Poker Bluff: No Quantitative Easing 3.0?

It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown. Once common principles for their circulation-credit policy are agreed to by the different credit-issuing banks, or once the multiplicity of credit-issuing banks is replaced by a single world bank, there will no longer be any limit to the issue of fiduciary media.-Ludwig von Mises

The US Federal Reserve’s Quantitative Easing programs will be terminated at the end of this month and some have suggested that this program will be discontinued for good.

I’ll say they’re dead wrong.

Same Old Song

I have heard this music before. In late 2009 going into 2010, as the markets recovered the mainstream blabbered about “exit strategies”.

I called this Bernanke’s poker bluff[1].

Bottom line: Interest Rate Derivatives, Expanding GSE Operations, Economic Ideology Record Debt Issuance, Rollover and Interest Payments, Devaluation as an unofficial policy, Political Influences On Policy Making and the Question Of Having To Conduct Successful Policy Withdrawals all poses as huge factors or incentives that would drive any material changes in the Federal Reserve and or the US government policies.

In knowing the above, I wouldn’t dare call on their bluffs.

In November or 10 months later, Bernanke’s Fed unraveled the QE 2.0[2].

Have any of the above variables changed for the better?

The short answer is NO.

All of the above factors seem in play and some may have turned for the worst.

One, while growth of derivatives (see right window) have slowed they remain sizeable. Importantly growth in interest rate contracts has reached pre-crisis highs.

Reports the Economist[3],

Interest-rate contracts, which make up the bulk of the market, reached $465 trillion in December 2010, exceeding their pre-financial-crisis level. While notional amounts are one measure of market size, the BIS says that gross market values, which measure the cost of replacing all existing contracts, more accurately assess the amounts that are actually at risk. The gross market values fell by 13% in the six months to December 2010, to $24.5 trillion.

So even if growth in gross market values of derivatives has been slightly reduced, an environment of higher interest rates will still risk unsettling the derivatives markets for its sheer size and complexity. That’s the reason why investment guru Mark Mobius currently warned that derivatives may trigger the next financial crisis[4]. For me, derivatives as shown by the sensitivity to interest rates movements represent a symptom rather than the cause.

Second, the average maturity holdings of US treasuries has declined to all time lows, which according to Zero Hedge’s Tyler Durden, just hit 62 months[5] (see left window)

This only means that aside from financing the current fiscal record[6] deficits, the shorter maturities adds to the financial burdens of rolling over of some of these old debts. In short, the US treasury will deal with new debts as well as old ones.

Yet considering that the foreign official sector represents as the only parties (aside from the Fed) that have significant control on the supply holdings of US treasuries to materially influence prices, their recent actions does not indicate continued support to finance of US spending programs.

Foreign buying of US treasuries have been on a decline based on yearly change basis and as % of overall ownership (chart from yardeni.com[7]).

Faced with the risk of bond auction failure, the US government will likely try to avert this or get some insurance by having another round of QE.

Proof of this, as I presented last week, exhibits that nearly 100%[8] of US treasury issuance has been presently financed by the US Federal Reserve.

Morgan Stanley’s David Greenlaw estimates FED buying has accounted for 88% during the first quarter of 2011[9]. He also mentions that QE 1 reduced interest rates by 50 basis points on longer maturity securities, according to a Fed study which has on their calculation.

There seems to be a deepening relationship of dependency taking hold. And this certainly is not an auspicious sign.

The private sector as I earlier mentioned have accounted for as a marginal buyer. In addition, new regulations have financially repressed these institutions which compels them to finance (or acquire) government debts to comply with capital adequacy ratios that would meet with the Basel standards[10].

The record debt levels should also mean higher interest rate payments which should place additional burden on the economy.

Thus, the existence of the central bank has been to manipulate rates to benefit the government, aside from the banking sector, which intermediates such financing in behalf of the government.

More Rationalization and Signaling channel

Of course, I have also pointed out that the US housing appears to have regressed to a recession[11]

And all these are being vented on the equity prices of banking and financial sector.

As the US property sector staggers, such dynamic impairs or adds pressures to the values of the banking system’s balance sheets. The S&P Bank Index (BIX), the Dow Jones Mortgage Finance Index (DJUSMF), S&P 500 Financials (SPF) and the (XLF) Financial Select Sector have all been rolling over.

To say that NO quantitative easing would be in the pipeline would either mean an apostasy in economic ideology or the recognition of the mistakes from the past policies.

This also means disregarding the trillions thrown to support the banking sector during the last crisis (Neil Barofsky, special inspector general for the Treasury’s Troubled Asset Relief Program says $23.7 trillion[12] or CNN says $11 trillion committed and $3 trillion invested[13])

The fact that the Fed has been obstinately denying the causal linkages between QE and the commodity price increases coupled with patent serial interventions in the commodity marketplace by private regulators (most likely from indirect political pressures applied) via continuous increases in credit margins further suggests that part of the pre-deployment of QE 3.0 has been to condition or rationalize to the public of its necessity[14].

That’s hardly signs of conversion.

Furthermore, political authorities have been addicted to inflationism, which I have argued as signifying economic ideology and path dependency. This seems not only confined to the Fed but likewise to every major governments around the world.

