Government Spending: Like a Valium for Lethargic Economies

To the fans of economic ‘pump priming’ or government stimulus for economic growth, the distinguished economist Art Laffer writes a splendid spoiler at the Wall Street Journal, (bold highlights mine)

If you believe, as I do, that the macro economy is the sum total of all of its micro parts, then stimulus spending really doesn't make much sense. In essence, it's when government takes additional resources beyond what it would otherwise take from one group of people (usually the people who produced the resources) and then gives those resources to another group of people (often to non-workers and non-producers).

Often as not, the qualification for receiving stimulus funds is the absence of work or income—such as banks and companies that fail, solar energy companies that can't make it on their own, unemployment benefits and the like. Quite simply, government taxing people more who work and then giving more money to people who don't work is a surefire recipe for less work, less output and more unemployment.

Yet the notion that additional spending is a "stimulus" and less spending is "austerity" is the norm just about everywhere. Without ever thinking where the money comes from, politicians and many economists believe additional government spending adds to aggregate demand. You'd think that single-entry accounting were the God's truth and that, for the government at least, every check written has no offsetting debit.

Well, the truth is that government spending does come with debits. For every additional government dollar spent there is an additional private dollar taken. All the stimulus to the spending recipients is matched on a dollar-for-dollar basis every minute of every day by a depressant placed on the people who pay for these transfers. Or as a student of the dismal science might say, the total income effects of additional government spending always sum to zero.

Meanwhile, what economists call the substitution or price effects of stimulus spending are negative for all parties. In other words, the transfer recipient has found a way to get paid without working, which makes not working more attractive, and the transfer payer gets paid less for working, again lowering incentives to work.

But all of this is just old-timey price theory, the stuff that used to be taught in graduate economics departments. Today, even stimulus spending advocates have their Ph.D. defenders. But there's no arguing with the data in the nearby table, and the fact that greater stimulus spending was followed by lower growth rates. Stimulus advocates have a lot of explaining to do. Their massive spending programs have hurt the economy and left us with huge bills to pay. Not a very nice combination.

Sorry, Keynesians. There was no discernible two or three dollar multiplier effect from every dollar the government spent and borrowed. In reality, every dollar of public-sector spending on stimulus simply wiped out a dollar of private investment and output, resulting in an overall decline in GDP. This is an even more astonishing result because government spending is counted in official GDP numbers. In other words, the spending was more like a valium for lethargic economies than a stimulant.

Just to add: “government spending is counted in official GDP numbers” represents just one of the many reasons not to trust GDP numbers as they have been designed to promote the crony capitalist-mercantilist-welfarism framework based from the highly flawed Keynesian theory backed social policies.

Flooding from Heavy Monsoon Rains Exposes Central Planning Failure

From the Manila Bulletin,

Malabon City government officials are criticizing the Camanava Area Flood Control and Drainage System Improvement Project for “failing to meet the expectations of the residents.“

After the meeting with Engr. Carla Bartolo, head of the project, Acting Malabon City Mayor Antolin Oreta III said the Camanava flood control project, “did nothing as regards to the perennial flooding particularly in Malabon.“

The Php 5.2 billion project also covered nearby areas in Caloocan, Navotas and Valenzuela, but a big bulk of the amount was purportedly utilized for constructing pumping stations, navigation gates and polder dikes in Malabon, according to Malabon City Engineer Edgar Yanga.

Two pumping stations were supposed to serve Caloocan, Malabon and Navotas areas, Yanga said.

The city officials noted some “flaws“ in the construction. Yanga said, “Ang expected na gagawin ay hindi ginagawa, paunti-unti. No target completion.“

He added: “The project is very much delayed. Five years na delayed.“

The project was started in 2003 and was supposed to be fully operational by 2007.

In the meetings with city officials, including 21 barangay chairmen, Bartolo attributed the delay of the project to the presence of some informal settlers covered by the project and changes in the conditions of the locations.

Oreta said the city continues to experience floods, citing some barangays which were affected by the heavy rains spawned by typhoon “Gener“ and recent tropical storms.

First of all, the nature of politics has all been about the blame game, where political agents benefit from stepping on someone’s shoes. Critics make the cavalier presumptions that under their guidance such problems will unlikely emerge.

Second, censures become the mechanical reaction once an event has already taken place. The usual culprit has been the private sector, but in one of the unusual case above, one government agency excoriates another.

But since politics has mainly been about the fetish for short term problems and fixes, fleeting popular concerns leads to intuitive shifts in policy directions.

This known as the time inconsistency dilemma, as per Wikipedia.com,

situation where a decision-maker's preferences change over time in such a way that what is preferred at one point in time is inconsistent with what is preferred at another point in time

Yet since experts cannot predict on the precise dislocations from weather disturbances, social policies result from “whack the mole” dynamics or from “fighting the last war” or to shifting priorities. So there will never be an end to central planning failures on reactionary based populist social policies.

