Global Poll: Free Trade Sentiment Gains In Emerging Markets, World

I am delighted to say that despite some short term setbacks, global sentiment on free trade appears to be gaining significant ground over the long term, and importantly, remains a dominant theme for the world.

This from the Economist, (bold emphasis mine)

FAITH in the free market is at a low in the world's biggest free-market economy. In 2010, 59% of Americans asked by GlobeScan, a polling firm, agreed "strongly" or "somewhat" that the free market was the best system for the world's future. This has fallen sharply from 80% when the question was first asked in 2002. And among poorer Americans under $20,000, faith in capitalism fell from 76% to 44% in just one year. Of the 25 countries polled, support for the free market is now greatest in Germany, just ahead of Brazil and communist China, both of which have seen strong growth in recent years. Indians are less enthusiastic despite recent gains in growth. Italy shows a surprising fondness for markets for a place that is uncompetitive in many sectors. In France under a third of people believe that the free market is the best option, down from 42% in 2002.

While free trade sentiment has skidded to low in the US, as a consequence of the crisis, the poll shows of an offsetting surge over most parts of the world.

A broader view of the poll shows this:

From Global Scan

Globescan.com writes, (bold highlights mine)

The results mean that a number of the world’s major emerging economies have now matched or overtaken the USA in their enthusiasm for the free market. The Chinese and Brazilians, 67 per cent of whom regard the free market system as the best on offer, are now more positive about capitalism than Americans, while enthusiasm in India now equals that in the USA, with 59 per cent rating the free market as the best system for the future.

Among the 20 countries polled in both 2009 and 2010, an average of 54 per cent today rate the free market economy as the best economic system, unchanged from 2009.

I am even more pleasantly surprised to see that the Philippines seems more “free market” oriented than some developed economies (e.g. Japan, Australia, France) or to some EM contemporaries (e.g. Indonesia).

Although operating from ground zero, I’d say that the free market sentiment may not be significantly accurate: many (even in the business community or in the elite academe or the media) don’t seem to understand or even resists the notion of free markets at all!

Some local 'free trade' experts see free markets more of a convenience or perhaps even a fad.

But there’s got to be some truth to this. that’s because probably the benefits of free trade (seen via globalization)—broader array of choices, cheaper and more affordable and quality and technologically enhanced products and services plus social mobility (tourism, migration) and more job or earning opportunities from external exposures (trade and remittances)—may have sublimely filtered to the sensibilities of the domestic populace.

Simply said, much of the world, including the Philippines, has been benefiting from increasing exposure to market economies and globalization.

And this has remarkably helped improved free market sentiments, mostly seen on the emerging markets which has been major beneficiaries of trade liberalization.

I am reminded of one of the champions of capitalism and free trade, the great Milton Friedman, in this historic interview about greed who said, (bold highlights mine)

Well first of all tell me, is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course none of us are greedy. It’s only the other fella that’s greedy. The world runs on individuals pursuing their separate interests. The greatest achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty that you are talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kind of societies that depart from that.

Socialized Healthcare: Intentions versus Reality

Socialized healthcare always seem as politically correct. That's because it is easy to sell compassion as a political theme. Gullible economically ignorant voters elect politicians who seem to connect with the needs of their constituents.

Unfortunately, free stuff in a world of scarcity is a fraud.

This from BBC, (bold highlights mine)

Surgeons say patients in some parts of England have spent months waiting in pain because of delayed operations or new restrictions on who qualifies for treatment.

In several areas routine surgery was put on hold for months, while in many others new thresholds for hip and knee replacements have been introduced.

The moves are part of the NHS drive to find £20bn efficiency savings by 2015.

The government said performance should be measured by outcomes not numbers.

Surgeons have described the delays faced by patients as "devastating and cruel". Peter Kay, the president of the British Orthopaedic Association (BOA), says they've become increasingly frustrated that hip and knee replacements are being targeted as a way of finding savings.

"We've started to get reports over the last nine months that access to these services are being restricted.

From Daily Mail, (hat tip: Dan Mitchell)

A former NHS director died after waiting for nine months for an operation - at her own hospital.

Margaret Hutchon, a former mayor, had been waiting since last June for a follow-up stomach operation at Broomfield Hospital in Chelmsford, Essex.

But her appointments to go under the knife were cancelled four times and she barely regained consciousness after finally having surgery.

Her devastated husband, Jim, is now demanding answers from Mid Essex Hospital Services NHS Trust - the organisation where his wife had served as a non-executive member of the board of directors.

Healthcare consumes scarce resources. The problem is, who determines the resources to be used: us (via the marketplace) or bureaucrats (rationed based on political guidelines or connections).

For the latter, apparently good intentions end up with bad outcomes.

