Phisix: The Journey Of A Thousand Miles Begins With A Single Step

The much awaited breathing space for the Phisix has finally arrived, but the crucial question is how long and how deep will this last?

This week’s marginal .71% decline has been only the second weekly decline for the year, or 2 out of the 10 weeks into the 1^st quarter of 2012.

Market Internals Exhibits Healthy Rotational Process

But the actions of the local benchmark have not been representative of the overall dynamics.

Despite this week’s profit taking, market internals continue to exhibit positive developments. The weekly advance-decline spread seems to be improving, highlighted by a positive market breadth where there had been marginally more advancing issues than declining issues.

This implies that the current retrenchment has been more about the big market caps.

Of the 10 largest free floated market cap components of the Phisix, only Bank of the Philippine Island [PSE:BPI] and San Miguel Corporation [PSE:SMC] posted gains thereby partly offsetting the losses seen in the major benchmark, while the rest were in the red, led by SM Prime Holdings [PSE:BPI] and Philippine Long Distance Company [PSE:TEL]. Combined these issues account for 62.2% of the Phisix market capitalization as of Friday’s close.

So market internals have only been affirming our rotational process at work.

As I previously wrote[1],

the rotational process extrapolates to the shifting market’s attention from heavyweights to second or third tier issues and vice versa which can also be a dynamic found within specific sectors.

And amidst the Phisix correction, sectoral performance had also been mixed. The industrials and the mining sector, whom have been this year’s laggards has apparently outperformed their peers.

Meanwhile the gains in the industrial sector has been led by water utility Manila Water Corporation [PSE:MWC] the laggard independent power producer Energy Development Corporation [PSE:EDC] and electricity distribution monopoly Meralco [PSE: MER]

Year-to-date EDC and SMC has deviated from the bullish path of their contemporaries. My hunch is that the anomalies in the correlations should end soon.

Average Daily peso volume (weekly basis) remains robust despite the profit taking sessions.

Peso Firming Against Inflating Currencies

Yet despite sporadic selling pressures in some of the big cap issues, net foreign trade exhibited sustained inflows. In short, locals took profits while foreign funds have been net buyers of local equities.

And on the account of a policy induced “search-for-yield” dynamics here and abroad which will likely be stimulated even more by cumulative efforts to keep interest rates at zero bound in major economies, I expect an acceleration of foreign fund flows into local assets (stocks, bonds and properties) to be priced into the local currency, the Philippine Peso.

Foreign portfolio flows in 2011 moderated[2], partly manifesting on global apprehensions on the Euro crisis. Yet if the currently instituted liquidity based rescue programs temporarily does alleviates the crisis in the Eurozone, the risk ON environment will whet the appetite of foreign arbitrageurs.

Again as I recently wrote[3],

should portfolio flows into the Philippines intensify, through the PSE and local bond markets, then the lagging Philippine Peso will likely see more room for appreciation.

And the local currency will not only appreciate against the US dollar but likewise against all countries undertaking massive credit easing measures.

We are already seeing this in the context of the Peso vis-à-vis the Euro (upper) and the Japanese Yen (lower), where we seem to be witnessing major trend reversals.

The Peso has also been appreciating against the Swiss Franc (upper) and the British Pound (lower)

The currency markets have only been validating what the great Ludwig von Mises taught us about valuing currencies[4].

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.

What this means is that the Philippines (and our ASEAN contemporaries) is likely to lure spread arbitrages or carry trades from US, Japanese, Swiss and European investors or punters that is likely to kick start a foreign stimulated boom in the local assets including those listed on the Philippine Stock Exchange.

The Journey Of A Thousand Miles Begins With A Single Step

The bottom line is that given the current conditions where major economies have just initiated on recalibrating their policies to ease credit further, then it is unlikely to expect a material profit-taking mode. Since the effects of these policies usually come with a time lag, we can expect a strong momentum perhaps until the 2^nd quarter of the year where some of the credit easing programs are due to end.

In addition, aside from a positive market breadth, the markets hardly showed of any signs of distribution. Last week only reinforced my long held view of a broad based rotational process where there had been a rotation away from big caps to the broader market (second and third tier issues), rotation among sectors (from leaders to laggards) and rotation of issues within specific sectors.

All of which have been manifestations of an inflationary boom.

Moreover, if a correction does occur, any profit taking of around 5-10% should be reckoned as healthy and a buying window. Remember, predicting the market over the short term can be very tricky.

