Sunday, March 09, 2014

Phisix: The BSP’s Self Imposed Hobson’s Choice

Because of pressures applied by some influential groups on the Philippine government over the risks of property bubbles, officials of the Philippine central bank, the Bangko Sentral ng Pilipinas (BSP), proposes to establish a “residential property-price index” index to monitor “asset bubble risks” in the property sector at the first half of the year. 

Overheating is a Sign of a Maturing Inflationary Boom

Yet while the government including the President rabidly denies the “overheating” of the economy, a private company Colliers International notes that “February projected property prices in Manila’s financial district Makati, which climbed to a record last year will rise a further 8 percent in 2014.”[1]

The tautology of “economic overheating” is what I had predicted would become the catchphrase for the mainstream[2],
Eventually, the current boom will get out of hand, which will be manifested through rising interest rates, which the mainstream vernacular will call “economic overheating” …
Of course, record property prices on itself are hardly sufficient representative of an escalating bubble, as record property prices are merely symptoms.

The question what has financed property prices to reach such record levels?

The answer as I have been pointing out here has been intensifying asset speculation financed by debt.

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The article further notes that “property loans and investments rose 6.8 percent to a record 900.1 billion pesos ($20 billion) in the second quarter of 2013 from the previous three-month period, the central bank reported in November. Property made up 22 percent of the total loan portfolio at banks.” (bold mine)

Record property prices backed by record debt. Record debt spending as expressed by a 30++% jump in money supply.

The fundamental problem with the mainstream’s heavy dependence to look at ‘select’ statistics in measuring economic activities has been at the risks of isolating economic variables which are really entwined or interrelated

As the great Austrian economist Ludwig von Mises reminds us[3].
Economics does not allow any breaking up into special branches. It invariably deals with the interconnectedness of all phenomena of acting and economizing. All economic facts mutually condition one another. Each of the various economic problems must be dealt with in the frame of a comprehensive system assigning its due place and weight to every aspect of human wants and desires.
And this is why overheating hasn’t just been as “property” problem. Measuring property and property related credit alone will tend to diminish the size and scale of risks. 

Bubbles operate like a vortex, they draw in associated industries which piggybacks on the main beneficiaries of the credit boom.

Think of it, will shopping mall operators continue with their wild expansion plans if they don’t project a sustained demand for their retail outlets? Will hotel developers also be in an expansion spree if they don’t foresee a sustained boom for their services from both resident and non-resident tourists? Will office building developers continue to expand if they don’t expect to see their units bought or leased out at profitable rates?

This is why the Philippine property bubble incorporates the shopping mall, hotel and restaurants and vertical non-residential edifices, as well as, the trade industry. 

The banking and other financial intermediaries and the capital markets (stocks and bonds) which have all served as the property sector’s financial conduits or agents are also considered as bubble beneficiaries or appendages. 

Statistics which signifies history of specific variable/s in numbers will not tell you this, it is economic deductive causal-realist logic that does.

This also means the BSP will gravely underestimate on their assessment of bubble risks by solely looking at “residential property-price index” while ignoring the other dimensions of the property sectors that have also been scampering to chase yields financed by debt.

As one would note, aside from record property prices, and the revival of the credit inspired mania in domestic stocks, the peso has been falling despite the this week’s region driven rebound and yields of Philippine treasuries remain stubbornly above 2013 levels while price inflation, despite so called .1% pullback from 4.2% to 4.1% this February[4] remains at the high end of the government estimates. All these come in the face of money supply growth going berserk.

And all these converge to depict that the statistical economy has been ‘overheating’ regardless of the official denial.

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As a side note; speaking of the domestic currency, the USD-peso has sharply fallen Friday to close the year almost unchanged. The two week rally in Emerging Asian currencies signifies a regional phenomenon brought about by “resistance-to-change” outlook in the attempt again to resuscitate regional bubbles.

For instance Indonesia’s rupiah has massively rallied over the past 2 weeks, even when there has only been marginal improvement in the so-called current account and balance of trade deficits. Indonesia’s external debt swelled by about 5% in 2013. Meanwhile the Philippine peso has seesawed from big rallies to big losses. Friday monster rally seems part of the recent sharp volatility swings. We will see how rallying ASEAN currencies will react to the crash in China’s exports.

Why the BSP seems Trapped

Going back to BSP’s proposed anti-bubble measures, and this seems why the BSP-Philippine government appears to be trapped.

An asset bubble thermometer has already been in existence. There is an extant 20% cap on bank lending to the property sector. But as early as May 2013, the cap or the quota has been breached[5]. Now property sector lending has swelled by over 10% or 22% of the threshold. In short, the BSP, despite the self-imposed legal proscription, has been tolerant of the breach.

While it may be partly true that banks have been tightening lending standards for the commercial property sector “for the sixth consecutive quarter in the three months through December”, there has been a vast discrepancy between reports framed from the government’s perspective and what the stock market has been cheering about.

I have noted last week that the expected expansion on capital spending for real estate and allied industries will reach a very conservative Php 250 billion[6]. Most of the companies have declared borrowing as the source of finance for such expansion.

