China’s Stock Markets: Sovereign Funds and Central Banks Open to Invest More

The Chinese government has a bias for international political contemporaries. 

They prefer central banks and government controlled Sovereign Wealth Funds (SWFs) to have greater exposure in their stock markets in the assumption that these entities are “long term” investors than the private sector counterparts

From Bloomberg,

China scrapped a ceiling on investments by overseas sovereign wealth funds and central banks in its capital markets, part of government efforts to encourage long-term foreign ownership and shore up slumping equities.

SWFs, central banks and monetary authorities can now exceed the $1 billion limit that still applies to other qualified foreign institutional investors, according to revised regulations posted yesterday on the State Administration of Foreign Exchange’s website.

The Shanghai Composite Index (SHCOMP) jumped the most since October 2009 yesterday after the head of the Hong Kong Monetary Authority said Dec. 13 that China may relax or abolish a rule that requires Renminbi Qualified Foreign Institutional Investors to keep most of their funds in bonds. The China Securities Regulatory Commission has cut trading fees, pushed companies to increase dividends and allowed trust companies to buy equities since Guo Shuqing took over as chairman last year.

Introducing more long-term funds from abroad will help improve market confidence, promote stable growth in capital markets and provide “robust” investment returns to domestic investors, the regulator said in May, a month after the government more than doubled the total quota for QFIIs to $80 billion from $30 billion….

QFIIs can repatriate their principal and investment returns after a lock-up period ends, though the monthly net remittances cannot exceed 20 percent of their total onshore assets as of the previous year, according to yesterday’s rules. Open-ended China funds can remit funds on a weekly basis under the new regulation, compared with monthly in the previous version announced in 2009.

The Hong Kong Monetary Authority, Norges Bank, Government of Singapore Investment Corp. and Temasek Holdings Pte.’s Fullerton Fund Management Co. have all reached the $1 billion limit as of Nov. 30, with QFIIs’ approved quotas totaling $36.04 billion, according to SAFE, the currency regulator. Foreign investors can only invest in capital markets through QFIIs.

The benefits from capital intermediation seems well understood by the Chinese government. 

It is only in the prism where the incentives driving public sector ownership appears to have been mistakenly lumped as purely profit oriented enterprises similar to private corporations which gave SWFs the precedence.

In reality, the positioning of political or public financial institutions on international capital markets are different. They are based on (political) priorities and parameters diverse from their private sector peers (such technical operating differences may due politically determined guidelines).

This article gives us a clue, from ai-cio.com

SWFs, similar to other institutional investors, are less likely to invest in private equity versus public equity internationally, according to a newly published paper, written by Sofia Johan of York University, April Knill of Florida State University, and Nathan Mauck from the University of Missouri.

However, the economic significance of this impact is surprisingly low, the paper asserted. "Unlike other institutional investors, SWFs are more likely to invest in private equity versus public equity in target nations where investor protection is low and where the bilateral political relations between the SWF and target nation are weak." The research demonstrates that contrary to non-governmental institutional investors, SWFs do not seek protection by investing in private equity in nations that provide strong investor protection.

Surprisingly, cultural differences play a marginally positive role in the choice to invest in private equity outside of a SWF's own sovereign nation. "Comprehensively, we find that SWFs act distinctively from other traditional institutional investors when investing in private equity," the authors claimed.

Furthermore, according to the paper, SWF investment in private equity may be primarily financially motivated as SWFs tend to underperform in the public markets.

As one can note the degree of bilateral relations differs and serves as example to a politically determined SWF fund management framework.

In 2009, pension funds, insurance companies and mutual funds dominated long term investing with over US$65 trillion in OECD economies. The share of SWF has also grown, given their hefty $4 trillion stockpile, but represents a fragment relative to the overall investible exposure by the private sector.

The above is a categorization of long term investors from the World Economic Forum shows that private sector remains the largest dynamic as long term investors

In addition, given the highly volatile politically charged environment, such priorities may change. Past performance may not serve as a useful guide for future actions. Long term may become short term and vice versa depending on how changes evolve.

Also, there is no technocratic magic on public investments. Bureaucrats don't outsmart the private sector.

Public funds like sovereign wealth funds are manned by people too. They are seduced to the herding effect as evidenced by their recent price chasing action of Emerging Market debt

This anecdotal evidence from Reuters.com

Sovereign wealth funds, along with other crossover investors, such as European pension funds, were in hot pursuit of EM credit in 2012, but US pension funds "missed the boat" after buying one too many underperforming EM equity trades, said Chang.

So SWFs can be short term as much as it can be long term

 

And to repeat the earlier point: The priorities of the public funds can be influenced by political circumstances whether domestic or international.

Take for instance, California Public Employees' Retirement System (CalPERS), the US largest public pension fund recently filed for bankruptcy in response to the bankruptcy proceedings made by two cities Stockton and San Bernandino. 

Bankruptcy may turn long term investments into short term.

Bottom line: While the Chinese government’s thrust to liberalize her capital markets should be seen in a good light, which I believe encapsulates her path or grand design towards the yuan’s convertibility in order to challenge the US dollar hegemony as international currency reserve, her order of priorities in favor of SWFs seems unjustified. 

Instead, China’s government should aggressively liberalize her capital markets. Capital flows are not the problem. Bubble policies are.

Finally, the above report has allegedly bolstered the Shanghai Index to break above the 50-day moving averages with Friday’s eye popping 4.32% gains

Such sharp recovery seems to indicate of a major inflection point for China's major benchmark. Part of which may be intended to paint a welcoming picture for the ushering in of the newly appointed leaders.