Nonetheless it is important to realize that the long term is an accretion of short term actions. To analogize, I would not see tomorrow if I die today, thus tomorrow is a function of my living of every moment until tomorrow, or as represented in a popular axiom, the journey of a thousand miles begins with a single step.

This extrapolates that for any long term projections to be fulfilled, the accumulated dominant direction of short term actions, in spite of sharp fluctuations, has to be in the path of the long term.

For instance, I’ve long asserted my audacious prediction that the Phisix is bound for and will breach the 10,000 levels.

This I believe my target isn’t an issue of an IF but a WHEN. This will possibly be fuelled by an amalgam of factors such as a domestic boom bust cycle[5], global wealth convergence trends and or globalization.

While there may be medium term obstacles such as the recent contagion from an external bubble bust 2007-2008, the general trend of the Phisix has been one of the upside and has been confirming the secular bull market trend.

This seems reminiscent of the past 17-year cycle where the previous bullmarket had two interregnums (green ellipses) prior to the Phisix climax in 1994-1997.

I am not certain whether we will see a repeat of the discontinuities similar to the 1986-1997 bull market cycle or will suffer more than the past cycle before reaching my goal or if the Phisix will proceed to double. What needs to be monitored are drivers of the current trends and the whereabouts[6] of the present boom cycle based on internal and external dynamics.

So far even as the Phisix has reached half of my target, domestic systemic leverage has yet to reach bubble proportions. Thus while another external contagion bust may hamper the current phase anew, for as long as any intermissions have NOT originated from domestic imbalances, the secular bullish trend of the Phisix should be expected to continue.

In finale, anyone who argues about the long term without the series of short term actions confirming their views is engaged in a practise of wishful thinking.

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[1] See New Record Highs for the Philippine Phisix; How to Deal with Tips February 20,2012

[2] IMF.org THE PHILIPPINES 2011 ARTICLE IV CONSULTATION, IMF Country Report March 2012

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

[4] Mises, Ludwig von 3. Trend Of Depreciation II. THE EMANCIPATION OF MONETARY VALUE FROM THE INFLUENCE OF GOVERNMENT On The Manipulation Of Money And Credit p.25 Mises.org

[5] See The Phisix And The Boom Bust Cycle, January 10, 2011

[6] See After 5,000: What’s Next for the Phisix? March 5, 2012

Central Bankers Whets Wall Street’s Fetish For Inflationism

In a fiat-money regime, however, increases in credit and money are not a one-off affair. As soon as signs of recession appear on the horizon, public opinion calls for countermeasures, and central banks try their best to "fight the crisis" by increasing the fiat-money supply through bank-circulation-credit expansion, thereby bringing interest rates to even lower levels. -Thorsten Polleit

At a recent speech Non-voting FOMC member and President of Federal Reserve Bank of Dallas Richard Fisher said that he was puzzled with Wall Street’s obsession with Quantitative Easing[1],

I am personally perplexed by the continued preoccupation, bordering upon fetish, that Wall Street exhibits regarding the potential for further monetary accommodation—the so-called QE3, or third round of quantitative easing.

Such a statement signifies a bizarre denial of the impact to people’s incentives of the policies implemented by the US Federal Reserve.

In response to this statement Dr. Ed Yardeni posted on his blog charts which exhibited the tight correlations between actions of the S&P 500 (as well as the TIPs) and the Fed’s bond market interventions called as the Quantitative Easing.

Writes Dr. Yardeni[2]

Let’s review the market’s medical chart to see how it responded to the injections and withdrawals of the Fed’s monetary medicine:

(1) The S&P 500 rose 36.4% during QE-1.0, which spanned from November 25, 2008 through the end of March 2010.

(2) The S&P 500 rose 10.2% during QE-2.0 from November 3, 2010 through the end of June 2011. It rose much more, by 24.1%, if we start the clock on August 27, 2010, when Fed Chairman Ben Bernanke first hinted that a second round of quantitative easing was on the way.

(3) Operation Twist was announced on September 21, 2011. Since then, the S&P 500 is up 15.9%.

(4) Between the end of QE-1.0 and Bernanke’s speech on August 27, 2010, the S&P 500 fell 9.0%. Between the end of QE-2.0 and the beginning of MEP, it fell 11.7%.

There is an even better correlation between the Fed’s QEs and expected inflation implied in the spread between the 10-year Treasury nominal and TIPS yields.

The relevance and relationship between monetary policies and financial markets has not been limited to the United States but to the global marketplace.

As I have been pointing out global stock markets have been on a tear on central bank steroids.