In terms of proportionality, 250 billion pesos amidst a record 900.1 billion pesos in property loans and investments in the banking system for 2013 will extrapolate to a 27.8% jump in credit! As a share of overall banking loans based on 2013 data, real estate loans will balloon to 26.5%. That’s if all these will be sourced from the banks.

Yet if the BSP stringently enforces the cap, there are many implications on these.
Property firms may circumvent the cap through camouflaged borrowing which is borrowing, coursed through other industries from which these property firms have exposure to. Say for instance, if a company’s portfolio includes energy or manufacturing or other non-real estate industries, the sister companies may secure borrowing from banks then execute intercompany loans.

This has been the case in the 2011 Bangladesh stock market crash. Lending caps on the banking system were dodged when loans were acquired through industrial companies and then diverted into the stock market. When the government tightened by raising bank reserves requirements, these loans came under pressure that led to the stock market collapse[7].

A second scenario is related to the first. This for current banks to do what has become one of the alternative main avenues for local government financing in China; the use loopholes via the establishment of non-property companies that serve as intermediaries to acquire and re-channel loans to the intended firms hobbled by such regulations. This is known as the Shadow Banks[8].

The Philippines have already existing shadow banks, according to the World Bank[9]. But one of the current main forms of shadow banks has been to finance buyers of property from the informal economy.

Nonetheless a strict enforcement of banking property loan quota by the BSP will impel for innovative ways to get around such regulations

A third way to go around the restrictions will be through deepening access of the domestic bond and international bond markets. Many companies have already expressed the former option.

Yet a ceiling on debt means reduced availability of funds from domestic sources which implies of HIGHER domestic interest rates. Should domestic interest rates rise faster than foreign based rates then these property companies may resort to more offshoring borrowings. Such may also include borrowing from offshore banks.

Again the Chinese experience can be instructive. In the face of relatively faster rising rates, US dollar loans by Chinese property companies have raised $40 billion over the past 2 years[10].

Of course expectations of currency conditions will play a big role in determining sourcing of credit for these companies. Then, the yuan had been a one way trade, so Chinese property companies underestimated on the currency risks by borrowing US dollar loans

The fourth setting will be for the industry to vastly reduce or even desist from expansions. But this will be devastating for the incumbent government who has been starved out of funds to finance their burgeoning boondoggles.

Bubble Revenues in Support of Government Spending Bubble

Easy access to finance would mean to impress upon to the creditors of the salutary state of financial conditions of the debtors. As such, in terms of the Philippine political economy, confidence has to be established by the impression of a booming economy.

And real estate has been a key anchor to the statistical boom. For instance, construction and Real Estate accounted for 18.18% of statistical GDP growth for the Philippines in 2013 based in the industry origins at current prices. If we should include trade and financial intermediation, the share of exposure of the said credit driven frothy industries balloon to 43.66%. In other words, tighten credit (either via interest rates or strict imposition of banking loan ceiling cap) and your “fastest economy in Asia” crumbles. 

Notice: Credit tightening doesn’t mean that the entire 43.66% will collapse. It means that big overleveraged participants in the sector, which when affected, will drag down many entities of the related sectors and even to the non-related sectors. Yet ironically some [debt free] companies from the same sector may benefit from the problems of their colleagues. The latter could be buyers of problematic assets at fire sale (market clearing) prices.

Also remember access to the formal banking and credit system has been very limited (2-3 out of 10 households), which means all these so-called growth has concentrated. Alternatively this means risks have also been concentrated.

On a side but related note, one has to just ask why is it that the Philippines, an agricultural country, have essentially no commodity spot and futures markets and have been left behind by her neighbors[11]. The benefits from commodity markets should have been the purge or reduction of the role of the middleman, diminished transaction costs, to empower and enrich the agricultural and commodity producers, generate pricing efficiency, spread risks and expand access to credit by allowing the informal sector to migrate to the formal sector. And yet the public blathers about the sins of rice smuggling[12], duh! 

This is also related to why the PSE dithers (or refuses) to integrate her bourses with region[13].

And this is also why there has been a growing divergence in sentiment between the informal and the formal sectors[14].

Also such divergence has brought about the mainstream’s perplexity on why the so-called boom has not been translating into more jobs. Paradoxically, highly paid experts have offered little but to associate joblessness with poverty rates[15].

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As I have been pointing out numerous times, real economic growth can’t happen when there is a huge formal-informal system divide. As one can see from the above chart[16], the degree of shadow economies has been tightly associated with degree of wealth conditions. Naturally any informal economy includes informal or shadow banking too.

The informal economy which is a product of economic and financial repression[17] extrapolates to high transaction costs, high cost of capital and equally inefficient means to accumulate real savings and capital[18]. This also means limited growth because substantial growth postulates migration to the formal economy which poses as a disincentive for many in the informal economy.

So the mainstream can continue to prattle about growth statistics but by ignoring the informal economy they will tend to miss out on the real conditions of the economy, that’s because the informal sector constitutes a huge share of the population.

This brings us back to issue of easy access to credit. The Philippine government missed her tax collection target by a slight 2.95% in 2013, albeit overall collections grew by 15% year on year. While this is good news so far as for the statistical concentrated economy, the bad news is that aside from stagflation, taxes will even grow at a faster rate this year.

