It is dangerously naive to trust chiefly in the competence and character of government officials while paying little attention to the temptations and complexities that confront such officials – temptations and complexities that grow exponentially with growth in government’s powers.
This from Professor Donald J. Boudreaux at the Café Hayek
When markets become disconnected with economic reality as I pointed out the other day, these are signs that capital markets have become dysfunctional or capital markets have been "destroyed" from mainly from central banking policies.
"Ron Paul is the only one who is right about the Fed, and the Fed is the heart of the problem. They have destroyed the capital markets and the money markets; interest rates mean nothing; everything is trading off the Fed and Wall Street isn't even home – as it's now a bunch of computers trading word-clouds emitted by this central banker and that"
"The Fed (and the lunatics that run it) are telling the whole world untruths about the cost of money and the price of risk."
It is vain to object that the public favors the policy of cheap money. The masses are misled by the assertions of the pseudo-experts that cheap money can make them prosperous at no expense whatever. They do not realize that investment can be expanded only to the extent that more capital is accumulated by savings. They are deceived by the fairy tales of monetary cranks from John Law down to Major C.H. Douglas. Yet, what counts in reality is not fairy tales, but people's conduct. If men are not prepared to save more by cutting down their current consumption, the means for a substantial expansion of investment are lacking. These means cannot be provided by printing banknotes or by loans on the bank books.Economic reality will inevitably and eventually prevail.
In discussing the situation as it developed under the expansionist pressure on trade created by years of cheap interest rates policy, one must be fully aware of the fact that the termination of this policy will make visible the havoc it has spread. The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptizing it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.
Why aren’t China’s leaders spending much more as they did in late 2008 and 2009 to boost economic growth? It might be because much of what they built was defective as a result of widespread corruption. The 8/4 issue of the London Times reported there were 99 road cave-ins in Beijing between July 21 and August 21 of this year. Roads and bridges are collapsing in other cities as well. Most are relatively new including a bridge that was built just 10 months ago.
The country's former railway minister, Liu Zhijun, was expelled from the Communist Party of China for corruption in May following the high-speed train collision that left 40 people dead and 172 injured near the eastern city of Wenzhou last year. In March of this year, part of a high-speed railway line due to open in May between the Yangtze river cities of Wuhan and Yichang collapsed after heavy rain. Engineers working on some projects have complained of problems with contractors using inferior concrete or inadequate steel support bars. Consider this excerpt from the 2/17/11 issue of the NYT:
“The statement underscored concerns in some quarters that Mr. Liu cut corners in his all-out push to extend the rail system and to keep the project on schedule and within its budget. No accidents have been reported on the high-speed rail network, but reports suggest that construction quality may at times have been shoddy. A person with ties to the ministry said that the concrete bases for the system’s tracks were so cheaply made, with inadequate use of chemical hardening agents, that trains would be unable to maintain their current speeds of about 217 miles per hour for more than a few years. In as little as five years, lower speeds, possibly below about 186 miles per hour, could be required as the rails become less straight, the expert said. Strong concrete pillars require a large dose of high-quality fly ash, the byproduct of burning coal. But the speed of construction has far exceeded the available supply, according to a 2008 study by a Chinese railway design institute.”
This is from Dr. Ed Yardeni on China’s slowdown.
China announced last week a 1 trillion yuan $157 billion infrastructure spending program which is much less than the 2008-2009 version.
Nonetheless, the above serves as further proof that infrastructure spending projects by governments, not only waste taxpayers money, but importantly promotes unethical transactions which results to MORE economic and social problems.
Rumors swirl over over China’s VP Xi Jinping’s disappearance from all official functions.
From Financial Times,
Where is Xi Jinping? The man anointed to run the world’s most populous nation and second-largest economy has disappeared from public view just weeks before his expected elevation to lead the Chinese Communist Party.
Over the past week Mr Xi has cancelled at least four scheduled meetings with visiting dignitaries including a Russian delegation, Singapore’s prime minister and US secretary of state Hillary Clinton last Wednesday and the prime minister of Denmark on Monday…
Mr Xi’s mysterious disappearance has sparked speculation about his whereabouts and renewed political infighting just months after the purge of senior Chinese leader Bo Xilai shook the ruling party. It also underscores the opacity and lack of a strong institutionalised mechanism for transferring power in China’s authoritarian one-party political system.
A Bloomberg article says this may be about “health” reasons
I have been saying that the apparent policy dithering to mount bailouts, given the Keynesian propensities of the incumbent, may have been a consequence of the ongoing power struggle within China’s government.
Weather forecasters are said to have markedly better batting average making predictions or are far more accurate prognosticators than most stock market experts. (Well this applies to foreign private weather forecasters and not the Philippine government counterpart.)
Justin Rohrlich at the Minyanville writes,
According to New York Times statistical wunderkind Nate Silver, the National Hurricane Center’s accuracy has improved 250% over the last 25 years.
More accurate weather predictions benefit the economy, boosting the efficiency of businesses like FedEx (FDX), which employs 15 in-house meteorologists, as well as companies working offshore, like BP (BP) and Transocean (RIG). Weather is such an important factor in financial markets that Goldman Sachs (GS) employs staff meteorologists, as do Citigroup (C) andJPMorgan Chase (JPM).
