William Gross’ Demographic Nightmare

PIMCO's chief honcho William Gross writes,

``The danger today, as opposed to prior deleveraging cycles, is that the deleveraging is being attempted into the headwinds of a structural demographic downwave as opposed to a decade of substantial population growth. Japan is the modern-day example of what deleveraging in the face of a slowing and now negatively growing population can do.”

Mr. Gross puts the blame on declining population from which to justify government’s bubble policies...

``The lack of population growth was likely a significant factor in the leveraging of the developed world’s financial systems and the ballooning of total government and private debt as a percentage of GDP from 150% to over 300% in the United States, for example. Lacking an accelerating population base, all developed countries promoted the financing of more and more consumption per capita in order to maintain existing GDP growth rates.”

That’s because his economic ideology leads him to believe that spending alone drives the economy.

``If anything, my thesis is anti-Malthusian in its assertion that there will always be enough production to satisfy a growing population, but perhaps not enough new people to sustain growing production.” (emphasis his)

This is plain vanilla folderol!

Despite Japan’s lost decade, [see Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionism], the post-market clearing phase from failed bubble policies has revealed that Japan’s per capita income has bottomed out in 2001 and appears to be on the mend. In fact, the wealth metric seems to be showing that the Japanese are getting rich anew, despite the declining population!

So Japan’s ‘deflation’ isn't a depression, but the opposite of what mainstream expects-net wealth accumulation (as shown above from google)!

Second, markets are not circularly flowing wherein people produce goods and the consumers mechanically buy them back, thus erringly conclude consumers drive the economy. This is the circular logic behind Mr. Gross' demographic nightmare where a declining population equals lesser consumption. Mr. Gross fails to appreciate that markets in essence is about the attainment of satisfaction from voluntary exchange.

Likewise, products and markets are not homogenous. Instead, the greater depth of the market economy, the greater the wealth, as people look to provide more products in a race to satisfy the consumers (themselves).

Hence, the more the purchasing power from wealth accumulation, the broader the diversity of products to choose from.

The chart above shows that as global trade deepens, per capita income is likewise growing-meaning more products to spend on from growing wealth--despite the declining rate of population growth.

In today's world, the major trend seems to be about the transition from the industrial economy to the post-industrial or information age (digital) economy, where niche markets, competition, innovation, specialization and dispersion of knowledge seem to be the predominant order.

In contrast to Mr. Gross, we see the demographic issue as non-sequitur.

Government Failure: Imported Surplus Rice

Looking at the headlines we observe that the Philippines seem to jump from one crisis to another.

I’d say such crisis is a lucid manifestation of the failure of government interventionism or government meddling.

Of course, many would make other insinuations (corruption) mostly emphasizing on the devious intent of the previous administration.

But I would argue that these are the effects and not the cause of the present problems.

The latest hullabaloo is that government imported too many rice says the headline. This from the Inquirer.net,

The group was reacting to a report on Tuesday by Banayo that the country was “swimming in rice” because the Arroyo administration had imported seven times more than the country’s needs.

Banayo said that the NFA under Arroyo had authorized the importation of some 20,000 metric tons of rice estimated at P100 million in late April or May despite the oversupply in the local market. He said that the shipment had started to arrive at Poro Point in La Union.

Mr. Aquino on Monday said that rice was rotting in warehouses while the NFA had accumulated debts totaling P177 billion.

This seems to be a wonderful example of time inconsistency or the sustainability of a policy given the changes of the circumstances over time.

Back in the October 2009, post Typhoon Ondoy and Typhoon Pepeng, headlines yelled fire! These typhoons wrought devastation on our rice production!

'Ondoy', 'Pepeng' hit areas producing 56% of RP's rice, bannered the ABS-CBN headline. And this article accompanied the table, as shown above, which depicted on the estimated scale of damages.

And because of this, the Arroyo government reacted to the calamity by...you guessed it...importing the problematic rice of today.

Below was media’s sentiment immediately during the post Typhoon days, according to GMA news,

Estoperez, however, said that while the damage caused by Ondoy and Pepeng would definitely have a negative effect on local rice farmers, a rice crisis in the coming year is a remote possibility.

“We have enough rice supply for the remainder of the year, and the DA is taking steps to mitigate the effects of the damage so we could have enough rice for next year," he said.

He said the prices of NFA rice will remain stable, including the subsidized P18.25/kilogram for qualified poor families, and the P25/kg rice.

He also said that the DA, on orders of President Gloria Macapagal Arroyo, is planning to import rice earlier than scheduled this year to prevent a possible rice supply crunch in 2010.

The article even cited an NGO study who said that the government ‘downplayed’ the impact of the typhoon on the rice fields which lent a sense of urgency to the missive.

The Arroyo Administration even tried to dramatize the impact of the calamity by declaring price controls, which I argued, could have used been as justification to declare martial law and a postponement of elections.

