Japan’s Inflationism Begins to Backfire

Changes to people’s behavior in response to devaluation policies adapted by the Bank of Japan (BOJ) have begun to manifest in the asset ownership mix by Japanese households.

Here is what I earlier pointed out,

The foremost reason why many Japanese may invest in the Philippines under the cover of “the least problematic” technically represents euphemism for capital fleeing Japan because of devaluation policies—capital flight!

As the great Ludwig von Mises wrote,

The holders of ready cash try as far as possible to avoid the dangers of devaluation which today threaten in every country. They keep large bank balances in those countries in which there is the least probability of devaluation in the immediate future. If conditions change and they fear for these funds, they transfer such balances to other countries which for the moment seem to offer greater security. These balances which are always ready to flee-so-called “hot money”—have fundamentally influenced the data and the workings of the international money market. They present a serious problem in the operation of the modern banking system.

The incipient developing signs of capital flight as noted by Zero Hedge (bold emphasis mine)

Bloomberg reports that "Finance Minister Jun Azumi’s efforts to get Japan’s households to increase investment in the nation’s debt are failing as holdings of government bonds fall to a seven-year low." Combing through the Japanese quarterly flow of funds report shows something very disturbing - the last bastion of JGB ownership, Japan's households, have started to shift out of bonds, which are now yielding 0.27% for the retail 5 Year bond, and about 1.00% for the 10 year, and are now putting their money straight into mattresses. "Japanese households owned 3.09 percent of domestic bonds in the final quarter of 2011, a decrease from 3.2 percent in the third quarter and the lowest since 2005, Bank of Japan data released March 23 show." And the worst news for any domestically funded ponzi regime: "Mrs. Watanabe” as many are housewives, have instead increased foreign-currency deposits and cash, according to the BOJ data. "It’s a case of retail JGBs not having enough yield,” said Naomi Fink, head of Japan strategy at Jefferies Japan Ltd."Households are accumulating cash and using financial investments to diversify into higher yields and JGBs don’t really provide this." ..."Individual investors are holding cash rather than bonds and other financial assets because they are wary of making risky investments, said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo." Needless to say, when even Japanese households have given up, it's game over... for bubbles in both bonds and in "conventional wisdom."

As the average Japanese flee domestic bonds and the yen, interest rates would significantly rise that would rock the proverbial boat of the balance sheets of their banking and financial system, whom accounts for as the largest financiers of the Japanese government through the JGB (Distribution of JGB owners as of 2009 shown in the below graph from Japan Bankers Association).

This would compel the BoJ to inflate even more in a futile attempt to suppress interest rates. The result would be a feedback loop—rising interest rates would be met with more inflationism which would fuel further rise in interest rates. Also Japanese authorities may resort to other means of financial repression, such as currency controls, mandates to own more bonds, and etc...

Thus, we can expect that the average Japanese to seek refuge either through precious metals or through foreign currency or both.

These are emergent signs of the unintended consequences of BoJ’s reckless policies that will lead to the self implosion of the yen, if, in the condition, that such inflationist policies should would be sternly pursued with. This would also presage the worsening of Japan's economic conditions.

Central bankers, mostly of developed economies, seem to think that they can wish away the law of scarcity through the printing (or should I say the digital) press.

Obviously reality has been catching up with them, as warned by Professor von Mises.

As a universal rule, inflation is a policy that cannot last.

Sustained Inflationism will End of the US Dollar Standard

The Economic Collapse Blog enumerates 10 reasons why they think the reign of the US Dollar is coming to an end.

The following are 10 reasons why the reign of the dollar as the world reserve currency is about to come to an end....

#1 China And Japan Are Dumping the U.S. Dollar In Bilateral Trade

A few months ago, the second largest economy on earth (China) and the third largest economy on earth (Japan) struck a deal which will promote the use of their own currencies (rather than the U.S. dollar) when trading with each other. This was an incredibly important agreement that was virtually totally ignored by the U.S. media. The following is from a BBC report about that agreement....

China and Japan have unveiled plans to promote direct exchange of their currencies in a bid to cut costs for companies and boost bilateral trade.

The deal will allow firms to convert the Chinese and Japanese currencies directly into each other.

Currently businesses in both countries need to buy US dollars before converting them into the desired currency, adding extra costs.

#2 The BRICS (Brazil, Russia, India, China, South Africa) Plan To Start Using Their Own Currencies When Trading With Each Other

The BRICS continue to flex their muscles. A new agreement will promote the use of their own national currencies when trading with each other rather than the U.S. dollar. The following is from a news source in India....

The five major emerging economies of BRICS -- Brazil, Russia, India, China and South Africa -- are set to inject greater economic momentum into their grouping by signing two pacts for promoting intra-BRICS trade at the fourth summit of their leaders here Thursday.

The two agreements that will enable credit facility in local currency for businesses of BRICS countries will be signed in the presence of the leaders of the five countries, Sudhir Vyas, secretary (economic relations) in the external affairs ministry, told reporters here.

The pacts are expected to scale up intra-BRICS trade which has been growing at the rate of 28 percent over the last few years, but at $230 billion, remains much below the potential of the five economic powerhouses.

#3 The Russia/China Currency Agreement

Russia and China have been using their own national currencies when trading with each other for more than a year now. Leaders from both Russia and China have been strongly advocating for a new global reserve currency for several years, and both nations seem determined to break the power that the U.S. dollar has over international trade.

