Resource Nationalism is a Cover For Crony Capitalism: Philippine Edition

Booming commodity prices are seen as opportunities by politicians to seize more money from private sector specifically, from mining companies, via higher taxes or increased equities to finance insatiable public spending.

Resource nationalism or the "tendency of people and governments to assert control over natural resources located on their territory" (Wikipedia.org) has been an affliction common with Latin America nations. Lately politicians from Indonesia and the Philippines seem to have been contaminated by the allure of MONEY. [Indonesia reportedly wants 51% ownership of mining companies]

Writes the Inquirer.net

The government wants a bigger share, possibly as high as 50 percent, in revenues generated by mining firms operating in the country, Finance Secretary Cesar Purisima said Tuesday.

Speaking at the Philippine Economic Forum held at the Philippine International Convention Center in Pasay City, Purisima described what the government was currently getting from mining firms as “measly” and that increasing its share in mining revenues would allow the public to benefit more from the use of the country’s natural resources.

He said the government was studying revenue-sharing schemes observed by governments and mining firms in other countries to determine what can be best implemented in the Philippines. So far, the 50-50 sharing scheme is preferable, he said.

Changing the rules in the middle of the game represents signs of political immaturity. Governments like Indonesia and the Aquino administration of the Philippines cannot live by the rules they established and change them as capriciously when so deemed expedient by the political class.

So not only do they trash upon property rights of investors and the rest of citizenry (by depriving them of legal and respectable jobs and economic opportunities), they invalidate contracts by force which will turn off prospective investors. This is yet another example of arbitrary regulations.

The response has been captured by the same article.

The plan to increase taxes or to require mining firms to pay royalties has elicited complaints from some members of the mining sector. They said such a plan would be a turnoff to investors as it constituted inconsistency of policies.

The sad part is that these feel good policies will have nasty side effects.

As I previously wrote,

Resource nationalism only adds to the supply imbalances which should mean lesser supplies and subsequently further upward price pressures.

Such actions are being prompted by expectations of governments to generate more revenues with the ultimate end of having more money to spend on political projects. They are doing this in the name of nationalism.

Yet because of the higher costs of doing business or a higher hurdle rate, aside from questions of security of ownership (property rights), investors naturally would back out or become reluctant to invest. This essentially defeats government’s agenda.

In addition, the lack of investments extrapolates to the promotion of unemployment and lost opportunity to grow.

Any local investments will not be sufficient. That’s why they have not been accessed.

Besides, local investments are likely to be “politicized” which means that only the political class and their economic patrons would become the beneficiaries.

And because the resources are there, illegal extraction would occur and proliferate. Subsequently, black markets will blossom.

And illegal activities will lead to more violence, more corruption and more environmental degradation.

Yet most people don’t see that resource nationalism is a front for crony capitalism. Since economic opportunities will be politicized the beneficiaries will be the political class and their allies.

The article again captures such potentials,

On the contrary, Pangilinan expressed willingness to agree to the government’s plan.

He was quoted in an earlier Inquirer report that mining firms might give a 50-percent revenue share to the government, but that it must be based on net revenues rather than gross revenues.

First an explanation of Net revenue. According to the Economic Glossary this means,

A common term for profit, as the difference between total revenue and total cost. When used in the real world of business wheeling and dealing, this notion of net revenue general refers to accounting profit rather than economic profit. The "net" aspect of net revenue indicates that some (that something being cost) is deducted from total or "gross" revenue. Other common terms used in this same context are net income and net earnings.

I read the Inquirer excerpt covering net revenue in the following context: The company’s expenses can bloated—through ‘subsidized’ pricing to friendly suppliers of the firm, ‘consultancy’ fees for politicians and/or their appointees to the company or through many other ‘accounting means’ of skinning the proverbial cat—to a manageable amount that would be subjected to taxes.

Reducing real profits essentially would represent a transfer of resources from minority shareholders to the managers of the mining companies and to the government. Most of the cost of the new tax will indirectly be borne by the minority shareholders, like me.

In other words, woe to the minority shareholders, as the balance sheets of mining companies will also be politicized thereby depriving us of profits via dividends.

And by increasing the cost of investments in the domestic mining industry, competition will be limited, and thus would entrench the position of the incumbent leaders, that also increases their leverage to negotiate on the copious untapped mining claims and to dominate deals within the industry.

President Aquino’s resource nationalism essentially hands the silver platter to the administration’s favored investors.

I guess political developments have been turning out as I predicted.

ECB’s Record Balance Sheet Tops the US Federal Reserve

From the Bloomberg,

The European Central Bank’s balance sheet surged to a record 3.02 trillion euros ($3.96 trillion) last week, 31 percent bigger than the German economy, after a second tranche of three-year loans.

