ASEAN’s Equity Divergence, Foreign Fund Flows and Politically Driven Markets

Trading is a psychological game. Most people think that they’re playing against the market, but the market doesn’t care. You’re really playing against yourself. You have to stop trying to will things to happen in order to prove that you’re right. Listen only to what the market is telling you now. Forget what you thought it was telling you five minutes ago. The sole objective of trading is not to prove you’re right, but to hear the cash register ring. Martin Schwartz

Divergence.

The week had been marked by divergences, where the ASEAN equity bellwether appears to have defied the performances of her contemporaries around the world.

The FTSE-ASEAN[1] (AWASEAN, yellow) scaled higher as the region’s index MSCI AC ASIA Pacific[2] (MXAP, red), the S & P Euro[3] (SPEURO, green) and the US S & P 500 seem to have rolled over on a year to date basis.

One would further note that except for the Eurozone, Asia, ASEAN and the S&P 500 came off from their recent highs.

It is an important reminder that any divergences should not be interpreted as representative of decoupling. Signs of decoupling will be manifested once the next crisis emerges. Yet given the depth or scale of today’s globalization or social interconnectedness which has not been limited to trade, labor, capital flows or to even monetary policies, I strongly doubt that this should transpire.

In addition I pointed out the commodities have been rallying in the face of an enfeebled global equity markets. We seem to be seeing some rotation from financial assets towards the commodity sphere as markets await political developments abroad.

And another significant point to consider is that given the variance in the political economic construct of each nation, the global transmission of credit easing policies and artificially suppressed interest rates everywhere would have different impacts on different asset classes.

Nations that had been least affected by the last bubble bust should outperform. And this perhaps explains the ASEAN divergence.

Yet this has been an important theme for us for the longest time.

Transmission Mechanisms from Policies Abroad

I have been saying that policies abroad are being transmitted to the Peso and the Phisix.

Interest rate spreads, devaluation policies, real economic growth rate differentials, degree of economic freedom and political, regulatory and tax costs and risks among the many other variables serve as major inducements to foreign money flows into the emerging markets.

Under current conditions, emerging markets are expected to receive fund flows to the tune of slightly $1 trillion for 2011.

Reports the Bloomberg[4],

Net private capital inflows to emerging market economies will keep growing this year and next to reach $1.1 trillion in 2012, attracted by economic growth above 6 percent in those countries, a banking industry group said.

The Washington-based Institute of International Finance today also raised its estimates for 2011 inflows by $81 billion to $1 trillion to reflect higher forecasts for Brazil and China. That more than offset lower flows to the Middle East and North Africa as a result of political turmoil there.

“The strength of capital flows is still presenting policy challenges in a number of emerging economies, especially those already facing pressures from rising inflation, strong credit and asset price growth and rising exchange rates,” the IIF wrote in its research note. Monetary policy in these countries is “generally too accommodative, in large part because policy makers are so focused on limiting capital inflows.”

Countries from Indonesia to South Africa are striving to manage inflows of overseas capital that put upward pressure on their currencies, making exports less competitive, and threaten to inflate asset-price bubbles. Nations including China and South Korea have argued that U.S. monetary easing has added to cross-border money flows in pursuit of higher returns.

The accompanying chart is from the IIF[5]

The Philippines is part of the EM rubric, thus should be one of the recipients of these fund flows.

Foreign trade has supported the current recovery, from the November 2010 consolidation or the profit taking phase, in the Philippine Stock Exchange.

Net foreign inflows, as of the end of May, tallied 14.3 billion php [US $324.127 million]. This accounted for about 40% of daily trade. Above chart shows of the weekly trend.

The big drop in foreign trade during the other week had been due to 2 special block sales in Meralco [PSE: MER] and San Miguel [PSE:SMC].

There is a strong correlation between foreign flows and the Peso. The vertical line from the Peso chart partitions the year-to-date performance.

The foreign volume inflow spikes in April and May appear to be reflected on the Peso (see two red arrows) with two concomitant surges over the same period.

Meanwhile the recent outflows seen from the special block sales have coincided with the recent price sluggishness of the Peso.

So even at 40% share of daily trades, foreign flows account for as a major determinant to the price activities in the Phisix and importantly the Peso.

And as I have long been saying the correlation between the Peso and other popular metrics as remittance or exports have been tenuous[6].

Foreign flows are representative of the degree of demand for a currency.

Hence, currency traders must take heed of the activities in the PSE as part of their studies from which to derive their predictions

Another aspect is that the above estimates made by the IIF, I think, largely depends on current conditions which seem to presuppose the QE in play.

Thus a furtherance of the QE should translate to more capital flows into emerging markets including the Philippines. This means buoyant stocks and a stronger peso.

QE’s basically connect the Emerging Markets by transmitting bubble conditions. Some countries appear to be aware of this, as the Bloomberg report says, “China and South Korea have argued that U.S. monetary easing has added to cross-border money flows in pursuit of higher returns”

So while some reads this as somewhat positive, this represents a bubble process at work. Boom days will be met by a greater bust. The success of a prudent investor would be how one negotiates the boom bust cycle.

Rotational Process Continues, Politics as Main Driver

Rotational activities continue to dominate the activities within the Philippine Stock Exchange.

The industrials spearheaded the gains of the Phisix. This was largely due to the upsurge in Meralco (6.35%) [PSE: MER], Energy Development Corporation (4.09%) [PSE: EDC] and San Miguel Corp (6.27%) [PSE: SMC].

