Why Forcible “Free Texting” Will Only Lead To Increased Poverty

``Congress, devoutly promise that all their actions are based on good intentions. But it doesn't matter: bad ideas regarding the nature and role of government breed bad results and suffering occurs nevertheless. Twisted logic, Machiavellian justifications, excuse making, and short-run benefits can never justify the removal of one iota of liberty from any one person if we intend to live in a free society.” US Congressman Ron Paul, The Economics of a Free Society

People always ask why the Philippines remain “poor”? Our reply has been “because of the lack of respect of markets, the dearth of economic common sense, the dependency culture, political hubris and the incessant pandering by authorities to buy public opinion through government intervention”.

``The problem is not that supply and demand is such a complex explanation. The problem is that supply and demand is not an emotionally satisfying explanation. For that, you need melodrama, heroes and villains”, wrote Thomas Sowell. And melodrama is what has prompted for the recent “Free Text” ruction, where in essence this is all about PRICE CONTROL.

Because of the huge profits accrued, domestic telecoms companies have been portrayed by some public officials as “villains” for not providing text messaging services for free. The assumption is that telecom companies have undeservingly been making huge profits at the “expense” of consumers (the “victims”) something analogous to taxation. Thus, the soi-disant “heroes” threatens to impose redistributive “justice” by compelling these “greedy” firms to make good free text messages as part of “social” service….or else!!!

The Survivorship Bias and Earnings Cycles

English novelist George Orwell once wrote, ``Power-worship blurs political judgment because it leads, almost unavoidably, to the belief that present trends will continue. Whoever is winning at the moment will always seem to be invincible.”

Thus before passing any generalization it would be best to examine the facts behind the issues.

For starters, the telecoms industry is a capital intensive industry; it requires Billions of Pesos in capital investments for its infrastructure rollout to be able to operate.

Yet the public or our so called “heroes” DO NOT SEE or REALIZE that the huge sums of investments DO NOT automatically GUARANTEE profits. This is why it is called as RISK CAPITAL. Nobody puts at risk his or her capital without the attendant expectations of profits or return on investments (ROI). If a venture goes wrong, investors LOSE equity, on the other hand, if they are right they deservingly REAP profits. So there is ALWAYS a TRADEOFF.

In the same way, even if the domestic telecom industry have been earning today, this DOES NOT GUARANTEE that they will NOT LOSE tomorrow or sometime in the future. Risk taking endeavor is always an ONGOING DYNAMIC because the challenge is the future. Yesterday’s performance may or may not be the same for tomorrow. The past has been perfected, but the future still needs to be ascertained.

Unfortunately people and those in power simply don’t understand this. They are skewed to only see the profits and NOT the ACCOMPANYING RISKS (called survivorship bias-the fallacy of seeing winners only), hence makes a bigoted issue out of these.

It is not always cloud 9 for the industry.

Figure 1 Ed Yardeni.com: S&P Telecom P/E Ratio

As an example, figure 1 courtesy of Yardeni.com shows of the Price-Earnings Ratio of the US S&P 500 Telecommunication sector. As you can see, the PE ratio peaked in 2000 and collapsed by more than half as the dot.com bust unraveled. This shows of how investors paid exuberantly for share prices of telecom issues in 1998-2000 in the EXPECTATIONS of the continuity of astronomic earnings growth seen in the recent past (early 90s). When reality sunk in, where expectations did not match with real earnings, prices retrenched. Until now or eight years from the pinnacle, the price earnings ratio of the US telecom companies remains depressed!

So huge profits are a permanent fixture for the industry? Think again.

Remember, earnings growth in any industry undergoes cyclicality. For instance, the wireless segment of the telecom sector, the biggest earnings revenue contributor today, is likewise subject to the innovation cycle (innovation, growth, shakeout, maturity and end phase).

As the cycle segues from rapid growth (today) to the maturity phase, the explosive pace of growth will eventually slowdown to match or track the pace of the country’s economic growth or GDP. It can only manage to sustain such extraordinary levels of growth if it is able to introduce more revolutionary innovative products which consumers will patronize. But then again, that is a risk which the industry has to bear with by spending largely for its research and development.

Telecom’s Success Formula: Competition

Another, the telecom industry operates under a deregulated environment. This means that industry firms would have to STIFFLY COMPETE among each other to be able to attract enough subscribers in order to recoup on their investments and eventually earn from it.

And how do they do that? By offering BEST POSSIBLE SERVICES at the MOST AFFORDABLE PRICES.

As the “Text capital” of the world, we are said to have been privileged with the lowest “texting” rates in the region. From the Philippine Star, `` [Globe Telecom senior vice president Rodolfo Salalima] Salalima also emphasized that the Philippines has the lowest text messaging rates in the region. Because of the various promotional campaigns being offered by local telcos, particularly unlimited texting, text-messaging rates in the country have gone down to as low as 13 to 14 centavos per message.

``This rate, he stressed, is extremely low when compared to India’s 61 centavos per text message, Malaysia’s 67 centavos, Indonesian Extelcomindos’ P1.18 per message, China’s P1.55 per text, and Hong Kong CSL’s P15.91 per message.”

Meanwhile, the penetration levels for domestic mobile have reached 51% or some 46 million in early 2007(marketreserach.com), which means more than half of the population is now connected.

Yes, the success to spread connectivity in the country today is principally due to intense competition, which has immensely LOWERED prices and thus added subscriber volume or by expanding coverage.

Economics 101 tells us that if you want more of anything you simply lower the cost and if you want less of anything you increase the cost. But as a caveat this important insight from Mr. Jeff Bezo, Amazon.com’s CEO, ``Lowering prices is easy. Being able to afford to lower prices is hard", which alternately means lowering prices has its limits. You can afford to lower prices enough to keep some profits to ensure the survivability of the company.

And this has not been an isolated or a Philippine only phenomenon but a global one as shown in Figure2.

Figure 2: ITU: Global Mobile Industry has been Powered by Competition

Where monopoly once dominated the telecom industry today competition has taken over. Because of competition which brought upon affordable pricing worldwide, in 2007 mobile the penetration level have exploded to around 49% or some 3.3 billion subscribers (news.com.au).

Enormous Capital Investments Need Huge Earnings

It does not end here.

Because the industry is technology laden, this means that it would require CONTINUOUS ACCESS to risk capital in order to EXPAND CAPACITY (think nationwide coverage, reduction of dead spots, reduced time lags from message sending to receiving, international roaming et. al.), UPDATE/UPGRADE TECHONOLOGY (think Multi-media messaging, 3G) or to INNOVATE (think WIMAX, IPTV) its infrastructure or to even CUSTOMIZE PRICING (think unlimited texting or calls) for the very same purpose of attaining viability of the project by offering QUALITY and EFFICIENT SERVICES at AFFORDABLE PRICES to attract MORE subscribers and earn profits from it. As earlier mentioned it has to also spend for considerable investments on RESEARCH and DEVELOPMENT.

