Financial Bubble: Shadow Banking System Soar to US $67 Trillion or 100% of World GDP

Each bubble carries with them their own individual or distinctive character. Bubbles are hardly identical, except for their monetary origins. 

Prudent Bear’s Doug Noland writes 

The current inflationary boom is unique.  It is global in nature unlike anything previously experienced.  The global Credit Bubble completely engulfed the “dollar reserve” global financial “system.”  The massive inflation of dollar financial claims fomented a corresponding historic inflation in various currency Credit systems worldwide.  Unprecedented global Credit inflation has been fueled by a globalized system of electronic “money” and Credit.  This prolonged cycle has been unique in terms of a global Credit expansion unconstrained by a monetary anchor, gold backing or even restraint imposed by bank reserve and capital requirements.  It’s been runaway non-productive debt growth on a scale never before seen.

Today’s unanchored US dollar standard system combined with the incumbent political economic architecture, which privileges the banking and financial sector, has brought upon the exploding growth of the Shadow Banking system

From Bloomberg,

The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight.

The size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce,” the Financial Stability Board said in a report, which utilized more data than last year’s probe into the sector…

At $67 trillion this accounts for about 100% of the world GDP

The informal economy should not be seen as similar to the shadow banking system.

The former mostly signifies guerilla capitalism, while the latter has been the consequence of government protected banking and financial institutions taking advantage of legal loopholes (regulatory arbitrage) to financially “engineer” their balance sheets through innovative investment vehicles and accounting maneuvers.

From the same Bloomberg article:

Supervisors consider shadow banking activities to be those that allow banks to carry out business off balance sheets, as well as those which allow investors to bypass lenders and the functions they traditionally fulfill on the markets.

Once concentrated in the US, weak economic conditions and the recent financial crisis has prompted the Shadow Banking system to shift activities the worldwide.

Some highlights from the Financial Stability Board’s Global Shadow Banking Monitoring report 2012 (bold mine)

-Aggregating Flow of Funds data from 20 jurisdictions (Argentina, Australia, Brazil, Canada, Chile, China, Hong Kong, India, Indonesia, Japan, Korea, Mexico, Russia, Saudi Arabia, Singapore, South Africa, Switzerland, Turkey, UK and the US) and the euro area data from the European Central Bank (ECB), assets in the shadow banking system in a broad sense (or NBFIs, as conservatively proxied by financial assets of OFIs) grew rapidly before the crisis, rising from $26 trillion in 2002 to $62 trillion in 2007. The total declined slightly to $59 trillion in 2008 but increased subsequently to reach $67 trillion in 2011.

-Expanding the coverage of the monitoring exercise has increased the global estimate for the size of the shadow banking system by some $5 to 6 trillion in aggregate, bringing the 2011 estimate from $60 trillion with last year’s narrow coverage to $67 trillion with this year’s broader coverage. The newly included jurisdictions contributing most to this increase were Switzerland ($1.3 trillion), Hong Kong ($1.3 trillion), Brazil ($1.0 trillion) and China ($0.4 trillion).  

-The shadow banking system’s share of total financial intermediation has decreased since the onset of the crisis and has been recently stable at a level around 25% of the total financial system, after having peaked at  27% in 2007.  In aggregate, the size of the shadow banking system in a broad sense is around half the size of banking system assets. 

-The size of the shadow banking system (or NBFIs), as conservatively proxied by assets of OFIs, was equivalent to 111% of GDP in aggregate for 20 jurisdictions  and the euro area at end-2011 (Exhibit 2-3), after having peaked at 128% of GDP in 2007

-The US has the largest shadow banking system, with assets of  $23 trillion in 2011 on this proxy measure, followed by the euro area ($22 trillion) and the UK ($9 trillion).  However, its share of the total  shadow banking system  for  20 jurisdictions and the euro area has declined from 44% in 2005 to 35% in 2011. The decline of the US share has been mirrored by an increase in the shares of the UK and the euro area

This shows how deeply interconnected and intertwined the global banking and financial system is. 

