PSE: The Handicaps Of A One Directional Reward Based Platform

``A free market has to and does coordinate current and future production against future unknown demands, supplies, and shocks; and it has to and does find ways to alleviate the negative effects of shocks. People generally accomplish this by planning, forecasting, conservative practices, saving, hedging, insuring, and diversifying. There are countless ways, each tailored to particular circumstances. When a man has a backup trade, he is hedging against being laid off in his main occupation. When a family saves, it is hedging against loss of income. When family members help one another in hard times, they are insuring each other. When a business is conservative in obtaining credit and expanding, it is hedging against possible stringent business conditions. When a person diversifies investments, he is hedging against loss in one part of the portfolio. When a business controls inventories, it is managing the risk of shocks to the business.”- Michael S. Rozeff, Destination Collapse

Over at a recent huddle, a good friend asked me “how does one maintain discipline if it is an extended bear market?” The underlying concern was that the temptation or the urge to “catch the falling knife” or to “scalp (day trades)” had been quite strong given the nearly 2 years of drought in profit opportunities.

I would believe that such sentiment fundamentally embodies the unappreciated circumstance that inhibits the progress of our capital markets.

The principal problem with the Philippine Stock Exchange (PSE) is that the sustainability of the equity market industry is almost entirely dependent on a UNIDIRECTIONAL trend- that’s because people and the industry generally make money only when the Phisix goes up or is in a bullmarket!

True, “short” or the securities borrowing and lending facilities lending have been recently introduced. But apparently unfamiliar to the public or to the authorities or regulators is that any regulatory framework operates on economic dimensions : It’s always about the tradeoffs between costs and benefits.

If brokers don’t implement these, for reasons of perceived cost outweighing perceived benefits, primarily due to the compliance albatross, then effectively the program is rendered inoperative. Even if it seems noteworthy in paper, what good is a new trading platform if it can’t be used at all?

Unforeseen Consequences

Nonetheless a one dimensional reward based market has these unforeseen consequences:

1. Deprives market participants to earn

Obviously since markets operate on secular cyclical trends, then the industry or the public profits only from a bullmarket and suffers from a period of agony of “deprivation” once the bearmarket reign.

In Biblical analogy, the PSE is reduced to FAT and LEAN years with basically nothing in between. This, sadly to say, reflects on the primitive state of our financial markets.

2. Limits Liquidity

Industry participants whine of the lack of liquidity or volume. But this is exactly why hardly volume hardly progresses:

In a bullmarket, the volume of trade improves because the public churn trades profitably. In contrast, in a bearmarket, buyers have essentially been confined to a “catching a falling knife” position, where loses from wrong market “timing” or “expectations” would compel a mostly “long” position, thereby containing incidences of trades which effectively shrivels volume.

And reduced liquidity diminishes the incentives for private companies to get publicly listed, increases the market’s risk profile and exaggerates volatility.

3. Restrains growth potential of the industry

Moreover, major industry participants, particularly, brokers, mutual funds or Unit Investor Trust Funds (UITFs) would be reluctant to invest for expansion under the recognition of operational handicaps of a unidirectional reward based market, hence, the growth rate mediocrity of the Philippine capital markets.

Figure 1: ADB Bond Monitor 1^st Quarter 2009: Year on Year Performance

The chart above (which shows the year on year changes) also shows state of the Philippine equity markets in terms of market capitalization calculated in US dollars, which has severely lagged the region.

4. Handicapped Financial Industry Is Transmitted To Suboptimal Economic Growth

Another underappreciated dimension is that a unidirectional reward based market has an economic wide impact.

While for most people, the stock market is seen as a gambling casino or as some form of legal embellishment, for us, the stock market functions as a fundamental pillar to national development. And to reprise its importance, from our A Primer On Stock Markets-Why It Isn’t Generally A Gambling Casino:

-The stock market is a vital part of the process from which we coordinate production. Ideally stock prices should reflect the productivity of business firm aside from market’s discernment of the entrepreneurial judgments concerning future productivity.

-It competes with the banking sector in determining the degree of mobilization of savings into investment. From a national scale this becomes a formidable channel for economic advancement in terms of efficiency of capital deployment.

-Unknown to many, stock markets often function as forward indicators, such that they have been known to predict upcoming recessions or prospective recoveries. Thus, movements in the financial and stock markets can give a clue to the transitioning business environment, which should help management or businessmen, in allocating resources or in applying their business strategies going forward.