Not only that…billions of Pesos of existing infrastructure is similarly subject to OBSOLESCENCE RISK-where the risk to infrastructure or extant technology becomes obsolete or outmoded!

Figure 3 Ray Kurzweil: Moore’s Law

Figure 3 from futurist Ray Kurzweil shows of how technology propelled innovation have accelerated exponentially or the “S” Curve. This means that technology based companies like those in the telecoms will have to be nimble enough to adapt to the swift advances in technology or lose subscribers and money.

In short, HUGE PROFITS are thereby REQUIRED for the UPKEEP of the capital intensive system of the telecom industry to ensure its survival. Nonetheless, what needs to be further stressed is that such profits are never guaranteed and is never static since it breathes upon the patronage of fickle consumers! Consumers like voters can easily change preferences for whatever reasons.

Consumer Sovereignty and Patriotism as Refuge of Scoundrels

When consumers subscribe to a company’s service (post paid or pre paid), this is because of the perceived satisfaction or utility derived from the services offered. They are done VOLUNTARILY and NOT BY FIAT. Consumers always have the option to terminate or transfer to other firms offering similar generic services (or more) because they see it fit according to their interests. This is called consumer sovereignty. It is unlike taxation which derives revenues by FIAT or decree. By the same token it means that earning by risk taking and earning by coercion are TWO different animals.

It is obvious that the failure to understand the dynamics of the industry is by itself a manifestation of grand myopia. Thus, the projection of the “immorality” of profits is totally unwarranted, unjustified and unfair.

Yet while pretending to serve for the best interest of the populace or consumers, this propaganda or threat to intervene via price controls actually seems more of a camouflage for punishing them.

The threats to compel free text messaging signify irresponsible statements which are wantonly absurd and have far reaching dire unintended consequences. The unfortunate part of government intervention is- “they make the rules, we the nation suffer from it”.

What possibly happens when such policies gets implemented?

Since text messaging for the telecom industry today is a MAJOR profit center, it will shift to a COST CENTER or at worst transform into a SUNK COST.

Stated differently, the telecom industry’s incentives will be overhauled overnight. Companies will either (at best) marginalize on improving on the cost center subject to subsidies from HIGHER PRICES of other services (higher toll fee for wireless, landline, data and other services) or look for other sources of revenue center (maybe via a shift towards content subscription) or (at worst and most likely path) totally ABANDON the text services altogether.

In the private sector, a nonprofit cost center can only exist when it indirectly contributes to other sources of revenues. (Think GOOGLE-it provides free search engine as a come on in order to generate significant traffic volume from which attracts advertisers-the company’s main revenue source). However, if the cost to maintain the cost center exceeds the profit potential from its major sources of revenues then it bleeds the overall operation of the company which leads to imminent closure.

Plainly said, the revenues lost from text messaging will now be recovered in the form of HIGHER prices of OTHER services. If they are not able to do so, you can kiss text messaging goodbye.

Think of it, who in the right mind would spend tens of millions or billions of capital to upgrade the network if it is non-revenue generating anyway or if it does not compliment to revenue generation?

Remember, this is NOT a government bureaucracy which can afford to subsidize one sector. In the market, revenues are derived from VOLUNTARY exchanges. In government, revenues are derived from seignorage (money issuance) or taxation-which comes out of compulsion as a subject of the state. In short, taxation is predatory-people don’t have the LEGAL option to say NO to taxes, except by tax evasion or smuggling which is punishable by law.

Put differently, in the market, people have the power to say NO to poor services by voting with their money. In government, people are NOT empowered with the same privilege. Instead we will have to bear with the inadequacy of public services because it is imposed by edict.

So applied to price controls, the choice would be having jerrybuilt or substandard services (think severely delayed text messages which may take hours, days, weeks to receive-if at all) or none at all! Besides, anything free could mean an exponential rise in usage which may vastly exceed the network capacity (systems overload) of telecom firms and thus heighten risks of a network system crash!

Moreover, because of reduced earnings, companies in the embryonic stage or with razor thin margins will simply vanish due to insolvencies.

All these combined, you can be guaranteed of even more HIGHER rates for the other residual services from the remaining service providers!

As Ludwig von Mises wrote, ``If the government fixes a maximum price for certain commodities below the level which the unhampered market would have determined for them and makes it illegal to sell at the potential market price, production involves a loss for the marginal producers. Those producing with the highest costs go out of the business and employ their production facilities for the production of other commodities, not affected by price ceilings. The government's interference with the price of a commodity restricts the supply available for consumption. This outcome is contrary to the intentions which motivated the price ceiling. The government wanted to make it easier for people to obtain the article concerned. But its intervention results in shrinking of the supply produced and offered for sale.”

Because reduced supply from policy initiated incentives equals higher prices, price controls do more harm than what is intended.

At the end of the day, the road to hell is paved with noble intentions. Free text messaging equals no text messaging and or higher cost of other communication services.

On the other hand, the only more viable way to bring down prices is to liberalize the industry or open it to MORE competition as shown above.

Aside, our authorities have another option of reducing prices: REDUCE TAXES but with CORRESPONDING DEDUCTION IN SOCIAL SPENDING. Our glib talking politicians should not only vent on the industry but should look at their own bureaucracy as a source of savings. They should consider giving back to the people their wasteful and inefficacious boondoggles in the form of pork barrel!

Nationalization Next?

So once interventionism creeps in, what’s to stop the government from going further?

The next step would probably be to put a cap or ceiling on prices of the other sources of revenue sources. This should translate to humongous losses and lead to industrywide foreclosures.

In the same manner if the government compels companies to operate free text services by bleeding them dry, the industry would simply allow itself to be taken over.

Hence, government completes the transition by effectively “nationalizing” the industry.

By nationalization, government would need tons of capital from which would come from taxpayer funding. Remember, the lifeblood of this industry requires recycling of huge capital. The assumption that government can manage the monopoly profitably is wishful thinking given its horrible track record and its LACK of resources.

As a political entity, the cosmetically rehabilitated state owned company will only be an endemic source for political appointments which will be hobbled with incompetence, abuse, corruption and other forms of capital allocation inefficiencies. It will be another potential cow to milk at the expense of consumers.

If the company will offer mobile services (at subsidized rates) under subsidies from the national government, losses accumulated will be charged to the unfortunate productive taxpayers, whom will bear the brunt of higher taxes and or higher costs of living.

