Quote of the Day: Rule of Law

The Rule of Law is a three-legged stool on which freedom sits. The first leg requires that all laws be enacted in advance of the behavior they seek to regulate and be crafted and promulgated in public by a legitimate authority. The goal of all laws must be the preservation of individual freedom. A law is not legitimate if it is written by an evil genius in secret or if it punishes behavior that was lawful when the behavior took place or if its goal is to solidify the strength of those in power. It also is not legitimate if it is written by the president instead of Congress.

The second leg is that no one is above the law and no one is beneath it. Thus, the law's restraints on force and fraud need to restrain everyone equally, and the law's protections against force and fraud must protect everyone equally. This leg removes from the discretion of those who enforce the law the ability to enforce it or to afford its protections selectively. This principle also requires that the law enforcers enforce the law against themselves. Of course, this was not always the case. In 1628, the British Parliament spent days debating the question "Is the king above the Rule of Law, or is the Rule of Law above the king?" Thankfully, the king lost – but only by 10 votes out of several hundred cast.

The third leg of the Rule of Law requires that the structures that promulgate, enforce and interpret law be so fundamental – Congress writes the laws, the president enforces the laws, the courts interpret the laws – that they cannot be changed retroactively or overnight by the folks who administer them. Stated differently, this leg mandates that only a broad consensus can change the goals or values or structures used to implement the laws; they cannot be changed by atrophy or neglect or crisis.

[bold emphasis added]

This is from Judge Andrew P. Napolitano at the LewRockwell.com

Chart Porn: The US-Asia Arm Race

The conservative Heritage Foundation comes up with a deck of wonderful charts on Asia.

Writes the Zero Hedge,

Asia is a study in contrasts. It is home to economic freedom and political liberty; it is also home to political instability and tyranny. Some of Asia’s borders are unsettled and volatile. And military budgets and capabilities are expanding, sometimes faster than economic growth. The rise of China as a great power presents both sides of this equation. It is being watched carefully by all the countries of the region. It is the U.S. that is recognized as the catalyst in ensuring a prosperous peace over conflict. America is a Pacific power. That much is a matter of geography and history. But the facts – and America’s principles and interests – demand more than resignation to geography. They call for continued American leadership, commitment, and the predominant comprehensive power that has enabled Asia’s very welcomed, opportunity-laden rise."

Thus prefaces the Heritage Foundation its Asian 'Book of Charts', which summarizes most of the key economic, financial, trade, geopolitical, most importantly militaristic tensions both in Asia and, by dint of being the global marginal economic force, the world itself. And while we will present the complete deck shortly, of particular interest we find the summary in 7 easy charts how Asia is slowly but surely catching up on that accepted by conventional wisdom GloboCop - the United States.

We present it in its entirety below.

In my view, the current sensationalist brouhaha over territorial claims has been more of a political diversion (from domestic political and economic woes, e.g. in China and the US) and a complicit attempt by both US-China to promote the interests of the neo-conservative protected military industrial complex through an arms race and a resurgent build up of bases around the world in order to justify government expenditures on defense and inflationism.

[Perhaps the real reason is the encirclement and domestic infiltration strategy against Russia by the US, but indirectly implemented with China as the bogeyman or as the smoke screen].

Lastly these may have been part of the desperate attempts by welfare-warfare governments to curb civil liberties (through nationalism and financial repression) in face of growing forces of decentralization.

More great charts of Asia here.

Note: charts can mean different things or perspectives depending on the person’s interpretations and biases.

Video: Murray Rothbard on the Origin of the US Federal Reserve

[hat tip Bob Wenzel]

Philippine Resource Curse: The Mindanao Security Problem

Most of the people don’t realize that the abundance of natural resources can pose as an impediment rather than a blessing for a political economy.

Wikipedia.org defines one of the main adverse effects of the resource curse as provoking social conflicts: (bold highlights added)

Natural resources can, and often do, provoke conflicts within societies (Collier 2007), as different groups and factions fight for their share. Sometimes these emerge openly as separatist conflicts in regions where the resources are produced (such as in Angola's oil-rich Cabinda province) but often the conflicts occur in more hidden forms, such as fights between different government ministries or departments for access to budgetary allocations. This tends to erode governments' abilities to function effectively. There are several main types of relationships between natural resources and armed conflicts. First, resource curse effects can undermine the quality of governance and economic performances, thereby increasing the vulnerability of countries to conflicts (the 'resource curse' argument). Second, conflicts can occur over the control and exploitation of resources and the allocation of their revenues (the 'resource war' argument). Third, access to resource revenues by belligerents can prolong conflicts (the 'conflict resource' argument).

The continuing insurgency and violence in Mindanao has been a manifestation of such political pathology, although this can be argued as piggybacking on the religious schism brought upon by again the earlier political persecution of Muslims during the Marcos regime.

Today’s Bloomberg article has an apropos observation,

Mindanao is no stranger to murder, with a four-decade insurgency in which as many as 200,000 people have died, frustrating efforts by companies including Xstrata and Sumitomo Metal Mining Co. (5713) to tap an estimated $312 billion in mineral deposits. Death squads that human-rights groups have linked to police and the military, contract killings over land disputes, and al-Qaeda-affiliated terrorists add to the mix of violence.

