am not implying that SMC subscribers are the greater fool. The greater fool is the one usually left holding the empty bag -or the old maid-which means that this applies to all issues, IPO or not]

The point is it pays to be prudent.

IMF Predicts The End of the “Age of America” in 2016

From the Marketwatch,

The International Monetary Fund has just dropped a bombshell, and nobody noticed.

For the first time, the international organization has set a date for the moment when the “Age of America” will end and the U.S. economy will be overtaken by that of China.

And it’s a lot closer than you may think.

According to the latest IMF official forecasts, China’s economy will surpass that of America in real terms in 2016 — just five years from now.

Put that in your calendar.

It provides a painful context for the budget wrangling taking place in Washington right now. It raises enormous questions about what the international security system is going to look like in just a handful of years. And it casts a deepening cloud over both the U.S. dollar and the giant Treasury market, which have been propped up for decades by their privileged status as the liabilities of the world’s hegemonic power...

Naturally, all forecasts are fallible. Time and chance happen to them all. The actual date when China surpasses the U.S. might come even earlier than the IMF predicts, or somewhat later. If the great Chinese juggernaut blows a tire, as a growing number fear it might, it could even delay things by several years. But the outcome is scarcely in doubt.

This is more than a statistical story. It is the end of the Age of America. As a bond strategist in Europe told me two weeks ago, “We are witnessing the end of America’s economic hegemony.”

We have lived in a world dominated by the U.S. for so long that there is no longer anyone alive who remembers anything else. America overtook Great Britain as the world’s leading economic power in the 1890s and never looked back.

Well that indeed is a bold prediction coming from the multilateral institution which failed to predict the emergence of the 2008 financial crisis.

IMF’s over reliance on econometric models makes them greatly dependent on constants as basis for their predictions. Constants do not exist in the world of human action and even in the environment (e.g. Japan’s science models failed to predict the last disaster).

In addition constant based models tend to generate linear progressions which means that methodological calculations greatly depends on data from past performances, thus subjecting them to flagrant errors from black swan ‘fat tail’ events.

I’d say that this supposed end of the “age of America” and the contemporaneous "rise of China" strongly depends on some major interrelated factors: bubble cycles, inflationism, the political resolution of the grand unwieldy fiscal deficits, state of economic freedom, and the progress of technological innovation and the scale of transition of the global economy to the information age.

Say for instance, if China’s bubble does unravel before 2016, then the IMF’s clock could suffer a substantial reversal.

To reminisce, many saw Japan as a contender to the US crown in the 1980s. Events turned out that the much heralded Japan Incorporated had been an illusion of prosperity and success brought about by funny money. Events could turn out the same for China. I am not saying it will, but it could.

Also, policies that “kick the can down the road” via inflationism may increase the fat tail risk of hyperinflation for the US, or even for the rest of the world if everyone embraces competitive devaluation as a common national monetary policy.

In other words, predicting the end of the Age of America is not going to be that simple. IMF should predict first, NOW before the Presidential primary, who will be the President of the US in 2012.

Events are as fluid as people adapt and respond to social and environmental changes.

US Federal Reserve Gambles With Untested Policy Tool: Paying Interest On Bank Reserves

Utilizing the “untested” policy tool of paying interest on bank reserves, the US Federal Reserve seems to be gambling away the US economy as well as the worlds’.

This Bloomberg article is a mouthful. (bold highlights mine)

Federal Reserve officials are staking their inflation-fighting credibility on an untested tool: the power to pay interest on bank reserves.

Congress granted the Fed this ability in 2008, and Chairman Ben S. Bernanke, Vice Chairman Janet Yellen and New York Fed President William Dudley have all cited it as a main reason why they’ll be able to keep the U.S. economy from overheating after pumping record amounts of cash into the financial system. Raising the rate, currently at 0.25 percent, is intended to entice banks to keep their money on deposit at the Fed instead of loaning it out and stoking inflation.