If they should charge for services, given the monopoly and inherent inefficiencies, whatever services will be paid for will be at VASTLY greater prices than what it is today even at the face of dysfunctional or shoddy quality of services.

Thus, your free text becomes both a DIRECT and INDIRECT tax to consumers!

In a world where technology has helped improved the lives of people by increasing communications, connectivity, interaction and business transactions and trades by lowering costs, price controls and unnecessary intrusions by government will undo these progress. We are likely to materially slowdown, if not regress.

Ultimately all these should lead to immense lost productivity, loss of competitiveness, loss of investments, capital flight, loss of jobs, higher taxes, higher cost of living, lower the standard of living, a more intensified corruption and worst of all increased poverty.

Politics Likely A Factor-“Flexing Political Muscles”

The incumbent President is an economist, so we are inclined to believe that she is very much aware of the negative repercussions from the derring-do actions of her subordinates, unless she is a closet hammer and sickle bearing ideologue (which so far enough hasn’t been the case).

That said, it is likely that the administration could be seen as “flexing its political muscle” as a demonstration of strength that it is still a power to reckon with even as her tenure approaches the twilight (or the projection that the administration is not in a lame duck state). This is especially directed to whom she perceives as her political opponents. (Yes some of the supporters of her adversaries are stalwarts from the industry).

Yet political maneuverings will do us no good by signaling to investors of the country’s vacillation to sanctify contracts and or uphold private ownership rights. Moreover, it is this kind of interventionist culture that inhibits a market economy from flourishing, aside from the perpetuation of the state of corruption.

As the illustrious economist Milton Friedman once said, ``There is no such thing as a FREE Lunch! To paraphrase, ``There is no such thing as a workable forced free texting!

As a final thought and disclaimer, my perception of the industry is one where it has been cherry picked or where the “low hanging fruits” have already been harvested. The rapid growth phase seems likely to transit into a mature phase which should grow in line with the economy over the coming years. Thus the performance of the telecom sector should reflect the growth of the Phisix than massively outperform as in the past, in my view. As a market participant who aims for “growth” and unpopular “value”, the industry has not been much of a priority, which means I DON’T OWN any telecom issues as of this writing.

Phisix: Plagued By Domestic Politics

``The interventionist doctrinaires and their followers explain all these undesired consequences [of government intervention] as the unavoidable features of capitalism. As they see it, it is precisely these disasters that clearly demonstrate the necessity of intensifying interventionism. The failures of the interventionist policies do not in the least impair the popularity of the implied doctrine. They are so interpreted as to strengthen, not to lessen, the prestige of these teachings. As a vicious economic theory cannot be simply refuted by historical experience, the interventionist propagandists have been able to go on in spite of all the havoc they have spread."-Ludwig von Mises, Human Action

One of the risks we mentioned in today’s marketplace, aside from external recessionary environment, is domestic political risk.

Considering that foreign money has not been much of a driver of late, the Phisix has been subjected to mainly domestic sentiment, which has gyrated from the flux of events dominated by politics as the inopportune MERALCO affair.

Political Grandstanding Amidst Global Inflation

While external markets have mainly recovered from the other week’s selloff (see figure 4), the Phisix closed .77% lower over the week weighed by the seeming “tightening of the noose” by government officials on the marketplace as seen in the sordid Meralco imbroglio aside from the “free texting” and Banking industry’s forex deals.

Figure 4: stockcharts.com: Phisix versus the World

As we have repeatedly noted, the rising prices of consumer goods and services have spurred officials to do “something” in the face of public pressure if not as a deflection from controversial issues surrounding the administration. Essentially officials have vented the blame on public utilities for such dilemma.

Our public officials have not been forthright though; in an interview over an international business network we even hear the chief of our central bank claim that “inflation pressures” arose from “supply shocks”. This isn’t exactly the picture.

Like the rice crisis, these supposed “shocks” have been exacerbated by knee jerk political reactions (e.g. restriction of exports by surplus food producers or panic buying from the Philippines abroad) than the genuine causality. To date, since the rice crisis emerged, there has been no indication of a rice crisis for the commercial rice, but in the past-on NFA or government subsidized rice level. What was featured as a nationwide crisis in media was certainly true for some areas but not all.

Figure 5 ino.com: July Rough Rice

Of course, since many governments have now regained their composures and tempered their trading curbs aside from supply side responses to high prices in terms of more harvests (Bloomberg), rice prices have moderated (see figure 5)—for now.

With a sharp correction in major commodity prices this week, it is likely that goods and services inflation will probably have a “reprieve” in the coming weeks or months. But it is highly unlikely that these inflationary trends will meaningfully subside given the penchant for governments to “socialize” under the present landscape.

However, the fact is every part of the world today has been experiencing “goods and services” inflation, even among developed countries suffering from a credit squeeze due to the recent housing industry bubble bust. This means that goods and services inflation has basically been IMPORTED and not simply due to a domestic/global “supply” shock. Rising demand from emerging markets as China and India represents similarly a “demand” shock.

What policymakers have eluded to say is that monetary (monetary pegs, negative interest rates, bridge liquidity provisions for the credit affected financial sectors in the developed worlds, currency debasement or “competitive devaluation” programs in emerging markets) and fiscal policies (subsidies, high taxes and tariffs, trading curbs, non-transparency, nationalization, et. al.) have severely distorted the functions of price discovery, price transparency, pricing efficiency as allocators of resources in the marketplace, pushed a tsunami of money into the financial system, which has been finding a refuge at hard assets, where others superficially interpret as “market fundamentalism”, a.k.a. speculation.

Yet because most people don’t understand what is truly going on, for simplification purposes, somebody or some entity would have to take the blame.

This means that the first line of assault would be on the public utility providers, where “profits” are scrutinized and condemned as “unjust” and contributing to “inequality” and “poverty” thus requiring redistribution. Bolivia is an example of this recent movement, as it recently nationalized energy and telecom companies. Could we be smelling the same pattern here?

The popular notion is, if you squeeze public utility operators of profits or “nationalize” them, prices of basic services will go down. Baloney. Yes, this will happen over the short period of time. You can party for as long as the booze will last, but not when it gets depleted.

The basics is that the government can only afford to “subsidize” for as long as the revenues it gets is enough to compensate for this, which is the same as saying picking from taxpaying (productive) Pedro and doling out to non-taxpaying (non-productive) Juan. The problem is that the source of looting is limited while the demand for financing is unlimited.

The key question now is “Can a country’s productive sector permanently sustain a non productive sector?” The obvious answer is no. Eventually the country which undertakes heavy socialization or welfare programs will pay for the political mountebank when it enters into a financial crisis or sees its standard of living decline.

