China And The Bubble Cycle In Pictures

Most of the time narratives haven't been convincing enough to present a strong case.

Hence I decided to put into pictures, some relevant data that may signal the whereabouts of China's bubble cycle.

In our earlier post [see Jim Chanos Goes From Micro To Macro With Bet Against China] we showcased the chart of a bubble cycle.

I am republishing it below for comparison purposes.


In the outset of the new millennium, the US dot.com bubble appears to have unraveled exactly as the dynamics shown above.

The Nasdaq chart (courtesy of bigchart.com) shown below went parabolic before collapsing.

Today, or nearly 10 years after, sadly the Nasdaq remains distant from its bubble highs.

And it's seems no different from the way the US real estate bubble unfolded in 2002-2006 (courtesy of the New York Times)...

...and as earlier stated bubble dynamics are manifested on asset prices via massive overvaluation and a manic 'euphoric' mood by the public.

China is alleged to be at a risk of an imploding bubble, which is deemed by some as a clear and present danger. Given such premise we should then expect some parallels with the bubble cycle template above to take shape.

In other words, China's asset markets should somewhat resemble the above dynamics.

So have these concerns been justified?

While it is true that there has been an unprecedented surge in credit expansion which has been the primary cause of concern of bears... (the following charts except indicated are sourced from World Bank China)

...these has not yet been apparent in property prices.(see below)

Even Bloomberg's own property index chart for China hasn't been frothy...yet.

We don't see the same phenomenon in China's stock markets too (unless one interprets the 2008 top as the main inflection from which today's rally accounts for merely a countertrend action)...
And so far the booming conditions experienced by China has emanated from government spending...
Although the massive credit expansion appears to be filtering into the domestic economy...
Bottom line: China's Bubble has yet to mature or transition into the mania phase. It's probably not the right time to bet against a bubble.

Yet if China is truly in a bubble but the timing of the bet is wrong, then a short position can be bloody or devastating (see bubble cycle template above) to a portfolio, since the manic phase has yet to emerge.

Mercantilism: Misunderstanding Trade And The Distrust Of Foreigners

One of goal is to expose on false doctrines peddled by mainstream media.

Here is another example of the fixation of the currency "magic wand" solution to global ills.

In a recent article by the Economist, the woes of Japan's diminishing share of world trade has unfairly been pinned to its firming currency.

From the Economist, ``Its 10% slice this year will equal that achieved by Japan at its peak in 1986, but Japan’s share has since fallen back to less than 5%. Its exporters were badly hurt by the sharp rise in the yen—by more than 100% against the dollar between 1985 and 1988—and many moved their factories abroad, some of them to China. The combined export-market share of the four Asian tigers (Hong Kong, Singapore, South Korea and Taiwan) also peaked at 10% before slipping back."

While it may be true that Japan's share of world exports have fallen, blaming the strong yen is far from accurate. There may have been some companies or industries that may be affected, but this can't be applied in the general or macro sense.

What this implies is that the article has engaged in selective perception of its presentation of facts or has engaged in fact twisting in of support of a preconceived bias, i.e. inflationism via anti-market bias currency interventions.


As you will note from the chart above by Google's public data, exports as % of GDP has been rising for the world.

This means that for most of the world's major economies, exports have been improving. This includes the BRIC's or particularly China or even the 'burdened' strong yen of Japan.

Yet, to give a better perspective, the world's GDP has been in an uptrend going into the 2008 crisis, with most of the world's economies reflecting such improvement.

In other words, the impression that China has been stealing export market share, by manipulating her currency, at the expense of Japan who 'suffers' from a strong currency is far from the reality.

Instead, what has been happening is that as globalization gets entrenched, the pie of world output has been increasing with an increasing share of contributions from more nations nations participating in global trade, particularly, from emerging markets as China.

In short, the major fallacy of the mercantilist view is the perspective that trade is a zero sum game. It isn't. In fact globalization has generally benefited the world.

And currencies, the favorite snake oil nostrum, have hardly been the determinant of the share of exports or competitiveness or economic growth. [see previous discussion: Big Mac Index: The Fallacy of Blessed And Burdened Currencies]

In fairness to the Economist, they mentioned other factors that may have helped China's expanding exports amidst a falling share of her major trading partners during the recent recession.

``Lower incomes encouraged consumers to trade down to cheaper goods, and the elimination of global textile quotas in January 2009 allowed China to increase its slice of that market."

Nevertheless, article's underlying theme seems slanted towards 'Sino phobia' -which unnecessarily portrays her as arbitrarily benefiting from the recession.

Again the Economist, ``Strong growth in China’s spending and imports is unlikely to dampen protectionist pressures, however. China’s rising share of world exports will command much more attention. Foreign demands to revalue the yuan will intensify. A new year looks sure to entrench old resentments".

Well perhaps it is more than just a misperception of the role of trade but from an anti-foreign bias endemic in the public's mind.

According to Professor Bryan Caplan, ``The root error behind 18th-century mercantilism was an unreasonable distrust of foreigners. Otherwise, why would people focus on money draining out of “the nation” but not “the region,” “the city,” “the village,” or “the family”? Anyone who consistently equated money with wealth would fear all outflows of precious metals. In practice, human beings then and now commit the balance of trade fallacy only when other countries enter the picture. No one loses sleep about the trade balance between California and Nevada, or me and iTunes. The fallacy is not treating all purchases as a cost but treating foreign purchases as a cost." (emphasis added)

Bottomline: Mercantilist solution deals with symptoms and not the cause. This means that policymakers who follow mainstream prescriptions is likely to suffer from the law of unintended consequences.

Jim Chanos Goes From Micro To Macro With Bet Against China

Jim Chanos, one of the most successful and well respected investors, who specializes is short selling, has reportedly bet against China.

This from the New York Times,

``Now Mr. Chanos, a wealthy hedge fund investor, is working to bust the myth of the biggest conglomerate of all: China Inc.

``As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

``“Bubbles are best identified by credit excesses, not valuation excesses,” he said in a recent appearance on CNBC. “And there’s no bigger credit excess than in China.” He is planning a speech later this month at the University of Oxford to drive home his point." [emphasis added]

Credit excesses is a necessary but not a sufficient condition in the formation of bubbles. That's because valuation excesses have always been a manifestation of the collective actions of mass psychology filliped by excessive doses of credit.