I plotted the Bloomberg charts of the Phisix [PCOMP:IND] along with major world’s major bourses as the US S&P 500 [SPX:IND], Japan’s Nikkei [NKY:IND] and Germany’s DAX [DAX:IND] as futher exhibit to this tight relationship.

Since the bottom in October of 2011, the wave-like motions or undulations of three bourses have almost been in identical. The difference can only be seen in the degree of gains (where Germany’s Dax has outperformed the pack).

A near synchronized motion can also be seen in the Phisix, but to a lesser scale than the developed economy peers.

The point of the above is that any perception that sees actions of specific markets as demonstrating “fundamentals” will signify as patent misimpression or a misread—that will be eventually exposed once the tide of monetary liquidity subsides.

And a further point is that I am dubious of the impact of Operation Twist to the recent market run up.

Operation Twist which was announced in September[3] during the heat of the Euro crisis was designed to manipulate the yield curve. Then the US Federal Reserve announced that their goal[4] was

to sell $400 billion of shorter-term Treasury securities by the end of June 2012 and use the proceeds to buy longer-term Treasury securities. This will extend the average maturity of the securities in the Federal Reserve's portfolio.

By reducing the supply of longer-term Treasury securities in the market, this action should put downward pressure on longer-term interest rates, including rates on financial assets that investors consider to be close substitutes for longer-term Treasury securities.

In other words, Operation Twist has been a modified QE with sterilization[5] functions (or the act of central banks to soak up new cash that would otherwise circulate in the economy).

Since sterilized monetary actions soak up freshly injected money, there won’t be similar narcotic effects on the markets as unsterilized interventions.

Instead I believe that other forms of interventions helped boosted global markets.

The US Federal Reserve opened foreign currency swap lines mainly targeted at the ECB and was also made accessible to many central banks at the end of November[6]. The announcement of the swap lines placed a floor on the plummeting S&P (as well as to major global markets) which at that time reeled from the eroding short term stimulant impact of the announcement of Operation Twist.

Also, the European Central Bank launched in December 22^nd of 2011, the first round of the massive rescue program by the infusion of €489 billion of credit[7] to the European banking system through the Long Term Refinancing Operation (LTRO) facility or repurchase auctions with expanded to maturity of 36 months[8] (typically during normal times LTROs had three month maturity[9]).

Both the Fed’s Swap Lines and the ECB’s LTRO operated like a 1-2 punch.

In addition, major interventions had been conducted during February of 2012, these had a follow through effect on the market’s speculative vim.

The Bank of Japan[10] along with the Bank of England[11] reengaged in more QE programs, while the ECB reopened the second round of LTROs which was met with record borrowings[12]. The second round of LTROs resulted to an expansion of the ECB’s balance sheets which has now topped the US Federal Reserve[13].

The asset purchasing program by developed central banks has been in conjunction with many major central banks slashing policy rates. This week India aggressively cut bank reserve requirements[14], while Brazil accelerated the reduction of policy rates[15].

This article has essentially captured today’s foundations which revolves around central banking actions

Reports the Dow Jones[16]

Central banking has become a global growth industry. But it is not just the size of balance sheets that's changed: so too have their composition. With rates close to zero, the U.S., U.K., Japanese and European central banks have pumped cash into the financial system. But each has chosen a different method - and will face different challenges when they try to shrink again. The growth in balance sheets has been startling: the combined assets of the four central banks will top $9 trillion by the end of March compared to $3.5 trillion five years ago, Deutsche Bank says. The European Central Bank's EUR3 trillion balance sheet is the biggest relative to the economy, at 32% of nominal euro-zone GDP, followed by the Bank of Japan with 24%, the Bank of England with 21% and the Federal Reserve with 19%. The BOE's balance sheet has expanded fastest in the crisis, more than tripling to GBP321 billion. But the change in composition and maturity profile of the balance sheets has been equally noteworthy. In January 2007, the Fed held $779 billion of U.S. Treasurys, of which 52% matured in under a year and only 19% in more than five years. Now, it holds $1.65 trillion of Treasurys, of which 57% mature in more than five years. Of the BOE’s GBP255 billion face value of gilts, 72% mature in more than five years, with 26% maturing in more than 20 years

Recently rumors of innovative QE via a reverse repo[17] have been floated. This is probably in designed as transition to the end of Operation Twist and could be part of the signaling channeled used by the Fed to see how the public would react.

Going back to the Wall Street’s fetish for QE, the answer is simple, the US Federal Reserve has been providing the narcotics and Wall Street became addicts. The inflationary dynamics has been accelerating because governments around the world has been working to protect an unsustainable welfare (and warfare) based political system that has been financed by debt and operates on the platform of cronyism.