Lending to euro-area banks jumped 310.7 billion euros to 1.13 trillion euros in the week ended March 2, the Frankfurt- based ECB said in a statement today. The balance sheet gained 330.6 billion euros in the week. It is now more than a third bigger than the U.S. Federal Reserve’s $2.9 trillion and eclipses the 2.3 trillion-euro gross domestic product of Germany (EUANDE), the world’s fourth largest economy.

The ECB last week awarded banks 529.5 billion euros for three years in the biggest single refinancing operation in its history, adding to the 489 billion euros it lent in December. The flood of money, which aims to combat Europe’s sovereign debt crisis by unlocking credit for companies and households, has increased the risk exposure of the 17 euro-area central banks that together with the ECB comprise the Eurosystem.

Here are the accompanying charts also from Bloomberg

ECB’s € 3.0 (US $ 3.96) Trillion

US $2.9 Trillion

In seeing the above, we understand that underneath today’s veneer of tranquility, there has been a lingering disorder that has yet to be manifested on the marketplace and on the real economy. These can be analogized to rapidly spreading cancer cells at the earlier stages.

Yet the above does not include the balance sheets of the Bank of England, Bank of Japan and the Swiss National Bank whom have all been undertaking similar actions.

Despite occasional publicized opposition, these policy palliatives will be sustained by political authorities in the hope of rehabilitation and the preservation of the incorrigibly degenerate political system.

Policymakers of developed economies will likely push this or exploit the use of central banks to the limits until a blowback in the economy and the monetary system becomes apparent.

Because the public is hardly aware of the operations of central banks, central bankers have assumed the role of hatch men for politicians and their privileged cronies the banking class.

Yet to desist from the current actions will translate to a collapse of too big to fail banking institutions that should drag along the welfare-warfare state, a development which current political agents have fervently been trying to defer, thus the unprecedented experiment.

There is no way for any person who understands the fundamentals of money to be bearish on prices of precious metals given the prospective extension of these policies.

The recent surge in global stock markets has been symptomatic or signifies as the initial outcome of the the second wave of central banking money therapy that is being applied. I expect that equity markets particularly those from emerging markets to mainly benefit from these remedial measures for the time being. This will hardly be an issue of earnings or valuations, but of the evolving state of money.

Lastly with the Euro balance sheet surpassing that of the US Federal Reserve, it’s time to be temporarily bearish the Euro. I say temporary because I expect the US Federal Reserve to eventually ramp up on their balance sheet through another QE (or a variant of it) for many earlier stated reasons.

However, I wouldn’t short the Euro though, the political management of fiat currencies have already been evincing of their innate tendencies of returning to their intrinsic value—zero. I’d buy precious metals instead

We have to be reminded that the relative valuations of currencies is determined by the relative demand and supply of currency units.

As the great Ludwig von Mises wrote,

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

Earnings Drive Stock Prices? International Container Terminal and Ayala Land

I picked the following charts because of the availability of charts that depict on their profit growth trends

The following is the 6 year chart of International Container Terminal [PSE: ICT]

During the three major cycles since 2006, ICT skyrocketed 410%, crashed by 78% (from peak to trough) and in the current uptrend soared by a whopping 474% from the bottom in the 1^st Quarter 2009.

Here is ICT’s profitability chart from 4-traders.com

While the growth rate for ICT’s profits did fall in conjunction with the decline in ICT share prices in 2007-2009, one should realize that profits were still strongly POSITIVE. In short, there has been no justification for the 70% decline under the premises of earnings-as-driver of stock prices.

Yet there are two notable discrepancies during the last 2 bull cycles of ICT. Profit growth had been modest in 2005-2007. Today, the same growth rate has seen a decline even as share prices continues to etch new record highs. In short, share prices have little correlation with actual earnings performance.

The next chart is Ayala Land Inc, [PSE: ALI] contemporary market leader of the Phisix since the start of the year

We see the same pattern in ALI. ALI surged 130% in the 2006 to the peak of 2007, plummeted 74% during the last bear market and is at an eye-popping 327% from the troughs of 2009.

Same story with ICT. Growth rate of profits does not justify ALI’s extreme price volatility in both directions during the last three cycles. The company exhibits steady, incremental and low volatility in earnings growth which is typical of blue chips.

Here is what I see.

-There has been a loose correlation between earnings and price values

-Considerable price volatilities do not match with the pace of earnings growth.

-Philippine stocks sink and swim in tides as discussed here and here

Looking at earnings as the main driver of prices seems like watching the Heisenberg uncertainty principle in quantum mechanics at work—“it is impossible to pin down the position and momentum of a subatomic particle beyond a certain degree of accuracy; the very attempt to determine the position of an electron (by firing light at it) will itself change its momentum” (Robert Murphy, Human Action Study Guide).

