Do We Need Central Banks?

Tim Price at the Sovereign Man asks why the need for a central bank? (bold emphasis original)

A typical if feeble answer is that we need a lender of last resort. To which the answer is… Why? Why do we need a government-appointed entity to support banks that get in over their heads?

A typical answer is that if our banks start failing, our society starts going down the toilet. (It already has, but never mind.)

So now we have the worst of all possible worlds. Our banks are already failing, in the sense of no longer functioning according to the principles of offering an economic rate to depositors and offering economic funding to borrowers.

Plus, now we have ended up with a handful of quasi-nationalised banking group zombies that appear to be being run for the sole purpose of being granted dollops of money that they are free to hoard whenever the central bank deems it appropriate to depreciate our currencies some more.

If our banks were free to fail, a) we would have no need of a central bank, and b) we would have no need for banking guarantees.

Banking deposit agreements would simply come with a giant ‘Caveat Emptor’ on them, and depositors might be able to start earning a positive real interest rate on their savings again.

Abolishing central banks and their core functions would have the happy and non-trivial side effect of reintroducing something akin to sound money into the world economy, rather than live with permanent inflation and have the entire economy held hostage by banking interests.

In reality central banks exists as backstop financiers to the welfare-warfare state. For instance, wars has been facilitated and enabled by the existence of central banks.

Professor Gary North explains

The sinews of war are strengthened by central banking. This is why textbooks praise the Bank of England. It let the British fight longer wars and more destructive wars. The message: get a central bank for your nation, so that your politicians can declare war more readily and stay in that war far longer.

Central banks signify as central planning and the politicization of money. They are part of the 10 planks of Karl Marx’s Communist Manifesto.

Centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly.

Yes it's a delusion to equate capitalism with 'communist' central banking.

Central banks also promote the interests of the banking and political class at the expense of society through inflationism which not only causes boom bust cycles, but importantly has been diminishing the purchasing power of our currencies. This why a huge amount of the public’s resources have been funneled to insolvent “zombie” banks and bankrupt states.

And this is why once zombie institutions become desperate they resort to other measures of financial repression and take the political route towards despotism. And this is also why the private sector will always become the scapegoat for policy errors. That's until people don't understand the essence of central banking.

Yes, I agree Mr. Price, we need the de-politicization of money or the return to sound money through the free markets.

End the Fed. End all central banking.

What the Political Rhetoric “You Didn't Get There on Your Own” Means

When a politician preaches that “you didn't get there on your own” they may only be half right. That’s because our world operates on the principle of division of labor where no one really produces things on their own.

No one, on his own, even knows how to make a simple product like the pencil, as Milton Friedman explained

But what the politicians really mean is that every entrepreneurial success (wealth) has been owed to the government.

The distinguished Thomas Sowell exposes such myth or deception {bold emphasis mine]

Let's stop and think, even though the whole purpose of much political rhetoric is to keep us from thinking, and stir our emotions instead.

Even if we were to assume, just for the sake of argument, that 90 percent of what a successful person has achieved was due to the government, what follows from that? That politicians will make better decisions than individual citizens, that politicians will spend the wealth of the country better than those who created it? That doesn't follow logically -- and certainly not empirically.

Does anyone doubt that most people owe a lot to the parents who raised them? But what follows from that? That they should never become adults who make their own decisions?

The whole point of the collectivist mindset is to concentrate power in the hands of the collectivists -- which is to say, to take away our freedom. They do this in stages, starting with some group that others envy or resent -- Jews in Nazi Germany, capitalists in the Soviet Union, foreign investors in Third World countries that confiscate their investments and call this theft "nationalization."

Freedom is seldom destroyed all at once. More often it is eroded, bit by bit, until it is gone. This can happen so gradually that there is no sudden change that would alert people to the danger. By the time everybody realizes what has happened, it can be too late, because their freedom is gone.

All the high-flown talk about how people who are successful in business should "give back" to the community that created the things that facilitated their success is, again, something that sounds plausible to people who do not stop and think through what is being said. After years of dumbed-down education, that apparently includes a lot of people.

Take Obama's example of the business that benefits from being able to ship their products on roads that the government built. How does that create a need to "give back"?

Did the taxpayers, including business taxpayers, not pay for that road when it was built? Why should they have to pay for it twice?

What about the workers that businesses hire, whose education is usually created in government-financed schools? The government doesn't have any wealth of its own, except what it takes from taxpayers, whether individuals or businesses. They have already paid for that education. It is not a gift that they have to "give back" by letting politicians take more of their money and freedom.

When businesses hire highly educated people, such as chemists or engineers, competition in the labor market forces them to pay higher salaries for people with longer years of valuable education. That education is not a government gift to the employers. It is paid for while it is being created in schools and universities, and it is paid for in higher salaries when highly educated people are hired.

One of the tricks of professional magicians is to distract the audience's attention from what they are doing while they are creating an illusion of magic. Pious talk about "giving back" distracts our attention from the cold fact that politicians are taking away more and more of our money and our freedom.

Bottom line: Reading between the lines helps to protect one from getting hoodwinked by political glib talkers.

US Social Mobility Hamstrung by Taxes and the Welfare State

One principal reason to expect future default and high interest rate environment can be seen from the micro level.

In the US, the repressive tax regime and the welfare state has deepened the public’s incentive to become unproductive and dependent on the government which comes at the expense social mobility.

Writes the Business Insider, (hat tip Sovereign Man) [bold added]

Upward mobility has been a foundation of America’s self-image since the 18^th century.

If you work hard enough, nothing can stop you from getting ahead. That, at least in the minds of many Americans, is what distinguishes us from much of the rest of the world.

Yet, according to my always-provocative Tax Policy Center colleague Gene Steuerle, our tax and spending priorities not only fail to promote mobility for those who are starting at the bottom, but they often actively discourage the hard work and savings that help us climb the socio-economic ladder.

