Rampaging Global Equity And Commodity Markets Are Symptoms Of Rampant Inflationism!

Credit expansion not only brings about an inextricable tendency for commodity prices and wage rates to rise it also affects the market rate of interest. As it represents an additional quantity of money offered for loans, it generates a tendency for interest rates to drop below the height they would have reached on a loan market not manipulated by credit expansion. It owes its popularity with quacks and cranks not only to the inflationary rise in prices and wage rates which it engenders, but no less to its short-run effect of lowering interest rates. It is today the main tool of policies aiming at cheap or easy money. Ludwig von Mises

Global stock markets appear to be on a juggernaut!

Figure 1: Stockcharts.com: Where Is the Oil-Stockmarket Negative Correlation?

Figure 1 tells us that despite soaring oil prices, last traded at $113 per barrel as of Friday (WTIC), global equity markets have been exploding higher in near simultaneous fashion as demarcated by the blue horizontal line.

The Global Dow (GDOW)[1] an index created by Dow Jones Company that incorporates the world’s 150 largest corporations, the Emerging Markets (EEM) Index and the Dow Jones Asia Ex-Japan Index (P2DOW) have, like synchronized dancing, appear as acting in near unison.

We have been told earlier that rising oil prices extrapolated to falling stock markets (this happened during March—see red circles), now where is this supposed popular causal linkages peddled by mainstream media and contemporary establishment analysts-experts[2]?

Yet, the current actions in the global financial and commodity markets hardly represent evidence of economic growth or corporate fundamentals.

And any serious analyst will realize that nations have different socio-political and economic structures. And such distinction is even more amplified or pronounced by the uniqueness of the operating and financial structures of each corporation. So what then justifies such harmonized activities?

As we also pointed out last week[3], major ASEAN contemporaries along with the Phisix have shown similar ‘coordinated’ movements.

In addition, the massive broad based turnaround in major emerging markets bourses appear to vindicate my repeated assertions that the weakness experienced during the past five months had been temporary and signified only profit taking[4].

Yet if we are to interpret the price actions of local events as one of being an isolated circumstance, or seeing the Philippine Phisix as signify ‘superlative performance’ then this would account for a severe misjudgment.

Doing so means falling into the cognitive bias trap of focusing effect[5] —where one puts into emphasis select aspect/s or event/s at the expense of seeing the rest.

Ramifications of Rampant Inflationism

So how does one account for these concerted price increases? Or, what’s been driving all these?

We have been saying that there are two major factors affecting these trends:

One, artificially low interest rates that have driven an inflationary boom in credit.

That’s because simultaneous and general price increases would not be a reality if they have not been supplied by “money from thin air”.

As Austrian economist Fritz Machlup wrote[6],

If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, a boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and amortization current amortization allowances is fairly inelastic, and optimism about the development of security prices, inelastic would promptly lead to a "tightening" on the credit market, and the cessation of speculation "for the rise." There would thus be no chains of speculative transactions and the limited amount of credit available would pass into production without delay.

Some good anecdotal examples:

Credit booms are being manifested in several segments of the finance sector across the world, such as the US Collateralized Mortage Obligations (CMO)

From Bloomberg[7], (bold emphasis mine)

The biggest year since 2003 for the packaging of U.S. government-backed mortgage bonds into new securities has extended into 2011, bolstered by banks seeking investments protecting against rising interest rates.

Issuance of so-called agency collateralized mortgage obligations, or CMOs, reached $99 billion last quarter, following $451 billion in 2010, according to data compiled by Bloomberg. The creation of non-agency bonds, which force investors to assume homeowner-default risks, is down more than 90 percent from a peak with parts of the market still frozen.

Facing limited loan demand and flush with deposits on which they pay close to zero percent, banks are turning to agency CMOs to earn more than Treasuries and gird for when the Federal Reserve boosts funding rates. Insurers, hedge funds and mutual- fund managers such as Los Angeles-based DoubleLine Capital LP are seeking different pieces of CMOs, which slice up mortgage debt, creating new bonds that pay off faster or turn fixed-rate notes into floating rates.

Or in Europe, the leveraged buyout markets...

Again from the Bloomberg[8], (bold emphasis mine)

ING Groep NV, the top arranger of buyout loans in Europe this year, sees a “liquidity bubble” building as lenders forego protection and accept lower fees.

“There is a liquidity bubble in the European leveraged loan market at the moment, driven by institutional fund liquidity,” said Gerrit Stoelinga, global head of structured acquisition finance at Amsterdam-based ING, which toppled Lloyds Banking Group Plc as no. 1 loan arranger to private-equity firms, underwriting 10 percent of deals in the first quarter.