The financial industry, which I earlier said could be a candidate likely to help buoy the Phisix[7], has taken the second place. Meanwhile the mining sector continues to bedazzle with the 10^th consecutive week of advances which has been defying my expectations[8]. In a bullmarket, overbought conditions can remain extended.

The Phisix continues to consolidate amidst signs of emerging weakness in the global markets. It is unclear if such divergences will hold or persist.

Although for as long as there would be no recession in the horizon, and where monetary conditions remain easy or accommodative as today, such variability in price actions remains a possibility.

True, there have been signs of economic slowdown in many parts of the world, but a downshift does not mechanically imply a collapse or a recession.

Seasonality can also be a factor. But this factor would come into play if other forces are restrained.

Yet barring any black swan or high sigma events, I don’t foresee any signs of an impending recession yet. So, over the short term, the Phisix or even global equity markets may just vacillate and look for direction.

Finally my expectations have largely been shaped by the prospective political actions by the political leadership, particularly by the US Federal Reserve on extending the QE program which is slated to end this month.

Although I expect that this extension won’t come automatically which I see as either tied to the US Congressional vote to raise debt limits or in reaction to growing pessimism in the some of the world’s economic environment due to a cyclical slowdown or to the accrued effects of signaling channels applied by governments or from mainstream’s addiction to inflationism. Besides if the debt ceiling will be raised this gives further excuse for the FED to activate QE 3.0.

However as clearly outlined, politics largely determines the outcome of the marketplace.

---

[1] Bloomberg.com The FTSE Asean Index is a free float market capitalization weighted index. FTSE All-World Indices include constituents of the Large and Mid capitalization universe for Developed and Emerging Market (Advanced Emerging and Secondary Emerging) segments. Base Value 100 as at December 31, 1986.

[2] Bloomberg.com The MSCI AC Asia Pacific Index is a free-float weighted equity index. It was developed with a base value of 100 as of December 31 1987.

[3] Bloomberg.com The S&P Europe 350 Index is a free float market cap weighted index that measuresthe performance of equities in 17 Pan-European markets, covering approximately 70% of the total market cap. It offers an effective balance between broad market representation and liquidity. The S&P Europe 350 is part of the S&P Global 1200. It has a base date of Dec. 31, 1997 with a base value of 1000.

[4] Bloomberg.com Capital Flows to Emerging Markets Seen Surpassing $1 Trillion, June 1, 2011

[5] Institute of International Finance Capital Flows to Emerging Market Economies, June 1, 2011

[6] See How The Surging Philippine Peso Reflects On Global Inflationism, December 6, 2009

[7] See A Bullish Financial Sector Equals A Bullish Phisix?, May 22, 2011

[8] See Phisix: Why I Expect A Rotation Out of The Mining Sector May 15, 2011

Serial Bailouts For Greece (and for PIIGS)

From the Bloomberg

European Union officials will focus on preparing a new aid package for Greece that includes a “voluntary” role for investors after the EU and International Monetary Fund approved the fifth installment of Greece’s 110 billion-euro ($161 billion) bailout.

“I expect the euro group to agree to additional financing to be provided to Greece under strict conditionality,” Luxembourg Prime Minister Jean-Claude Juncker said after meeting with Greek Prime Minister George Papandreou in Luxembourg yesterday. “This conditionality will include private-sector involvement on a voluntary basis.”

Papandreou agreed to 78 billion euros in additional austerity measures and asset sales through 2015 to secure the 12 billion euro bailout payment and meet conditions for receiving an additional rescue package. He agreed to make “significant” cuts in public-sector employment and establish an agency to manage accelerated asset sales, according to a statement released in Athens yesterday. The plan is fueling popular opposition and protests across Greece...

Under the original rescue, Greece was due to sell 27 billion euros of bonds next year. EU leaders and Papandreou have acknowledged that a return to markets won’t be possible with Greece’s 10-year debt yielding 16 percent, more than twice the level at the time of the bailout. The EU is looking to close that funding gap through new loans and bondholders’ willingness to roll over Greek debt, EU officials have said.

Europe’s financial leaders needed to hammer out a revised Greek package to persuade the IMF to pay its share of the 12 billion-euro tranche originally due in June. The IMF had indicated that it would withhold its 3.3 billion-euro piece unless the EU comes up with a plan to close Greece’s funding gap for 2012. The EU-IMF statement said the full payment would be made in early July. [all bold highlights mine]

These developments seem on the way to validate my views.

Mainstream has been ignoring the political role of the EU’s existence, the role of central bankers, the intertwined complex political relationships between the banking sector, the central banks and the national governments and the inherent ability of central banks to conduct bailouts by inflating the system.

If the US had QE [Quantitative Easing] 1.0, 2.0 and most likely a 3.0...until the QE nth, despite poker bluffing statements like this [Morningstar.com]

"The trade-offs are getting--are getting less attractive at this point. Inflation has gotten higher," Bernanke said. He cited the rising inflation expectations seen then and offered "it's not clear that we can get substantial improvements in payrolls without some additional inflation risk." He went on, "If we're going to have success in creating a long-run sustainable recovery with lots of job growth, we've got to keep inflation under control."

...or that the earlier consensus view that QE 3.0 is unlikely,

central bank watchers believe there is simply no appetite within the central bank to undertake such an effort, which some in markets are already referring to as QE3.

...QE 3.0 will be coming for the above reasons as earlier discussed.

The path dependence from previous actions of regulators and political leaders and the dominant ideological underpinnings which influence their actions combined with the framework of current network of political institutions are highly suggestive of the direction of such course of actions.

