Phisix 7,200: Up, up and away! The Illusions of Comfort

I said quoted Superman last week on the Phisix: Up, up and away!

And so it seems. 

This week, the Phisix soared by a whopping 2.7%. Woot! This adds to the accrued year to date gains now at a mammoth 24%. Woot! This comes amidst a seeming return of the “Risk On” environment in the global equity markets. 

If the current rate of returns at 5-6% a month will be sustained, this means that Phisix 10,000 will be reached by this yearend. Woot!

The Phisix Ascendancy. Malaysia as Periphery to Core?

The Philippine stock market has now assumed the role of the undisputed leader of Southeast Asia as three of our neighbors stumbled over the week.

In contrast to the Philippines, Indonesia’s downgrade by the S&P[1] has been attributed to this week’s modest decline. I am confident that such downgrade will unlikely to deter the Indonesia’s mania phase from unfolding.

But developments in Malaysia seem interesting and may have diverged from other ASEAN economies.

Since the year’s start, Malaysia’s equity benchmark, the KLCI, has been zigzagging between positive and negative territory. This could partly be due to the pre-elections uncertainty which culminates today, or could be due to signs of puffing on her homegrown property bubble.

Charts from global property guide[2] indicate that based on year on year changes, Malaysia housing prices have begun to materially decelerate (left). Malaysia’s home price index has ramped up as the global central banks flushed the world with a tsunami of money in 2008. 

Malaysia has also cut policy interest rates[3] from about 3.5% in 2008 to 2% in 2010, but raised them back to the 3% level in 2011. Nonetheless the banking system’s average lending rates are at the lowest levels (chart not included).

Housing loans now have grown to account for 25% of the GDP. Part of the slowdown could be due to recent anti-speculation or anti-bubble policies. But the fastest growth segment of both commercial and Islamic banks has been from unsecured loans or loans based on borrowers creditworthiness rather than backed by collateral as previously discussed[4].

Yet these mostly represent the demand side of Malaysia’s housing market. Housing is just a segment of the property markets which also includes office and commercial properties. I also lack data on the supply side to make further comments.

Yet it would seem that should Malaysia’s economy substantially slow, this heightens the risk of a regional bubble bust.

Are developments in Malaysia’s housing signs of the periphery to core dynamics?

We will see.

Nonetheless major global equity benchmarks have been reenergized by more central bank actions, particularly the ECB’s interest rate cut aside from plans to adapt a negative deposit rate policy[5].

Notice that the announcements of easing policies from central banks of developed economies have become more bolder and more frequent.

The Reflexivity Theory Nearly in Full Circle

The escalating vibrancy of the Phisix only continues to prove my point: we are in manic phase of a bubble cycle.

The 3-year chart (top) of the Phisix depicts of the 3 phased transition of the current uptrend which appears to be accelerating. A closer look via the six-month chart shows of renewed signs of parabola or the steepening of the price trend slope or what seems as a transition to a vertical ascent. Such price actions reveal of the rapidly expanding risk appetite and of the growing aggressiveness of market players to bid up equity prices.

So who says markets are about the conventional wisdom called “valuations”? Who says that there is such a thing called “expensive” in an environment where the public has decisively determined that there is no other way but up for Philippine assets?

The mainstream apparently doesn’t get it. Such dynamics has not been about statistics or about chart patterns. Instead all these have been about incentives and actions, where incentive drives people’s actions.

Why should the 5-6% statistical economic growth and supposed “fiscal discipline”, which are, in reality, masked by credit boom-embellished-growth data, justify a sustained upside trajectory of asset prices?

The domestic market has apparently lost its function as discounting mechanism and has transformed been into an object of speculative frenzy, underpinned by the prevailing bias of new paradigm, new order or “this time is different” mindset.

By prevailing bias, this means a self-reinforcing trend which tends to not only to influence market psychology channelled or expressed through prices but also through “fundamentals”[6]. 

Rising prices reinforce the belief of ‘good governance’ economics and “controlled deficits” meme. The deepening of public’s conviction has led bolder, more audacious and more adventurous moves from market players. Their actions raise the price levels of equity securities, most especially the popular ones.

Rising price levels has also prompted for the trifecta upgrades from the big three US credit rating agencies. This, in turn, boosts the craving for more equity market speculations. Thus, high prices will rationalize actions that will lead to even higher prices or the deepening of the price chasing or yield chasing dynamics: the mania phase.

Such two-way feedback loop mechanism between one, expectations, which are shaped by prices, and two, by the outcome, as signified by people’s responses and actions to the changes in prices, represent as the “reflexivity theory” as introduced by George Soros. The “reflexivity theory” essentially takes into account the sequential transformation of people’s psychology during the bubble cycle.