#4 The Growing Use Of Chinese Currency In Africa

Who do you think is Africa's biggest trading partner?

It isn't the United States.

In 2009, China became Africa's biggest trading partner, and China is now aggressively seeking to expand the use of Chinese currency on that continent.

A report from Africa’s largest bank, Standard Bank, recently stated the following....

“We expect at least $100 billion (about R768 billion) in Sino-African trade – more than the total bilateral trade between China and Africa in 2010 – to be settled in the renminbi by 2015.”

China seems absolutely determined to change the way that international trade is done. At this point, approximately 70,000 Chinese companies are using Chinese currency in cross-border transactions.

#5 The China/United Arab Emirates Deal

China and the United Arab Emirates have agreed to ditch the U.S. dollar and use their own currencies in oil transactions with each other.

The UAE is a fairly small player, but this is definitely a threat to the petrodollar system. What will happen to the petrodollar if other oil producing countries in the Middle East follow suit?

#6 Iran

Iran has been one of the most aggressive nations when it comes to moving away from the U.S. dollar in international trade. For example, it has been reported that India will begin to use gold to buy oil from Iran.

Tensions between the U.S. and Iran are not likely to go away any time soon, and Iran is likely to continue to do what it can to inflict pain on the United States in the financial world.

#7 The China/Saudi Arabia Relationship

Who imports the most oil from Saudi Arabia?

It is not the United States.

Rather, it is China.

As I wrote about the other day, China imported 1.39 million barrels of oil per day from Saudi Arabia in February, which was a 39 percent increase from one year earlier.

Saudi Arabia and China have teamed up to construct a massive new oil refinery in Saudi Arabia, and leaders from both nations have been working to aggressively expand trade between the two nations.

So how long is Saudi Arabia going to stick with the petrodollar if China is their most important customer?

That is a very important question.

#8 The United Nations Has Been Pushing For A New World Reserve Currency

The United Nations has been issuing reports that openly call for an alternative to the U.S. dollar as the reserve currency of the world.

In particular, one UN report envisions "a new global reserve system" in which the U.S. no longer has dominance....

"A new global reserve system could be created, one that no longer relies on the United States dollar as the single major reserve currency."

#9 The IMF Has Been Pushing For A New World Reserve Currency

The International Monetary Fund has also published a series of reports calling for the U.S. dollar to be replaced as the reserve currency of the world.

In particular, one IMF paper entitled "Reserve Accumulation and International Monetary Stability" that was published a while back actually proposed that a future global currency be named the "Bancor" and that a future global central bank could be put in charge of issuing it....

"A global currency, bancor, issued by a global central bank (see Supplement 1, section V) would be designed as a stable store of value that is not tied exclusively to the conditions of any particular economy. As trade and finance continue to grow rapidly and global integration increases, the importance of this broader perspective is expected to continue growing."

#10 Most Of The Rest Of The World Hates The United States

Global sentiment toward the United States has dramatically shifted, and this should not be underestimated.

All the above signifies as secondary causes to what truly will end the US dollar standard: Sustained Inflationism.

We must remember, inflationism is a policy that cannot last and would be put to an end by its adverse ramifications: massive disruptions in the marketplace (possibly hyperinflation) and or rapid deterioration in the political environment. Since inflationism distorts price signals, it affects economic calculation of entrepreneurs and of the average citizenry.

The result would translate to a decline society’s division of labor that negatively affects productivity. This in turn sows social conflicts.

I would add that for #10, this has been the combined result of foreign imperial policies and of inflationism. Wars have essentially been funded by inflationism.

As Professor Ludwig von Mises warned in Defense, Controls, and Inflation (p.109)

We have not to choose between financing the increased government expenditure by collecting taxes and borrowing from the public, on the one hand, and financing it by inflation, on the other hand. Inflation can never be an instrument of a fiscal policy continued over a long period of time. Continued inflation inevitably leads to catastrophe.

The Myth of the Middle Income Trap

The Economist writes,

The forces of economic convergence are powerful, but not all powerful. Poor countries tend to grow faster than rich ones, largely because imitation is easier than invention. But that does not mean that every poor country of five decades ago has caught up, as today’s chart shows. It plots each country’s income per person (adjusted for purchasing power) relative to that of America, both in 1960 and in 2008. The chart appeared in the World Bank's recent China 2030 report. If every country had caught up, they would all be found in the top row. In fact, most countries that were middle income in 1960 remained so in 2008 (see the middle cell of the chart). Only 13 countries escaped this middle-income trap, becoming high-income economies in 2008 (top-middle). One of these success stories, it should not be forgotten, was Greece.

This is an example of how macro statistics can be used to mislead people. Countries essentially don’t fall into “traps”, it is the individual who make or unmake their respective wealth.

What truly restrains people from advancing is when productive resources are diverted into non-productive use. That’s basic, and is a matter of the law of opportunity costs or the law of scarcity.

And what induces non-productive use of resources are insatiable government spending, the welfare state, bloated bureaucracy and trade restrictions, anti-competition laws, bubble policies (or policies which induces consumption), inflationism (QEs) and all sorts of market distorting interventionism. Yes, all of them are interconnected.