In short, using earnings as key parameter for investing in the Philippine market seems like a nebulous target, you’d never know if or when this is going to work for you, except that this serves as an excuse to piggyback on the current bullrun.

Above is the PE ratio of the Phisix according to the IMF.

Considering the huge jump in prices from the start of the year, we should be around at near the peak of 2007. So anyone who believes in this stuff ought to be shorting or selling the market. I won’t.

As a caveat, like individuals, national stock markets bear their own respective idiosyncrasies so they shouldn't be seen or valued in a one-size-fits-all dimension.

Also one should realize that as central banks around the world, including the Philippines, intervene in the financial monetary system, there will be material impacts to profitability, operating costs and leverages and other corporate matters. In short, business decisions or economic calculations will also be distorted.

Nevertheless, earnings for me, like charts, function as a secondary and or a confirmatory signal rather than the prime mover.

Are High IQs Key to Successful Investing?

Yale Professor Robert Shiller thinks so.

Writing at the New York Times,

YOU don’t have to be a genius to pick good investments. But does having a high I.Q. score help?

The answer, according to a paper published in the December issue of The Journal of Finance, is a qualified yes.

The study is certainly provocative. Even after taking into account factors like income and education, the authors concluded that people with relatively high I.Q.’s typically diversify their investment portfolios more than those with lower scores and invest more heavily in the stock market. They also tend to favor small-capitalization stocks, which have historically beaten the broader market, as well as companies with high book values relative to their share prices.

The results are that people with high I.Q.’s build portfolios with better risk-return profiles than their lower-scoring peers.

Certainly, caution is needed here. I.Q. tests are controversial as to what they measure, and factors like income, quality of education, and family background may not be completely controlled for. But the study’s results are worth pondering for their possible implications.

So how valid is such claim?

Let’s get some clues from some of my favorite investors.

Here is the legendary Jesse Livermore (bold emphasis mine)

The market does not beat them. They beat themselves, because though they have brains they cannot sit tight. Old Turkey was dead right in doing and saying what he did. He had not only the courage of his convictions but also the intelligence and patience to sit tight.

When I am long of stocks it is because my reading of conditions has made me bullish. But you find many people, reputed to be intelligent, who are bullish because they have stocks. I do not allow my possessions – or my prepossessions either – to do any thinking for me. That is why I repeat that I never argue with the tape.

Mr. Livermore simply posits that intelligence can be overwhelmed by egos and cognitive biases (particularly in the second quote the endowment effect, Wikipedia.org—where people place a higher value on objects they own than objects that they do not.).

Here is the 10 investing principles by another investing titan the late Sir John Templeton

1. Invest for real returns 2. Keep an open mind 3. Never follow the crowd 4. Everything changes 5. Avoid the popular 6. Learn from your mistakes 7. Buy during times of pessimism 8. Search worldwide 9. Hunt for value and bargains 10. No-one knows everything

More from John Templeton

“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

Here is value investor turned crony, Warren Buffett. I’d say that Mr. Buffett’s original wisdom has been a treasure. (bold emphasis mine)

‘I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.’

‘Read Ben Graham and Phil Fisher read annual reports, but don’t do equations with Greek letters in them.’

‘Never invest in a business you cannot understand.’

‘You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right – that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.’

Does all the above sound like high IQ stuff? Evidently they represent more common sense and the school of hard knocks stuff.

Yet to the contrary, high IQs can translate to portfolio disasters.

The landmark bankruptcy by Long Term Capital Management in 1998 had been a company headed by 2 Nobel Prize winners. The company’s failure has substantially been due to flawed trading models.

In 2008, the 5 largest US investment banks vanished. These companies had an army of economists, statisticians and quant modelers, accountants, lawyers and all sort of experts who we assume, because of their stratospheric salaries and perquisites, had high IQs.

When Queen Elizabeth asked why ‘no one foresaw’ the crisis coming, the reply by the London School of Economics (LSE)

"In summary, Your Majesty," they conclude, "the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole."

Imagination had been scarce because the same army of experts heavily relied on mathematical models in dealing with investments. They did not follow the common sense advise by the real experts.

My favorite iconoclast author Nassim Taleb in Fooled by Randomness offers an explanation (emphasis added)

it is also scientific fact, and a shocking one, that both risk detection and risk avoidance are not mediated in the “thinking” part of the brain but largely in the emotional one (the “risk as feelings” theory). The consequences are not trivial: It means that rational thinking has little, very little, to do with risk avoidance. Much of what rational thinking seems to do is rationalize one’s actions by fitting some logic to them.

What the consensus mistakenly thinks as rational is, in reality, the emotional. Thus, we need more Emotional Intelligence (EI) rather than high IQs

The most important observation or lesson is one of the repeated botched attempts by high IQ people to transform investing into ‘science’.