-It operates as alternative avenues for fund raising (public listing), intermediation (using shares as collateral for borrowing-lending) or liquidity generation (buying or selling a company).

-Because the markets operate as an organized platform of exchange, the ease from a market’s liquidity allows companies to save on transaction costs: search cost (matching buyers and sellers), contracting costs (cost of negotiation) and coordination cost (meshing securities of different industries into a single platform), which frees up capital for other usage.

-Allows wider public participation in the ownership of major companies, which expands the concept of private property ownership.

-Allows some individuals to save from taxation (e.g. inheritance taxes)

-Because stock markets function as repository of collateral or store of value, it can serve as protection or safehaven against hyperinflation or a severe form of a loss of purchasing power of a currency.

Hence in a unidirectional reward based market the following factors have been compromised:

-market pricing efficiency (reduced liquidity amplifies volatility and structurally raises risk premium or the hurdle rate),

-the optimum channeling of savings into investment or capital deployment (which translates to lesser investment opportunities and suboptimal returns),

-access to alternative financing (extrapolates to high cost of financing, which implies low public listings),

-investment opportunities that allows for a wider public participation or the “trickle down effect” (limited income growth opportunities for the public),

-the lowering of transactional costs (reduces the incentives for attracting wholesale or bulk institutional investments and requires higher hurdle rate) and

-hedging and other opportunity costs as seen from any sophisticated and deep markets (increases risk profile or premium, and heightens volatility)

From which all of these translates to lost opportunities for national wealth generation.

5. Emits Wrong Impressions and Reduces Role of Specialization

A unidirectional rewards based market exacerbated by Principal Agent problem reinforces the public’s perspective of the simplistic functionality of stock markets.

Information derived from commission based Sell Side institutions accentuates on the short term orientation of market exposure to most retail investors. And this also applies to some institutional accounts as well.

Where markets are seen as operating in a short term framework, the degree of risk taking appetite would be intensified by cyclical extremities. Again this magnifies volatility, increases perception of risk from the international institutional standpoint and diminishes the requirement or the need for division of labor or the role of specialization for domestic industry participants.

Who would want to invest in mutual funds, or UITFs or broker discretionary accounts, when the impression portrayed is -what the so-called experts can do is available to anyone? Who cares about risk, when mainstream literature almost always expounds on momentum, preened in the fundamental or technical charting garb?

To respond to such objections local sell side institutions would then expound on emphasizing on their capability to trade short term fluctuations-which is nothing more than a hokum operating on the graces of lady luck!

It’s is of no wonder why losses suffered by retail investors during bearmarkets, in many occasion, leads to abhorrence and complete desertion of the markets. This is mainly due to the wrong expectations inculcated from misleading foundations of how markets operate and the lack of alternative instruments to protect market participants from market losses during cyclical transitions.

6. Distorts Incentives

Some discretionary accounts operating under a bearmarket would prefer to withdraw proceeds than leave them with industry fund managers.

In my mind’s eye, the perception is that cash would be better off under the clients’ management since there would be no alternative options to put these at work in the capital markets. Hence, these risks skewing the incentives for managers to long the client’s account, despite the realities of an unfolding bearmarket cycle, than to lose handle.

In other words, because the operational arrangements of the fund industry could be impaired by the lack of instruments to employ idle funds in a market which only profits from one direction, fund managers could be motivated to take on more risks than required. Again, the Principal Agent Problem at work here.

From my standpoint, bearmarkets can be classified into two strains: structural or contagion based/cyclical. Both of which requires different investment approaches.

The latter of which is one that can be longed or endured with, since the national economy has no major fundamental impairment (mostly clustering errors from malinvestments from bubble policies) and could be expected to recover and to profit from a reversal of the cycle in the fullness of time. The 2007-2008 financial crises serves as lucid example of this scenario applied to the Philippine setting.

Nonetheless, the former requires total exodus regardless of the conditions of the portfolio when such a cycle emerges. That’s because bubble afflicted markets or industries can vaporize issues regardless of its previous stature. Think AIG, Bear Stearns, Lehman Brothers, General Motors and Chyrsler.

In short, there are no blue chips in an unwinding bubble afflicted industry! The idea that paper losses are merely paper losses without liquidations consummating the transaction is false.

So the analytical approach of the analyst or fund manager ultimately distinguishes between portfolio salvation and damnation, and matters more than what the public normally expects of them.