Yet the two way reflexive feedback loop that runs from expectations to outcome and from outcome to expectations “gives rise to initially self-fulfilling but eventual self-defeating prophesies and process”[7] and thus the boom bust cycles. 

The crucial psychological features[8] of boom bust sequence can identified as

-The Unrecognized trend

-The beginning of a self-reinforcing process

-The successful tests

-The growing conviction resulting in a widening divergence between reality and expectations

-The flaw in perception

-The climax

-A self-reinforcing process in the opposite direction

Today’s actions suggest that the Phisix operates anywhere between “the flaw in perception” to “the climax”

Credit markets are equally affected by the reflexive bubble behavior, again Mr. Soros, “when people are eager to borrow and when banks are willing to lend, the value of the collateral rises in a self-reinforcing manner and vice versa”[9]

In short, the reflexive feedback loop mechanism also works between markets and credit.

Phisix at 7,200 likewise means another month of significant expansion of credit growth.

The Philippine central bank, the Bangko Sentral ng Pilipinas (BSP) correctly notes that overall credit growth moderated in March[10]

Loans for production activities—which comprised more than four-fifths of banks’ aggregate loan portfolio—grew at a slower pace of 14.2 percent in March from 15.1 percent (revised) in February. Similarly, the growth in consumer loans eased to 10.8 percent in March from 11.9 percent in February due mainly to the slowdown across all types of household loans.

The expansion in production loans was driven primarily by increased lending to the following sectors: real estate, renting, and business services (25.2 percent); financial intermediation (28.8 percent); transportation, storage and communication (26.2 percent); wholesale and retail trade (10.4 percent); and, electricity, gas and water (15.4 percent). Meanwhile, lending to agriculture, hunting, and forestry (-10.3 percent) continued to decline in March.

But looking at the average omits the specifics. I would call this as hiding beneath the statistical averages. 

Financial intermediation and real estate loans, critical areas of the property stock-market bubble remains at same levels or even slightly higher. These sectors have been expanding by more than 25% even when statistical economic growth has only been 5-6%.

While growth in loans to the wholesale and retail trade shrunk in March, construction loans surged at still an astonishing rate of near 50%. I use wholesale and retail trade as gauge on the shopping mall bubble.

A better picture can be seen in the changes in the sectoral share of loans by the banking system.

By the end of 2012, the construction, trade, financial intermediation and real estate loans constituted 45.97% of all the production loans issued.

By March, this figure has swelled to 47.79%. In short, the growth of loans of these bubble sectors has been outpacing the rate of growth of loans from the other non-bubble sectors. And if such rate of growth will be sustained, by the yearend, the share of loans by the banking system on these bubble sensitive sectors will easily become the dominant force and will expose the banking system to unnecessary credit risk.

This despite all the blarney about the banking system as having adequate “capital” ratios. Banks in Cyprus supposedly passed the banking stress test held in 2011. The Bank of Cyprus also received many awards in 2011-2012[11]. Today, bank depositors in Cyprus will see large haircuts on their money.

Easy money from bank lending has also been reflected on liquidity conditions. Again the BSP on March activities[12].

Domestic liquidity (M3) increased by 11.4 percent year-on-year (y-o-y) in March to reach  P5.1 trillion. This growth was faster than the 9.4 percent (revised) expansion recorded in the previous month. On a monthly basis, seasonally-adjusted M3 also expanded at a faster pace of   1.5 percent compared to the 0.2 percent (revised) month-on-month growth in February.

The growth in money supply was driven largely by the sustained expansion in net domestic assets (NDA). NDA increased by 20.4 percent y-o-y in March from 16.5 percent (revised) in the previous month due largely to the continued increase in credits to the private sector, reflecting the robust lending activity of commercial banks. Claims on the private sector increased by 12.7 percent in March. Similarly, claims on the public sector increased by 12.3 percent in March, reversing the 6.5 percent decline (revised) in the previous month, a result of the increase in credits to the National Government (NG) and the decline in NG deposits.

Yield chasing tends to gravitate on the most popular sectors. Foreign money via portfolio investments has also participated in them. Again from the BSP[13]

Capital inflows went to PSE-listed securities (US$2.0 billion or 84.2 percent), Peso GS (US$351 million or 15.0 percent) and Peso time deposits (US$18 million or 0.8 percent). For PSE-listed securities, the main beneficiaries were holding firms (US$510 million), property companies (US$454 million), banks (US$333 million), telecommunication firms (US$185 million), and food, beverage and tobacco companies (US$183 million).

The biggest beneficiaries from the combined credit growth, portfolio flows and yield chasing activities can be seen mainly in the property, holding and financial sectors.

So we have the reflexivity theory running nearly in full circle.