This also underscores financial globalization, where the chain link of banking and finance amplifies contagion risks especially from from counterparty risks in the event of defaults.

This is also why central banks will likely keep on inflating as they will likely "move heaven and earth" to prevent the risks of cross-cascading defaults that would collapse the Shadow Banking system (and not to mention the collosal derivatives market which have reached $639 trillion as of June 2012 according to the BIS) and which would translate to a meltdown of the global banking industry and to sovereign defaults.

Current monetary inflation will require significantly more of the same monetary steroids to keep up the illusion of stability, which is why this inflationary boom has been no less different from the Ponzi operations, except that the central bank printing press has been the source of “something for nothing” operations.

Also the expanding depth of financial interdependency  poses limits to ‘decoupling’ or the idea that select national economies can move on a different path or become immune to a crisis.

Quote of the Day: Money Printing will lead the Sheep to Slaughter

The fallacy of the belief that countries that print their own currency are immune to sovereign crisis will be disproven in the coming months and years. Those that treat this belief as axiomatic will most likely be the biggest losers. A handful of investors and asset managers have recently discussed an emerging school of thought, which postulates that countries, as the sole manufacturer of their currency, can never become insolvent, and in this sense, governments are not dependent on credit markets to remain fiscally operational. It is precisely this line of thinking which will ultimately lead the sheep to slaughter.

(italics original)

 

This excerpt is from Kyle Bass, American fund manager and founder of Hayman Capital, from his November 15th newsletter (source Zero Hedge)

For many, the laws of economics don’t apply. Inflation is not about monetary expansion. Money printing has neutral effects and supersedes everything else. This myth which will eventually be shattered.

The Symmetry Between Ponzi Scams and Ponzi Financed Global Financial Markets

Lessons from the Aman Ponzi Scam

A few months back I warned that the current negative real rates regime will foster and bring about accounts of fraudulent financial operations such as Ponzi and pyramiding schemes 

I wrote last March[1],

Since fixed incomes will also suffer from interest rate manipulations, many will fall victim or get seduced to dabble with Ponzi schemes marketed by scoundrels who would use the current policy induced environment as an opportunity to exploit a gullible public.

I even followed this up last week[2],

instead of locking money through interest rate dividends from savings account in the financial institutions, zero bound regime or negative real rates which are part of financial repression have been forcing people to chase on yields and gamble in order to generate returns. So the public have become more of a “risk taker” and take on “greedy” activities in response to such policies. Some would even fall or become victims to Ponzi schemes which I expect to mushroom.

Enormous losses from Ponzi operations of the Aman Futures Group[3] to a whopping tune of Php 12 billion (US 289 million at 41.5 to a USD) from over 15,000 victims coming from various sectors, largely from Southern Philippines, particularly in Visayas and Mindanao, has been a recent revelation.

The streak of large scale financial hoaxes continues to surface.

Today, another financial scam in Lanao, also in Mindanao, by an alleged Jachob “Coco” Rasuman group[4], whom preyed on a smaller number, specifically 29 Muslims investors by defrauding them of Php 300 million (USD 7.22 m) was reported by media. Ironically, these scumbags got gypped or suffered a dose of their own medicine, when they invested in Aman Futures. Talk about karma. 

Negative real rates, which in reality punishes savers and creditors, have been forcing many people to chase on yields in order to preserve on their savings. Such environment has encouraged the vulnerable public to take unnecessary risks and gamble which unscrupulous agents take advantage of.

While negative real rates necessarily do provide the incentives for many in the public to get financially duped or hoodwinked, this has not been a sufficient reason.

A big part has been a mélange the lack of financial alternatives, which has been tied or linked to the dearth of financial education, as well as, the paucity of critical thinking and self-discipline which has been associated with the welfare mentality.

All Ponzi operations have been anchored on “something for nothing” dynamic.

