Phisix: Will the Risk ON Environment be Sustainable?

High Volatility Continues

The Philippines Phisix had an ENORMOUS ‘RISK ON’ week with a raucous shindig over the outcome of the Greece elections.

The Phisix jumped by an eye popping 3.84% for the week to take the top spot in the region. This week’s gain practically obliterated the previous two weeks of losses.

ASEAN markets somewhat shared the carousal.

Unknown to most the Phisix-ASEAN blast came amidst highly volatile global market actions.

While most of the world shared the early excitement brought about by the pro-Euro Greece victory, gains eventually succumb to heavy losses. It’s only in Japan and in the major ASEAN markets where gains were maintained until the week’s close.

Even in the US, market breadth has been decisively either ON or OFF or a phenomenon driven by a rising or sinking tide.

Bespoke Invest writes[1],

We consider all or nothing days in the market to be days where the net daily A/D reading in the S&P 500 exceeds plus or minus 400. After a slow start to the year, the pace of all-or-nothing days has really picked up as nine of the year's sixteen occurrences have all come since the beginning of May. At the current rate, the S&P 500 is on pace to see 34 all-or-nothing days this year.

This demonstrates of the continued high volatility that has dominated the financial markets.

Another “Political” Intervention to Bolster the Phisix?

I suspect that interventions from non-market forces may be responsible anew for the resiliency of the Phisix.

The Phisix was bizarrely unruffled by the rout of the US markets last Thursday and even closed slightly positive on Friday.

Friday’s session opened with the Phisix sharply down driven by the developments in the US. But in no time, aggressive buyers constantly bid up the heavy market cap stocks, particularly by PLDT [PSE: TEL] and Bank of the Philippine Islands [PSE: BPI] significantly higher, thus driving the major domestic composite higher.

The 75 point pendulum swing from the troughs to the highs translated to another amazing 1.5% intraday move (intraday chart from technistock.com).

Such peculiar aggressive buying behaviors occurred when the region’s bourses suffered from losses.

Friday’s closing scorecard for Asia from Bloomberg.

Why would any rational market agent aggressively buy up such index issues in the knowledge that they can take advantage of, and save a lot through bargain hunting or buying defensively, considering the prevailing dour market sentiment?

Are these forces really sooo exceedingly bullish such that they expect Philippine equities to immediately zoom even amidst all the surrounding risks? Are these forces price insensitive? Or are they assuming the role of market makers or of stock market operators?

Remember these entities are dealing with tens, if not hundreds of millions of pesos worth of equity positions. So they are unlikely to be gullible retail investors.

While it may be true that both issues posted heavy foreign buying on that day, statistics may not tell the true story. Foreign buying can come from offshore entities owned by local non-market entities or from foreign institutions allied to the local political class.

Besides, their actions appear to be inconsistent with actions of portfolio managers around the world as emerging market funds have registered net outflows.

From Reuters[2], (June 21^st)

Funds that focus on emerging markets also saw outflows last month, eVestment found. For the ninth consecutive month investor withdrawals outpaced allocations to those managers, with $1.1 billion in redemeptions in May.

Even if foreign investors have distinct treatment on various emerging markets, I find these seemingly deliberate market defying actions as very suspicious.

As a side note, the Phisix has posted two consecutive weeks of net foreign buying.

Also Friday’s action seems to parallel the dynamics executed over the same environment three weeks back[3]. Yet such an attempt had been shot down by a single day loss[4].

Three weeks into a recovery, these operators have hardly been significantly up today.

The point is ‘interventions’ will eventually be smoothed out or neutralized by the underlying forces which drives the financial markets.

Will the Current Phisix Divergence Last?

This week’s dramatic upside showing by the Phisix nonetheless highlights another anomalous divergence within the region; particularly the winners Philippines (PCOMP orange)—Malaysia (FBMKLCI red) and the laggards as Thailand (SET yellow)—Indonesia (JCI green).

In the past, ASEAN price trends have largely moved in consonance, inflection points have almost been synchronized (blue vertical lines)

So either divergence become a lasting (decoupling) feature, or that eventually a recoupling will happen—where the laggards catches up or the winners will fall in line with the laggards.

My bet is on the latter—recoupling. There have hardly been any durable signs of divergences. And a decoupling within the region must also mean a decoupling with the world. That would be unlikely.

As previously discussed[5] the Philippines IS sensitive to developments abroad particularly through the merchandise trade channel (which accounts for about 50% of GDP) and through the OFW-remittance channel (which is about nearly 12% of GDP)

I believe that the possibility of a decoupling may happen in the event of a currency crisis. However current setting which has been about unwieldy debt and boom bust cycles doesn’t seem conducive for such scenario. Of course I could be wrong.

Even in terms of conventional methodology, sustained divergences may seem implausible.

If economic growth should prove to be an indicator of future profits or earnings, then current manufacturing surveys of major economies does not seem to be supportive of further earnings or profit growth.

Europe’s largest economies Germany and France seem headed towards or if not have already been in a recession. The US manufacturing index has likewise slumped, while China’s manufacturing index has steadily been on a decline as shown by the charts from Danske Bank[6].

Of course this ultimately depends on the persistence of such trends.

The same applies to earnings growth.

The consensus view of earnings of global publicly listed companies according to the UBS appears to be rolling over[7].

So if stocks continue to rise even as economic growth begins to stagnate, which subsequently suggests of increasing risks of a downturn in profits, then deductive logic tells us that rising stocks won’t be sustainable.

Sustained rise in stocks means that valuations will eventually become ‘pricey’ and thus subject markets to the risks of the regression to the mean[8]—or outlier events that statistically reverts towards the mean.