The Concentrated Economy: Economic Boom and Booming Joblessness

When the S&P’s upgrade of the Philippines hit the headlines on Thursday, ironically, at the lower section of the same front page, I saw an article saying that domestic unemployment continues to swell.

From the Inquirer.net[14]

Joblessness in the country worsened in the first quarter of the year, the latest Social Weather Stations (SWS) survey found, with an economist tracing the rise in unemployment rate to fresh graduates joining the labor pool.

Filipino adults without jobs numbered 11.1 million, up 10 percent from the 10.1 million recorded at the end of 2012, results of the survey that SWS conducted from March 19 to 22 showed.

Wow a “boom” in joblessness.

Looking at the statistical unemployment figures[15], one would note that the biggest improvement came during 2005 where jobless rate fell from 14% to current levels, which paradoxically was prior to this booming regime.

Yet from 2006-2012, unemployment seems to have fluctuated in a range of 6.9 to 8%.

I do not trust surveys and unemployment data for the simple reason that significantly more than 40% of the Philippine economy has been informal or shadow or underground[16]. So if informal economies can hardly be measured, then the likelihood of substantial errors from statistical estimates.

Nonetheless what arouses my curiosity is that the much ballyhooed economic boom tagged as the “Rising Star of Asia”[17] seems to have been “concentrated” on few sectors of the economy. And this is most likely the reason behind the supposed “boom” in joblessness, as pointed out by the survey.

Even the government’s statistics has not shown any material improvement in joblessness, despite Phisix at 7,200, the Peso at 40s or 6.6% GDP growth in 2012.

Of course, such adverse information has been and will be ignored by the brainwashed gullible public. Hardly any of domestic media seems to have carried the recent warnings of ASEAN asset bubbles by the IMF[18] or from a report by the CNBC[19]. 

Apparently real world developments have been vacuumed into a vortex. People with rose colored glasses will think that all these signify as mere political rant, or that such systemic threats will not be enough to undermine today’s blissful nirvana, or political authorities will ride like the knight to save the damsel in distress in time, or that bad events will hardly befall on them (denigration of history).

Yet all these suggest that people openly embrace illusions in order to escape reality. As Nobel laureate psychologist and author Daniel Kahneman explains[20],

The illusion that one understands the past feeds further illusion that one can predict and control the future. These illusions are comforting. They reduce the anxiety that would experience if we allowed ourselves to fully acknowledge the uncertainties of existence. We all need for the reassuring message that actions have appropriate consequences, and that success will reward wisdom and courage. Many business books are tailor-made to satisfy this need.

Ironically despite the credit upgrade, which has been anchored mostly on strong external position and on the supposed improvement of debt burden, the credit rating agency S&P underscored what seems as the same theme of “concentrated growth”

From the Inquirer[21]:

S&P estimated that the country’s per capita income (the total value of the economy’s output divided by the population) would settle at $2,850 this year, a level lower than those of most countries with the same credit rating.

“The Philippine economy’s low income level remains a key rating constraint. The concentrated nature of the economy, infrastructure shortfalls and restrictions on foreign ownership, which deter foreign investment, are factors that hamper growth,” S&P said.

The good part is that in order to attract investments, the S&P recommended liberalization of the “regulatory environment in a manner that allows easier entry of foreign investors, according to S&P.” The S&P also recommends more infrastructure spending.

The S&P likewise acknowledges of the fundamental shortcomings of the Philippine political economy but bizarrely rewards or subsidizes such via a credit upgrade. By doing so, there will be lesser incentives for the incumbent officials to embrace real economic reform via liberalization.

Think Europe. Central bank’s backstopping (or subsidies) of the banking system which has led to lofty financial markets have prompted politicians and the mainstream to rationalize the jettisoning of reforms based on phony “austerity”[22], thereby resuscitating the risks of prolonged depression as well as the risks of a breakup of the euro.

Perhaps the S&P thinks that by putting their stamp of approval on the Philippine government they will heroically be able to convince investors.

Or perhaps, the S&P’s sees the need to be a part of the bandwagon because these have been the chic. 

The trenchant iconoclast and Black Swan author Nassim Nicolas Taleb warned of folly from the groupthink[23]

Alas, one cannot assert authority by accepting one’s own fallibility. Simply people need to be blinded by knowledge—we are made to follow leaders who can gather people together because the advantages of being in groups trump the disadvantages of being alone. It has been more profitable for us to bind together in the wrong direction than to be alone in the right one. Those who have followed the assertive idiot rather than the introspective wise person have passed us some of their genes

Ivory Tower Prescription: Solve Investment Problems with More Interventions

So if investments have been the problem, how does the BSP governor, Amando Tetangco Jr. propose to solve them? The following article gives a clue.