Proof of this is the second round of bailouts being worked out for Greece[15].

And perhaps in anticipation of this cyclical slowdown, China has been in the process of threshing out a new massive bailout scheme[16] for local governments and their banking system, as well as, partially implementing new stimulus measures aimed at boosting the economy with large scale low cost housing projects[17]. Combined, these two grand projects could even surpass in scale, the 2008-9 $586 billion stimulus[18].

Adding to such bailout fad has been Russia and IMF’s rescue of Belarus[19] which appears to be on the brink of hyperinflation[20].

To top it all, the current signs of weakness in the US[21] or in China[22] or in the Eurozone[23] appear to be changing market’s sentiment everywhere.

Like addicts to illegal substance, even a local (Philippine) broadsheet carried a foreign report which appears to be subtly arguing for the rational of QE 3.0[24].

Meanwhile even the commodity marketplace, which has been under duress from the recent spate of interventions, doesn’t seem to be suggesting of the end of QE.

Gold continues to swiftly recover lost ground, while silver appears to be consolidating. The Reuters CRB (CCI[25] is an equal weighted index representing 17 commodities) seems to chime with gold but to a lesser degree. Importantly, natural gas which has been the perpetual laggard among the commodity spectrum seems likewise in an ascendant mode.

Gold Says QE 3.0

Rallying gold prices are not emblematic of desistance of QE, but rather a continuity of currency debasement activities conducted by global governments especially by the country which holds the principal privilege of seignorage—the US dollar.

We are not in a gold standard. While gold has shown incredible improvement in its reception as part of the financial system, where gold has recently been reckoned as collateral eligible[26], it is not money yet. Not yet anyway. We don’t use gold in payment and in settlement transactions.

Having said so, a disinflationary environment from a cessation of QE will lead to its price decline. Since markets operate as information discounting mechanism, then gold prices should not be rallying.

This will even be more pronounced if debt deflation does occur. Gold is unlikely a debt deflation hedge[27] as demand for cash would vastly increase under such conditions. Such dynamic was clearly evident in 2008[28] until the US Federal Reserve began its QE operations.

I’d further add that surging natural gas prices would imply as the deepening of inflation cycle. As I wrote in November 2010[29]

I’d be convinced of the deepening risks of the inflation cycle, when Natural Gas chimes in. So far, this hasn’t been so.

Well, the bull market in natural gas prices could have just begun.

It’s important to point out that many people, as the great Ludwig von Mises said[30],

think that there are higher and more important aims of economic policy than a sound monetary system. They hold that although inflation may be a great evil, yet it is not the greatest evil, and that the state might under certain circumstances find itself in a position where it would do well to oppose greater evils with the lesser evil of inflation. When the defense of the fatherland against enemies, or the rescue of the hungry from starvation is at stake, then, it is said, let the currency go to ruin whatever the cost.

This has also been manifested by the mainstream doctrine, which mistakenly believes that currency devaluation signify as an important tool to solve the economic problems. QEs has, thereby, worked as part of this measure to devalue the US dollar for purported economic ends.

Thus, the current lust for inflation signifies as a severe misunderstanding of the economic phenomenon which the mainstream mistakenly sees politics as a facile means to attain an economic end, from which usually backfires.

One should not also forget that in the US, policymakers are biased towards rising stock markets which for them serves as the trickle down multiplier from the “wealth effect” that works to boost spending and likewise triggers the “animal spirits” of the marketplace.

Thus the US stock markets constitute part of the coverage of the Fed’s policies[31]. To end the QE would extrapolate to the end of the support on the confidence transmission mechanism and to severe what they see as an important wealth effect multiplier.

Bottom line: NONE of the premises I wrote about in 2010, where I accurately predicted QE 2.0, has improved or has been resolved. In some instances they have worsened.

Thus for many reasons, especially applied to the US—the risk of bond auction failure, risk of imploding derivatives from higher interest rates, debt rollover risks and higher interest payments on sovereign liabilities, the implied policy of devaluation, risks of deterioration of the balance sheets of the major banking institutions, dogged refusal to instill fiscal discipline, ideological leanings and the path dependency of central bankers, risks of a downturn in the stock markets, rallying gold prices—all of which are strongly suggestive that there will be QE 3.0, 4.0, 5.0 until the nth.

It would take another monumental catastrophic crisis or a major transformation of people’s belief to embrace sound money and eschew the principle of inflationism for such policies to end.

And this won’t be happening anytime soon.

Lastly never trust government’s words, they always seem mellifluous but are usually laced.

