Global CDS Review: Unclear Debt Default Contagion Causality

An updated chart from Bespoke Invest should provide us a better perspective of the actual state of the supposed concerns of "debt default risk" as the cause of the market's current turmoil.
According to Bespoke Invest, ``Portugal has seen the biggest spike in default risk this year with a gain of 145.5%. France ranks second at 87.7%, followed by Iceland, Germany, and Australia. Surprisingly, CDS for US debt has spiked 49.4%, which is more than both Dubai and Greece. (Why they even have CDS for the US and other large developed nations is a different story, and we're just highlighting where things stand.) While France, Germany, Australia, and the US have all seen pretty big spikes in default risk this year, they still have the lowest default risk of all the countries highlighted. Egypt, Lebanon, and Venezuela are the only countries that have seen default risk decline so far in 2010."

One thing to keep in mind is that reading market indicators, as the table above, can be reference-point sensitive.

As pointed out by Bespoke, even as Germany, US, France and Australia have topped the lists in terms of credit concerns (based on a year-to-date basis), as developed economies, their nominal CDS prices remain way below those of emerging markets.

So a spike in developed economy CDS could be interpreted as a nonevent.

Yet like Iceland and Greece, which used to have a low risk developed economy rating (see 2008 as reference), soaring CDS have placed them above many (high risk) emerging markets. So it would be a mistake to read past performances as indicative of future outcomes.

In short, the picture changes depending on the reference points used to justify a scenario.

Here is another example: Based on 2008 as the benchmark, Venezuela, this year's top performer, despite the incredibly high priced CDS, appears to be one of the least affected by present credit concerns behind Lebanon, Indonesia, Kazakhstan, Columbia, Philippines, Turkey and Brazil.

I haven't had time to check, but my assumption is that most of the stock market indices mentioned above suffered as much losses as those whose credit risks have surged.

In other words, dissonant signals from this week's market meltdown do not suggest that this is mostly about "debt default" concerns. The contagion doesn't justify the same impact on least affected countries.

And it would similarly be too simplistic to suggest the following causal impact: higher debt default risk=deleveraging=commodity meltdown=emerging stocks freefall. This redounds to available bias and to the post hoc ergo propter hoc fallacy or as per wikipedia.org-"after this, therefore because (on account) of this".

Beyond the surface, we read that it is likely the squall that hit financial markets could instead be signs of affliction from a liquidity addiction based "withdrawal syndrome".

Global Market Rout: One Market, Two Tales

Financial markets had reportedly been rattled by concerns over rising debt default risks.

As the chart from Bespoke Invest shows, US Credit Default Swaps (CDS) or the cost to insure US debt spiked as global markets swooned.

But it's a different tale when seen across the US yield curve: Treasury yields fell or bonds rallied!

If indeed the markets have been apprehensive about the default risks from government debts then US treasury yields should have risen as these would have come under strain. Fear of default translates to higher yields. But this didn't happen.

In short, bond markets have exuded inconsistent signals.

In my view, the markets seem to be enduring from the uncertainty brought up by conflicting indicators; where policymakers have generally turned hawkish, as they repeatedly or have been bombarding the press with talks of 'exit' strategies (or even experimenting on it as with the credit arm twisting tightening in China) amidst current markets conditions, whereby key financial markets have essentially been heavily dependent on government steroids, and by the state of sovereign overindebtedness, as a result of collective efforts to mount a rescue of respective national economies.

In other words, the markets appear to be violently responding to the prospects of policy (or liquidity) withdrawal and have used the debt default risks as an excuse for the recent actions. They maybe asking, without money printing who'd finance all these debts?

We may call this the withdrawal syndrome.

Here's our guess, continued pressure on the financial markets risks undoing the animal spirits and resurrect the specter of 'deflation', and thus, would prompt authorities to turn from hawkish to dovish.

Bloggin' Hiatus

I'll be away from my base for this week, so I'm not sure if I may be able to publish any post during the interim. Nevertheless, if time allows, I'll give a try.

Thanks for your patronage.

How The Information Age Is Changing Our Lives

The New economy or the information age is largely dismissed in the arguments of the mainstream. That's because while the gist of their discussions predominantly centers on what needs to be presumptively "fixed", they appear to be preoccupied with sustaining the status quo.

Needless to say, even if they communicate by email or by mobile phones or use the web as a key source to secure information, they seem to discount on the role these instruments play in shaping our lives or our economy, despite the fact that these gadgets have mostly been ABSENT about two decades ago.

Marketing guru Seth Godin, whose words of wisdom comes in remarkably terse but poignant messages, seem right anew: People resist change because ``These represent safety, because if you don't challenge the status quo, you can't be made fun of, can't fail, can't be laughed at." He calls this the Lizard brain.

Well, safety in the status quo is in reality utter nonsense. That's because life always changes and people through the markets respond to the incentives that the environment provides.

