Steepening Global Yield Curve Reflects Thriving Bubble Cycle

``The way out of a deflationary trap is to first induce inflation and then to reduce it. That is an intricate operation and success is far from assured. As soon as economic activity in the United States revives, interest rates on government bonds are liable to shoot up; indeed, the yield curve is likely to steepen in anticipation. Either way, a rise in long-term interest rates is liable to choke off the recovery. The prospect of the greatly increased money supply turning into inflation is likely to lead to a period of stagflation. That, however, would be a high-class, desirable outcome because it would avoid prolonged depression.” George Soros, My Outlook for 2009

The overwhelming performance of today’s stock markets and commodity markets has sent a few bears “capitulating”. The stunning surges in the markets has had powerful psychological leash that has been proselytizing much of the “consensus” to interpret for a “strong” economic recovery.

This clearly has been a manifestation of the operational aspects of the reflexivity theory feedback loop-where people interpret price signals as signifying real events, and where real events reinforce the price signals.

For mainstream analysts, the “animal spirits” have been roaring back to life!

For us, the present phenomenon have been reflecting the escalating symptoms of the influences of monetary forces over the markets and the real economy, which is another way of saying-we are witnessing anew serial bubble blowing dynamics at work which is being fueled by policy induced inflationary forces.

Upward Sloping Global Yield Curve Drives Maturity Mismatches

Notably steeping yield dynamics has been part of the bubble blowing framework, see figure 1.

Figure 1: BCA Research: Global Yield Curve Strategy

The independent Canadian Research outfit BCA Research believes that it would take central banks at least the 2^nd half of 2010 for the policymakers to begin raising rates thereby flattening the yield curve or the ``relation between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower in a given currency.” (wikipedia.org)

According to the BCA, ``During the last recession, the 2/10 Treasury slope peaked in August 2003 but did not begin to steadily flatten until early 2004, a few months before the Fed began its tightening campaign in June of that year. Last week, Atlanta Federal Reserve Bank President Dennis Lockhart outlined the unusual scenario that if faced with inflation, the Fed could potentially increase the target funds rate even as it continued to pursue quantitative easing. Although technically possible, thanks to the recent policy of paying interest on bank reserves, this outcome is highly unlikely. Rate hikes will be politically impossible in the near term. It would be far easier to gradually and quietly unwind monetary stimulus in the reverse order that it was implemented, i.e. by selling long-term securities. Bottom line: Government yield curves are at cyclical extremes but a material flattening phase may still take until late 2009 or early 2010.” (bold highlight mine)

This would be an example of looking at similar data sets but with divergent interpretations.

Notice that during the dotcom bust at the advent of the new millennium, produced a steepening of the global yield curve which coincided with the incipient boom in the US real estate industry (green circle).

Further notice of BCA’s observation that “the 2/10 Treasury slope peaked in August 2003 but did not begin to steadily flatten until early 2004”- eventually paved way for the real estate bust which emerged in 2006 albeit more than a year later, whereas the bearmarket in stocks finally surfaced in 2007 about a year after the cracks in the US real estate industry became unstoppable force.

Why is this?

Because, according to Professor Philipp Bagus and David Howden, ``maturity mismatching can turn out to be a very profitable business, involving a basic interest arbitrage. Normally, long-term interest rates are higher than their corresponding short-term rates. A bank may then profit the difference — the spread between short- and long-term rates — through these transactions. Yet, while maturity mismatching can turn out to be profitable, it is very risky as the short-term debts require continual reinvestment (i.e., a continual "rollover" must occur).” (bold highlights mine)

In other words, the widening yields spread greatly benefits banks which aside from profiting from maturity mismatch arbitrage also provide funding that fuels the speculative “animal spirits” in the marketplace through the “borrow short and lend/invest long” or the basic framework for what is popularly known as the “carry trade”.

And the ensuing risks emanates from the burgeoning mismatches of assets and liabilities, the liquidity and rollover risks. Why? Because according to Professor Jeffrey Herbener, ``The swollen liabilities of checkable deposits are payable on demand to customers while the matching assets of loans are not recoverable on demand by banks. Profits earned by entrepreneurs no longer correspondent completely to the satisfaction of consumer preferences, but are systematically distorted by the artificial spending stream fed by the central bank. Entrepreneurs are misled by the credit expansion into shifting the use of factors into activities considered less-valuable by consumers.” (bold highlights mine)

Borrowing short and investing long needs constant liquidity infusion because long term investments like real estate can’t be monetized soon enough in the same manner as placements in money market funds. And where a sustained episode of liquidity shortage surfaces, trades founded on this platform ultimately collapses. This had been one of the major hallmarks of the financial crisis of 2007.

But we seem to be presently seeing the resurrection of a similar edifice.

I would like to further add that present policies which induce speculative bubbles don’t generate ‘productivity gains’ that’s because the “artificial spending stream” have been causing entrepreneurs to misallocate or engage in malinvestments.

Moreover, speculating in the marketplace don’t generate net jobs as jobs added are those from the financing side (e.g. brokers, investment houses etc.) at the expense of “unseen” investment and jobs lost serving consumers.

And importantly, once the yield curve flattens or reverses to negative, capital instead of accumulating would be lost, as the unsustainable bubble structure would be eviscerated! In 2008, ADB estimates financial assets losses at $50 trillion (Bloomberg)!

