Quote of Day: The Last Hurrah of Socialist Welfare States

Today’s main quote of the day comes from Brian S. Wesbury, chief economist at the First Trust

The Social Welfare State is dying. Like the Berlin Wall and the Iron Curtain, the cradle-to-grave social welfare experiment must eventually collapse. A system of taxing work and profits, while subsidizing leisure, sloth, and retirement, must eventually fail.

The end of the Social Welfare State is painful for many, and it will not end quickly or quietly as the elections of this past weekend prove. Francois Hollande, a Socialist, was elected president of France, while Greece saw a surge in votes for “anti-bailout” political parties in parliament.

These elections are described as blows against “austerity.” They are also seen as anti-German. Germany resisted bailouts and pushed spending cuts.

In theory, a rejection of austerity could be a good thing. Some people include tax hikes in the concept of austerity and avoiding tax hikes would be a good thing for Europe. France has a top income tax rate of 45%, a wealth tax of 0.5% and a Value Added Tax (VAT) of 21.2%. Greece has a top income tax rate of 45% and a VAT of 23%. These burdensome tax rates hinder growth, investment and work effort and still don’t cover all the spending.

To solve the deficit problem, Francois Hollande wants to raise France’s top income tax rate to 75%. Greece’s “anti-bailout” parties, mostly on the left, also want higher taxes on the upscale, plus defense cuts. The Greek military helps break up domestic riots, so this is a self-serving demand.

So, in reality, French and Greek rejection of austerity does not mean policies that would enhance long term economic growth. Instead, it means they want to temporarily pull the wool over their own eyes, resist the obvious need to reduce government spending, and just hope for the best.

This chapter of the French story will not end well. The country has already gone much further along the road to socialism than the US, with general government spending equal to about 56% of GDP, very near the highest of any advanced or emerging market in the world. Greece, at 49%, is not far behind. Yet, voters are doubling down.

“Doubling down” simply means accelerating the pace of degeneracy that leads to an eventual collapse which will be marked by government bankruptcies and the dissolution of the EU via a series of debt default or through hyperinflation. As James Turk of goldmoney.com wrote (for the second related quote of the day),

the ideological bankruptcy of socialism will be laid bare by government insolvency

How US Federal Reserve Policies Stimulates the Public’s Speculative Behavior

In a book review, Douglas French, president of the Mises Institute, explains the physiological and psychological dimensions of how US Federal Reserve policies whets people’s appetite for speculation and gambling.

For the average Joe, the mere idea of making money fires the dopamine neurons in his brain, and because (crazy) people tend to herd, this leads investors to pile into the same investments at the same time, which happen to be investments that have done well in the past. Or in other words, investors gravitate en masse to investments that are overpriced. Merely watching the green arrows on CNBC stimulates dopamine.

So when the Fed hit the monetary gas in 2001, interest rates plunged and the lumpen investoriate collectively plunged into housing only to be massacred by the end of the decade. Before that, Greenspan's Fed lubricated the financial system thinking all kinds of things would go wrong at Y2K. The money sloshed into Internet stocks and investors piled in just in time to lose their shirts.

Dopamine neurons are stimulated only if the rewards exceed the expectation. If investments work as planned, even if the result is good, there will be no rush at reward. And when results are less than expected, dopamine neurons are depressed — creating immense regret.

As a real-estate developer told me in the early 2000s, "interest rates are so low, I have to do something." His brain was already feeling the dopamine tingle of anticipated profits by hearing of the lower rates. As Pavlov's dogs salivate at a bell that reliably signals food, low interest rates transformed investors into Greenspan's and now Bernanke's dogs.

Bernanke's zero-interest-rate policy has investors lunging for yield, buying junk bonds and junk houses. "The rally in junk bonds extends an advance that began in early 2009 and can be traced largely to the Federal Reserve's policy of keeping benchmark interest rates near zero," writes the Wall Street Journal's Matt Wirz. "A pretty robust cottage industry has developed and is absorbing [single family homes] at an incredibly fast pace," Richard Smith, chief executive of Realogy Corp., tells the WSJ.