Ron Paul’s Ten Principles of a Free Society

Here is US Congressman Ron Paul’s 10 Principles of a Free Society (from Lew Rockwell.com; bold emphasis mine)

This is the Appendix to Ron Paul's new book, Liberty Defined.

1. Rights belong to individuals, not groups; they derive from our nature and can neither be granted nor taken away by government.
2. All peaceful, voluntary economic and social associations are permitted; consent is the basis of the social and economic order.
3. Justly acquired property is privately owned by individuals and voluntary groups, and this ownership cannot be arbitrarily voided by governments.
4. Government may not redistribute private wealth or grant special privileges to any individual or group.
5. Individuals are responsible for their own actions; government cannot and should not protect us from ourselves.
6. Government may not claim the monopoly over a people's money and government's must never engaged in official counterfeiting, even in the name of macroeconomic stability.
7. Aggressive wars, even when called preventative, and even when they pertain only to trade relations, are forbidden.
8. Jury nullification, that is, the right of jurors to judge the law as well as the facts, is a right of the people and the courtroom norm.
9. All forms of involuntary servitude are prohibited, not only slavery but also conscription, forced association, and forced welfare distribution.
10. Government must obey the law that it expects other people to obey and thereby must never use force to mold behavior, manipulate social outcomes, manage the economy, or tell other countries how to behave.

Will Younger Political Leaders Translate to an Overhaul in the Welfare System of the West?

I came across this Economist chart which says that the age of western leaders appear to be getting younger.

The Economist writes,

THE developed world is getting older. But oddly enough, its leaders are getting younger. The chart shows the average age of the leaders of four Western countries (America, Britain, France and Germany) since 1950. In the 1950s, voters were happy to elect venerable leaders like Winston Churchill and Konrad Adenauer. The election of Jack Kennedy was the first sign that the cult of youth was flowering but then came the dominance of Ronald Reagan and Francois Mitterrand in the 1980s. Now the West’s leaders, including 40-somethings Barack Obama (just) and David Cameron, have never been younger. If the trend continues, the leaders will end up younger than the average citizen.

It dawned upon me that if the age trend of western leaders is indeed getting younger while their welfare programs (like in the US) has been benefiting seniors almost disproportionately, could these young leaders spearhead a radical change in the current welfare system?

For example in the US, a writer proposed that the future holds not for “class” warfare but for an “intergenerational” warfare—where the young will be pitted against the old.

Bruce Krastings at Businessinsider writes, (bold highlights mine)

As if on cue, the Congressional Budget Office has thrown out some numbers to fire up this emotive issue. The CBO report confirmed (to me) that age warfare is in our future.

CBO looked at all of the scenarios regarding Social Security. They ran a total of 500 simulations that reflect the different variables of the puzzle. The analysis assumed that there would be no changes in current law on SS. The objective of the exercise was to quantify the probabilities of which generation would most likely not get the benefits they were (A) paying for, (B) entitled to and (C) expecting.

The results of the CBO analysis is that there is societal/economic trouble in front of us on this issue. It should come as no surprise to readers that if you are young, you have a problem. The CBO report defines which generation(s) will be hurt and by how much. I found their conclusions to be very troubling.

If you were born in the 1940’s the probability that you will receive 100% of your scheduled benefits is nearly 100%. The people in this age group will die before SS is forced to make cuts in scheduled benefits.

If you were born in the Sixties things still do not look so bad. Depending on how long you will live the odds (76+%) are pretty good that you will get all of your scheduled benefits. However, if you were born in the Eighties you have a problem. The numbers fall off a cliff if you are between 30 and 40 years old today. In only 13% of the possible scenarios you will get what you are currently expecting from SS. If you were born after 1990 you simply have no statistical chance of getting what you are paying for. The full CBO report can be found here. This (hard to read) chart is from that report.

Could it be that the proverbial shot across the bow to reform the unsustainable welfare system has already been fired with the recent proposal of Congressman Paul Ryan?

Read Paul Ryan’s proposed Path to Prosperity here

As a caveat, I know the young Mr. Obama represents the other side of political fence which favors the continuation of the unsustainable system. But the point is, what cannot be sustained cannot last. And no amount of political prestidigitation will work for long because the laws of economics will make sure it doesn't.

And perhaps in the realization that this system can only mean imminent destabilization, thus young leaders might have the mettle to undertake drastic measures to reform the system.

Bottom line: The proverbial “kick the can down the road” for the West’s welfare system has perhaps has reached its near limits. And it might be possible that the trend of younger political leaders might just presage the required change to an unsustainable system.

Energy Information Administration: Shale Gas Is A Global Phenomenon!

When people talk about Peak oil or peak anything, they only look at current prices and the available quantity of declared reserves, which they see as fixed and which they equate with neo-Malthusian insights of shortages.