---

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

[2] CNN Money QE2: Fed pulls the trigger, November 3, 2010

[3] Economist.com Global OTC derivatives, May 31, 2011

[4] See Will Derivatives Cause the Next Financial Crisis? May 31, 2011

[5] Durden, Tyler Fed Balance Sheet And Monetary Base Update - New Records All Around, Zero Hedge, June 2, 2011

[6] Financial Times, Record US budget deficit projected, January 26, 2011

[7] Yardeni.com, US Government Finance

[8] See How External Forces Influence Activities of the Phisix, May 29, 2011

[9] Greenlaw David Who Will Be the Marginal Buyer of Treasuries Post-QE2?, Morgan Stanley June 2, 2011

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

[11] See How could the Euro be so strong? June 1, 2011

[12] See $23.7 Trillion Worth Of Bailouts?, July 29, 2010

[13] CNNMoney.com CNNMoney.com's bailout tracker

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

[15] See Serial Bailouts For Greece (and for PIIGS), June 4, 2011

[16] See China Prepares For Massive Bailout!, June 1, 2011

[17] See China’s Bubble Cycle Deepens with More Grand Inflation Based Projects, June 2, 2011

[18] Wikipedia.org Chinese economic stimulus program

[19] Bloomberg.com Belarus to Receive $3 Billion Russian-Led Loan, Kudrin Says (1), June 4, 2011

[20] See A Crack-up Boom in Belarus, May 26, 2011

[21] Businessinsider.com United States: Brace For The Slowdown, June 1, 2011

[22] Wall Street Journal, China Shares End At 4-Month Low; Slowdown Concerns Dominate, June 2, 2011

[23] Reuters.com GLOBAL ECONOMY-Asia's factories feel the chill as U.S., Europe cool, June 1, 2011

[24] Businessworldonline.com US Federal Reserve mulling third QE?, June 2, 2011

[25] Wikipedia.org Continuous Commodity Index (CCI)

[26] See Two Ways to Interpret Gold’s Acceptance as Collateral to the Global Financial Community, May 27, 2011

[27] See Gold Unlikely A Deflation Hedge, June 28, 2010

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

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

[30] Mises, Ludwig von Monetary Policy Defined, Part 2 Chapter 13 The Theory of Money and Credit, Mises.org

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

ASEAN’s Equity Divergence, Foreign Fund Flows and Politically Driven Markets

Trading is a psychological game. Most people think that they’re playing against the market, but the market doesn’t care. You’re really playing against yourself. You have to stop trying to will things to happen in order to prove that you’re right. Listen only to what the market is telling you now. Forget what you thought it was telling you five minutes ago. The sole objective of trading is not to prove you’re right, but to hear the cash register ring. Martin Schwartz

Divergence.

The week had been marked by divergences, where the ASEAN equity bellwether appears to have defied the performances of her contemporaries around the world.

The FTSE-ASEAN[1] (AWASEAN, yellow) scaled higher as the region’s index MSCI AC ASIA Pacific[2] (MXAP, red), the S & P Euro[3] (SPEURO, green) and the US S & P 500 seem to have rolled over on a year to date basis.

One would further note that except for the Eurozone, Asia, ASEAN and the S&P 500 came off from their recent highs.

It is an important reminder that any divergences should not be interpreted as representative of decoupling. Signs of decoupling will be manifested once the next crisis emerges. Yet given the depth or scale of today’s globalization or social interconnectedness which has not been limited to trade, labor, capital flows or to even monetary policies, I strongly doubt that this should transpire.

In addition I pointed out the commodities have been rallying in the face of an enfeebled global equity markets. We seem to be seeing some rotation from financial assets towards the commodity sphere as markets await political developments abroad.

And another significant point to consider is that given the variance in the political economic construct of each nation, the global transmission of credit easing policies and artificially suppressed interest rates everywhere would have different impacts on different asset classes.

Nations that had been least affected by the last bubble bust should outperform. And this perhaps explains the ASEAN divergence.

Yet this has been an important theme for us for the longest time.

Transmission Mechanisms from Policies Abroad

I have been saying that policies abroad are being transmitted to the Peso and the Phisix.

Interest rate spreads, devaluation policies, real economic growth rate differentials, degree of economic freedom and political, regulatory and tax costs and risks among the many other variables serve as major inducements to foreign money flows into the emerging markets.

Under current conditions, emerging markets are expected to receive fund flows to the tune of slightly $1 trillion for 2011.

Reports the Bloomberg[4],

Net private capital inflows to emerging market economies will keep growing this year and next to reach $1.1 trillion in 2012, attracted by economic growth above 6 percent in those countries, a banking industry group said.

The Washington-based Institute of International Finance today also raised its estimates for 2011 inflows by $81 billion to $1 trillion to reflect higher forecasts for Brazil and China. That more than offset lower flows to the Middle East and North Africa as a result of political turmoil there.

“The strength of capital flows is still presenting policy challenges in a number of emerging economies, especially those already facing pressures from rising inflation, strong credit and asset price growth and rising exchange rates,” the IIF wrote in its research note. Monetary policy in these countries is “generally too accommodative, in large part because policy makers are so focused on limiting capital inflows.”

Countries from Indonesia to South Africa are striving to manage inflows of overseas capital that put upward pressure on their currencies, making exports less competitive, and threaten to inflate asset-price bubbles. Nations including China and South Korea have argued that U.S. monetary easing has added to cross-border money flows in pursuit of higher returns.

The accompanying chart is from the IIF[5]

The Philippines is part of the EM rubric, thus should be one of the recipients of these fund flows.

Foreign trade has supported the current recovery, from the November 2010 consolidation or the profit taking phase, in the Philippine Stock Exchange.