Typically astronomical returns on placements by early investors are paid for by the infusion of new money from new investors. Of course, sky high returns are dangled as compelling motivation for financial patsies to ensnare the bait. Yet, once the critical mass or where insufficient money from new investors to pay for existing ones has been reached, the whole bubble operations collapses like a house of cards.

It is quite obvious that a yield offer of something like 50% a month would translate to a nominal 600% returns a year. Yet nobody seems to have the common sense to ask “what kind of businesses or investments would return at least 600% a year”?

The apparent insufficiency of financial common sense can be traced to the underdeveloped conditions of the country’s financial markets. 

The development of financial markets has been associated with greater degree of economic development. According McKinsey Global Institute[5], most of the emerging markets’ financial depth has been between 50 and 250 percent of GDP compared to 300 to 600 percent of GDP for developed countries. In other words, increasing standards of living from the accretion of individual savings, which became the cornerstone of financial intermediation that led to the development of financial markets, has played a significant role in capital formation and the subsequent growth in the economy.

Financial depth has been conventionally measured[6] through:

-the traditional banking system,

-the non-banking financial institutions[7] which comprises risk pooling institutions (Insurance), contractual Savings Institutions (Pensions and Mutual funds), Market Makers (broker dealer), Specialized Sectoral Financiers (real estate, leasing companies, payday lending) and Financial Service Providers (security and mortgage brokers) and finally

-financial markets[8], particularly capital markets (stock and bonds), commodity markets, derivatives, money markets, futures markets, insurance markets and foreign exchange markets.

One would note of the severe deficiencies of the state of non-banking financial institutions as well as the financial markets. Example the Philippines remains as a laggard in the ASEAN regions commodity markets having no existing commodity markets. Another example is that specialized investment vehicles have been inaccessible to the public such as short sales (short sales exist but operating rules render them useless), derivatives (which have been limited to banks), and select futures (e.g. currency forwards also restricted to banks) among many others.

Thus the immature state of financial markets essentially restricts the transmission mechanism of savings to investments that has functioned as one key hurdle to economic growth and development.

Again, no less than the heavily politicization, taxation and overregulation of the industry or the political unwillingness to openly promote alternative savings and investment vehicles, as well as incentivize industry competition, has been responsible for the backward state of affairs.

Because many lack the access to such legitimate financial alternative options, there has been similarly less desire or motivation to imbue the necessary knowledge to protect oneself from financial knavery.

And while education may help, in reality, contextual education to establish the virtues of self-discipline or emotional intelligence is paramount.

Education per se (or education as a function of social signaling) has not deterred the infamous Bernard Madoff from having to cream, bamboozle and embezzle $50 billion off from a legion of supposedly professional finance managers representing top banks, insurers, hedge funds[9] with his Ponzi version which got busted in 2008.

Also, the public’s increased reliance on politicians to exercise the paternalist ethical plane of behavioral guidance for financial operators and for market participants has prompted for the substitution of self-responsibility and mutual respect for dependency: the welfare mentality. Plainly put, such victims outsourced self-responsibility to equally gullible local politicians, who in a bizarre twist of events, “openly endorsed” and likewise became victims of the grand Philippine Ponzi scam. This simply serves as another lucid example of the knowledge problem at work.

So while national political authorities swiftly use such crisis as opportunity to pontificate on the supposed paternalist virtues in seeking redress and the rightful justice deserving for the aggrieved parties, these politicians skirt the blame of the adverse effects from their policies. Out of ignorance or in collusion with the political establishment or both, mainstream media has been equally culpable for concealing the social effects of bubble policies.

Nonetheless, bubble policies promote bubble psychology, bubble attitudes and bubble actions.

