How could the Euro be so strong?

That’s the usual question posed by people who read articles about the grim political economic situation in the Eurozone.

Since the Greece debt crisis has began unraveling in 2009 (see timeline here), the Euro had initially been affected (see red arrows) but eventually as the price chart shows, the Euro has been discounting the issue.

This isn’t to say the crisis isn’t real, but rather the crisis is a relative issue. One cannot tunnel on Europe without looking at the conditions of the US or of the other economies.

I superimposed gold’s price trend to illustrate the strong correlation between the Euro and gold. My bullishness in the Euro had been validated (see here and here).

Now going back to the question

Here is my terse reply:

The Euro has been strong because the problems of the US dwarfs the crisis in Europe.

Proof?

From Danske Bank

The Euro has been validating the theory of the great Ludwig von Mises [Causes of Economic Crisis, Stabilization of the Monetary Unit—From the Viewpoint of Theory] who wrote, [emphasis added]

These observers do not understand that the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one.

The above chart puts the entire global debt crisis predicament into perspective by showing how central banks has responded with ‘bailouts’ of their respective financial system

From the supply side, massively printing of money to resolve the debt issue represents the diminishing marginal value of additional money into the economic system.

Here the ECB has printed a lot less of money compared to the US Federal Reserve, perhaps owing to the trauma experienced from the hyperinflation of the Weimar Republic in 1921-23.

From the demand side, the quality and price value of securities absorbed and held in the balance sheets of the US Federal Reserve from the banking system during the crisis should be viewed as a continuing concern.

It’s a misplaced idea or belief that the seeming tranquil conditions today in the US be interpreted as the policy of inflation having successfully settled the legacies of the economic and financial crash in 2008.

The Fed has printed trillions yet home price indices appear to be in a double dip recession.

From yesterday’s S&P press release [bold highlight mine]

This month’s report is marked by the confirmation of a double-dip in home prices across much of the nation. The National Index, the 20-City Composite and 12 MSAs all hit new lows with data reported through March 2011. The National Index fell 4.2% over the first quarter alone, and is down 5.1% compared to its year-ago level. Home prices continue on their downward spiral with no relief in sight.” says David M. Blitzer, Chairman of the Index Committee at S&P Indices. “Since December 2010, we have found an increasing number of markets posting new lows. In March 2011, 12 cities - Atlanta, Charlotte, Chicago, Cleveland, Detroit, Las Vegas, Miami, Minneapolis, New York, Phoenix, Portland (OR) and Tampa - fell to their lowest levels as measured by the current housing cycle. Washington D.C. was the only MSA displaying positive trends with an annual growth rate of +4.3% and a 1.1% increase from its February level.

Chart from CLSA Greed and Fear

A double dip in home prices suggests that the value of the Fed’s assets have been deteriorating considering huge amounts of exposure on mortgage and agency papers.

So neither does this represent as a plus for the US dollar.

Add to that the unresolved fiscal issues.

So how will the US government act on the above? Quantitative Easing 3.0, 4.0, 5.0...nth? Will these make the case for a stronger US dollar relative to the Euro?

To argue so means that money printing won’t have negative effects on the US economy. This would be like believing in a philosopher’s stone—the alchemy of turning lead into stone.

Of course it’s also nonsense to believe in the argument that fiscal restraint or “austerity” as the sole or main basis for bearishness on the Euro, except when you see the world as being driven by “spending” alone. Yet this view appears gradually being disproven.

Putting one’s house in order should be seen as a virtue and not a vice.

Also the above discussion hasn’t been new, I have dealt with this before here

True, political events (the clash between the ECB and national officials) can undermine the Euro, but again the big picture, based on the above, says the balance of risks has been tilted against the US dollar.

And it isn’t in the political interests of both contending political entities to see a worsening of schism that would only undermine their statures and importantly their tenures.

As fund manager Axel Merk writes, (bold emphasis mine)

We have long argued that it is not in Greece's interest to default at this stage because Greece needs to get its primary deficit under control before restricting its debt. As further reforms are implemented, the risk/reward ratio for Greece will change to potentially favor a default to reduce its debt burden. Delaying any default benefits Greece because any default now would impose an immediate adjustment of the primary deficit as it may be impossible to get new loans at palatable terms.

However, if ECB deserts Greece, the risk/reward assessment for Greece is changing. If the ECB gets too tough on Greece, dynamics in Greece may drive political dynamics to favor a default or even a re-introduction of the drachma.

Mind you that this would not be in Greece's interest: a default now won't fix Greece's underlying structural issues. Leaving the eurozone might cause an implosion of Greece's financial system. But from Greece's point of view, if they feel deserted by the ECB, political dynamics may favor the worst of the bad choices at hand.

And that’s why a second round of bailout seems to be at work as of this writing. So both the US and the Euro will be inflating again and that the question would be which currency inflates more.

Popular analyst John Mauldin predicts “The euro appears to me to be a massive short.” I hope he puts his money on his forecast, and wish him a lot of good luck.

I’d be taking the opposite fence though, until I see signs of the Eurozone inflating more than the US or an imminent political instigated collapse of Euro.

However, instead of buying the Euro, the best position in my view, would be to buy gold.

Gold would not share the same risk of the Euro although both of them have paralleled each other’s moves.

Gold’s nemesis would be a fiscally disciplined limited government, sound money and free markets, forces which we won’t be seeing anytime soon yet.