They do this without comprehending the economic value of resources and without understanding the concept of human action—or that people don’t just standstill in the face problems, we react by working to resolve such unease via the price mechanism.

People, via the markets, respond to prices. This means when scarcities are projected via price signals, the market resorts to either conservation (rationing) or substitution.

This brings us to the announcement by the US EIA that shale gas production is a global phenomenon, with US having been the pioneer in its development.

The EIA writes, (bold highlights mine)

The use of horizontal drilling in conjunction with hydraulic fracturing has greatly expanded the ability of producers to profitably produce natural gas from low permeability geologic formations, particularly shale formations. Application of fracturing techniques to stimulate oil and gas production began to grow rapidly in the 1950s, although experimentation dates back to the 19th century...

The development of shale gas plays has become a “game changer” for the U.S. natural gas market. The proliferation of activity into new shale plays has increased shale gas production in the United States from 0.39 trillion cubic feet in 2000 to 4.87 trillion cubic feet in 2010, or 23 percent of U.S. dry gas production. Shale gas reserves have increased to about 60.6 trillion cubic feet by year-end 2009, when they comprised about 21 percent of overall U.S. natural gas reserves, now at the highest level since 1971

Shale gas production from the US has been exploding. (From the EIA) This accelerated progress has been buttressed by (free market induced) technological enhancements.

Shale reserves have likewise been expanding along with production. This proves the case of the growing economic value of Shale gas.

Shale Gas reveals of the substitution process in action.

Now for the global perspective, more from the EIA.... (bold highlights mine)

It appears evident from the significant investments in preliminary leasing activity in many parts of the world that there is significant international potential for shale gas that could play an increasingly important role in global natural gas markets... In total, the report assessed 48 shale gas basins in 32 countries, containing almost 70 shale gas formations...

The estimates of technically recoverable shale gas resources for the 32 countries outside of the United States represents a moderately conservative ‘risked’ resource for the basins reviewed. These estimates are uncertain given the relatively sparse data that currently exist and the approach the consultant has employed would likely result in a higher estimate once better information is available.

What does all this tell us?

The energy market is working quite well, despite numerous interventions applied by governments.

The diffusion of technological advancements combined with the attendant economies of scale enhances the commercial viability of these projects, which if the EIA is correct, would mean more nations utilizing their natural shale gas resources. This also means reserves will grow as usage grows, enabled by technology.

In short, shale gas is gradually being recognized as an economically valuable energy resource.

Shale gas is probably one of the possible candidates to compete, replace, if not compliment fossil fuel as a major energy source.

Only the markets will say.

Oh, I almost forgot: Please remember changes happen at the margins.

US Homeownership Program Had Been Meant To Promote Financialization

Cato’s Mark Calabria says that mortgage subsidies in the US has not materially improved homeownership but has instead promoted a culture of debt.

Mr. Calabria writes, (bold highlights mine)

One of the rationales commonly given for massively subsidizing our mortgage market is that without such homeownership would be out of reach for many households. Such a rationale implies that more debt should be associated with more homeownership. (Let's set aside the obvious, how are you actually an owner without any equity?)...

By 1960, the homeownership rate was already over 60%, yet debt-to-value was less than 30%, half of the current value. Even in 1990, when homeownership reached over 64%, debt-to-value was still under 40%. From 1990 until today, the percentage of mortgage debt to value increased by over 50%, all to gain a 2 percentage point increase in homeownership. So it seems the story of the last 20 years has been a massive increase in home debt with very little increase in actual homeownership rates. The converse should also hold: reducing homeowner leverage should have little, if any, impact on homeownership rates.

Increasing debt hasn’t substantially lifted homeownership. This represents a failure of the program.

I have been saying that intentions and actions are two different things. People may say one thing, but do another. Since politicians and bureaucrats are people too, they are likely to fall into the same intent-action disparity trap.

Importantly, many people, especially those in the political arena, rake in the dough out of deliberately fudging the relationship of intent and action. They say one thing which would sounds politically correct, but applies actions that covertly benefit another party using the former as a cover.

I’d say that homeownership has merely been a strawman meant to boost another sector’s profits.

The sector I am referring to is the US financial sector which has benefited greatly from government sponsored homeownership programs. Some calls this the financialization or financial capitalism.

According to Wikipedia.org, (bold highlights mine)

Financialization is a term that describes an economic system or process that attempts to reduce all value that is exchanged (whether tangible, intangible, future or present promises, etc.) either into a financial instrument or a derivative of a financial instrument. The original intent of financialization is to be able to reduce any work-product or service to an exchangeable financial instrument, like currency, and thus make it easier for people to trade these financial instruments.

Workers, through a financial instrument such as a mortgage, could trade their promise of future work/wages for a home. Financialization of risk-sharing makes all insurance possible, the financialization of the U.S. Government's promises (bonds) makes all deficit spending possible. Financialization also makes economic rents possible.