Third, finger pointing will always be about mismanagement, deficiency of funding and or the lack of regulatory oversight.

In reality, since government treats the symptoms than the problem, the outcome will always be a gamut of unintended consequences.

Paradoxically, failures and inefficiencies (and corruption) will be rewarded through demands for more taxpayer expenditures.

Yet the biggest fundamental flaw emanates from the public’s mysticism over the infallibility of the nanny state.

Ironically many, if not most, have been jaded to the reality of serial failures of central planning, as I previously wrote:

Two more important things to drive at:

The first is the KNOWLEDGE problem.

The fact is that while there are instruments to help predict the changes in the weather, that knowledge is limited. This means that policy responses will ALWAYS be insufficient, no matter what they do.

The second point is that these has been all about the HOT POTATO problem—everyone seems to toss the responsibility to another party.

Everyone has been HARDWIRED to EXPECT that the government must and shall deliver us from environmental disruptions and disasters.

Yet no matter the horrible track record, we maintain this illusion of infallibility.

People cannot seem to accept that government are composed by people, and like everyone else, has limitations in the possession of knowledge.

Most of the dogmatic belief on the ascendancy of the state emanates from economic ignorance and mass indoctrination.

As the great Professor Ludwig von Mises warned

What makes many people blind to the essential features of any socialist or totalitarian system is the illusion that this system will be operated precisely in the way that they themselves consider as desirable. In supporting socialism, they take it for granted that the "state" will always do what they themselves want it to do.

Online Scammers: Sophistication in Stupidity

Online fraud like the Nigerian Email Scam has been a growing billion industry, where victims has reportedly lost a hefty $9.3 billion in 2009 which has been up from $6.3 billion the year before.

Yet scammers ‘specialize’ on their predation, as their ‘marketing’ activities focus on duping on the most vulnerable of the society.

From the Wall Street Journal, (bold emphasis mine)

So why do the scammers persist in blanketing the world with outlandish propositions, announcing that they are from the very country whose name has become synonymous with online fraud?

Cormac Herley, a computer scientist at Microsoft Research who specializes in security issues, provides a convincing answer in a paper presented at a conference in Berlin and recently published on his website. In it, he analyzes the con mathematically, using an approach called signal detection theory. His crucial insight is to look at the situation not from the victim's point of view but from that of the scammers. Their challenge is to hook only people who will get sucked in deeply enough to send a significant amount of money—the "true positives." They must minimize the effort they devote to "false positives" (targets who might seem like dupes but are suspicious and/or never pay up).

It costs the scammers virtually nothing to spam the world, but it costs them a lot (especially in terms of time) to conduct all the follow-ups necessary to reel a sucker all the way in. The people behind "Captain Mbote" spent six months pursuing their quarry before he started wiring money to them.

A proposal offering a more realistic scenario might generate more replies, but most of them wouldn't pan out. The effort of sorting through them to find the real suckers would undermine the scheme's profitability. Instead, by screaming "This is another absurd instance of the familiar Nigerian scam," the fraudsters are filtering out what to them is spam—responses from suspicious people they don't want to deal with—and "letting through" only those most likely to play along. The fewer potential victims in the world, the more precisely the scammers must target them, and thus the more absurd and easy-to-spot the attacks should be.

The Nigerian scammers aren't alone in using this approach. Phishing attacks, like the urgent emails from the "IT Support Team" requesting our passwords to avert some Internet calamity, are so hackneyed that they likely ensnare only the extremely naive or credulous.

Mr. Herley's analysis of the Nigerian scam suggests a counterintuitive way to fight back. Most efforts to reduce Internet fraud focus on reducing the number of people who reply to scammers—by educating users or by filtering out the scam emails. But some attacks inevitably slip through, and some Internet neophytes inevitably fall prey.

A more effective solution, Mr. Herley suggests, would require considering the goal of the scammers. Increasing the number of responses to their emails, he shows, can reduce profits, as long as those responses come from people who never send money. Such "scam baiters" already exist (the community website "419 Eater," named after the Nigerian law that governs fraud, offers tips and support). The more scam baiters, the lower the average return to the scammers on each attack and the less incentive they have to continue the scam.

Perhaps clever artificial intelligence researchers could create automated scam-baiter bots that would simulate gullible victims, drawing out the interaction as long as possible. The most convincing victim-bot would possess sophisticated knowledge of how the scammers think and behave—precisely the knowledge that tends to elude us when we look at the world only from our own perspective. Similarly, the profitability of phishing scams could be reduced by sending bogus account numbers and other data back to the scammers.

As Mr. Herley's paper shows, what seems stupid can actually be quite sophisticated. It's only by imagining the situation with the roles reversed that we can see what we've been missing.

The growing size of the illicit industry accounts for a sad state of societal affairs which means there have been that big a number of precision targets or "suckers" in the world.