In short, markets will decline either orderly or in disorderly fashion depending if markets will adjust today or sometime in the future to reflect on the evolving realities.

So there hardly have been fundamentals (even in the conventional perspective) in support of a sustained upswing EXCEPT for interventions by central banks that supports the financial markets.

And here lies the essence of today’s volatile markets.

Diminishing Returns and the Withdrawal Syndrome

As I pointed out last week, expectations of central bank rescues have functioned as the focal point of the market’s directions.

I wrote[9],

Global financial markets have relied heavily on the “buy the rumor” from central banking rescues.

These are likely to have two short to medium term outcomes.

One, if central bankers FAIL to deliver in accordance to market’s expectations, then we will likely see another huge bout of downside volatility in global equity markets…

On the other hand, if markets may be temporarily satisfied with REAL actions of central banks (e.g. $1 trillion bailout) then we should see a minor or a slight “sell on news”. But this should be seen as opportunities to RE-ENTER the markets incrementally.

Like the bailout of Spain, the Greece elections have had a short term effect on most of the world markets.

[As a side note, to call the Philippine (Phisix) and Malaysia’s (KLSE) one week deviation as sustainable trends would be based on HOPE.]

The attention of global financial markets eventually shifted to the US Federal Reserve to deliver the promise of stimulus.

The Ben Bernanke led Federal Open Market Committee (FOMC) DID deliver, but did so reluctantly.

The FOMC extended Operation Twist until the yearend by only about three-fifths ($267 billion) of the original size ($400 billion)[10]. But along with it comes more assurance of “additional asset purchases would be among the things that we would certainly consider”

Unknown to most is that the current bailouts have been subjected to the laws of diminishing returns.

For instance, the positive impact to the marketplace from bailouts in Eurozone has been shortening or experiencing diminishing returns as measured and documented by a recent study[11].

The same diminishing returns can be seen from US Federal Reserve actions (QE 1, QE 2, and Operation Twist or Maturity Extension Program MEP) as shown by the yields from different debt instruments[12].

The point is that central bankers will need to step up or INTENSIFY the scale of balance sheets expansions. Otherwise similar or lesser degree of actions would mean vastly reduced positive impact to the marketplace which alternatively accentuates the risks from downside volatilities.

So the Fed’s announcement belatedly incited a huge slump on the S&P 500, Thursday.

Again, the slump can be construed as ventilation of the frustrated expectations or as consequence to “sell on news” or as manifestations of diminishing returns or a combo of the three.

Yet it would be misguided to view the FED’s actions as simply providing what the market wanted as proposed by the populist analyst John Mauldin[13],

So why did the Fed continue Operation Twist? Because the market (that amorphous, omnivorous blob) expected something from the Fed. This summer's version of Twist and Whisper was about the least they could do.

The FED has been CONDITIONING the markets of the coming FED actions that has artificially propped up the markets[14].

So the market expectations simply adjusted to pledges made by officials. Besides market participants have been brainwashed like Pavlov’s dogs with the Bernanke “inflation” Put.

And that’s why bad news became good news—or markets rose amidst a spate of bad news—for the simple reason that major central bank authorities continually whetted on the appetite of the marketplace with guarantees of support.

The genuine reason for the extension of Operation Twist is that the FED continues to finance the US treasury or bails out the US government.

While Operation Twist has been designed to nudge market’s appetite to take on more risk “by taking long-term bonds off the market”, notes the Wall Street Journal[15], what has been happening, instead, is that the US Treasury has been taking advantage of low interest rates to ramp up on the issuance of long term securities.

This means that the Fed has actually been accommodating the shift in the debt maturity profile by the US Treasury, whose moves may have been possibly intended to reduce rollover risks[16] or the risk from refinancing debt that could be triggered by an upward move of interest rates.

A surge in interest rate would balloon interest payments and deficits and most likely trigger a debt crisis ala the Eurozone (see chart above[17]). A US debt crisis would likely elicit a currency crisis if the FED insists on resorting to the printing press to solve her problem of debt.

But of course, the Fed’s accommodation has also been about the growing debt of the US which now stands at $15.809 trillion according to USdebtclock.org

US politicians have become so addicted to debt based spending such that House Minority Leader Nancy Pelosi, D-Calif., writes the Washington Examiner[18], thinks that President Obama should unilaterally eliminate the debt ceiling. Politicians really believe that they are above the laws of economics.

And perhaps the Fed’s parsimonious actions may have been due to the reduced number of short term instruments available for the twist (US Treasury securities held by the FED for 1-5 years maturity has been collapsing).

Or perhaps, Mr. Bernanke would like to avoid a political backlash similar to that of the last quarter of 2011, which may have prompted him to jilt the markets expecting for QE 3.0[19].

Bottom line, the current uncertainty dynamic comes with the growing gap between actualized policies and market expectations mainly premised on the pledges of backstops from central bank authorities.

The failure to meet such expectations is likely to provoke turbulent episodes symptomatic of a withdrawal syndrome.

Uncertainty leads to volatility.

As the past 3 weeks has shown, the Phisix has not been immune to volatility in both directions.

China’s Languid Economic Conditions Aggravates Political Uncertainty

Developments in China has been adding to the landscape of uncertainty.

Reports of a worsening decline in the manufacturing index[20] have not only led to a technical breakdown of China’s Shanghai markets but also to a breakdown of commodity prices.

The SSEC will soon test the immediate support level (green horizontal line)

China’s economy seems to be in a slomo burn rate.

