FED-ECB’s Nuclear Policies: Risk ON is Back!

Congratulations, Mr. Bernanke. I'm happy. My asset values go up but as a responsible citizen I have to say the monetary policies of the U.S. will destroy the world.-Dr. Marc Faber

We have practically reached a virtual denouement phase for central bank communication “inflation expectations” management strategies as well as the penultimate stage for central bank asset-purchasing programs.

“Whatever it takes” to support the incumbent political financial order has been discharged into actual policies.

Last week, the ECB launched its Quantitative Easing (QE) version of unlimited bond buying[1] program. This week, it was the US Federal Reserve’s turn to validate my predictions[2].

Political Desperation Leads to the Nuclear Option

Doing things over and over and expecting different results appears to have reached a culmination point too.

The mainstream has repeatedly argued that central bank policies have not attained the targeted goals because of the supposed insufficiency of the degree of measures undertaken to attain the desired traction. In short, for the interventionists throwing money at the problem has never been enough.

For instance, putting into the limelight the fragility or the resiliency of the current statistical economic recovery of US, the trend of non-participants in the US labor markets has been steadily increasing (upper window blue bar trend). This could mean many factors such as many people may have given up on the search for jobs or that many may have gone into the informal economy or that many could have become dependent on government welfare (lower window exhibits the recent surge in food stamps and disability participants) or a combination of the above. (chart from dshort.com[3])

In addition to this, jobs that have been created has been on a sustained decline even amidst the gamut of credit easing policies, particularly QE 1.0, QE 2.0, Operation Twist and Operation Twist Extension of the US Federal Reserve.

Thus, given the latest policies announced by the FED, as well as the ECB, the efficacies of open ended and unlimited measures will be put under the proverbial microscope.

There will hardly be any further excuses for any subsequent policy mistakes. Proponents of the inflationism appear to have been boxed into a corner.

RISK ON is Back, For Now

The reactivation of the RISK ON environment essentially comes with the German constitutional court’s clearing of the legal hurdle for the European Stability Mechanism (ESM)[4], but with some conditional[5] stipulations* and the US Federal Reserve’s announcement of the nuclear “open ended” MBS buying program.

*The ever changing rules to accommodate these bailouts, I think, will unlikely become a barrier. Central bankers have gradually been assuming the role of politicians. FT columnist Gideon Rachman captures the zeitgeist best[6]

As a result of the ECB’s actions, voters from Germany to Spain will increasingly find that crucial decisions about national economic policy can no longer be changed at the ballot box.

In the Q & A portion of the post-FOMC announcement, US Federal Reserve chief Ben Bernanke unreservedly expressed that these policies had been intended to boost prices of financial assets in order to stimulate the “wealth effect” demand-driven spending[7] or Mr. Bernanke’s financial accelerator.

The tools we have involve affecting financial asset prices. Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other rates, I mentioned corporate bond rates. Also the prices of various assets. For example, the prices of homes. To the extent that the prices of homes begin to rise, consumers will feel wealthier, they’ll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they’ll make a better return on that purchase. So house prices is one vehicle. Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend. One of the main concerns that firms have is that there is not enough demand…if people feel their financial position is better they’ll be more likely to spend….

Despite the economic justification which have been premised on popular economic fallacy, from where stones can be turned into bread through inflationism, Mr. Bernanke’s decision to trigger the nuclear option which validated my prediction, has been mainly about

1) funding the US budget deficits (what I called in the past as “poker bluff” or the propaganda that FED won’t do a QE[8]),

2) the fulfillment of the perpetual promises to stimulate (where a failed expectation would have meant a violent backlash), and

I wrote[9],

Mounting expectations and deepening dependence from central banking opiate, which has been clashing with the unfolding economic reality, will prompt for more price volatility on both directions. The Bank of America posits that QE 3.0 has been substantially priced in.

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.

3) Importantly, Mr. Bernanke’s implied support for the re-election of the President Obama, which ensures his tenure as Chairman of the US Federal Reserve[10].

Yet while it has been true that a huge amount of stimulus have been priced into the markets, the Fed’s extension of the zero bound rates through 2015 and the open ended $40 billion monthly purchases of mortgage bonds combined with the existing $267 Operation Twist have been aggressively beyond expectations of the marketplace.

So the initial impact of the FED-ECB policies to subsidize financial assets represents attained its short term goal, they succeeded to inflate asset prices first.

Steroid dependent global equity markets were in revelry as the FED-ECB programs were made public.

Most of the global markets surged. Among the major benchmarks, the BRICS (except for China) posted the biggest gains while the rest of the developed economies, along with, the ASEAN majors scored substantial weekly advances of over 1%.

In the US market breadth turned substantially positive 84% of stocks soared above the 50-day moving averages[11] while Advance Decline ratio decidely went for the bulls[12]

The unveiling of the joint central bank nuclear policies also resulted to a huge rally in the bonds of distressed nations as Spain and Italy. Yields fell hard as bond vigilantes were beaten back by the ECB’s actions (chart from Dankse Research[13])

And as expected, rallying bond prices have reduced pressures on politicians of the criss stricken nations as Spain, to underake required reforms.

