Ron Paul: Expect 50% Inflation

US Presidential candidate Ron Paul expects the US government to default via inflation

The unionleader.com writes, (hat tip lew rockwell political theatre)

Texas congressman Ron Paul on Friday predicted that inflation will hit 50 percent in the next couple of years, thanks to the massive debt the country has accumulated.

Paul, who spoke to admirers and Republican activists at a Manchester house party, said the inflation will act like default.

Social Security checks will still be cut and interest payments will still be made, but the inflated dollars will allow the government to repay borrowed dollars with devalued money, Paul said.

“They cannot pay the debt,” he said. “I don't think that means you shouldn't try and work things out, but with the size of this debt it never gets paid.”

The national debt is about $14.3 trillion.

Currently about 2/5 of the US CPI index accounts for housing which only means that for inflation to reach 50% that commodity prices will have to go vertical. There would be a flight to real assets. The inflation would have to be so devastating that even housing prices which currently has reverted to a declining price trend, would rise.

Thus Ron Paul sees that the US Federal Reserve will likely take, or experiment, on the path of hyperinflation rather than an outright default.

I would surmise that this is more of a warning than of a prediction.

Yet, this is one tail risk that the mainstream has continued to ignore which is why Ron Paul raises this concern. The obstinacy to maintain current path of government spending profligacy risks this outcome.

The next global financial crisis will likely signify what I call the Mises Moment—the critical moment where the set of choices of policymakers determines whether the entire paper money system collapses or major economies suffers from debt deflation.

Remember in 2008 the banking system nearly collapsed. Major economy governments assumed many of the banking system’s bad assets by flooding the world with money in the hope that these concerted rescue efforts can wish away the accrued malinvstements.

Today, both the banking system and governments have been disproportionately leveraged, and which continues to rely on further inflation (via serial bailouts) to maintain price levels that keeps the banking system afloat. The unfolding events in Europe, particularly the PIIGS, seem as appetizers to the next government-banking system crisis. The difference would be the intensity.

What is unsustainable can’t last.

Have a nice day.

Has Human Evolution Been Culturally Driven?

The ever spectacular author Matt Ridley proposes a thesis where our genes evolved from cultural developments.

Mr. Ridley writes,

The human genome provides penetrating and unexpected insights into human individual and collective history. Among them is the counterintuitive idea that genes are at the mercy of experience – that what we do in our lives affects which genes are switched on and off.

A stressful experience, for example, can make you more vulnerable to infection, because stress hormones indirectly alter the switches that control the expression of genes.

So, far from genes being the cause of how we act, the new understanding sees them as just as much a consequence of how we act. This subtler view of genes has yet to colonise the popular imagination.

On a much longer, evolutionary timescale, the same reversal of causation is necessary.

We now know that many genetic changes in human beings are driven by cultural ones, at least as much as the other way round.

For example, the ability to digest lactose as adults spread among Africans and Europeans because of dairy farming, rather than vice versa.

Read the rest of the fascinating theory here

Health Risks of Sitting and Smoking

Health risks from smoking parallels extended sitting.

So says the San Francisco CBS

Smoking cigarettes is the cause of so much preventable, deadly disease. But now new research shows sitting for long stretches of time may be just as dangerous.

“Smoking certainly is a major cardiovascular risk factor and sitting can be equivalent in many cases,” explained Dr. David Coven, cardiologist with St. Luke’s-Roosevelt Hospital Center in New York.

Dr. Coven said several new studies show prolonged sitting is now being linked to increased risk of heart disease, obesity, diabetes, cancer, and even early death.

Each of our action seems to be wrong. So what’s next? Regulate our seating hours? Ban sitting in public places like the current anti-smoking ban drive in Metro Manila?

New Animal Species versus Animal Species Extinction

I am glad to read about the possible discovery of NEW animal species in the Philippines

From Yahoo

The Philippines, located at the center of the coral triangle, may have even more secrets hidden in its various ecosystems.

The 2011 Philippine Expedition spearheaded by the University of the Philippines (UP) and the California Academy of Sciences (CAS) announced on Wednesday that it has discovered 75 possibly new species of animals, inserts and sea creatures endemic to the Philippines.

The coral triangle is refers to the area of tropical waters which holds the highest diversity of marine life, according to the World Wildlife Fund.

The reason I’m delighted is because despite claims of alleged risks from animal species extinction brought about ‘mostly’ by environmental destruction or habitat loss (as alleged by communists masquerading as environmentalists), the discovery of new species only shows of the natural life cycles of the animal species, in spite of our presence.

A Booming Anarcho-Capitalist City in India?

At the Mises Blog, Stephan Kinsella points to this fascinating article about a booming city in India.

Gurgaon appears to operate on a very unusual or unorthodox dynamic which the author calls as ‘dysfunctional’.

The New York Times, (bold emphasis mine)

With its shiny buildings and galloping economy, Gurgaon is often portrayed as a symbol of a rising "new" India, yet it also represents a riddle at the heart of India's rapid growth: how can a new city become an international economic engine without basic public services? How can a huge country flirt with double-digit growth despite widespread corruption, inefficiency and governmental dysfunction?