The BIR, which accounts for 70% of the government’s total revenues, expects a 16.16% increase in her 2014 target[19]. That’s because national government budget will expand by 13% to Php 2.265 trillion in 2014[20]. So government spending will grow about twice the statistical economy.

This explains why in spite of the so-called boom, the BIR has been tightening on the noose of practicing doctors[21], where the latter have pushed backed, and even on the ‘lechon’ or roast pork vendors[22]. As one would note, the government has been waging war on the informal economy. So one can’t expect real growth to occur when government tries to restrict commercial activities.

Oh by the way the Philippine national government has so far done well in containing budget deficit. As of November 2013, annualized deficit (Php 111.464 billion) has been sharply lower, down by 54% compared to the yearend of 2012 (Php 242.827 billion). That’s the good news. The bad news is that the good upkeep depends on revenues from an unsustainable bubble blowing economy.

All these means that the incumbent government will have to increasingly rely on a sustained credit financed boom of assets in the formal economy in order to fund her fast expanding spendthrift appetite, as well as, to maintain zero bound rates or negative real rates (bluntly financial repression) to keep her debt burden manageable.

So the supposed boom in statistical formal economy translates to a boom in government spending financed by a boom in taxes derived from bubbles

Aside from the government, the other beneficiaries of BSP subsidies are the asset holders and formal economy debtors, which come at the expense of savers, non-asset holders and peso holders (outside the beneficiaries whose assets offset the loss in purchasing power).

Yet the only way to neutralize the negative effects of excessive money supply growth is through productivity growth.

But blowing bubbles and taxes diverts resources from high value productive uses to non-productive consumption activities. Thus a statistical boom can occur in the face of a loss of productivity. Yet this isn’t real growth, but that’s how bubbles operate

Think of it, if the BSP rigidly imposes banking caps, a tightening would result to a market meltdown and which will most likely get transmitted to the real economy via a significant slowdown or even a contraction, if not a crisis. This will not only undermine the leadership’s political goals but also bring to the surface the economic and political imbalances that have been built to promote access to easy credit via populist politics. And economic strains will likely bring about a more intense popular demand for the scrutiny of political malfeasances.

So the Philippine government together with the BSP has been trapped. They will need to keep the musical chairs going by continuing to inflate on asset bubbles and hope that such bubbles won’t pop under their terms. Thus this explains two factors: one the Pollyannaish declarations by the officialdom, which has been bought hook, line and sinker by media and industry participants benefiting from the phony boom. Second, the public denials and the superficial measures announced by authorities supposedly to contain the risks of financial instability via asset bubbles.

Yet everything will depend on the bond vigilantes. If interest rates as expressed by bond yields continue to climb, then what is politically hoped for may not be attained, they may even backfire.

As John Adams US founding father and 2nd US President in his defense at the Boston Massacre Trial said,
Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.




[2] See What to Expect in 2013 January 7, 2013
[3] Ludwig von Mises, The Why of Human Action, Economic Freedom and Interventionism
[5] Bangko Sentral ng Pilipinas BSP Releases Results of Expanded Real Estate Exposure Monitoring, May 10, 2013
[12] Wall Street Journal Crackdown on Rice Smuggling Blamed for Price Jump February 26, 2014
[15] Wall Street Journal Few Good Jobs In Fast-Growing Philippines, March 4, 2014
[19] Malaya BIR MISSES 2013 TARGET BY 3% February 20, 14
[20] Rappler.com Aquino signs P2.265-T 2014 budget December 20, 2013
[22] Manila Standard Taxman roasts lechon traders January 9, 2014

US Stock Markets: Look Ma, This Time is Different!

Eat your heart out Carmen Reinhart and Ken Rogoff. Who says this time can’t be different? 

In 1999, writing at the Fortune magazine the former value investor (now a political entrepreneur) Warren Buffett’s revealed his two most important variables for determining investment returns. The first is interest rates where I quoted him in January[1], the second is after tax profit. 

Again the Warren Buffett of 1999[2] warning of the dotcom bubble
The second thing bearing on stock prices during this 17 years was after-tax corporate profits, which this chart [above] displays as a percentage of GDP. In effect, what this chart tells you is what portion of the GDP ended up every year with the shareholders of American business…

When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well…

The inescapable fact is that the value of an asset, whatever its character, cannot over the long term grow faster than its earnings do.

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Corporate profits after taxes are at a “this time is different” levels. Some have argued that Mr. Buffett has been wrong considering that revenues from today has been internationalized which justifies high valuations.

But fund manager Dr. John Hussman writes to dispute this and concludes[3]
Corporate after-tax profits as a share of GDP, GNP (or even net national product if one wishes to use that number) are steeply above historical norms, and the pre-tax profit share is also at record levels.
Mr. Buffett must also be scratching his head.

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More of ‘this time is different’.

Skyrocketing Russell 2000 has a PE ratio of 81.61!!! Nasdaq composite is now just a breath away from the 2000 highs. Nasdaq’s PE has been at a pricey 21.04.

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What has financed such elevated prices, aside from record bond financed buybacks? Well the answer is “this time is different” in the context of margin debt and net credit balance that has been on a record streak too.

Notes Doug Short[4],
There are too few peak/trough episodes in this overlay series to take the latest credit-balance trough as a definitive warning for U.S. equities.

