Negative Real Rates Breed Ponzi Schemes

I have been saying here that negative real rates will not only drive people to gamble but to fall prey to Ponzi scams

I wrote last March:

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

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

I wrote last week

instead of locking money through interest rate dividends from savings account in the financial institutions, zero bound regime or negative real rates which are part of financial repression have been forcing people to chase on yields and gamble in order to generate returns. So the public have become more of a “risk taker” and take on “greedy” activities in response to such policies. Some would even fall or become victims to Ponzi schemes which I expect to mushroom. 

Today’s headlines seem to validate my predictions:

From the Inquirer.net

A company managed by a former janitor and driver, and founded just early this year, has duped at least 15,000 people in Mindanao and the Visayas of P12 billion in a pyramid scam, an official of the National Bureau of Investigation said Tuesday.

The NBI identified the company as Aman Futures Group Phils. Inc.

“Some of the victims committed suicide and others have become violent and sick when they learned their hard-earned money was gone,” said Virgilio Mendez, NBI deputy director for regional operations services, who was investigating the scam.

Among Aman Futures’ victims were local politicians, police and military personnel, government workers, market vendors, farmers, drivers, retired employees and overseas Filipino workers, according to Mendez.

He said the number of “complainants from across the country is piling up.”

Aside from negative real rates, because of the overdependence on the government to do the legwork of supervision on the viability of such devious projects, the victim’s economic calculation has been substituted for the desire “to gain something from nothing”

More from the same article

He said Aman Futures was able to lure investors by offering a 30-percent to 40-percent return on investment within eight days, and a 50-percent to 80-percent profit for 18 to 20 days.

“The amount of interest varies depending on the investment or money placements,” Mendez said.

And worst Ponzi schemes have been endorsed by politicians

He said the victims trusted Aman Futures largely because of endorsements from local officials.

“They trusted Aman Futures because even local government officials had openly endorsed it and admitted to have invested also,” Mendez explained.

This shows how people have been duped in the same way as they see politics (via elections and legislation): they simply look at the superficialities (here in terms returns) without ever questioning the system (or in this case how such returns will be funded and what types of projects will lead to such astronomical returns).

Critical thinking, and most importantly, self responsibility has eschewed for endorsements and assurances from politicians, who ironically became victims themselves.  This is the welfare mentality.

Of course, under a negative real rates regime, there will be more instances of Ponzi, pyramiding and other fraudulent schemes which will snooker many. 

Again the morality of the policies inflationism from the great Henry Hazlitt (bold mine)

Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.

The above example is a validation of how negative real rates and the lack of self-responsibility due to overdependence on government debauches the morality of the public and private sector.

Obama’s Fiscal Cliff: The Effects of Taxing Wealth

Below is an article which “confirms my bias” or compounds on what I wrote last Sunday about the recent US stock market selloff as an outcome of rising political risks or regime uncertainty from President Obama’s soak the rich policies.

From the CNBC 

For many of the wealthy, 2012 is becoming a good year to sell.

They're worried about the "fiscal cliff," which is when tax cuts expire and spending cuts are set to go into effect at the end of the year.

Fearing an increase in capital gains and dividend taxes, many of the rich are unloading stocks, businesses and homes before the end of the year.

Wealth advisors say that with capital-gains taxes potentially going to 25 percent from 15 percent, and other possible increases in the dividend tax, estate tax and other taxes, many clients are selling now to save millions in taxes.

“Under almost any scenario, it makes sense to take the gains this year,” said Gregory Curtis, chairman and managing director of Greycourt & Co. “Clients aren’t selling willy nilly. But if they can and they have a huge gain, they’re selling now.”

Capital gains taxes represents a tax on wealth. In essence if you tax something you get less of it.  Thus an increase in capital gains taxes dissuades investors and entrepreneurs to undertake productive activities which becomes a hindrance to capital accumulation and to wealth generation.

So capital gains hike will have lasting adverse  effects

Raising dividend taxes also will hurt stock market investors.

The level of dividend tax rates affect dividend issuance. According to the Wall Street Journal

Historical experience indicates that corporate dividend payouts are highly sensitive to the dividend tax. Dividends fell out of favor in the 1990s when the dividend tax rate was roughly twice the rate of capital gains.

When the rate fell to 15% on January 1, 2003, dividends reported on tax returns nearly doubled to $196 billion from $103 billion the year before the tax cut. By 2006 dividend income had grown to nearly $337 billion, more than three times the pre-tax cut level.

