ECB’s Mario Draghi Unleashes “Unlimited Bond Buying” Bazooka, Fed’s Ben Bernanke Next?

So finally, the ECB via president Mario Draghi unleashed what seems as the penultimate “shock and awe” rescue mechanism for the EU: the supposed “unlimited but sterilized” buying of bonds.

From Bloomberg, (bold added)

European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond- purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup.

The program “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,” Draghi said at a press conference in Frankfurt after the ECB held its benchmark rate at a record low of 0.75 percent. “Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”

Draghi has staked his credibility on the bond plan, which is the most ambitious yet in the central bank’s fight to wrest back control of rates in a fragmented economy and save the euro after nearly three years of turmoil. Now it’s up to governments in Spain and Italy to trigger ECB bond purchases by requesting aid from Europe’s rescue fund and signing up to conditions

“Governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial-market circumstances and risks to financial stability exist -- with strict and effective conditionality,” Draghi said. The ECB reserves the right to terminate bond purchases if governments don’t fulfil their part of the bargain, he added…

The ECB’s program, called Outright Monetary Transactions, will target government bonds with maturities of one to three years, including longer-dated debt that has a residual maturity of that length, Draghi said. Purchases will be fully sterilized, meaning that the overall impact on the money supply will be neutral, and the ECB will not have seniority, he said.

Note that ECB bond purchases have not truly been “unlimited” as they supposedly conditional to the requested “aid” by crisis stricken nations from the ESM and will be “fully” sterilized. Aside from conditionality on reforms.

As usual political terminologies matter.

The idea of full sterilization means that money will be drained from the other sectors and will allegedly be neutral. This could be the reason behind the underperformance and the tepid gains of gold and other commodities as oil and copper despite the ECB's opening of the inflation spigot.

Moreover, perhaps too, the ECB assumes that need for bond buying may be checked or will have the desired effect of providing carrot and stick approach for governments to take appropriate corrective fiscal measures.

Unfortunately this won’t likely be the case.

Not only is the bond buying going to be an incentive for delaying the necessary reforms for the PIGS (out of moral hazard dilemma), but the ECB’s sterilization activities will likely be also restricted.

University of Chicago Professor John Cochrane at the Bloomberg explains…...

If past were to rhyme, in November of last year, the ECB has missed sterilizing her purchases.

So if the ECBs action to sterilize are encumbered, then this means either that the ECBs buying will have short run effects, or that designated conditions represents smoke and mirrors which may pave way for the massive unsterilized actions or monetary inflation.

Nonetheless, I think the ECB’s unlimited option has been coordinated with the US Federal Reserve.

Just a few days back, four Federal Reserve presidents discussed of the same open-ended buying option.

From another Bloomberg article,

Federal Reserve Chairman Ben S. Bernanke says the U.S. economy is “far from satisfactory.” His colleagues are moving to embrace policies that will stay in place until he’s satisfied.

Four Fed presidents have come out in favor of an open-ended strategy for bond buying, with three calling for the program to begin now. Rather than specify a fixed amount of bonds to purchase by a certain date, such a strategy would leave the Fed able to announce a pace of purchases that it could adjust as the economy gets closer to Bernanke’s goals.

“You would be able to react to the incoming data in an incremental way and not be in a situation where you have to either drop the bomb or do nothing,” St. Louis Fed President James Bullard said in an interview last week during the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming.

Bernanke used the forum to defend unorthodox policies such as bond purchases and made the case for further action to reduce an unemployment rate that he called a “grave concern.” Stocks and Treasuries jumped after the speech as investors increased bets the Fed will opt for further easing as soon as its next meeting Sept. 12-13.

I am inclined to the view that the FED will move to compliment the ECB for political reasons. I think that Bernanke’s tenure depends on President Obama’s re-election and thus would work to ensure of policies that will be “stock market friendly”

And as I previously said, the combined actions by central banks will eventually lead to deepening stagflation manifested through high consumer prices and the real risks of a food crisis that amplifies risks of social instability, as well as, overseas bubbles.

Central bank fixes has only short term narcotic effects, that risks long term unintended consequences.

As the great Professor Ludwig von Mises presciently warned,

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

For now, the risk ON “orgy of speculation” environment may have been activated based on a partial fulfilment of market’s addiction for central bank steroids.

But given the vagueness of conditionalities from the ECB program and of the response by other central bankers to real economic events, the sustainability of such risk ON conditions remains unclear.

We are approaching the Mises moment.

Has Communism been Shaped by Karl Marx’s Self-hatred?

Not to be accused of Tu Quoque “you too” fallacy, experience plays an important part in influencing our outlook and personal philosophy. Has self-hatred been the cornerstone of Karl Marx’s political philosophy known as Communism?

Here is an excerpt of the narration by Murray N. Rothbard of Karl Marx’s path to Marxism, (bold added)

Also prefiguring the man was a trait that Marx developed early in his youth and never relinquished: a shameless sponging on friends and relatives. Already in early 1837, Heinrich Marx, castigating his son Karl's wanton spending of the money of others, wrote to him that "on one point … you have wisely found fit to observe an aristocratic silence; I am referring to the paltry matter of money." Indeed, Marx took money from any source available: his father, mother, and throughout his adult life, his long-suffering friend and abject disciple, Friedrich Engels, all of whom fueled Marx's capacity for spending money like water.

An insatiable spender of other people's money, Marx continually complained about a shortage of financial means. While sponging on Engels, Marx perpetually complained to his friend that his largess was never enough. Thus, in 1868, Marx insisted that he could not make do on an annual income of less than £400-£500, a phenomenal sum considering that the upper tenth of Englishmen in that period were earning an average income of only £72 a year. Indeed, so profligate was Marx that he quickly ran through an inheritance from a German follower of £824 in 1864, as well as a gift of £350 from Engels in the same year.