In Gurgaon and elsewhere in India, the answer is that growth usually occurs despite the government rather than because of it…

In Gurgaon, economic growth is often the product of a private sector improvising to overcome the inadequacies of the government.

To compensate for electricity blackouts, Gurgaon's companies and real estate developers operate massive diesel generators capable of powering small towns. No water? Drill private borewells. No public transportation? Companies employ hundreds of private buses and taxis. Worried about crime? Gurgaon has almost four times as many private security guards as police officers.

The article continues with the success story.

Today, Gurgaon is one of India's fastest-growing districts, having expanded more than 70 percent during the past decade to more than 1.5 million people, larger than most American cities. It accounts for almost half of all revenues for its state, Haryana, and added 50,000 vehicles to the roads last year alone. Real estate values have risen sharply in a city that has become a roaring engine of growth, if also a colossal headache as a place to live and work.

Before it had malls, a theme park and fancy housing compounds, Gurgaon had blue cows. Or so Kushal Pal Singh was told during the 1970s when he began describing his development vision for Gurgaon. It was a farming village whose name, derived from the Hindu epic the Mahabharata, means "village of the gurus." It also had wild animals, similar to cows, known for their strangely bluish tint.

"Most people told me I was mad," Mr. Singh recalled. "People said: 'Who is going to go there? There are blue cows roaming around.' "

And makes a comparison with the sibling city which has been managed by orthodox means…

Gurgaon was widely regarded as an economic wasteland. In 1979, the state of Haryana created Gurgaon by dividing a longstanding political district on the outskirts of New Delhi. One half would revolve around the city of Faridabad, which had an active municipal government, direct rail access to the capital, fertile farmland and a strong industrial base. The other half, Gurgaon, had rocky soil, no local government, no railway link and almost no industrial base.

As an economic competition, it seemed an unfair fight. And it has been: Gurgaon has won, easily. Faridabad has struggled to catch India's modernization wave, while Gurgaon's disadvantages turned out to be advantages, none more important, initially, than the absence of a districtwide government, which meant less red tape capable of choking development.

Gurgaon’s success comes amidst a seeming absence of central planning agencies…

Ordinarily, such a wild building boom would have had to hew to a local government master plan. But Gurgaon did not yet have such a plan, nor did it yet have a districtwide municipal government. Instead, Gurgaon was mostly under state control. Developers built the infrastructure inside their projects, while a state agency, the Haryana Urban Development Authority, or HUDA, was supposed to build the infrastructure binding together the city.

And that is where the problems arose. HUDA and other state agencies could not keep up with the pace of construction. The absence of a local government had helped Gurgaon become a leader of India's growth boom. But that absence had also created a dysfunctional city. No one was planning at a macro level; every developer pursued his own agenda as more islands sprouted and state agencies struggled to keep pace with growth.

Where public services have been delivered by the private sector…

Even at the fringes of Gurgaon's affluent areas, large pools of black sewage water are easy to spot. The water supply is vastly inadequate, leaving private companies, developers and residents dependent on borewells that are draining the underground aquifer. Local activists say the water table is falling as much as 10 feet every year.

Meanwhile, with Gurgaon's understaffed police force outmatched by such a rapidly growing population, some law-and-order responsibilities have been delegated to the private sector. Nearly 12,000 private security guards work in Gurgaon, and many are pressed into directing traffic on major streets.

Well the above somewhat or partly resembles a society which Austrians call as anarcho-capitalism, where

law enforcement, courts, and all other security services would be provided by voluntarily-funded competitors such as private defense agencies rather than through taxation, and money would be privately and competitively provided in an open market.

Gurgaon's development may not be perfect, but her unorthodox model seems to have vastly outclassed her politically oriented development models adapted by her peers.

Nevertheless Gurgaon’s experience isn’t about attaining perfection but about relative efficiencies.

It’s one development model which should be look at, learned from and possibly assimilated.

US President Obama Mulls Tax Cuts as Compromise for Raising Debt Limits

If anyone thinks that the US government will allow market forces to determine her economy’s direction then they must be hallucinating.

US President Obama seems to be dabbling on another stimulus program aimed at arriving at a deal with Republicans to raise the debt limits.

From Bloomberg, (bold emphasis added)

President Barack Obama’s advisers have discussed seeking a temporary cut in the payroll taxes businesses pay on wages as they debate ways to spur hiring amid signs that the recovery is slowing, according to people familiar with the matter.

The idea, which is in preliminary stages of discussion, is among several being talked about at the White House as the economy holds center stage for the administration and Congress, the people said on condition of anonymity to discuss internal deliberations. The unemployment rate in May rose to 9.1 percent, the highest level this year.

The talks reflect the political constraints the White House is operating under with the Republican majority in the U.S. House pushing to cut federal spending. A hiring stimulus based on a tax break for employers may appeal to Republican lawmakers, many of whom have called for measures to help businesses.

This means that one deal will likely lead to another-a slippery slope of one intervention to another. The power to exert influence over the marketplace has been so irresistible. Likewise this reveals of the venality of politics.

