History Is Not A Closed Book: MARKET FAILURE or POLITICAL BIAS?

``If one rejects laissez faire on account of mans fallibility and moral weakness, one must for the same reason also reject every kind of government action.”- Ludwig von Mises, Planning for Freedom

Cramming results to mayhem, my apologies for the earlier unedited post.

Media Versus Reality

In our first History is not a closed book series March 12 to 16 (see Filipinos’ “Flawed” Culture? History Is Not A Closed Book) one of the issues we tackled on was the public’s common perception where a “virtuous” government would serve as the proverbial magic wand to save the Philippines from degeneration.

The assumption is, if we put in a saint-like leader, he/she will unshackle us from our poverty bondage and bring affluence to the nation. That is how public’s mindset is shaped by mainstream media in our society.

Part of the propaganda, circulating in the cyberspace, was to show countries with NO resources had attained their prominent status through “virtuous” leadership. The peculiar part was that the countries mentioned as examples are today’s thriving market economies where the domestic political leadership had opted to LEAVE the economic direction to the entrepreneurial “spirits” of their constituents instead of rigid central planning.

In other words, because governments OPTED to become LESS of an obstacle to the society’s economic development, LESS government became somewhat “virtuous”. But of course, less government was NOT indicated, virtuousness was. Such is selective presentation which unfortunately reveals of the political biases of the promoter. (see below The View from AT Kearney)

Where Morality is one’s expectations or perceptions of how government needs to be run, we DO NOT dispute that “virtuousness” is important. However, our contention is that government virtuousness can immensely be achieved ONCE ITS BUREAUCRACY CAN VASTLY BE TRIMMED TO THE BASICS and where GOVERNMENT ADOPTS A MARKET-ORIENTED PRACTICE OR A MARKET ECONOMY.

Once an economy depends on its politicians for direction or quasi-Central planning, it will all be “same dog with different a collar” affair. The more things change, the more they stay the same.

We can’t blame the public for buying up the blather that leadership musical chairs will result to economic recovery. It has been quite apparent that the public’s memory has been very short; we had 3 EDSA revolutions during the last 21 years yet still inhabit on the same wretched conditions; a mostly patron client (semi-feudal) system.

By watching media from an external view, one’s possible impression of the country is a perpetual chaos.

From the inside, having been inundated and constantly bombarded with day in and day out of scandals and intrigues, which is usually a common feature for showbiz, one’s perception is the need for an upheaval to restore some sense of stability. Hence, the persistent “coup” rumors. Even the recent Glorietta blast was imputed to be politically motivated.

While we sympathize with the public on their frustrations, we understand why they have been so desperate as to embrace any plausible rational, although illusionary, for the country’s emancipation from heretofore. Their problem appears to be the limited access to divergent information.

Recalling a recent splendid talk given by a youthful ex-mainstream media honcho who dealt on how technology changes affected the business sphere, he cited an example where media presentations and reality greatly differ. For instance, the Guimaras oil spill in 2006 impressed upon the general public that island had been a disaster zone. However, the emergent power of third generation media, seen through the eyes of the blogsphere or independent “resident” bloggers contested this perception which showed that the spill was insulated. So as traditional media painted the proverbial “mountain out of a molehill” picture, independent bloggers rebelled. Many, according to our speaker, responded in support of such bloggers.

As a result, the wired public has now started to get empowered with the option of having to choose from a diversity of opinions, and not been captive to mainstream thinking. In short, technology has begun to democratize information.

Yes while he likewise pointed out that with the growing worldwide technology diffusion, mainstream media’s role is seen to be gradually diminishing. Unfortunately, this country has been slow to pick up on such revolutionary trend (see below: The View From AT Kearney).

Our point is, for the public to become more empowered by information, it is a requisite for them to try to reach the far corners of the cyberworld and explore the rich availability of information. This should give them a more balanced view of the political economic sphere rather than swallowing hook line and sinker the controversy laden business motive/incentives of mainstream media.

Lastly, many today are talking of “virtuous” leadership possibly arising from the ranks of the church as a future head of the country. We won’t dispute the rights of these advocates, but one must be alerted that if the church ends up controlling the government machinery then such political system would be identified as a theocracy.

Some theocracies exist today as Iran, Saudi, the Vatican (wikepidia.org) and some in the past, e.g. Florence, Deseret, Montenegro. But in contrast to the public’s expectation of an economic Nirvana, theocracies have not been proven to be a guaranteed success, or otherwise such would have been a universal formula. So be careful of what you wish for.

Market Failure or Government Failure?

As we study the functionality of markets, we coincidentally come across observing the evolution of several political economic structures by different countries. Our observation has led us to suggest that market oriented economies have been a common feature of modernizing nations and could be applicable to us.

Recently, our suggestions had been criticized by a member of mainstream media. The critic’s main objection was that because market economies do not achieve equal distribution, they are thus pejoratively labeled such as “MARKET FAILURE”.

Our rebuttal to this is quite simple. The argument is basically a squid tactic, otherwise known as a NON CAUSA PRO CAUSA or false causes, operating under the LOGICAL fallacy of “Cum hoc ergo propter hoc”, or “with this, therefore because of this” or as we always say-correlation does not imply causation.

How? When somebody argues that a system is a failure, or attributes causation to it, because the BASIS OF REFERENCE is that of a correlation to perfection or in this case failed to achieve “equitable distribution” or otherwise economic UTOPIA, then obviously we recognize this to be extremely flawed.

Why? Because, there is simply NO PURE market economy. The fact that poverty or even Money exists signifies IMPERFECTION in this world. Money would not exist in a Perfect world, just ask the hardcore communist ideologue.

Why again? Because Money as medium of exchange represents inequality; under a normal scenario for instance, a baker is not a shoemaker and vice versa hence the uniqueness (inequality) of their jobs entails that their needs of a bread (by the shoemaker) and a pair of shoes (by the baker) be fulfilled via the exchange route based on the terms of exchange agreed upon by both parties. To fill the vacuum of needs money therefore becomes its means of exchange. Note: the above example represents real money, not inflated money for charitable purposes.

Hence, would it not be common sense to say that NO system can be a “total” success in this “imperfect” world?

We can turn the table and apply the same logic; since money and poverty still exists then all systems are hence FAILURES, including those advocated by the critic!

