ASEAN Markets Surge, Where will The Next Bubble Emerge?

``Hot money flows are principally associated with pegged exchange rates. Many analysts have misdiagnosed the so-called hot money problem because they have failed to appreciate this all-important linkage. In consequence, they have prescribed exchange controls as a cure-all to cool off the hot money. That prescription treats the symptoms. It fails to treat the disease: pegged exchange rates. Until pegged rates are abandoned, there will be volatile hot money flows and calls to cool the hot money with exchange controls.”- Steve Hanke, The Dead Hand of Exchange Controls

In this issue:

ASEAN Markets Surge, Where will The Next Bubble Emerge?

-The Bubble Or Inflation Psychology

-No ASEAN Bubble Yet

-Why Capital Controls Can Enhance The Bubble Cycle

-Will The Next Bubble Emanate From Technology Or The Kindleberger Model?

-Will The Next Bubble Emerge From Commodity-Emerging Markets?

Since financial markets have mostly been ‘copacetic’ [slang for ok] and performing in the milieu which we had largely anticipated, ironically I find little to write about this week.

While definitely, we will be encountering several “wall of worries” along the way, I feel that, for this year, it’s going to be mostly a “wait-and-harvest” or “wait-to-be-validated” dynamic.

Of course, it’s never going to be a walkover to challenge many of mainstream’s deeply held superstitions, where people ascribe sundry plausible explanations to the underlying conditions in spite of the falsity of the premises-most of them grounded on either tradition or [political/economic] indoctrination, but in frequently doing so occasionally gets one to be weary.

Nevertheless facts are facts.

Perhaps, no one will dispute that the ASEAN-4 equities appear to be in high octane. As we previously noted, once signs of instability in developed economies become subdued[1], we are likely to see a fervid pace of advance among the ASEAN-4 bourses.

And this exactly what happened this week.

True, the ASEAN-4 has underperformed the US and European markets, but the difference have been starkly remarkable—US and European markets have emerged from the current lows, while ASEAN markets have either been breaking away from recent resistance levels [price ceilings] or adrift at near the resistance levels. (see figure 1)

Figure 1: Bloomberg: ASEAN Equities: Raging Bull Market?!

Well Indonesia’s Jakarta Composite (red line) and Malaysia Kuala Lumpur (orange) are clearly in the second category, while the Philippine Phisix (yellow) and Thailand’s SET (green) are in the breakout zones.

But of course, Indonesia’s JCI has been treading at the newly established milestone highs. And the rest are still below but knocking at record highs, particularly the Philippine Phisix (11.5%) and Malaysia’s KLSE (12.7%).

Meanwhile, Thailand too has been 9.5% off the 5 year (recent boom bust cycle) high, but is still way way way or 54% below her 1994 high.

Figure 2: ChartRUS[2]: Thailand’s Boom Bust Cycle-Asian Crisis

Incidentally as a grim reminder of a bubble cycle, Thailand had been the epicenter of the Asian Crisis of 1997, which during the heyday saw the Thailand’s SET zoom by about 10x (trough-to-peak) before the harrowing crash.

The Bubble Or Inflation Psychology

Thailand’s SET resembles the typical boom-bust or bubble chart seen at the right window. Meanwhile, the crash notably eviscerated almost entirely ALL the gains accrued by the bubble boom days, whereby from peak-to-trough, the SET lost nearly 90%.

The lesson is that bubble cycles, which are fundamentally policy induced, fosters false or deceptive prosperity which results to a net loss in the society (see figure 3).

Bluntly put, short term panaceas have large negative ramifications which basically offset any short term gains.

Professor Ludwig von Mises described exactly how such cycle would result to undeserved sufferings[3] to the populace, (italics mine)

``The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. 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.”

How true.

The general perception of the public has been to parse events extensively based on superficial treatment of causal linkages.

Many of these are rooted upon the stakeholder’s problem, whereby the incentive to acquire knowledge is proportional to the degree of direct stakeholdings involved in the decision making process, i.e. anent a specific concern, the lesser the direct stakes involved, the lesser the need to obtain knowledge, and vice versa.

Importantly yet, many apply heuristics or cognitive biases in the way they account for the unfolding events. Thus, even if a person has direct stakes in the marketplace, social pressures which influences one’s mental faculties can lead to reckless undertakings borne about by policy induced false signals.

Particularly prominent is “The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions”─ which largely describes the social attributional bias[4].

This is likewise apparent in the vicissitudes in the relationship between clients and or the public with those engaged in the industry [like me!] (Notice the explosion of the public’s revulsion towards Wall Street as the bubble imploded) or even amongst political leaders (Notice too how politicians are always quick to grab credit on the account of positive economic/financial developments which they intuitively would ‘attribute; to their actions, or notice how politicians hastily blame speculators for greed when an inimical event surfaces).

In addition, the mainstream economic doctrine has mostly been slanted towards using mathematical formalism or what I would call “hiding behind the skirts of accounting identities” to rationalize on policies predicated on time preferences of having instantaneous impact. This is in tradeoff to the possible longer term adverse effects.

The visible short term effect has predominantly been what sells easily to the gullible public, who mostly lack economic comprehension. Economic experts, thus, provide the mathematical or scientific justification, to overwhelm the uninformed public, at which politicians gladly employ at everyone’s expense.

All these combined with human nature’s desire for immediate gratification, skews the public towards “more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about” ─where failure to identify the genuine cause-and-effect would reflexively lead the public to desire for more of the same short term nostrums, which seems similar to the mechanics of illegal substance abuse. Thus, the cumulative psychological distortions induced by inflationary policies.

Figure 3: Google Public Data: ASEAN 5 GNI per Capita Atlas Method[5]

Yet this has been the same phenomenon which has blighted nations afflicted by the current bubble bust cycle seen in the US and several European economies.