While meteorologists have improved, other analysts -- specifically financial ones – are still off the mark more often than not.
“In November 2007, economists in the Survey of Professional Forecasters -- examining some 45,000 economic-data series -- foresaw less than a 1-in-500 chance of an economic meltdown as severe as the one that would begin one month later,” Silver writes.
“Why are weather forecasters succeeding when other predictors fail? It’s because long ago they came to accept the imperfections in their knowledge. That helped them understand that even the most sophisticated computers, combing through seemingly limitless data, are painfully ill equipped to predict something as dynamic as weather all by themselves. So as fields like economics began relying more on Big Data, meteorologists recognized that data on its own isn’t enough.”
So the admission of the knowledge problem is one crucial factor contributing to the weather forecaster’s edge.
I’d add that the unwillingness to think outside the box has been another key variable to why stock market experts underperform.
More…
In a slightly larger than usual nutshell, the crux of the issue was this: Weather forecasters have an “awareness of uncertainty” about the natural world that “causes these experts to manifest a lower overconfidence effect than experts from the other domain.”…
Further, financial analysts were also found to be unwilling or unable to be self-critical after a failure -- something that Raymond Dacey, Professor of Finance and of Statistics and Adjunct Professor of Philosophy at the University of Idaho, suggested to the authors “could pertain to the clients.”
Simply put, the “Disposition Effect” has to do with risk attitude and what Shefrin and Statman colloquially term “get-evenitis” -- an aversion to loss realization.
Another major obstacle is the overconfidence bias
I’d add that egotism has always been a hurdle to self discipline.
Here is a relevant investment ‘war’ tip from Sun Tzu’s Art of War
If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle
Think about it. If you steal my chicken or I steal your cow, this is a dispute between us; what does the government care about it? The answer should be it doesn't care at all but because the state loves power and the state does not like to share power, it likes to resolve all disputes the way it wants to resolve them. This drives up the cost and diminishes justice because it forces the disputants to follow the state's rule and the state's command and the state's way, and this does not inure to politeness, civility or even the idea that a dispute could possibly be resolved amicably and justly, without the state being involved.
The state is not an instrument of justice; it's an instrument of power
This is from Judge P. Andrew Napolitano interviewed by Anthony Wile at the Daily Bell (source lewrockwell.com)
Despite the recently announced $157 billion infrastructure spending based bailout, China’s economic decline continues…
From Bloomberg, (bold mine)
China’s imports unexpectedly fell and industrial output rose the least in three years, signaling more stimulus may be needed after the government last week said it approved subway and road projects across the nation.
Inbound shipments slid 2.6 percent in August from a year earlier as exports rose 2.7 percent, the customs bureau said in Beijing today. Production increased 8.9 percent, the National Bureau of Statistics said yesterday. Inflation accelerated for the first time in five months.
The data underscore risks that full-year growth in the world’s second-biggest economy will slide to the lowest in more than two decades, undermining support for the ruling Communist Party before a once-in-a-decade leadership transition due later this year. The rebound in inflation, excess capacity in some industries and banks’ bad debt risks from past monetary easing highlight the potential cost of ramping up stimulus efforts…
China’s trade surplus was a more-than-estimated $26.7 billion as imports fell for the first time since 2009 outside of the Lunar New Year, today’s report showed. Fixed-asset investment growth in the first eight months eased to 20.2 percent, yesterday’s reports showed.
Slowing imports corroborates signs of a steepening slowdown in China’s economic activities.
But for the steroid starved mainstream, inflationism has been never enough. People simply adore the idea of turning stones into bread.
However a rebound in consumer price inflation may put a kibosh on current bailout policies. (chart from Tradingeconomics.com)
Nonetheless, China’s economic deterioration gives more evidence of the seminal phase of the global stagflation dynamic
Well bad news has not been limited to China though, Japan’s economy has reportedly slowed materially.
From the same article…
Japan’s economy expanded in the second quarter at half the pace the government initially estimated, underscoring the risk of a contraction as Europe’s debt crisis caps exports, a government report showed today.
Gross domestic product grew an annualized 0.7 percent in the three months through June, less than a preliminary calculation of 1.4 percent. The nation’s current-account surplus fell to 625.4 billion yen ($8 billion) in July, the lowest for that month since 1996, according to a finance ministry report and Bloomberg historical data.
Both developments exhibit the ongoing global economic slowdown dynamic which stock markets seems to ignore.
The momentum from last week’s rejuvenated equity markets from the combined announcement of bailout packages from ECB and China has so far been carried over today.
It would be interesting to see how Chinese authorities will respond to sustained news of pronounced downswing of their economy.
China’s massive gold imports which in 2012 according to Zero Hedge, has “imported more gold than the ECB's entire official 502.1 tons of holdings” and the current inflationist bailout policies seem as conflicting political moves.
Wow. Markets have already (nearly) fully factored in Team Ben Bernanke to implement QE 3.0.
From Bloomberg,
Just six months ago, money market traders expected the Federal Reserve to raise interest rates by the end of 2013. Now, they see borrowing costs staying at record lows for about three more years as the economic outlook worsens.