With the benchmark overnight lending rate trading at 0.1 percent, less than half the deposit rate, it isn’t clear how much control the central bank can exert over borrowing costs by raising the interest on reserves, said Dean Maki, chief U.S. economist at Barclays Capital. Internal critics also have cast doubt on the tool’s effectiveness. Philadelphia Fed President Charles Plosser said last month it isn’t a cure-all because it doesn’t address the need to shrink the central bank’s balance sheet and reduce the amount of reserves in the system.

“There is some concern in markets about whether the Fed will keep inflation under wraps as it goes through this exit strategy,” Maki said in a telephone interview from his New York office. “It’s unknown exactly what interest on reserves does to the economy.”

Cash in the banking system has ballooned since the credit crisis began in 2007, when the Fed embarked on its unprecedented monetary accommodation, which includes two bond-purchase programs that have swelled the central bank’s balance sheet to a record $2.69 trillion...

The amount of excess reserves climbed to $1.47 trillion this month from $991 billion at year-end and $2.2 billion at the start of 2007, Fed data show.

The Federal Open Market Committee begins a two-day meeting tomorrow and will decide whether to continue with its planned $600 billion of bond purchases through June.

The effectiveness of using interest on reserves, or IOR, as a main policy tool may depend on how closely the federal funds rate, or overnight inter-bank lending rate, follows its movements. The Fed has kept its target for the fed funds rate at zero to 0.25 percent since December 2008.

“The big unknown is how tight the spread between the IOR and effective fed funds rate will be,” said Dino Kos, a managing director at economic-research firm Hamiltonian Associates Ltd. in New York. “If the fed funds rate trades at a stable, and preferably narrow, discount to the IOR, then tightening policy through the IOR is doable. But a wide and unstable spread undermines the strategy.”

More...

The Fed probably would like to mimic the so-called corridor system in Europe, where the deposit rate acts as a floor to the overnight lending rate, according to Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. The U.K. central bank’s benchmark, now at 0.5 percent, is the rate it pays on the reserves it holds for commercial banks. That’s below the overnight sterling London interbank offered rate of 0.57 percent.

The Frankfurt-based European Central Bank pays a rate on the deposits banks park with it overnight. The ECB raised this rate a quarter point to 0.5 percent on April 7, the same day it increased its benchmark refinancing rate by the same margin to 1.25 percent...

Before the Fed boosts the deposit rate, it likely will use reverse repurchase agreements and its new Term-Deposit Facility to gain more control over the federal funds rate, Stanley said. He predicts the Fed will raise rates as soon as November, which he said is an “aggressive” time frame that reflects his concern inflation will accelerate.

In a reverse repo, the Fed lends securities for a set period, draining bank reserves from the financial system. At maturity, the securities are returned to the Fed, and the cash goes back to the primary dealers.

Stanley said he’s skeptical these transactions can operate at a scale big enough to suck sufficient cash from the system to control the federal funds rate. The rate fell as low as 0.08 percent on April 13 after the Federal Deposit Insurance Corp. began adjusting calculations of U.S. banks’ deposit-insurance fees this month to cover all liabilities instead of just domestic deposits.

Yet banks have been the major beneficiaries of this grand experiment via massive ‘risk-free’ subsidies.

From the same article...

The overnight lending rate has traded below the interest rate on reserves for almost two years, partly because Fannie Mae and Freddie Mac, the mortgage-finance companies under government control, became “significant sellers” of funds in the overnight market and aren’t eligible to place cash on deposit at the Fed, according to a December 2009 research paper by the New York regional reserve bank.

The “theory” of interest on reserves is “proved wrong every day: Why would a bank ever lend at less than what they’re earning at the Fed?” Maki said. “There are more issues here than it sometimes is made to sound. Chairman Bernanke mentioned the Fed could raise rates in 15 minutes if they decided to, but it’s not clear they have that kind of control on the funds rate.”

Where Ben Bernanke cheerfully says that “Paying interest on reserves should allow us to better control the federal funds rate”, this looks more like blind optimism than a verified method.

Economic Policy Journal’s Bob Wenzel says that the FED pays “EIGHT times equivalent market rates when they keep the funds as excess reserves” and that this rate is also “more than eight times the rate on one-month T-bills” which is almost like “gifting banks $890 million every three months”

And it’s of no doubt why the financial sector continues to outperform.

