Swiss National Bank’s Currency Interventions Spawns Property Bubble

The unintended consequences from massive currency interventions conducted by the Swiss National bank, designed to curb huge inflows from a capital diaspora in the Eurozone by putting a ceiling on the euro, has apparently spawned a monster property bubble.

From Bloomberg,

Thomas Jordan’s fight to protect the Swiss economy is set to widen beyond currency markets and too- big-to fail risks as the central bank chairman considers how to curb the biggest real-estate boom in two decades.

The Swiss National Bank may act to stem what it called risks from “excessive credit growth,” economists from Bank Sarasin to UniCredit Group said. An option available to the central bank would be to force lenders to hold additional capital of as much as 2.5 percent of their domestic risk- weighted assets to help buffer against losses.

The SNB has already put a cap on the franc to counter the currency’s ascent and protect the economy. After leading efforts to boost capital requirements for UBS AG (UBSN) and Credit Suisse Group AG (CSGN), the country’s two largest banks, Jordan is now turning his focus to smaller lenders as the risk of a significant drop in property prices increases.

“The SNB has been warning for quite a while of a real- estate bubble and it wants to see a cooling,” said Andreas Venditti, a senior analyst at Zuercher Kantonalbank in Zurich. “It’s very possible that the buffer will be implemented before the end of the year.”

In the SNB’s June Financial Stability Report, which also called on Credit Suisse, Switzerland’s second-largest bank, to boost its capital, the central bank said the mortgage market poses a significant risk to Swiss lenders. Home loans have increased by almost 300 billion francs ($307 billion) in a decade and gained 5.2 percent last year to 797.8 billion francs. That’s about 140 percent of Swiss gross domestic product.

Surging Prices

The cost of owner-occupied apartments with as many as five rooms has risen the most over the past 10 years, with prices jumping 40 percent, SNB data shows. Prices of rental apartments have increased 29 percent.

UBS and Credit Suisse had combined outstanding mortgages of 240.6 billion francs at the end of 2011, up 2.8 percent from the previous year. Cantonal banks, which are largely owned by the regions, had a 6 percent increase, while the cooperative-based Raiffeisen banks saw mortgages surge 7.4 percent.

UBS said on July 31 that if property values fell by 20 percent, 99.7 percent of its exposure to Swiss real estate would remain covered by collateral. While prices are still climbing in some regions, “at this time, we don’t believe this could destabilize the Swiss economy or cause major losses for UBS,” Chief Financial Officer Tom Naratil said.

Chart courtesy of La Chronique de Crottaz Finance

To what extent has the SNB expanded their balance sheet?

Here’s the Financial Times,

Foreign exchange reserves rose to SFr406bn ($419.7bn) last month, up from SFr365bn in June, marking the third consecutive month that the Swiss National Bank has been forced to add tens of billions to its balance sheet in its efforts to weaken the Swiss currency.

The SNB has had a policy of keeping the franc at a ceiling against the euro of SFr1.20 since September and has vowed to buy as many euros as necessary to prevent the franc from strengthening beyond that level.

Recent interventions in the forex market have seen the SNB’s balance sheet expand to record levels. Forex reserves have risen 71 per cent since April, the latest figures show.

The credit boom seems to have percolated into the stock market too.

As of yesterday the Swiss Market Index has returned 9% and about 29% from the trough last August or about a year ago.

And considering that the growth of SNB’s balance sheet has vastly outpaced the the US Federal Reserve and other major central banks, the Swiss franc has even weakened substantially against the US dollar.

Taking cue from the Great Depression, the distinguished dean of Austrian economics Murray N. Rothbard wrote,

The trouble did not lie with particular credit on particular markets (such as stock or real estate); the boom in the stock and real estate markets reflected Mises's trade cycle: a disproportionate boom in the prices of titles to capital goods, caused by the increase in money supply attendant upon bank credit expansion

Yet if the SNB succeeds to restrain the banking system’s unsustainable credit expansion then a bust should be expected.

The boom-bust (Austrian Business) cycle as explained by the great Professor Ludwig von Mises,

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

In a fiat money central banking standard, boom bust cycles have been the dominant landscape.

Growing Risks of Food Crisis: Blame US Government’s Ethanol Policies

Surging food prices ‘has not merely been caused by drought, it has been rooted from government policies intended to promote the ethanol biofuel energy industry.

Jeffrey A. Tucker at the Laissez Faire Books explains:

Looking this up and examining the history, it appears that government has been trying to put corn in our gas tanks for decades, even back to the 1960s. There were tax breaks, subsidies, lofty national goals, smiley stickers for executives who publicly backed this nonsense, but none of it took. Finally, our masters brought out the brass knuckles and everyone shaped up, culminating in a coercive mandate imposed six years ago.

Now we are stuck with this de facto mandate that we have to put corn in our gas tanks, all based on the kooky idea that fossil fuels are just too primitive, that we have to mix our gas with a movie-theater treat to make it truly clean and efficient.

But clean and efficient are two things that ethanol is not. The reason your edger and weed whacker don’t fire up in the spring months is most likely due to the presence of corn in the tiny gas tanks. The fuel mixture does not stay stable over time and tends to gum up engines. This is why the store shelves are filled with gas-tank additives of all sorts that did not used to exist. The whole point is to correct for the mess that ethanol makes.