And as previously experienced, the ASEAN-5, which includes the Philippines and South Korea, in the aftermath of the 1997 Asian Crisis saw their GNI per capita based on Atlas Method plummet (see figure 3).

And this is concrete evidence that bubble cycles have always been net negative. Yet policymakers seem to be always looking for an artificially triggered unsustainable boom.

No ASEAN Bubble Yet

Let me be clear, this isn’t to say that ASEAN is already in a bubble. This hasn’t been concretely established.

A Bubble essentially is a symptom of government interventionism via extensive inflationism (e.g. interest rate manipulation, guarantees, subsidies, tax policies etc...) which is ultimately vented on the marketplace.

Figure 4: World Bank[6]: World Development Indicators World View

Because bubble cycles have become a regular feature of the global marketplace (see figure 4) since the transition to the current paper money system, we should expect the reappearance of the bubble phenomenon elsewhere.

This is especially true considering the intensive degree of interventionism implemented by global governments to apply band-aid therapy to any economic or financial predicaments including today’s post crisis landscape. As derivative expert and author Satjayit Das narrates[7],

``Botox is commonly used to improve a person’s appearance by removing facial lines and other signs of aging. The effect is temporary and can have significant side effects. The world is currently taking the “botox” cure. A flood of money from central banks and governments -- "financial botox" -- has temporarily covered up unresolved and deep-seated problems.The surface is glossy and smooth, the interior decayed and rotten.”

Moreover, the current state of openness of the international financial system easily functions as transmission mechanism of money in search of yield phenomenon.

Capital mobility, thus, could facilitate to transport bubble conditions from one place to another. It has been no coincidence that bubble cycles has shifted from Japan bubble crash[8] to Mexico’s Tequila Crisis[9] to the Asian Financial Crisis to the Russian Financial Crisis[10] which prompted for the near collapse of the US hedge fund the Long-Term Capital Management[11] to the tech/dot.com[12] bust and finally the US Mortgage crisis triggered Financial crisis of 2007[13]--as global marketplace has become more integrated.

As a caveat, it would be a mistake to treat financial or trade integration as the cause of the crisis. Like knives, trade or financial liberalizations which tend to integrate economic flows are merely tools, whose outcome is based on how it has been utilized.

Why Capital Controls Can Enhance The Bubble Cycle

Globalization cannot by itself engender a bubble because they don’t expand circulation credit (or issuance of credit unbacked by savings). Creation of fiduciary media would be to the account of the banking system.

In addition, globalization isn’t responsible for carefree government expenditures which results to massive budget deficits that periodically have been monetized by government. Thus, inflationism gets to be transmitted outside of the sphere of operations by virtue of the rerating (devaluation) of the currency relative to the others. Devaluation affects the cost structures in the economy and equally this applies to capital flows in reaction to such policies.

Nevertheless financial openness as applied to Asia hasn’t seen any noteworthy progress since the Asian Crisis (see figure 5)

Figure 5: Asian Development Bank: Outlook 2010

According to Asian Development Bank[14],

``The index of de jure financial openness constructed by Chinn and Ito (2008) confirms that, after the Asian financial crisis, restrictions on capital accounts were introduced more often in many Asian economies, including Indonesia, Malaysia, and Thailand. For the rest of developing Asia, de jure financial openness was relatively stable or slightly increasing (i.e., had higher de jure financial index values).”

Capital flows are not significantly a function of ‘fundamentals’, as they are as much determined by relative monetary policies and the relative currency regime, thus capital flows are likely to reflect on the evolving conditions as corollary to these measures, more than “fundamentals” which usually reacts to the incentives provided by the regulatory environment.

Moreover, in contrast to the ADB, which sees the need for capital account restriction as a “guard against economic instability as well as to preserve monetary autonomy”, seems to be a “strawman” argument.

Capital restrictions do not only increase the risk premium by putting property rights into question which inhibits market efficiency thereby restrain economic growth and reduce investment flows, capital controls also fails to account for the backdoor channels where hot money flows can seep into, or smuggled through, which should exacerbate the bubble conditions. As example, despite Venezuela’s stringent capital controls, capital flight[15] from residents appear to accelerate as they flee and seek a safehaven from an increasingly despotic regime.

What deceives people today as the seeming functionality of capital controls is that internal policies have not yet reached enough pressure levels for markets to seek a relief valve.

In other words, regulations will not put a stop to economic order; it will only reconfigure the flows from what is known as legal channels to the underground. Regulations will also not shape the economy in accordance the chimerical whims of the political class. Instead, failed policies will manifest itself in the marketplace or the economy, in terms of shortages, higher rates of inflation, increased unemployment, higher poverty levels and etc..., no matter how the political class exhaustively tries to conceal them.

The basic lesson is that economic laws cannot be repealed by arbitrary regulations.

Yet what is deemed as today’s global imbalances can partly be ascribed to such capital restrictions.

Asian economies may have preferred to recycle to the US their trade surpluses, than within the region largely because of this. And oppositely, the liberal capital flows in the US has attracted Asian money because of the relatively secure property rights which redounds to reduced perception of risks. The liberal capital markets also provide enhanced liquidity which capital restricted markets can’t. So capital restrictions and liquidity are two major factors that also contribute to what mainstream calls as “global imbalances”.

Thus, policy reforms should be directed at capital convertibility for China and more liberalization for Asia and the ASEAN, including the Philippines, than simplistic currency adjustments which does little but promote nonsensical politicking.

Of course, given the fluid political conditions, this equation could dramatically change, especially if China decidedly aims for an aggressively expansion of her influence with her neighbours via economic integration[16], or if the US embarks on policies in the direction of developing economies by virtue of adapting capital controls or by rampant inflationism.