Obviously such blatantly fallacious statements reflect again on skewed biases instead of objective analysis.

Yes, our critic can further cite again “Market failure” as part of the “textbook” academia, but again textbooks are written from the perspective, and not exclusive of the biases, of its authors. Japan’s recent TEXTBOOK row with China is a recent example.

Moreover, textbook themes are usually grounded on what the authorities would like their constituents to learn. To suggest that a theory exists doesn’t extrapolate to outright acceptance or refutation of its universality, just ask Philosopher Karl Popper (Problem of Induction).

As an aside, academics can recite all sorts of “Market failures” mumbo-jumbo technicalities such as externalities, public good, monopoly, information asymmetry or path dependence but this does not again suggest that these are truisms. On the other hand, the laissez faire school of thought led by the Austrian School of Economics has a library rebutting all these.

In essence, while Market failure is a THEORETICAL argument, central planning failure is a FACT, evidenced by HISTORICAL examples of the collapse of the Stalinist USSR and the 180° turnaround from Mao Tse-tung’s China. So the argument that market fails lies on a tenuous ground compared to its obverse alternative, central planning.

Let us take the Philippine setting as one particular example, this excerpt from ADB’s March outlook, as we quoted earlier see History is Not A Closed Book: The View From IMF.

``In the 1950s, a sophisticated manufacturing sector emerged in the Philippines, supported by protection and a well-developed human capital base (Hill 2003). The problems for manufacturing began subsequently. A combination of factors appear to have played a part, including a period of costly and badly directed interventions, a tendency to focus on protecting rents rather than improving efficiency, poor physical infrastructure, and, to a lesser extent than in India, some problems with labor market regulation. High levels of corruption, disputed property rights and difficulties with contract enforcement have also played their part (ADB 2005). These facets of everyday economic life seem to reflect deeply embedded institutional difficulties including high concentration of wealth and a political system based on patron-client relations (World Bank 2005, p.3).”

Let me repeat the litany of misdeeds cited by ADB, curiously a MULTILATERAL institution owned by several governments…

costly and badly directed interventions,
focus on protecting rents,
some problems in labor market regulation,
high levels of corruption,
disputed property rights,
difficulties with contract enforcement,
institutional difficulties and
political system based on patron-client relations

Does this in any small way suggest that there is a so-called market prompted failure during the past 50 years???? Nada, zilch, zap.

As we have always argued, policies REFLECT on markets, instead of the other way around.

Incidentally, the protection of property rights and the enforcement of contracts serve as the cornerstone of ANY well functioning market economy.

By contrast, all of these signify or sum up to P-O-L-I-C-Y or G-O-V-E-R-N-M-E-N-T Failures!

Yet, behind the scenes these are the very same attributes we see intact today. Why do you think the intense obsession by the public to politics? Because economic opportunities are determined by the state and not through market forces! If you don’t have the right connections you can’t get things done…sounds familiar?

So despite all the leadership musical chairs the country had been through, we see same operating inefficiencies, which have led to persistently high costs and low levels of competitiveness hence the low investment levels. Is it any wonder why these persist to reflect on our continuing difficulties? Funny thing is we constantly carp about low investments yet insists to look on the other way.

And the unfortunate part is that markets always to get to be blamed even when they have been to a lesser degree, part of our heritage.

Market’s Social Dimensions and Unspecified Goals

By definition, a market economy, according to Wikipedia.org, “(also called a free market economy or a free enterprise economy) is an economic system in which the production and distribution of goods and services take place through the mechanism of free markets guided by a free price system.”

Since markets basically serve as mechanisms or platforms that allows for the people to conduct VOLUNTARY exchanges, as examples-buying from a fish vendor in the public market, or acquiring an insurance policy from an agent or obtaining a loan from a bank-it is thereby a social phenomenon and has no specifically stated goals for accomplishment.

To add, a free market system allows people accumulate capital and redeploy these to areas of production and services to which bests serves its consumers.

This is unlike a government where it has to face up with specific stated goals usually measured by economic or financial statistical yardsticks as GDP, per capita or etc.

Importantly, government functions to CONSUME private savings or CAPITAL with the purported aim to redistribute, no matter how inefficient or unequal-depending on which interest group gets to the blessings from the incumbent. These social programs eventually have a way of belatedly manifesting itself through the law of unintended consequences. Why do you think gold prices are rising?

As an example, the Philippine Stock Exchange has no specific function to equitably partition wealth or income compared to the Philippine government which has to contend with the demands of its fickle minded short term oriented voters.

One might say that such is an apples-to-oranges comparison but this is exactly the point, the economic direction of a market economy is driven by the aggregate actions of individuals partaking in a system of voluntary exchange or Adam Smith’s “invisible hands” with less participation from the government. The latter being mostly limited to protecting property rights and enforcing contracts.

So based on goals alone, there can hardly be a system “failure” when markets as a social phenomenon are simply avenues for exchanges…unless people stop acting as people.

Prices, in effect, act as a stimulus from which people conduct exchanges and allocate accordingly for their intended purposes. Governments fail when specific benchmarks are unmet.

Market Economies: Uncharitable and A Zero Sum Game?

Then there is the specious argument that markets function similarly to a zero-sum game or the law of the jungle, where the assumption is markets cannot move the economy forward because there would be so many losers in as much as there would be gainers.

Of course this is patently untrue, empirical evidences in our daily lives alone can disprove such assertion.

Maybe we have all seen the phenomenon called Cluster Effect, where same or similar businesses are located in one area healthily competing with one another other. Take Greenhills’ Cellphone Tiangge as an example.

Naturally, there would be losers as some store owners would find such dog-eat-dog competition to be so fierce that it would result to losses and eventual closures to the most inefficient stores. That’s where our critic’s sympathies lie with; the losses of some parties.

On the other hand, stiff competition has allowed the consumers to benefit from LOWER prices, so as with more diversified scope of services. Another, is that these network effects draw in more consumers to the area which effectively reduces their transaction costs (don’t have to scour from places to places), by the allowing them the privilege of having more options. Besides as competition lower prices of goods and services this should translate to more purchasing power. So how bad can that be?

In other words, losses by some have been more than offset by the gains of the general public or the consumers.

Notwithstanding, if such model had been defective outright, then we should see less and not more of these “cluster effects”, instead these privately initiated models appear to be sprouting everywhere!