Investors more than doubled loans to finance private-equity led takeovers in the first quarter to $6.7 billion as the economy shows signs of strengthening, reducing risk that the neediest borrowers will default. Inflows to funds dedicated to loans and floating-rate debt jumped to $8.5 billion this year, compared with $1.7 billion in the same period in 2010, data from Cambridge, Massachusetts-based EPFR Global show.

Second, it’s all about the dogmatic belief espoused by the mainstream and the bureaucracy where printing of money or the policy of inflationism is seen as an elixir to address social problems.

Figure 2: Swelling Central Bank Balance Sheets and Commodity Prices (Danske Bank[9] and Minyanville[10])

The balance sheets of developed economies central banks have massively been expanding (except the ECB, see figure 2 left window), as respective governments undertake domestic policies of money printing or Quantitative Easing (QE) programs, even as the global recession has passed.

Commodity prices have, thus, risen in conjunction with central banks QE programs (right window).

What this implies is that both inflationary credit and the ramifications of various QE programs appear to be mainly responsible for the rise in most commodity markets. This is a phenomenon known as reservation demand, which as I wrote in the past[11]

“commodities are not just meant to be consumed (real fundamentals) but also meant to be stored (reservation demand) if the public sees the need for a monetary safehaven.”

As the great Ludwig von Mises explained[12], (bold highlights mine)

with the progress of inflation more and more people become aware of the fall in purchasing power. For those not personally engaged in business and not familiar with the conditions of the stock market, the main vehicle of saving is the accumulation of savings deposits, the purchase of bonds and life insurance. All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to be indicated. The ultimate reaction of the public, the “flight into real values,” is a desperate attempt to salvage some debris from the ruinous breakdown. It is, viewed from the angle of capital preservation, not a remedy, but merely a poor emergency measure. It can, at best, rescue a fraction of the saver’s funds.

Ironically as I earlier pointed out, even the Bank of Japan (BoJ) has recognized the causal effects of money printing and high food prices[13], but they continue to ignore their own warnings by adding more to their own “lending” program using the recent disaster as a pretext [14]!

Yet despite increases of policy rates by some developed economy central banks as the European Central Bank (ECB) and the Denmark’s Nationalbank[15], not only as interest rates remain suppressed but the ECB pledged to continue with its large scale liquidity program[16].

To add, policy divergences will likely induce more incidences of leveraged carry trade or currency arbitrages.

Record Gold Prices and Poker Bluffing Exit Strategies

And it is of no doubt why gold hit new record nominal highs priced in US dollars last week (now above $1,470 per oz.)

Figure 3: Surging Gold prices versus G-5 currencies (gold.org)

It wouldn’t be fair to say that gold has been going ballistic only against the US dollar because gold has been in near record or in record territory against almost all major developed and emerging market currencies.

Gold, as shown in Figure 3, has been drifting near nominal record highs against G-5 currencies[17] (US dollar, euro, Yen, sterling and Canadian dollar).

Figure 4: Gold Underrepresented as an Asset Class (US Global Investors[18])

Gold, despite record nominal prices, appears to be vastly underrepresented as a financial asset class compared to other assets held by global finance, banking, investment, insurance and pension companies.

Should the scale of inflationism persists, which I think central bankers will[19], considering the plight of the foundering “too big to fail” sectors or nations e.g. in the US the real estate markets (see figure 5), in Europe the PIIGS, this will likely attract more of mainstream agnostics (see figure 4) to gold and commodity as an investment class overtime.

This only implies of the immense upside potential of gold prices especially when mainstream finance and investment corporations decide to load up on it or capitulate.

Figure 5: Tenuous Position of US Real Estate, Bank Index and Mortgage Finance

This brings us back anew to “Exit” strategies that is said to upend gold’s potentials.

The Fed can talk about exit strategies for all they want, but they are likely to signify another poker bluff similar to 2010[20].

The Fed’s inflationist programs which had been mostly directed at the US banking system seem to stand on tenuous grounds despite all the trillions of dollars in rescue efforts.

US real estate appears to stagger again[21] (left window), while the S & P Bank Index (BIX) and the Dow Jones Mortgage Finance (DJUSMF) appears to have been left out of the bullish mode seen in the S&P 500 Financials (SPF) and the Dow Jones US Consumer Finance (DJUSSF), possibly reflecting on the renewed weakness of the US real estate.

In addition, there is also the problem of financing the enormous US budget deficits. And there is also the excess banking reserves dilemma.

So in my view, the US Federal Reserve seems faced with the proverbial devil and the deep blue sea. Other major economies are also faced with their predicaments.

Going back to the stock markets, as Austrian economist Fritz Machlup explained[22],

if all of these indices show an upward (or downward) movement, the presumption is very strong that inflation (or deflation) in the sense defined is taking place, even if the level of commodity prices does not show the least upward (or downward) tendency.

Well some commodity prices have paralleled the actions in the stock markets if not more.