Philippine Yield Curve Reflects Global Direction

Figure 2: Asian Bonds Online: Philippine Benchmark Yield Curve

The elevated slope of the yield curve also applies to the Philippine setting see figure 2.

Remember, the Philippine private sector is largely little leveraged on both absolute and relative levels (compared to Asia).

Hence, when our Central Bank officials as BSP deputy governor Diwa Guinigundo say ``Having the scope for higher savings does not mean of course that we should discourage consumption expenditure in the economy…Consumption sustains higher level of economic activity,” we should expect a boom in credit take up to occur as policies shapes the public’s incentives.

So you can expect domestic bankers and financers to knock on your door and, to paraphrase Mark Twain, lend you their umbrella (offer you generous loans or credit) when the sun is shining (as markets appear to be booming), but eventually would want it back the minute it begins to rain (crisis).

Rest assured present policies will foster persistent expansion of “circulation credit” that should benefit the Philippine Stock Exchange (PSE) and the Phisix over the interim and the present cycle.

Yield Curve Could Steepen Further, “Benign” Inflation

We agree with the BCA when they suggested that ``Rate hikes will be politically impossible in the near term.” That’s because the economic ideology espoused by Central Bankers and mainstream analysts essentially ensures the continuation of asset supportive policies.

More than that, as Emerging Market (EM) economies begins to experience a cyclical “boom” EM central banks will likely continue to add on US dollar reserves, which most likely will be recycled into US treasuries. The BRICs or the major emerging markets of Brazil, Russia, India and China reported the fastest pace of US dollar buying worth-$60 billion of US dollar reserves in May (Bloomberg).

US dollar purchases by Asia and Emerging markets will likely be sustained for political goals, but the composition of purchases has been substantially changing. This most likely reflects on EM central bankers concerns over US policies, as EM officials have been openly saying so.

Meanwhile the concentration of official purchases has markedly weaned away from agencies with diminishing exposure on long term securities (T- bonds) and has apparently been shifting into short term bills.

Yet if the present direction of US treasury acquisitions persists, then the short end of the yield curve will likely remain supported and probably won’t rise as fast as the longer term maturity.

Figure 3: Northern Trust: Rising Treasury Yields versus Falling Private Security Yields

On the other hand, yields of US treasury bonds have been rising perhaps mostly due to “expectations” on economic recovery as private sector credit spreads has meaningfully declined, see figure 3.

Northern Trust chief economist Paul Kasriel explains, ``If the current and increased supply of Treasury debt coming to market were “crowding out” private debt issuance, then the yields on privately-issued debt would be holding steady or rising in tandem with the rise in the Treasury bond yield. But again, yields on privately-issued debt are falling. In sum, investor risk appetite is returning, which is a good thing for the prospects of an economic recovery, not a bad thing.”

And last week’s 30 year bond auctions successfully drew up a good number of buyers. Despite higher yields (since August of 2007) the bid to cover and number of indirect buyers (possibly foreign central banks) saw significant improvements (Bloomberg).

So maybe, for now, markets appear pricing in a US economic recovery as the credit markets, stock markets and commodity markets, the Volatility or Fear Index and Credit Default Swaps on sovereigns debts have all been in confluence to reveal signs of dramatic improvements over the marketplace.

As my favorite foreign client recently observed, this is could be the benign phase of inflation.

Nevertheless in congruence with the observation of the BCA Research, it seems that the yield curve for US sovereign securities could remain in an upward sloping direction even if it has already been drifting at the cyclical extremes. The massive funding requirements by the US government (estimated at $2 trillion for 2009 out of the $3 trillion estimated for the world) for its deficit spending programs ensure higher yields for the longer maturity sovereigns. This combined with US official policy rates at zero interest levels and emerging market central banks purchases on the shorter end.

And we could expect the slope of the global yield curve to track the direction of the US but perhaps at a much subdued scale as debt issuance compete with limited global capital.

So as long as the yield spreads continues to widen, we should expect the fury of monetary “speculative” forces nurtured by the global central banks to be vented on the global stock markets and commodity markets.

US Financial Crisis: It Ain’t Over Until The Fat Lady Sings!

``For speculative and especially for Ponzi finance units a rise in interest rates can transform a positive net worth into a negative net worth. If solvency matters for the continued normal functioning of an economy, then large increases and wild swings in interest rates will affect the behavior of an economy with large proportions of speculative and Ponzi finance.” Hyman Minsky, Inflation Recession and Economic Policy

Price signals have a powerful psychological impact. The recent upsurge in global stock markets has been heralded by many as an end to the crisis.

We beg to differ.

In contrast, we think that this is a lull before the storm for the US.

Further, we think that this appears to be seminal phase to an even more severe crisis in the future; one that will deal with a possibility of combined bubbles of private and public sector debt in the face of outsized inflation!

Figure 4: IMF: Global Financial Stability Report (2007)

As you can see in Figure 4, for most of 2009 the reset schedule for subprime mortgages have indeed been at a diminishing pace. Hence, the seeming moratorium in the market turmoil as these subprime resets ease.