As I wrote last Sunday:

Given the recent record liquidity injections by the People’s Bank of China (PBoC) which coincided with the latest leadership changes, and improving signs of credit growth, perhaps from stealth stimulus coursed through State Owned Enterprises (SoE), accelerating signs of improvements on infrastructure investments, and with retail investors almost abandoning the stock market out of depression, China’s reflationary policies may yet spark new bubbles in both the stock market and the property sectors…

Recovering prices of industrial metals also seem to underpin and or portend for China’s stock market recovery.

A reflation of China’s asset bubbles will likely be supportive of the recent gains attained by ASEAN bourses.

Recent surge in industrial metals (GYX) have presaged this. And I believe that China’s market participants have been looking for an excuse to push up the stock market and found one in the liberalization report that favored SWFs.

Quote of the Day: Every Act of Entrepreneurship is Revolutionary

Every act of entrepreneurship is revolutionary and rooted in the anarchist spirit. It strikes at the heart of the status quo. It dares to be dissatisfied with what is. It imagines something new and better. It brings about unexpected, unapproved, and progressive change by adding a new dimension of experience to how we understand ourselves and how we interact with others.

Without entrepreneurship, history would lack forward motion, our understanding of the uniqueness of our time in this world would be forever undefined, and society itself would atrophy and finally die. With it, every attempt to control and freeze the world faces opposition and long-run failure.

History teaches that those who dare stand in the way of human progress will eventually be run over. Yes, there is plenty of friction and too many victims as we get from here to there. But we will get there, one creative act of disobedience at a time.

This is from the highly articulate publisher and editor Jeffrey A. Tucker of the Laissez Faire Books on the forces of decentralization founded on entrepreneurship.

Warren Buffett’s Berkshire Share Buy Backs: Do What I Say and Not What I Do

When people talk or preach about politics, the best measure of candidness is to see how they act rather than to simply adhere to what they say. In Austrian economics lingo this is called demonstrated preference.

Crony Warren Buffett is a wonderful example. As a major beneficiary of Mr. Obama’s policies, he continues to promote President Obama’s class warfare “tax-the-rich” policies. That’s because the yoke of his proposed taxation will be borne more by his peers as he deftly applies tax avoidance schemes. So taxes becomes an anti-competition or protective “moat” for his companies.

Recently, along with other cronies such as Mr. George Soros, Mr. Buffett even signed a petition to increase estate taxes.

Because of his political rhetoric you’d probably have the impression that Mr. Buffett would have no qualms with paying the US government on what he believe are his "obligations".

Yet in real life, Mr. Buffett does the opposite: he fervently avoids taxes.

From the Guardian.co.uk

Billionaire Warren Buffett's conglomerate Berkshire Hathaway spent $1.2bn buying its own shares from the estate of an unnamed investor. The anonymous purchase was made at $131,000, or 117% of book value. Berkshire said it bought 9,200 Class A shares from "the estate of a long-time shareholder". The shares represent 1% of Berkshire's Class A stock.

Buffett – known as the Sage of Omaha – has always been reluctant to conduct share buybacks and agreed to it last year only after Berkshire hit historically low valuations. In its most recent filing, Berkshire said it had not made any repurchases in the first nine months of 2012, and spent just $67.5m on buybacks in 2011.

Berkshire's Class A shares rose after its announcement, up 2.8% at $134,500.

The repurchase came less than a month before the looming "fiscal cliff", automatic tax rises and spending cuts set for 1 January that the White House and members of Congress are negotiating to avoid.

Among other levies, the estate tax is expected to rise in the new year package by as much as 20 percentage points.

Buffett was a signatory to an open letter released on Tuesday that called for a lower starting point for the tax and a higher tax rate, beginning at 45%.

So Berkshire's recent buyback has been meant to protect “the estate of a long-time shareholder” from the same estate taxes which he proposes to raise.

I'd see this as galling pretentiousness.

Quote of the Day: The Virtue of Market Inefficiency

an inefficiency exists when, for a given person at a given time and place, the cost of an action outweighs the benefit.  We’ve seen that to rationally calculate costs and benefits you need money prices of inputs and outputs, of steel and bridges.  So when government erodes private property rights, interferes with trade, distorts prices, and manipulates money, it doesn’t just make it harder to be efficient; it also pulls the rug from under the very ability to spot inefficiencies at all.

Using the rules of arithmetic, for example, it’s easy to see that the statement 1 + 2 = 4 is wrong, but what about  _ + _ = _ ?  What’s the solution to this “problem”?  Is there even a problem here?  Money prices fill in the blanks; they “create errors”—i.e., reveal mistakes that no one could see without them—that alert entrepreneurs might then perceive and correct. If mistakes and inefficiencies remain invisible, the search for better ways of doing things could never get off the ground.

An economy without inefficiencies is either one where knowledge is so perfect that no one ever makes a mistake, or it’s one in which government policy has effectively foreclosed the very possibility of inefficiency.  In a world of surprise and discovery, of experiment and innovation, the former is impossible; the latter sort of economy, as Mises showed almost 100 years ago, is impossible as well as intolerable.

So a living economy needs to “create” inefficiencies, and lots of them, to set the stage for greater efficiency and ongoing innovation.

This excerpt is from Professor Sandy Ikeda at the Freeman talking about the essence and or the significance of the price mechanism.  (hat tip Prof. Don Boudreaux)

Graphic of the Day: MIT Academes Govern World’s Money Policies

Could revolving door relationships between central banks and the highly protected banking industry signify manifestations of more than just the Goldman Sachs connection?