Bottom line: Rampaging stock markets and commodity markets are symptomatic of rampant inflationism.

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[1] Wikipedia.org The Global Dow

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

[3] See Phisix and ASEAN Equities: The Tide Has Turned To Favor The Bulls! April 3, 2011

[4] See I Told You So Moment: Emerging Markets Mounts A Broad Based Comeback! April, 8, 2011

[5] ChangingMinds.org, Focusing Effect

[6] Machlup, Fritz The Stock Market, Credit And Capital Formation Mises.org p.92

[7] Dailybusiness.com CMO sales at 7-year high as banks gird for Fed: credit markets, Bloomberg, April 5, 2011

[8] Bloomberg.com ING Sees ‘Liquidity Bubble’ in European LBO Financing Market, April 5, 2011

[9] Danske Bank Flash Comment Japan: BoJ upgrades its view on economy, April 7, 2011

[10] Minyanville.com When Will Fed-Created Melt-Up Turn Into a Meltdown?, April 8, 2011

[11] See Oil Markets: Inflation is Dead, Long Live Inflation November 4, 2010

[12] Mises, Ludwig von The Effects of Changes in the Money Relation Upon Originary Interest, Human Action, Chapter 20 Section 5 Mises.org

[13] See Correlation Isn't Causation: Food Prices and Global Riots, April 2, 2011

[14] Bloomberg, BOJ Offers Earthquake-Aid Loans, Downgrades Economic Assessment, April 7, 2011

[15] Reuters.com Danish c.bank raises lending rate by 25 bps, April 7, 2011

[16] See ECB Raises Rates, Global Monetary Policy Divergences Magnifies, April 8, 2011

[17] Gold.org, Daily gold price since 1998

[18] Holmes, Frank The Bedrock of the Gold Bull Rally, US Global Investors

[19] See The US Dollar’s Dependence On Quantitative Easing, March 20, 2011

[20] See Poker Bluff: The Exit Strategy Theme For 2010, January 11, 2010

[21] Economist.com Weather warning America's housing market is in the doldrums, March 30, 2011

[22] Machlup, Fritz Op.cit p.299

Phisix-Philippine Peso Back In Rhythm

Upon examining the curves developed by institutes using the Harvard method, it becomes apparent that the movement of the money market curve (C Curve) in relation to the stock market curve (A Curve) and the commodity market curve (B Curve) corresponds exactly to what the Circulation Credit Theory asserts. The fact that the movements of A Curve generally anticipate those of B Curve is explained by the greater sensitivity of stock, as opposed to commodity, speculation. The stock market reacts more promptly than does the commodity market. It sees more and it sees farther. It is quicker to draw coming events (in this case, the changes in the interest rate) into the sphere of its conjectures. Ludwig von Mises

The Philippine Phisix made another substantial rally this week (+2.7%) to finally move up to the positive column.

Rotation, Improving Market Breadth and Bull Market Rules

And as we have been saying we see lots of ongoing rotational dynamics in place.

Figure 6: PSE Weekly Performance

Where last week we saw the telecom sectors take the center stage, this week it had been a story of the Property, Industrial and the Mining sector which has elevated the gains of the Phisix.

Last week’s front runner, the service sector led by the telecoms, had a lackluster but still posted a positive performance. The drab performance of this sector could have signified a natural reprieve following the other week’s sizzling performance.

This week’s broad market gains basically lifted most of the sectoral performance which left only the finance and service sector in the red on a year to date basis.

If the bullish momentum should continue over the medium term, which I expect it would, then I expect to see these laggard sectors to do some catching up which should equally lend a boost to the Phisix.

In addition, we see material progress in the market breadth.

Aside from a huge jump in net foreign buying which mostly came from block sales last April 5, we see broader gains through more trades and number of issues traded. Importantly the advance-decline spread has been tilted in favor of the bulls (see figure 7).

Figure 7: Advance-Decline Spread Shows Bullish Breadth

Thus, the rotational dynamics plus several progress in the market internal activities appear to highlight the Philippine Stock Exchange’s current intrinsic bullishness.

Of course mechanical chartists may argue that given the overbought conditions we may see some profit taking. That’s possible. Resolving short term movements, for me, is a matter of luck (noise) than of (signals) skills.

Nevertheless, major trends of bull and bear markets have some shared characteristics which could be translated into one of the many guideposts for market participants.

As prominent US chartist Carl Swelin notes[1], (bold emphasis mine) writes,

In a bull market oversold conditions are seen as a buying opportunity and will usually result in a rally to relieve the condition. When a bull market becomes overbought, it is not usually cause for concern, because corrections from these conditions are often small, and sometimes the market will continue to rally, while the overbought conditions are relieved internally.

In other words, even if the Phisix does correct, it is likely to be short, and it is likely to see internal rotations that would relieve issue specific conditions (not all issues will go down).