While Philippine economic growth is accelerating, stocks are close to a record high and the country pursues its first investment-grade credit rating, failure to resolve the unrest and murders in Mindanao damages President Benigno Aquino’s efforts to further boost foreign investment, surveys show.

“There is no evidence of a strategic solution to the security problems in Mindanao,” said Steve Vickers, chief executive officer of Hong Kong-based Steve Vickers & Associates, a corporate-intelligence and security-consulting company. “Some of the activities are truly well-organized terrorism, but much of it is feudalism or out-and-out criminality, which needs to be stamped on hard.”

Business Cost

The Philippines ranked 130th of 142 countries in the World Economic Forum’s latest survey on the cost to business of terrorism; and 112th in terms of crime and violence -- the worst in Southeast Asia. Fifty-four percent of mining companies said issues such as attacks by terrorists, criminals and guerrilla groups are a strong deterrent for investors in the Philippines, the second highest among 93 jurisdictions in a Fraser Institute poll released in February.

The violence also exacerbates poverty, a Jan. 26 report by the foreign chambers of commerce in the country said. Sixty-five percent of respondents in Mindanao, home to about a quarter of the Philippines’ 100 million people, described themselves as poor, according to a May survey by Manila-based polling company Social Weather Stations. That was the highest among the three main regions in the country, and up from 39 percent in March 2010, before Aquino was elected.

I think that the causal link has been reversed; instead of violence exacerbating poverty, it is poverty through political distribution of resources (compounded by politically fueled religion based conflict) that has been exacerbating violence.

This represents another example of the failure of political solutions whose stealth objective has been to advance the interests of the political class and their favorite businesspeople through claims on these resources.

Yet violence, in truth, represents an attack against property, as the great professor Ludwig von Mises warned, (Socialism p.44-45)

All violence is aimed at the property of others. The person – life and health -is the object of attack only In so far as it hinders the acquisition of property. (Sadistic excesses, bloody deeds which are committed for the sake of cruelty and nothing else, are exceptional occurrences. To prevent them one does not require a whole legal system. To-day the doctor, not the judge, is regarded as their appropriate antagonist.) Thus it is no accident that it is precisely in the defence of property that Law reveals most clearly its character of peacemaker. In the two-fold system of protection accorded to having, in the distinction between ownership and possession, is seen most vividly the essence of the law as peacemaker - yes, peacemaker at any price. Possession is protected even though it is, as the jurists say, no title. Not only honest but dishonest possessors, even robbers and thieves, may cIaim protection for their possession.

This brings us to the most viable solution: protection of private property and the promotion of the division of labor, again Professor Mises, (Socialism page 374)

The desire for an increase of wealth can be satisfied through exchange, which is the only method possible in a capitalist economy, or by violence and petition as in a militarist society, where the strong acquire by force, the weak by petitioning. In the feudal society ownership of the strong endures only so long as they have the power to hold it; that of the weak is always precarious, for having been acquired by grace of the strong it is always dependent on them. The weak hold their property without legal protection. In a militarist society, therefore, there is nothing but power to hinder the strong from extending their wealth. They can go on enriching themselves as long as no stronger men oppose them.

Media, experts and politicians can fantasize about political solutions, when the market approach has barely been given a chance to succeed.

Who will be in Charge of the Martians?

What happens if NASA’s exploration—via the Curiosity—in Mars finds life (microbes) in the Gale Crater? How will politics on earth deal with this?

The profound thinker and author Matthew Ridley at the Wall Street Journal offers some ideas

Like the announcement of the Higgs boson last week, however magical the moment may be in historical terms, it will not affect most people's daily lives. We can celebrate, congratulate, revel in the detail and philosophize on the meaning, but earthly life will continue as if little had happened.

Pretty soon, though, a political angle will emerge. For one thing, politicians and journalists from countries other than America will start to grumble that this discovery must "belong" to all humankind and not just to NASA. The U.S. government, despite having forked out all the costs of exploring Mars so far, including the $2.5 billion cost of Curiosity, will probably agree. But who will end up making the key decisions?

The United Nations is almost bound to set up an agency to oversee what experiments are planned, but the U.S. may prefer a different body. Private consortia may conceivably start to plan how to go and retrieve a sample, dreaming of the riches to be garnered from displaying it on Earth. If so, nongovernmental organizations will quickly begin to worry about the safety of such a scheme and to champion the rights of Martian microbes to be conserved and respected in their lairs.

In other words, the discovery of extraterrestrial life would produce some predictably messy earthly responses.

As far as I can discern there has been very little public discussion of these issues. The Outer Space Treaty, opened for signature in 1967 by the U.S., U.K. and Soviet Union and ratified by 100 governments, says that no country can claim political sovereignty over land in outer space. The treaty does not forbid private ownership of land in space, however, and it would be up to terrestrial courts to decide if such claims were recognized. Also NASA has clear policies on how to prevent the contamination of one planet with the life of another.