That’s why politics is always about short term convenience at the expense of the long term pain. The fundamental problem is that the public is easily directed away from the true causes.

A Snippet on Meralco’s Controversies

Energy issues have been taking the brunt with monopoly distributor Meralco down 3.91% over the week (down 25% from the week ending May 2^nd), aside from First Philippine Holdings (14% w-o-w) and Petron (10.53%-it’s a wonder if foreign investors are now anticipating a political spillover to this issue).

Fortunately enough, the strong performances in Friday ended the week positive for telecom issues and banking issues (led by Banco De Oro up 7.45% and Union Bank up 11.11%-could some prospective deals be brewing between them?).

As for Meralco we have not scrutinized on the nitty-gritty of the ongoing controversy but have construed the recent developments as possibly emanating from the following motivations:

One, a political retribution or a ruse to engage a vocal supporter of a well entrenched political adversary or

Two, an attempt to sidetrack the controversies surrounding the recent government scandals by redirecting the public attention to “goods and services” inflation by effectively focusing on utility providers as culprits, or

Three, a possible economic opportunity for certain interests group to wrest the management in order to benefit from the ongoing changes under the Electric Power Industry Reform Act (EPIRA) in the power sector. As a distribution monopoly, grabbing hold of this strategic network by any of the power producers ensures of a captive market.

Lastly, a combination of any of the three.

What are the major points of contention we can observe of in the corporate dispute:

-Take or Pay provision, a derivative of the 1993 Electric Power Crisis Act of the Ramos Regime which is the source of the wrangling over the charging of system losses.

-Royalty taxes and VAT charges

-alleged conflict of interest from cross ownership

So essentially you have a technical LEGAL spat over a government monopoly franchise operating under an intensely regulated industry.

Since the Lopezes have not been cordial or in good graces with the administration, the present environment of rising good and services inflation makes them susceptible targets for politicking.

But of course, other tangential concerns have brought upon by left leaning groups as;

-Subsidies
-market abuses from operators
-regulatory capture or regulators overwhelmed by those regulated
-corruption
-high rates required to sell Napocor assets
-“high prices breed inefficiency”

…our unsolicited comments;

-subsidies-see above
-market abuses (because of the monopoly), corruption and regulatory capture (the latter two are intertwined-regulators get controlled because they can be bought) are principally offshoots to overregulation. They represent the symptoms and not the cause.
-high prices in itself do not “breed” inefficiency but reflects on demand and supply even if they have been contorted with misaligned or skewed policies (e.g. high taxes) or lousy management. Simply said, high prices are the result of accrued inefficiencies. High prices DO NOT create, breed or foster inefficiencies; policies do. You put the horse before cart, and not the other way around.
-high rates needed to sell NPC assets accounts for a slippery slope argument. Investors invest because of the attractiveness of returns relative to risks not because of high prices. High prices do not guarantee returns. It’s the net margins or the ROI that counts!

Yes while a new management maybe able to trim down rates to achieve so called “efficiency” (which is highly doubtful), the fact that our problems is basically one of “imported inflation” ensures that over the long term energy prices will continue to rise unless:

One- demand destruction overtakes the global economy via ‘stagflation’ or

Two- alternative energy or unconventional energy sources will be able to generate sufficient economies of scale to overhaul the energy dynamics of the global transport and energy consumption infrastructure.

Three-policies will be undertaken to remove excess liquidity in the global financial system (meaning a policy induced recession)

Next, for the local energy sector, I’d like to give the EPIRA a chance to be fully implemented compared to a centralized energy policy since 1972 (Presidential Decree 40 - “Establishing Basic Policies For The Electric Power Industry”), where Napocor’s unwieldy P 600 billion debt should be enough lesson for us.

Risks of Owning Public Utilities

Figure 6: PSE: Industrials Taking the Heat

Of course, the major risk of owning “sensitive” public utilities today is that political powers will probably use them as scapegoats to pass populist policies which should be detrimental to the industry or to the society. The least is to harass them for publicity purposes as we might be probably witnessing today.

Figure 6 shows how the PSE Industrials have been buffeted by political volatility (aside from the recent bearmarket pressures) and is seen in a continued downdraft, where Meralco (26% of the Index) and other energy and public utilities are benchmarked. Overall the Industrials have been a sizeable drag to the “recovering” Phisix.

Besides, the risks of nationalization or instituting price caps or government takeover are enough reasons to dissuade foreign investors from owning these issues, even if it were just mere rhetoric. The problem is that it could be seen as an attempted assault on private ownership rights which tarnishes our credibility and takes sometime to restore.

Of course we don’t discount that there is a possibility that all these could also signify tactical moves of a facelift poop and scoop operation where investors flee from anxiety while giving entry opportunities for those fostering such scenario.

But on the contrary, we also understand that a declining Phisix isn’t a good reflection for the administration (especially if world markets begin to markedly advance) which habitually likes to take credit or bask in the glory of its past successes.

This means that if the Phisix will lag the world because of continued politicking, the meddling into these industries might suddenly or surprisingly fade! But this is being hopeful.

Important Disclosure:

This is not to say that you should own or not own public utilities shares. Instead, this is to evaluate on the risks of owning public utility shares given today’s “inflation” driven politicized environment. It represents risks or opportunities to gain from such risks. This is a market critically dependent on the path of government action.

Besides, not all of the public utilities share the same or equal measure of risks.

Writer owns shares of First Gen (FGEN).

If Oil Is A Bubble, Then It Is A Government Sponsored Bubble!

``The economic hardship, of which we had a taste in 1981 and 1982, will be much worse. That in itself is bad enough news, but historically, when a nation debauches its currency international trade breaks down — today 40 percent of international trade is carried out through barter — protectionist sentiments rise — as they have in Congress already — eliciting hostile feelings with our friends. Free-trade alliances break down, breeding strong feelings of nationalism — all conditions that traditionally lead to war; a likely scenario for the 1990s, unless our economic policies and attitudes regarding government are quickly changed.”- Congressman Ron Paul, The Economics of a Free Society

Are Oil and Commodities In A Bubble?

Oil prices dashed to a phenomenal record at $135 per barrel and many have screamed “BUBBLE”!

By definition a bubble means assets or securities priced far from its perceived “fundamentals” or irrationally and impulsively driven by excessive speculation.

The stated reasons for the commodity “bubble”: forced short covering from miscalculated bets, frenetic inventory accumulation by big oil consumers (e.g. airlines) or by nations- such as China use of diesel generation for rescue efforts and for stock piling ahead of the Olympics and worst, alleged collusion to manipulate oil prices such as evidences of government contracted oil tankers holding inventories at seas, rerouting of speculative trades from regulated markets to unregulated markets such as OTC and International Exchange (ICE) and massive jump of investments from pension funds and banks via “Indexed” Speculation.