Oh, the federal budget is loaded with subsidies that encourage work and savings. But they are almost always aimed at improving the lot of middle- and upper-income households, not those who most need a leg up.

In testimony last week to the Senate Finance Committee, Gene estimated that of the nearly $750 billion in mobility-enhancing tax and spending programs in 2006, $540 billion–or nearly three-quarters– went to higher income households. Those with low-incomes received only about 2 percent of the benefit of subsidies for home ownership and almost none of the benefit of employer-related work subsidies or incentives for savings and investment.

Some of these programs not only fail to help poor and lower middle-class households, they actively hurt them. For instance, if home ownership is a key to upward mobility (an arguable proposition, but one many believe), we need to acknowledge that subsidies such as the mortgage interest deduction inflate home prices and make it harder, not easier, for poor families to buy.

Worse than that, Gene argues, once low-income households reach poverty level, government policy discourages work. True, social welfare programs provide a valuable safety net for the very poor. For instance, the Earned Income Tax Credit and the Child Tax Credit are important income supports for low-income families.

But because these safety net programs phase out as incomes rise, some people face marginal tax rates as high as 80 percent for getting a better job or even a raise. A new Urban Institute calculator shows how this works.

With a budget that encourages consumption rather than work and savings, the gap between the American Dream of unfettered mobility and the reality will only widen, Gene fears. His solution: Rethink those tax subsidies and spending programs that too often hinder mobility, paradoxically in the name of enhancing it.

A deepening of the socio-political parasitical relationship will come with great costs. Such will be vented not only in the political economy but likewise on the financial markets.

The Coming Debt Default Binge: US Debt Surged $6,866,712,084,997.92 in 5 Years!

The policy of record debt financed spending in the US continues…

From CNSNews.com (hat tip Sovereign Man)

By the end of the third quarter of fiscal 2012, the new debt accumulated in this fiscal year by the federal government had already exceeded $1 trillion, making this fiscal year the fifth straight in which the federal government has increased its debt by more than a trillion dollars, according to official debt numbers published by the U.S. Treasury.

Prior to fiscal 2008, the federal government had never increased its debt by as much as $1 trillion in a single fiscal year. From fiscal 2008 onward, however, the federal government has increased its debt by at least $1 trillion each and every fiscal year.

The federal fiscal year begins on Oct. 1 and ends on Sept. 30. At the close of business on Sept. 30, 2011—the last day of fiscal 2011—the total debt of the federal government was $14,790,340,328,557.15. By June 29, the last business day of the third quarter of fiscal 2012, that debt had grown to $15,856,367,214,324.44—an increase for this fiscal year of $1,066,026,885,767.29.

In the fourth quarter of fiscal 2012, the federal debt has continued to accumulate, hitting $15,874,365,457,260.40 at the close of business on Thursday, July 19—marking a total increase so far in fiscal 2012 of $1,084,025,128,703.25.

In fiscal 2007, according to the U.S. Treasury, the federal government’s debt increased $500,679,473,047.25. But that marked the last fiscal year in which the federal government's debt did not increase by at least $1 trillion.

In fiscal 2008, the debt increased $1,017,071,524,650.01. In fiscal 2009, it increased $1,885,104,106,599.26. In fiscal 2010, it increased $1,651,794,027,380.04. And in fiscal 2011, it increased $1,228,717,297,665.36.

So far this fiscal year (which is a leap year of 366 days), the Treasury has increased the net debt of the federal government at an average rate of $3,699,744,466.56 per day. If that average were to hold up for the 73 days that remained in the fiscal year after July 19, the debt would increase in fiscal 2012 by a total of $1,354,106,474,762.13—a greater increase than last year.

At the close of business on Sept. 30, 2007--which marked the beginning of fiscal 2008--the total debt of the federal government stood at $9,007,653,372,262.48. At the close of business on July 19, it stood at $15,874,365,457,260.40--an increase of $6,866,712,084,997.92 in less than five years.

I find the argument of a sustained low interest environment from the intensifying growth of the current level of indebtedness as specious reasoning.

Japan in the 90s or the Great Depression days of the 1930s signify as apples to orange comparison for the simple reason that current degree of indebtedness has been global and has been unprecedented.

Again one cannot count on history alone (e.g. Reinhart-Rogoff) as an accurate roadmap for the future as everything will depend on how such dynamics will be dealt with. Will the growth rate of debt based political spending continue? Who will finance these? And up to what extent? If funded by central banks up to what point before (consumer price) inflation surfaces and becomes an economic menace (stagflation, if not hyperinflation)? Will governments strangulate the economy with more repressive regulations or will governments undertake “shock liberalization” (J. Cochrane)?

The current scale of debt implies that these countries will be competing with each other for limited savings from residents and non-residents for financing. (chart from Zero Hedge)

This is why we are seeing a crisis in the Eurozone…

…a crisis that will likely spillover to the rest of the nations encumbered by huge liabilities.

For crisis affected PIIGS, obviously a low interest rate regime has gone pfffftt. This is the revenge of the bond vigilantes.

The (liberal) counterargument will say that the crisis stricken PIIGS doesn’t have the same ability as Japan or the US to print their own money. That’s unalloyed hogwash.

Any argument that sees printing money as a way to prosperity IS delusional. Eventually such craving for the philosopher’s stone will be exposed for what they truly are: a fraud.

As the great Ludwig von Mises warned,

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

Interest rates will eventually rise (everywhere) to reflect on either the disproportional distribution or imbalances between the level of savings and debt OR an inflationary surge (or perhaps even both). There is no such thing as a free lunch.

Quote of the Day: Freedom and Prosperity are Inextricably Linked

These places– Estonia and Lithuania in particular– are essentially devoid of natural resources. They’re tiny countries without oil or gold deposits.

And yet they’ve been able to achieve very high living standards simply because their governments got out of the way, especially compared to the rest of Europe.