Bond market measures from overnight index swaps, which indicate no rise in the federal funds rate until mid-2015, to a 62 percent decline in a measure of volatility in government bonds signal that rates will stay near zero for longer. The gap between two- and five-year Treasury yields, which decreases when traders expect benchmark rates to remain subdued, is more than 50 percent narrower than its average since 2008.
Investor expectations for sluggish growth and low inflation remain intact even though the collapse of Lehman Brothers Holdings Inc., which triggered the worst financial crisis since the Great Depression, happened four years ago. While the economy expanded in the second quarter, the unemployment rate remained above 8 percent for the 43rd-straight month in August…
A gauge of indicators of market expectations for additional central bank stimulus rose to 99 percent in August, the highest ever, according to Citigroup Inc. The measure increased to 82 percent in the months before QE2 in November 2010.
Here is what I wrote earlier,
Mounting expectations and deepening dependence from central banking opiate, which has been clashing with the unfolding economic reality, will prompt for more price volatility on both directions. The Bank of America posits that QE 3.0 has been substantially priced in.
Eventually stock markets will either reflect on economic reality or that central bankers will have to relent to the market’s expectations. Otherwise fat tail risks may also become a harsh reality.
My guess is that Mr. Bernanke, like his ECB counterpart Mr. Draghi, will relent. Otherwise whatever gains accumulated of late may all go down the drain.
Besides, it seems Bernanke’s personal interest to see rising stock markets.
Philippine authorities suddenly become “cognizant” of internal bubbles.
From the Bloomberg,
The Philippines’s move to enhance oversight of real-estate lending this year will help curb speculation and improve its ability to prevent a property bubble from forming, the central bank said.
The regulator ordered banks to provide more details on their real-estate exposure in August, including reporting investments in stocks and bonds that fund property ventures and loans to developers of low-cost homes. Closer monitoring will encourage banks “to exercise more self-restraint,” Deputy Governor Nestor Espenilla said in a phone interview Sept. 7.
“It’s a preemptive move,” Bangko Sentral ng Pilipinas Deputy Governor Diwa Guinigundo said in an interview the same day in his office. “We don’t see at this point signs of strains in the market but we don’t want to wait for that. That’s the trick with asset bubble; when you see it, that means it has formed and you’re too late.”
The country joins Asian nations including China and Singapore seeking to temper soaring property prices and avoid the economic fallout created by the bursting of the U.S. subprime bubble and real-estate crashes from Spain to Ireland. Philippine bank loans and investments in the property sector surged to a record in March, central bank data show, and rising prices have spurred Ayala Land Inc. (ALI) and other developers to build more homes.
More signs of blowing bubbles. Again from the same article…
The number of condominium units built in the Philippines rose 48 percent to 33,000 last year as construction of 50,000 units started, Colliers said in its report. The PSE Property Index (PPROP), which tracks developers including Ayala Land and SM Development Corp. (SMDC), has risen 36 percent this year, surpassing the 19 percent increase in the Hang Seng Property Index. (HSP)
Philippine banks’ loans and investments in the property sector rose to a record at the end of March to 538.1 billion pesos, 21 percent higher than a year earlier and 3.8 percent more than the previous quarter, central bank data show. Real estate made up 15.2 percent of lenders’ total loans in the first quarter, rising from 14.5 percent a quarter earlier, according to the central bank.
25,000 Homes
Ayala Land, the nation’s biggest developer, plans to start construction of a record 25,000 homes this year, 20 percent more than last year, Chief Executive Officer Jaime Augusto Zobel de Ayala said in an interview in March. It boosted 2012 spending to 47 billion pesos from an earlier budget of 37 billion pesos, Ayala Land said in a report posted on its website last month.
The central bank’s latest moves “are credit positive for Philippine banks with substantial real estate lending because they will prompt the banks to tighten credit controls,” Moody’s said on Aug. 30.
This despite current regulatory measures…
Bangko Sentral currently caps banks’ real-estate exposure at 20 percent of total lending, with some exclusions. With the additional information now required from lenders, the central bank will decide if its policy needs to be reviewed, Espenilla said.
The central bank said Aug. 23 it will expand reporting of real-estate exposure to include real-estate projects and “ancillary services like buying and selling, rental and management of real estate properties.” The scope is broader than the previous ruling, which limited real-estate activities to the acquisition, construction and improvement of property, it said.
Who decides and what makes of a bubble? Or how will bubbles be defined? The definition of bubbles essentially shapes the path of regulation.
Will bubbles be based at specified price levels? Designated number of units available or being constructed? Amount of lending? Shadow banking?
Yes there have been regulatory caps, but as I have been pointing out (I am partly being validated by these, see some past articles here, here and here) nobody really knows where money will flow into. Nobody really knows how proceeds of loans will be allocated or spent. All statistics bruited by the political agencies are presumptions of the strict compliance. They ignore human action.
There is such a thing called regulatory arbitrage.
A good example is the stock market crash of Bangladesh in 2011. Money borrowed for supposed industrial uses has been diverted to the stock market which led to a stock market bubble. The ensuing crash came about as government tightened money.
Yet how will regulators “prevent the bubble”? Supply side caps? Demand side caps? Financial caps?
