Inflationary Policies Drives China’s Shanghai Market; Clues of Reflexivity Theory at Work

This is an example of what I refer to as liquidity or inflationary policy driven and not earnings or economic driven markets.

From Bloomberg, (bold highlights mine)

``Chinese companies may be using record bank lending to invest in stocks, fueling a rally that’s made the benchmark Shanghai Composite Index the world’s best performer this year, according to Shenyin & Wanguo Securities Co.

``As much as 660 billion yuan ($97 billion) may have been converted by companies into term deposits or used to buy equities, Li Huiyong, Shanghai-based analyst at Shenyin Wanguo, said in a phone interview today, citing money supply figures.

``China’s banks lent a record 1.62 trillion yuan in January as part of a government drive to stimulate the world’s third- largest economy, while M2, the broadest measure of money supply, climbed 18.8 percent from a year earlier. The Shanghai Composite has surged 29 percent since the start of 2009, compared with a 10 percent decline in the MSCI World Index.

``“Part of the liquidity flowing into the stock market could be from companies using borrowed funds to invest in the stock market instead of working requirements,” said Li….

``Equity transactions rose last week to the highest in at least three years. The Shanghai and Shenzhen exchanges handled a combined 32 billion shares Feb. 13, the most since Bloomberg started compiling the data in January 2006. An average of 17.3 billion shares have changed hands daily this year, compared with 9.8 billion shares in 2008…

``“Corporates are in need of working capital right now,” said Gondard, who helps oversee about $7.2 billion. “There may be exceptions, but it’s not big enough an impact to explain the rally.”

``China’s domestic stock market capitalization has increased by $743.1 billion since November, when the government announced its 4 trillion yuan stimulus plan.

``The rally has drawn more Chinese investors. About 224,000 accounts were opened to trade equities on the Shanghai and Shenzhen exchanges last week, the fastest pace in almost two months. That’s still about a quarter of the record 1.07 million set up in the week to Sept. 7, 2007.”

Some may argue that this isn’t about the $580+ billion stimulus at all. This perspective sees only half of the picture.

There are two basic government policy measures: one is fiscal stimulus and the other is monetary stimulus.

Apparently, the Chinese government embarked on easing monetary policies since December of 2008.

From CCTV.com (all bold highlight mine),

``To begin with, China will implement a moderately easy monetary policy to promote reasonable growth in money supply and credit. It will also use various measures, including required reserves, interest rates and the exchange rate, to ensure an adequate supply of liquidity in the banking system. China will also add 100 billion yuan to the loan quota for policy banks by the end of the year.

``Meanwhile, local governments will be urged to inject money into credit guarantee firms and provide subsidies for them.

``More measures will be taken to stabilize stock markets and increase bond issuance. Infrastructure bonds in particular will be encouraged.

``Other moves include promoting insurance related to agriculture, the buying of houses and cars, healthcare and pensions. China will encourage insurance companies to invest in transport, communications, energy and other infrastructure projects.

``In addition, China will provide new financing channels, including loans for mergers and acquisitions, real estate investment trusts, private equity funds and private lending.

``Authorities will improve their management of foreign exchange to facilitate trade, while also upgrading its payments system. China will increase fiscal support to financial institutions to help tackle problems arising from non-performing loans.

``And finally, China will enhance the control of risk to ensure financial security.

From tradingeconomics.com

The above chart shows how China has rapidly cut its interest rates.

And as the news account say, the recent rally in the Shanghai index may have been fueled by a surge in corporate bank lending which had been channeled into stocks. This signifies China's inflationary policies at its incipient phase of gaining traction.

And this is what we have been saying all along; the directives or thrusts to drag down rates below market levels compels the public to speculate or "hunt for yields".

In today’s environment where there is a marked downdraft in the real economy, long term investments are likely to be postponed until the inflationary policies succeeds to alter people’s outlook.

Look at this news from Shanghai Daily,

``FOREIGN direct investment in China tumbled 32.7 percent to US$7.54 billion in January year on year, the fourth straight monthly decline, as companies scaled back spending in the face of the international financial turmoil, the Ministry of Commerce said yesterday.”

Hence, the propensity to speculate has resulted to a sharp ascent of the Shanghai index over the past week, but had been equally met by a drastic decline of late.

Today, the Shanghai index was down by over 4% following yesterday’s 2.93%.

Skeptics have disparaged the recent the signs of recovery as some “false dawn”, where the 2 day slump have been quickly cheered as a reality check.

We aren’t convinced.

The Shanghai index has met some significant resistance at its 200—day moving averages (red line), which if it had succeeded to breakaway from, could have reinforced its progression to the advance phase.

However, what needs to be pointed out is that the Shanghai Index has been in an extremely overbought condition and deserves its much needed hiatus.

It could make another attempt for the 200-day moving average sometime in the near future after clearing its overbought state.

The furious pace of global central banks collectively printing money is bound to end up somewhere, and the above data serves only to validate this view.

Finally, markets aren't just about traditional economics or conventional finance. It is mostly about psychology or how government inflationary policies may trigger significant "reflexivity" in market psychology.

To quote anew the chief architect of the reflexivity theory, [The Alchemy of Finance p. 318], Mr. George Soros...

``The structure of events that have no thinking participants is simple: one fact follows another ending in an unending casual chain. The presence of thinking participants complicates the structure of events enormously: the participants thinking affects the course of action and the course of action affects the participants thinking. To make matters worst, participants influence and affect each other. If the participants’ thinking bore some determinate relationship to the facts there would be no problem: the scientific observer could ignore the participants’ thinking and focus on the facts. But the relationship cannot be accurately determined for the simple reason that the participants’ thinking does not relate to facts; it relates to events in which they participate, and these events become facts only after the participants’ thinking has made its impact on them. Thus the causal chain does not lead directly from fact to fact, but from fact to perception and from perception to fact with all kinds of additional connections between participants that are not reflected fully in the facts.