As the great Professor Ludwig von Mises wrote, (bold emphasis added)

Each authoritarian interference with business diverts production, of course, from the lines it would take if it were only directed by the demand of the consumers as manifested on the market. The characteristic mark of restrictive interference with production is that the diversion of production is not merely an unavoidable and unintentional secondary effect, but precisely what the authority wants to bring about. Like any other act of intervention, such restrictive measures affect consumption also. But this again, in the case of the restrictive measures we are dealing with in this chapter, is not the primary end the authority aims at. The government wants to interfere with production. The fact that its measure influences the ways of consumption also is, from its point of view, either altogether contrary to its intentions or at least an unwelcome consequence with which it puts up because it is unavoidable and is considered as a minor evil when compared with the consequences of nonintervention.

Restriction of production means that the government either forbids or makes more difficult or more expensive the production, transportation, or distribution of definite articles, or the application of definite modes of production, transportation, or distribution. The authority thus eliminates some of the means available for the satisfaction of human wants. The effect of its interference is that people are prevented from using their knowledge and abilities, their labor and their material means of production in the way in which they would earn the highest returns and satisfy their needs as much as possible. Such interference makes people poorer and less satisfied.

In short, the more intervention, the lesser the capital accumulation or reduced economic growth. When politicians become greedy enough to divert much wealth into policy driven consumption activities then productivity diminishes. And that's where the so-called statistical 'trap' comes in.

Bottomline: the so-called Middle income trap represents a macroeconomic hooey.

UK’s Government Discourages Charity

We are often told that the private sector is instinctively greedy, and thus requires intervention to spread ‘charity’ and ‘compassion’.

Well, in the UK, acts of private sector charity or philanthropy will be penalized.

From Wall Street Journal Wealth Blog,

The U.K.’s new budget has ignited all manner of class warfare. Retirees say it’s a gift to the rich at the expense of the poor. The wealthy say it’s another attack on success and job creators.

But one piece has gone largely unnoticed: the limit on philanthropic giving. The measure would cap the tax relief for wealthy givers at 25% of their annual income, or £50,000, whichever is higher. It takes effect next year.

It’s similar to the Obama proposal, which would limit charitable deductions for high earners to 28% for couples with incomes of $250,000 or more or individuals with income of $200,000. The White House says limiting itemized deductions would shrink the deficit by $584 billion over 10 years.

The U.K. expects its measure (along with caps on business deductions) to result in $490 million in saved revenue.

“Giving shouldn’t mean you pay no tax,” according to the U.K. Treasury.

Yet charities say the plan would put a chill on philanthropic giving just as the U.K. government is trying to create a new culture of giving.

The “new culture of giving” is that the government forcibly takes what you own (by taxation), which in turn discourages acts of private charity (both by administrative limits and again by taxation--what you opt to donate will be taken instead).

And as the norm, governments spend these confiscated resources charitably on their pet projects (to the benefit of cronies and or to vote rich welfare dependents or for photo Op sensational projects).

This is not really new. It has been the nature of governments to undertake lawful plunder of the resources of the citizenry when so deemed politically expedient.

As the great Frédéric Bastiat wrote in The Law published in 1850

When does plunder cease, then? When it becomes more burdensome and more dangerous than labor. It is very evident that the proper aim of law is to oppose the fatal tendency to plunder with the powerful obstacle of collective force; that all its measures should be in favor of property, and against plunder.

But the law is made, generally, by one man, or by one class of men. And as law cannot exist without the sanction and the support of a preponderant force, it must finally place this force in the hands of those who legislate.

This inevitable phenomenon, combined with the fatal tendency that, we have said, exists in the heart of man, explains the almost universal perversion of law. It is easy to conceive that, instead of being a check upon injustice, it becomes its most invincible instrument.

It is easy to conceive that, according to the power of the legislator, it destroys for its own profit, and in different degrees amongst the rest of the community, personal independence by slavery, liberty by oppression, and property by plunder.

It is in the nature of men to rise against the injustice of which they are the victims. When, therefore, plunder is organized by law, for the profit of those who perpetrate it, all the plundered classes tend, either by peaceful or revolutionary means, to enter in some way into the manufacturing of laws. These classes, according to the degree of enlightenment at which they have arrived, may propose to themselves two very different ends, when they thus attempt the attainment of their political rights; either they may wish to put an end to lawful plunder, or they may desire to take part in it.

By preventing the private sector from engaging in philanthropic activities and by coercively taking their resources by law, who’s greedy now?

Quote of the Day: War Equals Presidential Greatness

Our data analysis suggests that wars in which a large percentage of the U.S. population is killed will, all other things equal, cause historians to judge as great a president on whose watch those wars occurred. Certainly, this was the perception of presidents Theodore Roosevelt and John F. Kennedy. It was probably also the perception of other presidents.

This conclusion is troubling. Most presidents, after all, probably want to be thought of as great. When they spend resources on war, they are spending almost entirely other peoples money and lives. They get little credit for avoiding war. Martin Van Buren, for example, effectively avoided a war on the northern border of the United States. How many people know that today?
Indeed, how many people have even heard of Martin Van Buren?

Woodrow Wilson, by contrast, inserted the United States into World War I. That was a war that the United States could easily have avoided. Moreover, had the U.S. government avoided World War I, the treaty that ended the war would not likely have been so lopsided. The Versailles Treaty`s punitive terms on Germany, as Keynes predicted in 1919, helped set the stage for WorldWar II.

So it is reasonable to think that had the United States not entered World War I, there might not have been a World War II. Yet, despite his major blunder and more likely, because of his major blunder, which caused over 100,000 Americans to die in World War I, Wilson is often thought of as a great president.