Any markets always contain certain degrees of speculative element simply because of varying expectations and interests by market participants which are essentially reflected on prices. Some are there to hedge their produce, some are there to profit from short term/momentum trades or take advantage of arbitrage spreads, some are there to profit from long term investments and in cases of a bubble, most will be there simply to be a part of the crowd!

As for the supposed commodity bubble, as we noted previously, while there have been some signs of an emergent bubble, they seem far away from being a Bubble “bubble” as we know of.

Mainstream analysts continue to cavil as they did in early 2006. For us, this represents signs of denial. They think of the financials (with all its present hurdles) and the tech industry as still the vogue place to be and such represents as high quality investments, while the commodity industry has always been condemned and is still relegated to account of low grade cyclical driven speculation. They think past performance will produce the same distribution outcomes.

Under the framework of the psychological cycle operating under a boom-bust or bubble cycle, until the mainstream thinking capitulates, the commodity boom has an enormous room to run.

Yes, we don’t deny that sharp movements of prices assets in one direction should equate to equally dramatic movements to the downside, but what concerns us is the long term trend because trying to time markets for us is a vanity play.

In May of 2005 The Cure Is Worse Than The Disease, we outlined our case for the bullmarket in oil…

``1. US Federal Reserve for expanding credit to an unprecedented scale and its negative real interest rate policy which fueled massive speculative positions globally,

``2. The excess printing of paper monies by the collective governments stoking an inflationary environment,

``3. The OPEC members for nationalizing their respective oil industries thereby misallocating capital investments that led to the present underinvestments,

``4. The Chinese government for adapting a market-based economy (from less than 100,000 cars in 1994 to over 2 million cars 2004),

``5. The US dollar-remimbi peg that accelerated an infrastructure and real estate boom thereby increasing demand for oil,

``6. The war on terror that has disrupted oil supplies,

``7. The Bush administration for the continually loading up the Strategic Petroleum Reserve, and…

``8. The lawyers and environmentalists for increased regulations on explorations and oil refinery requirements.

Have any of the above factors changed? Except for the recent suspension of the stockpiling of the US Strategic Petroleum Reserves, generally all of these fundamentals remain in place.

But we’d like to make some modifications if not additions; for the demand side it’s not only about China but of emerging markets (we are talking about India, Brazil, Russia, Southeast Asia and others representing about 80% of the world’s 6.6 billion population).

Most importantly, we missed one very important variable which ensures the longevity of the commodity cycle….PRICE CONTROLS.

Nonetheless, have oil prices risen enough to impact demand? We doubt so, simply because the market price of oil has not been reflected equally in different countries because of the varying extent of PRICE CONTROLS and if not tax structures encompassing the industry.

Politicization Of The “Oil Bubble”

The recent “bubble” perspective arises from mostly the arguments of the “DEMAND” side.

Just because investments in commodity indices (of which oil makes up a significant share) allegedly surged from $13 billion to $260 billion doesn’t imply that it is in a bubble. Not everything that attracts investments automatically equates to a bubble. Not everything that goes up is a bubble.

Media’s “framing” of information based on relative figures depicts of a bias. And this cognitive bias is known as the Contrast Principle where-we notice difference between things, not absolute measures (changing minds.org). In contrast, the market for derivatives exploded by 44% to $596 TRILLION (and not billions) or to over TEN times the global GDP, yet mainstream seems quiescent about such development. Derivatives are financial instruments or contracts based on the underlying assets such as foreign exchange, interest rates, equities, commodities, inflation indices or even weather predictions.

Why? Because commodity prices impact the real world. And in the real world, people’s lifestyles are affected by commodity price movements, thus have the tendency to be politicized.

And because people refuse to understand the underlying issues, instead they seek for emotionally satisfying terse explanations via melodramatic narratives as seen through heroes and villains. To quote Thomas Sowell ``Voters don't want to hear about impersonal things like supply and demand. They want to hear about how their political heroes will stop the villains from "gouging" them or "exploiting" them with high prices. Moral melodrama is where it's at, politically.”

Nonetheless, when measured relative to its exposure as financial derivatives, according to the Bank of International Settlements, commodities account for only 1.5% (26.5% growth year on year) of the outstanding derivatives in 2007 compared to interest rates 65% (34.83% growth year on year), foreign exchange 9.4% (39.65%), credit default swaps 9.7% (102%), equities 1.4% (13.6%) and others. So as a function of the derivatives markets in relative terms, we don’t see any signs of bubble like performances from commodities.

Yet, commodities cannot be qualified in the same way we evaluate stocks or housing assets, as Ms. Caroline Baum of Bloomberg rightly argues (highlight mine),

``With other asset classes, there are metrics that allow us to quantify the degree to which prices have strayed from their fundamental moorings. Stock prices have an historical relationship with underlying earnings. House prices don't stray too far from their ``earnings'' stream, or rental value.

``With commodities, no such quantifiable ratio exits. Instead, analysts point to verticality, or the rate of price increases in a short period of time; to the fact that open interest in futures contracts dwarfs actual supply; or to the sheer volume of trading.”

In other words, in the absence of any valid metrics to assess if commodities prices have meaningfully careened away from fundamentals, market price actions have been the principal criteria for labeling the activities of oil and commodity prices as a bubble. And market price actions do not tell the whole picture.

This leads us to politicization.

Some have argued to regulators to restrict or limit the participation and speculative positions of institutional investors (pension funds, hedge funds and etc.) into investing in oil and commodity space since they have accounted for a substantial increase in the market capitalization of commodity based index funds.

Backed by circumstantial evidence, the claim is that additional demand from institutional investors represents a form of “hoarding” in the futures market unduly driving up prices. Investors have been able to go around Commodity Futures Trading Commission (CFTC) market position limits on commodity acquisitions by swapping with investment banks, who in turn hedges the (total return) swap by buying futures contract. This loophole of allowing swap for hedges has paved way for the unlimited size positioning which concurrently drives up the market caps of commodity index funds.

But cash and futures market signify two distinct functions which essentially refutes such argument, according to the Economist (emphasis mine),

``Yet few bankers agree that speculation has much to do with price rises. For one thing, indexed funds do not actually buy any physical oil, since it is bulky and expensive to store. Instead they buy contracts for future delivery, a few months hence. When the delivery date approaches, they sell their contract to someone who actually needs the oil right away, and then invest the proceeds in more futures. So far from holding oil back from the market, they tend to be big sellers of oil for immediate delivery.