Importantly, the implicit priority to support the politically privileged industries as the banking system—which functions as the main intermediary that channels private sector funds to governments. Alternatively, this means policies has been designed to sustain the status quo for politicians and their allies.

Further, it would be misplaced to put alot of emphasis on political protestations by the public as measure to predict future policies.

Political leaders have learned the lessons of Egypt and Tunisia and have been applying organized violence as seen in Libya, in Yemen or in Syria.

It won’t be different for the political leaders of the developed world. As indications of their prospective actions against popular political pressure, even several protestors on US Memorial Day have suffered from police brutality from just “dancing”

In addition, sentiment can shift swiftly.

Recent soft patches in economic data, which I think has been part of the signaling channel maneuver, which has likewise began to affect markets, appear to be reversing previous sentiments which says that the Fed has “no appetite” for QE 3.0.

Again from Morningstar

Having received the strongest indication yet of a slowing economic recovery, traders of U.S. interest rate futures on Friday backed off on the notion that the Federal Reserve will start raising its short-term federal-funds rate during the first half of next year.

Finally, for those who say they are ‘massively’ short the Euro...

...it’s gonna be alot of pain for them.

So like the US, the above only reveals that the Eurozone crisis will mean that Greece and the PIIGS will experience bailouts after bailouts after bailouts. Thus, an implied currency war in the process until the unsustainable system of fiat money collapses or people awaken to the risk thereof and apply political discipline.

For now, the policy of bailouts and inflationism will continue to be the central feature of today’s global policy making process where currency values will be determined by the degree of relative inflationism applied.

War on the Internet: Threat to National Security as Pretext for Controls

As earlier posted, governments around the world will be rationalizing control of the web or the cyberspace by putting up various bogeymen (strawmen).

The US has now been considering cyber attacks as a threat to national security that would justify military response.

From the Wall Street Journal,

The Pentagon has concluded that computer sabotage coming from another country can constitute an act of war, a finding that for the first time opens the door for the U.S. to respond using traditional military force.

The Pentagon's first formal cyber strategy, unclassified portions of which are expected to become public next month, represents an early attempt to grapple with a changing world in which a hacker could pose as significant a threat to U.S. nuclear reactors, subways or pipelines as a hostile country's military.

This is an overblown reaction.

Writes Cato’s Benjamin Friedman

Actually, our claim is not that we should never use military means to respond to cyberattacks. Our point instead is that the vast majority of events given that name have nothing to do with national security. Most “cyberattackers” are criminals: thieves looking to steal credit card numbers or corporate data, extortionists threatening denial of service attacks, or vandals altering websites to grind personal or political axes. These acts require police, not aircraft carriers.

Even the cyberattacks that have affected our national security do not justify war, we argue. There is little evidence that online spying has ever done grievous harm to national security, thinly sourced reports to the contrary notwithstanding. In any case, we do not threaten war in response to traditional espionage and should not do so merely because it occurs online.

Moreover, despite panicked reports claiming that hackers are poised to sabotage our “critical infrastructure” — downing planes, flooding dams, crippling Wall Street — hackers have accomplished nothing of the sort. We prevent these nightmares by decoupling the infrastructure management system from the public internet. But even these higher-end cyberattacks are only likely to damage commerce, not kill, so threatening to bomb in response to them seems belligerent.

I am reminded by this wonderful quote from General Douglas MacArthur who said that government has always peddled fear to expand over us.

Our government has kept us in a perpetual state of fear -kept us in a continuous stampede of patriotic fervour -with the cry of grave national emergency. Always, there has been some terrible evil at home, or some monstrous foreign power that was going to gobble us up if we did not blindly rally behind it

Always somewhere a deception designed to curtail our liberties.

Nassim Taleb: US Federal Reserve will Cease to Exist in 25 years

Nassim Taleb celebrated author of the Black Swan theory makes a bold forecast

The Federal Reserve won’t exist in 25 years and the reappointment of Ben Bernanke as head of the central bank was a “management failure,” said Nassim Taleb, author of ‘The Black Swan.’

Allowing Bernanke to stay at the helm of the Fed is equivalent to “letting an unqualified pilot fly a plane,” Taleb, a principal at Universa Investments LP, told a conference in Moscow, Russia today.

From Moneynews.com

Tornadoes and Technology

From Patrick Michaels at the Forbes (ht: Don Boudreaux)

Despite 2011, there’s strong evidence that we are saving a tremendous number of lives with modern technology.

After the 1953 disasters, developers of weather radar convinced Congress to support a national network of detectors known as the WSR-57 (for 1957), a very acceptable machine for picking up tornadoes capable of causing significant damage. By the mid-1970s, WSR-57′s pretty much covered the tornado-prone regions of the nation.

An interesting thing happened to tornado frequencies. Before the WSR-57 went online the number of reported tornadoes averaged about 500 per year nationwide. By the time the network was complete, we leveled out around 800. Tornado death frequency–the number of fatalities per million–dropped precipitously. This was an unqualified technological success.

This only demonstrates how capitalism via technological advancement has helped saved many lives.

Global War on Drugs a Failed Policy

Here is the statement from a report of the Global Commission on Drug Policy, a nineteen-member panel that includes, among others, world figures such as former United Nations Secretary General Kofi Annan, former Brazilian President Fernando Henrique Cardoso and former NATO Secretary General Javier Solana. The current Prime Minister of Greece, George Papandreou is also a signatory which makes him the only representative of government.