Of course, there is a huge industry out there dedicated to debunking the idea that there is anything the matter with ethanol. But here’s the problem: People who make the pro-ethanol argument are either 1) the same people who think we ought to turn our toilets into composting pits or 2) speaking for industries highly dependent on the many forms of ethanol subsidies, so they have every incentive to deny the obvious for as long as possible.

But ask people who depend on a stable and reliable fuel for their livelihoods, and sometimes their lives. Talk to any boaters. You don’t have to know any. Head over to any boaters’ forums and see what they say. They go out of their way to find the few gas stations that actually sell ethanol-free gasoline, mainly because they can’t afford to take risks that come with bad gas and bad engines. They find stations that sell no ethanol gas, like those listed at pure-gas.org.

Another fact: Though people have thought for centuries that corn is a decent fuel, it took the mandates to force it into cars. Why? Because consumers knew better. Manufacturers knew better. The petroleum industry knew better. Government and the corn industry had a different idea and gave it to us all good and hard.

Nor is it efficient. As even Paul Krugman admits, “Even on optimistic estimates, producing a gallon of ethanol from corn uses most of the energy the gallon contains.” We also have to add the huge expenditure associated with fuel additives, engine fixes, lawn mower replacements and the vast frustration that comes with the regulatory wrecking of the internal-combustion engine.

Now let’s look at what’s happened to crops since 2005. The percentage of crops devoted to corn have gone from 24% in 1999 to 30% today. Meanwhile, the crops devoted to soybeans, hay and wheat have all gone down, thereby increasing feed costs for ranchers and consumers. Again, this is not the market talking. This is not what any actual market players are pushing. This all results from government mandates.

Meanwhile, the price index of Illinois farmland has tripled in the same period. Even though every price signal would otherwise indicate to farmers to plant less corn, they plant more. And even though land values all over the U.S. went into a major bust in 2008 and following, Illinois farmland goes up and up. This is a result of government intervention, building artificiality into the system and creating unpredictable distortions.

It almost seems hard to believe. It’s a scandal that government has degraded home appliances, indoor plumbing, paint, cosmetics, gas cans and so much else. Yet the ethanol nonsense might be the worst of all, because it represents a fundamental attack on the technology and literal fuel of modernity itself. As you look back at it, it’s been going on a very long time, from the initial ban on lead fuels, and now look where we are.

In the name of efficiency and “clean fuels,” the government is shutting down the technology essential to life as we know it. And the spillover effects are everywhere, affecting nearly everything we eat. As usual, all these regulations are premised on the supposition that conditions will never change and that the state can take the existing world and pound it into its preferred shape. But the existing world as the state knows it is always a world of the past. Introduce one change and the whole model blows up.

That is what is happening with ethanol right now. The mandate is causing vast distortions and crazy costs for everything and everything. The scandal is how little we know or care. Maybe famine will make the difference?

Add central banks inflationism to the above conditions and we end up with the potential risks of stagflation and a food crisis.

Yet a global food crisis does seem like a growing menace. Proof?

China’s government announced of the release corn and rice reserves to ease shortages

Reports the China Daily

China will release corn and rice from state reserves to help tame inflation and reduce imports as the worst US drought in half a century pushes corn prices to global records, creating fears of a world food crisis.

Friday's announcement was the first release since September last year, when China said it would sell 3.7 million tons of state corn to keep inflation under control.

The release may prompt Chinese importers to cancel shipments in the near term and take some pressure off international corn prices, which set a new all-time high on Friday as the US government slashed its estimate of the size of the crop in the world's top grain exporter.

"Bottom line - rationing is in full force, and given the continually declining state of the US corn crop, more will be needed," said Christopher Narayanan, head of agricultural commodities research at Societe Generale.

China's State Administration of Grain did not specify the volume of corn or rice to be released from reserves. The Grain Reserves Corp will be responsible for selling the crops, but no details were given on the timing.

Some traders estimated the government might sell around 2 million tons to help stabilize prices ahead of the harvest, when supply is usually tight.

Beijing will probably need to replenish reserves towards the end of the year, and therefore the release will have only a limited impact on prices.

More uncertainties ahead.

Information Age: Fly In Fly Out Workers

I have been saying that the information age will radically alter the way we do things.

Signs of such transformation can be seen in Indonesia where some foreign expats practice what Tim Staermose of Sovereign Man calls as the ‘fly in fly out’ work.

In the modern age, the concept of clearly defined national and supranational borders is a symbol of a bygone model made obsolete by technological and philosophical change. It’s amazing we still pay so much attention to them.

The Internet has made it possible to build relationships with people across the world who share your interests and beliefs, not the color of your passport.

Modern transport and telecommunication options make it possible for someone to live in one place and earn money in another… or in the case of large companies, to headquarter somewhere and earn money everywhere.

This trend is increasingly prevalent here in Bali as an increasing number of foreigners are making a permanent home here. To these new residents, national boundaries are becoming less relevant.

One group is called the ‘fly in fly out’ mine workers. Perth, Western Australia is in the midst of a mining boom, and it’s just three hours’ flight from Bali. Rather than pay the stupidly high costs of living in Australia, a growing band of miners are basing themselves in Bali. They fly down to Perth to work for 14 days straight in the mines (staying out on site), and then fly back to Bali for their 14 days off to relax with family and friends.

Given that it takes the typical Balinese one month to earn what a worker in Australia can make in a day, the cost of living in Bali is understandably MUCH lower… and in my opinion, is much higher quality.