Net foreign inflows, as of the end of May, tallied 14.3 billion php [US $324.127 million]. This accounted for about 40% of daily trade. Above chart shows of the weekly trend.

The big drop in foreign trade during the other week had been due to 2 special block sales in Meralco [PSE: MER] and San Miguel [PSE:SMC].

There is a strong correlation between foreign flows and the Peso. The vertical line from the Peso chart partitions the year-to-date performance.

The foreign volume inflow spikes in April and May appear to be reflected on the Peso (see two red arrows) with two concomitant surges over the same period.

Meanwhile the recent outflows seen from the special block sales have coincided with the recent price sluggishness of the Peso.

So even at 40% share of daily trades, foreign flows account for as a major determinant to the price activities in the Phisix and importantly the Peso.

And as I have long been saying the correlation between the Peso and other popular metrics as remittance or exports have been tenuous[6].

Foreign flows are representative of the degree of demand for a currency.

Hence, currency traders must take heed of the activities in the PSE as part of their studies from which to derive their predictions

Another aspect is that the above estimates made by the IIF, I think, largely depends on current conditions which seem to presuppose the QE in play.

Thus a furtherance of the QE should translate to more capital flows into emerging markets including the Philippines. This means buoyant stocks and a stronger peso.

QE’s basically connect the Emerging Markets by transmitting bubble conditions. Some countries appear to be aware of this, as the Bloomberg report says, “China and South Korea have argued that U.S. monetary easing has added to cross-border money flows in pursuit of higher returns”

So while some reads this as somewhat positive, this represents a bubble process at work. Boom days will be met by a greater bust. The success of a prudent investor would be how one negotiates the boom bust cycle.

Rotational Process Continues, Politics as Main Driver

Rotational activities continue to dominate the activities within the Philippine Stock Exchange.

The industrials spearheaded the gains of the Phisix. This was largely due to the upsurge in Meralco (6.35%) [PSE: MER], Energy Development Corporation (4.09%) [PSE: EDC] and San Miguel Corp (6.27%) [PSE: SMC].

The financial industry, which I earlier said could be a candidate likely to help buoy the Phisix[7], has taken the second place. Meanwhile the mining sector continues to bedazzle with the 10^th consecutive week of advances which has been defying my expectations[8]. In a bullmarket, overbought conditions can remain extended.

The Phisix continues to consolidate amidst signs of emerging weakness in the global markets. It is unclear if such divergences will hold or persist.

Although for as long as there would be no recession in the horizon, and where monetary conditions remain easy or accommodative as today, such variability in price actions remains a possibility.

True, there have been signs of economic slowdown in many parts of the world, but a downshift does not mechanically imply a collapse or a recession.

Seasonality can also be a factor. But this factor would come into play if other forces are restrained.

Yet barring any black swan or high sigma events, I don’t foresee any signs of an impending recession yet. So, over the short term, the Phisix or even global equity markets may just vacillate and look for direction.

Finally my expectations have largely been shaped by the prospective political actions by the political leadership, particularly by the US Federal Reserve on extending the QE program which is slated to end this month.

Although I expect that this extension won’t come automatically which I see as either tied to the US Congressional vote to raise debt limits or in reaction to growing pessimism in the some of the world’s economic environment due to a cyclical slowdown or to the accrued effects of signaling channels applied by governments or from mainstream’s addiction to inflationism. Besides if the debt ceiling will be raised this gives further excuse for the FED to activate QE 3.0.

However as clearly outlined, politics largely determines the outcome of the marketplace.

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[1] Bloomberg.com The FTSE Asean Index is a free float market capitalization weighted index. FTSE All-World Indices include constituents of the Large and Mid capitalization universe for Developed and Emerging Market (Advanced Emerging and Secondary Emerging) segments. Base Value 100 as at December 31, 1986.

[2] Bloomberg.com The MSCI AC Asia Pacific Index is a free-float weighted equity index. It was developed with a base value of 100 as of December 31 1987.

[3] Bloomberg.com The S&P Europe 350 Index is a free float market cap weighted index that measuresthe performance of equities in 17 Pan-European markets, covering approximately 70% of the total market cap. It offers an effective balance between broad market representation and liquidity. The S&P Europe 350 is part of the S&P Global 1200. It has a base date of Dec. 31, 1997 with a base value of 1000.

[4] Bloomberg.com Capital Flows to Emerging Markets Seen Surpassing $1 Trillion, June 1, 2011

[5] Institute of International Finance Capital Flows to Emerging Market Economies, June 1, 2011

[6] See How The Surging Philippine Peso Reflects On Global Inflationism, December 6, 2009

[7] See A Bullish Financial Sector Equals A Bullish Phisix?, May 22, 2011

[8] See Phisix: Why I Expect A Rotation Out of The Mining Sector May 15, 2011

Serial Bailouts For Greece (and for PIIGS)

From the Bloomberg

European Union officials will focus on preparing a new aid package for Greece that includes a “voluntary” role for investors after the EU and International Monetary Fund approved the fifth installment of Greece’s 110 billion-euro ($161 billion) bailout.

“I expect the euro group to agree to additional financing to be provided to Greece under strict conditionality,” Luxembourg Prime Minister Jean-Claude Juncker said after meeting with Greek Prime Minister George Papandreou in Luxembourg yesterday. “This conditionality will include private-sector involvement on a voluntary basis.”