Central bank policies appear to have another a common denominator; they seem to be undergirded by academic pedantry from the stealth sanctums of the Massachusetts Institute of Technology (MIT). 

From the Wall Street Journal (bold mine) [hat tip zero hedge]

Of late, these secret talks have focused on global economic troubles and the aggressive measures by central banks to manage their national economies. Since 2007, central banks have flooded the world financial system with more than $11 trillion. Faced with weak recoveries and Europe's churning economic problems, the effort has accelerated. The biggest central banks plan to pump billions more into government bonds, mortgages and business loans.

Their monetary strategy isn't found in standard textbooks. The central bankers are, in effect, conducting a high-stakes experiment, drawing in part on academic work by some of the men who studied and taught at the Massachusetts Institute of Technology in the 1970s and 1980s.

How the world’s tightly knit central bank cabal operates, again from the same article:

Central bankers themselves are among the most isolated people in government. If they confer too closely with private bankers, they risk unsettling markets or giving traders an unfair advantage. And to maintain their independence, they try to keep politicians at a distance.

Since the financial crisis erupted in late 2007, they have relied on each other for counsel. Together, they helped arrest the downward spiral of the world economy, pushing down interest rates to historic lows while pumping trillions of dollars, euros, pounds and yen into ailing banks and markets.

Three of the world's most powerful central bankers launched their careers in a building known as "E52," home to the MIT economics department. Fed Chairman Ben Bernanke and ECB President Mario Draghi earned their Ph.D.s there in the late 1970s. Bank of England Governor Mervyn King taught briefly there in the 1980s, sharing an office with Mr. Bernanke.

Many economists emerged from MIT with a belief that government could help to smooth out economic downturns. Central banks play a particularly important role in this view, not only by setting interest rates but also by influencing public expectations through carefully worded statements.

While at MIT, the central bankers dreamed up mathematical models and discussed their ideas in seminar rooms and at cheap food joints in a rundown Boston-area neighborhood on the Charles River.

This gives light to the cartel-like operations of world’s central banks, who operate in consonance or in apparent collaboration with each other. 

Experimental policies, which encompasses excessive reliance on mathematical models, centralization and presumption of knowledge, are a fatal mix to the real world. 

As Nassim Taleb wrote in The Bed of Procrustes: Philosophical and Practical Aphorisms; p.72

Academics are only useful when they try to be useless (say, as in mathematics and philosophy) and dangerous when they try to be useful.

How US Federal Reserve Policies Linked the Bond Markets with Equity Markets

Fed policies have enormous impact on the financial markets. Part of this has been to interlink the actions between the bond and equity markets. Perhaps this could be part of the US Federal Reserve Chair Ben Bernanke’s Portfolio Balance channel or “once short-term interest rates have reached zero, the Federal Reserve's purchases of longer-term securities affect financial conditions by changing the quantity and mix of financial assets held by the public.”

At his blog, Dr. Ed Yardeni explains (bold mine)

The bond cult is dominated by individual and institutional investors desperate to get some yield north of zero on their fixed-income investments. This is most evident in the monthly mutual fund data compiled by the Investment Company Institute. Over the past 12 months through October, net inflows into bond funds totaled $392 billion; equity funds experienced an $80 billion net outflow. Since the start of the latest bull market in stocks during March 2009, net inflows into equity funds was virtually zero, while bond funds attracted $1.25 trillion.

Nonfinancial corporations have been borrowing money from the bond cult, whose members have been desperately scrambling to lock in yields as the Fed has driven them closer to zero. Over the past four quarters, mutual funds purchased $267 billion in corporate and foreign bonds. To the extent that some of these funds have been used to buy back shares, the bond cult has been financing the bull market in stocks. This was all masterminded by the Fed’s equity and bond cults and implemented with their NZIRP and QE programs.

Such relationship partly explains the Risk ON-Risk OFF scenarios, as well as the current recovery in US housing. 

The bottom line is that asset markets have become immensely interdependent with each other that enhances the risks of contagion. 

Oh you can bet that such interrelationships have not just been limited to the US but to the world.

FED Converts Operation Twist to QE 4.0

As expected, the US Federal Reserve via the Federal Open Market Committee (FOMC) has converted the expiring Operation Twist into a monthly $45 billion US Treasury buying program or chapter 4 of its unlimited QE program (QE 4.0).

From the Bloomberg

The Federal Reserve for the first time linked the outlook for its main interest rate to unemployment and inflation and said it will expand its asset purchase program by buying $45 billion a month of Treasury securities starting in January to spur the economy.

“The conditions now prevailing in the job market represent an enormous waste of human and economic potential,” Fed Chairman Ben S. Bernanke said in a press conference in Washington today after a meeting of the Federal Open Market Committee. The Fed plans to “maintain accommodation as long as needed to promote a stronger economic recovery in the context of price stability,” he said.

Rates will stay low “at least as long” as unemployment remains above 6.5 percent and if inflation is projected to be no more than 2.5 percent, the FOMC said in a statement. The thresholds replace the Fed’s earlier view that rates would stay near zero at least through the middle of 2015.

The move to economic thresholds represents another innovation by Bernanke, a former Princeton University professor and Great Depression expert who has stretched the bounds of monetary policy as he battled the recession and then sought to jolt the world’s biggest economy out of a subpar recovery.

How the Fed “innovates”, from the same article:

While the FOMC dropped its calendar-based guidance on interest rates, it said the new thresholds are “consistent” with the previous outlook. A majority of Fed officials don’t expect to raise the main interest rate until 2015, when the jobless rate is forecast to fall to between 6 percent and 6.6 percent, according to projections released after the statement.