As Murray Rothbard wrote in Man, Economy and State,

``The free market, in fact, is precisely the diametric opposite of the “jungle” society. The jungle is characterized by the war of all against all. One man gains only at the expense of another, by seizure of the latter’s property. With all on a subsistence level, there is a true struggle for survival, with the stronger force crushing the weaker. In the free market, on the other hand, one man gains only through serving another, though he may also retire into self-sufficient production at a primitive level if he so desires. It is precisely through the peaceful co-operation of the market that all men gain through the development of the division of labor and capital investment. To apply the principle of the “survival of the fittest” to both the jungle and the market is to ignore the basic question: Fitness for what? The “fit” in the jungle are those most adept at the exercise of brute force. The “fit” on the market are those most adept in the service of society. The jungle is a brutish place where some seize from others and all live at the starvation level; the market is a peaceful and productive place where all serve themselves and others at the same time and live at infinitely higher levels of consumption. On the market, the charitable can provide aid, a luxury that cannot exist in the jungle.”

Like the stock market, companies have value added components such as dividends and are notably distinct from the currency market, where when one goes down the other equally reacts in reverse (known as currency pairs). The sad part is that all markets get slapped with the same charges. As for the currency market, they can always serve as hedges.

And as Mr. Rothbard said, aside from the benefits of social cooperation through trade which paves way for advancement, charity can happen VOLUNTARILY coming from excess real savings. So it isn’t simply true that free market is a system for savages.

So if free markets can be charitable, can governments be as charitable as implied by some?

Again from Murray Rothbard, Man Economy and State (emphasis mine),

``The appeal to “charity” is a truly ironic one. First, it is hardly “charity” to take wealth by force and hand it over to someone else. Indeed, this is the direct opposite of charity, which can only be an unbought, voluntary act of grace. Compulsory confiscation can only deaden charitable desires completely, as the wealthier grumble that there is no point in giving to charity when the State has already taken on the task. This is another illustration of the truth that men can become more moral only through rational persuasion, not through violence, which will, in fact, have the opposite effect."

The unfortunate part is to look for all sorts justifications to discredit the markets in order to promote the welfare system which for all these years has been proven to be ineffective.

Yet, in contrast to the pleasantly sounding missions, government charity undertakings in most instances bear the insidious side effects of reducing our purchasing power unknown to many.

The View From AT Kearney

For clarity purposes the following are some empirical evidences from the international consulting firm AT Kearney which expounds on our missives:

Figure 2: AT Kearney: Tiny Countries Trade Big!

The public have been long made to believe that central planning “virtuousness” is the key to the successes or the affluences attributable to small countries with no resources. Instead, we suggested that the responsible factors had been the operating efficiency through open competition and trade, as shown in Figure 2.
Here we lengthily excerpted AT Kearney (ours emphasis)…

``If there is one big factor that many of the most globalized countries have in common, it’s their size: They’re tiny. Eight of the index’s top 10 countries have land areas smaller than the U.S. state of Indiana; and seven have fewer than 8 million citizens. Canada and the United States are the only large countries that consistently rank in the top 10.

``So, why do small countries rank so high? Because, when you’re a flyweight, globalizing is a matter of necessity. Countries such as Singapore and the Netherlands lack natural resources. Countries like Denmark and Ireland can’t rely on their limited domestic markets the way the United States can. To be globally competitive, these countries have no choice but to open up and attract trade and foreign investment, even if they’re famously aloof Switzerland.

``Indeed, economic integration is where these top-performing, tiny countries flex their muscle. All eight rank in the top 11 on the economic dimension of globalization, which incorporates trade and foreign direct investment. Hong Kong and Singapore, the top two performers in this category, leave other economies in the dust. Additionally, the World Bank placed all the high-ranking, small countries except Jordan in the top 25 out of 175 economies in ease of doing business. Jordan, though, ranks first on the index’s measure of political engagement, due to its participation in treaties and U.N. peacekeeping missions.

``And if you’re living in a small country, reaching out beyond your country’s borders may be the only way to find new opportunities.”

Oops! No central planning “virtuousness”, no philanthropy, but just plain “opening up to trade and attracting foreign investments”….all hallmarks of market economies…

Next, as we earlier mentioned, the perceptive resource person we recently listened to, dealt with how businesses models have been rapidly evolving across the globe due to the widespread adoption of technology changes. Again such outlook has been confirmed by AT Kearney as shown in Figure 3.

Figure 3: AT Kearney: Trafficking Information

Again AT Kearney on technology enabled integration,

``An advanced highway system is often credited for the rise of the Roman Empire; goods, soldiers, and tax revenues could move across great distances at remarkable speed for the age. But if all roads once led to Rome, today’s Internet superhighway leads to the world’s most open countries. More-globalized countries tend to have more international Internet bandwidth, a measure of the size of the “pipe” through which e-mail and Web pages cross borders.”

Unfortunately the Philippines is not included in the chart, but since an estimated 6% of the population is wired where only a small fraction of probably around 5% are into broadband connection or about .5% of the population (Businesswire; Sept. 11, 2006) we should be situated around the lowest spectrum.

The idea is, the more wired or connected a country or its population, the more chances of its being part of the economic integration or collaboration with other countries through trade….

Of course we expect that market critics to raise the issue of “digital divide” again. There always has to be an issue where government’s big hand should play a role or risk obsolescence.

But we believe that digital divide, even if it has a slow take up today in the country, will eventually pickup. AT Kearney believes it is one of the key weaknesses of ASEAN countries. If the issue is about affordability then technological advances will clearly compel prices to substantially fall.

Today, Walmart is said to offer $200 computers, comments Bill Bonner chief editor of the Daily Reckoning, (emphasis ours) ``Now every yahoo with $200 in his jeans can read what we write. This is a big step forward for society, too, say the commentators, because now we will have ‘digital equity,’ meaning everyone can have access to all the digital information, news and opinions they want. Of all the crackpot notions to come along in recent years, the idea of the ‘digital divide’ was among the looniest. If you didn’t have access to the Internet, they said, you would be left behind...doomed to live in poverty and obscurity all your life…”

Patricia Yim, managing director of IBM Singapore in 2005 wrote in YaleGlobal “The Blurring Digital Divide” (highlight mine), ``Put it all together. Modern telecommunication is spreading like wildfire - even to areas with little prior contact with the outside world. Falling hardware costs, grid computing and pay-as-you-go pricing options are reducing, if not eliminating, barriers to IT entry. The open source movement is being embraced by developing nations even more enthusiastically than in the West. And with a growing and increasingly well-trained cadre of indigenous IT professionals, the notion of a permanent structural digital divide is fast succumbing to a far rosier reality.”