Yet “something out of nothing” has been the basic trap laid out by scammers for unsuspecting victims.

Ironically, “something out of nothing” is the same principle that undergirds politics—only that they come in the jargon of “free lunch” or the “Santa Claus fund”.

The difference is that politics has been rationalized as having to provide the services of “public goods” whereas online scams have been outright frauds.

My guess is that these two may have important causal connections; personal responsibilities may have likely been relinquished for the dependence on the welfare state, making many people vulnerable and highly sensitive to predation.

Nevertheless, knowing what you are getting into, understanding that there is no such thing as a free lunch, critical thinking, conducting research to self-educate, and importantly, self discipline will always serve as the best insurance against fraud of any kind—online scammers, stock market (e.g. boiler rooms), Ponzi schemes and etc., and most importantly, against political tomfoolery.

To Fix the Culture of Secrecy, Reduce Government’s Role in Society

Internet sites as Wikileaks and Anonymous has gone on exposing much of government “secrets” through "leaks", thereby putting immense pressure on governments to become more “transparent”.

For some politicians and experts in the US, the way to deal with a “culture of leaks” translates to the management classification of information.

This from the CNN,

At the end of July, the Senate intelligence committee marked up legislation drafted in response to recent high-profile leaks of classified information. The committee's chairwoman, Dianne Feinstein, claims that the bill will address the "culture of leaks" in Washington. But the leaks are a symptom of the intelligence community's culture of secrecy -- and the bill would make that problem worse in a host of ways.

Any insider will tell you that the government classifies far too much information. Top military and national security officials estimate that between 50% and 90% of classified documents could safely be released. That adds up to a massive amount of unnecessary secrecy when one considers there were 92 million decisions to classify information in 2011 alone.

The WikiLeaks disclosures featured some vivid examples, such as a cable from an American diplomat who classified his description of a typical wedding in the province of Dagestan.

Put simply, officials who routinely see innocuous documents stamped "Secret" lose respect for the system, and that puts all secrets, the real ones as well as the purely nominal ones, at risk.

Excessive classification also means that even low-level or nonsensitive government positions often require clearances. One in every 50 American adults now has access to classified information, not a winning formula for keeping secrets.

The Senate bill, however, does nothing serious to address the problem of overclassification. Indeed, it perpetuates the fiction that all classified information poses a dire threat.

The bill strips intelligence community employees of their pensions if the Director of National Intelligence decides they leaked classified information, even if the information reveals only that Dagestani weddings last three days. It revokes the clearances of officials who disclose the existence of classified covert operations -- even if the operations, like the raid on Osama bin Laden's compound, are in the past and could not possibly be jeopardized by disclosure.

Worse, the Senate bill extends the shroud of secrecy to encompass even unclassified information. Intelligence officials already must submit any publications that discuss their work to their agencies for pre-publication review and approval; under the bill, they must submit "anticipated oral remarks" as well. On its face, the provision could require pre-publication review for dinner party conversations.

This is an example of how politics addresses symptoms rather than the disease.

In reality, the political institution called the government operates on the principle of mandated organized violence.

And much of these acts of violence and repression have been deliberately concealed from the public for reasons which works to the interests or benefits of the political authorities.

It is only when violence has been seen as popular or politically expedient, when these are made public, or when they are uncovered or exposed by media.

In short, the political nature of governments has been one of advancing the culture of secrecy or of scapegoatism. Transparency, thus, is nothing but a political jingoistic charade.

SM Oliva, formerly of the Mises Institute, has this highly relevant quote

“Transparency” is a buzzword associated with all sorts of good-government movements. But it’s something of a libertarian Trojan horse. No government can ever be transparent, for that would rob of it of its very substance. All monopoly government is predicated on the ability to actively mislead and misdirect the majority — the public — away from the truth, whether it’s political truth, economic truth, or personal truth. Even government attempts at transparency are themselves usually little more than misdirection by another name. One can be transparent in such a way as to satisfy most inquisitors while revealing nothing that compromises the basic pillars of the state.

Bottom line: Managing information classifications will hardly solve on the issue of the “culture of secrecy” the latter of which signifies on the essence of government. To attain government “transparency” extrapolates to the vast reduction or retrenchment of government’s role in society.

And another thing; the pressure by Wikileaks and by other social media outfits on governments reveals of the process of the slomo ungluing of centralized political structure. Centralized institutions have been feeling the heat from, and or have been fervently fighting against, the forces of decentralization.

Quote of the Day: Criminals Write the Rules, Good People Go to Jail

Throughout it all, despite so many taxpayer bailouts and the damage that their fractional reserve system has caused to the global economy, the banking elite has still managed to maintain its wealth and status.

Sure, the oddball Madoff or Rajaratnam case occasionally surfaces, but for the most part, not a single member of the banking elite has been charged with a crime.