Next a swath of investors will get hurt, not limited to the scorned “wealthy”. From the same article

IRS data show that retirees and near-retirees who depend on dividend income would be hit especially hard. Almost three of four dividend payments go to those over the age of 55, and more than half go to those older than 65, according to IRS data.

But all American shareholders would lose. Higher dividend and capital gains taxes make stocks less valuable. A share of stock is worth the discounted present value of the future earnings stream after taxes. Stock prices would fall over time to adjust to the new after-tax rate of return. And if investors become convinced later this year that dividend and capital gains taxes are going way up on January 1, some investors are likely to sell shares ahead of paying these higher rates.

The question is how this helps anyone. According to the Investment Company Institute, about 51% of adults own stock directly or through mutual funds, which is more than 100 million shareholders.

So again, unless there will be a bipartisan deal reached, US stock markets will remain highly vulnerable to sharp downside volatility.

And President Obama will increasingly rely on team Bernanke and the FED to offset the effects of wealth destructive policies.

Ironically while Mr. Bernanke has been doing his darned best to keep asset markets afloat, Mr. Obama has been undoing them. Such paradox accounts for as the proverbial "the left hand does not know what the right hand is doing". That's the way of politics.

The Informal Economy Drives Latin America’s Middle Class

Experts are puzzled at Latin America’s rapid growth of the middle class.

The Economist writes

But the political implications of Latin America’s growing middle class are not yet clear. Some commentators have argued that the “new middle class” is entrepreneurial, is partly drawn from the informal sector, and will be hostile to statism and high taxes. (In fact, the bank finds that the middle class tend to be salaried employees of private companies.) Some of them send their children to private schools that have sprung up in many once-poor communities.

The mainstream vehemently denies it, but the share of informal economy in Latin America has been substantial.

Notes the Worldwatch Institute

For many poor people in urban areas, the primary means of economic survival is the production or sale of goods or services through semi-legal or illegal ventures, known as the informal economy. Conservatively, informal employment accounts for half to three quarters of all nonagricultural employment in developing countries: 48 percent in North Africa, 51 percent in Latin America, 65 percent in Asia, and 72 percent in sub-Saharan Africa.

You cannot have sustained rising standards of living or a middle class or a broadening of societal wealth without an increase in capital accumulation.

As the late great Professor Ludwig von Mises wrote,

Saving—capital accumulation—is the agency that has transformed step by step the awkward search for food on the part of savage cave dwellers into the modern ways of industry. The pacemakers of this evolution were the ideas that created the institutional framework within which capital accumula­tion was rendered safe by the principle of private ownership of the means of production. Every step forward on the way toward prosperity is the effect of saving. The most ingenious technological inventions would be practically useless if the capital goods required for their utilization had not been accumulated by saving.

So despite the many statist regimes in Latin America, the informal economy has been representative of guerrilla capitalism which has breathed life to the region's middle class.

Sovereign Life Cycles and the Bubble Psychology

The Zero Hedge gives a summary of Bridgewater’s Ray Dalio’s interesting description of the Life Cycles of nations (bold and italics original)

Via Bridgewater:

Throughout history, Dalio advises these two influences have changed countries’ competitiveness and indebtedness which have caused changes in their relative wealth and power. He goes on to add that since different experiences lead to different psychological biases that lead to different experiences, etc., certain common cause-effect linkages drive the typical cycle of a nation's growth, power and influence.

To summarize, we believe that countries typically evolve through five stages of the cycle:

1) In the first stage countries are poor and think that they are poor.

In this stage they have very low incomes and most people have subsistence lifestyles, they don’t waste money because they value it a lot and they don’t have any debt to speak of because savings are short and nobody wants to lend to them. They are undeveloped.

2) In the second stage countries are getting rich quickly but still think they are poor.

At this stage they behave pretty much the same as they did when they were in the prior stage but, because they have more money and still want to save, the amount of this saving and investment rises rapidly. Because they are typically the same people who experienced the more deprived conditions in the first stage, and because people who grew up with financial insecurity typically don’t lose their financial cautiousness, they still a) work hard, b) have export-led economies, c) have pegged exchange rates, d) save a lot, and e) invest efficiently in their means of production, in real assets like gold and apartments, and in bonds of the reserve countries.

3) In the third stage countries are rich and think of themselves as rich.