Spain’s prime minister, Mariano Rajoy, according to a news report[14], said last week that “he won’t allow the European Union or the ECB to stipulate how the nation narrows its budget deficit as a condition for buying the country’s bonds”.

So the ECB’s asset purchases have only increased the moral hazard aspects in the behavior of politicians. Efforts to redress such the imbalances that caused the crisis will likely be delayed. Instead of the ECB buying time for politicians to commence on reforms, the ECB has become THE tool for EU’s politicians to do the latter’s bidding.

The risk on rally has also diffused into global corporate bond markets.

In the US, a surge in corporate bond issuance has prompted yields on speculative-grade debt to drop to an unprecedented low, which according to Bloomberg, breaks the previous record set more than 15 months ago[15].

Unintended Consequences of the FED-ECB policies

In spite of all the euphoria, the FED’s operations may likely be reaching a tipping point.

The combined monthly $40 billion MBS purchases by US Federal Reserve, as well as, the $45 billion long term (10-30 year) US treasury bond buying from Operation Twist means that the Fed’s balance sheet is likely to expand to about $4 trillion by the end of 2013 from $ 2.8 trillion or an increase of about $1.17 trillion, according to Zero Hedge[16].

Yet the sterilization measures by Operation Twist of selling $45 in short term bonds to offset the long end buying will likely end by this year as the Fed runs out of short term securities to sell.

Essentially, roughly half of the US budget deficit will be monetized by the FED. Also the FED’s buying operations will accrue to about 24% of the GDP (see chart above)

Moreover, since the FED holds about $843 billion of Agency MBS[17], the open ended MBS purchases will extrapolate to expansion of the FED’s share of ownership of the entire mortgage market to about 33%, again according to the estimates of Bank of America BofA cited by Zero Hedge[18].

In addition the bond purchasing program means that ownership share of the FED “across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013 and an average of 65% by end of 2014”, where “in just over two years the Federal Reserve will hold two thirds of the entire bond market with a maturity over 5 years” again according to the calculation of the BofA.

The FIRST point being that FED’s buying program may end up with FED owning a very large segment, if not all, of both the Agency MBS and the US Treasuries and may run out of bonds to buy to pursue their asset purchases.

Of course they can always resort to buying equities (similar to Bank of Japan[19]) and corporate bonds. But as appropriately pointed out by the only dissenting voice at the Federal Open Market Committee (FOMC) Jeffrey Lacker of the Richmond Federal Reserve, this would be unethical[20].

Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve.

In the world of politics, moral relativism belongs to those in power.

Also the NEXT point is that these combined policies will usher in a high period of Price inflation. Aggressive expansion of money through QE will eventually filter into the economic system.

Even from the monetarist perspective, particularly the Philip Cagan model which according to Professor Garrett Jones[21] states that “Today's price level depends mostly on the future supply of money”, the communication to the public of the FED and the ECB’s combined programs should imply for higher price levels than today.

Yet the huge amount of coming infusions from the FED-ECB will likely be complimented by the Bank of England, and Bank of Japan, as well as the Swiss National Bank whom has been the quasi-pioneer implementer of the unlimited option via the Swiss-Franc Euro price cap[22]

Seminal Signs of a Crack-UP Boom?

The recent strong performance of commodities may have altered balance between the recently outperforming stock market (S&P 500) and commodity prices (CCI or the CRB Reuters Index).

Commodities could be in a major inflection point relative to the stock market.

The same dynamics seems are being channeled into the currency markets.

It would be a mistake to see a rallying euro as a sign of “progress”. The rallying euro has been a manifestation of the obvious shift to a RISK ON environment through massive central bank manipulations.

As Doug Noland of the Credit Bubble Bulletin rightly points out[23]

I’ll state what others hesitate to admit: this week our central bank took a giant leap from radical to virtual rogue central banking. If Bernanke’s plan was to leapfrog the audacious Draghi ECB, our sinking currency – even against the euro – is confirmation of his success. If his goal was to provide markets a Benjamin Strong-like “coup de whiskey” – he should instead fear the dangerous instability central bankers have wrought on global markets and economies.

It would also be oversimplistic and misguided to see strengthening currencies as tempering “price inflation”.

In a world of fiat currencies and globalization, strengthening currencies could be a sign of a bubble in progress rather than of a structural advancement

The chart above shows that the race to devalue through unlimited or open ended QEs between Fed’s Bernanke and ECB’s Draghi have been transmitted through a rally in commodities priced in the US dollar (CCI:USD) and the Euro (CCI:XEU).

Put differently, both currencies, the US dollar and the Euro, have now been devaluing against the broad based benchmark of commodities. In the Austrian school of economics, these could signify as seminal signs of a crack-up boom

And contra mainstream empirical analysts, we must be reminded that the valuation of a monetary unit, according to the great Ludwig von Mises[24], depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one

A good example seems to be Brazil’s real. The real has firmed against the US dollar since 2008 post Lehman debacle (yahoo chart left window).