The dual forces of the information age and globalization will usher in the growing obsolescence of the political flimflam concept called as “nationalism”.

Aggressive Interventions from Philippines and Emerging Market Central Banks

Actions speak louder than words.

Central banks of emerging markets including the Philippines have aggressively been intervening in the marketplace signaling an ambiance of heightened instability.

From the Bloomberg,

Just three months after the biggest developing economies sold dollars to support their currencies, policy makers from Colombia to China are moving to weaken exchange rates and revive exports as the International Monetary Fund forecasts the slowest trade growth in three years.

Colombian Finance Minister Juan Carlos Echeverry urged the central bank on Aug. 3 to boost minimum dollar purchases from $20 million a day, saying the country needs “more ammunition” to drive down the peso in the global “currency war.” The Philippines banned foreign funds from deposit accounts and unexpectedly cut interest rates in July as the peso hit a four- year high. In China, authorities lowered the yuan reference rate to the weakest since November, which according to Citigroup Inc. will create “headwinds” for other Asian currencies.

After spending more than $59 billion in foreign reserves in May and June to stem currency depreciation, developing nations are reversing policies as the European debt crisis outweighs the risk of faster inflation. South Korea and Chile may weaken exchange rates to make their exports cheaper, according to UBS AG. The IMF estimates global trade will expand at the slowest pace since 2009.

“Policy makers will become more aggressive,” said Bhanu Baweja, a London-based strategist at UBS. “The currency strengthening is in contrast with the state of the economy. That argues for much weaker foreign-exchange rates.”

Again the elixir of cheap currencies reveals of the deep seated mercantilist dogma espoused by central bankers. ‘Cheap currencies’ to promote exports have signified as the standard slogan in justifying ‘inflationism’. The real concealed reason has been to promote the interests of the elites.

The Philippine’s Bangko Sentral ng Pilipinas has been no exception.

From the same article,

In the Philippines, the central bank tightened rules on capital inflows last month by prohibiting foreigners from parking funds in so-called special deposit accounts. Policy makers also cut the benchmark interest rate by a quarter- percentage point on July 26 to a record 3.75 percent, a move that Deputy Governor Diwa Guinigundo said will help “temper” peso gains. The currency’s 4.6 percent advance versus the dollar this year is the best performance in Asia. The peso fell 0.2 percent yesterday.

There are many ways to skin a cat as the old saw goes. This means that should foreigners decide to put in money here, they can do so through many law circumventing options such as padding of local export receipts or transfer pricing and etc…, so the BSP’s action can be seen as superficial and symbolical.

None the less, given that the risks of a global economic slowdown seems to be intensifying, home bias has been the natural response resorted to by foreign investors. The possible exception would be from the capital flight dynamic in response to the Euro debt crisis.

All these inflationism resorted to by global central bankers will distort the real economy through the pricing system. This only means that boom bust cycles will be global and will intensify.

Quote of the Day: The Myth of the Greater Good

The 19th-century British individualist Auberon Herbert addressed the issue of the “good of the greatest number.” He stated, “There never was invented a more specious and misleading phrase. The Devil was in his most subtle and ingenious mood when he slipped this phrase into the brains of men. I hold it to be utterly false in essentials.”

Why is it false? Because the phrase assumes as a given that a higher morality requires the violation of individual rights. Or in Herbert’s words, “It assumes that there are two opposed ‘goods,’ and that the one good is to be sacrificed to the other good — but in the first place, this is not true, for liberty is the one good, open to all, and requiring no sacrifice of others, and secondly, this false opposition (where no real opposition exists) of two different goods means perpetual war between men.” [Emphasis added.]

Herbert is relying on two intimately related theories: first, “the universality of rights”; and, second, “a natural harmony of interests.” The universality of rights means that every individual has the same natural rights to an equal degree.

Race, gender, religion or other secondary characteristics do not matter; only the primary characteristic of being human is important. A natural harmony of interests means that the peaceful exercise of one person’s individual rights does not harm the similar exercise by any other person.

My freedom of conscience or speech does not negate my neighbor’s. The peaceful jurisdiction I claim over my own body does not diminish anyone else’s claim of self-ownership. Indeed, the more I assert the principle of self-ownership, the stronger and more secure that principle becomes for everyone.

Only in a world where rights are not universal, where people’s peaceful behavior conflicts, does it make sense to accept the need to sacrifice individuals to a greater good. This is not the real world, but one that has been manufactured for political purposes.

Herbert explained a key assumption that underlies this faux world: the acceptance of the “greater good” itself. He asked, “Why are two men to be sacrificed to three men? We all agree that the three men are not to be sacrificed to the two men; but why — as a matter of moral right — are we to do what is almost as bad and immoral and shortsighted — sacrifice the two men to the three men? Why sacrifice any one… when liberty does away with all necessity of sacrifice?”

Herbert denied the validity of “this law of numbers, which… is what we really mean when we speak of State authority…under which three men are made absolutely supreme, and two men are made absolutely dependent.” Instead of accepting the law of numbers as an expression of greater good, Herbert viewed it as a convenient social construct, calling it “a purely conventional law, a mere rude, half-savage expedient, which cannot stand the criticism of reason, or be defended… by considerations of universal justice. You can only plead expediency of it.”