Well, because investing involves people’s valuations and preferences, all of which constitutes human action, in truth, investing is more than science…

As the great Ludwig von Mises explained. (bold highlights mine)

For the science of human action, the valuations and goals of the final order at which men aim constitute the ultimate given, which it is unable to explain any further. Science can record and classify values, but it can no more "explain" them than it can prescribe the values that are to be acknowledged as correct or condemned as perverted. The intuitive apprehension of values by means of understanding is still not an "explanation." All that it attempts to do is to see and determine what the values in a given case are, and nothing more. Where the historian tries to go beyond this, he becomes an apologist or a judge, an agitator or a politician. He leaves the sphere of reflective, inquiring, theoretical science and himself enters the arena of human action.

...but rather, investing is an art.

Again Professor Mises from the same article.(emphasis added)

The position of science toward the other values of acting men is no different from that which it adopts toward aesthetic values. Here too science can do no more with respect to the values themselves than to record them and, at most, classify them as well. All that it can accomplish with the aid of "conception" relates to the means that are to lead to the realization of values, in short, to the rational behavior of men aiming at ends.

Bottom line: The art of managing our emotions or emotional intelligence, via common sense and self-discipline, is more important than having high IQs.

Quote of the Day: Wind Power Scam

To the nearest whole number, the percentage of the world’s energy that comes from wind turbines today is: zero. Despite the regressive subsidy (pushing pensioners into fuel poverty while improving the wine cellars of grand estates), despite tearing rural communities apart, killing jobs, despoiling views, erecting pylons, felling forests, killing bats and eagles, causing industrial accidents, clogging motorways, polluting lakes in Inner Mongolia with the toxic and radioactive tailings from refining neodymium, a ton of which is in the average turbine — despite all this, the total energy generated each day by wind has yet to reach half a per cent worldwide…

The real enemy is not wind farms per se, but groupthink and hysteria which allowed such a flawed idea to progress — with a minimum of intellectual opposition.

That’s from prolific author Matt Ridley writing at the spectator.co.uk, who is sponsoring an essay contest to challenge the “consensus-worshipping, heretic-hunting environment”, called “Matt Ridley prize for environmental heresy” with prize money of £ 8,500 (estimated 575k pesos).

The Politics of Climate Change

Analyst Martin Spring gives a concise but trenchant description or explanation of the politics of climate change.

Writes Mr. Spring (bold emphasis added)

Following the resignation of Nobel Prize-winning physicist Ivar Glaever from the American Physical Society because of its insistence that the evidence of human-caused global warming is “incontrovertible,” 16 eminent scientists have published an attack on “the oft-repeated claim that nearly all scientists demand that something be done to stop global warming.”

They say that’s “not true.” Indeed, a large and growing number of distinguished scientists and engineers disagree, recognizing that there is much contrary evidence.

Such “heretics” are persecuted, one example being the campaign to fire Dr Chris de Freitas, editor of the journal Climate Change, for daring to publish a peer-reviewed, factually-correct article that recent warming has not been unusual in the context of what happened over the past thousand years.

Many young scientists say they have serious doubts about the global-warming message, but “they are afraid to speak up for fear of not being promoted – or worse.”

The reason such savage efforts are taken to suppress contrary opinion and inconvenient facts is that “alarmism over climate is of great benefit to many, providing government funding for academic research and a reason for government bureaucracies to grow.

“Alarmism also offers an excuse for governments to raise taxes, taxpayer-funded subsidies for businesses that understand how to work the political system, and a lure for big donations to charitable foundations promising to save the planet.”

The scientists argue that even if one accepts the “inflated climate forecasts,” aggressive policies to control emissions of greenhouse gases are not justified economically.

“A recent study of a wide variety of policy options by Yale economist William Nordhaus showed that nearly the highest benefit-to-cost ratio is achieved for a policy that allows 50 more years of economic growth unimpeded by greenhouse gas controls.

“This would be especially beneficial to the less-developed parts of the world. And it is likely that more CO2, and the modest warming that may come with it, will be an overall benefit to the planet.”

The anthropomorphic global warming or climate change dogma has mostly been about the expansion of political power or control over the marketplace (via mass indoctrination and propaganda through government influenced institutions and media outfits), crony capitalism and covert socialism.

After 5,000: What’s Next for the Phisix?

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. Ludwig von Mises

Phisix breaks 5,000!

As I previously wrote[1], we should expect this soon. But this happened much sooner than I expected. I was looking at 2 weeks to a month as my window for this projection to materialize.

I am hardly indulgent towards crafting short term predictions, however the slew of events combined with momentum seemed too compelling, as the popular idiom goes, “The writing was on the wall”.

Nevertheless Friday’s breach of the psychological threshold signifies as another fulfilment or “I told you so moment”.

I even thought that I might be operating with overconfidence such that Monday turned sharply in the opposite direction from my expectations—the Phisix fell nearly 2%!