And markets are primarily and basically psychology, which means people respond to incentives from which government policies have been a key instrument.

So yes, while we agree with Mr. Chanos that current policies in China, and the continued pursuit thereof may bring her towards a full bubble cycle, we don't agree that China has reached a manic phase of typical bubble cycle [as we have argued in China's Bubble And The Austrian Business Cycle.]

There will be more convincing and obvious signs where China would have reached its 'euphoric' or manic zone. Mr. Chanos may be betting too early and too soon which may be catastrophic (see below).
Here is the next chink in the armor for Mr. Chanos, again the same New York Times article,

``For all his record of prescience — in addition to predicting Enron’s demise, he also spotted the looming problems of Tyco International, the Boston Market restaurant chain and, more recently, home builders and some of the world’s biggest banks — his detractors say that he knows little or nothing about China or its economy and that his bearish calls should be ignored.

``“I find it interesting that people who couldn’t spell China 10 years ago are now experts on China,” said Jim Rogers, who co-founded the Quantum Fund with George Soros and now lives in Singapore. “China is not in a bubble.”

``Colleagues acknowledge that Mr. Chanos began studying China’s economy in earnest only last summer and sent out e-mail messages seeking expert opinion."

``But he is tagging along with the bears, who see mounting evidence that China’s stimulus package and aggressive bank lending are creating artificial demand, raising the risk of a wave of nonperforming loans. [emphasis added]

Two noteworthy developments here:

One, in contrast to Mr. Jim Chanos' former exploits where he had been one of the originating or 'lead' contrarian, here we have the famous short seller cramming with a crowd of China bears or skeptics.

In other words, instead of relying on his convictions from self-analysis, he seems to be simply borrowing the unproven idea of others.

As Warren Buffett warned, "risks comes from not knowing what you are doing".

Two, Mr. Chanos appears to confuse interpreting actions of profit driven corporations as similar with that of an economy. The latter of which is more complex with multitude of working parts driven by distinct incentives, e.g. enterprises-profits, government leadership-politics, bureaucracy-technical guidelines provided by leadership, state owned enterprises- a mixture of both etc...

In addition he appears to be bewitched by mainstream's "aggregate-ism" or the flawed notion that the world operates in simplistic dynamics-so as to fall for inane sloganisms as China Inc.

In short, Mr. Chanos appears to have departed from his field of specialization (residual specific risk), and now dabbles with issues which he seems unfamiliar with, particularly by engaging in macro bets (systematic risks).

Considering that policy based imbalances have brought upon many opportunities to engage in specific risks globally, it a curious thing for Mr. Chanos to deviate from his expertise.

And this leads us to wonder, "Could Mr. Chanos have reached what is known as the Peter Principle or "Rising to one's level of incompetence"? Or could his actions reflect on overconfidence from his strings of successes?

Big Mac Index: The Fallacy of Blessed And Burdened Currencies

The Economist recently published its updated Big Mac Index aimed at demonstrating whether a currency is cheap or expensive relative to the US dollar, as benchmarked to the price of the a McDonald's Big Mac Burger in the US.


According to the Economist, (bold highlights mine)

``THE Big Mac index is based on the theory of purchasing-power parity (PPP)—exchange rates should equalise the price of a basket of goods in different countries. The exchange rate that leaves a Big Mac costing the same in dollars everywhere is our fair-value benchmark. So our light-hearted index shows which countries the foreign-exchange market has blessed with a cheap currency, and which has it burdened with a dear one. The most overvalued currency against the dollar is the Norwegian kroner, which is 96% above its PPP rate. In Oslo you can expect to pay around $7 for a Big Mac. At the other end of the scale is the Chinese yuan, which is undervalued by 49%. The euro comes in at 35% over its PPP rate, a little higher than half a year ago.

Looking at the chart above, 'expensive' nations hail mostly from the Euro zone except for Australia, Canada and Turkey.

On the other hand, emerging markets, especially our ASEAN neighbors Indonesia, Thailand and Malaysia have been classified along with China as "cheap".

So by virtue of association we assume that the Philippine Peso is likely to be in the 'cheap' category.

Yet reading through the article we observe that 'cheap' currencies have been reckoned as "blessed" whereas 'dear' currencies have been deemed as "burdened".

This is just an example of the perverted mainstream view [as recently discussed in Dueling Keynesians Translates To Protectionism?] which gives prominence to mercantilist ideology that the advocates "inflationism" and varied form of regulatory protectionism.

The oversimplistic idea is that 'cheapness' equals export strength and competitiveness which translates to economic growth.

Yet such preposterous prejudice is unfounded.


Based on the list of world's export giants from wikipedia.org estimates (left window), 8 nations from Europe plus Canada comprise the top 15 biggest international exporters belong to the "expensive" category. In short, a majority.

Meanwhile, only 3 of the ultra blessed 'cheapest' currency nations (Mexico, Russia and China) and marginally cheaper (South Korea and Japan) are part of the roster of elite exporters.

Moreover, in terms of competitiveness, except for Singapore, Japan and the US, 7 out of the 10 most competitive nations, according to the World Economic Forum, come from the 'burdened' expensive currency group.

In other words, the rationalization of 'cheap' as blessed and 'dear' as burdened greatly misleads because, as evidence reveals, cheapness doesn't guarantee competitiveness or export strength.

Why the mainstream's predisposition on such a view? Because of the fixation to parse on economic disequibrium predicated current account asymmetries.

Zachary Karabell writes in the Wall Street Journal that global imbalance is a myth because in no time in history has there been a global economic equilibrium.

From Mr. Karabell (bold highlights mine), ``The blunt fact is that at no point in the past century has there been anything resembling a global economic equilibrium.

``Consider the heyday of the "American century" after World War II, when Western European nations were ravaged by war, and the Soviet Union and its new satellites slowly rebuilding. In 1945, the U.S. accounted for more than 40% of global GDP and the preponderance of global manufacturing. The country was so dominant it was able to spend the equivalent of hundreds of billions of dollars to regenerate the economies of Western Europe via the Marshall Plan, and also of Japan during a seven year military occupation. By the late 1950s, 43 of the world's 50 largest companies were American.