``How does this complex structure affect the ability of an observer to make valid statements about the course of events? His statements must also be more complex. In particular, they must allow for a fundamental difference between past and future: past events are a matter of record, while the future is inherently unpredictable. Explanation becomes easier than prediction.” (all emphasize mine)

The reflexivity theory applied to the Shanghai's index suggests that if the course of actions (inflationary policies) succeeds to alter participants thinking, then the subsequent changes in perception will ultimately be followed by changes in the facts.

Put differently, if the Shanghai Index's will continue to rally, it will be 'rationalized' by the public as a recovery (perception), when this is all about central banks' massive 'serial bubble blowing' inflation (fact).

Eventually when the perception of recovery is reinforced by economic data, (fact) the market trend deepens (perception).

Video: How Will A Dollar Crash Look Like?

A 1981 movie by Alan J. Pakula entitled Rollover depicted the fictional breakdown of the US dollar system.

Together with some great splices by George4title of the recent events which includes US Congressman Paul Kanjorski's narrative of the September 15th 2008 "electronic bank run" in C-Span, the simulated dollar crash scenario from the movie evokes an eerie and distressing vicarious sensation...

[Hat tip: Casey Research "The Room" and George4title]

Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?

``But innovation, in Schumpeter’s famous phrase, is also “creative destruction”. It makes obsolete yesterday’s capital equipment and capital investment. The more the economy progresses, the more capital formation will it therefore need. Thus, the classical economist-or the accountant or the stock exchange-considers “profit” is a genuine cost, the cost of staying in business, the cost of a future in which nothing is predictable except that today’s profitable business will become tomorrow’s white elephant.”- Peter F. Drucker, Profit’s Function, The Daily Drucker.

We read from creditwritedowns.com that Morgan Stanley Asia Chairman Stephen Roach made some predictions, namely:

1 “Asia will have a less acute impact from the global financial and economic crisis”

2. “Export-led regions are followers, not leaders.” Hence would recover after their main export markets, the US and Europe, recovered.

3. “The only possibility (to recover earlier) is China, as it has large infrastructure spending in place that could provide support for economic growth.”

Dr. Roach has been one of the unassuming well respected contrarian voices, whom I have followed, who sternly warned of this crisis.

Nonetheless while we agree with some of his prognosis, where we depart with Dr. Roach is on the aspect of a ‘belated recovery’ of Asia because of its “export dependence” on US and Europe.

Creative Destruction: The Telephone Destroyed The Telegraph

While it is true that the Asian model had functioned as an export-led region over the past years, our favorite cliché, ``Past performance does not guarantee future results” would possibly come into play in the transformation of the playing field.

Let us simplify, if a business paradigm doesn’t work do you insist on pursuing the same model or do you attempt a shift?

Marketing Guru Seth Godin has a terse but poignant depiction of “solving a different problem” response to our question. We quote the terrific guru Mr. Godin,

``The telephone destroyed the telegraph.

``Here's why people liked the telegraph: It was universal, inexpensive, asynchronous and it left a paper trail.

``The telephone offered not one of these four attributes. It was far from universal, and if someone didn't have a phone, you couldn't call them. It was expensive, even before someone called you. It was synchronous--if you weren't home, no call got made. And of course, there was no paper trail.

``If the telephone guys had set out to make something that did what the telegraph does, but better, they probably would have failed. Instead, they solved a different problem, in such an overwhelmingly useful way that they eliminated the feature set of the competition.” (bold highlight mine)

In short, we see human action basically at work. To quote Ludwig von Mises, ``Action is an attempt to substitute a more satisfactory state of affairs for a less satisfactory one. We call such a willfully induced alteration an exchange.”

People who relied on old models didn’t see this coming. They would have resisted until they were overwhelmed.

The fact is the telephone replaced an entrenched system. Joseph Schumpeter, in economic vernacular coined this as “creative destruction”. And creative destruction essentially leads to new operating environments: the rise of the telephone.

Similarly, the Asian export model has been built upon the US credit bubble structure. That bubble is presently deflating and would most possibly dissipate. So is it with Europe’s model.

In other words, the global economy’s trade and investment framework will probably reconfigure based on the present operating economic realities. Countries and regions would probably operate under a set of redefined roles.

Here are three clues of the possible creative destruction transformation.

Deepening Regionalism

Figure 3: ADB: Emerging Asian Regionalism

This from the ADB’s Emerging Asian Regionalism, ``In large part due to the growth of production networks just discussed, trade within Asia has increased from 37% of its total trade in 1986 to 52% in 2006 (Figure 3.3). The share of trade with Europe has risen somewhat, while that with the US and the rest of the world has fallen. As set out in Chapter 2, Asia’s intraregional trade share is now midway between Europe’s and North America’s. It is also higher than Europe’s was at the outset of its integration process in the early 1960s.

``But trade has not been diverted from the rest of the world. On the contrary, trade with each of Asia’s four main partner groups has increased in the last two decades—not just absolutely, but also relative to Asia’s GDP (Figure 3.4). For example, Asia’s trade with the EU has more than doubled as a share of its GDP, from 2.6% in 1986 to 6.0% in 2006. The increase is even larger as a share of the EU’s GDP. The aggregate trade data thus suggests that Asia is steadily integrating both regionally and globally.”

The fact is that Asia has steadily been regionalizing or developing its intraregional dynamics even when the bubble structure had been functional. Today’s imploding bubble isn’t likely to alter such deepening trend.

Moreover, the current unwinding bubble structure is emblematic of a discoordination process from a ‘market clearing’ environment.