Was the IMF Chief Jailed for Discovering that Gold held by the US has Vanished?

That’s what Russia claims, according to the Eutimes.net

A new report prepared for Prime Minister Putin by the Federal Security Service (FSB) says that former International Monetary Fund (IMF) Chief Dominique Strauss-Kahn was charged and jailed in the US for sex crimes on May 14th after his discovery that all of the gold held in the United States Bullion Depository located at Fort Knox was ‘missing and/or unaccounted’ for.

According to this FSB secret report, Strauss-Kahn had become “increasingly concerned” earlier this month after the United States began “stalling” its pledged delivery to the IMF of 191.3 tons of gold agreed to under the Second Amendment of the Articles of Agreement signed by the Executive Board in April 1978 that were to be sold to fund what are called Special Drawing Rights (SDRs) as an alternative to what are called reserve currencies.

This FSB report further states that upon Strauss-Kahn raising his concerns with American government officialsclose to President Obama he was ‘contacted’ by ‘rogue elements’ within the Central Intelligence Agency (CIA) who provided him ‘firm evidence’ that all of the gold reported to be held by the US ‘was gone’.

Upon Strauss-Kahn receiving the CIA evidence, this report continues, he made immediate arrangements to leave the US for Paris, but when contacted by agents working for France’s General Directorate for External Security (DGSE) that American authorities were seeking his capture he fled to New York City’s JFK airport following these agents directive not to take his cell-phone because US police could track his exact location.

Read the rest here

I wouldn’t know how valid this report is. One thing for sure, whether it is Russia, the US or the IMF, all appears to be dogged by credibility problems.

China Prepares For Massive Bailout!

China spent around $586 to shield itself from the global meltdown in 2008. The aftermath has been to engender bubble conditions as evidenced by the ballooning balance sheets of their banking system and the local government. Recognizing the risk of a bust, China mulls a massive bailout.

The following report from Reuters, (bold emphasis mine)

China's regulators plan to shift 2-3 trillion yuan ($308-463 billion) of debt off local governments, sources said, reducing the risk of a wave of defaults that would threaten the stability of the world's second-biggest economy.

As part of Beijing's overhaul of the finances of heavily-indebted local governments, the central government will pay off some of their loans and state banks including some of the "Big Four" will be forced to take some losses on the bad debt, said the sources, both of whom have direct knowledge of the plans.

Part of the debt will also be shifted to newly created companies, while private investors would be welcomed in projects previously off-limits to them, sources said.

Beijing will also lift a ban on provincial and municipal governments selling bonds, a step aimed at bolstering their finances with more transparent sources of funding.

Many analysts see China's pile of local government bad debt as a major risk to the economy, especially as the economy slows, but few see widespread banking fallout as they believe cash-rich Beijing can step in to soak up losses.

The clean-up plan could boost investor confidence in Chinese banks, which have provided many of their loans as part of the massive economic stimulus program launched by Beijing in late 2008 to counter the global financial crisis.

The program resulted in unfettered lending to local government financing vehicles, hybrid government-company bodies that governments used to get around official borrowing restrictions.

After a months'-long investigation into local government liabilities, Beijing has determined that local governments have borrowed around 10 trillion yuan, said one of the sources.

Additional comments:

1. The previous bailout (stimulus spending) fostered a political economic environment of moral hazard whose consequence was to propagate massive misdirection of capital investments.

2 While lifting the ban on selling provincial and municipal governments seems good, as bond markets will supposedly reflect on the economic conditions, alternatively seen, this measure is meant to soak up private savings into government bailout programs. In short, this represents no more than China’s version of financial repression at work.

3. It is true that China has massive savings that perhaps may afford her to conduct another bailout, but as previously discussed, bailouts would only consume productive capital by diverting them into non-productive activities. Additionally part of the bailouts will surely be accommodated with inflationism.

4. The proposed bailout which accounts for as 20-30% of local government could be understated. Yet this seems like more evidence of the maturing phase of China’s bubble cycle.

5. If China applies the above bailouts before the bust then this could extend the boom but at the risk of that the next crisis will come with a greater intensity.

How Anti-Dumping Leads to Reduced Competitiveness

For the left, because trade is a zero sum game and an activity done by nations and not by individuals, imbalances are always someone’s fault. Thus prescribe policies that lean towards protectionism.

One of their populist claim is that asymmetric currency values leads to the alleged imbalances. But they hardly talk about how extant protectionist policies have been contributing to the loss of competitiveness and consequently high unemployment rates.

One of such protectionist policy is the anti-dumping emasures

Cato’s Dan Ikenson elaborates (bold highlights mine)

During the decade from January 2000 through December 2009, the U.S. government imposed 164 antidumping measures on a variety of products from dozens of countries. A total of 130 of those 164 measures restricted (and in most cases, still restrict) imports of intermediate goods and raw materials used by downstream U.S. producers in the production of their final products. Those restrictions raise the costs of production for the downstream firms, weakening their capacity to compete with foreign producers in the United States and abroad.

In all of those cases, trade-restricting antidumping measures were imposed without any of the downstream companies first having been afforded opportunities to demonstrate the likely adverse impact on their own business operations. This is by design. The antidumping statute forbids the administering authorities from considering the impact of prospective duties on consuming industries—or on the economy more broadly—when weighing whether or not to impose duties.