To add insult to injury, Burnham points out that people are "systematically overconfident. We are bad at doing the calculations required to analyze investments, and simultaneously we are unaware of our shortcomings." And if this isn't bad enough, Burnham points out that numerous studies show that people "reveal themselves to be proud. They are willing to lose money to retain their self-esteem."

Of course this all flies in the face of the efficient-market hypothesis, which claims all market participants are rational, and therefore all news is priced into particular investments at any one time, and there is no such thing as a speculative bubble.

As he wound up his Atlanta speech, Burnham had some sobering thoughts. "Financial markets are the watering hole of society," he quipped. Like thirsty animals on the African Savannah, humans are attracted to the speculative gains that financial markets promise. But, stopping for a drink is likely hazardous to our financial health.

Incentives drives people’s actions. Yet policies plays a substantial role in influencing people’s incentives. What some see as inappropriate behavior (such as “speculation”) driven by individual character flaws, is in reality, mostly a reflection of people’s responses to such policies.

This simply shows that inflationism is immoral.

Bank of Japan Hearts the Stock Market

From the Marketwatch.com

The Bank of Japan stepped back into the stock market Monday, making its largest single-day purchase of exchange-traded funds to date, though the move failed to prevent a sharp fall for the Tokyo equity market.

The Japanese central bank said it spent 39.7 billion yen (about $500 million) buying up stock ETFs as part of its ongoing asset-purchase program, breaking a previous record of ¥28.5 billion, set on April 16.

In addition to the ETF buys, the Bank of Japan also acquired ¥2.3 billion in real-estate investment trusts Monday.

Since the 2008 collapse of Lehman Brothers and ensuing global crisis, central banks around the world have embarked on a spree of asset-buying meant to avoid deflation and, to a certain extent, support the markets.

But Japan’s monetary authority is almost unique among its peers in the major developed economies in its high-profile purchases of ETFs, which it began in December 2010 as part of aggressive easing measures.

Since then, the Bank of Japan has bought almost ¥1 trillion worth of ETFs — along with another ¥78.9 billion in REITs — and has an additional ¥642 billion to spend on the stock funds after raising the program’s size at it last policy meeting in April.

The central bank emphasizes that the program has only broad goals such as supporting interest rates and reducing risk premiums, rather than supporting financial markets.

The Bank of Japan (BoJ) has shown that they have been true and blue disciples of US Federal Reserve chair Ben Bernanke, who once preached that

History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

Yet the real reason why the BoJ has been transferring resources from their economy to stock market investors, via the Bernanke doctrine, have been to provide support to the banking system which has substantial exposure on the equity markets through the interlocking shareholdings relationship.

As this paper from the faculty of Hirosaki University explains,

In Japan, interlocking shareholdings among firms have its own peculiar character, and they have contributed to accumulating the enormous amount of hidden profits in firms by adapting the accounting system based on cost and realization basis. A feature of interlocking shareholdings is that firms hold each other’s shares as stable shareholders. Stockholding relations between banks and its client firms are present in any main bank relationship. On another plane, the large securities appraised loss arises by such system every year, and it has became one of factors that make the finance of firms and banks more unhealthy with non-performing loans. On the other hand, there will be few merits in contributing to enhancement of competitiveness and economic development, while the relationship between firms and banks gives the incentive, which commit long-term investments to the management of firms through interlocking shareholdings.

Of course, not only did interlocking shareholdings play an important part in the implementation of stable shareholding arrangements and maintaining of trade relation but also became institutional measures to avoid the threat of international capital markets, i.e. take-over bid (TOB), mergers and acquisitions (M&A) etc.

In any case, the mechanism of interlocking shareholdings delicately influences the relationship between banks and firms.

See how the BoJ promotes the interests of their politically favored institutions or cronies?

Video: Corporate Taxes Hurt the People

Professsor Steve Horwitz in the following video explains how corporate taxes hurt the people, and not the rich. (Thanks to Michael Moroney of LearnLiberty.org and George Mason University for sending this)

Here is the prologue from LearnLiberty.org

Corporations are not monoliths -- they are made up of individuals, including workers and non-wealthy shareholders. So are corporations distinct from the people that comprise them? When corporations are taxed, who pays the tax? Economics professor Steven Horwitz shows why a tax on corporations is not the equivalent of a tax on the wealthy. Instead, workers and consumers will pay these taxes. A tax on a corporation is also a tax on the workers who work at the corporation, the consumers who buy from the corporation, and the shareholders who own the corporation as part of their retirement fund.