As the great Henry Hazlitt wrote

The political appeal of inflation comes from fostering the
illusion in the great majority of voters that they will somehow get the better of the swindle, and profit at the expense of a few unidentified victims.

Pieces of the jigsaw puzzle keep falling into place, more signs of the imminence of QE 3.0.

China Warns US on Debt Default as ‘Playing with Fire’

Here is another spectacle, China warns the US of ‘playing with fire’ by tinkering with the prospects of default.

From yahoo.com

Republican lawmakers are "playing with fire" by contemplating even a brief debt default as a means to force deeper government spending cuts, an adviser to China's central bank said on Wednesday.

The idea of a technical default -- essentially delaying interest payments for a few days -- has gained backing from a growing number of mainstream Republicans who see it as a price worth paying if it forces the White House to slash spending, Reuters reported on Tuesday.

But any form of default could destabilize the global economy and sour already tense relations with big U.S. creditors such as China, government officials and investors warn.

Li Daokui, an adviser to the People's Bank of China, said a default could undermine the U.S. dollar, and Beijing needed to dissuade Washington from pursuing this course of action.

"I think there is a risk that the U.S. debt default may happen," Li told reporters on the sidelines of a forum in Beijing. "The result will be very serious and I really hope that they would stop playing with fire."

China is the largest foreign creditor to the United States, holding more than $1 trillion in Treasury debt as of March, U.S. data shows, so its concerns carry considerable weight in Washington.

"I really worry about the risks of a U.S. debt default, which I think may lead to a decline in the dollar's value," Li said.

This just shows how governments have been addicted towards profligacy and inflationism as recourse to economic predicaments.

By advocating an increase of US debts, the US will genuinely be “playing with fire”.

Eventually this spending-deficit cycle will reach a point where the US economy won’t be able to pay her liabilities and will prompt her to an outright default or pursue hyperinflationary policies. So China is effectively asking the US to kick the can down the road.

However, these warnings do not just come from China, but also from the Fed’s James Bullard and one of the key credit rating agency, the Fitch Ratings

From the Reuters (hat tip Dr Antony Mueller)

A default would have severe reverberations in global markets, a top Federal Reserve official said just hours after Fitch Ratings warned it could slash credit ratings if the government misses bond payments.

St. Louis Federal Reserve Bank President James Bullard told Reuters on Wednesday "the U.S. fiscal situation, if not handled correctly, could turn into a global macro shock."

"The idea that the U.S. could threaten to default is a dangerous one," he said in an interview.

"The reverberations in those global markets would be very severe. That's where the real risk comes in," Bullard warned.

So the political pressure to raise debt limits has apparently been escalating.

Once the US Congress approves such actions, which I think they will, this gives the Fed another rational for QE 3.0: insurance against the risk of a bond auction failure as previously discussed here.

But while China warns of a default, the fact is that the US has already been partially defaulting on her debt via inflationism (QE 1.0 and 2.0)

Repeating what Murray Rothbard wrote,

Inflation, then, is an underhanded and terribly destructive way of indirectly repudiating the "public debt"; destructive because it ruins the currency unit, which individuals and businesses depend upon for calculating all their economic decisions.

So China prefers indirect default by inflation than an outright default.

Finally another paradox is that this warning of China comes amidst what appears to be her declining interest to finance the US.

True China owns lots of US debts (following charts from zero hedge)

But China has been buying less during the past months

Bottom line: Global policymakers appear to be averse at imposing fiscal discipline and would choose the inflationism route instead.

These actions manifest what I call path dependency or the bailout mentality via inflationism. Until the next crisis implodes such dogmatist approach simply won’t change.

US Capital Markets: Dominance Erode as Investors Shift Overseas

In the world capital markets, the US appears to be losing its leadership

Reports the New York Times (bold highlights mine)

Reva Medical did what a small but increasing number of young American companies are doing — it looked abroad for money, in Reva’s case the Australian stock exchange.

After an eight-month road show, meeting investors and pitching the prospects of a biodegradable stent, the 12-year-old company sold 25 percent of its stock for $85 million in an initial public offering in December.

“There are so many companies that require capital like our company, and they don’t have access to the capital markets in the United States,” said Robert Stockman, Reva’s chief executive. “People are looking at any option to stay alive, which is what we did.”

Reva’s example shows that nearly three years since the financial crisis began, markets in the United States are barely open to many companies, leading them to turn to investors abroad. Denied a chance to list their stock and go public here, they are finding ready buyers of their shares on foreign markets.

Nearly one in 10 American companies that went public last year did so outside the United States. Besides Australia, they turned to stock markets in Britain, Taiwan, South Korea and Canada, according to data from the consulting firm Grant Thornton and Dealogic.

The 10 companies that went public abroad in 2010 — and 75 from 2000 to 2009 — compares with only two United States companies choosing foreign exchanges from 1991 to 1999.

The trend reflects a decidedly global outlook toward stocks, just as the number of public companies in the United States is shrinking.