(bold emphasis mine)

The global war on drugs has failed, with devastating consequences for individuals and societies around the world. Fifty years after the initiation of the UN Single Convention on Narcotic Drugs, and 40 years after President Nixon launched the US government’s war on drugs, fundamental reforms in national and global drug control policies are urgently needed.

Vast expenditures on criminalization and repressive measures directed at producers, traffickers and consumers of illegal drugs have clearly failed to effectively curtail supply or consumption. Apparent victories in eliminating one source or trafficking organization are negated almost instantly by the emergence of other sources and traffickers. Repressive efforts directed at consumers impede public health measures to reduce HIV/AIDS, overdose fatalities and other harmful consequences of drug use. Government expenditures on futile supply reduction strategies and incarceration displace more cost-effective and evidence-based investments in demand and harm reduction.

Cato’s Juan Carlos Hidalgo writes, (bold highlights added)

The 20-page report says all the right things: prohibition has failed in tackling global consumption of drugs, and has instead led to the creation of black markets and criminal networks that resort to violence and corruption in order to carry out their business. This drug-related violence now threatens the institutional stability of entire nations, particularly in the developing world. Also, prohibition has caused the stigmatization and marginalization of people who use illegal drugs, making it more difficult to help people who are addicted to drugs. The report also denounces what it properly calls “drug control imperialism,” that is, how the United States has “worked strenuously over the last 50 years to ensure that all countries adopt the same rigid approach to drug policy.”

In the recommendations section, the report praises the experience of Portugal with drug decriminalization, mentioning Cato’s study on the subject. But perhaps more importantly, it states that drug legalization “is a policy option that should be explored with the same rigor as any other.” Until now, similar reports have denounced the war on drugs and perhaps called for the decriminalization of marijuana and other soft drugs, but they also have stopped short of mentioning drug legalization as a policy alternative.

Prohibition laws represents an example of noble intent, whose visible effects, fails to account for the cost of the unseen—the economic effects and people’s response to such repressive laws.

Free Trade’s Influence on Culture

Even a culture of hate, bigotry and intolerance can be reformed by free trade.

From the Slate, (hat tip David Boaz)

If a century seems like a long time for a culture of racism to persist, consider the findings of a recent study on the persistence of anti-Semitism in Germany: Communities that murdered their Jewish populations during the 14^th-century Black Death pogroms were more likely to demonstrate a violent hatred of Jews nearly 600 years later. A culture of intolerance can be very persistent indeed.

Changing any aspect of culture—the norms, attitudes, and "unwritten rules" of a group—isn't easy. Beliefs are passed down from parent to child—positions on everything from childbearing to religious beliefs to risk-taking are transmitted across generations. Newcomers, meanwhile, may be attracted by the culture of their chosen home—Europeans longing for smaller government and lower taxes choose to move to the United States, for example, while Americans looking for Big Brotherly government move in the other direction. Once they arrive, these migrants tend to take on the attitudes of those around them—American-born Italians hold more "American" views with each subsequent generation.

"Good" cultural attitudes—like trust and tolerance—may thus be sustained across generations. But the flipside is that "bad" attitudes—mutual hatred and xenophobia—may also persist.

How trade changes culture... (bold highlights mine)

Not all cities like Würzburg were so unwavering in their anti-Semitism, however. Those with more of an outward orientation—in particular, cities that were a part of the Hanseatic League of Northern Europe, which brought outside influence via commerce and trade—showed almost no correlation between medieval and modern pogroms. The same was true for cities with high rates of population growth—with sufficient in-migration, the newcomers may have changed the attitudes of the local culture.

The simple point is that trade promotes social cooperation and has the power to change beliefs and culture. And the above is an anecdotal evidence of this.

Once again this validates the theories of the great Ludwig von Mises who wrote,

The market is that state of affairs under which I am giving something to you in order to receive something from you. I don't know how many of you have some inkling, or idea, of the Latin language, but in a Latin pronouncement 2,000 years ago already, there was the best description of the market — do ut des — I give in order that you should give. I contribute something in order that you should contribute something else. Out of this there developed human society, the market, peaceful cooperation of individuals. Social cooperation means the division of labor.

Technology Uncovers the Secrets of the Pyramid

Like it or not, this is the information-digital age.

Work that used to take years to uncover can be done over a short period time with rapidly developing technologically enhanced instruments. Moreover, long held secrets of nature have greater chances to be discovered.

Below is an example of another important breakthrough: a specially designed robot has unearthed the ancient markings of the pyramid’s secret chamber. And this discovery has gone viral.

From Yahoo (bold emphasis mine)

Are the glory days of the archaeologist over? Has everything cool and ancient already been discovered? Nope. Thanks to ever-improving technology, several new findings have electrified the Web.

A robot explorer recently discovered ancient markings at the Great Pyramid of Giza in Egypt. The robotic device found the markings inside a secret chamber inaccessible to humans--and then proceeded to film the painted hieroglyphics and stone markings, which hadn't been seen by human eyes in 4,500 years, via a small robotic camera that was fit through a tiny hole in a stone wall.

It is too soon to tell what the markings mean, but experts are hoping they may shed some light on why the ancient Egyptians originally built the tunnels. An article from CNN explains that the tunnel is "one of several mysterious passages leading from the larger king's and queen's chambers."

This wasn't the first time a robot explored the passageways--but it was the first time a robot could focus on details on the walls. This breakthrough occurred thanks to a new kind of micro-camera that can be bent side-to-side instead of just focusing straight ahead.