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And who has been buying record stocks with increasing leverage? It seems that US households have been in a ‘this time is different’ pile up mode. Household buying as represented by equity mutual funds and equity ETFs have been blazing hot[5]. The scale of buying has reached 2007 highs (right window), as institutional investors register net selling. Meanwhile foreign flows which posted net selling have been largely flippant.

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And here is another ‘this time is different’ picture. Total equity market cap as % of GDP exhibits a breakaway run beyond the average market cap and beyond the one (if not two) standard deviation of the mean.

Of course the ‘this time is different’ series won’t be complete without record levels in household wealth based on record stocks.

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Writes the Zero Hedge[6], (bold mine, italics original)
On the surface, the increase in household net worth to a record $80.7 trillion is good news. The problem is that with $2.5 trillion of the $3 trillion purely thanks to an increase in financial assets, which as has been made quite clear over the past several years, benefit only the 1%, what the lede should say is "another quarter down, another $3 trillion added to the net worth of America's richest." Put another way: of the $94.4 trillion in total assets (gross, not excluding $13.8 trillion in household liabilities), a record 71% or $66.9 trillion, is in financial products. And now you know why the Fed can not possibly allow any hiccups on the road to trickle down Fed balance sheet nirvana. If only for the 1%.
Very much like the Philippines, serial bubble blowing has been required to keep statistical mirage alive. Of course Wall Streets of the world loves this, while the mainstream agonizes with slow growth and reduced purchasing power.

But for as long the returns from the chronic speculative excesses funded by roaring expansion of credit expansion surpasses the burden of servicing debt then such game of musical chairs or might I say that the blowoff top may continue…until the Wile E. Coyote moment arrives.

Dr. John Hussman has a very pertinent view of calling for bubble tops[7].
The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top, and most of the signals that have been most historically useful for that purpose have been blazing red since late-2011.






[3] John P. Hussman Do Foreign Profits Explain Elevated Profit Margins? No. March 3, 2014

[4] Doug Short, NYSE Margin Debt Hits Another All-Time High March 3, 2014 Advisers Perspective

[5] Yardeni.com US Flow of Funds: Equities March 6, 2014


[7] Dr. John Hussman A Textbook Pre-Crash Bubble November 11, 2013 Hussman Funds

Friday, March 07, 2014

China’s First Onshore Default!

So it appears that the Chinese government won’t be bailing out every credit delinquent companies that surfaces. So the first default for the the year of horse.

From Bloomberg:
A Chinese solar-cell maker failed to pay full interest on its bonds, leading to the country’s first onshore default and signaling the government will back off its practice of bailing out companies with bad debt.

Shanghai Chaori Solar Energy Science & Technology Co. (002506) is trying to sell some of its overseas plants to raise money to repay the debt, Vice President Liu Tielong said in an interview today at the company’s Shanghai headquarters. The company said March 4 it will only be able to pay 4 million yuan ($653,990) of an 89.8 million yuan coupon due today.

The number of Chinese companies whose debt is double their equity has surged since the global financial crisis, suggesting this first onshore bond default won’t be the nation’s last. Publicly traded non-financial companies with debt-to-equity ratios exceeding 200 percent have jumped 57 percent since 2007, and Chaori Solar may become China’s own “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. securities firm was rescued in 2008, according to Bank of America Corp.

“There will be more defaults in China’s onshore bond market,” said Qiu Xinhong, a bond fund manager in Guangzhou at Golden Eagle Asset Management Co., which oversees 13.9 billion yuan in assets. “The next default will be likely to happen in overcapacity industries, such as steel, nonferrous metals and coal. Bond investors will shun private companies with heavy debt burdens because they’re the most at risk.”
The default has just been announced (about 1-2 hours ago) when Asian markets have already closed. So it would be interesting to see how Chinese and Asian financial markets will respond to these on Monday. So far European markets and US markets seem to ignore this.

The question now is: will this and the coming defaults create a contagion (some say the "Bear Stearns" moment) thereby triggering a global Black Swan event or will this default or the coming ones be contained and shrugged off?

Quote of the Day: The Rights Trap: They haven’t made you free

The Rights Trap is the belief that your rights will make you free.

It’s not hard to fall into this trap and become preoccupied with your rights as a way of getting what you want. You’ve probably heard since childhood that you have certain rights — to life, liberty, property, the freedom to pursue your happiness.

In addition, it’s easy to feel that someone owes you certain things in a relationship — such as respect, honesty, or fair play.

Unfortunately, rights exist only in theory. In practice, they don’t accomplish much — no matter how much people may discuss them.

By implication, a right to something means that someone else must provide that something, whether or not he wants to. A right to your property, for instance, means that you should be allowed to keep your property — even if others want to take it. A right to a job means that someone must provide a job for you even if he prefers not to.

Rights are invoked only when there’s a conflict of interest. Otherwise, there’s no need for them.

One reason it’s so easy to walk into the Rights Trap is that it sometimes seems to be the only way to deal with a conflict. But that’s only one of three methods of handling such situations. You can:

1. Rely upon your rights to get you what you want.

2. Find a way to make it in the other person’s self-interest to provide what you want.

3. Find a way of getting what you want without his being involved.
This is from American writer, politician and investment analyst Harry Browne from How I Found Freedom in an Unfree World (pdf here) as excerpted by the Daily Reckoning.