From a peak of more than 8,800 American companies at the end of 1997, that number fell to about 5,100 by the end of 2009, a 40 percent decline, according to the World Federation of Exchanges.

The drop comes as some companies have merged, or gone out of business, or been taken private by private equity firms. Other young businesses have chosen to sell themselves to bigger companies rather than go public.

Here’s why...

Again from the New York Times, (bold emphasis mine)

A variety of factors explain each company’s decision to list on a foreign exchange, like the increased regulatory costs of going public in the United States. Underwriting, legal and other costs are typically lower in foreign markets, companies say.

The Alternative Investment Market, or AIM, a part of the London Stock Exchange intended for small company listings, is a popular destination for some American companies. The cost of an initial public offering there is about 10 to 12 percent of total capital raised, compared with 13 to 15 percent on Nasdaq, according to Mark McGowan of AIM Advisers, which helps American companies list on AIM.

In addition, the extra annual cost of maintaining a public listing, including complying with Sarbanes-Oxley rules, can be typically much higher in the United States: $2 million to $3 million each year depending on the size of a company compared with a cost as low as $320,000 on AIM or $100,000 to $300,000 in a market like Taiwan, according to advisers.

There are concerns that some foreign exchanges attract companies because their oversight may be less stringent. But companies insist standards are high.

A more important factor than cost, said Sanjay Subhedar, managing director of Storm Ventures, a California venture capital firm, is that investors in the United States who traditionally participate in I.P.O.’s and the banks that underwrite the offerings are no longer interested in share sales by small companies.

Institutional investors like mutual funds want the liquidity of larger offerings with abundant buyers and sellers, he said; bank underwriters want to focus on the more lucrative fees that bigger deals generate.

So fundamentally the article cites compliance cost, cost of listing and maintenance and liquidity as direct costs for the erosion of the dominance of the US.

True, direct compliance costs have been a major hurdle.

Many see that the cost-benefit trade off of the Sarbanes Oxley act (SOX) has been weighted towards costs. In short, the law has been economically unviable and has prompted for unforeseen consequences.

Companies have been spending billions of dollars a year to comply with the SOX with little benefit in return.

Richard Karlgaard of Forbes magazine exhorts for the repeal of SOX

Dump Sarbanes-Oxley. Enacted in 2002 to prevent the next Enron scandal, Sarbox has thrown sand into the gears of entrepreneurship. It has severely slowed the U.S. market for IPOs, since companies earning less than $200 million in revenue can't afford the legal and accounting costs of being a public company today. Deprived of capital, young companies not named Facebook or Twitter prematurely stagnate or sell out. Investors are deprived of opportunity, and the nation is deprived of independent companies that surpass the $1-billion-in-revenue mark.

But there are other indirect factors that also contributes to such dynamic

There is the expanding risk of changing the rules of the game midway or “regime uncertainty” as government intrusions adds onus to the business climate by the contorting expectations and upsetting the balance of risk-reward tradeoffs. This penalizes existing firms and provides disincentives for prospective ventures.

Part of which have been policies that push for boom bust cycles which engenders widespread malinvestments or misdirection of resource allocation.

Another is the effects of policies to devalue. Eroding value of the US dollar may have prompted US companies to go overseas and tap (or arbitrage on) savings denominated in foreign currencies.

There is also the crowding out effect where companies spend money on lobbying to protect their political interests than for expansion.

The Business Insider gives an example of how tech companies have been spending to placate the political deities of Washington.

All these interventions add up to the intensive diversion of productive resources, raise the cost of doing business and consequently reduce the public’s appetite to invest, thereby adding to pressure on jobs creation.

It doesn’t stop here. Taxes have also been a significant part of these growing costs.

Tax Laws have been mounting as government intervention increases.

Chart from Taxes for expats

Also US government’s social spending will likely mean higher taxes.

From Heritage Foundation

And this has already been hurting small businesses which makes up the biggest share of jobs creation.

From Small Business Trends

Total compliance cost for the US economy on current regulations has been estimated at $380 billion per year

So much money has been lost to politics.

As supply-side economist Art Laffer writes at the Wall Street Journal in June of last year

On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush's tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts.

Tax rates have been and will be raised on income earned from off-shore investments. Payroll taxes are already scheduled to rise in 2013 and the Alternative Minimum Tax (AMT) will be digging deeper and deeper into middle-income taxpayers. And there's always the celebrated tax increase on Cadillac health care plans. State and local tax rates are also going up in 2011 as they did in 2010. Tax rate increases next year are everywhere.

So with the prospects of tax increases, capital investments are likely to be constrained (manifested by declining number of public companies) or will shift outside (raising capital overseas).

Bottom line: The eroding dominance of the US capital markets signifies a symptom of an underlying disease- government interventionism (mostly via inflationism)

Ron Paul For President 2012 Cartoon Ad

Nice Ron Paul for US President in 2012 cartoon ad (ht: Lew Rockwell Blog)

Socialism on its Way Out in Europe?