It’s the same story in places like Hong Kong and Singapore… not to mention the multitude of examples throughout history.

Venice, for example, introduced something called the commenda in the 10th century; this was a sort of limited partnership in which one person (the commendator) was the passive investor in the arrangement, and the other (the tractator) was the trader who would go overseas and try to make a fortune.

When the commenda expired, the tractator would return home with a full accounting of the trip and split the profits in the way that was designated in the contract.

A lot of people became very wealthy through this system… and by extension, Venice became the richest place in Europe.

It didn’t happen because of government regulation, currency inflation, or spending intitatives. People prospered because the government got out of the way; they had the economic freedom to work hard and succeed from their own sweat, not handouts.

Of course, after a few hundred years, Venice managed to screw it up.

By the 13th century, a political elite had formed. They began to heavily regulate trade, nationalize some routes, impose heavy taxes on merchants, and even introduce a police force to do their bidding.

Devoid of the economic freedom they once had, Venice shrank into a shell of its former self.

This is, by far, one of the most important lessons from history: freedom and prosperity are inextricably linked. Free societies prosper… and as freedom declines, so does prosperity.

And it’s a very slippery slope: the more prosperity declines, the more politicians try to regulate the economy through wage controls, price controls, capital controls, etc. And the more they regulate the economy, the faster prosperity declines.

This is from the Sovereign Man's Simon Black debunking the quack solutions peddled by the mainstream especially by a Nobel Prize winner.

Tax Avoidance: U.S. Banks Spawn 10,000 Subsidiaries Worldwide

Below is a great example of what is called as tax avoidance which Wikipedia.org defines as

legal utilization of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law.

For the politically endowed US banks, tax avoidance means establishing numerous subsidiaries around the world.

From Bloomberg,

The biggest U.S. banks created more than 10,000 subsidiaries in the past 22 years as they expanded, using legal structures to pay lower taxes and escape tighter regulation, according to a Federal Reserve study.

JPMorgan Chase & Co. (JPM), the largest U.S. lender, has the most units at 3,391, followed by Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. (BAC) with more than 2,000 each, the study by the Federal Reserve Bank of New York shows. Citigroup Inc. (C), the third-largest lender, has 1,645.

Critics including Thomas Hoenig, a Federal Deposit Insurance Corp. board member, say the biggest firms are too complicated to manage. The 2010 Dodd-Frank Act asked the FDIC and Fed to make sure the largest banks, if they get into trouble, can be wound down without collapsing the rest of the financial system. U.S. Senator Sherrod Brown has proposed legislation to force their breakup.

“When regulators are left to curtail the risk of trillion- dollar megabanks with hundreds of affiliates, we know that too big to fail is also too big to manage” said Brown, an Ohio Democrat and member of the Senate Banking Committee.

Well this is just the banking system, I would conjecture that many significantly sized companies, as well as, the wealthy, do the same. The rich according to CNBC has an estimated $21 to $32 trillion stashed overseas. Of course this claim has been made by political parasites eyeing to seize their property.

The lesson here is that people will respond to changes in tax regimes. So any puritanical statist idea of imposing taxes to generate revenue without considering people's responses are likely to fail.

Quote of the Day: Freedom is not Defined by Safety

Freedom is not defined by safety. Freedom is defined by the ability of citizens to live without government interference. Government cannot create a world without risks, nor would we really wish to live in such a fictional place. Only a totalitarian society would even claim absolute safety as a worthy ideal, because it would require total state control over its citizens’ lives. Liberty has meaning only if we still believe in it when terrible things happen and a false government security blanket beckons

This is from Ron Paul’s latest outlook Security and Self Governance

Brain Damage and Better Investment Decisions

Jason Zweig in his latest article at the Wall Street Journal cites a study which suggests that people with brain damage are likely to make superior investment decisions than normal people…

With computerized traders that "hold" stocks for only a few seconds at a time and markets that can swing wildly in a matter of moments, long-term investing seems to be on the verge of extinction.

Perhaps this is inevitable. It turns out that short-term thinking is deeply embedded in the workings of the human brain. New research suggests that in order to avoid trading your accounts to death, you must counteract some of the very tendencies that make Homo sapiens the most intelligent of all species.

In a study published last month in the Journal of Neuroscience, researchers from California Institute of Technology, New York University and the University of Iowa looked at how people use past rewards to predict future payoffs.

Directly behind your forehead is a region of the brain known as the frontopolar cortex. Much larger in humans than in other primates, this area is critical to such advanced mental functions as memory, exploring new environments and making decisions about the future.

In the new study, the researchers wanted to see how the frontopolar cortex contributes to predicting rewards. So they compared people with damage to the frontopolar cortex against two control groups of healthy people and those with injuries elsewhere in the brain (but not the frontopolar cortex)….

When confronted with the unpredictable, however, the frontopolar cortex refuses to admit defeat. It draws on all your computational abilities to search for patterns in random data.

In the absence of real patterns, it will detect illusory ones. And it will prompt you to act on them.

No wonder so many investors find it hard to muster the willpower to buy and hold a handful of investments for years at a time.

But if "buy and hold is dead," as growing numbers of investors argue, it isn't clear what else is alive. In the lousy markets of the past decade, various alternatives such as "tactical asset allocation" (or market timing), mathematical risk-reduction techniques and even plain old intuition haven't worked out all that well, either.

Most of the folks who say buy and hold is dead don't talk much about their long-term returns. Instead, they stress how they have done recently, a tactic that for many potential clients has the same irresistible appeal as the last couple of pulls on a slot machine.

The solution to short-term thinking isn't to bash yourself in the forehead with a hammer, of course. But you can use your brainpower to your advantage.

Every investing decision you make should be the result of a deliberate process.

The implication that it would take brain damage to make for a better investor would seem downright preposterous (the same goes with the theory of high IQs)

Pseudo scientific studies like the above disparages the individual’s distinctive capacity to deal with the ever changing circumstances we are faced with.