Hence, safety in the status quo represents as sheer absurdity or rabid denial or plain simplemindedness or the lack of observation skills or at worst delusional attachments to ideologically based economic creeds.

And yet the stage of technology adaption determines the chances of winning or losing in terms of career or investments.

This also shows that an enabled technology based revolution translates to a new way of living.

It's not just in terms of business structures (operational platforms, distribution process, organizational capital, new markets etc.), but also in many other human aspects (values, attitudes, fashion etc.).

In terms of economics, we may call this the lengthening of the capital or production structure or the enhancement of capital tools or "inventing machines to make more- and-better machines" as Alvin and Heidi Toffler describes in Revolutionary Wealth. To quote Mr. & Mrs. Toffler anew, ``This same process on a vastly larger scale is now happening to what may be termed "K-tools- the instruments we use to generate knowledge, the most important form of capital in advanced economies."

How substantial is the information age to our global economy?


Some important notes from the International Telecommunications Union (bold highlights mine)

-Between 2008 and 2009, mobile cellular penetration in developing countries surpassed the 50% mark to reach an estimated 56% end 2009

-There are now more than twice as many mobile subscriptions in the developing world than in the developed world (3.2 billion vs. 1.4 billion)

-China 750 million, India 480 million

-26% of world population (1.7 billion people) are using the Internet (64% in developed, 17.5% in developing countries)

- 1 billion Internet users in developing countries, one third of which in China

-Almost 500 million fixed broadband subscribers globally, China overtook US in
2008 as largest market

-Half of the 200 million broadband subscribers in the developing countries are in China

-23.3% broadband penetration in developed countries; 3.5 % penetration in developing countries


Let's add that in the US, according to the Business Insider,

``More kids are getting mobile phones: Last year, more than 35% of U.S. children ages 10-11 had cellphones, almost double the amount in 2005, according to Mediamark data, via eMarketer. And even more than 5% of 6-7-year-olds had cellphones last year."

So the spread of the information technology is clearly diffusing across all the demographic categories.

Well, the above exhibited the infrastructure aspect of the information technology.

Here is the applications or how people have been using the infrastructure...


We'd like to focus on the web, where presently 26% of world population or 1.7 billion are participants or users.

From Marketingcharts.com ``Global consumers increased the amount of time they spent on social networking sites like Facebook and Twitter by 82% in December 2009 compared to December 2008, according to The Nielsen Company.

``In December 2008, global consumers spent an average of three hours, three minutes and 54 seconds on social networking sites. That amount of time increased to five hours, 35 minutes and five seconds one year later. In addition, unique audience increased 27%, from 242 million in December 2008 to 307.4 million in December 2009." (emphasis added)

The Economist has a national breakdown on time spent on these applications....

According to the Economist, ``SOCIAL networks are now a ubiquitous part of daily life in western countries. Facebook, for example, which was launched in 2004, now boasts over 350m users, more than two-thirds of them outside of America. The keenest social-network users, Australians, spent over seven hours a month on such sites, “poking” friends and “twittering” in late 2009, twice as much as users in Japan. Yet making big revenues and profits from such habits remain Facebook’s greatest challenges."

Think of it, for developed nations some 3-6 hours are spent on social networking sites or people are spending some 20-40% of their active time on the web via social networks (assuming 8 hours of sleep). That's how important the web has been transforming our lives.

Well this seems to be the core trend of technological advances....

It's practically Moore's Law at work

Steve Jurvetson neatly explains, ``Moore’s Law is commonly reported as a doubling of transistor density every 18 months. But this is not something the co-founder of Intel, Gordon Moore, has ever said. It is a nice blending of his two predictions; in 1965, he predicted an annual doubling of transistor counts in the most cost effective chip and revised it in 1975 to every 24 months. With a little hand waving, most reports attribute 18 months to Moore’s Law, but there is quite a bit of variability. The popular perception of Moore’s Law is that computer chips are compounding in their complexity at near constant per unit cost. This is one of the many abstractions of Moore’s Law, and it relates to the compounding of transistor density in two dimensions. Others relate to speed (the signals have less distance to travel) and computational power (speed x density).

``Unless you work for a chip company and focus on fab-yield optimization, you do not care about transistor counts. Integrated circuit customers do not buy transistors. Consumers of technology purchase computational speed and data storage density. When recast in these terms, Moore’s Law is no longer a transistor-centric metric, and this abstraction allows for longer-term analysis.

``What Moore observed in the belly of the early IC industry was a derivative metric, a refracted signal, from the bigger trend, the trend that begs various philosophical questions and predicts mind-bending futures"

``Moore’s Law is a primary driver of disruptive innovation, such as the iPod usurping the Sony Walkman franchise , and it drives not only IT and Communications and has become the primary driver in drug discovery and bioinformatics, medical imaging and diagnostics. As Moore’s Law crosses critical thresholds, a formerly lab science of trial and error experimentation becomes a simulation science and the pace of progress accelerates dramatically, creating opportunities for new entrants in new industries."