The bond buying announced today will be in addition to $40 billion a month of existing mortgage-debt purchases. The FOMC said asset buying will continue “if the outlook for the labor market does not improve substantially” and hasn’t set a limit on the program’s size or duration.

The latest move will follow the expiration at the end of this year of Operation Twist, in which the central bank each month has swapped about $45 billion in short-term Treasuries for an equal amount of long-term debt. That program kept the total size of the balance sheet unchanged, while the new purchases will expand the Fed’s holdings.

The decision to embark on outright Treasury purchases doesn’t “significantly” increase the level of monetary stimulus, Bernanke said. The Fed “intends to be flexible” in setting the pace of its asset purchases, and will use “qualitative” criteria to determine the size of its bond- buying program, he said.

Markets have practically greeted this with a yawn. Gold fell, oil rose, the US stock markets closed the day mixed.

That’s practically because the FED has telegraphed this move where 48 of the 49 economists earlier polled by the FOMC expected such actions from the FED.

Fed’s communication strategy (signaling channel) has been to float a trial balloon then lather rinse and repeat the message as part of a classical conditioning approach in shaping market’s expectations.

Yes realize that the FED effectively tries to apply mind control techniques on the markets.

The implication is that the FED’s supposed “innovation”, has in reality been a grand experimentation whose unintended consequences, which should impact the entire world, has yet to be revealed.

The FED’s buying of US treasuries will account for an estimated NINETY percent (90%) of US treasury supply!!!

From another Bloomberg article,

With the Fed buying about $85 billion a month in Treasuries and mortgage bonds next year, the net supply to the private sector will be about zero as the central bank effectively soaks up about 90 percent of new issuance of those assets.

So you have the FED fertilizing the already implanted or sown seeds of hyperinflation or a currency crisis. To be clear, what I am saying is that the doubling down of current FED actions have been INCREASING the risks of such scenario.

For now, such FED purchases will provide tailwinds to global financial markets, as well as, the Philippine Phisix, which will be seen as a "boom"

I maintain my prediction:

Since price movements of gold seems aligned with global stocks which have accounted for a risk ON or risk OFF environment, a confirmation of the Fed’s expansion of the QE most likely during the FOMC’s meeting in December 11-12 will likely push gold and global stock markets higher.

So this also means that both external and domestic policies will likely serve as tailwinds in support of a higher Phisix perhaps at least until the first quarter of 2013. Of course this is conditional to the above. Emergence of unforeseen forces, most likely from the dimensions of political risks may undermine this scenario.

But do expect sharply volatile markets with an upside bias until at least the first half of 2013.

Education: The Difference Between Learning How to Think and What to Think

Professor of Law Butler Shaffer at the LewRockwell.com in the following excerpt, eloquently distinguishes between independent and conformist thinking [bold mine]

Education is an ongoing confrontation between those who want to help children learn how to think, and those who want to teach them what to think. While there are numerous variations on these themes, the contrast can most clearly be found in the distinctions between child-centered Montessori systems, and teacher- and test-centered schools. Government schools usually fall into the latter category. Homeschooling, religious schools, un-schooling, and other forms tend to emphasize either the "how" or the "what" in their efforts with children.

Those who focus on learning how to think have in mind helping children develop their own methods of questioning and analyzing the world around them; to control their own inquiries and opinions; to the end of helping children become independent, self-directed persons. The role of the teacher in such a setting is to provide new learning situations (e.g., open up new subjects of inquiry when the student is ready to do so) and to facilitate the processes of questioning so as to help the students get to deeper levels of understanding.

People who have developed the capacity for epistemological independence are not easy to control for purposes that do not serve their interests. Institutions – which have purposes of their own that transcend those of individuals – require a mass-minded population that has been conditioned to accept outer-imposed definitions of "reality." Any deviation from this systemic purpose – as would derive from students questioning how the arrangement would benefit them – would be fatal to all forms of institutionalism.

The established order has, from one culture and time period to another, insisted on educational systems that train young minds into what to think. "Truth" becomes a set of beliefs that conform to an institutional imperative, and it becomes the purpose of schools to inculcate such a mindset. Whereas "how to think" learning that finds its purpose and focus within the minds of self-directed, independent students, "what to think" education derives from outside the students’ experiences and analytical skills. As Ivan Illich so perceptively expressed it, "[s]chool is the advertising agency which makes you believe that you need the society as it is."

To this end, the established order has helped generate – with eager assistance from academia – a belief that all understanding is a quality requiring phalanxes of self-styled "experts" who, by virtue of their prescribed status, enjoy monopolies to offer opinions about their respective fields of study. Plato’s designation of "philosopher kings" has been sub-franchised into categories of "experts" to be found in "history," "physics," "psychology," "economics," "law," and seemingly endless sub-groupings that negate the role once respected for those who had received a "liberal arts" education.

Read the rest here.

Austrian Bureaucrat Loses $439 million of Taxpayers Money on Derivatives Gamble

This is a prime example of negative externalities (or cost of a mistake to the society) derived from centralized institutions has far more damaging effect than errors incurred by entrepreneurs or so called "market failures".

A mistaken decision from political authorities extrapolates to greater tax burden for the citizenry.

From Reuters (hat tip Zero Hedge)

Austria said it planned stricter controls over regional finances after a Salzburg civil servant gambled hundreds of millions of euros of taxpayers' money on high-risk derivatives.

Finance Minister Maria Fekter said on Tuesday she was preparing new national legislation to impose stricter conditions on how regional administrations could use money borrowed at preferential rates from the Federal Financing Agency (BFA).