While it may be true that many people have the tendency to fall for cognitive biases, in reality all of people’s actions are driven by incentives

Incentives are shaped by the dynamic admixture of many factors—including genes and the environment, peer pressure and social status, educational background, culture, religion, technology and even to social policies such as zero bound rates—in relation to changes to the environment, social relations and the economy (even if some of their actions can be read as cognitive biases or heuristics—pattern seeking behavior).

This applies to short-term thinking.

Deliberate process is more about containing the urge for the dopamine to govern one’s action, or importantly, managing emotions through emotional intelligence (EI) to attain self-discipline.

Superior investing decisions can be attained even if you have a normal brain.

Anonymous Libor Expert Explains on How the Fed has Destroyed LIBOR

As explained by an anonymous Libor ‘trader’ expert, courtesy of the Business Insider, (bold emphasis added)

LIBOR isn't really based on a tangible number; it's based on a compilation of bank responses to the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?"

Banks need to find money to settle transactions denominated in other currencies or involving transactions abroad. Therefore they use instruments like Eurodollar futures, which allows them to borrow or lend dollars at banks outside the United States for a certain period of time.

The effects of any central bank action are felt directly in these markets. When the Federal Reserve wants to lower the federal funds rate, it uses open market operations—this means it states its intention of depositing more money in banks' accounts at the Fed, making it cheaper for other financial firms to get dollars.

In the years leading up to the financial crisis, the relative stability in rates allowed algorithmic traders to take advantage of very minute changes in LIBOR at various maturities, like those mentioned by Barclays traders in documents released by European regulators. The Fed and other central banks could control that rate by adjusting interest rates, but LIBOR moved pretty much in tandem with the federal funds rate.

"My colleagues and I, we say that [LIBOR] is 14 bps over the federal funds rate...as a joke," the trader told Business Insider, pointing to the uncanny correlation between the two rates up until 2007 and since 2009. When the rate at which banks lent to each other began to jump in late 2007, however, "the system couldn't take it at all," he added.

In the lead-up to and during the financial crisis, real interbank lending for any length of time beyond overnight practically stopped. Thus, saying that banks were pushing down their reports of the prices at which they could borrow is at best misleading, because the demand for lending long-term was nonexistent.

"We submitted a hallucination," said the source.

Central banks responded to the credit stress by offering massive lending facilities, which allowed banks to to access money—in particular, dollars—through a vehicle outside the traditional private money markets. That has changed the way the markets work.

The trader explained, "Since the crisis, banks don't fund themselves [through the traditional money markets] because they don't want to. It's really now about old contracts," that were purchased ahead of the crisis.

But while markets may have exited the crisis credit crunch, markets for securities determined by LIBOR have not, the trader told us. Instead, he says there's an implicit push by the Fed to keep the lending rate low, even though it should be much higher now.

By releasing interest rate projections and jumping to non-standard measures like quantitative easing and dollar facilities, the Fed destroys the incentive to actually exchange money via Eurodollar contracts. This means the Fed is refusing to let LIBOR function as a true, independent indicator.

"If you're long the TED [you believe there will be more financial stress] in a time of trouble, you buy T-bills and take the money offered to you, so you sell a Eurodollar." Essentially, you believe you'll be profiting off of higher lending costs for banks in the future. But if the LIBOR is kept artificially low, then you lose money on a Eurodollar futures contract.

But now, the Fed has become so committed to keeping interest rates down indefinitely—and has jumped so quickly to measures that distort the market—that it has completely destroyed any faith or interest in new contracts.

The trader believed that central banks have recognized that disaster happens when the LIBOR begins to deviate from its general relationship to the federal funds rate, and therefore the Fed (and perhaps other central banks) have suppressed it to make sure rising rates don't generate fear while it develops another money market system.

"I think what they want to do is make sure the system doesn't go crazy." Otherwise, he argues, "You're not just embracing a fantasy. You're embracing a fantasy that created the great credit bubble."

The above observation has basically been congruent with my earlier thesis

China’s Blossoming Peer to Peer Credit Industry

More proof that markets abhor a vacuum.

While we seem to be getting mixed signals about the real credit conditions in China, where I suspect that lending growth has been happening among State Owned Enterprises (SoE) but may have been contracting in the private sector due to the overleverage in the shadow banking system (mostly from financial vehicles setup by regional authorities), many of the average Chinese seems to be exploring direct credit transactions via the internet: Peer to Peer lending.

From Bloomberg,

Peer-to-peer lending is taking off in China as traditional methods of private lending among family and acquaintances, part of the country’s unregulated $2.4 trillion shadow-banking system, move online. More than 2,000 websites have been set up nationwide since 2007, China National Radio reported in May. Loans brokered online increased 300-fold to 6 billion yuan in the first half of 2011, the latest figures available, from the full year total in 2007, the report said.

’Innovative Lending’

Akin to LendingClub.com or Prosper.com in the U.S., China’s peer-to-peer lenders let individuals invest a minimum of 50 yuan in projects ranging from small-business expansion to funding newlyweds’ honeymoons for as much as 23 percent interest, the highest rate allowed under Chinese law. While the returns are higher than parking the money in bank accounts earning 3 percent, they’re dwarfed by some underground shadow-banking investment yields that can go as high as 100 percent.

“This is an interesting and innovative lending platform with a lot of goodwill,” said Liao Qiang, a Beijing-based director for financial institutions at Standard & Poor’s.

Existing outside of regulators’ jurisdiction, online lending sites aren’t without risks. The China Banking Regulatory Commission in September issued a warning about web-based brokers, cautioning that their bad-loan ratio is “significantly higher” than that of banks -- without specifying the figure -- and that they can cross the line into illegality such as fraud, funding illegitimate businesses or money laundering.