You know who has been charged with a crime, though? Gary Harrington. In case you haven’t heard of this criminal mastermind, Mr. Harrington was recently sentenced to 30 days in jail and fined $1,500 for a most heinous crime against humanity.

His transgression? NINE misdemeanor convictions of collecting rainwater on his private property. That’s right… this vile miscreant had the felonious intent to set up rainwater collection systems on his private property to capture water that falls freely from the sky… an obvious violation of Medford, Oregon’s 1925 law which awards ALL water to the government.

So Gary Harrington goes to jail for collecting rainwater. And every single banker who has been complicit in defrauding billions of people around the world walks freely on the streets. Or rather drives freely on the streets in their Maseratis.

There are countless other stories of what I call the ‘criminalization of existence’– people like Gary getting abused by the state for the most innocuous activities. There are so many laws, rules, policies, and regulations on the books, you can hardly breathe without violating one of them.

And yet, despite all of these rules and regulations, there’s not a single one that can be brought against those who lie, cheat, steal, and collude to defraud the entire world.

This is the nature of democracy today. It is the criminals who write the rules and the good people who go to jail.

This is from Simon Black at the Sovereign Man. Today’s justice system has been dictated by the political class and their cronies.

Quote of the Day: People's Access to State Power Results in Persecution

Basically, I contend that contrary to "religion" being responsible for the Crusades, the Inquisition, the St. Bartholomew's Day Massacre, the treason against the Waldensians, the purges in England, and the oppression in Geneva, to name but a few, it was the fact that these religious positions held a controlling interest in the State that resulted in the terror exacted upon innocents. For instance, Lutheran segregation in post-Luther Germany was a result of the marriage of church and State in that country, the oppression in England of differing religious positions was because of the involvement of the State in religion, Calvin's oppression was because his religion WAS the State, and, most egregiously, the Vatican itself IS a State, to which over a billion souls worldwide pledge (unwittingly, in most cases) their allegiance, even before their own home countries.

Thus, while religionists have played a significant role in the history of the world, it's always those people's access to State power that results in persecution. For instance, you'll never hear of Baptists, Quakers, or Amish oppressing other religions, as these groups (I am a Baptist) have never sought to control the political reins of any region or State. In fact, Rhode Island's charter was premised on the Baptistic doctrine of Soul Liberty, a Biblical principle that I would suggest is the foundation for the concepts of Liberty as taught by John Locke and his intellectual descendants.

(bold emphasis added)

This is from a comment by Vince LaRue at the lewrockwell blog, in reply to Professor Walter Block’s article on Religion and Libertarianism.

Will Swimming Bring Olympic Medals for the Philippines?

Overheard at a conversation: “The Philippines has a chance to win Olympic medals from swimming”

While I am not a supporter of Olympics, I occasionally do patronize the competition (when there is nothing to do).

Does the Philippines have a chance on swimming? I doubt so.

Why? Because like basketball, swimming is a sport which favors height.

To give examples of the recent Olympic Gold medalists:

US Michael Phelps 1.93 meters, 6 feet 4 inches

US Ryan Lochte 1.8 m, 6’2

China’s Sun Yang 1.98 m, 6’6

China’s controversial female Ye Shiwen 1.72 m, 5’8

US Missy Franklin 1.85 m, 6’1

Reason?

From BBC Sports Academy:

Because of the standing start, taller swimmers can often cover a greater distance before they've even entered the pool, meaning less work to do once they're in. This is particularly important in sprint events.

They can also cover a greater distance per stroke, and turn and finish with an outstretched hand.

From the New York Times:

Tall swimmers also have another advantage: because swimmers are horizontal in the water, their long bodies give them an automatic edge. “It’s the difference between long canoes and short canoes,” Dr. Joyner said.

But height may not be everything as other physical traits also contributes, this would be dependent on the swimming stroke, particularly for breaststroke and butterfly and even in women's freestyle and backstroke events.

Again BBC.

Key characteristics
Whatever your stroke, there are certain characteristics that make the body better suited to swimming:

• Wide shoulders
• Slim hips
• Large hands and feet
• Large arm girth
• High arm span to height ratio

The average height of Filipinos is 5’4 for male and 4’11 for female (disabled-world.com). I doubt if Filipinos have the other stated key physical features required for swimming to compensate for the height deficiency.

Nevertheless, Filipinos have been enthralled with basketball, even if there barely has been a chance to get international awards, because basketball has long been a political sport.

As an aside, here is a trivia or a graphic detailing the trail to Michael Phelps’ record 18 medals. (Zero Hedge)

In tennis: British Andy Murray vindicates Wimbledon loss by whipping record world champ ‘aging’ Roger Federer for gold (Washington Post).

Divergences: US Stock Markets Rally Amidst Weakening Market Breadth

Stockcharts.com regular weekly contributor Carl Swenlin of Decision Point thinks, as I do, that the recent rally of the S&P 500 has been poorly supported by market breadth.

