Phisix: BSP’s Tetangco Catches Taper Talk Fever

The BSP’s Version of Taper Talk

JUST a little over two weeks back, Bangko Sentral ng Pilipinas (BSP) Governor Amando Tetangco said that the low inflation environment, “gives us room to maintain interest rates and our current policy stance”[1].

In short, the easy money environment will prevail.

This week in an interview on Bloomberg TV, the gentle BSP governor signaled a forthcoming change in the BSP’s policy stance noting that since the Philippine economy is “strong”, “we don’t see any real need for stimulus at this point”[2].

Oh boy, the BSP chief echoes on the ongoing predicament of US Federal Reserve of testing the “tapering” waters.

The BSP was cited by the same Bloomberg article as raising its price inflation forecasts by putting the burden of inflation risks on the weakening peso.

So the BSP essentially has begun to signal a backpedalling from easy money stance.

As I’ve noted in the past, similar to the Fed’s “taper talk”, the BSP’s subtle change in communication stance represents “tactical communications signaling maneuver to maintain or preserve the central bank’s “credibility” by realigning policy stance with actions in the bond markets.”[3]

While the BSP’s preferred culprit has been the weakening peso, the reality has been that higher yields in the global bond markets including emerging Asia and the Philippines has forced upon this discreet volte-face.

The attempt to substitute the influence of bond yields on domestic monetary policies with the weakening peso, the latter having been premised on alleged expectations of higher price inflation represents, as the stereotyped political maneuver of shifting of the blame on extraneous forces—the self-attribution bias.

The peso as culprit for general price inflation has been premised on the fallacious doctrine of balance of payments. The weak peso, according to the popular view, will prompt for an increase in price inflation via higher import prices. But in reality, rising import prices will lead to reduced demand for imports or on consumption of other goods, thereby offsetting any increase in general prices.

This means that the depreciation of the Peso represents a symptom rather than a cause where the principal cause has been due to domestic inflationary policies.

As the great Austrian economist Ludwig von Mises explained[4]

Prices rise not only because imports have become more expensive in terms of domestic money; they rise because the quantity of money was increased and because the citizens display a greater demand for domestic goods.

Since 2001, the asset segment of the BSP’s balance sheet have ballooned by a Compounded Annual Growth Rate (CAGR) of 11% where International Reserves comprises 86% of the asset pie as of December 2012 based on the BSP’s dataset[5].

On the other hand, the gist of BSP’s liabilities or 73% has been on deposits. Special Deposit Accounts (SDA) constitutes 57% of total deposits with Reserve deposits from other deposit accounts signifying a 19% share and deposits from the Philippine treasury at 9%.

Meanwhile, currency issued, which had a 17.7% share of BSP’s liabilities, grew by 9.05% CAGR over the same period.

The rate of growth in the BSP’s balance sheet increased in 2006, but has been in acceleration in 2009 through today.

This also implies that the bulk of the credit expansion in the banking sector have ended up as deposits in the BSP.

The CAGR of BSP’s balance sheet at 11% has nearly been double the 5.97% CAGR of Philippine GDP at constant prices[6] over the same period.

Thus inflation pressures hardly emanates from imports but from the rising quantity of money and assets with moneyness functionality or money-substitutes[7].

Of course, when the BSP governor referred to a “strong” economy as basis for the subtle change in his policy signaling of a reduced need for stimulus, he has actually been resorting to the anchoring bias (behavioral finance) and to the time inconsistent dilemma. That’s because “strong” conditions had all been predicated on the easy money environment.

And with the projection of higher interest rates in a system whose leverage has been rapidly building up over the recent years, as shown by the double digit growth of overall banking debt (left) and the surging rate of loans on what I suspect as the epicenter of the Philippine bubble (right), this means higher cost of servicing debt and higher cost of capital. This also means interest rate and credit risk will mount.

And for the financial world who are dependent on computing for Discounted Cash Flows[8] (DCF) analysis based mostly from Net Present Value[9] (NPV), changes in discount rates will impact heavily on the feasibility of projects and investments. New projects or investments built upon discount rates at current levels will likely be exposed to losses from miscalculations or errors brought about by the expectations of the perpetuity of the low interest rate regime when the BSP officially begins its tightening.

All these means that if the path of interest rates is headed higher, as the BSP chief implies, then conditions will materially change and such will likewise be reflected on risks premiums.

As I previously wrote[10], (bold original)

“Fundamentals” tend to flow along with the market, which is evidence of the reflexive actions of price signals and people’s actions. Boom today can easily be a recession tomorrow.

The Unwarranted Fixation on Credit Rating Upgrades

The continuing optimism by the BSP has been based on the fundamental assumption that changes in interest rates are likely to be gradual and stable.

This seems uncertain as the recent actions in the bond markets have been anything but gradual and stable.

Of course the BSP’s view has been consonant with the Philippine President’s Benigno Aquino III. Such concerted efforts are likely representative of a PR campaign to generate high approval ratings.

In his State of the Nation Address (SONA), the Philippine president blustered over the same 7.8% statistical GDP and of the recent “improvements” on trade competitiveness as key accomplishments of his administration. He also mentioned that current conditions should merit another credit rating upgrade.