To whom was the social construct of conflict convenient? Why would a faux world of inherent conflict be created? By solving the manufactured problems, a great deal of power was transferred from individuals to a ruling class.

Herbert wrote, “The tendency of all great complicated machines is to make a ruling class, for they alone understand the machine, and they alone are skilled in the habit of guiding it; and the tendency of a ruling expert class, when once established, is that at critical moments they do pretty nearly what they like with the nation…”

Rather than solve a social problem, the ruling class had a devastating effect on the welfare of common people, who became “a puzzled flock of sheep waiting for the sheepdog to drive us through the gate.” Ironically, by claiming the collective was greater, the few were able to assume control over the many. The “greater good” devolved to whatever served the interests of the ruling class.

This is from Ms. Wendy McElroy at the Laissez Faire Books.

All the popular appeal to the emotions couched on (collectivist) 'nationalism' have been no more than vicious propaganda intended to uphold the interests of the ruling class.

Philippine Mining Index: Will The Divergences Last?

In my view, a very significant divergence unfolding within the Philippine Stock Exchange over the past few weeks could highlight a pivotal development.

A Southbound Philippine Mining Index

While the local benchmark, the Phisix continues to drift at the near record highs, the biennial market leader, the mining sector, appears to have substantially weakened.

I say biennial because as I have pointed out in the past, the mining index outperformance-underperformance has been rotating every other year[1].

Year-to-date, the mining sector has plummeted by about 10%.

Yet more than half or 5.8% of such losses accrued only from this week. This makes the mining sector a dismal laggard relative to the others.

The mining sector has fundamentally spearheaded the “rising tide” or the broad based rally of the Philippine Stock Exchange since 2002. This can be seen via nominal returns. Measured by the sector’s index trough in 2002 as against recent peaks, the mining sector produced an astounding 26x as against 4x for the Phisix.

Nevertheless, the ebbs and flows or the undulations of the Phisix (green line chart) have been for most of the time, highly correlated with the mining sector (black candle) throughout this duration.

In other words, even during years where the mining sector trailed the others, the former flowed along with the rest to reflect on the same (positive or negative) directions of returns. The nuances have only been in the degree.

The correlation has not been perfect though, as there had been accounts of divergences.

This can be seen in the colored ovals in the above charts. In 2010, the Phisix outperformed (orange) as the mining index hibernated. In 2011, the mining index sprinted miles ahead (red) as the Phisix wavered. However eventually, these anomalies got smoothed out and both moved towards the same path.

In short, the rotating market leadership meant that as one index stagnated, the other index advanced.

The Mining Sector’s Divergence From the Phisix

Today there appears to be a different type of divergence; the Phisix and the Mining sector has moved in opposite directions.

Technically speaking, the mining index has already infiltrated into the bear market territory (20% loss). Based on Friday’s close and from the recent top this May, this translates to about 22% decline. Thus the year-to-date figure understates the true extent of the losses. As always, the point of reference matters.

Yet the last time the mining index fell into a bear market, which came in conjunction with a bear raid on the Phisix and on global equity markets as the public’s heavy expectations for QE 3.0 had been frustrated by the politically shackled US Federal Reserve chair Ben Bernanke[2], the mining index lost 33% peak-to-trough before recovering.

I do not expect a repeat of the same pattern as the major influence will emanate from external forces.

Besides, the technical picture likewise exhibits a bearish ‘double top’ which may only exacerbate the current negative sentiment.

There has been imputation that the recent declines have been due to issue specific related incidents. For instance, some people have speculated that political authorities may initiate investigations on an innuendo of alleged malfeasances committed by a firm as exposed by a blind item article in a popular broadsheet. This, they think, has been an important factor in the recent price declines.

It is interesting to see that many people fall prey to such scuttlebutts.

Yet it is dangerous to believe that all hearsays require government intervention. If this becomes reality then serial witch-hunting would only mean severely politicized and convoluted markets and a bloated government which only would extrapolate to chronic economic and political imbalances. Think Greece.

People seem to forget that many accounts of the financial market improprieties have operated in the shadows of the underhand of politics.

The infamous Dante Tan led BW Scandal sets a shining example of the political complicity and the failure of insider trading regulations[3]. The accused Mr. Tan has been absolved of two criminal cases for violation of The Revised Securities Act by the Supreme Court in August of 2010[4]. How about the US property-mortgage bubble crash of 2008[5]?

Worst, people seem to have developed impression of entitlements, such that the only politically correct direction for the stock market has been UP. Thus, falling markets become objects for political interventions. The unfortunate Calata episode serves an example[6].

And this is why central banking inflationist interventions have become so popular, it gives a boost to the gambling appetite and to the serotonin, all at the expense of personal accountability and responsibility.

I don’t have a clue to the truth or validity of such allegations. But as Black Swan author Nassim Taleb points out from his upcoming book[7] we easily get hooked to sensationalism.

There was even more noise coming from the media and its glorification of the anecdote. Thanks to it, we are living more and more in virtual reality, separated from the real world, a little bit more every day, while realizing it less and less. Consider that every day, 6,200 persons die in the United States, many of preventable causes. But the media only reports the most anecdotal and sensational cases (hurricanes, freak incidents, small plane crashes) giving us a more and more distorted map of real risks. In an ancestral environment, the anecdote, the “interesting” is information; no longer today. Likewise, by presenting us with explanations and theories the media induces an illusion of understanding the world.