Last night I wrote,

the strong Friday rally in the US stock markets may not be that convincing as market internals reveals of a “narrowing breadth” or declining participation of gains by key index issues. This means that the large gains posted by the S&P 500 have been mostly concentrated to a few index heavyweights.

Pardon me, I may be seen as guilty of confirmation bias (looking for views in support of my belief), but Mr. Swenlin’s post, as excerpted below, appears as somewhat a detailed validation to my claim above.

The “unhealthy rally” can be seen from Mr. Swenlin’s own constructed index "Blue Chip Top 10 Index”.

The index according to Mr. Swenlin (via stockcharts.com; bold original) is constructed

by calculating the daily change of the Index as being the daily average percent change of the securities in the Blue Chip Top 10 list. Stocks are tracked from the day after they enter the Top 10 list through the day they drop off the list.

The Top 10 Index is equally weighted, so theoretically one could only replicate the performance of the list with real money by reallocating an equal amount to each stock each day (and somehow avoid transaction fees in the process). More to the point, the Top 10 list are a good place to look for securities that will out-perform the market, but it will be impossible for you to duplicate the Index. You could also lose a ton of money if you are long these top ranked securities during an extended market decline.

Mr. Swenlin concludes:

In spite of upward movement of the SPX, the Blue Chip Top 10 Index tells us that the leadership of the market has been rotating too rapidly, which suggests confusion and weakness. By the time a stock reaches the Top 10, it loses momentum and drops right back out again. This is evidence that for a long time the internal condition of the market has been turbulent and confusing, in spite of generally rising market prices.

In contrast to my expectations, it’s even surprising to see that other stockcharts.com contributors as having an antsy outlook, because like Mr. Swenlin, they also have taken note of others signs of divergences between the performance of the US major bellwether S&P 500 and other indices (e.g. Russell 2000 vis-à-vis S&P 500: See Tom Baley).

Such murky outlook are simply consequences of distortions from political talk therapy (verbal interventionism through Pavlov’s conditioning and or Central banking signaling channel) aimed at artificially propping up of markets—mostly by surreptitiously assailing short sellers.

Phisix: Managing Through Volatile Times

Understanding the effect of emotion on your actions has never been more important than it is now. In the midst of this great financial and economic crisis that grips the world, Central Banks are printing money in one form or another. This makes our investment world even more prone to bubbles and panics than it has been in the past. Either plague can kill you.-Barton Biggs (1932-2012)

My mantra of “Bad News is Good News” has gone mainstream.

I begin this week’s outlook with an excerpt from the Wall Street Journal’s Real Time Economics Blog[1],

The U.S. stock market has recently been buoyed by notions of central bank nirvana, an expectation of more easing help for economies and therefore a boon for riskier assets such as stocks here and in Europe.

So a ‘bad’ jobs number for the economy might still have been interpreted as ‘good’ in stock markets because of the presumed certainty of easing in September from the Federal Reserve.

Stocks are indeed rallying, perhaps on the notion that the economy is not destined to decelerate into full stall, and because the gain might not be ‘good’ enough to be ‘bad,’ ‘bad’ meaning it would deter an active Fed from moving.

“Bad news is good news is” may also extrapolate to permanent quasi-booms in that if true, means that there will never be a bust. Political talk have almost always wished away economic laws.

Symptoms of Bipolar Disorder from Bubble Policies

“Bad news is good news” today emanates from the entrenched expectations by financial markets that central bank interventions will effectively counteract on the unfolding negative developments in the economic realm.

In the past, financial securities including the stock markets reflected on the adverse changes in the economic and financial dimensions through price declines.

Today, the concept of central bank inflationist “nirvana”, which represents in psychology “conditioned stimulus”[2], has severely been distorting the price mechanism of the financial marketplace.

Financial markets become operationally detached from reality. And central bank assurances and pledges of rescues have only underscored the moral hazard of policy making that has been evident through policy induced rampant speculations.

The popularity of inflationism as the great Professor Ludwig von Mises once warned is about getting something from nothing[3].

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.

This has not just been theory. To my experience such policies have indeed been manifesting negative influence to the unsuspecting public. For instance, my counsel to take on a defensive posture have been begrudged and misinterpreted by some as depriving them of the opportunity to earn [and of course, the urge to satisfy one’s dopamine neurons...or the gambling instinct]

Yes inflationism brings out the worst in many people.

Yet for the past two weeks, global equity markets have exhibited increasing symptoms of a bipolar disorder[4] through flashes of abruptly shifting manic-depressive moods that has been ventilated on the markets through sharp volatilities.