At this stage, their per capita incomes approach the highest in the world as their prior investments in infrastructure, capital goods and R&D are paying off by producing productivity gains. At the same time, the prevailing psychology changes from a) putting the emphasis on working and saving to protect oneself from the bad times to b) easing up in order to savor the fruits of life. This change in the prevailing psychology occurs primarily because a new generation of people who did not experience the bad times replaces those who lived through them. Signs of this change in mindset are reflected in statistics that show reduced work hours (e.g., typically there is a reduction in the average workweek from six days to five) and big increases in expenditures on leisure and luxury goods relative to necessities.

4) In the fourth stage countries become poorer and still think of themselves as rich.

This is the leveraging up phase – i.e., debts rise relative to incomes until they can’t any more. The psychological shift behind this leveraging up occurs because the people who lived through the first two stages have died off or become irrelevant and those whose behavior matters most are used to living well and not worrying about the pain of not having enough money. Because the people in these countries earn and spend a lot, they become expensive, and because they are expensive they experience slower real income growth rates. Since they are reluctant to constrain their spending in line with their reduced income growth rate, they lower their savings rates, increase their debts and cut corners. Because their spending continues to be strong, they continue to appear rich, even though their balance sheets deteriorate. The reduced level of efficient investments in infrastructure, capital goods and R&D slow their productivity gains. Their cities and infrastructures become older and less efficient than those in the two earlier stages. Their balance of payments positions deteriorate, reflecting their reduced competitiveness. They increasingly rely on their reputations rather than on their competitiveness to fund their deficits. They typically spend a lot of money on the military at this stage, sometimes very large amounts because of wars, in order to protect their global interests. Often, though not always, at the advanced stages of this phase, countries run “twin deficits” – i.e., both balance of payments and government deficits.

5) In the last stage of the cycle they typically go through deleveraging and relative decline, which they are slow to accept.

After bubbles burst and when deleveragings occur, private debt growth, private sector spending, asset values and net worths decline in a self-reinforcing negative cycle. To compensate, government debt growth, government deficits and central bank “printing” of money typically increase. In this way, their central banks and central governments cut real interest rates and increase nominal GDP growth so that it is comfortably above nominal interest rates in order to ease debt burdens. As a result of these low real interest rates, weak currencies and poor economic conditions, their debt and equity assets are poor performing and increasingly these countries have to compete with less expensive countries that are in the earlier stages of development. Their currencies depreciate and they like it. As an extension of these economic and financial trends, countries in this stage see their power in the world decline.

I agree that the final stage has always been about “relative decline which nations are slow to accept”, but this has not translated to “deleveraging”.

On the other hand, in most occasions, the final phase has been marked by hyperinflation or war, as revealed by the conditions of their respective currencies. Others simply defaulted.

In my view Ray Dalio’s Sovereign Life Cycle represents no more than Bubble psychology shaped by political trends. 

As caveat, history rhymes but events which led to them have been markedly different.

US Post Election Politics: 20 States Petition to Secede

In the Philippines, accusations of cheating typically marks the post-election political environment.

In the US, the recently concluded presidential and national elections has prompted malcontents from 20 states to petitioned the White House to secede.

From the BBC,

More than 100,000 Americans have petitioned the White House to allow their states to secede from the US, after President Barack Obama's re-election.

The appeals were filed on the White House's We the People website.

Most of the 20 states with petitions voted for Republican Mitt Romney.

The US constitution contains no clause allowing states to leave the union. By Monday night the White House had not responded.

In total, more than 20 petitions have been filed. One for Texas has reached the 25,000-signature threshold at which the White House promises a response.

'Blatant abuses'

The last time states officially seceded, the US Civil War followed.

Most of the petitions merely quote the opening line of America's Declaration of Independence from Britain, in which America's founders stated their right to "dissolve the political bands" and form a new nation.

Currently, the most popular petition is from Texas, which voted for Mr Romney by some 15 percentage points more than it did for the Democratic incumbent.

The text complains of "blatant abuses" of Americans' rights

Growing secession movements in the US and in Europe are symptoms of snowballing forces of decentralization, or the paradigm shift to localize and diversify power which have been gnawing at the architectural foundations of the 20th century political establishments.

Yet secession movements could turn out to be bloody as governments typically tend to resist or counteract the prospects of yielding territorial and taxation privileges by the suppression of political dissident by force.

Nevertheless secession movements are signs of grassroots opposition to centralized political power.

As Austrian economics Professor Thomas DiLorenzo duly notes,

Government will never be limited unless the citizens take matters into their own hands by resurrecting the states’ rights mechanisms of nullification, interposition, and secession.