I should further stress that capital restrictions will not “guard against economic instability” because as stated above, capital controls will not prevent markets from ventilating the accrued imbalances as a result of failed policies.

Will The Next Bubble Emanate From Technology Or The Kindleberger Model?

Going back to the risk of an ASEAN bubble, the tendency for bubbles is to look for areas previously unaffected by a bubble bust or from a dislocation such as new technology or new markets (Charles Kindleberger’s model).

It’s not clear if the latter would place a significant influence in the shaping today’s bubble cycles. But as previously pointed out[17], since technology leads the sectoral weightings today in terms of the largest share of market cap of the S&P index, we shouldn’t rule out an emergent bubble from the technology sector.

Technology in terms of services is making an immense headway in shaping today’s global economic trends (see figure 6)

Figure 6. McKinsey Global Institute[18]: How To Compete And Grow

Some factors that may prompt for a technology based dislocation (Kindleberger model) bubble are the following:

-less government intrusion in the market clearing process of the previous dot.com bust,

-swift obsolescence rate of the technology cycle and or rapid rate of innovation could mean new applications

-globalization means more consumers of technology products and services, thus a wider reach and bigger markets, albeit a more niche oriented one (another potential source of dislocation)

-importantly, freer markets which allows for more intensive competition could spawn heightened innovation from which new products with widespread application could emerge.

Yet there are many factors from which technology should play a role in shaping markets and the economy. Fundamentally this involves greater dispersion of knowledge and the deeper role of specialization, which some have labeled as the Hayekian Moment.

The impact of which should include vastly improved business processes via the development of organizational capital[19], provide for more real time activities which immensely reduces transaction costs thereby generate an explosion of commercial or commercial related activities, and significantly flatten organizational hierarchy which becomes attuned to the dynamics of a more competitive environment.

Economic development trends appear to be tilted towards having a greater share of technology based service sector (left window). The more competitive an economy is, the greater the share of the technology based service economy (right window).

This, essentially, is the running transition away from the industrial age towards the information age.

Thus, free market based competition has been directing economic development towards more specialization, or in Austrian economics terms-the lengthening of the production structure.

So a Kindleberger bubble should be on our watch list.

As a caveat bubbles, will not occur without leverage or expanded credit, thus the Kindleberger applies in conjunction with the Austrian Business cycle.

Will The Next Bubble Emerge From Commodity-Emerging Markets?

Of course the other prospective bubble area which I’d remain vigilant with are economies that were largely unscathed by the recent bubble bust.

Figure 7: IMF GSFR[20]: Subdued Property Transactions; Deutsche Bank[21]: BRIC Financial Markets

While it may be true that property prices in major Asian markets could have eased (left window, figure 6), as evidenced by the subdued rate of property transactions, this perhaps suggest of a temporary reprieve than from a prolonged hiatus or even a slump.

In addition, as one of the least exposed in terms systemic leverage, Emerging Asia’s financial markets are vastly underdeveloped (right window) relative to the developed markets.

This implies that in today’s highly expansionary policies, areas with the least leverage could likely be more receptive to these conditions, which I suspect is mainly responsible for the outperformance of ASEAN bourses.

Furthermore, sustained momentum generates followers or believers. This is known as the bandwagon or the herding effect.

Hence, should the ASEAN momentum persists, it is likely to draw in more participants from both the local and international arena. And this will likely reinforce expectations which should prompt for a feedback loop mechanism that enhances the trend. A bubble dynamic will become evident once systemic leverage will accelerate combined with a stratospheric surge in the price levels of assets whereby people will rationalize this as ‘this time is different’ or in different lingo as “tiger economy” or etc…

But this is likely a few years away from now, as systemic leverage is hardly on the radar screen.

At the present moment, momentum is likely to gather speed for ASEAN markets if the global marketplace should see continued reduced volatility. I think that the price signals from the US dollar index should be a great indicator.

Figure 8: Stockcharts.com: Euro And Global Equity Markets Bounce Back

Major global equity markets appear to be confirming the Euro’s rally (see figure 8) as we fortuitously predicted[22].

Major equity markets seemed to have waited out for more confirmation of the sustainability of Euro’s bounce before taking cue. And coincidence suggests to us that from Shanghai (SSEC), the US S&P (SPX) and the Euro Stoxx 50 (STOX), the actions appear to be simultaneous.

Yet what needs to be established is if the current rally signifies as a major reversal of the current trend or just another countercyclical bounce.

While I don’t think the US or European markets are in a bullmarket, they are likely to be higher at the year end from the current conditions. The steep yield curve as we have been saying will be a major factor in providing cushion to the marketplace.

Finally I am in general agreement with those who think that government debts are a bubble.

But the problem is that US treasuries are unlikely to implode if inflation doesn’t pick up and hamstring the US government’s ability to influence the markets. Global governments in collusion can directly or indirectly intervene in the marketplace which I suspect could have been taking place. The US governments needs low interest rates to finance the burgeoning fiscal deficits, aside from low rates to sustain a steep yield curve to keep her banking system afloat.

And intervention is the most likely route since they will have confidence to do so because yields are low. In fact, present low rates are almost the effect of what quantitative easing has previously done. And as we have been saying for the longest time, any signs of economic weakness will prompt for the US government to use the opportunity to intervene anew.

Proof?

From the Washington Post[23],

``Federal Reserve officials, increasingly concerned over signs the economic recovery is faltering, are considering new steps to bolster growth.

``With Congress tied in political knots over whether to take further action to boost the economy, Fed leaders are weighing modest steps that could offer more support for economic activity at a time when their target for short-term interest rates is already near zero. They are still resistant to calls to pull out their big guns -- massive infusions of cash, such as those undertaken during the depths of the financial crisis -- but would reconsider if conditions worsen.”

Q.E.D.