Papandreou agreed to 78 billion euros in additional austerity measures and asset sales through 2015 to secure the 12 billion euro bailout payment and meet conditions for receiving an additional rescue package. He agreed to make “significant” cuts in public-sector employment and establish an agency to manage accelerated asset sales, according to a statement released in Athens yesterday. The plan is fueling popular opposition and protests across Greece...

Under the original rescue, Greece was due to sell 27 billion euros of bonds next year. EU leaders and Papandreou have acknowledged that a return to markets won’t be possible with Greece’s 10-year debt yielding 16 percent, more than twice the level at the time of the bailout. The EU is looking to close that funding gap through new loans and bondholders’ willingness to roll over Greek debt, EU officials have said.

Europe’s financial leaders needed to hammer out a revised Greek package to persuade the IMF to pay its share of the 12 billion-euro tranche originally due in June. The IMF had indicated that it would withhold its 3.3 billion-euro piece unless the EU comes up with a plan to close Greece’s funding gap for 2012. The EU-IMF statement said the full payment would be made in early July. [all bold highlights mine]

These developments seem on the way to validate my views.

Mainstream has been ignoring the political role of the EU’s existence, the role of central bankers, the intertwined complex political relationships between the banking sector, the central banks and the national governments and the inherent ability of central banks to conduct bailouts by inflating the system.

If the US had QE [Quantitative Easing] 1.0, 2.0 and most likely a 3.0...until the QE nth, despite poker bluffing statements like this [Morningstar.com]

"The trade-offs are getting--are getting less attractive at this point. Inflation has gotten higher," Bernanke said. He cited the rising inflation expectations seen then and offered "it's not clear that we can get substantial improvements in payrolls without some additional inflation risk." He went on, "If we're going to have success in creating a long-run sustainable recovery with lots of job growth, we've got to keep inflation under control."

...or that the earlier consensus view that QE 3.0 is unlikely,

central bank watchers believe there is simply no appetite within the central bank to undertake such an effort, which some in markets are already referring to as QE3.

...QE 3.0 will be coming for the above reasons as earlier discussed.

The path dependence from previous actions of regulators and political leaders and the dominant ideological underpinnings which influence their actions combined with the framework of current network of political institutions are highly suggestive of the direction of such course of actions.

Importantly, the implicit priority to support the politically privileged industries as the banking system—which functions as the main intermediary that channels private sector funds to governments. Alternatively, this means policies has been designed to sustain the status quo for politicians and their allies.

Further, it would be misplaced to put alot of emphasis on political protestations by the public as measure to predict future policies.

Political leaders have learned the lessons of Egypt and Tunisia and have been applying organized violence as seen in Libya, in Yemen or in Syria.

It won’t be different for the political leaders of the developed world. As indications of their prospective actions against popular political pressure, even several protestors on US Memorial Day have suffered from police brutality from just “dancing”

In addition, sentiment can shift swiftly.

Recent soft patches in economic data, which I think has been part of the signaling channel maneuver, which has likewise began to affect markets, appear to be reversing previous sentiments which says that the Fed has “no appetite” for QE 3.0.

Again from Morningstar

Having received the strongest indication yet of a slowing economic recovery, traders of U.S. interest rate futures on Friday backed off on the notion that the Federal Reserve will start raising its short-term federal-funds rate during the first half of next year.

Finally, for those who say they are ‘massively’ short the Euro...

...it’s gonna be alot of pain for them.

So like the US, the above only reveals that the Eurozone crisis will mean that Greece and the PIIGS will experience bailouts after bailouts after bailouts. Thus, an implied currency war in the process until the unsustainable system of fiat money collapses or people awaken to the risk thereof and apply political discipline.

For now, the policy of bailouts and inflationism will continue to be the central feature of today’s global policy making process where currency values will be determined by the degree of relative inflationism applied.

War on the Internet: Threat to National Security as Pretext for Controls

As earlier posted, governments around the world will be rationalizing control of the web or the cyberspace by putting up various bogeymen (strawmen).

The US has now been considering cyber attacks as a threat to national security that would justify military response.

From the Wall Street Journal,

The Pentagon has concluded that computer sabotage coming from another country can constitute an act of war, a finding that for the first time opens the door for the U.S. to respond using traditional military force.

The Pentagon's first formal cyber strategy, unclassified portions of which are expected to become public next month, represents an early attempt to grapple with a changing world in which a hacker could pose as significant a threat to U.S. nuclear reactors, subways or pipelines as a hostile country's military.

This is an overblown reaction.

Writes Cato’s Benjamin Friedman

Actually, our claim is not that we should never use military means to respond to cyberattacks. Our point instead is that the vast majority of events given that name have nothing to do with national security. Most “cyberattackers” are criminals: thieves looking to steal credit card numbers or corporate data, extortionists threatening denial of service attacks, or vandals altering websites to grind personal or political axes. These acts require police, not aircraft carriers.

Even the cyberattacks that have affected our national security do not justify war, we argue. There is little evidence that online spying has ever done grievous harm to national security, thinly sourced reports to the contrary notwithstanding. In any case, we do not threaten war in response to traditional espionage and should not do so merely because it occurs online.