Chart from Bespoke Invest

Nevertheless the continued interventions via manipulation of interest rates, the policy of quantitative easings and all other forms of monetary tools including the experiment of paying interest on bank reserves are likely to give us more uncertain outcomes through heightened volatility (bubble cycles) which should translate to even more interventionism.

Do Americans Buy Stuffs They Don’t Need?

One of the most outrageous obsessions by the mainstream is to substitute statistics for human action then apply political correctness when interpreting them.

This Wall Street Journal Blog should be an example (bold highlights mine)

As it turns out, quite a lot. A non-scientific study of Commerce Department data suggests that in February, U.S. consumers spent an annualized $1.2 trillion on non-essential stuff including pleasure boats, jewelry, booze, gambling and candy. That’s 11.2% of total consumer spending, up from 9.3% a decade earlier and only 4% in 1959, adjusted for inflation. In February, spending on non-essential stuff was up an inflation-adjusted 3.3% from a year earlier, compared to 2.4% for essential stuff such as food, housing and medicine.

To be sure, different people can have different ideas of what should be considered essential. Still, the estimate is probably low. It doesn’t, for example, account for the added cost of certain luxury items such as superfast cars and big houses.

Interestingly, people who spend more on luxuries have experienced less inflation. As of February, the weighted average price of non-essential goods and services was up only 0.2% from a year earlier and 82% from January 1959, according to the Commerce Department. By contrast, the cost of all consumer goods was up 1.6% from a year earlier and 520% from January 1959.

The sheer volume of non-essential spending offers fodder for various conclusions. For one, it could be seen as evidence of the triumph of modern capitalism in raising living standards. We enjoy so much leisure and consume so much extra stuff that even a deep depression wouldn’t – in aggregate — cut into the basics.

Alternately, it could be read as a sign that U.S. economic growth relies too heavily on stimulating demand for stuff people don’t really need, to the detriment of public goods such as health and education. By that logic, a consumption tax – like the value-added taxes common throughout Europe—could go a long way toward restoring balance.

It’s absurd to say that we buy stuff which we don’t need.

While the author does say “different people can have different ideas of what should be considered essential”, he seems confused on why people engage in trade at all.

Moreover, saying that Americans "buy stuffs they don’t need" translates to an ethical issue with political undertones: the author seems to suggest that Americans have wrong priorities or have distorted set of choices! Of course the implication is that only the government (and the author) knows what are the stuffs which people truly needs, thus his justification for a consumption tax! (Put up a strawman then knock them down!)

Although the author attempts to neutralize the political flavor of his article by adding an escape clause: that the stats signify as “evidence of the triumph of modern capitalism in raising living standards”.

People buy to express their demonstrated preference. Yet such preference gets screened from a set of given ordinal alternatives (e.g., 1st, 2nd, 3rd, etc..) from which the individual makes a choice or a decision. And that choice (buying) constitutes part of human action.

As Professor Ludwig von Mises explained, (bold highlights mine)

Action is an attempt to substitute a more satisfactory state of affairs for a less satisfactory one. We call such a willfully induced alteration an exchange. A less desirable condition is bartered for a more desirable. What gratifies less is abandoned in order to attain something that pleases more. That which is abandoned is called the price paid for the attainment of the end sought. The value of the price paid is called costs. Costs are equal to the value attached to the satisfaction which one must forego in order to attain the end aimed at.

If I buy beer (1^st order) at this moment at the cost of my other alternatives: a steak (2^nd order) or a chocolate (3^rd order), does my choice for beer represent stuff I don’t need?

The instance that I made a sacrifice (steak and chocolate) to make a choice (beer) makes my decision part of my act to fill a personal unease or a “need”.

It may not be your need, but it is mine. My actions reflect on my preference to solve my need.

The fact that beer is produced and sold implies that it is an economically valuable product (estimated at $325 billion industry for the world for 2008). Many people “needs” it and would pay (hard earned or otherwise) money for it.

The difference lies in the values ascribed to it by different consumers.

Some see beer as a way to socialize, or a way to get entertained or to get promoted or to close deals or as stress relief or a part of the ancillary rituals for other social activities or for many other reasons as health.

Some may not like beer at all!