Salzburg officials said last week they had sacked a finance director after determining she used doctored documents and false signatures to hide a trail of losses from deals that started more than a decade ago, causing a book loss of 340 million euros ($439 million).

The incident has sparked calls for fresh elections in Salzburg state and for regional financing rules to be reformed. Austrian states have 8.2 billion euros of debt, or 8.1 percent of the country's public debt.

"It can't go on that one keeps getting cheap money from the BFA and then starts gambling with it," Fekter told journalists, adding that the states could save 150 million euros per year by using the BFA for all their financing needs.

The above is another great example of knowledge problem. This shows that political agents are also human beings who possesses or embodies the same set of shortcomings as everyone else. Except that they command resources and privileges via mandated budges and guns.

Losses from “gambling” is actually fait accompli or a side issue. If the gamble paid off then this won’t have been in the news.

But even if we presume the noble intentions have guided the actions of bureaucrats, the real issue is why governments are given the latitude to put taxpayer resources at risk and why their losses means greater tax burdens instead of reducing them.

The irony of politics is that political errors have always been rewarded-- although the culprits does get sacked, the system remains in place--instead of being punished, all these comes at the expense of taxypayers—in terms of opportunity costs via resources and time, as well as, civil liberties.

HK Monetary Authority: QE is NOT a Panacea

Hong Kong’s Monetary Authority headed by Chief Executive Norman Chan appears to have come to grip with reality and indirectly censures the US Federal Reserve

From CRI English (hat tip Zero Hedge) [bold mine]

Hong Kong Monetary Authority Chief Executive Norman Chan said Monday that if the process of deleveraging is disrupted by quantitative easing, asset prices might drop sharply and remain volatile.

When delivering a speech entitled the Global Deleveraging: The Right Track at the Hong Kong Economic Summit 2013, Chan said that excessive leveraging, or over-borrowing, in major industrialized countries was the root cause of both the global financial crisis and the more recent sovereign debt crisis plaguing Europe.

Chan said quantitative easing is not a panacea, but it is the exact opposite of deleveraging. In the past three years, quantitative easing had limited stimulating effect on the real economy. "In order to solve the structural imbalances built up in the past two decades, we must get to the bottom of the problem."

There is a possibility that quantitative easing produces the desired results, which is a very desirable scenario as global economy will return to its normal growth path, he noted.

However, there is a possibility that the process of deleveraging is disrupted by quantitative easing, leading to sharp increases in asset prices in the first place. Yet, since such increases are not supported by economic fundamentals, any increase in wealth will be seen as transient.

As a result, households are unwilling to increase spending and in the end, the real economy fails to rebound, if inflationary pressure builds up alongside asset price increases, central banks may consider exiting the market and raise interest rates, the authority's head said.

When economic performance, inflation or monetary policy falls short of market expectation, asset prices might drop sharply and remain volatile, he added.

Translation to central bank vernacular: QE only buys time and further inflates current bubbles.

I may further add that by disallowing markets to clear to reflect on its real state or conditions “not supported by economic fundamentals”, imbalances will accrue “inflationary pressure builds up” to the point of greater volatility ahead. 

Euphemism aside, Mr. Chan means a bursting bubble (see last highlighted statement).

Quote of the Day: Leading Myths About Entrepreneurship and Effective Start Up Communities

What are the leading myths about building more effective startup communities?

There are there common ones: 'We need to be more like Silicon Valley,' 'We don't have enough capital,' and 'Angel investors must be organized.'

For decades, cities have been proclaiming themselves the next Silicon Valley. That’s nonsense — cities — and the entrepreneurial leaders — should focus on creating the best startup community for their city, based on the unique attributes of their city. Learn from the amazing things in Silicon Valley, but instead of trying to be like Silicon Valley, be the best Boulder, or best Chicago, or best New York, or best Portland. You already have an identity as a city — you don’t need to be Silicon Alley or Silicon Slopes.

Next, there never is a balance between supply and demand of capital. Entrepreneurs shouldn't worry about this — instead they should focus on creating amazing companies. Capital will always find amazing companies. While there are many things that can be done over time to attract more capital to a region, the biggest thing is for entrepreneurs to actually go create some significant companies.

Finally, related to this is the notion that angel investors should be organized into formal angel investor groups. While this can be helpful, it’s often extremely harmful and stifling, as many angel investor groups try to look like small venture capital firms rather than acting like helpful angel investors.

(bold original) 

This is from Brad Field and Rich Florida as quoted by Paul Kedrosky at the Kauffman Foundation’s Growthology blog.

My comments:

On the myth of the next Silicon valley.

What is needed is an intensely competitive environment that will foster and reward the virtues of failure or risk-taking that encourages innovation.

In other words, entrepreneurship thrives best on economic freedom.

On the the fantasy of the equilibrium of capital.

The same argument has been used to justify government’s role on public works or infrastructure spending.

Economic freedom nurtures capital accumulation. As the great Ludwig von Mises reminds us “Progressive capital accumulation results in perpetual economic betterment.” As noted in the above quote, capital and great companies will co-exist, given an environment that is conducive to business or business friendly.

On groupthink in terms of Angel investors.

Groupthink, as explained before, reduces critical, creative and independent thinking as well as  individual responsibility and discipline, all necessary ingredients for entrepreneurship.

Groupthink fallacy applies not only to Angel investors but to the financial markets, as well as to other social activities, specifically magnified in politics.

Remember, entrepreneurship is foremost an art before it is science.

Manny Pacquiao Didn’t Let Fans Down, Prodded by Media Fans Deluded Themselves

I empathize with boxing legend Manny Pacquiao for undeservingly feeling “guilty” over public pressures, following his stunning KO loss which he suffered from older Juan Manuel Marquez, a few days.