Under pressure from increasing evidences of a global economic slowdown, financial markets have been treated promises to inflate—such as European Central Bank’s Mario Draghi recent pledge to do “whatever it takes to save the Euro[5]”—that has prompted financial markets to soar[6]

The two day risk ON mode from the pep talk by ECB President Mario Draghi resulted to a short term price convergence from supposedly disparate asset classes that has been labeled as the “Super Mario’s trifecta”[7].

The furious synchronized rally in global stocks (represented by the US S&P 500), can also be seen in gold and in US 10 treasury prices.

An almost similar pattern has emerged this week.

Again following early accounts of weaknesses in the financial markets, reports of a concession have been in the works by ECB and EU officials that could likely facilitate for the much anticipated “Big Bazooka”, fired up the global equity markets on Friday[8].

Most of the biggest gains last Friday were seen in major European equities bellwethers such as the Stox 50, the German Dax and UK’s FTSE 100.

However in contrast to the previous week, in the bond markets, US treasuries fell (yields increased) but Spanish (orange) and Italian (green) 10 year bonds climbed or yields fell.

For the past two weeks, each time reality returned to the markets (as seen by the spike in yields and selling pressures in equity) the recourse of ECB’s Mario Draghi has been to wheedle the markets with pledges.

Friday’s massive rally in the US came despite the questionable gains in the job report (as indicated by the above opening excerpt)—the improvements in the US job markets has eclipsed the increase in the unemployment rates, and importantly, has discounted on the large number of the people who dropped out of the labor force[9].

This implies that the real reason behind the rally in the US markets has been about the return of the global RISK ON mode initiated from the prospective ECB-EU deal which may be forged anytime.

Nonetheless, despite all the popular attributions of the recent rally, the constant declarations of support by central bankers have apparently been mainly designed to keep short sellers at bay.

Yet any deal will likely prompt Spain (and or Italy) to access the fast depleting European Financial Stability Facility EFSF (temporary fund) first. The ECB would likely function as bridge financier as the access to the European Stability Mechanism (permanent fund) will have to be fully ratified by EU member states, notwithstanding the much awaited German Supreme Court ruling on the opposition filed by several German lawmakers against the German parliament’s swift passage of the bailout fund or the ESM[10].

As I noted in a blog, I think that the US Federal Reserve may defer on the mulled QE as they are likely to wait for the ECB to take the initiative and consequently watch for the effect before taking action.

The Foggy Outlook of US Markets and the US Economy

Let me add that the strong Friday rally in the US stock markets may not be that convincing as market internals reveals of a “narrowing breadth” or declining participation of gains by key index issues. This means that the large gains posted by the S&P 500 have been mostly concentrated to a few index heavyweights.

Also the Dow transports appear to diverge with the Dow Jones Industrials. According to one of the 6 basic tenets of the Dow Theory[11], the averages must confirm each other. A genuine economic recovery will become evident in the profits of both transports and industrials which should get reflected on the respective prices of these benchmarks. Thus, the conflicting signals translate to market ambiguity.

The jumbled outlook in the market internals may even signify signs of distribution or of the diminishing forces of the bulls.

This could also signal indirect interventions by political authorities via ETFs as the Bank of Japan (BoJ) has been openly conducting.

Bad news is good news.

US stocks markets respond to Pavlovian classical conditioning even as the quarterly spread between companies raising or lowering earnings guidance has been materially deteriorating during the past four consecutive quarters[12].

With 45% of revenues of the S&P 500 index companies exposed to the world economy[13] the decline in earnings guidance should be expected considering the intensifying downdraft of global economies[14].

Mohamed El-Erian, CEO of one of the leading investment firms, PIMCO, has even expressed apprehensions by citing “frightening”, “serious, synchronized slowdown”[15]

But a US slowdown may come from both internal and external forces

Capital spending in the US as measured by new factory orders has also shown significant downturn.

Dr. Ed Yardeni observes[16], (see left chart on the left window)

As go profits, so goes business spending. The recent stall in S&P 500 forward earnings isn’t a good omen for new factory orders, which have already stalled so far this year. Profitable companies expand their capacity by spending more on plant and equipment. Unprofitable companies scramble to cut their costs by reducing their capital outlays. In the real GDP accounts, the pace of capital spending has been slowing. It rose 5.3% (saar) during Q2 following a gain of 7.5% during Q1. Last year, such spending increased 8.6%.

And this has also been true with US export orders (right window from Sean Corrigan/Zero hedge[17])

There always will be something to be optimistic about. The question is which force will likely have a more powerful influence, the positive or the negative?

So far the continuing expansion of US business and industrial loans looks like one of the major bullish signs, but this would be highly dependent on business or capital spending indicators.

Also seasonality of stock market performances during US presidential elections, as well as, extreme bearishness of hedge funds (right window) and continued efflux by retail investors (left window Wall Street Journal[18]) represent as “crowded trade” sentiment.

Overall, I cannot see how seasonal forces and or how sentiment will overcome current fundamental deficiencies brought about the global central banking tentativeness and political gridlocks which has been prompting for today’s sluggish (bubble popping) economic outlook.