News of the discovery quickly took the Web by storm. Over the past 24 hours, Web searches for "great pyramid of giza" and "egypt pyramids" both spiked into breakout status. Also seeing big bumps in lookups: "hieroglyphic dictionary" and "hieroglyphic meanings."

Meanwhile, other technologically enhanced discovery expeditions have turn up other fascinating new information about the pyramids in recent days. Archaeologists from the United States (with some help from the BBC) used satellite imagery to discover 17 pyramids beneath the sand and silt in Egypt. An article from Canada's CBC explains that 1,000 tombs and around 3,000 other buildings were also discovered thanks to the technology.

Technology and information are proving to be a potent force.

People will have increasing access to information or acquire the capability to secure knowledge from formerly unconventional channels and on real time.

Science will enhance economic progress which should open doors to new industries (lengthening of the production process), organizational and business processes and new markets.

Also by increasing knowledge and with the introduction of specialized tools, productivity will be enhanced. This should mean more prosperity and wealth or a higher living standard for society.

Although despite the good news, there will always be the opposition. They will be personified by people who resist change (luddites), people who feel entitled (welfare beneficiaries) and people who desire control (progressives or liberals, politicians and the bureaucracy) who will use political force to oppose this progress.

Yet despite all the hurdles, breakthroughs like this is a refreshing news.

China’s Bubble Cycle Deepens with More Grand Inflation Based Projects

So China isn’t just preparing for a bailout, she has also put into the pipeline another huge stimulus program to prevent the risk of a slowdown.

Reports the Bloomberg, (bold emphasis mine)

China’s plan to rein in property prices with a record homebuilding program may worsen local debt risks even as it proves a boon to companies from domestic cement makers to Chilean copper exporters.

Premier Wen Jiabao aims to build 36 million low-cost homes by 2015, an initiative that will see 2 trillion yuan ($307 billion) added to local government borrowing by 2012, bringing it to a total 12 trillion yuan, Standard Chartered Plc estimates. The surge of loans to local authorities may spark a wave of bank bailouts that hobble economic growth.

And the symptoms of a bubble are getting visible as time passes; China has even her version of financial innovation or regulatory arbitrage or “shadow banking system”!

From the same article, (emphasis added)

Local governments have created more than 8,000 investment companies that allow them to get around regulations prohibiting direct borrowing. Fitch Ratings cites lending to the vehicles and to property developers in a worst-case scenario predicting bad loans could reach 30 percent of the total at China’s banks.

Moody’s Investors Service also built a 10 percent bad-loan ratio into its stress tests on China’s banks, which the company says probably will provide most of the social-housing funding.

So where will China get the money to finance these grand projects?

Again from the same article, (bold underscore mine)

Banks had a total of 50 trillion yuan of all loans outstanding in April. Standard & Poor’s has said the bad-loan ratio may climb next year to as high as 10 percent, from 1.1 percent now.

Social housing projects have “a pretty thin profit,” said Zhang Yi, senior analyst at Moody’s in Beijing. “It’s not like you are lending to highly profitable companies.”

Chris Ruffle, who helps manage $19 billion for Martin Currie Inc. in Shanghai, said, “it’s not a great situation and I wouldn’t want to be an investor in banks” after the record boom in lending.

The government hasn’t spelled out how construction of low- income housing will be financed over the full five years or how local governments will recoup their costs.

The central and local governments combined will provide 500 billion yuan of a total of at least 1.3 trillion yuan to build 10 million homes this year, Vice Minister of Housing and Urban- Rural Development Qi Ji said March 9, without saying how they will come up with the money. The central government will provide about 121 billion yuan.

While officials have pressed banks not to expand lending to local government financing vehicles, China Banking Regulatory Commission Chairman Liu Mingkang said that credit dedicated to affordable-housing developments with “repayment capability” was exempted from the push, the China Securities Journal reported March 7.

By building cheaper homes, either for rent or sale below market prices, Wen seeks to prevent social unrest caused by record property prices. He’s also countering rising prices in major cities with curbs on lending and mortgages, and a trial property tax in some cities. The risk is a slowdown in land sales that contribute about a third of local government revenue...

The program is front-loaded, with 10 million units planned for this year, a 170 percent surge from the 2010 total. Vice Premier Li Keqiang said Feb. 24 that the 2011 target is “mandatory” and local governments must increase funding for the plan.

A “financing hole” of between 817 billion yuan and 1.4 trillion yuan this year alone means most of the construction will probably be funded through bank loans, said Stephen Green, head of China research at Standard Chartered in Shanghai. He estimates that construction this year may cost as much as 1.9 trillion yuan.

Well like all bubbles, financing will emanate from inflationism and financial repression or via the diversion of private sector savings through money printing and expansion of circulation credit from the banking system to fund government pet projects.

China’s government looks desperate to avert a slowdown by attempting to maintain the current price levels, so as to maintain the profitability of sectors benefiting from the stimulus programs. The government, as shown above, does this by applying more inflation. So on one hand the government facetiously pretends to prevent a bubble by applying preventive tightening on some sectors. On the other hand, she inflates more. The left hand does not know what the right hand is doing.

As the great Murray Rothbard explained, (bold emphasis added)

First it pumps in a great deal of new money because, in the depth of recession, prices go up very little in response. Emboldened by this "economic miracle," it pumps more and more new money into the system. Then, when prices finally start accelerating, it tries to prolong the inevitable and thereby only succeeds in delaying market adjustments.

The policy of quasi booms eventually will end up with a bust. China is playing well into the Austrian Business Cycle script.