---

[1] See Why The Sell-Offs In Global Markets Are Unlikely Signs Of A Double Dip Recession

[2] Chartrus.com, Thailand’s SET

[3] Mises, Ludwig von; The Market Economy as Affected by the Recurrence of the Trade Cycle, Chapter 20 Section 9, Human Action

[4] Wikipedia.org, Attributional Bias

[5] NationMaster.com, GNI (formerly GNP) is the sum of value added by all resident producers plus any product taxes (less subsidies) not included in the valuation of output plus net receipts of primary income (compensation of employees and property income) from abroad. Data are in current U.S. dollars. GNI, calculated in national currency, is usually converted to U.S. dollars at official exchange rates for comparisons across economies, although an alternative rate is used when the official exchange rate is judged to diverge by an exceptionally large margin from the rate actually applied in international transactions. To smooth fluctuations in prices and exchange rates, a special Atlas method of conversion is used by the World Bank. This applies a conversion factor that averages the exchange rate for a given year and the two preceding years, adjusted for differences in rates of inflation between the country, and through 2000, the G-5 countries (France, Germany, Japan, the United Kingdom, and the United States).

[6] WorldBank.org, World Development Indicators World View, p.10

[7] Das, Satyajit, Botox Economics – Part 1, Satyajit Das’s Blog-Fear & Loathing in Financial Products

[8] Wikipedia.org, Japan Asset Price Bubble

[9] Wikipedia.org, 1994 economic crisis in Mexico

[10] Wikipedia.org 1998 Russian financial crisis

[11] Wikipedia.org, Long-Term Capital Management

[12] Wikipedia.org, dot-com bubble

[13] Wikipedia.org Financial crisis of 2007–2010

[14] Asian Development Bank: Outlook 2010 Macro Management Beyond The Crisis, p.87

[15] Venezuelaanalysis.com, Inflation in Venezuela Higher This Half Year July 9, 2010

[16] See Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone

[17] See What The Distribution Of S&P 500 Sector Weightings Seem To Say

[18] McKinsey Global Institute, How To Compete And Grow A Sector Guide to Policy, March 2010

[19] Garrett Jones, ``Organizational capital is basically the ideas and habits of work that people build at work. We know what physical capital is--the machines. Businesses also build cultures, R&D labs and trained people. A lot of what we are doing at work is building patterns, processes.” Professor Russ Roberts, Garrett Jones on Macro and Twitter, ecotalk.org

[20] IMF, Global Financial Stability Report, Financial Stability Set Back as Sovereign Risks Materialize, July 2010

[21] Deutsche Bank Research, BRIC Capital Markets Monitor, June 2010

[22] See Buy The Peso And The Phisix On Prospects Of A Euro Rally

[23] Irwin, Neill Federal Reserve weighs steps to offset slowdown in economic recovery Washington Post, July 8, 2010

Stephen Roach: Bernanke Is Just Rerunning Greenspan’s Movie

Morgan Stanley Stephen Roach interviewed by Wall Street Journal in "the Big Interview"

Here are some notes from the interview

-Double dip 40% next year
-Interest rates should be higher
-Bernanke is just rerunning Greenspan’s movie
-I would have voted against Ben Bernanke
-Bernanke-condones asset bubbles
-Chinese monetary policy is preemptive, US is reactive
-China property bubble in High end (10 major cities)
-China has micro bubbles (high end), but not a macro bubble (affordable-socially driven housing etc...)
-Demand is strong for China: 15-20 million people a year from countryside to urban areas
-Economists recommending fiddling around with currency are giving bad advice to political leaders and misleading the public
-Consumer should be more prudent in managing finances

Hayek’s Ideas As Marketing Strategy

In McKinsey Quarterly’s latest paper, “Capturing the world’s emerging middle class”, authors David Court and Laxman Narasimhan recommends several strategic steps for companies to capture and profit from the rapidly growing and huge middle class markets in emerging economies.

It occurred to me that the gist of the proposals have been latched upon harnessing local knowledge which appears no less than F. A. Hayek’s ideals.

From McKinsey, (all bold highlights mine)

``Another tack is to work at a more local level, gaining scale in specific regions and categories by teaming up with deeply knowledgeable on-the-ground partners. They can help not only in product development but also in distribution and market positioning—the crucial final steps to reaching highly local consumer markets.”

More...

``Other strategies for penetrating this affordable, accessible, and local market are to use celebrity endorsements and to leverage local knowledge, either selectively, in areas such as distribution, or through more comprehensive alliances...