That asymmetry has always been insane, but given the emergence and proliferation of transnational production and supply chains and cross-border investment (i.e., globalization)—evidenced by the fact that 55% of all U.S. import value consists of raw materials, intermediate goods, and capital equipment (the purchases of U.S. producers)—it is now nothing short of self-flagellation.

Most of those import-consuming, downstream producers—those domestic victims of the U.S. antidumping law—are also struggling U.S. exporters. In fact those downstream companies are much more likely to export and create new jobs than are the firms that turn to the antidumping law to restrict trade. Antidumping duties on magnesium, polyvinyl chloride, and hot-rolled steel, for example, may please upstream, petitioning domestic producers, who can subsequently raise their prices and reap greater profits. But those same “protective” duties are extremely costly to U.S. producers of auto parts, paint, and appliances, who require those inputs for their own manufacturing processes.

Read the rest here

Environmental Apocaplytics: Put Money Where Your Mouth Is

Professor Don Boudreaux at the Wall Street Journal does a Julian Simon (free market economist Julian Simon made a famous wager against Malthusian Paul Elrich over the false notion of resource scarcity and handily won)

Writes Don Boudreaux, (bold emphasis added)

I reject this pessimism. I do so because economics and history teach that human beings in market economies have proven remarkably creative and resourceful in overcoming challenges. And there's no reason to think that this creativity and resourcefulness will fail us in the face of climate change.

Since 1950 there have been 57 confirmed F5 tornadoes, with winds between 261–318 miles per hour, in the U.S. Of those, five struck in 1953; six in 1974. So far this year there have been four F5 tornadoes in the U.S., including the devastating storm that killed more than 130 people in Joplin on May 22. F5 tornadoes are massive, terrifying and deadly. But they generally touch down in unpopulated areas, thus going unnoticed. The tragedy of Joplin and other tornadoes this year is that they touched down in populated areas, causing great loss of life. Yet if these storms had struck even 20 years ago there would have been far more deaths.

So confident am I that the number of deaths from violent storms will continue to decline that I challenge Mr. McKibben—or Al Gore, Paul Krugman, or any other climate-change doomsayer—to put his wealth where his words are. I'll bet $10,000 that the average annual number of Americans killed by tornadoes, floods and hurricanes will fall over the next 20 years. Specifically, I'll bet that the average annual number of Americans killed by these violent weather events from 2011 through 2030 will be lower than it was from 1991 through 2010.

If environmentalists really are convinced that climate change inevitably makes life on Earth more lethal, this bet for them is a no-brainer. They can position themselves to earn a cool 10 grand while demonstrating to a still-skeptical American public the seriousness of their convictions.

But if no one accepts my bet, what would that fact say about how seriously Americans should treat climate-change doomsaying?

Do I have any takers?

Quote of the Day: Challenging Monopolies

From excerpt from Forbes Magazine on how John Gokongwei owned Cebu Pacific [PSE: CEB] grabbed the airline industry tiara from Lucio Tan’s Philippine Airlines [PSE: PAL]. (emphasis mine)

It was Lance's father, legendary ragsto- riches entrepreneur John Gokongwei Jr., who had the idea to start Cebu Pacific. John, now 84, sits atop JG Summit Holdings, one of the Philippines' largest conglomerates, and a family fortune that FORBES ASIA pegged at $1.5 billion last year. His interest in aviation was piqued after reading about U.S. discounter Southwest Airlines at the same time the Philippine government decided to open up the airline industry. But Lance believes there was another layer to his father's interest: "About a year before we bid for PAL and lost. So when deregulation came up, well, my dad loves challenging monopolies."

Read more here

Monopolies, which signify as government privileges, operate on principles of anti-competition. This implies that monopolies are fundamentally inefficient, are driven by political goals and irresponsive to consumer demands which all add up to say that monopolies are slow to adapt to the changes in the marketplace.

And so when industries once dominated by monopolies are deregulated, this ‘chink in the armor’ becomes exposed. In a newly deregulated environment, entrepreneurs should pounce on the opportunities to challenge government monopolies as the Gokongwei’s did.

Will Derivatives Cause the Next Financial Crisis?

So predicts investing guru Mark Mobius

According to this Bloomberg report,

Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group, said another financial crisis is inevitable because the causes of the previous one haven’t been resolved.

“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said at the Foreign Correspondents’ Club of Japan in Tokyo today in response to a question about price swings. “Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”

The total value of derivatives in the world exceeds total global gross domestic product by a factor of 10, said Mobius, who oversees more than $50 billion. With that volume of bets in different directions, volatility and equity market crises will occur, he said.

The global financial crisis three years ago was caused in part by the proliferation of derivative products tied to U.S. home loans that ceased performing, triggering hundreds of billions of dollars in writedowns and leading to the collapse of Lehman Brothers Holdings Inc. in September 2008. The MSCI AC World Index of developed and emerging market stocks tumbled 46 percent between Lehman’s downfall and the market bottom on March 9, 2009.

A financial crisis may be around the corner, but I highly doubt if derivatives will be the principal cause of it.

Derivatives were symptoms of the 2008 crisis rather than the cause. A bubble in the US housing prices had been pricked by rising interest rates which eventually got vented on the marketplace, part of which had been seen on derivatives.

Prescribing regulations, which for some function as an elixir, seems oversimplistic and naïve.