Mr. Aquino declared[11] “For the first time in history, the Philippines was upgraded to investment-grade status by two out of the three most respected credit ratings agencies in the world, and we are confident that the third may follow”

Well the public just loves the visible which politicians gladly feed them with.

Yet people hardly realize that credit rating upgrades can even signify as the proverbial “kiss of death”.

A historical overview of some sovereign ratings changes from Fitch Ratings[12] serves as great examples. The above table reveals to us that credit rating agencies hardly sees risks even when these have been staring at them on their faces.

From 1995-2008, Greece (upper pane) had a series of upgrades and positive watches (blue box) in both the long and short term of foreign and local currency ratings. The Fitch began a string of downgrades on Greece only when the country’s debt crisis imploded in 2009[13]. Today Greece has been rated junk “substantial credit risk[14]”, four years after the unresolved crisis.

The successions of credit upgrades basically helped motivate the Greek government to indulge in a borrowing spree which eventually unraveled.

Venezuela has a different story (lower pane). But again we the same credit rating upgrades on the socialist country in 2005, who today suffers from a hyperinflationary episode or a real time destruction of the country’s currency the bolivar[15].

The Fitch eventually regretted their decision, they downgraded Venezuela. Ironically hyperinflating Venezuela has a higher rating than deflating Greece where both defaults on their debts but coursed through different means.

The above examples reveal of how credit rating agencies align their assessment with unfolding market conditions. Rating agencies hardly anticipate them accurately.

So a manipulated asset boom may easily draw credit rating agencies to upgrade sovereign debt.

It is important to draw some very vital lessons from history where banking crises, sovereign debt defaults, currency crises, and serial debt defaults, as chronicled by Harvard’s Carmen Reinhart and Kenneth Rogoff, which spanned “more than 70 cases of overt default (compared to 250 defaults on external debt) since 1800”[16] the common denominator has been overconfidence and denigration of history[17] (will not happen to us) [bold mine]

The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many booms that preceded catastrophic collapses in the past (even in our country), is built on sound fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes.

I would add my conspiracy theory. Credit rating upgrades have been tied with the US bases. The American government has been endeared with the incumbent administration because the President pursues the path of his mother, the former President the late Cory Aquino, who fought to retain US military bases here[18]. 

Today, using territorial disputes as an excuse or a bogeyman, the Aquino government has allowed and defended the so-called non-permanent access of “allies” on former US bases[19].

The Illusions of the Benefits from Government Spending

Another mainstream obsession today has been the devotion towards statistical economic figures which has been presumed as an accurate measurement of economic growth.

As explained last week[20], the statistical 7.8% growth has been mainly rooted on growth by the construction, real estate and financial sectors, as well as, government spending.

And much of the ballyhooed statistical growth in the private sector has been financed by an unsustainable credit bubble.

Yet the public has been mesmerized by the $17 billion of proposed investments by the incumbent government. 

If the government spending is the elixir, then why stop at $17 billion? Why not make it $1 trillion or even $ 10 trillion?

And if such assumption is true, then why has the communist models like China’s Mao and the USSR evaporated? 

Why has China’s recent economic growth been substantially slowing amidst a splurge of government spending in 2008-2009? The newly installed Chinese has announced another $85 billion of railway stimulus to allegedly stem the growth slowdown[21].

With enormous money thrown as fiscal stimulus from the late 90s to the new millennium, why has Japan’s lost decade been extended to two decades+ three years?

Apparently this seemingly perpetual economic stagnation has prompted the new administration to launch the boldest monetary modern day experiment by a central bank which will be complimented by even more fiscal spending stimulus and on the minor side trade liberalization.

Yet growing internal dissension[22] on the risks of Abenomics even from within the ranks of the Bank of Japan has been hounding on the popular expectations of the success of such derring-do political program aside from the risks of a fallout from an economic hard landing in China.

No matter the glorification of mainstream media’s on the alleged success of such policies, Japan’s financial markets are saying otherwise. Has the denial rally in Japan’s major equity benchmark Nikkei fizzled? Japan futures suggest that Monday’s opening will likely break below the 14,000 threshold.

Obviously what government spends will have to be financed by debt, taxes or inflation. Or simply said, whatever government spends has to be taken from someone else’s savings and or productive output. Government spending represents thus a disequilibrating force, because the recourse to institutional compulsion to attain political objectives means a shift of resources from higher value (market determined) uses to lower value (politically determined) uses.

Importantly, since most of government services are institutionalized or mandated monopolies, the absence of market prices means that there hardly have been accurate measures to calculate on the cost-benefit utility of the services provided. And since there are no market price utilized, returns are non-existent. Government spending, hence, represents consumption and not investments.

So the contribution of government spending has mostly been negative rather than positive to real economic growth.

But this is a different story from the mainstream’s statistical aggregate demand management based point of view.

And relative to the statistical 7.8% growth, this only means two things, one—economic boom has largely been concentrated on a few sectors which has been benefiting from the zero bound rates induced credit fueled manic speculation on the asset markets, and two—beneficiaries from government spending have always been the political class, their politically connected affiliates and welfare beneficiaries

And regardless of the egging of the Philippine president, in the latest State of the Nation’s Address (SONA), on the Congress to revamp Presidential Decrees 1113 and 1894 which according to news has been a Marcos era legacy that favors “businessmen close to the dictatorial administration”[23], the politicization of economic opportunities, where the government “picks on the winner” means that cronyism and regulatory capture have been the natural consequences or outcome from such anti-competitive politically distributed economic arrangements.