Essay of the Day: Tom Palmer: The Origins of State and Government

A profound essay on the origins of the state and government from Cato’s Tom G. Palmer

Some excerpts: 

People’s savings as the foundation of the state: 

What exactly is a state? The canonical definition was offered by MaxWeber,who defined the state as “that human community which (successfully) lays claim to the monopoly of legitimate physical violence within a certain territory.”

In fact, it cannot be the case that all wealth is attributable to the state.

Historically, the existence of a state apparatus required a pre-existing surplus to sustain it in the first place. The state,in other words, would not exist without wealth being produced before its emergence. Let’s explore that a bit further

Why do people have wealth? Charles Dunoyer, an early libertarian sociologist, explained that “there exist in the world only two great parties; that of those who prefer to live from the produce of their labor or of their property, and that of those who prefer to live on the labor or the property of others.” Simply put,makers produce wealth while takers appropriate it…

Predatory nature of the state:

State formation represents a transformation from “roving bandits” to “stationary bandits.” As the economist Mancur Olson wrote, “If the leader of a roving bandit gang who finds only slim pickings is strong enough to take hold of a given territory and to keep other bandits out, he can monopolize crime in that area—he can become a stationary bandit.”That is an important insight into the development of human political associations.

The state is, at its core, a predatory institution. Yet, in some ways, it also represents an advance, even for those being plundered. When the choice is between roving bandits—who rob,fight, burn what they can’t take, and then come back the following year—and stationary bandits—who settle down and plunder little by little throughout the year—the choice is clear. Stationary bandits are less likely to kill and destroy as they loot you and they fend off rival bandits. That is a kind of progress—even from the perspective of those being plundered..

 Incentives of the governing class and the roots of taxation:

What are the incentives of the rulers? Overly simplistic models posit that rulers seek to maximize wealth, or gross domestic product. Scott,however, argues that the ruler’s incentive is not to maximize the GDP,but to maximize the “SAP,” the state-accessible product,understood as that production that is easy to identify, monitor, enumerate, and confiscate through taxation: “The ruler. . .maximizes the state-accessible product, if necessary, at the expense of the overall wealth of the realm and its subjects.”

The inculcation of society for the need of the state

State systems of social control—from military conscription to compulsory schooling—have thoroughly permeated our consciousness.Consider,for example, the passport. You cannot travel around the world to day without a document issued by the state. In fact, you can no longer even travel around the United States without a state-issued document.Passports are very recent inventions. For thousands of years, people went where they wanted without permission from the state.

Laws originated from spontaneous order and not from the state;

Modern states also claim to be the sole source of law. But historically,states mainly replaced customary law with imposed law. There is a great deal of law all around us that is not a product of the state,for law is a byproduct of voluntary interaction. As the great jurist Bruno Leoni argued, “Individuals make the law insofar as they make successful claims.” Private persons making contracts are making law.

The need to educate people in order to free our captive minds from our dependence on the state

The evolution of freedom has involved a long process of bringing power under law. The imposition of force has none the less left a powerful imprint on our minds. Alexander Rüstow, a prominent sociologist and a father of the post war revival of liberty in Germany, meditated on the origins of the state in violence and predation and its lingering imprint: “All of us, without exception, carry this inherited poison within us, in the most varied and unexpected places and in the most diverse forms, often defying perception. All of us, collectively and individually, are accessories to this great sin of all time, this real original sin, a hereditary fault that can be excised and erased only with great difficulty and slowly, by an insight into pathology, by a will to recover, by the active remorse of all.” It takes work to free our minds from our dependence on the state

Read the complete essay here

The Phisix in the Shadow of the US Fiscal Cliff

People like to assume that we are voting on issues. The media hector politicians to “stick to the issues.” We are supposed to do our civic duty and bone up on the “issues.” But when you get to the voting booth, there are no issues on the ballot on the federal level. There are only people’s names. That’s what we are voting for: person x or person y. All the rest is guesswork based on fleeting, gassy words in the air. All the talk about issues only distracts from this devastating reality that no one has a clue what this or that elected official is going to do in reality. Jeffrey A. Tucker

History has been etched on the stone. The US will endure four more years under Barack Obama.

Last week I wrote[1]

So whether Obama or Romney, there will unlikely be any radical changes in the political structure to headoff the looming debt crisis.

This goes to show that elections have mainly been used to justify policies which benefit many entrenched power blocs operating behind the scenes.

Given the above conditions, the pricing dynamics of the markets will, thus, represent expectations from the feedback loop mechanism between policies and market responses to them.

President Obama’s Regime Uncertainty Factor

Optimism exuded by the mainstream media on the US electorate’s decision to award another term for President Obama does not seem to be shared by the US and global equity markets. 