7. Cognitive Biases Also Shaped In One Direction

Again since markets are basically psychologically driven, participants are thereby influenced by cognitive biases or the reflexivity theory.

Analysts or experts as well as the general public, here, are predisposed towards a bullish bias simply because the current operating environment rewards participants only when the markets move in a sustained upward trajectory.

And we see the same dynamics applied to politics, market participants audibly cheer upon policies that temporarily boost market prices at the expense of the future simply because the public’s general expectation is predisposed towards the short term expectations.

And it is the same reason why many participants, like my good friend, despite the understanding of key market tenets, have been tempted to defy such guidelines to engage in ‘catching a falling knife’ trades- out of the psychology directed by the reward incentives provided for by the present operational market mechanism.

And such a bias doesn’t elude me entirely.

Conclusion and Recommendations

And so what could be done?

For PSE authorities:

We suggest that the “ease of use” principle founded on a sound legal framework, or the proverbial horse before the cart, as the main thrust to introduce market reforms.

New market platforms depend on the functionality or utility more than mere technical legal vernaculars which risks of high compliance costs or choking regulatory requirements that could render reforms inapplicable.

Remember, all regulations operate on latent economic dimensions. Fundamentally, success of any market platform will depend on the cost-benefit tradeoffs and not on intricate legalese.

Moreover, it would be more convenient and pragmatic to rush market reforms to include expanded local investor access to markets as Exchange Traded Funds, basic derivatives (such as options-put or call) and commodity spot and futures markets (I’d say currency markets as secondary) to enable local investors:

-the ability to hedge on or minimize risks by diversification or by utilizing hedge instruments,

-to increase capital efficiency allocation, and

-to utilize moderate leverage to augment returns

Markets that profits from the upside or the downside or sideways complimented with the ability to minimize risks by hedging or diversification will likely attract a larger and more diversified base of capital and deepen the local financial markets that should translate to value added economic growth.

For market participants:

We can only operate under the platform from which the PSE operates on, this means identifying and positioning based on cyclical or secular trends.

Next, for sophisticated investors is to tap the same aforementioned hedge instruments such as ETFs (an inventory list here), basic derivatives or commodity markets overseas. [For a related article see my previous outlook see Should Filipinos Invest Abroad?]

Finally, choose wisely on your investment analyst for guidance or for managing your funds. Avoid from selecting opinions which merely confirms your biases and from embracing viewpoints that merely deduce present price signals as basis for prospective market action. Market analysis should be objective and dispassionate where risk must always be weighed against prospective gains.

In short, avoid the bias traps.

The Asian-Emerging Market Momentous Historical Bubble?

``When a long-term trend loses momentum, short-term volatility tends to rise, it is easy to see why that should be so: the trend-following crowd is disoriented.”- George Soros

Excess volatility is the name of today’s game.

Global equity markets have been in a wild rollercoaster ride of late.

While US and European markets continue to sag following last week’s sharp decline, many of key Asian markets rallied hard recovering substantial segments of losses from the previous week.

So we seem to be witnessing another round of divergences at play, see figure 2.

Figure 2: stockcharts.com: Asia and EM stocks OUTPERFORM anew

The Dow Jones Asian Index which includes Japan appears to be testing for a new high, along with the less robust Emerging Market index (EEM) and the US S&P 500 (SPX). The weakest link seems to be European Stocks (STOXX).

Momentous Historical Bubble, Elixir Trade Model

The same friend, who commented earlier about the temptations of falling captive to gravity pulled “knives” in a bearmarket, likewise remarked of his friend who earlier paid for a series of monthly subscriptions to a local analyst, who is on the business of issuing regular technical charting outlook.

His friend came to realize that chart reading can be variable, vacillating and couldn’t be relied on, and hence, after a few months desisted from extending this “privilege”.

It’s simply amazing how people can be so captivated or bedazzled by the allure of short horizon Holy Grail type of market approaches, such that they have been shelling out substantial amounts to pay for guidance that dwell mostly on momentum driven or support-resistance trades or simply confirming biases of market participants through the technical picture. It seems like an incredible business model, I might add.

Yes, although this has been an opportunity cost for me in terms of the newsletter business paradigm, nonetheless, we’d rather stick by our principles to deal with prudent investing.

So aside from illustrating the possible dynamics of how the retail market works and how the some local subscription model business had profited immensely from the need for elixir based trades, the point of this article is to prove that today’s market can truly confound mechanical technicians or even macroeconomic fundamentalists.