Under this phase, spare capacities are being shut or sold, excess labor are being laid off, surplus inventories are being liquidated and losses are being realized. Essentially new players are taking over the affected industries. And new players will be coming in with fresh capital to replace those whom have lost. Fresh capital will come from those economies with large savings or unimpaired banking system (see Will Deglobalization Lead To Decoupling?)

And like any economic cycles, this adjustment process will lead to equilibrium. Eventually a trough will be reached, where demand and supply should balance out and a transition to recovery follows.

The post bubble structure is likely to reinforce and not reduce this intraregional dynamic.

So in contrast to the notion of a belated recovery in Asia hinged on the old decrepit model, a China recovery should lift the rest of Asia out of the doldrums.

Asia and not the old stewards should lead the recovery based on the new paradigm.

And in every new bullmarket there always has been a change in market leadership. We are probably witnessing the incipience of such change today.

Real Savings Function As Basic Consumption

The assumption of the intransigence of Asia as an export led model is predicated on Keynesian theory of aggregate demand. In essence, for as long as borrowing and lending won’t recover in the traditional ‘aggregate demand’ economies, there won’t be a recovery in export led economies.

But in contrast to such consensus view, demand is not our problem, production from savings is.

According to quote Dr. Frank Shostak, ``At any point in time, the amount of goods and services available are finite. This is not so with regard to people’s demand, which tends to be unlimited. Most people want as many things as they can think of. What thwarts their demand is the availability of means. Hence, there can never be a problem with demand as such, but with the means to accommodate demand.

``Moreover, no producer is preoccupied with demand in general, but rather with the demand for his particular goods.”

``In the real world, one has to become a producer before one can demand goods and services. It is necessary to produce some useful goods that can be exchanged for other goods.”

A sole shipwrecked survivor in an island will need to scour for food and water in order to consume. This means he/she can only consume from what can be produced (catch or harvest). It goes the same in a barter economy; a baker can only have his pair of shoes if he trades his spare breads with surplus of shoes made by the shoemaker.

Surplus bread or shoes or produce, thus, constitute as real savings. And to expand production, the shoemaker, the baker or even the shipwrecked survivor would need to invest their surpluses or savings to achieve more output which enables them to spend more in the future.

Instead of getting x amounts of coconuts required for daily nourishment, the shipwrecked survivor will acquire a week’s harvest and use his spare time to make a knife so he can either make ladder (to improve output), build a boat (to catch fish or to go home) or to hunt animals (to alter diet) or to make a shelter (for convenience). Essentially savings allows the survivor to improve on his/her living conditions.

To increase production for the goal of increasing future consumption, the savings of both the shoemaker and the baker would likely be invested in new equipment (capital goods).

Again to quote Dr. Shostak (bold highlight mine), ``What limits the production growth of goods and services is the introduction of better tools and machinery (i.e., capital goods), which raises worker productivity. Tools and machinery are not readily available; they must be made. In order to make them, people must allocate consumer goods and services that will sustain those individuals engaged in the production of tools and machinery.

``This allocation of consumer goods and services is what savings is all about. Note that savings become possible once some individuals have agreed to transfer some of their present goods to individuals that are engaged in the production of tools and machinery. Obviously, they do not transfer these goods for free, but in return for a greater quantity of goods in the future. According to Mises, "Production of goods ready for consumption requires the use of capital goods, that is, of tools and of half-finished material. Capital comes into existence by saving, i.e., temporary abstention from consumption.”

``Since saving enables the production of capital goods, saving is obviously at the heart of the economic growth that raises people's living standards. On this Mises wrote, “Saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material condition of man; they are the foundation of human civilization.”

So what changes this primitive way of production-consumption to mainstream’s consumption-production framework?

The answer is debt. Debt can be used in productive or non-productive spending. But debt today is structured based on the modern central banking.

Think credit card. Credit card allows everyone to extend present consumption patterns by charging to future income. If debt is continually spent on non-productive items, it eventually chafes on one’s capacity to pay. It consumes equity. Eventually, overindulgence in non productive debt leads bankruptcy. And this epitomizes today’s crisis.

But debt issued from real savings can’t lead to massive clustering of errors (bubble burst) because they are limited and based on production surpluses. It is non productive debt issued from ‘something out of nothing’ or the fractional banking system combined with loose monetary policies from interest manipulations that skews the lending incentives and enables massive malinvestments.

To aptly quote Mr. Peter Schiff’s analysis of today’s crisis, ``Credit, whether securitized or not, cannot be created out of thin air. It only comes into existence though savings, which must be preceded by under-consumption. Since savings are scarce, any government guarantees toward consumer credit merely crowd out credit that might otherwise have been available to business. During the previous decade too much credit was extended to consumers and not enough to producers (securitization focused almost exclusively on consumer debt). The market is trying to correct this misallocation, but government policy is standing in the way. When consumers borrow and spend, society gains nothing. When producers borrow and invest, our capital stock is improved, and we all benefit from the increased productivity.”

Now if capital comes into existence by virtue of savings, we should ask where most of the savings are located?

The answer is in Asia and emerging markets.

Figure 4: Matthews Asian Fund: Asia Insight

According to Winnie Puah of Matthews Asia, ``The economic potential and impact of Asian savings have yet to be fully unleashed at home. Indeed, Asia’s excess savings fuelled the recent boom in U.S. consumption and housing markets. Creating a consumption boom in Asia would mean that Asia needs to borrow and spend more. To date, governments are supporting domestic demand with fiscal stimulus packages—but it is household balance sheets that hold the key to developing a consumer culture. Overall, Asian households are well-positioned to increase spending—most have low debt levels and high rates of savings… there is a noticeable divergence in saving patterns between emerging and mature economies over the past decade, particularly since Asia learned a hard lesson from being overleveraged during the Asian financial crisis. Today, most Asian households save 10%—30% of their disposable incomes. China’s households, for example, have over US$3 trillion in savings deposits but have borrowed only US$500 billion.”