Seasonal forces mainly rely on the statistical probabilities of historical performance. This assumes previous historical conditions in the context of mathematical aggregates, as if the past had similar conditions. In reality conditions of the past have been unique. This makes reliance on statistics as a poor road map of the future.

Black Swan author and distinguished mathematician and iconoclast Nassim Nicolas Taleb in an interview with McKinsey Quarterly[19] warns about the inappropriate use of statistics

The field of statistics is based on something called the law of large numbers: as you increase your sample size, no single observation is going to hurt you. Sometimes that works. But the rules are based on classes of distribution that don’t always hold in our world. All statistics come from games. But our world doesn’t resemble games. We don’t have dice that can deliver. Instead of dice with one through six, the real world can have one through five—and then a trillion. The real world can do that.

The world is complex while aggregates rely on constants and assume simplifications.

Sentiments, on the other hand, signify as symptoms to an underlying cause.

The Phisix Ascendancy Depends on the Developments in the US

What do all these have to do with the Phisix and ASEAN stocks?

Everything.

I believe that the Phisix outperformance may continue for as long as the US does not fall into a recession.

China remains to be a significant factor too but she will likely be subordinate to the developments in the US. [I may be wrong here, as a deeper downturn in China may likely to affect many emerging market commodity exporters as well as the global supply chain networks]

However should the US economy and the financial markets capitulate to market forces, who will be exposing the massive misdirected investments through falling asset prices and through an economic recession, the chances are local and regional financial markets will likewise suffer from such agonizing cyclical adjustments.

Again like in 2007-2008 the Philippines and ASEAN may be subject to the risk of contagion.

Yet there has been little evidence in support of a regional decoupling.

And this brings us to the risk-reward trade off: I believe that under current conditions excessive optimism for the sustained ascension of the Phisix seems unwarranted. This is until central banks of major economies lay down their cards on the table or until we see some substantial improvements in the economic dimensions for major economies. However considering that inflationist policies has dominated much of the world’s economic and financial markets much of the misallocated capital will likely translate to the unwinding of speculative positions through economic and financial losses.

Also given the fluidity of developments as manifested by the alternating manic-depressive phases of how events unfold, the risks seems high that any policy errors may prompt for a swift and dramatic deterioration of conditions that may wipe any gains that may be temporarily acquired.

For me, to be excessively sanguine over local stock markets under the present conditions means the following;

1. unbounded faith in the capabilities of global and local central bankers (as well as politicians) to fix the current predicament.

2. belief that geopolitical and national political gridlocks will be resolved soon

3. a firm disposition to the theory of decoupling where the Philippines is presumed as having distinctive immunity to the risks of a global recession

4. to be hopeful that current global economic slowdown has reached an inflection point and will recover immediately

5. to simply believe for the sake of believing.

All the above simply posits of the severe underestimation of the risks conditions.

As English biologist Thomas Henry Huxley[20] once commented,

Logical consequences are the scarecrows of fools and the beacons of wise men

A US recession may not be in the cards yet, as we need to see more evidence on this. However considering the heavy dependency on the Fed’s or central banking steroids, much of the fate of the US economy will likely depend on how US political authorities will react. For instance if the FED forcefully inflates then this would likely produce a temporary patch.

While the risks of a US recession may not be imminent, such risks seem to be growing.

More Symptoms of the Philippine Boom-Bust Cycle

One of the big factors that has, so far, worked in favor of domestic stock market, as I have repeatedly been pointing out[21], has been the negative real rates which has impelled for a domestic version of yield chasing dynamic.

This yield chasing dynamic in the domestic financial market and the economy has been supported by a steep yield curve, which is likely to accelerate a credit driven boom. The Philippines has the steepest yield curve in Asia (chart from ADB[22]).

Such credit boom has already been visible via a double digit loan growth of the banking industry last May[23].

Also the business cycle has become quite evident in the performance of the stocks.

The banking and capital intensive property sectors have outclassed all other sectors. [If there should be no US recession, my guess is that mining and oil will resume as the market’s darlings in 2013]

As I wrote last November[24]

Although I am not sure which sector should give the best returns over the short term, I am predisposed towards what Austrian economics calls as the higher order stages of production or the capital goods industries, which are likely the beneficiaries of the business cycle, specifically, mining, property-construction and energy, as well as financials whom are likely to serve as funding intermediaries for these projects.

But again such credit driven boom will likely be subject or sensitive to the developments in the international sphere, and given the current conditions, I suspect that the credit boom may be deferred.

Miniature Bubbles: The Calata Episode

Negative real rates also give us miniature boom bust cycles or bubbles within bubbles.

I think the experience by Calata Corporation[25] [PSE: CAL], the recently listed agri product distributor, looks like a great example.