From the Inquirer[24]:

To avoid the middle-income trap, one must increase investments and expand the economy’s absorptive capacity. Now is a very good time to do that given the low interest rates and sufficient liquidity that can be tapped for investment activities

Government spending has gone up over the last three years, and it has significantly contributed to the country’s growth. The private sector should now invest more and serve as the main growth driver of the economy

Some important nuggets of wisdom from such comments:

One, as pointed out last week, aside from sectors driven by massive credit expansion, government spending has been artificially bolstering the statistical economy. This is the reason the why the Philippine government has been tightening the noose on taxes and why the government has launched a shame “class warfare” campaign against wealthy Chinese and members of the Forbes billionaires list.

Does it not seem odd or a logical self-contradiction to think that taxes increases have been thought as being compatible with investments?

Raising taxes increases a firm or an enterprise’s cost of doing business which also means the reduction of the rate of profitability or increases the hurdle rate required for a business to survive, all these extrapolates to penalizing investments. So how will raising taxes lead to more investments?

Yet there are also other political aspects serving as obstacles to promoting businesses, such as more regulations, mandates, inflation, bureaucracy, welfare and other political interventions.

Does the good governor also not realize that by the government’s engagement of class warfare rhetoric translates to the heightening risks of political instability? Will companies invest in economies where property rights are not secured and whose assets are at the risks of arbitrary confiscation from populist policies?

The sad part is that ivory tower based experts have little idea of what goes on in the real world and have been blinded by math based models.

Two, the good governor appears to be saying join the bubble! Interest rates will forever be low. The laws of economics do not exist in the Philippines.

But an economy operating in bubbles would translate to relative price instability. And price instability will impact economic calculation. Price instability will be pronounced especially in the input costs of sectors experiencing bubbles. Economic calculation problems will reduce the investor’s motivation to invest. People will be induced to speculate more in financial markets than to invest in productive activities. 

And this could be why the seeming preference by foreigners on portfolio flows (US $3.911 billion; 2012) rather than to foreign direct investments[25] (US$1.053 billion; 2012) as shown above.

In short, price instability and distortion in the capital structures leads to a shrinking of the markets or real economy and capital losses. How then will these attract investments?

Third, the middle income trap is a macroeconomic hooey. Just take a look at the Phisix. Do the punters and speculators stop buying the Phisix after hitting certain income or price level? Or are they “trapped” at certain income or price levels? Apparently not.

On the contrary, the yield chasing phenomenon into voguish themes based on flawed perception of reality that has been enabled and facilitated by credit expansions has been dramatically escalating. This signifies of the deepening of the mania phase. Such mania has been frequently characterized as “greed”.

While people operate within their own “comfort zones” or limits on the activities they engage in, these are subjectively and individually determined. These cannot be captured by aggregates or by statistics as they are constantly changing.

Yet when people’s income rises or when the middle class grows, they don’t really get “trapped” or get caught in a stasis which is a very foolish way to see the world.

Instead, political officials see and use such as opportunities to impose expansions on myriad political programs. Such diversion of productive resources to non-productive use essentially becomes the “trap”.

As I previously pointed out[26],

the more intervention, the lesser the capital accumulation or reduced economic growth. When politicians become greedy enough to divert much wealth into policy driven consumption activities then productivity diminishes. And that's where the so-called statistical 'trap' comes in.

The fallacious middle income trap theory does not even see people as human beings but as some statistical abstract, who are incapable of thinking.

The problem of investments will not be solved by interventionist policies, but by the promotion economic freedom through the dismantling of anti-competitive laws that benefits the concentrated few.

Philippines Government Balks at ASEAN Integration: Delays Joining ASEAN Trading Link

But real reforms haven’t really been on the cards.

Just take a look at the latest ASEAN integration talks. The Philippine president threw cold water on the possibility of a free trade zone in 2015

From the Rappler[27]:

Southeast Asia's efforts to create a single market by 2015 are in their hardest phase owing to protectionist reflexes on sensitive sectors, Philippine President Benigno Aquino said.

Despite the challenges, however, leaders of the Association of Southeast Asian Nations are working hard to meet the target, Aquino told reporters on Wednesday night, April 24, in Brunei where he is attending ASEAN's annual summit.

"They have finished with the easy parts but the accomplishments will not be as fast as in discussing the hard parts. When you reach that point, there can be some protectionist measures taken by each economy," Aquino said.

"But since we are focused on reaching the target, everyone who believes that one community is beneficial to everybody concerned will really try hard (to reach the goal)."

“Protectionist reflexes on sensitive sectors” represents as the “concentrated” segments of the economy that are controlled by the unholy alliance of political elites and their cronies. They are the key beneficiaries of today’s central bank asset market friendly policies. Many of them are into the yield chasing bubbles in the real economy. And so the unevenness of the much touted economic boom.