If we hear a radio signal from an extraterrestrial intelligence, there's also a protocol in place, drawn up by the International Academy of Astronautics and invoking three principles: that the decision on whether to reply should be made by an international body; that it should be sent on behalf of all humankind; and that its content should reflect a broad consensus.

Maybe the preeminent Milton Friedman’s Sahara desert concept of politics may apply to extraterrestrial life: If you put the federal government in charge of the Sahara Desert Mars, in 5 years there'd be a shortage of sand microbes. :D

Cartoon of the Day: The Logic of Keynesian Economics

Circular reasoning plus the broken window fallacy.

Thanks to Cato’s Dan Mitchell.

The World First Genetically Modified Babies

Given that the technology has been existing then having the first genetically modified humans seems of no surprise to me.

From Daily Mail.com

The world's first genetically modified humans have been created, it was revealed last night.

The disclosure that 30 healthy babies were born after a series of experiments in the United States provoked another furious debate about ethics.

So far, two of the babies have been tested and have been found to contain genes from three 'parents'.

Fifteen of the children were born in the past three years as a result of one experimental programme at the Institute for Reproductive Medicine and Science of St Barnabas in New Jersey.

The babies were born to women who had problems conceiving. Extra genes from a female donor were inserted into their eggs before they were fertilised in an attempt to enable them to conceive.

Genetic fingerprint tests on two one-year- old children confirm that they have inherited DNA from three adults --two women and one man.

The fact that the children have inherited the extra genes and incorporated them into their 'germline' means that they will, in turn, be able to pass them on to their own offspring.

Altering the human germline - in effect tinkering with the very make-up of our species - is a technique shunned by the vast majority of the world's scientists.

Geneticists fear that one day this method could be used to create new races of humans with extra, desired characteristics such as strength or high intelligence.

One way or another people’s curiosity will lead to more experimentation, which is why we should expect human cloning to be next, in spite political opposition.

This reminds me of two “cloning is bad'” movies: Scarlett Johansson’s The Island and Arnold Arnold Schwarzenegger‘s the 6th Day

Expect the rapid changes in technology to challenge people’s ingrained beliefs and lifestyles.

Quote of the Day: Care about the Future? Reduce Capital Taxes

There are only three things you and I can do to make the future world a better place.

First, we can consume less, leaving more resources behind. Second, we can work harder, planting trees, building factories and writing poems that will live on after we’re gone. Third, we can innovate, advancing science and technology so that our children’s children’s children can make better use of the resources they inherit.

As it happens, there’s one key policy variable that drives all three of these things, and that’s the tax rate on capital income (which includes interest, dividends, corporate income and capital gains). Capital taxes are a disincentive to save, and when people don’t save they consume instead. Capital taxes are a disincentive to work and a disincentive to innovate.

This is not a plea for lowering taxes in general, and it’s not a plea for making the tax system either more or less progressive. (If you want to soak the rich, there are plenty of things to tax besides capital.) As a matter of fact, this isn’t even a plea for lowering taxes on capital. It’s simply an observation that if your goal is to leave a better world for our descendants, then your best bet is to support lower capital taxes.

This is from author and professor Steven Landsburg at the business.time.com.

Professor Landsburg is being coy or attempting to be apolitical at this. Let me improvise: ABOLISHI capital taxes, if your goal is to leave a better world for our descendants.

One more thing to make a better place, spread the truth or educate the public about the political economic inequality between the repressive state and the oppressed individuals.

Media’s Rationalization of the ASEAN Standout

Remember I spoke about the ASEAN standout here?

Well, mainstream finally sees this or this now is in the news.

From Bloomberg,

Southeast Asia (MXSO), the heart of the 1997 currency crisis, produced the best risk-adjusted returns for Asian stocks since global markets started to rebound three years ago, as investors sought a haven from Europe’s debt turmoil.

Benchmark indexes in the Philippines, Malaysia, Thailand, Indonesia and Singapore returned the most among Asia-Pacific markets worth more than $100 billion in the three years ended July 17, according to the BLOOMBERG RISKLESS RETURN RANKING. All five beat an index of developed markets by risk-adjusted returns, and four came out on top over five years.

“Investors have been focused on and rewarded in the smaller Asean markets because they have been more defensive and domestic-oriented,” said Timothy Moe, a Hong Kong-based strategist at Goldman Sachs Group Inc., referring to the Association of Southeast Asian Nations. “That’s been a better source of growth than what we see in the other more cyclical markets in North Asia. It probably will continue,” he said in a Bloomberg television interview in Hong Kong on June 26.

Southeast Asian governments have bolstered spending on infrastructure and stepped up efforts to spur domestic consumption in a bid to reduce their economies’ reliance on exports. That’s helping to shield the nations from Europe’s debt crisis and a global economic slowdown, which has fueled volatility in the northern Asian markets.

Asean countries shipped 32.9 percent of their exports to the U.S. and European Union in 2010, down from 72.4 percent in 2000, according to data from the organization’s website. China’s exports to the EU and U.S. accounted for a combined 38 percent of total overseas shipments in 2010, according to Bloomberg calculations based on data from the customs bureau.