So yes, free market based technology innovations has indeed been meaningfully transforming our lives.

Ignore this at your own peril.

Does This Look Like A US Dollar Carry Bubble?

In 2008, the reason why the US dollar skyrocketed during the post Lehman incident was because of the gridlock in the US banking system which practically siphoned off global liquidity in the system.

The ensuing demand for cash unleashed a massive wave of demand for the US dollar. This scramble for cash led to a tsunami of selloff that resulted to a meltdown in the asset markets. The panic selling was specially sensitive on leveraged position such as the carry trade.

Today we have officials and experts who continually warn about carry trade bubbles.



This is the latest figures from the Bank of International Settlements which shows of external claims of BIS reporting banks.

This from BIS, (all bold highlights mine)

``Banks’ external claims continued to decline in the third quarter of 2009, falling by 1% ($235 billion) to $30.6 trillion. $36 billion of new claims on non-banks in emerging markets (up 3%) were balanced by $32 billion (down 0.4%) in reductions to non-banks in developed countries. Cross-border claims on banks in developed countries dropped by a further 1% ($181 billion) after a 2% decrease in the second quarter of 2009, and total interbank claims continued to decrease, although at a reduced pace, for the fourth consecutive quarter, by $224 billion or 1%

"Location of counterparties: Claims on non-banks in Latin America and Asia increased by $18 billion (7%) and $16 billion (6%), respectively.

"Instruments: Loans declined across all regions, while holdings of securities picked up everywhere except in offshore centres.

"Currencies: Banks’ cross-border claims denominated in US dollars increased for the first time since the third quarter of 2008, by $154 billion or 1%. This was more than accounted for by a $240 billion increase in US and Caribbean interbank claims on other Caribbean centres, the United States and the United Kingdom.

"Foreign currency claims on residents of reporting countries: Claims in US dollars, sterling, euros, Swiss francs and yen declined further, by $88 billion or 2% (after $65 billion in the previous quarter), while claims in other foreign currencies went up by $32 billion (14%)."

Given the figures and the charts above does this look anywhere like a carry trade?

Next we don't have another banking gridlock. What's being touted as the reason for the rally in the US dollar has been "tightening".

We think this is nothing but a hooey, see [What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?]

Beware of propaganda masquerading as analysis.

What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?

``This pessimistic bias is a general-interest prop to political demagoguery of all kinds. It creates a presumption that matters, left uncontrolled, are spiraling to destruction, and that something has to be done, no matter how costly or ultimately counterproductive to wealth or freedom. This mind-set plays a role in almost every modern political controversy, from downsizing to immigration to global warming.” Bryan Caplan The 4 Boneheaded Biases of Stupid Voters

What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?

-The Pavlovian Response Stimulus Behavior
-Unlike The Bear Market Of 2007
-Posttraumatic Stress Disorder Revisited
-Economic Relativism And Zero Bound Rates
-Authorities Seem Clueless With Bubbles And Operate On Fear

Most of the global financial markets have ended the month mostly in the red. And with momentum appearing to falter, we are seeing marginally more price signal convergence than of a divergence over the past few weeks [both of the prospects we discussed in When Politics Ruled The Market: A Week Of Market Jitters]

By price signal convergence, I mean eerily somewhat similar shades that characterized the bear market of 2007-2008, namely, generally frail equity markets, feeble commodity markets, buoyant US dollar as foreign currencies fumble, lower treasury yields and rising credit default swap premiums, as shown in Figure 1, aside from a higher fear index.

Figure 1: Danske Bank: Negative Interest Rates In US and Resurgent CDS

US T-Bills turned negative for the first time since the Lehman episode in 2008 (left window). However, in spite of the spike in the credit default index of Europe’s most liquid investment grade companies, this has yet to even reach or top its most recent high in 2009 (about 75-right window).

The Pavlovian Response Stimulus Behavior

But does this mean a redux of bear market meltdown of 2007-2008? I don’t think so.

As we have earlier stated, markets appear to be acutely discordant or confused on what has truly been prompting for such apparent broad based weakness.

And as usual, media and mainstream analysts has repeatedly focused on any available current events to ascribe on the possible causal relations: the Chinese government enforcing a curb on bank credit, the Greece debt crisis and or the US proposed enhanced regulatory policies, aside from employment concerns.

Unfortunately, markets have not entirely been confirming such suppositions (see figure 2)

Figure 2: US Global Funds: S&P Weekly Performance

If read from the equity market activities in the US, aside from the Materials and Energy Index, which could be extrapolated as having been influenced by the China factor, it isn’t financials but the Info Tech index that has suffered the worst beating after the China factors this week.

Financials, consumer staples and consumer discretionary, or “economic sensitive” sectors declined marginally relative to its other contemporaries as the US economy registered a faster than expected 5.7% growth mainly due to inventory build up.