The supposed leakage from the sterilzation process from Brazil’s huge foreign reserve accumulation—where government bonds issued by Brazil’s central bank to sterilize foreign exchange purchases, has been used as collateral by banks to issue debt thereby expanding their balance sheets—has fueled a credit boom in Brazil’s economy. Claims on government have skyrocketed in 2011 as the real soared (right window).

The Brazilian government recently tried to curb through a series of tightening via interest rate hikes which may have prompted for the recent economic weakening.

The recent economic boom which could have been orchestrated through a covert quantitative easing scheme by Brazil’s central bank has been questioned by Jonathan Wheatley at the Financial Times blog[25] as a possible product of a central bank fueled boom-bust cycle.

Have inflows, then, been driving Brazil’s credit boom – and has the government been guilty of quantitative easing? It is hard to explain the expansion of credit from about R$500bn in 2005 to about R$2.2tn today on the basis of economic growth alone. Over that period, GDP growth has averaged 4 per cent a year – hardly a Chinese performance.

If quantitative easing really is the answer, it doesn’t just put the Brazilian government’s account of its monetary policies in question. It questions the basis of the whole Brazilian growth story.

By the way, Brazil’s government has recently joined the stimulus bandwagon with a $66 billion infrastructure stimulus[26].

The point being: In a world where central banks compete to destroy their currencies through devaluation, rising currencies may signify as symptoms of relative devaluation and they could also mask the bubble policies that underpins the statistical economic growth.

It would also be an error to likewise view rallying commodities signs of economic recovery, China who plays a major role in the commodity business, seems to be struggling from a bubble bust.

Despite the recent announcement of what seems as a reluctant and limited bailout program through infrastructure spending and through extension of bank loans to state owned enterprises, the deteriorating conditions of China’s shadow banking system[27] seems to be worsening. In addition, China’s oil imports continue to plummet[28] which is most likely a manifestation of a rapidly slowing economy.

Where commodities rise against a broad spectrum of fiat currencies, then this should be a cause of concern as they could be symptoms of the transition to a crack-up boom.

Again the from great Professor von Mises[29]:

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.

FED-ECB Policy Impact on Asia, Philippine Peso and the Phisix

Asian currencies have rallied strongly in response to the FED-ECB easing programs.

While Asian currencies have been on an upswing from previous pledges to inflate since June, as shown by the JP Morgan Bloomberg ADXY[30] Asian basket of currency index (upper window), the biggest of the advances came from last week (lower window).

The Philippine Peso has been slightly up by .6% to 41.42 a US dollar from 41.68 last week but has strong year to date gains of 5.5%--in harmony with the scintillating gains of the local equity market.

I believe that the interim response from the FED-ECB policies, designed to prop up financial assets, will likely provide strong support to the global stock markets including the Philippine Phisix perhaps until the yearend, at least.

The mining index, which has underperformed all sectors, will likely expunge its year to date losses at least by the yearend.

The mining index will likely retake command of the leadership in 2013 as it has outperformed biyearly since 2007[31].

In a world where central bank policies become the dominant factor in establishing price levels, the new normal is to expect dramatic price swings in both directions and of the amplification of risks

Former Federal Reserve Governor Kevin Warsh in a recent CNBC interview nails it[32].

If you continue to look at the markets right now, where asset prices continue to melt up where asset prices are driven less by fundamentals in particular companies and more by speeches and policies come out of Washington you are taking this risks. Risk are highest in the economy when measures of risk ARE lowest, when I look at the VIX at this level and you compare that to the headlines you guys read every morning they certainly do not seem in sync that’s when shocks happen

But given the projected substantial infusion of steroids, the current environment strongly favors an upswing. That’s until real problems will resurface such as concerns over the quality of credit, and or price inflation becomes more pronounced and or if politics becomes an obstacle to the central banks inflationism and or a combination of the above.

And since no trend goes in a straight line where I expect some interim reprieve from the bullish momentum, I would use any interim corrections as opportunity to position on resource issues.

No Justification for Bubbles

As a final note the FED-ECB policies will affect Asian economies and markets immensely as I have discussed before[33].

These policies will likely incentivize strong capital flows into the region, as investors “search for yields” or seek refuge to protect their savings from deliberate and sustained currency debasement—in reality these accounts for as the capital flight dynamic.

Capital inflows coupled with domestic negative real rates regime will likely translate into serial bubble blowing dynamics.

So yes, the risks of bubbles in Asia will become more enhanced. Even the local central bank or the Bangko Sentral ng Pilipinas (BSP) has recently acknowledged of such risks[34] which they arrogantly claim they can control.

In addition, domestic and global bubbles will increase the risks of a global stagflation which is likely slam emerging markets harder.

The risks of ballooning bubble or stagflation will likely become evident in 2013-2014.

Yet the idea that bubbles are good for Asia emanates from a warped, demented and disoriented understanding of economic reality and theories.