A Beijing-based spokesman for the banking regulator said peer-to-peer lending isn’t under its official purview.

“There is no discipline at all,” Liao said, calling it a “short-lived fad” that won’t affect the role banks play in the economy. “There’s no enforcement should borrowers default.”

P2P lending will hardly be a short-lived fad, as they are in reality representative of free markets and of the deepening trend of the information age.

It’s bizarre how the mainstream talks about the paucity of discipline when today’s over-indebted shadow banking in China has mainly been fueled by reckless local government units in pursuit of political goals. China’s shadow banking industry consists of the investment trust industry, pawn shops, guarantors, underground banks and wealth management products.

Politicians and their apologists always try to shift the blame on markets the monsters which are, in reality, products of their self-creation.

Eventually P2P credit markets will get significant volume enough to challenge the conventional banking and financial industries, where the latter would seek interventions to curb competition. Don’t forget that conventional banking and governments will strive to uphold their symbiotic relationship which has been backed by the central bank.

Nonetheless, again China’s blossoming P2P credit markets are growing evidences of the deepening of the information age and of the parallel free markets (free banking?) that can be accessed, in case the conventional political- interdependent banking system undergoes a seizure (similar to Lehman episode of 2008). if not a collapse.

Strength of Singapore Stocks Largely Depends on the US Equity Markets

The ASEAN 4 has been having an outstanding performance relative to the world. So as with ASEAN ‘developed’ economy Singapore.

From Bloomberg,

Singapore stocks have gained 13 percent in 2012 with volatility that is the lowest in Asia, luring the region’s biggest investors to a rally that trails only Denmark among developed nations.

The Singapore Straits Times Index (FSSTI) has risen 15 of the last 19 days while its 30-day implied volatility, a measure of risk derived from options prices, held below levels in Japan, Hong Kong, China, South Korea, India, Taiwan and Australia. Shares in the gauge yield 3.6 percent in dividends, compared with 3.2 percent for the MSCI Asia Pacific Index (MXAP), data compiled by Bloomberg show.

Nikko Asset Management Co. and Schroders Plc are finding bargains even after the Straits Times Index closed at its highest level of the year last week. Companies trade at 9.9 annual earnings, compared with 21 times for Denmark’s OMX Copenhagen 20 Index, the best-performing index among developed countries with a 21 percent gain. The MSCI Asia Pacific Index trades at 14 times profit, data compiled by Bloomberg show.

“Singapore equities are very, very cheap,” said Ng Soo Nam, Singapore-based chief investment officer at Nikko Asset Management, which oversees about $165 billion. “Valuations have been bashed down so much that the dividend yields are getting interesting even for Singapore banks, which are traditionally not dividend yield stocks.”

It has been true that Singapore, like her ASEAN ‘emerging’ contemporaries, has had a low beta relative to the world.

Chart from DBS Vickers.

A beta (based on CAPM) of less than 1 means that the security will be less volatile than the market (Investopedia.com)

But as caveat, past performance must not be read as future outcome as today’s conditions has been highly fluid and volatile which means correlations can shift in a finger’s snap.

As I recently pointed out, like the ASEAN-4, much of the strength of Singapore’s STI has been anchored on the US.

The bottom line is that the seemingly resilient stock markets of ASEAN, including Singapore, largely depends on the directions of the US counterparts.

All prices in the financial markets are relative: pricey issues may still become pricier, also cheap issues may become cheaper.

Prudent Investor Newsletters at Before It’s News

Some of my articles have recently been cross-posted at the Finance section of Before It’s News, a people powered syndication platform.

Although Before It’s News (via Sean Melehan) wrote me on this about a year ago, only recently have I noticed that many of articles got published and linked on their site.

You can visit the finance section of Before It’s News here.

Anyway thanks to Before It’s News (and to Sean Melehan)

Shoot the Messenger: Spain, Italy Ban Short Selling of Equities

When markets expose on the errant ways of the political system, the mechanical reaction by politicians has always been to shoot the messenger.

From the Bloomberg,

Spain and Italy moved to ban short- selling of stocks as prices dropped and the euro traded below its lifetime average against the dollar on concerns about the European Union debt crisis.

Spain’s stock market regulator, the CNMV, said it was banning short selling of all stocks for three months, amid “extreme volatility.” Italy’s Consob said its ban, scheduled to last a week, was introduced on some banking and insurance shares because of the “recent performance of stock markets.”

Today’s bans echoes decisions in August of last year by France, Belgium, Spain and Italy to temporarily ban short selling of financial stocks in an effort to stabilize markets after European banks, including Societe Generale SA (GLE), hit their lowest levels since the credit crisis of 2008…

The Spanish prohibition also covers over-the-counter derivatives, the CNMV said. Market making activities are excluded from its measures.

The underlying hope of politicians has been to reverse the lessons of the famous legend of King Canute who commanded sea waves “to advance no further”. King Canute tried to show “his flattering courtiers” that his power meant “nothing in the face of God's power”

The modern version is that politicians hope that by pinning or diverting the blame on the markets, and through edict or fiat, the basic laws of economics can be overturned.

Spain’s Bolsa de Madrid Index

Dow Jones Italy Stock Index

Note the article says, “Today’s bans echoes decisions in August of last year by France, Belgium, Spain and Italy”, yet both the charts of Spain and Italy, in spite of the last year’s ban, has been trading much much much lower than when the attack against the markets had been implemented.

As I previously wrote,

1. Bans hardly have been effective. Instead they are mostly symbolical as the “need to be seen as doing something”

2. Regulators react almost always too late in the game (which means that their markets may be at the process of nearly bottoming out.)

3. I would further add current policies have clearly or overtly been in support of the banking system and the stock market.

4. This only validates the theory that the policy direction of governments and global central bankers has primarily been anchored upon the Bernanke ‘crash course for central bankers’ doctrine of saving the stock market.