Yet following the outperformance of the Nasdaq (44%) and by the S&P 500 info tech (53%) in 2009, it should be natural that any correction should impact the biggest gainers most. The same force appears to have earlier influenced the financial sector, which accounted for last week’s biggest loser but this week’s least affected.

In other words, what we may have been witnessing could be an intrasector rotational profit taking process more than a rerun of the bear market.

And if we are to assess market sentiment (see figure 3) using the Fear index, following 3 successive weeks of decline, the financial markets doesn’t appear to be as apprehensive similar to the 2007-2008 experience…yet.

Figure 3: Fear Index: Not As Fearful

The Fear index has been on a relative downtrend compared to the 2007-2008 patterns where we saw massive contiguous spikes (blue ellipses).

While the surges in 2007 had little impact on the US dollar (USD) which then continued to decline, the recent upswing in the Fear index seems to somewhat replicate on the post Lehman syndrome October 2008 climatic drama, wherein the stock markets collapsed, the US dollar skyrocketed, US treasuries soared and commodities crumbled.

Like the famous experiment known as Pavlov’s dogs, where Nobel Laureate awardee Ivan Petrovich Pavlov successfully proved that dog’s behavior could be shaped by stimulus (ringing of bells)-response (bell ringing means food!), the markets appear to have assumed the same behavior by cognitively anchoring on the post Lehman syndrome as template for any correction: When the US dollar started edging up (or the perceived stimulus), markets have thus interpreted these as signals for “carry trade unwinds” and has equally responded by selling off in almost the same pattern as in the 2008.

In short, a morbid fear from the 2008 meltdown still seems fresh and deeply entrenched into the market’s mind. Yet with fear deeply-rooted into the market’s mindset (even policymakers are fretful of these), it is thus unlikely that the market should experience another bust, until complacency and overconfidence rules anew.

Of course, alternatively, a bust may occur only if the 2006 US housing mortgage crisis meltdown is seen as a continuous process extending until today, where the recent improvements in the markets and economies signify as merely bear market rallies or countercyclical trends.

Well our argument is if this should apply to the US then why should it also plague Asia or the rest of the world? Because the US is the world’s ONLY consumer and Asia is the world’s manufacturer? What nonsense.

Unless the global markets are inferred as sooooo hopelessly and incorrigibly stupid, static and rigid enough to fail to respond to the drastic and dramatic changes in the economic sphere, then this scenario should apply.

But in reality, the only thing rigid is NOT the market but the economic dogma espoused by mainstream analysts whose idée fixee is to resurrect past models and whose prisms of reality is as prisoners of the past. This month we discussed some of these subtle but highly material changes: Asia Goes For Free Trade, Asian Companies Go For Value Added Risk Ventures, Global Science and R&D: Asia Chips Away At US Edge, and Japan Exporters Rediscovers Evolving Market Realities.

The intense fixation on aggregates and on quantitative models which simultaneously ignores the human dimension to adapt to changes and respond to stimulus is the basic flaw for analysts who presuppose omniscience.

Unlike The Bear Market Of 2007

Well, sorry, but it’s not entirely like 2007-2008. Going back to the VIX and the European iTraxx index, both of the current surges haven’t undermined the dominant downtrend trends, and could reflect instead on normal countertrend cycles.

Moreover, while short term yields have admittedly shown some strains, these have not been reflected on the broad yield curve spectrum in the US and abroad.

Figure 4: stockcharts.com: US Yield Curve

The short term rates have indeed been falling but long term rates have held ground in spite of the recent pressures in the market. In short, it seems hardly like the 2007-8 chapter where yields have synchronically fallen.

True, the massive interventions of the US government has helped, but over the past 3 weeks the Federal Reserve has offloaded US treasuries in what some experts see as an experiment to rollback liquidity, aside from some FED activities that may have resulted to negative adjustments in November-December in US money supply (M1) and Adjusted Monetary Base.

But from our standpoint these actions could also be construed as insurance Ben Bernanke underwrote to extend his term [as discussed in Federal Reserve Tightening: Exit Experiment or Bernanke's Confirmation Insurance?].

Think of it, a market meltdown amidst the wrangling over Bernanke’s extended mandate would likely influence positively lawmakers to approve of his stay. That’s because the recent ‘successful’ market actions (money printing) have been correctly attributed to him. Yes, policymakers are not transcendental entities and are also human beings whom are subject to cognitive biases.

Yet, Mr. Bernanke epitomizes the public’s desire for inflationism, as Ludwig von Mises has been validated anew, ``In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.”

So in effect, the US yield curve appears to have steepened and should incentivize the maturity transformation or conversion of short term liabilities (deposits) to long term assets (loans).

In addition, Asian sovereign yields have not substantially appreciated amidst the recent turmoil. In 2008, except for US treasuries all assets including sovereign debt yields of Asia fell.