The Phisix-Peso Symmetry

Of course the rising Phisix has also been in conjunction with the firming Peso whose dissonance appears to have been finally resolved.

As I earlier wrote[2],

I can see a paradox—a strong Peso and equity outflows—or a meaningful divergence...

These variables appear to imply that the negative foreign trade in the PSE had NOT been repatriated abroad, but possibly rotated into other local assets.

And this perhaps explains the continued strenght of the Peso despite a weak equity market environment. Again, a divergence that is likely to be resolved soon

Figure 8: Phisix-Peso Back in Rhythm

Given the realities of the Philippine financial markets, the Phisix can’t go on a full downswing cycle on a firming Peso. It’s either a bear market that goes with a falling peso or the weakness in the Phisix represents an anomaly relative to the Peso. And that’s the essence of the recent paradox.

Obviously, the asymmetry appears as being resolved in the way have seen it.

Figure 9: Yardeni.com[3]: Non Gold Philippine Foreign International Reserves Surge Anew

Nevertheless with the country’s foreign international reserves on a new milestone high, and with the BSP’s reluctance to see the Philippine Peso appreciate meaningfully for political reasons, this only means lots of liquidity[4] will be sloshing throughout the domestic financial system.

This together with artificially suppressed interest rates should also imply that much these money will find their way into various Peso based assets such as those listed in the Philippine stock exchange, real estate or local bonds.

Of course, after financial markets, we get higher (CPI) inflation in the mainstream definition and subsequently public unrest.

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[1] Swenlin, Carl, Bull/Bear Market Rules Apply Decisiopoint.com

[2] See Are The Current External Event Risks Signals or Noise?, March 13, 2011

[3] Yardeni.com, (subscription required) Global Liquidity, April 7, 2011

[4] See Questions and Answers on Philippine Monetary and Fiscal Issues, April 8, 2011

Earth’s Possible Close Encounter With An Asteroid This November

Earth might have a close encounter with a huge asteroid this November, that’s according to Space.com [bold emphasis mine]

Mark your calendars for an impressive and upcoming flyby of an asteroid that’s one of the larger potentially perilous space rocks in the heavens – in terms of smacking the Earth in the future.

It’s the case of asteroid 2005 YU55, a round mini-world that is about 1,300 feet (400 meters) in diameter. In early November, this asteroid will approach Earth within a scant 0.85 lunar distances.

Due the object’s size and whisking by so close to Earth, an extensive campaign of radar, visual and infrared observations are being planned.

Asteroid 2005 YU55 was discovered by Spacewatch at the University of Arizona, Tucson’s Lunar and Planetary Laboratory on Dec. 28, 2005. En route and headed our way, the cosmic wanderer is another reminder about life here on our sitting duck of a planet

Read the rest here

This article hasn’t been meant to scare anyone, but as Space.com says our planet looks like a sitting duck.

And gloomy environmental stories about climate change seem to pale against the prospects of a wayward asteroid hitting us-the ultimate Black Swan.

President Obama’s Use of Regime Uncertainty and the Political ‘Government Shutdown’ Blackmail

All of a sudden, President Obama embraces the Austrian perspective of Regime Uncertainty (Robert Higgs).

From the Washington Post, (hat tip Russ Roberts)

At a town hall meeting near Philadelphia on Wednesday, President Obama warned that the uncertainty of a shutdown could slow the economic recovery.

“Companies don’t like uncertainty, and if they start seeing that suddenly we may have a shutdown of our government, that could halt momentum right when we need to build it up — all because of politics,” Obama said.

Of course, the use of uncertainty here is all about political convenience. This have been predicated on the ongoing battle over proposed budget cuts from the Republicans.

The administration appears to use “government shutdown” as leverage to negotiate to prevent or mitigate these.

Graphics from Cato’s David Boaz

Yet what is being argued looks inconsequential relative to the budget (government spending) gains over the years.

And based on the Cato’s graphics, the Republican proposal would seem not as a NET reduction, but rather a reduction of expansion.

As Jacob Sullum of the Reason foundation writes,

The cuts represent less than 2 percent of the total budget, less than 4 percent of the deficit, and less than 5 percent of discretionary spending, which rose in real terms by 75 percent from 2000 to 2010 and by about 9 percent in each of the last two fiscal years.

Yet the administration is trying to spook (blackmail) the public with the prospects of mayhem from a prospective government shutdown.

US government shutdowns have not been rare.

Below is a table from Bespoke Invest showing previous shutdowns.

Bespoke writes, (bold highlights mine, table above from Bespoke)

“funding gaps in the federal government are hardly rare. While we all remember the two shutdowns in 1995, there have actually been a total of 17 shutdowns going back to 1975. However, due to their length as well as changes in federal law over the years, not all funding gaps are created equal. For starters, of the seventeen funding gaps highlighted, only eight lasted longer than three days. In other words, in most cases the shutdown was a one day affair or else it occurred over a weekend.