And...

```Using local vendors is critical to running a lean operation: many multinationals have found, for example, that capital outlays in emerging markets are often only 30 percent of those required for a factory in the West if they use local resources for plant and process engineering and to execute projects.

Here is Friedrich August von Hayek on “The Use of Knowledge in Society” (bold emphasis mine)

Today it is almost heresy to suggest that scientific knowledge is not the sum of all knowledge. But a little reflection will show that there is beyond question a body of very important but unorganized knowledge which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the particular circumstances of time and place. It is with respect to this that practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active coöperation. We need to remember only how much we have to learn in any occupation after we have completed our theoretical training, how big a part of our working life we spend learning particular jobs, and how valuable an asset in all walks of life is knowledge of people, of local conditions, and of special circumstances. To know of and put to use a machine not fully employed, or somebody's skill which could be better utilized, or to be aware of a surplus stock which can be drawn upon during an interruption of supplies, is socially quite as useful as the knowledge of better alternative techniques. And the shipper who earns his living from using otherwise empty or half-filled journeys of tramp-steamers, or the estate agent whose whole knowledge is almost exclusively one of temporary opportunities, or the arbitrageur who gains from local differences of commodity prices, are all performing eminently useful functions based on special knowledge of circumstances of the fleeting moment not known to others.

Bottom line: The Hayekian concept of knowledge does not just function as an economic theory, but importantly has micro applications in other fields as marketing. In short, the application of Hayek’s Knowledge problem could translate to an edge in business application.

What Agricultural Bank of China’s IPO Should Imply For Asian Financial Markets

The world’s largest IPO will reportedly be launched in China next week.

According to the Economist,

``THE initial public offering of Agricultural Bank of China, the country's third-largest bank, looks set to become the biggest IPO on record. On July 6th and 7th the bank raised a reported $19.2 billion in a dual listing on the Shanghai and Hong Kong stock exchanges. If the bank takes up a further 15% allotment of shares, that would value the deal at a total of $22 billion, slightly more than the offering in another Chinese bank, ICBC, in 2006. In the 1990s telecommunications was the investors' choice but in the last decade the biggest IPOs have been mostly in the financial sector, and mainly of Chinese banks”

Hong Kong, whom dominated world IPOs in 2009, will be eclipsed by China’s state-owned Agbank’s IPO.

According to USA Today,

``In 2009, Hong Kong was the world's largest IPO market, with companies raising a combined $32 billion in capital, according to Dealogic, a data-tracking firm. This year, China is on track to assume the mantle, with $31.7 billion raised by early July.

``The reason for these markets' strong performance amid a tepid global environment: "Investors are looking to put their funds in high-growth regions, and the financial tsunami" has affected growth in Europe and the U.S., says Edward Au, southern China regional leader in Deloitte's National Public Offering Group. (Deloitte is an auditor for AgBank's IPO.)

``AgBank's dual listing in Shanghai and Hong Kong could raise as much as $22.1 billion if an option is exercised to boost the number of shares for sale. This would break a $21.9 billion world record set in 2006 by Industrial & Commercial Bank of China.

``Monday, AgBank will also begin offering an undisclosed number of shares to Japanese investors, says Kenji Yamashita, a spokesman for Nomura, one of AgBank's lead offering coordinators in Japan.”

None the less, the changes in the global IPO market dynamic, as shown above from Renaissance capital, suggests that most of the capital raising activities have now been directed towards Asia.

In other words, Asia has seized the leadership and that global capital may accelerate inflows to Asia, despite doom and gloom predictions from mainstream experts.

The Agbank offering comes amidst the tinges of the unresolved transition from China’s bear market cycle.

The bear market seen in the China’s Shanghai index [upper window] (Bloomberg), emerged in the backdrop of an economic growth slowdown amidst the global financial crisis. China’s official growth figures fell by half 13% to 6.2% [lower window] but conspicuously escaped a recession (tradingeconomics.com).

Yet as I have been propounding; why should the Shanghai Index collapse by 71%, even more than the US markets, when she has eluded recession unlike the US?

From here we have explained that ‘fundamentals’, which has been the deeply entrenched mainstream wisdom, do not sufficiently ‘rationalize’ market activities, as the latter have been more influenced by liquidity flows (or my Machlup-Livermore paradigm).

Yet, from such premises, despite the heavy demand for Agbank share, the success of Agbank’s IPO listing isn’t clear, considering that China has been tightening in order to prevent an overheating or a bubble from running berserk.

Yes, the Shanghai index has bounced off strongly up (3.69%) from the dive (6.66%) during the previous week and could be work favorably to Agbank’s advantage.

Asian IPO’s have generally been well received this year (Reuters) and most likely the Agbank’s one day performance could also register a positive return.

But measuring IPOs for one day performance would appear equivalent to betting on a horse race-an inappropriate approach for serious or prudent investors.

Nevertheless IPO activities are one of the major indicators for bear markets.

And this has been accurately pointed out in July of 2007, see The Prudent Way To Profit From IPOs!, where in terms of Philippine based IPOS (upper window) surged.

And this appears to be same trend for global markets, as seen in the lower window (renaissance capital) as the boom climaxed.

Even as Asia today has commanded the biggest share of IPO activities (renaissance capital) it doesn’t automatically imply that Asian markets are in “bubble proportions”.

IPO activities in 2009 haven’t even surpassed the previous highs. And even if Asian IPOs do exceed the 2006 highs, other indicators will need to be scrutinized to ascertain the risk of bubbles.

All these suggest of the following:

-a deepening and growing sophistication of financial markets (of course, it could also mean a bubble)

-reduction of the excessive reliance of financial intermediation away from the banking system

-competition should bring about pricing efficiency, expanded accessibility and lower transaction costs which should enhance structural economic growth

-more emergent signs of decoupling

-relative higher equity returns are likely to put Asia on top of the heap and attract more capital flows

-as capital would likely to chase higher relative returns, IPOs activities in Asia are would likely to experience a feedback loop mechanism—high returns lead to more IPOs and vice versa--at the risks of fostering bubble conditions.

