“I Told You So!” Moment: Being Right In Gold and Disproving False Causations

“The list of qualities [an investor should have] includes patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit mistakes, and the ability to ignore general panic.” - Peter Lynch

Allow me for my “I TOLD YOU SO” moment!

It’s not easy writing about financial markets (or about political philosophies too). Some feedbacks occasionally do test one’s patience, especially if they are meant, not as a serious critique, but as one to nitpick. The latter is directed at testing one’s esteem rather than to test the validity or soundness of an idea.

Thus when my views are validated by the market, contra the quibblers, I think I deserve to vent...“I told you so!”

First “I Told You So!” Moment: Gold

There are two important milestones deserving of “I told you so!” this week.

First is gold.

Gold prices are now drifting at the near record nominal levels. Early this year, gold’s lackluster price performance has prompted some commentaries to call on an inflection point or a major reversal from which I argued against.

Here is what I wrote[1],

So I unlike those who see a surge in the “event risks” from the current string of upheavals in the Middle East as a reason to sell, I see gold rebounding from these uncertainties, fed by the inflationism in central banks and eventually a rally in most of the global equity markets, including the Phisix.

With a bounce in gold, a month after, I followed this up with[2],

Don’t look now, but gold is surging right back! (I have to wait for a successful test of 1,430 before I could blurt out ‘I told you so’)

If gold is surging right back, then it is likely that global equity markets will follow gold’s path.

Figure 1: I Told You So Moment No. 1: Record Gold prices (stockcharts.com)

My self-made conditions have been met. Gold has recently passed 1,430 and was last traded 1,427.9. Importantly, global equity markets appear to be in consonance, most of which appear as moving higher, if so indicated by the indices as the Dow Jones World (DJW), Dow Jones Asia ex-Japan (P2DOW) and Emerging Markets (EEM) in Figure 1.

This would appear similar to the 2008 post Lehman event where gold reversed to the upside a few months ahead of the global equity markets.

However, the conditions for my “I told you so!” moment for the Phisix, ASEAN and emerging market stocks has not been sufficiently met, as technical barriers have yet to be breached, thus would remain pending or unsettled for now.

Diminishing Returns of Information

Before I proceed to my second “I told you so!” moment which is about the unmasking of the false causation of “MENA political crisis + high oil prices = falling stock markets”, I must admit that while the attributed events, like the MENA crisis and lofty oil prices, may not posit as the main variables for today’s major market movements, they do account for some degree of influence or relevance.

Because the emergence of such unforeseen events are considered as uncertainty (immeasurable risk, and not possible to calculate[3]), the markets work to reappraise of ‘uncertainty’s’ influence or impact, which gradually digests on them. So the influence of uncertainty depends mostly on the scale and the time value of influence.

You can go back to the chart in figure 1 and see how markets did somewhat react adversely to the outbreak of the Arab revolution highlighted by the culmination of the Tunisian Jasmine revolution (downside green arrows) which swiftly spread to Egypt (2^nd to 3^rd week of January). This, I think represented as the initial reaction to the uncertainty posed by the Arab ‘People Power’ revolts.

Once the markets learned of and adjusted to such uncertainty, or to the new information, and subsequently established its cost-benefit expectations around it, uncertainty gets to be transformed into risks (measurable potential losses) via discounting. Discounting, thus, signifies as the diminishing returns of information or the marginal value theorem[4] applied to information.

So when the temporal effects of the perceived event risks have been discounted, market dynamics eventually gives way or returns to the fold of the major influences or drivers.

Second “I Told You So!” Moment: Popular False Causations

So the du jour explanations on much of today’s market action, especially for the local media and so called experts, has been the due to the causation “MENA political crisis + high oil prices = falling stock markets”.

Figure 2: “I Told You So” Moment 2: Say What? Oil and MENA Crisis Equals Falling Phisix? (stockcharts.com)

The beauty of last week’s action or the invalidation of a flawed popular theory comes with the remarkable divergence in the price actions of the global equities relative to oil and the MENA equities.

WTIC or West Texas Intermediate Crude[5] or a major benchmark representing US sweet crude oil, which is traded at the New York Mercantile exchange, closed at $104.65 over the week. Friday’s closing price accounts for over $13 a barrel from the start of the year or about $7 up from last week! (red circle)

Meanwhile, Europe’s contemporary oil bellwether, the Brent Crude[6] has even been higher, Brent Crude was last traded at $114.79 per barrel on Friday or about $10 premium to the WTIC!

Figure 3: WTI-Brent Spread At Record Variance (Bloomberg)

Brent crude mostly comes from the North Sea and is used mostly by European and Asian consumers whereas WTI originates and is used mostly in the US.

The WTI-Brent spread (figure 3) has risen to a record premium. This record spread could perhaps be due to possible variance in the relative production levels (relative depletion rate) or reportedly concerns over the the tanker shipment routes via the Suez canal[7], where 1m barrels a day pass through. But others argue that this is likely based on arbitrages[8]. So there seems to be no unison or consensus opinion on this.

It is not clear how the Middle East crisis plays into this WTI-Bremt spread anomaly. I would have to dig deeper.

Anyway, the Middle East crisis has likewise been reflected on the region’s stock markets as represented by T. Rowe Price Africa & Middle East Fund (TRAMX).

The TRAMX has currently been undergoing a dramatic liquidation or a selloff, as exhibited by the recent collapse of major MENA benchmarks.

While news say that retail and foreign investors have been mainly responsible for this, I argued otherwise[9]—entrenched (political economic) interests could be scrambling for the exit gates.

Fearing political retribution by sequestration or by a freeze on their assets, these politically connected elites (along with the political leadership) could be scurrying to convert and safekeep their wealth outside the region and or through alternative assets, that could hide their identities.

So given the above accounts, where the MENA political crisis and oil prices appear to be amplifying the so-called event risks, we should, according to the mainstream, expect the Philippine Phisix and other Emerging Market bourses, as well as developed markets to likewise feel the heat or pressure.

Ironically, we seem to be witnessing the opposite price actions.

The Phisix (PSEC) and ASEAN Equities (FSEAX) seem to be making a signifcant inroads to the upside, as shown by this week’s substantial gains in both price actions (Figure 2).

True, one week does not a bullmarket make. Or that these rallies could constitute as ‘dead cat’s bounce’, since they are yet far from establishing technical metrics to suggest of a convincing comeback (but this would mean even bigger rallies!).