Regulators and the markets have played a perpetual cat and mouse game. Regulators usually apply regulations premised on the past events and markets usually find ways to circumvent them. Eventually fueled by monetary inflation, such loopholes become conduits for the next bubble. So regulations would look like the whack-a-mole game. Regulators hit the moles only as they appear.

And as pointed in the post below, regulations and complex relationships between politically privileged groups and regulators functioned as main causes to the last US mortgage crisis. History may rhyme but not necessarily repeat. Players and markets involved may be different, but principle will be the same. Bubble cycles from inflationism.

Besides, regulators are people too and so with market participants. While both may differ in their respective operating incentives, shared relationships and interactions will cause difficulties in the administration or implementation of regulations. Not even a total ban on derivatives will erase or reduce the risks of another financial crisis caused by inflationism. That would be barking on the wrong tree.

2008 US Mortgage Crisis: The US Federal Reserve and Crony Capitalism as Principal Causes

Stanford University’s John B. Taylor reviewed Gretchen Morgenson and Joshua Rosner’s newest book, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon.

He finds that the Ms. Morgenson and Mr. Rosner placed the blame mostly on a complex crony based system between the financial industry and US Federal Reserve.

Mr. Taylor writes, (hat tip David Boaz) [bold emphasis mine]

The book focuses on two agencies of government, Fannie Mae and the Federal Reserve. The mutual support system is better explained and documented in the case of Fannie, the government-sponsored enterprise that supported the home mortgage market by buying mortgages and packaging them into marketable securities which it then guaranteed and sold to investors. The federal government supported Fannie Mae — and the other large government-sponsored enterprise, Freddie Mac — by implicitly backing up those guarantees and by providing favorable regulatory treatment and protection from competition. These benefits enabled Fannie to rake in excess profits — $2 billion in excess, according to a 1995 study by the Congressional Budget Office.

Fannie Mae was established as a government agency but became a private, shareholder owned company with a charter from Congress requiring the company to support the housing finance system. During the culmination of the crisis in 2008 Fannie Mae along with another Government Sponsored Enterprise (GSE) Freddie Mac was nationalized.

The point is that politically motivated enterprises operate distinctly from the incentives of free market forces. Such entities are wards of the state.

Yet none of this is new to followers of the Austrian school.

Murray N. Rothbard narrated on a parallel unholy relationship between the US Federal Reserve and the commercial banks [bold emphasis mine]

It should now be crystal clear what the attitude of commercial banks is and almost always will be toward the Central Bank in their country. The Central Bank is their support, their staff and shield against the winds of competition and of people trying to obtain money which they believe to be their own property waiting in the banks' vaults. The Central Bank crucially bolsters the confidence of the gulled public in the banks and deters runs upon them. The Central Bank is the banks' lender of last resort, and the cartelizer that enables all the banks to expand together so that one set of banks doesn't lose reserves to another and is forced to contract sharply or go under. The Central Bank is almost critically necessary to the prosperity of the commercial banks, to their professional career as manufacturers of new money through issuing illusory warehouse receipts to standard cash.

So whether it is the politically backed GSEs or the commercial banks, the US Federal Reserve implicitly treats them as natural political constituents.

Mr. Taylor adds,

The book then gives examples where Fannie’s executives — Jim Johnson, CEO from 1991 to 1998, is singled out more than anyone else — used the excess profits to support government officials in a variety of ways with plenty left over for large bonuses: They got jobs for friends and relatives of elected officials, including Rep. Barney Frank, who is tagged as “a perpetual protector of Fannie,” and they set up partnership offices around the country which provided more jobs. They financed publications in which writers argued that Fannie’s role in promoting homeownership justified federal support. They commissioned work by famous economists, such as Nobel Prize-winner Joseph Stiglitz, which argued that Fannie was not a serious risk to the taxpayer, countering “critics who argued that both Fannie and Freddie posed significant risks to the taxpayer.” They made campaign contributions and charitable donations to co-opt groups like the community action organization ACORN, which “had been agitating for tighter regulations on Fannie Mae.” They persuaded executive branch officials — such as then Deputy Treasury Secretary Larry Summers — to ask their staffs to rewrite reports critical of Fannie. In the meantime, Countrywide, the mortgage firm led by Angelo Mozilo, partnered with Fannie in originating many of the mortgages Fannie packaged (26 percent in 2004) and gave “sweetheart” loans to politicians with power to affect Fannie, such as Sen. Chris Dodd of Connecticut. The authors write that “Countrywide and Fannie Mae were inextricably bound.”

The above only shows that political distribution, whether it is in the Philippines or in the US, are apportioned not by merits but by political affiliations. And on the same plane, the gaming of the system by vested interest groups.

Again from Mr. Taylor,

The Fed takes a beating throughout the book. Early on the authors take on the Boston Fed, and in particular its research director Alicia Munnell, for using a study documenting racial discrimination in mortgage lending to justify the relaxation of credit standards, even though the study’s findings were found to be flawed by other researchers. And they criticize the very low interest rate set by the Fed when Alan Greenspan was chairman and Ben Bernanke was a Fed governor, saying it “contributed mightily to the mortgage lending craze,” adding that “with the Fed on a rate-cutting rampage, demand for adjustable-rate mortgages with relatively low initial interest costs had become incendiary.”

Well aside from low interest rates and the administrative policies to boost homeownership, there had been many other factors that has likewise contributed to the bubble, such as tax policies which encouraged exposure on debt rather than equity, agency problems and moral hazard (implicit backing from the Fed or the Greenspan Put), regulatory arbitrage which resulted to the creation of the (off balance sheet) shadow banking system, regulatory capture which played a substantial part of the crony relationships, the conflict of interest on credit rating agencies which had skewed incentives in favor debt issuers (investment banks) and many more.