Posttraumatic Stress Disorder Revisited

It would also be similarly foolish to assume that following a bust cycle or a recession, especially in the aftermath of a banking crisis, markets would automatically respond to a renewed borrowing spree or rapid revival of confidence, even if they have been supported by governments. (On the contrary, government support could even be the cause of uncertainty, since expectations would have been built on the continual dependency of the markets from government crutches)

Blind believers of the theory that markets operate on “animal spirits” think that this can happen, we don’t. It would take a bevy of spirits to bodily possess a significant segment of the population to enable these to happen. Unfortunately, the concept of animal spirits escapes the fact that people react based on incentives and NOT on some senseless randomness or mood based decisions.

So aside from the hackneyed arguments of overleveraged consumers and capital scarce banking system, the credit markets is likewise subject to Pavlov’s doggy experiment; children burned from touching a hot stove will refuse to touch it anew. Again it is a stimulus-response dynamic.

Airplane traffic fell (response) post 9/11 (stimulus) as people opted to travel in cars even if the latter mode of transportation has been statistically proven to be more fatal. In short, a person traumatized by a specific action (e.g. flying or swimming) due to a certain set of circumstances will most likely refrain from engaging the same activity, even if the circumstances that generated the trauma is absent.

Since markets are primarily psychologically driven then obviously prices reflects on human action based on people’s varied expectations.

So unless people buy or sell financial securities because their “dream” or a “fairy godmother” or their nanny instructs them to get ‘confident’ and buy up the market, we expect people to act on the markets with the expectations to profit or to hedge or to get entertained or to study or to get some needs or wants to be fulfilled from rationally related goals.

We have said this before and we’re saying it again-it’s called Posttraumatic Stress Disorder syndrome (PSTD). [we brought this up last February and has been validated, it’s time to refresh on the idea What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis]

Figure 5: IMF GFSR: Bank Credit to Private Sector In OECD and Emerging Markets

So it would be natural for markets to react negatively to the credit process, in the aftermath of a bust, which had been preceded by an inflationary boom, because the environment turned into a “proverbial hot stove”.

Let’s get some clues from the IMF on its latest Global Financial Stability Report on the state of bank credit to developed economies, ``Bank credit growth has yet to recover in mature markets, despite the recent improvement in the economic outlook. Bank lending officer surveys show that lending conditions continue to tighten in the euro area and the United States, though the extent of tightening has moderated substantially. Although credit supply factors play a role, presently weak credit demand appears to be the main factor in constraining overall lending activity.” (emphasis added)

Again the IMF on Emerging Markets, ``Outside of China, credit growth in many emerging markets has yet to recover appreciably. This suggests that leverage is not yet a key driver of the rise in asset prices. That said, policymakers cannot afford to be complacent about inflows and asset inflation. As recoveries take hold, the liquidity generated by inflows could fuel an excessive expansion in credit and unsustainable asset price increases.” (emphasis added)

We see TWO very important messages from the IMF outlook: one Asset Markets have NOT been supported by credit growth and most importantly FEAR.

This brings to my mind some questions:

If global asset prices haven’t been pushed up by the global credit expansion then how can asset prices materially fall (assuming they’ve been pushed up by savings)? Or how can a bust happen when there has been no preceding boom? Unless the global stock markets are ALL being manipulated by developed governments, which have taken most of the balance sheet expansion these days!

Another way to look at this is from the time delayed impact of the steep global yield curve which obviously hasn’t taken a footing yet.

As we have argued in What’s The Yield Curve Saying About Asia And The Bubble Cycle?, it takes some 2-3 years as in the case of 2003 to generate traction in the credit markets.

``Credit growth can be a powerful accelerator in expansions and usually kicks in strongly in later phases of upswing, but it rarely leads markets or real economy on the way up. Put simply, we do not need a pickup in bank lending to see an economic recovery or pickup in asset prices” comments Morgan Stanley’s Joachim Fels and Manoj Pradhan.

In short, the focus on credit, which is predicated on mainstream ideology, is actually a lagging indicator. Credit lags and not lead the economic cycle. This is perhaps due to the median expectations to see more concrete signs of stability, since everyone’s risk profile isn’t the same.

So while mainstream seems unduly focuses on the state of credit, little attention has been given to market’s ability to adjust based on existing the stock of savings, aside from the repercussions of money printing to the asset markets.

Hence if we go by the feedback mechanism from the previous credit cycle (2002-2006) then a more meaningful improvement could probably be expected by late this year and well into 2011. Yet the impact will be dissimilar.

Economic Relativism And Zero Bound Rates

But the mainstream would object, how about the overindebted consumers and the overleveraged banking and financial system, will they not affect the credit process?

Again the problem is to engage in heuristics or parse from angle of aggregates or oversimplifying problems or issues. For even in the economies that have seen the absorption of extraordinary or excessive leverage, debt assumption is largely a relative sectoral issue. Not all the industries have over expanded by taking up too much debt.