Costs are not benefits. What seem as the illusion of progress through asset price inflation has in reality been transfers of resources from the rest of society to the owners of financial assets (stocks bonds and property).

The benefits which accrue to these politically privileged sectors do not take into account the social and economic costs of these transfers[35].

Bailouts benefit the rich at the expense of the poor. Rampant speculations fueled by inflationism are not productive undertaking which adds to products and services to the society. Addiction to debt for speculation or for consumption leads to bankruptcy. The shrinkage of purchasing power of the currency through price inflation hurts the middle class and the poor most.

Misallocated capital cannot be seen as “benefits” since at the end of the cycle, misdirected capital will be exposed as wasted or consumed capital through a bubble bust or a financial crisis. In short, boom bust cycles destroy capital, lowers society’s standard of living or impoverishes people.

The Asian crisis of 1997 as a consequence of the prior inflation boom reveals of how Thailand’s GDP per capita[36] fell by 66% and only recovered when imbalances were allowed to clear. It took roughly 10 years for Thailand’s per capita GDP to recover the high of 1996.

Myopic thinking that mistakes symptoms as causes and that promotes short term ‘benefits’ at the expense of long term ‘costs’ is very unhelpful and will not help produce better returns.

---

[1] See ECB’s Mario Draghi Unleashes “Unlimited Bond Buying” Bazooka, Fed’s Ben Bernanke Next? September 7, 2012

[2] See I Told You So Moment: US Fed’s Bernanke Unveils Open Ended QE 3.0 Bazooka September 14, 2012

[3] Lance Roberts QE3 And Bernanke's Folly - Part I Advisor Perspectives dshort.com September 14,2012

[4] See German Court Clears Way for ESM Fund, September 12, 2012

[5] OpenEurope.org.uk What will the German Constitutional Court ruling mean for the eurozone? September 12, 2012

[6] Gideon Rachman Democracy loses in struggle to save euro Financial Times September 10, 2012

[7] Cullen Roche A Disturbing Look Inside the Mind of Ben Bernanke, Pragmatic Capitalism, September 13, 2012

[8] See Poker Bluff: No Quantitative Easing 3.0? June 5, 2011

[9] See Phisix: Why The Correction Cycle Is Not Over Yet September 2, 2012

[10] See Phisix: The Correction Cycle is in Motion August 27, 2012

[11] Bespokeinvest.com Breadth Breakout? September 14, 2012

[12] Bespokeinvest.com Breadth Finally Makes a Higher High September 13, 2012

[13] Danske Research The Fed takes a major step forward, September 14, 2012

[14] San Francisco Chronicle European Stocks Fall on Concern Spain, German May Harm ECB Plan September 11, 2012

[15] Bloomberg.com Corporate Bond Sales in U.S. Busiest in Six Months as Fed Acts September 14, 2012

[16] Zero Hedge The Fed's Balance At The End Of 2013: $4 Trillion September 3, 2012

[17] Zero Hedge Rosenberg: "If The US Is Truly Japan, The Fed Will End Up Owning The Entire Market" September 14, 2012

[18] Zero Hedge, BofA Sees Fed Assets Surpassing $5 Trillion By End Of 2014... Leading To $3350 Gold And $190 Crude September 14, 2012

[19] See Bank of Japan Hearts the Stock Market May 08, 2012

[20] See Quote of the Day: Dissenting Opinion on Open Ended QE at the FOMC September 16, 2012

[21] Garett Jones Future money and today's NGDP Econolog September 14, 2012

[22] See Swiss National Bank’s Currency Interventions Spawns Property Bubble August 14, 2012

[23] Doug Noland QE Forever Credit Bubble Bulletin Prudentbear.com September 14, 2012

[24] Ludwig von Mises CHAPTER 1—STABILIZATION OF THE MONETARY UNIT —FROM THE VIEWPOINT OF THEORY (1923) The Causes of Economic Crisis p.18 Mises.org

[25] Jonathan Weathley Quantitative easing, Brazilian style Beyond BRICs September 10, 2012 Financial Times Blog

[26] See Brazil’s Government Unveils $66 Billion Stimulus August 16, 2012

[27] See More Signs that China’s $2.4 Trillion Shadow Banking System is in Big Trouble September 14, 2012

[28] Zero Hedge Chinese Crude Imports Plunge To Mid-2010 Levels September 11, 2012

[29] Ludwig von Mises, III. INFLATION AND CREDIT EXPANSION, Interventionism An Economic Analysis

[30] Bloomberg.com JP Morgan Bloomberg Asian Dollar Index ADXY

[31] See Graphic of the PSE’s Sectoral Performance: Mining Sector and the Rotational Process July 10, 2011

[32] See Video: Former Fed Governor on Bernanke’s QE: Unproven Experiment , Risks of Exit have to be Higher September 15, 2012

[33] See The Impact of Open Ended QEs on Asia: Bubbles or Stagflation September 15, 2012

[34] See Fatal Conceit: Philippine Authorities to Avert Asset Bubbles September 10, 2012

[35] See Inflationism Promotes Inequality, Immorality and Economic Hardship September 15, 2012

[36] KNOEMA.com GDP per Capita by Country Thailand

Quote of the Day: Dissenting Opinion on Open Ended QE at the FOMC

The Federal Open Market Committee (FOMC) decided on September 13, 2012, to purchase additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee released a statement after the meeting saying that it expects a highly accommodative stance of monetary policy to remain appropriate for a considerable period after the economic recovery strengthens, and that it currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

I dissented because I opposed additional asset purchases at this time. Further monetary stimulus now is unlikely to result in a discernible improvement in growth, but if it does, it’s also likely to cause an unwanted increase in inflation.