``The 1970s were hardly balanced—not with the end of the gold standard, the oil shocks and the 1973 Arab oil embargo, inflation and stagflation, which spread from the U.S. through Latin America and into Europe.

``The 1990s were equally unbalanced. The U.S. consumed and absorbed much of the available global capital in its red-hot equity market. And with the collapse of the Soviet Union and the economic doldrums of Germany and Japan, the American consumer assumed an ever-more central position in the world. The innovations of the New Economy also gave rise to a stock-market mania and overshadowed the debt crises of South America and the currency implosion of South Asia—all of which were aggravated by the concentration of capital in the U.S. and the paucity of it in the developing world. When the tech bubble burst in 2000, it had little to do with these global dynamics and everything to do with a glut of telecommunication equipment in the U.S., and stock-market exuberance gone wild."

In looking at the US current account chart from globalpolicy.org one would note that deficits began to explode during the 80s.

This probably implies that, aside from the above assertion by Mr. Karabell, as the China and emerging markets got into the globalization game, the US deficits soared. This bolsters the Triffin Dilemma theory as vastly contributing to such phenomenon.

Moreover, mainstream experts seem mixed up on the participating identities of those involved in current account and trade deficits with that of budget deficits.

With budget or fiscal balancing it is the government that accrues the surpluses or deficits. In contrast with trade balances, individuals through enterprises and not nations engage in commerce.

Professor Mark Perry makes a lucid explanation, (all bold underscore mine)

``It might be a subtle point, but it's important to realize that countries don't trade with each other as countries - rather it's individual consumers and individual companies that are doing the buying and selling. The confusion gets reinforced when we constantly hear about the "U.S. trade deficit with Japan" or China, which might again imply that the "unit of analysis" for international trade is the country, when in fact the unit of analysis is the individual U.S. company that engages in trade with other individual companies on the other side of an imaginary line called a national border.

``It's possible that some of the confusion about international trade can be traced to confusion about the "trade deficit" and the "budget deficit." The relevant unit of analysis for the budget deficit is indeed the country, since it's the entire country via elected officials that is responsible for the "budget deficit." By conflating these two distinctly different deficits, it's then easy to assume that the relevant unit of analysis for both is the "country" when in fact that only applies to the "budget deficit" and not the "trade deficit."

``Once one understands that it's individual companies, not countries, that are doing the trading, then it's not so easy to get fooled by statements or headlines like "Punitive tariffs are being imposed on China," or "Obama to hit China with tough tariff on tires." Since China doesn't actually trade with the United States at the national level, tariffs cannot be imposed on the country of China - it's not like the United States government sends a tax bill to the Chinese government.

``Rather, since it is companies that are trading, it's companies that have to pay the taxes (tariffs) TO their OWN government. In the case of U.S. tariffs on Chinese tires or steel, the tariffs (taxes) are being imposed not on the Chinese government or even the Chinese steel-producers, but on American companies who now are taxed for buying tires or steel from China, and then those taxes are ultimately passed along to the individual Americans who purchase the tires and purchase the consumer products like automobiles that contain Chinese steel."

In addition, it would seem similarly incoherent and ironic to think that manipulating currencies to subsidize "exporters" would generally benefit the country engaged in such policies.

That's because as a general rule for every subsidy someone has to pay for the "subsidized" cost. In short, subsidies redistribute rather than generate wealth.

Professor Donald Boudreaux debunks the favorite fixation of the mainstream: the US-China imbalances,

``The real costs of the resources and outputs exported by the Chinese people are not lowered simply because Beijing keeps the price of the yuan artificially low. And the resources spent to supply the extra American demand that results from an artificially low price of yuan—even though they are unseen by the untrained eye—represent a huge cost that harms the Chinese economy."(emphasis added)

So not only have mercantilists been barking up at the wrong tree, they have been brazenly promoting policies that focuses on short term fixes, which favors a select political group, and importantly, raise the risks of provoking a mutuality destructive trade war.

In closing this apt quote from John Chamberlain, ``when nations begin worrying about the "balance of trade," they are saying, in effect, that the price of a currency expressed in an exchange rate is more important than bananas, or automobiles, or whatever. This is a perversion that sacrifices the consumer to an abstraction; better let the currency seek its own level in the world's money markets."

Federal Bailout For US States In 2010?

In spite the seemingly sanguine outlook radiated by the key markets, which appears to be reflected on many economic indicators as to signify a 'recovery', fiscal conditions of US states continue to languish.

That's because the profligate spending during the boom days haven't not been filled by falling tax revenues amidst the recent recession until the present. And this has resulted to huge budget deficits for US states.

The chart below by Casey Research shows of the dramatic fall of State revenues over the last 12 months.


According to Casey's Bud Conrad, ``The important point is that the revenues are still in decline, indicating that we are not yet out of the recession."

State fiscal conditions are lagging indicators.

Nevertheless last year's collapse in State revenues, which appears to have bottomed, still reflects on the fragile state of the US economy.

Moreover, the enormous deficits will likely entail a drastic austerity (cut in social services and bureaucratic personnel) or raise taxes or entreat for a Federal bailout in 2010 or a combination of these measures.


The Center on Budget and Policy expects budget shortfalls for the 48 States at an estimated $193 billion for 2010 and $180 billion for 2011, or some $350 billion for the next two years.

Possibly compounded by the deficits haunting the US public pension system and the still struggling real estate industry whose next wave of resets [see 5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects],may further place additional strains on the crisis affected States, the Federal government may likely to opt for a bailout route.

And in accord with Minyanville's Todd Harrison who recently wrote,

``States across the union -- particularly those that benefited from the housing bubble and the taxable income associated with it -- are now experiencing a massive reversal of those golden years. The decline is so swift that it will take several years for the real estate reset to flush its way through municipal budgets.Additionally, The US public pension system -- one of our 2009 themes -- faces a higher-than-expected shortfall of $2 trillion that will increase pressure on strained finances and further crimp economic growth, according to the chairman of New Jersey’s pension fund, as quoted in the Financial Times.