In Pictures: The Eurozone’s “Austerity” Programs

I’ve been saying that whatever politicians, media and their zealot followers label or lay claim as “austerity” programs has been a blatant canard.

The precious deck of graphs below from tradingEconomics.com give us the perspective

First the Eurozone’s Government Debt to GDP

Ok, one might argue that the steady ascent of government debt relative to GDP has been happening because of recessions or economic growth slowdown.

So the second set of graphs which exhibits their respective fiscal conditions is meant to give us a better understanding.

Note, reference points of comparisons are very important and sensitive to making claims.

It is TRUE that government spending in the aforementioned countries above has somewhat been reduced compared to, or when based from 2010.

But except for Portugal, whose authorities have admitted that government spending does NOT work, spending levels have substantially been elevated compared to, or based from 2000-2007 for most of the Eurozone, especially the crisis afflicted nations. Add to this the ballooning balance sheets of the ECB.

From the above, we can see that whatever claims of “austerity” have been representative of half-truths, and which in reality, signifies as terminological prestidigitation.

So the return of pro-welfare governments will only exacerbate their current woes based on unsustainable political economic conditions and amplifies the transmission of the many risks (credit, currency, inflation, interest rate and etc...) to the world.

Results of European Elections Points to More Inflationism

From Bloomberg,

Francois Hollande, who defeated French President Nicolas Sarkozy to become the first Socialist in 17 years to control Europe’s second-biggest economy, pledged to push for less austerity and more growth in the region.

“Europe is watching us,” he told supporters in Tulle, France, last night after he won about 52 percent of the vote. “Austerity isn’t inevitable. My mission now is to give European construction a growth dimension.”

Hollande inherits an economy that is barely growing, with jobless claims at their highest in 12 years and a rising debt load that makes France vulnerable to the financial crisis that has rocked the euro region the past two years. Sarkozy became the ninth euro leader to fall in that time and the first French president in more than 30 years to fail to win re-election.

Hollande’s comments were echoed in Greece, where voters flocked to anti-bailout groups, leaving the two main parties, New Democracy and Pasok, a seat short of a majority if they govern together, an Interior Ministry projection showed. His victory may sharpen tensions with key allies with Hollande advocating a more aggressive European Central Bank role in spurring growth -- a measure opposed by Germany.

As I earlier said politics has always been about gross distortions of reality and the manipulation of the public.

There really has been no “austerity” going on in the crisis affected Eurozone economies. Just look at how ECB’s balance sheets have been exploding…

chart from mybudget360.com

As I wrote earlier,

What has been really happening has been a transfer or a redistribution of resources from both the private and the public sectors into the politically privileged banking system. Taxes have been increased or are in the process of being raised to pay for the bailouts of the banks.

In genuine austerity programs, resources would be made available for the productive use of the private sector. This means growth in the private sector relative to a reduction of government expenditures.

So with the so-called “pro-growth anti-austerity” governments in power, the policy options likely to be taken by them will be 1) to stop the bailouts of the banking system and to resume welfare spending or 2) have the ECB finance both the banking system and the welfare state. [As an aside, the pro-growth and or anti-austerity is actually a mislabel, which in reality, should be called “pro-welfare” governments]

Cato’s Dan Mitchell has a fitting description,

the new political parties are pro-bailout. They are quite happy to mooch off German taxpayers, American taxpayers, and anyone else who is stupid enough to send money (after all, somebody has to finance critical functions of government, such as collecting stool samples from people who want to set up online companies and subsidizing pedophiles).

What gets them upset is the notion that they should do anything in exchange for these handouts. Perish the thought!…

And given the current budgetary mess they are into and given the market’s reluctance to finance them, both options imply more reliance on the ECB to backstop their proposed spending.

Said differently, if the pro-welfare governments act to fulfill on their campaign platform promises of more welfare spending, then I expect increased pressure on the ECB to finance their spending splurges. And if the ECB complies, then we are likely to see even more bailouts mostly through inflationism.