As the great Ludwig von Mises wrote[18],

A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, i.e., of antidemocratic, policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. It explains why inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. When governments do not think it necessary to accommodate their expenditure to their revenue and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism.

And the politics of inflation requires piggybacking inflationism one after another until the whole structure self-implodes.

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[1] Fisher, Richard W. Not to Be Used Externally, but Also Harmful if Swallowed”: Projecting the Future of the Economy and Lessons Learned from Texas and Mexico Remarks before the Dallas Regional Chamber of Commerce Dallas, Texas March 5, 2012 Dallasfed.org

[2] Yardeni Ed Stocks & QE, March 8, 2011

[3] CNN Money Federal Reserve launches Operation Twist September 22, 2011

[4] Federal Reserve.gov What is the Federal Reserve's maturity extension program (referred to by some as "operation twist") and what is its purpose? September 21, 2011 Official statement FederalReserve.gov FOMC Press Release September 21, 2011

[5] Wikipedia.org Sterilization Capital account

[6] Wall Street Journal Real Times Economics Blog What Are Fed Swap Lines and What Do They Do? November 30, 2011

[7] Wikipedia.org Long Term Refinancing Operation (LTRO) European sovereign-debt crisis

[8] European Central Bank Press Release ECB announces measures to support bank lending and money market activity 8 December 2011

[9] European Central Bank, THE LONGER TERM REFINANCING OPERATIONS OF THE ECB, working paper series, May 2004

[10] See Bank of Japan Yields to Political Pressure, Adds $128 billion to QE February 14, 2012

[11] See Bank of England Adds 50 billion Pounds to Asset Buying Program (QE), February 9, 2012

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

[13] See ECB’s Record Balance Sheet Tops the US Federal Reserve March 7, 2012

[14] New York Times In India, Bank Moves To Stimulate Economy, March 9, 2012

[15] Bloomberg.com Brazil Accelerates Interest Rate Cuts Amid Signs of Lackluster Growth, March 8, 2011

[16] Dow Jones News Wires, Now, Sterilized QE? PrudentBear.com March 9, 2012

[17] Hilsenrath Jon 'Sterilized' Bond Buying an Option in Fed Arsenal March 7, 2012 Wall Street Journal

[18] Mises Ludwig von 3 Inflationism CHAPTER 13 Monetary Policy The Theory of Money and Credit, Mises.org

Chart of the Day: Greece Austerity?

chart from tradingeconomics.com

Some experts question the “benefits of austerity” on the Greece economy.

The graph above prompts for the question, where the heck is “austerity”?

Should a one year slump in Greece’s government budget (referenced only to 2010) be discerned as austerity? But how about comparing the Greece’s budget since 1995…does this look anywhere like austerity?

Reference points can be manipulated or framed to fit biases. But that would translate to intellectual dishonesty.

Germany Wants New EU Constitution: Lebensraum Merkel Version?

Sometimes I ponder upon the possibility that today’s crisis has been engineered to impose ulterior goals. In the resonant words of former White House Chief of Staff Rahm Emmanuel,

You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before.

This I think may apply to the European Union

The Reuters reports,

Germany wants to reignite a debate over creating an EU constitution to strengthen the bloc's ability to fight off financial troubles and counter-balance the rising influence of emerging economies, Germany's foreign minister said on Friday.

Guido Westerwelle said the bloc's Lisbon treaty, drafted after Dutch and French voters rejected a proposed constitution in 2005, was not enough to keep European decision-making structures effective.

"We have to open a new chapter in European politics," Westerwelle told reporters on the sidelines of a meeting of EU foreign ministers in Copenhagen. "We need more efficient decision structures."

The German minister presented the idea to his counterparts at the Copenhagen meeting, during which they also discussed plans to run foreign policy more cheaply. He said discussions on the issue of a new constitution should continue in Berlin.

The desire and the insistence to centralize the EU translates to an implied expansion of Germany’s political power over the region. Since the EU crisis unfolded, it has dawned on me that the path towards a fiscal policy union seems like a variant of one of Adolf Hitler’s major goals—Lebensraum (living space) for the German people.

But instead of forcible (military based) annexations, the Germans have leveraged the acquisition of political power through stealth ‘expansionist policies’ such as bailouts and the attendant ‘proposed’ changes in EU’s political and regulatory framework as the above.

Yet in a world where forces of decentralization has been snowballing, these surreptitious designs are likely to meet the same fate as with the Hitler version.