Nevertheless, the important thing is that markets appears to be consistently validating on my outlook despite pressures for me to turn “short term”.

Divergent Signals Between Currencies and Equities

I’d like to add that relative to the Philippine assets, I have been making a point that the actions of the Philippine Peso and the Phisix have been diverging[10].

Falling local stocks and a strong Peso represent an incompatible relationship. That’s because given the relatively underdeveloped capital markets here, where alternative avenues to generate returns via the financial markets are deeply constrained, the traditionally route for the elite has been to export capital (a.k.a. capital flight) when endogenous market or economic conditions are weak.

Though this correlationship may not be perfect, as there accounts for some intermittent time lags, the Peso-Phisix serves as a reliable barometer for the direction of the movement of the local stock market.

So when you have a strong Peso and a weak Phisix, you can be sure that one of them is about to give way.

And by looking at the bigger picture, we see a similar correlationship between Asian currencies and Asian equity markets (figure 4).

Figure 4: Strong correlations between Asian Stocks and Asian Currencies

The Bloomberg-JP Morgan currency basket [ADXY:IND AP Dollar Index] (green line) can be seen simultaneously weakening along with the MSCI AC Asia Pacific Index [MXAP:IND MSCI AC ASIA PACIFIC] (yellow line) during key downturns over the past 3 years. The four red ellipses have exhibited the strength of such correlationship. Of course, such correlationship also works on the upside.

The important point is that when the Philippine Peso has been firming along with Asian currencies, and where East Asian equity markets as Japan have been on the upside (Asia Pacific markets as Australia and New Zealand are likewise on the upside), even when most are either consolidating or on the downside, then it is likely that ASEAN markets, including the Phisix, are not in a bear market, but rather in a hiatus, and will likely be bouncing back as they seem to be happening.

Even the local bond markets appear to be suggesting the same.

There is also the role of retail participants, whom we have been closely monitoring[11]. As previously stated, retail participants are mostly emotionally driven participants whom Wall Street refers to as the proverbial pigs who always become a fodder for the bulls and the bears. Excessive actions (buy or sell) by retail participants usually highlight the end of the ongoing trend—in this case the downside.

For all its worth, I am simply reiterating my points which I already stated but with the providence of being complimented by current market actions that appears to validate on my theories.

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[1] See Gold Fundamentals Remain Positive, January 31, 2011

[2] See Resurgent Gold Equals Resurgent Emerging Market Bourses? February 20, 2011

[3] Wikipedia.org Knightian uncertainty

[4] Wikipedia.org Marginal value theorem

[5] Wikipedia.org, West Texas Intermediate

[6] Wikipedia.org, Brent Crude

[7] AMEINFO.com Trading opportunity WTI versus Brent, February 10, 2010

[8] Commodity online, Will WTI-Brent price difference stay? March 4, 2011

[9] See Middle East Stock Market Meltdown: Likely Driven By (Political Economic) Insider Selling March 3, 2010

[10] See Phisix: Panicking Retail Investors Equals Buying Opportunity, January, 31, 2011

[11] See Phisix: What Market Internals Are Saying, February 20, 2011

Knowledge Acquisition: The Importance of Information Sourcing and Quality

“The Pen Is Mightier Than The Sword”- coined by Edward Bulwer-Lytton English author, (also attributed to Dr. Jose P. Rizal)

Any serious or prudent investors in the financial markets would normally try to look for ways to improve on one’s returns. That’s if one recognizes what is workable and what isn’t. Thus, the main task of prudent investors in the financial markets is to screen information and theories and test them, and apply those that would seem as the most cogent, accordingly.

But again this isn’t true for many as returns might seem as a secondary importance. That’s because these economic agents obstinately adhere to biased or selectively chosen data (selective perception) which they interpret as applying to the whole (fallacy of composition), fixate on what is current (survivalship bias) while ignoring the rest, apply misleading definitions and embrace self contradictory and inconsistent theories.

I am just repeating what I said before. Sometimes it takes a deluge of information before the message sinks in.

Ignorance versus foolishness

Ignorance is one thing, foolishness is another. People who fail based on ignorance could be looked upon with compassion. They perhaps hardly knew of the consequences of their actions, which were most likely guided by wrong quality or sources of information.

But it’s different when people lose despite being informed or forewarned. This may be called as doggedness or practising financial religion.

For instance, when people refuse to heed of the inherent risks of conflict of interests that may arise among interacting agents[1], they are likely to fall into the Agency problem trap. Information embellished with statistics and presented as facts could mislead investors. It’s clearly an intangible or unseen risk, that’s because investors are likely to be unaware of the underlying incentives behind these presentations, which may shape or influence the way we think and how we allocate our resources.

And for non-exclusive reasons, boom-bust cycle happens because of information too. Credit fuels greed which impels people to look for information that would confirm on their preconceived notions. Bias, thereby, seeks information or analysis which performs the way dopamine functions, to serve the pleasure centers. So like drugs, misleading information will always have a market.

Also, in as much as price distortions from government policies affect the way people think, these are likewise exhibited through literatures. That’s because the mainstream usually focuses on the symptoms which are read as the cause and transmitted to the public as valid information or facts. This is also because mainstream information caters to short term orientation. In short, boom bust cycles occur also when people gorge on too much of false information.

Stakeholder’s Problem, If Birds Can Write

Most have been unwittingly seduced to the oversimplification of reading current events into market prices, for the reason that being wrong may have little consequence to them. In short, it’s usually a stakeholder’s dilemma or stakeholder’s problem[2]—where the incentives to secure knowledge are driven by the degree of stakeholdings.

Take for instance, a person who dabbles with the stock market, as sideline or for entertainment, will likely have a lesser intensity of incentives to acquire knowledge relative to an individual who lives by the stock market. The latter’s perceived risk factor is greater than the former who has other lines of revenues.

The varying situational incentives, thus, become crucial factors in determining knowledge acquisition.

Yet luck also plays a crucial role. Because no matter how wrong one’s ideas can be, for as long as such errors are made on the side of the general trend where the market is headed, market trends eventually remedies on such errors. And as a result, false ideas could lead to a self-attribution or self serving bias which according to Wikipedia.org[3], people attribute their successes to internal or personal factors but attribute their failures to situational factors beyond their control.