Of course I expect the US Federal Reserve to work behind the scenes to assist the ECB as they have done so, like in the recent past.

Also if these governments will insist on imposing policies based on the Santa Claus (Free Lunch) principle, and refuse to see the reality through lens of the law of scarcity, then we may see defaults to occur soon, or if not, the EU may die a natural death either from internal political dissension or hyperinflation.

Worst is that instead of achieving the objectives of an EU integration which in part has been meant to avert perennial wars of the past, more political redistribution will mean more discord that raises the risks of war.

Writes Professor Philipp Bagus

The EMU provokes conflicts between otherwise peacefully cooperating nations. Redistribution is always a potential cause of social stress. The monetary redistribution in the EMU was not understood by the bulk of the population and, thus, did not cause conflicts. The bailouts, the rescue fund, and the interventions of the ECB that were ultimately caused by the setup of the EMU have made the redistribution between countries more obvious.

The Message Behind the Phisix Record High

The theory of reflexivity developed by billionaire (and crony) George Soros underscores the dynamics of bubble psychology, as expressed through a feedback loop mechanism between people’s expectations and their attendant actions in response to the changes in the prices.

Mr. Soros wrote[1]

The underlying trend influences the participants' perceptions through the cognitive function; the resulting change in perceptions affects the situation through the participating function. In the case of the stock market, the primary impact is on stock prices. The change in stock prices may, in turn, affect both the participants' bias and the underlying trend.

Reflexive Theory Applied to the Phisix

The foundation of this theory seems to be anchored on the confirmation bias, where changes in prices that reinforces the underlying trend, gives confidence or strengthens the convictions of people to undertake action in the direction of the same trend. Such action feeds into the price mechanism and thus the feedback loop.

Applied to the Philippine equity market, many people will interpret the current state of the Phisix, which is at fresh record levels, as positive changes in the real economy. Believers would see this as having raised confidence levels, which that merits further actions through additional investments. Again this eventually feeds into higher prices.

An article at the Financial Times sings hallelujah to the Philippines[2],

Whisper it if you will, but the Philippines may at last be getting its act together. These are early days. But there are definite signs that the country – with its young population of nearly 100m people, the world’s 12th largest – has turned a corner…

The Philippines may still be the llama of south-east Asia. But, for the moment at least, the llama has broken into a trot.

President Noynoy Aquino has also used this opportunity to grab credit

From the Inquirer.net[3]

“Investors and Filipinos alike see what is happening: Here is a country determined to turn the corner by instituting genuine, wide-ranging, meaningful reform, and acting on its belief that good governance is the bedrock of equitable progress,” the President said.

We have had six positive ratings actions since we took over government a little less than two years ago—a stark contrast to the single upgrade and six downgrades in the nine years of the previous administration,” he added.

He said the country’s stock market also experienced 27 all-time highs in his 22 months in office.

Let’s put this into perspective.

While the Philippine equity bellwether has indeed been at record levels, such gains have not been unique or limited to the Philippines. In reality, major ASEAN bellwethers have ALL been on a bullish rampage. In other words, what has been portrayed as a special case is, in fact, a regional phenomenon.

Three of the ASEAN-4 majors are in ALL time record highs, particularly Indonesia [JCI:IND, dark orange], the Philippines [PCOMP:IND, green] and the seemingly underperforming Malaysia [FBMKLCI:IND, light orange] whom has marginally encroached the 2007 highs.

Meanwhile, Thailand [SET:IND, yellow] treads at a milestone 14-year high, but has yet to breach the 1993 record.

Yet these can hardly be construed as coincidental, as the undulations of the ASEAN-4 stock markets have eerily been similar for the last 5 years.

The other way to say this is that there has been a seemingly tight correlation between the Phisix and ASEAN markets. While correlation is not causation, there has been linking factor to their parallel performances.

So if there should be any special developments this must be attributable to the region and not to specific nations.

On a year-to-date basis, the Philippine Phisix, posted a 21.17% gain as of Friday’s close, ranked third only in the Asian region.

The top spot has been Vietnam with 35% returns, while Pakistan has is in second with 28.77% gains.

Notice that except for India, equity benchmarks of Asian majors Japan, Singapore and Hong Kong have yielded over 10%.