This week, developed market economies suffered heavy losses which rippled through the world. Except for the Philippines, ASEAN contemporaries had also been marginally affected by the selloff.

From the big picture, one can observe that this week’s hefty losses by the S&P 500 represents a two-month old downtrend (vertical blue trend line).

As of Friday’s close, the S&P 500 have fallen by 5.8% from its peak in September 14^th, incidentally a day after US Federal Reserve chairman Ben Bernanke announced QE 3.0[2] or QE forever. 

In total, nearly 42% of the overall decline—from September 14^th until Friday—came from this week.

Some claim that Obama’s victory barely played a role in the current correction phase. For me, this seems foolhardy and politically bigoted. That’s because Obama’s lead in the prediction markets as shown by Intrade.com[3] culminated in mid-September (red ellipse). Again this coincides with the unlimited QE announcement from Ben Bernanke, giving more credence to my thesis that Mr. Bernanke’s policies had partly been designed to improve on or advance the chances of Mr. Obama’s electoral victory from which Bernanke’s career has been tied to[4].

Moreover as I recently pointed out a significant jump in terms of defense (13%) and all levels of government—federal, state and local—spending (3.7%) which accrued to an increase in the real federal spending (9.6%) over the past quarter[5] also bolstered US statistical economic growth which appears to have been part of the Obama’s electoral strategy.

As I also wrote last week

In a close battle, the incumbent have the edge. This is because they hold the political machinery which can be used to their advantage through whatever means

While I earlier stated that the current correction phase may have mostly been a “buy on rumor, sell on news dynamic”[6], there seems to be increasing evidences where political risks or regime uncertainty from Obama’s post re-election policies may have become a significant factor which has contributed to the current sluggishness in US equities.

I may further add that instead of a generalized Risk Off environment, or a broad selloff in risk assets, global financial markets have exhibited some signs of diversified actions but not meaningful enough to draw conspicuous divergences.

For instance, gold prices recently bounced off strongly on Obama’s re-election (see window below S&P 500). This implies of an extension of Bernanke’s credit easing policies. Although gold’s sharp rebound has hardly been reflected on the movements of the overall commodity markets (see CRB window).

The jury is out whether gold’s bounce will be sustained and which may spearhead and be accompanied by a general rally in prices of commodities, or if the financial market selloffs will broaden and accelerate to pose as hurdle or become a drag to gold’s recent rebound.

The important thing to point out is that the S&P 500, global equity markets (see MSWORLD on third window), gold and commodities prices have floated or sank based almost in tandem over the past year.

This exhibits high correlationship among risk assets. While the statistical correlations may vary among asset markets, tight correlations of trend undulations reveals of the risk ON (asset inflation) or risk OFF (asset deflation) nature of the current markets. 

Besides, the S&P 500 moves almost uniformly along with gold relative to the volatility (fear) index seen in both new (VIX) and old (VXO) measurements over the past 3 years. 

Rising gold over volatility conformed with higher S&P and vice versa.

Thus any deeply held idea that gold is about or represents as hedge against “fear” has largely been unfounded. Rather, gold has been a hedge against inflationism or currency debasement policies.

Greed and fear alone are symptoms and not sufficient forces enough to drive gold and stock market prices. Instead, emotional excesses account for as volatility from policy induced boom bust cycles

This means that an environment of rising prices gold and commodities amidst falling stock markets suggests of a transition towards stagflation.

Last week’s selloff has hardly shown any significant moves toward such direction, yet.

I would further input that it may be a mistake to interpret relative low statistical correlations by ASEAN markets[7] relative to developed economies as indicative of a “decoupling” landscape.

Statistical relationships can change overnight depending on how markets move. There is nothing constant except change in the marketplace.

This means that ASEAN outperformance may likely remain for as long as the US does not fall into a recession

But it would be a different story when a full blown US recession is in motion, and of course, the reactions of policymakers, particularly the central bankers, will matter under such setting.

Given the uncharted territory which current markets operate, assumptions based on past episodes could prove to be dicey.

The Fiscal Cliff’s Influence on the Recent US Equity Market Selloff

Going back to the global market’s selloff on anxiety over Obama’s policies.

Media has put a spotlight on newly re-elected President Obama to resolve the stalemate over the so-called fiscal cliff[8].

Markets supposedly disdain uncertainty. However the deepening and intensifying politicization of the financial markets imply of more uncertainties as people’s incentives have been skewered or redirected from consumer desires, which almost always goes in conflict with, the pronounced or latent objectives of political agents. 