Thus I wouldn’t underestimate the power of Asia’s savings that could be converted or transformed into spending.

Asia’s Tsunami of Middle Class Consumers

In my August 2008 article Decoupling Recoupling Debate As A Religion, we noted of the theory called as the “Acceleration Phenomenon” developed by French economist Aftalion, who propounded that a marginal increase in the income distribution of heavily populated countries as China, based on a Gaussian pattern, can potentially unleash a torrent of middle class consumers.

Apparently, the Economist recently published a similar but improvised version of the Acceleration Phenomenon model. And based on this, the Economist says that 57% of the world population is now living in middle class standards (see figure 5)!

Figure 5: The Economist: The Rise of the Middle Class?

From The Economist (bold highlights mine), ``In practice, emerging markets may be said to have two middle classes. One consists of those who are middle class by any standard—ie, with an income between the average Brazilian and Italian. This group has the makings of a global class whose members have as much in common with each other as with the poor in their own countries. It is growing fast, but still makes up only a tenth of the developing world. You could call it the global middle class.

``The other, more numerous, group consists of those who are middle-class by the standards of the developing world but not the rich one. Some time in the past year or two, for the first time in history, they became a majority of the developing world’s population: their share of the total rose from one-third in 1990 to 49% in 2005. Call it the developing middle class.

``Using a somewhat different definition—those earning $10-100 a day, including in rich countries—an Indian economist, Surjit Bhalla, also found that the middle class’s share of the whole world’s population rose from one-third to over half (57%) between 1990 and 2006. He argues that this is the third middle-class surge since 1800. The first occurred in the 19th century with the creation of the first mass middle class in western Europe. The second, mainly in Western countries, occurred during the baby boom (1950-1980). The current, third one is happening almost entirely in emerging countries. According to Mr Bhalla’s calculations, the number of middle-class people in Asia has overtaken the number in the West for the first time since 1700.”

So apparently, today’s phenomenon seems strikingly similar to Seth Godin’s description of the creative destruction of the telegraph.

The seeds of the rising middle class appear to emanate from the wealth transfer from the developed Western economies to Asia and emerging markets. Put differently, Asia and EM economies could be the fruits from the recent ‘creative destruction’.

Some Emerging Signs?

However, there are always two sides to a coin.

For some, the present crisis signify as a potential regression of these resurgent middle class to their poverty stricken state, as the major economies slumps and drag the entire world into a vortex.

For us, substantial savings or capital (the key to consumption), deepening regionalism, underutilized or untapped credit facilities, rapidly developing financial markets, a huge middle class, unimpaired banking system, and most importantly policies dedicated to economic freedom serve as the proverbial line etched in the sand.

One might add that the negative interest rates or low interest policies and the spillage effect from stimulus programs from developed economies appear to percolate into the financial systems of Asia and emerging markets.

Although these are inherently long term trends, we sense some emergent short term signs which may corroborate this view:

1. Despite the 30% slump in the global Mergers and Acquisitions in 2008, China recorded a 44% jump to $159 billion mostly to foreign telecommunication and foreign parts makers (Korea Times). Japan M&A soared last year to a record $165 billion in 2008 a 13% increase (Bloomberg).

2. Credit environment seems to be easing substantially.

According to FinanceAsia (Bold highlights), ``The fallout from Japan's banking crisis offers clues to how the current situation may resolve itself. Back then, healing started first in the areas that had been most affected -- interbank lending recovered earliest, followed by credit markets, volatility markets and finally, many years later, equity markets.

``In today's crisis, interbank lending is already starting to recover. The spread between three-month interbank lending rates and overnight rates, which provides a key measure of the health of credit markets, has dropped significantly from its peak of 364bp in early 2008 down to less than 100bp today. As the interbank market recovers, credit should be next to heal.

``However, at the moment, triple-B spreads are at their highest levels in more than 100 years, which makes credit look like an extremely attractive investment opportunity. And there is every reason to expect that Asian corporates will participate in the healing, perhaps even as quickly as their counterparts in the US. (Oops and I thought everyone said divergence wasn’t possible or decoupling is a myth)

3. Asian companies have begun to engage in debt buyback. Again from FinanceAsia, ``Asian companies are buying back their debt with gusto and this could be a sign that credit markets are on the mend, according to Morgan Stanley.

``Asian companies are betting that credit will offer the best returns in 2009 and, like the smart traders they are, executives in the region are busy buying back their debt with gusto.

4. A picture speaks a thousand words…

Figure 6: A BRIC Decoupling?

China and Brazil appear to be leading the BRIC recovery while India (BSE) and Russia (RTS) seem to initiating their own.

For financial markets of developed economies, don’t speak of bad words.

The Tenuous Correlation of Remittances and the Philippine Peso

``Whether we like it or not, it is a fact that economics cannot remain an esoteric branch of knowledge accessible only to small groups of scholars and specialists. Economics deals with society's fundamental problems; it concerns everyone and belongs to all. It is the main and proper study of every citizen." Ludwig von Mises, Human Action The Place of Economics in Learning

Recently an amusing article in a local business broadsheet predicted that the Peso will likely fall to Php 52 against the US dollar at the end of the year. The article anchored its prediction from the analysis of a prominent economist, whose assessment was rooted on “remittances”.