However, renewed pressures on foreclosures will likely be felt or experienced later this year as Option adjustable rate and Alt-A mortgage resets mount and is expected to accelerate and culminate by 2011!

Burning Platform’s James Quinn gives us the details (bold highlights mine), ``There are over 4 million homes for sale in the U.S. today. This is about one year’s worth of inventory at current sales levels. You can be sure that another one million people would love to sell their homes, but haven’t put their homes on the market. The shills touting their investments on CNBC every day fail to mention the approaching tsunami of Alt-A mortgage resets that will get under way in 2010 and not peak until 2013. These Alt-A mortgages are already defaulting at a 20% rate today. There are $2.4 trillion Alt-A loans outstanding. Alt-A mortgages are characterized by borrowers with less than full documentation, lower credit scores, higher loan-to-values, and more investment properties.

``There are more than 2 million Alt-A loans in the U.S. 28 percent of these loans are held by investors who don’t live in the properties they own. That includes interest-only home loans and pay-option adjustable rate mortgages. Option ARMs allow borrowers to pay less than they owe, with the rest added to the principal of the loan. When the debt exceeds a pre-set amount, or after a pre- determined time period has passed, the loan requires a bigger monthly payment.”

And yes, the US economic system will be envisaged with more bouts of deflation….

McKinsey Quarterly estimates that some $2 trillion worth of losses has yet to be recognized.

About half of these losses will be accounted for the US financial system, see Figure 5.

Figure 5: McKinsey Quarterly: $3.12 trillion of losses from 2007-2010

Let me quote the McKinsey Quarterly in What’s Next For US Banks (bold emphasis mine),

``While 2008 was the year for taking losses on broker–dealers, this year and next will be the years for taking losses on assets subject to hold-to-maturity accounting. These are the losses that show up in stress tests, in which regulators make assumptions about how the economy will perform and calculate the resulting loan losses under various economic outcomes. For example, credit card losses are highly correlated with unemployment. By projecting unemployment rising to a certain level, stress testing can then project the attendant credit losses.

``McKinsey research estimates that total credit losses on US-originated debt from mid-2007 through the end of 2010 will probably be in the range of $2.5 trillion to $3 trillion, given the severity of the current recession (Exhibit 2). Some $1 trillion of these losses has already been realized. Since US banks hold about half of US-originated debt, the US banking and securities industry will incur about $750 billion to $1 trillion of the remaining $1.5 trillion to $2 trillion of projected losses on this debt, which includes residential mortgages, commercial mortgages, credit card losses, and high-yield/leveraged debt. These numbers are in the same range as those of the US government, which calculated a $600 billion high-end estimate of credit losses for the 19 largest institutions.”

So despite the declaration by Mr. Ben Bernanke in the US Congress last week that, ``The Federal Reserve will not monetise the debt” and even warned of the burgeoining deficits (Financial Times), we believe that Mr. Bernanke isn’t being forthright.

He wasn’t even trying to be funny.

The fact that the US Federal Reserve earmarked $1.25 trillion to acquire $750 billion of agency mortgage backed securities and $300 billion in longer term treasury securities belies Mr. Bernanke’s statement.

Moreover, the Wall Street Journal reports that the ``Fed has purchased $156.5 billion of government bonds” and ``has bought $555.9 billion of mortgage securities.” (see figure 6)

In short, the Mr. Bernanke hasn’t only been talking, he has been nearly exhausting its allocation for Quantitative Easing (QE) or effectively monetizing debt!

Figure 6: WSJ: Fed to Keep Lid on Bond Buys

So we can’t easily buy into cacophonous signals shown by the Fed that they are having second thoughts on buying more of the above government securities. As the WSJ reports, ``Fed officials have become more confident recently that they have stabilized the economy and set the stage for recovery. But divisions are brewing within the Fed over whether it should do more to speed the healing, pause, or start pulling back to avoid an outbreak of inflation.”

Just wait until the pressures from Alt-A and Option adjustable resets, combined with strains from the commercial mortgages, credit cards and auto and leveraged loans escalates, then all these appearances of jawboning against inflation will be moot.

This means that more episodes of systemic deflation should translate to even more inflation from the US government via Ben Bernanke’s Federal Reserve and Tim Geithner’s US Treasury!

Global Inflation Transmission From Quantitative Easing

I might like to also add that perhaps the US dollar reserves recently harvested by the BRICs, as earlier noted, could have been proceeds from US Federal Reserves purchases of Long term Treasuries and Agency backed mortgages than from export revenues or portfolio inflows, both of which while exhibiting some signs of improvements are less likely to have contributed to such material reserve accumulation.

Foreigners own a substantial segment of US treasuries as much as it owns mortgage debt backed by the Agencies. As of 2007, according to Yale Global’s Ashok Bardhan and Dwight Jaffee, ``Foreign ownership of US Agency securities, bonds and mortgage-backed securities (MBS) issued or backed by agencies such as Ginnie Mae, Fannie Mae and Freddie Mac totaled just under $1.5 trillion. While the absolute amounts may be large, it’s the share held by foreign investors of total US securities outstanding that conveys the significance of these global financial flows.”

So even while foreigners have been selling agency debt prior to the Fed QE program, the recent activities could have opened the window for more accelerated liquidations on the part of Emerging Market central banks on their portfolio holdings of US mortgage securities backed by Federal Agencies.