``This evolution should lead to a comprehensive Federal bailout package in 2010. TARP money returned to the government will likely be funneled back to the states, including but not limited to Arizona, California, and New York, as taxpayers shoulder the load and bear the burden of our outsized societal largesse."

Finally, while authorities appear to be engaged in a rhetorical deliberation towards a transition to an "exit" mode, where administrative (but political) therapy is supposed to pave way for organic growth dynamics, it is my view that 2010 will continue with policy accommodations (a euphemism for inflationism).

Nonetheless the string of prospective interventions will also likely put pressure on US savings, as shown in the chart below from Bloomberg's chart of the day...


...where government expenditures have more than offset accrued savings from individuals and corporations.

To quote the Bloomberg article,

``The savings shortfall widened to negative 2.3 percent in the first three quarters of last year from negative 0.2 percent in all of 2008. Before 2008, there hadn’t been a full-year drop since 1934, the last year of a four-year period when rates were below zero.

``Deficit spending by the federal government reduced net savings at an annual rate of $1.33 trillion during last year’s third quarter. State and local government deficits widened the gap by another $14.9 billion. At the same time, personal and corporate savings increased by a record $983 billion."

The grand question is who gets to finance this shortfall? The answer of which is likely to determine the fate of the markets for 2010.

Asian Companies Go For Value Added Risk Ventures

In the ambiance of globalization or free markets, Asian companies have now been boldly embarking to enhance their competitiveness by scaling up the value chain in the technology sphere.

Yes, Asians appear to realize that we are transitioning into a post-industrial era or the third wave or the information age more than mainstream would like us to believe.

This telling article from the New York Times, (all bold highlights mine)

``For years, the process remained relatively static: PC makers like Hewlett-Packard and Apple, with well-staffed research labs and design departments, would dream up their next product and then hire a Chinese or Taiwanese fabricator to manufacture the largest number of units at the lowest possible cost."

``But lately, this traditional division of labor has been upended. Many of those Asian companies have moved well beyond manufacturing to seize greater control over the look and feel of tomorrow’s personal computers, smartphones and even Web sites.

``The investment arms of large Taiwanese and Chinese manufacturers have created an investment network in Silicon Valley operating under the radar that pumps money into a variety of chip, software and services companies to gain the latest technology. As a result, some Asian manufacturers have proved more willing than entrenched Silicon Valley venture capitalists to back some risky endeavors.

``“In the past, the manufacturers would sneak around and get inside information on technology by investing in these companies,” said K. Bobby Chao, the managing partner at DFJ DragonFund China, a business that invests in technology companies in China and the United States. “Now, they’re more involved, more visible and charging after more complex maneuvers.”

``As manufacturing of electronics in the United States began moving offshore decades ago, some feared the American economy would suffer. But the American companies, as well as economists and policy makers, said that as long as the high-value jobs like research and design remained in the United States, there was little danger.

``Asian investments in Silicon Valley present some risks for America’s top technology companies, which could lose their connection to top innovations."

The recent crisis, perhaps, may have opened the windows for Asians to make use of their accumulated savings, liberal access to financing, manufacturing and technology experience accrued over the years, revitalized confidence to take on new challenges and importantly a freer market environment, aside from a continually advancing research and development capabilities to advance on their risks ventures.

Again from the New York Times,

``The investments by Asian companies have already started to pay off. At the Consumer Electronics Show this week in Las Vegas, people will see laptops that end sluggish start times and instead boot up instantly and TVs that do not require remotes because they can see the gestures of viewers. These features are a result of strategic investments in technology by Asian manufacturers. One Asian manufacturer turned investor is Quanta, based in Taiwan, which has long been one of the largest manufacturers of laptops and personal computers for major brands like H.P., Acer and Dell.

``To keep those customers coming back, it needs unique product designs and technologies that give it an edge over competitors."

In other words, for Asia to improve its wealth and economic conditions requires capital accumulation or added economic value (or the lengthening of the economic structure) by producers competing to satisfy the needs of the consumers. The article appears to underscore on such a transition.

And it is only under free market environs where producers become sensitive to changes of consumer desires, as Professor Ludwig von Mises explains, ``But it is precisely modern capitalism that is faced with rapid changes in conditions. Changes in technological knowledge and in the demand of the consumers as they occur daily in our time make obsolete many of the plans directing the course of production and raise the question whether or not one should pursue the path started on."

The Lost Decade: US Edition Part 2

As we earlier pointed in The Lost Decade: US Edition, stock market returns had been dismal, a decade since the new millennium.

Well, America's blemished decade hasn't just been confined to the performance of its stock markets, but likewise reflected on major economic indicators as magnificently shown in the chart below from the Washington Post.
According to the Washington Post, (bold emphasis mine)

``The U.S. economy has expanded at a healthy clip for most of the last 70 years, but by a wide range of measures, it stagnated in the first decade of the new millennium. Job growth was essentially zero, as modest job creation from 2003 to 2007 wasn't enough to make up for two recessions in the decade. Rises in the nation's economic output, as measured by gross domestic product, was weak. And household net worth, when adjusted for inflation, fell as stock prices stagnated, home prices declined in the second half of the decade and consumer debt skyrocketed."

The obvious lesson is that policies that promote short term prosperity through inflating asset bubbles negates the ephemeral yet unsustainable policy driven gains.

As Ludwig von Mises presciently warned in his magnum opus, ``The boom squanders through malinvestment scarce factors of production and reduces the stock available through overconsumption; its alleged blessings are paid for by impoverishment."

In short, bubble blowing policies simply don't work.

To add, the impact of the fast ballooning Federal regulations as seen in the Federal Register journal [as earlier discussed in Has Lack Of Regulation Caused This Crisis? Evidence Says No] should likewise be considered in the decomposition of the prevailing conditions of the US economy.

As previously quoted,``According to the Washington, DC-based Competitive Enterprise Institute’s 2009 edition of “Ten Thousand Commandments” by Clyde Crews, the cost of abiding federal regulations is estimated at $1.172 trillion in 2008 – 8% of the year’s GDP. This “regulation without representation,” says Crews, enables the funding of new federal initiatives through the compliance costs of expanded regulations, rather than hiking taxes or expanding the deficit."