Yet like typical politicians, promises have been made but fulfilment will be pushed into the future.

Proof?

Take the ASEAN Trading Link[28]. This is milestone pan-Asian financial platform project aimed at linking 7 stock exchanges from 6 countries that would allow more than 3,600 companies to be traded within the ASEAN region.

Think of trading Thai, Malaysian, Singaporean, Vietnam, Indonesian stocks under the PSE platform. Integrating these exchanges would mean vastly expanded supply of equities (more choice), greater access to capital and investors (bigger markets), lower transaction costs, trading efficiency, promote competition and transparency, more integrated economies which should promote REAL economic growth, and many other multiplier effects as cross cultural relations and more. Think about communicating with more ASEAN people due to cross border trading (e.g. stock market forums, or annual meetings)

As of 2012, Thailand has joined Singapore and Malaysia[29]. Vietnam has conducted a roadshow on INVEST ASEAN 2013 and will join sometime within the year[30].

But the Philippines for two years or from 2011[31] has resorted to dilatory manoeuvres to defer on participating in the trading link. In 2012 the PSE, a monopoly regulated by the SEC, will be delayed due to flimsy reasons; supposedly for getting the system into place and for updating regulations[32].

Let me guess, should there emerge a crisis from anywhere that will affect the region, this will again be used as pretext for postponement.

Yet the refusal to integrate with the region can be seen as parallel to the absence of spot or commodity futures markets. Reason: vested interests. We are the only major ASEAN country without commodity markets. That’s because commodity markets will displace the highly connected middlemen.

Such refusal to equitably distribute economic opportunities via marketplace particularly through economic freedom is simply a sign of protecting economic interest of the politically connected or cronyism.

Good governance? Duh!

This also means that the statistical growth based on government spending, concentrated “crony” based economy and credit driven expansion all adds up illusions from a credit driven asset bubble.

George Magnus: Asia’s Vulnerabilities

The prominent economist George Magnus, who coined the Minsky Moment, recently wrote that Asia needs to rely on real reforms than from “miracles”. He states that one of the six major vulnerabilities of Asia as[33]:

Asia's 'financial' indicators are flashing warning signs, even if there does not appear any immediate threat of instability, and many financial regulation lessons from the Asia crisis have remained 'learned'.

But excluding China, the ratio of credit to GDP has risen to over 100% — higher than it was in 1997. Also, land loan to deposit ratios in Asian banking systems are rising significantly again.

Those who refuse to learn the lessons of history are bound to repeat them.

Yet the other vulnerabilities cited by Mr. Magnus are China’s economic performance, the export centric models of ASEAN and East Asian giants, more complex Asian economies, India’s demographic dividends, and income inequality.

Except for China, I am not so concerned for the others as these problems that are mostly products of interventions which economic liberalization should be able to address. For instance, wealth or income inequality, as shown above, has been products of cronyism and corporate protectionism or corporatism.

While the public is being deceived by an artificial boom masked by credit expansion, the real beneficiaries are the financial asset holders, since central bank policies essentially provide subsidies to these assets at the expense of the real economy whether in the US, or Philippines or elsewhere.

As analyst Doug Noland enunciates of the nature of inflationism[34]

Once its takes root, monetary expansion enjoys powerful momentum and powerful constituents. The bias is always to get bigger, with system deficiencies amply available for justification and rationalization.

Record US Stocks, Near Record Net Margin Debt

Finally as the US stock markets soar to unprecedented heights this chart is a must look

US Stock markets has likewise been driven by a credit bubble, as margin debt nearly hits record highs[35]. Margin debt is just one of the many symptoms of blossoming credit bubble in the US. But such would be a subject for another day.

For now, the mania phase seems as gaining more momentum.

Up, Up and Away!

Trade cautiously.

---

[1] Jakarta Globe Indonesian Officials Confident Economy to Grow Despite Rating Outlook Downgrade, May 3, 2013

[2] Global Property Guide Malaysian house prices continue to rise, albeit at a slower pace April 11, 2013

[3] Tradingeconomics.com MALAYSIA INTEREST RATE

[4] See More Signs of Manic Phase in The Phisix, ASEAN and the US March 4, 2013

[5] See ECB Cuts Rates, Mulls Negative Deposit Rates May 3, 2013

[6] See Reflexivity Theory In Commodity Markets November 3, 2008

[7] George Soros The Alchemy of Finance John Wiley $ Sons 2003 p.5

[8] Soros ibid p. 58

[9] Soros ibid p .23

[10] Bangko Sentral ng Pilipinas Bank Lending Growth Sustained in March April 30, 2013

[11] See Example of the Mania Phase: Awards Received by the Bank of Cyprus March 27,2013