And this also applies even in academics, where wrong models can be seen as “workable”.

Prodigious author of the bestselling book, the Black Swan, Mr. Nassim Taleb writes of a marvellous example of in his forthcoming book[4],

Think of the following event. A collection of priestly persons from Harvard or some such place lecture birds how to fly. The bird flies. They write books, articles, and reports that in fact the bird has obeyed them, an impeccable causal link. They even believe their own theories. Birds write no such books, conceivably because they are birds, so we never get their side of the story. Meanwhile, the priests broadcast theirs.

Behind Media’s Altruisms And Biased Information

And as stated above, the quality and source of information matters.

The most likely source of information are usually the popular ones, such as mainstream media. They cater too our brain’s desire to get fed with visible, emotional, sensational, shocking or graphic linkages.

Take for instance, in the event of a disaster, media routinely appeals to the public to ask for donations. They appeal to the emotions by advocating charity work for the unfortunate victims. Media outfits create an aura where they are seen as doing purely social work. They become instantaneous heroes especially when celebrities lead them.

But this is only half true, what’s not seen is that by connecting to the public’s emotions and wallets they increase viewership on their medium. And the key to their revenues—advertisement—largely depends on the number of audiences. So media’s missives have almost always been attuned towards winning the public’s viewership. It’s like politics in a private format.

Thus for media, intention can be interpreted two ways, social work to help the community or self interests camouflaged by altruism.

In covering political philosophy, this is the same manner why socialism sells, it appeals to emotional center of the brain but are bereft of how “intentions” parlay into reality.

In terms of investment, it’s also the been same. Most people are continually deceived by information aired or disseminated by the media and their cohorts of experts, which for most instances have little value or are irrelevant.

As Rolf Dobelli writes[5],

Out of the approximately 10,000 news stories you have read in the last 12 months, name one that – because you consumed it – allowed you to make a better decision about a serious matter affecting your life, your career, your business – compared to what you would have known if you hadn’t swallowed that morsel of news.

The point is: the consumption of news is irrelevant to the forces that really matter in your life. At its best, it is entertaining, but it is still irrelevant.

Bottom line: information is vital to one’s decision making process, whether applied to the financial markets or in many other vital aspects of life.

The beauty of today’s technological advances is that information is not restricted or centralized but operates from a free market competitive environment.

And I am just part of the multitude of lowly voices here in the cyberspace trying to speak out what I see as true.

And unknown to most, revolutions begins with ideas.

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[1] See Dealing With Financial Market Information, February 27, 2010

[2] See Philippine Elections: Why I Will Vote For President "None Of The Above”, May 5, 2010

[3] Wikipedia.org, Self-serving bias

[4] Taleb, Nassim Nicolas, Birds Do Not Write Books on Birds, Chapter 8, Anti Fragility

[5] Dobelli Rolf Avoid News, Towards a Healthy News Diet Dobelli.com (hat tip Bryan Caplan)

Video: Lawrence White On Free Banking, Gold Standard and Central Banking

GMU Professor Dr. Lawrence White speaking at a monetary conference at the Cato Institute deals with free banking, the Gold Standard Banking and Central Banking. (hat tip: Tom Palmer)

The Failure Of Centrally Planned Democracies And Of Foreign Aid Dictatorships

GMU Professor Chris Coyne over at the Coordination Problem blog has some valuable insights on the current spontaneous People Power revolutions at the Middle East.

He cites two important lessons: The failure of the foreign policy of imposing ideals (democracy) abroad, and in accessory to the first, the failure of foreign aid to promote democracies via dictatorships.

On imposing western ideals Prof Coyne writes,

what is happening in the Middle East is an indictment of U.S. 'nation building' and more specifically the idea that social change toward freedom must be initiated by outsiders. Consider that the U.S has now been in Afghanistan for nearly 10 years and have been unable to ‘win the hearts and minds’ of Afghan citizens. In Egypt it was a matter of weeks between the initial indigenous uprising and Mubarek’s resignation.

The spontaneous and unexpected events in Egypt, and the Middle East more broadly, highlight the flaws in the planning mentality that underpins most, if not all, U.S. foreign interventions. This view holds that (1) certain societies are unable to move towards freedom without outside assistance and (2) that the complex array of institutions that underpin societies are the result of some ‘grand plan’ which can be engineered by experts.

People’s actions have fundamentally been aimed at achieving the removal of unease. Thus, the political economic conditions have always been evolving as people yearn and strive to attain satisfaction or a better life.

And through trial and error, society has reflected on such perpetual discovery process as seen from the lens of the economy, and subsequently, politics.

And this is why the character of Arab revolutions has shifted from Nationalist to Islamist and now to People Power movements.

The quest for liberty may not be an immediate outcome of the recent spontaneous MENA upheavals, but from signs we see, we can be confident that the appreciation and adaption of the concept of freedom and liberty by Muslims have been gradually deepening.

As Michael Novak writes at the Wall Street Journal,

Yet it took the Jewish and Christian worlds centuries to begin cashing in their own longings for liberty. And so also it took the consciences of nonbelievers from the slave society of Aristotle and Plato until the Universal Declaration of Human Rights. The universal hunger for liberty is not satisfied in any one generation, or in all the generations put together. It is an unlimited desire. (bold highlights mine)

And such endogenous ‘universal’ freedom inspired revolutions has NOT been imposed. The failed foreign policies designed for this has essentially backfired.

And to repeat what Mr. Novak points out, the desire for freedom has also been a long painstaking process mostly accrued from generational experience. I might add that this process will likely become accelerated as the facilities that stimulates these interchanges of experience or ‘emprical’ knowledge via the web or internet will dramatically be improved and whose usage will become widespread.

In addition, the concept of propping up dictators in the name of democracy via foreign aid has also been exposed as a disastrous model.

Again Mr. Coyne, this is

an excellent opportunity to reconsider the longtime U.S. practice of giving foreign aid to the world’s worst dictators...

These are not the only cases of the U.S. providing assistance to the world’s worst governments. Every year Parade magazine compiles a list of the “World’s Worst Dictators.”...

This means that the source of the problem—the predatory state—is tasked with playing a central role in solving the problem of which its very existence is the cause. The result is the well-known pitfalls of aid such as increased corruption and issues of aid effectiveness.” (bold emphasis mine)

At the end day, freedom is a bottom up process which can only be experienced, shared, learned, and assimilated, and not imposed from a top down dynamics especially through the state, or at worst, by dictatorships. As people learn about freedom, vertical structures and power centers are bound to crumble.