Economic activity has been growing, on average, at a modest pace, and inflation has been fluctuating around 2 percent, which the Committee has identified as its inflation goal. Unemployment does remain high by historical standards, but improvement in labor market conditions appears to have been held back by real impediments that are beyond the capacity of monetary policy to offset. In such circumstances, further monetary stimulus runs the risk of raising inflation in a way that threatens the stability of inflation expectations.

I also dissented because I disagreed with the characterization of the time period over which the stance of monetary policy would be highly accommodative and the federal funds rate would be exceptionally low. I believe that such an implied commitment to provide stimulus beyond the point at which the recovery strengthens and growth increases would be inconsistent with a balanced approach to the FOMC’s price stability and maximum employment mandates.

Finally, I strongly opposed purchasing additional agency mortgage-backed securities. These purchases are intended to reduce borrowing rates for conforming home mortgages. Such purchases, as compared to purchases of an equivalent amount of U.S. Treasury securities, distort investment allocations and raise interest rates for other borrowers. Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve. As stated in the Joint Statement of the Department of Treasury and the Federal Reserve on March 23, 2009, “Government decisions to influence the allocation of credit are the province of the fiscal authorities.”

(bold highlights mine)

This is from Richmond Federal Reserve president Jeffrey Lacker [hat tip Zero Hedge]

The Impact of Open Ended QEs on Asia: Bubbles or Stagflation

At least some foreign experts have an idea of the risks posed from inflationist policies, adapted by political authorities of developed economies, on Asia.

From CNBC-Finance.yahoo

The Federal Reserve's measures to revitalize the U.S. economy pose risky side effects half way across the world in Asia, warn experts, particularly in the form of asset bubbles driven by an inflow of speculative funds into the region.

Pumping cash into the U.S. financial system tends to have a spillover effect on other parts of the world and Asia, in the past, has been a big beneficiary of the extra cash looking for a home.

"The problem is that the Fed is simply not paying attention to Asia because they are so concerned about the internal economic dynamics in the U.S. and they are trying to resuscitate the U.S. labor market," Boris Schlossberg, Managing Director, BK Asset Management told CNBC Asia's "Squawk Box" on Friday.

"It is creating a bifurcated result where you (get) higher asset prices, but not necessarily quality growth," he added.

Hot money flows into the region are likely to return.

Currency debasement policies in the developed nations would motivate investors to move funds elsewhere. This has been widely known as “the search for yields” which in reality signifies as a capital flight dynamic where investors seek refuge for savings.

More from the same article:

The Fed announced on Thursday its third round of monetary stimulus, in which it pledged to buy mortgage related debt and other securities until the country's labor market showed sustained improvement.

The last two rounds of quantitative easing in 2009 and 2010 resulted in massive capital inflows into the region of $66 billion and $96 billion, respectively, according to data from the Asian Development Bank (ADB), some of which was withdrawn in 2011, contributing to a subsequent slump in markets.

The ADB warned earlier this week that history could repeat itself should the region be hit by a surge in speculative fund inflows, adding that policymakers should brace for a scenario where money exits the region as quickly as they entered.

Vishnu Varathan, Market Economist at Mizuho Corporate Bank, says Asia could see an even higher level of capital inflows this time around, since the Federal Reserve is unlikely to be the only major central bank launching renewed quantitative easing - the European Central Bank, for instance, may also step in with asset purchases.

He says the region's property market is most vulnerable to sharp price increases, particularly in countries such as Singapore and Hong Kong - where the seeds were sown a few years ago from previous rounds of monetary stimulus - and nascent markets like Indonesia.

Earlier I postulated that intensifying inflationism in Japan and in western nations will drive savers (or the capital flight dynamic) into Asia. This should include the Philippines.

But since (inward) capital flows into ASEAN will reflect on global central bank activities, this dynamic would not be limited to Japan but would likely include western economies as well.

With the Fed and the ECB riding into the open ended-unlimited options, it’s not far fetched for central banks of Japan (BoJ), England (BoE) and others to join the club.

By putting a cap on the Euro-Swiss Franc, the central bank of Switzerland (SNB) have been the frontrunner of the open ended asset purchasing policy options where signs of internal bubbles have emerged.

Yet unlimited inflationism will likely to spur consumer price inflation that increases the risks of stagflation especially on emerging Asia.