In short, Asia in general has posted substantial gains, but emerging Asia has outperformed.

Nonetheless while it may be true that the Philippines has exhibited material improvements on the dimensions of fiscal balances and debt[4], the bulk of the improvements came prior to the incumbent Aquino administration.

In relative dimensions, the degree of progress of the Philippines has been subordinate to the ASEAN peers.

Importantly, ASEAN in general has shown similar path of improvements in both aspects.

Real Reforms? Informal Economy Says No

So admittedly while there have been noteworthy advances in the management of government finances, the question is, has the Philippines been adapting reforms to encourage investments through a business friendly environment?

Well, the World Bank figures suggest otherwise.

Out of 183 countries, the Philippine scorecard[5] for Ease of Doing Business for 2012 has seen marginal improvements in 3 aspects (getting electricity, trading across borders, and enforcing contracts) while 7 areas posted declines in 2012.

Overall, the Philippines fell from 134^th ranking in 2011 to 136^th in 2012, where 1 accounts for the easiest place to do business while the last rank represents the most difficult place for business.

The above diagram from Doing Business report on the Philippines for 2012[6] gives as a better view of the domestic business climate.

Fundamentally, the Philippines have long lagged the region and the world because of the manifold political hurdles that has undermined relative competitiveness and has raised the bars (or hurdle rate) for attracting investments.

More, while the mainstream meme has touted remittances, which signifies about 8.9% of the economy (Wikipedia.org[7]), as powering the Philippine economy, what they don’t tell you is that there has been a far far far larger of the share of the domestic economy that has a more significant influence: the informal or shadow economy.

The Philippines has one of the largest informal sectors in the world[8], which accounts for nearly half of the economy. They are the balut (fertilized duck egg), peanut and cigarette vendors, carinderias, family drivers, household helps, and etc…

People tend to ignore the obvious.

As Black Swan author Nassim Taleb posted on his facebook account[9]

We are all, in a way, handicapped in a similar way, unable to recognize ideas when presented in a different contexts. It is as if we were doomed to be fooled by the most possibly superficial part of things, the packaging, the gift-wrapping paper around the object. This is why we don’t see antifragility in places that are obvious, too obvious.

For instance, the mainstream overemphasizes on the much heralded 10% (remittances) while ignoring the 45% (informal economy). In behavioral finance, the fixation on the visible while overlooking the others is a logical error that is called the survivorship bias[10]

About a year ago, I interviewed a balut and a peanut vendor from our neighborhood. The peanut vendor told me that he earns about 400-500 pesos a day. But because he can’t read and write, he has been reluctant to open a bank account and instead keeps his money in some physical storage (I think in a can). Yet over the years, his savings has enabled him to buy 2 tricycles which he lent out to 2 relatives for business.

The balut vendor on the other hand told me that his eldest son has been self financing his college engineering education. The son rides the bike which he uses to sell balut at night, and goes to school in the late mornings until the afternoon. The balut vendor father is even in a better position than I am. He owns his house.

Even if people from the informal sectors have been beyond the radar screens of the government and of the institutions of the establishment, the money they save (capital accumulation) helps increase the standard of living of Filipinos. And amazingly these are stuffs which statistics has not been able capture and has left mainstream experts lost at explaining the consumption economy which they mistakenly attribute to “multiplier” from remittances.

And this is why I have long believed that the statistics has understated the real savings rate of Philippines. And it is from such unseen sources of savings that has enabled the Philippines to have 3 out of the 10 largest shopping malls in the world (as of 2008)[11].

Yet the informal sector is an offshoot to economies that has been unduly burdened by a labyrinth of regulations, stifling taxes, onerous social security payments, restrictions in the official labor market, mandated wage rates and other labor restrictions, maze of bureaucratic red tape, politicization of economic opportunities and the many other various forms of interventions[12].

The peanut vendor told me that because he has been a mainstay in the area where he operates, local officials have not been a menace to him, because he got acquainted with them. But other vendors have not been as fortunate, many has to shell out “under-the-table” money for them to operate even during night time, while the others operate on a dictum of “when the cat’s away the mouse will play”.

That’s precisely why informal economies have been associated with greater incidence of corruption.