Inflationism compounded by various forms of interventions represents as the anatomy of a bubble.

Massive Power Outages Looms on China’s Price Controls

China’s government is predicting a massive power outage which according to Forbes’ columnist Gordon Chang

a shortfall larger than the total installed capacity of Argentina—will be the worst ever, even more serious than the one in 2004.

In an earlier post, I mentioned that policies of price controls will definitely lead to unintended consequences, one of which will be shortages. Here is my comment on China’s reactionary policy to fix prices to combat inflation last April

This serves as a politically convenient short-term approach but nonetheless a foolish one because it defies basic economics that comes nasty repercussions (rationing, long lines, more political instability).

The Romans tried it, US President Nixon tried it and many political authorities spanning 4 centuries tried it but all of them failed. Venezuela’s Hugo Chavez has also recently implemented this but has even worsened inflation and shortages.

And these have been so predictable.

First politicians create inflation by debasing the currency.

Next, politicians blame the market for self inflicted ills, thereby, superficially react to such imbalances by imposing price controls which eventually backfires.

Forbes’ Gordon Chang narrates on how China’s price controls have been affecting her energy economics (bold emphasis mine)

The more important factor is that the cost of this commodity has been soaring. Spot coal is up 20% this year, in part because Japan is buying more of it to replace the output of nuclear power stations that have recently gone offline. Yet China’s electricity tariffs have risen only 2.5% this spring.

This mismatch has also been evident for the last half decade when coal prices have more than doubled while Chinese electricity charges have increased by only a third. As a result, electricity producers have been squeezed hard. Coal-fired plants lost 10 billion yuan during the first four months of the year. The chairwoman of China Power International, a utility, recently warned that a fifth of China’s 436 coal plants could go bankrupt.

Beijing created this crisis by fixing the price of electricity. At a time when inflation would be out of control were it not for price controls—formal and informal—Chinese leaders are especially determined to hold the line on power charges.

Technocrats can tell producers what they can charge, but they cannot prevent the inevitable. Because power companies are losing money generating each kilowatt of electricity, they have acted to minimize losses. They are not going ahead with expansion plans, they are not running at full capacity, and some of them are not running their plants at all. Many generating stations—an abnormally large number of them—are now closed for maintenance despite the desperate need for electricity.

Which businesses are getting juice? Technocrats in the Chinese capital can’t help but meddle, and they are favoring state-owned energy-intensive industries—chemicals, construction materials, iron and steel, and non-ferrous metals, for instance—over others—private businesses, exporters, and service industries. The result is that the economy is becoming even more dominated by the state.

It’s worth repeating that price controls have been futile experiments continually exercised by political leaders around the world for over FOUR centuries! The attempts to defy demand and supply always end in repeated failures which eventually penalize the citizenry.

Politicians and bureaucrats think that they can apply Lenin’s dictum where “a lie told often enough becomes a truth”. Unfortunately, such lies ultimately unravels in the face of economic reality. As Winston Churchill once said “The biggest mistake leaders can make is to give people false hope that melts like snow”. Such false hope has always been meant to obtain people’s approval over the short term. And overtime, this will likely turn into despair and rage.

In addition, like any redistributive measures based on inflationism, benefits accrue to the government at the expense of the private sector. Metaphorically speaking, China has been killing “the goose that laid the golden eggs”.

Chinese authorities appear to be blindsided by overconfidence, basking from her recent economic successes. Yet overconfidence is a conventional trait that hallmarks the pinnacle of the boom phase of the bubble cycle.

To add, China appears to be reverting back to her old ways which makes me even more a skeptic on predictions that China will trigger the end of “the Age of America” in 2016.

At the end of the day, the above developments only reinforce my view of the maturing phase of China’s bubble cycle. China may not yet implode, but the writings on the wall suggest that we are likely headed on that direction.

How Multilateral Agencies Profit From Global Taxpayers

I have suggested that we should end or abolish the IMF, for many reasons such as the seeming perpetual advocacy of various forms of interventionism, incompetence, wealth transfer, moral hazard and political inequality.

This suggestion should also apply to the other multilateral agencies as well.

Pajama Media reveals how these institutions have used politics to foster wealth inequalities (bold emphasis added, italics original)

Many of Washington’s 2,600 technocrats working at the International Monetary Fund do not regard Dominique Strauss-Kahn’s lavish lifestyle as an anomaly.

Privately they admire it, recognizing it as a description of their own standard of living. They call their many unseen perks “golden handshakes.” At the World Bank, Inter-American Development Bank, the African Development Bank, and at the IMF, you find extravagantly paid men and women who masquerade as anti-poverty fighters for the Third World. As one World Bank vice president said upon his resignation: “Poverty reduction is the last thing on most World Bank bureaucrats’ minds.”

These global institutions are supposed to act as non-profits, but big salaries and big perks rule as the norm. And you’re paying for them: as the largest single contributor, American taxpayers pick up the tab.

By now everyone knows about DSK’s extravagant $420,000 employment agreement that included an additional $73,000 for living expenses — a provision explained thusly by the IMF: “To enable you to maintain … a scale of living appropriate to your position.” Most of the non-profit development world remained silent when the Fund announced a $250,000 “golden parachute” severance for the indicted managing director.