5. Importantly, applied policies have been meant to preserve the tripartite cartelized system of the welfare state, central banks and the crony banking system.

Except for #2 which does not seem to apply today as events seem to exhibit accelerating deterioration, everything else seem pertinent

I would further add that such bans are, in reality part of the price control mechanisms employed by desperate and frantic politicians that only aggravates the imbalances of the system.

Doing the same thing over and over again and expecting different results has been the stereotyped reaction by political authorities everywhere. Yet as one can observe, politicians never really learn, which is why we should expect the crisis to worsen. Also, this shows how politics has been mainly about short term fixes and the struggle to preserve of political entitlements. Someone once defined this as “insanity”.

Why We Should Be Wary of the Confirmation Bias

From the prodigious Matt Ridley writing at the Wall Street Journal,

One of the alarming things about confirmation bias is that it seems to get worse with greater expertise. Lawyers and doctors (but not weather forecasters who get regularly mugged by reality) become more confident in their judgment as they become more senior, requiring less positive evidence to support their views than they need negative evidence to drop them.

The origin of our tendency to confirmation bias is fairly obvious. Our brains were not built to find the truth but to make pragmatic judgments, check them cheaply and win arguments, whether we are in the right or in the wrong.

I find this very relevant, especially the last sentence. Debates at social network sites seem as testament to these.

Will North Korea Pursue Economic Liberalization?

This should signify as a wonderful development if this would materialize.

From Reuters,

Impoverished North Korea is gearing up to experiment with agricultural and economic reforms after young leader Kim Jong-un and his powerful uncle purged the country's top general for opposing change, a source with ties to both Pyongyang and Beijing said.

The source added that the cabinet had created a special bureau to take control of the decaying economy from the military, one of the world's largest, which under Kim's father was given pride of place in running the country.

The downfall of Vice Marshal Ri Yong-ho and his allies gives the untested new leader and his uncle Jang Song-thaek, who married into the Kim family dynasty and is widely seen as the real power behind the throne, the mandate to try to save the battered economy and prevent the secretive regime's collapse.

The source has correctly predicted events in the past, including North Korea's first nuclear test in 2006 days before it was conducted, as well as the ascension of Jang.

The changes could herald the most significant reforms by the North in decades. Previous attempts at a more market driven economy have floundered, most recently a drastic currency revaluation in late 2009 which triggered outrage and is widely believed to have resulted in the execution of its chief proponent.

"Ri Yong-ho was the most ardent supporter of Kim Jong-il's 'military first' policy," the source told Reuters, referring to Kim Jong-un's late father who plunged the North deeper into isolation over its nuclear ambitions, abject poverty and political repression.

The biggest problem was that he opposed the government taking over control of the economy from the military, the source said, requesting anonymity to avoid repercussions.

North Korea's state news agency KCNA had cited illness for the surprise decision to relieve Ri of all his posts, including the powerful role of vice chairman of the ruling party's Central Military Commission, though in recent video footage he had appeared in good health.

Ri was very close to Kim Jong-il and had been a leading figure in the military. Ri's father fought against the Japanese alongside Kim Jong-il's late father Kim Il-sung, who founded North Korea and is still revered as its eternal president.

The revelation by the source was an indication of a power struggle in the secretive state in which Kim Jong-un and Jang look to have further consolidated political and military power.

Kim Jong-un was named Marshal of the republic this week in a move that adds to his glittering array of titles and cements his position following the death of his father in December. He already heads the Workers' Party of Korea and is first chairman of the National Defence Commission.

Observe that despotic or totalitarian regimes, in realization of the futility of their centralized political institutions, have slowly been giving way to globalization.

However this runs in contrast to formerly free (developed) economies who seem to be progressively headed towards fascism if not despotism.

The opposite path of political directions represents the major force that will drive wealth convergence.

Quote of the Day: Constructing Freedom-Oriented institutions

From libertarian Wendy McElroy at the Laissez Faire Books, (bold original)

What is an institution?

An institution is any stable and widely-accepted mechanism for achieving social and political goals. Traditional institutions of society include the family, court systems, the free market, and churches. Institutions generally evolve over time to reflect the history and dynamics of a culture. For example, the institution of common law evolved on a grassroots level to meet the demand for justice by average people. Equally, the institutions of money and the market arose to satisfy human need and desire for goods.

As those needs and desires change, so do the institutions. Sometimes the change occurs due to conscious human design. Trial by a jury of one’s peers, for example, was a procedure consciously designed to maximize the justice of verdicts. This court procedure weathered the test of time well enough to now be viewed as a cornerstone of Western jurisprudence. When institutions are responsive and grassroots in nature, they become such a natural part of human progress that they change in a spontaneous manner, as in the continuing evolution of language. Like the free market, they strongly encourage peaceful interaction because that is what benefits the vast majority of people.

The political system is the institution upon which libertarians focus. They commonly observe that politics ‘institutionalizes corruption’; political structures and procedures encourage bad results like the personal malfeasance of elected figures. A large reason for the corruption is that the political system is not responsive, not grassroots. As a static institution, it serves the embedded interests of an elite class rather than the dynamic ones of the average person. (The elite class consists of politicians and those with political pull.) What libertarians call ‘corruption’ is what the elites call ‘profit’. They have consciously sculpted the institution to increase their profits through such procedures as non-transparency.

In a sense, the embedded corruption of politics is good news for libertarians because it spotlights a basic truth about institutions. They can promote liberty or statism depending upon their structure, procedures and the embedded incentives. The Founding Fathers knew this. For example, they attempted to limit the government by constructing a tripartite system of checks and balances designed to prevent the centralization of power. The Bill of Rights created incentives toward liberty by laying down societal ground rules to be upheld by the Supreme Court. (Whether the best intentions of the Founding Fathers were doomed to defeat by the inherent nature of politics is debatable.)