And part of these proceeds could have been recycled into short term US T-bills.

AND as the Federal Reserve prints money to buy US securities held by foreigners, this could, effectively, serve as transmission channels for many of the global monetary inflation taking place, aside from, of course, the collective national fiscal spending being undertaken worldwide.

So it matters less that the current account balances have been improving due to reduced consumption and rising savings, since the inflationary mechanism appears to be retransmitted via the financial claims channel into the world.

And perhaps part of the outperformance by emerging markets could have been driven by such inflationary leakages.

And more of this could be in play see figure 7.

Figure 7: Casey Room: Rapidly Expanding Government Debt

And perhaps too, Mssrs. Bernanke and Geithner could be tacitly rooting for Emerging markets and Asia to miraculously pull the US out of the doldrums which implies even more QE!

Conclusion

The main issue is if US government liability issuances to fund the US deficit spending programs would eclipse the ability by the world or by US savers to finance these. Then the US will either be faced with massively inflating or defaulting.

Don’t forget that aside from rescue packages and the prospective entitlement (Social Security, and Medicare) strains, President Obama has ambitious health, environment, infrastructure, education and energy programs that could equally pose as additional pressures to US taxpayers.

Hence the recent overtures by BRICs to fund the IMF (WSJ) instead of recycling spare reserves into the US could be another proverbial “writing on the wall”.

Lastly, it isn’t total borrowing that should be THE concern, as some observers opine as necessary.

The last boom saw household and financial sector borrowing explode, which brought the world economy to the brink of a collapse through its unraveling.

This was in spite of US Federal debt not being in play.

The crux of the issue is if the present debt load incurred by either the private sector or by government or both can be paid for by the economy operating under a new environment characterized by higher tax rates, vastly increased regulations, lesser degree of a free markets and a hefty politicization of the economy.

As Hyman Minsky wrote in Finance and Profits: The Changing Nature of American Business Cycles, 1980 ``Three financial postures for firms, households, and government units can be differentiated by the relation between the contractual payment commitments due to their liabilities and their primary cash flows. These financial postures are hedge, speculative, and ‘Ponzi.’ The stability of an economy’s financial structure depends upon the mix of financial postures. For any given regime of financial institutions and government interventions the greater the weight of hedge financing in the economy the greater the stability of the economy whereas an increasing weight of speculative and Ponzi financing indicates an increasing susceptibility of the economy to financial instability.” (bold highlight mine)

Hence if the deficit spending programs equates to another form of “Ponzi financing” then financial instability is to be expected in the fullness of time.

So it ain’t over until the fat lady sings!

On Feasibility Studies: Research Quality Is Subjective And Not Commoditized

``Irrationality as a real economic attribute is not only the pith of behavioral finance; it is the next frontier for all market research.”-Woody Dorsey

At a recent social function, a colleague opined that some professors at post-graduate universities ‘moonlight’ by selling feasibility studies through consultancy services. Yet these feasibility studies were adduced to have been consigned to the students, from which the professors consolidate, package and deliver to clients as their own. The negative connotation is that professors monetize on these by “using” their students to do their work. Hence, the conclusion was, instead of contracting consultancy services from such professors, it would be better off simply hiring students to conduct such feasibility requirements at much cheaper rate.

Nonetheless while there are merits to the allegation of delegating some work to students (which I say would be mostly be data gathering), the hasty generalization is that feasibility studies are homogeneous or monolithic. Unfortunately, they are not.

Feasibility studies, while constituting basic components, are highly subjective and greatly dependent on the reference points, data set or data coverage, methodology, interpretation and importantly the author’s biases.

This may somewhat be seen analogous to market reports, where similar data sets would induce different interpretations which ultimately arrives at different conclusions for these observers. That because researchers, like anybody else, have different marginal utilities or set of values or priorities.

For instance, while conventional market reports focuses mainly on micro (e.g. PE ratio, national GDP) or macro fundamentals (e.g. current account balances) or technical charting theme, my methodology would flow from the monetary and behavioral aspects, to inflation dynamics to prospective political directions. Hence my conclusions or projections are frequently seen as unorthodox or “contrarian”.

The point is, research quality is highly subjective and variable and can’t be “commoditized” or seen as a “one-size-fits-all” template.

Applied to business strategies, contracting “cheap” feasibility studies would only amplify business risk. This isn’t your school requirement, where you rush to C.M. Recto to ‘buy’ a stereotyped report (a road in Manila reputed for “outsourcing or for hire school reports researchers” and “fake” legal documents), and where the stake is only choice between “passing” or “failing” grade; business strategies involve long term capital allocation, where wrong decision/s from haphazard analysis subjects investors to financial losses.

Herding Behavior and Awkward Dancing

Paul Kedrosky calls this video Contagious Behavior and Bad Dancing.

I would say that this is a manifestation of the cognitive bias called the Bandwagon effect or the Herd Behavior where "individuals in a group can act together without planned direction" plus really bad or awkward dancing.

WHO's Pandemic Alert On Swine Flu: Real Pandemic Threat Or Other Unspecified Motives?