The GDP share of the US Financial Industry has been exploding. Recently even after the crisis, profits from the financial industry now accounts for ONE third of all operating profits.

Notes the Wall Street Journal Blog, (bold highlights mine)

During the darkest days of the financial crisis, when Lehman Brothers and Washington Mutual went belly up and the U.S. government had to bail out other institutions, the finance sector reported an annualized loss of $65.2 billion in the fourth quarter of 2008. It was the only quarterly loss recorded in the government data.

Since then, the sector has come roaring back. The GDP report shows finance profits jumped to $426.5 billion. While profits haven’t returned to their high levels of 2006, the gain in finance profits last quarter more than offset a drop in profits posted by nonfinancial domestic industries.

After rising like the Phoenix, the financial industry now accounts for about 30% of all operating profits. That’s an amazing share given that the sector accounts for less than 10% of the value added in the economy.

Wall Street and banking critics have pointed out the finance industry enjoys government supports not given to other companies. That includes the low cost of funds from the Federal Reserve. As a result, critics say, the U.S. economy is overly skewed toward finance.

From Yardeni.com

In my view, homeownership is a (political) means aimed at promoting an end (crony capitalism of the financial industry)

US Federal Reserve Lent To (or Bailed Out?) Libya’s Qaddafi in 2009

Part of the US Federal Reserve’s post Lehman market stabilizing scheme included loans to Libya’s state owned bank, the Bloomberg reports, (bold emphasis mine)

Arab Banking Corp., the lender part- owned by the Central Bank of Libya, used a New York branch to get 73 loans from the U.S. Federal Reserve in the 18 months after Lehman Brothers Holdings Inc. collapsed.

The bank, then 29 percent-owned by the Libyan state, had aggregate borrowings in that period of $35 billion -- while the largest single loan amount outstanding was $1.2 billion in July 2009, according to Fed data released yesterday. In October 2008, when lending to financial institutions by the central bank’s so- called discount window peaked at $111 billion, Arab Banking took repeated loans totaling more than $2 billion.

Fed officials say all the discount window loans made during the worst financial crisis since the 1930s have been repaid with interest.

The U.S. government has frozen assets linked to the regime of Libyan ruler Muammar Qaddafi and engaged in air strikes against his military forces, which are battling a rebel uprising in the North African country. Arab Banking got an exemption that allows the firm to continue operating while barring it from engaging in any transactions with the Libyan government, according to the U.S. Treasury Department.

Some comments:

This represents as the continued the love-hate relationship between the US and Libya’s Qaddafi

The Federal Reserve has been bailing out the world, which included despots, and not just US banks.

No wonder the US Federal Reserve has been getting brickbats not only from Americans but also from some other authorities elsewhere in the world.

Remarkable Welfare Gains From The Power of Computing Represent Signs Of Things To Come

Two economists project that the welfare benefits from Personal computers adds up to $1,700 per person annually. And this represents a tremendous growth from the previous years.

The Wall Street Journal Blog reports, (bold emphasis mine)

Despite all the wrenching change the computer age has brought, humanity is probably better off than it would have been if the PC had never been invented. Now, economists have taken a stab at figuring out exactly how much better off we are.

The economists — Karen Kopecky of the Federal Reserve Bank of Atlanta and Jeremy Greenwood of the University of Pennsylvania — traced the history of the computer market back to the introduction of the Apple II in 1977 to calculate how much value, or “utility”, American consumers derive from a given amount of computing power. They then looked at how much we actually paid for that computing power, in the form of desktop PCs, laptops, notebooks, software and so on. The difference, known as the “welfare gain”, is the benefit we get from personal computers above and beyond what we pay for them.

Back in the days of magnetic-tape memory, the annual benefit was pretty small — somewhere between zero and about $6 for the average American, adjusted for inflation, depending on the method of calculation. But by 2009, the price of computing power had fallen more than 99.8% and personal computers had become a lot better and more widely used. As a result, the welfare gain rose to somewhere between $1,300 and $2,100 per person, the economists’ estimates suggest. Ballpark average: $1,700.

That’s a massive benefit, adding up to about $500 billion, or 5% of total consumer spending in 2009.

To be sure, the economists’ estimates are based on some assumptions that, while common in the world of economics, are open to debate. For one, they assume that people are extremely rational, and always buy exactly the number of personal computers that maximizes their utility. To the extent that irrational impulses drive people to buy computers, or to the extent that the use of computers entails costs people don’t recognize (say, attention-span deficits or Internet addiction), then the actual benefit could be significantly smaller.

My comments:

First of all, I am flabbergasted that the article would resort to the word “probably” as to ascribe the personal computer’s benefit to mankind, as if such benefits have not been conspicuous.