And the epicienter of China’s weakness (bursting bubble?) emanates from the property sector (see chart above[21]) which continues to reel from a slomo decline, and which has spread to the manufacturing sector.

An even grimmer news is that reports say that China has been artificially been propping up economic statistics for political reasons[22], particularly for the coming national elections, as local officials pad up statistical output in order to get promotions. The implication is that China’s economic performance has been weaker than what has been published

So far, the Chinese national government has repeatedly shown reluctance to aggressively intervene. Most of interventions has been marginal, done on a stealth State level[23], on the monetary aspects (lowering of interest rates)[24] and on the cosmetic inflation of economic statistics.

So the deterioration in China’s economy has been aggravated by political deadlock.

Low Oil Prices Jeopardizes the Oil Welfare State and Enhances Risks of War

The ongoing economic slowdown in multiple fronts (most especially in China) has hurt commodity prices and has led the US Oil (WTIC) benchmark to break below the $80 level.

And with oil prices slightly below the $80 threshold, this should begin to affect the fiscal balances of many welfare states of oil producing economies, whose critical welfare threshold is at the $80 level and above (see chart[25]).

As I previously wrote[26],

The welfare states of many of the major producers, particularly OPEC economies or even non-OPEC such as Russia greatly depends lofty oil prices, perhaps about $85 and above. Even President Obama’s green energy projects have been anchored on high oil prices.

This means that if oil prices breaks below their welfare threshold for a prolonged period, then this would incite popular uprising and the eventual collapse of the current political order.

And this is why oil producing governments have been limiting private sector’s access to oil reserves. Yet the capacity by these governments to bring oil to the surface has been constrained by government budget, which has been mostly spent on welfare (yes to buy off their political privileges from their constituents), and the lack of technology.

The implication of the above is that these governments will probably try to restrict production, seek the war option (e.g. urge the US to militarily take on Iran), inflate their economies to pay for their welfare system or influence major central banks and politicians of major economies to resort to more inflationism.

And it is why the brinkmanship politics in the Middle East has scaled up the drumbeats of war not just on Iran, but also on Syria.

Foreign policy interventions have been about promoting the interests of the welfare states allied to the West and the interests of the neoconservative political class who represents the interests of the military industrial complex.

As Ron Paul rightly points out[27],

And once again, we are about to engage in military action against Syria and at the same time irresponsibly reactivating the Cold War with Russia. We're now engaged in a game of "chicken" with Russia which presents a much greater threat to our security than does Syria…

Controlling Iranian oil, just as we have done in Saudi Arabia and are attempting to do in Iraq, is the real goal of the neo-conservatives who have been in charge of our foreign policy for the past couple of decades.

So politicians are looking for political scapegoats from which to divert people’s attentions, as well as, to create justifications for more inflationism.

Bottom line: Either from demand-supply perspective or from monetary inflation, falling commodity prices can hardly be seen as positive for stock markets for the moment.

Falling commodity prices are manifestations of an ongoing liquidation process from malinvestments and from the political uncertainty over ambiguous policies.

We would need to wait for declared actions from political authorities. Otherwise, should markets awaken to the reality of false promises, downside volatility will likely be amplified.

---

[1] Bespoke Investment Group Another All or Nothing Day!, June 21, 2012

[2] Reuters.com Investors fled Europe-linked hedge funds in May-report, June 21, 2012

[3] See Phisix: Very Impressive Day or Month End Close for May 2012, May 31, 2012

[4] See Phisix: Last Week’s Big Surge Wiped Out in a Single Day! June 4, 2012

[5] See Will the Phisix Divergence Last? June 4, 2012

[6] Danske Research Time for another important EU summit, June 22, 2012

[7] Zero Hedge Three Charts Your Stockbroker Won't Want You To See, June 18, 2012

[8] Chegg.com Definition of Regression to the Mean Regression to the mean, or regression threat, refers to the statistical phenomenon of outlier data moving toward the mean in subsequent non-randomly selected tests. Statisticians need to take regression to the mean into account when designing experiments.

[9] See Dealing with Today’s Uncertainty: Patience is the Better Part of Valor June 17, 2012

[10] See US Federal Reserve Extends Operation Twist, Commodities Drop June 21, 2012

[11] See The Diminishing Returns from Euro Bailouts Becoming Evident June 20, 2012

[12] Zero Hedge The Diminishing Returns Of Central Planning, And Why More Printing Would Have No Impact June 15, 2012

[13] Mauldin John, Daddy's Home Goldseek.com June 24, 2012

[14] See Bad News Is Good News: Global Markets Rise on MORE Stimulus Expectations June 20, 2012

[15] Wall Street Journal Economics Blog Bernanke Acknowledges Treasury Strategy at Odds With Fed Policy, June 22, 2012

[16] Investopedia.com Rollover Risk

[17] Zero Hedge Presenting Dave Rosenberg's Complete Chartporn, June 1, 2012

[18] Washington Examiner Pelosi: Obama should unilaterally eliminate the debt ceiling, June 22, 2012

[19] See Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms, September 22, 2012

[20] See China’s Manufacturing Troubles Hasn’t Gone Away June 21, 2012

[21] Businessinsider.com SocGen: China's Housing Market Correction Is 'Sending Shock Waves Through Its Economy', June 18, 2012

[22] See China’s Economy has been Artificially Embellished for Politics June 24, 2012

[23] See China’s New Loans Unexpectedly Surged in May June 12, 2012

[24] See HOT: China Cuts Lending Rates and Deposit Rates June 7, 2012

[25] King Byron What’s the Deal With Oil Prices? June 13, 2012 Daily Reckoning.