The danger is that modern presidents understand these incentives. Those who want peace should take historians` ratings of presidents seriously. Beyond that, we should stop celebrating, and try to persuade historians to stop celebrating, presidents who made unnecessary wars. One way to do so is to remember the unseen: the war that didn`t happen, the war that was avoided, and the peace and prosperity that resulted. If we applied this standard, then presidents Martin van Buren, John Tyler, Warren G. Harding, and Calvin Coolidge, to name four, would get a substantially higher rating than they are usually given.

That’s from a paper by Professors David Henderson and Zachary Gochenour.

Seeing greatness in war or destruction is an example of the public’s misconceived glorification of the state, which has mostly been a product of indoctrination and political propaganda.

War, according to writer Randolph Bourne, is the health of the state.

Wars are the ramifications of societies that worship the state, where the gullible public are misled to exalt the illusions of the supposed virtues of nationalism by ignoring the destructive real effects of such political actions.

Wars will always be a recourse or an option of any society that depends on political redistribution of resources.

US Federal Reserve Admits Bailout of the Eurozone

The US Federal Reserve finally admits or officially confirms of their bailout of the Eurozone

The Bloomberg reports,

Federal Reserve Bank of New York President William Dudley said that the central bank holds a very small amount of European sovereign debt and that he sees a “high bar” to additional purchases.

The standard for buying more European sovereign debt “is extraordinarily high for the U.S., for the Federal Reserve, to actually go out and buy foreign sovereign debt for its own portfolio, apart from the very small foreign exchange holdings that we have,” Dudley said today to a House Financial Services subcommittee hearing.

And US intervention in the EU has been no dollop, they consist of nearly hundred of billion of dollars of which ups the stake of US taxpayers on the EU. Well, billions in a bailout world of trillions does look like a "very small amount", but this would be linguistic misrepresentation.

The US has been expanding its ‘imperialist’ interventions formerly limited in the scope of foreign policies (military and geopolitics), which now seems to be swiftly expanding to cover finance and banking aspects.

In other words, the US is not just a policeman of the world, but also the world’s lender or banker of last resort.

Ron Paul recently wrote to expose on this central banking legerdemain

Essentially, beginning late last year the Fed provided U.S. dollars to the European Central Bank in exchange for Euros-- sometimes as much as $100 billion at a time. The ECB then funneled those dollars to European banks to provide liquidity and prevent crises from bank insolvencies. Since the currency swap was not technically a loan, the Fed did not have to embarrass itself by openly showing foreign bank debt on its balance sheet. The ECB meanwhile did not have to print new Euros and expose the true fragility of big European banks.

The entire purpose of this unholy arrangement was to obscure the truth: namely that the Fed was bailing out Europe with U.S. dollars.

But why is it the business of the Federal Reserve to bail out European banks that find themselves short of dollars to pay their dollar-denominated contracts? After all, those contracts often were hedges taken to protect banks against weakness of the Euro. Hedges are supposed to reduce risk, but banks that miscalculate should suffer their own losses accordingly. It’s not our business if the ECB chooses to create moral hazards by providing liquidity to European banks, but why should the Fed prop up Europe’s bad decisions!

The Fed has promised to provide unlimited amounts of dollars to the ECB, should circumstances require it. It boggles the mind. Of course when Fed officials first entered into these swap agreements with the ECB last September, they did so quietly. The American public only found out via websites of the ECB, the Bank of England, or the Swiss Central Bank.

The Fed already has pumped trillions of dollars into the economy since 2008, and US banks currently hold $1.5 trillion of excess reserves. So why don't American banks lend those excess trillions to European banks if they really need dollars? If US banks could earn 1 or 2 percent on those loans, they might just be interested. But they can't compete with the ½ percent interest rate charged by the Fed to the ECB. That's one glaring example of the harm caused by the Fed's ability to create money and loan it at below-market interest rates.

The Fed argues that these loans will be temporary, merely providing a little boost to get Europe over the hump. But that's what they thought a few years ago when such lines of credit to the ECB were set to expire, only to see the Fed reauthorize them. What happens if the European financial system collapses? Will the Fed be left holding a bunch of worthless Euros? Will the ECB simply shrug and turn over the collateral it received from European banks, maybe in the form of bonds from Ireland, Italy, or Greece? Have the 17 individual central banks backing the ECB pledged their gold holdings as collateral?

The Fed has placed a hundred-billion dollar bet on the future of the Euro, with the strength of the dollar on the line. This is absolutely irresponsible, and directly contrary to market discipline. Let private banks, European or otherwise, take their own risks. Let foreign central banks inflate their own currencies and suffer the consequences. In other words, it’s time to apply market principles to banks and money.

Clearly, Fed policies have not been designed to "devalue" the US dollar, which many in the left alleges as meant to promote exports (putting lipstick on a pig), but to survive the incumbent the crumbling unsustainable welfare-central banking and banking cartel based political institutions.

The world operates in a de facto US dollar standard or a banking system whose currency reserves have been built mostly on US dollar holdings. This means that Fed policies does not only expose US taxpayers to undue burden from policy risks, Fed policies has far reaching consequences which needlessly exposes the world to destabilizing financial and monetary risks that could ripple throughout national economies.

This also shows how centralized actions engender systemic risks.