In short, Marx was able to run through the munificent sum of almost £1200 in two years, and two years later accept another gift of £210 from Engels to pay off his newly accumulated debts. Finally, in 1868, Engels sold his share of the family cotton mill and settled upon Marx an annual "pension" of £350 from then on. Yet Marx's continual complaints about money did not abate.

As in the case of many other spongers and cadgers throughout history, Karl Marx affected a hatred and contempt for the very material resource he was so anxious to cadge and use so recklessly. The difference is that Marx created an entire philosophy around his own corrupt attitudes toward money. Man, he thundered, was in the grip of the "fetishism" of money. The problem was the existence of this evil thing, not the voluntarily adopted attitudes of some people toward it. Money Marx reviled as "the pander between … human life and the means of sustenance," the "universal whore." The Utopia of communism was a society where this scourge, money, would be abolished.

Karl Marx, the self-proclaimed enemy of the exploitation of man by man, not only exploited his devoted friend Friedrich Engels financially, but also psychologically. Thus, only three months after Marx's wife, Jenny von Westphalen, gave birth to his daughter Franziska in March 1851, their live-in maid, Helene ("Lenchen") Demuth, whom Marx had "inherited" from Jenny's aristocratic family, also gave birth to Marx's illegitimate son, Henry Frederick. Desperately anxious to keep up haute bourgeois conventions and to hold his marriage together, Karl never acknowledged his son, and, instead, persuaded Engels, a notorious womanizer, to proclaim the baby as his own. Both Marx and Engels treated the hapless Freddy extremely badly, Engels's presumed resentment at being so used providing him a rather better excuse. Marx boarded Freddy out continually, and never allowed him to visit his mother. As Fritz Raddatz, a biographer of Marx, declared, "if Henry Frederick Demuth was Karl Marx's son, the new mankind's Preacher lived an almost lifelong lie, and scorned, humiliated, and disowned his only surviving son." Engels, of course, picked up the tab for Freddy's education. Freddy was trained, however, to take his place in the working class, far from the lifestyle of his natural father, the quasi-aristocratic leader of the world's downtrodden revolutionary proletariat.

Marx's personal taste for the aristocracy was lifelong. As a young man, he attached himself to his neighbor, Jenny's father Baron Ludwig von Westphalen, and dedicated his doctoral thesis to the baron. Indeed, the snobbish proletarian communist always insisted that Jenny imprint "nee von Westphalen" on her calling card.

I suggest a read of the entire article which is rather short and includes Karl Marx’s supposed conversion to "militant atheism"

The point being; people who in good intentions believe that public welfare can be acquired through the collectivist route via communism or related socialist branches thereto, are in fact running contrary to their desires. A philosophy founded on seeming self-hatred or founded on base human instincts will not bring about prosperity but perdition through violence.

Proof of this has been the harrowing 20th century experiment where about 94 million people perished, according to the Black Book of Communism, out of the desire to achieve a utopian communist society. In other words, it took 94 million lives to prove a failed experiment and an unfulfilled utopia. Yet many are still out there preaching the same.

US Federal Reserve Policies Promotes Anti-Market Sentiment in Hong Kong

Like Singapore, I pointed out that incumbent politicians have used symptoms of current bubble (negative real interest rates) policies to impose populist measures which in reality represent gradualist trend towards interventionism. This applies to Hong Kong too.

From Bloomberg,

Hong Kong’s new leader is taking up the battle his predecessor failed to win, seeking to overcome record low mortgage rates and an influx of Chinese buyers to make housing in the world’s most expensive city more affordable.

Leung Chun-ying, the property surveyor who took over as the city’s chief executive in July, on Aug. 30 said he’ll boost the supply of homes and start drafting laws giving preference to locals over buyers from mainland China. He’s trying to cool prices that surged 85 percent since 2009 even as predecessor Donald Tsang raised minimum mortgage deposits, added taxes and increased land sales in a losing bid to stem the boom.

Like Tsang, Leung has had to tweak demand and supply through curbs and land releases rather than monetary policy as Hong Kong’s currency peg to the U.S. dollar pushes borrowing costs to a record low. Banks, including HSBC Holdings Plc (HSBA) and Standard Chartered Plc (STAN), are charging homebuyers an average 2.17 percent, less than half that of six years ago, fueling demand along with the rising wealth of buyers from China’s mainland.

Hong Kong dollar has been pegged to US dollar via the currency board managed by the Hong Kong Monetary Authority. This means that US monetary policies has had significant influences to Hong Kong’s monetary environment which has mainly been vented through a local property boom.

Again from the same article,

U.S. Federal Reserve Chairman Ben Bernanke has pledged to keep interest rates low until at least 2014 and on Aug. 31 made the case for further easing to reduce unemployment in the world’s largest economy. The Hong Kong Monetary Authority keeps its lending rate tied to the Fed to maintain the currency’s peg to the U.S. dollar…

Tsang raised the minimum deposit for some mortgages three times since August 2010, with borrowers now having to put down 40 percent for home purchases of more than HK$7 million ($902,000). He also introduced an additional stamp duty on residential units sold within two years of purchase.

While transactions are down, prices are up. The value of new mortgages fell 42 percent to HK$98.1 billion in the first seven months of this year, while the number of homes sold dropped 22 percent, according to data from the HKMA and the Land Registry. Home prices have gained 12 percent this year, according to Centaline Property Agency Ltd.