However with lady luck on my side, what I thought could be signs of falsification of my thesis turned out to be a springboard instead. The local benchmark expunged the one-day loss and carved a hefty 2.52% gain over the week to close at 5,016.3! That’s a full 4.5% swing.

Well, riding on a bullish momentum, market participants have palpably been looking for some events to nudge them into a buying spree. And they found one in BSP’s [Bangko Sentral ng Pilipinas] lowering of key policy rates, the second time this year.

Misleading Focus to Justify Low Policy Rates

Local central bank authorities justified their actions based on the crisis in the Eurozone.

From the Inquirer.net[2]

“Global economic conditions are expected to stay subdued as fiscal and banking sector headwinds in advanced economies affect global output growth and as market confidence remains fragile,” BSP Governor Amando Tetangco Jr. said in a statement Thursday.

The unfavorable global factors Tetangco was referring to included the prolonged debt crisis in the eurozone that would likely to continue dragging export earnings of the Philippines and other countries that have been exporting goods to the Western region. The crisis is also seen dampening outlook on the global economy, thereby dragging appetite for investments even in countries outside the eurozone.

Apparently many mainstream institutions also see events in the lens of political authorities as the chart above from Danske Bank showed[3]

But how valid has this view been?

The problem that haunts the mainstream is the same problem that plagues political authorities. In behavioural finance, this is called as the focusing effect. People tend to focus on some aspects which they construe as a generalized phenomenon. This is really a fallacy of composition.

Why?

Outside the Eurozone crisis, global events don’t support this view.

The CPB Netherlands Bureau for Economic Policy Analysis in its recent monthly report indicates that both world trade volume and world industrial output ended last year or December 2011 at record highs[4].

In reality, in spite of the Eurozone crisis, world industrial production and exports soared to new record highs which should hardly have been a drag on local exports or the local economy.

This means that whatever slowdown that has afflicted Philippine exports has little to do with global DEMAND but has been mostly about relative competitiveness and relative productivity.

As always what is available and visible will be used as cover, or in this case, the Eurocrisis has been used as scapegoat to justify the redistributionist policies via interest rates interventions.

Psychological Disorientation from Low Interest Policies

The local inquirer article continues

“Cut in interest rates is seen boosting demand for loans, which in turn support increase in consumption and investments. However, since lower rates spur demand, it has the tendency to accelerate inflation.”

In reality what the lowering of interest rates below market levels does is to increase people’s time preferences or magnifies people’s time orientation towards present consumption activities than of the future.

Again to quote Professor Roger W. Garrison[5],

Time preference is simply a summary term that refers to people's preferred pattern of consumption over time. A reduction in time preferences means an increased future-orientation. People willingly save more in the present to increase the level of future consumption. Their increased saving lowers the natural rate of interest and releases resources from the final and late stages of production. Simultaneously, the lower natural rate, which translates directly into reduced borrowing costs, makes early stage production activities more profitable. With the reallocation of resources from late to early stages of production, the preferred temporal pattern of consumption gets translated into an accommodating adjustment of the economy's structure of production.

This means, yes, consumption activities will increase, enhanced by more borrowings (credit cards, home, car chattel loans and personal loans etc…), but this will also reflect on a shift in the balance of people’s savings and investment patterns with a bias for consumption.

Borrowings accrued from artificially lowered interest rates does not distinguish between productive and consumption demand. They are seen as homogenous when they are not. This is misleading. That’s because consumption activities are not growth inducing for the simple reason that they are not productive.

As Dr. Frank Shostak explains[6],

We suggest that an individual's effective demand is constrained by his ability to produce goods. Demand cannot stand by itself and be independent — it is limited by production. Hence what drives the economy is not demand as such but the production of goods and services. The more goods an individual produces, the more of other goods he can secure for himself.

In short, an individual's effective demand is constrained by his production of goods. Demand, therefore, cannot stand by itself and be an independent driving force.

And as I earlier pointed out[7], bank lending growth in the Philippine has surged by 19% in 2011 according to the BSP. The BSP assumes the categorization of loan disbursement is accurate, I believe it is not. In many occasions loans can be redirected to other uses.

And since savings are penalized from such policies, people will be induced to take on high risks activities in order to generate profits (search for yield), such as intensive speculation and gambling, to sustain their consumption activities.

As I have repeatedly been pointing out[8], negative real rate environment has been instrumental for the record rise of the local stock market.

Local investors has lorded it over foreign investors for this cycle which incepted in 2009. The chart above shows that foreign investor’s share of total trade has been below 50% since 2011. This is in contrast to the 2003-2007 cycle, where foreigners were dominant. This should serve as evidence to the policy impact of a negative real rate environment to the stock market. While today’s actions look pleasant, we must keep in mind that the obverse side of a (inflation driven) boom phase is a (deflation driven) bust.