Moreover, despite panicked reports claiming that hackers are poised to sabotage our “critical infrastructure” — downing planes, flooding dams, crippling Wall Street — hackers have accomplished nothing of the sort. We prevent these nightmares by decoupling the infrastructure management system from the public internet. But even these higher-end cyberattacks are only likely to damage commerce, not kill, so threatening to bomb in response to them seems belligerent.

I am reminded by this wonderful quote from General Douglas MacArthur who said that government has always peddled fear to expand over us.

Our government has kept us in a perpetual state of fear -kept us in a continuous stampede of patriotic fervour -with the cry of grave national emergency. Always, there has been some terrible evil at home, or some monstrous foreign power that was going to gobble us up if we did not blindly rally behind it

Always somewhere a deception designed to curtail our liberties.

Nassim Taleb: US Federal Reserve will Cease to Exist in 25 years

Nassim Taleb celebrated author of the Black Swan theory makes a bold forecast

The Federal Reserve won’t exist in 25 years and the reappointment of Ben Bernanke as head of the central bank was a “management failure,” said Nassim Taleb, author of ‘The Black Swan.’

Allowing Bernanke to stay at the helm of the Fed is equivalent to “letting an unqualified pilot fly a plane,” Taleb, a principal at Universa Investments LP, told a conference in Moscow, Russia today.

From Moneynews.com

Tornadoes and Technology

From Patrick Michaels at the Forbes (ht: Don Boudreaux)

Despite 2011, there’s strong evidence that we are saving a tremendous number of lives with modern technology.

After the 1953 disasters, developers of weather radar convinced Congress to support a national network of detectors known as the WSR-57 (for 1957), a very acceptable machine for picking up tornadoes capable of causing significant damage. By the mid-1970s, WSR-57′s pretty much covered the tornado-prone regions of the nation.

An interesting thing happened to tornado frequencies. Before the WSR-57 went online the number of reported tornadoes averaged about 500 per year nationwide. By the time the network was complete, we leveled out around 800. Tornado death frequency–the number of fatalities per million–dropped precipitously. This was an unqualified technological success.

This only demonstrates how capitalism via technological advancement has helped saved many lives.

Global War on Drugs a Failed Policy

Here is the statement from a report of the Global Commission on Drug Policy, a nineteen-member panel that includes, among others, world figures such as former United Nations Secretary General Kofi Annan, former Brazilian President Fernando Henrique Cardoso and former NATO Secretary General Javier Solana. The current Prime Minister of Greece, George Papandreou is also a signatory which makes him the only representative of government.

(bold emphasis mine)

The global war on drugs has failed, with devastating consequences for individuals and societies around the world. Fifty years after the initiation of the UN Single Convention on Narcotic Drugs, and 40 years after President Nixon launched the US government’s war on drugs, fundamental reforms in national and global drug control policies are urgently needed.

Vast expenditures on criminalization and repressive measures directed at producers, traffickers and consumers of illegal drugs have clearly failed to effectively curtail supply or consumption. Apparent victories in eliminating one source or trafficking organization are negated almost instantly by the emergence of other sources and traffickers. Repressive efforts directed at consumers impede public health measures to reduce HIV/AIDS, overdose fatalities and other harmful consequences of drug use. Government expenditures on futile supply reduction strategies and incarceration displace more cost-effective and evidence-based investments in demand and harm reduction.

Cato’s Juan Carlos Hidalgo writes, (bold highlights added)

The 20-page report says all the right things: prohibition has failed in tackling global consumption of drugs, and has instead led to the creation of black markets and criminal networks that resort to violence and corruption in order to carry out their business. This drug-related violence now threatens the institutional stability of entire nations, particularly in the developing world. Also, prohibition has caused the stigmatization and marginalization of people who use illegal drugs, making it more difficult to help people who are addicted to drugs. The report also denounces what it properly calls “drug control imperialism,” that is, how the United States has “worked strenuously over the last 50 years to ensure that all countries adopt the same rigid approach to drug policy.”

In the recommendations section, the report praises the experience of Portugal with drug decriminalization, mentioning Cato’s study on the subject. But perhaps more importantly, it states that drug legalization “is a policy option that should be explored with the same rigor as any other.” Until now, similar reports have denounced the war on drugs and perhaps called for the decriminalization of marijuana and other soft drugs, but they also have stopped short of mentioning drug legalization as a policy alternative.

Prohibition laws represents an example of noble intent, whose visible effects, fails to account for the cost of the unseen—the economic effects and people’s response to such repressive laws.

Free Trade’s Influence on Culture

Even a culture of hate, bigotry and intolerance can be reformed by free trade.

From the Slate, (hat tip David Boaz)

If a century seems like a long time for a culture of racism to persist, consider the findings of a recent study on the persistence of anti-Semitism in Germany: Communities that murdered their Jewish populations during the 14^th-century Black Death pogroms were more likely to demonstrate a violent hatred of Jews nearly 600 years later. A culture of intolerance can be very persistent indeed.