Yet, then, NOBODY averred that imported rice would pose as a problem because the POPULAR issue of the day was the looming risk of a RICE CRISIS.

Now, since NO rice crisis have emerged, the Arroyo government gets slammed for what is seen as an improvident or even perverted action.

To put in perspective, in 2009 importing rice was deemed as politically correct, today it is politically wrong. The change in circumstances results to a corresponding change in the political climate. So a time inconsistent policy.

I’d further add that such policy faux pas represents as government’s knowledge problem.

In other words, government simply DOES NOT know the future and the specific needs of the society enough to justify repeated interventionism.

Obviously, the miscalculation resulted to massive wastages and economic distortion which presently adversely impacts the local farmers. Hence, the crisis.

One could add icing on the cake by saying that the previous administration used the incident as political cover to profit.

Whether this is true or not, it is the nature of politics to attain credit by attributing sensationalism and discrediting foes.

In short, instead of analyzing the genuine cause of the failure, just blame the personality involved as this would be the fashionable thing. Nevertheless, the offspring of interventionism is corruption.

Yet all these three factors combine to reveal why government interventionism is not only wrong, but immoral and a waste of capital.

Of course if you listen to politicians, their solution is more of the same.

$23.7 Trillion Worth Of Bailouts?

Nassim Taleb spoke of definancialization as the main cure to the system.

However, his suggestion would be revolutionary since we cited that financialization is the heart of the US political economic system (and globally) which has operated around the central banking platform, particularly in the US, the US Federal Reserves.

Proof? This from Bloomberg,

U.S. taxpayers may be on the hook for as much as $23.7 trillion to bolster the economy and bail out financial companies, said Neil Barofsky, special inspector general for the Treasury’s Troubled Asset Relief Program.

The Treasury’s $700 billion bank-investment program represents a fraction of all federal support to resuscitate the U.S. financial system, including $6.8 trillion in aid offered by the Federal Reserve, Barofsky said in a report released today.

“TARP has evolved into a program of unprecedented scope, scale and complexity,” Barofsky said in testimony prepared for a hearing tomorrow before the House Committee on Oversight and Government Reform.

Treasury spokesman Andrew Williams said the U.S. has spent less than $2 trillion so far and that Barofsky’s estimates are flawed because they don’t take into account assets that back those programs or fees charged to recoup some costs shouldered by taxpayers.

“These estimates of potential exposures do not provide a useful framework for evaluating the potential cost of these programs,” Williams said. “This estimate includes programs at their hypothetical maximum size, and it was never likely that the programs would be maxed out at the same time.”

Barofsky’s estimates include $2.3 trillion in programs offered by the Federal Deposit Insurance Corp., $7.4 trillion in TARP and other aid from the Treasury and $7.2 trillion in federal money for Fannie Mae, Freddie Mac, credit unions, Veterans Affairs and other federal programs.

We shouldn’t forget that the US banking system has been plagued by toxic securities mostly from mortgage lenders, such as Fannie and Freddie and other private labels, thus the encompassing system wide rescue package.

This can clearly be seen in the Federal Reserve’s Balance sheet, where the bulk (brown) of the assets held comprise Federal Agency Debt Mortgage Backed Securities

This reminds us of President Woodrow Wilson who once wrote,

“A great industrial nation is controlled by its system of credit. Our system of credit is privately concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men who, even if their action be honest and intended for the public interest, are necessarily concentrated upon the great undertakings in which their own money is involved and who necessarily, by very reason of their own limitations, chill and check and destroy genuine economic freedom.”

Nassim Taleb: Government Deficits As The Next Black Swan

Speaking of political incentives Nassim Taleb has one great example, in an interview he says

The massive one is government deficits. As an analogy: You often have planes landing two hours late. In some cases, when you have volcanos, you can land two or three weeks late. How often have you landed two hours early? Never. It's the same with deficits. The errors tend to go one way rather than the other. When I wrote The Black Swan, I realized there was a huge bias in the way people estimate deficits and make forecasts. Typically things costs more, which is chronic. Governments that try to shoot for a surplus hardly ever reach it.

The problem is getting runaway. It's becoming a pure Ponzi scheme. It's very nonlinear: You need more and more debt just to stay where you are. And what broke [convicted financier Bernard] Madoff is going to break governments. They need to find new suckers all the time. And unfortunately the world has run out of suckers.

In other words, the incentive for politicians has been to run up unsustainable deficits through lavish spending.

And he thinks that definancialization should be the way to go

I think we should not need financial reform. What we need is definancialization. What we need to do is break the financial community's grip on society. And you can do it very easily by transformation of debt into equity. Banks have an interest in building debt, but equity in society is vastly more stable than debt.

But in my view, we can’t definancialize without overhauling the political system which has been tied to Central Banking. Therefore, definancialization should mean the end of central banking.