The Swine Flu has officially been declared by the WHO as a pandemic.
This from the Economist, ``THE World Health Organisation raised the threat level for swine flu on Thursday June 11th to pandemic status, the highest possible. It is the first influenza pandemic since 1968, when Hong Kong flu killed 1m people. Almost 28,000 cases of swine flu and 141 deaths have been confirmed in 74 countries since the A(H1N1) virus was first identified in Mexico in late March. In Australia alone, the number of people infected has jumped from around 500 to 1,200 in one week. However, in a new paper published in Nature on Thursday, researchers suggest that the strain had probably been in existence for months before it was isolated, highlighting the need for good surveillance."

I'm no health expert, but I remain a skeptic.

The figures are telling; 141 out of 28,000 cases translates to a .5% fatality rate. The 1918 pandemic had a case fatality (CF) ratio of 3-6% according to wikipedia.org.

Moreover, 28,000 cases in 3 months against a world population of 6.7 billion doesn't seem to project anywhere near the same degree of impact relative to the 1918 case.

Then, some 25 million people had reportedly been killed during the first 25 weeks of the outbreak according to wikipedia.org.

Of the world population of approximately 1.6 billion, estimated fatalities for the 2 year lifespan of the pandemic reached a third or about 500 million-again from wikipedia.org.

Under the same rate, we would now have tens of millions of infected people and casualties that would run in the hundreds of thousands if not in millions.

Of course, one may argue that- this is what the pandemic alert is for-to prevent the spread of the disease and fatalities!

But where should the line be drawn between the use of "fear" from pandemics (or as an excuse) for expanded government control of our lives and the real menace of swine flu as pandemic? Or how do we know if the pandemic alert is genuinely about disease prevention or about some implicit interests being foisted on us by government/s? How do we know if this isn't about propping up sales of pharmaceuticals, some of which are said to be partly owned by certain politicos or a thrust to impose global taxes or other concerns outside of the pandemic issue?

See past articles:
Swine Flu: Mostly A Media Fuss
Swine Flu: The Politics of Fear and Control
Swine Flu: The Black Swan That Wasn’t

Soaring Oil Prices Isn't Just Relative To The US Dollar, But On Most Currencies!

Oil prices as benchmarked by the West Texas Intermediate Crude (WTIC) recently hit $73 per barrel where many analysts attributed oil's climb to the US dollar.

Having checked on the WTIC compared with different currencies we realized that this had only been partially accurate-oil has been surging across major currencies!

Against the Euro

Against the Aussie Dollar

Against the Japanese Yen

Against the Canadian Dollar (loonie)

Against the Swiss Franc

and even Against the South African Rand!

Decoupling in Oil Markets: The Centre of Gravity in Energy Markets Has Shifted To Emerging Markets

Mr. Tony Hayward, chief executive of BP made a dramatic revelation about the evolving energy industry published at the Telegraph last week.

He said that the "centre of gravity" of the energy markets had permanently shifted towards emerging markets.

We quote Mr. Hayward (emphasis added), ``But one event went almost unnoticed. 2008 was the year when the centre of gravity in the energy market tilted sharply and permanently towards the emerging nations of the world. For the first time ever, non-OECD energy consumption outstripped that of the OECD nations.

``This really is a decisive moment. People have been predicting such fundamental shift, with its implications for the world economy and geopolitics, for some time. Now it has happened."

Yet, ironically, many so called experts stubbornly insist that the world can't decouple.

chart from BP Statistical Review on World Oil consumption

Adds Mr. Hayward, ``As has been the case for several years, China again led the way in incremental energy consumption in 2008, accounting for three-quarters of the extra growth, and India took second place.

``Both countries rely heavily on coal for power generation. China in particular has extensive coal reserves and this means that coal remains the fastest-growing fuel, as it has for six consecutive years.

``The shift in energy consumption towards the non-OECD is not a temporary phenomenon. On the contrary, I believe it will increase still further over time. It is a trend which will continue to affect prices and raise questions about the sustainability of economic growth, energy security and climate change."

Chart from McKinsey Quarterly/Reserach Recap

Well it isn't just Mr. Hayward or BP saying so, research institute McKinsey Quarterly observes the same dynamics in motion too.

Mckinsey Quarterly's Interactive chart depicting of the World Energy Demand (I placed it under a severe downturn scenario).
Also Mckinsey Quarterly's Interactive chart on World oil consumption (I also placed it under a severe downturn scenario)

From McKinsey, “More than 90 percent of this demand expansion will come from developing regions, with China, India, and the Middle East leading the way. Five sectors within China—residential and commercial buildings, steel, petrochemicals, and light vehicles—will account for more than 25 percent of global energy demand growth. India’s light-vehicle, residential-buildings, and steel sectors and the Middle East’s light-vehicle and petrochemicals sectors will be other notable contributors to the growing demand for energy.” (bold highlight mine)

So Emerging Market demand, restricted supplies, inflationary policies and limited geographical access adds up to $200 oil or more as we wrote in $200 Per Barrel Oil ,Here We Come!

Philippine Politics: "Con Ass" Much Ado About Nothing?

I have not been following the controversy over the so called Constitutional Assembly (Con-Ass) or an attempt by adherents of the present administration to railroad a modification on the Philippine constitution purportedly for extending the tenure of incumbent officials.

It's because my interpretation of the furor has been more of a "noise" than of a genuine concern.