For instance, instead of locking money through interest rate dividends from savings account in the financial institutions, zero bound regime or negative real rates which are part of financial repression have been forcing people to chase on yields and gamble in order to generate returns. So the public have become more of a “risk taker” and take on “greedy” activities in response to such policies. Some would even fall or become victims to Ponzi schemes which I expect to mushroom. 

Yet it is mostly the individual’s behavior rather than the cause—the policies that encourage such behavioral deviances—which mainstream media and politicians focuses on.

Recently many blamed the recent market carnage on political gridlock. Where political risks is concerned, I think that the prospects of more regulatory and policy obstacles or regime uncertainty, and perhaps an arbitrage on prospective policy transitions have been the culprit.

Unless there will be an agreement reached by the bi-partisan controlled legislative branches, the fiscal cliff[9] means the end of the Bush tax cuts, which translates to tax increases to the tune of $532 billion, as against automatic sequestration or spending cuts to the tune of $136 billion[10] under Budget Control Act of 2011.

Note that the balance of spending cuts (.8% of GDP) and tax increases (3.1% of GDP) has been tilted in favor of tax increases.

Nonetheless any deal reached by the two houses of Congress will likely be cosmetically in favor of increasing taxes, as against farcical spending cuts where the latter will likely be premised on growth rates rather than real cuts.

Also, spending cuts on defense will likely be subject to US foreign military engagements. A new war may disable such provisions.

According to New York University Economics Professor Mario Rizzo[11],

There will probably be defense cuts for now. But should the US encounter “unexpected” expenses, including any new war, they will be quickly eliminated. Unexpected events that increase the defense budget will definitely occur. The only thing that is uncertain is the precise events that will arise.

So spending cuts may not hold for long.

Importantly, while there is little to expect from legislation which may arise from the current politically deadlocked setting, most of the damage to US businesses will likely emanate from executive orders or regulations particularly centered on (as per University of Chicago Professor John H Cochrane[12]):

-Obamacare. Affordable Care Act regulations should include the expansion of Medicaid, health insurance “exchanges”, mandate to buy insurance, the ban on discriminatory charges on preexisting conditions and “accountable care organizations”.

-Dodd-Frank. Financial regulations will cover the expiration date for CEA exemption for swaps, broadened leverage and risk based capital requirements, FDIC Investment grade definition, Final rule OCC credit rating alternatives, Joint final rule Market risk capital, OCC lending limit rule compliance, Supervision of consumer debt collectors, Incorporating swaps, Clearing agency standards and more…

-US Environmental Protection Agency EPA regulations may cover tighter fracking regulations, much higher ozone standards, Cut sulfur in gas from 30 ppm to 10 ppm EPA: $90 billion a year, Temperature standards to protect fish in powerplant cooling ponds, tighter standards for farm dust, farms have to submit mediation plans, Water quality control for every body of water in the country, strict regulation of industrial boilers ($10-20 billion) formaldehyde emissions from plywood and more.

The recent bludgeoning of Utility stocks, which suffered most this week[13], can be traced to forthcoming environmental regulations from the Obama regime.

For instance tighter regulatory limits on mercury, sulphur dioxide and other pollutants may be used against the coal industry[14] as part of President Obama’s campaign to promote his beloved renewable energy sector which has been heavily subsidized by US taxpayers[15].

Tax increases on dividends could have also been a factor.

Writes Growth Stock Wire’s Small Stock Specialist editor Frank Curzio[16] (italics original)

Today, the tax rate on dividend income is 15%. If this expires, the tax rate on dividends would jump to 39.6%. That would significantly reduce the rate of return on dividend-paying stocks like utilities….

…But we're talking about a potential 25% tax hike on dividends. We've never seen anything like this before.

Current market pressures may have also been from policy arbitrage

Market participants expecting the fiscal cliff could be selling to take advantage of the transitions from the current to next year’s tax regime.

The end of the Bush tax cuts would mean a reversion of capital gains taxes to 20% from 15%. Adding the PPACA Obamacare provisions, capital gains will increase by 3.8% on high income individuals which should take effect in 2013, according to Tax Foundation.org[17]

As a tax analyst recently recommended[18]

If a taxpayer owns appreciated stock outright –– not through a tax-deferred retirement account –– that the individual has owned for more than a year and wants to lock in the 0 percent to 15 percent tax rate on the gain, but thinks the stock still has plenty of room to grow, he or she should consider selling the stock and then repurchasing it

So yes, material changes in the Obama’s largely anti-business regime have had material influences to the current pressures experienced by the US markets.