[26] See Phisix: The Correction Phase Cometh, May 14, 2012

[27] Paul Ron When Will We Attack Syria?, June 20, 2012, lewrockwell.com

China’s Economy has been Artificially Embellished for Politics

China’s economy may be weaker than publicized as local officials manipulate data for the coming elections

Reports the New York Times

As the Chinese economy continues to sputter, prominent corporate executives in China and Western economists say there is evidence that local and provincial officials are falsifying economic statistics to disguise the true depth of the troubles.

Record-setting mountains of excess coal have accumulated at the country’s biggest storage areas because power plants are burning less coal in the face of tumbling electricity demand. But local and provincial government officials have forced plant managers not to report to Beijing the full extent of the slowdown, power sector executives said.

Electricity production and consumption have been considered a telltale sign of a wide variety of economic activity. They are widely viewed by foreign investors and even some Chinese officials as the gold standard for measuring what is really happening in the country’s economy, because the gathering and reporting of data in China is not considered as reliable as it is in many countries.

Indeed, officials in some cities and provinces are also overstating economic output, corporate revenue, corporate profits and tax receipts, the corporate executives and economists said. The officials do so by urging businesses to keep separate sets of books, showing improving business results and tax payments that do not exist.

The executives and economists roughly estimated that the effect of the inaccurate statistics was to falsely inflate a variety of economic indicators by 1 or 2 percentage points. That may be enough to make very bad economic news look merely bad. The executives and economists requested anonymity for fear of jeopardizing their relationship with the Chinese authorities, on whom they depend for data and business deals.

The following chart Zero Hedge shows of electricity production trends during the first quarter.

It would appear that the decline may have been deeper than what is shown, if indeed the observations by executives in the report are valid.

As always, politics has always been THE reason for the statistical chicanery. Again the New York Times,

Questions about the quality and accuracy of Chinese economic data are longstanding, but the concerns now being raised are unusual. This year is the first time since 1989 that a sharp economic slowdown has coincided with the once-a-decade changeover in the country’s top leadership.

Officials at all levels of government are under pressure to report good economic results to Beijing as they wait for promotions, demotions and transfers to cascade down from Beijing. So narrower and seemingly more obscure measures of economic activity are being falsified, according to the executives and economists.

“The government officials don’t want to see the negative,” so they tell power managers to report usage declines as zero change, said a chief executive in the power sector.

Many Chinese politicians think that they can sucker the public by inflating statistical data, but all these masquerade are really being manifested in the financial markets; particularly in the commodity sphere, in China’s equity benchmark and even the yuan, which has been on a downdraft.

Bottom line is that more artificialities (statistical inflation, aside from real inflation) equates to more uncertainties which implies of more market volatilities.

Video: Can the Federal Government Mandate Health Insurance?

The US Supreme Court is about to decide on the constitutionality of Obamacare or the Affordable Care Act by next week. The monumental decision is expected impact the US economy that could ripple to the world.

From LearnLiberty.org.

States can require people to buy insurance for automobiles and health care. So why can't the federal government? According to Professor Elizabeth Price Foley, the U.S. Constitution gives the federal government limited and enumerated powers that confine it. The Constitution gives different powers to the states than it does to the federal government. Just because states have the power to establish mandates for insurance does not suggest that the federal government has the same power.

Thanks to Learn Liberty's Tim Hedberg for the video.

Cartoon of the Day: Greece’s Pro-Euro Victory

This cartoon by Robert Ariail depicting the recently concluded Greece elections gave me a good laugh.

It’s hilarious but that’s the way the Euro crisis operates.

Thanks to Cato’s Dan Mitchell

Spotting Technology Winners is a Judgment Call

Forbes’ brilliant technology analyst and venture cap investor Josh Wolfe gives as a clue on how to identify winning technology innovation, (bold caps original)

And the stakes are always highest when the forces of technological disruption, oft too weak to be detected, catalyze massive industry change and become too strong to be resisted.

Common conception holds that brilliant inventions burst straight from research labs to take over markets. But in studying and investing in change, it becomes apparent that the enabling technologies have often been in existence for some time, developing quietly in the background in ancillary markets or other incarnations. It’s only at the confluence of parallel technological developments and shifting market forces that, often unexpectedly, “Aha!” – a new application takes hold. The combinatorial chemistry of industry and invention yields an explosive reaction, and then: everything changes. Thus we’re always hunting for two things: cutting-edge technologies and rapidly changing markets.

In short, the success of identifying winning disruptive technology innovators comes with the ‘right timing’. Technology may have been "in existence for some time", but markets may not be ripe for it.

This gives merit to Professor Peter Klein’s definition of entrepreneurship as one of speculative judgment.

At the Mises Blog Professor Salerno writes,

So, Klein maintained, the profit opportunity was not an ex ante fact waiting to be discovered; rather the profit opportunity was only realized , ex post, as the successful outcome of an action based on a speculative judgment. Whether or not the plans of economic agents are better coordinated and the economy is closer to equilibrium than before is “irrelevant,” Klein explained; the important point is that ex post profits indicate that resources have been reallocated from less valuable to more valuable uses from the point of view of consumers.

Anyway, Mr. Wolfe’s present candidate is the 3D printer.

I talked about the potentials of 3D printers at an earlier post.

I also share the view that 3D printers will function as one of the three major forces of the information age.

Belarus Hyperinflation: Money Abhors a Vacuum

I previously pointed out of the developing crack-up boom or hyperinflation in Belarus.