BOC Hong Kong Holdings Ltd. (2388), the biggest Hong Kong-based lender, has risen 33 percent this year, the best performer in the 12-member Hang Seng Finance Index. Hang Seng Bank Ltd. (11) has the second best return in the index with 19 percent. The two lenders accounted for a combined 32 percent of the city’s mortgage market, according to mReferral Mortgage Services…

Hong Kong home prices are 65 percent higher than Tokyo’s, the world’s second-priciest place to buy a home, according to a study by Savills Plc (SVS) published last September that compares prices in 10 global cities including New York and London.

Hong Kong’s negative real rate regime has been very pronounced. (chart from Tradingeconomics.com)

Yet instead of dealing with disease, the new leadership will practically will apply the same process of the politicization of land sales and distribution that has not only been ineffective but has promoted charges of cronyism.

As I previously wrote,

While some of Hong Kong’s wealthiest may have made their fortunes from cronyism (or politicized real estate policies), the above critics who resort to claims of “oligopolies and monopolies” that leads to “high prices land policy” and “glorified slavery” fails to recognize that Hong Kong’s property boom has also been influenced by the US Federal Reserve policies via the US dollar peg.

The point is that not only has the easy money policies of the US Federal Reserve been blowing Hong Kong’s bubble cycles, at worst such policies have been gnawing at Hong Kong’s relative free market environment by whetting or stoking on populist anti-market sentiment and the promotion of the mixed economy-welfare state. In short, bubble policies function like a political Trojan horse for destabilization

Hong Kong authorities should deal with the US dollar peg rather than intervene in the marketplace. Perhaps they should consider the proposal, which I earlier noted here, by Prof Joseph Yam, the former head of the Hong Kong Monetary Authority (HKMA), who is also one of the architects of Hong Kong-US dollar peg through a monetary board, to alter Hong Kong’s monetary system by shifting from US dollar peg towards China’s yuan or through a basket of other currencies. They could also consider Yuanization or using mainland currency by scrapping the Hong Kong dollar altogether.

By the way, price actions of Hong Kong’s Hang Seng Index seems ominous.

(chart from Bloomberg)

The bearish head and shoulder pattern may become a reality if Hong Kong’s domestic bubble will implode or if China will endure a recession-financial crisis or if a global recession happens. Incidentally, thanks to Ben Bernanke and his global central bank colleagues, all three factors are seemingly in play.

Quote of the Day: Fiscal Cliff: The Dangerous Idea of the Permanence of Low Interest Rates

The current national debt is about $16 trillion. This is just the funded portion — the unfunded liabilities of the Treasury, such as Social Security and Medicare, and off-budget items, such as guaranteed mortgages and student loans, loom much larger. Our recent era of unprecedented fiscal irresponsibility means we are throwing an additional $1 trillion or more on the pile every year. The only reason this staggering debt load hasn’t crushed us already is that the Treasury has been able to service it through historically low interest rates (now below 2 percent). These easy terms keep debt-service payments to a relatively manageable $300 billion per year.

On the current trajectory, the national debt likely will hit $20 trillion in a few years. If, by that time, interest rates were to return to 5 percent (a low rate by postwar standards) interest payments on the debt could run around $1 trillion per year. Such a sum would represent almost 40 percent of total current federal revenues and likely would constitute the single largest line item in the federal budget. A balance sheet so constructed would create an immediate fiscal crisis in the United States.

In addition to making the debt service unmanageable, a return to normal rates of interest would depress the kind of low-rate-dependent economic activity that characterizes our current economy. A slowing economy would cut down on tax revenue and trigger increased government spending to beleaguered public sectors. Higher rates on government debt also would push up mortgage rates, thereby putting renewed downward pressure on home prices and perhaps leading to another large wave of foreclosures. (My guess is that losses on government-insured mortgages alone could add several hundred billion dollars more to annual budget deficits.) When all of these factors are taken into account, I think annual deficits could quickly approach, and then exceed, $3 trillion. This would double the amount of debt we need to sell annually.

Currently, foreign creditors buy more than half of all U.S. debt issuance. Most of these purchases are motivated by political reasons that are subject to change. The buyers, who legitimately can be described as “investors,” extend credit to the United States at such generous terms largely because of America’s size, power and perceived economic unassailability. If those perceptions change, 5 percent could quickly become a floor, not a ceiling, for interest rates. Given that America’s balance sheet bears more than a casual resemblance to those of both Spain and Italy, it should not be radical to assume that one day we will be asked to pay the same amount as they do for the money we borrow. The brutal truth is that 6 percent or 7 percent interest rates will force the government to either slash federal spending across the board (including cuts to politically sensitive entitlements), raise middle-class taxes significantly, default on the debt, or hit everyone with the sustained impact of high inflation. Now that’s a real fiscal cliff.

By foolishly borrowing so heavily when interest rates are low, our government is driving us toward this cliff with its eyes firmly glued to the rearview mirror. Most economists downplay debt-servicing concerns with assertions that we have entered a new era of permanently low interest rates. This is a dangerously naive idea.

This is from Peter Schiff at the Washington Times.

My impression is that once a recession becomes a reality, the likely actions by the US government will be to undertake bailouts of the politically favored institutions similar to 2008.

Such rescue efforts will easily bring to fulfillment Mr. Schiff’s $20 trillion debt target in no time.

Eventually the US will default directly (most likely path; read Gary North and Jeffrey Hummel) or attempt to default first indirectly through monetary inflation.

Keynesians, who look to the Great Depression and the Japan lost decade as model, fails to see or are blinded to the fact that today’s problem has not only been a banking based financial crisis but compounded by sovereign debt crisis which has been unprecedented.

The root of the problem hasn't been the lack of aggregate demand but from the sustained consumption of capital which mostly has been burned through serial political rescues, malinvestments from easy money policies and worsened by unsustainable welfare warfare systems.