While the odds may seem small for a recession to occur, this cannot be discounted. The distortionary effects from the transition to a heavily regulated, compounded by higher tax environment, may become strong and self-fulling enough to heighten the risk premium and the hurdle rates to dissuade investment spending, as well as, to dampen the market’s favorite “animal spirits”.

Of course, given the increased political risks, President Obama seems to be relying more on the US Federal Reserve’s Ben Bernanke to do the economic weightlifting (well, in terms statistical figures).

There have been more chatters, possibly as part of policy signaling channel by the FED, of expanding unlimited QE 3.0 from $600 billion now to $ 1 trillion[19]. Federal Reserve Bank of St. Louis President James Bullard has even floated on the possibility of the replacement of Operation Twist with an expanded QE 3.0[20]. I have been saying that the FED-ECB program will reach $2 trillion or more. 

So President Obama’s proposed solutions to the nation’s economic predicament will be to continue with trillion dollar annual deficits through more government spending (but perhaps at a slightly reduced growth rate), which will likely be financed by more debt and by the US Federal Reserve’s monetization of such debts.

At same time, President Obama plans to strangle businesses with supposedly ‘class warfare’ policies of higher taxes—which in reality will cover even taxpayers of the middle class—and promote cronyism with a maze of EO’s and regulations. So appeasing the political class to generate more hiring opportunities should mean hiring more lobbyists and lawyers.

President Obama surely knows how to kill the goose that lays the golden egg.

It’s only in politics where bad or mediocre performance gets rewarded. That’s relative to the perceived worst option: the political opposition. 

And this why, despite the seeming exuberance from media, the search for “renouncing citizenship” in Google trend has been on a material upswing since 2012.

Perhaps increased searches for a second passport[21] have not only been a US dynamic but also in the Eurozone where more people could be looking at the exit or migration option or Tiebout Model[22] given the growing etatism (socialism and interventionism) practised by these economies.

What the US Fiscal Cliff Means to the Phisix

What has all these to do with Philippine stocks?

One, the prices of my neighborhood sari sari retail store’s San Miguel Beer Pale Pilsen have increased from 21 pesos (USD 51 cents at 41) per bottle to 23 pesos (USD .56 cents) or a 9.5% beer price inflation. This has not merely been due to sin taxes but through negative real rates regime as food prices and gasul, in the sphere of my operations have sizably risen.

The idea that domestic price inflation has been contained through supposed “good governance” has been arrant political canard[23] and represents statistical manipulation which eventually will lead to Argentina like political protests[24] overtime.

Yet there will be more pressure from domestic stock market participants to chase prices out of the growing evidence of the inflation tax from the Bangko Sentral ng Pilipinas’ (BSP) negative real rates regime. This means we should expect more bubble movements of specific issues within the Philippine Stock Exchange, many of which will be blamed on “manipulation”.

Nonetheless price inflation pressures will become more evident in 2013 and all the blarney about the “Asian Tiger” will be exposed as nothing more than a credit driven bubble.

I am not suggesting of a bear market, although stocks will likely come under pressure from tightening conditions. I am saying that we should expect price inflation to transform into street rallies and a drop in approval ratings.

Two, for as long as the selloff in US stocks moderates and in the condition that US will not fall into a recession, the year-end rally for ASEAN and the Phisix markets should continue.

However if the selling pressure does not abate, and if the risk of a US recession gets amplified, then these will eventually be transmitted to the Phisix and to the ASEAN markets. And all the low correlations will likely be transformed into high correlations similar to 2008.

Three, watch the actions of FED which will increasingly become President Obama’s major instrument for obtaining statistical economic growth, as well as, the actions of the Fed’s major collaborator, the ECB. Both of whom will likely aggressively employ balance sheet expansions that may get reflected on gold and other commodity prices.

The Phisix has vastly outpaced gold in terms of returns over the past year (lower window PSEC/Gold where rising trend means PSE outperforming gold in nominal terms). Year-to-date, nominal returns exhibit that gold has been up by only 10.49% while the Phisix has been up by a robust 25.09%. Since the Peso have risen by 6% against the USD, the equivalent US dollar returns on the Phisix translates to over 31%

Nevertheless gold and Phisix have shown some important correlations. A fall in gold prices eventually meant a similar fall in the Phisix, although the timing has not been synchronous. Yet under consolidation or on a rally mode gold prices have shown the Phisix the path higher although at a faster pace.

This demonstrates of the RISK ON or OFF environment where both gold and the Phisix operates.