Integrating the EU, should not be coursed through centralization but through economic freedom and sound money. With economic freedom, the relevance of geographical political borders diminishes.

When College Education Isn’t Sufficient

Work place education matters more than a college degree, so argues Professor Alex Tabarrok at the Chronicle Review (hat tip Prof Mark Perry; bold emphasis mine)

The obsessive focus on a college degree has served neither taxpayers nor students well. Only 35 percent of students starting a four-year degree program will graduate within four years, and less than 60 percent will graduate within six years. Students who haven't graduated within six years probably never will. The U.S. college dropout rate is about 40 percent, the highest college dropout rate in the industrialized world. That's a lot of wasted resources. Students with two years of college education may get something for those two years, but it's less than half of the wage gains from completing a four-year degree. No degree, few skills, and a lot of debt is not an ideal way to begin a career.

College dropouts are telling us that college is not for everyone. Neither is high school. In the 21st century, an astounding 25 percent of American men do not graduate from high school. A big part of the problem is that the United States has paved a single road to knowledge, the road through the classroom. "Sit down, stay quiet, and absorb. Do this for 12 to 16 years," we tell the students, "and all will be well." Lots of students, however, crash before they reach the end of the road. Who can blame them? Sit-down learning is not for everyone, perhaps not even for most people. There are many roads to an education.

Consider those offered in Europe. In Germany, 97 percent of students graduate from high school, but only a third of these students go on to college. In the United States, we graduate fewer students from high school, but nearly two-thirds of those we graduate go to college. So are German students poorly educated? Not at all.

Instead of college, German students enter training and apprenticeship programs—many of which begin during high school. By the time they finish, they have had a far better practical education than most American students—equivalent to an American technical degree—and, as a result, they have an easier time entering the work force. Similarly, in Austria, Denmark, Finland, the Netherlands, Norway, and Switzerland, between 40 to 70 percent of students opt for an educational program that combines classroom and workplace learning.

In the United States, "vocational" programs are often thought of as programs for at-risk students, but that's because they are taught in high schools with little connection to real workplaces. European programs are typically rigorous because the training is paid for by employers who consider apprentices an important part of their current and future work force. Apprentices are therefore given high-skill technical training that combines theory with practice—and the students are paid! Moreover, instead of isolating teenagers in their own counterculture, apprentice programs introduce teenagers to the adult world and the skills, attitudes, and practices that make for a successful career.

Elites frown upon apprenticeship programs because they think college is the way to create a "well-rounded citizenry." So take a look at the students in Finland, Sweden, or Germany. Are they not "well rounded"? The argument that college creates a well-rounded citizen can be sustained only by defining well rounded in a narrow way. Is someone who can quote from the school of Zen well rounded? Only if they can also maintain a motorcycle. Well-roundedness comes not from sitting in a classroom but from experiencing the larger world.

The focus on college education has distracted government and students from apprenticeship opportunities. Why should a major in English literature be subsidized with room and board on a beautiful campus with Olympic-size swimming pools and state-of-the-art athletic facilities when apprentices in nursing, electrical work, and new high-tech fields like mechatronics are typically unsubsidized (or less subsidized)? College students even get discounts at the movie theater; when was the last time you saw a discount for an electrical apprentice?

Our obsessive focus on college schooling has blinded us to basic truths. College is a place, not a magic formula. It matters what subjects students study, and subsidies should focus on the subjects that matter the most—not to the students but to everyone else. The high-school and college dropouts are also telling us something important: We need to provide opportunities for all types of learners, not just classroom learners. Going to college is neither necessary nor sufficient to be well educated. Apprentices in Europe are well educated but not college schooled. We need to open more roads to education so that more students can reach their desired destination.

College education has been designed for the industrial age or the mass production political economy.

The deepening of the information age, marked by the increasing transition towards niche markets, will lead to leaner but highly specialized business processes that will be reflected on the evolving dynamics of organizational structures.

Job requirements will thus be driven by specialization. And meeting these would translate a change in the delivery medium of educational content, which are likely to move away from classroom models towards personalized education (such as P2P collaborative tutoring, and many other online models) or the demassification of education.

And in this regards Mr. Tabarrok’s observation of education derived from apprenticeship/vocational/technical degree or workplace education will be magnified.

It is also important to point out that taxpayer spending on current public educational programs will become increasingly irrelevant.

Draghi’s Defense of ECB’s Balance Sheet Expansion: Two Wrongs Make a Right

From the Wall Street Journal Blog

One thing we all know about Mario Draghi now: he reads the papers.