Euthanasia of the Rentier: The Greatest Ponzi Scheme

Since fixed incomes will also suffer from interest rate manipulations, many will fall victim or get seduced to dabble with Ponzi schemes marketed by scoundrels who would use the current policy induced environment as an opportunity to exploit a gullible public.

In the US, Ponzi schemes skyrocketed as the US Federal Reserve has taken on a zero bound interest rate environment in response to the recent crisis in 2008.

“Bad times” have been attributed as pretext to such incidences[9]. In reality, US Federal Chair Ben Bernanke’s zero bound rates have altered people’s value scales and time preferences such that they became vulnerable to high risks yield chasing actions as exemplified by large accounts of people being duped by fraudsters.

And despite declining incidences, Ponzi schemes remain outrageously high compared to the 2003-2007. Of course, the chart omits one major critical factor: 2003-2007 highlighted the property boom phase that morphed into a worldwide crisis where huge number of Americans (and foreign bankers and financial houses) got sucked into the bubble.

What this means is that Fed policies have transformed many Americans to become inveterate gamblers who jump from the proverbial frying pan to the fire by motivating them to plunge into every unsustainable booms in search of the elusive Holy Grail.

In other words, policies of the US Federal Reserve, which have been embraced or imbued by the central banking class all over the world—including the Philippines—seem to be the grandest Ponzi scheme ever hatched, except that central bank policies have been politically mandated.

Negative interest rate environment will also adversely affect financial companies dependent on fixed income such as life and non life insurance, pre-need, HMOs and pension companies. If their revenues (premiums, fixed income placements and investments) do not grow enough to match the increase in liabilities (where the latter will be affected by price inflation), then these companies will be tempted or motivated to undertake adventurous risk matching portfolios for survival, that may lead to future bankruptcies. So do exercise discretion in selecting your insurer.

Serial Bubble Blowing from Negative Real Rates Policies

Further, below market interest rates will encourage capital intensive “early stage production” ventures.

As I have been pointing out, even the activities in the domestic stock markets have been validating this concept.

This week, the property sector has dominated the field. Led by Ayala Land (+5.21%), the property indiex has risen above the weekly gains of the Phisix, which means that the breach of the 5,000 level has been mostly due to the property index.

Year to date, the property and the financial indices have running nose to nose for the leadership.

And in contrast to what the news article says, demand alone does not accelerate inflation, it is the bank-circulation credit (fiduciary media) and or direct central bank asset purchases which manifested through the expansion money supply that spawns inflation.

Yet the silence of media and political authorities in dealing with the truth has been tainted by political goals.

As the great Ludwig von Mises observed[10],

The hindrance that the monetary or circulation-credit theory had to overcome was not merely theoretical error but also political bias. Public opinion is prone to see in interest nothing but a merely institutional obstacle to the expansion of production. It does not realize that the discount of future goods as against present goods is a necessary and eternal category of human action and cannot be abolished by bank manipulation.

In the eyes of cranks and demagogues, interest is a product of the sinister machinations of rugged exploiters. The age-old disapprobation of interest has been fully revived by modern interventionism. It clings to the dogma that it is one of the foremost duties of good government to lower the rate of interest as far as possible or to abolish it altogether.

All present-day governments are fanatically committed to an easy money policy.

Gosh, how relevant this has been today.

Said differently present day governments are fanatically committed to serially blowing bubbles.

So far, bank lending growth has not yet reached alarming levels in the Philippines and in the region.

So in spite the recent surge in bank lending, the low base of lending growth (relative to the past and relative to the ASEAN peers) seem to have provided BSP authorities the confidence to take the gambit of further lowering interest rates.

Despite the highly visible construction boom, which should serve as empirical evidence, growth in the loan category to the property sector as percentage of total loans has hardly improved over the last three years. Both charts from ADB[11]

We must understand that bubble cycles function as a process which means they develop overtime and undergo several stages.

Thus, it takes constant vigilance to identify or guess estimate on the whereabouts of which particular stage we could be in.

How the Credit Fuelled Boom Unfolds

What this implies is that the BSP’s move will fuel more upside to the Phisix where the prospective gains will be bankrolled mainly by the substantial expansion of domestic bank credit. Although auxiliary markets equities and bonds will tapped, most likely price expression of the bubbles will become apparent or ventilated in these markets too.

Importantly this credit boom will also filter into the real economy most likely to the property and the mining sector.

Such dynamics represents the business cycle at work.

The credit boom will be highlighted by a reflexive feedback mechanism between prices of securities and collateral values.

When people are eager to borrow, as George Soros writes in the Alchemy of Finance[12], and the banks are willing to lend, the value of the collateral rises in a self-reinforcing manner. High prices of securities extrapolate to higher collateral values which encourages more borrowings that eventually feed into higher prices which reinforces the feedback loop.