Thus actions meant to purportedly sanitize projected “immorality” are good as photo opportunities or for Public Relations purposes.

The reactionary rant against officials[24] and personnel of the Bureau of Customs, Bureau of Immigration and Deportation and the National Irrigation Administration (NIA) whom the President severely criticized for an unabated smuggling in the SONA should be a great example. That’s because one of the tarnishes of the incumbent approval rating obsessed regime has been in smuggling, where critics have labeled the Philippines as “Asia’s smuggling capital”[25].

In the world of politics, moral order has mostly been a function of either populism or legalities.

Yet what is popular or legal have not always or frequently been moral. Venezuela’s late Hugo Chavez died a popular leader due to massive wealth redistribution even if he ran the Venezuelan economy aground. Adolf Hitler was also a popular leader until he was defeated in World War II.

In the eyes of populist politics, immorality has hardly been thought about as legal or institutional blemishes. It has always focused on personal virtues: the personality cult mentality.

As the 30^th President of the US Calvin Coolidge aptly warned[26]:

It is difficult for men in high office to avoid the malady of self-delusion. They are always surrounded by worshipers. They are constantly and for the most part sincerely assured of their greatness. They live in an artificial atmosphere of adulation and exaltation which sooner or later impairs their judgment. They are in grave danger of becoming careless and arrogant.

So when politicians or political leaders impose some edict or restrictions, they mostly expect people to behave like sheep. Such arrogant leaders forget that social policies affect people’s real lives, not limited to commerce. 

And in response to such laws, thinking and acting man intuitively find ways to sustain their preferred way of living, and in many times, acting in defiance of arbitrary legislations or regulations or the “rule of men”.

So, for instance, when the Philippine government via the BSP raised sales taxes significantly on gold sales, over 90% of gold output has been smuggled out in reaction[27]: the law of unintended consequences.

The same political agenda goes for India, where gold has a deep cultural attachment. The profligate Indian government wants to ‘balance’ fiscal conditions by reining on gold sales. First they apply import tariffs then restrictions spread to banks, bullion banks, and finally to the retail sector[28]. Remember the Indian government essentially has been attacking India’s culture in the name of fiscal balance.

The consequence: an explosion of gold smuggling. Cases of smuggling has shot up to 205 from 21 a year earlier, value of gold seized by officials has soared by 10 times or 270 million rupees compared to 25 million rupees over the same period, according to the Wall Street Journal[29]

So at the end of the day, the formal sector ends up in the informal ‘illegal’ sector. The government forced the average Indians to migrate underground to maintain tradition. Practicing tradition have now been rendered as illegitimate and a crime. Many will suffer from political oppression out of the insensitive and inhumane whims of the political leaders.

It is still nice to see that the average Indians still have practiced civil disobedience via smuggling. But if the political repressive dragnet intensifies, then perhaps it will not be farfetched to expect civil disobedience to transform into violent public protests, ala Turkey, Brazil, or Egypt.

The bottom line is politicization of the economy have been key sources of social strains. What the largely economically ignorant or politically blind public initially sees as a boon from interventionism and inflationism will mostly regret of their advocacies.

And another thing, in today’s euphoric phase, I even read a commentary proclaiming today’s boom as “unstoppable”.

Well Mr. Tetangco has just fired the warning shot across the proverbial bow. Yet if bond markets continue to unsettle, what has been bruited as “unstoppable”…will not only become stoppable, but they will likely stop soon.

Despite the recent advances, current environment remains risky.

Trade cautiously.

---

[1] Malaya.com Tetangco: We will stay the course July 10, 2013

[2] Bloomberg.com Philippines Doesn’t Need Additional Stimulus, Tetangco Says July 26, 2013

[3] See Phisix in the Shadows of a Bursting Global Bond Market Bubble June 24, 2013

[4] Ludwig von Mises 1. Inflation III. INFLATION AND CREDIT EXPANSION Interventionism An

[5] Bangko Sentral ng Pilipinas Economic and Financial Statistics

[6] Tradingeconomics.com PHILIPPINES GDP CONSTANT PRICES

[7] Ludwig von Mises 11. The Money-Substitutes XVII. INDIRECT EXCHANGE Mises.org

[8] Wikipedia.org Discounted cash flow

[9] Wikipedia.org Net present value

[10] see Phisix: Don’t Ignore the Bear Market Warnings June 30, 2013

[11] Inquirer.net Aquino: No stopping change July 23, 2013

[12] Fitch Rating Complete Sovereign Rating History - Fitch Ratings

[13] BBC.com Timeline: The unfolding eurozone crisis June 13, 2012

[14] Fitch Rating Definitions of Ratings and Other Forms of Opinion

[15] See Hyperinflation: Venezuela’s Intensifying Stock Market Melt up Amidst a Currency Meltdown June 29, 2013

[16] Carmen Reinhart and Kenneth Rogoff, This Time is Different Princeton University Press p. 111

[17] Ibid p. 15

[18] See A US-Philippines Bases Treaty (2012 Edition) in the Making? January 26, 2012