The point is people consume or don’t consume beer for different reasons. As an economic good, beer is just part of the ordinal alternatives for people to choose from, aside from chocolate or steak or other goods or services.

Suggesting that beer isn’t a stuff we need, as a beer consumer, severely underappreciates the way we live as humans.

Abraham Maslow proposed that human needs come in the form of a pyramid. He breaks them down into 5, namely physiological, safety, social (love and belonging), esteem and self-actualization.

As the Wikipedia explains, (bold highlight mine)

Maslow's hierarchy of needs is often portrayed in the shape of a pyramid, with the largest and most fundamental levels of needs at the bottom, and the need for self-actualization at the top.

The most fundamental and basic four layers of the pyramid contain what Maslow called "deficiency needs" or "d-needs": esteem , friendship and love, security, and physical needs. With the exception of the most fundamental (physiological) needs, if these "deficiency needs" are not met, the body gives no physical indication but the individual feels anxious and tense. Maslow's theory suggests that the most basic level of needs must be met before the individual will strongly desire (or focus motivation upon) the secondary or higher level needs. Maslow also coined the term Metamotivation to describe the motivation of people who go beyond the scope of the basic needs and strive for constant betterment Metamotivated people are driven by B-needs (Being Needs), instead of deficiency needs (D-Needs).

From my example, my choice for a beer may not signify a physiological (basic need), yet they could reflect on my other deficiency needs (emotion or esteem or social needs).

In other words, B (being)-needs may not be D (deficiency)-needs but they still represent as human ‘intangible’ NEEDS.

Bottom line:

Statistics, which accounts for mainstream’s obsessions, fails to incorporate the intangible or non-material aspects of human nature.

It is, thus, misleading to make the impression that by reducing people’s activities to quantitative equations, or to dollar and cents, patterned after physical sciences, governments can manage society efficiently.

As the great Friedrich von Hayek admonished, in his Nobel lecture “the Pretence of Knowledge” (bold highlights mine)

While in the physical sciences it is generally assumed, probably with good reason, that any important factor which determines the observed events will itself be directly observable and measurable, in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, for reasons which I shall explain later, will hardly ever be fully known or measurable. And while in the physical sciences the investigator will be able to measure what, on the basis of a prima facie theory, he thinks important, in the social sciences often that is treated as important which happens to be accessible to measurement. This is sometimes carried to the point where it is demanded that our theories must be formulated in such terms that they refer only to measurable magnitudes.

Lastly the notion that people don’t know of their priorities seems plain silly and downright sanctimonious.

Besides, governments compose of people too which makes the whole quantitative statistical exercise as self-contradictory.

Central Planning Failure: China’s “Train Wreck” Edition

Think government knows what is best for us?

This from Charles Lane of the Washington Post (hat tip Cato’s Dan Mitchell) [bold emphasis mine]

For the past eight years, Liu Zhijun was one of the most influential people in China. As minister of railways, Liu ran China’s $300 billion high-speed rail project. U.S., European and Japanese contractors jostled for a piece of the business while foreign journalists gushed over China’s latest high-tech marvel.

Today, Liu Zhijun is ruined, and his high-speed rail project is in trouble. On Feb. 25, he was fired for “severe violations of discipline” — code for embezzling tens of millions of dollars. Seems his ministry has run up $271 billion in debt — roughly five times the level that bankrupted General Motors. But ticket sales can’t cover debt service that will total $27.7 billion in 2011 alone. Safety concerns also are cropping up.

Faced with a financial and public relations disaster, China put the brakes on Liu’s program. On April 13, the government cut bullet-train speeds 30 mph to improve safety, energy efficiency and affordability. The Railway Ministry’s tangled finances are being audited. Construction plans, too, are being reviewed.

Liu’s legacy, in short, is a system that could drain China’s economic resources for years. So much for the grand project that Thomas Friedman of the New York Times likened to a “moon shot” and that President Obama held up as a model for the United States.

Rather than demonstrating the advantages of centrally planned long-term investment, as its foreign admirers sometimes suggested, China’s bullet-train experience shows what can go wrong when an unelected elite, influenced by corrupt opportunists, gives orders that all must follow — without the robust public discussion we would have in the states.