Does Government Have The Right Incentive?

Professor David Henderson writes,

``what so few advocates of government intervention even try to show us, is how a government regulator will have the right incentive to do the right thing. Will the government regulator be fired if he screws up? Not typically. Will he get a huge bonus if he does something right? Not typically. And how, with a centralized information system, will he get the information needed to make a good decision...”

Exactly.

This is in contrast to the conventional or popular expectation where political entities function as supposed saviours of mankind. Or that once people get ushered into public office, they are elevated or transformed into entities who assume omniscience and superhuman virtues. Or as Professor Henderson points out, government is expected to play the role of Deux ex Machina.

But as we keep pointing out regulators, bureaucrats, or politicos are merely human beings. They are all influenced by the knowledge problem, stakeholder’s dilemma, time consistency, cognitive bias, perceptional variance, networks, personal values and others, all of which adds up to what shapes their priorities.

With markets people are driven by mainly profit and loss incentives. How about politics? Isn’t the incentives all about power over the others? So how does power over the others or political become a better alternative in solving social and distributional problems relative to the market?

On President Aquino’s SONA: The More Things Change....

I have not heard or read the entire transcript of the First State of the Nation (SONA) address by President Noynoy Aquino yesterday. Thus I’ll be basing my comments on the content or quotes of the President Aquino by mainstream media.

Fundamentally the Inquirer ‘We can dream again’ article seems to give alot of weight on Mr. Aquino’s penchant for public-private partnerships arrangement.

So what is a public private partnership? It is basically government project/s outsourced to the private sector.

This from Wikipedia.org, ``PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project. In some types of PPP, the cost of using the service is borne exclusively by the users of the service and not by the taxpayer. In other types (notably the private finance initiative), capital investment is made by the private sector on the strength of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government. Government contributions to a PPP may also be in kind (notably the transfer of existing assets). In projects that are aimed at creating public goods like in the infrastructure sector, the government may provide a capital subsidy in the form of a one-time grant, so as to make it more attractive to the private investors. In some other cases, the government may support the project by providing revenue subsidies, including tax breaks or by providing guaranteed annual revenues for a fixed period.” (bold emphasis mine)

In other words, PPP’s signifies as politically privileged economic rent/concessions to favoured private entities that will undertake the operations in lieu of the government. They will come in the form of monopolies, cartels or subsidies that will benefit only the politically connected.

Since the private partner partnerships aren’t bound by the profit and loss discipline from the consumers, the interest of the private partners will most likely be prioritized or aligned to please the whims of the new political masters.

And because of it, much of the resources that go into these projects will not only be costly or priced above the market to defray on the ‘political’ costs, but likewise, they will be inefficiently allocated.

Moreover, PPPs risk becoming ‘milking cows’ for these politically entitled groups and could be a rich source of corruption.

Hence, PPPs are no less than emblematic of the status quo, which I had been predicting, that highlights on the legacy of crony capitalism, which seemingly, the new administration is headed for.

Of course one may argue that these projects will be transparently offered to the public. But that would be a non-sequitur. As we should know, there are many stealthy ways to maneuver the process or to ‘skin the cat’.

Going back to the SONA it is further a wishful thinking for President Aquino to assume government knows best in allocating resources,

From the same article,

``To put a stop to the wasteful use of funds, the government would eradicate “wrong projects” and adopt a “zero-based” approach to crafting the national budget, the President said.

“What used to be the norm was every year, the budget merely gets reenacted without plugging the holes,” he said. “Next month we will be submitting a budget that accurately identifies the problem and gives much attention on the right solution.”

When resources are allocated politically, they become impervious to market pricing thus, are always subjected to waste.

Even to the most well-meaning politician, it is hardly the interest of the public that comes into play, but the interest of the public as perceived by the political leaders.

Yet these perceptions can be skewed by biases, familiarity, networks, vested interest groups, and many other influences.

Lastly, not everything is bad news though, we hope that the new president will indeed not only streamline processes “to make them predictable, reliable and efficient for those who want to invest” on the PPPs, but we hope that this will be applied to the broader businesses environment.

So there you have it, more proof that the more things change, the more they stay the same.

How Money Dies-The Process

Telegraph’s Ambrose Evans Pritchard has a nice narrative on hyperinflation.

He writes, (all bold highlights mine)

Ebay is offering a well-thumbed volume of "Dying of Money: Lessons of the Great German and American Inflations" at a starting bid of $699 (shipping free.. thanks a lot).

The crucial passage comes in Chapter 17 entitled "Velocity". Each big inflation -- whether the early 1920s in Germany, or the Korean and Vietnam wars in the US -- starts with a passive expansion of the quantity money. This sits inert for a surprisingly long time. Asset prices may go up, but latent price inflation is disguised. The effect is much like lighter fuel on a camp fire before the match is struck.