In other words, numerous opportunity costs from the costs of compliance, costs of an expanded bureaucracy and the attendant corruption, the cost of the crowding out of private investments, the misdirection and wastage from inefficient use of resources and other forms 'unseen' distortions from the said regulations should also be reckoned with in appraising the economy.

To argue that America's decade have been emblematic of the frailties free markets is to engage in Ipse Dixitism or plain falsehood.

That's because it's easy to use the strawman to blame others, yet the worst is to admit one's mistakes. And passing the buck won't solve anything but agitate for more restriction of individual liberties and possibly provoke unnecessary conflicts.

In 2009, Stocks Over Bonds Means Inflation Over Deflation

This should be an interesting chart from Bloomberg's chart of the day.

According to Bloomberg,

``U.S. stocks beat 30-year Treasury bonds by a record 36 percentage points in 2009 as investors bet on a recovering economy and the government sold a record $2.11 trillion in debt.

``The CHART OF THE DAY shows the performance of 30-year bonds versus the Standard & Poor’s 500 Index since 1978, according to data compiled by Bloomberg and Bank of America Merrill Lynch. Last year, the debt lost about 13 percent, while the benchmark index for U.S. stocks surged 23 percent. Gold futures added 24 percent in New York.

``Stocks trailed bonds in 2008 as the worst financial crisis since the Great Depression drove investors to the relative safety of Treasuries. They switched places in 2009 as the yearlong contraction in U.S. gross domestic product ended and President Barack Obama raised money to fund economic stimulus programs."

I'd like to add to the perspective where 2009's outperformance of stocks over bonds essentially validates the camp of those who argued for inflation to prevail over the camp of those who advocated for deflation. And the difference hasn't been marginal.

Yet this serves as an example where a misread would have been devastating to the real returns of a portfolio.

We should see the same dynamics for the 2010.

Dueling Keynesians Translates To Protectionism?

Finger pointing seems to be the favorite but fatalistic past time for self-righteous mainstream experts and their gullible followers.

Not content with assigning blame on the marketplace for last year's crisis, a further step is to engage and rebuke foreign central planners on their elected policies.

For instance, the mainstream tends to focus on global imbalances as a source of the present tensions, where savers mainly from China have been blamed for the troubles in the US, primarily by manipulating the former's currency.

Hence, the prescription from the mercantilist camp is simplistically to demand China to conform to the interests of Americans by revaluing its currency, in order to rebalance the world by regenerating the lost "aggregate demand".

And on the other end, for the Americans to devalue their currency.

In short, a waving of the magical wand in view of currency adjustments will automatically resolve today's problems in the eyes of the politically correct mainstream.

Mainstream seem to see the problem like a shower faucet that can simply be turned hot or cold. It's that simple.

Never mind, if a "manipulated" Chinese currency translates to overall cheaper goods for US and global consumers.

Yet, if we go by the words of Adam Smith consumers and not producers should be the chief concern, ``Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce."

The mercantilist policy of forcing currencies to adjust benefits a politically privileged select "producers" more than the consumers or society in general.

Never mind too, that even when some currencies had been repriced, evidence doesn't automatically extrapolate to support expected benefits.

For instance the Japanese yen, which firmed from 350 (in the 70s) to about 100 (today) remains as one of the world's major exporters, and is ranked 8th among the world's most competitive nations in 2009 according to the World Economic Forum is said to be still deficient in domestic demand after all these years of currency strength.

On the other hand, following the recent hyperinflation episode, Zimbabwe has yet to transform into a major exporting powerhouse, while the Philippines, following over 4 decade of devaluation from Php 2 to Php 55 to a US dollar, remains an underdog in terms of goods and services exports.

And if one were to argue in the context of low net wages then the Philippines, India and Indonesia should be powering ahead based on a study by UBS.

As previously argued, currencies aren't everything. Capital and economic structures, political framework and its underlying institutions aside from cultural influences essentially varies from country to country.

Besides mainstream's dogmatism on the currency panacea presumes that all products have similar price sensitivity and is sold to one class of consumers, which isn't anywhere true.

Never mind too that when the mainstream argue about oversimplified nostrums, which is for China to revalue and for the US to devalue, exports as % of the GDP for the US translates to only 11%.

This means that devaluation isn't truly directed at boosting exports at the expense of the society, but instead tacitly aimed at reducing outstanding liabilities (about 350% of the GDP) to the benefit of select industries as the banking system and Wall Street.

Never mind too that the world operates on the US dollar standard system where according to the Triffin Dilemma, expanding global trade requires US dollar financing via expanded deficits. It would appear that the mainstream sees no distinction in the economic and trade categorization of China and the US.

Never mind too that the Chinese didn't force Americans to engage in a euphoric mania to buy houses, or for US institutions to engage in excessive risk taking or for the lapses of American regulators who had been caught asleep at the wheel.

Never mind too that Americans had responded to an ad hoc cocktail mix of domestic policies that promoted a bubble:

An extended ultra low interest rate regime, administrative housing policies that encouraged speculation and subsidized mortgage indebtedness, tax policies that tilted the public's incentives towards assuming debt than equity and capital regulations that prompted for regulatory arbitrage via financial innovation.

Yet the mainstreamism parses their perception of 'macro' problems on their perceived one dimensional framework than considering the mutual or bilateral aspects.

NYU's Professior Mario Rizzo asserts that the conflicting interests of international policymakers operating on the Keynesian framework leads to a negation of their system.

From Professor Rizzo,(emphasis added)

``But, as some economists freely admit, the problem is that this pits one country’s interest against another. Either China could gain or the US could gain by manipulating exchange rates.

``Yet I cannot help imagining that a Beneficent World Planner with Keynesian views might think it equitable to permit unemployment to stay high in the US but not in China. Not only is the US safety net better, many of our poor or lower middle class are better off than Chinese workers.

``However, the ideal Keynesian solution, we are told, is to have an internationally coordinated policy of low interest rates. Of course, China has been following a low interest-rate monetary policy; credit is abundantly available. But Chinese bankers and economists have become increasingly worried about bubbles. Should they not be?