Small and domestic seems now the flavor.

I don’t have any qualms of being small, but I do mind when media implies that financial markets today rewards cronyism and protectionism via “domestic-orientation”…scarcely a positive aspect to extol.

Of course, it is even ridiculous to say that ASEAN’s advantage has been about “bolstered spending on infrastructure and stepped up efforts to spur domestic consumption”.

Which economies have not been ‘spending’ to bolster consumption? Has not today’s crisis emerged from too much debt financed spending in order to uphold ‘consumption’?

It is also worth pointing out that despite the huge reduction in exports to the US and EU by ASEAN, they still make up a third of exports.

And it misleads to focus only on exports because there are other important external linkages as remittances, capital or investment flows and the banking system.

Yet a reduction in exports down to such level does not imply or guarantee of immunity from a global recession (that’s if a recession occurs)

More ASEAN hallelujahs…

Five Asean economies -- Indonesia, Thailand, Philippines, Malaysia and Vietnam -- along with China and India will outpace the rest of the world over the next two years, the International Monetary Fund said in an April report. In 2013, the Asean-5 will grow 6.2 percent, compared with 2.4 percent in the U.S., 0.9 percent in the euro area and 1.7 percent in Japan, it said.

Faster economic growth has fueled stock-market gains and valuations. The MSCI South East Asia Index has rallied 13 percent this year, including dividends, and more than doubled since 2008. The MSCI Asia Pacific Index has gained 3.8 percent in 2012 and returned 43 percent since the end of 2008.

The supposed ASEAN brilliance has really not about ‘faster economic growth’ but about three major unseen factors.

First is low debt as consequence of restructuring from the Asian crisis

As rightly pointed out by the article,

Southeast Asia “does not have debt problems like Europe,” Alan Richardson, a Singapore-based fund manager for Samsung Asset Management Co., who helps oversee $82 billion, said by phone on July 2. The region “hasn’t been through a strong investment up-cycle compared to the BRIC economies, so increasingly investors are seeing Asean has an alternative equity class.”

The second and most important which has been tightly correlated to the first is domestic negative interest rates.

Negative interest rates have been conducive or encourages debt take up in low debt economies.

So what has been deemed as relatively ‘faster’ economic growth is in reality an ongoing credit boom as discussed here. I mentioned that even Fitch rating has recently warned the Philippines on this.

The third interrelated factor has been the monetary easing policies by developed economies.

Many international investors have taken ASEAN as quasi-refuge justified as ‘investment’ based on growth when in reality (particularly the Japanese), they represent as yield searching dynamic or rampant speculation meant to preserve the purchasing power of their savings (euphemism for capital flight) against reckless monetary policies at home.

Be reminded that one major characteristic of a bubble is to broadcast a "new paradigm". This seems what we are seeing today in ASEAN

The BRICs has initially been thought to have been the 'new paradigm'; now this has been shattered.

Booms brought about by bubble policies will eventually be exposed for what they are, as they have always been.

Be careful out there.

Money Abhors a Vacuum: Alternative Digital Based Barter-Currency System Emerge in Greece

Money and trade abhors a vacuum and a replacement will always emerge at the margins.

From BBC.com

In lean economic times, alternative financial systems are sprouting up around the world. And now they come with a digital twist.

"The Greek state is completely absent," says Katarina with a deep chuckle. We are standing across from each other inside a sweltering building on the outskirts of the Greek city of Volos, about 200 miles north of Athens on the Mediterranean. Both Katarina and her daughter, who stands beside her, have been unemployed for months. They are at this makeshift market to sell their array of homemade jams, pickled vegetables and liqueurs, which are spread out on the table between us.

But this isn't a typical market. In fact, there isn't a euro in sight. Katarina is part of a network of more than 500 people in Volos who are taking financial matters into their own hands as part of an alternative local currency, known here by its Greek acronym TEM. "In the network, people can trade their goods and services," says Christos Papaioannou, one of the network's founders. "If I do a service for you, then you owe me a favour. And I can use that favour to get some service from someone else. So, we don't have to exchange directly, I can get it from some third person."

To be clear, there is no actual currency or scrip exchanged. Credits are tracked via an open-source community banking software system called Cyclos. Katarina, for example, banks her credits from selling jam to buy staple foods such as eggs and fresh vegetables that are offered through the network.

The barter idea is catching on in a number of cities in Greece during these lean economic times, returning communities to a centuries old system but with a digital twist. And it's not just in Greece. The global economic downturn has created renewed interest worldwide in alternative economic models.

"I think that people are becoming increasingly aware, over the past few years, that financial systems aren't sustainable. And that boom and bust is always going to be with us, despite politicians continually telling us they are going to work to remove [them]," says Ken Banks, who recently launched a project called Means of Exchange. The idea behind the project, says Banks, is to create a "toolbox" of web-based and mobile apps that will make it easier for people to engage in things like bartering, swapping and alternative currencies.

This has clearly been the free market alternative; spontaneous order, no taxes and strictly competition based.