Why is this so?

To put on our Ivory Tower thinking cap, we quote Prof. Steve Horwitz in The Microeconomic Foundations of Macroeconomic Disorder: An Austrian Perspective on the Great Recession of 2008, ``The Austrian approach to macroeconomics can already be seen as being fundamentally microeconomic. What matters for growth is the degree to which microeconomic intertemporal coordination is achieved by producers using price signals, especially the interest rate, to coordinate their production plans with the preferences of consumers. However, this coordination process can be undermined through economy-wide events that might well be called “macroeconomic.” In particular, the very universality of money that makes possible the coordination that characterizes the market process can also be the source of severe discoordination. If there is something wrong with money, the fact that it touches everything in the economy will ensure that systemic “macroeconomic” problems will result. When money is in excess or deficient supply, interest rates lose their connection to people’s underlying time preferences and individual prices become less accurate reflectors of the underlying variables of tastes, technology, and resources. Monetary disequilibria undermine the communicative functions of prices and interest rates and hamper the learning processes that comprise the market.” (emphasis added)

In short, too much of monetary inflation distorts the function of price signals which essentially increases speculative activities, massively misallocates capital away from consumer preferences and engenders excessive market volatility.

And if we go by the market savant George Soros’ perspective of the market, ``Many momentous historical developments occur without the participants fully realizing what is happening.”

Incidentally we’ll be quoting much of George Soros’ market wisdom for this article.

And such “momentous historical development” could essentially be a seminal formation of the next bubble, in Asia and in Emerging Markets, see figure 3.

Figure 3 US Global Investors: Excess Liquidity Drives Up Asian Markets

According to the US Global Funds, ``U.S. Federal Reserve’s reluctance to withdraw from quantitative easing programs should bode well for Asian asset prices going forward. The past 25 years suggest that when money supply expansion outpaced GDP growth in the U.S., excess liquidity would typically drive equity prices higher the following two years in emerging Asia.” (bold emphasis added)

Oops, let me repeat… “excess liquidity would typically drive equity prices higher the following two years in emerging Asia”!!!

We are hardly into the first year of liquidity driven boom, which subsequently means more upside ahead.

So while markets can go anywhere over the interim, and that infirmities may follow the recent strength due to numerous variables: such as technical corrective patterns in the US [see INO's Adam Hewison On The S&P 500: Market Tenor Has Changed, Emphasis On The Negative-this is assuming the Phisix will track the US] or in the Phisix itself, seasonality weakness (July to September statistically is the weakest quarter for stocks), volatility brought about by next wave of US mortgage resets [see US Financial Crisis: It Ain’t Over Until The Fat Lady Sings!] and plain vanilla momentum- the sheer might of the combined stimulus package from Emerging Markets, (see figure 4) aside from those applied in OECD economies, could translate to an awesome impact for the markets in Asia and the Emerging markets to behold.

Figure 4: Deutsche Bank: EM-Anti Crisis Measures

The Philippines relative to other Emerging Market contemporaries seems hardly one of the most lavish spenders for government stimulus. Think about it, if deficit spending equates to weak currencies as discussed last week in Philippine Peso: Interesting Times Indeed, then it follows that China, Russia, Hong Kong, Brazil, South Africa, Vietnam, Thailand would all have weak currencies relative to the US dollar due to their larger deficit spending. Unfortunately this hasn’t been the case.

Nonetheless, ``Asian and Latin American banks, notes the Deutsche Bank, “seem to have learnt from their past crisis episodes. In general, they have restricted foreign-currency exposures and funded credit expansion with domestic deposits. Thus, most banking systems have suffered from tighter liquidity conditions but only a few have needed recapitalisation (Korea, India and Hong Kong). On the fiscal side, government packages seek to neutralise the effect of shrinking domestic demand as well as supporting local companies unable to roll over their foreign debt obligations.” (emphasis added)

As we have long been saying, an unimpaired banking system in the region and in Emerging markets coupled with substantial savings has the potential to take up the credit slack from the bubble bust plagued OECD economies to shore up domestic demand. And this alone is a massive force to reckon with.

Another empirical example, just this week, it’s like I received numerous calls or text messages from different banks on daily basis, offering me bank loans mostly based on the unused portion of my credit cards. I’d assume that this applies to their entire customer base.