Do Central Banks Uphold Or Undermine Free Market Principles?

When I read Professor Art Carden’s statement from this article,

Far too often, people use terms like "capitalism" and "socialism" sloppily, either because they don't understand them or because the words make for cheap but effective (albeit inaccurate) political rhetoric. The Great Conversation suffers because of it.

It struck me that many arguments supposedly for the so-called advancement of the political philosophy of libertarianism, free markets and or classical liberalism have precisely been anchored on this—rhetoric misrepresented as principles.

And this is exactly the essence of my last article, The Middle Of The Road Policy Of A Local Free Market Group. Where I was earlier disappointed about the issue of principles, I was even more dismayed by the responses.

Given the benefit of the doubt that perhaps my article or my “spin” could have lacked clarity, or that specialization may have lead to the misunderstanding of my message, my argument against the positive relationship between central banking and the free market was certainly not about utility nor was it about market failure.

By utility, I mean it would seem misguided to compare what is essentially is a monopoly—operating on the power of coercion, funded by taxpayer resources and whose decision making process by the authorities are (externality) risk borne by the taxpayers—with private and semi-private enterprises operating mostly on a competitive environment.

By market failure, the standard statist ‘Paul Krugman’ tactic—throw up a strawman, assail or shoot it down with econometric gibberish or economic models, and declare “market failure”, thus justifying government intervention—eludes the question about this relationship between free markets and the central bank.

The fact that the local central bank began only in the Philippines in 1949, goes to show that even in our colonial past the nation has survived without it, thereby, disproving the presumed sine qua non nature of central banking to the local economy.

As my colleague Paul How writes in his 'as-yet unpublished manuscript', the “Philippine Banking And The Business Cycle” about how the domestic monetary system operated, (bold emphasis mine)

During the 19^th century, the monetary system had a gold standard in place, where each monetary note was presumed to redeem a fixed amount of gold...

Clearly, people, in their private capacity, preferred the use of a medium of exchange whose value was based not on government decree but on the amount of rare metals contained in the item. Even after the Spanish handed the Philippines over to the United States in December 1898, Filipinos continued using the Mexican coin, much to the chagrin of US officials keen on imposing their culture on the new colony’s inhabitants.

Where half of our transactions are settled for by money which is issued by an institution owned and controlled by the government, this extrapolates to half of our trading activities under the indirect purview of the government. Thus it is very important to put in question the role of such institution under the Free Market precept.

Ultimately, what for stands as the most important issue is through this question:

Do central banks promote or undermine the Free Market Principles?

This brings us back to definition. A free market, according to Wikipedia, is a market in which there is no economic intervention and regulation by the state, except to enforce private contracts and the ownership of property.

If freedom to contract and private property rights are the key pillars of free market principles as stated by such definition, do central bank activities promote these?

As a side note, under classical liberalism I would not say that free market is the absence of intervention or regulation, but instead a free market is self regulated by (mostly non-state) institutions operating under the rule of law.

Nevertheless the entire concept of freedom to contract and private property or even the rule of law are put into a test under the central bank’s operations: (bold highlights under below quotes are my emphasis)

1. Inflation of the monetary system

Thus, credit expansion unavoidably results in the economic crisis. In either of the two alternatives, the artificial boom is doomed. In the long run, it must collapse. The short-run effect, the period of prosperity, may last sometimes several years. While it lasts, the authorities, the expanding banks and their public relations agencies arrogantly defy the warnings of the economists and pride themselves on the manifest success of their policies. But when the bitter end comes, they wash their hands of it.

The artificial prosperity cannot last because the lowering of the rate of interest, purely technical as it was and not corresponding to the real state of the market data, has misled entrepreneurial calculations. It has created the illusion that certain projects offer the chances of profitability when, in fact, the available supply of factors of production was not sufficient for their execution. Deluded by false reckoning, businessmen have expanded their activities beyond the limits drawn by the state of society’s wealth. They have underrated the degree of the scarcity of factors of production and overtaxed their capacity to produce. In short: they have squandered scarce capital goods by malinvestment.

Ludwig von Mises, The Causes of Economic Crisis,

Does price signalling distortion, reduction of purchasing power of money and capital consumption from these forces represent as free market principle? The same question should all be applied on the following aspects shown below.

2. The nature of central bank’s fractional reserve system

As Huerta de Soto points out, the problem of the tragedy of the commons always appears when property rights are defined improperly. In the case of fractional reserve banking, bankers can infringe on property rights because it is not clearly defined who owns the deposit.

When customers make their deposits, the promise is that the deposit is always available for withdrawal. However, the deposits, by the very definition of fractional reserve banking, are never completely available to all customers at one time. This is because banks will take a part of these deposits and loan them out to other customers. In other words, they issue fiduciary media. By issuing more property titles than property entrusted to them, the banks violate the traditional property rights of their customers. (One of the most important contributions of Huerta de Soto's exhaustive book is to demonstrate how banking developed historically and that fractional reserve banking evolved as a perversion of deposit banking.)

Philipp Bagus, The Commons and the Tragedy of Banking

3. Externality costs from the knowledge problem

The odds that 19 men and women (a.k.a. the Federal Open Market Committee) will be able to select the overnight interest rate that keeps the U.S. economy growing at its potential in perpetuity are next to nil.

There would be a huge outcry if the Fed set the price of oil or copper or soybeans. Yet we accept the central bank as a price setter, a monopolist, when it comes to the interbank lending rate.

Caroline Baum Capitalism Still Has Legs That Are Long and Sexy

3. Operates from an environment of arbitrary rules

The concept of the rule of law in jurisprudence and political philosophy has several dimensions. At its core is the classical liberal principle of nondiscretionary governance that stands in contrast to the arbitrary or discretionary rule of those people currently in authority. In shorthand, either we have the rule of law or we have the rule of authorities. Under the rule of law, government agencies do nothing but faithfully enforce statutes already on the books. Under the rule of authorities, those in positions of executive authority have the discretion to make up substantive new decrees as they go along, and to forego enforcing the statutes on the books.

Dr. Lawrence H. White Rule of Law or the Rule of Central Bankers?