Yet the emergence of digital bartering and currency alternatives are likely the future trend

As Professor Gary North rightly points out,

This is going to spread. It will appear whenever governments and banks break down. When this happens, production will scape the tax collector’s nets. The tax collector cannot track everything. He cannot brig charges against everyone. The more people who get away with unreported income, the more difficult it will be for governments to avoid contraction.

The future will have smaller, weaker governments.

The Homeless and Nomad Billionaire: Burger King Boss Nicolas Berggruen

From the Daily Mail (hat tip Sovereign Man)

Like most nomads, Nicolas Berggruen travels light.

He doesn't own a house, car or even a watch and the few belongings he does have are carried around in a paper bag.

Possessions have 'zero appeal', he says. It's our actions that have real value.

But what sets the 50-year-old apart from nearly all other homeless people is the small matter of his £1.5billion fortune.

Berggruen got rid of his New York pad and private island 12 years ago. Home is far more transient nowadays.

Life for him is a jet-set one - trotting the globe, hanging out with beautiful women and staying in luxury hotels, sometimes in 14 different cities in a month as he builds his enormous business empire.

His most recent acquisition has been a £881million stake in Burger King.

But in spite of his wealth, the Franco-German tycoon insists he doesn't need, or want, material goods.

'Possessing things is not interesting,' he told the Daily Mirror. 'Living in grand environments to show myself and others that I have wealth has zero appeal.

'Whatever I own is temporary, since we're only here for a short period of time. It's our actions that will last for ever. That's real value.'

A billionaire with no house, car, watch and a few belongings but hangs out with different beautiful women exhibits unique values and priorities.

Mr.Berggruen’s life philosophy seem to revolve around the non-attachment creed of Buddhism. Yet where he says ‘our actions’ signifies as the ‘real value’ then his penchant for many chicks must be his ‘real’ non-attachment value.

Since like Mr. Berggruen, I only rent my home, don’t have a car, watch and only have a few treasured belongings (yeah books), and used to desire traveling, he should be my idol.

Unfortunately, I am nowhere near being like him (in money, women, and importantly, in philosophy).

Pavlovian Markets Rise on Hopes of the Bernanke Put

More bad news is good news.

Asian equity markets rises on HOPES that Ben Bernanke will (tonight) deliver the much sought after opiate.

From Bloomberg,

Asian stocks advanced for a third day, oil climbed and the Japanese yen weakened as an unexpected drop in U.S. retail sales stoked speculation Federal Reserve Chairman Ben S. Bernanke will hint at further stimulus today. Corn rose toward a record as U.S. crop conditions worsened…

Bernanke will deliver his semiannual report on the economy and monetary policy before Congress today, after a report yesterday showing a contraction in June retail sales kindled speculation the Fed will introduce more measures to support the world’s largest economy. Corn has risen 55 percent since June 15 as further evidence of damage from the worst U.S. drought in a generation stoked concern yields will drop, hurting output in the biggest exporter and lifting global food costs.

“There is market positioning for Bernanke to deliver something today,” said Joseph Capurso, a strategist in Sydney at Commonwealth Bank of Australia, the nation’s biggest lender. “There is a high risk of more policy easing before the end of this year.”

A third monthly drop in U.S. retail sales showed limited employment gains are taking a toll on the biggest part of the economy. The IMF lowered its 2013 forecast for global economic growth yesterday to 3.9 percent from 4.1 percent as Europe’s debt crisis prolongs Spain’s recession and slows expansions in emerging markets from China to India.

Will hope become reality or will the Bernanke led FOMC give in to the yearnings of the steroid addicted markets?

What happens if the FOMC spurns the markets’ slabbering for more stimulants?

Until when will hope be able to forestall reality?

Regime Uncertainty: Dodd-Frank

Regulations can be a major source of risk and uncertainty. Repressive and arbitrary regulations may diminish the entrepreneurs incentives to invest or allocate capital to productive ventures which in aggregate adds to economic woes.

Peter Klein at the Independent Institute quotes Peter Wallison on the adverse effects of the Dodd Frank law

“The question is why—why did this act have such a dramatic effect on the U.S. economy, essentially stifling the modest recovery that had begun almost a year earlier? The most likely explanation is uncertainty. The Dodd-Frank Act was such a comprehensive piece of legislation—and required so many new regulations before its effects could be fully evaluated—that many financial institutions and firms simply decided to wait for regulatory developments before expanding, hiring new workers, or rehiring workers who had previously been laid off. . . .

Following the precept of the president’s then-chief of staff Rahm Emanuel that “You never want a serious crisis to go to waste,” the law was rushed through Congress only 18 months after the Obama administration took office and 13 months after the first draft of the law was available to Congress and the public. This would have been warp speed for any one of the major provisions in the act. For a law with dozens of complex, radical, and occasionally contradictory provisions, adopting it so quickly and with so little real understanding of its effects verged on dereliction of duty.

Once business firms got a look at the language, they realized that they would have to change their financing arrangements in significant ways, and the costs were largely unknown.

Will China Ease Banking Curbs? Has the Railway Stimulus been Launched?