All these talks about curtailing bubbles again represents authorities superficially dealing with symptoms. In reality, they are pretentious actions. They are intended to paint the imagery of the politics of “do something” in the assumption that they “know” or fully comprehend the situation.
Really?
Bubbles serve to bloat statistical economic growth. This gives media mileage and approval ratings for the incumbent authority. They also enrich the political as well as the politically favored economic class whom are usually the first recipients of easy money policies.
So why they should political authorities curb a bubble? Should they kill the goose that lays their golden eggs?
Why do governments pursue easy money policies anyway?
Let me give the stereotyped political economic answer, because they want to achieve “permanent quasi-booms” by inducing statistical economic growth via demand management policies channeled through debt acquisition and the socialization of investments (deficit spending). In short, DEMAND MANAGEMENT POLICIES are in reality BUBBLE POLICIES.
Let me quote Henry Hazlitt again. The Inflation Crisis and How to Resolve It (p.121)
In sum, if we directly lower the interest rate, we encourage more borrowing and therefore encourage an increase in the money-and credit supply. If we begin by increasing the money-and-credit supply, we thereby lower the interest rate. So one begets the other: lower interest rates bring about inflation, and inflation brings about lower interest rates
So political authorities ease policies which generate internal bubbles and then blame the private sector from which they call for more restrictions on civil liberties. Nice. A great set up for totalitarianism.
I previously quoted Nassim Taleb’s caustic attack on intellectuals
Intellectuals and academics (except for Hayekians) tend to treat the rest of the population as total idiots. So it is very hard for them to swallow the statement that, statistically, an intellectual is as much, much more likely to be the total idiot.
Let me add that defining bubble in itself will become a political issue. Developers, construction industry, property owners, banks, financial industry (e.g. stock market, mutual funds, pension and insurance and etc…) and OFWs the among many specific interests groups who benefit from the current bubble will compete to influence decisions of policymakers.
Politicians, as noted above, will also prefer to see bubbles in order to push on their political agenda (example near record high stock market backed by high approval ratings facilitates national credit rating upgrades that lends to increased government spending and more debt based accumulation by political favorites)
Of course, no politicians will admit to this directly. They channel these mostly through their expert allies who intimidate the public with technical ‘spending and welfare economics ’ gobbledygook.
Yes F. A. Hayek was right.
The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design
Spurious knowledge of containing bubbles presented as self-righteous omniscience.
Here is what I wrote last week[1],
Mounting expectations and deepening dependence from central banking opiate, which has been clashing with the unfolding economic reality, will prompt for more price volatility on both directions. The Bank of America posits that QE 3.0 has been substantially priced in.
Eventually stock markets will either reflect on economic reality or that central bankers will have to relent to the market’s expectations. Otherwise fat tail risks may also become a harsh reality.
The ECB and China’s government eventually relented to the market’s expectations
“Unlimited government bond buying” bazooka program[2] launched by the European Central Bank (ECB), last Thursday, spurred one of the best one-day rally for many global stock markets for the year.
China also announced of a modest infrastructure spending stimulus to the tune of the 1 trillion yuan or US 157 billion[3] last Friday. China’s rescue program seems to have been timed or coordinated with the ECB’s action.
China’s package looks “modest” because the earmarked amount for fiscal spending projects accounts for only a little over a quarter of the $586 billion stimulus implemented in 2008-2009.
Nonetheless the combined stimulus by the ECB and China nudged an astounding reprisal by the browbeaten bulls: the Shanghai index soared by 3.7% on Friday!
The steroid boosted activities of China’s Shanghai index exhibited the same theme for most of the major equity benchmarks for the week.
The weekly advances concealed the real activities.
Much of the global equity markets were marginally changed when both announcements provoked end of the week spikes. Only Malaysia among the majors lost ground.
Deepening Gulf Between Market Prices and Economic Events
This week’s remarkable rally reveals of two important insights.
ONE. Financial market has been responding to interventions rather than to actions in the real world.
Increasing detachment has characterized the actions in the financial markets relative to real economic activities.
Industrial production in the Eurozone[4] (see left window) have generally been cascading throughout 2012, however European stocks, particularly the German DAX, French CAC, and Italy’s iShares MSCI and Spain’s IBEX has been ascendant since May (see right window).
Year to date, the DAX has been an up by an outstanding 22.31%, the CAC 40 11.37% and Italy’s iShares MSCI 6%. Spain’s Ibex has trimmed losses to only 8%.
Economic performance and stock prices have been going in opposite directions.
Well this has not been limited to the Eurozone.
Divergences can be seen from accounts of declining GDP or economic growth for the G-7, the Eurozone and the US, although the OECD projects that America may defy the global momentum for the rest of the year.
The OECD projection according to the Economist[5],
The global economy has weakened since the spring and the OECD predicts that in the next quarter the GDP of the G7 group of richest countries will grow by just 0.3% (at an annual rate), down from an already anaemic 0.9% in the second quarter. America provides a rare bright spot, but the three biggest economies in the euro zone, Germany, France and Italy, are set to shrink by 1% in Q3, worse even than their 0.3% contraction in Q2. Indeed, figures released on the same day by Eurostat show that GDP growth in the 17 euro-zone countries fell from zero in the first quarter to -0.2% in the second, and from zero to -0.1% in the 27-country European Union.