Think currency interventions in behalf of exporters and OFWs at the expense of importers and consumers via elevated prices of goods and services.

4. Operate on persistent political pressures

To put it into the hands of an institution which is protected against competition, which can force us to accept the money, which is subject to incessant political pressure, such an authority will not ever again give us good money

Friedrich August von Hayek A Free-Market Monetary System

5. Choosing winners and losers

The real reason for the adoption of the Federal Reserve, and its promotion by the large banks, was the exact opposite of their loudly trumpeted motivations.

Rather than create an institution to curb their own profits on behalf of the public interest, the banks sought a Central Bank to enhance their profits by permitting them to inflate far beyond the bounds set by free-market competition.

Murray N. Rothbard, The Case Against the Fed

6. Crony Capitalism

The answer was the same in both cases: the big businessmen and financiers had to form an alliance with the opinion molding classes in society, in order to engineer the consent of the public by means of crafty and persuasive propaganda.

Murray N. Rothbard, The Case Against the Fed

7. Promote Government Expansion

While, as we shall see presently, government's exclusive right to issue and regulate money has certainly not helped to give us a better money than we would otherwise have had, and probably a very much worse one, it has of course become a chief instrument for prevailing governmental policies and profoundly assisted the general growth of governmental power. Much of contemporary politics is based on the assumption that government has the power to create and make people accept any amount of additional money it wishes. Governments will for this reason strongly defend their traditional rights. But for the same reason it is also most important that they should be taken from them.

A government ought not, any more than a private person, to be able (at least in peace-time) to take whatever it wants, but be limited strictly to the use of the means placed at its disposal by the representatives of the people, and to be unable to extend its resources beyond what the people have agreed to let it have. The modern expansion of government was largely assisted by the possibility of covering deficits by issuing money-usually on the pretence that it was thereby creating employment. It is perhaps significant, however, that Adam Smith [54, p. 687] does not mention the control of the issue of money among the 'only three duties [which] according to the system of natural liberty, the sovereign has to attend to'.

Friedrich August von Hayek Denationalization of money

In my view, the fundamental case for free market capitalism begins with sound money and sound banking institutions (whether it is a 100% gold reserve or a free banking standard).

Quote of the Day: Popular or Workable?

From my favorite marketing guru, Seth Godin

The thing that makes it popular...

might be precisely the thing that keeps it from working….

There are a hundred ways you and your organization can become more popular, earn more clicks, generate more comments... but is popular what you're after?

In terms of the markets and of the political economy I vote on ideas that are workable.

Video: How Wealth Is Derived From Mutually Beneficial Free Trade

Trade is human action: we do this everyday with the aim at attaining better life and live past self sufficiency which characterized the lives of our primitive ancestors.

Trade today is mostly voluntary, it is done by individuals at the community level or provincial or regional or at the national level. The difference in the trading environment depends on the degree of trade freedom, which are mostly shaped by the governing political policies.

Because trade appears as a mundane activity, its manifold benefits seem as hardly sentiently appreciated by the public. In short, the benefits of trade are frequently underappreciated.

And when trade is framed as an aggregate, i.e. substituted with statistics and accounting figures, trade becomes subject to waffling political talking points, and importantly, loses its human touch. Trade, then, becomes subject to acrimonious disputes, many of which results to perverse laws that curtails trade--and prosperity.

The following video, from LearnLiberty.org, presents Professor Art Carden who discusses the basics of free trade from the perspective of the LAW OF COMPARATIVE ADVANTAGE (also known as the law of comparative costs) and how free trade leads to prosperity.

Comparative advantage deals with achieving efficiency out of relative opportunity costs or according to wikipedia,

In economics, the law of comparative advantage refers to the ability of a party (an individual, a firm, or a country) to produce a particular good or service at a lower opportunity cost than another party. It is the ability to produce a product with the highest relative efficiency given all the other products that could be produced.

Self Promotion: Prudent Investor Newsletters Referenced By Money.co.uk

Here is a little self-promotion.

A UK based financial website Money.com.uk wrote me to say that my article had been referenced for their 2010 year end review.

Click on the site here or on the truncated picture from their website below.

Press the May 2^nd heading “Greece and Package Settled Upon”.

And press “read more” at the right column which redirects the link to my site.

Ms. Sophie Lamble of Money.co.uk writes,

Of all the articles covering that particular event, we found yours to be the most concise and well-written – for this, I’d like to express my appreciation and sincere hope that the great work continues on Prudent Investor Newsletters. I’m sure our readers will agree and find the extra information useful.

Thanks Sophie and the Money.co.uk.

Middle East Stock Market Meltdown: Likely Driven By (Political Economic) Insider Selling

I wouldn’t deny that the meltdown in Saudi stocks, which had been down for 21% for 13 consecutive days have been politically driven. This applies to most bourses in the region too.

But before my explanation let’s go to some expert opinion or mainstream reporting.

According to Bespoke Invest (also the source of the chart above) [emphasis added]

Back in late January, the TASI saw a one-day decline of over 6% on 1/29 when tensions began to escalate in Egypt. When things settled down in Cairo, the TASI rebounded back above its 50-day moving average, but it then began to roll over again when tensions moved to Libya. Watching the charts must be a popular past time in Saudi Arabia, because once the index broke below its January lows, the bottom literally fell out of the index. With the March 11th Day of Rage coming up in Saudi Arabia next week, are traders in this market anticipating a replay of Egypt or Libya?

The Wall Street Journal adds, (emphasis added)

Large scale instability in North Africa and protests in neighboring countries [Bahrain, Oman, Yemen] have culminated in a significant selloff as investors are growing increasingly concerned that protests and subsequent instability could ultimately reach the Saudi market," said an analyst at Riyadh-based NCB Capital. "We firmly believe that fears of instability reaching the Saudi market are overdone, despite reports of calls for demonstrations in the coming days."

Saudi Arabia recently introduced a number of nonpolitical changes, estimated to cost around $36 billion, but there have still been signs of domestic discontent since Tunisia's popular uprising in January.

While foreign investors continued to cut their equities exposure to the region, the selling was mainly retail-driven—exacerbated by margin calls and redemptions at local Saudi funds, traders said.

The reason I’m not gonna deny this politically instigated collapse as a valid driver is that the declines have been far stretched or extended than the counterparts in non-MENA emerging market bourses. This implies something more than meets the eye.