From an intuitive layman's point of view I would require answers to these questions:

1. Is there a legal basis to amend the Philippine constitution with only one house of the bicameral legislative branch in support of such action?

2. Assuming there is, since any amendment would require a people's referendum or plebiscite, would there be a legal framework for a CON ASS referendum to supersede next year's scheduled national elections?

3. And would there be enough resources and time earmarked to do so?

In my view, a NO answer to any of these 3 questions would likely torpedo these efforts to advance the CON ASS agenda.

Notwithstanding, considering the unpopularity of the present administration, legal hurdles can be utilized by the political opposition to derail such agenda. This would essentially constrict the window for a referendum, in lieu of or prior to next year's national elections.

In short, such actions doesn't look feasible even from the start.

Then why does it seem that the administration has been adamant to play this card?

We offer two guesses here:

One, it could be a diversionary tactic to lure the political opposition into concentrating their efforts over such useless issue while the administration, behind their backs, works to strengthen its logistics and networks in preparation for the upcoming national election.

Two, it could also be a trial balloon to gauge on the "winnability" of PGMA's "anointed" bets via her popularity going into next year's election.

It is political season in the Philippines hence most sensationalist events disseminated by media, including the Halili Kho scandal, are likely to be instruments for political agenda.

As I responded to a colleague at a recent social function:

We must remember, in politics, those in power will always work or attempt to preserve their political privileges, while those in the periphery will always work or attempt to usurp such privileges. Such is the vicious cycle of politics.

Why? Because political privileges are usually products of an interventionist welfare state. Where, to quote Richard Eberling, ``The political process is the mechanism that these individuals and groups use to get that money via regulation, protections, and redistribution."

Politics is hardly about social "weal" or the "people" as much as it has been bruited about, it's mostly about privileges.

India's Surging Markets Lures Companies From The Government and The Private Sector To Raise Financing

Surging financial markets in India have lined up companies from the private sector and government to raise financing.

From the trough, India's BSE 30 is up about 84% and is 26% shy from its 2008 peak.

The Indian rupee has also rallied furiously since the simultaneous trough in the stock and currency markets.

According to the Wall Street Journal, ``So far this year, issues of new shares have been scarce. But with the Bombay Stock Exchange's benchmark index at a 10-month high, many companies have plans to raise capital to bolster balance sheets and fund growth, bankers say.

``The new government's budget, scheduled for release in early July, also could usher in new sales of stakes in public companies. The frenzy may be welcome news to investors looking to ride a rapid rise in India's stock market over the past few months...

``Data provider Thomson Reuters expects $50 billion of new shares to be issued in India this year. So far, there has been just $1 billion.

The newly elected government is also in a rush to join the financing bandwagon.

Again from the same article, ``On the IPO front, state-owned hydro-power outfit NHPC Ltd. and oil-exploration company Oil India Ltd. are expected to issue shares. On Monday, Rahul Khullar, the outgoing top bureaucrat in the department in charge of state company disinvestment, said the government is likely to sell stakes in NHPC and Oil India by September, followed by six to seven other companies before March 31, 2010.

``The government's budget could offer further divestment plans amid the need to stimulate the economy without severely worsening the fiscal deficit.

``Air India, India's national airline, and state-run telecommunications company Bharat Sanchar Nigam Ltd., or BSNL, are likely to sell some shares, market watchers say."

The phenomenal activities in India are likely to be replicated in major Emerging Markets and in Asia.

Search Trends Reveal Growing Concerns Over Hyperinflation

During the last quarter of 2008, the near collapse of the US banking system prompted by some accounts of institutional or electronic bank runs paved way for the predominant concern of deflation.

The one year search trend in Google Trends reflected this (see below). Now with surging stock markets and turbocharged commodity prices, the pendulum has apparently shifted from deflation to the other extreme end-hyperinflation.

Deflation searches have been on a decline while searches for hyperinflation has been on the rise (see below).

As of this writing, deflation still dominates with 6.58 million articles against 2.5 million for hyperinflation. Meanwhile, inflation has 67.5 million articles while stagflation has 735,000 articles.

So there seems less interest on the middleground.

The point is we seem to be at the crux of a trend transition where public concerns appear to weigh on hyperinflation.

Power Curves Applied To Economy, Markets And Nature

This is an interesting study from The McKinsey Quarterly which dwells with power curves in "Power Curves": What Natural And Economic Disaster Have In Common

The power curve or the power law according to wikipedia.org,``A power law is a special kind of mathematical relationship between two quantities. If one quantity is the frequency of an event, the relationship is a power-law distribution, and the frequencies decrease very slowly as the size of the event increases. For instance, an earthquake twice as large is four times as rare. If this pattern holds for earthquakes of all sizes, then the distribution is said to "scale". Power laws also describe other kinds of relationships, such as the metabolic rate of a species and its body mass (called Kleiber's law), and the size of a city and the number of patents it produces. What this relationship means is that there is no typical size in the conventional sense. Power laws are found throughout the natural and manmade worlds, and are an active area of scientific research.