World Competitiveness: Philippines Jumps to 65th Place

The World Economic Forum (WEF) recently released, The Global Competitiveness Report for 2012-2013 which attempts to measure relative competitiveness among 144 nations that provides “insight into the drivers of their productivity and prosperity”

It is important to highlight that the competitive ranking have been defined by the WEF as

as the set of institutions, policies, and factors that determine the level of productivity of a country. The level of productivity, in turn, sets the level of prosperity that can be earned by an economy. The productivity level also determines the rates of return obtained by investments in an economy, which in turn are the fundamental drivers of its growth rates. In other words, a more competitive economy is one that is likely to sustain growth.

Here is the roster of the top 30 most competitive nations.

Notice that the WEF says the ranking is about productivity, and not about “cheap labor”.

If competitiveness is about the “cheap labor” then the Philippines and Africa will be on top of the list. Unfortunately mainstream demagoguery has obstinately been focused on this, so as to justify the inflationist-interventionists doctrines.

Also notice that the most competitive nations have been developed economies. The GCI rankings have been closely aligned with the list of most economically free nations (Heritage Foundation: 2012 Index of Economic Freedom).

It is important to note that the above rankings are comparative or relatively based. This implies that changes in standings may not necessarily translate to advancement or deterioration in domestic policies but about quantified comparative measures.

First the good news.

According to the report, the Philippines leapt from 75^th to 65^th

Yet despite the huge gains, which obviously will be construed and used by the mainstream and political forces to grab credit as “achievement” for the administration, the Philippines trails vastly behind the ASEAN peers.

Curiously Africa’s Rwanda has even been ahead.

The bad news is that despite the remarkable gains, the gap in the per capita GDP figures has been widening relative to our developing Asian peers.

This means that yes the Philippines has shown material progress but such gains has not been enough to cope up with the scale of advancement in the region.

Lastly, the reason for the lag in productivity has been about over politicization of the domestic economy which has been manifested through a bloated bureaucracy, lack of infrastructure (which has been politically determined—see below), tax and labor regulations and high tax rates.

Of course corruption has still been the biggest deterrent to business. But, in truth, corruption signifies as symptoms of interventionism expressed through arbitrary policies and regulations, the bureaucracy, welfare-warfare state and state determined allocation of resources.

The informal economy, which is also a symptom of interventionism, takes up a huge chunk of economic activities. This is a clear manifestation of the failures of interventionism and of the incumbent political institutions.

Ironically the salutary conditions of the shadow economy could be suggestive of the alternative positive aspects of corruption, where people pay bribe money to authorities in order to do productive endeavors. This in spite of the major negative attribution on the survey.

The burgeoning informal gold mining sector, which comes mostly in response to recently imposed higher taxes should serve as a wonderful anecdotal example.

Yet the media and the social desirability bias afflicted pop culture cheers about the Php 407 billion proposed infrastructure or so-called “investment” spending without the realization that productive money will be diverted to the pockets of cronies (who will get the contracts), bureaucrats (who will pick the winners) and politicians (which most likely will be the source of electoral finance for the upcoming 2013 national elections).

chart from US Global Investors

All these supposed stimulus will only translate to greater inequality (enrichment of the political class and of the politically connected enterprises), more debts, higher taxes (for the middle class and the politically unconnected), more PRICE inflation (which will be blamed on the private sector) and importantly adds to the ballooning bubble dynamics driven by current easy money policies.

These so-called public work policies are a chimera, as the great Professor Ludwig von Mises explained.

The fundamental error of the interventionists consists in the fact that they ignore the shortage of capital goods. In their eyes the depression is merely caused by a mysterious lack of the people's propensity both to consume and to invest. While the only real problem is to produce more and to consume less in order to increase the stock of capital goods available, the interventionists want to increase both consumption and investment. They want the government to embark upon projects which are unprofitable precisely because the factors of production needed for their execution must be withdrawn from other lines of employment in which they would fulfill wants the satisfaction of which the consumers consider more urgent. They do not realize that such public works must considerably intensify the real evil, the shortage of capital goods.

For media and the dumb downed (“madlang people”) electorate which sees this as good news hardly understands that effects of so-called government stimulus would be based on the illusions of statistics [mainstream economic statistics are based on Keynesian formula constructs] and not from real growth.

Thus, temporary good news will eventually become long term bad news.

However, despite such realities, the relatively better competitive standings today will likely continue to improve. Again, this is hardly because of internal ‘business friendly’ improvements but because of positional standings which will mostly be determined by the political responses to the unfolding crisis abroad.

Again the WEF’s GCI

The global economy faces a number of significant and interrelated challenges that could hamper a genuine upturn after an economic crisis half a decade long in much of the world, especially in the most advanced economies. The persisting financial difficulties in the periphery of the euro zone have led to a long-lasting and unresolved sovereign debt crisis that has now reached the boiling point. The possibility of Greece and perhaps other countries leaving the euro is now a distinct prospect, with potentially devastating consequences for the region and beyond. This development is coupled with the risk of a weak recovery in several other advanced economies outside of Europe—notably in the United States, where political gridlock on fiscal tightening could dampen the growth outlook. Furthermore, given the expected slowdown in economic growth in China, India, and other emerging markets, reinforced by a potential decline in global trade and volatile capital flows, it is not clear which regions can drive growth and employment creation in the short to medium term

The big picture gives us an objective dimension of the real developments rather than fall for trap to political demagoguery

Updated to add:

I was unaware when I wrote a few hours back that the competitiveness issue accounts for today's main headline story.