As the late economic historian Charles P. Kindleberger wrote in Mania’s, Panics and Crashes (p.66 John Wiley)[10]

Commercial and financial crisis are intimately bound up with transactions that overstep the confines of law and morality shadowy though these confines be. The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom. Crash and panic, with their motto of sauve qui peut induce still more to cheat in order to save themselves. And the signal for panic is often the revelation of some swindle, theft embezzlement or fraud

The Addiction to Legalized Ponzi Financing

Think of it, if Ponzi schemes are considered illegitimate because they arise from financing investment operations by enticing new money[11] from new investors by offering surrealistic returns, how would one call today’s financial markets which operate on the deepening dependency on central banks to provide ever increasing “new” money to bolster or at least maintain elevated asset prices? 

Everyday we see signs of these.

A parallel universe represents an alternative reality. If doctrinal finance teaches that economic growth serves as indicator to corporate earnings which should get reflected on stock prices then Japan’s financial markets and her economy appear to operate on a parallel universe. That’s because economic growth and stock market pricing seems to move in diametrical directions which jettisons the conventional wisdom.

Ever since the 2011 triple whammy Earthquake-Tsunami-Fukushima Nuclear disaster, Japan’s economy continues to weaken. Japan has reportedly entered a mild recession in the 3^rd Quarter[12]. Yet since April’s bottom, the Japan’s major equity bellwether the Nikkei 225 continues to gain grounds.

Yet much of these pronounced gains had been made last week, ironically when the Prime Minister Yoshihiko Noda dissolved the parliament and simultaneously called for a snap election on December 16^th[13].

His expected replacement, Shinzo Abe, leader of the once dominant Liberal Democratic Party (LDP) has been widely expected to pressure the Bank of Japan (BoJ) to aggressively stimulate the economy.

Thus like the Pavlovian conditioned stimulus, the smell of freshly minted or digitally created money sends the financial markets into a rapturous bliss

So amidst the announcement of a recession, the Nikkei 225 jumped 3.4% for this week. That’s effectively half of the modest year to date return of 6.73%. The reversal of the Nikkei’s year to date performance from loss to gains come at the heels of further weakening of major global equity bellwethers.

In other words, Japan’s politicians, media and the marketplace continue to carry unwavering faith and undying hope over the BoJ’s action, despite the series of QEs launched since. In short, all the money printing did has been to boost asset prices even as the economy tumbled. Such Pollyannaish belief is tantamount to “doing the same thing over and over again and expecting different results”. Someone once defined this as insanity.

Just last month, the BoJ announced a back to back QE 8^th[14] and QE 9^th[15] in a span of one week.

Yet despite all the easing polices by other major economies, previous gains continue to dissipate from the current string of losses.

Since the latest peak of the S&P 500 in mid-September 2012, the major US bellwether has lost in 6 out of 9 weeks, which as of Friday’s close, has been off about 7% from the zenith and has pared down year to date gains to just 6.42%. 

President Obama’s class warfare policies which will raise capital gains and dividend tax substantially, contradicts the US Federal Reserve’s easing policies, thus US equity markets remain plagued by political uncertainties[16]. US markets remain hostaged to politics. 

Yet what has been apparent is the volatile environment from the addiction to central bank Ponzi financing.

Financial analyst and fund manager Doug Noland of the Credit Bubble Bulletin[17] at the Prudent Bear neatly captures the soul of today’s policy based Ponzi-bubble dynamics

a Credit Bubble is sustained only through ever-increasing quantities of “money” and Credit.  The greater the Bubble, the greater the required policy response to sustain the inflation.  But, importantly, the greater the policy measures imposed the greater the market reaction – and the greater the market reaction the greater the necessity for even bigger policy interventions in the future.  