This exemplifies what has been wrong in China. Similar to our previous accounts of ghost cities and Potemkin malls, what has largely been touted as the “Chinese growth miracle” seems more like a boom bust cycle from reckless centrally planned ‘delusions of grandeur’ financed by Chinese taxpayers.

And cracks appear to be widening as time goes by. Once malinvestments reach a “tipping point” or a critical mass then these cracks will break into a torrent.

Next, this further shows how wastage and inefficiency of government spending translates into huge negative externality costs. Centralization "orders that all must follow" translates to systemic fragility where losses are borne by everybody "could drain China's economic resources for years", while losses from decentralization are distributed hence anti (less) fragile (Nassim Taleb-Fooled By Randomness).

In addition, the above likewise exhibits how taxpayer resources are wasted on facilities or infrastructure projects that are hardly demanded for by consumers. Because non-profit oriented central planning decision making neglects the risk-reward tradeoffs and are instead guided by political goals, taxpayers end up absorbing the consequences of wrong decisions (sales can't cover debt service and safety issues).

Moreover, this is another example where government finds it too easy to spend someone else’s money. To quote the illustrious economist Milton Friedman “If you put the federal government in charge of the Sahara Desert, in 5 years there'd be a shortage of sand.” Apparently this is a universal trait for politicians and bureaucrats.

And importantly, discretionary power over spending other people’s money becomes too much a temptation to resist claims over other people’s money as one’s own. Thus, concentration of power, enabled by arbitrary laws, serves as breeding and nestling grounds for corruption, in the above case "embezzlement".

Finally central planners believe that they know better of what society needs than of the individual through the markets. As the above also shows, they don’t.

This further validates the knowledge problem proposed by the great F. A. Hayek as evidenced by majestic mistakes which continually plagues the “unelected elite”:

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

Philippine Mining Index Surfs The Commodity Tide

Domestic mining issues have been one of the recent ‘darlings’ of the Philippine Stock Exchange for the second week.

The Rising Commodity Tide

And these have been happening on the backdrop of record metal prices mostly led by precious metals.

Sizzling hot silver (+51% year to date) has skyrocketed reportedly from a massive short squeeze[1] and so with also gold (+5.91%).

Meanwhile copper also drifts near its record price highs even if its year-to-date performance has been lacklustre (marginally down .63%).

Importantly, prices of commodity products lead mining issues, and this phenomenon seems to take place around the world as global mining issues (S&P/TSX), Emerging Market Mining Titans (EMT), Gold Bugs (HUI) and Industrial Metals ($DJAIN) can be seen in an ascending trend (red line).

Philippine Mining Index Surfs The Tide

Domestic Mining issues have likewise been markedly moving higher too.

Since mid-2010, major mining component issues as Philex (black candle), Semirara (blue), Lepanto (green), Atlas (violet) and Manila Mining (orange) have lifted the Philippine Mining Index (red line). These companies constitute about 89% of the Philippine Mining index and whose pecking order shown above are based on market capitalization.

Some may suggest that the current price actions have been prompted by corporate deals. For instance, the yet to be formalized joint venture agreement of Philex with Manila Mining [MA] for the combined development of Philex’s Boyongan with Manila Mining’s Kalayaan properties[2].

While this may be partly true, one should understand the function of the market is to discount the flow of information that are perpetually being disseminated through the ticker tape. I call this the diminishing returns[3] or the marginal value of information as market prices incorporate future expectations rather than the present or the past.

In other words, there are bigger forces than just mergers and acquisitions (M&A) or joint ventures that drive equity share prices. Although, M&A and JVs characterize the climate of the underlying bull market trend.

Looking at the bigger picture, chart actions reveal of the same narrative: Mining issues has been on an uptrend since 2009, but the actions differ in terms of degree and in timing.

As I earlier described in 2009[4], (bold emphasis original)

Since the domestic mining industry remains broadly underinvested and where current crops of mining firms lack the capital to expand or operate, the major catalysts for prospective runs would be speculations on joint ventures and or prospective M&A developments from new investors (they could be foreign or local godfathers)

Actions among the mining components appear to be rotational- a classic symptom of bullmarket driven by inflation. This implies that the next major moves could likely come from those that have been in a reprieve.