Quote of the Day: Politics Drives Social Divisions

The pathology of mass democracy translates into ugly social divisions. Great liberal thinkers from Bastiat to Mises have demonstrated that all classes have nothing to fear from one another in a market economy. Freedom of exchange results in the harmonization of interests. Politics, on the other hand, creates fissures that need not exist. Every minor issue becomes blown up into a Manichean struggle. This happens especially over relatively minor issues, because these are the only ones over which the mainstream politicians evince even a rhetorical disagreement. The truly foundational issues of our time—mass confiscation of wealth, IRS despotism, mass imprisonment, militarized policing at home and unending warfare abroad—unite both major parties behind an establishment agenda. They bicker instead over relatively small matters, each one of which becomes amplified into the greatest battle in the history of the world at election time.

This is from Anthony Gregory at the Independent Institute writing on US democracy.

This applies to the social democracy of the Philippines as well. Simply observe the scale of priorities from the way domestic media frames events. Or even the dominant pattern of comments on social media. Trivial matters are frequently moralized and sensationalized which becomes part of the national sports called politics. It’s pop culture that has been little different from the way gossip and slapstick entertainment have been aired on prime time. It’s also about Social Desirability Bias or the need to be seen favorably by others or status signaling. Yet most don’t realize that this obsession for the superficial makes us vulnerable to political manipulation. Politics does foster social divisions

Spain’s Capital Flight Intensifies

In Spain, political solutions have been prompting for a deepening crisis.

From the New York Times,

“The macro situation in Spain is getting worse and worse,” Mr. Vildosola, 38, said last week just hours before boarding a plane to London with his wife and two small children. “There is just too much risk. Spain is going to be next after Greece, and I just don’t want to end up holding devalued pesetas.”

Mr. Vildosola is among many who worry that Spain’s economic tailspin could eventually force the country’s withdrawal from the euro and a return to its former currency, the peseta. That dire outcome is still considered a long shot, even if Spain might eventually require a Greek-style bailout. But there is no doubt that many of those in a position to do so are taking their money — and in some cases themselves — out of Spain.

In July, Spaniards withdrew a record 75 billion euros, or $94 billion, from their banks — an amount equal to 7 percent of the country’s overall economic output — as doubts grew about the durability of Spain’s financial system.

The deposit outflow in Spain reflects a broader capital flight problem that is by far the most serious in the euro zone. According to a recent research note from Nomura, capital departing the country equaled a startling 50 percent of gross domestic product over the past three months — driven largely by foreigners unloading stocks and bonds but also by Spaniards transferring their savings to foreign banks.

The withdrawals accelerated a trend that began in the middle of last year, and came despite a European commitment to pump up to 100 billion euros into the Spanish banking system. Analysts will be watching to see whether the August data, when available, shows an even faster rate of capital flight.

More disturbing for Spain is that the flight is starting to include members of its educated and entrepreneurial elite who are fed up with the lack of job opportunities in a country where the unemployment rate touches 25 percent.

According to official statistics, 30,000 Spaniards registered to work in Britain in the last year, and analysts say that this figure would be many multiples higher if workers without documents were counted. That is a 25 percent increase from a year earlier.

“No doubt there is a little bit of panic,” said José García Montalvo, an economist at Pompeu Fabra University in Barcelona. “The wealthy people have already taken their money out. Now it’s the professionals and midrange people who are moving their money to Germany and London. The mood is very, very bad.”

It is possible that the outlook could improve if the European Central Bank’s governing council, which meets Thursday, signals a plan to help shore up the finances of Spain and other euro zone laggards by intervening in the bond markets.

Spain’s capital flight dilemma has mainly been symptoms from fears of devaluation (or rampant inflationism) from the possible reinstitution of the peseta. Such actions to preserve savings flies in the face of those who argue for the devaluation snake oil fixes.

And where “members of its educated and entrepreneurial elite” shifts money out of the system, Spain’s economic recovery will remain dim as productive capital seek refuge or allocate savings elsewhere.

Moreover, the political solution of perpetual bailouts [“plan to help shore up the finances of Spain and other euro zone laggards by intervening in the bond markets”], accounts for as doing the same thing over and over and expecting different results, have only been intensifying the predicament

Yet the above account represents as another sign where ground economic activities have been moving in the opposite direction relative to the actions of financial markets.

Eventually reality will be priced in.

Contagion Risk: US Manufacturing Index Falls

The risks of a global recession have been increasing.

Even the US economy has been feeling the pressure.

From the Northern Trust,

The US Purchasing Managers’ Index (PMI) of the Institute of Supply Management edged down to 49.6 in August from 49.8 in July, the third consecutive monthly reading that is below 50. Readings below 50 denote a contraction in factory activity. Indexes tracking new orders (47.1 vs. 48.0 in July) and production (47.2 vs. 51.3 in July) declined in August. The new orders index stands at the lowest level since April 2009. In addition, the index measuring new export orders (47.0 vs. 46.5) continues to hover below the cutoff mark of 50 for the third straight month. The decline in new orders combined with increase in the inventories index (53.0 vs. 49.0 in July) bodes poorly as it reflects soft demand conditions. The gain in the price index (54.0 vs. 39.5 in July) points to the impact of higher energy prices. The overall tone of the US factory survey of August and below 50.0 readings of the PMI for three straight months raises expectations of additional monetary policy support at the close of the September 12-13 FOMC meeting.

A deepening slump will surely add to the justification for the US Federal Reserve to inflate. But this won’t necessarily mean that such programs will reverse the course of the present dynamics. The exactitude, particularly the quantity, of the coming FED program will matter a great deal.

Of course price inflation pressures have been existing amidst the slowdown. Proof of this that gas prices in the US touched three month highs during the labor day.

So Fed policies will only complicate matters.

Be careful out there.

US Companies Prepare for Greece Exit

More evidence of the financial market-real world detachment.

Seen from the financial markets, Euro’s problems seem headed for a silver lining. But from the ground, events seems turning for the worst.