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[1] See After 5,000: What’s Next for the Phisix? March 5, 2012

[2] See The Phisix in the Shadow of the US Fiscal Cliff November 11, 2012

[3] Inquirer.net Thousands duped in P12-billion scam November 14, 2012

[4] Inquirer.net Bigger scam in Lanao Sur November 18, 2012

[5] McKinsey Global Institute Mapping global capital markets 2011 August 2011

[6] Financial Depth (Size) Rethinking the Role of the State in Finance WorldBank.org

[7] Wikipedia.org Non Bank Financial Institutions

[8] Wikipedia.org Financial market

[9] See Madoff Ponzi Scam and Boom-Bust cycles December 21, 2008

[10] Charles Kindleberger, Mania’s, Panics and Crashes A History of Financial Crisis, p.66 John Wiley

[11] Wikipedia.org Ponzi scheme

[12] Editorial Japan Times Nip the recession in the bud, November 17, 2012

[13] The Globe and Mail Election call puts spotlight on Bank of Japan, November 14, 2012

[14] See Bank of Japan Adds More Stimulus October 27, 2012

[15] See Bank of Japan’s Back to Back Stimulus November 1, 2012

[16] See Obama’s Fiscal Cliff: The Effects of Taxing Wealth November 13, 2012

[17] Doug Noland, When Money Dies, Prudent Bear November 16,2012

On China’s New Leaders

China’s unveiling of new leaders has not equally received warm reception from her domestic markets. The Shanghai index dropped 2.63% this week. The weekly losses account for 31% of the accrued year to date losses of 8.43%. 

Many have speculated on the whether currently selected leaders are “conservative” or “progressive” and of their possible policies when they assume their positions in 2013.

What has been known is that the current appointments by the top party leaders and retired officials[1] had been based on the rival factions of retired President Jiang Zemin, who seem to have prevailed over faction of outgoing President Hu Jintao (as noted by the table above from Merk Investments[2]).

What has also been a fact is that incoming President Xi Jinpin has a daughter studying at the Harvard University since 2010 (under a pseudonym and under 7/24 protection from bodyguards[3]) and that many of the contenders for China’s premier political power positions like Li Yuanchao (although he failed to get appointed), as well as with many incumbent bureaucrats and state officials, have been trained by or has affiliations with Harvard University. In short, perhaps the Harvard connection[4] may play an important role in China’s national and international political and economic affairs.

The reality is that we can never say what policies these people would assume in spite of their personal, academic and political backgrounds.

As a side note, US Federal Reserve Alan Greenspan comes to mind. Thought to have been influenced by free market leader Ayn Rand[5], upon the assumption of the chairmanship of the US Federal Reserve in August of 1987, Mr. Greenspan turned out to be a serial inflationist or bubble blower.

Once in command, the political environment will differ from their past experience since these leaders will have to deal with variegated political pressures from competing interests from every corner of China’s territorial borders.

Yet political pressures will not emanate solely from domestic front. External relations will be an ongoing concern too where China’s geopolitical and international economic interests lies.

In other words, the incoming leaders may or may not be influenced by the values or priorities of their benefactors or by their political parties, aside from the influences exerted by people surrounding them.

One thing that can be assured is that such leaders will operate along their self-interests. And that they would work under a mixture of limited knowledge, their perspectives and interpretations of events will be shaped by how information has been framed on them, their academic or ideological or cultural orientations, time preferences, value scales and the varying degree of influences from their networks will also matter, and lastly how all these political issues will harmonize or synthesize with their career (or even financial) interests or ambitions.

So far, following a series of record injections by the People’s Bank of China[6] (PBOC), the last of which has been made last month, credit activities appears to have picked up. The PBoC has made injections lately but has pulled back[7] from last month’s record highs

While the growth in new local currency bank loans has been weaker than consensus expectations, other credit measures such as corporate bonds, has shown marked advances[8]. Some say that this is bullish. Maybe. But perhaps the bulk of such improvements may be due to politically directed credit channeled through State Owned Enterprises (SOE) rather than from private sector. If this is true, then artificial stimulus may likely have a short term effect. Again everything depends on the feedback loop between the market’s response and the attendant policies adapted by the PBoC to address them and vice versa. 

Also part of China’s transitional government will involve PBoC Governor Zhou Xiaochuan departure or retirement. Albeit Governor Zhou says that the PBoC’s direction will work for the convertibility[9] of her currency the yuan, that would allow market forces to determine its value aside from opening China more to financial reforms.