The article signifies a practical advice on how to steer clear of politics and concentrate instead on productive undertakings, read the rest here

Thursday, March 06, 2014

China’s Bear Stearns Moment? First Bond Default Looms

Following the bailout of a delinquent trust company late January, China’s credit markets seem to have returned to a placid state, thereby signaling a possible easing of credit woes. 

Well it turns out that such credit tranquility has only shifted the financial pressures to the currency market, the yuan.

Now even as the agitations in the currency markets remain unsettled, reports say that a debt delinquent solar company may spark a “Bear Stearns moment” with China’s first possible bond default.

From Bloomberg: (bold mine)
The growing risk of default by Shanghai Chaori Solar Energy Science & Technology Co. may become China’s “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. securities firm was rescued in 2008, according to Bank of America Corp.

“We doubt that the financial system in China will experience a liquidity crunch immediately because of this default but we think the chain reaction will probably start,” Hong Kong-based strategists David Cui, Tracy Tian and Katherine Tai wrote in a note yesterday. During the U.S. financial crisis, it took a year “to reach the Lehman stage” when investors began to panic and shadow banking froze, the strategists added.

The maker of solar cells said March 4 it may not be able to make an 89.8 million yuan ($14.7 million) interest payment in full by the deadline tomorrow. As sub-prime mortgages fell amid the 2008 U.S. financial crisis, banks began hoarding cash, causing two Bear Stearns Co. hedge funds to seek bankruptcy protection. The troubled bank was sold to JPMorgan Chase & Co. in March of that year in a deal facilitated by the U.S. Federal Reserve. Six months later, Lehman Brothers Holdings Inc. collapsed in the biggest bankruptcy in U.S. history.

Chaori’s potential failure to pay investors would mark the first bond default in Asia’s largest economy, highlighting the strain in China’s $4.2 trillion bond market after a trust product issued by China Credit Trust Co. was bailed out in January. There haven’t been any defaults in China’s publicly traded domestic debt market since the central bank started regulating it in 1997, according to Moody’s Investors Service.
Will this lead to another bailout within the week?

Let me add that China’s troubles have not been entirely captured by Western media. For instance, a report just surfaced that in late January, there has been a reported “run” on three cooperatives

From the Chicago Tribune
In the run-up to the holiday in late January, word had spread that at least three rural cooperatives were running short on funds. In what the local government described as a "panic", depositors rushed to withdraw cash. Local officials say several co-op bosses fled after committing fraud…

Depositors would normally be protected by China's banking regulator, which requires lenders to keep a certain amount of cash on reserve to meet depositor demand.

But as participants in a pilot program, the depositors quickly woke up to an unpleasant reality: so-called "Farmers' Mutual Help Funding Cooperatives" aren't technically banks. Not only did they not have sufficient reserves on hand, they weren't legally required to.
Farmer’s cooperatives reportedly emerged in 2006 and ballooned fast over the years. According to the  same report
By the middle of last year, 137 such co-ops had been established in Yancheng, with total membership reaching 170,000, deposits of 2.3 billion yuan, and total loans outstanding of 1.9 billion yuan, according to figures cited by official media.

But in practice, many co-ops shifted into riskier forms of lending. Jiangsu, along with neighboring Fujian province, is known for its vibrant grey-market lending networks, serving small factory owners and real estate developers who often cannot obtain bank loans.

Informal lending generally occurs through family and friends, but the rise of farmers' co-ops created a platform for informal lenders to scale up their operations by collecting funds in a bank-like setting.
If you might notice China’s financial markets seem to have been faced with increasing frequencies of financial tremors. This may lead to a financial Pompeii.

I am not sure if Bear Stearns should even be the right parallel. That’s because all it takes is for China’s fragmented highly indebted financial system to become unglued, as the Chinese government to lose control that results to the crumbling of the castle built on the proverbial sand. 

Remember financial strains will always function as the initial symptoms. Then a liquidity squeeze follows (this is where the PBoC has been actively intervening in the hope to kick the can). After, the contagion spreads to the real economy via a financial crisis that leads to a economic crisis or vice versa.

Interesting times indeed.

Wednesday, March 05, 2014

Video Roundtable Discussion: Why Do People Believe Stupid Things?

I saw this interesting video from Lew Rockwell Blog's Charles Burris who writes
Sit back and enjoy this rousing Boiling Frogs Post Roundtable discussion where James Corbett, Guillermo Jimenez and Sibel Edmonds ask (and attempt to answer) the vexing question of “why people believe stupid things?” Is it willful ignorance? Moral cowardice? Deference to authority figures’ palatable lies and tasty untruths? Intellectual sloth or cognitive laziness? Or is it a self-imposed mental imprisonment of not wanting to face the inconvenient and unpleasant reality outside their comfort zone matrix? So put on your critical thinking cap and join in the reflective conversation.
I may add: is it because of social desirability bias or groupthink? Is it because of the law of least effort? And or is it because of brainwashing?