People’s willingness to hold money can change suddenly for a "psychological and spontaneous reason" , causing a spike in the velocity of money. It can occur at lightning speed, over a few weeks. The shift invariably catches economists by surprise. They wait too long to drain the excess money.

"Velocity took an almost right-angle turn upward in the summer of 1922," said Mr O Parsson. Reichsbank officials were baffled. They could not fathom why the German people had started to behave differently almost two years after the bank had already boosted the money supply. He contends that public patience snapped abruptly once people lost trust and began to "smell a government rat".

The point is hyperinflation is an outcome of a political process which begins in a nondescript mode or on a benign phase but eventually turns unwieldy.

Murray Rothbard aptly described this process in Mystery of Banking

``When expectations tip decisively over from deflationary, or steady, to inflationary, the economy enters a danger zone. The crucial question is how the government and its monetary authorities are going to react to the new situation. When prices are going up faster than the money supply, the people begin to experience a severe shortage of money, for they now face a shortage of cash balances relative to the much higher price levels. Total cash balances are no longer sufficient to carry transactions at the higher price. The people will then clamor for the government to issue more money to catch up to the higher price. If the government tightens its own belt and stops printing (or otherwise creating) new money, then inflationary expectations will eventually be reversed, and prices will fall once more—thus relieving the money shortage by lowering prices. But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to “catch up” to prices, then the country is off to the races. Money and prices will follow each other upward in an ever-accelerating spiral, until finally prices “run away,” doing something like tripling every hour. Chaos ensues, for now the psychology of the public is not merely inflationary, but hyperinflationary, and Phase III’s runaway psychology is as follows: “The value of money is disappearing even as I sit here and contemplate it. I must get rid of money right away, and buy anything, it matters not what, so long as it isn’t money.”

And as one would observe, the process involves a feedback loop between government actions and market responses or an action-reaction stimulus-response mechanism until everything gets out of hand—and thus, money perishes.

Of course Mr. Pritchard ends up downplaying such risks.

He concludes, ``There is a clear temptation for the West to extricate itself from the errors of the Greenspan asset bubble, the Brown credit bubble, and the EMU sovereign bubble by stealth default through inflation. But that is a danger for later years. First we have the deflation shock of lives. Then -- and only then -- will central banks go to far and risk losing control over their printing experiment as velocity takes off. One problem at a time please.”

He contravenes his earlier anecdote about the benign origins of hyperinflation.

Because inflation is a symptom of the consequences of the actions of policymakers in attempting to attain certain political goals, which as shown above are channelled through the feedback mechanism, this means that if the actions to sustain these political goals would imply the increasing application of inflationism, then the risks of hyperinflation can’t be discounted. The current benign conditions does not signify the remoteness of such risks.

One must put in mind, that what seems to drive the actions of the present batch of policymakers is the seductive appeal of the immediacy of the impact from inflationism, the economic ideological bias and path dependency from recent “successes” of such actions.

Yet Mr. Pritchard can thank his lucky stars that globalization could serve as a counterbalancing force that might be able to reduce (if not delay) the risks of any of the two extreme outcomes of deflation or hyperinflation.

Is Hyperinflation A Bogus Theory?

Ellen Brown thinks hyperinflation is a bogus theory, she writes...(bold emphasis mine)

``So long as workers are out of work and resources are sitting idle, as they are today, money can be added to the money supply without driving prices up. Price inflation results when “demand” (money) increases faster than “supply” (goods and services).”

Let’s take her assumptions and apply it to Zimbabwe (all colored charts courtesy of indexmundi.com)

Checklist number 1: Zimbabwe has 95% unemployment rate (idle workers)

Checklist number 2: Zimbabwe has also seen a successive collapse of GDP -depression! (idle resources)

1+1=2? Or unemployment + idle resources = no inflation? Of course, not.

In fact inflation skyrocketed at an annual rate of 11,200,000% (according to Index Mundi’s data) or Hyperinflation!

Based on Professor Steve Hanke’s calculation this actually much higher...

79.6 billion % for 2008! The second worst in world history.

The reason for this is that the Mugabe-Gono government financed public debt (expenditures) with seemingly endless printing of money, because the nation’s access to credit has been severed externally (international) and internally (domestic savings).

So unless the US is immune to the universal laws of economics, whereby unfettered printing of money equals no inflation and is a recipe to prosperity, which has been falsified when applied to the experience of other countries, I wonder who embraces a theory that is bogus?

How Philippine Capital Markets Will Benefit From Free Trade

In this issue:

How Philippine Capital Markets Will Benefit From Free Trade

-Will Lady Luck Probably Smile On The Aquino Regime?