Changing any aspect of culture—the norms, attitudes, and "unwritten rules" of a group—isn't easy. Beliefs are passed down from parent to child—positions on everything from childbearing to religious beliefs to risk-taking are transmitted across generations. Newcomers, meanwhile, may be attracted by the culture of their chosen home—Europeans longing for smaller government and lower taxes choose to move to the United States, for example, while Americans looking for Big Brotherly government move in the other direction. Once they arrive, these migrants tend to take on the attitudes of those around them—American-born Italians hold more "American" views with each subsequent generation.

"Good" cultural attitudes—like trust and tolerance—may thus be sustained across generations. But the flipside is that "bad" attitudes—mutual hatred and xenophobia—may also persist.

How trade changes culture... (bold highlights mine)

Not all cities like Würzburg were so unwavering in their anti-Semitism, however. Those with more of an outward orientation—in particular, cities that were a part of the Hanseatic League of Northern Europe, which brought outside influence via commerce and trade—showed almost no correlation between medieval and modern pogroms. The same was true for cities with high rates of population growth—with sufficient in-migration, the newcomers may have changed the attitudes of the local culture.

The simple point is that trade promotes social cooperation and has the power to change beliefs and culture. And the above is an anecdotal evidence of this.

Once again this validates the theories of the great Ludwig von Mises who wrote,

The market is that state of affairs under which I am giving something to you in order to receive something from you. I don't know how many of you have some inkling, or idea, of the Latin language, but in a Latin pronouncement 2,000 years ago already, there was the best description of the market — do ut des — I give in order that you should give. I contribute something in order that you should contribute something else. Out of this there developed human society, the market, peaceful cooperation of individuals. Social cooperation means the division of labor.

Technology Uncovers the Secrets of the Pyramid

Like it or not, this is the information-digital age.

Work that used to take years to uncover can be done over a short period time with rapidly developing technologically enhanced instruments. Moreover, long held secrets of nature have greater chances to be discovered.

Below is an example of another important breakthrough: a specially designed robot has unearthed the ancient markings of the pyramid’s secret chamber. And this discovery has gone viral.

From Yahoo (bold emphasis mine)

Are the glory days of the archaeologist over? Has everything cool and ancient already been discovered? Nope. Thanks to ever-improving technology, several new findings have electrified the Web.

A robot explorer recently discovered ancient markings at the Great Pyramid of Giza in Egypt. The robotic device found the markings inside a secret chamber inaccessible to humans--and then proceeded to film the painted hieroglyphics and stone markings, which hadn't been seen by human eyes in 4,500 years, via a small robotic camera that was fit through a tiny hole in a stone wall.

It is too soon to tell what the markings mean, but experts are hoping they may shed some light on why the ancient Egyptians originally built the tunnels. An article from CNN explains that the tunnel is "one of several mysterious passages leading from the larger king's and queen's chambers."

This wasn't the first time a robot explored the passageways--but it was the first time a robot could focus on details on the walls. This breakthrough occurred thanks to a new kind of micro-camera that can be bent side-to-side instead of just focusing straight ahead.

News of the discovery quickly took the Web by storm. Over the past 24 hours, Web searches for "great pyramid of giza" and "egypt pyramids" both spiked into breakout status. Also seeing big bumps in lookups: "hieroglyphic dictionary" and "hieroglyphic meanings."

Meanwhile, other technologically enhanced discovery expeditions have turn up other fascinating new information about the pyramids in recent days. Archaeologists from the United States (with some help from the BBC) used satellite imagery to discover 17 pyramids beneath the sand and silt in Egypt. An article from Canada's CBC explains that 1,000 tombs and around 3,000 other buildings were also discovered thanks to the technology.

Technology and information are proving to be a potent force.

People will have increasing access to information or acquire the capability to secure knowledge from formerly unconventional channels and on real time.

Science will enhance economic progress which should open doors to new industries (lengthening of the production process), organizational and business processes and new markets.

Also by increasing knowledge and with the introduction of specialized tools, productivity will be enhanced. This should mean more prosperity and wealth or a higher living standard for society.

Although despite the good news, there will always be the opposition. They will be personified by people who resist change (luddites), people who feel entitled (welfare beneficiaries) and people who desire control (progressives or liberals, politicians and the bureaucracy) who will use political force to oppose this progress.

Yet despite all the hurdles, breakthroughs like this is a refreshing news.

China’s Bubble Cycle Deepens with More Grand Inflation Based Projects

So China isn’t just preparing for a bailout, she has also put into the pipeline another huge stimulus program to prevent the risk of a slowdown.

Reports the Bloomberg, (bold emphasis mine)

China’s plan to rein in property prices with a record homebuilding program may worsen local debt risks even as it proves a boon to companies from domestic cement makers to Chilean copper exporters.

Premier Wen Jiabao aims to build 36 million low-cost homes by 2015, an initiative that will see 2 trillion yuan ($307 billion) added to local government borrowing by 2012, bringing it to a total 12 trillion yuan, Standard Chartered Plc estimates. The surge of loans to local authorities may spark a wave of bank bailouts that hobble economic growth.

And the symptoms of a bubble are getting visible as time passes; China has even her version of financial innovation or regulatory arbitrage or “shadow banking system”!