I might add that, aside from foreign investors, importantly, I suspect that the insiders (meaning those economic and political agents whose stakes had been built around the current regimes over the years) could have been liquidating their stakes in fear, that in the event these People Power revolts become successful, the new administrations would resort to the sequestration or a freeze on their assets to appease the incensed populace or as indemnity for their political misconduct.

This has already happened to former Egypt President Hosni Mubarak, whose assets have been frozen by the Egyptian government, while other foreign banks as the Swiss appear to be headed for the same route as seen with its scrutiny of Tunisia’s deposed president Zine al-Abidine Ben Ali’s transactions.

So the likelihood would be for these embattled political economic agents to scramble and exit from conventional asset holdings, and subsequently, divert their assets outside of the region.

So yes, insider selling could likely be a crucial factor in the current market actions, while foreign selling and panicking retail investors have all combined to worsen these conditions.

The Bloomberg GCC 200 Index, a capitalization weighted index of the top 200 equities in the GCC region based on market capitalization and liquidity, reveals of the broad market declines of major Middle East stocks as the People Power movements ripple across the region.

And possibly gold and other commodities could signify as alternative ways to shelter the assets of these insiders.

How To Reform The Global Debt Biased Economic System

Harvard economist Kenneth Rogoff argues that the world’s problem has been “rooted in excessive concentrations of debt” and that the fix should focus on rebalancing debt into equity. I agree.

Mr. Rogoff writes,

But policy-induced distortions also play an enormous role. Many countries’ tax systems hugely favor debt over equity. The housing boom in the United States might never have reached the proportions that it did if homeowners had been unable to treat interest payments on home loans as a tax deduction. Corporations are allowed to deduct interest payments on bonds, but stock dividends are effectively taxed at the both the corporate and the individual level.

Central banks and finance ministries are also complicit, since debt gets bailed out far more aggressively than equity does.

I’d like to add that this is exactly why central banks exist: they have been designed to finance and bailout the government and or her agencies (mostly by inflation), aside from promoting “consumption” debt as path to economic growth. As for the latter, don’t you see the excessive focus by the mainstream on “employment” based on “consumer spending”?

And these composite policies, all this time, has favored or privileged the central bank supported banking industry cartel.

Since the political leadership (governments) has also benefited from these arrangements, then obviously even administrative or tax policies had been molded into a “debt” bias—which incidentally becomes a feedback loop mechanism (more government spending more inflationism by central banks).

And that’s how boom bust cycles have been playing out.

And as earlier discussed in The Myth Of Risk Free Government Bonds even bank capital regulatory requirements have been tilted towards incentivizing these institutions to hold on to “less risky” government debts.

That’s because institutional holdings on “short term” government securities, under Basel Accord, which were considered as “risk free”, were not required of capital in contrast to holdings of corporate bonds. So major institutions were incentivized to fund governments, from which politicians capitalized on, and which only bloated their nation’s respective fiscal balance sheets.

But the recent crisis has only been exposing the “nudity” of the fabled risk free “emperor”.

I would say that this systemic debt bias has been intrinsic for the paper money system build around the welfare-redistributive state.

And parallel to this been the unseen incentives that drives governments and their respective central banks to gain political capital (via extended tenure and via expanded government control over the political economy) by selling “something out of nothing” to voters via the welfare state—and to reemphasize, all of which have been propped up and funded by the debt based central banking system.

In other words, for the world economic-financial framework—estimated at some $200 trillion, and which have been configured or evolved around these embedded incentives—to be able to shift from a debt to equity bias, would require an overhaul of the monetary system first and the political systems next.

Otherwise, the markets, like it or not, will do the radical debt-to-equity makeover for us.

Why The Best and The Brightest Don’t Fit Into Public Service

Author and Economic Professor Steven Landsburg writes,

The main reason to hold down public salaries/benefits is not to save money for the taxpayers. I have no a priori reason to care any more (or less) about the taxpayers than I do about the public employees themselves. Instead, the main reason to hold down public salaries/benefits is to avoid drawing the “best and the brightest” away from more productive careers into public service.

More thoughts:

Aside from the crowding out effect, “best and the brightest” into public service translates to more fatal conceit (or the presumption that the knowledge they have is better than the markets). This subsequently impels them to boldly dabble or experiment with more interventionist policies at the cost and risk of the taxpayers. In other words, they tend to find new creative ways to pick on someone else's pocket.

In addition, “best and the brightest” also means figuring out cunning ways to game the political economic system (corruption, arbitrages, cronyism).

Hong Kong’s Vicious Inflation Cycle

Even supposed free market economies are susceptible to the follies of “free lunch” politics

From the Bloomberg, (bold highlights)

Hong Kong’s financial secretary caved in to protests over plans to bolster residents’ pension funds, opting to hand out cash and tax rebates that a week ago he said would stoke inflation.

John Tsang said he will give HK$6,000 ($770) to permanent residents aged 18 or above, abandoning a Feb. 23 budget plan to inject the same amount into their pension fund accounts after polls showed the government’s popularity slumped. The government also plans to give the 38 percent of the workforce that pays income tax a 75 percent rebate capped at HK$6,000.

“The fact that half a year of hard work preparing the budget can be thrown away and started again shows populism and not rationality dictates the policy-making process,” said Ivan Choi, a lecturer at the Chinese University of Hong Kong’s government and politics department. “The government will pay for the damage done to its integrity.”

Political parties attacked Tsang for failing to do enough to alleviate the impact of soaring food and housing costs. Asian governments are grappling with inflation fueled by rising commodity costs and capital flows from developed economies drawn by the region’s faster economic growth.

Tsang said when he announced his budget a week ago that battling inflation and getting ahead of a property bubble are his government’s main tasks this year. The cash handouts and tax rebates will cost the government about HK$40.5 billion, a government spokesman Patrick Wong said today. The pension handout was to cost the government HK$24 billion.

Politicians and the bureaucracy always attack the symptom rather than the cause. Politicians and the bureaucracy will not address the primary cause which is the inflationist “bubble” or “wealth effect” policies implemented by both the Hong Kong government and the implied transmission of the US Federal Reserves policies via the US pegged Hong Kong Dollar.

And inflation will be fed by more inflation, which eventually will be countered by price controls leading to more imbalances, and more political accommodation via inflation—until the whole process implodes.