-Explaining Free Trade

-Anti-Free Trade: Political Dynasties and The Maguindanao Massacre

-The Invisible Hand

-How Free Trade Should Benefit The Philippine Capital Markets

At a recent speaking engagement, I was asked of what I thought of the new Aquino administration and his economic policies. My reply, first that I was apolitical, and second, that there are major forces such as globalization, regionalization and the technological revolution that has been and will be driving global policymaking and this includes the Philippines.

Obviously far from being a populist answer, such reply would seem stoic since it didn’t whet the sensationalist craving of the audience.

Will Lady Luck Probably Smile On The Aquino Regime?

As any regular reader would know, in my opinion, the new administration is NO more than representative of the status quo[1], which for me would seem better, compared to activist ‘messianic’ left-leaning leaders, such as Venezuela’s Chavez or even the US president Obama.

And yes, most signs have been validating my perspective, be it on the pronounced policies on jueteng[2], cabinet appointments[3] packed with representatives from big business and even to populist sound bite (or what Mark Twain would refer to as "a minimum of sound to a maximum of sense" or simply “attention generating”) policies such as the “Wang Wang”[4] or the recent administrative action: the censure of PAG-ASA[5] (government weather forecasting) personnel in the wake of the recent widespread brownouts caused by typhoon Basyang.

And based on my analysis I predict that the administration’s performance (success or failure) will likely be aligned with the patterns of “global” if not regional political economic trends.

As previously stated[6], ``the direction of political winds in the Philippines is likely to get influenced more by our deepening interactions with external forces-particularly, the new free trade zone (with ASEAN and China), China's growing role as a major political force as regionalism deepens, a deeper impact from globalization buttressed by technology and OFWs (or migration flows) and deepening financial globalization which includes transmission effects of inflationism, steep yield curves, bubble policies and etc.”

In short, luck or the lack of it, will dominate the Aquino regime.

Well it didn’t take long for more signs to surface which would seem to validate my prognosis.

This from yesterday’s article from the Inquirer.net[7], (all bold emphasis mine)

``In a speech before members of the Philippine Chamber of Commerce and Industry Wednesday evening, Trade Secretary Gregory Domingo said it was now common practice among economies to participate in multilateral trade pacts.

“You have to be part of every trade agreement because to be excluded is a disadvantage for you. We’re not yet part of [the TPP], but at some point, I think it is our desire to join as well,” he said.”

It is unfortunate enough for the Aquino administration’s trade secretary to seem to have little appreciation of the essence of free trade agreements. For Mr. Domingo, and if this should represent the insights of the administration, free trade agreements are simply a fad, take note of “common practice”.

So while I applaud the Aquino administration for supposedly espousing free trade, the essence of the administration’s policymaking, as stated before, is because “everybody else is doing it”. It’s definitely not out of principle, but out of the socio-economic signalling known as “Keeping up with the Joneses”.

This again lends credence to our projection of: one—popularity based policies (in this case globalization) and two—the deepening influence of global political trends which has been influencing local policymaking.

Let me add that while the practice of free trade seem to get more ingrained globally, this remains a virtually unpopular or severely misunderstood concept in the eyes of the domestic populace.

Take for example, this free trade agreement definition from the media; from the same article

``The aim of the free trade agreement is to bring all tariffs down to zero by 2015. The coverage of the deal spans trade in goods and services, rules of origin, trade remedies, sanitary and phytosanitary measures, technical barriers, intellectual property, government procurement and competition policy.”

True, these are mostly technically “legal” definitions, but this hardly dwells on the kernel or the cost-benefits tradeoffs from the said policy.

And in evincing more proof of miscomprehension of free trade, but this time from the officialdom; the same article quotes the incumbent trade secretary anew, (bold highlights mine)

“We will be very vigilant in joining various trade agreements. We’ll try to join as many trade agreements as possible, but still keeping in mind that our interest is really to protect the interest of Philippine businesses and Philippine consumers,” Domingo said.”

But free trade is of the interest of the Filipino consumers and businesses!

Free trade is VOLUNTARY exchange! It allows people to conduct exchanges to satisfy personal and commercial needs.

When we go to a store to ‘freely’ purchase things or services which we deem to need, don’t we achieve immediate satisfaction from the activity?

If people, on their unfettered disposition, buy from me, do I not use the proceeds from the exchange to subsequently also buy from the marketplace, either to fulfil my consumption goals or expand or replenish my business needs or even make contribution to social projects for the betterment of our community/society? Because producers are themselves consumers, then trade is a benefit to all parties involved.

Hence, the fundamental role of the marketplace is to satisfy our sundry needs by means of voluntary, and NOT coercive, exchange. So why does Mr. Domingo express scepticism with “protect the interest of Philippine businesses and Philippine consumers”?

Explaining Free Trade

There are two way to acquire wealth. German sociologist Franz Oppenheimer[8] once said that there is the ‘economic means’ via work and exchange and there is the ‘political means’ by forcible exploitative means either by plunder or by redistribution.