Second, while I agree that the personal benefits from these computers have been immense, given that the article does not say how or what sort of utility had been measured or rated, I would posit that the figures had been vastly underestimated.

Had the PC been assessed solely from PC sales and turnover? How about time saving gains from added productivity and work process efficiency via diversified applications?

How about savings or value added derived from declining communication costs or from diminishing [Coase’s laws—search costs, contracting and coordination costs or otherwise known as] transaction costs, or the enhancement of business processes or even organizational capital (Garrett Jones)?

And how about the benefits of leisure (e.g. games, etc…) and other intangible gains such as real time connectivity with parents, relatives, friends and associates? Or how about the virtue or non-virtue of self-expression via social networking media?

Three, all these go to show why economists fall for the aggregate trap. They tend to quantify things even if they can’t.

Lastly, nonetheless the above only gives more proof that the world has been transitioning to the age of digitization or the information age, where more and more activities of our lives are becoming decentralized (Third Wave) enabled by technology.

Chart from Ray Kurzweil: Law of Accelerating Returns

I’d add that should the trend of innovations of applications and devices accelerate, this will even deepen and make this transition more widespread.

As Law Professor and author Butler Shaffer writes, “Decentralized technologies are causing us to rethink and redefine what we mean by "society."

The welfare gains of the PC are just signs of things to come.

Video: Tom Woods on the Basics of the Military Industrial Complex

In the video below, Professor and author Tom Woods explains the military industrial complex in 5 minutes (hat tip: Bob Wenzel)

Video: John Stossel Interviews Jeffrey Tucker "Society Can Manage Itself"

In this interview by John Stossel, Mises Institute editor and author Jeffrey Tucker shows how government intervention impedes on our choices, which affects even the routinary things we do, that ultimately impacts the quality of our lives.

(Hat tip: Professor Robert Murphy)

Agency Problem: David Sokol’s Controversial Resignation From Warren Buffett’s Berkshire Hathaway

A good running example of the principal-agent or the agency problem in play has been the unravelling controversy over Warren Buffett’s supposed “would be” successor-David Sokol.

David Sokol recently resigned from Berkshire Hathaway following allegations of unethical practice.

According to Steve Shaefer of Forbes,

Berkshire Hathaway executive David Sokol, who served as chairman of MidAmerican Holding Company and Johns Manville as well as Chairman and CEO of NetJets, resigned from the company in a letter to Warren Buffett Monday.

Buffett announced his departure in a press release Wednesday, which also noted that Sokol owned shares in Lubrizol, a company Berkshire recently agreed to acquire for some $9 billion. The departure of Sokol comes as a shock to Berkshire watchers who figured the executive was one of the potential successors for Buffett.

In the announcement, Buffett stressed that he and Sokol do not feel there was anything illegal in his trades of Lubrizol shares.

Although both David Sokol and Warren Buffett via Berkshire Hathaway denied that this has been the cause of his resignation, media has been all over what has been perceived as ethical impropriety.

The Sokol affair simply highlights what we have been talking about as the conflict of interests by participating agents—based not only from asymmetric information but from asymmetric interests or incentives that drives people’s actions.

Principal Agent Problem Diagram from Wikipedia.org

Mr. Sokol, who acquired shares of Lubrizol before pitching it to his boss, Mr. Buffett, saw nothing wrong with this. In fact, in a CNBC interview Mr. Sokol cites Mr. Charles Munger, Mr. Buffett’s close friend and vice chairman of Berkshire Hathaway of doing the same.

“I don’t believe I did anything wrong. Charlie Munger owned 3% of BYD before he asked me to go look at it.” [dawnwires.com]

In the stock market, when agents or brokers pre-empt their clients by taking positions for his/her account, in the expectations that the clients orders could affect the price movements of specific stocks, is known as “frontrunning” (investopedia.com) an illegal practise that is punishable by law.

Although Mr. Sokol’s case hardly resembles frontrunning, because he bought the shares before he offered it to Mr. Buffett, this goes to show how such practices has punctured on the current laws.

Notes Mr. Jason Zweig at the Wall Street Journal, (bold emphasis mine)

Mr. Sokol's trading falls under what Stephen Bainbridge, an expert on securities at the UCLA School of Law, calls "an enormously gray area of the law." It also is a reminder that a basic principle of securities law—disclosure cures conflicts—is nonsense.

"Even assuming that [Mr. Sokol] did nothing illegal, [his action] is typical of the kinds of conflicts of interest permitted by our financial system that undermine the integrity of markets," says Max Bazerman, an ethicist at Harvard Business School and co-author of the new book "Blind Spots."

Most people have what Mr. Bazerman calls an ethical blind spot. Faced with a potential conflict of interest, you automatically conclude that it couldn't possibly offer any temptation to someone of superior character—like you or those closest to you.