This is just one fundamental reason to abolish the FED.

End the Fed. End central banking and the politicization of money.

Quote of the Day: Democracy as Instrument of Oppression

Great stuff from Professor Butler Shaffer at the LewRockwell.com,

Beyond this simplistic faith in a "social contract" theory of the state lies the reality that such systems have always been under the control of small groups of persons who are answerable to no one, particularly those they presume the authority to rule. "Democracy" is just one abstraction that the state owners have employed to distract the attention of their victims; to create in the minds of their subjects the illusion that they, not the owners, are running the system.

Believing that the state represents their interests, and that – through "democratic" processes - they control its direction and energies, most men and women identify themselves with that state. In this way, people and the state share the same "ego boundaries." When millions of people come together in this manner, it becomes easy for each to lose his or her individuality – and, hence, responsibility - in a collective identity. By engendering fear of others who share different ego-boundary identities, the state is able to mobilize "dark side" forces of the collective unconscious into a critical mass that allows the state to aggrandize its powers through violent, destructive means. Adolf Hitler used such methods to organize Germans against those he called non-Aryans. In the same way has the United States employed the specters of "communism," "drug-dealers," and "terrorism" to bamboozle its ego-boundary adherents into participating in its continuing war against life itself.

To anyone who makes a sincere effort to understand the nature of a supposedly democratic state, it is apparent that such a system rests on the flimsiest of foundations. People must be given the impression that, by voting, they are the show; they are steering the ship-of-state. But the corporate-state interests – the political establishment – that actually own the system, are not burdened by such delusions. The entire institutional order – including the state, major corporations, schools and universities, organized religions, and the mainstream media – share a common interest in keeping people subservient to their authority and control. At its most basic level – and as more of us have been learning of late – there are too many trillions of dollars of despoiled wealth, and too much power over the direction of human energy, to permit the establishment to allow preferences or even whims of ordinary people to upset institutional interests. In the words of Emma Goldman, "if voting changed anything, they’d make it illegal."

Read the rest here

The Coming Global Yen Carry Trade

I earlier noted that Japan’s currency, the yen, may function as a funding currency for interest rate and currency value arbitrages, or known as the carry trade, that may augment the ongoing bubble process in Philippines, as well as, in other ASEAN asset markets. It appears that the Yen carry may well be a global phenomenon.

Writes analyst Howard Simons at the Minyanville,

the BOJ may be ready to fly the Mission Accomplished banner in its war on the yen (yes, I just wrote this). The yen has regained its status as the cheapest currency to borrow, edging out other worthies such as the Hong Kong and Singapore dollars, the Swiss franc, and the US dollar.

That status is pushing more and more currencies into a positive carry against the yen. Even in those many cases where the yen has gained on a spot-rate basis, the loss is being offset by a higher interest rate spread. The overall result is a positive total carry. As recently as November 2011, 20 currencies had negative carries against the yen over the post-March 2009 era; that number is down to six.

In short, more positive carries should translate to more carry trades.

Central bank policies have indeed been spawning numerous imbalances globally. And if the BoJ’s debasement policies continues, then we should expect international investors to take advantage of these emerging arbitrage opportunities.

Profit from folly.

The Suddenness of Inflation

Bloomberg columnist, author and Council on Foreign Relations (CFR) analyst Amity Shlaes warns about the complacency of political authorities over inflation. (hat tip Professor Antony Mueller)

“Sudden” is more like it. The thing about inflation is that it comes out of nowhere and hits you. Monetary policy is like sailing. You’re gliding along, passing the peninsula, and you come about. Nothing. Then the wind fills the sail so fast it knocks you into the sea. Right now, the U.S. is a sailboat that has just made open water, and has already come about. That wind is coming. The sailor just doesn’t know it.

“Sudden” has happened to us before. In World War I, an early version of what we would call the CPI-U, the consumer price index for urban areas, went from 1 percent for 1915 to 7 percent in 1916 to 17 percent in 1917. To returning vets, that felt awful sudden.

The popular mainstream ‘begging the question’ argument on consumer price inflation goes something like this: inflation risk is minimal, because there has been little signs of inflation today.

Present and past actions have been construed as extending to the future, with little regards to the cause-and-effect relationship from implemented policies such as money printing or zero bound rates. In reality, these arguments have been pushed to justify more inflationist-interventionist policies: No inflation? Have more inflation.

Yet like natural disasters, inflation wreaks havoc at the least expected moments.

The volatile episodes of US CPI inflation coincided with wars (World War I, World War II and the Vietnam War). (chart from tradingeconomics.com)

In a relative sense, today’s US CPI inflation environment has been ‘calmer’ than the current periods. Even if the US has been engaged in numerous imperialist wars, along with the huge welfare state that substantially contributes to the ballooning record fiscal or budget deficits. (chart from the Heritage Foundation)

chart from Cleveland Federal Reserve

And this comes amidst the exploding balance sheet of the US Federal Reserve. The US Federal Reserve has topped China as the largest owner of US treasuries, which means that the US central bank has become the key source of financing for the US government.

And these banking based financing of public expenditures are inflationary. The great Murray N. Rothbard explained

Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling Treasury bonds to the public, then the deficits are not inflationary. No new money is created; people and institutions simply draw down their bank deposits to pay for the bonds, and the Treasury spends that money. Money has simply been transferred from the public to the Treasury, and then the money is spent on other members of the public.