China’s worsening slowdown has been prompting for a stream of news pouring out this morning.

One should note that the Shanghai Index broke down yesterday, but has opened mixed (slightly higher) today.

Yesterday I asked,

will China's policymakers ease on bank capital regulations?

I guess the initial indications points to the easing of restrictions on China’s shadow banking system perhaps as part of the proposed stimulus

Here is the Bloomberg,

China’s economic slowdown threatens to derail efforts to curb underground lending -- measures championed by Premier Wen Jiabao as crucial to future growth.

The country grew in the second quarter at the slowest pace since the depths of the global financial crisis in 2009, 7.6 percent, putting pressure on China’s leaders to boost stimulus spending. Wen’s proposals to rein in the shadow-banking system, estimated to be about one-third the size of official lending, may be sidelined as a result, according to half a dozen economists interviewed by Bloomberg News.

“With an economy slowing more aggressively than the authorities perhaps want, the imperative to crack down on shadow financing becomes increasingly conflicted,” said Alistair Thornton, a Beijing-based economist with research firm IHS Global Insight Ltd. (IHS) “With the government increasingly in firefighting mode, the desire to push through tough reform in the financial sector inevitably takes a back seat to staving off a hard landing and managing global economic volatility.”

Wen, whose term ends next year, has led calls to control what IHS estimates is $1.3 trillion of private financing, an amount equal to last year’s U.S. budget deficit. He has proposed channeling that money through government-regulated institutions to break what he called a “monopoly” on lending by state-owned banks and open a cascade of capital to China’s 42 million small and medium-sized businesses.

‘Terrible Damage’

Only 3 percent of those companies are able to get bank loans, according to Citic Securities Co. (6030), the nation’s biggest publicly traded brokerage, with underground lending by family, friends and acquaintances largely funding the rest.

If and when this becomes a reality, then this does nothing to solve the problem of systemic overleveraging, and in fact, should worsen it. What Chinese authorities are likely to do like their developed economy peers is to inflate aggressively.

Another Bloomberg article also says that China may have already launched a railway based stimulus.

China’s railway infrastructure investment may double in the second half of this year from the first six months, aiding efforts to reverse a slowdown in the world’s second-biggest economy.

Full-year spending will be 448.3 billion yuan ($70.3 billion), according to a statement dated July 6 on the website of the National Development and Reform Commission’s Anhui branch. That indicates about 300 billion yuan of investment in the second half, up from about 148.7 billion yuan in the first.

China’s fixed-asset investment has already started to pick up and a jump in spending on railway construction would echo the stimulus rolled out during the global financial crisis. A decline in foreign direct investment reported by Vice Commerce Minister Wang Chao in Hong Kong yesterday underscored the toll that Europe’s debt woes and austerity measures are taking on Asia’s largest economy.

In my view, both are signs of the growing desperation by the Chinese authorities, who may trying to offset adverse market developments with public relations work.

None of the above seems to have been made official yet. “May be sidelined” or “may double” seem like the psychological power of suggestion.

The recourse to managing public communications or public relations campaign seem as manifestations of the ongoing political deadlock within the Chinese political system

This means that, so far, political actions has mostly been about promises or “talk therapy”.

The frictions from the clash of hope and reality will likely produce more market volatilities in either direction over the interim but enhances the risks of a fat tail event (crash).

Be careful out there.

Quote of the Day: Hubris has its Costs, the Decoupling that Never Was

The lesson from recent economic data and policy moves in Asia (MXAP) is this: Hubris still has its costs.

In recent years, Asia believed its own press a little too much. The way it steered around the financial crisis of 2008, the dizzying stock gains, the migration of bankers from New York to Hong Kong and the region’s mergers-and-acquisitions binge were all interpreted as immutable signs of Asia’s economic arrival.

Decoupling-from-the-West euphoria flooded emerging markets in general. The BRIC economies -- Brazil, Russia, India and China -- thought their rapid growth rates would pick up the slack as America and Europe reeled. Debt markets in developing nations reveled in their new roles as sanctuaries.

Disappointing data and interest-rate cuts in Beijing, Hanoi and Seoul last week show the extent to which Asia got ahead of itself. Asia isn’t re-coupling; it never decoupled much in the first place. That leaves us with two stark realities for the second half of 2012: Emerging markets aren’t ready for prime time globally, and Asian policy makers need to get more aggressive about finding new avenues for growth.

That’s from Bloomberg’s Asian columnist William Pesek.

And this why it is equally dangerous, if not a folly, to believe that ASEAN markets and economies will decouple.

Dealing with Spain’s Labor Rigidities

The Wall Street Journal editorial has some interesting insights, particularly facts (marked by bullets) and micro based recommendations in resolving Spain’s rigid labor markets.

[bold emphasis mne]

• After Cyprus, Spain ties with Malta for the most public holidays (14) in Europe. The Spanish Workers' Statute also guarantees 22 days of paid vacation annually, 15 days to get married and two to four days when anyone in an employee's family has a wedding, birth, hospitalization or death.