Quote of the Day: Success in all endeavors is requires absence of specific qualities

Success in all endeavors is requires absence of specific qualities. 1) To succeed in crime requires absence of empathy, 2) To succeed in banking you need absence of shame at hiding risks, 3) To succeed in school requires absence of common sense, 4) To succeed in economics requires absence of understanding of probability, risk, or 2nd order effects and about anything, 5) To succeed in journalism requires inability to think about matters that have an infinitesimal small chance of being relevant next January, ...6) But to succeed in life requires a total inability to do anything that makes you uncomfortable when you look at yourself in the mirror.
This is from mathematician, philosopher, author and my favorite iconoclast Nassim Nicolas Taleb from his collection of Aphorisms, Maxims & Heuristics.

Let me add my two cents. I will piece together, like a jigsaw puzzle, anecdotally of what I think as interrelation from these variables.

#2 or the "absence of shame at hiding risks" would seem as not only relevant or applicable to much of the banking sector but generally (but with a few exceptions) to other financial market participants as well, including both sellside and buyside institutions. Think Wall Street (and their equivalents worldwide).

#4 I believe represents the essence of the mainstream “economics”. Shout enough statistics and or economic models (technical/econometric gobbledygook) for one to be reckoned as practicing “economics” by the uninformed public (who has little understanding of economics) overwhelmed by mathematical abstractions. Never mind if the practitioner/s have been entirely blind to the "risks" from "2nd order effects". 

Of course #4 is related or tied to #2; in the context that # 4 (the ideological foundation for the absence of risks) serves as justification for the actions of #2 (blatant hiding of risks). 

Think of "mania" or the frantic bidding up of asset prices regardless of risks of ballooning debt underlying such bidding binge, where "euphoria" has mostly been premised on statistical growth stories or from the prospects of more central bank support.

#5 (or the focus on the sensational rather than to the relevant) could most likely be part of the design to promote the interests of the entrenched political-economic order. When people see or tunnel at the sensational at the expense of the relevant then they are most likely to become complacent or dismissive of "risks". For instance, the mainstream have been oriented to see property booms as equivalent to economic growth, while disregarding the 2nd order effects of soaring property prices to the economy (via dramatic changes in relative price levels) and to politics (benefits the asset holders at the expense of to the non-asset holders that becomes part of the issue underlying the inequality controversy).

#2, #4 and #5 are linked in the sense that these sectors most likely constitute the central bank-banking-government cartel. 

Moreover, #3 is connected to #5 in that this represents the indoctrination process. The absence of common sense (and critical thinking) makes #5 (mainstream journalism) credible and reliable sources of information. And this applies, as well as, to the extent of ideas promoted by #2, #4 and #5 that becomes popular knowledge or mainstream dogma.

And finally, when a vast majority of the population becomes agreeable or complacent to #2, #4 and #5, then #1 appears easy to be implemented. This via social policies of financial repression (where inflationism is part of) which entails the (direct and indirect) redistribution of resources from society to the political class helped by their allies #2, #4 and #5 (also #3), who are also beneficiaries, in the "absence of empathy" transfers.  

And when a crisis occurs #5 blame such economic-financial malaise on "greed" from capitalism. But #2 and #4 gets a bailout from the government and or from the central bank, deepening further the financial repression policies.

#6 now depends on where you stand. 

So when Mr. Taleb in another quote (117th) from the same source says "there is this prevailing illusion that debt is a renewable source", then such illusion signifies a product of the 5 "absence of specific qualities" ingredients of "success".


Contra Warren Buffett, America’s best days exists for a tiny elite

Sovereign Man’s Simon Black points out why Warren Buffett is wrong with the latter’s sanguine view of America. (bold mine) 
In his most recent annual report just released yesterday, Mr. Buffet lauds the United States of America, writing:

“Indeed, who has ever benefited during the past 237 years by betting against America? If you compare our country’s present condition to that existing in 1776, you have to rub your eyes in wonder. And the dynamism embedded in our market economy will continue to work its magic. America’s best days lie ahead.”

Such language is typical for Mr. Buffett, he is one of America’s biggest cheerleaders. Again, with good reason.

For one, the unprecedented monetary expansion over the last decades has created a major boon for Mr. Buffet and his net worth. 

His company Berkshire Hathaway has a balance sheet worth $485 billion. 25% of that is simply invested in the stock market with big chunks of Coca Cola and American Express. 

These stock prices have boomed in an era of unprecedented money printing, adding billions to Mr. Buffett’s net worth.

Second, it’s important to note that over 75% of Berkshire’s revenue comes from highly regulated, absurdly profitable, tax advantageous businesses that are simply not accessible to the average guy. 

For example, Mr. Buffett gleefully writes about the $77 billion ‘float’ from his insurance businesses.

This is money that is collected from insurance customers. And while he might have to pay out insurance claims someday, for now he gets to borrow from that kitty at 0% and generate higher returns elsewhere.

On top of this, Mr. Buffett has been able to defer a full $57 billion in tax, indefinitely kicking the can down the road on his IRS bill thanks to industry-specific tax rules.

Again, you and I couldn’t do this because we don’t have access to these special privileges. Warren Buffett does.

Warren Buffett also has special access to lawmakers in the US who clamor to be in his favor.