I do hope that his successor will indeed push through with this reform agenda.

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[1] Rappler.com FAST FACTS: China's 18th Communist Party congress November 8, 2012

[2] Axel Merk and Yuan Fang China's New Leadership: Progressive, Not Conservative Merk Investments, November 16, 2012

[3] DailyMail.co.uk China's new Princess - the daughter of Communist president Xi Jinping studying quietly at Harvard November 18, 2012

[4] See Uh Oh. China’s New Set of Policymakers could be Harvard Trained Keynesians November, 9, 2012

[5] Wikipedia.org Alan Greenspan

[6] Wall Street Journal PBOC Injects Record Amount of Liquidity November 1, 2012

[7] Wall Street Journal PBOC Continues to Trim Fund Injections November 12, 2012

[8] Danske Bank Political events take centre stage Weekly Focus November 16, 2012

[9] Bloomberg Businessweek China’s Next Step on Yuan Is Convertibility, Zhou Says, November 17, 2012

Into the Eyes of the Gorgon: IMF’s Endorsement of the Philippines

The mainstream implies that accolades made by the IMF on the Philippines must be read as bullish for the stock market.

I’d say that the Philippine stock market and the IMF’s approval are two different issues.

Well with the IMF pushing for SMS Taxes[1] as well as Sin Taxes[2], the only thing bullish here is for politicians, who will have more political control over the populace, but not necessarily more money.

As I pointed out earlier[3], Sin Taxes in the United Kingdom have not only failed to achieve the desired tax revenues and the supposed morality to be attained from such a regulation. Instead sin taxes spawned a bootleg industry, increased health risks of alcohol patrons who decided to go underground, and importantly increased corruption, as well as risks of violence.

Sin taxes are equivalent to prohibition laws focused on human vices like drugs, cigarettes gambling, prostitution and etc… that seems noble sounding humanitarian based, but have been hardly in touch economic reality.

As exiting US Congressman Ron Paul said in one of the greatest speech ever[4],

Humanitarian arguments are always used to justify government mandates related to the economy, monetary policy, foreign policy, and personal liberty. This is on purpose to make it more difficult to challenge.  But, initiating violence for humanitarian reasons is still violence.  Good intentions are no excuse and are just as harmful as when people use force with bad intentions.  The results are always negative.

Importantly a common mistake has been to misinterpret taxes rates as a constant or linear function of revenues. An important economic axiom to realize is that “when you tax something, you get less of it.”

And such economic law applies to the effects of raising taxes on gold sales that has only prompted for the skyrocketing of smuggling activities[5] from the output of small scale gold mining or the informal gold economy in the Philippines. In fact, some lawmakers have appealed for the repeal of these taxes[6].

Rampant smuggling has not been limited to gold but has broad based.

According to an Inquirer report[7], smuggling activities in the incumbent administration has exploded to a $39.2 billion industry, or an average of $19.6 billion per year or for the two years of President Aquino’s tenure. This is far from the average of $3.1 and $3.8 billion for the Estrada and the Arroyo administration respectively. As a side note, mainstream economists may deny it but this seems to be one of the real factors contributing to the economic vitality. 

Political agents and the apologists of the state would like make us believe that edicts, ordinances and regulations can supplant the law of economics. Guess who will be wrong?

Or is it that President Aquino realizes that the informal economy has been real force behind the growth in the domestic economy for him to promote populist regulations that drives economic activities underground? So could he be hitting two birds with one stone?

Another more important point is that the diversion of productive resources to redistributive unproductive or politically directed activities will eventually lead to more debt and more inflation whose outcome will be worse than the cumulative effects of individual’s vices. Think Greece.

SMS taxes regardless of the form, on the other hand, will raise the cost of texting at the expense of consumers. Given that the mobile phone market will reach nearly 100% in terms penetration level[8], this implies that kernel of text users are likely to be from the middle to the lower income levels. 