If money is being perverted by governments to the point where it triggers a total loss of confidence by the public, while gold and silver may be the best refuge, people will stampede to any real assets—when gold and silver are not available and on short notice.

Belarus Ruble: US dollar From XE.com

Simon Black of the Sovereign Man gives the evidence (bold emphasis mine)

More than two decades after the fall of the Soviet Union, the Iron Curtain is still alive and well in an often forgotten corner of Eastern Europe… albeit a kindler, gentler version.

Belarus has been ruled by the same person, Alexandr Lukashenko, practically since its independence in the early 1990s.

He has total control of every facet of the country, from media and information flow, to education, to the military and ‘State Security Agency’ (which is still called the KGB), to the centrally planned economy.

Perhaps nowhere is this more obvious than with respect to the nation’s currency, the Belarusian ruble.

In 2009, one US dollar bought roughly 2,200 Belarusian rubles. In 2010, that number rose to 2,800. A year later, over 3,000. And today, one US dollar is worth over 8,000 rubles. On the black market, it’s much, much higher.

(You can just imagine how much the ruble has lost against gold and silver over the same period.)

My friends here tell me that, last summer after another bout of devaluation, it became nearly impossible to purchase euros and dollars. The currency was falling too rapidly, and no trader was willing to take the risk. Even the central bank stopped exchanging its reserves.

Consequently, small businesses in Belarus couldn’t get their hands on the hard currency they needed to pay foreigners for imported goods. Store shelves, including groceries, emptied quickly.

And people took whatever savings they had and traded it for anything they could find– sugar, toilet paper, ironing boards… you name it. As I’ve been told, hand tools were especially popular as a store of value in some parts of the country.

This is the key difference between ‘inflation’ and ‘hyperinflation’. Inflation involves a lot of painful price increases that reduce the standard of living for most people in society.

Hyperinflation, on the other hand, is a complete loss of confidence in a currency.

Anyone here who has held on to the local currency has gotten completely screwed. The few people at the top making the decisions have held on to power and become very wealthy at the expense of everyone else.

Bottom line: Like nature, money abhors a vacuum. People will switch to any form of assets with real value.

This would represent the flight into real values as warned by the great Professor Ludwig von Mises,

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

Fiscally Pressured Governments go for Crony based Privatizations of ‘Public Goods’

Money pressured governments are looking to privatization of parts of politically sensitive functions such as security services.

The Telegraph reports,

Private companies will be running large parts of the UK's police service within five years, according to the world's biggest security firm.

David Taylor-Smith, the head of G4S for the UK and Africa, said he expected police forces across the country to sign up to similar deals to those on the table in the West Midlands and Surrey, which could result in private companies taking responsibility for duties ranging from investigating crimes to transporting suspects and managing intelligence.

The prediction comes as it emerged that 10 more police forces were considering outsourcing deals that would see services, such as running police cells and operating IT, run by private firms.

Privatization of government functions are akin to Public-Private Partnership (PPP) enterprises on political controlled or regulated sectors. They really NOT about free markets but about cronyism.

As I previously pointed out

PPP’s signifies as politically privileged economic rent/concessions to favoured private entities that will undertake the operations in lieu of the government. They will come in the form of monopolies, cartels or subsidies that will benefit only the politically connected.

Since the private partner partnerships aren’t bound by the profit and loss discipline from the consumers, the interest of the private partners will most likely be prioritized or aligned to please the whims of the new political masters.

And because of it, much of the resources that go into these projects will not only be costly or priced above the market to defray on the ‘political’ costs, but likewise, they will be inefficiently allocated.

Moreover, PPPs risk becoming ‘milking cows’ for these politically entitled groups and could be a rich source of corruption.

In the US even Keynesian high priest, Paul Krugman, who I vehemently disagree with on most issues, resonates with our perspective over the issue of phony privatizations (in Krugman’s case he refers to New Jersey’s “new kind of privately run halfway house” prison systems).

From Paul Krugman (hat tip Bob Wenzel, bold emphasis added)

So what’s really behind the drive to privatize prisons, and just about everything else?

One answer is that privatization can serve as a stealth form of government borrowing, in which governments avoid recording upfront expenses (or even raise money by selling existing facilities) while raising their long-run costs in ways taxpayers can’t see. We hear a lot about the hidden debts that states have incurred in the form of pension liabilities; we don’t hear much about the hidden debts now being accumulated in the form of long-term contracts with private companies hired to operate prisons, schools and more.

Another answer is that privatization is a way of getting rid of public employees, who do have a habit of unionizing and tend to lean Democratic in any case.

But the main answer, surely, is to follow the money. Never mind what privatization does or doesn’t do to state budgets; think instead of what it does for both the campaign coffers and the personal finances of politicians and their friends. As more and more government functions get privatized, states become pay-to-play paradises, in which both political contributions and contracts for friends and relatives become a quid pro quo for getting government business. Are the corporations capturing the politicians, or the politicians capturing the corporations? Does it matter?

The point, then, is that you shouldn’t imagine that what The Times discovered about prison privatization in New Jersey is an isolated instance of bad behavior. It is, instead, almost surely a glimpse of a pervasive and growing reality, of a corrupt nexus of privatization and patronage.

Additional thoughts:

This is proof that governments have really been getting desperate over their state of finances.

But, privileges are hard to let go. Instead, politicians have used austerity from today’s crisis as opportunity to dispense concessions to friends, allies or favored special interest groups for political goals. This signifies a form of economic fascism

Politicians use accounting trickery to shield reforms.

Moreover, such privatizations represent fundamental admissions that even the most sensitive ‘public goods’, whether security or defense and prison services, can be delegated or outsourced to the private sector. This implies that these services can be depoliticized and delivered, through the competitive marketplace or (hold your breath) even without government.