Privately led technological breakthroughs have far accelerated more than regulations can keep up with. In the financial markets these were revealed through the credit implosion in the US of several securitized instruments as CDOs, CLOs, SIVs and etc.

Next, changes in demographic trends have been one important economic trend which we keep track of simply because these influence savings, investment and consumption patterns. Hence from such standpoint we define our investments criteria and position accordingly.

AT Kearney shows us how globalization affects this trend in Figure 4…

Figure 4: AT Kearney: Urban Outfitted

Again AT Kearney on Urban Outfitted,

``Cities can be a blessing or a curse. Millions leave their villages each year and head to bustling cities to find a better life. But urban centers can also be home to massive slums or sprawl, and the crime, disease, and poverty that come with it. It is generally true that the more urban a country, the more globalized it tends to be. Top-ranking Singapore is the best example; it is 100 percent urban, and its citizens are well educated and relatively affluent. Meanwhile, a less globalized society like Bangladesh is a quarter urban. In fact, less globalized countries often have faster-growing cities. And that is hardly good news. For example, in low-ranking Nigeria, the urban jungle grows by more than 2.5 million people each year. Dhaka, the capital of Bangladesh, was originally designed for a population of 1 million people; today that number stands at 12 million, and demographers predict that the city will be home to more than 23 million people by 2015. Pressures that great can push any city beyond its breaking point.”

Again the idea is, Urbanization works provided an economy is more “globalized”. And it becomes pernicious if such trend is not met with sufficient trade or investments. Naturally if we add the connectivity component, given today’s evolving platform where people can work REMOTE from urban Centers, these trends should slow, which is why we see More globalized countries with slower urban growth.

AT Kearney likewise gives us a profile of an Emerging “Baltic Tiger” in Estonia, which it describes,

``Milton Friedman would be at home in Estonia. That’s because the small former Soviet republic has put many of the late Nobel Prize-winning economist’s ideas to the test. The result? Estonia, having shaken itself free from its communist-era shackles, may now qualify as the first Baltic Tiger; it debuts this year at number 10 in the index.

``In keeping with Friedman’s free-market philosophy, the country’s government has moved aggressively to open itself up to the outside world. For all practical purposes, Estonia has no corporate income tax, and shareholder dividends are subject to a simple flat tax. Bureaucracy isn’t a problem, either; the government just steps aside to let investors do their thing. The World Bank ranks Estonia 17th among 175 economies in ease of doing business, and sixth in ease of trading across borders. Additionally, the government places no restrictions on foreign ownership of real estate, which has fueled a property investment boom among overseas buyers.

``Although the index ranks Estonia 21st in technological connectivity, the country seems poised to pounce higher. The country, dubbed by some as “E-Stonia,” has launched a large online government initiative and even declared Internet access a fundamental human right. In March, it held the world’s first general election that allowed e-voting over the Web.

``Former Prime Minister Mart Laar, who stepped down in 2002, is widely credited with introducing most of the policies that have helped his country roar ahead of the pack. But among his many awards and accolades, one seems particularly apt: the Cato Institute’s Milton Friedman Prize.”

Aside from debunking the allegations of “Zero sum game” and “uncharitable”, these examples from AT Kearney clearly show how market models can transform an economy for the better. Further, personality based politics or “virtuous politics” would greatly be reduced allowing people to focus on productively enhancing their competitive positions.

Finally, the United States had long been a chief proponent of market economies, where according to the US government, particularly the USINFO.State.gov through Mr. Michael Watts (emphasis ours),

``Yet for many, the fundamental principles and mechanisms of the alternative, a market economy, remain unfamiliar or misunderstood -- despite its demonstrable successes in diverse societies from Western Europe to North America and Asia. In part, this is because the market economy is not an ideology but a set of time-tested practices and institutions about how individuals and societies can live and prosper economically. Market economies are, by their very nature, decentralized, flexible, practical and changeable. The central fact about market economies is that there is no center. Indeed, one of the founding metaphors for the private marketplace is that of the "invisible hand."

``Market economies may be practical, but they also rest upon the fundamental principle of individual freedom: freedom as a consumer to choose among competing products and services; freedom as a producer to start or expand a business and share its risks and rewards; freedom as a worker to choose a job or career, join a labor union, or change employers.

``It is this assertion of freedom, of risk and opportunity, that joins together modern market economies and political democracy.

``Market economies are not without their inequities and abuses -- many of them serious -- but it is also undeniable that modern private enterprise and entrepreneurial spirit, coupled with political democracy, offers the best prospect for preserving freedom and providing the widest avenues for economic growth and prosperity for all.

Need we say more?

On Political Controversies: A Little Economic Analysis Can Go Along Way

``All data indicate that the more objectively educated people become today, the more likely they are to trust the state as a means of social salvation. You can map this demographically. The higher the level of education, the more the inclination toward socialist thinking. Why is this? Hayek might say that it has something to do with the hubris of intellectuals who believe that they can concoct a better social order in their minds than the one that freedom can create. Mises might draw attention to the resentment on the part of intellectuals, that they are not as valued by society as entrepreneurs or sports stars. Rothbard might point out that intellectuals are drawn to the state as a way of legitimizing their ideas and securing their financial well-being.”-Lew Rockwell, President and founder of the Ludwig von Mises Institute, the First and the Next 25 years

If the Glorietta 2 blast turns out to be an accident instead of a ghastly terrorist activity, then our observation, which had earlier demystified the political complicity largely sold by politicians and media and bought by the politically obsessed public, appears to have been validated.

Like in the financial markets, this simply shows how the fickle public easily embraces oversimplified explanations to issues bereft of logical arguments. And naturally, when an issue is stripped of the political equation, the public’s attention simply gravitates to the next controversy. Easy come easy goes.