The specific structures and procedures of any institution will determine the results it produces. As long as the procedures are followed, the motives of those participating in the institution are irrelevant. Elsewhere, I offered the example of a man who works in a candy factory with the intention of producing canned tuna. As long as he follows the workplace rules and procedures, however, he will produce candy. A police officer may want to promote libertarian justice but as long as he enforces the laws of a totalitarian state, he will produce injustice.

Equally, as long as everyone respects the rules of the free market, it will function as a mechanism of peace and prosperity even if some of its participants are ill intentioned human beings. You may buy goods from a man whom you would never allow into your home; he can detest your religion or skin color even as money peacefully changes hands. As long as the rules of the free market are observed, freedom itself is served.
The burning question now becomes: how do we construct institutions that encourage liberty?

Conclusion

There are two answers on how to construct freedom-oriented institutions. The first: do not to construct them at all. Allow them to evolve through the spontaneous interaction of individuals pursuing their own self-interest. This is how free markets function, families are created, free speech rings out… Many institutions require merely to be unobstructed.

But other institutions require some design beyond the “anything that is peaceful” rule. For example, a court system requires procedures of justice such as “innocent until proven guilty.” And, so, the second answer to designing institutions is: do so in as minimal a manner as possible and only to promote individual rights.

The Impact of Financialization on Economic Growth and the Austrian Business Cycle

Great stuff from the Bank of International International Settlements (BIS), where they come up with a study on the diminishing returns from the financial sector.

Stephen G Cecchetti and Enisse Kharroubi of the BIS concludes, (bold emphasis mine)

In this paper, we study the complex real effects of financial development and come to two important conclusions. First, financial sector size has an inverted U-shaped effect on productivity growth. That is, there comes a point where further enlargement of the financial system can reduce real growth. Second, financial sector growth is found to be a drag on productivity growth. Our interpretation is that because the financial sector competes with the rest of the economy for scarce resources, financial booms are not, in general, growth enhancing. This evidence, together with recent experience during the financial crisis, leads us to conclude that there is a pressing need to reassess the relationship of finance and real growth in modern economic systems. More finance is definitely not always better

In my view this BIS study exhibits tight relevance to, if not provides proof of the Austrian Business Cycle theory (ABCT)…

From the great Professor Murray N. Rothbard [Economic Depressions: Their Causes and Cure] (bold my comments)

The Ricardian analysis of the business cycle went something as follows: The natural moneys emerging as such on the world free market are useful commodities, generally gold and silver. If money were confined simply to these commodities, then the economy would work in the aggregate as it does in particular markets: a smooth adjustment of supply and demand, and therefore no cycles of boom and bust. But the injection of bank credit adds another crucial and disruptive element. For the banks expand credit and therefore bank money in the form of notes or deposits which are theoretically redeemable on demand in gold, but in practice clearly are not…

The banks, then, happily begin to expand credit, for the more they expand credit the greater will be their profits. This results in the expansion of the money supply within a country, say England. As the supply of paper and bank money in England increases, the money incomes and expenditures of Englishmen rise, and the increased money bids up prices of English goods. The result is inflation and a boom within the country.

But this inflationary boom, while it proceeds on its merry way, sows the seeds of its own demise. For as English money supply and incomes increase, Englishmen proceed to purchase more goods from abroad. Furthermore, as English prices go up, English goods begin to lose their competitiveness with the products of other countries which have not inflated, or have been inflating to a lesser degree. Englishmen begin to buy less at home and more abroad, while foreigners buy less in England and more at home; the result is a deficit in the English balance of payments, with English exports falling sharply behind imports. But if imports exceed exports, this means that money must flow out of England to foreign countries. And what money will this be? Surely not English bank notes or deposits, for Frenchmen or Germans or Italians have little or no interest in keeping their funds locked up in English banks. These foreigners will therefore take their bank notes and deposits and present them to the English banks for redemption in gold — and gold will be the type of money that will tend to flow persistently out of the country as the English inflation proceeds on its way. But this means that English bank credit money will be, more and more, pyramiding on top of a dwindling gold base in the English bank vaults. As the boom proceeds, our hypothetical bank will expand its warehouse receipts issued from, say 2,500 ounces to 4,000 ounces, while its gold base dwindles to, say, 800. As this process intensifies, the banks will eventually become frightened. For the banks, after all, are obligated to redeem their liabilities in cash, and their cash is flowing out rapidly as their liabilities pile up. Hence, the banks will eventually lose their nerve, stop their credit expansion, and in order to save themselves, contract their bank loans outstanding. Often, this retreat is precipitated by bankrupting runs on the banks touched off by the public, who had also been getting increasingly nervous about the ever more shaky condition of the nation's banks.

The bank contraction reverses the economic picture; contraction and bust follow boom. The banks pull in their horns, and businesses suffer as the pressure mounts for debt repayment and contraction. The fall in the supply of bank money, in turn, leads to a general fall in English prices. As money supply and incomes fall, and English prices collapse, English goods become relatively more attractive in terms of foreign products, and the balance of payments reverses itself, with exports exceeding imports. As gold flows into the country, and as bank money contracts on top of an expanding gold base, the condition of the banks becomes much sounder. [the boom is followed by a bust which extrapolates to the financial sector size has having an inverted U-shaped effect on productivity growth. Boom initially drives up productivity and eventually contracts when the bust appears, hence the U-shape effect—my comment].

This, then, is the meaning of the depression phase of the business cycle. Note that it is a phase that comes out of, and inevitably comes out of, the preceding expansionary boom. It is the preceding inflation that makes the depression phase necessary. We can see, for example, that the depression is the process by which the market economy adjusts, throws off the excesses and distortions of the previous inflationary boom, and reestablishes a sound economic condition. The depression is the unpleasant but necessary reaction to the distortions and excesses of the previous boom. [the boom which is followed by a bust shows that “financial sector growth is found to be a drag on productivity growth”. Whatever temporary gains acquired from the boom are lost through capital consumption thus “financial booms are not, in general, growth enhancing”—my comment]

Chinese Political Neo Luddites and How Productivity Means More Employment

The clashing visions of entrepreneurs, whom in general desires to improve productivity through the marketplace (profit and loss system), and political agents, who looks at immediate needs for the purpose of staying in power, can be best illustrated by the proposed wide scale adaption of robotics in China’s economy.