The European Central Bank president used his monthly press conference to take issue with a recent Wall Street Journal article on the ECB’s balance sheet now exceeding three trillion euros after it pumped a total of one trillion euros in three-year loans into European banks.

The ECB’s balance sheet equals one-third of euro-zone GDP, a bigger share than the Federal Reserve’s balance sheet, which makes up 19% of U.S. GDP, and the Bank of England’s, which is 21% of U.K. GDP, the article noted.

“You conclude that the expansion in the euro area is bigger than it is in the U.S. or the U.K.,” Mr. Draghi said.

Mr. Draghi’s point was that looking at the total size of the balance sheet gives an incomplete view. The ECB holds large amounts of gold and currency reserves on its books that have nothing to do with monetary policy, he said. The Fed’s balance sheet, he said, “is very, very lean” in that regard, and “the Bank of England is also the same.”

Instead, Mr. Draghi said the share of assets related to monetary policy is the more relevant indicator of risk. By that measure the ECB’s balance sheet is at 15% of GDP compared to 19% for the Federal Reserve and 21% for the Bank of England, he said.

“At the present time to say the risks for the ECB balance sheet are now higher than what they are in the Fed and Bank of England is not correct,” he said.

Mr. Draghi does not deal with the merits or the essence and risk-reward or the consequences of the ECB’s actions, instead he applies the logical fallacy of two wrongs make a right—everybody is doing it, mine has been less than the others. This is also an example of a red herring (Ignoratio elenchi) argument which attempts to distract the public.

Yet the above is an illustration of the typical communications approach anchored on sophistry used by political authorities to justify their proposals or actions.

Quote of the Day: The Seen and Unseen

If one-sidedness is the other side of literature’s emphatic concreteness, emphatic awareness of strangers’ pains and pleasures is the unexpected other side of economists Gradgrindian detachment. Consider rent control. The beneficiaries are plain to see: they are the tenants when the rent-control law is adopted. The victims are invisible: they are the future would-be tenants, who will face a restricted supply of rental housing because landowners will have a diminished incentive to build rental housing and owners of existing apartment buildings will prefer to sell rather than rent the apartments in them. Economics brings these victims before the analyst’s eye…. A jurisprudence of empathy can foster short-sighted substantive justice because the power to enter imaginatively into another person’s outlook, emotions, and experiences diminishes with physical, social, and temporal distance.

That’s from Richard Posner’s 1995 Overcoming Law (as quoted by Professor Don Boudreaux).

Capital Markets in the Information Age: P2P Lending

The information age has been bring about changes in the capital markets, I earlier showed crowd funding, now comes a variant, P2P lending

Writes Alex Daley at the Casey Research

It's a new idea but is based on the familiar technologies of the Internet; it's known as peer-to-peer (P2P) lending. The premise is simple: cut the bankers out of the loan market and keep the difference for yourself by making loans directly to other consumers.

I know, that sounds rather risky. When I see my neighbor pull up in his driveway with a shiny new car that I can guarantee costs more than his annual salary, the idea of loaning money directly to other consumers seems a little crazy. However, that's where the real innovation lies. With peer-to-peer lending, an individual investor doesn't make a single $10,000 loan. Instead, he can buy 400 different loans, taking only $25 of risk per loan, for example. Services that offer this option pull together large numbers of investors, who each take a small slice of large numbers of loans, thereby distributing risk much like an index fund. The result is usually a steady and expected rate of return after fees and defaults.

And there are plenty of defaults. Consumer credit is a risky space, after all. With peer-to-peer lending one can choose among unsecured loans only. However, despite what you may have gathered from your last attempts to find a parking space at Home Depot on a Saturday, the majority of people are good. And those good people have a tendency to pay back their loans. As an investor, these P2P services allow you to pick loans by risk category. Credit scores, debt-to-income ratios, income verification, and all the familiar tools of the professional lender are there, allowing you to make decisions about what kind of loans to buy and which to avoid.

This allows individual investors to tailor a portfolio to their own risk tolerance. Whether selecting all the individual loans by hand, or using the bulk investing tools each of the suppliers provide, a portfolio can be built in a variety of ways: from only investing in "A" grade loans with single-digit interest rates and predictably low defaults, to debt-consolidation loans for consumers with much lower credit scores, paying much higher interest but coming with significantly higher defaults as well, and everything in between.