The answer isn't to privatize (euphemism for fascism-cronyism) but to depoliticize and liberalize the sector.

Lastly, these are writings on the wall in favor of the growing forces of decentralization.

When governments become totally bankrupt then the de-politicization or decentralization process of political functions will become apparent.

ECB Eases Collateral Rules as Banking System Runs out of Assets

From the Wall Street Journal,

The European Central Bank said Friday it will widen the range of securities it will accept from euro-zone banks in exchange for its loans with the aim of helping boost lending to companies and households.

The ECB will now accept certain mortgage-backed securities, car loans and loans to small and medium-size firms.

The measure is seen as an attempt by the ECB to provide much needed liquidity to Spanish banks, which possess a large quantity of mortgage-backed securities after its real-estate bubble burst. Spain's government is expected to submit a formal request Monday to the European Union for a bailout of up to €100 billion ($125.4 billion) to help recapitalize its distressed banks. On Thursday, two independent consulting firms submitted results of stress tests conducted on 14 Spanish lenders, which put total capital need for the banking sector of Spain at up to €62 billion.

The ECB's step will reignite worries over a deterioration of the ECB's balance sheet, which is already at an all-time high after the ECB injected more than €1 trillion into the region's banking system in December and February to avert a credit crunch.

The German central bank, the Bundesbank, which has repeatedly criticized the ECB for the continued easing of its collateral rules as the euro-zone's debt crisis deepened over the past two years, was quick to respond.

This practically is an admission of the depletion of assets as collateral for loans in the Euro’s banking system.

And this also implies that ECB has been stuffed with ‘toxic’ assets and how rules has been easily changed or altered to accommodate interests of the political class and of the economic interests of the privileged politically protected few.

Eventually, the ECB may resort to directly accepting equities (or even commodities) as collateral.

Also, collateral rule adjustments may be a precursor to a coming 'shock and awe' policy coming from the ECB that would likely have a short lived 'buy another day' outcome.

All these reveals of the extent of desperation by EU officials, and more importantly, the current heavy state of distortions in the global financial markets.

Libertarianism: Political Career and Risks

When society has been lobotomized or programmed into believing that government is a “given”, and that the individual is not only branded as immoral (e.g. greed) but more importantly, nonexistent (e.g. nationalism), then looking for a political career from the standpoint of liberty seems almost close to nil.

But this shouldn’t stop passionate freedom loving disciples from preaching the truth. Austrian economist Bob Wenzel writes,

And that's what libertarians need to know about running for office. It's not about compromising your principles to gain more votes, its not about hiding your true views on taxes and minimum wage laws to gain more votes, it's about running to get the hardcore libertarian message out.

It's about hoping that after you give a speech where you denounce minimum wage laws, all taxes and the local public fire department, that at least one person, maybe two, wander over to you after your speech and tell you that what you said sounded interesting. It's about losing the election, but at the same time advancing the libertarian cause.

In other words, it's okay for a libertarian to run for office, if it's the Ron Paul way. If it's about losing the election but spreading the word. If it's about writing op-eds, appearing in debates and being interviewed on radio about hardcore libertarianism.

Libertarians aren't close to getting elected in most places with just a libertarian message. But the message can be spread. Ron Paul has proved that. If this is done in enough places, enough times, the message can be spread even more, and more people will catch on.

Then some day, perhaps five years from now, perhaps ten, we may hear of people sticking completely to libertarian principle and winning here and winning there. That will be the signal that large numbers of people at that time want liberty and understand what liberty is.

Embracing the principle of freedom confronts mountains of sacrifices and risks, particularly the risk of ostracism and of losing social privileges in the face of massive tentacle of influence by governments in almost every aspect of our lives.

The great Ludwig von Mises sets a shining example of this fight of principle over convenience; Professor Mises sacrificed a glamorous teaching career.

In an encomium, one of the greatest student by Professor Mises, the preeminent dean of the Austrian school Murray Rothbard reveals of the career life of Mises,

But it remains an ineradicable blot on the record of American academia that Mises was never able to find a paid, full-time post in any American university. It is truly shameful that at a time when every third-rate Marxoid refugee was able to find a prestigious berth in academia, that one of the great minds of the twentieth century could not find an academic post. Mises's widow Margit, in her moving memoir about life with Lu, records their happiness and her gratitude that the New York University Graduate School of Business Administration, in 1945, appointed Mises as Visiting Professor teaching one course a term. Mises was delighted to be back at university teaching; but the present writer cannot be nearly as enthusiastic about a part-time post paying the pittance of $2,000 a year. Mises's course was, at first, on "Statism and the Profit Motive," and it later changed to one on "Socialism." This part-time teaching post was renewed until 1949…

Likewise, in the face of Keynesian revolution, the great Mises stuck to his convictions when the rest sold out, again from Professor Rothbard,

It must have been galling to Mises that, in contrast to his shabby treatment at the hands of American academia, favorite former students who had abandoned Misesian doctrines for Keynesianism, but whose only real contributions to economics had come as Misesians, received high and prestigious academic posts. Thus Gottfried Haberler was ensconced as full professor at Harvard, and Fritz Machlup went to John Hopkins and later to Princeton. Oskar Morgenstern, too, landed at Princeton. All of these high academic positions were, of course, paid for by the university

Well, even the soul of American revolution Thomas Paine, known for this famous passage…

Society in every state is a blessing, but government, even in its best state, is but a necessary evil; in its worst state, an intolerable one.