[19] Inquirer.net Aquino defends use of bases by US, Japan July 3, 2013

[20] See Phisix: The Myth of the Consumer ‘Dream’ Economy July 22, 2013

[21] See China’s Railroad Stimulus is now Official: It’s an $85 billion boondoggle July 25, 2013

[22] Reuters.com Japan central bank finds the pessimists come from within, July 26, 2013

[23] Sunstar Aquino seeks Congress' approval of priority measures July 22, 2013

[24] Inquirer,net Of heroes, anti-heroes: Biazon offers to quit July 23, 2013

[25] Gulf News.com Aquino: Philippines not Asia’s smuggling capital April 11, 2013

[26] New York Times Unusual Political Career of Calvin Coolidge, Never Defeated for an Office, January 6, 1933

[27] See Gold Smuggling: A Deepening Trend Not Just in the Philippines November 24, 2013

[28] See Why the Indian Government’s War on Gold will Fail May 18, 2013

[29] Wall Street Journal Gold Smuggling Takes Off in India July 26, 2013

The Four Horsemen of the Financial Apocalypse

In the Book of Revelation in the Christian Bible, the end of the world or the ‘Last Judgment’ will be presided by the four horseman of the apocalypse. These figurative horsemen embodies conquest, war, famine and death.

While not exactly according to biblical prophesy, such allegorical omen may be seen as applicable to today’s modern day financial and monetary central bank based fractional reserve money system.

From the Sovereign Man’s prolific Simon Black (bold mine)

Today’s financial system is dominated by central bankers who have been awarded nearly dictatorial control of global money supply.

In allowing them to set interest rates, they are able to control the ‘price’ of money, thus controlling the price of… everything.

This power rests primarily in the hands of four men who control roughly 75% of the entire world money supply:

-Zhou Xiaochuan, People’s Bank of China

-Mario Draghi, European Central Bank

-Haruhiko Kuroda, Bank of Japan

-Ben Bernanke, US Federal Reserve

Four guys. And they control the livelihoods of billions of people around the world.

So, how are they doing?

We could wax philosophically about the dangers of fiat currency. Or the dangers of the rapid expansion of their balance sheets. Or the profligacy of wanton debasement through quantitative easing.

But let’s just look at the numbers.

In theory, a central bank is like any other bank. It has income and expenses, assets and liabilities.

For a central bank, assets are typically securities or commodities which have value in the international marketplace, such as gold or US Treasuries.

Central bank liabilities are all the trillions of currency units floating around… dollars, euros, yen, etc.

The difference between assets and liabilities is the bank’s equity (or capital). And this is an important figure, because the higher the capital, the healthier the bank.

Lehman Brothers famously went under in 2008 because they had insufficient capital. They had assets of $691 billion, and equity of just $22 billion… about 3%.

This meant that if Lehman’s assets lost more than 3% of their value, the company wouldn’t have sufficient cushion, and they would go under.

This is exactly what happened. Their assets tanked and the company failed.

So let’s apply the same yardstick to central banks and see how ‘safe’ they really are:

US Federal Reserve: $54 billion in capital on $3.57 trillion in assets, roughly 1.53%. This is actually less than the 1.875% capital they had in December. So the trend is getting worse.

European Central Bank: 3.69%

Bank of Japan: 1.92%

Bank of England: 0.843%

Bank of Canada: 0.532%

Each of these major central banks in ‘rich’ Western countries is essentially at, or below, the level of capital that Lehman Brothers had when they went under.

What does this mean?

Think about Lehman again. When Lehman’s equity was wiped out, it caused a huge crisis. The company’s liabilities instantly lost value, and almost everyone who was a counterparty to Lehman Brothers lost a lot of money because the company could no longer pay its debts.

Accordingly, if the US Federal Reserve’s assets unexpectedly lose more than 1.5% of their value, the Fed’s equity would be wiped out. This means that any counterparty holding the Fed’s liabilities (i.e. Federal reserve notes) would lose.

More specifically, that means everyone holding dollars.

Theoretically if a central bank becomes insolvent, it can be bailed out. It happened in Iceland a few years ago.

There’s just one problem with that thinking.

Iceland’s government wasn’t in debt at the time. So they were able to borrow money in order to bail out their central bank. Today the government is in debt over 100% of GDP, but the central bank is solvent.

But governments in the US, Europe, Japan, England, etc. are all too broke to bail out their central banks. These governments are already insolvent. So if the central bank becomes insolvent, there won’t be anyone to bail them out.

This is one of the strongest indicators of all that the financial system as we know it is finished. When central banks can no longer credibly issue liabilities, and their home government are too broke to bail them out, this paper currency standard can no longer function.

Such data really underscores the importance of owning real assets such as productive land and precious metals.

Given its nominal roller coaster ride lately, there has certainly been a lot of scrutiny and skepticism about gold.

But to paraphrase Tony Deden of Edelweiss Holdings, if you dispute the validity of gold as a hedge against declining fiat currency, that makes you, by default, a paper bug. Can you really afford to be confident in this system?

As been repeatedly noted here, QEs by major central banks have been meant to shore up asset markets which underpins the assets on the balance sheets of crony banks, and their guardians, the central banks. 

Of course QEs has fostered a low interest rate environment, which in effect, subsidizes debt financed government spending and the welfare warfare bureaucracy that the banking system, by virtue of Basel regulations, holds mainly as 'risk free' collateral.