“As shown in the table, however, funding gaps prior to 1980 all lasted one week or more, and then from 1980 to 1995 all funding gaps lasted three days or less. The reason for this change is the fact that beginning in 1980 the US Attorney’s Office ruled that any time there was a funding gap, non essential federal agencies were required to begin terminating activities and ‘shutdown.’ Once that opinion was issued, funding gaps took on added urgency forcing lawmakers to come to an agreement. This is why the shutdown in 1995 was so notable.

Bottom line:

This serves as a lucid example that when it comes to cutting government (privileges) in terms of spending and control, you can hear the shrill of cry OUCH from politicians! Even if the proposed spending cuts seem inconsequential or even perhaps symbolical.

And in desperation or as a political maneuver, politicians employ various ‘strawmen-bogeyman’ tactics to scare the wits out of the public so that the public would be stampeded to approve their desires.

As former US President John Adams once wrote [The Foundation of Government],

Fear is the foundation of most governments; but it is so sordid and brutal a passion, and renders men in whose breasts it predominates so stupid and miserable, that Americans will not be likely to approve of any political institution which is founded on it.

Milton Friedman’s 4 ways money is spent

Stripping away control and spending other people’s money is so addictive that politicians can’t seem to do away with it and would fight heaven and hell to avoid it.

Update: Bespoke appears to have been proven right, a deal has been reached according to marketwatch.com. Details have yet to come in.

Cartoon of the Day: Econometrics Work! Not.

Here is a nice parody of how economic 'math or econometric' models are contrived and sold to the public as “workable”.

From xkcd.com, [click on this link to go to original site for clearer illustration]

(hat tip: Russ Roberts)

EU’s Bailout Structure, Behind The Scene Role of the US

Speaking of the policy of bailouts (possibly financed by inflationism), here is nice graphic from the Economist.

The Economist writes,

PORTUGAL’S bail-out means another stage in Europe’s debt crisis and another call on non-European coffers. The total €865 billion ($1.2 trillion) pot available for euro-area rescues looks enormous, more than enough to cope with Greece, Ireland and Portugal’s anticipated needs besides. Almost half of that comes from the European Financial Stability Facility, a €440 billion euro-zone fund whose major contributors are Germany, France and Italy. But the EFSF’s effective lending capacity is only €250 billion, because only six of its 17 members have a AAA credit rating. European leaders have pledged to bring the fund’s actual firepower up to €440 billion by the summer but in the meantime the IMF has more cash on hand, at €280 billion. If all that money were used (a very big if), America would end up lending indebted euro-zone nations €50 billion.

Oops, the last statement shows why the US dollar will likely keep falling…the US appears to be bailing out the rest of the world! (this included Libya’s Gaddafi in 2009)

ECB Raises Rates, Global Monetary Policy Divergences Magnifies

The European Central Bank lifted policy rates yesterday.

From the Bloomberg, (bold highlights mine)

European Central Bank lifted interest rates for the first time in almost three years to quell inflation even as Portugal became the third nation to succumb to the region’s sovereign debt crisis.

ECB policy makers meeting in Frankfurt today raised the benchmark interest rate to 1.25 percent from a record low of 1 percent, as predicted by all 57 economists in a Bloomberg News survey. It also raised the marginal lending rate to 2 percent from 1.75 percent and increased the deposit rate to 0.5 percent from 0.25 percent, maintaining 75 basis-point corridors either side of the benchmark....

The ECB is joining China, India, Poland and Sweden in raising interest rates even as the Federal Reserve remains reluctant to tighten amid divisions among its policy makers.

Today’s ECB rate increase is the first since July 2008 and also the first time in 40 years that Europe’s benchmark has risen before the U.S. equivalent.

The ECB has repeatedly been forced to delay the withdrawal of emergency policy settings put in place during the global financial crisis as Europe’s debt woes threatened to tear the 17-nation currency bloc apart.

The ECB has raised rates alright but continues to pump money into the system.

From the same article,

The ECB has also said it will keep providing banks with as much liquidity as they need at least through the second quarter, and has left its bond-purchase program in place.

So we revert to the proverbial, ‘the left hand doesn’t seem to know the right hand is doing’.

Well this just underscores the vast monetary policy divergences across the globe highlighted by this fantastic interactive chart by the Wall Street Journal Blog.

Proceed to the Wall Street Journal Blog to see original interactive chart.

Bottom line: Great deal of countries are still at ultra-accommodative phases (which provides fuel to commodity inflation)

Questions and Answers on Philippine Monetary and Fiscal Issues

The following is my to answer some of the questions that my colleagues have posted on facebook group which they say is required for their research.