``That is important because it means that there is no hoarding, typically a prerequisite for a speculative bubble. Indeed, as discussed, America’s stocks and those of most other countries are at normal levels. If the indexed funds were indeed pushing the price of oil beyond the level justified by supply and demand, then they would be having trouble selling their futures contracts at such high prices before they matured. But there is no sign of that. In fact, until recently, oil for immediate delivery was more expensive than futures contracts.”

This is especially elaborate in the non-storable commodities (livestock and meats). The point is cash markets represents the actual balance of demand and supply and is unlikely to be subjected to massive speculations as alleged to be in contrast to houses or stocks.

Governments Controls The Supply Side Of The Oil Market

This brings us to the arguments vastly overlooked by Keynesian populists, the supply side.

Given today’s highly anticipated global economic slowdown, reduced economic activities should have translated to lower demand, thereby pulling down prices. Yet with oil prices having doubled over the past year, pricing signals should have dictated for more supplies, as shown in figure 1.

Figure 1 courtesy of US Global Investors: Oil Supplies remain Stagnant

But conventional supplies have hardly made a dent to the oil pricing market possibly due to the stagnant production by both OPEC (green line) and Non-OPEC (blue line) even amidst a global economic growth slowdown. With a slim spread between supply and demand, any drop in demand could easily be offset by an equivalent drop in supplies, and if supply falls faster than demand prices then prices will continue to rise!

And importantly, we must not forget that the supply side of the oil market is basically controlled (about 80% of reserves) by governments through national oil companies. Hence, the oil market is NOT a laissez faire or free market, but like rice or food markets, they account as political commodity market functioning under the auspices of nation states.

If oil is indeed in a “bubble” and government intends to pop the “bubble”, then common sense tell us that oil producing governments can simply deliver the coup de grace by offloading its “surplus” oil into the market! No amount of “speculative futures” can withstand the forces of actual supplies crammed into the markets. But has this happened? No.

If the oil markets have NOT been responding to the price signals, it is because the national oil companies, aside from governments themselves, have been responsible for the supply constraints and nobody else.

Underinvestments arising from misallocation of resources, geological restrictions emanating from environmental concerns, legal proscriptions to allow private and or foreign capital for domestic oil explorations and development of the industry (as in Mexico), nationalization of the oil industry (see Figure 2) and capital and technological inhibitions from national governments have all contributed to these imbalances.

Figure 2 Resource Investor/ Guriev, Sergei, Anton Kolotilin, and Konstantin Sonin: High Oil Prices lead to Expropriation or Resource Nationalism

Resource nationalism or nationalization or expropriation happens during high oil prices as the Resource Investor.com quotes Sergei Guriev, Anton Kolotilin, Konstantin Sonin’s paper (highlight mine),

``On the one hand, it seems natural that the higher the oil price, the more valuable the oil assets and the stronger the incentive to expropriate. On the other hand, given the costs of expropriation, it is not immediately clear why a government of an oil-producing country would respond to a positive oil price shock with expropriation rather than just with imposing higher taxes. Using taxes contingent on (observable and verifiable) oil prices, the government can preserve oil companies' incentives for investment in new fields and cost-reducing technologies. This straightforward solution, however, relies on the external enforcement of contracts, which is not the case: the government is both an enforcer and a contracting party. Therefore, this contract can only be self-enforced. As BP’s then-CEO recently said, “There is no such thing in the [Petroleum] E[xploration] & P[roduction] business as a contract that is not renegotiated” (Weiner and Click, 2007). The only protection for a private company is the government's desire to benefit from more efficient production in the future and checks and balances that assure that the government in office pursues the long-term national interest…We show that expropriations are indeed more likely to take place when oil price (controlling for its long-term trend) is high and in countries where political institutions are weak. The results hold for both measures of institutions that we use (constraints on the executive and the level of democracy from the Polity IV dataset). Most importantly, the results hold even if we control for country fixed effects; in other words, in a given country, expropriation is likelier in periods of weakened institutions.”

With due respect to Mssrs. Guriev et. al., the main difference between nationalization and higher taxes essentially boils down to control.

Private companies operating under high tax regime may use accounting ruses to go around taxes or resort to technical smuggling. In contrast, nationalization denotes of complete control over oil revenues.

Further, countries with politically weak institutions only underscore such dilemma. Companies can bribe their way out of taxes and unevenly distribute pelf to the bureaucracy. On the other hand, under nationalized industries bribes or corruption are most likely systemically organized.

Besides, the main incentive why countries engage in resource nationalism is almost entirely about politics. Oil companies can be a source of rewarding political affiliates or dispensing of political favors. Oil revenues can also be meant for expanding bureaucratic spending such as popular social welfare programs in order to preserve the incumbent’s grip on to power.

This is of course aside from what we mentioned earlier, accrued material personal benefits by those in power. Like cows, national governments find a way to milk these oil companies until they dry.

Besides, future development is only a catchword for vote generation applicable mostly during election seasons.

Governments Also Influence Demand Side Of The Oil Market

Governments have likewise been directly and indirectly responsible for pumping up demand.

This by inordinately expanding money and credit intermediation via a loose monetary, price caps and subsidies that has led to widespread smuggling across borders and expanded demand because of profit incentives through price arbitrage and “hoarding” and the amassing of strategic reserves by oil importing countries.

Figure 3: Whiskey and Gunpowder: Money Supply and Oil Prices

Chris Mayer of Whiskey and Gunpowder opines that US money supply and oil prices has an unusually powerful correlation as shown in Figure 3.

Quoting Mr. Mayer (emphasis mine), ``Since January 2001, you can explain the move in the price of oil largely as a function of increasing money supply. As the amount of money grows, the price of oil rises. In fact, almost 87% of the move in the price of oil can be explained by the increase in money supply.

``Basically, $100 per barrel oil is what we would expect to see, given this relationship between the oil price and money supply. Given that we are still in the midst of a credit crisis of sorts, it seems unlikely the Fed will tighten money in any way at all. That leaves a clear path for the price of oil and commodities to continue to rally in nominal terms.”

Since the US is presently engaged in a currency debasing policy as seen with its ongoing “nationalization” of mortgage related losses or whose financial sector have been undergoing a “liquidity” transfusion from the US Federal Reserve, such loose policies have been weighing enormously on the US dollar. The softening economy likewise has contributed to these dollar infirmities.

And since oil prices have been traded mostly in US dollars, the weakening of the US dollar has similarly accounted for a strong inverse correlation with oil prices. In short, a weak dollar-strong oil phenomenon as seen in figure 4.

Figure 4: Stock charts.com: US dollar Index, Euro and Oil

From the Sydney Morning Herald: ``The correlation coefficient between oil and the euro-dollar exchange rate has been 0.95 for the past year, indicating they have moved in the same direction 95% of the time. The correlation is calculated based on the price changes of oil and the currencies.”