It never ceases to amaze how we never seem to realize of mainstream media’s implicit principal role of SELLING SENSATION, with politicos and their affiliates serving as their feedstock--where the heavily promulgated notion of a “collectivist” political economic renaissance can be seductively acquired from the simplistic exercise of “virtues based governance” or from the leadership “game of musical chairs” or from a bigger “welfare based system”. Since the said solutions appear to be so easy to achieve, isn’t it a wonder why such “appealing” formulas has been paradoxically so elusive…since time immemorial? Yet, for most analysis, selectively choosing on facts to prove assertions on such premises rather than objective appraisal manifests of how we never seem to learn from history or even from developing trends.

For us, any present gains derived from such dynamics are likely to be short-term in nature and illusory. Without the attendant material reforms in the country’s deeply entrenched system of a political “semi-feudal” patronage framework to a culture of entrepreneurship, we are unlikely to see our version of “Shangri-La” or an end to such controversy focused political leadership cycles. Today’s affluent modern nations have existed mostly not due to a single particular leader, but through its economically empowered people. We recall China’s opening campaign transit towards a market economy from a communist regime with Deng XiaoPeng catchphrase, “To get rich is glorious.”

Besides, since it is mainstream media’s business to sell controversies, hence there will always be controversies to be found. Moreover, as information gets diffused via the non traditional channels aided by advances of technology, controversies are likely to permeate to wider range of issues and to flourish even more. Again like in the financial markets, today’s environment can drown you with an ocean of information, yet, what matters aren’t the superficialities of the sensational, but of the substance. Author Steven Landsburg says it best, excerpted from his book More Sex is Safer Sex, The Unconventional Wisdom of Economics (highlight mine)…

``The problem with the news is that it tends to be reported by journalist majors. That’s probably better than letting them design bridges, but it does call for a certain skepticism on the part of the reader.

``Even when the facts are right, the interpretation can be very wrong—especially on hot button issues like racial profiling or outsourcing, where prejudices run deep. If you want to know what’s really happening, a little economic analysis can go along way.”

Phisix and Global Markets: A Momentum Play In the Face of Adversity

``The moment we want to believe something, we suddenly see all the arguments for it, and become blind to the arguments against it."-George Bernard Shaw

We had earlier contended that the market would react with temporal influence from the recent unfortunate Glorietta 2 incident. Unluckily we have not been accorded the opportunity to witness its solitary effect, since a big drop in the US markets preceded a bloodbath in global markets, particularly reflected in Asia, this week. Succinctly put, the 3.98% drop of the Phisix last Monday was seen from the reflections of the Glorietta 2 blasts and most importantly, a ripple from the US markets. It is the latter that has likely impacted the Phisix more than the sordid Makati incident.

Anyway, global markets recovered strongly from Monday but our Phisix ended the week down by .91%. The Philippine benchmark greatly lagged its highly spirited neighbors, such as Indonesia (up 2.37%), Thailand (+2.14%), Malaysia (+2.06%) and Korea (+2.94%) this week, where we cannot yet rule out the potential impact of the last Friday’s incident, as shown in Figure 1. Although, since the authorities have leaned towards the accident angle, media have correspondingly shifted away from the issue to focus on ex-President Joseph Estrada’s pardon which has similarly dissipated analysts attribution of Glorietta 2 incident to market actions.

Figure 1: Stockcharts.com: Buoyant ASEAN indices

What can be factually observed was that foreign selling had stepped up for the second straight week to the tune of Php 2.561 billion, its highest scale since the week which ended in March 2 of this year. Another, the share of foreign participation has been below 50% of the aggregate Peso trading volume for the third consecutive week or about 45% this week. Notably, all these suggest that local investors have taken the drivers seat.

Now since local investors are likely to be politically infatuated than their foreign contemporaries based on the PSE’s previous experiences, then it would be sensible to argue that if the Glorietta blasts had a negative impact then such could have negatively affected the trading activity patterns of local investors, which doesn’t seem so.

Nevertheless, foreign selling has been seen even prior to last Friday, although they doubled from last week. So while these data suggests that the recent activities could have little connection from last Friday’s adverse Makati incident, it remains to be seen if present operatives will continue.

Bullish Premise: Buoyant Region, Halloween Indicator and Strong Asian Currencies

Given that the US markets have closed strongly last Friday, together with upbeat sentiments in ASEAN markets, also seen in Figure 1 where Indonesia ($IDDOW-highest pane below Phisix) appears working for another breakout, Malaysia ($MYDOW-lowest pane) recently brokeout, and Thailand ($SETI-middle pane) at resistance levels, we are inclined to view that the present optimistic momentum could likely continue for the Phisix (main window) barring any shocks.

Further with the Peso at Php 44.06 against the US dollar, a SEVEN year high, where if the recent firming short-term Phisix-Peso correlation should hold, this should augur well anew for the Philippine equity assets.Figure 2: chartoftheday.com: Halloween Indicator

Next, if we take the potential direction from the US markets, the inspirational leaders of global equities, seasonal strength could likely be a force that may support momentum, as shown in Figure 2, where the November to April cycle has been historically favorable for investors. This should likewise support the US presidential cycle which could translate to a positive yearend.

Bearish Premise: Rising Risk Aversion, Worsening US Housing Recession, Narrowing Market Breadth

Nonetheless, we cannot write off the risks which persist to becloud the US economy and its financial markets aside from questioning the health of the global credit system as risk aversion has not been the same as prior to the July Credit Crunch.

The highly reputed independent BCA Research, shown in Figure 3, while maintaining a bullish stance remains equally cautious…

Figure 3: BCA Research Risk Aversion Returns

From BCA Research (emphasis mine), ``Renewed concerns emanating from weakness in U.S. housing, further turmoil in the financial sector and credit markets have sparked a broad-based selling of financial assets. Over the past couple of days, implied volatilities have moved higher, carry trades have begun to unwind, stock indexes across the globe have taken a haircut and government bond markets have rallied. While further downside is probable in the near term, a bear market in risky assets is unlikely: The global economic backdrop remains decent despite a weak U.S. economy, and further monetary easing will be provided. Investors should continue to bet on reflation, but also to expect heightened volatility and a further narrowing in breadth of the advance to persist heading forward, particularly in the U.S.”