This is just another example depicting how central planning, whether executed by the government or the central banks, does not contribute to the upholding of free market principles.

As the Ludwig von Mises wrote,

An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: The Santa Claus principle liquidates itself.

The Santa Claus principle will end with the collapse of the present monetary system.

Exploding Global Tablet Shipments: More Signs of The Third Wave

More signs of the evolving technology advances that should influence our lives.

From the Economist,

APPLE is due to launch a new version of its popular iPad on March 2nd. The company sold some 15m iPads in 2010, the year in which the device was launched, and according to one forecast it could sell more than 40m of them in 2011. But other tablet computers, in particular those based on Google's Android operating system, are expected to erode its share of a fast-growing market. In 2010 iPads accounted for about 80% of total tablet sales; by 2015 Apple's market share could fall below 40%.

Outside the context of the providers and their market shares, if you look at the forecasts, in 4 years tablet shipments are about to explode by nearly 5 times with the gist of the growth coming from tablets based on mobile technology (as we dealt with here)

The internet based “third wave” knowledge revolution is indeed accelerating.

The Philippine Government’s War Against Facebook

The Philippine government has initiated its stealth war against social media.

From the Philippine Inquirer,

Be wary of foreigners suddenly “liking” you on Facebook or other social networking sites, an official of the Philippine Drug Enforcement Agency (PDEA) advised netizens.

PDEA spokesperson Derrick Carreon said many drug mules or persons used to transport drugs through international borders were befriended and recruited online.

The Philippine government is on a slippery slope towards social media censorship and has used its war against drugs as justification.

It’s best to know that there are two different issues: war against drugs and war against social media.

Slippery slope simply means the government uses the war on drugs as a launching pad to expand political control over social media. They start with “warnings” first. Later this will be buttressed with statutes. Interventionism begets interventionism.

The war against social media is aimed at restricting the flow of information that runs against the interest of the government—via censorship.

Governments have been reeling from spontaneous People Power movements abroad fueled by social media, thus sees this information medium as a threat which must be neutralized.

For now, the so-called “warnings” are directed at the recruitment of drug Mules or carriers.

Shown below from PDEA (2008),

Drug mules have been exploding, the chart has not been updated. Yesterday’s TV news program reported 600+.

The propaganda: social media will be a major tool for the growth of drug abuse, thus must be controlled. Creeping government interventionism starts with public conditioning by indoctrination.

The Philippines is now among the top 10 major Facebook users (checkfacebook).

This means that the sin of 1,000 or less, will be used as an excuse to control the activities of 22 million Filipinos. As usual, interventionists apply the fallacy of composition to justify their actions.

Yet PDEA does NOT explain why from 20,000 reported cases of drug abuse in 1972, in 2004, the year Facebook was launched, drug usage has exploded to 6.7 million. (PDEA timeline)

The Philippine population in 1972 was 38.7 million, in 2004, the number of Filipinos grew to 83.9 million: this means about 8% of Filipinos are drug users (as of 2004), despite the statutes RA 9165, EO 218.

In short, drug trade and use has been flourishing in spite of Facebook. Facebook as a social medium functions as aggravating factor rather than the root cause.

However, Facebook will likely bear the brunt of the government [regulatory] failure (drug war) and the attempts to curtail the freedom of speech and expression.

MENA Revolts: Unfit For Democracy?

One of the most bigoted statements I’ve recently heard is that countries like the MENA are unfit or unprepared for democracy.

I’m glad to see New York Times’ Nicolas Kristof take up the cudgels against such arrogance.

Mr. Kristof writes,

“this line of thinking seems to me insulting to the unfree world. In Egypt and Bahrain in recent weeks, I’ve been humbled by the lionhearted men and women I’ve seen defying tear gas or bullets for freedom that we take for granted. How can we say that these people are unready for a democracy that they are prepared to die for?

“We Americans spout bromides about freedom. Democracy campaigners in the Middle East have been enduring unimaginable tortures as the price of their struggle — at the hands of dictators who are our allies — yet they persist.”

People who say this seem to think that the world owes them their privileges. They suffer from chronic delusions.

As Bill Bonner aptly writes,

World improvers are nice peo­ple. But they are ego­tis­ti­cal morons. They always want the best for humankind. How do they know what’s best for peo­ple on the other side of the planet? Well, they don’t. But they’re vain enough to assume that every­one wants to be like they are.

Exactly. World improvers are consumed by the conceit of the having to know better (when they don’t). And likewise believe that they hold the upper ground in the moral standings (again when they don’t) against the people of these nations.

They’re dead wrong.

As Mr. Kristof points out, people are actually risking life and limbs in pursuit of toppling the current political order to attain freedom.

Do these improvers honestly think that the lives of these revolutionaries are so cheap? Or that people revolting actually don’t know about what they’re doing? Or that these hapless people are better off living under tyrants?

Today’s MENA revolutionaries may not have a good grasp of what freedom really is, but this does not in anyway justify world improvers to make prejudicial claims about which nation deserves or don’t deserve democracy. “Judge not, that you be not judged.” says the Bible (Matthews 7:1)

We, in the Philippines, had our own experience of ousting a tyrant and an abusive leader. We just celebrated the 25^th anniversary last February 25^th.

Despite the less than idealistic outcome, as crony capitalism still plagues the country, chaos certainly has not been the outcome of the post-People power socio-political environment. Democracy, despite my protestations, has been a revered process here. The 2010 Presidential elections was marked by a high 75% voter turnout.

Also post-communist People Power revolutions in Romania, Georgia, Ukraine and others also did not turn these countries into failed states either.

And as human beings, we are no different from those in MENA despite cultural or religious variances—we all operate under the laws scarcity.

We have to be reminded that in contrast to the previous eons, today’s MENA revolutions have not been driven by ideology or by religion but about economics.

The outcome of these revolts may not end up entirely as a libertarian utopia, but this is just a step in the ongoing process towards decentralization.

I close anew with Nicolas Kristof, (bold highlights mine)

In the 21st century, there’s no realistic alternative to siding with people power. Prof. William Easterly of New York University proposes a standard of reciprocity: “I don’t support autocracy in your society if I don’t want it in my society.”

That should be our new starting point. I’m awed by the courage I see, and it’s condescending and foolish to suggest that people dying for democracy aren’t ready for it.