In the US, the technology and communications sectors bore the brunt of the dot.com boom bust cycle during the new millennium which spent the entire decade cleaning up their mess. The recent US boom bust phenomenon was largely a banking-real estate crisis and would likely spend years doing the same, unless government continues to socialize the losses, whereby taxpayers will shoulder the burden.

A similar relative effect should apply to the US households or even on the highly politicized issue of employment (By the way, the employment issue is being politicized as a way to shore up lost political capital following the electoral setbacks by the President and his party. On the other hand the pandering to the masses could also mean a diversionary strategy from a beleaguered political party whose goal is to secure the Senate majority this year).

Yet even if unemployment rate is at 10% or 17% on a broader scale last September, then still some 90% and 83% are presently employed and could possibly take up some form of credit but maybe to a lesser degree.

So the issue of absolutism is totally out of whack. So we may yet see some credit improvements in the future from the current levels (see chart again above) even if they are muted relative to the height of the previous boom.

The same dynamics should be applied to the world, where only some nations engorged on excessive credit. Many haven’t, such as Asians and the BRICs.

Figure 6: CLSA/Zero Hedge: Asia’s Loan To Deposit Ratio

In most of East and Southeast Asia bank loan to deposit ratios are under 100% which translates to generally underleverage in the system (more deposits than lending) except for Korea, Australia and India whose ratios are marginally above 100%.

Thus it would be foolhardy to argue that these economies won’t generate credit improvements when there is low systemic leverage, high savings rate, unimpaired banking system, current account surpluses, a trend towards deepening regionalization and integration with the world economy.

So the low leverage figures as shown by the IMF in figure 5 will likely see major improvements for as long as current policies are skewed towards favoring debtors at the expense of creditors.

Moreover I just can’t foresee a market meltdown given interest rates have been zero bound in major economies.

Figure 7: Japan’s Interest Rate and the Nikkei 225

Japan is a favorite for the mainstream peddling the deflation theme (which implies that money printing has no effect on consumer prices or the ‘liquidity trap’ which is disputed by the Austrian school as the money is neutral fallacy).

Although we believe that present conditions DON’T MEET anywhere near a Japan scenario, there seems no example of markets operating on near ZERO rates for comparison. So even if it is an apples to oranges comparison the point is to prove that a meltdown is unlikely at Zero bound, at current levels.

As you can see in figure 7, Japan’s stock market has basically shadowed the actions of its interest rate. In 2003, Japan’s zero bound rates hit the lowest level which apparently had been in coordination with the US, and these has been followed by a stock market rally. Interest rates then chimed, it moved higher. Today, Japan’s rates remain at near the lowest or near zero even while the Nikkei has modestly advanced. The interest rate chart in the lower window is only until 2005.

In other words, interest rates are pivotal factors in determining relative asset pricing, resource distribution and risk considerations.

In a bubble cycle, a credit boom will force interest rate higher as demand for resources will be artificially buttressed as investors compete with each other to invest in projects with long time horizon and also with consumers, whose consumption patterns will focus on the present. This hasn’t been the case yet.

Hence, ZERO bound interest rates amidst comparable yet depressed treasury yields or even cash will likely favor riskier assets as stocks and commodities.

In addition, major economies have been growing national leverage as the crisis erupted. National leverage comes in the form of government spending. And government spending has been backed by the issuance of these sovereign paper receipts, from which spending results to relative scarcity of goods and services. Hence the relative abundance of government paper receipts over goods and services implies prospective inflation.

And an upsurge of inflation likewise implies that given the loftily priced levels of sovereign instruments or paper receipts, risks appears titled more towards “risk free” instruments, particularly from nations which PIMCO’s Bill Gross calls the Ring of Fire [see Bill Gross: Beware The Ring Of (DEBT) Fire!]

So the risk reward tradeoff should benefit equity and commodity assets more than the conventional “risk free” instruments.

Authorities Seem Clueless With Bubbles And Operate On Fear

The second most important message conveyed by the IMF is Fear.

Again according to the IMF on emerging markets, ``policymakers cannot afford to be complacent about inflows and asset inflation. As recoveries take hold, the liquidity generated by inflows could fuel an excessive expansion in credit and unsustainable asset price increases.”

Even if the stock and commodity markets have gone substantially up, as we earlier pointed out, fear remains a dominant feature in the landscape.

Again the PTSD and or the Pavlov’s stimulus response behavior exhibits that not only many investors but most officials and policymakers have bubbles chronically embedded on their mindsets. The wound is apparently still fresh.

Yet this is one of a policy paradox, policymakers create bubbles by artificially lowering rates in order to boost the credit cycle, aside from other policies as manipulating the treasury and mortgage market via quantitative easing or providing assorted Fed as THE market via an alphabet soup of programs and other forms of fiscal or government spending.