Role of Central Bank and Currency Interventions

With reference to the record $66.2 billion Gross International Reserves (GIR) the Philippines has tallied for the first quarter of 2011, this can be broken down into Foreign Investments, Gold, Special Drawing Rights (SDRs), foreign exchange and Reserve position in the fund.

Breakdown of Gross International Reserves (Bangko Sentral ng Pilipinas)

Reserve assets can further be broken down into securities mostly in foreign bonds and notes and secondly in foreign currency cash and deposits.

Reserve asset breakdown Bangko Sentral ng Pilipinas

The role of the BSP, like all other central banks, is to manage exchange rate fluctuation and or the state of balance of payments.

They do this by either indirect foreign currency intervention (tweaking money supply) or indirect foreign currency intervention (buy or sell foreign currencies with local currency) [Steven M. Suravonic, International Finance Theory and Policy]

And in managing capital inflows they can be sterilized or non-sterilized. Non sterilized intervention can result to inflation.

Jang-Yung Lee explains [IMF 1997 Sterilizing Capital Inflows]

Capital inflows result in a buildup of foreign exchange reserves. As these reserves are used to buy domestic currency, the domestic monetary base expands without a corresponding increase in production: too much money begins to chase too few goods and services.

To ease the threat of currency appreciation or inflation, central banks often attempt what is known as the "sterilization" of capital flows. In a successful sterilization operation, the domestic component of the monetary base (bank reserves plus currency) is reduced to offset the reserve inflow, at least temporarily. In theory, this can be achieved in several ways, such as by encouraging private investment overseas, or allowing foreigners to borrow from the local market. The classical form of sterilization, however, has been through the use of open market operations, that is, selling Treasury bills and other instruments to reduce the domestic component of the monetary base. The problem is that, in practice, such sterilization can be difficult to execute and sometimes even self-defeating, as an apparently successful operation may raise domestic interest rates and stimulate even greater capital inflows. Unfortunately, many developing countries also lack the tools available to run a classical sterilization policy, or find it simply too costly to do so. This is often the case wherever the financial system is not fully liberalized.

The Philippines has undertaken both measures with questionable results.

From the ADB Institute,

As described earlier, the BSP has engaged in both sterilized and unsterilized intervention. A simple correlation analysis indicates that intervention, as measured by the percentage of international reserves, has limited impact on the exchange rate’s level, percentage change, and volatility (Table 11 [ PDF 53.5KB | 1 page ]).¹⁰ The results indicate that intervention had a modicum of success in reducing exchange rate volatility in the Philippines between 1993 and 1996. Meanwhile, intervention prevented a rise in the exchange rate (measured in US$/peso) after the crisis, particularly during the period 2003–2007. In many instances the results are counter-intuitive, i.e. the correlation coefficient is positive, similar to the result of the impulse response function that was presented in Section III (Figure 4 [ PDF 42.8KB | 1 page ]). ADB Institute, Evaluation of Policy Responses, March 5, 2008

External Debt (Fiscal and Monetary Issues)

The question of debt has also been raised.

External debt as defined by the BSP covers all short-term and medium-term obligations of the BSP, commercial banks, public and private sectors payable to non-residents.

One must be reminded that external debt which covers by the national government is a fiscal issue whose repayment is allocated by the Philippine Congress. The 2011 php 1.645 trillion budget allocates 23% to debt servicing (dateline Philippines, President Aquino’s Budget message—Office of the President’s Official Gazette)

The BSP’s role according to Manila Bulletin/Cuervo Far East is to set “internal annual debt ceiling to monitor foreign borrowings, either from commercial sources or from official development assistance funds or donor aids.”

External Objectives and the Role of Forex Currency Reserves

Now domestic monetary policy is about domestic political and economic issues, and is hardly about coordinating inflation with external sources.

External issues are assumed by currencies that play the role of foreign currency reserves, where the conflict of interest between domestic and international objectives engenders what is known as the Triffin Dilemma.

IMF During the 1997 Asian Crisis and the Philippine Debt Moratorium in 1970-80s

During the Asian crisis the left has blamed liberalization, pegged currency and high interest rates (Walden Bello) when the problem has been a global rotational issue of bubble cycles.

Paper money has never been about sound money. It has been about political objectives.

As to whether the restricting Peso ‘inflation’ would hurt the US dollar hegemony, US dollar’s hegemony depends largely on the sustainment of its inflationist policies. If the US recklessly pursues a dollar debasement as their main policy thrust, countries will either jointly devalue (race to the bottom or competitive devaluation) or abandon the US dollar as a foreign currency reserve.