A sustained bullmarket in commodities- arising from monetary “pass through” or from BRIC and emerging markets demand- is likely to underpin the secular case for investing in local mines.

Compared to other sectors mines are likely to generate ALPHA.

IT has not always been a boom, nonetheless nearly all of what we have described above been fulfilled.

And the rotation has not been limited to companies within the mining index but signifies largely a phenomenon of the general market, as different sectors flow in a single direction but gets differentiated by timing and by the degree of price motions.

Yet there will always wall of worries to climb.

Anti-Mining Politics, It’s Economics Stupid!

The recent landslide in Compostela Valley that has resulted to 3 fatalities, has largely been blamed on the mining activities.

In the understanding of the public’s anti-mining bias which has been buttressed by the Church, and the attendant environmental hysteria that has been promoted by mainstream media, accidents like this could lead to a political backlash that could risk political outcomes. Though I would say that this is likely to be attention-span based which means public’s attention is usually short term, fickle and limited and would shift to new controversies as they emerge.

Yet the anti-mining political hysteria fails to distinguish that the environmental hazards emanate NOT from market based mining activities but from underground based activities as consequences of the feckless prohibition laws.

As the Inquirer reports[5],

Many of these operations are illegal and unregulated, and there are frequent accidents, Reuters said in a report.

The point is: One CANNOT legislate away demand and supply. Politics can only shift them.

If resources, as mineral commodities, are there for the picking, and considering that these products has been generating higher values (ergo MORE profits), then either the markets or political means will resolve its extraction.

The essence is, since these politicized commodities have imputed economic values, then prohibition laws won’t stop the economics of mining.

It’s downright dimwittedness for anyone to suggest they can.

And if politics is the chosen option, then mining will become either an activity rewarded as concessions to the politically favoured—who would seek to please the political benefactors as their priority than of the environment—or an activity that will be implemented in a guerrilla warfare fashion. Of course, the latter would most likely operate under the inferred blessings of venal local officials.

In addition, in guerrilla type of mining operations, since illegal miners operate under temporary implicit licenses or are reckoned as completely underground, this implies that operators won’t care about the environment since they are illegal anyway.

Besides, illegal operators are most likely to be amateurs from within the locality or from the surrounding areas, instead of professional miners. Thus by rendering illegitimate the industry, this would lead to more frequency of accidents and of damages in larger scales.

Yet unknown to most, because economics is what drives the mining business, prohibition laws would only breed and nurture corruption. High profits and reduced competition would allow illegal operators to payoff politicians and the police.

Again it is all about economics.

So the more the prohibition, the more we can expect accidents from underground activities to take place.

Conclusion

Rising commodities prices have been filtering into global mining issues.

We see the same phenomenon impact the local market.

Momentum appears to favor a continued rise.

Political risks from recent catastrophe may affect mining sentiment on the short run but this should be muted.

In terms of politics, prohibition laws won’t ever succeed to stop the forces of demand and supply. It’s just the distribution that changes.

Yet the above dynamics has once again been validating my predictions since 2003, as published in safehaven.com[6] (there are two more articles I published thereafter[7])

The prospects of a continuing rise in commodity prices due to the tightening of supplies and possibly in combination with mounting demand from the rapidly expanding China and India, or from the steep fall of the US dollar, should highlight the potentials of mining and resource based companies in our region too.

No trend moves in a straight line. Yet, mining issues will function as the main beneficiary of inflationism and the emerging market consumption story.

So I’d stick by them. So should you. (My other favourite industry would be technology)

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[1] See Hi Ho Silver! April 23, 2011

[2] Philstar.com Manila Mining says deal with Philex on Kalayaan 'done', April 20, 2011

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

[4] See Prediction Fulfilled: Philippine Mining Index Tops 9,000 (Now 11,300!) November 15, 2009

[5] Inquirer.net 15 buried miners saved, April 24 2011

[6] Safehaven.com The Philippine Mining Index Lags the World, September 26, 2003

[7] Safehaven.com Author Benson Te