On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money, in the form of bank deposits, is then spent by the Treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of one-tenth that amount. Thus, if banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately $10 billion of old Treasury bonds. This purchase increases bank reserves by $10 billion, allowing the banks to pyramid the creation of new bank deposits or money by ten times that amount. In short, the government and the banking system it controls in effect "print" new money to pay for the federal deficit.

Thus, deficits are inflationary to the extent that they are financed by the banking system; they are not inflationary to the extent they are underwritten by the public.

While we cannot exactly predict exactly when CPI inflation is bound to hit the US economy, given the recent actions by the US Federal Reserve and US Federal government, we understand though that inflation will eventually rear its ugly head.

The question is a WHEN rather than an If. And to what degree of inflation.

And worst, since the world has operated on a monetary standard based on the US dollar, the effects of US inflation will be worldwide.

The basis for such prediction is our theoretical understanding of the 3 stages of inflation

As the great Ludwig von Mises pointed out, (bold highlights mine)

In the early stages of an inflation only a few people discern what is going on, manage their business affairs in accordance with this insight, and deliberately aim at reaping inflation gains. The overwhelming majority are too dull to grasp a correct interpretation of the situation. They go on in the routine they acquired in non-inflationary periods. Filled with indignation, they attack those who are quicker to apprehend the real causes of the agitation of the market as "profiteers" and lay the blame for their own plight on them. This ignorance of the public is the indispensable basis of the inflationary policy. Inflation works as long as the housewife thinks: "I need a new frying pan badly. But prices are too high today; I shall wait until they drop again." It comes to an abrupt end when people discover that the inflation will continue, that it causes the rise in prices, and that therefore prices will skyrocket infinitely. The critical stage begins when the housewife thinks: "I don't need a new frying pan today; I may need one in a year or two. But I'll buy it today because it will be much more expensive later." Then the catastrophic end of the inflation is close. In its last stage the housewife thinks: "I don't need another table; I shall never need one. But it's wiser to buy a table than keep these scraps of paper that the government calls money, one minute longer."

A fundamental example has been the most recent bout of hyperinflation which buffeted Zimbabwe’s economy during the last decade, which I posted three years back.

When inflation strikes, it slams like a tidal wave. Zimbabwe’s hyperinflation produced a hockey stick like effect, similar to Weimar Germany’s experience.

While the risk of hyperinflation is not yet imminent, if the current path of inflationist policies is sustained, then this would enhance the probability of such a risk.

Why Socialists Hate the Internet

Writes Mary O’Grady at the Wall Street Journal, (bold emphasis mine) [hat tip Mark Perry]

'There's a reason the people in Cuba don't have access to the Internet. It is because the government [couldn't] survive it."

That was Florida Sen. Marco Rubio last week at a Washington conference titled "Cuba Needs a (Technological) Revolution: How the Internet Can Thaw an Island Frozen in Time." The event was sponsored by Google Ideas, a for-profit venture of the giant Internet search enterprise, and the nonprofit Heritage Foundation. I was asked to kick off things with a Rubio interview. So I began by asking him what he makes of the Cuban military's reference last year to technology that allows young people to exchange thoughts digitally as "the permanent battlefield."

Mr. Rubio responded that it isn't communication with the outside world that the regime fears the most, but Cuban-to-Cuban chatter. "I think Raúl Castro clearly understands that his regime cannot survive a Cuban reality where individual Cubans can communicate [with] each other in an unfettered manner." He called "unfiltered access to the Internet and social media" Cuba's "best hope" of avoiding "a stagnated dictatorship" for "the next 50 years that would survive even the death of Raul and Fidel."

The internet or the information age isn’t just about connectivity though. Rather the age of the internet is about the knowledge revolution or democratization of knowledge through “geographically noncontiguous communication” as author Jeffrey Tucker recently described.

The information age brings about unfettered opportunities to learn or to expand one’s horizon of wisdom. Say for instance anyone who wants to access literatures from libraries around the world may try openlibrary.org.

How about basic materials for self learning or home schooling? You may also try the revolutionary Khan Academy.

The political power of despots and their socialists supporters principally derives from ignorance. This is why the public has been vulnerable to fear and to mind manipulation—via indoctrination and propaganda.

People hardly realize that conventional education, for instance, has been surreptitiously designed for the worship of the state. The internet brought me to this reality and made me an apostate to the religion of the state.

The internet essentially provides the platform for the unceasing struggle to attain civil and economic liberties, through the effective neutralization of political manipulations of the people’s minds.

The chief proponent and inspiration of nonviolent resistance and civil disobedience, the great philosopher anarchist Étienne de La Boétie once wrote,

Obviously there is no need of fighting to overcome this single tyrant, for he is automatically defeated if the country refuses consent to its own enslavement: it is not necessary to deprive him of anything, but simply to give him nothing; there is no need that the country make an effort to do anything for itself provided it does nothing against itself. It is therefore the inhabitants themselves who permit, or, rather, bring about, their own subjection, since by ceasing to submit they would put an end to their servitude. A people enslaves itself,
cuts its own throat, when, having a choice between being vassals and being free men, it deserts its liberties and takes on the yoke, gives consent to its own misery, or, rather, apparently welcomes it. If it cost the people anything to recover its freedom

Thus enslavement and freedom is a matter of people’s choice. And the state of knowledge or ignorance by every individual in a society determines that choice.