While I agree that this seems like an issue of ‘ethical blind spots’, I don’t share the impression that “conflicts of interest permitted by our financial system that undermine the integrity of markets” or of the insinuation that ‘ethical’ laws are needed to keep the “integrity of markets”. That would be misstating the case.

And that’s because it is the nature of people to be guided by self-interest based on the individual’s distinctive value preferences or priorities. And people’s diversified self interests always conflict with each other, but still could represent benefits for all the concerned, though not equally.(This is the essence of trade)

What has actually undermined the financial system is the conflict of interest (agency problem) between the political agents along with their regulatory patrons and their economic clients. Regulatory arbitrages, regulatory capture, revolving door politics, bailouts to name a few, has been significant contributors to the political-economic inequality.

And as one can see from the above account, current disclosure laws can’t stop people from circumventing them.

Besides, if Mr. Sokol’s allegation of Mr. Munger is accurate, then Mr. Buffett has been obviously tolerant of such practice.

To see why, Mr. Buffett probably sees this as a way to reward his underlings, who by diligent scrutiny over the target companies, takes on risks directly to emphasize their vote of confidence. It’s not even sure that what the underlings buy will be bought by Mr. Buffett.

As Mr. Buffett stressed on Berkshire’s recent press release,

Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest. (bold emphasis mine)

Thus such actions represent risks borne solely by both Mr. Munger and Mr. Sokol.

Perhaps, for Mr. Buffett this could have signified as parallel to a finder’s fee, that’s if he ever agrees with their investment concept.

This also highlights on the differences of what is seen as an ethical issue. What may seem wrong to the others may seem right to Mr. Buffett (although I would assume that he would distance himself from this controversy)

I think the editorial of Financial Times captures this well, (bold highlights mine)

That Mr Sokol has left to build his own investment portfolio is more than unintentionally ironic. The whole affair highlights Berkshire’s informal style of operation. This is possible because of the high degree of confidence reposed in the company by investors. Mr Buffett and his team can scour the world for opportunities untrammelled by investment mandates and other bureaucratic restraints.

The licence exists, of course, because of Mr Buffett’s superior investment record. He has beaten the stock market indices by a broad margin since the mid-1960s. But it will be harder for Berkshire to continue outperforming given its now-vast size, as even Mr Buffett has admitted. This should give investors pause. The risk of executives abusing informal processes is greatest at times when operational performance is under pressure.

In short, this hasn’t been an issue to Berkshire’s investors because of the rewards these investors have been showered with over these years. It would all be a different story if Berkshire lost money or has underperformed.

The other point is that people should be self-vigilant over their investments in the knowledge that there will always be conflict of interest issues at hand.

To rely on government to resolve ethical issues will only bring about dependency, complacency, and equally, conflict of interest issues but not between private agents but among public and private agents, which should even complicate and worsen the case, as manifested during the last crisis. In other words, more problems will arise from regulations meant to address ethical issues.

The market mechanism for discipline enforced by such perceived misconduct is social stigma or ostracism or reputational risk.

Finally, the public trial faced by Berkshire Hathaway and Mr. Sokol simply highlights of the uniqueness of Mr. Buffett’s management style.

Once Mr. Buffett goes, perhaps Berkshire would most likely lose its magic. All these seem ominous with Moody’s projecting the “Sokol affair” as negative for Berkshire’s credit rating standings (Reuters).

Berkshire’s Corporate Structure and Investment Holdings From theofficialboard.com

Still yet, the complexity of Warren Buffett’s flagship Berkshire Hathaway’s organizational structure operating on her vast investment holdings also underscores the FT’s editorial observations of Berkshire at “now-vast size” or perhaps reaching its growth limit.

And that’s why I have argued here that Mr. Buffett has resorted to political entrepreneurship perhaps out of the desperation to maintain public’s high expectations from a Warren Buffett managed Berkshire.

Bottom line: the principal-agent problem is an inherent feature of the marketplace, which has been immensely underappreciated but must be understood by all.

Video: Don Boudreaux On Understanding Trade Deficits

Professor Donald Boudreaux explains why trade deficits shouldn't be feared (HT: Mark Perry)

Phisix and ASEAN Equities: The Tide Has Turned To Favor The Bulls!

A good trader has to have three things: a chronic inability to accept things at face value, to feel continuously unsettled, and to have humility. -Michael Steinhardt, American investor and philanthropist

The tide must have turned immensely to favor the bulls.

Figure 1: Bloomberg: Jumpstarting the ASEAN Equity Markets

ASEAN markets appear to have been jumpstarted.

We have been repeatedly pounding on the table saying that this turnaround was about to happen. The bulls have been knocking on the door, but few had the grit to pay heed.