Acquiring wealth through work and exchange is NET beneficial to the society since it fosters the creation of value added products or services.

Figure 1: World Bank[9]: Explosion In Global Mobile Subscribers (left window) and Internet Use (right window)

Think the internet and the mobile phones. Twenty years ago these were non-existent. Yet competition in the marketplace cultivated a sweeping technological innovation, which the introduction of these highly efficient revolutionary tools exponentially expanded access to communication and greatly reduced transaction costs.

Today, I can talk with my mom in Hong Kong everyday at the minimal cost of the bandwith, compared with costly occasional long distance phone calls 20 years back.

Of course there will always be losers anywhere. Creative destruction from free market innovation led to the phasing out or the obsolescence of the pager and the telegraph, the reduced usage of the fax machine, postal mail and even a decline in the newspaper industry[10]. However the gains from innovation have virtually eclipsed the selective losers. In short, by large, society benefited from the new technology.

Moreover, because of the immensely lowered transaction cost, global trade blossomed.

Meanwhile, the obverse side of acquiring wealth from economic means is the political means.

‘Political means’ essentially is parasitic which lives off the work of others. This involves taxation and forcible redistribution, war and corruption. The benefits only accrue to the parties involved in conducting such affairs, primarily government. And such actions signify a ZERO SUM game- where one benefits, as the others losses, which in general do NOT add wealth to the society—since resources is just taken away from someone else.

Furthermore, by allowing people to exchange voluntarily, this furthers the division of labor that creates jobs, and importantly, accumulates capital or wealth.

And increased global trade or globalization, as noted above, has definitely been the prime engine of wealth accumulation (see figure 2).

Figure 2: Google: Deepening Free Trade And Exploding Global Wealth

The correlation of the growth of global merchandise trade relative to the explosion of global per capita income may not be perfect, but it has been strong and rigorously supported by theory and empirical micro evidences as the rapid diffusion of the mobile phone and the web around the world.

Anti-Free Trade: Political Dynasties and The Maguindanao Massacre

In addition, free trade greatly reduces pressures from political redistribution which frequently leads to internecine political conflicts.

Take for instance the Maguindanao massacre[11]. The fundamental reason why such atrocious and barbaric act had been committed was allegedly due to the political insecurity by the incumbent local leadership over the preservation of his regime.

The horrid Maguindanao incident appears to be symptomatic of the latent inherent defects of the Philippine political ‘democratic’ framework, which has cultivated a brood of political dynasties (estimated at about 250) that has used politics to arrogate upon themselves economic opportunities and thus the imperative to remain in power at nearly all cost.

Even this New York Times article of 2007[12] presciently noted of the violent nature from this political arrangement, ``For generations, political dynasties have dominated elections and governments in the Philippines...As these clans protect their reign, they often resort to violence to frustrate any attempt by rivals to unseat them.”

And how do you sustain political dynasties? By systematic redistribution. The above board taxes generated from the local economy are used to pay off voters indirectly by virtue of massive welfare programs [e.g. free movies, free health care, senior citizens discount and etc...] or directly (vote buying) during elections. For instance, local authorities discreetly allow people to squat on empty government and private lands and are given protection from doing so in exchange for votes.

Yet this form of squatting has been provided with a legal cover in the face of the Lina Law (RA 7279)[13], where relocation is required for squatters evicted from their domicile. In short, the law rewards the violation of property rights.

Of course there is also the issue of the undeclared tax payments, which usually ends up in the pockets of the politicians.

Hence, the violence in Maguindanao has been representative of the state of economic deprivation from the operative highly skewed political-legal environment.

According to the Focus on the Global South, Maguindanao remains as one of the poorest provinces in the country. With a population of more than 1 million in 2006, six out of ten people are considered poor in the province, which is almost three times higher than the national average. Maguindanao is also a “mainstay” in the list of ten provinces with the biggest income gap, poverty gap, and severity of poverty[14]

In other words, where politics has been substituted for trade, we get violence as a result of the exploitative grab for resources by the use of political means, as Franz Oppenheimer has postulated.

And this also validates the great Frédéric Bastiat who once said that, “When goods do not cross borders, soldiers will.”

Apparently, in Maguindanao, the order of private armies determined past economic fortunes which had largely been held and distributed by the entrenched political class and which appears as modern day vestiges of a medieval age political structure known as feudalism.

Likewise, history has revealed that the same political means to attain wealth in favour of vested interest groups had been responsible for the mass slaughter of humanity seen in the two horrendous world wars of the 20^th century, where the casualties as estimated by the Wikipedia.org[15] for World War I is anywhere in the range of 10-64 million people while World War II at 40-72 million people.

As historian Michael A. Heilperin poignantly observed[16], Economic nationalism was the real victor of World War I, just as collectivism was to be the real victor of World War II.

So why does the new trade secretary remain fearful of free trade?