That’s what the Economist claims, (bold highlights mine)

TEN years ago almost half of the 27 countries that now make up the European Union, including Germany, Britain and Italy, were ruled by left-wing governments. Today, following the defeat of the ruling Socialists in Portugal's general election on June 5th, the left is in charge of just five: Spain, Greece, Austria, Slovenia and Cyprus. In Spain, by far the largest of these, polls suggest the Socialists will be removed from office at an election that must be held by next March. There are many theories for the left's weakness in Europe. One is simply that left-wing parties struggle when times are hard. Our chart shows the number of left-wing governments in the EU-27 countries over the past couple of decades against the annual GDP growth rate in the region. The growth figure is shown with a two-year lag, the hypothesis being that economic changes take time to have political effects. So the five left-wing governments this year are shown against the growth (or, in this case, contraction) figures for 2009.

Well if this true then this should be good news. This only goes to show that socialism has been and will always be a failed economic development model.

Although I think Europe's socialism has merely been replaced by crony capitalism or state capitalism as evidenced by the string of bailouts which is not exactly a good or promising development.

Besides, I’d add two more factors to what seems as fueling a structural decline of socialist leaderships: one is globalization and two is the internet. More people interacting with each other across the globe impels for the growth of forces of decentralization which goes against the rigid vertical structure of industrial era based governments.

Anyway, the next crisis will blow up both the balance sheets of the politically favored banking system and that of the governments’ (and this includes Central Banks). This will likely push political developments away from socialism, unless governments successfully enforce mass protectionism circa 1930s by shutting down the web and trade.

My guess is that people around the world are beginning to appreciate economic and political freedom more than what has been depicted by the mainstream.

Bernanke’s Comments Mirror Those of Pre-QE 2.0 in 2010

Bernanke’s comments seem as writing on the wall for QE 3.0

This is from yesterday’s comment by Ben Bernanke. From the Bloomberg, (bold emphasis mine)

Federal Reserve Chairman Ben S. Bernanke said record monetary stimulus is still needed to boost a “frustratingly slow” recovery and repeated that a rise in inflation is likely to prove temporary.

“The economy is still producing at levels well below its potential; consequently, accommodative monetary policies are still needed,” Bernanke said today in a speech to a conference in Atlanta. At the same time, the Fed “will take whatever actions are necessary to keep inflation well controlled,” he said.

Recent data showing weakness in the economy, including a rise in the unemployment rate to 9.1 percent in May, have increased the odds the Fed will hold the benchmark interest rate near zero into next year. Bernanke said growth is likely to pick up in the second half of the year as fuel prices recede and disruptions of parts supplies dissipate as factories in Japan recover from an earthquake and tsunami.

“Overall, the economic recovery appears to be continuing at a moderate pace, albeit at a rate that is both uneven across sectors and frustratingly slow from the perspective of millions of unemployed and underemployed workers.”

Here is Bernanke’s pre-QE 2.0 statement in March 2010

From Bloomberg, (bold highlights mine)

Federal Reserve Chairman Ben S. Bernanke said the U.S. economy still needs low interest rates and that the central bank will be ready to tighten credit “at the appropriate time.”

“The economy continues to require the support of accommodative monetary policies,” Bernanke said today in prepared testimony to the House Financial Services Committee, repeating parts of a statement to the panel from last month. “However, we have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus.”

The central bank chief and his colleagues have been outlining their strategy for tightening credit in time to prevent the recovery from stoking inflation. Officials are concerned that the federal funds rate, their main policy tool for 20 years, isn’t as effective as before in influencing borrowing costs.

“As the expansion matures, the Federal Reserve will need to begin to tighten monetary conditions to prevent the development of inflationary pressures,” Bernanke said in the text of remarks. “We have full confidence that, when the time comes, we will be ready to do so.”

See that poker bluff?

First Bernanke talks ‘weakness’, then he talks of the need for policy accommodation to justify their proposed implied actions and lastly assures the public that the Fed knows how to go about with the ‘exit’ approach. It’s all signaling channel or the conditioning of the public for an upcoming move.

Finally here is Bernanke’s speech in October 2010 or a month before the activation of QE 2.0

From the US Federal Reserve, (bold emphasis mine)

Despite these challenges, the Federal Reserve remains committed to pursuing policies that promote our dual objectives of maximum employment and price stability. In particular, the FOMC is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation over time to levels consistent with our mandate. Of course, in considering possible further actions, the FOMC will take account of the potential costs and risks of nonconventional policies, and, as always, the Committee's actions are contingent on incoming information about the economic outlook and financial conditions.

Sounds very much like QE 3.0 is underway.

UPDATE: I don't expect QE 3.0 to happen immediately. The span of QE 1.0 and QE 2.0 was around 5 months, i.e. end of QE 1.0 in June 10 and the activation of QE 2.0 on November 2010. That's why there will be more managing of the public's 'inflation expectations' over the interim.

Myth of War as Political and Economic Solution

Some people here or abroad seem to be agitating for war.

In the Philippines, recent unfortunate incidents over at the Spratlys Islands have prompted some officials to call for increased military spending as countermeasure against alleged provocations by foreign marauders.