Read more here

The above represents changes in the investment sphere (perhaps some of these companies will be publicly listed someday), as well as, changes in the social dimensions which should impact the political economy: The growth of P2P lending and Crowd Funding will eventually reach a tipping point where it will be seen or becomes a threat to the establishment. And that threat will be met with a feedback mechanism: response-counter response feedback by political authorities and the markets.

Nonetheless the internet has been providing the platform to expedite dramatic and rapid innovation based transformations.

Quote of the Day: When Corruption is a Good Thing

If you're going to have a ridiculous number of impossible laws, corruption is a good thing. Increasingly, what matters is not the number or even nature of laws on the books in the place you live, but the amount of actual control the state has over private individuals. Corruption subverts idiotic laws; it's the next best thing to abolishing them.

That’s from the legendary investor Doug Casey

China Promotes the Yuan to the BRICs

China has been promoting her currency as alternative to the US dollar

Writes the Reuters/Financial Times

China is planning to extend renminbi loans to other major emerging BRIC countries, in another step toward the expansion of the yuan's role in foreign exchange, the Financial Times reported on Wednesday.

The China Development Bank (CDB) will sign a memorandum of understanding at a meeting with its BRICs counterparts - Russia, South Africa, Brazil and India - in New Delhi on March 29, the newspaper reported, citing people familiar with the talks.

Under the agreement CDB, which lends mainly in dollars overseas, will make renminbi loans available, while the other BRICs nations' development banks will also extend loans denominated in their respectivecurrencies, the FT said in an article published on its website.

The renminbi is the official currency of China and its primary unit is the yuan. Of the six largest economies in the world, China is the only one whose currency does not have reserve status.

The initiative aims to boost trade between the five BRICs nations and promote use of the renminbi, rather than the U.S. dollar, for international trade and cross-border lending, the FT said.

China appears to be ‘flanking’ the US by promoting her currency with ASEAN through trade, and now with other major emerging markets.

This is not to say that China’s yuan will replace the US dollar (whatever monetary standard the world will embrace in the future is beyond our ken, as I can only guess), instead these seem emblematic of attempts by several nations to wean away from the US dollar standard, possibly as insurance or as diversification strategy to reduce currency risks.

Capital Markets in the Information Age: The Advent of Crowd Funding

I believe that the information age will also introduce material changes in the capital markets. And part of such changes may have emerged through crowd funding, which according to the Wikipedia.org,

signifies as the collective cooperation, attention and trust by people who network and pool their money and other resources together, usually via the Internet, to support efforts initiated by other people or organizations.

And social media networks are likely to serve as major platforms for crowd funding with Facebook leading the way.

From the Wall Street Journal,

Facebook Inc., with an eye toward future business relationships, wants to be friends with more social-media start-ups.

So it is going after those start-ups' investors.

Facebook's new fbStart program is open to early-stage business investment groups, also known as "seed funds" and business "accelerators," that have social-media developers in their portfolios. Developers at companies supported by the fbStart partner firms will get an advanced look at new tools and features Facebook is creating for its site. In return, Facebook hopes that some of those start-ups could eventually build a business around its platform.

So far partners in the fbStart program include Seedcamp, sFund, 500 Startups, TechStars, and Y Combinator, among others, a Facebook spokesman said.

In documents filed for its initial public offering last week, part of Facebook's pitch to potential shareholders is that it can serve as a platform for other companies, and ultimately take a percentage of those companies' revenue. Since Facebook first opened up to developers in 2007, a growing number of start-ups, such as social-gaming firm Zynga Inc., have built almost their entire business around the social network. Other examples include BranchOut Inc., a professional network, and Color Labs Inc., which provides live phone-based broadcasts to Facebook friends.

"We've been asking Facebook for ways to get better access and advance information for our companies, and this is their way of doing that," said David Cohen, founder and chief executive of TechStars, a Boulder, Colo., start-up accelerator that has helped nearly 100 new businesses raise more than $125 million since 2007.

About half of TechStars' portfolio of more than 80 active companies are expected to make use of the program, he said, ranging from ventures that develop entire platforms on Facebook, to others that incorporate social-media tools and features from the site.

Most of the 70 start-ups in 500 Startups, a $30 million seed fund and business accelerator in Mountain View, Calif., use the Facebook platform in one way or another, said Christine Tsai, a 500 Startups partner. With fbStart, "they're putting a lot more manpower behind working with us in a more formal way," she added.

As internet based crowd-funding grows, we should expect incumbent financial institutions to integrate them or if not social media networks will likely get a larger slice of the capital markets.

The internet has been validating the great F. A. Hayek’s knowledge revolution through the forces of decentralization.