A weak rule of law, which emanates from unilateral, arbitrary, partisan, repressive and selectively enforceable laws, edicts, regulations, ordinances, impels people to circumvent them, much of it through bribery. And this has been further exacerbated by weak institutions.

As Ms. Ana Eiras at the Heritage Foundation writes[13],

Informality is a response to economic repression, not to something inherently unethical in those who circumvent legislation. What is most unethical about informality is the condition in which the government forces the poor to live. Informally employed people are condemned to a standard of living that is significantly lower than that of formally employed people, who have credit access. Also, informality creates a culture of contempt for the law and fosters corruption and bribery in the public sector as a necessary means to navigate the bureaucracy.

And as the great Austrian economist Professor Ludwig von Mises reminds us[14],

Corruption is a regular effect of interventionism.

So talks about abolishing corruption have simply been misleading. That’s because informal economies, again, exist as consequences of repressive and abusive laws which fosters corruption and are symptoms of economically unfree nations.

Yet if we should give credit where credit is due, then it is the informal economy through the various domestic entrepreneurs and the silent labor force, whom has been defying all these regulatory and political obstacles, that has mostly breathed life to the Philippine economy. Otherwise, chaos would rule.

Until the government meaningfully dismantles the obstacles that inhibit commercial activities, then the “good governance is the bedrock of equitable progress” represents nothing more than a flimflam.

Remittances are Partly Symptoms of Unfree Economies

Politics has always been about distortion of the truth.

The mainstream savors the romanticized notion that OFWs are the “modern day heroes”. In a way they are. Yet hardly any of these experts deal with why OFWs thrives and why they are heroes, outside of the context of $ remittances.

People seem to have mental blackout if we point out that today’s modern day heroes, the OFWs, like their shadow economy counterparts, have been products of unfree economies.

The inadequacy or insufficiency of economic opportunities (particularly for investments which has been diffused into jobs, yes about 4 out of 10 college graduates have been unemployed), have been prompting Filipinos to seek livelihood or greener pastures abroad (13% of graduates go abroad[15]).

Emerging economies whom have been highly dependent on remittance contributions have mostly been unfree economies.

Of the 30 countries on the table, 20 are mostly unfree if not repressed economies. While others like Lebanon, Samoa, El Salvador, Kyrgyz Republic, Jamaica, Albania, Guatemala, Cape Verde, Armenia and the Domincan Republic are moderately free according to the rankings based from Heritage Foundation[16]. Yet many of these “moderately free” nations are on the “borderline”.

The remittance phenomenon serves as an incredible paradox: The lack of economic opportunities as manifested by high unemployment which has been the outcome of the towering walls of arbitrary regulations and the politicization of markets, has been offset through migration and overseas employment. Yet politicians and media glorify what in reality has been exposing on their flagrant mistakes of collectivization.

Yet the heroic part of the OFW is this; oppressive laws have not prevented them from finding ways and means to survive. So they go abroad and elude domestic government. This has been the part not seen by the mainstream. What has been mostly seen has been the dollars sent and social costs of parting ways with the family, a theme that has been assimilated in media (tv series or movies).

To wit, individuals work to find ways to survive and thrive through circumventing laws by either going to the informal sectors, by corruption (bribery) or by voting with their feet through working abroad as OFW or emigration.

This is the real world and not a figment of someone’s political alter ego (in psychology these are dissociative identity disorders[17] where people live in their dreams and to have a life of what they had always wanted.[18]). Yet it has been inherent for politicians to engage in semantical abstractions to hoodwink the gullible public.

Bottom line: For Filipino politicians to deservingly claim credit for their deeds, we need to see three outcomes from the thrust to promote a business friendly environment or economic freedom: an explosion of legitimate small medium scale businesses, a natural decline in the informal economy out of the reduction of politicization of commerce and a voluntary repatriation of OFWs as a result of the increased economic opportunities at home.

The Disconnect: Stock Market and the Economy

This brings us back to the reflexivity theory.

Whatever “progress” that is largely being interpreted from buoyant financial markets has not yet been representative of the actual performance of the real economy.

If we go by the simple theory where corporate earnings growth has been a part of GDP[19] the implication is that stock prices should be somehow reflect on the expected GDP growth trend.