As I have been saying, the phase of China’s inflation cycle have been more advanced compared to her major counterparts, as exhibited by this chart from Pragmatic Capitalist

And the above development represents as more signs that the next financial crisis will likely emanate from China.

Chart of the Day: Earnings Don’t Drive Stock Prices

I’ve been arguing since that earnings have hardly been the principal drivers of stock prices.

Today’s Bloomberg’s chart of the day appears to bolster my case. And this time such dynamic applies to the S&P 500

Here’s a passage from the Bloomberg article,

Stocks with the most reliable earnings are underperforming those with the least predictable results by the most since at least 1997 and may soon start to outperform, Morgan Stanley Investment Management said.

The CHART OF THE DAY compares the performance of so-called high-quality companies on the Standard & Poor’s 500 Index with low-quality businesses. S&P awards all equities a quality rating based on the sustainability and robustness of both their earnings and their balance sheets.

“Despite all the uncertainty in the market, quality is very cheap at the moment,” said Bruno Paulson, the portfolio manager of MSIM’s global franchise strategy, which has $6.3 billion under management, in London. “It’s not unreasonable to expect some re-rating from here. I don’t know what will trigger it; it might be the end of liquidity.”

So the quoted expert partly attributes ‘liquidity’ to this phenomenon but sounds rather tentative. I would suggest that this represents the mainstream view (again I am applying representative bias here) where the mainstream don’t get it.

Inflationism has been the main culprit. Flooding the world with too much money leads to speculative excess. This amounts to the bidding up of prices of low quality stocks more than the high quality counterparts. When people chase prices, rumor based plays are rife and earnings become a side story.

I would like to reiterate Austrian economist Fritz Machlup’s dictum (bold highlights mine)

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.

Each day that passes, evidences seem to emerge in favor our views.

How could the Euro be so strong?

That’s the usual question posed by people who read articles about the grim political economic situation in the Eurozone.

Since the Greece debt crisis has began unraveling in 2009 (see timeline here), the Euro had initially been affected (see red arrows) but eventually as the price chart shows, the Euro has been discounting the issue.

This isn’t to say the crisis isn’t real, but rather the crisis is a relative issue. One cannot tunnel on Europe without looking at the conditions of the US or of the other economies.

I superimposed gold’s price trend to illustrate the strong correlation between the Euro and gold. My bullishness in the Euro had been validated (see here and here).

Now going back to the question

Here is my terse reply:

The Euro has been strong because the problems of the US dwarfs the crisis in Europe.

Proof?

From Danske Bank

The Euro has been validating the theory of the great Ludwig von Mises [Causes of Economic Crisis, Stabilization of the Monetary Unit—From the Viewpoint of Theory] who wrote, [emphasis added]

These observers do not understand that the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one.

The above chart puts the entire global debt crisis predicament into perspective by showing how central banks has responded with ‘bailouts’ of their respective financial system

From the supply side, massively printing of money to resolve the debt issue represents the diminishing marginal value of additional money into the economic system.

Here the ECB has printed a lot less of money compared to the US Federal Reserve, perhaps owing to the trauma experienced from the hyperinflation of the Weimar Republic in 1921-23.

From the demand side, the quality and price value of securities absorbed and held in the balance sheets of the US Federal Reserve from the banking system during the crisis should be viewed as a continuing concern.

It’s a misplaced idea or belief that the seeming tranquil conditions today in the US be interpreted as the policy of inflation having successfully settled the legacies of the economic and financial crash in 2008.

The Fed has printed trillions yet home price indices appear to be in a double dip recession.

From yesterday’s S&P press release [bold highlight mine]

This month’s report is marked by the confirmation of a double-dip in home prices across much of the nation. The National Index, the 20-City Composite and 12 MSAs all hit new lows with data reported through March 2011. The National Index fell 4.2% over the first quarter alone, and is down 5.1% compared to its year-ago level. Home prices continue on their downward spiral with no relief in sight.” says David M. Blitzer, Chairman of the Index Committee at S&P Indices. “Since December 2010, we have found an increasing number of markets posting new lows. In March 2011, 12 cities - Atlanta, Charlotte, Chicago, Cleveland, Detroit, Las Vegas, Miami, Minneapolis, New York, Phoenix, Portland (OR) and Tampa - fell to their lowest levels as measured by the current housing cycle. Washington D.C. was the only MSA displaying positive trends with an annual growth rate of +4.3% and a 1.1% increase from its February level.

Chart from CLSA Greed and Fear

A double dip in home prices suggests that the value of the Fed’s assets have been deteriorating considering huge amounts of exposure on mortgage and agency papers.

So neither does this represent as a plus for the US dollar.

Add to that the unresolved fiscal issues.

So how will the US government act on the above? Quantitative Easing 3.0, 4.0, 5.0...nth? Will these make the case for a stronger US dollar relative to the Euro?

To argue so means that money printing won’t have negative effects on the US economy. This would be like believing in a philosopher’s stone—the alchemy of turning lead into stone.

Of course it’s also nonsense to believe in the argument that fiscal restraint or “austerity” as the sole or main basis for bearishness on the Euro, except when you see the world as being driven by “spending” alone. Yet this view appears gradually being disproven.

Putting one’s house in order should be seen as a virtue and not a vice.

Also the above discussion hasn’t been new, I have dealt with this before here

True, political events (the clash between the ECB and national officials) can undermine the Euro, but again the big picture, based on the above, says the balance of risks has been tilted against the US dollar.