As earlier pointed out, suggestions of an ‘arms race’ are foolish because they are not only economically unfeasible but political brinkmanship risks escalation which might lead to undesired consequences that may be baneful for both parties. In addition war spending robs the local economy of productivity and resources which leads to poverty.

Since the Philippines have an existing Mutual Defense treaty with the US, which other nations recognize, then perhaps current incursions by China represents a test of this relationship or has been merely been flexing her brawn in order to flaunt her new hardwares of destruction.

Besides, China’s actions have not shown aggressiveness elsewhere, and to the contrary, has been more investment oriented.

This is unless China’s military and incumbent political leaders have different agendas.

In the US, experts like Dr. Paul Krugman seem to be arguing for increased war spending to bolster the economy. Professor William Anderson quotes Krugman

“If we had the threat of war, had a military buildup, you’d be amazed at how fast this economy would recover.”

For people who view the world in the context of dollar and cents, then this view would seem plausible.

Yet as rightly pointed out by Professor Anderson the US has been waging war on different fronts,

I'm not sure what we call Iraq, Afghanistan, Libya, and wherever else the U.S. Armed Forces are shooting people. I think I call it war, and we can see just how good it has been not only for our economy, but also the economies of the lands this government has attacked.

From Google’s Public Data

From Cato.org

In relative terms, the US has the largest share of military spending in the world and has continuously outspent the world. And this has been growing trend since 2000 (obviously post 9/11).

So has increased war spending or other forms of government spending been boosting the US economy? Unfortunately not.

From Dan Mitchell

War as a demand booster is a myth.

Henry Hazlitt in his must read classic Economics in One Lesson debunked this fallacious dollar and cents view based on ‘aggregates’.

The great Mr. Hazlitt, (italics original)

Now there is a half-truth in the "backed-up" demand fallacy, just as there was in the broken-window fallacy. The broken window did make more business for the glazier. The destruction of war will make more business for the producers of certain things. The destruction of houses and cities will make more business for the building and construction industries. The inability to produce automobiles, radios, and refrigerators during the war will bring about a cumulative post-war demand for those particular products.

To most people this will seem like an increase in total demand, as it may well be in terms of dollars of lower purchasing power. But what really takes place is a diversion of demand to these particular products from others

In wars, it is not just the diversion of resources from productive to consumptive activities, which brings about a lower standard of living, but the intangible costs from losses of human lives (capital)! Death from war or disasters or any form of destruction cannot serve as economic boosters.

Those who argue for war do so either because they know someone else will do the dying for them or have not envisioned of the brutalities of a real war.

Maybe this is part of what historian Arnold Toynbee calls as the “Generational Cycle in the transmission of a social heritage”.

Dr. Marc Faber quotes Toynbee,

The survivors of a generation that has been of military age during a bout of war will be shy, for the rest of their lives, of bringing a repetition of this tragic experience either upon themselves or upon their children, and... therefore the psychological resistance of any move towards the breaking of a peace ....is likely to be prohibitively strong until a new generation.... has had the time to grow up and to come into power. On the same showing, a bout of war, once precipitated, is likely to persist until the peace-bred generation that has been lightheartedly run into war has been replaced, in its turn, by a war-worn generation'

In short, the lack of exposure to war whets the desire for war.

Here is a suggestion: Dr. Krugman and all his ilk and his followers (including Filipino politicians and their adherents), who yearn for war for whatever reasons, should go to the front line, instead of getting ensconced in the proverbial ‘ivory towers’, and bring their family along with them.

If you want war, go fight them yourself!

Perma Bears Declare: Expect QE 3.0

Popular Perma Bears of different persuasions have jointly declared “QE3 is gonna happen!”

I am no perma bear, but a realist. Although this time I’m on their camp with regards to the prospects of QE 3.0. [pardon me for this seeming appeal to authority, my point is to show that even different ideologies or perspectives can come up with same conclusions]

From the Wall Street Journal, (bold emphasis original)

How’d you spend your weekend? Some of the biggest (and most bearish) guns in economic and market prognostication put their heads together at a small confab on Lake Winnipesaukee in New Hampshire this past weekend. In attendance: David Blanchflower, formerly of the Monetary Policy Committee of the Bank of England; Swiss doom-and-gloomer Marc Faber; Fred Hickey, the bearish editor of the High-Tech Strategist newsletter; Morgan Stanley exec Stephen Roach; and economic forecasters David Rosenberg, Nouriel Roubini and Gary Shilling.

Their conclusion: QE3 is gonna happen! Ed Yardeni, who was there, had this little insider snippet for readers of his daily newsletter (emphasis is MarketBeat’s):

“The conversations were spirited with lots of debates. The consensus was quite pessimistic about the outlook for the US and global economies.

“Everyone seemed to agree that the Fed would most likely leave the federal funds rate at zero for a long time and that a third round of quantitative easing is likely later this year. David Blanchflower, who is a former member of the MPC of the BoE, is in favor of QE-3.0. The rest of us were against it. Most agreed that it would probably boost stock and commodity prices again, though not as much as QE-2.0.