I don’t share the OECD’s sanguine expectations on the US. The US will, like her global contemporaries, be hobbled by contagion linkages, political bickering and an internal slowdown.
Come to think of it, the OECD expects Germany to fall into a recession by the end of the year[6]. But the German equity benchmark, the DAX, seems to negate all the troubles ahead and seems approaching April 2011 highs. One of them is wrong, so which is which?
In addition, global trade (light blue line, lower window from the Economist chart) has been drifting in conjunction with global manufacturing activities (Purchasing manager’s index based on new export orders, dark orange line) to the downside. Yet except for the Shanghai index which has been slightly down, aside from Japan’s Nikkei and Malaysia’s KLCI, which has lagged, all other major indices have posted superior double digit year to date returns.
Importantly, the deterioration in global trade and global manufacturing activities has not just been a decline in the trend of growth, instead current data suggests that both indicators have exhibited signs of contraction. About 80% of global manufacturing activities have reportedly been in contraction[7].
So once again stock markets live in a different reality from the economic picture.
We go next to US corporate profits.
Corporate profits seem to have also diverged from the upside price momentum of US major equity prices.
Based on the following profit measures, 1) S&P 500 Earnings Per Share, 2) After-Tax Net Income 3) Pre-Tax Profits by Source, 4) Financial Corporate Profits and 5) Profits from Abroad, Dr Ed Yardeni chief of prominent research firm Yardeni Research, weighs on the profit segment based on an empirical analysis and makes the following conclusions.
In enumerated order, Dr Yardeni[8] says that profits has 1) “lost its upward momentum”, 2) have been “running out of steam”, 3) “have stalled in a zigzag fashion”, 4) “looking especially toppy” and 5) “weakest growth rate since Q3-2009” which implies of “a decline twice as much for overseas profits”.
Mr. Yardeni’s seemingly drab undertone comes prior to Thursday’s ECB-China fueled boom. The point here is that sustained upside price increases for US stocks will push valuations into overpriced territory.
Domestic data hasn’t been that promising too.
Last week’s US jobs data came worse than expected but apparently have been either ignored by the US markets because ECB’s action may have drowned out such negative news or could have been interpreted as the du jour “bad news is good news”.
The job data on the surface showed mediocre signs of improvement. But this came amidst a decline in the labor force. The labor force participation rate (63.5%) dropped to lowest level since May 1979, according to Northern Trust[9] (left window).
Compounding on this, notes the Wall Street Journal Blog[10], is that for June there had been fewer jobs created, manufacturing shed 15,000 jobs which essentially reflected on the ongoing downturn, and fewer people are working.
Many talking heads see this unimpressive and lacklustre economic performance as rationalization for the FED to pursue further easing measures during their FOMC meeting by next week.
From a fundamental standpoint, surging US markets suggest either that 1) moves by central banks (particularly the ECB which will likely be complimented by the FED for political reasons*) will dramatically reverse the dynamics of all of the above concerns, in order for the global equity markets to justify on their current price levels, or 2) the price-fundamental disconnect will only amplify risks for a violent “reversion to the mean”.
* as stated last week, Mr. Bernanke will seek to retain his tenure by propping up the markets to support President Obama’s re-election
The great disconnect is in reality signs of contortions from inflationism.
As the great American economist, philosopher and journalist Henry Hazlitt once wrote[11]
Because inflation leads inevitably to distortions in the interest rate, because during it nobody knows what future prices, costs, or price-cost relations are likely to be, it inevitably distorts and unbalances the structure of production. It gives rise to multitudinous illusions. Because the nominal interest rate, though it rises, does not rise enough, funds are more heavily borrowed than before; uneconomic ventures are encouraged; corporations making high nominal profits invest abnormal sums in expansion of plant. Many regard this, when it is happening, as a happy byproduct of inflation. But when the inflation is over much of this investment is found to have been misdirected—to have been malinvestment, sheer waste. And when the inflation is over, also, there is found to be, because of this previous misdirection of investment, a real and sometimes intense capital shortage.
The second implication from the current rally is that whatever one has conventionally learned from investing has been rendered irrelevant, if not obsolete, by sustained manipulation of prices of financial markets for political reasons.
That political reason has been to effect price controls in the financial markets by burning shorts in order to save the current political order.
Fund manager and Credit Bubble Bulletin (CBB) analyst Doug Noland is spot on with the dynamics behind the current developments[12]
With the financial world fixated on Draghi, Bernanke and endless QE, global markets now wildly diverge from economic fundamentals. Many are content to celebrate, holding firm to the view that financial conditions tend to lead economic activity. Markets discount the future, of course. And, traditionally, an easing of monetary policy would loosen Credit and financial conditions - spurring lending, spending, investing and stronger economic activity.
Importantly, traditional rules and analysis no longer apply. Monetary policy has been locked in super ultra-loose mode now entering an unprecedented fifth year.
This serves as further proof that earnings, economic growth or chart patterns have become subordinate to the actions of central bankers and government authorities in determining stock price movements
ECB’s Actions Enhances Stagflation Risks, Bernanke Next?