US companies are reportedly preparing for a “Greece exit”

From the New York Times,

Even as Greece desperately tries to avoid defaulting on its debt, American companies are preparing for what was once unthinkable: that Greece could soon be forced to leave the euro zone.

Bank of America Merrill Lynch has looked into filling trucks with cash and sending them over the Greek border so clients can continue to pay local employees and suppliers in the event money is unavailable. Ford has configured its computer systems so they will be able to immediately handle a new Greek currency.

No one knows just how broad the shock waves from a Greek exit would be, but big American banks and consulting firms have also been doing a brisk business advising their corporate clients on how to prepare for a splintering of the euro zone.

That is a striking contrast to the assurances from European politicians that the crisis is manageable and that the currency union can be held together. On Thursday, the European Central Bank will consider measures that would ease pressure on Europe’s cash-starved countries.

Public’s opinion has been shifting rapidly. Again from the same article… (bold emphasis mine)

In a survey this summer, the firm found that 80 percent of clients polled expected Greece to leave the euro zone, and a fifth of those expected more countries to follow.

“Fifteen months ago when we started looking at this, we said it was unthinkable,” said Heiner Leisten, a partner with the Boston Consulting Group in Cologne, Germany, who heads up its global insurance practice. “It’s not impossible or unthinkable now.”

Mr. Leisten’s firm, as well as PricewaterhouseCoopers, has already considered the timing of a Greek withdrawal — for example, the news might hit on a Friday night, when global markets are closed.

A bank holiday could quickly follow, with the stock market and most local financial institutions shutting down, while new capital controls make it hard to move money in and out of the country.

“We’ve had conversations with several dozen companies and we’re doing work for a number of these,” said Peter Frank, who advises corporate treasurers as a principal at Pricewaterhouse. “Almost all of that has come in over the transom in the last 90 days.”

From the hindsight everything looks easy to explain, but as I have been saying events can be so fluid, where moves can be swift and dramatic.

I’d say that an exit will mark the climax of the bear market of Greece equity markets.

The Athens General Exchange index has fallen by nearly 90% since 2007. (chart from Bloomberg)

Greece will likely devalue (inflate) intensively. These should put a floor and perhaps reverse the bear market trend. But rising stocks doesn’t necessarily translate to an economic recovery, instead they can be symptoms of severe inflation or even hyperinflation.

How the Rent Seeking Model Failed Enron

When companies shift focus from servicing the consumers to seeking to profit from regulation, trouble lies ahead. That’s the story of Enron’s debacle according to a former employee.

Enron used to be the seventh largest corporation in the US, but filed for bankruptcy in 2001 (see timeline of Enron scandal here)

Writes Robert L Bradley Jr. at the Library of Economics and Liberty (hat tip Professor David Henderson)

Enron was a political colossus with a unique range of rent-seeking and subsidy-receiving operations. Ken Lay's announced visions for the company—to become the world's first natural-gas major, then the world's leading energy company, and, finally, the world's leading company—relied on more than free-market entrepreneurship. They were premised on employing political means to catch up with, and outdistance, far larger and more-established corporations.

A big-picture Ph.D. economist with Washington, D.C. experience regulating oil, gas, and electricity, Lay found his niche in the private sector managing federally regulated interstate gas-transmission companies, first at Florida Gas Company and then at Transco Energy Company. When Lay became CEO of Houston Natural Gas Corporation, he transformed a largely unregulated intrastate natural-gas company to a federally regulated (interstate) one in 1984-85. Then, during the next 16 years, he steadily moved the renamed Enron into rent-seeking.

The interesting part is how Enron gamed the system (bold added)

Any analysis of Enron's business history will reveal entrepreneurial error and unhealthy government dependence that left major divisions of Enron in the red or just marginally profitable. But rather than make midcourse corrections, Enron manipulated the highly prescriptive—indeed politicized—tax and accounting systems to create the illusion of profitability. Such gaming was another crucial government front for the company.

The corporate tax division acted as a profit center at Enron by meeting earnings targets. Federal investigators identified 881 offshore subsidiaries as part of Enron's tax-sheltering strategy. Enron's general tax counsel remembers reaching his gaming limit: "When the [tax-saving] number got up to $300 million [in 2001] I said... 'We have to come up with a way to get this through [real] earnings—through regular business'."

Gamed financial reporting was a second "profit center," as Enron scoured the Generally Accepted Accounting Principles (GAAP) rulebook to book paper earnings where economic profit (positive cash flow from operations) was absent. "Financial engineering" also hid liabilities and inflated assets, allowing Enron to meet investor expectations and concoct peculiar narratives about its business performance.

A particularly contrived business in this regard was Enron Energy Services (EES), which purportedly split energy savings with customers via long-term outsourcing agreements. EES buttressed Enron's "green" image, but the green was not monetary. Mark-to-market accounting turned into mark-to-model, under which arbitrary assumptions about future energy prices turned losses into profits. The GAAP game was even explained in Enron's employee Risk Management Manual:

Reported earnings follow the rules and principles of accounting. The results do not always create measures consistent with underlying economics. However, corporate management's performance is generally measured by accounting income, not underlying economics. Risk management strategies are therefore directed at accounting rather than economic performance.

A third exercise in government gaming that gave Enron false profitability concerned electricity trading in California in 2000-2001. Through contrived schemes with code names like "Get Shorty" and "Ricochet," Enron exploited loopholes in the state's highly regulated system, which generated hundreds of millions of dollars of paper profits that utilities and their ratepayers could not and would not pay. One manipulation was described in an Enron memo: "The net effect of these transactions is that Enron gets paid for moving energy to relieve congestion without actually moving any energy or relieving any congestion."