Not that I like it, I think QE is wrong and immoral.

But that’s the way the US political economy has been structured, and that’s how events will likely play out. As earlier pointed out, it’s not just the US but every developed nation’s political leader’s guiding principle or path dependency to policymaking.

The role of the prudent investor is to take advantage of this silliness. As investment guru Doug Casey writes of government interventions,

All such distortions have consequences, and one of them is to create opportunities for speculators.

Correlation isn’t Causation: Commodity Prices and Interest Rates

Correlations interpreted as causation.

This represents one of the most dangerous premises in making predictions.

An article in the Bloomberg suggests that the low interest rate environment may continue to fuel a rally in commodity prices.

From Bloomberg,

Commodities will resume a rally after their worst month in a year as the Federal Reserve keeps its benchmark interest rate at a record low following the end of a $600 billion asset-purchase program, said HSBC Holdings Plc.

The Standard & Poor’s GSCI Total Return Index of 24 commodities tumbled 6.9 percent last month, the first loss since August and the biggest drop in a year on concern growth may slow. The gauge rose 16 percent this year through April after rising 9 percent in 2010 and 13 percent in 2009 as output trailed demand.

Fed Chairman Ben S. Bernanke has indicated the bank won’t remove stimulus immediately after the second round of so-called quantitative easing concludes this month. The central bank will hold its policy rate in a range of zero to 0.25 percent until the year-end, a Bloomberg survey of 72 economists showed.

The CHART OF THE DAY tracks the S&P GSCI Total Return Index and the Federal Reserve’s target rates in the past three decades. Commodities typically move counter to borrowing costs and the GSCI index has advanced 33 percent since the end of December 2008, the month the Fed cut its benchmark rate amid recession.

Though I would agree that commodity prices could rally, partly coincidental to an artificially suppressed interest rates climate over the interim, I’d say that such correlation does not always hold.

Again reference point matters.

The framing of the Bloomberg chart begins in the 1980s and spans through 2010. This is the epoch of globalization.

However, prior to 80s, as the above chart from economagic.com shows, the correlation was much about rising commodity prices (CRB-Reuters-blue) along with rising interest rates (Fed Funds rate-red, 10 year Treasury yield-green), i.e. 1960s until 1980.

That’s because this era marked the ‘guns and butter’ policies of the US (Vietnam War and entitlement programs as Medicare and easy money policies of the US Federal Reserve).

In other words, this period characterized the economic environment known as stagflation (high inflation, high unemployment-which wasn’t incorporated in the traditional Keynesian model).

Bottom line: Correlations of variables highly depends on the underlying forces which drives them. Occasionally, some correlations reflect on the causal nexus, but for most instances they don't.

In my view, the current level of interest rates reflects on the du jour actions of monetary policies. And this seemingly benign trend may radically change, which subsequently, could upset the balance of the low interest rate-high commodity price correlation premise.

Spratlys Dispute: Why AFP’s Plan to Build Up Military Signifies War on the Filipinos

Governments always look for an excuse to expand power. And General Douglas MacArthur was right, government always try to keep “us in a continuous stampede of patriotic fervor -with the cry of grave national emergency” by conjuring “terrible evil at home, or some monstrous foreign power that was going to gobble us up if we did not blindly rally behind it”

The geopolitical tensions over Spratlys Island have prompted the Philippine government to shop for arms, according to yesterday’s news.

From the Philippine Daily Inquirer,

Amid increasing concern over renewed tensions in the South China Sea, the Philippine Embassy here is shopping for excess defense equipment from the United States under Washington’s Foreign Military Sales (FMS) program.

Jose L. Cuisia Jr., the Philippine ambassador to the US, said he has asked the Department of National Defense and Armed Forces back home to provide him with a wish list of military equipment they will need to shore up the country’s defense capability.

He said he expected the defense department to “prioritize” its modernization goals, but was careful not to explicitly link the purchase of US excess defense articles to the Philippine military’s job of securing the territorial sovereignty of the country in the face of China’s alleged intrusions into the areas of the disputed Spratlys group claimed by the Philippines

The idea that the Philippines can resolve the current dispute with China over an ‘arms race’ or by brinkmanship is not only unfeasible and anachronistic but outright ridiculous.

Unfeasible because in almost every aspect, the Armed Forces of the Philippines cannot measure up to China’s People Liberation Army in terms of numbers and in technology.

In addition, China is by far wealthier (in terms of GDP per capital) than the Philippines and thus can afford to spend more for her military services. [Google Public Domain]

Chart from Tradingeconomics.com

Considering that China has unveiled its newest stealth warplane and aircraft carrier, it would seem that no amount of nonsensical ‘arms race’ will prevent a ‘determined’ China from encroaching on Spratlys.

But this isn’t to say that China will do so.

I say anachronism too because military engagement has not been the du jour foreign policy for China.

Had she assimilated an imperialist path, Taiwan, which China claims as part of her territorial sovereignty, would have been invaded. And so with the Japanese held Senkaku Islands, which China has claims too along with the Spratlys. A similar political friction arose in Senkaku Island in 2010 following a collision between Japan’s Patrol boats and a Chinese trawler.