From the same article, (emphasis added)

Local governments have created more than 8,000 investment companies that allow them to get around regulations prohibiting direct borrowing. Fitch Ratings cites lending to the vehicles and to property developers in a worst-case scenario predicting bad loans could reach 30 percent of the total at China’s banks.

Moody’s Investors Service also built a 10 percent bad-loan ratio into its stress tests on China’s banks, which the company says probably will provide most of the social-housing funding.

So where will China get the money to finance these grand projects?

Again from the same article, (bold underscore mine)

Banks had a total of 50 trillion yuan of all loans outstanding in April. Standard & Poor’s has said the bad-loan ratio may climb next year to as high as 10 percent, from 1.1 percent now.

Social housing projects have “a pretty thin profit,” said Zhang Yi, senior analyst at Moody’s in Beijing. “It’s not like you are lending to highly profitable companies.”

Chris Ruffle, who helps manage $19 billion for Martin Currie Inc. in Shanghai, said, “it’s not a great situation and I wouldn’t want to be an investor in banks” after the record boom in lending.

The government hasn’t spelled out how construction of low- income housing will be financed over the full five years or how local governments will recoup their costs.

The central and local governments combined will provide 500 billion yuan of a total of at least 1.3 trillion yuan to build 10 million homes this year, Vice Minister of Housing and Urban- Rural Development Qi Ji said March 9, without saying how they will come up with the money. The central government will provide about 121 billion yuan.

While officials have pressed banks not to expand lending to local government financing vehicles, China Banking Regulatory Commission Chairman Liu Mingkang said that credit dedicated to affordable-housing developments with “repayment capability” was exempted from the push, the China Securities Journal reported March 7.

By building cheaper homes, either for rent or sale below market prices, Wen seeks to prevent social unrest caused by record property prices. He’s also countering rising prices in major cities with curbs on lending and mortgages, and a trial property tax in some cities. The risk is a slowdown in land sales that contribute about a third of local government revenue...

The program is front-loaded, with 10 million units planned for this year, a 170 percent surge from the 2010 total. Vice Premier Li Keqiang said Feb. 24 that the 2011 target is “mandatory” and local governments must increase funding for the plan.

A “financing hole” of between 817 billion yuan and 1.4 trillion yuan this year alone means most of the construction will probably be funded through bank loans, said Stephen Green, head of China research at Standard Chartered in Shanghai. He estimates that construction this year may cost as much as 1.9 trillion yuan.

Well like all bubbles, financing will emanate from inflationism and financial repression or via the diversion of private sector savings through money printing and expansion of circulation credit from the banking system to fund government pet projects.

China’s government looks desperate to avert a slowdown by attempting to maintain the current price levels, so as to maintain the profitability of sectors benefiting from the stimulus programs. The government, as shown above, does this by applying more inflation. So on one hand the government facetiously pretends to prevent a bubble by applying preventive tightening on some sectors. On the other hand, she inflates more. The left hand does not know what the right hand is doing.

As the great Murray Rothbard explained, (bold emphasis added)

First it pumps in a great deal of new money because, in the depth of recession, prices go up very little in response. Emboldened by this "economic miracle," it pumps more and more new money into the system. Then, when prices finally start accelerating, it tries to prolong the inevitable and thereby only succeeds in delaying market adjustments.

The policy of quasi booms eventually will end up with a bust. China is playing well into the Austrian Business Cycle script.

As I have been saying, the phase of China’s inflation cycle have been more advanced compared to her major counterparts, as exhibited by this chart from Pragmatic Capitalist

And the above development represents as more signs that the next financial crisis will likely emanate from China.

Chart of the Day: Earnings Don’t Drive Stock Prices

I’ve been arguing since that earnings have hardly been the principal drivers of stock prices.

Today’s Bloomberg’s chart of the day appears to bolster my case. And this time such dynamic applies to the S&P 500

Here’s a passage from the Bloomberg article,

Stocks with the most reliable earnings are underperforming those with the least predictable results by the most since at least 1997 and may soon start to outperform, Morgan Stanley Investment Management said.

The CHART OF THE DAY compares the performance of so-called high-quality companies on the Standard & Poor’s 500 Index with low-quality businesses. S&P awards all equities a quality rating based on the sustainability and robustness of both their earnings and their balance sheets.

“Despite all the uncertainty in the market, quality is very cheap at the moment,” said Bruno Paulson, the portfolio manager of MSIM’s global franchise strategy, which has $6.3 billion under management, in London. “It’s not unreasonable to expect some re-rating from here. I don’t know what will trigger it; it might be the end of liquidity.”

So the quoted expert partly attributes ‘liquidity’ to this phenomenon but sounds rather tentative. I would suggest that this represents the mainstream view (again I am applying representative bias here) where the mainstream don’t get it.

Inflationism has been the main culprit. Flooding the world with too much money leads to speculative excess. This amounts to the bidding up of prices of low quality stocks more than the high quality counterparts. When people chase prices, rumor based plays are rife and earnings become a side story.

I would like to reiterate Austrian economist Fritz Machlup’s dictum (bold highlights mine)

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.

Each day that passes, evidences seem to emerge in favor our views.