Yet from the big picture perspective, the appeal to innuendos represents the cognitive fallacy of availability heuristic[8] or judgment based on information that can easily be remembered. This may even the account as the logical Post Hoc “after this therefore because of this” fallacy which mistakes coincidences as causes[9].

How do I say so? Because of the synchronized actions of the mining issues.

From the one year chart, we can note that the Phisix and the mining index suffered from the recent post-Operation Twist and Euro crisis selloff this May.

However in contrast to the broader markets, which piggybacked on the swift resumption of the RISK ON environment primed by serial promises by major central banks of interventions, the rally in the domestic mining index have faltered.

What is in front of us or have been self-evident we have frequently overlooked in favor of those narrated, the tangible or the personal.

Again some behavioral lessons from Nassim Taleb[10]

people tend to concoct explanations for them after the fact, which makes them appear more predictable, and less random, than they are. Our minds are designed to retain, for efficient storage, past information that fits into a compressed narrative. This distortion, called the hindsight bias, prevents us from adequately learning from the past.

Yes coincidentally, a day AFTER Philippine president Benigno Aquino III affixed his signature on the much ballyhooed Mining-Tourism compromise via Executive Order 79[11], stock prices of MOST of the mining issues began to deteriorate.

Except for Semirara Corporation [PSE:SCC, black candle] prices of the mining heavyweights—Philex Mining [PSE: PX, blue], Lepanto Consolidated [PSE:LC, light green], Atlas Mining [PSE:AT, orange] and Manila Mining [PSE: MA violet]—have all been suffering from synchronized decline.

Such seemingly coordinated downturn have been no different from the second tier issues, whose string of losses has exceeded the majors: Nihao Minerals [PSE: NI black candle] Nickel Asia [PSE: NIKL, green] Geograce Resources [PSE:GEO, blue] and Oriental Peninsula [PSE:ORE, red].

Oil issues, whether as component of the mining index or not, have not been spared: Oriental Petroleum [PSE:OPM, black candle] and PetroEnergy [PSE:PERC, red] seem to have stagnated while The Philodrill Corporation [PSE:OV, green], and Philex Petroleum [PSE: PXP, blue] have exhibited signs of contagion based selling pressures.

Yet current infirmities in the domestic mining-oil sector may represent a belated response to the falling prices of products which underpins the operations of these companies: Gold, copper and industrial metals (GYX) have been on a slump for at least a last year. Oil (WTIC) on the other hand, still trades below the May 2011 high.

The state of the commodities has apparently been replicated on the benchmarks of global mining issues. These can be seen in the performance of US mining stocks [XME—SPDR S&P Metals & Mining Index], global mining stocks [CMW.TO—iShares S&P/TSX Global Mining Index Fund], emerging market mining stocks [EMT—emerging global shares dow jones emerging markets metals/mining titans], and US oil stocks [$DJUSEN Dow Jones US Oil & Gas Index]

In short, falling commodity prices may have been interpreted as crimping on the operating leverage[12] of these resource companies, thereby reducing profitability[13] whose consequence has been the year-long torpor of global mining equities.

Ironically, however, global mining and oil issues seem to have staged a rally despite the languid state of commodity prices.

This perhaps could have been prompted by snowballing anticipations of the possible “grand bazooka” to be launched by the European Central Bank and or the US Federal Reserve.

Implications of Divergences and of Philippine Mining Political Trends

There are several insights from the above: In defying global market trends, domestic mining and oil equities may have overextended gains. Perhaps current the correction phase exhibits the market process of regression to the mean or similarly defined in psychological terms[14] or in finance[15] as the tendency of the markets to average out.

Yet one cannot discount that such valuations overreach may also represent symptoms of excessive speculations or the unwinding of mini-bubbles.

Add to these the elements of political and regulatory uncertainty introduced by the new executive order by the President and on the suggestion by the IMF for the Philippine government to hike taxes on the mining industry[16].

Reports say that a tax increase in the mining industry for President Aquino may momentarily not be a priority “for the next year or two”. But prospects of it may have also compounded on the current uncertainties considering the proposed doubling of excise taxes from “the current 2% to a range of 5-7%”, as well as “a 5% royalty in future mining contracts and areas to be declared as mineral reservations”[17].

Of course given that the mining sector has been one of the industries that have the biggest potential to boost President Aquino’s obsession with approval ratings through statistical economic growth, I believe the political burdens of the mining industry will likely be mitigated.

The compromise between mining and tourism industry via EO 79 and tax deferment seems like evidences of these. I might add that the same instances also serve as wonderful proof public choice theory at work, where vested political interest groups have a significant sway or influence or logrolling on policymaking[18]. Yes tourism industry has their share of political concentrated group interest too.

While the Executive Order has been meant to placate on these squabbling groups, the major beneficiary here is the Philippine government whose attendant edict extrapolates to more control and discretion of choosing winners and losers and bigger budgets for the bureaucracy for the supervision and enforcement of such fiat, all at the expense of society through prospective higher taxes and politicized distribution of economic opportunity.

Of course another major beneficiary will be the cronies who will get the gist of the license to explore and operate mines.

This means that the increased politicization of the mining industry will favor the entrenched groups at the expense of small scale miners and other professional miners.

Yes despite the massive scale of regulations by the Philippine government, the informal gold mining sector has fundamentally become the dominant contributor to the nation’s gold production output.