During the early days of the financial crisis in 2008, for example, Buffett was getting desperate phone calls from the Treasury begging him to make investments in the financial system.

And as a result, he was able to arrange sweetheart deals, brokered by the US government.

It also may just be a wild coincidence that the US government has rejected the Keystone XL pipeline… and Mr. Buffett’s railways just -happen- to be among the prime beneficiaries.
Yes, I think if we all had the special privilege, access, and benefit that Warren Buffett enjoys, we too would all be jumping for joy about America.

But Uncle Warren lives in a different America– the America of the past.

With due deference to his investment acumen, Mr. Buffett should know that no nation in history has been able to -permanently- stand atop the world’s economic mountain. 

Like human beings ourselves, nations also rise, peak, and decline. It is their own life cycle. 

And the America that Mr. Buffett doesn’t acknowledge is the one that is in debt past its eyeballs. 

It is the America that spies on its citizens and threatens people with imprisonment for victimless crimes and administrative transgressions.

It is the America that conjures trillions of paper dollars out of thin air in total desperation, sending the labor force participation rate to multi-decade lows.

It is the new America that exists for a tiny elite at the expense of everyone else.
The above article exposes on what I call as “people up talking their industry” or a prime example of the the agency (principal agent) problem or the invisible conflict of interests between industry participants and their clients and or the public. [I should know I am a part of Mr. Buffett's industry but based on the Philippines.]

The cheerleading of Mr. Buffett on the economy has been designed to bolster Berkshire's financial interests (through implied advertisement) by encouraging the unwitting public to patronize the businesses offered by his companies via the "economy".

The other ramification is that the average investors pile into Berkshire’s stocks thereby pumping up share values and therefore magnify Berkshire's "returns" which will eventually reflect on Mr. Buffett's wealth status.

Of course what Mr. Buffett didn’t say too, which has been lucidly explained by Mr. Black, has been that Berkshire’s “economic moat” or competitive advantage has hardly been due to Ben Graham’s “value investing” but rather to “value” provided by political privileges via rent seeking political entrepreneurship, which meant special access to politicians and their regulations or exemptions in order to protect Berkshire’s interests. In terms of proportionality, 25% in stocks and 75% in rent privileges hardly speaks of value investing. 

In addition, some of the 25% of Berkshire's portfolio also benefits from political cover, as noted above.

The point is that what benefits Mr. Buffett’s Berkshire isn’t largely shared by the public. But Mr. Buffett makes it appear otherwise.

I’d like to add that Berkshire Hathaway is just one of the major recipients of government subsidies. According to a report by Philip Mattera of the taxpayer watch group Good Job First over the last two decades: 
…subsidy awards worth more than $1billion have been given to Warren Buffett’s Berkshire Hathaway by way of its holdings such as Geico, NetJets, Nebraska Furniture Mart, General Re Corporation, Lubrizol Advanced Materials, and Webb Wheel Products.
It’s not just Mr. Buffett though. An increasing number of US companies have become welfare recipients of the US government. About 75% of cumulative disclosed subsidy dollars to the tune of a whopping $110 billion notes PandoDaily.com have gone to 965 large companies where Fortune 500 firms have received receive more than 16,000 subsidies at a total cost of $63 billion. And more US government subsidies have also covered foreign firms. The 10 largest welfare corporate beneficiaries include Boeing, Alcoa, Intel, General Motors, Ford, Fiat, Royal Dutch, Nike, Nissan and Cemer. Mr. Buffett's Berkshire ranks 15th.

Bottom line: Be careful of what industry promoters say. In today’s world where politics has increasingly become a dominant force whether in the US, Asia, Europe, Latam and even in the Philippines, the rose colored-Pollyannaish outlook may all be about promoting the interests of the “tiny elite at the expense of everyone else".

Tuesday, March 04, 2014

A former Central Banker's Confession: Central Bankers are making up as they go along

The analytical underpinnings of what we [mainstream economists] do are actually pretty shaky. A reflection of that fact, is that virtually every aspect you can think of with respect to monetary policy, about best practice, has changed and changed repetitively over the course of the last 50 years. So, this stuff ain’t science.

Think about what’s happened recently. One, its completely unprecedented. People are making it up as they go along. This is hardly science – building on the pillars of the past.

Secondly, what they’ve been making up as they go along actually differs across central banks [The Bundesbank, for example, is fighting the threat of high inflation, whereas the Fed is more concerned about the prospect of deflation]. They can’t even agree amongst themselves about what’s the best way to do things.

I’m becoming more and more convinced that all of the models we use are basically useless.

It’s surprising that we’ve had this huge crisis that the mainstream didn’t predict. It’s gone on for years, which the mainstream absolutely didn’t predict. I would have thought this was a basis for a fundamental rethink about what we used to think we believed. But that hasn’t happened.

The policies that we’ve followed – on the monetary side at least – since 2007 are just more of the same demand-stimulating policies that we’ve been following, I think, erroneously, for the last 30 years.

We’ve got the potential to do so much harm by not getting the creation of fiat credit and money right. We’ve got the capacity to do so much harm that we should be focusing much more on making sure that doesn’t happen.
(bold mine)

This is from William White, former central banker (Bank of England, Bank of Canada and the Bank of International Settlements) and current chairman of Economic Development and Research Committee (EDRC) at the OECD, as quoted by Tim Price at the Sovereign Man

Central bankers have turned the world into guinea pigs, whose costs are carried by the average non-political citizenry.