As the Deutsche Bank concludes, ``The crisis is not over yet and we do not rule out additional bumps in the road. However, it is fair to state that in a more globalised world characterised by stronger linkages among economies, emerging markets are proving to be better prepared to face external shocks than in the past.”

Well “proving to be better prepared to face external shocks than in the past”, can be interpreted in a relative sense and applicable only when compared today against the recent past.

But if the bubble cycle is brewing from within, then such conclusion won’t hold when the bubble pops.

Inflation Analytics Over Technical And Fundamental Approach

Remember in a highly globalized world, the transmission mechanism from inflationary policies could be very substantial and has far reaching consequences.

And that is why in spite of the most recent global meltdown, out of the 77 countries monitored by Bespoke Investments [see our earlier article Inflation or Deflation? The Global Perspective], 59 nations experienced consumer price inflation against 14 nations that saw consumer price declines (consumer price deflation) while 4 nations saw flat CPI rates. This translates to a ratio of 4:1 in favor of inflation with an average inflation rate at 4%! And that includes the peak of the meltdown!

For all the claptrap about the global deflation bogeyman, this should have disproved such an assertion.

Figure 5: Danske Weekly Focus: The tide is turning

And the credit boom appears to be filtering into the real economy as Industrial production in key Asian regions has sharply picked up, shown in Figure 5.

Nonetheless, aside from disoriented chart technicians, we also have conflicting predictions from multilateral agencies.

The readjusted outlooks saw the World Bank projecting a downgrade, whereas the IMF has raised its forecasts for world economic growth. On the other hand, OECD has joined IMF to forecast a modest increase in global growth.

2 out of 3 doesn’t mean that the majority is right.

Nonetheless, to put this anew in the context of George Soros’ reflexivity, `` The greater the uncertainty, the more people are influenced by the market trends; and the greater the influence of trend following speculation, the more uncertain the situation becomes.”

So yes, more reflexive actions are unfolding in the marketplace. As the market prices continue to move higher, the public will likely interpret market performance as indicative of the real economy.

Again from Mr. Soros, ``People are groping to anticipate the future with the help of whatever guideposts they can establish. The outcome tends to diverge from expectations, leading to constantly changing expectations and constantly changing outcomes. The process is reflexive.”

So not only do we speak of excess liquidity, but of excess liquidity translated into a secular weak dollar trend see Figure 6.

Figure 6: US Global Investors: Inverse Correlation Weak US Dollar, Strong Asian Markets vice versa

The weak dollar has had a strong inverse correlation with the performance of Asian stock markets, where a strong US dollar trend translates to weak equity markets and weak US dollar equals strong Asian markets trends.

With the US dollar trade weighted index expected to suffer from a secular decline as a consequence to its massive deficit spending, the continuity of these correlation suggests of the persistence of a revitalized or reenergized Asian markets.

Moreover, the prospective weaknesses in the respective bubble bust scourged economies combined with the appearances of the “right” and “effective” remedy measures ensures that present policy directions will be sustained.

Proof?

The ECB recently announced that it will be lending a historic €442 billion ($621 billion) over the next 12 months to backstop liquidity within the region.

The US Federal Reserves’ FOMC meeting recently announced that it would be extending most of its liquidity facility programs specifically, the Board of Governors approved an extension to 1 February 2010 of the following: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), Commercial Paper Funding Facility (CPFF), Primary Dealer Credit Facility (PDCF) Term Securities Lending Facility (TSLF).

The expiration date for the Term Asset-Backed Securities Loan Facility (TALF) remains set at December 31, 2009. The Term Auction Facility (TAF) does not have a fixed expiration date. In addition, the temporary reciprocal currency arrangements (swap lines) between the Federal Reserve and other central banks have been extended to February 1. (Danske Bank)

The Swiss National Bank conducted a series of intervention in the currency markets last week to keep the Franc from rising amidst a deflationary environment and shrinking economic growth (WSJ).

And this hasn’t been confined to the Swiss Franc, market chatters speculated on possible government interventions in the currency market in the Kiwi (New Zealand Dollar), the Loonie (Canadian Dollar) and the Aussie (Australian Dollar). (Bloomberg)

Moreover, the issuance of the new Won 50,000 banknotes in South Korea, after 35 years (the largest had been Won 10,000), further fueled speculations that the South Korean government could be expecting higher inflation from current policies undertaken (Financial Times).

As you can see, global governments have been conducting mercantilist “race to bottom” policies for their respective currencies to maintain their “export” latitude.