Another implied goal is to see higher asset prices with the implicit aim to recharge confidence or the “animal spirits”.

However, rising asset prices is likewise seen as a bogeyman arising from the previous experience (anchoring) where such officials have excruciatingly learned that a bust follows a boom, ergo a bubble.

Yet, we’re quite sure authorities won’t be able to determine how to distinguish when high prices redound to a bubble. Why? Based on what metric? Who determines when it is a bubble? Since prices are subjective they will always arguable or debatable by some other officials. Besides market based politics will likely influence policymakers. Regulatory capture anyone?

We are seeing signs of such ambiguity or confusion today.

Here is International Monetary Fund chief Dominique Strauss-Kahn who recently warned against ``easing their stimulus programs "too early" before private demand becomes strong enough.”

From the Japan Times, ``"If countries exit too early (from stimulus), and if we have a new downturn in growth, then really I don't know what we can do," the IMF managing director said at the Foreign Correspondents' Club of Japan.

``Although the IMF does not forecast a double-dip recession, he said, "You never know. It may happen."

So the IMF chief wants easy policy to remain, while their GSFR is cautioning against higher asset prices (implying an intervention is required). Are they simply pretending caution? Or are they merely playing safe by offering a contingent clause?

Here is another contradiction, this time from a Chinese official who rebukes US authorities for low interest rates which he believes risks exacerbating a US dollar carry trade bubble. This was when the US dollar was falling last November.

From Marketnews.com ``Liu Mingkang, the director of the China Banking Regulatory Commission, warned a forum here at the weekend that a falling dollar and low U.S. interest rates are providing a vehicle for speculation worldwide, and are exposing risks for the emerging markets in particular as asset prices soar.

"The carry trade in U.S. dollars is huge because of U.S. dollar depreciation and the U.S. government's policy to keep interest rates unchanged and that has had a big impact on global asset prices, encouraging speculation in stock and property markets," he said. (emphasis added)

With the US dollar apparently rising today and where outflows from China’s swooning stock market reached an 18-week high, we see a reversal of sentiment.

From the Telegraph, ``China's deputy central bank chief Zhu Min warned that tighter US monetary policy could spark a sudden outflow of capital from emerging markets, evoking the 1990s Asian financial crisis.”

So China initially smacks the US for low interest rates, easy policies and a weak dollar policy and then currently China censures the US for tightening, which is which?

Have authorities been seeing their shadows (policies) as if it have been chasing them (boom bust cycles)? Or is it a case of a tail (policy errors) that wags the dog (unintended consequences vented on the marketplaces)?

Given the prevailing undertones which reflect on the heightened apprehensions of policymakers, it is doubtful if true tightening would ever take place in the near future. Instead, what would force up interest rates would be the same dynamics that haunt China now, market based inflation from a boom bust process.

At present, global stock markets don’t seem to clearly manifest signals on these yet. Moreover, the dissonance or the incoherence of the opinions of the experts appear to demonstrate a market undergoing a reprieve more than one suffering from a bout of depression based meltdown as alleged by some grizzly bears.

As we have been saying it’s seems mostly about poker bluffing.

Divergence, Momentum And China's Historical Patterns

``As a general rule, the public believes economic conditions are not as good as they really are. It sees a world going from bad to worse; the economy faces a long list of grim challenges, leaving little room for hope. We can call this the pessimistic bias, a tendency to overestimate the severity of economic problems and underestimate the economy’s performance in the recent past, the present, and the future.” Bryan Caplan The 4 Boneheaded Biases of Stupid Voters

A short discourse on the present market activities and momentum.

One odd development is that while Europe has belabored on Greece’s credit standings, where her CDS premium has run amuck, Europe’s stock markets appears to have diverged from Asia. Europe appears to have suffered lesser degree of losses, this week, in spite of the fears of a protracted crisis which risks a contagion.

In other words, in Europe the credit markets and equity markets appear to have decoupled. Yes I know, experts will assert that credit markets are smarter than the equity market counterpart. But past performance may not guarantee future outcome. Aside, market risks appear to have shifted to Asia. That’s based on this week’s activities.

Importantly even as most of the major European economies absorbed losses, the losses haven’t been broad based, as some nations like Norway, Denmark, Finland, Belgium and even the crisis stricken Greece (!!) managed to register modest gains. Moreover, the frenzied bullmarket momentum in some of the Baltic States and that of other parts of Eastern Europe remains streaking hot!

Greek Tragedy Or Comedy?

So the market and opinion pages have not been saying the same.

An analyst recently commented that austerity won’t be popularly embraced in Greece which risks political chaos. Perhaps. But it doesn’t mean that it shouldn’t be done. If a person ails, no matter how bitter the medicine or how inconvenient the treatment, these will have to be taken if the preference is to expect a recovery. To add, regardless of the choice inconvenience will prevail during state of ailment. But we aren’t talking of a person but of a nation state called Greece.