From technologyreview.com

One of the defining narratives of modern China has been the migration of young workers—often girls in their late teenage years—from the countryside into sprawling cities for jobs in factories. Many found work at Foxconn, which employs nearly one million low-wage workers to hand-assemble electronic gadgets for Apple, Nintendo, Intel, Dell, Nokia, Microsoft, Samsung, and Sony.

So it was a surprise when Terry Guo, the hard-charging, 61-year-old billionaire CEO of Foxconn, said last July that the Taiwan-based manufacturing giant would add up to one million industrial robots to its assembly lines inside of three years.

The aim: to automate assembly of electronic devices just as companies in Japan, South Korea, and the United States previously automated much of the production of automobiles.

Foxconn, one of China's largest private employers, has long played an outsize role in China's labor story. It has used cheap labor to attract multinational clients but now faces international scrutiny over low pay and what some see as inhumane working conditions.

"Automation is the beginning of the end of the factory girl, and that's a good thing," says David Wolf, a Beijing-based strategic communications and IT analyst. Wolf, who has visited many Chinese factory floors, predicts an eventual labor shift similar to "the decline of seamstresses or the secretarial pool in America."

Since the announcement, Guo hasn't offered more details, keeping observers guessing about whether Foxconn's plans are real. (Through its public-relations firm, Burson-Marsteller, Foxconn declined to describe its progress.) Trade groups also haven't seen the huge orders for industrial robots that Foxconn would need, although some experts believe the company may be developing its own robots in house.

"Guo has good reasons for not waving his flag about this too much," says Wolf. Keeping quiet could give Foxconn a jump on competitors. What's more, with the Chinese economy slowing down, "it is politically inadvisable to talk too much about replacing people with robots," he says.

China's leaders see employment as essential to maintaining a harmonious society. The imperative of creating jobs often trumps that of efficiency. For instance, Wang Mengshu, deputy chief engineer at China Railway Tunnel Group, says that labor-saving equipment isn't always used even when it's available. "If all the new tunnels were built with the advanced equipment, that would trim the need for the employment of about six million migrant workers," he says. "In certain fields we don't want to have fast development in China, in order to solve the national employment problem."

Political leaders are shown here as practitioners of neo-Luddism—opposed to many forms of modern technology.

They are either unaware that advances in technology leads to greater productivity and more employment or simply have been looking at their narrow interests.

Hedge fund Andy Kessler eloquently explains the causal relationship in layman’s lingo.

From the Wall Street Journal, (bold emphasis mine)

So how does productivity result in more employment?

Three ways. First, some new technology comes along that allows something never before possible. Cash from an ATM, stock trading from an airplane's aisle seat, ads next to Google search results.

The inventor or entrepreneur who uses the invention benefits from sales and wealth and hires people to produce the good or service. We don't hear about this. Instead we hear about the layoffs of bank tellers, stockbrokers and media salesmen. So productivity becomes the boogeyman for job losses. And many economic cranks would prefer that we just hire back the tellers and toll collectors.

This is a big mistake because new, cheaper technology becomes a platform for others to create or expand businesses that never before made economic sense. Adobe software killed typesetters, but allowed millions cheaply to get into the publishing business. Millions of individuals and micro-size businesses now reach a national, not just local, retail market thanks to eBay. Amazon allows thousands upon thousands of new vendors to thrive and hire.

Consider Uber, a 20-month-old start-up, whose smartphone app knows where you are and with a simple click arranges a private car pickup to take you where you want. It doesn't exist without iPhones or Androids. Taxi and limousine dispatchers lose. Customers win. We'll all be surprised by new tablet applications being dreamed up in garages and basements everywhere.

The third way productivity results in more employment is by attracting capital to satisfy new consumer demands. In a competitive economy, productivity—doing more with less—always lowers the cost of products or services: $5,000 computers become $500 tablets. Consumers get to spend the difference elsewhere in the economy, and entrepreneurs will be happy to sell them what they want or create new things they never heard of, but will want. And those with capital will be eager to fund these entrepreneurs. Win, win.

The mechanism to decide the most effective use for this capital is profits. The stock market bundles profits and is the divining rod of productivity, allocating capital in cycle after cycle toward the economy's most productive companies and best-compensated jobs. And it does so better than any elite economist or politician picking pork-barrel projects and relabeling them as "investments."

The productive use of capital is not an automatic process, of course. It is all about constant experimentation. And it is never permanent: Railroads were once tremendously productive, so were steamships and even Kodachrome. It takes work, year in and year out—update, test, tweak, kill off. Staples is under fire from Amazon and other productive online retailers. Its stock has halved since its 2010 peak and is almost at a 10-year low. So be it.

With all the iPads and Facebook and cloud-computing growth, why is unemployment still 8.2% and job creation stalled? My theory is that productivity is always happening but swims upstream against those that fight it. Unions, regulations and a bizarre tax code that locks in the status quo.

Read more of the fallacies of Luddism from must read classics of the great Frederic Bastiat from “That Which is Seen and That Which is NOT Seen” (Machinery) or from the equally distinguished Henry Hazlitt’s Economics in One Lesson (The Curse of the Machinery)

I am reminded by the recent conversation I had with the charter president of Rotary of Mandaluyong, Fred Borromeo, who at age 86 ironically is an avid fan of technology.

In his recent encounter with some local government neo-luddites who objected to his suggestion to adapt to new (farming) technology for the same reasons as Chinese politicians, Mr Borromeo told them, “the world will move along with or without you”. Indeed.