McKinsey suggests that the laws of nature can be applied to economies or marketplace, ``Scientists, sometimes in cooperation with economists, are taking the lead in a young field that applies complexity theory to economic research, rejecting the traditional view of the economy as a fully transparent, rational system striving toward equilibrium. The geophysics professor and earthquake authority Didier Sornette, for example, leads the Financial Crisis Observatory, in Zurich, which uses concepts and mathematical models that draw on complexity theory and statistical physics to understand financial bubbles and economic crises.

``Sornette aims to predict extreme outcomes in complex systems. Many other scientists in the field of complexity theory argue that earthquakes, forest fires, power blackouts, and the like are extremely difficult or even impossible to foresee because they are the products of many interdependent “agents” and cascades of events in inherently unstable systems that generate large variations. One symptom of such a system’s behavior is that the frequency and magnitude of outcomes can be described by a mathematical relationship called a “power law,” characterized by a short “head” of frequently occurring small events, dropping off to a long “tail” of increasingly rare but much larger ones...

``If, for instance, you plot the frequency of banking crises around the world from 1970 to 2007, as well as their magnitude as measured by four-year losses of GDP for each affected country, you get a typical power curve pattern, with a short head of almost 70 crises, each with accumulated losses of less than 15 percent of GDP, quickly falling off to a long tail of very few—but massive—crises . While the most extreme cases involve smaller, less developed countries, the same distribution also applies to more developed ones—and with much larger absolute values for GDP loss. Earthquakes, forest fires, and blackouts yield a similar power curve pattern—for instance, from 1993 to 1995, Southern California registered 7,000 tremors at 2.0–2.5 on the Richter scale, falling off to the 1994 Northridge earthquake, at the end of the tail, with a magnitude of 6.7. The curve highlights a key property of the power law: extremely large outcomes are more likely than they are in a normal, bell-shaped distribution, which implies a relatively even spread of values around a mean (in other words, shorter and thinner tails)."

The power law applied to the industrial production...

``These examples indicate that power law patterns, with their small, frequent outcomes mixed with rare, hard-to-predict extreme ones, exist in many aspects of the economy. This suggests that the economy, like other complex systems characterized by power law behavior, is inherently unstable and prone to occasional huge failures. Intriguing stuff, but how can corporate strategists, economists, and policy makers use it? This is still a young field of research, and the study of power law patterns may be part of the answer, but it isn’t too early to consider and discuss potential implications."

Read the rest here

Jim Grant On Federal Reserve Policies, Federal Reserve Audit, and Gold

Jim Grant at CNBC.com deals with Federal Reserve policies, the possibility of the Federal Audit and its repercussions and gold.

The interesting part comes from Mr. Grant's reaction to Congressman Ron Paul's initiative to have the Federal Reserve audited.

This from lewrockwell.com ``The Federal Reserve's balance sheet is so out of whack that the central bank would be shut down if subjected to a conventional audit, Jim Grant, editor of Grant's Interest Rate Observer, told CNBC.

``With $45 billion in capital and $2.1 trillion in assets, the central bank would not withstand the scrutiny normally afforded other institutions, Grant said in a live interview."

``If the Fed examiners were set upon the Fed's own documents – unlabeled documents – to pass judgment on the Fed's capacity to survive the difficulties it faces in credit, it would shut this institution down," he said. "The Fed is undercapitalized in a way that Citicorp is undercapitalized."(bold highlights mine)

Ouch!

Barry Ritholtz: How to Fix Financial Television

Prolific blogger Barry Ritholtz in one of his latest post "How to Fix Financial Television" submits a wish list of how media should conduct their TV programs when discussing financial affairs (some of this seem applicable to the Philippine equivalent).

Except for number 3, all bold highlights mine. We quote Mr. Ritholz...

1. Stop Yelling. Stop interrupting. Stop Talking Over Each Other: This is not Jerry Springer, its serious business. People’s retirement and investments are at stake. Please treat it that way.

2. Bring us People We Don’t Have Access to. What various FinTV channels do really well is when they bring us long, thoughtful interviews with the likes of Warren Buffett, WIlliam Ackman, David Einhorn, and others. People we wouldn’t ordinarily have access to. Example: This morning, CNBC had on James Rickard. More of this please.

3. S - L - O - W D - O - W - N

4. Risk: All traders must appreciate the potential downside of trades. So too, must FinTV. Explain stop losses. Understand Risk/Reward. Recognize there are periods when Buy & Hold is a jumbo loser.

5. Lose the Octobox. Fire whoever came up with the Decabox. ‘Nuff said.

6. Separate the Signal from the Noise. Understand that most of the day-to-day action is simply noise. Look at a long term chart, you can barely see 9187 or 9/11. If those major events get lost in the long term trend, what does the intraday jags, kinks and reversals mean? Very little. Recognize that not every data release, slice of news, or rumor is at all significant. Stop treating them as if they were.

7. Fact Check: An awful lot of things on air get stated with authority and confidence. Much of them are little more than junk or pop myths. Why is it that the more dubious a proposition is, the greater the confidence the speaker seems to muster? Consider fact checking as much of the statements that are made on air as possible, and making frequent corrections.

8. Accountability is important: I am astounded at some of the money losing hacks that are various shows again and again. These are the “articulate incompetants” to use Bennett Goodspeed’’s phrase. Why not keep track of the records of guests — and let the viewers know how their past few calls have been. Are they Perma-bulls or bears? Are their stock picks awful? Are they reliable money makers? If not, let us know. (Of course, the better question is, if not, why even have them on?)