The bottom line:

Although an Enron could not have been predicted, it is yet another example of the unintended consequences of interventionism in the field of energy, as well as from the politicized accounting and tax systems that governed all corporations

And then there is the ultimate consequence from the dynamics of intervention. Historically, the failures of the mixed economy have been an excuse to further politicize the economy. Richard Epstein warned: "The greatest tragedy of the Enron debacle is not likely to be the consequences of the bankruptcy, but from the erroneous institutional reforms that will take hold if its causes are not well understood." The Sarbanes-Oxley Act (2002) and the Bipartisan Campaign Reform Act (2002), enacted with Enron in mind, proved him right.

Read the rest here

Natural-Shale Gas Revolution Spreads to Israel

The natural-shale gas boom spreads to Israel.

Reports the Financial Times (hat tip Carpe Diem’s Professor Mark Perry)

With reserves of almost 10 trillion cubic feet of natural gas, the Tamar field is a hugely valuable asset for the Israeli economy. Discovered in January 2009, it was the biggest gas find in the world that year, and by far the biggest ever made in Israeli waters. But the record held for barely two years. In December 2010, Tamar was dwarfed by the discovery of the Leviathan gasfield some 20 miles farther east – the largest deepwater gas reservoir found anywhere in the world over the past decade. The two fields, together with a string of smaller discoveries, will cover Israel’s domestic demand for gas for at least the next 25 years, and still leave hundreds of billions of cubic feet for sale abroad. The government take from the gasfields alone is forecast to reach at least $140bn over the next three decades – a staggering sum for a relatively small economy such as Israel’s.

It’s not just in Israel but as I previously pointed out the Natural-Shale gas revolution will become a world wide phenomenon.

And we are seeing some evidence of such progress. Again the FT,

Experts are convinced that Tamar and Leviathan will not be the last big Israeli discoveries. They point to the US Geological Survey, which estimates that the subsea area that runs from Egypt all the way north to Turkey, also known as the Levantine Basin, contains more than 120 trillion cubic feet of natural gas. Israeli waters account for some 40 per cent of the total. Should these estimates be confirmed through discoveries in the years ahead, Israel’s natural gas reserves would count among the 25 largest in the world, on a par with the proven reserves of Libya and ahead of those of India and The Netherlands.

Earlier Israel seems to have been devoid of energy resources.

For decades a barren energy island, forced to import every drop of fuel, Israel today stands on the cusp of an economic revolution, fuelled by the vast riches that lie below its waters.

left chart from Financial Times, right chart from Financial Post

But thanks to human ingenuity, massive advances in technology have transformed what was once resources of little economic value to become abundant highly economically valuable commodities.

Hopefully Israel’s newly discovered energy resources will serve as blessings than a (resource) curse. But this will depend on how the domestic and geopolitical trends in Israel and the Middle East will evolve.

Quote of the Day: Economic Numbers Cannot Stand Without the Logic that Produces Them

Economic models aren’t engineering models. If you ask several aeronautical engineers to project how adding flaps affects an airplane’s takeoff speed, their models will be complex, but they will come up with about the same, and reliable, answers. You don’t need to know why.

But good economic models are quantitative parables, not authoritative black boxes. They only are trustworthy if they illustrate clearly understandable and explicitly stated pathways…

But economic numbers cannot stand without the logic that produces them. Clarity and transparency are far more important to a good quantitative parable than the illusion of authoritative precision.

This is from professor John H. Cochrane of the University of Chicago at the Bloomberg discussing the unrealistic Keynesian based assumptions and projections made by the CBO on the “Fiscal Cliff”.

80% of World Manufacturing Activities Contracting

About 80% of world manufacturing activities have been shrinking. Yet many of the world’s equity markets seem detached to this reality. Negative developments have been offset with positive expectations from promises of central banking rescues.

From Zero Hedge, (bold original)

With the US closed today, the rest of the world is enjoying a moderate rise in risk for the same old irrational reason we have all grown to loathe in the New Normal: expectations of more easing, or "bad news if great news", this time from China, which over the weekend reported the first official sub-50 PMI print declining from the magical 50.1 to 49.2, as now even the official RAND() Chinese data has joined the HSBC PMI indicator in the contraction space for the first time since November. Sadly, following today's manufacturing PMI update, we find that the rest of the world is not doing any better, and in fact of the 22 countries we track, 80% are now in contraction territory. True, Europe did experience a modest bounce from multi-month lows of 44 in July to 45.1 in August (below expectations of 45.3), but this is merely a dead cat bounce, not the first, and certainly not the last, just like the US housing, and now that China is officially in the red, expect the next shoe to drop in Europe. Also expect global GDP to eventually succumb to the manufacturing challenges faced by virtually every country in the world, and to post a negative print in the coming months.

The above only exhibits of the growing risk of a global recession.

This means central banks will either make good their promises soon or that the diminishing returns of returns from political promises may jolt the markets back to reality.

Be careful out there.

Quote of the Day: Voting and Complaining

I have solved this political dilemma in a very direct way: I don't vote. On Election Day, I stay home. I firmly believe that if you vote, you have no right to complain. Now, some people like to twist that around. They say, 'If you don't vote, you have no right to complain,' but where's the logic in that? If you vote, and you elect dishonest, incompetent politicians, and they get into office and screw everything up, you are responsible for what they have done. You voted them in. You caused the problem. You have no right to complain. I, on the other hand, who did not vote — who did not even leave the house on Election Day — am in no way responsible for what these politicians have done and have every right to complain about the mess that you created.

This is from comedian George Carlin (source The LRC Blog)

Asian Stocks: Bad News is Good News Redux

Here we are again, Asian stocks supposedly have risen due to bad news being interpreted as good news. (Below is a run down on Asian stocks as of this writing from Bloomberg)

First the bad news…

Fresh report says China’s manufacturing has contracted

This from Bloomberg,

In China, the Purchasing Managers Index fell to 49.2 in August from 50.1 in July, the National Bureau of Statistics and China Federation of Logistics and Purchasing said Sept. 1. It’s the first time in nine months that the measure has fallen below the 50 level that signals contraction.