From MSN News

"The low morale, the sadness, I accept that. This is my job.... But the reaction of the Filipinos, the many who cried, especially my family, it really hurts me," he said in an interview on the GMA network.

The former eight-division world champion wiped tears from his eyes listening to his wife, Jinkee, make a tearful appeal on camera for her husband, who turns 34 next week, to hang up his gloves. 

Pacquio shouldn’t be so hard on himself. He lost because he is just human. 

A random one-punch shot, in a round which he so-dominated, at the last two seconds virtually changed the outcome to his opponents favor.

Nassim Taleb would have called this Pacquiao’s black swan.

Failure to adhere to reality has made Pacquiao’s loss unwarrantedly controversial. This is hardly about the lack of conditioned training, the charge on Marquez’s alleged use of steroids, and other rubbish attributions. Religion has even been absurdly imputed on this. Others have used this as pretext to try to impose political correctness on the contrasting opinion of the others.

He lost because he lost. He was at wrong place at the wrong time. Period. The rest of supposed 'expert' rationalization represents post hoc fallacy.

It has been my impression that the media has made the public believe that sheer nationalism or the force of nationalism by itself would lead to Pacquiao’s sustained invincibility, immortality and everlasting string of victories. 

Pacquiao’s decisive loss exposed such hogwash. In the same way, belief in extreme nationalism has been demolished after 60-78 MILLION lives had needlessly been lost due to World War II.

Pacquiao didn’t let his fans down. The fans have no one else to blame but themselves, for unduly placing extremely high expectations in his supposed ‘superhuman’ capabilities, and importantly, for falling prey into mainstream media’s hype. 

This is a great example of bubble psychology. The same lessons which will permeate and eventually apply to the Philippine capital markets.

As British essayist, critic, poet, and novelist Gilbert Keith Chesterton once sarcastically remarked, 

"Journalism is popular, but it is popular mainly as fiction. Life is one world, and life seen in the newspapers is another."

Reality simply dealt false dogmatism a rude and painful awakening.

Quote of the Day: Why Regulation Does Not Work

Regulations do not make markets safer, more efficient, or work better for consumers in anything but a superficial sense. Regulation only provides “confidence” and assurance that only leads to crisis. Regulation does not produce harmonization of markets or insurance for consumers.

Regulation simply does not work. It is designed with hopes of success, but with no mechanism to achieve this success. We hope for efficiency, but what we get is bureaucracy. We hope for effectiveness, but what we get is rules and red tape that serves neither producer nor consumer. We hope for safety, but what we eventually get is chaos.

This is from Austrian economics Professor Mark Thornton at the Mises Institute.

Professor Thornton cites as examples of the highly regulated financial industry that nurtured Bernie Madoff's Ponzi and the housing bubble. Yes, Washington had “over 12,000 bureaucrats devoted to financial regulation”. 

Professor Thornton also mentions stringent regulations on the oil industry which led to the BP Gulf oil spill and to the Enron scandal.

Professor Thornton concludes: (italics original, bold mine)

The regulator is portrayed as a public-spirited specialist. They know the public good. They know the results that are expected. They know how to bring about those results. It is as simple for them to regulate their corner of the economy as it is for Emeril Lagasse to make crab cakes or for Martha Stewart to make a simple doily.

The public is told that regulators do not cause problems; they prevent them. They police the economy. They are the watchmen that have been endowed with the wisdom, ability, and selfless devotion to the public good.

There are indeed many people who work as government regulators that are very smart and well-trained that have public spirit and the public good in their hearts. There are also plenty of cads and knuckleheads that work as regulators.

The problem with government regulation is that you cannot fine-tune the regulations: nor can you perfect the regulatory work force in such a way to make regulation work in anything but a superficial way. The truth is that regulation instills confidence in the public so that they let down their guard and makes them less cautious while at the same time distorting the competitive nature of firms in the marketplace.

After every economic crisis there are calls for new regulations, more funding, and more controls. Economic wisdom dictates that we be ready to contest those calls when the next crisis of the interventionist state occurs.

Chart of the Day: The Bursting of the Renewable Energy Bubble

Environmental politics expressed through “manmade global warming” or now revamped as “climate change” has basically the same intent: promote political favored energy, as well as, establish social controls to supposedly protect the climate.

Yet the public hardly realizes that when government intervenes the result has always been the same: imbalances emerge and the laws of economics ventilated through markets will correct them.  This is simply the law of unintended consequence.

The renewable energy industry, which has been the principal beneficiary from climate change policies, have been thrashed by marketplace. Moreover politicization has led to unethical practices or has exposed cronyism such as the Solyndra scandal.

The chart above consisting of the market cap of the 30 of the world’s largest renewable energy companies has plummeted by more than 90% since the 2008 peak. 

From oversupply or to a build up of high capacity, to high energy prices, to the realization of fiscal realities and the European debt crisis, and to the stalemate in global climate negotiations, as explained by the Washington Times (chart also from them, hat tip AEI’s Mark Perry), has brought such politically hyped-to-the-firmament expectations back to earth.

Such outcome has been diametric to the largely free market based Shale gas revolution.

Bottom line: the market eventually explodes the illusions brought upon by politically inflated bubbles.

Symptoms of Welfare Crisis: French Actor Gérard Depardieu Joins Ballooning Lists of Tax Exiles

French actor Gérard Depardieu joins the growing list of wealthy French residents fleeing “soak the rich” politics.

The increasing number of so-called "tax exiles" is one of the major symptoms of the chronic disease called the welfare state crisis.