And the same set of collateral have been used by crony banks to get loans from discount windows of central banks, and likewise, these collateral constitutes one of the major instruments used by central banks to conduct QE.

So all these ‘merry-go-around” or 'cul-de-sac' or 'loop-a-loop' arrangement has been designed to eliminate the threat of insolvencies of the cartelized unsustainable centralized debt-based political economic system

But there’s more. For the major economies, central banks can use changes in accounting methodologies to elude insolvencies, similar to the US Federal Reserve in January 2011.

As Austrian economist Robert Murphy noted, “It is now mathematically impossible for the Fed to become insolvent, through the magic of "negative liabilities."”

Ultimately central banks will tap the printing press should "bank runs” occur. 

Again Professor Murphy: 

But for the case of the Federal Reserve — with dollar-denominated liabilities — it is hard to see what actual constraints it would face, should its accountants suddenly announce its insolvency. Even if there is a "run on the Fed," where all of the commercial banks want to withdraw their electronic reserves on the same day, the central bankers need not panic: they can order the Treasury to run the printing press in order to swap paper currency for electronic checkbook entries. (This is a neat trick unavailable to the mere commercial bankers.)

The smaller central banks will not have the same privileges. Nonetheless, their assets are also anchored on assets of their major contemporaries.

I would like to further point out that aside from Iceland, another example of a bailed out insolvent central bank has been the defunct Central Bank of the Philippines (CBP)

As I wrote in June 2012

Central Bank of the Philippines, the predecessor of the BSP, suffered massive losses to the tune of an estimated Php 300 billion as consequence of the series of bailouts provided by then President Cory Aquino to her favorites.

The losses were eventually transferred to the central bank board of liquidators.

Don’t take just take it from me. Canadian monetary analyst JP Koning recently noted (bold mine) 

Consider the case of the Central Bank of Philippines (CBP), for instance. According to Lamberte (2002), the CBP was harnessed by the government in the 1980s to engage in off-balance sheet lending and to assume the liabilities of various government-controlled and private companies. All of this was to the benefit of the government as it lowered the deficit and kept spending off-budget. Later on these loans proved to be worthless, leaving the central bank holding the refuse. This has shades of Enron, which used various conduits and SPVs to hide its mounting losses.

The CBP was replaced in 1993 by the newly chartered Bangko Sentral ng Pilipinas (BSP). The BSP took over the CPB's note and deposit liabilities, as well as its foreign reserves and other valuable assets (the bad assets were allocated elsewhere).

A non-partisan observation on the populist perception which sees political leadership then as a 'virtuous' regime.

Bottom line: Small central banks will be bailed out. But if troubles of the four biggest and the most important central banks aggravates, then as Mr. Black notes “the financial system as we know it is finished” or financial apocalypse from the biblical equivalent of the four horsemen.

Cartoon of the Day: State of California Celebrates Phil Mickelson’s British Open Victory

From rn-t.com:

Of the approximately $2.16 million winnings over the last two weeks from his victories at the British Open Championship and the Scottish Open, Mr. Phil Mickelson, winner of 42 events in the PGA Tour including 5 major championships, will get to keep approximately only $842,000 or 39% of the total earnings as the United Kingdom, Scotland and California take the (61%) rest of his earnings, according to Breitbart.com.  

Updated to add: Here is Thomas DiLorenzo via Lew Rockwell Blog on zero income tax Florida resident native Californian Tiger Woods compared to Phil Mickelson the latter incidentally has put his $7 million California abode on the market

US Home Builders Slammed as 10 Year UST Yield Rise

In my post yesterday I noted that the rebound in US housing looks increasingly tenuous in the face of the continuing turmoil in the bond markets.

Yields of 10 US Treasury Notes has rebounded strongly during the past few days. Yesterday, 10 year yields recaptured the 26 levels

The result of yesterday’s bond market sell-off?

The US largest residential house builder,  DR Horton (DHI) fell off the cliff, down by 8.58%!

This comes even amidst a reported “better-than-expected profit” for the second quarter of 2013. Good “past” news didn’t deter the selloffs on the prospects of sustained elevated higher mortgage rates.

Rising yields also smacked Pulte Homes (PHM) largest homebuilding company hard. PHM essentially collapsed—down by 10.3%!

Lennar Corporation (LEN) the second largest homebuilder has had a better fortune yesterday. The bulk of the early steep losses was recovered. Nonetheless LEN still posted a 1.62% loss.

(charts above from stockcharts.com)

These has important implications

During the 2003-2007 boom phase of the US stock market, the housing downturn preceded the collapse of the S&P 500 by about a year. This has been manifested by the decline in the stock price of DR Horton DHI (leftmost arrow) and eventually the S&P 500 (second or middle arrow).

The same story holds true with Pulte Homes (PHM).

(charts from bigcharts.com)

As in 2006-2007 boom phase, US stock markets may continue to rise, but if the recent downshift in US homebuilders should deepen or intensify, prompted by higher mortgage rates, the lessons of the 2008 US mortgage crisis tells us that such widening divergences would likely spell the Wile E Coyote moment for US stocks in the fullness of time.

Interesting times indeed.