A separate report released today by HSBC Holdings Plc and Markit Economics showed China’s manufacturing contracted last month at the fastest pace since March 2009.

China should “decisively” expand the strength of its policy fine-tuning based on economic developments and market changes, according to a front-page commentary published in China’s People’s Daily newspaper.

Next, more negative data from other Asian economies…

In Japan, a report showed companies’ capital spending gained less than expected. In South Korea, inflation slowed to the weakest pace in 12 years last month. Australia’s retail sales fell in July by the most in almost two years. In New Zealand, a gauge of the country’s terms of trade dropped for a fourth consecutive quarter.

Now the supposed good news… (bold added)

Asian stocks rose, reversing earlier losses, as economic reports from China, Japan, South Korea and New Zealand fueled speculation that central banks will boost stimulus measures…

The MSCI Asia Pacific Index added 0.5 percent to 118.32 as of 1:44 p.m. in Tokyo after earlier falling as much as 0.5 percent. U.S. Federal Reserve Chairman Ben S. Bernanke said on Aug. 31 that further monetary easing is an option.

Bernanke “is defending the case that quantitative easing and unconventional policy have been effective, and that could be a controversial statement,” said Tim Leung, a portfolio manager who helps manage about $1.5 billion at IG Investment Ltd. in Hong Kong, referring to the Fed’s large-scale asset purchases. “If in the future the economy is not performing as good as they expect, they still have room” for more stimulus.

I’d say that for China, the today’s reaction seems more of a dead cat’s bounce than from “bad news is good news” phenomenon

China’s Shanghai index has been under pressure for the past few weeks, so today’s bounce should come as a natural response. But this may have been misinterpreted by media

But I don’t think this applies with the rest.

What really has been happening is that the seduction of marketplace from promises of central bank steroids has been intensifying. As I noted last night,

Eventually stock markets will either reflect on economic reality or that central bankers will have to relent to the market’s expectations. Otherwise fat tail risks may also become a harsh reality.

Yes central banks will either have to deliver on their promises soon enough, or that financial markets will react violently if expectations have not been met or if economic data continues to exhibit pronounced deterioration.

A quote from the same Bloomberg articles gives a clue on the diminishing returns from central bank promises.

“It’s going to be difficult for the market to keep rallying on the promise of QE and other measures without some improvement in the data,” said Donald Williams, chief investment officer at Sydney-based Platypus Asset Management Ltd. that manages about $1 billion.

Inflationism distorts the pricing system which eventually spawns bubble cycles. The above accounts accounts for anecdotal evidences.

Hyperinflations and the Mickey Mouse Peso

In a transcript from a lecture, the illustrious Austrian economist Percy L. Greaves Jr. explains the stages of inflation.

Sales to these buyers cannot be continued forever. As the quantity of money is increased and prices rise, injections of larger and larger quantities of money are required to produce the same effects. If the quantity of money increases in ever larger quantities, prices will rise faster and faster as the value of each monetary unit falls. Sooner or later, the increases must be stopped. If they are not stopped before the value of the monetary unit falls to zero, people will eventually run away from the money and spend it on anything they can get, because, in their minds, anything will soon be worth more than a constantly depreciating money.

When governments increase the quantity of money, the effects tend to follow a certain pattern. Of course, the inflation can be stopped at any point. The first stage of inflation is when housewives say: "Prices are going up. I think I had better put off buying whatever I can. I need a new vacuum cleaner, but with prices going up, I'll wait until they come down." During this stage, prices do not rise as fast as the quantity of money is being increased. This period in the great German inflation lasted nine years, from the outbreak of war in 1914 until the summer of 1923.

During the second period of inflation, housewives say: "I shall need a vacuum cleaner next year. Prices are going up. I had better get it now before prices go any higher." During this stage, prices rise at a faster rate than the quantity of money is being increased. In Germany this period lasted a couple of months.

If the inflation is not stopped, the third stage follows. In this third stage, housewives say: "I don't like flowers. They bother me. They are a nuisance. But I would rather have even this pot of flowers than hold on to this money a moment longer." People then exchange their money for anything they can get. This period may last from 24 hours to 48 hours.

56 countries including the Philippines experienced the nasty consequences of inflation run amuck, caused by government’s sustained tampering of money

Below is the table which lists the accounts of world hyperinflations.

Unknown to most, the Philippines had a short episode of hyperinflation during World War II.

Cato’s Steve H. Hanke and Nicholas Krus in their paper World Hyperinflations narrates,

Another largely unreported hyperinflation episode occurred in the Philippines, during World War II. In 1942, during its occupation of what was then the Commonwealth of the Philippines, Japan replaced the Philippine peso with Japanese war notes. These notes were dubbed “Mickey Mouse money”, and their over-issuance eventually resulted in a hyperinflation that peaked in January 1944. It should be noted that the U.S. Army, under orders from General Douglas MacArthur, did add a relatively small amount of fuel to the Philippine hyperinflation fire by surreptitiously distributing counterfeit Japanese war notes to Philippine guerilla troops (Hartendorp 1958). (Mickey Mouse Peso image from Wikipedia.org)

History gives us lessons of what may happen if governments continue to abuse money.

As the great Ludwig von Mises wrote,

History looks backward into the past, but the lesson it teaches concerns things to come. It does not teach indolent quietism; it rouses man to emulate the deeds of earlier generations.

Unfortunately, in the world of politics, such lessons never sink in, and this is why history rhymes.