However the growth in lending based on artificial price signals through the interest markets, whether in the asset markets or in the real economy, will lead to the accretion of misdirected allocations of resources since artificial interest rates will skew the economic coordination process

As Professor Steve Horwitz[13] writes,

Once that bad interest rate signal is in place, intertemporal discoordination will result. The nature of money and the time-ladenness of production mean that we don't see that discoordination at first, as it is masked by the boom. The increased activity at both the higher orders of goods and the consumption level looks like growth until the fact that there is insufficient real savings to support the increased (now "mal") investment at the highest orders makes itself known.

Nonetheless, the phases of the bubble will run in conjunction with credit cycles (based from post Keynesian economist Hyman Minsky’s hypothesis[14]) which transitions from the current state of hedge financing (income flows will meet interest and principal liabilities) to speculative financing (income flows will meet interest payments only) and ultimately to Ponzi financing (income flows will not cover both interest and principal liabilities but will depend on asset prices which today has been very evident in the sovereign debts of western nations and which subsequent actions by central banks has been engineered to keep propping these up by zero interest rates, asset purchasing programs and direct interventions in the marketplace). Israel’s central bank buying into US stocks can be seen as direct intervention although cloaked as “investments”[15].

Actions in the external environment actions will substantially affect returns in the local markets too. As developed economies intensify their credit easing policies, these could lead to heightened capital inflows, partly through yield arbitrages or carry trades and partly through portfolio flows, into emerging markets as the Philippines which should amplify the domestic credit boom. Of course a credit boom will also occur in the international that would finance these carry trades and portfolio flows.

Given these interconnectedness of world markets, the Philippines will remain highly sensitive to the international risk environment.

The Ponzi dynamics of government debt markets, as well as the heavily politicized financial markets assures of outsized volatilities in both directions for financial markets.

The seeming epiphany of global stock markets on the side of the bulls have been underpinned by actions of major central banks who recently has jumpstarted the next wave of asset purchases such as Bank of Japan and Bank of England and indirectly through the ECB’s LTRO facilities which as predicted had an overwhelming reception[16].

The continuity of the current boom conditions has been principally dependent on liquidity conditions which emanates from feedback loop of market’s reactions to policy responses and vice versa.

For the recent past years, stock markets tend to experience amplified downside volatility when policy programs approached their maturity (such as in the US).

Yet given the rabid fear of another episode of recession or deflationary scare, the mechanistic response by central bankers has been to reflate the system with more credit easing programs. Thus we should expect mini-bubble cycles amidst a larger bubble framework.

Also, we cannot discount any upsurge in consumer price inflation given the scale of monetary injections. This will have repercussions on the market too. This is why markets will be volatile.

After 5,000: What’s Next for the Phisix?

Interim profit taking following the recent breakout of the Phisix from the 5,000 threshold level should be expected, given the partially overbought conditions.

But any retracements are likely to be minor and will not exhibit large scale broad market deterioration in the strict condition that the current domestic and international markets remains on a RISK ON mode.

Instead we should expect rotations among sectoral performances or issues within specific sectors.

The recent interest rate cut by the BSP will provide more fuel to the bulls. Given the relatively less leverage financial system, the booming Phisix will be augmented by a surge in domestic bank credit and possibly credit driven portfolio flows and carry trades from overseas investors.

Yet returns in the Phisix will be subject to the highly fluid conditions abroad.

Lastly the mercantilist goal of “promotion of exports” through low interest rate policies won’t work. What this will do is to foster an unsustainable domestic boom that will become evident in the stock market and in the real economy through specific sectors, that leads to an eventual bust in the fullness of time.

Moreover domestic inflation will undo any ephemeral cost advantage from policies that have been designed to undermine a currency’s purchasing power.

What I believe is that the real goal by the BSP has not been to promote export growth (which is in itself is a very bad mercantilist-protectionist idea). The economy has always been used as a veneer to promote certain unstated or unpublicized political agenda.

I believe that the BSP has been working in conjunction or in collaboration with other global central banks to enforce the Keynesian doctrine of “the euthanasia of the rentier” or to keep interest rates permanently low, not just to promote permanent quasi-booms, but also to assist in the rehabilitation of an unsustainable welfare based political, which plagues many developed economies today, along with their banking cronies.

Yet we can expect a blowback from such actions overtime.

For now profit from folly.