Simplistic Analysis Equals Misdiagnosis

I say it is “amusing” because journalistic reporting projects the operational nature of the marketplace as seemingly so simplistic. The Peso’s path is deterministically portrayed as one dimensional. It assumes that “remittances” which only account for 11% of our GDP as the most powerful driver (survivorship bias-focusing on the popular or winners at the expense of the rest) and further assumes that its “pair”, the US dollar, is a fixed or non-dynamic state (selective perception bias).

Importantly, as Nassim Taleb of the Black Swan fame wrote in Fooled by Randomness, ``The problem with information is not that it is diverting and generally useless, but that it is toxic”. (bold highlight mine)

And as the public gets flimflammed over the perceived linearity of the causal relationship, they develop false impressions or notions that “simplistic” markets can ultimately be tamed or mastered by the state. And this applies to everything else. Think rice, meat, LPG and etc….

And this is why local media never fail to impress upon the public of the significance of government control over prices, which almost always don’t work.

What is Popular Isn’t Necessarily Economically Viable

The fact that prices, through money, exists is a manifestation of scarcity. And money functions as the medium of exchange meant to bridge on such deficiencies.

For example, if you have pizzas and I have beers, then we can make a trade. How many pizzas in exchange for beers will be determined by our relative values, i.e. how much a pizza is worth to me and how much a beer is worth to you. And where our relative values meet, these allow us then to conduct such exchange. You have (x quantity) beers and I have (y quantity) of pizza. Thus, we are both satisfied.

That’s because pizzas and beers are scarce goods. And exchanges of scarce goods or service are the natural state of the markets. Hence, satisfaction is derived by voluntary exchange. Alternatively this means, in a world of abundance, ipso facto, we don’t need money (markets or prices at all).

And where the allocations of scarce resources are implemented by the state, in order to attain efficiency requires the comprehensive and foolproof understanding of (marginal utility) the values or priorities of each individual within its constituency (e.g. the number of pizzas or beers you and I would have for a day, month or year) and the perfect assessment of the balance of supply and demand.

In short, this essentially requires omniscience- a trait only attributable to God.

Going back to our example; if the government ascertains a fixed rate of exchange for pizzas against beers and vice versa, which goes against the perceived pleasure or benefits of the producers, then the tendency is to produce less (quantity) and or inferior (quality) products. The end result is product shortages, black markets, higher prices and dissatisfied consumers.

Yet, the purported government predominance over the marketplace signifies nothing less than a GRAND DELUSION constantly peddled and perpetuated by politicians, so called economic “experts” and mainstream media used to gain mileage for tacit political or financial agenda.

Rationalization Meant For Political Agenda

Going back to the Peso, we’ve long been a skeptic over the Peso-remittance connections, as we wrote years ago in Philippine Peso And Remittances: The Unsecured Knot or What Media Didn’t Tell About the Peso, where experts have incessantly broached the causal relationship of the advancing Peso with remittance trends.

And as we earlier noted, while economic experts boisterously bruit about the multiplier impact of remittance growth to Philippine consumption, none of these experts or even the local authorities have given an estimate of the presumed multiplier or how much of local consumption has been captured by remittances.

Yet, this is the reason why populist “Keynesian” experts continue to blazon on a “depreciating Peso” as a virtue, which means printing of more money, bigger government, more redistributive policies from the productive and competent sectors to the non productive incompetent sectors and a rent seeking and dependency culture which ultimately leads to higher prices and more (not less) poverty. Nonetheless, if currency depreciation is a virtuous act then Zimbabwe should be the world’s richest country today.

One must be reminded that misdiagnosis extrapolates to false prescriptions.

On the other hand, the same school of thought disingenuously lambastes or assails on corruption as the principal and proximate cause of our miseries. Yet none of them have the audacity to decry the association between how CORRUPTION is correlated to BIG government. And this concerns NOT just the bureaucratic nightmare but also government spending and general economic intervention.

The silence is deafening. Naturally, an enlightened and empowered public could strip away their authority or means of control over the populace. Hence, self interest calls for looking at superficial measures as diversion than dealing with harsh cold reality.

What Peso-Remittance Relevance? Where?

It is hard NOT to associate the markets with political correctness as markets always function as the political scapegoat for government failures. Nonetheless it is ironic how these self-righteous all knowing pretentious experts claim to have the right solutions to deal exactly with our economic plight when they can’t even predict markets accurately in both short or long term basis.

Remember, markets function as signals to allocate the basic economic forces of demand and supply. This means that if they can’t read markets correctly, what additional qualifications have they to know the degree of distinctive individual values required to allocate resource efficiently? Mathematical models based on classroom conditions?

So under the remittances driven Peso concept, the reasoning or logic goes- growing remittances equals a stronger Peso. Inversely, negative remittances equal to a weaker Peso.

Here are the facts: The Peso in 2008 fell 15% even as remittance growth accounted for 15% for the first 11 months according to the IHT (estimated by World Bank to account for 18% growth for 2008). Growing remittances against a falling Peso, so how valid is this concept?

Figure 1: World Bank: Remittance Outlook, First Quarter Report

More Proof of inconsistencies?

Despite the present deterioration in macro economic conditions, World Bank estimates growth trends of remittances will decelerate and NOT grow negative see figure 1 (left window-gray line). However, the growth clip of East Asia and Pacific remittance trends have been on a decline since 2006. Yet when looking at Philippine economic growth composition (right window) where the services industry has allegedly been the primary beneficiary of remittances, services growth continue to surge in 2007 amidst a declining rate of growth in remittances. The services industry only began to moderate in the last 2 quarters of 2008. A case of lagged effect perhaps?

So, if the Peso should reflect the relative health of its economy with its comparable pair, then I am lost in ascertaining the said “steamy” correlations between remittance growth and the service industry.

Figure 2: Danske Bank: Emerging Market Currencies Monthly Performance

In addition, since remittance trends could grind to a halt or even go negative, why does it seem that the Peso is consolidating if not appreciating (see figure 2) than declining? Has the currency markets been “discounting” the remittance factor?