The answer is simply because the entrenched political and economic class are concerned and apprehensive that their current economic privileges, which on the other hand signify as economic inefficiencies, brought about by protective walls of legal and political barriers, might not cope with the onslaught of market based competition.

In short, free trade means putting to risks inefficient and uncompetitive firms which has operated on the premises of political concessions such as monopolies, cartels, subsidies, liberal access to state financing, tax shields, various licensing or other state based privileges which has been an enduring trait for Southeast Asian economies, as journalist and author Joe Studwell rightly notes[17], “The lesson of the past decade has been that the relationship between political and economic elites in Southeast Asia is more enduring than almost anyone imagined.”

Thus, by reading in between the lines, the trade secretary appear to signal the administration’s possible intent to enforce gradual change on a regime that thrives on the status quo.

The Invisible Hand

It is likewise foolhardy and mendacious to assert that free trade works to harm consumers as free trade primarily benefits consumers through manifold choices.

Free trade allows consumers to benefit from the various offerings from the producers or service providers, all in competition to satisfy their needs. And the thrust to market products to satisfy consumers comes in many facets such as pricing, quality, utility, aesthetics, self-esteem and etc...

In short, for the consumers, the essence of free trade is choice, the more the array of choices, the greater the value of the exchange.

On the other hand, for the producers, the essence of trade is profits,

As Ludwig von Mises wrote[18],

Profits are the driving force of the market economy. The greater the profits, the better the needs of the consumers are supplied. For profits can only be reaped by removing discrepancies between the demands of the consumers and the previous state of production activities. He who serves the public best, makes the highest profits. In fighting profits governments deliberately sabotage the operation of the market economy.

Thus in connecting the two, free trade gives the consumers the best possible alternative while for producers, the profit incentive from doing so. In short, free trade signifies as the best possible arrangement for achieving satisfaction and profits.

Yet sometimes media gives the illusion that consumers are too dumb that they can’t distinguish between what’s good enough for them and what’s not, and thus require the nanny state via various regulatory interdictions.

Ironically, the same media would pontificate on the virtues of democracy where people get to vote on political leaders, as if people have been bequeathed with intelligence only when they vote for leaders and the lack of it when they spend their own money.

In reality, it works the opposite way.

When people spend for goods and services they expect to get direct benefits from an exchange and thus always exercise the option to choose based on perceived order of needs and of the accompanying value from the available choices.

Isn’t it commonsensical for consumers not to further patronize on what they feel as inferior, inadequate, substandard, or a product or service that is perceived as worth less than the price which they had earlier paid for?

By the pattern of spending, consumers, thus, impose market discipline on producers without the need for state intervention.

The father of modern economics, Adam Smith called this as the Invisible Hand.

In contrast, in elections when people vote for political leaders, what you vote for isn’t what you exactly get. Whether it is Philippine President Joseph Estrada of 1998, Japanese PM Yukio Hatoyama[19] or US President Obama, the point is—populist politics usually ends up with the opposite expectations from which they had been ushered into office.

Of course in any field, one can’t discount that there will always be unscrupulous agents. But such devious entities are likely to fool people ONCE and will be refused further patronage. Thus, any gains will be temporary and by deceiving consumers, they will be penalized by the virtue of monetary and reputational losses, if not lawsuits.

Yet, in the case where physical harm that should emanate from the use of their products or services, then this should also be subjected to legal remediation.

How Free Trade Should Benefit The Philippine Capital Markets

So if the Aquino regime will truly usher the Philippines more as an active participant in free trade engagements this should augur very well for the Philippine economy.

Of course, the Philippines has been a signatory of many free trade[20] accord, even prior to the Aquino regime, which includes including the Asean Trade in Goods Agreement, Asean-Australia-New Zealand Free Trade Agreement, and the Japan Philippines Economic Partnership Agreement, but sustaining and more importantly (and hopefully) expanding the ‘gradualist’ momentum will be a very crucial dynamic.

However, given the administration’s faddish perception of globalization, the consistency of this policy is yet unclear.

Theoretically, increased free trade and/or economic freedom should bode well for the local capital markets, since more investments should translate to the increased access to domestic and global savings which should get intermediated via the banking system or through the capital markets.

Figure 3: McKinsey Global Institute[21]: Share of Financial Assets By Region 2008

In developed economies, except for Japan, bank deposits make up a smaller share of the capital markets as shown by figure 3. The greater part of the distribution of financial assets has been into the private sector debt securities and in the equity markets.

Thus while there are cultural and domestic regulatory dynamics that could also shape the divergences in the distribution of financial assets, we should expect a larger share of private bond and equity markets for mature market economies. This implies Emerging Asia could likely be headed on that path.

Considering that the Philippines, whose primary line of financing has been channelled through the banking sector, where banking penetration level is only 35% of the population, according to McKinsey Quarterly[22] estimates, this means there is a huge amount of unaccounted capital afloat in the system.