[12] Bangko Sentral ng Pilipinas Domestic Liquidity Growth Higher in March April 30, 2013

[13] Bangko Sentral ng Pilipinas Foreign Portfolio Investments Grow in March April 11, 2013

[14] Inquirer.net 1M join ranks of jobless Filipinos, May 3, 2013

[15] Tradingeconomics.com PHILIPPINES UNEMPLOYMENT RATE

[16] See Shopping Mall Bubble: Will Remittances, BPOs and the Informal Economy Save the Day? January 21, 2013

[17] See Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania April 29, 2013

[18] See IMF to Asia: Put a Brake on Credit Bubbles! April 30, 2013

[19] See CNBC: The Growing Risks from ASEAN’s Asset Bubbles May 1, 2013

[20] Daniel Kahneman Thinking, Fast and Slow p.204-205

[21] Inquirer.net S&P gives PH second credit ratings upgrade May 03, 2013

[22] Bloomberg.com European Leaders’ Softening on Austerity May Accelerate April 29, 2013

[23] Nassim Nicolas Taleb, The Black Swan The Impact of the Highly Improbable, Allen Lane p.192

[24] Inquirer.net BSP: PH likely to avoid ‘middle-income trap’ May 2, 2013

[25] BSP Foreign Direct Investments Post US$576 Million Net Inflows in January 2013 April 10, 2013

[26] See The Myth of the Middle Income Trap March 28, 2013

[27] Rappler.com ASEAN single market push in hardest phase: Aquino, April 25, 2013

[28] Asiaetrading.com THE ASEAN TRADING LINK EXPLAINED

[29] Wikipedia.org ASEAN Exchanges

[30] Thetradenews.com ASEAN Trading Link extends to Vietnam April 3, 2013

[31] ABS-CBN PSE delays joining ASEAN trading link November 18, 2011

[32] Business Mirror Cross-border e-trading link will just have to wait for PSE December 9, 2012

[33] George Magnus Is Asia's Miracle Over? May 02, 2013

[34] Doug Noland Too Much Asset Inflation Credit Bubble Bulletin Prudent Bear May 3, 2013

[35] Bloomberg.com Near-Record NYSE Margin Debt Leads to Caution: Chart of the Day, May 2, 2013

Richard Ebeling: No Voting Right for Those Living at the Taxpayer’s Expense

Parasites should be disenfranchised from the rights to suffrage argues Austrian economist and Northwood University professor Richard Ebeling at the Epic Times

One of the most sacred ideas in our democratic era is the belief in the universal and equal right of all citizens to have the voting franchise. Yet, some have argued against this “right.” But their challenge to an unlimited right to vote has not been based on grounds of gender, age, or property ownership.

One such critic was the famous British social philosopher and political economist, John Stuart Mill. In his 1859 book, “Reflections on Representative Government,” (Chapter 8, ‘Of the Extension of the Suffrage’), Mill argued that those who received “public assistance” (government welfare) should be denied the voting franchise for as long as they receive such tax-based financial support and livelihood.

Simply put, Mill reasoned that this creates an inescapable conflict of interest, in the ability of some to vote for the very government funds that are taxed away from others for their own benefit. Or as Mill expresses it:

“It is important, that the assembly which votes the taxes, either general or local, should be elected exclusively by those who pay something towards the taxes imposed. Those who pay no taxes, disposing by their votes of other people’s money, have every motive to be lavish and none to economize.

“As far as money matters are concerned, any power of voting possessed by them is a violation of the fundamental principle of free government . . . It amounts to allowing them to put their hands into other people’s pockets for any purpose which they think fit to call a public one.”

Mill went on to explain why he considered this to be especially true for those relying upon tax-based, redistributed welfare dependency, which in 19th century Great Britain was dispersed by the local parishes of the Church of England. Said Mill:

“I regard it as required by first principles, that the receipt of parish relief should be a peremptory disqualification for the [voting] franchise. He who cannot by his labor suffice for his own support has no claim to the privilege of helping himself to the money of others . . .

“Those to whom he is indebted for the continuance of his very existence may justly claim the exclusive management of those common concerns, to which he now brings nothing, or less than he takes away.

“As a condition of the franchise, a term should be fixed, say five years previous to the registry, during which the applicant’s name has not been on the parish books as a recipient of relief.”

Read the rest here.

Side Effects of Inflationism: Rat Meat, Horsemeat and Fake Tuna Scandals

Due to price instability brought about by inflationist policies, one of the major nasty side effects has been to encourage a decline in quality of products (value deflation) or even promote fraud in the marketplace in order for many to survive.