So IMF’s Christine Lagarde in essence discriminates the poor by taxing them in favor of the political class.

Should I be bullish with the IMF’s endorsement? Ms Lagarde’s acclaim seems tantamount to the risk of catching the eyes of the mythical gorgon: victims turn to stone.

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[1] Manila Bulletin IMF chief says SMS tax could help Philippines November 16, 2012

[2] GMANetwork.com Sin tax bill a transparent way to raise revenues — IMF’s Lagarde November 16, 2012

[3] See The Unintended Effects of Alcohol “Sin” Taxes: UK Edition November 26, 2012

[4] See Video: Ron Paul's Farewell Speech to Congress November 15, 2012

[5] See Philippine Informal Gold Mining Industry Booms August 24, 2012

[6] Inquirer.net Stop gold tax, BIR urged November 12, 2012

[7] Rigoberto Tiglao Smuggling at its worst under Aquino Inquirer.net November 14, 2012

[8] GMANetwork PHL mobile penetration to hit 100 percent in 2012, telco claims July 17, 2012

Picture of the Day: Thanks to Capitalism, These Gadgets Now Fit in your Pocket

(Hat tip AEI’s Prof Mark Perry)

Capitalism has brought about dematerialization, which has converged the benefits of manifold technologies to fit in a single devise.

Quote of the Day: Manufacturing Fetishism

The rear cover of the iPhone tells you it is designed in California and assembled in China. The phone sells, in the absence of carrier subsidy, for about $700. Purchased components – clever pieces of design such as the tiny flash drive and the small but high-performing camera – may account for as much as $200 of this. The largest supplier of parts is Samsung, Apple’s principal rival in the smartphone market. “Assembled in China” costs about $20. The balance represents the return to “designed in California”, which is why Apple is such a profitable company.

Manufacturing fetishism – the idea that manufacturing is the central economic activity and everything else is somehow subordinate – is deeply ingrained in human thinking. The perception that only tangible objects represent real wealth and only physical labour real work was probably formed in the days when economic activity was the constant search for food, fuel and shelter…

When you look at the value chain of manufactured goods we consume today, you quickly appreciate how small a proportion of the value of output is represented by the processes of manufacturing and assembly. Most of what you pay reflects the style of the suit, the design of the iPhone, the precision of the assembly of the aircraft engine, the painstaking pharmaceutical research, the quality assurance that tells you products really are what they claim to be.

Physical labour incorporated in manufactured goods is a cheap commodity in a globalised world. But the skills and capabilities that turn that labour into products of extraordinary complexity and sophistication are not. The iPhone is a manufactured product, but its value to the user is as a crystallisation of services

This is from British author and journalist John Kay debunking the mainstream predilection to use manufacturing as a measure or excuse to promote mercantilist policies (hat tip Professor David Henderson)

Southern Europeans Flee to Germany

The crisis affected European nations or the PIGS (Portugal Italy Greece and Spain) have not just been enduring capital flight from fears of prospective devaluation by a forced exit, but likewise have seen a mass exodus from residents.

As I earlier pointed out, many European emigrants seem to have opted for emerging markets, meanwhile fresh reports tells us that many others have been flocking into Germany at a steepening rate.

From the Wall Street Journal

The influx of Southern Europeans into Germany has gathered pace in recent months, as a growing number of Greeks, Spaniards and Portuguese ventured north to escape deepening recession and growing social tensions.

The biggest increase came from Greece. The number of Greeks moving to Germany jumped 78% in the first half of 2012 from a year earlier, Germany's statistics office said.

In all, more than 16,000 people moved to Germany from Greece between January and June, an acceleration of a trend that began in 2010 after the Greek crisis began. The number of immigrants to Germany from Spain and Portugal was up by 53% for each country.

The trend bodes ill for countries on Europe's southern periphery at a time of worsening economic malaise. Many of those leaving are young professionals with valuable skills. Their departures could have long-term consequences for countries such as Greece and Portugal as they struggle to recover.