And it isn’t in the political interests of both contending political entities to see a worsening of schism that would only undermine their statures and importantly their tenures.

As fund manager Axel Merk writes, (bold emphasis mine)

We have long argued that it is not in Greece's interest to default at this stage because Greece needs to get its primary deficit under control before restricting its debt. As further reforms are implemented, the risk/reward ratio for Greece will change to potentially favor a default to reduce its debt burden. Delaying any default benefits Greece because any default now would impose an immediate adjustment of the primary deficit as it may be impossible to get new loans at palatable terms.

However, if ECB deserts Greece, the risk/reward assessment for Greece is changing. If the ECB gets too tough on Greece, dynamics in Greece may drive political dynamics to favor a default or even a re-introduction of the drachma.

Mind you that this would not be in Greece's interest: a default now won't fix Greece's underlying structural issues. Leaving the eurozone might cause an implosion of Greece's financial system. But from Greece's point of view, if they feel deserted by the ECB, political dynamics may favor the worst of the bad choices at hand.

And that’s why a second round of bailout seems to be at work as of this writing. So both the US and the Euro will be inflating again and that the question would be which currency inflates more.

Popular analyst John Mauldin predicts “The euro appears to me to be a massive short.” I hope he puts his money on his forecast, and wish him a lot of good luck.

I’d be taking the opposite fence though, until I see signs of the Eurozone inflating more than the US or an imminent political instigated collapse of Euro.

However, instead of buying the Euro, the best position in my view, would be to buy gold.

Gold would not share the same risk of the Euro although both of them have paralleled each other’s moves.

Gold’s nemesis would be a fiscally disciplined limited government, sound money and free markets, forces which we won’t be seeing anytime soon yet.

Was the IMF Chief Jailed for Discovering that Gold held by the US has Vanished?

That’s what Russia claims, according to the Eutimes.net

A new report prepared for Prime Minister Putin by the Federal Security Service (FSB) says that former International Monetary Fund (IMF) Chief Dominique Strauss-Kahn was charged and jailed in the US for sex crimes on May 14th after his discovery that all of the gold held in the United States Bullion Depository located at Fort Knox was ‘missing and/or unaccounted’ for.

According to this FSB secret report, Strauss-Kahn had become “increasingly concerned” earlier this month after the United States began “stalling” its pledged delivery to the IMF of 191.3 tons of gold agreed to under the Second Amendment of the Articles of Agreement signed by the Executive Board in April 1978 that were to be sold to fund what are called Special Drawing Rights (SDRs) as an alternative to what are called reserve currencies.

This FSB report further states that upon Strauss-Kahn raising his concerns with American government officialsclose to President Obama he was ‘contacted’ by ‘rogue elements’ within the Central Intelligence Agency (CIA) who provided him ‘firm evidence’ that all of the gold reported to be held by the US ‘was gone’.

Upon Strauss-Kahn receiving the CIA evidence, this report continues, he made immediate arrangements to leave the US for Paris, but when contacted by agents working for France’s General Directorate for External Security (DGSE) that American authorities were seeking his capture he fled to New York City’s JFK airport following these agents directive not to take his cell-phone because US police could track his exact location.

Read the rest here

I wouldn’t know how valid this report is. One thing for sure, whether it is Russia, the US or the IMF, all appears to be dogged by credibility problems.

China Prepares For Massive Bailout!

China spent around $586 to shield itself from the global meltdown in 2008. The aftermath has been to engender bubble conditions as evidenced by the ballooning balance sheets of their banking system and the local government. Recognizing the risk of a bust, China mulls a massive bailout.

The following report from Reuters, (bold emphasis mine)

China's regulators plan to shift 2-3 trillion yuan ($308-463 billion) of debt off local governments, sources said, reducing the risk of a wave of defaults that would threaten the stability of the world's second-biggest economy.

As part of Beijing's overhaul of the finances of heavily-indebted local governments, the central government will pay off some of their loans and state banks including some of the "Big Four" will be forced to take some losses on the bad debt, said the sources, both of whom have direct knowledge of the plans.

Part of the debt will also be shifted to newly created companies, while private investors would be welcomed in projects previously off-limits to them, sources said.

Beijing will also lift a ban on provincial and municipal governments selling bonds, a step aimed at bolstering their finances with more transparent sources of funding.

Many analysts see China's pile of local government bad debt as a major risk to the economy, especially as the economy slows, but few see widespread banking fallout as they believe cash-rich Beijing can step in to soak up losses.

The clean-up plan could boost investor confidence in Chinese banks, which have provided many of their loans as part of the massive economic stimulus program launched by Beijing in late 2008 to counter the global financial crisis.

The program resulted in unfettered lending to local government financing vehicles, hybrid government-company bodies that governments used to get around official borrowing restrictions.

After a months'-long investigation into local government liabilities, Beijing has determined that local governments have borrowed around 10 trillion yuan, said one of the sources.

Additional comments:

1. The previous bailout (stimulus spending) fostered a political economic environment of moral hazard whose consequence was to propagate massive misdirection of capital investments.

2 While lifting the ban on selling provincial and municipal governments seems good, as bond markets will supposedly reflect on the economic conditions, alternatively seen, this measure is meant to soak up private savings into government bailout programs. In short, this represents no more than China’s version of financial repression at work.

3. It is true that China has massive savings that perhaps may afford her to conduct another bailout, but as previously discussed, bailouts would only consume productive capital by diverting them into non-productive activities. Additionally part of the bailouts will surely be accommodated with inflationism.