---

[1] See Phisix: Expect A Breakout from the 5,000 level Soon, February 26, 2012

[2] Inquirer.net BSP cuts interest rates to 4% for overnight borrowing, 6% for lending, March 1, 2012

[3] Emerging Market Weekly Global monetary easing is helping sentiment, February 22, 2012 Danske Bank

[4] Perry Mark, Dec. 2011 Sets Record for the Highest-Ever Volume of Global Trade and Global Output in History mjperry.blogspot.com February 28, 2012

[5] Garrison Roger W. Natural and Neutral Rates of Interest in Theory and Policy Formulation April 21, 2007 Mises.org

[6] Shostak Frank, It's Not Really about the Debt, March 1, 2012 Mises.org

[7] See Global Equity Market’s Inflationary Boom: Divergent Returns On Convergent Actions February 13, 2011

[8] See Investing in the PSE: Will Negative Real Rates Generate Positive Real Returns?, November 20, 2011

[9] Economist.com, Fleecing the flock, January 28, 2012

[10] Mises, Ludwig von The Monetary or Circulation-Credit Theory of the Trade Cycle, June 11, 2010 Mises.org

[11] ADB.org Asia Economic Monitor December 2011

[12] Soros George The alchemy of finance, p 23 John Wiley & Sons

[13] Horwitz Steve Austrian Cycle Theory is Not a Morality Play, March 3, 2011 CoordinationProblem.org

[14] Wikipedia.org Understanding Minsky's financial instability hypothesis, Hyman Minsky

[15] See Applying Bernanke’s Doctrine: Central Banks ‘Invests’ in Stock Markets, March 2, 2012

[16] See Record Bank Borrowing from ECB’s Second Round LTRO, March 1, 2012

Japan’s Speech-jamming gun and Censorship

From My Fox Orlando, (hat tip Bob Wenzel)

Japanese researchers have invented a speech-jamming gadget that painlessly forces people into silence.

Kazutaka Kurihara of the National Institute of Advanced Industrial Science and Technology, and Koji Tsukada of Ochanomizu University, developed a portable "SpeechJammer" gun that can silence people more than 30 meters away.

The device works by recording its target's speech then firing their words back at them with a 0.2-second delay, which affects the brain's cognitive processes and causes speakers to stutter before silencing them completely.

Describing the device in their research paper, Kurihara and Tsukada wrote, "In general, human speech is jammed by giving back to the speakers their own utterances at a delay of a few hundred milliseconds. This effect can disturb people without any physical discomfort, and disappears immediately by stopping speaking."

Question is who benefits from this invention, will it be the public or political authorities? Since National Institute of Advanced Industrial Science and Technology is a public research institution and Ochanomizu University is a public national university for women, round 1 goes to the politicians.

For Iceland, Canadian Loonie is Better than the US Dollar

From Globe and Mail (hat tip Zero Hedge)

Iceland’s newfound love for the loonie is sparking a wave of controversy, from Reykjavik to Ottawa.

For 150 years, the rest of the world has shown scant interest in the Canadian dollar – the poor cousin to the coveted U.S. greenback.

But now tiny Iceland, still reeling from the aftershocks of the devastating collapse of its banks in 2008, is looking longingly to the loonie as the salvation from wild economic gyrations and suffocating capital controls.

Canadian ambassador to Iceland Alan Bones had planned to deliver remarks to a conference on the future of the Icelandic Krona, making it clear that if Iceland decided to adopt the Canadian dollar, with all its inherent risks, Canada was ready to talk.

The actual adaption to non-US Dollar reserves for the banking system represents as more evidence of the ongoing erosion of the foundations of the US dollar standard.

For now, intentions to shift signify as just that--proposals to act. Nevertheless, anxiety over the untenable state of the today's currency platform appear to be snowballing. Once a tipping point has been reached, then the decline will be pronounced.

Quote of the Day: Why Intellectuals are Predisposed to Socialism

Intellectuals who consider inequalities in wealth evidence of injustice often seek political remedies. These take the form of legislation and, more often, regulation. In the process, of course, they are able to portray themselves as heroic opponents of injustice. If they have sufficient support, they are also able to acquire significant power, wealth and status. We know from experience, however, that these intellectuals rarely consider their own wealth evidence of injustice.

That’s from Patrick Cox at the Daily Reckoning. In the above passage, substitute intellectuals with politicians, we get the same outcome.

Murray Rothbard’s 86th Birthday

Murray Rothbard, the late dean of the Austrian School of Economics, had his 86th birthday yesterday. [hat tip Bob Wenzel]

My favorite quote from Professor Rothbard,

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a "dismal science." But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

Quote of the Day: Ideas Grow on Blogs

Social networks, like real life, are driven by influencers—not necessarily those with the most friends or followers, but those whose thoughts, ideas and opinions have the biggest impact. Mr. Collegio notes that for political action committees "to seed opinion makers, Twitter is the ultimate platform. Ideas grow into stories on blogs and eventually in the mainstream media." Not the other way around.

That’s from author and former hedge fund manager Andy Kessler in an Op Ed column at the Wall Street Journal. The flow of ideas seem to be reversing; from the mainstream media to the public and now from the public--through social media networks as blogs--to the mainstream.