Mr. Rajoy has tried, with only moderate success, to tweak the public-holiday schedule and discourage "bridge" weeks—when, say, the Assumption of Mary falls on Wednesday and your entire staff takes off Thursday and Friday too. But if Mr. Rajoy wants a reform that would also be popular, why not ditch the statute's clause that bars employees from trading vacation time for extra pay? If Spaniards could earn greater rewards for taking fewer holidays, they might eventually want to scrap state-mandated vacations.

• Sick employees can get most or all of their wages for 18 consecutive months if they have a doctor's note. An employer could opt to fire chronically ill employees—and pay up to 24 months of guaranteed severance. That's excessive. Then again, the mandatory national insurance to cover sick wages, severance pay, health care and so forth takes 39.9% from the gross average Spanish wage.

Mr. Rajoy has trimmed unemployment benefits and pledged to reduce compulsory "social contributions" by one percentage point next year and another in 2014. He could do much better by letting Spaniards opt out of some entitlements entirely, such as paternity pay or child-care coverage. Spain would be a far better place to work and hire if its laborers and businesses could choose how to spend more of what they earn.

• Spain's 52% youth unemployment remains the subject of countless government training programs and tax exemptions for businesses hiring those under age 30. The programs don't work but they are expensive.

A free alternative: Repeal the Workers' Statute clauses that forbid most trainees and apprentices from earning less than 60% of the wages of full employees and from working more than 85% of a regular shift. It's harder to hire young people if you know you'll get much less work out of them for not much less pay.

Mr. Rajoy could also expand the one-year period during which businesses may dismiss new employees without severance. This only applies to firms with fewer than 50 workers, which helps explain why 99% of Spanish companies have no more than 49 employees of any age.

• Once a Spanish business reaches 50 employees, its workers must also elect five workplace reps to bargain on wages and conditions. These delegates must each receive at least 15 paid hours off monthly for their duties, and the quotas rise as companies grow. By the time a business hires its 751st staffer, it must have at least 21 workplace reps, each getting a minimum of 40 paid hours off per month.

Eliminating these costly sops and letting workers negotiate individually would no doubt provoke a declaration of war from labor bosses. So what? Fewer than 16% of Spaniards today opt to unionize, and far fewer than that join in already-frequent union demonstrations.

Read the rest here

From the above, one can see that the predicament of Spain’s competitiveness has scarcely been about the adverse effects of a “strong” currency, but because of the compounded negative side-effects of suffocating regulations, the barnacles of bureaucracy and the unwieldy welfare state.

Video: What Murray Rothbard thought of John Maynard Keynes

[hat tip Bob Wenzel]

Video: Official Trailer of the Bubble Film

The official trailer from a film which questions the roots of the bubble, inspired by the book Meltdown written by Austrian economist Tom Woods (hat tip lewrockwell.com)

Video: Repealing Obamacare Isn't Enough, Ending the Third Party Payer System is the Main Issue

courtesy of Dan Mitchell of the Cato Blog

Contagion Risk: Watch for China’s Catastrophic Deleveraging

Dee Woo at the Business Insider has an insightful analysis on why we should continue to keep vigil on China’s banking and financial system. (bold emphasis mine)

China’s policy makers have been caught in a dangerous bind.

1. The frustrated and aggressive central bank

If one wants to know how bad the health of China's economy has gone, look no further than the PBOC's composure, which seems rather frustrated and aggressive as of late. On 5th July, the central bank cut benchmark interest rates for the 2nd time in less than a month. This happened right after the fact that in December 2011, PBOC cut the reserve requirement ratio(RRR) by a 50 bp to 21%, it followed up with another 50 bp in February and another 50 bp in May to 20% currently.

On top of all the rate cuts, PBOC also made its biggest injection of funds into the money market in nearly six months. The PBOC injected a net 225 billion yuan ($34.5 billion) through the reverse-repurchase operations(repo) on last Tuesday and Friday, following a combined injection of 291 billion yuan in the previous four weeks.

2. The systematic short-circuit of debt financing's in order

So why PBOC is in such an urge to open the floodgate of liquidity? This economist will spare you the boredom of looking at the diagrams of China's economic misery: HSBC PMI, etc, since you can find those eye candies everywhere else on the web. Let me cut to the chase: However high it aims, PBOC's action in practice merely work as the band aid to the bleeding economy. But it won't be able to fix it. The central bank's aggressive pro-liquidity maneuvers at best serve to sustain the over-leveraged economy and avoid the systematic short-circuit of debt financing. Now allow me to divulge:

The main drivers of China's debt financing,China's state-owned banks, are starving for cash. According to Citigroup estimates, in 2011 seven of the biggest Chinese banks raised 323.8 billion renminbi ($51.4 billion) of new fund. Several financial firms are expected to raise another $17.7 billion in the next few months, with China’s fifth-biggest lender, the Bank of Communications, accounting for $9 billion. The unprecedented lending binge encouraged by the central government,increasingly rigorous requirement of regulatory capital and excruciating maintenance of excessive dividend payouts have rendered the most-profitable banks in the world--Chinese banks--in a rather precarious position.