Indeed.

Proof of The Austrian Business Cycle: US Car Sales Rise On East Credit

More proof of the Business Cycle (Austrian) at work.

From the New York Times, (bold emphasis mine)

After radically scaling back auto lending during the financial crisis, banks and the lending arms of the automakers have started to issue loans more aggressively. Borrowers of all types are now finding it much easier to obtain a loan compared with a few months ago.

Even car buyers with tarnished credit histories are getting financing, in some cases without making a down payment. More than 859,000 new cars were sold to consumers with a so-called subprime credit rating in 2010, a nearly 60 percent increase from the year before, according to CNW Marketing Research.

The revival of auto lending is emblematic of an increased appetite for risk in the American economy. Consumers, showing renewed confidence in the recovery, are opening their wallets again after putting off car purchases during the recession.

Banks, flush with deposits to lend out, have eased their standards for extending credit. And investors, who fled from the bond market during the throes of the crisis, are starting to snap up higher-risk debt as they seek higher yields.

Wall Street’s loan packaging business has once again become a crucial engine for supplying money to auto and credit card lenders — and it is happening much faster than most economists had predicted.

Well I told ya’ so...

Confusing Freedom With Collectivism

Sometimes experts are at a seeming loss of what’s been happening in the MENA region.

PIMCO’s Mohamed El Erian at the Reuters writes,

Post-regime change countries, such as Egypt and Tunisia, are working hard to complete their revolutions and to ensure an orderly and complete transition to greater democracy and individual freedoms. Success lies in the following factors: defining a vision and associated action plan which command sufficient popular support; coordinating simultaneous progress on related economic, political and social issues; and implementing appropriate mid-course corrections as needed.

If “greater democracy and individual freedoms” means sovereignty of the individual over government then how does “defining a vision and associated action plan” happen?

Individual “plans” are much different than from those of the central planners, for the fundamental reason that the individual views the world differently and has priorities, values and preferences that are unique, thereby the individuals “plans” according to their perceived ‘unique’ interests. In short, one’s actions are one’s own.

However, since governments are composite of people, except that they are mandated to use the power coercion over the others, then “defining a vision and associated action plan” would be inconsistent with the individual sovereignty.

That’s because so-called “plans” spring from the perspective, values, preferences and priorities of the central planners and not from the collective individuals.

In essence, “greater democracy and individual freedoms” under the above context would represent a sham.

As Henry Louise Mencken once wrote, "For every problem there is one solution which is simple, neat, and wrong."

MENA’s Third Wave-Knowledge Revolts

The Heritage Foundation partly channels Alvin Toffler’s Third Wave and what I have called as the Hayekian knowledge revolution via the web/internet as previously discussed here.

Heritage’s Conn Carroll writes, (bold highlights mine)

The first wave of revolutions in the region came in the middle of the last century and was made up of nationalist revolts against European colonialism. The next wave, the Islamist revolt, came a generation later, upending corrupt monarchies and nationalist regimes set up after the colonial era. Each of these movements—nationalist and Islamist—pretended to be “pan” movements of some kind. But they never caught on because their universal claims were myths, undermined by tribal, religious, and nationalist divisions. The third wave we are witnessing today is completely different. Heritage Foundation Vice President and former Assistant Secretary of State Kim Holmes explains:

“Arab nationalism was largely an elite phenomenon that drove and exploited popular sentiments. Islamism is driven by clerics and political ideologues like the Muslim Brotherhood who likewise exploit peoples’ religious beliefs and social resentments. The current third wave of revolt is truly a bottom-up, people driven movement. It’s driven not by nationalism, Islamism or any other 20th Century “ism,” but by a 21st Century socially linked-up mass movement of people who are sick of corruption, the lack of representative government, and being poor. … Despite the unique national and tribal features of each movement, it is united by the same emotional revulsion to the ruin and corruption created by the first two waves of revolution in the Middle East. The people of Libya are no less disgusted with Qadhafi than the people of Iran are with Ahmadinejad. One may be largely Sunni Arabs and the other Shiite Persians, but both are utterly finished with the ideologies, pretentions, and results of the Middle East’s first two failed revolutions.”

The evolving political order in the Middle East can somewhat be viewed in the context of the developmental stages of the global economy.

The first wave’s “nationalist revolts against European colonialism” can be paralleled to the closure of agriculture based economy, where colonialism signified as the political economy of conquest and plunder.

The second wave’s “Islamist revolt” directed against the “monarchies and nationalist regimes” could be seen in lens of the industrial age, the age of centralization through mass production. Again these revolts perhaps reflected on the evolving desire to see a shift of political ‘centralized’ power from the failed nationalist model to an experiment with theocracies.

And the third wave’s “bottom-up, people driven movement” fundamentally an Étienne de La Boétie paradigm of grassroots based nonviolent revolution appears to represent a non-ideological backlash “sick of corruption, the lack of representative government, and being poor” against centralized institutions. And the internet has been a crucial force in providing the platform for information, inspiration and the spontaneous coordination and mobilization of these grassroots activities.

Of course one may argue that the old order (e.g. military) are the still dominant force and still would resist changes that has benefited them. While this is may be true, as all changes will be met by resistance, this ignores the point about the evolving character of how these revolutions have been taking place, which the Heritage have clearly explained.

As a caveat: since economic development varies from country to country and the timeline for these political transitions cannot be concretely established.

The Heritage Foundation raises the point that foreign policies applied by the US government have been outdated or obsolete.

I don’t think it is just the US government. I think this applies to all governments and to conventional or mainstream insights or analysis as many refuse to see how informational flows, mostly channelled through the social media, have significantly influenced the ongoing revolts against the old centralized political order.

The evolving economic order simply influences the political order. The point is that the current centralized institutions will undergo a flattening process or decentralization, which is what people power revolts have been about.

The presumption that people will simply revert to past models, simply ignores human action or the people’s capacity to LEARN and ADOPT to the changes in the environment and technology as manifested through evolving social interactions.

Another Example Of Financial Market-Real World Disconnect

People like to believe what they want to believe. Well, they are free to do so.

Here is another example of the blatant disconnect between the stock market and GDP. All charts from Tradingeconomics.com

Venezuela has still been in a recession but her stock market continues to climb.

Believing in the infallibility of conventional wisdom can mislead. Unknown to many, negative knowledge is a risk.