9. Bring Back Louis Rukeyser: Not the man, but rather, his style. Wall $treet Week — Rukeyser hosted it from 1970 to 2005 — was plain-spoken, thoughtful and accessible. Quiet, contemplative, discussions, with intelligent market participants, revealing helpful information. The investing public would appreciateagain. something of that sort —

10. Sound FX: What is with all the bizarre sound effects every time a screen changes? Its financial news, not a video game. Kill ‘em.

11. Embed your video (on your own website or YouTube) instead of using WMP. At long last, thank you.

12. Investigative Pieces: David Faber seems to have a monopoly on deep, long thoughtful analyses. Be they on Wal-Mart, the credit crisis, whatever, his long format work is a highlight of CNBC. More of these, please.

13. Most stock picks are losers. That’s normal, but the audience does not realize this. A big part of the challenge is informing the viewer that finding the biog winners is a low probability, high outcome event. As in a baseball, a 350 hitter is a star. Explain this to your audience.

14. Stop the Bull/Bear Debate: This is a vast over-simplification of the market, and often does not serve the audience well. There are nuances and variables that get lost when you reduce everything to black and white.

15. Partisanship: Leave your personal politics at home. Viewers don’t care what most of you think.

16. Respect the Audience: We are adults. Treat us that way.

Great stuff, Barry.

I'd like to add, for the Philippine setup -stop projecting markets as some sort of a "game" similar to horse racing. It is one reason why locals have a poor understanding of the markets.

10 World's Largest Energy Renewable Projects

Interesting trivia on the world's largest renewable energy projects from Scientific American.

According to Sciam, ``Today, renewable energy sources generate 12 percent of electricity in the U.S. But wind, wave, sunshine and others represent more than 93 percent of the energy the country could be producing, according to the Energy Information Administration of the U.S. Department of Energy."

The list includes wind, geothermal, biomass, tidal or wave power, hydroelectric, solar and landfill gas...

Here are two samples of the renewable energy landmarks.


World's Biggest Offshore Wind Farm Lynn and Inner Dowsing Wind Farm Near Skegness, Lincolnshire, England

World's Largest Photovoltaic Power Plant Olmedilla Photovoltaic Park in Olmedilla de Alarcón, Spain

For the complete list and details, Pls click here

Peter Bernstein on Risk and Risk Managment

McKinsey Quarterly presents Peter Bernstein [my apologies I erroneously placed Richard Bernstein earlier]

``The celebrated author of Against the Gods: The Remarkable Story of Risk explores the history of risk and how it works in real-world markets and in our lives.

``Risk doesn’t mean danger—it just means not knowing what the future holds. That insight resides at the core of risk management for companies, whether in managing the potential downside of an investment or putting a value on the option of waiting when making irreversible decisions. In this video Peter L. Bernstein also explains why in the real world the most sophisticated mathematical models can sometimes fail."

Peter Bernstein in this video deals with Risk, Risk Control and Management, Options and Option pricing, and mathematical models that can't input world dynamics.

"It's how you deal with it when it happens"

Update: Learned today June 10th, that risk guru Peter Bernstein has recently passed away at age 90 (Bloomberg). Sad to lose such an inspirational icon, he will surely be missed.

WSJ Economic Scenarios: Just, Right, Too Cold or Too Hot

Here is a quaint chart from Wall Street Journal depicting on the possible scenarios for the US economy and its financial markets

Here are some excerpts from the article...

Just Right

``Hefty government stimulus -- easy Federal Reserve monetary policy and $787 billion in government spending, tax breaks and other perks -- encourages consumers to spend and businesses to hire. This bolsters economic growth, keeps a lid on unemployment and finally ends the pain in the housing market.

``At the same time, the massive structural problems facing the economy, including burdensome debt on consumer and government balance sheets, keep just enough of a brake on growth to keep inflation in check.

``Under this scenario, corporate profits and economic growth limp their way back to recovery through the second half of the year, setting up a stronger 2010. Stocks rise, though perhaps not by much. The consensus view among many strategists is that the broad Standard & Poor's 500-stock index will stagger its way to somewhere between 1000 and 1100 by the end of the year, a 17% gain from Friday's close.

Too Hot

``Under the too-hot scenario, surging asset prices trigger worries about inflation, hurting the dollar and causing the interest rate on government debt to rise. That might force the Fed to buy more Treasurys to keep interest rates low -- yields move in the opposite direction of prices -- fueling more worries about higher inflation and a devalued dollar.

Too Cold

``This pessimistic scenario is a recipe for retesting the stock market's March lows. In the longer run, it could also lead to deflation, in which prices tumble as consumers keep delaying purchases. Deflation can be long-lasting and have a chilling effect on stock markets."

Here is how I see it

Just Right is a fantasy premised on the efficacy of the Obama administrations' magical powers to successfully subvert the laws of scarcity and heal the economy.

Too Cold (or deflation)-a scenario where the US is insulated from the world and or that money has no impact on real economic activity.

Too Hot (or inflation)- a scenario presupposing the reemergence of inflation.

Our take: hot, too hot and possibly boiling hot!