Hence, the issue isn’t about austerity. The issue is about austerity or reforms aimed at recovery under an independent Greece or under the wards of the European Union.

Yes, the Union may have to bend legal rules from the Stability and Growth Pact and may have to face the risks of moral hazard or a chain effect of bailouts among member nations, but as we have written, politics will govern. Politics that would encompass the preservation or the disintegration of the Union, where the direction of policies will likely buttress the former in spite of the costs of bailouts even at the risks of future dismemberment.

It’s rare to see officials to take on policies that have long term impact, as this would defy public choice economics, where actions of policymakers are most often associated with reelection goals.

Besides, austerity programs will likely undermine the socialist government of Greece, which should translate to a long term positive.

Yet a naughty part of me is toying with the idea that perhaps the Greek episode is being deliberately prolonged so as to extend the decline of the Euro against the US dollar.

In a world where everyone seems to hanker for a devalued currency, out of the prevailing mercantilist tendencies by global officialdom, a market based decline predicated on such adverse development, without intervention, could be part of the tactical operations. Could ECB’s Jean Claude Trichet be snickering behind the scenes?

Market Momentum And Will China Repeat Historical Patterns?

Many markets have broken trend channels (e.g. Euro and gold) or is situated at support levels (e.g. China’s Shanghai), this means that assuming market momentum persists without the interference from officials, then momentum suggests that for the interim, these markets could suffer from an extended malaise. Let’s be clear, no bubble bursting here.

Although, since some markets have technically been in oversold conditions, a bounce could be in the offing, perhaps by the coming week. However, the mid term momentum will likely translate to 1-2 months of consolidation (or downside) before a renewed upside.

In addition, in the US markets, as measured from the futures market, weak hands appear to dominate which further implies disappointments, according to the Danske Team ``The equity market is filled with investors who do not believe in holding equities long term, but who instead trade equities hoping mainly for a quick profit. This is reflected in e.g. the number of long speculative positions as a share of total open interest in the S&P500 futures market. Contrary to the norm, long speculative positions now account for 15% of total positions (down from 20% two weeks ago), something not seen since summer 2002. At that time the market corrected sharply, reflecting that the tech bubble had not fully deflated. Last week’s negative focus on the necessary Chinese and US tightening measures is thus probably a warning that equity investors collectively have little tolerance of disappointments, and that expectations for the global economy in 2010/11 have risen too high.”

Again this speaking from the context of market momentum in the assumption that markets will be left alone to operate by authorities.

Figure 8: BCA US Global Investors: History Rhymes?

Finally, this is an interesting set of charts on China’s markets, all of which illustrates how China’s market has endured from tightening concerns and how they responded after.

In the past two occasions 2003-4 and 2006-7, interim weakness eventually paved way for stronger markets. Today we are seeing the same phase of weakness.

According to US Global Investors, `` While the recent correction in China has been steep and swift, history suggests buying opportunities in the medium term. In early 2004 and early 2007, when tightening fears haunted investors in a policy environment similar to the current one, Chinese stocks underwent a sharp selloff for a couple of months and yet finished the year higher as investors realized the economy was not headed for a hard landing.”

In my view, in going against James Chanos, I’d say that China’s has ample room to inflate! And today’s weakness is a buying opportunity as the BCA chart suggests.

To be clear, it’s wrong to interpret a bubble to mean a peak of the cycle! Instead, Bubble is a process characterized by a boom followed by a bust.

Video Interview: Macro Economist Kenneth Rogoff Versus 'Enterpreneur' Tom Gloser On The Global Economy

This is an interesting video interview by CNBC of Harvard's Ken Rogoff and Tom Gloser of Thomson Reuters in Davos.

It is interesting because the message of both distinguished personalities evokes deeply contrasting views, even if they claim to represent different approaches (Mr. Rogoff-macro while Mr. Gloser-micro) in how they see the world.

Besides, CNBC's designated title "Economy to Crash if It Keeps Debt Appetite: Rogoff" seem to mislead, because Mr. Rogoff says it's gonna "get worse before it gets better" which hardly implies of a crash. Moreover, Mr. Rogoff consumed about only 5-10% of the total time interviewed, yet got the top billing for the video's title. If this is not a case of sensationalism, I don't know what is.

I say contrasting too, because while Mr. Rogoff spoke of difficult times ahead, Mr. Gloser sanguinely articulated on his ex-US "cautious" but manifold expansions, primarily on the "places that are growing", particularly the BRICs in order to "stay a step ahead".

For me, this exhibits the classic informational conflict between the interpretation of statistical aggregates against that of the information from what F. A. Hayek calls as the "man on the spot" or localized knowledge in ascertaining changes in the economy.

Another very important distinction is that while one operates in the realm of theories, the other votes with risk money. I wonder who among them would be right. Interesting indeed.