Part of the newly announced ECB program includes the replacement of Securities Markets Programme (SMP) with new Outright Monetary Transactions programme (OMT) which is conditional to the EFSF/ESM facility, the ECB also removed the senior status on its purchases and importantly “the easing of collateral rules, namely suspension of the minimum rating threshold for countries with an OMT or an EU-IMF programme. Thus, government bonds (and government guaranteed bonds) no longer face the risk of not becoming eligible collateral (unless countries do not deliver on reforms of course). This should remove an important risk for banks buying government bonds” according to Danske Research[13].
Optimism derived from the tinkering with so called self-made regulations shares the same myopic political idea that edicts have the power to eliminate risks and overpower economic reality.
There are many aspects to deal with covering the ECB’s latest announcement.
These include among the many
-the willingness of crisis stricken nations to sacrifice their sovereignty to the supervising troika (EU, ECB and the IMF) by applying for the EFSF/ESM facility in order for the ECB mechanism to be triggered,
-the political support from the average Germans for the sustained wealth transfer mechanism to the PIGS. Germany’s Constitutional Court will decide on the ESM court case by next week amidst political street protests[14] and
-if these measures will ever work at all.
I think what really matters now will be undeclared objectives by the ECB for such measures. Despite the conditionality to allegedly “sterilize” such interventions, the ECB will have limited means to do so.
First, the ECB will have to sell assets to offset its direct bond purchases. Indirect purchases can also be made through the commercial banking system financed by the ECB.
This means that for the ECB to conduct sterilization, only non-crisis tainted (PIIGS) assets presently held or owned by the ECB will be available for sale, or that the ECB has to shrink its loans to banks collateralized by non-PIGS bonds[15]
Since non PIIGS assets are limited, once used up, the ECB will likely be engaged in unsterilized actions.
Next, if these will be sterilized by fixed term deposits or weekly deposit tenders[16], which function as another form of reserves, the build up of reserves at the ECB will only amplify the debt pyramiding dynamic of the cartelized tripartite political system comprising the banking system, central bank and the government/welfare state through cross financing (banks finance government, the government capitalizes and provides monopoly legal tender status to central banks, central banks backstops the banks and provides financing indirectly to governments through banks (bond buying).
By having to artificially reduce interest rates, governments of the PIIGS will likely defer on making the required reforms and continue with their spending binges, thus, exacerbating the current conditions.
Importantly, the easing of collateral rules may have opened the floodgates for the feedback loop of mechanism of massive debt issuance and ECB buybacks since “banks under the programme”, according to Austrian economist Bob Wenzel who quotes another expert [17], will be able “to use the self-issued government guaranteed debt as collateral”
The point is that the recent price action of commodities seems to have “seen through” the legerdemain over so-called “sterilization”, and have moved significantly up nearly across the board. Such actions appear to be signaling the resurgence of an inflationary boom.
Gold will probably test the 1,800 level by the yearend, oil (WTIC), copper and the broad based commodity benchmark the Reuters CRB (CCI) index have turned materially to the upside.
I hardly believe that this will be the same prolonged Risk ON environment as before. With unlimited or open ended options (US Federal Reserve has already been taking this in consideration), central bankers have been increasingly signaling urgency and desperation.
Yet there are very important differences from today’s implementation of easing programs compared to the past: interventions are being done amidst elevated commodity price levels.
And if commodity price inflation will spillover to the real economy, such euphoria will likely be short term. This will likely be seen first in emerging markets such as the Philippines.
Current environment, for me, seems like very fragile and precarious.
Stocks Under a Stagflationary Environment
As I pointed out in the past, imposing inflationary measures under the current environment heightens the risks of stagflation.
Signs of stagflation have also been transmitted not only to gains in commodity prices but also on global mining stocks.
I would further add that if the US Federal Reserve joins the ECB next week, then the current short term RISK ON momentum may persist, but advances will likely be skewed towards commodities.
Eventually I expect a structural departure between mining and resource with the general trend once the stagflation dynamic becomes entrenched.
Resource companies have the potential to surf the stagflation tide, while others will be restrained by consumer price controls, realignment of economic activities towards consumer staples and higher input costs that will crimp on profits.
Mr. Hazlitt on why the stock market in general faces downside risks during high inflation-stagflation regimes[18].
The causes of these disappointing results have been somewhat complex. Let us recall once more that in any inflation, individual prices and costs never go up at a uniform rate but at widely different relative rates and times. Cost-price relationships become discoordinated. Individual firms find it increasingly difficult to know or guess what their own future costs or future selling prices are going to be, and what will be the ratio between them. During an inflation demand shifts quickly from one product to another. This makes it increasingly difficult to plan production ahead, or to estimate future profit margins. In the later stages of an inflation, wage rates are more certain to go up than individual prices. Even if aggregate profits increase in monetary terms, the range of deviation and dispersion is much greater as between different firms. The investor faces increasing uncertainty. This always tends to lower stock prices.