``The Keynesian world-view is skeptical of the classical liberal idea of the international harmony of interests under free trade, when the economy is operating at less than full-employment. In this world, there are definite conflicts of interest among nations. A Chinese Keynesian would not have the same views as Krugman. This is not because they differ about theory but because the theory sets up conflict. Such conflict is naturally settled by the partiality of their perspectives.

``If the Keynesians are right, this is another example of traditional microeconomic theories being annulled in their system. I suggest that the formal limitation to conditions of less than full employment is not as stringent as it sounds. Much, perhaps most, of the time the economy will arguably be in either a state of less than full employment or be threatened with some change in the news that will knock it out of full-employment equilibrium."

I would add to Prof Rizzo's position that not only would the result be a nullification but 'settled by the partiality of their perspective' via a non-zero sum game theory called the Prisoner's dilemma or a game theory which "demonstrates why two people might not cooperate even if it is in both their best interests to do so".(wikipedia.org)

This involves policymakers to either cooperate or adversely outdo or undertake policies that clashes with each other, even to the extent that they could be mutually destructive, possibly in the form of protectionism.

And indications of the partiality of political policies in the direction of an internecine trade war between two camps of opposing Keynesian practitioners seems to have emerged.

As observed by John Stossel,

``The administration continues their relentless march towards a Trade War with China:

``Trade disputes between Beijing and Washington over exports of tires, chickens, steel, nylon, autos, paper and salt are multiplying and further damaging the already tense relationship between the two economic powers.

``The Obama administration says it only aims to protect the country's rights, but the Chinese counter that the United States started the whole thing by launching an unprovoked attack".

So while China has been opening up to its neighbors, a gamut of "beggar thy neighbor" or tit-for-tat policies appears to be engaged by Keynesian adherents of both US and China at risks of another world recession or even depression.

Again John Stossel, (bold highlights mine)

``This is madness. Even if China is subsidizing their exports, the US consumer benefits at China's expense. A Trade War will simply make everyone worse off (except maybe unions), leaving consumers with fewer choices and higher prices. The Administration needs to swallow its pride and drop the tarriffs, because if the US doesn't lead on free trade, no one will. A recent study by Global Trade Alert, a trade policy think tank based in Europe, shows that global protectionism is on the rise, with the wealthiest nations imposing more than 180 protectionist measures in the last year. Congress, meanwhile, won't even bring the Colombia Free Trade Agreement to a vote".

In the past free market devotees had been deceptively labeled as ruthless 'liquidationists'. We turn the tables and ask, what should we call policymakers and their adherents who espouse on belligerent or hostile short term oriented policies predicated on ideological zealotry that places society at extreme risks?

Prices, Statistics and Lies

Here is an interesting table that compares prices of select items in the US in 1999 (before) and in 2009 (after) or over a period of ten years.

courtesy of walletpop.com (tip of the hat to Jeffrey Tucker of the Mises Blog)

The table shows that prices don't move up or down uniformly and are relative (some prices move more than the others).

Over the decade, most of the prices of goods or services had been higher although some were lower.

Prices reflect an amalgam of factors: government policies, supply demand or market dynamics, productivity, globalization, innovation, competition, demographics, cultural and others.

Would it not be a puzzle as to how these widely variant figures can be cobbled or aggregated as simplified statistical measures that are deemed by the officialdom and the public as accurately representing "inflation"?

Nevertheless these are the same tools used by central planners to determine and effect political and economic policies. No wonder the laws of unintended consequences exist.

As Mark Twain once observed, "There are three kinds of lies: lies, damned lies and statistics."

Japan Exporters Rediscovers Evolving Market Realities

Mainstream economists tell us that falling aggregate demand from developed economies will cause global deflation. Hence they justify government intervention via various kinds of stimulus to replace "lost demand".

Unfortunately, such oversimplified concept mistakenly infers that markets trades based on one type of product with single class of producer and buyer, and operates on similar level of price sensitivity.

In the real world, markets are complex and respond or adjust to reflect on where the consumers are.

As marketing guru Seth Godin aptly writes, ``Your customers define what you make, how you make it, where you sell it, what you charge, who you hire and even how you fund your business. If your customer base changes over time but you fail to make changes in the rest of your organization, stress and failure will follow." (emphasis added)

That's the reality of business.

Proof?

While it may be true that consumption in developed economies have been slowing, Japan's export producers have reportedly been devising or adopting new marketing strategies that would instead cater to emerging markets and deal with "volume" than stick to old unprofitable models (based on the dynamics of the previous bubble cycle).

This from the Japan Times, (bold highlights mine)

``Although Japanese electronics enjoy a widespread reputation for high quality and stylish design, electronics makers no longer seem able to maintain their presence in the global market by simply relying on these elements.

``Until recently, many makers focused on targeting wealthy overseas consumers who were willing to pay for high quality and expensive Japanese products.

``But given the shrinking domestic market and lackluster consumption in developed countries, they have begun switching their attention to middle-class consumers in emerging nations. Accordingly, they have started making efforts to produce simpler and more affordable products for middle-class workers in those countries.

``Such consumers are often referred to as the "volume zone," and it is believed that about 1 billion people worldwide fall into this category.

``While it won't be easy due to the fierce competition from other Asian electronics makers, analysts agree that winning a leading share of emerging markets is key to the growth of Japan Inc. in the coming years."

Rediscovering the market or "seeking the money trail" is the key to any entrepreneurs or any nation's economic success.

In the Philippines, based on empirical evidence one would be astounded by packed malls last Christmas, considering that we host 4 of the 11 largest mall of the world [see A Nation Of Shoppers??!!] in defiance of the economic assumptions of experts and of self-righteous politicians that the Philippines is "poor".

Businesses or entrepreneurs more than professional economists or politicians dictate on the economic path of a nation.

As Ludwig von Mises once wrote, ``The direction of all economic affairs is in the market society a task of the entrepreneurs. Theirs is the control of production. They are at the helm and steer the ship. A superficial observer would believe that they are supreme. But they are not. They are bound to obey unconditionally the captain's orders. The captain is the consumer. Neither the entrepreneurs nor the farmers nor the capitalists determine what has to be produced. The consumers do that. If a businessman does not strictly obey the orders of the public as they are conveyed to him by the structure of market prices, he suffers losses, he goes bankrupt, and is thus removed from his eminent position at the helm. Other men who did better in satisfying the demand of the consumers replace him."