This simply means that given the same rate of a near lockstep association, if the US dollar index (whose basket comprise over 50% weightings by the Euro) continues to weaken, oil prices will most likely continue with its advance or vice versa.

The blue vertical lines, in Figure 4, shows of some notable congruence (interim inflection points) in the prices activities of the US dollar and Oil or Euro.

In addition to US money supplies and the inverse correlation of the US dollar Index and Oil, we have long argued that the US policy of “reflation” are being transmitted to emerging countries via monetary pegs which results to even looser policies leading to a more intense “goods and services” inflation on a globalized scale, see Figure 5.

Figure 5: Economist: Negative Real Rates and A Boom in Global Money Supplies

We have always emphasized on the importance of interest rates because it determines the saving, spending and consumption patterns of individuals, industries or economies and thus shape economic growth, direction of asset domestic asset prices and “inflation” expectations. Meanwhile, the yield spread is one of the many major contributory factors that generate investor incentives or disincentives for allocating scarce resources.

The chart shows how the world has embarked on a loose monetary policy characterized by a booming money supply (right) mostly in emerging markets and negative real interest rates (left) as measured by short-term yields over nominal GDP growth, where the Economist notes ``So it is worrying that global monetary policy is now at its loosest since the 1970s: the average world real interest rate is negative.”

Loose monetary policies threaten economic growth by price instability or the acceleration of “goods and services” inflation. Again from the Economist (emphasis mine),

``Even if the Fed's interest rate suits the American economy, global interest rates are too low. In turn, the unwarranted stimulus to demand in emerging economies is further pushing up commodity prices; so too is speculative buying by investors seeking higher returns than from bond yields, which are still being depressed by the emerging economies' build-up of reserves. This stokes inflationary pressures in America and Europe and makes life difficult for rich-country central banks.

``Loose money in America and rigid exchange rates in emerging economies are a perilous mix. The longer emerging economies hold down their exchange rates, the greater the risk of rising global inflation. Admittedly, exchange-rate appreciation is not as simple a remedy for emerging economies as some claim: a rise in interest rates and the expectation of a further appreciation in the exchange rate could, perversely, exacerbate inflation by sucking in more capital; and setting the exchange rate free risks massive overvaluation. But with an economic serial killer on the loose, one way or another monetary policy will have to tighten and exchange rates rise.”

So those worried about the pockets of “deflation” in some parts of the world should likewise reckon with how in a global economy, the US Federal Reserve policies as the de facto international currency reserve, has diffused into the emerging markets and how these policies have affected the investing and consumption patterns which has been affecting commodity prices now spreading over to a more pronounced politically sensitive “goods and services” inflation.

Moreover, the investing pattern arising from the growth stories of commodity backed emerging countries have provided further backstop to commodity and commodity based investments.

Next we have price controls.

In an effort to control goods and prices inflation many countries have used price controls or subsidies to buy political stability. Price controls have created arbitrage opportunities within borders, escalating demand for oil to profit from spreads. Such arbitrage opportunities have prompted for incidences of fuel smuggling even within China or in parts of the Asian region and elsewhere.

I even read an account somewhere where some Hong Kong residents have been said to transit to nearby China in order to have their gas tank filled, since gas prices in China is said to be a third of the world market.

These price distorting schemes have helped in the expansion of outsized demand for fuel around the world which has led to elevated oil prices at these levels.

Since rising commodity prices affect the real economy, the clamor for political subsidies will continue to mount.

Commodity bears argue that emerging markets can’t afford such subsidies because it will impair their fiscal positions, thus by lifting subsidies demand will slow.

If political survival is at stake, it is highly questionable if the present set of leaders will undertake unpopular measures that would compromise their positions.

Besides, the other factors possibly influencing the demand supply imbalances in the oil market could due to geopolitical considerations, the structural decline of conventional global oil production (otherwise known as “peak-oil”) or as an unintended consequence from stringent regulations.

If it is also true that government tankers were reportedly kept at seas or seemed to have withheld inventories on the account of expectations for higher prices then it all also goes to show that governments themselves have been engaged in speculations over oil prices.

Needless to say, if oil is in a bubble, then it is obviously a government sponsored bubble!

Commodity Boom Driver of Emerging Market Powered Global Decoupling?

``Commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. Developing, BRIC-like economies are obvious choices for investment dollars.”-William Gross, Pimco, Hmmmmm?

Faced with oil at $135, global equity markets fumbled over the week over the prospects of “inflation” according to mainstream media.

We doubt such premise. As we have earlier pointed out in Has Inflationary Policies of Global Central Banks Boosted World Equity Markets?, our view is that a recessionary risk in the US has been more of a force to reckon with. Higher oil or food prices simply compounds the economic woes of the US.

Major US benchmarks fell hard this week with the Dow Jones Industrials losing 3.91%, the S & P 500 down 3.47% and the Nasdaq down 3.33%. Surprisingly, global markets had been least affected compared to the past.

In fact, a key emerging market benchmark, the MSCI Emerging Market index earlier in the week managed to recoup the year’s losses (Bloomberg) but fell back following this week’s correction. As of Friday’s close, the MSCI EM is down 3% after falling as much as 16% in March.

Figure 6: stockcharts.com: Soaring Commodity based Benchmarks!

Yes, despite record oil and food prices, major commodity bellwethers as in Brazil’s Bovespa (upper window), Canada (Dow Jones Canada-main window), South Africa (Dow Jones South Africa-pane below center window) and Russia’s RTS (lowest pane) have all been drifting at fresh record highs as shown in figure 6.

While one may argue that three of the four indices are major oil exporters, this hasn’t been entirely the case for all major oil exporters if one considers the performances of the GCC countries. Among GCC states, Oman, Bahrain and Qatar are now at record high levels, while UAE, Saudi Arabia and Kuwait have been drifting sideways. In Asia, only Thailand, a non oil exporter, among all Asian countries seems to be fast closing in on its previously set record.

The point is that the commodity boom has managed to keep emerging market indices afloat despite the ongoing travails of the US and some European countries. The trend is likely to continue over the long term.

For the Phisix, as a former major commodity exporting nation, the bullish sentiment on commodity exporting countries should spillover to our equity assets. Maybe not all, but on select commodity related issues.

Yes, goods and price inflation poses as a threat to the economy but it does not necessarily mean equity markets cannot survive as previously discussed in Phisix, Inflation and the Available Bias and Inflation Data Brings Philippines Into Deeper Negative Real Rates; NOT A Likely Cause of Today’s Decline. Essentially there will be assets that would still benefit from such environment.