The more the diffusion of knowledge in a society, the balance of power shifts towards individual sovereignty at the expense of political entities.

And that’s why welfare warfare based governments have been averse to the internet, and that’s why political authorities will continue to wage an all out war of control of the internet.

Phisix: Massive Global Credit Easing Policies Means Short Term Profit Taking

Economic weakness of China and of high oil prices, which supposedly threatens global economic growth, has been attributed by media as the cause for this week’s anemic performance by global stock markets[1].

The Perils of Relying on Media’s Availability Heuristics

It’s has been the intuitive inclination of media to oversimplify the causation process in the narration of events. In reality, such oversimplification represents the available bias or availability heuristic—judgment based on what we can remember, rather than complete data[2] or the fallacy of attributing current events to most recent market actions—than about the real forces driving the market’s action.

And applying heuristics to market analysis can lead one astray, and thus, amplifies the odds of erroneous decision making. One of Warren Buffett’s most precious investment advice has been

Risk comes from not knowing what you're doing.

This applies to sloppy thinking based on heuristics.

Financial markets rarely moves in a straight line.

If they do, then markets must be experiencing an episode of extreme stress, symptomatic of the ventilation of acute systemic imbalances on the marketplace. They appear in the form of a blowoff phase (climax) of a bubble cycle or of hyperinflation in motion.

Yes, stock markets soar to the firmament during episodes of hyperinflation. Although whatever gains seen is largely illusory as the local currency, enduring hyperinflation, depreciates so much faster than the nominal price gains in stock market values.

Zimbabwe which suffered from hyperinflation just a few years back saw its stock markets zoom[3], so as with the German stock market[4] during the horrific days of the Weimar hyperinflation.

Here, the role of stock markets shifts from intermediaries of capital to a monetary lightning rod. Of course, this cannot be explained by the orthodoxy of earnings or corporate fundamentals, since the public’s flight to safety motives has been driven by the desire to protect one’s wealth through ownership of real assets.

As one would note, stock markets becomes the fiduciary alternative to money under such conditions.

Yet in a normal bullmarket (or boom phase of a credit driven bubble cycle), intermittent profit taking sessions should be expected. This is where profit taking sellers of financial securities overwhelm the buyers that result to countertrend price actions. Nevertheless, financial markets tend to move in a general direction (uptrend, consolidation or downtrend) for a given period of time, despite interim countercylical fluctuations.

The pulsating surge of key global equity benchmarks suggests that this week’s retracement represents more of a profit taking process than signs of anxiety, where the losses (left window) have hardly dented on the enormous nominal local currency gains posted by the bellwethers of major economies since the start of the year (right window).

The US S&P 500 posted its second weekly loss in 12 weeks into 2012, while the Germany’s Dax, Japan’s Nikkei and the Philippine Phisix had 3 non-consecutive weekly losses. So far this translates to 1 week loss for every 3 weeks of gains for the latter 3 and 1 loss for every 5 weeks of gain for the S&P. Of course past performance is no guarantee for future outcomes.

In addition our ASEAN neighbors, Indonesia and Malaysia whom has largely missed the recent bullrun seems to defy last week’s profit taking mode. Instead they have posted modest gains, which in essence, incrementally closes on the gap between the region’s leaders the Philippines and Thailand and the laggards.

Moreover, Thailand has finally caught up with the Phisix.

So if we are seeing a rotational process among sectors and in the PSE and issues within specific sectors, then we seem to see the same process at work in global equity benchmarks.

The rotation in relative performances has been symptomatic of an inflationary boom.

As for media’s narrative, one week does not a trend make.

Huge Credit Easing Policies Means Profit Taking Will Be Short Term

If we examine the chart patterns of US equities, they seem to imply that this week’s profit taking mode might be extended.

And this could coincide with a breakdown of the ascending wedge pattern of the S&P 500 below.

Aside from the S&P, the Dow Jones Industrials and the Nasdaq chart patterns seem to tell the same tale.

What makes charts occasionally credible is that many believers can make such patterns a self-fulfilling process over the short run. And perhaps they can be augmented or complimented by trades based on algorithm or computer programs, which buy or sell triggers have been programmed to activate based on specific data points derived from chart patterns and or their corresponding indicators.

Yet any such breakdown could see some support at the 1,350 area. From Friday’s close, a downside move to this level will translate to about 3.3% retracement.

Yet chart patterns of the Philippine Phisix reveals of a subtle difference compared to the US benchmarks.

The Phisix seems to be partly in a symmetrical triangle—fundamentally this is a trend neutral pattern, which either signals continuity or a reversal[5]. Yet the recent double bottom pattern breakout also seems to suggest of a fresh upside trend at work. The implication is that any correction may be short term and shallow.

The Phisix and the S&P has had loose correlations from the last quarter of 2010 until late last year, where there had been numerous accounts of divergent actions between the two bourses. As a reminder, divergence does not represent decoupling.

Their correlations seemed to have tightened only from last October, where the combined actions of major central banks have forcibly led to major short coverings, as well as, yield chasing arbitrages that has painted an aura of ‘recovery’ as evidenced by resurgent global markets.

Another important reminder is that it is a misguided notion to assume that the current financial market developments have entirely been about ‘liquidity’.