Chinese company uses drones for cake delivery services

Drones serve as instruments to an end. 

In politics, drones have been used to kill political opponents or for spying/surveillance. As a destructive weapon to attain foreign policy goals, for every drone strike, 50 civilians are killed for every terrorist, notes the Policymic.com. The children death toll from drones attacks in Pakistan has now reached 94 according to Foreign Policy

But there is a brighter side for the alternative uses of drones.

A company in China uses “cheap drones” to service cake deliveries

From Shanghai Daily: (hat tip zero hedge)

HAVE the cake and eat it too.

And get it delivered in style as well.

In a crazy story that would make even spy master James Bond sit up and take notice, a local cake factory is using drones to deliver cakes in Shanghai! And China's civil aviation authorities are not too happy about it.

The factory used remote-controlled aircraft on five different occasions to "fly" cakes across the Huangpu River to customers in downtown, claimed Men Ruifeng, the marketing manager of the Incake company, which only accepts orders online.

The drone, measuring 1.1 meters in diameter and fitted with five propellers, flies at a height of about 100 meters and can be remotely controlled over several kilometers. It has two cameras and the controller can pilot it from a nearby vehicle, Men said.

The company has three such drones, all of them refitted from a Chinese-made aviation model.

Commercial applications of drones, as previously pointed out, will largely be positive or constructive for society.

Quote of the Day: The main difference between non-profit and for-profit

The main difference between non-profit and for-profit is that non-profits are accountable to donors and for-profits are accountable to customers. This means that the non-profit sector is going to be more elitist and more less efficient than the for-profit sector. It does not mean, as so many people think, that the non-profit sector operates from better motives or provides more social benefit.

I am not saying that a non-profit sector is a bad thing. Just remember that it is inherently paternalistic, and that is problematic.

(italics original)

This is from economist, author and entrepreneur Arnold Kling at his blog.

Will Slowing Foreign Buying of US Properties Derail the Housing ‘recovery’?

Foreign buying of US real estate appears to be slowing, will these compound on the recent setback brought by rising bond yields?

Reports the CNBC.com

The flood of money pouring into U.S. real estate from the overseas rich may be slowing.

Foreign purchases of real estate in the U.S. dropped 17 percent in the 12 months ended in March compared with the same period a year ago, according to the National Association of Realtors. The high end of the market felt the brunt of it.

Sales of homes priced at $1 million or more to overseas buyers dropped to about 6.5 percent of sales from 10 percent—the sharpest drop in any price category.

There are several possible reasons for the slowdown. A stronger dollar makes U.S. real estate less attractive on a currency basis. The NAR said mortgage standards also tightened, making it harder for overseas buyers to qualify for loans.

But the main reason is economic weakness overseas. "Economic slowdowns in a number of major foreign economies appear to have been a major reason for a drop in sales; a number of potential customers apparently held off on purchases," the report said.

Wealthy buyers from China, Brazil and Russia have been critical to the real estate recovery at the high end of the market—especially in Miami, New York and parts of California. Brokers fear that if wealth creation slows in emerging markets, high-end home sales could also weaken.

Since bond yields exploded last May, the “recovering” US real estate industry has shown signs of fatigue strains. 

Mortgage applications has gone down along with rising  mortgage rates (lower window, rates are inverted).

This has also been reflected on a sharp downturn in Home Sales (upper window) according to the Zero hedge

Housing starts and housing permits has also tumbled, again from another Zero Hedge report

The Reuters recognizes of the June decline of US existing home sales, but attempts to paint a bullish picture by referencing year on year increases. But last year bond yields were at a low, the tumult in the bond markets began only this May. So one data covers differing conditions at different time frames.

Meanwhile contra Reuters, the cynical Zero hedge notes of negative month on month changes on existing home sales.

Construction trends haven’t been rosy too. Multi starts and single family starts have been in a short term decline even as builder’s sentiment soared.

Don’t worry, be happy. The Northern Trust economic team believes that the “bloom is not off the housing recovery yet” since they see a “steep and rapid climb” of mortgage rates as “unlikely”. This means that experts from Northern Trust see the recent “steep and rapid climb” as an anomaly. 

However, stock prices of major homebuilders as DR Horton (top) and Lennar (bottom) have hardly been lifted by record US equity bellwethers.

Both interest rate sensitive stocks plunged on the re-emergence of the bond vigilantes.

The general decline of Lumber prices have also barely been in support of a sustained recovery on US housing.

And so with copper prices (which has also been a China story)

And finally, while negative equity has fallen, many millions of “Americans still owe more than what their homes are worth”, according to the Dr. Housing Bubble.

Delinquent loans continue to rise.

These indicators don’t seem to support a "robust" "real" housing recovery but instead reveals of a fragile boom prompted by easy money speculations.

Yet if the bond market vigilantes continue to impose their presence on the global markets, then yes, growth in emerging economies are likely to suffer a pullback, which will also likely affect buying patterns on US properties. 

Equally, higher bond yields transmitted to higher mortgage rates risks reversing the current boom phase of the reflated US housing bubble.

So the bond vigilante triggered headwinds confronts both internal and external dynamics of the US housing boom.

Interesting times indeed.

China’s Railroad Stimulus is now Official: It’s an $85 billion boondoggle

So the rumored railroad stimulus has become official.