Will North Korea's Version Of The 'Berlin Wall' Fall In 2010?

[my regular financial market analysis will resume next week]

A ‘capitalist crisis’ had been speciously described as the main cause of the recent global financial crisis centered on the US.

This ‘failure of capitalism’ had been utilized by the progressive persuasion to justify on more regulation and call for an increase in the socialization of many aspects of the economy.

Yet, in spite of the vitriolic rhetoric against a chimerical unadulterated ‘free markets’ [mostly corporatism not free markets], large scale protectionism which used to be an intuitive policy response had not generally occurred.

As we pointed out in Could Asians Be Assimilating On Western Free Market Ideals? , temporary tariffs in 2008, at the crest of the crisis, had been less than the annual average from 2000-2008-where India and the US accounted for most of the protectionist actions.

On the contrary, some emerging markets, as China, have embarked on the direction of freer markets through regional integration [see Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone]

Now that the financial crisis seem to have somewhat ebbed with least adverse reactionary policies from most of the world, the table seems to have turned.

This time socialism or its extreme form-communism-as signified by the unfolding events in North Korea, has reportedly been buffeted by a political upheaval; ironically from the emergence of capitalism.

This from the Washington Post, (bold emphasis added) (Hat tip: Mark Perry)

``North Korean leader Kim Jong Il moved early this month to wipe out much of the wealth earned in the past decade in his country's private markets. As part of a surprise currency revaluation, the government sharply restricted the amount of old bills that could be traded for new and made it illegal for citizens to have more than $40 worth of local currency.

``It was an unexplained decision -- the kind of command that for more than six decades has been obeyed without question in North Korea. But this time, in a highly unusual challenge to Kim's near-absolute authority, the markets and the people who depend on them pushed back.

``Grass-roots anger and a reported riot in an eastern coastal city pressured the government to amend its confiscatory policy. Exchange limits have been eased, allowing individuals to possess more cash.

``The currency episode reveals new constraints on Kim's power and may signal a fundamental change in the operation of what is often called the world's most repressive state. The change is driven by private markets that now feed and employ half the country's 23.5 million people, and appear to have grown too big and too important to be crushed, even by a leader who loathes them."

In short, markets have begun to reassert themselves by placing increased pressures on the political dimension of the Kims of North Korea.

In addition, some clues from the same report tell us of the striking difference between what used to work and what hasn't today.

Again from the Washington Post, (bold emphasis added)

``But capitalism seems to have already taken root. U.N. officials estimate that half the calories consumed in North Korea come from food bought in private markets, and that nearly 80 percent of household income derives from buying and selling in the markets, according to a study last year in the Seoul Journal of Economics.

``Private markets are flooding the country with electronics from China and elsewhere.

``Cheap radios, televisions, MP3 devices, DVD players, video cameras and cellphones are seeping into a semi-feudal society, where a trusted elite lives in the capital Pyongyang. Surrounding the elite is a suspect peasantry that is poor, stunted by hunger and spied upon by layers of state security.

``In the past year, the elites in Pyongyang have been granted authorized access to mobile phones -- the number is soon expected to reach 120,000. In the border regions with China, unauthorized mobile phone use has also increased among the trading classes. And unlike most of the mobile phones in Pyongyang, the illegal phones are set up to make international calls.

``Chinese telecom companies have built relay towers near the border, providing strong mobile signals in many nearby North Korean towns, according to the Chosun Ilbo, a Seoul-based daily.

``Those phones have become a new source of real-time reporting to the outside world on events inside North Korea, as networks of informants call in news to Web sites such as the Seoul-based Daily NK and the Buddhist aid group Good Friends."

Get it?

China, who used to be a staunch and a key ally to the success of the Kim's communist regime, appears to be influencing a political shift.

By allowing telecom "relay towers near the border" seems quite a revelation. Prying open North Korea's highly restricted market to trade with China and emancipating North Korean consumers should blend well with China's newfangled strategy to integrate the region.

Lastly, more liberal "blackmarket" communications appears to be providing support for the blossoming free market, as well as a backbone for the political foundation which underpins such dynamic in one of the last remnants of communism.

Since free trade in North Korea appears to have assimilated political legs, it looks like a question of when (and not if) will the transition to a market economy will take hold (this would seem like a 1-3 year event).

From which we ask, Will North Korea's version of the 'Berlin Wall' Fall or the Korean Demilitarized Zone fall in 2010?

Mint.com: World's Most Expensive Cities

We will start 2010 with an interactive graphic from mint.com on the world's most expensive cities...



Budgeting – Mint.com

This from mint.com (bold emphasis mine)

``Which are the world’s most expensive cities? The cities included on this interactive map are from a 2009 study by the UBS, which tracked the ups and downs of various places in the wake of the financial crisis. Many cities have changed ranks, with some cities become more, and others becoming less expensive. Currency devaluations played a a major role in the change of rankings, specifically in regards to emerging market cities. High inflation rates also were a factor, especially in areas such as Caracas, Venezuela (30% per year, for the last three years) When a cursor is placed over each highlighted city, an information window will pop up, showing whether it has become more or less expensive to live in this city than it was last year, as well as last year’s rankings for that city."

My assumption is that the UBS calculations had been based on local currency terms, since inflation would imply the cheapening of the currency relative to foreign exchange, particularly the US dollar. As the above example, Caracas, Venezuela takes a leap to the 12th most expensive from the 40th spot last 2008.

China's Bubble And The Austrian Business Cycle

Is China in a bubble?

That's THE current debate between China optimists and pessimists.

And this has been accentuated by reports that China will surpass Japan, by next year, as second in the order of ranking among the world's economic heavyweights.

The Economist underscores the mainstream polemic, (bold emphasis mine)

``NEXT year China will overtake Japan to become the world’s second-largest economy. Its rapid ascent has led some to question whether China will follow in Japan’s footsteps, with the bursting of a massive bubble followed by years of decline. But China is still far poorer than Japan was at its peak, and thus has more room to improve productivity. A transition of surplus labour from agriculture to industry and services would increase efficiency and bring its economy more in line with the developed world. And China’s stimulus package has produced much needed infrastructure that will reinforce future growth. But in the long run, a shift away from investment and exports towards domestic consumption would make China’s output more sustainable, and help it to avoid experiencing a bubble like Japan's."