From the Telegraph.co.uk 

French actor Gérard Depardieu has set up legal residence in a Belgian village just over the French border to escape his country's punitive taxes, the local mayor has confirmed.

The 63-year-old star has bought an unglamorous-looking former customs official's house in the village of Nechin, a stone's throw from the nearest French town of Roubaix.

The corpulent screen icon is the latest rich Frenchman to flee the country ahead of a new tax of 75 per cent on all earnings over one million euros - around 850,000 pounds. Belgium's top rate is 50 per cent.

Around a third of the 2,800-strong population of Nechin was already French, the village mayor Daniel Senesael said.

The Depardieu case once again exhibits of how people’s incentives are shaped by social policies.

Apparently new repressive tax policies have breached Mr. Depardieu’s tax paying tolerance threshold level for him to consider voting with his feet and become a "tax exile". 

This could be seen as the curse of the Laffer curve.

Obviously the current tax policies have been meant to preserve the nation’s unsustainable welfare state. As this Op ED from Forbes.com notes,

In 2009, 11.2 million French persons received welfare payments, out a total population of 65.3 million. This amounted to $78 billion in payments. Moreover, these 11 million beneficiaries have families (parents, spouses, children); thus, more than 35 million people are actually benefiting directly or indirectly from welfare payments, which is more than 50 percent of the French population.

France’s welfare state may have seemed to work before, when there had been enough resources from productive citizens for the government to forcibly redistribute. But such era's curtains have been coming down.

Demographical forces particularly declining fertility rate amidst higher life expectancy, diminishing economic freedom and increasing politicization of the marketplace has led to a marked decline in relative global competitiveness according to the World Economic Forum. 

All these have combined to reduce the nation’s capability to finance the bulging welfare state.

And repressive tax policies have been the recourse of increasingly desperate French politicians wishing to maintain a highly fragile welfare based system based on debt and taxes. 

Yet myopically imposing stratospheric taxes on the rich seems to be backfiring as manifested by the expanding number of tax exiles. 

This seems similar to the recent experience in the United Kingdom, where 2/3 of the rich has recently disappeared.

Worst, aside from a growing anti-business environment from politics, the welfare state has been promoting a deepening culture of dependency. 

France has fallen to a poverty trap, says the same Op Ed from the Forbes.com, 

Since work cannot significantly bring a real improvement in daily life, it is better to stay “poor” and do nothing, which is not rewarding. Assistantship becomes more important than entrepreneurship.

A looming French debt crisis will likely represent as the proverbial final nail in the coffin for the centralization fantasies of the unelected bureaucrats in Brussels which should lead to more political instability in the region.

I worry that the risks of war is greater in the Eurozone (than in Asia) which may be triggered by the EU’s abrupt disintegration. 

And another thing. Here is another symptom of French entropy; there have been proposals for scheduled lighting outrages or a lighting ban in Paris, which has been popularly known as the "City of Lights", in order to "save energy". Beautiful Paris now a victim of politics.

Video: Murray Rothbard on Why People are Attracted to Statism

From Bob Wenzel

Asian Banking: China and Asian Banks Fill Void Left by European banks

Nature abhors a vacuum.

In Asia, the Bank of International Settlements recently remarked that China and Asian banks filled the void left by retrenching European banks

The Central Banks News notes…

A pullback by Swiss and euro area banks from Asia-Pacific has been countered by an expansion of local banks, including Chinese and offshore centers, resulting in a continuous rise in international credit to the booming region, the Bank of International Settlements (BIS) said.

Fears of a lack of funding in Asia-Pacific due to the retrenchment of European banks after the global financial crises and the euro area’s debt crises thus never materialized….

The statistics…

Foreign lending to Asia Pacific rocketed by 41 percent, or $613 billion to total outstanding claims of $2.1 trillion by mid-June 2012 from mid-2008, just before the collapse of Lehman Brothers, BIS said in its December quarterly review.

This expansion is in stark contrast to a drop in international lending to emerging Europe of 14 percent, or $230 billion, and a more modest increase in lending to Latin America of 24 percent, or $254 billion, in the same period.

In Asia Pacific, the total claims of euro area banks shrank by an estimated 30 percent, or around $120 billion, between mid-2008 and mid-2012 and their share of foreign lending fell from 27 percent  to 13 percent by mid-2012, BIS said.

More stats…

Drawing on other sources, such as Bankscope, BIS found that the unconsolidated total assets of Chinese banks’ foreign offices in Asia (excluding Singapore) grew by $135 billion, or 74 percent, from 2007 to 2011.

And based on data from Dealogic, BIS learned that Asian banks, including those from Hong Kong and Singapore, increased their syndicated loans to emerging Asia Pacific by 80 percent, or $223 billion, from 2007 to 2001. Asian banks' share of total signings rose to 64 percent from 53 percent.

Insights to draw from the above.

Unlike mainstream thinking, Chinese and Asian banks’ picking up of where European banks vacated signifies as spontaneous market action at work. This has essentially dissipated “fears” over the lack of funding. Again, nature abhors a vacuum.

The withdrawal of European banks in Asia may perhaps be read as “home bias”. Due to the ongoing crisis, European banks may have taken a defensive posture or may have reconfigured their corporate strategies to optimize on their competitive advantages on the domestic arena or has been made to raise capital by reducing expenses and by taking lesser external risks.

Yet such void presented an economic opportunity for Chinese and Asian banks. The report does not indicate that the actions of Asian banks have been under the directives of respective governments.

Also, the increasing role of China’s banks in providing financial intermediation to Asia has been consistent with her government’s push to promote the yuan as an international reserve currency. Deepening trade and financial relations and exposures will help promote regional currency based transactions.