But the volatility of prices of the Phisix simply does not match with such measures. [As a side note, aside from earnings, a portion of GDP growth[20] also comes from capital increases such as new share issuances, rights issues, or IPOs].

Take note that the Phisix fell by over 50% in 2007-2008 yet the GDP growth hardly turned negative.

Also, note that in the same context GDP growth fell from 8% in 2010 to a little less than 4% yet in late 2011 yet the Phisix continued to set record after record.

In other words, such disconnect simply means either one of the two measures (the Phisix or the GDP) has been emitting false signals or that reality simply defies conventional wisdom.

And where “a flaw in the participants’ perception of the fundamentals” becomes recognized and escalates, this “sets the stage for a reversal of the prevailing bias”[21].

In short, the artificially embellished boom transforms into an ugly bust.

---

[1] Soros George The Alchemy of Finance p.53 John Wiley & Sons

[2] Pilling David South-east Asia’s llama breaks into a trot, April 25, 2012 Financial Times

[3] Inquirer.net Aquino tells ADB: Corruption over, May 5, 2012

[4] HSBC Global Research Step by step October 11, 2011

[5] Doingbusiness.org Ease of Doing Business in Philippines

[6] Doingbusiness.org Economy Profile: Philippines 2010

[7] Wikipedia.org Philippines Remittance

[8] Pyramid Research Emerging Market Operators Go Underground, January 29, 201

[9] Taleb Nassim Nicholas Facebook

[10] Wikipedia.org Survivorship bias

[11] See A Nation Of Shoppers??!!, April 9, 2008

[12] See Does The Government Deserve Credit Over Philippine Economic Growth? May 31, 2010

[13] Eiras Ana, Ethics, Corruption, and Economic Freedom December 9, 2003 Heritage Foundation

[14] Mises, Ludwig von 6. Direct Government Interference with Consumption XXVII. THE GOVERNMENT AND THE MARKET

[15] See College Isn’t For Everybody, February 3, 2011

[16] World Bank Migration and Remittances: Top Countries Migration and Remittances Factbook

[17] Wikipedia.org Alter ego

[18] Healthguidance.org Alter Ego Definition

[19] Wikipedia.org Relationship with GDP growth Earnings growth

[20] MSCI Barra Is There a Link Between GDP Growth and Equity Returns?, May 2010

[21] Soros, op. cit. p.57

Bubble Signs at the PSE: Raising Capital Through Pre-selling Model

Current developments in the marketplace also suggest of the high tolerance of speculative activities or of greater risk appetite or where markets simply don’t buy earnings in the traditional sense.

Bloombery as Trendsetter

From Finance Asia[1],

Bloomberry Resorts has raised Ps8.84 billion ($209 million) from its first follow-on share issue since it listed through a reverse takeover late last year, after fixing the price just above the mid-point of the range.

The Philippine company, which is set to become the first licence holder to open an integrated casino resort in Manila’s new Entertainment City gaming hub early next year, attracted strong demand from international investors in particular and sources said the deal was multiple times covered throughout the price range. In fact, the subscription level and the quality of the book were deemed strong enough for the bookrunners to close the fully marketed deal two days early…

Bloomberry holds one of the four licences to build integrated tourism resorts in Entertainment City that were awarded in 2009, and started construction on its Solaire Manila project in July last year. Phase one, which will include 300 gaming tables, 1,200 slot machines, one 500-room hotel, seven specialty restaurants and a number of other food and beverage outlets, is scheduled to open in the first quarter of 2013.

In short, Bloombery [PSE: BLOOM] which has YET to generate cash flows has successfully raised Ps8.84 billion from local and global investors.

As of Friday’s close, BLOOM’s market capitalization surged to a surreal 87,343,301,226 which beat property giants Robinsons Land [PSE:RLC] 72,215,173,283 or SM Development Corp [PSE:SMDC] 59,757,133,523

So how was the company valued?

Again from Finance Asia,

At the final price, Bloomberry is valued at an enterprise value-to-Ebitda multiple of about 7 to 7.1 times, which puts it at a sizeable discount to all the Macau casino operators. However, even at the top of the range, the Philippine company was pitched only at an EV/Ebitda multiple of 7.8 times, which compares with a valuation range of 7.5 times to 10.4 times for the Macau players and explains why some investors were comfortable to pay the maximum price.