Should gold breach above the 50-day moving averages, and backed by a rebound in other commodity prices, the Phisix should follow suit.

As usual, heightened volatility remains the order of politicized markets. So do expect sharp swings on both directions with an upside bias strictly based on the abovementioned conditions.

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[1] see The Likely Impact of US Presidential Elections on the Stock Markets November 4, 2012

[2] The Telegraph Federal Reserve announces QE3 to aid US recovery September 13 2012

[3] Intrade.com Barack Obama to be re-elected President in 2012

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

[5] See Obama’s Potemkin Economy November 6, 2012

[6] See Dealing with Today’s Uncertainty: Patience is the Better Part of Valor June 17, 2012

[7] DBS Research Economics Markets Strategy p.55 September 13, 2012

[8] Bloomberg.com Obama Faces Pressure to Lead on ‘Fiscal Cliff’ After Win, November 8, 2012

[9] Wikipedia.org United States fiscal cliff

[10] Wall Street Journal Blog What Is the Fiscal Cliff? November 8, 2012

[11] Mario Rizzo Fiscal Cliff: Sense and Nonsense Thinkmarkets November 9, 2012

[12] John H. Cochrane Predictions November 7, 2012

[13] US Global Investors Investor Alert, November 9, 2012

[14] SeattlePI.com Coal stocks plunge after Obama victory November 7, 2012

[15] See CFR: US President Obama’s Renewable Energy Jobs Comes at High Cost to Taxpayers November 3, 2012

[16] Frank Curzio It's Time to Exit This "Safe" Sector The Growth Stock Wire, November 9, 2012

[17] Tax Foundation.org The Fiscal Cliff: A Primer, November 8, 2012. The tax on long-term capital gains would rise from a maximum of 15 percent to a maximum of 20 percent. Additionally, a 3.8 percent capital gains tax on high-income individuals, enacted as part of PPACA (Obamacare), takes effect in 2013. The top capital gains tax rate would thus be 23.8 percent (20 percent plus 3.8 percent). President Obama’s budgets have recommended retaining the 15 percent preferential rate for taxpayers whose income is below $200,000 ($250,000 for couples).

[18] Businessinsider.com Capital Gains Taxes Will Skyrocket In The New Year––Here's How To Cope November 9, 2012

[19] see US Equity Markets Welcomes Obama Re-election with a Thud! November 8, 2012

[20] Wall Street Journal Blog Fed’s Bullard Sees Twist End, More QE3 on the Table November 9, 2012

[21] Simon Black “Renounce citizenship” is now one of the fastest growing search terms in Google Sovereign Man, November 9, 2012

[22] Wikipedia.org Tiebout model

[23] see Philippine Economy: Lower Inflation Rates from Good Governance? November 7, 2012

[24] See Argentina Politics: Biggest Protest Rally in Decades November 11, 2012

Argentina Politics: Biggest Protest Rally in Decades

The president of Argentina’s Central Bank (BCRA), Mercedes Marcó del Pont, recently declared

it is totally false to say that printing more money generates inflation, price increases are generated by other phenomena like supply and external sector’s behaviour

Add to this the Argentine government’s statistical manipulation to suppress inflation measures, currency controls (banning of the US dollars), and other political controls (such as ban on imported books), as well as cronyism, the result has not only been intensifying capital flight but growing social instability which has been ominous of mounting social crisis.

Writes the London Evening Standard, (hat tip Bob Wenzel)

Tens of thousands of Argentinians blocked the streets of Buenos Aires in the country’s largest anti-government protests in more than a decade.

Demonstrators marched against rising inflation, crime and corruption under President Cristina Fernandez de Kirchner, whose popularity has plummeted since she was re-elected last year as the economy wobbles.

Argentina’s etatism or a combination of both socialism and interventionism (fascism) only validates the admonitions of the great late Professor Ludwig von Mises,

State interference in economic life, which calls itself "economic policy," has done nothing but destroy economic life. Prohibitions and regulations have by their general obstructive tendency fostered the growth of the spirit of wastefulness. Already during the war period this policy had gained so much ground that practically all economic action of the entrepreneur was branded as violation of the law. That production is still being carried on, even semi-rationally, is to be ascribed only to the fact that destructionist laws and measures have not yet been able to operate completely and effectively. Were they more effective, hunger and mass extinction would be the lot of all civilized nations today.

Our whole life is so given over to destructionism that one can name hardly a field into which it has not penetrated. "Social" art preaches it, schools teach it, the churches disseminate it.

The consequences of destructionism has now become evident in the streets of Buenos Aires.