Science: Is the Creative Right Brain Theory a Myth?

Yes. That’s according to an article at the Kurzweil Accelerating Intelligence

Yet another brain myth bites the dust, joining “we only use 10 percent of our brain,” and other pseudoscience nonsense that tries to cram people in nice neat boxes.

The left hemisphere of your brain, thought to be the logic and math portion, actually plays a critical role in creative thinking, University of Southern California (USC) researchers have found, at least for visual creative tasks (and musical, as previously found).

“We need both hemispheres for creative processing,” said.Lisa Aziz-Zadeh, assistant professor of neuroscience.

More from the same article…

The “creative right brain” myth apparently originated from misinterpretations of Roger Sperry’s split-brain experiments on epileptics in the 60s, which earned him a Nobel Prize in 1981. It has already been debunked.

See, for example, University of Washington neurobiologist Dr. William H. Calvin’s excellent 1983 book,Throwing Madonna:Essays on the Brain (the text of chapter 10, “Left Brain, Right Brain: Science or the New Phrenology?” is accessible here).

Despite that, there are still lots of suppliers of education and training materials based on this myth, and lots of bureaucratic teachers, self-help writers, financial charlatans, polarizing politicians, and quick-buck counselors eager to put people into programmed slots where they can be easily manipulated and controlled.

Caveat emptor

Ben Bernanke Plays with the Inflation Fire

From Bloomberg,

Federal Reserve Chairman Ben S. Bernanke spent six years pushing for an inflation goal. Now that he has it, some investors are betting he’ll breach the 2 percent target in the short run to lower unemployment.

The Fed chairman told lawmakers last week that an increase in energy costs will boost inflation “temporarily while reducing consumers’ purchasing power.” He also said the central bank will adopt a “balanced approach” as it pursues its twin goals of price stability and full employment, which it defines as a jobless rate of between 5.2 percent and 6 percent.

Things that team Bernanke could be working on with the 'inflation goal': inflating away debt, boosting asset prices to give strength to balance sheets of the embattled banking and financial industry, the money illusion or the lowering real wages by inflation and currency devaluation.

I don’t think inflation targeting has been about competitive devaluation, as central bankers have collaborated in conducting current monetary policies. Neither has these been the money illusion.

I am sure Mr. Bernanke is aware that elevated inflation (upper window) and high unemployment (lower window) coexisted in the 1970s, known as the stagflation era. In short, Mr. Bernanke understands the risk of inflation, i.e. inflation does not solve the unemployment problem. In reality, in contrast to mainstream thinking, inflation even worsens economic performances by distorting economic calculation of entrepreneurs and businesses which impairs the market's functionality through the division of labor.

So by process of elimination this leads us to Bernanke’s primary goal of saving the banking system and the welfare state.

Yet Mr. Bernanke’s inflation goal is like playing with fire. Since the world's monetary system operates in a de facto US dollar standard, Bernanke's playing with fire translates to the risk that we all get burned.

Germany and Switzerland to Review Policy on Gold Reserves

So some central bankers appear to be getting apprehensive over their own set of actions, such that they are now contemplating to secure physical gold ownership—much of which have been stored overseas.

Reports the Resource Investor,

German lawmakers are to review Bundesbank controls of and management of Germany’s gold reserves. Parliament’s budget committee will assess how the central bank manages its inventory of Germany’s gold bullion bars that are believed to be stored in Frankfurt, Paris, London and the Federal Reserve Bank of New York, according to German newspaper Bild.

The German federal audit office has criticised the Bundesbank’s lax auditing and inventory controls regarding Germany’s sizeable gold reserves – 3,396.3 tonnes of gold or some 73.7% of Germany’s national foreign exchange reserves.

There is increasing nervousness amongst the German public, German politicians and indeed the Bundesbank itself regarding the gigantic risk on the balance sheet of Germany's central bank and this is leading some in Germany to voice concerns about the location and exact amount of Germany’s gold reserves.

Writes ZeroHedge,

As it turns out, Germany is not alone: as part of the "Rettet Unser Schweizer Gold", or the “Gold Initiative”: A Swiss Initiative to Secure the Swiss National Bank’s Gold Reserves initiative, launched recently by four members of the Swiss parliament, the Swiss people should have a right to vote on 3 simple things: i) keeping the Swiss gold physically in Switzerland; ii) forbidding the SNB from selling any more of its gold reserves, and iii) the SNB has to hold at least 20% of its assets in gold.

The above account exhibits the growing importance of precious metals even among central bankers.

Interesting times indeed.

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.