And as Steve Horwitz, echoing the Austrian school perspective, says that, ``If there is something wrong with money, the fact that it touches everything in the economy will ensure that systemic “macroeconomic” problems will result.”

And the continuation of these developments will only compound on the growing risks of a global inflation crisis.

So in my view, globally coordinated policy based programs to ensure excess liquidity through zero bound rates, quantitative easing and intensive stimulus fiscal spending programs, which has been manifested in the steepening of the global yield curve [see Steepening Global Yield Curve Reflects Thriving Bubble Cycle], a floundering US dollar, currency interventions or the implicit currency war, the reflexive market action which has been diffusing into the real economy and rising risk appetites based on credit boom outside the bubble plagued economies- all conspire to pose as more powerful or potent forces to deal with than simply technical or seasonal factors over the next “two years” at least.

Since market timing isn’t likely to be anyone’s expertise especially in the context of short term trades, we’d rather focus on the major trend as defined by George Soros.

The Boom Bust Cycle Of George Soros

This brings us to the boom bust stage cycle as defined by George Soros which we last mentioned in 2006:

1) The unrecognized trend,

2) The beginning of a self-reinforcing process,

3) The successful test,

4) The growing conviction, resulting in a widening divergence between reality and expectations,

5) The flaw in perceptions,

6) The climax and finally

7) A self-reinforcing process in the opposite direction.

In my assessment, present developments are highly indicative of the transition from 1) the unrecognized trend-as manifested by the substantial skepticism over the present market cycle and 2) the beginning of a self-reinforcing process.

In other words, the bubble cycle has much to accomplish yet.

Since this article has been a George Soros quotefest, the last statement belongs to Mr. Soros, ``Economic history is a never-ending series of episodes based on falsehood and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited"

Stranger, Friendlies or My Friend?

Quote of the day from the ever eloquent and adroit marketing guru Seth Godin-from his latest terse but inspiring missive, The difference between strangers and friends.

(bold emphasis added)

``Strangers are justifiably suspicious.

``Friends give you the benefit of the doubt.

``“Friend” is more broadly defined as someone you have a beer with or meet up with to go on a hike. A friend is someone who has interacted with you, or who knows your parents or reads your blog—someone with history. If you’ve made a promise to someone and then kept it, you’re a friend. If you’ve changed someone for the better, you’re a friend as well.

``We market to friends very differently than we market to strangers. We do business differently as well.

``Thanks to social networks and the amplification of stories online, we have far more friends per person than at any other time in human history. Nurturing your friends—protecting them and watching out for them—is an obligation, and it builds an asset at the same time.

``(I want to distinguish friends from 'friendlies', the people you have a digital link to, but no real connection. Friendlies are basically strangers with a thumbnail of their face on your screen. They're not friends. And, while we're at it, the moment you treat a friend like a stranger (form mail, for example) they're not a friend any more, are they?)"

(end quote)

My comment: Will you be more than a 'friendlies' and be my friend?

World's Priciest Emerging Market Properties

The Real Estate Business Intelligence Services (REDIN) showcases the most expensive properties in the emerging market world as categorized by...

Residential
Office

Retail

Industrial

and Land

(HT: Paul Kedrosky)

War on Drugs: Learning From Portugal's Drug Decriminalization

In an earlier post,[see Nicolas Kristof: Why The War On Drugs Is A Failure], we dealt with the unorthodox suggestions of how to deal with the Drug menace.

Drugs isn't just a social problem, it encapsulates economic, political and the regulatory dimensions. Hence, the required approach should be holistic than simply "moralistic".

Of course, theories won't be persuasive if unmatched by actual experience, thereby, Portugal's 7 years experience on the drug decriminalization path could serve as noteworthy paradigm.

The essence of drug decriminalization seems simple: it transforms government's role from strong arm "fear-based" antagonistic approach into "mentorship" guidance, where government spends the substance of its efforts in education and treatment than from prohibition.

Moreover, the diminished operating costs enables the freeing up or shifting of government resources into more constructive means to deal with the problem, which in essence lowers the barriers of collaboration with the public.

And because the relationship switches to a more congenial climate, the impact from enforcement tends to have a high degree of success.

In short, from fear based approach to a cooperation, sympathy and treatment based solution.

The following is an article, which includes a video interview from Reason.tv ., explains the Portugal experience....