IPO activities represent as one critical indicator of capital market development and bubble activities.

Bad Record Of Doom Mongering And Interest Group Politics

Here is Matt Ridley on the dismal track record of doom mongerers (or the pessimism bias). [hat tip Mark Perry] (all bold emphasis mine)

``By then I had begun to notice that this terrible future was not all that bad. In fact every single one of the dooms I had been threatened with had proved either false or exaggerated. The population explosion was slowing down, famine had largely been conquered (except in war-torn tyrannies), India was exporting food, cancer rates were falling not rising (adjusted for age), the Sahel was greening, the climate was warming, oil was abundant, air pollution was falling fast, nuclear disarmament was proceeding apace, forests were thriving, sperm counts had not fallen. And above all, prosperity and freedom were advancing at the expense of poverty and tyranny.

``I began to pay attention and a few years ago I started to research a book on the subject. I was astounded by what I discovered. Global per capita income, corrected for inflation, had trebled in my lifetime, life expectancy had increased by one third, child mortality had fallen by two-thirds, the population growth rate had halved. More people had got out of poverty than in all of human history before. When I was born, 36% of Americans had air conditioning. Today 79% of Americans below the poverty line had air conditioning. The emissions of pollutants from a car were down by 98%. The time you had to work on the average wage to buy an hour of artificial light to read by was down from 8 seconds to half a second.”

The incentives for doom mongering? Apparently “interest Group politics”

Back to Mr. Ridley…

``I now see at firsthand how I avoided hearing any good news when I was young. Where are the pressure groups that have an interest in telling the good news? They do not exist. By contrast, the behemoths of bad news, such as Greenpeace, Friends of the Earth and WWF, spend hundreds of millions of dollars a year and doom is their best fund-raiser. Where is the news media's interest in checking out how pessimists' predictions panned out before? There is none. By my count, Lester Brown has now predicted a turning point in the rise of agricultural yields six times since 1974, and been wrong each time. Paul Ehrlich has been predicting mass starvation and mass cancer for 40 years. He still predicts that `the world is coming to a turning point'.

``Ah, that phrase again. I call it turning-point-itis. It's rarely far from the lips of the prophets of doom. They are convinced that they stand on the hinge of history, the inflexion point where the roller coaster starts to go downhill. But then I began looking back to see what pessimists said in the past and found the phrase, or an equivalent, being used by in every generation. The cause of their pessimism varied - it was often tinged with eugenics in the early twentieth century, for example - but the certainty that their own generation stood upon the fulcrum of the human story was the same.

``I got back to 1830 and still the sentiment was being used. In fact, the poet and historian Thomas Macaulay was already sick of it then: `We cannot absolutely prove that those are in error who tell us that society has reached a turning point, that we have seen our best days. But so said all before us, and with just as much apparent reason.' He continued: `On what principle is it that, when we see nothing but improvement behind us, we are to expect nothing but deterioration before us.'

Let us back this up with some graphs (source google public data)

Ballooning global merchandise trade soaring global GDP per capita

Lengthening of world's life expectancy

Explosion in Mobile Phone Usage

Bottom line: Beware of the false 'politically tainted' messiahs.

F. A. Hayek On Keynes: I Think He Would Have Been Fighting The Inflationary Policy

Here is a short video interview of F.A. Hayek in discussion of wage rates and the deflation during the British Depression of the 20s and 30s.(Hat tip Greg Ransom)

Some important quotes,

“While I’d spent a year analyzing in great detail his earlier book the Treatise on Money and then only to hear him by the time the second part of my criticism was published “oh I no longer believe in all that”, I didn’t want to invest more effort in criticising the general theory who’s success is still a puzzle to me, because it reverted to a very primitive idea which had been clearly refuted in the nineteenth century that there is a single relation between the demand-aggregate demand for final products and employment. So much so that Leslie Steven in the 1880s had pointed out “The test of a good economist is that he does not make that particular mistake. Well Keynes revived it and gave a plausible explanation and, I should add that he did not succeed while he lived. But when he died he was suddenly raised to sainthood.”

“The very last time I saw him about six weeks before his death...and talked to him after dinner and asked him whether he wasn’t alarmed by what his pupils naming two....were agitating for more expansion. when in fact, the danger was clearly inflation. He completely agreed with me and assured me my theory was frighteningly important in the 1930s when the question was of combating deflation. If inflation ever becomes a danger, I am going to turn around public opinion like this and six weeks later he was dead and couldn’t do it. I think he would have been fighting the inflationary policy.”

NBA And Taxes

Here is an interesting article on how taxes plays a critical role in shaping of NBA’s recruitment and team performance.

From Bill Bradley of the SacBee (Hat tip SM Oliva Mises Blog)

“The absence of state income tax in Florida and Texas is a big reason the Miami Heat and Dallas Mavericks can be active in free agency.

“Compare that to the New York Knicks, whose players have to pay combined state and city income taxes of 12.618 percent. That means Amar'e Stoudemire's five-year, $99.8 million deal with the Knicks is worth about $12 million less than if he had signed with the Heat.

“While athletes are taxed by other states when playing road games, they come out well ahead if they live in Texas or Florida.

“Yes, these Florida and Texas teams had to have salary cap space to get involved in this circus. Yes, they wanted to improve their rosters.

“But think about this: There are five NBA teams in Florida and Texas. Those are the only teams without state income tax. All five are among the most competitive in the league. (bold highlights mine)

Bottom line: taxes function as a major influence on how resources or manpower are allocated, and this is obvious even in sports!

Forbes’ Philippines 40 Wealthiest

Here is the updated list of the Philippines’ who’s who or the wealthiest 40 from Forbes.

Click here for a crispier image

While attaining wealth by providing consumers their invaluable goods and services is the most admirable trait of successful entrepreneurs, in the Philippine setting, some may have achieved their lofty status from political entrepreneurship or obtaining economic privileges from political concessions.

They are what author Joe Studwell calls as the Asian Godfathers who are “highly effective traders in rent-offering environment.”

The Problem With ‘All Things Constant’

Northern Trust’s Asha Bangalore writes,

``All other things constant, a stronger currency reduces exports of a nation as does weakening economic conditions in importing economies.”