Vasu Menon, Vice President, Wealth Management Singapore, adds that rising prices will pose a challenge for Asian central banks going forward.

"I think central bankers are worried about inflation - the Philippines for example held its rates steady because they are concerned about inflation," Menon said, referring to a decision by the Philippine central bank on Thursday to leave its benchmark interest rates steady at 3.75 percent.

As I recently wrote,

High commodity prices are likely to influence emerging markets consumer price inflation more. Food makes up a large segment of consumption basket for emerging Asia including the Philippines. This would prompt for their respective central banks to reluctantly tighten. Monetary tightening will put pressure on the stock market.

Stagflation, thus, also represents both a contagion and internal (political and market) risk for the Philippines and for emerging Asia.

Yes the risk ON environment has been re-triggered by massive inflationism by the Fed and the ECB.

And one of the above risks (a bubble or stagflation) will become a force to reckon with in Asia, possibly in 2014 or 2015. All these will essentially depend on the feedback mechanism between the dynamics at the marketplace and policy responses on them.

Quote of the Day: The Roots of Arab and Islamic Hatred

What are the roots of that Arab and Islamic hatred?

Osama bin Laden in his declaration of war against us gave three reasons as his casus belli.

His first reason for war was the presence of U.S. troops on the soil of Saudi Arabia, sacred home to Mecca and Medina. His second was the U.S. sanctions on Iraq then said to be causing the premature deaths of as many as 500,000 Iraqi children.

Third was U.S. support for Israel, seen in the Arab world as a colonial implant to humiliate them and deny to the Palestinian people their right to a nation of their own.

Lately, new causes of Arab and Muslim hatred of us have arisen.

The first is what devout Muslims regard as our immoral and decadent culture, which they see as a threat to their societies and their young.

The second are the Islam haters and baiters in America and the West who deliberately provoke them with insulting and blasphemous portrayals of the Prophet and their faith.

While the U.S. bases in Saudi Arabia have by now largely been closed, and the United States is largely withdrawn from Iraq and the sanctions there have all been lifted, America is not going to change herself to accommodate their world.

Support of Israel is the declared position of both parties. And, though Secretary of State Hillary Clinton rightly called the crude amateur film "Innocence of Muslims," which caused the latest anti-American rioting, both disgusting and reprehensible, we are not going to repeal the First Amendment, which protects provocateurs and pornographers.

Yet, worldwide, there are hundreds of millions of Muslims for whom their faith is their most priceless possession. They live it. They will die for it. And not a few will kill for it. Others will seize upon real or imagined insults to that faith to excite the crowds to expel us from their world.

And some Americans will accommodate them by using books, films and videos to manifest their contempt of Islam.

So we have here an irreconcilable conflict.

The Islamic word, especially across the Arab region, is undergoing a transformation, a Great Awakening. Muslims from Nigeria to Mali to Ethiopia to Sudan to the Maghreb and Middle and Near East are growing more militant and more hostile toward Christianity and other faiths.

This is from Patrick J. Buchanan, co-founder and editor of The American Conservative writing at the Lew Rockwell.com

Inflationism Promotes Inequality, Immorality and Economic Hardship

Contra to what has been advertised by politicians and the mainstream, the policy of inflationism has essentially been political than about economics (e.g. couched by technical vernacular as “unemployment” or economic recovery) or social welfare.

That’s because inflationism is a policy which redistributes resources from society to the government and to politically favored groups.

I previously pointed out how a study from the Bank of England subtly admitted that their QE policies favored the political elites which indirectly has promoted “inequality”.

Yet we see more evidences of how central bank’s inflationist policies deepens the economic divide, from the CNBC,

The latest round of QE announced by Bernanke yesterday has sparked growing controversy about how Fed policy has mainly helped the wealthiest Americans.

Economist Anthony Randazzo of the Reason Foundation wrote that QE “is fundamentally a regressive redistribution program that has been boosting wealth for those already engaged in the financial sector or those who already own homes, but passing little along to the rest of the economy. It is a primary driver of income inequality.”

Donald Trump – not usually one for distributional analyses of monetary policy – said on CNBC yesterday that “People like me will benefit from this.”

The reason is simple. QE drives up the prices of assets, especially financial assets. And most of the financial assets in America are owed by the wealthiest 5 percent of Americans.

According to Fed data, the top 5 percent own 60 percent of the nation’s individually held financial assets. They own 82 percent of the individually held stocks and more than 90 percent of the individually held bonds.

By helping to reinflate the stock market in 2009 and 2010, the Fed created a two-speed recovery. The wealthy quickly recovered much of their wealth as stocks doubled in value. But the rest of the country, which depends on houses and jobs for their wealth, remained stuck in recession.

Put another way, most Americans have most of their wealth tied up in their houses (about 50 percent for most). For the top 5 percent, homes account for only 10 percent of wealth, while financial assets account for between one third and 40 percent.

By boosting the value of financial assets, Fed has helped the economy of Richistan but not the broader United States.