I recall of the passionate or even heated debates on a social network forum over the so-called merits of ‘investing’ based on corporate ‘fundamentals’.

Since the company listed in May, the wild price fluctuations of the issue exhibits, not of public’s perception about the company’s business model, but about the quick buck or short term mentality and the emotionally charged (greed and fear) speculative activities.

My guess is that most of those who dabbled with the issue have suffered excruciating losses than gains as Calata now trades below the IPO price at 7.5 pesos a share.

And yet due to the excessive volatility, like their counterparts in the Eurozone and elsewhere, the local authorities via the Security and Exchange Commission (SEC) recently launched an investigation for possible “stock market manipulation”[26].

This would seem more like chapter of witch-hunting that will likely end up nowhere. Nonetheless, such activities are seen as good for the populist politics of “do something”.

This unfortunate Calata incident also reveals of the way government deals with symptoms rather the disease, and who adroitly shifts the blame of the unintended consequences of social policies to the private sector.

While the Calata episode may not be representative of the entire Philippine stock markets yet, the basic lesson is that negative real rate regime molds the public’s orientation towards short term thinking, and importantly, whets on the public’s gambling appetite.

Yes many will always find ‘excuses’ to endeavor on supposed rationally based ‘investments’ when in reality they are only after “high risk-low return” dopamine seeking punts.

Negative real rates compel them towards speculative activities which in aggregate will become the dominant feature of the financial marketplace and the economy. Political suppression of interest rates therefore lays the foundations to the business or bubble cycles as speculations replace productive undertakings.

The Calata event signifies as the tip of the iceberg. Eventually as the markets go higher there will be more incidences of miniature bubbles ahead. Yet as the Japan bubble bust of 1990, Tequila crisis of 1994, Asian crisis of 1997, LTCM episode of 1998, dot.com bust in 2000 and US housing mortgage bubble bust 2008 have all shown, the broader market will likely transform into a full scale credit driven bubble if social policies remain attuned towards inflationism or the creation false prosperity from policy induced credit expansion.

As for the present state of the markets my bottom line is: For as long as global central bankers remain hesitant and only resorts to talking up the markets, in the face of a deepening slump in the global economy, I think global financial markets including the Philippines will be subject to intense price oscillations or a high risk environment.

Given the high correlationships of financial markets which has been the reason for RISK ON RISK OFF environments. Prudent investing means not having to put all your eggs in one basket.

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[1] Real Time Economic Blog Are Jobs Data Bad Enough to Be Good for Stocks? Wall Street Journal, August 3, 2012

[2] Wikipedia.org Classical conditioning

[3] Mises, Ludwig von 9. The Market Economy as Affected by the Recurrence of the Trade Cycle XX. INTEREST, CREDIT EXPANSION, AND THE TRADE CYCLE, Human Action, Mises.org

[4] Wikipedia.org Bipolar disorder

[5] See What Draghi’s Statement “The ECB is Ready to do Whatever it Takes to Preserve the Euro” Means, July 29, 2012

[6] See The Magic of Central Banking Talk Therapy, July 28, 2012

[7] See Explaining Super Mario’s Trifecta, August 4, 2012

[8] See Will the Accord by the ECB-EU Politicians Pave Way for the Big Bazooka? August 3, 2012

[9] See Has Friday’s Surge by the US Stock Markets Been about the ‘Positive’ Jobs Report? August 4, 2012

[10] See Global Financial Markets: Will the EU Summit’s Honeymoon Last? July 2, 2012

[11] Wikipedia.org Dow theory

[12] Bespoke Invest Bad Guidance Continues, July 29, 2012

[13] See Why Current Market Conditions Warrants a Defensive Stance, July 9, 2012

[14] US Global Investors The Race for Resources, Investor Alert, August 3, 2012

[15] See PIMCO’s Mohamed El-Erian: “Frightening” Global Synchronized Slowdown, August 3, 2012

[16] Yardeni Ed, Capital Spending, Dr. Ed’s Blog July 31, 2012

[17] Zero Hedge US Export Orders Are Collapsing August 2, 2012

[18] Zweig Jason When Will Retail Investors Call It Quits? August 2, 2012, Wall Street Journal

[19] Mckinsey Quarterly Taking improbable events seriously: An interview with the author of The Black Swan December 2008

[20] Wikipedia.org Thomas Henry Huxley

[21] See Investing in the PSE: Will Negative Real Rates Generate Positive Real Returns? November 20, 2011

[22] ADB Key Developments in Asian Local Currency Markets AsianBondsOnline July 30, 2012

[23] Business Inquirer, Bank lending maintains double-digit growth rate in May—BSP, July 11, 2011

[24] See Phisix-ASEAN Equities: Awaiting for the Confirmation of the Bullmarket November 13, 2012

[25] Philippine Stock Exchange Calata Corporation

[26] Business Mirror Calata shares plummet as SEC confirms probe, August 2, 2012