A PJM survey found that a common annual compensation package for senior management at the anti-poverty banks exceeds $500,000 — tax-free. World Bank President Robert Zoellick currently receives $441,980 in base salary and $284,500 in other benefits. Strauss-Kahn’s deputy, John Lipsky, receives $384,000 in base salary plus “living allowances.”

Some may argue as the IMF did that global financial leaders — even from governmental organizations – should be highly compensated. But the IMF and World Bank payments for their executives are three times the annual salary for U.S. Federal Reserve Chairman Ben Bernanke, and four times the salary of America’s Federal Reserve governors: Bernanke’s gross annual salary is set at $199,700; his governors receive $179,000.

The global banks’ stratospheric governmental salaries are not limited to chief executives. Ten of Zoellick’s deputies receive tax-free base pay of $321,00 to $347,000, plus enjoy an additional $210,000 in benefits. Even mid-level World Bank employees earn well into six digits: the average salary for a professional manager is $181,000, plus $97,000 in benefits. A senior adviser receives on average $238,000 plus $127,000 in benefits. A vice president receives $286,000 plus $153,000 in benefits.

The biggest hidden benefits are the off-the-book perks called “living allowances.” These perks can nearly double a stated salary. Of the 2,600 IMF and 10,000 World Bank full-time employees, all receive some form of supplemental living allowances in addition to their base pay. These include home leave grants, dependent allowances, travel perks, and education “grants” for their children to attend private schools. In addition, they offer generous pensions and health insurance policies.

Where do they get their lavish “golden handshakes”? From us, the productive sector, the taxpayers.

True, I am delighted that some of them have rediscovered the importance of economic freedom. But this isn’t anything new, as economic freedom has been long been advocated by classical liberals since the 19^th century.

In other words we don’t need to have highly paid bureaucrats to tell us something our ancestors knew, long ago.

Yet if economic freedom is to be nurtured, then the more these institutions are hardly needed because the services that they offer can sufficiently be provided for by the private sector.

Remember, the resources used to finance “golden handshakes” are resources that could have been used to generate productive rather than consumptive activities.

Worst, the above only shows of how the political divide from these institutions increases social inequality.

And as Cato’s Dan Mitchell aptly points out,

Redistribution from rich to poor is not a good idea, but it is far more offensive when the coercive power of government is used to transfer money from ordinary people to the elite.

This serves as another instance of politically based parasitism.

Quote of the Day: Focusing Effect

Focusing effect is a mental heuristic where

we tend to weigh attributes and factors unevenly, putting more importance on some aspects and less on others

Again from the prodigious Matt Ridley on interpreting events, (emphasis added)

Another way of making the same point is that good news tends to be gradual, incremental and barely visible, while bad news almost by definition comes in sudden, newsworthy lumps: wars, crashes, disasters, epidemics. It is impossible to see a field of wheat growing, but easy to see it washed away by a flood.

Awesome.

Are Renewable Energy ‘Renewable’?

One of the most valuable lessons I have learned in life is not to see things as presented or as they are. That’s because things or events that we see or sense does not cover on how they existed or how they got there in the first place.

I am indebted to the late great proto-Austrian Frederic Bastiat, who inspired an overhaul of life’s outlook personified by this stirring passage

In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause - it is seen. The others unfold in succession - they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, - at the risk of a small present evil.

This applies to everything we do.

And these have been most pronounced especially in the domain of politics where populist political solutions are sold on the merits of superficiality or visibility.

In the realm of environmental politics, one good example would be the politically correct populist practice of ‘Earth Hour’.

We are told to close lights for an hour so that we can symbolically celebrate on ‘saving the environment’ by reducing carbon footprints.

However in reality, unless we decide to stop living, we will be using energy. PERIOD.

And the alternative to using ‘environmental hazardous’ conventional fossil based energy would be to revert to the medieval age and use candles. People hardly see that candles signify as more environmental unfriendly than the conventional energy.

Of course by proposing to cut lights also extrapolates to stopping or to reducing production and trade. Doing so means creating shortages in people’s needs. This means widespread hunger and famine. This brings the Malthusian nightmare to a reality.

How do you suppose that we would be able to survive 6.77 billion people by reverting to the medieval age of economic system?

So saving the environment means we end up killing one another (politics of plunder-via war) or killing ourselves (man made catastrophe).

It isn’t that Malthus was right. Instead, it is because political correctness founded the concept of saving earth signifies as concealed misanthropy.

The same blight haunts proponents of renewable energy.

From the surface, renewable energy would seem as environmental friendly. That is what is seen. What is not seen is how environmental damaging renewable energy would be when they are constructed for commercial operations.

Matt Ridley eloquently explains, (bold emphasis added)

It turns out that the great majority of this energy, 10.2% out of the 13.8% share, comes from biomass, mainly wood (often transformed into charcoal) and dung. Most of the rest is hydro; less than 0.5% of the world's energy comes from wind, tide, wave, solar and geothermal put together. Wood and dung are indeed renewable, in the sense that they reappear as fast as you use them. Or do they? It depends on how fast you use them.