And speaking of narrowing market breadth, since the US markets have been strongly up due advances in the overseas levered technology sector, analyst Mish Shedlock points out that the chunk of these advances came from only three stocks see figure 4…

``Of the 400 NASDAQ points we're up this year, 206 came from three stocks. Apple (AAPL): 127, Research in Motion (RIMM): 47, Google (GOOG): 31”

Figure 4: stockcharts.com: Narrowing Market Breadth?

A narrowing market breadth refers to growing divergences in the general market where the advances of an index have been mostly due to select issues. Such deteriorating breadth could be indicative of a maturing bullmarket or could even presage a top.

Nevertheless Mr. Shedlock notes of the high P/E ratios from which the investors have priced in for the recent market leaders: “Google (GOOG): 55.91, Research in Motion (RIMM): 81.39, Apple (AAPL): 52.57”

Reflation Trades And Policy Steroids

Better still, global markets have presently been elevated from expectations of “reflation trades”, where as we had repeatedly pointed out (market on steroids or Dr. Jeckll and Mr. Hyde), each time the financial market undergoes some volatility, chatters of policy actions by central banks have cushioned and stirred up a buying frenzy in the equity markets.

Nonetheless such reflation trades have been quite visible with the record breaking week for the global financial markets as reflected in a record low US dollar, all time high for oil prices and 27-year gold prices! See figure 4.

Figure 4: stockcharts.com: Evidences of Reflation trades

The Euro heavy US dollar trade (upper pane) weighted index continues to decline on expectations that Fed instituted monetary policies will be effected in support of the asset markets while gold (upper pane below main window) and oil (main window) have risen on the account of fundamental demand supply disequilibrium aside from the deterioration of the US dollar.

In addition, the continued strength of emerging markets appears to have been backstopped by rising commodity prices as the Reuters-CRB Index (lower window).

We think that the markets have been manifestly underestimating the potential threats posed by the continued degeneration of US real estate industry to its economy as well as to the global credit markets, which has not fully recovered.

Recently the Bank of England said that its financial system is vulnerable to another shock which threatens to spillover to its economy, from the Timesonline (highlight mine),

``Britain’s financial system is vulnerable to new shocks in the wake of its most severe challenge for decades, and banks and authorities must learn the lessons of the crisis, the Bank of England says today.

``In its first detailed analysis of the squeeze that has engulfed credit markets since the summer, the Bank says that financial institutions have become more fragile and that the availability of credit may tighten. In turn, it sounds a warning that tighter lending conditions could spell serious fallout for the economy, with sub-prime borrowers and highly-leveraged companies particularly exposed.

Similarly the IMF recently warned of the heightened risks of a Global slowdown, from Allafrica.com (highlight mine),

``World economic growth is expected to slow next year, with recent turbulence in financial markets triggered by the fallout from the US subprime mortgage market clouding prospects," the IMF said in the October 2007 World Economic Outlook.

``Risks to the outlook, however, are firmly on the downside, cantred around the concern that financial market strains could deepen and trigger a more pronounced global slowdown. Thus, the immediate focus of policymakers is to restore more normal financial market conditions and safeguard the expansion," the report adds

While remaining long term bullish on Asian equities we think that there is a real risk where volatility could pop out from nowhere and spoil the fun over the interim. Staying completely out seems to be a poor option, unless one believes that the world will undergo a depression spasm. Instead, selective positioning based on one’s risk profile should be considered. Nonetheless, as the markets remain heavily on policy steroids, we will play by the momentum and manage risk accordingly.

Learning From Warren Buffett’s Recent Actions

``Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.” - Warren Buffett

Unlike the average speculator, who prefers mainstream media and general forums as primary sources of information, it has become an obsession for us to improve the way we manage our portfolios by learning on how great investors manage theirs.

So instead of paying a hefty price for a Certified Financial Analyst (CFA) title, which does not guarantee one’s success except for a job at an investment house or financial institution, we try to keep track of materials or developments or analysis of our favorite investing icons on how they deploy their capital while comprehending on the way they approach the financial markets by possibly reading them literally or through their actions.

While we cannot totally assimilate on their investing styles, where like thumbprints our investing patterns are unique from each other with respect to returns expectations, risk profiles, time preferences, value formation and tools utilized to make investment decisions; we can adopt from them some of the positive characteristics as part of our portfolio management.

For instance, we have long noticed that the world’s greatest stock investor, the Sage of Omaha, Mr. Warren Buffett who was once a micro “bottom up” investor have been transformed into a macro “top-down” investor when he became cynical of the US economy, the US markets and the US dollar.

As an example the following are some of his known earlier quotes…``If we find a company we like, the level of the market will not really impact our decisions. We will decide company by company. We spend essentially no time thinking about macroeconomic factors” or ``Betting against America has been the stupidest thing since 1776.”

Today, Mr. Buffett is looking at “macroeconomic factors” as well hedging against America by heavily betting against the US dollar. Recently, one of the revealed secret currency holdings of Mr. Buffett had been the Brazilian Real as disclosed in an interview in Fox News.

In short, Mr. Buffett assumes on the changing conditions of the financial markets with an appropriate adjustment in his capital deployment strategies. So aside from patience, discipline, humility and full appreciation of risk return trade offs, Mr. Buffett’s other strong attribute is his ability to be flexible by keeping an open mind.

Yes, while his flagship company, the Berkshire Hathaway, recently sold their holdings in PetroChina shares with a stupendous gain of over 10 times, his move could have been construed as having yielded to pressures from several shareholders protesting PetroChina’s indirect political exposure to Sudan, through its parent company China National Petroleum Corp, where the African government is accused by the US of supporting the latest incidences of genocide. It is said that Berkshire has retained a very small exposure (about 3.15%) to the company from which would not require much of public disclosure.

Following last year’s $4 billion acquisition of 80% of Israel’s Iscar Metalworking Company and UK based retailer TESCO, Mr. Buffett has been on a spree to acquire about 20 South Korean Companies such as Posco (a steelmaker whose largest export market is in China and Japan), Kia Motors, Shinyoung Securities Co, Dae Han Flour Company and others.

Aside, Mr. Buffett’s acquisition during the last 6 months included 3 railway companies in the US, Burlington Northern Santa Fe, Norfolk Southern Corp and Union Pacific Corp, health care providers as United Health Group and WellPoint Inc., Pharmaceuticals as SanofiAventis and Johnson and Johnson, Financials as Bank of America and Dow Jones and Industrials as Ingersoll Rand (according to Gurufocus.com).