As the great Murray N. Rothbard explained (bold mine)

By creating illusory profits and distorting economic calculation, inflation will suspend the free market's penalizing of inefficient, and rewarding of efficient, firms. Almost all firms will seemingly prosper. The general atmosphere of a "sellers' market" will lead to a decline in the quality of goods and of service to consumers, since consumers often resist price increases less when they occur in the form of downgrading of quality.  The quality of work will decline in an inflation for a more subtle reason: people become enamored of "get-rich-quick" schemes, seemingly within their grasp in an era of ever-rising prices, and often scorn sober effort. Inflation also penalizes thrift and encourages debt, for any sum of money loaned will be repaid in dollars of lower purchasing power than when originally received. The incentive, then, is to borrow and repay later rather than save and lend. Inflation, therefore, lowers the general standard of living in the very course of creating a tinsel atmosphere of "prosperity."

Take for instance the recent horsemeat scandal that hit Europe. UK’s The Guardian offers the origin: (bold mine)

Supermarket buyers and big brands have been driving down prices, seeking special offers on meat products as consumers cut back on their spending in the face of recession. The squeeze on prices has come at a time when manufacturers' costs have been soaring. Beef prices have been at record highs as has the price of grain needed to feed cattle. The cost of energy, heavily used in industrial processing and to fuel centralised distribution chains, has also soared. There has been a mistmatch between the cost of real beef and what companies are prepared to pay.

Such price mismatching gives credence to the economic logic that inflationism encourages value deflation or fraud. The next question is what causes such mismatches?

There has also been reportedly growing incidences of mislabeling of tuna and other growing seafood fraud in the US from 2010-2012.

In China, food scams has become a recent fixture. Some of what has been sold as lamb meat have been substituted with rat meat.

From Washington Post:

BEIJING — Chinese police have broken up a criminal ring accused of taking meat from rats and foxes and selling it as lamb in the country’s latest food safety scandal.

The Ministry of Public Security released results of a three-month crackdown on food safety violators, saying in a statement that authorities investigated more than 380 cases and arrested 904 suspects.

Among those arrested were 63 people who allegedly ran an operation in Shanghai and the coastal city of Wuxi that bought fox, mink, rat and other meat that had not been tested for quality and safety, processed it with additives like gelatin and passed it off as lamb.

The meat was sold to farmers’ markets in Jiangsu province and Shanghai, it said.

Despite years of food scandals — from milk contaminated with an industrial chemical to the use of industrial dyes in eggs — China has been unable to clean up its food supply chain.

There seems to be a coincidence: China’s food scandals emerged at the same period where accounts of seafood fraud in the US surfaced. 

From the same article

The supreme court said 2,088 people have been prosecuted in 2010-2012 in 1,533 food safety cases. It said the number of such cases has grown exponentially in the past several years. For example, Chinese courts prosecuted 861 cases of poisonous food in 2012, compared to 80 cases in 2010.

And all these likewise coincides with accounts of Ponzi and pyramiding scams in the Philippines and the world.

Media predominantly points the finger on individual aberrations or the lack of regulations as source of such misdemeanor, misdeeds or iniquities. Yet such would only signify as dealing with the superficial or the symptoms rather than the cause.

Media either have deliberately overlooked or have been ignorant of the incentives brought about by social policies that has led to such repulsive erosion of the public's moral fiber. Like price controls, culpability has been shifted to the private sector to justify more politicization when such logic gets it backwards. 

In reality, these offenses represent the unintended effects from the distortions of price signals brought about by monetary inflationism, which central banks have employed and which has been growing at accelerating scale, since 2008. (chart from Tradingeconomics.com)

Quote of the Day: Power is the root of corruption; other aspects are its symptoms

The  following insightful but lengthy quote references China’s political economy, as written by Professor Weiying Zhang in "The Logic of Markets" (courtesy of and thanks to Mao Money, Mao Problems) [bold mine] 

I once used a mathematical equation to analyze and show that the increase in actual corruption has a few origins. One is that with the increase in the degree the Chinese economy has monetized; the economic value of power has increased. The second is that the complexity of economic relations has caused supervision to become more and more difficult. The third is the growth in market opportunity caused government officials to “preserve utility” (the utility they would receive if they were forced out of the government as punishment for corruption). The fourth is the level of punishment has been reduced (such as the amount embezzled to receive the death penalty was increased significantly). The fifth is the formal salaries of government officials are relatively low. 