Of course one may argue that it is still 10 months away from the day of reckoning.

But with some credit indicators materially manifesting easing conditions, some markets have begun to reflect these conditions. Again as shown above Asian currencies appear to be outperforming the other emerging market counterparts. Again further signs of brewing divergences.

Could it be that this isn’t mainly about remittances, or to include about trade account, but one from the diminishing impact of forcible selling in the developed world? Or could this possibly imply that the “spillage effect”, from nearly concerted inflationary policies abroad, may have began regain some traction in pockets of the economy? Or perhaps a combination of both?

If I would apply Winston Churchill’s ``Out of intense complexities, intense simplicities emerge" or adopt Occam Razor’s principle, ``one should not increase, beyond what is necessary, the number of entities required to explain anything” then I would have to say that the state of relative capital (accumulation or consumption) conditions will determine the fate of the currency.

This includes remittances, net trade and portfolio/investment flows- all of which constitutes the Balance of Payment (BoP), combined with forward contracts, derivatives, evolving economic and fiscal policies, the economy’s capital and production structure, national government and central bank balance sheets- all of which likewise contributes to the health of the domestic currency at varying degrees, dependent on the flux of the political economy.

In today financial crisis prompted global recession, the burden could possibly to shift to the extent of the degree of deployment of government resources to “fix” or “cushion” the economy. This means that relative accessibility of liquidity flows and inflationary policies could weigh more on currency values than the traditional metrics.

None of these suggests, however, that we are in denial of the incremental deepening of correlations between the price value of the Peso relative to remittances, and correspondingly, the latter’s intensifying role to the nation’s economic pie overtime.

Where we depart from the mainstream is the apparent patent overplaying of the causality of the said trends relative to the value of the Peso.

Nonetheless, such dramatization by the spinmeisters, as pointed earlier, has been vested with political-financial dimensions. Why? Because of the salability of the concept, which could translate to future votes, justification for bigger government spending on programs aimed to “benefit” the 11% of the GDP sector (against the 89%) or a wider audience for commercial gains.

The irony is that people always claim that they are after the truth, but the sordid reality is that instead of using economic common sense, they NOT only buy into rubbish information but the toxicity of politically slanted “expert” opinion as their version of facts, reality or truth.

Julius Caesar was right, ``People readily believe what they want to believe".

Not All Aaa Credit Ratings Are Cut From The Same Cloth

Faced with today's financial hurricane, credit ratings agency Moody's announced how it ascertians risks conditions that may impact Aaa sovereign debt ratings of developed economies.

Researchrecap quotes Moody's, ``For a Aaa government to be downgraded, Moody’s must have concluded that the deterioration in credit metrics is (1) observable and material in absolute terms; (2) observable and material in relative terms; and (3) unlikely to be reversed in the near future,” Moody’s says. “The decision underlying a potential downgrade would also depend on the extent of the actual and potential deterioration of a government’s balance sheet; whether a country’s economic model can be regenerated, thereby allowing the economy to rebound; and whether governments can repair their fiscal position by raising taxes or cutting expenditure.”

graph from Moody's

So from the said conditions Moody's categorizes them into three groups:

1. Resistant Aaa countries, such as Germany, whose rating is so far largely untested despite strong headwinds;

my comment:

Germany, France, Austria and Switzerland are rated higher than the US or UK even if they are all Aaa.

2. Resilient Aaa countries, such as the UK and the US, whose ratings are being tested but, in our view, display sufficient capacity to grow out of their debt and repair the damage;

my comment:

Moody's is being too optimistic. Once the latest stimulus measures fail to achieve its objectives, we will probably see more of the same efforts.

And additional government resources thrown to resuscitate the economy may constrain strained economic resources which may eventually risk jeopardizing the present ratings standing.

Remember, during the credit bubble days, Moody's was instrumental in providing Aaa ratings to obscure structured finance products, which eventually turned out to be "toxic" and which remains a key burden to the banking system's seeming inextricable balance sheets.

3. Vulnerable Aaa countries (Ireland and, to a lesser extent, Spain) who face equally stern challenges and whose rating will depend on their ability to rapidly regenerate their economies. Indeed, in the case of Ireland, Moody’s placed its Aaa rating on negative outlook on 29 January 2009.

my comment:

Aaa ratings like ALL government guarantees are never risk free.

Besides, grading sovereign papers isn't entirely about finance or economics but likewise subject to political impediments or possibly conflict of interest issues.

Perhaps we will see some material downgrades among some of these Aaa sovereigns as the crisis reach maturity.

(Source Research Recap )

Entrepreneurship During Recessions: Booming Industries, Recession Babies, Reasons to Start and 999 Business Ideas

It’s not all gloom and doom despite the dire outlook emanating from a financial crisis triggered economic recession in the US.

Businessweek in a slideshow shows of 9 small business/ industries enjoying a boom which according to Stacy Perman of the Businessweek has been “giving new relevance to the old adage that one man's misfortune is another's opportunity.”

The list includes…

1. Companies specializing in credit counseling, debt and budget management, consolidation, or debt settlement.

2. Mortgage and Foreclosure Rescue Companies

3 Repair services

4. Alcohol

5. Safe

courtesy of Baumann Safe & Businessweek

6. Repossession

7. Thrift stores

8. Pawnshops

9. Private detectives

Don’t forget some of the known establishments were born during economic slumps, insidecrm.com enumerates 14 famous recession babies:

1. Hyatt Corp

2. Burger King Corp.

3. IHOP Corp.

4. The Jim Henson Company

5. LexisNexis

6. FedEx Corp.

7. Microsoft Corp.

8. CNN

9. MTV Networks

10. Trader Joe's

11. Wikipedia Foundation Inc.

12. Sports Illustrated

13. GE (General Electric Co.)

14. HP (Hewlett-Packard Development Company LP)

Nonetheless, there are reasons why recessions could be a good time to start a business. Melissa Chang, founder of Pure Incubation, an Internet incubator based in the Boston area, elaborates in thestandard.com [HT: Mark Perry].