Such statutory compromise will hardly bring such informal sector to the surface for the reasons stated above.

And yet part of the growth of the informal sector, ironically, has been facilitated by the Bangko Sentral ng Pilipinas (BSP), through their gold buying program.

As the World Gold Council notes[19]

Looking at informal production, it is understood that the bulk of this is sold at buying stations maintained by the central bank. This is due to the fact that gold is normally bought on a noquestions-asked basis, and on very attractive terms. Nevertheless, there remains a small portion of informal production, mainly from the province of Mindanao, that is not sold to the central bank.

It is important to impress to readers that mining per se has not been responsible for environmental degradation. If such allegations were true then Chile, the US, Australia, Canada would have been transformed into howling wilderness.

In reality, environmental preservation and optimizing revenues from the mining industry are strongly associated with the resource curse dilemma[20], that which is the politicization of the resource industry.

As the World Bank a 2002 study notes[21],

Fighting corruption, self-interested rent-seeking, and a general deterioration in the quality of governance in the face of large revenue streams is no doubt a challenge for countries with otherwise short histories of sound and competent institutions. There is no easy panacea to managing this challenge. At the same time, there is simply no other way to manage a mining sector successfully, and indeed a successful economy in general, than to engage in the challenging task of building effective political and economic institutions and finding competent individuals to run them. This is the essence of the development process.

Informal economy, corruption, rent seeking and a general deterioration in the quality of governance are symptoms or are products of asphyxiating regulations, bureaucracy, high burdens from taxes and the cost of compliance[22], insecure property rights and involuntary exchanges or the intense politicization of the industry.

Nevertheless also do expect more massive illegal and wildcat mining in the 78 areas that has been prohibited from mining which should lead to environmental degradation. The people who will undertake the fly by night mining operations will likely be wards of politicians.

In the realm of politics, natural laws of economics simply vanish or will submit to the will of politicians.

Short Term Bearish, Long Term Bullish

Have recent events signaled the end for the bullmarket in Philippine mining? I guess not. This looks more cyclical than structural as explained above. The momentum suggests that the ongoing retrenchment phase could or may likely continue.

Although I also think, over the interim, the mining industry’s divergence signals two major routes:

One, the leveling out of the divergences through

A. A sustained rally in the global equity markets or a prolonged RISK ON environment that will eventually percolate to prices of general commodities and thus would likely truncate the current correction phase of the local mines or

B. The Mining sector’s bear market could spillover to the general market.

Second, that the divergence becomes a lasting feature. This eventually paves way for stagflation. In such scenario, I expect the mines to go opposite ways with the general stock market. But this will likely become a global phenomenon too. So actions in the local markets should be in sync with the world. So far there has been little evidence on this.

I lean on condition (B) or where the bear market of the mining sector will likely percolate into the general market, due to growing risks of contagion.

However everything really depends on how and what future policies will be conducted, especially in the US, as previously discussed.

So far, gains from the global equity markets have emerged from intensifying hopes and prayers of rescue (if not narcotics) from central banks. The Bank of America estimates that the markets has already priced or factored in a humungous 80% of QE 3.0[23] which implies of the enormous pressure on policymakers to deliver. And market now becomes highly sensitive or susceptible to changes in expectations which may be swift and dramatic.

Central banking stimulus continues to exhibit diminishing returns[24].

This also suggests that in order to have a meaningful effect, central bank steroids would need to have a “shock and awe” in scale or a far larger than the current dosage. Failure to satisfy the markets could switch sentiment to a RISK OFF volatility.

This is why current environment seems so uncertain and so vulnerable to instability.

Yet given that political election season approaches in the US, one cannot discount that markets may be boosted by political authorities for political goals[25].

But at the same time, market risks from a global slowdown contagion have continuously been escalating.

Trade cautiously.

---

[1] see Graphic of the PSE’s Sectoral Performance: Mining Sector and the Rotational Process, July 10, 2011

[2] see Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms September 22, 2011

[3] See Insider Trading: What is Legal isn’t Necessarily Moral, November 17, 2011

[4] Supreme Court of the Philippines SC Clears Dante Tan of BW Charges

[5] See 2008 US Mortgage Crisis: The US Federal Reserve and Crony Capitalism as Principal Causes, May 31, 2011

[6] See Phisix: Managing Through Volatile Times August 6, 2012

[7] Taleb Nassim Nicolas NOISE AND SIGNAL Facebook (May 21)

[8] changingminds.org, Availability Heuristic

[9] nizkor.org Post Hoc Fallacy

[10] Taleb Nassim Nicholas Learning to Expect the Unexpected, New York Times April 8, 2004

[11] ABS-CBN News PNoy's Mining EO No. 79, July 9, 2012

[12] Investopedia.com Operating Leverage

[13] Wikipedia.org Investment vehicles, Gold as an Investment

[14] Alleydog.com Regression Toward the Mean Psychology Glossary

[15] Wikipedia.org Mean reversion (finance)

[16] Abs-cbnnews.com Mining companies in PH not paying enough taxes: IMF August 9, 2012

[17] Abs-cbnnews.com Raising taxes on mining not a priority: Aquino July 18, 2012

[18] See Public Choice in Action: Logrolling in the Philippine Mining-Tourism Policy, June 21, 2012

[19] World Gold Council Central Bank case studies: The Philippines

[20] Wikipedia.org Resource curse

[21] World Bank Treasure or Trouble? MINING IN DEVELOPING COUNTRIES, WORLD BANK AND INTERNATIONAL FINANCE CORPORATION 2002 p.14