Because the future of the business is increasingly uncertain, corporations become more reluctant to pay out dividends. If, as in many cases, profits are particularly high in money terms, if inventories and plant and equipment are constantly rising in price, more and more plant managers conclude that the best use of their current profits is to plow them back immediately into expansion of the business. This seems especially the most profitable thing to do in a hyperinflation. It then seems foolish to declare dividends when, by the time the stockholders receive them, they may be worth much less than they were when declared
Bottom line: Bubbles: Illusions of Progress
Financial markets have become materially detached from the unfolding real events. Markets are suggesting not only of recovery, but of a strong upside momentum in terms of economic recovery, whereas present global economic trends have been increasingly portentous of the risks of a global recession. If current diametric positions will remain, such growing divergences may accelerate a buildup on the risks of sharp downside volatility.
Such distortions seem to have become embedded into the market’s psyche. An upside market has now become an entitlement as impressed upon to the public through inflationist policies.
Yet current policies as noted above have been rewarding the bulls while punishing the bears (particularly the shorts). Policies have been designed to wrench economic reality with hope (some call it “hopium” or concatenation of hope and opium or addictive hope) that inflationism will work even if history has shown that it hasn’t.
And not only has such inflationist policies been promoting the “orgy of speculation”, this has been intensely obscuring price signals and economic coordination while giving the public illusion of progress.
As a side note, I recall last week when I presented signs of “portfolio pumping” in the domestic stock exchange, I read a remark somewhere that there should be a congressional investigation on this. Oh puhleez (to borrow Mr. Bob Wenzel’s expression), spare the market from further politicization. It has been bad enough that markets are already being directly and indirectly manipulated and assaulted for political reasons through various policies hardly understood public.
By adding more political interferences, eventually we all get what we deserve real hard.
[1] See Phisix: Why The Correction Cycle Is Not Over Yet September 2, 2012
[2] See ECB’s Mario Draghi Unleashes “Unlimited Bond Buying” Bazooka, Fed’s Ben Bernanke Next? September 7, 2012
[3] See China Joins Stimulus Bandwagon via Massive Infrastructure Spending September 7, 2012
[4] Weekly Focus ECB back as fire fighter and it works, Danske Research, September 7, 2012
[5] Graphic Detail The European effect Economist.com Blog September 6, 2012
[6] Speigel Online OECD Predicts Recession for Largest EU Economy September 6, 2012
[7] See 80% of World Manufacturing Activities Contracting, September 4, 2012
[8] Ed Yardeni Profits Dr. Ed’s Blog September 4, 2012
[9] Asha Bangalore August Employment Data Contain Ample Evidence to Justify QE3, Northern Trust, September 7, 2012
[10] Wall Street Journal Blog Five Key Takeaways From Jobs Report September 7, 2012
[11] Henry Hazlitt The Inflation Crisis, And How To Resolve It, p.125 Mises.org
[12] Doug Noland Diverging Like It's 1929, September 7, 2012 Credit Bubble Bulletin Prudent Bear.com
[13] Danske Research ECB meeting: ECB is now waiting for Spain, September 6, 2012
[14] Reuters.com Hundreds of Germans protest against euro rescue steps September 8, 2012
[15] Lawrence H. White How much dodgy debt will the ECB buy?, September 7, 2012 Freebanking.org
[16] The Tell, Euro gets boost from ECB sterilization speculation Marketwatch.com September 6, 2012
[17] Robert Wenzel The Magic Tricks of Mario Draghi Economic Policy Journal September 8, 2012
[18] Henry Hazlitt op cit p.146
Author Robert Neuwirth of Stealth of Nations: The Global Rise of the Informal Economy makes a great talk at the TED anent the vastly underrated informal or shadow economy
The TED introduces Mr. Neuwirth for his "out-of-the-box" thinking, or as challenging
“the conventional thinking by examining the world's informal economy close up. To do so, he spent four years living and working with street vendors and gray marketers, to capture its scope, its vigor--and its lessons. He calls it “System D” and argues that it is not a hidden economy, but a very visible, growing, effective one, fostering entrepreneurship and representing 1.8 billion jobs worldwide.
Mises Institute’s Jeff Riggenbach quotes Mr. Neuwirth’s definition of the informal economy based on his book…
This "informal economy," he writes, "produces, cumulatively, a huge amount of wealth.… It is how much of the world survives, and how many people thrive." And he has a name for it: System D.
"System D," he quickly explains, “is a slang phrase pirated from French-speaking Africa and the Caribbean. The French have a word that they often use to describe particularly effective and motivated people. They call them débrouillards. To say a man (or woman) is a débrouillard(e) is to tell people how resourceful and ingenious he or she is. The former French colonies have sculpted this word to their own social and economic reality. They say that inventive, self-starting, entrepreneurial merchants who are doing business on their own, without registering or being regulated by the bureaucracy and, for the most part, without paying taxes, are part of 'l'economie de la débrouillardise.' Or, sweetened for street use, 'Systeme D.' Thisessentially translates as the ingenuity economy, the economy of improvisation and self-reliance, the do-it-yourself or DIY economy.