From Bloomberg:

Chinese Premier Li Keqiang said the nation will speed railway construction, especially in central and western regions, adding support for an economy that’s set to expand at the slowest pace in 23 years.

The State Council also yesterday approved tax breaks for small companies and reduced fees for exporters, according to a statement after a meeting led by Li. China plans a railway development fund, the government said.

Additional spending would help the world’s second-largest economy, after the government signaled this week it will protect its 7.5 percent growth target for this year following a second straight quarterly slowdown…

China had planned to invest 520 billion yuan ($85 billion) in railway construction this year, according to a rail-bond prospectus published July 19. Total fixed-asset investment by the railroads, which also includes train purchases and maintenance, will be 650 billion yuan. 

The report didn’t say that the Chinese government embarked on a massive US $586 billion fiscal stimulus program in 2008-9 as shield against the global US epicenter based crisis. 

Yet, Chinese economic growth has been faltering, that’s after a short period of “traction” from such policies (chart from tradingeconomics.com).

This means that stimulus work only for the “short term”. Also if $586 billion didn't do the job, then why would $85 billion of 'targeted' spending work?

Adding railroads to what seems as faltering railway activities (chart from Business Insider), not only reflects on an ongoing downshift of economic activities, but importantly such would translate to surpluses or wastages of capital—where losses of public companies will be passed on to taxpayers.

So the Chinese government appears to be buying time by providing a short term statistical boost to a floundering economy.

Of course, another thing the report didn’t mention is that much of the 2008-2009 stimulus has been funded heavily by debt.

Debt of State Owned Enterprises (SoE) have now been estimated at an eye-popping 4.5x leverage. Private sector debt has also ballooned. One shouldn’t forget that a lot of private sector companies are tied to or related to the government, a lot of of them as vehicles for the local government.

The outcome of the 2008-2009 stimulus has been a colossal credit bubble that has fueled a runaway property bubble.

So the freshly installed Chinese government essentially will implement the same policies as the former administration. The more things change the more they stay the same…

The thrust towards public works means that Chinese stimulus program will be channeled via SoEs, which transfers economic opportunities to the political class and to the politically connected firms.

Public works also heightens credit risks on both the public and the private sector, as these $85 billion projects would be funded by more debt. 

Such would further magnify bubble conditions, despite the cosmetic measures to curtail the shadow banking.

Unfortunately for taxpayers, $85 billion spending means higher taxes overtime.

While it may be true that part of Li’s program would be to cut taxes for small businesses which should be good news…

Resolutions passed at yesterday’s cabinet meeting included the exemption of companies with monthly sales of less than 20,000 yuan from value-added and business taxes starting Aug. 1, according to the statement. The move will benefit more than 6 million small businesses and affect jobs and income of tens of millions of people, the government said.

…such is likely a superficial attempt or effort.

The hope is that China’s economy would grow enough to pick up the public spending tab seems as wishful thinking as the 2008-2009 stimulus has shown.

Japan has had the same post-bubble fiscal and monetary stimulus experience through the 90s into the new millennium, or the lost decade, a failed practice which have been repackaged today as “Abenomics”, or differently put, doing the same things over and over again (but at a bigger and more audacious scale) and expecting different results—insanity.

Also the Chinese government’s grand 2008-2009 stimulus program has a growing list of public work disasters. 

Politicization of economic activities means lower “real” economic growth as resources are allocated on non-market preferences and to vote or approval generating political pet projects, thus compounding on imbalances (bubbles), increasing waste and losses, higher taxes overtime, redistribution to the political class which implies greater inequality and cronyism, capital consumption and a lowered standards of living.

Meredith Whitney: Detroit as precedent to the staggering aftershocks of the largest municipal bankruptcy in US history

Bank analyst Meredith Whitney who correctly called on the Citibank fiasco during the 2007-2008 crisis warns in the Financial Times that  the Detroit episode serves as precedent to a coming wave of municipal bankruptcies. (bold mine)

As jarring as the reality may be to accept, Detroit’s decision last week to declare bankruptcy should not be regarded as a one-off in the US municipal market – which is what the bond-peddlers are now telling their clients. The aftershocks of the largest municipal bankruptcy in US history will be staggering, and Detroit will set important precedents.

Municipal bankruptcies have historically been rare for a number of reasons – including the states’ determination to preserve their credit ratings, their access to cheap funding and the stigma of bankruptcy. But, these days, things are very different in the world of municipal finance.

At the root of the problem is the incentive system that elected officials used to face. For decades, across the US, local leaders ran up tabs for future taxpayers; they promised pensions and other benefits for public employees that have strong legal protection. That has been a great source of patronage for elected officials: they can promise all sorts of future perks to loyal supporters (state and local workers) with very little accountability on the delivery of those promises.

Today, we are left with the legacies of this waste. The bill for promises past is now so large for some cities and towns that it is crowding out money for the most basic of services – in the case of Detroit, it could not even afford to run its traffic lights. Across many American cities, cuts to basic social services have already been so deep that they have made the communities unpleasant places.

Read the rest here.

Ms. Whitney has had strident critics for predicting defaults by 50 to 100 cities to the tune of of “$100s of billion dollars” in 2010 such as David Kotok of the Cumberland Advisors.