Finally, with regards to the role played by the IMF during the Philippines during the Philippine debt moratorium

Country-data com provides some clue: (bold emphasis mine)

On October 17, 1983, it was announced that the Philippines was unable to meet debt-service obligations on its foreign-currency debt of US$24.4 billion and was asking for a ninety-day moratorium on its payments. Subsequent requests were made for moratorium extensions. The action was the climax of an increasingly difficult balance of payments situation. Philippine development during the decade of the 1970s had been facilitated by extensive borrowing on the international capital market. Between 1973 and 1982, the country's indebtedness increased an average of 27 percent per year. Although government-to-government loans and loans from multilateral institutions such as the World Bank and Asian Development Bank were granted at lower-than-market rates of interest, the debt-service charges on those and commercial loans continued to mount. In 1982 payments were US$3.5 billion, approximately the level of foreign borrowing that year and greater than the country's total debt in 1970. The next year, 1983, interest payments exceeded the net inflow of capital by about US$1.85 billion. In combination with the downturn in the world economy, increasing interest rates, a domestic financial scandal that occurred when a businessman fled the country with debts estimated at P700 million, escalating unrest at the excesses of the Marcos regime, and the political crisis that followed the Aquino assassination, the debt burden became unsustainable (see table 16, Appendix).

The Philippines had turned to the IMF previously in 1962 and 1970 when it had run into balance of payments difficulties. It did so again in late 1982. An agreement was reached in February 1983 for an emergency loan, followed by other loans from the World Bank and transnational commercial banks. Negotiations began again almost immediately after the moratorium declaration between Philippine monetary officials and the IMF. The situation became complicated when it came to light that the Philippines had understated its debt by some US$7 billion to US$8 billion, overstated its foreign-exchange reserves by approximately US$1 billion, and contravened its February 1983 agreement with the IMF by allowing a rapid increase in the money supply. A new standby arrangement was finally reached with the IMF in December 1984, more than a year after the declaration of the moratorium. In the meantime, additional external funds became nearly impossible to obtain.

In each of these arrangements with the IMF, the Philippines agreed to certain conditions to obtain additional funding, generally including devaluation of the peso, liberalization of import restraints, and tightening of domestic credit (limiting the growth of the money supply and raising interest rates). The adjustment measures demanded by the IMF in the December 1984 agreement were harsh, and the economy reacted severely. Because of its financial straits, however, the government saw no option but to comply. Balance of payments targets were met for the following year, and the current account turned positive in FY (fiscal year--see Glossary) 1986, the first time in more than a decade. But there was a cost; interest rates rose to as high as 40 percent, and real GNP declined 11 percent over 1984 and 1985. The dire economic situation contributed to Aquino's victory in the February 1986 presidential election.

Hope this helps,

Benson

P.J. O’Rourke On Atlas Shrugged (Movie): A Hundred Years Spent Proving Classical Liberalism Right

Libertarian author P.J. O’Rourke reviews Atlas Shrugged The Movie (source Wall Street Journal Blog; bold emphasis mine)

But I will not pan “Atlas Shrugged.” I don’t have the guts. If you associate with Randians—and I do—saying anything critical about Ayn Rand is almost as scary as saying anything critical to Ayn Rand. What’s more, given how protective Randians are of Rand, I’m not sure she’s dead.

The woman is a force. But, let us not forget, she’s a force for good. Millions of people have read “Atlas Shrugged” and been brought around to common sense, never mind that the author and her characters don’t exhibit much of it. Ayn Rand, perhaps better than anyone in the 20^thcentury, understood that the individual self-seeking we call an evil actually stands in noble contrast to the real evil of self-seeking collectives. (A rather Randian sentence.) It’s easy to make fun of Rand for being a simplistic philosopher, bombastic writer and—I’m just saying—crazy old bat. But the 20^th century was no joke. A hundred years, from Bolsheviks to Al Qaeda, were spent proving Ayn Rand right.

Then there is the audacity of bringing “Atlas Shrugged” to the screen at all. Rand devotees, starting with Rand herself, have been attempting it for 40 years. The result may be as puzzling as a nude sit-in anti-Gadhafi protest in Tripoli’s Green Square, but you have to give the participants credit for showing up.

In “Atlas Shrugged” Rand set out to prove that self-interest is vital to mankind. This, of course, is the whole point of free-market classical liberalism and has been since Adam Smith invented free-market classical liberalism by proving the same point. Therefore trying to make a movie of “Atlas Shrugged” is like trying to make a movie of “The Wealth of Nations.” But Adam Smith had the good sense to leave us with no plot, characters or melodramatic clashes of will so that we wouldn’t be tempted to try.

Patching it all up, P.J. O’Rourke simply says that a hundred years had been spent proving classical liberalism right.

I Told You So Moment: Emerging Markets Mounts A Broad Based Comeback!

Early this year, I was told that I did not predict the ‘correction’ in emerging markets.

Of course, I didn’t. I have to admit I am just human. I can’t predict or KNOW ALL events (human or environmental) that may affect the financial markets over the short term.

I won’t even pretend to do something close to it.