(all bold highlights mine)

Glenn Greenwald is a civil rights attorney, a blogger for Salon, and the author of a new Cato Institute policy study called “Drug Decriminalization in Portugal: Lessons for Creating Fair and Successful Policies.” The paper examines Portugal’s experiment with decriminalizing possession of drugs for personal use, which began in 2001. Nick Gillespie, editor of reason.com and reason.tv, sat down with Greenwald in April.

Q: What is the difference between decriminalization and legalization?

A: In a decriminalized framework, the law continues to prohibit drug usage, but it’s completely removed from the criminal sphere, so that if you violate that prohibition or do the activity that the law says you cannot do you’re no longer committing a crime. You cannot be turned into a criminal by the state. Instead, it’s deemed to be an administrative offense only, and you’re put into an administrative proceeding rather than a criminal proceeding.

Q: What happened in Portugal?

A: The impetus behind decriminalization was not that there was some drive to have a libertarian ideology based on the idea that adults should be able to use whatever substances they want. Nor was it because there’s some idyllic upper-middle-class setting. Portugal is a very poor country. It’s not Luxembourg or Monaco or something like that.

In the 1990s they had a spiraling, out-of-control drug problem. Addiction was skyrocketing. Drug-related pathologies were increasing rapidly. They were taking this step out of desperation. They convened a council of apolitical policy experts and gave them the mandate to determine which optimal policy approach would enable them to best deal with these drug problems. The council convened and studied all the various options. Decriminalization was the answer to the question, “How can we best limit drug usage and drug addiction?” It was a policy designed to do that.

Q: One of the things you found is that decriminalization actually correlates with less drug use. A basic theory would say that if you lower the cost of doing drugs by making it less criminally offensive, you would have more of it.

A: The concern that policy makers had, the frustration in the 1990s when they were criminalizing, is the more they criminalized, the more the usage rates went up. One of the reasons was because when you tell the population that you will imprison them or treat them as criminals if they identify themselves as drug users or you learn that they’re using drugs, what you do is you create a barrier between the government and the citizenry, such that the citizenry fears the government. Which means that government officials can’t offer treatment programs. They can’t communicate with the population effectively. They can’t offer them services.

Once Portugal decriminalized, a huge amount of money that had gone into putting its citizens in cages was freed up. It enabled the government to provide meaningful treatment to people who wanted it, and so addicts were able to turn into non–drug users and usage rates went down.

Q: What’s the relevance for the United States?

A: We have debates all the time now about things like drug policy reform and decriminalization, and it’s based purely in speculation and fear mongering of all the horrible things that are supposedly going to happen if we loosen our drug laws. We can remove ourselves from the realm of the speculative by looking at Portugal, which actually decriminalized seven years ago, in full, [use and possession of] every drug. And see that none of that parade of horribles that’s constantly warned of by decriminalization opponents actually came to fruition. Lisbon didn’t turn into a drug haven for drug tourists. The explosion in drug usage rates that was predicted never materialized. In fact, the opposite happened.

Watch Glenn Greenwald and Reason.tv's Nick Gillespie discuss both the lessons from Portugal and Barack Obama's disappointing performance so far on drug policy, executive power, and civil liberties by clicking on this link

Global Stock Market Performance Update: Rotational Effects and Tight Correlations

Another fantastic chart from Bespoke Invest giving us an update on the recent turn of events.

According to Bespoke (bold highlight mine),``Bloomberg's World Index made a rally high on June 2nd. Below we highlight the stock market performance for 83 countries since June 2nd and year to date. Since the 2nd, 14 countries have seen stock prices continue to rise, while the other 69 have seen prices fall. Lebanon, Kenya, Sri Lanka, and Mauritius are the only countries with double-digit percentage gains. The biggest country to show gains during a time when global stocks have struggled is China. China's Shanghai Composite has rallied 6.18%. The other three BRIC countries have not fared as well. India is down 3.7%, Brazil is down 7.82%, and Russia is down a whopping 21%. Russia has been the second worst performing country during the recent downturn.

``Looking at G-7 countries, Japan has held up the best since June 2nd with a decline of 1.59%. The US has been the second best at -5.21%, followed by the UK, Canada, France, Germany, and then Italy."

My comment:

If global markets have been driven by liquidity or monetary forces or inflation dynamics then it is quite obvious that there will be rotational effects and secondly, for the early movers some tight correlation, as global liquidity transmission interlinks divergent markets.