GaveKal's data will illustrate this is no exaggeration: In 2010, China’s five biggest banks — the Big Four plus the Bank of Communications — paid more than 144 billion yuan in dividends while raising more than 199 billion yuan on the capital markets. The ballooning balance sheet caused by the loan frenzy and strict capital requirement make China's banks' cash-craving burning at both ends:this march, China’s big four— Industrial and Commercial Bank of China, the Bank of China, China Construction Bank and Agricultural Bank of China — have a combined 14 percent increase in total assets, to 51.3 trillion yuan, which is roughly the size of the German, French and British economies combined.

Meanwhile, under a new set of rules, the country’s biggest banks will need to increase their capital levels to 11.5 percent of assets by the end of 2013.Their core Tier 1 capital ratio will need to be at least 9.5 percent. These requirements are more stringent than the rules that apply to American and European banks. Hereby, we shouldn't be surprised why the world's most profitable banks are in the dire need of cash. It has to be PBOC who comes to the rescue.

Diminishing returns of China’s inflationism…

According to the great Ray Dalio's principles, the credit-fueled China's economy is so over-leveraged that a great de-leveraging is going to be the only way out. The pyramid of debt/credit is cracking and will collapse since the conditions of underlying economic agents are deteriorating.There's no mount of monetary band aids that can alter that destiny.

According to Fitch’s data, the ratio of total financing/GDP in China rose from 124% at end‐2007 to 174% at end‐2010, and rose by another 5pp to 179% in 2011.In 2012 the growth of broad credit will slightly decelerate but still outpace GDP. Clearly China is not suffering a liquidity crisis but the diminishing economic return on credit. According to Fitch, in 2012, each CNY1 in new financing will yield ￥0.39 yuan in new GDP versus ￥0.73 yuan pre-crisis.Returns would have to rise above ￥0.5 yuan for domestic credit/GDP to stabilize at 2011’s 179%.

The dilemma is that business entities will need more and more credit to achieve the same economic result, therefore will be more and more leveraged, less and less able to service the debt, more and more prone to insolvency and bankruptcy. It will reach a turning point when the increasing number of insolvencies and bankruptcies initiate an accelerating downward spiral for underling assets prices and drive up the non-performing loan ratio for the banks.

And then the over-stretched banking system will implode. A full blown economic crisis will come in full force. The chain of reaction is clearly set in the motion now. The question is when we will reach that turning point. What PBOC has done is only adding fuel to the fire because it is unable to tackle the root causes of China's economic ills.

Again interventionism will require more interventionism. Yet interventionism via inflation is a policy that will not and cannot last. Has China reached that moment?

More, insufficient savings to tap for bank recapitalizations…

Let's examine the structural reasons that China's domestic demand will have its work cut out to refill the tank space of the economic growth left out by collapsing investment and export:

1st, Contrary to what many choose to believe, China's trade surplus is not caused by Chinese consumers' high saving rate, but has much to do with their deteriorating disposable incomes which far lag behind GDP growth and inflation. According to the All China Federation of Trade Unions (ACFTU), workers' wages/GDP ratio have gone down for 22 consecutive years since 1983. It goes without saying that the consumption/GDP ratio is shrinking all the while.

Meanwhile, Aggregate Savings Rate has increased by 51% from 36% in 1996 to 51% in 2007. Don't jump to your conclusion yet that Chinese consumers has been over-tightening their purse strings. The truth is far away from conventional perceptions: according to Development Research Center of the State Council's report, that increase is mainly driven by the government and corporations and not by the household. For the past 11 years, Household Saving Rate has only increased from 19% to 22%. Even India's Household Saving Rate of 24% is higher than China's right now.

All the while, government and corporations' saving rate has increased from 17% to 22%, which accounts for nearly 80% of the increase on Aggregate Savings Rate. For the past decade, Government's fiscal income is growing faster than GDP or Household Income. In 2009, the fiscal income was 687.71 billion yuan, and achieved an annual growth of 11.7% while GDP growth was 8.7%, Urban household disposable income growth was 8.8% and agriculture household disposable income growth was 8.2%. It is obvious that the state and corporations has taken too much out of national income and hence they continue to weaken the consumers rather than empower them.

All inflationism is deceptively about self-serving politics…

The biggest problem for China is the state, central enterprises and crony capitalists wield too much power over national economy, have too much monopoly power over wealth creation and income distribution, and much of the GDP growth and vested interest groups' economic progress are made on the expanse of average consumers stuck in deteriorating relative poverty. If these problems aren't solved, the faster the Chinese GDP growth, the less Chinese consumers will be able to support the over-capacity expansion, the more export momentum China will need to sustain its growth. This is a vicious circle of global imbalance. Even the revaluation of RMB can't break it.

Read the rest here

To recall the admonitions of the great Professor Ludwig von Mises against Keynesian policies…

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.

Will China's policymakers ease on bank capital regulations? Or will China's authorities opt to finance these through PBoC's money printing that increases the risk of hyperinflation? Or will China be forced to deleverage? Many questions that has yet to be answered.

Be careful out there.