Figure 5: Gurufocus.com: Berkshire Hathaway’s Portfolio Distribution

Berkshire Hathway’s distribution has been weighted towards the financials, since his core business is the insurance unit General Re, and consumer goods, which he finds as easy to understand-ergo in a much better position to weigh risk, as seen in Figure 5 courtesy of Gurufocus.com.

If there are any clues that we can get from Mr. Buffett’s recent activities is that aside from directly hedging against the US dollar via the currency market routes, Mr. Buffett has been steadily building his company’s portfolio’s exposure towards emerging markets especially in Asia.

It is likely that this move could be representative of his first wave of investing forays into the Asian markets and could possibly increase his exposure soon, possibly in Japan and Taiwan, although he has recently warned of the steep appreciation of stocks in China. In effect, Mr. Buffett’s increasing presence in Asia buttresses our position that Asian stocks are in a secular advance phase.

Another, his recent exposure towards the railway business could be construed as a parallel play on commodities which has been levered to global growth. In addition, his recent buys in the pharma and healthcare sectors is a position on the retiring Baby Boomer generation and demographic trends.

In all, this is not to imply that we should copy his investing patterns or mimic on the issues which he positions but rather understand the reason why he has taken such actions. If we agree on the premises of his investing themes then we can act to invest accordingly based on the domestic market’s universe of available stocks.

Glorietta 2 Bombing: A Message In A Box?

``The idealist argument -- that a country that pursues only its physical and economic security will lose its moral foundation -- is not a frivolous argument. At a certain point, the pursuit of security requires the pursuit of power, and the pursuit of power is corrupting. At the same time, pursuing justice without a sufficiently large sword will get you whipped.”-George Friedman, Stratfor

Our deepest condolences and sympathies to those affected by the recent blasts in Glorietta 2.

Coming across the news reports, numerous speculations or accusations had been made as to who or which party has been responsible for such dastardly act. Of course, the easiest part is to fingerpoint, the hardest part is to produce evidence supporting such allegation.

Most of the missions undertaken by terrorists are about political missives or symbolisms which it desires to project or convey to the public or to their constituents. Usually deaths and destructions are merely associate collateral damages or part of the props of which the culprits or perpetrators use to highlight their message.

Take the case of the infamous Sept 11, the said essence of such undertaking was to send a message to some ideological religious factions that the perceived impregnable state of the US was actually “vulnerable” to attack, and simultaneously should have stirred as a rallying point for similar religious ideological upheavals in some parts of the world.

According to Stratfor’s Fred Burton (emphasis mine), ``Among its primary objectives in carrying out the 9/11 attacks was sending a message of empowerment to the Muslim people and sparking a general uprising that would culminate in the rebirth of the Caliphate. While the envisioned uprising did not materialize, it has become increasingly obvious that al Qaeda's message of empowerment and the call to jihad has resonated strongly with some people.

``Another objective of 9/11 was to spark an American retaliation -- a goal in which al Qaeda obviously succeeded. The U.S. invasions of Afghanistan and Iraq have been viewed by many in the Muslim world as aggression against Islam, and for grassroots militants (especially those of Generation Y) this is reason enough to act.”

Put simply, if a mission was specifically designed to transmit a particular message then the underlying tactical operatives had been thoroughly acquired as to signify its context.

Said differently, the targets was not picked out of the blues or by mere randomness, the Glorietta 2 attack was deliberately determined, planned and executed like any high profile terrorist projects over the past years in order convey a particular message directed to a specific audience.

For instance, it took Al Qaeda’s 9/11 about two years for realization. In the same frame, it is highly probable that the Glorietta 2 project had taken some considerable time period for gestation. The implication that anyone could have pulled out such events randomly for specious political goals runs on the lines of politically biased and logically incongruent arguments. If the latter had been the truism then evidently Metro Manila bombings would have been a regular fare or subjected to daily if not weekly bombings.

To the point that if the objective had been simply to scare off investors, then the potential targets could have been instead the Bangko Sentral ng Pilipinas or the Asian Development Bank, the NAIA, Export Processing zones or even the Philippine Stock Exchange.

Or why not Boracay or known beaches or tourism spots where foreigners frequent as the Bali bombers targeted in 2002…if foreigners had been the target? This apparently isn’t so.

Now using the same line of reasoning we ask why Glorietta 2? Why NOT the other malls or marketplaces?

Given the security complacency arising from the recent nonevents, our two cents tells us that these areas had been equally vulnerable if such had been their premeditated goal.

On the other hand, if the objective was allegedly to create a “martial law” atmosphere, then simultaneous terrorist activities all over the metropolis ala the Rizal Day December 2000 irrespective of the quality of the targets would have been more plausible to paint the appearance of concerted destabilization or to portray the inability of the administration to secure the premises of its sovereignty, most especially within its natural domain, the Malacañang. Hence, the required police or military state.

For a martial law planner, the more the incidences, the better, as the degree of casualties won’t be much of a concern relative to the scale of attacks. But this doesn’t look so, as the large number of casualties appears to be part and parcel of the design.

Yet, a one-off event like Glorietta 2 unlikely justifies the “purported” mission. This is not 1972, where communists groups were at the fringes waiting for the opportunity to pounce on the metropolis for control, from which the administration had sufficiently used an alleged internally generated ambush to secure a mandate for 14-year dictatorship. Meanwhile, the residual rabid Communists regimes of today are fast decaying societies so much so that the progressive counterparts have “opened” their economies and culture to a much globalized world. In short, there exists no conditional resemblance to 1972 to rationalize such actuations.

The allegation of employing political diversion is a probable motive but seemingly not a compelling one, unless one has become so desperate as to distort their values to exact tributes of blood from the populace. And this applies to both political camps. Political diversion or destabilization can always come in different forms or avenues without the necessary bloodletting especially from the vulnerable public, from which we ask anew why Glorietta 2?

Lastly we must not forget that the executioners of the plot are risk takers, in other words, success of their mission depends on the continued secrecy and the effective precision implementation by the participants involved in exchange for a desired goal.

As risk takers they require calculated action. And perhaps these incorporates operational procedures such as detailed planning, surveillance, logistics and resource mobilization, role modeling to actual execution. Any miscues would have given them away to the web of intelligence of the authorities or to the mall securities. A single deviation jeopardizes the entire project or diminishes the efficacy of their mission.