Bernanke is obviously aware of this criticism, which is why the latest round of easing is focused on mortgages. But here too, there is a divide between the rich and the rest. Despite lowered rates, banks remain strict on lending, restricting access to credit for most Americans. The wealthy and the asset-rich, however, will now enjoy even lower rates on their credit.

The policy of inflationism does not only promote societal inequality, they advance immoral actions such as “orgy of speculation”, recklessness and the sense of entitlement-dependency (moral hazard) which ultimately sows seeds to social instability.

At worst, inflationism fosters boom-bust cycles if not the destruction of the currency which leads to economic depression

As the late distinguished Professor Hans F. Sennholz warned,

Evil acts tend to breed more evil acts. Inflationary policies conducted for long periods of time not only foster the growth of government but also depress economic activity. Standards of living may stagnate or even decline as growing budget deficits thwart capital accumulation and investment that are sustaining the standards.

Inflation misleads businessmen in their investment decisions, which causes much waste and many bankruptcies. In fact, it is the root cause of the boom-and-bust cycle which wreaks havoc on economic activity. Indeed, inflation breeds many evils of which most Americans are unaware.

Open ended inflationism by the US Federal Reserve and the European Central Bank, will ultimately lead to economic impoverishment and social chaos.

Graphic of the Day: Quantitative Easing

From the Wall Street Journal Blog

Video: Former Fed Governor on Bernanke’s QE: Unproven Experiment , Risks of Exit have to be Higher

Former Federal Reserve governor Kevin Warsh in this CNBC interview elucidates of the potential risks from Bernanke’s Open Ended QE

Here are some key points:

Ben Bernanke is a “modest man” with “an immodest move”

Yesterdays move was an “aggressive move”…which means that “They are really worried with the state of the economy”….part of it could be that “They must be dealing with some of the Tail Risk Europe is in an early innings of a recession” while Asia has been “weakening too”

For Mr. Warsh “Exit is a four letter world” where “exiting from a monetary policy is technically difficult”. He sees the benefits from QE as “incontestably small and that the risks are unknown”…He further notes that “This is an unproven experiment so risks of exit have to be higher”

So the FED’s hands are essentially tied and risks are magnified rather than suppressed.

Mr. Warsh also talks about the moral hazard risks by open ended QE on Washington where

“The risk in Washington is real too. I don’t mean political risks. What I mean is if the Federal Reserve is now in a business of private pullout, “rabbit out of hat” everytime the economy loses control, then the rest of Washington can say there is not much we can do or need to do because Bernanke has got my back. I do not think that is his intent”.

The implied incentive provided by QE to Washington is to rely on more inflationism.

Mr. Warsh adds that in reality the US state of the economy has been struggling “We’re not in a panic we are in a lousy recovery”

Short term oriented “informercial” policies have also been amplifying risks, yet this has been the framework guiding Fed and Washington policies

“For 4-5 years…Washington has been in the business of solving the next quarter, solving for the next election $5 trillion trying to turbocharge the economy we’ve been running stimulus program after stimulus program and GDP can look a little better next quarter but we’ve been running this program like it’s an infomercial…this time of short term policy has not served as well. I don’t they served the politicians well. We need to fundamentally change what our time horizon is”

Real recovery must come through improving competitiveness

“The private sector has much better at asset allocation than the government”

And that central planning has been hobbled by the knowledge problem

“There is lots of talent there, but they do not know which direction capital should go”

Mr. Warsh delineates what central banks can and cannot do

“Central banks are in the business of buying time…until the economy gets into the groove. But what we heard yesterday was that we will be buying time for a very long time”

He also notes that

“Policy makers should be humble”

Most importantly Mr. Warsh sees the market as I see it

“If you continue to look at the markets right now, where asset prices continue to melt up where asset prices are driven less by fundamentals in particular companies and more by speeches and policies come out of Washington you are taking this risks. Risk are highest in the economy when measures of risk ARE lowest, when I look at the VIX at this level and you compare that to the headlines you guys read every morning they certainly do not seem in sync that’s when shocks happen”

Shocks happen because inflationism has obscured the market price signals.

More Signs that China’s $2.4 Trillion Shadow Banking System is in Big Trouble

China’s shadow banking system has been feeling the heat from the deepening economic woes

From Bloomberg

China’s slowest economic growth in three years and a slumping property market, where many so-called shadow-banking investments are parked, are squeezing millions of Chinese who have invested the money of friends and acquaintances chasing higher yields to honor those payments. The slowdown also is putting pressure on the government to rein in private lending to avoid a spate of defaults that could increase the number of victims and lead to social unrest.

Suicide, Bankruptcy

The shadow bankers are now disappearing, committing suicide or reneging on agreements, leaving thousands of victims in their wake. In the first half of the year, more than 58,000 lawsuits involving disputes over 28.4 billion yuan in private lending were filed in Zhejiang province, where Wenzhou is located, up 27 percent from the same period in 2011 and the most in five years, according to the provincial supreme court. One-fifth of the cases were in Wenzhou, where authorities have set up a special court to handle the surge.