Since 2008, political actions have included the widespread alteration of the rules of the game (such as changes in accounting rules[6], easing of collateral requirements[7], indiscriminate changes in the rights of private ownership to sovereign debt[8], arbitrary determination of credit event conditions for derivatives contracts[9]), direct and indirect bailouts, guaranteeing access to credit, implicit and explicit guarantees on assets, manipulation of the yield curve, interest rate payment on excess reserves, market making, buyer of last resort, lender of last resort, and etc..., has not only been about liquidity (liquefying of illiquid assets) but about arbitrary interventions in various forms and degree. In short, today’s financial markets have massively been in violation of various forms property rights of the private sector to the benefit of the banking system and the welfare state.

The mass politicization of the markets has been distorting price signals and has been misdirecting the allocation of resources. The piper in the fullness of time will be paid.

And given that the gist of the current tidal wave of major central asset purchasing programs have only been announced and put into action last month (such as ECB’s LRTO[10]), the effects of these massive cash infusions, compounded by the policy trends to adapt a negative rate regimes for many major emerging markets will likely put a floor on any recent corrections.

Thus it is unclear if the adverse signal emitted by these chart patterns, possibly signifying an extension of the corrective phase, will play out. And even if it does, any correction will likely be shallow.

Market Internals Reveal Profit Taking and Rotational Process

Yet market internals of the Phisix still exhibits some positive signs despite this week’s hefty correction.

True, decliners led advancers, but the spread between them has not deteriorated in a panic stricken scale as the previous sell-offs.

Moreover, of the 12 Phisix heavyweights representing 67% of the free float market cap last Friday, 3 posted gains and provided cushion to the index, specifically, Alliance Global [PSE:AGI], SM Investments [PSE: SM] and Bank of the Philippine Islands [PSE: BPI].

Meanwhile all the rest of the biggest caps posted losses led by SM Prime Holdings [PSE: SMPH], Philippine Long Distance Telephone [PSE:TEL], market leader Ayala Land [PSE:ALI] and Banco de Oro [PSE: BDO], all of which weighed on the index.

The decline as seen by the Phisix biggest market caps have equally been mirrored on the sectoral performance.

Again, we note that the mining index appears to have regained some appeal as many of the majors fell.

Finally foreign trades posted hefty net selling this week amidst a largely unchanged Peso.

But this came on the heels of the completion of the sale Alaska Milk Corporation[11] [PSE:AMC] from the seller, the Uytengsu family to the new owners the Dutch dairy giant Royal Friesland Campina for Php 12.86 billion.

My puzzle is that the buyer was a foreign group but the seller was a local group yet during the date of execution of the AMC trade, net foreign trade showed net selling almost to the tune of the AMC transaction.

Perhaps the foreign group incorporated a local company to execute the transaction, while the selling group, the Uytengsus’ equity ownership had been divested through a holding company incorporated abroad.

This could be another example of the inaccuracy of statistics which fails to capture the real developments behind each transaction.

The Political Imperative to Inflate the System

Bottom line: It is really very difficult to predict short term moves.

Nevertheless my basic premise still holds, the recent actions of major central banks combined with negative interest rate policy regime by the Philippine central bank, the BSP, as well as other emerging markets, will impact stock markets over the 3-6 months window as it has done before[12]. Most likely, we may see renewed selling pressures as these steroids come to a close.

Manipulating the financial markets including the stock markets has been part of the Bernanke’s doctrine[13] to save the banking system and indirectly to finance the welfare state. And the Bernanke creed seems to have been imbued as the de facto global policy handbook for central bankers.

And hawkish overtones[14] by some members of the US Federal Reserve or the ECB[15] may change as quickly, as so required by political exigency, especially when faced with the reemergence of selling pressures.

It would take a really big and nasty surprise and an equally static or passive or non response by central bankers to such event for the markets to feel pressure again.

And the only thing that may demobilize central bankers will be massive price inflation. As for politics, the arcane world of central banking has so far eluded the scrutiny of the benighted public.

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[1] Businessweek.com Mounting global growth concerns push markets lower, March 23, 2012 Associated Press

[2] Changingminds.org Availability Heuristic

[3] Koning John Paul Zimbabwe: Best Performing Stock Market in 2007? April 10, 2007 Mises.org

[4] Nowandfutures.com Germany, during the Weimar Republic & the hyperinflation

[5] Incrediblecharts.com Triangles and Wedges

[6] Wikipedia.org Effect on subprime crisis and Emergency Economic Stabilization Act of 2008 Mark to Market Accounting

[7] The Euro Crisis Amidst the Cheer, Could the LTRO Be Storing Up Problems for Later?, February 29, 2012 Wall Street Journal Blog

[8] Kotok David R. Moral Hazard-CAC Cumber.com, February 23, 2012

[9] Reuters.com Deeper Greek losses 'unlikely' to trigger CDS -ISDA, October 27, 2011

[10] Weekly Focus, Concerns about fragile global recovery March 23, 2012 Danske Research

[11] Business.inquirer.net Uytengsus complete sale of Alaska Milk stake March 21, 2012

[12] Zero Hedge, Operation Twist Is Coming To An End: A Preview Of The Market Response March 19, 2012

[13] See US Stock Markets and Animal Spirits Targeted Policies, July 21, 2010

[14] Bloomberg.com Fed’s Bullard Sees Price Threat From G-7 Delaying Tighter Policy, March 23, 2012

[15] Bloomberg.com Asmussen Says ECB Must Start to Prepare Exit, Die Zeit Reports, March 21, 2012