And that the previous weakness was not a manifestation of an inflection point nor was it representative of a reversal back to the bear market days. Instead, such market infirmities accounted for as a normal countercyclical process called profit-taking. The basic market lesson is that trends do not move in a straight line.

Yet the profit taking theme seemed unacceptable for the consensus. First because it is boring stuff. And second, because it would seem unworthy of conversations. Part of social conformity requires contemporaneous expressions. And unstylish themes don’t fit such bill.

Social signalling is prioritized more than the relevance of the returns on investments.

Moreover, because people’s intuitive desire is for the graphic, the controversial and the sensational, mainstream experts fed on this false attribution by fixating on the current exogenous factors—the political crisis in Middle East and Africa and Japan’s triple whammy calamity—which they interpreted as having driven markets.

Never mind if evidences hardly supported such assertions, the important thing was to blabber on what seemed fashionable and conversational.

Hardly anyone appear to realize that applying mental shortcuts or heuristics (such as available bias) draped with technical gobbledygook, which would look good from the outside or from the surface, are hardly the pertinent factors when accounting for real investment returns.

In reality, risks and uncertainties stare at our faces at every moment of our lives. Yet, it is just a matter of managing the diversified degree of risk-uncertainty environment that makes the difference. The proverbial wheat is, thus, separated from the chaff.

And as predicted, markets have gradually been digesting on the uncertainty-risk environment from these events. The constant stream of variable, localized, fragmented and frequently contradictory information, which allows markets to discount[1] the uncertainty-risk factor[2], has apparently reduced the perception of the event risk.

The aesthetics of the marketplace is the scintillating evidence of the perpetual flow of the great F. A. Hayek’s description of knowledge[3] and its indispensible role in breathing life to the marketplace via the pricing mechanism and the coordination and discoordination process underpinning the dynamism of prices.

We are now in the process of being vindicated anew!

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[1] See Managing Risk and Uncertainty With Emotional Intelligence, March 20, 2011

[2] See “I Told You So!” Moment: Being Right In Gold and Disproving False Causations, March 6, 2011

[3] Hayek, Friedrich von The Use of Knowledge in Society, econolib.org, 1945

Some Thoughts On The PLDT’s Buyout Of Digitel

Investing without research is like playing stud poker and never looking at the cards. - Peter Lynch

The story of the week belongs no less than to the buyout of Taipan Gokongwei owned Digitel Telecommunications [DGTL] by the largest phone company and publicly listed firm Philippine Long Distance Telecommunication [TEL].

PLDT’s Buyout of DGTL Provides Bulls The Excuse To Bid Up Markets

Figure 2: Recovering Phisix Buttressed By PLDT Buyout Story

It would be inaccurate to say that the PLDT-DGTL story entirely drove the domestic market higher.

The fact that MAJOR ASEAN markets were significantly higher this week, only suggests that bullish sentiment underpinned the markets in the Philippines and among our ASEAN contemporaries.

In addition, the Phisix (red bar chart in Figure 2) has been recovering even prior to the recent spike in PLDT (black candle) share prices last week.

Figure 3: Weekly Sectoral Performance

Besides, while the service sector vastly outperformed the general market led by PLDT rival Globe Telecoms [GLO] (up 22.3%) which ironically eclipsed PLDT’s superb (16.4%) gains over the week, even if Globe had been outside the buyout story, the Phisix which surged by an astounding 6.5% was also driven by advances from the broader market.

Yes, all sectors registered positive gains (figure 3). But only the service sector posted gains far above the Phisix while the financial sector was nearly at par with that of the Phisix. All the rest underperformed.

This means that the extraordinary surge in PLDT prices has materially influenced the gains of the Phisix, given that PLDT commands the largest share in terms of market cap weightings of the Phisix basket.

In other words, the PLDT-DGTL buyout story has nudged the overall market higher. Bulls, whom have been looking for a crucial excuse to bid up the markets (as shown by the gradual ascent prior to last week), appears to have found one in the PLDT-DGTL narrative.

Figure 4: Rotational Effects In Play

Yet this week’s exemplary actions have nearly closed the year-to-date deficits of the various sectors in the Philippine Stock Exchange including the Phisix.

As of Friday’s close, the Phisix is just down 1.7% from the start of the year.

But the more important story is one of the rotational effects.

The tale of the two sectoral outperformers (service and financials) for this week is a splendid manifestation of the Livermore-Machlup model[1] in action-where stock price movements are largely or mainly influenced by inflationist policies (Machlup) which can be empirically observed by relative price actions (rotations) but results to increases in general price levels overtime (Livermore).

Both these sectors have alot of catching up to do, considering that both have lagged the general market as shown above. In short, erstwhile laggards have turned into leaders.