And this squares with the estimated 40% share of the informal economy[23] and with 4 of the top 11 largest malls[24] in the world, according to the Forbes Magazine, housed in the Philippines.

In other words, free trade and or economic freedom will compel enterprises and institutions to deal with this enormous untapped savings which should translate to a huge boom for the domestic capital markets.

Part of the early move on this has been the advent of mobile banking.

In terms of bond markets the Philippines accounts for one of the smallest in Asia (see figure 4)

Figure 4: IMF[25]-Size of Corporate Bond Market, ADB[26]-Local Currency Bonds Outstanding

Aside from the untapped savings, which is most likely sourced from the informal economy, the existing bank deposit base is likely to tap into both the bonds and the equity markets.

The factors that are likely to drive these would be amplified relative returns, reforms that would enable the lowering of transaction costs, introduction of derivatives and other more sophisticated financial instruments that allows the public to hedge. Incidentally, if I’m not mistaken only the Philippines among the ASEAN-4 have yet to introduce derivatives in the stock exchanges.

Figure 5: Reuters[27]: Market Capitalization of Emerging Asia

I’d also like to further point out that the Philippine Phisix accounts for as one of the smallest bourse in Asia (not included in Figure 5).

As of Thursday’s close the Phisix free float market cap is estimated at US $66.5 billion (exchange rate of Php 46.5 to a US dollar) compared to $188 billion of Thailand last January 12^th or possibly at $212 billion today adjusted for the 12.7% advance from the aforementioned period.

And it is of no surprise to us that the ASEAN-4, which comprises as the smallest bourses of the region, has accounted for the biggest gains.

The trend of the ASEAN-4 towards freer markets, aided by technological revolution, is just one of the major positive structural long-term factors at play.

Nevertheless, the other major and more influential medium term dynamic is the risks of blowing asset bubbles originating from the current concerted global central banks’ bubble policies, which is likely responsible for today’s buoyant asset markets.

Since the risk for Asia and the ASEAN seem to be a brewing boom-bust cycle, where a boom is a positive and bust is a negative, the larger net effect of a bust which constitutes as capital consumption signifies as a NET NEGATIVE. So we have major two forces counteracting on each other.

But this is a story we have long been talking about.

Anyway, in closing, speaking of bubbles, this news report is just too compelling for me to exclude from this week’s report.

From Bloomberg[28],

``South Korea will ‘soon’ announce plans to stimulate the nation’s property market, Yonhap News reported… The nation’s land ministry is drawing up measures to boost real-estate prices, and the ruling Grand National Party may begin discussions on easing debt-to-income restrictions on homeowners…”

People never seem to learn.

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[1] See Philippine Election Aftermath: Goodbye Illusion, Welcome Reality!

[2] See Plus Ca Change: President Aquino's Policy On Jueteng

[3] See President Aquino’s Cabinet Appointments: The More Things Change, The More They Remain The Same

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

[5] See Privatize Pag-Asa or Open Weather Forecasting To Competition

[6] See Philippine Election Myth: New President Will Determine Direction of Economy And Markets

[7] Inquirer.net, RP eyes participation in free trade deal, July 23, 2010

[8] Oppenheimer Franz, The State

[9] World Bank, States and Markets, World Development Index 2009

[10] See Is The Newspaper Industry Dead? Probably Not If It Is For Free

[11] Wikipedia.org, Maguindanao massacre

[12] SFGate.com, Philippine political dynasties stifle democracy, nurture violence / Powerful clans have a stranglehold on system, experts say, New York Times, March 13, 2007

[13] Answers.com, What is the Lina Law?

[14] Manahan, Mary Ann Maguindanao in Focus Focusweb.org

[15] Wikipedia.org, List of wars and disasters by death toll

[16] Heilperin, Michael A. Heilperin Economic Nationalism: From Mercantilism to World War II

[17] Studwell, Joe, Ties That Bind, July 22, 2007

[18] Mises, Ludwig von Confiscatory Taxation, Chapter 32, Section 3

[19] See How Populist Leadership Goes Kaput: Japan Edition

[20] Inquirer.net, loc. cit.

[21] McKinsey Global Institute Global capital markets: Entering a new era, September 2009

[22] See How Free Markets In The Telecom Industry Aids Economic Development

[23] See Does The Government Deserve Credit Over Philippine Economic Growth?

[24] See A Nation Of Shoppers??!!

[25] IMF Regional Economic Outlook Leading the Global Recovery Rebalancing for the Medium Term

[26] Asian Bond Monitor, Asian Development Bank, March 2010

[27] Reuters ANALYSIS-For Singapore bourse, IPOs remain the Achilles heel, January 13, 2010

[28] Prudentbear.com, Trichet Challenges Inflationism, Bloomberg July 19, 2010