But at what point of our lives or of anyone’s life has all things been constant?

The sun rises tomorrow if we are lucky enough to be alive to see it. Yet ultimately the sun dies in a few billion years.

So if there is anything constant is the cycle of life and death, but we never know WHEN. Therefore not knowing equals inconstancy or uncertainty.

Of course, as Benjamin Franklin would have it, there are taxes too…

But if one argues in terms of the relationship between currency-exports/economy, there is hardly any merit to such premise.

Proof?

“Stronger currency reduces exports”...

Here is the Euro since its inception...

From Yahoo Finance

Here is the 15-year chart of the Japanese Yen...

From Index Mundi

And here are Japan’s and Germany’s Exports as % of their respective economies...

From Google

All things constant?

iPhone Global Supply Chain, The Power of the Market Through The Division of Labor

The New York Times talks about supply chain structure of the iPhone and its costs,

``According to the latest teardown report compiled by iSuppli, a market research firm in El Segundo, Calif., the bulk of what Apple pays for the iPhone 4’s parts goes to its chip suppliers, like Samsung and Broadcom, which supply crucial components, like processors and the device’s flash-memory chip.

``In the iPhone 4, more than a dozen integrated circuit chips account for about two-thirds of the cost of producing a single device, according to iSuppli.

``Apple, for instance, pays Samsung about $27 for flash memory and $10.75 to make its (Apple-designed) applications processor; and a German chip maker called Infineon gets $14.05 a phone for chips that send and receive phone calls and data. Most of the electronics cost much less. The gyroscope, new to the iPhone 4, was made by STMicroelectronics, based in Geneva, and added $2.60 to the cost.

``The total bill of materials on a $600 iPhone — the supplies that go into final assembly — is $187.51, according to iSuppli.

However, when I reached the portion when the article mentioned “The world of contract manufacturers is invisible to consumers”, it dawned upon me that the author was dealing with wonders of the division of labor in passing.

Yes indeed, the iPhone is a product of a global division of labor!

And a great illustration of the magic of the division of labor was written by Leonard Read in his classic “I, the Pencil”, where he shows how people from diverse places and distinct cultures work spontaneously and invisibly in harmony to produce what seems like a simple product- the pencil- which you and I use.

The illustrious Milton Friedman does a great job discussing Mr. Read’s classic, below…

Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionism

Many of you may be familiar with the idiom to “fit a square peg to a round hole”. This simply means, according the Free dictionary, “trying to combine two things that do not belong or fit together.”

From Oftwominds.com

I think this expediently characterizes mainstream’s misplaced notion about Japan’s long held predicament: deflation.

Because of the mammoth boom-bust cycle seen in Japan's property and stock markets, which led to Japan’s economic “lost decade”, the image of the Great Depression of the 1930s has frequently been conjured or extrapolated as the modern version for it.

Of course, there is a second major reason for this, and it has been ideologically rooted, i.e. the bubble bust has been used as an opportunity to justify the imposition of theoretical fixes by means of more interventionism.

Has a deflationary depression blighted Japan?

If the deflation is measured in what mainstream sees as changes in the price level of the consumer price index, then the answer is apparently a NO.

As you would notice from the graph from moneyandmarkets.com, deflation isn’t only episodic (or not sustained), but likewise Japan’s intermittent economic growth (blue bars) came amidst the backdrop of negative or almost negative CPI (red line)! In other words, economic growth picked up when prices where in deflation--this translates to real growth.

And if measured in terms of changes in monetary aggregates, then obviously given that the changes in Japan's M2 has been steadily positive, as shown by the chart above from Northern Trust, all throughout the lost decade, then we can rule out a "monetary deflation".

Of course, the next easiest thing for the mainstream to do is to pin the blame on credit growth.

chart from McKinsey Quarterly

While there is some grain of truth to this, this view isn’t complete. It doesn’t show whether the lack of credit growth has been mainly from demand or supply based. It doesn't even reveal why this came about.

We can even say that such generalizations signify as fallacy of division. Why? Because the problem with macro analysis is almost always predicated on heuristics-or the oversimplification of variables involved in the analytic process.

Banks have not been the sole source of Japan’s ‘credit’ market. In fact, there are many as shown below.

According to Promise.co.jp (bold emphasis mine)

``Providing credit to consumers is generally referred to as "consumer credit." This can be classified into two types. The first is providing credit to allow consumers to buy specific goods and services, which is called "sales on financing," and the second is providing credit in cash, which is called "consumer finance." There are many types of financial service companies that offer consumer finance, including banks, but compenies which specialize in providing small loans to consumers are referred to as "consumer finance companies."

Further promise.co.jp describes the function of consumer finance companies as providing credit

``including loans but, unlike banks, do not take deposits are referred to as "non-banks." Leasing companies, installment sales finance enterprises, credit card companies, and consumer finance enterprises belong to the non-bank category.”

So how has Japan’s alternative financing companies performed during the lost decade?

Promise provides as an especially noteworthy chart. It shows of the following:

1) During the lost decade or from 1989-2007, the share of consumer financing companies (yellow-orange bar) has exploded from 15.6% to 41.9%!

2) Other forms of credit (apple green bar) also jumped from 13.4% to 30.1% during the same period.

3) The bubble bust has patently shriveled the share of 'traditional bank' based lending or the share of lending from commercial financial institutions collapsed from 48% to 12.4%.

4) The sales financing companies likewise lost some ground from 22.4% to today’s 15.6%.

All these reveals that while it is true that nominal or gross lending has declined, there has been a structural shift in the concentration of lending activities mainly from the banking to consumer financing companies and "other" sources.

And importantly, it disproves the idea that Japanese consumers have “dropped dead” or that the decline in lending has been from the demand side.

Obviously banks were hampered by the losses stemming from the bubble bust. But this wasn’t all, government meddling in terms of bailouts were partly responsible, as we wrote in 2008 Short Lessons from the Fall of Japan

``One, affected companies or industries which seek shelter from the government are likely to underperform simply because like in the Japan experience, productive capital won’t be allowed to flow where it is needed.