If we are to see a reprise of the real asset boom of the 70s to the 80s then as the table 1 shows (courtesy of Dr. Marc Faber) and as previously discussed in September 2005’s Gold At Fresh 17 Year Highs; Currency-wide bullmarket begins!, a similar pattern of return distribution could emerge where commodity related investments are likely to outperform the market.

Risk Of A US Dollar Crisis: Benign or The Austrian Endgame?

``The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”-Ludwig von Mises, Human Action, The Monetary or Circulation Credit Theory of the Trade Cycle

As a final thought, many people ignore the risks of a US dollar crisis.

Crisis happens because they are an unexpected. It is a black swan or statistical fat tail. The US housing crisis was a much anticipated outcome yet many got caught owing to the belief that they would be able to get out on time. They never expected a buyer’s boycott.

Another, the repercussions from the US housing bust was largely unforeseen. Nobody saw that the investment grade AAA papers would lose sizably in value. Nobody predicted the extent of the contagion from the mortgage bust which would lead to a seizure of global credit markets.

Today, the US dollar continues to fall. The conventional expectation is that the declining trend of the dollar will be orderly. The culmination of the US dollar crisis is presumed to be a benign “overshoot” of the currency’s valuation which would fall low enough to attract enough foreign buyers and reverse the decline. We hope this is the right scenario.

However, the Austrian school’s endgame outcome is different. The risk from a US dollar crisis probably suggests of the collapse of the global currency standard and the end of the US dollar as the world’s de facto foreign exchange reserve. It also suggests that the world may experience a bout of hyperinflation, as the entire chain structure of paper money collapses. To quote Anthony Mueller, The End of Dollar Supremacy, ``Losing trust does not mean that there must be a ready substitute. On the contrary: when distrust will emerge towards the US dollar this would affect the attitude towards all paper currencies. In the final stages of the currency crisis, the dollar will most likely devalue not so much against the euro and the yen, but all of these currencies and most of the rest will devalue drastically against gold.”

Yet the common denominator of countries that experienced hyperinflation had war related expenditures, protectionist walls and uncompromising leadership which pursued onerous welfare policies that eventually resulted to a lose of faith in the country’s currency. These ingredients have been not absent from today’s landscape. The difference is at least we remain globalized.

I came across a sober article from a blogger Steve Waldman who suggests that today’s commodity boom could be seen as “a run on central banks”.

To quote Mr. Waldman (highlight mine) ``Capital devoted to precautionary storage would be better employed building new enterprises, laying a foundation for tomorrow's prosperity. But claims on future money are only promises, easily broken or devalued. A run on central banks, a flight from financial assets to stored goods, sacrifices the hope of future abundance for certain present scarcity. Governments can shut futures exchanges, confiscate gold, ban "hoarding, profiteering, and price-gouging". People will hoard anyway if they don't believe in the paper. People are losing faith in financial assets for good reason. Rather than organizing productive economies, the machinery of finance has recently functioned as an anesthetic, masking the pain while resources were mismanaged and stolen. We need a solid financial system, but confidence cannot be imposed or legislated. It will have to be earned. There has to be a plan. Earnest promises to do better soon won't suffice. Nor will yet another drink from the punch bowl.

Since the pillar of the world’s Paper money standard depends solely on faith on the credibility of the issuer of money, all it needs to topple the entire system is to lose such binding faith. I hope we don’t lose it.

Driver Of The Philippine Peso: Available Bias, Oil or the China’s Yuan? Part II

We are told today told that rising food and energy prices have been wreaking havoc to some emerging market balance sheets and thus have "caused" the fall in the respective currencies.

Korean Won, Philippine Peso and Indonesia’s Rupiah
Courtesy of Danske Bank

As we commented earlier, we are not persuaded with this argument because it seems to gloss over the other side of the trade-if emerging markets are expanding liabilities for social safety nets in face of “higher inflation”, have not the US likewise been throwing money at its financial markets in order to “reflate” the economy?

USD/Yuan courtesy of yahoo

We might be charged with the cognitive bias of “clustering illusions” or looking for pattern where there is none, BUT it does seem that the price actions of the Korean Won, Indonesia’s Rupiah and the Philippine Peso appears to have coincided with the movements of the Chinese Yuan, as we earlier argued at Driver Of The Philippine Peso: Available Bias, Oil or the China’s Yuan?.

The chart above shows that last September’s speed bump of the Yuan was nearly in consonance with the spike in the USD/WON, USD/PHP and USD/INR.

Today as the Yuan seemed to have paused from advancing against the US dollar, the aforementioned currencies lost meaningful ground.

USD Index courtesy of stockcharts.com

Now seen from the lens of the US dollar index, we uncannily observe of a pattern resemblance with the Yuan; the US dollar index paused from its recent downtrend and attempted a rally which appears to have fizzled out.

Could it be that once the US dollar index resumes its downdraft, the Chinese Yuan would recommence with its appreciation? And if the Chinese Yuan plays a more significant role than energy or food prices, as we suspect it to be, perhaps we might see these Emerging Asian currencies strengthen anew, despite higher oil or food prices?

World Bank’s Prescription for Sustained Economic Growth: Governance Committed To A Market Economy

The World Bank recently made a prescription for an ideal sustained growth; notes the Economist (highlight mine)...

“SINCE 1950 13 countries have grown at an average rate of 7% a year, or more, for 25 years or longer. Were these exceptional “economic miracles”, or models for others to follow? On Wednesday May 21st a new study on the subject, “The Growth Report: Strategies for Sustained Growth and Inclusive Development”, was published by a body of thinkers and policymakers brought together by the World Bank (one of our Delhi correspondents was involved in editing the final report). The report notes that the causes of breakneck growth varied significantly between countries, but it identifies five points of broad resemblance:

1. FULL EXPLOITATION of the world economy (importing bright ideas and technology; producing exports that others want);

2. MACROECONOMIC STABILITY;

3. HIGH RATES of saving and investment;

4. letting the MARKET ALLOCATE RESOURCES; and

5. COMMITTED, CREDIBLE, CAPABLE governments.

courtesy of the World Bank

“Given their steady years of growth, India and Vietnam may be on their way to joining this select group.

The 13 economies as listed by the World Bank…

courtesy of the Economist

The common characteristics of these high growth countries, to quote the World Bank,

``The high-growth countries benefited in two ways. One, they imported ideas, technology, and knowhow from the rest of the world. Two, they exploited global demand, which provided a deep, elastic market for their goods. The inflow of knowledge dramatically increased the economy’s productive potential; the global market provided the demand necessary to fulfill it. To put it very simply, they imported what the rest of the world knew, and exported what it wanted.”

In short, governance committed to the Market Economy which benefits from a global division of labor buttressed by exchanges of ideas, technology and optimum resource allocation as dictated by the market forces.