One of the greatest threats to rain forests is the cutting of wood for fuel by impoverished people. Haiti meets about 60% of its energy needs with charcoal produced from forests. Even bakeries, laundries, sugar refineries and rum distilleries run on the stuff. Full marks to renewable Haiti, the harbinger of a sustainable future! Or maybe not: Haiti has felled 98% of its tree cover and counting; it's an ecological disaster compared with its fossil-fuel burning neighbor, the Dominican Republic, whose forest cover is 41% and stable. Haitians are now burning tree roots to make charcoal.

You can likewise question the green and clean credentials of other renewables. The wind may never stop blowing, but the wind industry depends on steel, concrete and rare-earth metals (for the turbine magnets), none of which are renewable. Wind generates 0.2% of the world's energy at present. Assuming that energy needs double in coming decades, we would have to build 100 times as many wind farms as we have today just to get to a paltry 10% from wind. We'd run out of non-renewable places to put them.

You may think I'm splitting hairs. Iron ore for making steel is unlikely to run out any time soon. True, but you can say the same about fossil fuels. The hydrocarbons in the earth's crust amount to more than 500,000 exajoules of energy. (This includes methane clathrates—gas on the ocean floor in solid, ice-like form—which may or may not be accessible as fuel someday.) The whole planet uses about 500 exajoules a year, so there may be a millennium's worth of hydrocarbons left at current rates.

Read the rest here.

What you see isn’t always what you get.

Prudent Investor Newsletters at the Stock Market Pilipinas Forum

Stock Market Pilipinas has willfully opened a (discussion) thread on their forum for my articles on the domestic and global stock markets.

So aside from my insights, anyone interested in investing in the Philippine Stock Exchange may find this forum as a rich and valuable source of info and a good venue to exchange ideas.

Proceed to Stock Market Pilipinas here (registration required)

Thanks Ollie.

How External Forces Influence Activities of the Phisix

There are secrets to our world that only practice can reveal.-Nassim Nicolas Taleb, Anti Fragility, Chapter 4 How (Not) To Be A Profit

We definitely live in interesting times.

It has long been my position that gold and global equity markets including the Philippine Phisix have been strongly correlated where the price actions of the gold market frequently leads equity markets.

Look at the beauty of such correlationship.

The above 2- year chart represents the price actions of the Phisix (PSEC red-black candlesticks) and gold prices in US dollar (black line). The relationship even looks like a 5-wave Elliott Wave count.

One would note that the oscillations may not be in exactitude, but clearly a symmetric cadence has been in motion.

The implication is: for as long as the trend of gold prices remains to the upside, the Phisix will likely follow unless domestic factors become powerful enough to impel a disconnect.

Prices of gold have served as reliable barometer so far.

Alternatively, this also means that accrued corporate earnings or micro economics or mainstream’s macro views can hardly explain this phenomenon.

Consumption demand, which has been the popular perspective, can hardly explain the broad based increases in commodity prices along with equity prices.

Of course correlation does not imply causation or that there presents no causal relationship between gold and the Phisix.

The point is: both gold and the Phisix account for as symptoms of an underlying pathology, which has largely been an unseen factor.

The Phisix-gold phenomenon has not been isolated.

This can also be observed elsewhere.

This relationship appears evident also in the global equity markets: commodities (represented by the CCI) have strongly been correlated with the S&P 500 and the Dow Jones World (DJW).

Financial Repression and Inflationism

Anyone can say what they want but it can’t be denied that the price actions in the commodity markets have been tightly connected with actions in the global equity markets.

Meanwhile the divergences in bond markets can be explained. Bond markets have essentially been rigged, have been heavily distorted and used as main instruments by governments to conduct financial repression[1]. They hardly account for as signs of deflation as deflation exponents argue.

Government interventions have been rampant almost everywhere: in the commodity markets[2] by the precipitate doubling of credit margins over a very short time frame, on the bond markets by banning short sales[3] and even seizing of private pensions such as in Argentina, Hungary, Ireland and demanding partial control of private savings in Bulgaria and Poland[4].

Even the construction of Consumer Price statistics [CPI] in the US has been severely contorted[5] which has largely been skewed towards housing.

The general incentive appears to be to keep CPI low so as to continually justify the policy of inflationism, which benefits the banking sector and the bureaucracy most.

Furthermore, the ongoing problems in the Eurozone (fiscal reforms), in China (inflation), in Japan (aftermath of the triple whammy calamity) and in the US (fiscal reforms) will likely prompt US authorities to avoid the risk of a bond market auction failure and similarly the potential risk posed by a further downslide in the housing industry which could destabilize the balance sheets of the highly protected banking industry[6]. This suggests of the likelihood of more Quantitative Easing (QE) programs to come.

Yet clamor for more QE from the mainstream has grown louder[7] which I think is part of the mind conditioning of the public meant for its acceptance.

Incidentally, the US Federal Reserve has been the largest buyer of US treasury [8]. This implies that without the QE, and with lower purchases from foreign entities, interest rates in the US will rise.

Hence, the overall direction of policies by global governments has been to expropriate private sector savings via printing money, keeping interest rates artificially down and outright confiscation (taxation or nationalization of pensions).

The leakages from these activities have percolated into commodity and stock markets.

Yet stock markets have also served as a target[9] of government policies considering their predominant guiding policy of the “wealth effect” doctrine.

So the traditional metrics to evaluate stock markets investments has been eclipsed by the direction of government policies as I have been predicting since 2008[10].

The Currency-Equity Link

If you should doubt such transmission mechanism, there are more proofs that the Phisix has been driven mainly by external forces.