1) A recession forces founders to be frugal.

2) Recessions force entrepreneurs to take another close look at their ideas.

3) Recessions lead to committed startup teams.

4) Startups get a head start.

5) Recessions toughen up companies.

Finally, sixmonthmba.com offers 999 business ideas (Hamster Burial Kits & 998 Other Business Ideas) [HT: Seth Godin]

Alternatively, this reminds us that we can also opt to view today's predicament as windows of opportunities for progress or as ex-US President John F. Kennedy once said ``When written in Chinese, the word "crisis" is composed of two characters-one represents danger, and the other represents opportunity.”

Bring Back The Gold Standard?

A splendid article in the Wall Street Journal, from Ms. Judy Shelton, opines of the return to the gold standard to compete with modern Central Banking.

Why? Because of the insidious and nasty impacts of policy prompted inflation….

Excerpts from Ms Shelton’s articles (all bold highlights mine)

``Under a gold standard, if people think the paper money printed by government is losing value, they have the right to switch to gold. Fiat money -- i.e., currency with no intrinsic worth that government has decreed legal tender -- loses its value when government creates more than can be absorbed by the productive real economy. Too much fiat money results in inflation -- which pools in certain sectors at first, such as housing or financial assets, but ultimately raises prices in general.

``Inflation is the enemy of capitalism, chiseling away at the foundation of free markets and the laws of supply and demand. It distorts price signals, making retailers look like profiteers and deceiving workers into thinking their wages have gone up. It pushes families into higher income tax brackets without increasing their real consumption opportunities.

``In short, inflation undermines capitalism by destroying the rationale for dedicating a portion of today's earnings to savings. Accumulated savings provide the capital that finances projects that generate higher future returns; it's how an economy grows, how a society reaches higher levels of prosperity. But inflation makes suckers out of savers.

``If capitalism is to be preserved, it can't be through the con game of diluting the value of money. People see through such tactics; they recognize the signs of impending inflation. When we see Congress getting ready to pay for 40% of 2009 federal budget expenditures with money created from thin air, there's no getting around it. Our money will lose its capacity to serve as an honest measure, a meaningful unit of account. Our paper currency cannot provide a reliable store of value.

Thus, the importance to bring about governance based on the principles of sound money…

``So we must first establish a sound foundation for capitalism by permitting people to use a form of money they trust. Gold and silver have traditionally served as currencies -- and for good reason. A study by two economists at the Federal Reserve Bank of Minneapolis, Arthur Rolnick and Warren Weber, concluded that gold and silver standards consistently outperform fiat standards. Analyzing data over many decades for a large sample of countries, they found that "every country in our sample experienced a higher rate of inflation in the period during which it was operating under a fiat standard than in the period during which it was operating under a commodity standard."

``Given that the driving force of free-market capitalism is competition, it stands to reason that the best way to improve money is through currency competition. Individuals should be able to choose whether they wish to carry out their personal economic transactions using the paper currency offered by the government, or to conduct their affairs using voluntary private contracts linked to payment in gold or silver.

``Legal tender laws currently favor government-issued money, putting private contracts in gold or silver at a distinct disadvantage. Contracts denominated in Federal Reserve notes are enforced by the courts, whereas contracts denominated in gold are not. Gold purchases are subject to taxes, both sales and capital gains. And while the Constitution specifies that only commodity standards are lawful -- "No state shall coin money, emit bills of credit, or make anything but gold and silver coin a tender in payment of debts" (Art. I, Sec. 10) -- it is fiat money that enjoys legal tender status and its protections…

Nevertheless, we should learn how the gold standard has contributed immensely to human development, which helped buttress the ethical values in the marketplace.

``Private gold currencies have served as the medium of exchange throughout history -- long before kings and governments took over the franchise. The initial justification for government involvement in money was to certify the weight and fineness of private gold coins. That rulers found it all too tempting to debase the money and defraud its users testifies more to the corruptive aspects of sovereign authority than to the viability of gold-based money.

``Which is why government officials should not now have the last word in determining the monetary measure, especially when they have abused the privilege.

``The same values that will help America regain its economic footing and get back on the path to productive growth -- honesty, reliability, accountability -- should be reflected in our money.

However, economics based on false premises have dominated mainstream thinking which has only misled people…

``Economists who promote the government-knows-best approach of Keynesian economics fail to comprehend the damaging consequences of spurring economic activity through a money illusion. Fiscal "stimulus" at the expense of monetary stability may accommodate the principles of the childless British economist who famously quipped, "In the long run, we're all dead." But it shortchanges future generations by saddling them with undeserved debt obligations.

``There is also the argument that gold-linked money deprives the government of needed "flexibility" and could lead to falling prices. But contrary to fears of harmful deflation, the big problem is not that nominal prices might go down as production declines, but rather that dollar prices artificially pumped up by government deficit spending merely paper over the real economic situation. When the output of goods grows faster than the stock of money, benign deflation can occur -- it happened from 1880 to 1900 while the U.S. was on a gold standard. But the total price-level decline was 10% stretched over 20 years. Meanwhile, the gross domestic product more than doubled.

``At a moment when the world is questioning the virtues of democratic capitalism, our nation should provide global leadership by focusing on the need for monetary integrity. One of the most serious threats to global economic recovery -- aside from inadequate savings -- is protectionism. An important benefit of developing a parallel currency linked to gold is that other countries could likewise permit their own citizens to utilize it. To the extent they did so, a common currency area would be created not subject to the insidious protectionism of sliding exchange rates.”