…had a melancholic-tragic ending.

Author George Smith accounts for Mr. Paine’s demise,

The man who inspired the country to secede from a corrupt state had six people in attendance at his funeral, none of whom were dignitaries.

The struggle for the cause of liberty is a tall order.

But I think the information age will most likely tilt the balance from the dominant political mindset towards liberty.

Quote of the Day: Ethical Defense of Liberty Knows NO Borders

an ethical defense of liberty, as well as an economic defense of liberty, applies equally to both sides of any national border. Anyone who claims to defend market liberty for his own people should be equally prepared to defend market liberty for the people on the other side of the national border. This is the doctrine of the rule of law. This widespread acceptance of this principle has made the West rich.

This is from Professor Gary North from his excellent article on the immorality of tariffs or why tariffs are undeclared acts of war against other nations.

Video: The Economics of Drug Prohibition, Why Prohibition Laws Fail

Holier-than-thou politically inclined people always like to preach about how we should prohibit drugs legally to "save society".

Despite the mountains of regulations, and the multitude of arrests and incarcerations, drug use has been rapidly expanding globally. On the contrary, these constitutes as failures of such regulations.

Yet this is does not just apply to drugs but almost to every other instances of prohibitions on social vices, e.g. smoking, prostitution, gambling (e.g. Philippine jueteng) and etc...

[As a side note, I might add that people who argue from the high perch of morality are those mostly out there to get social acceptability or "likes" from the uninformed than to objectively discuss the merits or demerits of such regulations]

The following video from LearnLiberty.org explains the economics of prohibition and why such laws engenders adverse unintended effects than what is supposed to be accomplished. (hat tip Professor Mark Perry)

In its history, America has experienced two major periods of drug prohibition. This first was the Federal alcohol prohibition from 1920-1933. The second is the current war on drugs, which began in 1971.

According to Prof. Angela Dills, during these periods of prohibition in America, both homicide rates and police enforcement costs increased. This makes sense, as prohibitions never actually eliminate use. Rather, prohibitions convert peaceful and legal markets into black markets. In black markets, when disputes arise over sales territory, product quality, or money, the government legal system is not available. This forces drug dealers to resolve disputes on their own, which often leads to violence.

The violence of black markets, along with the enforcement of drug policy, attracts the attention of law enforcement. Law enforcement is costly, and the time spent enforcing drug laws could have been spent preventing other crimes like murder, theft, and rape. Drug prohibition not only generates more violence and increases the cost of law enforcement; it also distracts law enforcement and puts citizens at greater risk of crime.

In short, not only does prohibition statutes corrupt a society, at worst they kill.

Bear Market in Commodities Isn’t Bullish for Stocks

The Bloomberg reports that commodities have entered a bear market, (bold emphasis mine)

Commodities tumbled into a bear market as U.S. reports on manufacturing, jobless claims and home sales signaled a faltering economy after the Federal Reserve refrained from announcing another round of stimulus.

The Standard & Poor’s GSCI Spot Index of 24 raw materials fell 2.8 percent to settle at 559 at 3:56 p.m. New York time. The gauge has dropped 22 percent from this year’s highest close of 715.52 on Feb. 24, entering a bear market. Earlier, the measure touched 558.14, the lowest since November 2010. Metals and energy led today’s slump.

Manufacturing in the Philadelphia region contracted in June at the fastest pace in almost a year. Existing U.S. home sales fell more than forecast by analysts, and jobless claims topped estimates. Yesterday, the Fed, led by Chairman Ben S. Bernanke, reduced its 2012 forecast for economic growth, and policy makers decided against a third round of debt purchases.

“We got nothing significant from Bernanke, and data continues to paint a horrible picture,” said Steve Mathews, the chief investment officer of Flintlock Capital Asset Management LLC in New York, which manages $105 million of assets. “We have to wait until the next Bernanke event to know if the Fed will indeed do something to perk the economy.”

The GSCI index surged 92 percent from the end of December 2008 to June 2011 as the Fed kept borrowing costs at a record low and bought $2.3 trillion of debt in two rounds of so-called quantitative easing.

Let me put the the news into the proper perspective. Slackening economic developments in the US only aggravates the already existing weak conditions around the world.

As pointed out earlier, China’s markets continue to tumble on fresh accounts of sluggish manufacturing. This in spite of the recent tepid inflationist policies in ‘support’ of China’s economy (it’s really not the economy but the cronies).

Bear market in commodity prices (GTX) has more been consistent with actions of China’s Shanghai index (SSEC) than the US S&P 500 (SPX).

Add to the mix the Euro crisis, dwindling growth of emerging markets and most importantly, the seemingly irresolute or halfhearted central bankers, such as the US Federal Reserve’s miserly extension of Operation Twist, who may be tacitly wishing for a crash to justify their interventions, you’ve got a recipe for a reversal in expectations.

A reversal in expectations will mean bad news IS bad news.

Let me repeat what I have been warning about and what I said yesterday,

If GLOBAL political agents will continue to withhold steroids from the steroid-starved or stimulus-addicted financial markets, expectations will likely reverse soon.

And that reversal could be swift, deep and dramatically violent.

“We got nothing significant from Bernanke” are signs of growing demand for REAL actions and increasing frustrations with current set of political actions. The allure of promises appears to be fading.

This also implies of the possible inflection of market’s expectations on mere pledges and guarantees.

So seen from both the dimensions of consumption or from monetary inflation, a bear market in commodities cannot be bullish on (steroid dependent) global equities (including the Phisix).

Be very careful out there.