This is further evidenced by the turnaround in the ALL shares index which has popped to the positive zone. This also means that the broader market has been substantially outperforming key Service and Financial issues until last week.

Yet if the tailwinds should persist to fuel the bull’s newfound momentum in the coming sessions or weeks, where the former laggards, many of which constitute as the core Phisix heavyweights, should spearhead an accelerated recovery, then we should see the Phisix clamber out of the rut and possibly post hefty positive returns by the end of April.

Stake In PLDT: Taipan Gokongwei’s Dream Come True

As we earlier said, the bulls found a pretext to fillip the markets, which was through the announcement of PLDT’s buyout of rival company Gokongwei owned Digitel [DGTL].

Here are some information on the buyout as per PSE disclosure[2]

Almost the entire transactions for the buyout (or 51.5% of DGTL) will be executed and financed via share swaps.

A tender offer will be made to the minority shareholders at a ratio of 2,500 pesos or 1 PLDT share for the equivalent number of DGTL shares held—valued at 1.60 per share.

The value of transactions for the Gokongwei owned shares are at php 69.2 billion. If an all cash outlay for the minority tender will be incorporated, the transaction value would rise to php 74.1 billion. If it will be an all share swap transaction minority plus the Gokongwei group will own 13.7% of PLDT. Definitely, the tender offer will translate to somewhere in between (cash tenders or PLDT swaps).

The completion of the buyout would mean that the Gokongwei flagship company JGS summit would hold 12.8% of PLDT.

Ascertaining the derivative value per share of the PLDT’s acquisition of DGTL seems ambiguous because it includes other matters that had not been appropriately detailed—such as the treatment of DGTL’s zero coupon convertible bonds which represents an approximate 18.6 billion of shares (or php 29.76 billion @1.6 per share-my estimates) and DGTL’s intercompany cash advances of 34.1 billion.

If we add both the intercompany cash advance with the estimated convertible bond equivalent, then the net value of the transaction would tally to php 63.86 billion. Thus, the variance between the broadcasted prices of the deal at php 69.2 billion and the above (cash advances plus bond convertible) or php 5.34 billion could have represented as goodwill money.

Digitel’s current outstanding shares is at 6,356,976,310 (PSE data) while the 51.5% stake involved in the PLDT buyout transaction is declared at 3,277,135,882 shares.

Simply dividing the net declared amount of php 69.2 billion with the outstanding or with the 51.5% stake or even including the 18.6 billion shares (from zero bond convertible) would result to prices far above the current share value. This is not to imply of an undervaluation, but of the black area arising from the incompleteness of the divulged or disclosed information.

The more important issue for me is that the Gokongwei group has been eyeing a significant stake in PLDT since October of 2002. The botched attempt in 2002 had been predicated on conflict of interest issues from the former’s ownership of Digitel[3].

Apparently this time around, the conflict of interest issue has been circumvented or resolved by using DGTL as the key vehicle for Gokongwei’s long wish to gain a foothold at PLDT.

I am partly puzzled by the seeming obsession of Taipan Gokongwei to secure a stake on PLDT despite some makeover in PLDT’s business model from the 2002 and today.

PLDT has branched out to the energy industry through a substantial claim on Meralco’s equity[4].

Meralco, as we have earlier written[5], epitomizes the Philippine brand of state capitalism. Meralco’s legalized monopoly translates to economic rents for the economic clients of the high echelon political patrons. Remember, Meralco’s pricing system is controlled by the Energy Regulatory Board (ERB) an agency which is directly under the Office of the President. In short, the President of the Philippines decides on how much these private sector owners of the energy monopoly franchise earns[6].

Though of course, Gokongwei’s passion for PLDT could also be due to the latter’s stranglehold of having the significant majority in the market share of the mobile business in the Philippine telecom industry.

Figure 5: nadventures.com[7] mobile market share

My naughty (outside the box) mind whispers to me that this buyout, which has its roots since 2002, could also have been incented from either flows of political money trying to find a legitimate front or that such acquisition could have operated from more from political incentives than from an economic one.

Nevertheless, my suspicions are just that...suspicions until evidence can back these up.

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[1] See Are Stock Market Prices Driven By Earnings or Inflation? January 25, 2009

[2] Digitel Telecommunications, JG Summit To Acquire Stake In PLDT In All-Share Transaction, Philippine Stock Exchange, March 29, 2011

[3] CNN.com Gokongwei still eyeing PLDT stake, October 3, 2002

[4] Philstar.com PLDT buys 20% Lopez stake in Meralco, March 14, 2009

[5] See Bubble Thoughts Over Meralco’s Bubble August 2, 2009

[6] See Has Meralco’s Takeover Been A Good Sign?, March 22, 2009

[7] Zita, Ken Philippine Telecom Brief (Network Dynamics Associates) nadventures.com