EM Crisis Over? Explaining the Meltdown in Russian Financial Markets

In contradiction to the consensus outlook whom sees that EM volatility as just an aberration, well three months into the year, from China to Thailand to Ukraine to Kazakhstan, yet we see another financial market seizure: This time it is on Russia. 

The Russian Central Bank, Bank Rossii declared a 150 basis point hike in interest rate last night, from Bloomberg:
Russia raised its main interest rate the most since 1998 as the currency plunged to a record and investors pulled money from the stock market on concern that President Vladimir Putin will invade Ukraine.

The one-week auction rate, the benchmark introduced in September, was increased temporarily to 7 percent from 5.5 percent, the Bank Rossii said on its website today. The regulator also temporarily raised its other major lending rates by 150 basis points, or 1.5 percentage points.
The response has been a ghastly havoc in Russia’s financial markets

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The Russian equity index the MICEX collapsed by a staggering 10.79%!!! 

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The MICEX meltdown represents another wonderful example of “volatility in both directions but with a downside bias”. Months of accrued gains only to vanish in one day.

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Russian bonds were also crushed! Yields of 10 year Russian bonds soared by 54 points.

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Adding insult to injury has been a rout in Russia’s ruble (vis-à-vis the US dollar). The Russia's central bank, the Bank Rossii has been reported to have sold $10 billion worth of US dollar and raised interest rates. The ruble sank by a record 1.8% last night, bringing back the specter of 1998 as noted by the article.

It’s easy to blame Russia’s military involvement in Ukraine’s political quagmire as possible proximate cause, but as a bank analyst rightly commented "But today's price moves are hardly related to Ukraine exposures. What's happening today is that people are factoring in higher country risks" for Russia”

But the most important issue is; why would a 150 basis point hike spur a stampede out of Russian assets?

Well the answer all boils down a four letter word which the consensus shun at: DEBT

Political and economic uncertainty from Russia’s intervention in Ukraine signifies only a secondary cause or an aggravating circumstance acting as the release valve for what has been a seething buildup of economic and financial imbalances. 

Russia’s predicament has become evident even as early as late January when the Bank of Rossii announced “unlimited intervention” in the face of EM convulsions and a suspension of deposits from a local bank MY Bank.

Then I asked “The question is will this serve as a temporary patch or will this enough to calm Russia’s financial tantrums?” 

Well yesterday’s actions seem to have provided an answer. 

I also noted that Russia’s dilemma—contra mainstream expectation—has centered on resident capital flight. The weakness of the ruble has been a resident, and barely, a foreign instigated dynamic. And the Ukraine political impasse will only compound on this. Because not only residents will see increasing uncertainty as a factor in influencing Russia’s credit quality conditions, foreigners will likely exacerbate on this. Thus the meltdown.

From the same Blooomberg article above:
Foreign reserves fell to a three-year low of $490 billion on Feb. 7, a week after Deputy Economy Minister Andrey Klepach said that capital outflows may reach $35 billion in the first quarter, more than half of the $63 billion that left Russia in all of last year. Reserves have since risen to $493 billion.
So by raising interest rates, the Bank Rossii hopes to stanch the outflows by preempting them. Weak ruble will mean higher rates, so Bank Rossii gave it to them in one shot.

The question now is the how will the hike in interest rates affect the highly indebted entities, including Russian local governments? Will defaults become an issue? Will defaults spread or will they be constained? How will the Russian government respond to such a scenario? Bailouts? Massive inflation?

Importantly, for those in the consensus who thinks that huge foreign reserves, surpluses in current account and balance of trade should function as a talisman against the debt demon, well it appears that in Russia's case such expectations have proven to be a myth. 

A Moscow Times headline noted that Russian banks can easily absorb credit losses in Ukraine
Moody's estimated in a December report that the exposure to Ukraine of four Russian banks — Gazprombank, Vneshekonombank, Sberbank and VTB — was about $20 billion to $30 billion.
Another Wall Street article downplays European Bank exposure on Russian debt
Ukraine's impact on western European banks will be more limited than it would have been in the past, as direct cross-border exposures are less than half their level in 2008, said Elena Romanova, an analyst with Raiffeisen International. Prior to the financial crisis, European banks were chasing market share in what they perceived to be one of the continent's last high-growth markets. However, those banks now hold less than 20% of Ukrainian bank assets.
But such optimistic perspective appears opposite to how the financial markets responded last night.

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European banks, as measured by Euro Stoxx Banks, got crushed also last night down by a terrifying 3.84%.

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Add to this Germany’s major bellwether the DAX was also hammered by 3.44%.

While the above may just be a knee jerk reaction, which I think is not, they serve as a lucid paradigm of the transmission mechanism from the periphery-to-the-core phenomenon.

The end of the EM crisis? Hardly. 

All these represent a process unfolding over time. First, financial market disruption. Next, liquidity squeeze. Then, either financial crisis that leads to economic crisis or vice versa.

All these increasing incidences of emerging market turmoil signifies just an appetizer to the forthcoming global Black Swan event.