The expectation of omniscience is sheer absurdity. Sometimes some people (who have been mostly wrong in reading the markets) just like to engage in nitpicking, perhaps to look for company (misery loves company) or to look for conversation (signaling).

As an avid watcher of markets based on the boom bust cycle, I always say that NO trend moves in a straight line and have argued repeatedly on this space that the so-called unpredictable spontaneous events (MENA political crisis and Japan’s calamities) represented no less than profit taking. [But who would listen to uncontroversial non-faddish non-current event related ideas?]

And that I further argued that emerging markets, including the Philippine Phisix, will eventually move higher once uncertainty would have been discounted to as risk.

Well I guess, broader signs suggest that I’ve been right all along...

These beautiful looking charts from Bespoke Invest reveal that Emerging Markets have been making a HUGE broadbased comeback!!!!

If you want to know what’s keeping up this streak, well, I would suggest for you to study the Austrian Business Cycle Theory (ABCT). While there are other boom bust cycle theories too such as George Soros, Hyman Minsky, Charles Kindelberger et.al., all of whom are relevant, I would say that the Austrians have mostly nailed it.

Of course, the ABCT isn’t mainstream thinking (which means there are attendant social ‘conformity’ risks that goes with it and that you won't need credentialism as CFA or an MBA for this but simply go to mises.org for self study--as I--or take Mises academy online course).

And neither is the ABCT about the Holy Grail investing (which is why you won’t see or predict the interim volatilities).

Rebecca Black’s ‘Friday’ and Demonstrated Preference

Yesterday, while I was watching and listening to this video posted at the Mises Blog my daughter stepped in my room and yelled, “don’t watch it, Pa, it’s a lousy video!”

Initially the rap pop music sounding video indeed seemed quite unimpressive. And for that moment I agreed with my daughter. Yet, instead of leaving the page, I marveled at the 86 million hits!

More interestingly, the video showed a lopsided number of dislikes compared to the likes by almost 6:1. And this has even been reflected on the comment page where many, if not the majority, of the audiences were shouting pejoratives such as “BACON!” (I really don’t know what this idiom meant.)

Wikipedia has even a short history of the viral propelled popularity of Rebecca Black’s Friday music video.

What struck me is that if the video has it so bad as critics (as my daughter and even my youngest son) would have it, what could have prompted 80+ million people to watch it or to keep watching it???!!!

Fittingly, Jeffrey Tucker at the Mises Institute cleared these puzzles in my mind with his article. An excerpt, (bold emphasis mine)

The astonishing popularity of Rebecca Black's "Friday" video — which became the YouTube meme of all memes in the course of a wild six weeks — has mystified many critics.

Was it shared and watched so wildly because it was so bad? Certainly the overwhelming judgement on the part of viewers is that it is atrocious — and yet it is hard to know what that means, since 85 million people not only watched the video but also downloaded the song, bought the ring tone, and devoured every available bit of news about the singer and the song.

Using the principle of "demonstrated preference," this music video ranks as the most popular in human history.

Perhaps it is the digital-age version of Mel Brooks's smash Broadway play The Producers, a story about an attempt to write a play so bad that it flops on the first night. But, in Brooks's hilarious telling, the results were the opposite: the play was so bad that it was brilliant, and it became a smash success, however inadvertently.

Lovers of liberty are often drawn to such scenarios because they highlight the unknowability of the future, the unpredictability of human choice, and the way in which the intentions of the planners (in this case, the producers and writers) are easily upended by consumer choice, which is the driving force of economic progress.

The concept of Demonstrated Preference, according to Murray N. Rothbard, is simply this: that actual choice reveals, or demonstrates, a man’s preferences; that is, that his preferences are deducible from what he has chosen in action. Thus, if a man chooses to spend an hour at a concert rather than a movie, we deduce that the former was preferred, or ranked higher on his value scale. Similarly, if a man spends five dollars on a shirt we deduce that he preferred purchasing the shirt to any other uses he could have found for the money. This concept of preference, rooted in real choices, forms the keystone of the logical structure of economic analysis, and particularly of utility and welfare analysis.

In other words, demonstrated preference applied to this case means that there may have been many critics alright, but apparently there have been more admirers, who may not have been as vocal as these critics.

Besides, one can't claim disliking the music video but keep returning to it as there are thousands of video to choose from. The marginal effort to keep going back simply means that there is a demonstrated preference for this video relative to others.

And perhaps most of these admirers were expressing their tacit approval by clicks (or views) to this music video. Simply said, they voted with the mouse clicks. (It’s now 87.4 million and growing as of this writing!).

This simply signifies the free market process (as expressed by the silent majority) at work!

Nevertheless Mr. Tucker expounds on the music’s allegory for libertarianism. Read the entire article here.

Bottom line: What people say can always be tested by their actions!

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.