The video from TED Ideas Worth Spreading (hat tip Professor Mark Perry)
Some highlights:
-“Something like this is totally open, it’s right there for you to find. All of this is happening openly and above board there is nothing underground about it. It is our prejudgment that it is underground”
-Governments dislike this
-“We are all focused on the luxury economy” ($1.5 trillion per year)
-“It excludes two-third of the workers of the world, 1.8 billion people work in an economy that is unregulated and informal”
-It is where employment is
-It engenders a more egalitarian world
In reality, the so called “prejudgment” of the informal economy has been part of orchestrated government campaign propaganda to derogate them, for the simple reason that the existence of the informal economy diminishes the importance of the role of governments.
More significantly, the informal economy represents the stark account of government failure
As John Sullivan of the Huffington Post writes,
The informal sector -- those businesses and entrepreneurs who work outside of the formal market economy -- is huge and largely undocumented in most developing economies. Almost everywhere, the root cause is the same: cumbersome, unresponsive, unfair, and overwhelmingly status quo-driven bureaucracy. People simply cannot get through the wall of red tape or the maze of regulations to gain access to the formal economy.
Moreover, author Robert Neuwirth points to the survivorship bias by public of focusing on the “luxury” economy (euphemism for consumption economy) which has been much smaller than the informal economy.
Again this represents the indoctrination by the mouthpieces of government conduits particularly through mainstream media.
Take the Philippines, hardly any serious study dwells with the informal economy. Every news exaggerates on the contributions of OFWs to the economy whose remittances accounts about 10% more or less of the economy.
When it comes to the informal economy, even when we deal with them or see them daily as a fact of life, they become a vacuum in mainstream’s eyes
The following excerpt is an example of one distorted perspective relative to OFW’s contribution to property development, the Global Property guide writes,
Overseas Filipinos’ remittances are powering the low-end to mid-range residential property market. They are snapping up housing projects and mid-scale subdivisions in regions near Metro Manila such as Cavite, Batangas and Laguna Provinces, while the expansion of the upper residential market, including the luxury market, is due to increased housing demand from BPO employees and expatriates, according to the World Bank.
Overseas Filipino Workers (OFW).account for around 17% to 18% of residential sales of Ayala Land, one of the country’s major developers. In the next five years Ayala Land President Antonio Aquino expects to double this, by branching out to the affordable and low-end market segment.
If OFWs account for say 20% of the housing or property demand, so what happened to the 80%? Which is mathematically bigger 20% or 80%? Since when has 20% become a dominant factor?
Let me add that OFWs also contributes to the informal economy, that is if the recipient families engage in unregulated or untaxed commerce.
This is why I have been repeatedly pointing out that for a country, whom according to mainstream has supposedly been living in Third World and has been allegedly 'poor', the Philippines hosts three of the largest malls in the world (Forbes 2008). Yet these malls, have not been like those ghost malls in China, as they have near full occupancy (which means profitable retail enterprises)
Further, the thrust of mall development in the Philippines has been spreading to the rural area which I recently argued, as suggesting of the deepening role of decentralization and of signs of the plateauing or the reversal of urbanization.
All these can HARDLY be supported by consumption spending by OFWs alone (or even if you add exports, which has been the favorite source of Keynesian influenced media).
The fact is that the informal economy has far been a larger contributor to the Philippines’ economic growth than has been projected.
Remember since the informal economy has been largely undocumented thus statistical estimates will bear significant errors.
Despite the survivalship bias practiced by the mainstream, Mr. Neuwirth’s putting into perspective of the real state and of the potentials of the informal economy appears to have been indirectly acknowledged by the World Bank,
the shadow economy has reached a remarkably large size with a weighted (unweighted) average value of 17.2 (33.1)% of official GDP. However, equally important is the clear negative trend of the size of the shadow economy over time. The unweighted average size of the 162 countries decreased from 34.0% of official GDP in 1999 to 31.0% in 2007; for the 21 transition countries from 36.9% in 1999 to 32.6% in 2007.
While the World Bank says the trend has been slowing, this has, I think, has mostly been a result of recent trends of globalization and economic freedom which tend to increase participation of the some erstwhile segments of the informal sector to the formal sector.
But such dynamics should not be construed as past performance determining future outcome. If the informal or shadow economy has signified as the public’s response to the politicization of the markets, then increased politicization means the tendency to shift economic activities towards the informal sector.
A quote from this Forbes article nails it…
“These are not really people oppressed by poverty,” says writer Stewart Brand. “They are getting out of poverty as fast as they can.” This isn’t to say that cellphones are about to save the world. But they have become the tool of choice for people who are determined to save themselves.
The informal economy, thereby represents free trade in motion and has been about people’s natural recourse to survival.
As the distinguished Austrian economist Percy Greaves Jr. once said,
For men, life is a series of choices by which we seek to exchange something we have for something we prefer. We know what we prefer. No other man or bureaucrat is capable of telling us what we prefer. Our preferences are our values. They provide us with a compass by which we steer all our purposeful actions. Because few people fully understand this, we have some serious economic problems…
Anything that raises cost or hinders the free and voluntary transactions of the market place must keep human satisfactions from reaching their highest potential. Today the greatest obstructions to the attainment of higher human satisfactions are the well-meaning but futile political interferences with the mutually beneficial transactions of a free market economy.
So any obstacles placed against activities which facilitates people’s survival will intuitively lead to the informal economy.
This is common sense.
Unfortunately common sense has been unavailable to politically brainwashed mindsets.