Ebitda or earnings before interest, tax, depreciation, and amortization[2]???

Ebitda has been the prominent financial metric used to value technology[3] companies during the height of the dot.com bubble.

This simply shows that many people hide behind numbers. Financial metrics, valid or not, have been used either as marketing instruments or as justification for buying actions.

In reality, the BLOOM case represents nothing more than a promise to build. The difference is that this promise has been backed by a prominent name, tycoon Enrique Razon.

Mr. Razon deftly capitalized on the bullish market sentiment through a “fast break play”: he bought Active Alliance at 3.3 per share[4] last February, backdoor listed BLOOM and sold part of the portion of his shares to the public at 7.5 per share for a whopping 127% gain in just THREE months!

Yet like the dot.com boom, I believe that BLOOM’s highly successful “pre-sellling” strategy (similar to pre-selling condo units) would set a trend for succeeding IPOs or secondary listings or follow on offerings.

We should not forget that the dot.com bubble was highlighted by an IPO boom[5]

Volume, Money Flows and Profit Taking

And of course, a continuing boom will likely to attract volume. The US Global Investor suggests that the recent improvements in trading volumes may attract foreigners.

The US Global Investor writes[6],

increasing trading volume in the Philippine stock exchange, explaining why the Philippine market has outperformed Asian peer’s year-to date and the last year. Morgan Stanley research shows $829 million new money has flowed into the Philippine stock market so far this year, encouraged by better macro economic indicators and strong corporate growth prospects.

Rising volumes signify effects rather than causes. The yield chasing phenomenon as consequence of easy money policies here and abroad has been driving the domestic markets and will continue to spur interest from foreigners.

As governments of developed economies continue to debase their currencies, discreet capital flight into asset markets and currencies of ASEAN economies and other emerging markets, may become an entrenched trend.

Second, what they refer to as new money could probably mean money from “new” investors. That’s because the popular concept of money “flows” in stock markets are fallacious[7].

For every peso of traded, this means that the peso exchanged from the buyer of a specific security goes to the seller of that security. So there are no money flows. Perhaps there are more “new” retail investors today as “old” investors take profits or go cash.

All that has been discussed above demonstrates growing symptoms of market’s response to bubble policies. Today’s record or near record lows in nominal interest rates[8] are policies designed to promote consumption (and speculation) via a negative real interest rate regime.

In a bubble cycle, systemic distortion of prices means that markets neither manifest earnings nor the real economic performance, but one of malinvestments and rampant speculations.

In predicting the continued rise of the Phisix in 2010 I wrote[9]

The point is inflationism creates an illusion of prosperity by inflating asset bubbles in domestic market such as in the Philippines or in the Asian region, which eventually would exact toll on the society. The normative outcome of any bubble bust would be high rate of unemployment, output and capital losses, political turmoil, aside from a lowered standard of living via more incidences of poverty.

That illusion is now being interpreted as real progress.

And as a final note, given the recent dramatic record run up, we should expect natural profit taking process to follow. And perhaps such profit taking will take cue from weakening commodity prices (CRB) and stock markets abroad led by the S&P 500 (SPX). This is likely to be a temporary event, or another episode where steroid propped financial market clamors to be fed with more steroids of inflationism.

Perhaps the weekend elections in the Eurozone could also spice things up.

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[1] FinanceAsia.com Bloomberry re-IPO raises $209 million May 3, 2012

[2] Thismatter.com Enterprise Value

[3] Brennan Linda L. Social, Ethical and Policy Implications of Information Technology p.161 Google Books

[4] Philstar.com Razon-led Active Alliance hikes capital February 7, 2012

[5] Wiki Mises.org IPO Boom Dot-com bubble

[6] US Global Investors Do Emerging Markets Win, Place or Show in Your Portfolio? Investor Alert May 04, 2012

[7] See The Myth Of Money Flows Into The Stock Markets, April 5, 2009

[8] Asian Development Bank ASIA BOND MONITOR APRIL 2012 p.29

[9] See Why The Philippine Phisix Will Climb The Global Wall Of Worries June 7, 2010