Private-lending victims nationwide filed more than 600,000 lawsuits valued at 110 billion yuan in 2011, an increase of 38 percent from the previous year. In the first half of 2012, the number of filings rose 25 percent to 376,000, according to People’s Court, a newspaper run by China’s Supreme Court.

In Wenzhou, an export hub where almost 90 percent of families have taken part in underground lending, more than 100 people have fled, committed suicide or declared bankruptcy since August 2011, and at least 800 lending brokers have gone bankrupt, Xinhua News Agency reported in May. Home prices there declined 16 percent in July compared with a year earlier, the fifth consecutive monthly decline, according to the National Bureau of Statistics of China.

China’s shadow banking system hasn’t been just the private informal sector but likewise involves state owned enterprises (SoE) and financing vehicles established by local governments. From the same article

The lending is part of a shadow-banking system that also includes the off-balance-sheet business of banks and trust companies and totals as much as $2.4 trillion, about one-third of China’s official loan market, according to estimates by Societe Generale. Shadow banking is prevalent in China because more than 90 percent of the nation’s 42 million small businesses are unable to get bank loans, while such investments offer returns at least several times higher than deposits.

As I previously pointed out since mainstream banks have been dominated by the state, where access to credit has been biased towards non-finance state owned companies

State banks discriminate in terms of lending where “only four percent of their loans to private businesses”. Thus, the recourse of private businesses has been through the informal or shadow banking systems. Ironically, transacting with unofficial credit markets “can be a criminal offense punished by long jail terms or worse”

The natural consequence has been that private savings resorted to alternative channels to employ their funds for profit.

Evidence from the same article,

Still, households and families nationwide withdrew 500.6 billion yuan of saving from banks in July, or 0.6 percent of the total. Chinese savers seeking higher returns have triggered swings in deposits during the past year as they’ve shifted funds among savings accounts, higher-yielding wealth-management products and shadow-banking investments.

About 619 million yuan of capital has been registered at the Wenzhou Private Lending Registration Center, which was set up in April to help control shadow lending by matching individuals holding excess capital with small businesses in need of funds. As of July, less than 10 percent of that was loaned out, even with collateral, according to the city government.

While China’s savings rate of more than 50 percent of gross domestic product is the highest among major economies, exceeding India’s 34 percent and 12 percent in the U.S., according to a June 2010 Bank for International Settlements report, people have few legitimate investment options for their deposits.

Retirees such as He can’t take advantage of annuities, IRAs or other such products to derive income in their old age. China’s pension program, like Social Security in the U.S., typically provides payments that don’t meet monthly expenses.

The nation’s stock market also is lackluster, and the bond market is largely off-limits to individual investors. The Shanghai Composite Index (SHPROP) has declined 3.3 percent this year after losing 14 percent in 2010 and 22 percent in 2011.

One obvious outcome from the stringent regulations by China’s authorities on the financial industry has been the underdeveloped domestic capital markets.

(charts from Business Insider)

Again since the world does not operate on a vacuum, given the limited access to credit from mainstream banks, negative real rates monetary regime and largely limited capital markets, China’s private sector savers engaged the shadow banking system by jumping on property bubble spurred by China’s government’s credit driven (left window) capital-infrastructure spending ‘socialization of investment’ boom.

Anecdotal proof from the same article,

Only 30 percent of the funds in Wenzhou’s shadow-banking market have gone to finance small companies, while 60 percent went to property speculation and re-lending, pushing up the cost of funds by end-users, the Wenzhou branch of People’s Bank of China said last year. The city’s economy expanded 5 percent in the first half, the slowest in three years.

That boom seems to be collapsing (chart above right window).

As of last week China’s government has re-engaged in the same fiscal stimulus through infrastructure spending but at a much lesser amount ($157 billion) compared to 2008-2009.

Also China has reportedly stepped up bank lending, reports the Botswana Gazette,

China ramped up bank lending in August, according to central bank figures released Tuesday, as the government seeks to give a boost to the slowing economy.

Chinese banks granted 703.9 billion yuan ($112 billion) in new loans in August, up from 540.1 billion yuan in July, the People's Bank of China said in a statement.

The August figure is higher than market expectations of 600 billion yuan, according to a forecast of 13 economists surveyed by Dow Jones Newswires.

Analysts said the increase in bank lending reflects China's moves to ease monetary policy with economic growth at its slowest pace in three years.

Given that these loans are likely directed towards China’s state owned enterprises, it’s not clear if these money easing will filter into the seemingly insolvent shadow banking system

My guess is that given the Keynesian leaning policies by China’s incumbent political authorities, the above rescue measures could be just installments.

Besides, given that the ECB and the Fed has both declared the next moves to expand their balance sheets, China’s authorities may find comfort in crowd, and thus, more easing moves should be expected.

It’s just a reminder that all these inflationism by global central banks will only temporarily provide a boost to financial markets, does nothing to help the economy (except to redistribute resources to the political and the banking class) and at worst amplify the risks of global stagflation.