Nonetheless currently the unfunded state and local pension liabilities has been estimated at a huge $3.8-4 trillion. This should gobble up a huge share of state budgets in the backdrop of a highly fragile steroids dependent economy. Also, pension shortfalls increases state or muni credit risks, if expected or targeted returns are unmet.

Yet if bond vigilantes continue to unsettle the interest rate markets, and or, if the FED does “taper”, where Dr. Bernanke said last week, “If we were to tighten policy, the economy would tank”, then it wouldn’t be far fetched for Ms. Whitney’s predictions to come to fruition.

Has the Skyscraper Curse Hit China?

The Skyscraper Index introduced by Dresdner Kleinwort Wasserstein research director Andrew Lawrence has been a reliable but a not perfect leading indicator of business cycles. 

Skyscraper booms tend to highlight the peak of a business cycle, as I discussed in 2009, or tends to rise on “the eve of economic downturns” according to Wikipedia.org.

The peak of the Skyscraper cycles has frequently signaled the advent of recessions, the Wikipedia.org elaborates, “where investment in skyscrapers peaks when cyclical growth is exhausted and the economy is ready for recession”

Has the Skyscraper curse become a reality in China?

The construction of the world’s tallest building in China has reportedly been suspended.

According the Dubai Chronicle: (bold mine)

In May, the Dubai Chronicle reported that China is planning to challenge Dubai’s Burj Khalifa’s status as world’s tallest building. The Asian country is preparing to build a skyscraper which is even taller than Burj Khalifa’s 2,716 feet. The building, called Sky City, was initially planned for completion by the end of the year. However, the date is now pushed forward, slowing down the mega project.

Only a couple of months ago, China’s Sky City project was said to be ready by end of 2013. The developers behind the ambitious project were confident in their prognosis even though the construction works on the tower had not even begun. According to them, the 2,739-feet Sky City would take only half a year to complete due to its unique construction process.

But despite the forecasts, Sky City’s completion is now delayed to April 2014. There is no specific information on why the project is taking so long, given that it is enjoying the great support of the Chinese government.

In addition, this is not the first time in which Sky City’s opening is being delayed. Originally, the project was supposed to be ready at the beginning of 2013. However, the construction work started last week.

The cost of the record-aiming building has also been changed. In May, Sky City was expected to consume only $625 million. Now, its construction is estimated at over $855 million.

Skyscraper manias have always been accompanied by overconfidence, similar to the stock market.

Next, the cost overrun has simply been a manifestation of the inadequate savings in sustaining of such grandiose project. As the great Austrian economist Ludwig von Mises explained:

The whole entrepreneurial class is, as it were, in the position of a master builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master builder's fault was not overinvestment, but an inappropriate employment of the means at his disposal.

The “lack of material needed” has been expressed by higher input prices as the construction-real industry earlier bid up on input prices, enabled and facilitated by cheap interest rates, thus resulting to the ballooning cost of the project.

The Zero Hedge has an illustration of the Sky City…

…and of China’s simmering skyscraper mania.

Unraveling of malinvestments are presently being manifested through cash squeezes which has been ventilated via higher interest rates.

Austrian economist Professor Mark Thornton, who expanded the study on the Skyscraper Index to cover the Austrian Business Cycle, notes that,

Higher interest rates discourage the building of taller buildings and of construction in general because capital is scarcer and land is less in demand and available at lower prices.

And the weakness in the Chinese economy seem to be intensifying. This would further expose on the massive misallocations of capital that would further translate to even higher interest rates or higher costs of capital.

A fresh Bloomberg article reports that China’s manufacturing index “weakened further in July, signaling the worst of the nation’s slowdown has yet to be reached, according to a preliminary survey of purchasing managers”

And its not just in the economy, current social policies may help prick the runaway property bubble.

In what seems as another attempt by the Chinese government to curtail such property bubbles, a 5 year ban has been imposed on construction of new government buildings.

From another fresh Bloomberg report:

China banned government and Communist Party agencies from constructing new buildings for five years and told them to suspend projects that have already won approval as the country seeks to cut wasteful spending.

The ban includes construction for purposes of training, meetings and accommodation, the government said in a statement on its website yesterday, calling for resources to be spent instead on developing the economy and improving public welfare. All localities should report the implementation of the new rules by Sept. 30, according to the statement.

The suspension of the construction of the world’s tallest building, intermittent cash squeezes, the reappearance of the bond vigilantes, tanking stock markets, signs of intensifying weakness of the economy, declining yuan-US Dollar (see above)  and the Chinese government’s policy path to break the runaway property bubble seem to reinforce the Skyscraper curse. 

And a severe downturn may lead to a "period of instability" says a state researcher. 

Oh, don't forget, ASEAN has her own Skyscraper mania. 

Ignore these signs at your own peril.

Quote of the Day: Social Engineering is about Unequal Justice

Understand that social engineering, by its very nature, calls for a double standard. Under social engineering, blacks with night sticks at voting stations are given a pass. Union thugs beating up a black Tea Party member is no problem. Killing more than a million unborn (and some born) babies a year is okay. Make no mistake about it, social engineering is not about equal justice. It’s about unequal justice. It’s about the power thugs having it all their way.

This is from self help and libertarian author Robert Ringer at his website discussing implementing socialism via social engineering.