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

[23] Real Time Economics Blog, BofA Sees 80% Chance of QE3 Priced Into Markets Wall Street Journal, August 10, 2012

[24] Zero Hedge It's A Centrally-Planned World After All, With Ever Diminishing Returns August 11, 2012

[25] See Has Ben Bernanke Been Working to Ensure President Obama Re-election, February 5, 2012

Quote of the Day: Political Insanity

It is easy to prescribe improvement for others; it is easy to organise something, to institutionalise this-or-that, to pass laws, multiply bureaucratic agencies, form pressure-groups, start revolutions, change forms of government, tinker at political theory. The fact that these expedients have been tried unsuccessfully in every conceivable combination for six thousand years has not noticeably impaired a credulous unintelligent willingness to keep on trying them again and again. This being so, it seems highly probable that the hope for any significant improvement of society must be postponed, if not forever, at any rate to a future so far distant that consideration of it at the present time would be sheer idleness.

This is from Albert Jay Nock from Memoirs of a Superfluous Man p.308 (pdf)

Olympic Medals and Economic Health

The state of a nation’s economy seem to have a tight correlationship with the score of Olympic medals acquired.

As New York University’s William Easterly points out: (charts from Mr. Easterly too)

“what determines Olympic medals?” The answer is income per capita and population, or in other words total GDP.

But such correlationship may not be perfect.

Mr. Easterly notes of the outliers and of the lessons:

The big underachievers are (in order of underachievement) India, Mexico, Indonesia, Turkey, Saudi Arabia.

The big overachievers are Belarus, Ukraine, Kazakhstan, Romania, Iran, , and Jamaica.

The lessons seem to be:

(1) World Bank national development strategies in key emerging markets have failed miserably in the Olympics sector.

(2) a history of Communism may not have been so awesome for development and liberty, but it’s still amazing for Olympic medals.

(3) Islamist ideology is a mixed medal producer (Saudi Arabia no, Iran yes).

(4) if nothing else works, just run really fast.

Interesting.

The Major Risk from Currency Union Breakups: Hyperinflation

At the Peterson Institute for International Economics, Mr. Anders Aslund has an interesting paper on the historical aftermaths of the dissolution of currency unions.

Mr. Aslund opens with a refutation of the Nirvana fallacy of the Keynesian prescription on the currency devaluation elixir. Here Mr. Aslund rebuts Nouriel Roubini. (all bold highlights mine)

While beneficial in some cases, devaluation is by no means necessary for crisis resolution. About half the countries in the world have pegged or fixed exchange rates. During the East Asian crisis in 1998, Hong Kong held its own with a fixed exchange rate, thanks to a highly flexible labor market. The cure for the South European dilemma is available in the European Union. In the last three decades, several EU members have addressed severe financial crises by undertaking serious fiscal austerity and reforms of labor markets, thus enhancing their competitiveness, notably Denmark in 1982, Holland in the late 1980s, Sweden and Finland in the early 1990s, all the ten post communist members in the early 1990s, and Germany in the early 2000s. Remember that as late as 1999, the Economist referred to Germany as “the sick man of the euro.”

More recently, the three Baltic countries, Estonia, Latvia, and Lithuania, as well as Bulgaria have all repeated this feat (Åslund 2010, Åslund and Dombrovskis 2011). Among these many crisis countries, only Sweden and Finland devalued, showing that devaluation was not a necessary part of the solution. The peripheral European countries suffer in various proportions from poor fiscal discipline, overly regulated markets, especially labor markets, a busted bank and real estate bubble, and poor education, which have led to declining competitiveness and low growth. All these ailments can be cured by means other than devaluation.

Mr. Aslund on the currency union dissolution during the gold standard eon.

It was rather easy to dissolve a currency zone under the gold standard when countries maintained separate central banks and payments systems. Two prominent examples are the Latin Monetary Union and the Scandinavian Monetary Union. The Latin Monetary Union was formed first with France, Belgium, Italy, and Switzerland and later included Spain, Greece, Romania, Bulgaria, Serbia, and Venezuela. It lasted from 1865 to 1927. It failed because of misaligned exchange rates, the abandonment of the gold standard, and the debasement by some central banks of the currency. The similar Scandinavian Monetary Union among Sweden, Denmark, and Norway existed from 1873 until 1914. It was easily dissolved when Sweden abandoned the gold standard. These two currency zones were hardly real, because they did not involve a common central bank or a centralized payments system. They amounted to little but pegs to the gold standard. Therefore, they are not very relevant to the EMU.

“Abandonment of gold standard” simply suggests that some members of these defunct unions wantonly engaged in inflationism which were most likely made in breach of the union’s pact that had led to their dissolution.

Mr Aslund tersely describes on one account of “successful” post gold standard breakup…

Europe offers one recent example of a successful breakup of a currency zone. The split of Czechoslovakia into two countries was peacefully agreed upon in 1992 to occur on January 1, 1993. The original intention was to divide the currency on June 1, 1993. However, an immediate run on the currency led to a separation of the Czech and Slovak korunas in mid-February, and the Slovak koruna was devalued moderately in relation to the Czech koruna. Thanks to this early division of the currencies, monetary stability was maintained in both countries, although inflation rose somewhat and minor trade disruption occurred (Nuti 1996; Åslund 2002, 203). This currency union was real, but thanks to the limited financial depth just after the end of communism, dissolution was far easier than will be the case in the future. In particular, no financial instruments were available with which investors could speculate against the Slovak koruna

It seems unclear why the Czech and Slovak experience had been the least worse or had the least disruption compared to the others.