Yet China’s geopolitical strategy has been to expand trade and investments around the world.

Derek Scissors of Forbes magazine writes,

China's hefty investments in sub-Saharan Africa have received deserved attention, but its investment in Latin America has been overblown by some. One reason is a common event in bilateral commercial transactions--grand announcements that never come to fruition. In mid-April Venezuela proclaimed a $20 billion oil-for-loans deal with China, but Caracas' track record in this area encourages skepticism. China has little investment in the Arab world, which is perhaps surprising in light of its focus on energy, but it has sizable engineering and construction contracts there. Australia, at $30 billion, is the single biggest draw for Chinese investment. The U.S. is second at $21 billion, Iran third at $11 billion.

The places where the Chinese have invested most often are also the places where their investments have been most often thwarted: Australia, the U.S. and Iran, in that order. Failures stem from a variety of causes, such as nationalist reactions in host countries, objections by Chinese regulators and mistakes by the Chinese firms themselves. According to the Heritage tracker, the value of failed investments from 2005 to 2009 is a staggering $130 billion. Chinese investment could have been a full 40% larger than it was had the failed deals closed.

So the more appropriate action to resolve any territorial dispute should be to actively increase trade with China.

As Frederic Bastiat once said,

When goods don't cross borders, armies will

Greater trade will likely ensure an amicable or diplomatic settlement because both China and the Philippines would like to see a continuity of this mutually beneficial relationship.

And this goes back to the reason why the call for more military spending represents a war against the citizenry.

As the great Ludwig von Mises wrote,

The adequate method of providing the funds the government needs for war is, of course, taxation. Part of the funds may also be provided by borrowing from the public, the citizens. But if the Treasury increases the amount of money in circulation or borrows from the commercial banks, it inflates. Inflation can do the job for a limited time. But it is the most expensive method of financing a war; it is socially disruptive and should be avoided.

More military spending means higher taxes and risks of higher inflation. It also means redistribution of wealth from the ‘productive’ private sector to government appointed intermediaries and suppliers or non-productive capital consuming activities.

Doing so leads to lower economic growth, higher unemployment, lower investments, higher risk premium and a lower standard of living. Also this amplifies the risks of corruption.

In addition a military build-up could also extrapolate to using newly acquired weapons against the citizenry to suppress political dissent or for repression or to expand in the engagement of military conflict with local subversives.

So instead of seeking diplomatic solutions, the likely path is to have more turmoil which heightens political instability which should further weaken the economy. It's another lesson we never seem to learn.

War on Commodities: UN Endorses Price Controls

UN endorses more price controls on commodities

Reports the Bloomberg,

Commodity markets need international oversight, more transparency and intervention to deflate bubbles because increasing speculation means prices are no longer driven by supply and demand, the United Nations said.

Increased investment in commodity markets has encouraged “herding behavior” and creates bubbles, the UN’s Conference on Trade and Development said in a report published today. Anticipation of the global economic recovery played a “disproportionate role” in higher commodity prices, it said.

“Prices can move far from levels justified by the fundamentals for extended periods, leading to an increasing risk of price bubbles,” the UN said in the report. “Due to these distortions, commodity prices do not always provide correct signals about the relative scarcity of commodities.”

By how exactly does the UN determine “prices are no longer driven by supply and demand”? Their math models?

It’s an irony because earlier they had been warning about a US dollar collapse

From the IBTimes FX

Rob Vos, a senior UN economist involved with the report, said if emerging markets "massively start selling off dollars, then you can have this risk of a slide in the dollar."

Are they assuming that “selling off dollars” and “prices are no longer driven by supply and demand” are not at all connected?

Put differently, that there is absolutely no connection between debasing one’s currency and rising prices?

Maybe Zimbabwe did not experience a socio-economic depression from hyperinflation (2004-2009).

Instead Zimbabwe could have suffered from the herding effects of speculators. Speculators cratered the Zimbabwe dollar and caused consumer prices to double every day

Such is UN's prism of economics.

In the real world, rising commodity prices in response to government’s continued debasing of a currency is a symptom known as the “Flight to Real Values”.

From Mises.org

The frantic rush to spend all monetary savings and other available cash, buying goods, whether needed or not, in order to avoid holding, even for a short time, any rapidly depreciating monetary units. This occurs at that point in the development of inflation when the public is convinced that prices will continue to rise endlessly and at an accelerated pace. The flight into goods or real values is also known as a "Crack-up boom" (q.v.) and marks the complete breakdown of a monetary system.

The UN can only pretend. But they will not succeed in controlling prices if they do not treat the root of the problem—government’s inflationism.

As Ludwig von Mises warned in Planning for Freedom

those engaged in futile and hopeless attempts to fight the inevitable consequences of inflation-the rise in prices-are masquerading their endeavors as a fight against inflation. While fighting the symptoms, they pretend to fight the root causes of the evil. And because they do not comprehend the causal relation-between the increase in money in circulation and credit expansion on the one hand and the rise in prices on the other, they practically make things worse.