On the other hand, this again reveals of the paradox between China’s militant regional (territorial claims) policy and economic and financial relations with the region—another instance of Dr Jekyll and Mr. Hyde relationship.

Importantly, this report shows of the deepening trend of financial integration in the region. The implication is that regional markets will be more correlated and more intertwined which should optimize the region’s economies of scales and hasten the financial and economic development

Alternatively, greater interconnectivity and interdependence infers to greater contagion risks.

Juan Marquez Shows Manny Pacquiao is Only Human

I expected younger opponents to deliver the closing chapters of Manny Pacquaio’s glorious and unparalleled boxing career, and hardly 39 year old Mexican Juan Miguel Marquez.

Whatever reasons attributed; deficient physical conditioning, reduced practice, lack of concentration, politics and et. al. that bout showed how luck can play a big and decisive role in determining outcomes.

I haven’t been watching boxing matches but the alternating knockdowns from both pugilists which I read via ESPN’s live forum, prompted me to do so from the replay. And I’d reckon that Marquez-Pacquiao 4 was a classic bout at par with Thrilla in Manila, Ali-Foreman, Sugar Ray Leonard-Roberto Duran etc...

And as I have been saying, Manny Pacquiao heralded as national pride, is only human. That match, contra populist sentiment, delivered the poignant message.

While boxing legend Pacquiao says he will consider retirement only after losing the second time, I’d say that the law of diminishing returns has been getting the better of him. The reason Pacquiao’s denies or refuses to accept retirement is that as I previously wrote

Of course reality bites, Mr. Pacquiao’s fame, fortune and political career have all been tied up with his boxing career. Once Mr. Pacquiao retires this privilege will erode overtime, as with all of the local celebrity sporting forebears.

So he may push his boxing career to the limits or take unnecessary risks in order to struggle to preserve this privilege.

Pacquiao’s attachment to his present privileges reflects on the people’s natural affinity to entitlements.

Yet Pacquiao’s devastating loss has stirred an outpouring of mushy comments on mainstream and social media. Most seem to forget that his national stature has come about due to his string of victories. That era may have ended. 

Where victory has a thousand fathers, said the late US President John F. Kennedy, defeat is an orphan. Such truism will likely expose on the public’s penchant for survivorship bias or the attachment or fixation on winners. If Pacquiao  continues to lose (and lose badly) will he remain the national pride? I doubt. My intuition is that like the other predecessor sporting legends, he will be forgotten. And this will likely even be manifested in his political career. The public will look for other talking points.

But not for me, as a former boxing fan, I’d say Pacquiao’s most valuable legacy have been one for the sporting history books: a feat that will remain unrivaled for a long long long period of time. 

When Corruption Greases the Wheels of Prosperity

Mainstream media seems befuddled by the connection between economic growth and corruption

The Reuters reports,

Uzbekistan, Bangladesh and Vietnam found themselves cheered and chided this week.

The Corruption Perceptions Index, compiled by Berlin-based watchdog Transparency International, measured the perceived levels of public sector corruption in 176 countries and all three found their way into the bottom half of the study.

Uzbekistan shared 170th place with Turkmenistan (a higher ranking denotes higher perceived corruption levels) . Vietnam was ranked 123th, tied with countries like Sierra Leone and Belarus, while Bangladesh was 144th.

Those findings are unlikely to surprise. But consider this. All three countries are said to boast some of the best prospects for business and growth over the next two decades. That’s according to the findings of a separate study released in the same week.

Uzbekistan, Vietnam and Bangladesh made it into the top 20 countries with the best growth prospects for business, outranking the United States, a study by political risk consultancy Maplecroft found…

They conclude:

Corruption and good growth prospects may seem uneasy bedfellows, but the findings of the two studies do hint that dodgy dealing might sometimes be a symptom of  a fast-moving, unshackled economy. Transparency International’s corruption study ranks China and India 80th and 94th respectively but these have also been the the world’s fastest growing economies, and its worth recalling that Maplecroft ranks them 1st and 2nd in terms of business growth potential.

Roman orator, lawyer, historian and senator Gaius Cornelius Tacitus or popularly known as Publius Tacitus accurately described the essence of corruption in the Annals: Corruptissima re publica plurimae leges or

The more numerous the laws, the more corrupt the government.

It is naïve or myopic to see people as inherently having perverse values as driving corruption. Instead, when politics, via legislation, ordinances, regulations, decrees or political institutions become an obstacle to survival, people will resort to corruption.

In short, the political environment influences people’s actions. The harder it is to engage in openly working for a living due to social controls, the more likely people’s economic activities will be driven underground or the informal economy (guerrilla capitalism), which would partly entail paying off or bribing political authorities.

Corruption, in this sense, signifies an intuitive reaction against political restrains on economic activities.

As University of Columbia assistant professor of political science Chris Blattman observes (hat tip Prof Pete Boettke) [italics original]

Most of us fail to imagine that corruption can also grease the wheels of prosperity. Yet in places where bureaucracies and organizations are inefficient (meaning entrepreneurs and big firms struggle to transport or export or comply with regulation), corruption could improve efficiency and growth. Bribes can act like a piece rate or price discrimination, and give faster or better service to the firms with highest opportunity cost of waiting.

In theory, this improves overall efficiency. If bribes subsidize large chunks of the government, then corruption reduces the need to collect taxes and allocate government spending efficiently–difficult and expensive tasks in poor countries. The “tax” that corruption imposes could be more efficient than the seemingly clean alternative.

It’s really not people who are immoral, but the politicians and the political environment which they made, that inhibits people's right to live.