Yes, while it may seem like a lost cause…bringing back the gold standard would be very ideal as governments hate competition.

A Policy Of Bailouts Will Increase Their Number

Former President of Federal Reserve Bank of St. Louis, William Poole once accurately observed that ``Everyone knows that a policy of bailouts will increase their number.”

And the addiction to bailouts seem to be snowballing at a very rapid clip.

Following yesterday's passage of the $838 billion stimulus package in the US Senate, the US government through its Treasury Secretary Timothy Geithner announced a far bigger rescue package and "envisions a far greater government role in markets and banks than at any time since the 1930s", reports the New York Times.

And the rescue plan translates to commitment of as much as $2.5 trillion!

Again from the New York Times, ``Administration officials committed to flood the financial system with as much as $2.5 trillion — $350 billion of that coming from the bailout fund and the rest from private investors and the Federal Reserve, making use of its ability to print money."

The $2.5 trillion Geithner plan...

Bloomberg quotes Treasury Secretary Geithner, “Instead of catalyzing recovery, the financial system is working against recovery, at the same time, the recession is putting greater pressure on banks. This is a dangerous dynamic, and we need to arrest it....I want to be candid: this strategy will cost money, involve risk, and take time."

Obviously, the US government's approach in resolving the unsustainable debt problem is to do the same, pile on more debts.

So far, the US government commitments have reached nearly $8.8 trillion and spent $2 trillion according to the New York Times and the Geithner plan and the latest stimulus package should add to this.

Nonetheless all of these government spending will translate to exploding fiscal/budget deficits which the Casey Research team estimates to reach nearly $3 trillion (Investor's Business Daily)

But with bank related losses nearly at $ 6 trillion, according to Robert Reich (RGE Global), ``Goldman Sachs -- not one to exaggerate the overall problem -- recently estimated the total value of troubled U.S. bank assets to be $5.7 trillion", we can expect even MORE taxpayer exposure in the future.

And Prudent Bear's Doug Noland has nailed it in his article (bold highlights mine) , ``The Government Finance Bubble is being called upon to reflate with little assistance from private Credit, while at the same time it is faced with a Deeply Maladjusted Economic Structure still overly dependent upon inflationary Credit expansion. Throwing mega-Trillions at our distorted economy is just asking for trouble.

``It is in this context that I fear that the Trillions of Government Finance spent to save the world from “deflation” will, in the end, require perpetual needs for Trillions more. There will be no kick-starting asset Bubbles or a return of private-sector Credit excess. Instead, it will be a case of throwing repeated doses of government-directed finance/purchasing power at the system. Temporary but fleeting economic boosts will then require only stronger doses of artificial stimulus.

``We’ve commenced a new cycle dominated by government electronic printing presses in all their various forms. The inflationary consequences will be a different variety than we’ve grown accustomed to from previous reflations. But the bottom line is – and there’s ample history to support this view – that once the “printing presses” get humming along it’s going to be darn difficult to slow them down."

Overall, a policy of inflation begets more inflation.

And that's where we are likely headed for. But don't count on a benign outcome.

Global Property Prices: More Downside

Property prices in many countries seem to be priced dearly still despite the recent financial crisis.

According to the Economist, ``HOME to the super-rich, Monte Carlo is the most expensive property market in the world, according to an annual report by Global Property Guide, a research firm. An apartment of 120 square metres cost an average of $47,600 for each square metre in 2008, over double the rate in Moscow, the next most expensive city. Prime property in the Russian capital fetched a shade more than in London, where prices fell for most of the year. Cairo is not only the cheapest for buyers, but it may even be a good prospect for buy-to-let investors. Property in Cairo and Jakarta saw gross rental yields of over 11% last year, bettered only by the 14.2% returns in Chisinau, Moldova. By contrast most European cities offered feeble returns of under 5%.

However, the recent market turmoil should continue weigh on global property prices. According to Global Property Guide, there are three influences that entrenches these trends, namely...

``1. Economic growth. The deep recession now beginning will have strongly negative effects on house prices. Not only do people have less disposable income, but the uncertainties are pushing them to raise their saving rates – leaving less money available for spending on houses.

``2. Expectations and price momentum are strongly down in many major markets. People tend to derive their impression of what is likely to happen to house prices, from neighbours and from the news, and the news is bad. This increases the likelihood that things will, actually, get worse, on the (well-established) basis that one of the strongest predictors of property price movements in Period T, is what happened to property prices in Period T-1.

``3. Interest rates. Base rates have been reduced, but mortgage lending rates have not fallen. The UK is typical here. Banks and building societies are refusing to lower mortgage interest rates, despite the Bank of England’s base rate cuts.

We'd like to add another two: the continued unraveling of unserviceable debt and reduced access to credit should also serve as major headwinds.

Nonetheless based on 3rd quarter 2008 data from Global Property Prices, much of the damaged have been seen in the economies that joined the property bubble shindig.

And much to our surprise, property prices in the Philippines was not spared from the global rout (as measured from Makati CBD), even if the country missed the real estate party.

Although the optimistic angle is that the degree of decline or the damage wasn't as hefty (1.4% quarter on quarter and .16% year on year).

Meanwhile, a "spectacular" investment rating had been provided for by Global Property Guide on Metro Manila which had a Gross rental yield of 10.99% per annum. This should be supportive of the domestic property prices.

Itemizing The Proposed $819 billion Magical Stimulus Package

How will the proposed US $819 billion stimulus package be distributed?

The chart from the Washington Post gives as some clues. Click on Washington Post link for a bigger picture.