4. The proposed bailout which accounts for as 20-30% of local government could be understated. Yet this seems like more evidence of the maturing phase of China’s bubble cycle.

5. If China applies the above bailouts before the bust then this could extend the boom but at the risk of that the next crisis will come with a greater intensity.

How Anti-Dumping Leads to Reduced Competitiveness

For the left, because trade is a zero sum game and an activity done by nations and not by individuals, imbalances are always someone’s fault. Thus prescribe policies that lean towards protectionism.

One of their populist claim is that asymmetric currency values leads to the alleged imbalances. But they hardly talk about how extant protectionist policies have been contributing to the loss of competitiveness and consequently high unemployment rates.

One of such protectionist policy is the anti-dumping emasures

Cato’s Dan Ikenson elaborates (bold highlights mine)

During the decade from January 2000 through December 2009, the U.S. government imposed 164 antidumping measures on a variety of products from dozens of countries. A total of 130 of those 164 measures restricted (and in most cases, still restrict) imports of intermediate goods and raw materials used by downstream U.S. producers in the production of their final products. Those restrictions raise the costs of production for the downstream firms, weakening their capacity to compete with foreign producers in the United States and abroad.

In all of those cases, trade-restricting antidumping measures were imposed without any of the downstream companies first having been afforded opportunities to demonstrate the likely adverse impact on their own business operations. This is by design. The antidumping statute forbids the administering authorities from considering the impact of prospective duties on consuming industries—or on the economy more broadly—when weighing whether or not to impose duties.

That asymmetry has always been insane, but given the emergence and proliferation of transnational production and supply chains and cross-border investment (i.e., globalization)—evidenced by the fact that 55% of all U.S. import value consists of raw materials, intermediate goods, and capital equipment (the purchases of U.S. producers)—it is now nothing short of self-flagellation.

Most of those import-consuming, downstream producers—those domestic victims of the U.S. antidumping law—are also struggling U.S. exporters. In fact those downstream companies are much more likely to export and create new jobs than are the firms that turn to the antidumping law to restrict trade. Antidumping duties on magnesium, polyvinyl chloride, and hot-rolled steel, for example, may please upstream, petitioning domestic producers, who can subsequently raise their prices and reap greater profits. But those same “protective” duties are extremely costly to U.S. producers of auto parts, paint, and appliances, who require those inputs for their own manufacturing processes.

Read the rest here

Environmental Apocaplytics: Put Money Where Your Mouth Is

Professor Don Boudreaux at the Wall Street Journal does a Julian Simon (free market economist Julian Simon made a famous wager against Malthusian Paul Elrich over the false notion of resource scarcity and handily won)

Writes Don Boudreaux, (bold emphasis added)

I reject this pessimism. I do so because economics and history teach that human beings in market economies have proven remarkably creative and resourceful in overcoming challenges. And there's no reason to think that this creativity and resourcefulness will fail us in the face of climate change.

Since 1950 there have been 57 confirmed F5 tornadoes, with winds between 261–318 miles per hour, in the U.S. Of those, five struck in 1953; six in 1974. So far this year there have been four F5 tornadoes in the U.S., including the devastating storm that killed more than 130 people in Joplin on May 22. F5 tornadoes are massive, terrifying and deadly. But they generally touch down in unpopulated areas, thus going unnoticed. The tragedy of Joplin and other tornadoes this year is that they touched down in populated areas, causing great loss of life. Yet if these storms had struck even 20 years ago there would have been far more deaths.

So confident am I that the number of deaths from violent storms will continue to decline that I challenge Mr. McKibben—or Al Gore, Paul Krugman, or any other climate-change doomsayer—to put his wealth where his words are. I'll bet $10,000 that the average annual number of Americans killed by tornadoes, floods and hurricanes will fall over the next 20 years. Specifically, I'll bet that the average annual number of Americans killed by these violent weather events from 2011 through 2030 will be lower than it was from 1991 through 2010.

If environmentalists really are convinced that climate change inevitably makes life on Earth more lethal, this bet for them is a no-brainer. They can position themselves to earn a cool 10 grand while demonstrating to a still-skeptical American public the seriousness of their convictions.

But if no one accepts my bet, what would that fact say about how seriously Americans should treat climate-change doomsaying?

Do I have any takers?

Quote of the Day: Challenging Monopolies

From excerpt from Forbes Magazine on how John Gokongwei owned Cebu Pacific [PSE: CEB] grabbed the airline industry tiara from Lucio Tan’s Philippine Airlines [PSE: PAL]. (emphasis mine)

It was Lance's father, legendary ragsto- riches entrepreneur John Gokongwei Jr., who had the idea to start Cebu Pacific. John, now 84, sits atop JG Summit Holdings, one of the Philippines' largest conglomerates, and a family fortune that FORBES ASIA pegged at $1.5 billion last year. His interest in aviation was piqued after reading about U.S. discounter Southwest Airlines at the same time the Philippine government decided to open up the airline industry. But Lance believes there was another layer to his father's interest: "About a year before we bid for PAL and lost. So when deregulation came up, well, my dad loves challenging monopolies."

Read more here

Monopolies, which signify as government privileges, operate on principles of anti-competition. This implies that monopolies are fundamentally inefficient, are driven by political goals and irresponsive to consumer demands which all add up to say that monopolies are slow to adapt to the changes in the marketplace.

And so when industries once dominated by monopolies are deregulated, this ‘chink in the armor’ becomes exposed. In a newly deregulated environment, entrepreneurs should pounce on the opportunities to challenge government monopolies as the Gokongwei’s did.