``Thus, the unproductive use of capital in shoring up those affected by today's crisis will likely reduce any industry or company’s capacity to hurdle its cost of capital.

``Two, since capital always looks for net positive returns then obviously capital flows are likely to go into sectors that aren't hampered by cost of capital issues from government intervention.

``This probably means a NEW market leadership (sectoral) and or money flows OUTSIDE the US or from markets/economies heavily impacted by the crisis.”

Apparently, our observation was correct, the new leadership had shifted to the financing companies.

But there is more.

Because the banking system had been immobilized, which conspicuously tightened credit access, the explosive growth of the financing companies emerged as result of demand looking for alternative sources of supply.

In addition, financing companies, who saw these opportunities circumvented tight regulations or resorted to regulatory arbitrage, in order to fulfill this role.

According to the Federal Bank of San Franscisco, (bold emphasis mine)

``Prior to the passage of the new legislation, Japan had two laws restricting consumer loan interest rates. The Interest Rate Restriction Law of 1954 set lending rates based on the size of the loan, with a maximum rate of 20 percent. The Investment Deposit Interest Rate Law, last amended in 2000, capped interest rates on consumer loans at 29.2 percent on the condition that any rate exceeding 20 percent requires the written consent of the borrower. Most Japanese CFCs have been operating in this “gray zone” of interest rates, charging rates between 20 and 29.2 percent.

``Non-bank consumer finance companies in Japan comprise a ¥20 trillion industry, averaging 4 percent annual loan growth over the past decade while bank loan growth was negative. Most of the approximately 14,000 registered lenders are small, with the largest seven operators-which include the consumer finance arms of GE Capital and Citigroup- having a 70 percent market share. The significant growth in this industry can be traced directly to the collapse of the asset bubble in the early 1990s when consumers whose collateral had dwindled in value turned to CFCs offering uncollateralized loans. Adding to the success of the industry was the fact that CFCs were more service-oriented than the retail operations of Japanese banks, offering a wider network of loan offices, 24-hour loan ATMs, and faster credit approval.”

In short, banking regulations and policies proved to be an important obstacle to credit access.

Yet, the Japanese government worked to rehabilitate on these legal loop holes. This led to further restrictions to credit access.

According to Yuki Allyson Honjo, Senior Vice President, Fox-Pitt Kelton (Asia), [bold emphasis mine]

``The Supreme Court made a ruling in 2006 to make it easier for individuals to collect repayment of interest in excess of that allowed under the Interest Rate Restriction Law (grey zone interest). The court ruling called into question the legality of the grey zone. This prompted revisiting of the rules governing money lending and forced companies to create grey zone reserves. People were entitled to claim the "extra" interest they paid from their lenders.

``Revisions to the money lending laws were passed, and by June 2010, the maximum lending rate will be unified to rates specified under the Interest Rate Restriction Law, thereby eliminating the grey zone. Loans will be limited to a third of borrowers' annual income. For loans exceeding 1 million yen, moneylenders would be obligated to inquire about the applicant's annual income. Implementation is still ambiguous. Regulators are to have more power, such as the ability to issue business improvement orders.

``The rate decline held various consequences for the industry. Margins were lowered as lenders were forced to lower their lending rates. There was a reduction in volume, with loans to current borrowers no longer being profitable, some customers were deemed too high-risk to borrow at the lower rates. Customers could borrow less due to new legislation restricting total loans as a percentage of income. Also, there has been a rise in write-offs.

``The result of all of this is that the number of registered money lenders has dropped precipitously since regulation began in 1984. The loan market is an oligopoly with 60% of the total loan balance with the Big Four, and 90% percent with the top 25 firms. This oligopoly was created in reaction to regulation.

``Stock prices for money lending companies began to drop steadily in 2006, predating the current economic crisis. The necessity for grey zone reserves has caused problems in money lenders' balance sheets. In March 2007, there are many large negative numbers visible in the balance sheets of Aiful, Takefuji, Acom and Promise. Loans approval rates crashed around 2006, with Aiful only accepting 7% of loans recently, down from over 50% before the 2006 Supreme Court rulings. Every month, 25-30 billion yen is paid out by money lenders to customers in grey zone claims, increasing steadily since 2006. Grey zone refunds have begun to pick up recently as a result of the recent economic crisis.

``The consequences of the court ruling and the re-regulation are that the Big Four companies found direct funding difficult. Credit default swaps have increased dramatically for Takefuji and Aiful, who are now essentially priced to fail. Bond yields also increased and going to market is difficult for these companies.

``From the regulator's perspective, re-regulation has been largely a success, given their aims. The size of the industry and the number of players have been reduced. The government has greater control on the industry and over-borrowing has been reduced. In regard to this last goal, its success is unclear as black market statistics are not reliable. In fact, anecdotes suggest that black market lending demand has increased.”

So aside the aftermath bubble bust, the bailouts of zombie institutions and taxes we discovered that government diktat have been the instrumental cause of supply-side impairments in Japan's credit industry.

Moreover, the other consequences has been to restrain competition by limiting the number of firms which led to the persistence of high unemployment rates, and fostered too-big-to-fail "oligopolies" institutions.

So we can conclude two things:

1. Japan’s economic malaise hasn’t been about deflation but about stagnation from wrong policies.

2. The weakness in Japan’s credit growth essentially has also not been about liquidity preference and the attendant liquidity trap, or the contest between capital and labor, or about subdued aggregate demand, but these has been mostly about the manifestations of the unintended consequences of the Japanese government's excessive interventionism.

As Ludwig von Mises wrote,

``The various measures, by which interventionism tries to direct business, cannot achieve the aims its honest advocates are seeking by their application. Interventionist measures lead to conditions which, from the standpoint of those who recommend them, are actually less desirable than those they are designed to alleviate. They create unemployment, depression, monopoly, distress. They may make a few people richer, but they make all others poorer and less satisfied.”

And it is here that we see how the mainstream can't seem to fit the square peg (deflation) to the round hole (stagnation).