This runs in contrast to the common perception brought about by media reporting-bombers don’t just walk into malls and casually explode themselves to thy kingdom come. These are not suicide bombers. Nor do they walk in liberally unchecked by the security to deliver their package and leave. That would look too easy and would be seeing these happen all too frequently.

Nonetheless, it is unlikely too that such misdeed could represent as vindictive action against the owners of the property. The risks and logistics involved are simply too high in order to attain an “emotional/egotistical” outcome.

Of course, we could be wrong about all of these. But the likelihood is that the architect/s of such despicable act is one/are those that bears some malevolent ideological underpinnings against the local elite from which their message appears to be directed at. As to what benefits was gained or would be gained is simply beyond us for now.

But as the recent event shows, politics like the markets appear to function somewhat similarly in the sense that people can easily attribute causes to events to the point of absurdity or incredulousness.

Glorietta 2: Event Driven Reactions Are Short-Term Oriented!

``Prices are not driven solely by real-world events, news and people. When investors, speculators, industrialists and bankers come together in a real marketplace, a special, new kind of dynamic emerges-greater than, and different from, the sum of the parts. To use the economist terms: In substantial part, prices are determined by endogenous effects peculiar to the inner workings of the markets themselves, rather than solely by the exogenous actions of outside events.”- Benoit Mandelbroit, The (Mis) Behaviour of Markets

The public tends to equate bombing incidences to affect the markets negatively. While in many instances such observations have proven to be accurate, the connections have not been CATEGORICAL.

For instance, the December 30, 2000 or the series of “Rizal Day” bombings, which resulted to 22 fatalities and over 100 injuries, the Phisix reacted with a 3% decline during the following trading session.

On the other hand, the much deadlier February 27^th Superferry bombing which according to wikipedia.org had been the “worst” terrorist attack in the Philippines that accounted for 116 deaths, was largely ignored by the markets; the Phisix even registered a marginal gain of .8% during the next trading day!

We see the same reaction across the globe.

In October 12^th 2002, the bombing of Indonesia’s tourist haven of Bali killed 202 of which 164 were foreigners, saw its main benchmark fell 10.3% in the next session. Madrid’s March 11, 2004 coordinated bombing in its commuter train system which accounted for a death toll of 191 and over 2,500 injuries, also suffered 3.5% loss the day after.

Just last Thursday, a day prior to the unfortunate Glorietta 2 incident, Pakistan’s former Prime Minister Benazir Bhutto’s return from exile was met by suicide bombings which claimed 133 lives. Meanwhile, Pakistan’s Karachi 100, which had been on a sizzling hot winning streak, simply shrugged off the event to even post a measly .2% advance on Friday.

As a possible clue to how the local market would respond, the Philippine Peso had enough time to reflect on last Friday’s day of abomination, since the bombing occurred at around 1:30-40 pm while the domestic currency market closed at 4:30 pm.

The USD-Peso opened higher at 44.15, compared to Thursday’s 44.05 closing. In the wake of the Glorietta 2, the Peso stormed to a high 44.355 but eventually closed at 44.24 or .4% higher than Thursday. In short, while such terrorist actions negatively affected the markets as a knee jerk reaction, such events tend to get DISCOUNTED going forward.

Figure 1: Previous Bombing Incidences and the Phisix

In Figure 1, the previous bombing encounters, marked by the green arrows, shows of the disparate reactions by the Phisix over different time frames, the purpose of which is to prove the LASTING effects of the perceived “event” based determined market reactions.

The 2000 Rizal day bombing saw a one day decline, but surged over the quarter following Ex-President Estrada’s ouster, and massively declined going to the end of the year (down by about 37%).

In contrast, the February 2004 Superferry bombing registered slight one day gains, was mixed over the quarter but was significantly higher at the end of the year (up over 20%).

No, Rizal day’s bombing was not the causative agent for the year end decline of the Phisix. By looking at the big picture, one would understand that the 2000-2002 as the LAST LEG of the Phisix BEAR market cycle which COINCIDED with the decline in US markets and its ancillary economic RECESSION. The Rizal day bombing was an unfortunate incident that was eventually glossed over by the market.

A similar reaction can be viewed from the US. The infamous 9/11 2001 incident occurred when its markets had already been cascading, this we discussed in our September 17 to 21 edition (see Comparing Past Outcomes From FED Actions Is A Gambler’s Fallacy). The shocking event aggravated the prevailing dour sentiment and steepened the market’s decline instead of prompting it.

Incidentally, both markets (US and the Phisix) bottomed in late 2002 to 1^st Quarter of 2003 and interestingly, rose almost synchronically until recently.

The same dynamics goes with 2004 Superferry incident; the year end gains had been confluent with the STRENGTH in the global markets. All the negative reactions arising from the bombing incidences of Bali or Madrid or the rest of the world have proven to be BUYING opportunities since all of the equity yardsticks had been significantly higher today relative to the occurrences of such incidences simply because global markets have surged!

True enough, while the odds are strongly tilted in favor of a significantly lower Phisix (give or take 3% down) on Monday’s opening, or of any markets subjected to terrorist’s activities, the dominant sentiment which will determine long term investor returns will be established by much larger and far more complex factors than simply than the aftermath of Glorietta 2.

Unless one is privy to the plans by criminal perpetrators, no one can accurately predict when such events will happen and correspondingly take requisite actions. A rational investor would instead ascertain variables which should determine the longer horizon of the market’s direction rather than ridiculously attempt to “time” the markets over the short run. In short, investors should weigh on the risk-return tradeoffs in determining their decisions rather than be held hostage to emotional vagaries.

Lessons:

1. “Events” based market reactions are largely knee jerk reactions and dissipate over the longer period.

2. The markets have NOT been EVER been SINGLE variable determined over the broad picture. While one factor (as events) could outstrip the others into influencing the short term activities in the markets, many long term variables determine directional flows of the each of the markets (currency, commodities, bonds, stocks etc.). Paraphrasing Warren Buffett mentor Ben Graham, over the short term the market is a voting machine, over the long term a weighing machine.

3. Investor’s returns are determined by the appreciation of and corresponding action in terms of long term cycles and trends.