It has also been a position of mine that the Philippine Peso and the Phisix have long had a symbiotic relationship.

Such actions are apparently being reinforced anew.

On the upper window, the recent feebleness in the Phisix (black candle stick) seems also reflected on the USD-Peso (green line).

In the past, a rising Peso would mirror a buoyant Phisix and vice versa. Recently both the Phisix and Peso seems to have hit the wall simultaneously (red trend lines) at the start of May (violet vertical line)!

And this has NOT been confined to a Peso-Phisix relationship. The same equity-currency collegial relationship pervades in Asia (see lower window).

The rally in the JP Morgan-Bloomberg Asian Dollar basket (ADXY- yellow line) and the MSCI Asia Pacific (MXAP:IND) has also been foiled at the start of May! So the rallies in both Asian currencies and Asian equity markets have been thwarted also on the first week of May.

Globalization Decoupling and Political Tea Leaves

The above only exhibits the depth of the interdependence of the global financial markets.

Those who extrapolate ‘decoupling’ on this highly globalized environment, will get the analysing and predicting the directions of the markets all wrong.

Globalization should not be seen only as a function of trade, labor, investment and capital flows but also on the transmission effects of global monetary policies (financial globalization) where the US as the world’s de facto currency reserve has the most influence.

Also the above price weaknesses share a common denominator: the early days of May 2011.

It is during this period where administrative interventions against the markets transpired, such as the war on commodity markets.

So whether it is the commodity markets or Asian currencies and Asian equities the coordinated reaction from interventions has been quite evident.

The chart also suggests that a seeming reprieve in the interventions has palpably led to a bounce.

Whether this rally is a function of a dead cat’s bounce (a natural counter reaction to a previously extended action) or simply a reversion to the major trend has yet to be established. Of course governments may use such occasion to further intrude on the marketplace that may add to market’s instability.

It’s not in my crystal ball to go for short term trends. Although in the understanding that politics drives the markets today, governments could use market volatility to justify prospective money printing programs. So markets could go either way from here.

Of course, it is true that seasonal factors (such as “Sell on May and Go Away”[11]) can affect the market’s activities. These signify as statistical metrics that are subject to margins of error.

In other words, there would likely be more significant variables that may influence the markets than plain seasonality. And as said above, a major force will be politics.

Bottom line:

The actions in the Phisix reflect on its tight connection with the global financial markets. And these activities have likewise echoed the actions of commodity markets.

These conjoint motions represent as symptoms or signs of major forces operating beyond the superficial understanding of the consensus on what propel the actions in the marketplace. Such force is the policy induced boom bust cycles.

Because of this tight correlations, any extrapolations or predictions of decoupling will likely be falsified when the markets undergoes another episode of spasms. Decoupling under today’s US Dollar based system will prove to be a charade.

For now, the stalled rally in the Phisix has coincided with the weakness of global equity markets and commodity prices. Such infirmities appear to have been orchestrated, perhaps specifically designed to achieve unannounced political goals.

Yet a rally in the commodity sphere, which should manifest mostly a decline of the US dollar, will translate to a rally in the Phisix and the Peso.

This rally could happen anytime.

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[1] See Financial Repression Drives The Bond Markets, May 23, 2011

[2] See War on Commodities: Intervention Phase Worsens and Spreads With More Credit Margin Hikes!, May 14, 2011

[3] See War on Speculators: Restricting Short Sales on Sovereign Debt and Equities, May 18, 2011

[4] nation.foxnews.com Watch Out! Feds Could Seize Your Private Retirement Savings, May 23, 2011

[5] See US CPI Inflation’s Smoke and Mirror Statistics, May 18, 2011

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

[7] See Mainstream Calls For More Quantitative Easing, May 24, 2011

[8] Wood, Christopher The new bond conundrum, Greed & Fear, CLSA May 6, 2011 scribd.com

[9] See The US Stock Markets As Target of US Federal Reserve Policies, May 12, 2011

[10] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?, November 30, 2008

[11] See Global Equity Markets: Sell in May and Go Away?, May 16, 2011

Phisix: Market Consolidation and Rotational Process

It was a seesaw week for the Phisix. The local benchmark fumbled at the start but rallied strongly to close marginally lower (.25%). Year to date the Phisix remains on a positive ground up 1.75%.

The pressure encountered by the Philippine market appears to have been mainly influenced by the activities in the global equity markets where, except for Latin America, most of the major world indices posted losses for the week.

Though the markets have been biased towards the profit takers, the balance has not been lopsided.

Market breadth as shown by the advance decline spread reveals of a consolidation phase.

This means that the market sentiment, while slightly tilted towards decliners, has been mostly mixed.

The varied performances can even be seen from the sectoral performance perspective which continues to manifest signs of rotation.

Except for the mines which have been on ablaze for the NINETH consecutive week, the only sector that outclassed the mines had been the service industry, led by PLDT and Globe Telecoms.

Meanwhile the industrial sector piggybacked on the advances of URC and Meralco to squeeze out marginal gains.

On the other hand, the property, financial (last week’s outperformer) and holding firms accounted for most of the losses.

The mixed market performance also indicates that the balance of prices, in terms technicals (particularly overbought or oversold conditions) as a function of profit-taking activities, appear as being resolved on a specific issue basis that are likewise being reflected on the sectoral indices.

The Phisix appears to be waiting for a second wind or the right moment to flex her muscles.

Finally the actions in the oil sector appears to validate my projections.