Quote of the Day: Understanding Classical Liberalism

Liberalism is no religion, no world view, no party of special interests. It is no religion because it demands neither faith nor devotion, because there is nothing mystical about it, and because it has no dogmas. It is no world view because it does not try to explain the cosmos and because it says nothing and does not seek to say anything about the meaning and purpose of human existence. It is no party of special interests because it does not provide or seek to provide any special advantage whatsoever to any individual or any group. It is something entirely different. It is an ideology, a doctrine of the mutual relationship among the members of society and, at the same time, the application of this doctrine to the conduct of men in actual society. It promises nothing that exceeds what can be accomplished in society and through society. It seeks to give men only one thing, the peaceful, undisturbed development of material well-being for all, in order thereby to shield them from the external causes of pain and suffering as far as it lies within the power of social institutions to do so at all. To diminish suffering, to increase happiness: that is its aim.

This is from the great Professor Ludwig von Mises, The Future of Liberalism, in Liberalism in the Classical Tradition

China’s Manufacturing Troubles Hasn’t Gone Away

More bad news from China: China's manufacturing woes hasn't gone away and has reportedly worsened.

From Bloomberg,

China’s manufacturing may shrink for an eighth month in June, matching the streak during the global financial crisis in a signal the government’s stimulus has yet to reverse the economy’s slowdown.

The preliminary reading was 48.1 for a purchasing managers’ index today from HSBC Holdings Plc and Markit Economics. Above- 50 readings indicate expansion. The lowest crisis level was 40.9 in November 2008, when industrial output grew 5.4 percent from a year earlier, compared with 9.6 percent last month.

Today’s report contrasts with comments by officials expressing confidence growth will rebound, with President Hu Jintao saying in remarks published June 17 that China has taken “targeted measures” to boost domestic demand. Asian stocks fell and the yuan weakened for a second day against the dollar.

“Beijing’s policy easing so far has not been enough,” Qu Hongbin, Hong Kong-based chief China economist for HSBC, said in a Bloomberg Television interview. “Probably more needs to be done if they really want to stabilize the growth.”

If confirmed on July 2, the gauge would be at the lowest since November 2011 and equal the run of below-50 readings from August 2008 to March 2009…

The Chinese government signaled a more-aggressive approach to sustaining expansion last month when Premier Wen Jiabao called for more efforts toward stabilizing growth. The People’s Bank of China on June 7 cut interest rates for the first time since 2008 and the economic planning agency is stepping up approvals of investment projects.

Apparently China’s interest rate cuts and stealth SOE based stimulus has yet to weave its magic.

As I have been saying, China persists to show signs of reluctance or has continually dithered to engage in aggressive stimulus, perhaps until the national elections this October.

The ongoing slowdown (or perhaps a bubble bust?) in China’s bubble economy has been consistent with the recent downdraft of commodity prices, despite the US Federal Reserve’s half-hearted extension of Operation Twist.

For now, BAD news is BAD news.

Much of Asia, as of this writing, has been in the red except for Japan and the Philippines. Most of the damage can be seen in China’s Shanghai index who seem to suffer from a technical breakdown.

If GLOBAL political agents will continue to withhold steroids from the steroid-starved or stimulus-addicted financial markets, expectations will likely reverse soon.

And that reversal could be swift, deep and dramatically violent.

Be very careful out there.

Public Choice in Action: Logrolling in the Philippine Mining-Tourism Policy

Well it seems that President Aquino will be delivering a compromise over the controversial (I would add nonsensical) mining-tourism squabble.

From the Inquirer,

A new mining policy expected to be issued Friday by President Benigno Aquino hopes to generate more revenues for the government in the face of a high demand for metallic resources while excluding about 78 more areas from mining activities.

Aquino said here on Wednesday that he hoped to come out soon with the much-awaited executive order (EO) spelling out the government’s revised mining policy in the midst of intense debate between industry leaders and environmentalists through the years.

Without going into details, the President said small-scale mining would be further regulated throughout the country under the new EO, which, he added, was undergoing “fine-tuning” in certain provisions for being “superfluous.”…

Asked how the new EO will be able to balance out concerns on environment protection and economic gains, Mr. Aquino said that one of its provisions would designate “roughly” 78 areas to be reserved for tourism “and mining cannot happen there.”

Extractive activities would be disallowed in agricultural and ecotourism areas, according to the source. At present, mining is barred only in areas under protected status.

The President noted that the provision in the draft EO that “mining cannot happen in prime agricultural lands” had also been stated in the law extending the implementation of the Comprehensive Agrarian Reform Program which, in turn, prohibited the conversion of irrigated lands.

There are lots of things to discuss here, particularly side effects of these policies, nevertheless, this represents another wonderful example of the public choice theory in action: a political compromise between two vested interest groups.

Here’s Professor Don Boudreaux and Dwight Lee on “logrolling” (bold emphasis mine)

democratic politics falls short of achieving optimal compromise not only because of immoderate ideological restraints imposed on representatives by voters, but also because it displaces voluntary market arrangements which achieve a far greater and more inclusive amount of compromise. In fact, politics stymies more beneficial compromise than it promotes. Politics should more appropriately be called the art of confining compromise--political compromises are confined to the relatively few parties with ample political power to participate in political bargaining.

The lesson here is that political mandates or edicts or regulations work in the favor of the interests of politically organized and politically connected groups than over the unorganized-invisible groups (yes, this means you, me and the rest of the Juans, Marias, and Pedros).

I call this political inequality.

[disclosure: I have equity exposures in the mining industry, but I favor free markets rather than 'compromises' or logrolling or the use of fiat to secure economic advantage over the rest]