Notice that most of the today's (from June 2nd) topnotch performers (e.g. Kenya, Bangladesh, Latvia, Slovakia, Oman, Morroco, Bostwana et. al.) have had sluggish year to date gains or had earlier underperformed.

Additionally, the decline of the BRICs (except China) have been in parallel with the decline of the front running EM leaders, as well as, having tracked OECD market performance in terms of price direction over the interim.

Russia's hefty decline exhibits overheating. The Russian benchmark is still the 5th best year to date performer IN SPITE of the recent (21%) downturn. It trails Peru, Sri Lanka, China and India.

This implies of an ongoing rotation, where previous laggards are now ahead, while former leaders appear to undergo a hiatus.

Next, despite the recent correction, Emerging Markets continue to outperform developed economies, albeit at different rates-again an obvious impact from inflation dynamics-as that of being relative.

Inflation or Deflation? The Global Perspective

The following chart from Bespoke is quite revealing. It shows of the present inflation rates around the world.

We quote Bespoke (underscore mine), ``For those interested, below we highlight a big bar chart showing the most recent inflation rates for 77 countries. The average unweighted inflation rate for all of the countries is 4.11%. Fifty-nine countries are currently seeing prices rise versus a year ago, 14 are seeing prices decline, and 4 are flat. Venezuela has the highest inflation rate at 27.7%, followed by Kenya, Iran, Ukraine, Pakistan, Guatemala, and Russia. Ireland is seeing the most deflation with a year over year decline in prices of 4.7%. China has the third biggest decline in prices at -1.4%, while the US is right behind at -1.3%. Whether or not you use this chart to make any investment decisions, it does provide a good look at where each country stands in regards to price movements."

Our observations: one in four countries have been experiencing inflation in the face of the crisis.The average inflation rate is 4%.

Nonetheless, Two things clearly standout:

One, inflation is relative. Common policy programs aimed to address national problems which have been structurally idiosyncratic apparently results to different levels of inflation.

Two, for those arguing about global deflation, these chart appears to strongly refute such an argument.

To add further, consider that the present climate has yet been operating under a "benign" phase of the inflation, what more if inflation secures a strong foothold in countries impacted by debt deflation??!!!

As Edward Chancellor of GMO aptly wrote in the Financial Times, ``There is no question that a determined central bank can get rid of deflation. It is simply a question of printing enough money. Economists have another term to describe the monetisation of government debt. The history of “seigniorage” goes back to the debasement of the coinage under the Roman emperors. Seigniorage is really a tax on holders of money and government debt which is paid via inflation. When carried to excess, it leads to hyperinflation."

You've got a serious inflation crisis ahead!

Depression Stories: Are We Worst Off?

With stock markets melting around the world, what would seem more timely than to compare today's conditions with that of the Great Depression.

Here are two articles showcasing sundry charts dealing with such comparisons.

First, comes from Barry Eichengreen and Kevin O'Rourke's A Tale of Two Depressions (Hat tip: safehaven.com/John Maudlin)

Volume of World Trade worst than the Great Depression

Falling world industrial output in line with the Great Depression

See the rest of the charts here

Mssrs. Eichengreen O'Rourke concludes (underscore mine): ``To summarise: the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30."

``The good news, of course, is that the policy response is very different. The question now is whether that policy response will work."

Council of Foreign Relations' Paul Swartz makes the same comparison but this time it's more US centric.

Industrial production hasn't fallen in the scale of the Depression

"Although the labor market has deteriorated more than at any time since World War II, it is much healthier than during the Great Depression."

"The federal budget has deteriorated far more rapidly than in any past recession, in part due to the first economic stimulus and bank bailouts.The current stimulus implies an even larger and more prolonged deficit in the future."

See the rest of the charts here

Concluding remarks from Paul Swartz, ``The collapse in the federal government’s finances is unprecedented, raising questions about how the government deficit will be brought under control.

``By most measures, the current recession is far milder than the Great Depression. But the appendix shows that house prices have recently fallen much more sharply than in the 1930s."

So essentially we have two opposing opinions.

Eichengreen-O'Rourke sees Depression like developments for the world and cheers on government policy actions while Mr. Swartz sees it otherwise and worries over government deficits.

That's the nature of economics, divergences in interpretations. What you see depends on where you stand-perhaps influenced politically or ideologically or from personal bias.

Marc Faber: Risk of Hyperinflation Is Very High

Marc Faber says that in 5-10 years, US inflation rates will hit 10-20%. And equities and real estate would perform better than US Treasuries.