"There are absolutely no jobs here—that's the main reason why people move away," said Charalampos Koutalakis, a politics professor at the University of Athens.

Jobs are symptoms of a deeper systemic malaise.

On the one hand, the productive class have been finding diminished economic opportunities from which to go about or to work on, given the political trends of deepening financial and economic repression that has led to the asphyxiation of the business and entrepreneur class

Such includes the risks of the erosion individual savings which has prompted for capital flight—again from the perceived risk of more inflationist policies, the risks of an implosion of the banking system and a wider confiscatory tax dragnet for these insolvent and desperate nations.

On the other hand, the parasitical class have been fighting to retain their entitlements which have been bringing about greater political risks.

Picture from Spiegel Online

Strikes and demonstrations in protest of so-called “austerity” have only been intensifying social frictions that have sparked political violence. This has only worsened the investment climate that has brought Europe down to its knees through a double dip recession.

"The problem with socialism is that eventually you run out of other people's money [to spend]" remarked former UK’s PM Margaret Thatcher. This has been the zeitgeist of the social feud in Europe as welfare and bureaucrats bitterly contest with the ruling political class and the privileged and protected (crony) bankers on how to divvy up the residual spoils from an unsustainable system of mandated plunder.

And for the citizens who refuses to partake of political of the struggles, and who may have chosen to stay or who may have been trapped by the inability to migrate, the desire to normalize life have led to a booming informal economy which now averages 17.3% of the euro GDP or EUR 1.5 trillion.

As I have been pointing out, the informal economy seems like guerrilla capitalism operating under business or investment hostile or adverse political landscape

Bottom line: People respond to developing political trends or political risks. A political trend towards economic repression leads to violence, to capital flight, to the informal economy and to emigration.

Emerging Market Central Banks Pile Up on Gold at Near Record Pace

Emerging market central banks, who seem to be growing apprehensions over the actions or policies of their developed contemporaries, continue to stockpile on gold at an accelerating pace.

From IBTimes

Central banks continued to purchase gold in the third quarter at near-record pace, driven by emerging market central banks looking to diversify away from traditional reserve currencies amid heightened economic insecurity and continuous unconventional monetary easing, according to World Gold Council data released Thursday.

Gold reserves at central banks increased by 97.6 metric tons during the July-September period, albeit at a slower pace compared with a record year-ago quarter. The official sector accounted for 9 percent of overall gold demand during the third quarter.

“I wouldn’t emphasize the fall of 31 percent [from a year ago],” said Marcus Grubb, managing director for investment at the WGC. “Anything close to 100 tons is very high by the last 15 years.”

The world’s central banks collectively bought 374 tons of gold in the first nine months of this year. That’s higher than last year’s 343 tons for the same period.

“We still think we might beat last year’s total for central banks of 456 tons, though it’s going to depend on Q4,” Grubb said. “[This year will likely come in at] somewhere between 455 tons and 500 tons, which will be another record since the early 1960s.”

As one would note, the combined balance sheet expansions of developed central banks have reached unprecedented scale.

And the price action gold has been highly correlated with the balance sheet expansion of major central banks (chart from Zero hedge)

I may further add that China’s record gold accumulation could have been understated

Notes the Zero Hedge (bold original)

Year-To-Date China has now imported a whopping 582 tons of gold, more than the official holdings of India at 558 tons, and which through November has certainly surpassed the holdings of the Netherlands, and make China's gross imports in just 2012 nominally the equivalent of Top 10 largest sovereign holder of gold.

This way at least we know where China is recycling all that vast trade surplus, which incidentally in October just printed, goalseeked or not, at the highest level - $32 billion - since January of 2009. Too bad China no longer recycles all those excess reserves into US Treasury paper (as we showed previously here).

YTD China gross imports from Hong Kong:

In my view, the recent decline of prices of gold seems inconsistent with the real world events that drives the direction of gold prices. Or perhaps, I may have missed something.