I do not share the mainstream economic gobbledygook.

Although establishing China's current conditions would likely be tricky and complicated.

First, we share with the bears that China could be in a bubble if they continue to pursue current interventionist policies on their banking, finance and the real economy.

For instance, easy monetary policies and a massive jump in money supply are suspected to have buoyed prices of real estate and the stock market as bank credit (circulation credit) have been presumed to have channeled into speculative activities.

Empirical evidence of this would be the emergence of several uninhabited or ghost cities [see China's Ghost Cities].

In the Austrian Business Trade Cycle, the manipulation of interest rates essentially leads to massive clustering errors or huge malinvestments that will eventually unravel-hence the boom bust cycle.

To quote Dr. Richard M. Ebeling, (bold emphasis mine)

``Unfortunately, as long as there are central banks, we will be the victims of the monetary central planners who have the monopoly power to control the amount of money and credit in the economy; manipulate interest rates by expanding or contracting bank reserves used for lending purposes; threaten the rollercoaster of business cycle booms and busts; and undermine the soundness of the monetary system through debasement of the currency and price inflation.

``Interest rates, like market prices in general, cannot tell the truth about real supply and demand conditions when governments and their central banks prevent them from doing their job. All that government produces from their interventions, regulations and manipulations is false signals and bad information. And all of us suffer from this abridgement of our right to freedom of speech to talk honestly to each other through the competitive communication of market prices and interest rates, without governments and central banks getting in the way."

Nonetheless, Chines corporations have remained cash liquid and may not have reached the state of wild orgy of misdirected investments.

According to the US Global Investors, ``Despite government infrastructure spending boom in China this year, Chinese companies have not aggressively deployed cash so far and corporate bank deposits kept soaring and reached around $3 trillion as of October. There exists a remote risk of “herd spending” down the road when domestic demand picks up strongly and profit cycle restarts, eventually resulting in economic overheating." (see Chart upper right window)

Moreover, private spending has taken over public spending since September; see chart above from US Global Funds

In other words, for the meantime it would seem like some semblance of economic recovery, however as earlier cited, the persistence of present policies are likely to foster massive economic and financial imbalances.

Moreover, China's stock market as signified by the Shanghai (topmost chart below) and the Shenzhen (bottom) benchmarks are quite distant yet from ALL time highs. [chart courtesy of Bloomberg]


Like in most bubbles, both real estate and the stock market benchmarks would likely reach new highs before inflecting as in the case of the Japan (1990) and the Asian Crisis (1997) with the exception of the US mortgage crisis (2007-8) [see previous post The Lost Decade: US Edition].

One possible factor that could offset or extend the bubble cycle would be China's thrust to integrate with Taiwan [see Tomorrow’s Investing World According To The Bond King] and with ASEAN [see Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone].

In addition, while there have been indeed some signs of bubble, usually in the context of grandeur edifices such as China's unveiling of Speeding Bullet Train program, to quote Bloomberg,

Picture from Bloomberg

``Train C2019 covers the 120 kilometers between Beijing and Tianjin in 30 minutes, passing peasants in fields burning corn stalks and warrens of shacks occupied by people who aren’t sharing in China’s economic boom.

``The line is part of China’s 2 trillion yuan ($292.9 billion) investment in a nationwide high-speed passenger-rail network that may be too much train, too fast."

...these may not seem as extravagant yet-relative to other recent bubble afflicted economies or markets as Dubai.

In Why Dubai’s Debt Crisis Isn’t Likely THE Next Lehman, we noted, ``Dubai’s meteoric rise via profligate projects produced many of the world’s landmark projects (boondoggles), such as the only seven star hotel, the Burj Al Arab, the world’s tallest skyscraper, Burj Dubai (uncompleted), biggest indoor ski slope, Ski Dubai, largest shopping mall (in terms of total area and not gross leasable space), the Dubai Mall, the world’s biggest theme park, the Dubailand and the Palm Islands, the Palm Jumeirah, has virtually challenged Abu Dhabi’s role."

You see, 'delusions of grandeur' typically herald bubble climaxes, such as the emergence of towering skycrapers...
or even in the art markets as previously posted see Global Art Market As Bubble Meter, China's Fast Expanding Role

Bottom line: Political policies based on path dependency suggest that China will mostly endure a boom-bust cycle, although it may not necessarily redound to a Japan model or experience. However, these policy based imbalances would likely evolve overtime, and will be manifested in diverse asset markets, before facing her fateful day of reckoning.

E-Readers: A Hallmark Transition To The Information Age

We are truly getting entrenched into the information age.

Aside from the dramatic transformation of communication devices and the advent and growing ascendancy of computers into our lives, even books today are turning digital. And its not just about the disruptive innovation based technology but how these are being facilely assimilated by society.

In short, our lifestyle is increasingly becoming electronically based, prompted by innovation emanating from the adoption of freer markets (globalization) worldwide.

This from The Economist, (bold highlights mine)

``CONSUMERS are beginning to warm to the idea of viewing their novels and news on plastic tablets, thumbing buttons instead of flipping pages. E-reader sales have been gathering momentum since Amazon launched the Kindle in 2007. In 2009 falling prices, combined with a flurry of deals, announcements and technical upgrades, primed the market for a vast expansion. There are about 5m e-readers in circulation worldwide and double that amount will be sold in 2010, according to iSuppli, a market-research firm. Apple, with its record of improving upon existing technologies and triggering mass adoption, is expected to shake up the business by launching a tablet-style computer—which would make an ideal e-reader—in 2010."

Like most of technological innovations, as seen in the tremendous success of wireless or mobile phones, falling prices-not from debt deflation but from productivity based deflation- have been the key reason for "mass adoptions".

In the Philippines, there are more mobile phone users than there are bank depositors. And technology based mass adoption phenomenon will likely continue to accelerate overtime over an expanded or larger spectrum of utility.

And since it has been a goal of mine to become more mobile-than being always stuck in one corner of the room-Kindle or the coming Apple e-book would be part of my wishlist for 2010.

Happy New Year!