Yet considering that inflation is a monetary phenomenon with political objectives, “limited financial depth” seems unlikely a significant factor the “success”. Instead it may have been that political authorities of the Czech and Slovak experience, aside from the “early division of currencies” which may have given a transitional time window, may have likely implemented some form of monetary discipline which lessened the impact.

Mr Aslund finds that the the incumbent European Union seems more relevant with three recent accounts of currency disintegration which had cataclysmic results.

The situation of the EMU is very different from these three cases. It has no external norm, such as the gold standard, and it is a real currency union with a common payments mechanism and central bank. The payments mechanism is centralized to the ECB and would fall asunder if the EMU broke up because of the large uncleared balances that have been accumulated. The more countries that are involved in a monetary union, the messier a disruption is likely to be.

The EMU, with its 17 members, is a very complex currency union. When things fall apart, clearly defined policymaking institutions are vital, but the absence of any legislation about an EMU breakup lies at the heart of the problem in the euro area. It is bound to make the mess all the greater. Finally, the proven incompetence and slowness of the European policymakers in crisis resolution will complicate matters further.

The three other European examples of breakups in the last century are of the Habsburg Empire, the Soviet Union, and Yugoslavia. They are ominous indeed. All three ended in major disasters, each with hyperinflation in several countries. In the Habsburg Empire, Austria and Hungary faced hyperinflation.

Yugoslavia experienced hyperinflation twice. In the former Soviet Union, 10 out of 15 republics had hyperinflation. The combined output falls were horrendous, though poorly documented because of the chaos. Officially, the average output fall in the former Soviet Union was 52 percent, and in the Baltics it amounted to 42 percent (Åslund 2007, 60).

According to the World Bank, in 2010, 5 out of 12 post-Soviet countries—Ukraine, Moldova, Georgia, Kyrgyzstan, and Tajikistan—had still not reached their 1990 GDP per capita levels in purchasing power parities. Similarly, out of seven Yugoslav successor states, at least Serbia and Montenegro, and probably Kosovo and Bosnia-Herzegovina, had not exceeded their 1990 GDP per capita levels in purchasing power parities two decades later (World Bank 2011).

Arguably, Austria and Hungary did not recover from their hyperinflations in the early 1920s until the mid-1950s. Thus the historical record is that half the countries in a currency zone that breaks up experience hyperinflation and do not reach their prior GDP per capita as measured in purchasing power parities until about a quarter of a century later, which is far more than the lost decade in Latin America in the 1980s.

The causes of these large output falls were multiple: systemic change, competitive monetary emission leading to hyperinflation, collapse of the payments system, defaults, exclusion from international finance, trade disruption, and wars. Such a combination of disasters is characteristic of the collapse of monetary unions.

Why hyperinflation poses as the greatest risk for the disintegration of the fiat money based currency unions?

A common reflex to these cases is to say that it was a long time ago, that things are very diferent now, and that other factors matter. First of all, it was not all that long ago. Two of these economic disasters occurred only two decades ago. Second, hyperinflation was probably the most harmful economic factor, and it is part and parcel of the collapse of a currency zone, regardless of the time period. About half of the hyperinflations in world history occurred in connection with the breakup of these three currency zones. The cause was competitive credit emission by competing central banks before the breakup. Third, monetary indiscipline and war are closely connected. The best illustration is Slovenia versus Yugoslavia. In the first half of 1991, the National Bank of Yugoslavia started excessive monetary emission to the benefit of Serbia. On June 25, 1991, Slovenia declared full sovereignty not least to defend its finances. Two days later, the Yugoslav armed forces attacked Slovenia (Pleskovic and Sachs 1994, 198). Fortunately, that war did not last long and Slovenia could exit Yugoslavia and proved successful both politically and economically

Again since inflationism essentially represents monetary means to attain political ends, previous accounts of hyperinflation in post currency union dissolution may have been a result of policy miscalculations from political leaders trying to attain the illusory positive effects from devaluation.

Or most importantly or which I think is the more relevant is that in absence of access to local and foreign savings through banking or financial markets, political authorities in pursuit of their survival have resorted to massive money printing operations.

Also since hyperinflation means the destruction of division of labor or free trade, one major consequences have been to seek political survival through plunder, thus the attendant war. Inflationism, according to great Ludwig von Mises has been “the most important economic element in this war ideology”.

Looking at history has always been deterministic. We look at the past in the account of how narrators describes the connections of the facts in them. But we must not forget of the importance of theory in examining these facts.

As Austrian economist Hans Hermann Hoppe explains,

There must also be a realm of theory — theory that is empirically meaningful — which is categorically different from the only idea of theory empiricism admits to having existence. There must also be a priori theories, and the relationship between theory and history then must be different and more complicated than empiricism would have us believe.

I concur that hyperinflation could likely be the outcome for many European countries once a breakup of the Eurozone becomes a reality. This will not happen because history will merely repeat itself, but because the preferred recourse by politicians has been to resort to inflationism. Theory and history have only meshed to exhibit the likelihood of such path dependent political actions.