The five factors described above are all related to power. Power is the root of corruption; other aspects are its symptoms. Anti-corruption measures must address both the symptoms and its root, but direct action would cure the root. That direct action is to reduce the power of government officials. Some have proposed “high salaries to encourage honesty,” which makes a bit of sense. In a situation where the power of government officials is excessive, honesty cannot be encouraged with high salaries. If officials’ salaries are too high, the masses will not accept it. The key issue here is that government departments in our country have monopolized many rights that belong to private citizens and businesses in other countries with a market economy. Examples include starting a business and engaging in investment activities, which require government approval. Individuals and businesses have no option but to “buy out” by means of corruption rights to engage in normal economic activity that should belong to them in the first place. In connection with anti-corruption measures at present that only cure the symptoms without curing the cause, I said in 1994 that if we do not change the fundamentals of our government controlled economic system, and reduce the government’s administrative approval authorities, corruption of private goods (according to the definition in economics, without exclusiveness) is instead a “sub-optimal” choice. My meaning is that to stop corruption we must cure its root, not its symptoms. On the one hand stressing anti-corruption measures without wanting to reduce government power on the other hand is self deception. Not only can it not succeed, or even if it succeeds in the short term, it comes at the price of a huge impairment to society. A prerequisite for high economic growth without corruption is the abolition of the government’s monopoly over the power to allocate resources. Some say that I am defending corruption, but actually this is a misunderstanding of my views. Penetrating discussion of issues is the responsibility of scholars. In 1999, at the High Level Forum on Chinese Development, I said, “Government control needs to be given up just as drugs need to be given up,” and added, “If government examination and approvals were abolished, corruption could be reduced by at least 50%.” This message had a large impact on the proceeding system of examination and approvals reform. Ten thousand good wishes cannot match one effective action!

As shown above, corruption is a byproduct of a raft of arbitrary statutes, regulations and edicts, that bequeaths unnecessary political power to political agents which incentivizes abuse or what public sees as immoral 'corrupt' actions.

And when the media and credit rating agencies pontificate on political ascendancy from so-called anti-corruption reforms by merely persecuting ‘corrupt’ officials, pay heed or be reminded of the reverberating words of Professor Weiying Zhang 

stressing anti-corruption measures without wanting to reduce government power on the other hand is self deception.

In other words, never confuse substance with form, or symptoms with the cause.

By the way here, is a short comical skit depicting "Too Much power" culled from a 1957 movie called "A King in New York City" played by the late British comedian icon Charlie Chaplin and his son Michael. (hat tip Prof Bob Murphy)

Free Market’s Response to Government Drone Spying: The Drone Shield

The US government has been foisting the legitimization of the use of drones (as many as 30,000) to patrol the skies to allegedly to maintain ‘public safety’. 

While there may be emergent anti-drone technology such as the laser weapon system, the free markets seems to have a cheaper response to the threat of UAV government surveillance or of the intrusion to privacy: the Drone Shield 

From the USNews.com (hat tip EPJ)

Worried about drones spying on you? Soon, a device might be able to send you text and email alerts that let you know when a drone is nearby.

A Washington, D.C.-based engineer is working on the "Drone Shield," a small, Wi-Fi-connected device that uses a microphone to detect a drone's "acoustic signatures" (sound frequency and spectrum) when it's within range.

The company's founder, John Franklin, who has been working in aerospace engineering for seven years, says he hopes to start selling the device sometime this year. He is using the Kickstarter-like Indiegogo to finance the project.

The device will cost $69 and will be about the size of a USB thumb drive. It will use Raspberry Pi – a tiny, $25 computer – and commercially available microphones to detect drones. He says he imagines that people will attach the Drone Shield to their fences or roofs to protect their home from surveillance.

"People will get the alert and then close their blinds," Franklin says.

Every attempt by governments to establish a police state through technology will eventually be met by a pushback from the markets.

In the future, drones will likely be used more by the markets.

ECB Cuts Rates, Mulls Negative Deposit Rates

Central banks are reinforcing their assumed roles as superheroes for the global political economy.

Justifying a weak regional economy, the ECB has once again pared down interest rates…

From Bloomberg:

The European Central Bank cut its key interest rate to a record low as the 17-nation euro region struggles to emerge from recession.

Policy makers meeting in Bratislava today lowered the main refinancing rate to 0.5 percent from 0.75 percent, a move predicted by 45 of 70 economists in a Bloomberg News survey. The ECB kept the deposit rate at zero and reduced the marginal lending rate to 1 percent from 1.5 percent to preserve a symmetrical rate corridor. President Mario Draghi holds a press conference in the Slovakian capital at 2:30 p.m.

Since Draghi said last month that he stood ready to act if Europe’s economic outlook worsened, inflation plunged, economic confidence slumped and unemployment rose. Today’s cut, the first since July last year, takes the ECB closer to exhausting its conventional policy tools, raising the prospect of a negative deposit rate or new non-standard measures.

I have been expecting bolder and more aggressive experiments or tinkering with the financial system from central bankers. Central bankers will push using central banking (inflationism) tools to the limits.

The ECB has mulled on negative deposit rates since 2012, then I wrote:

Central banks have only one thing in mind: That is to expand to credit (inflationism) to supposedly boost aggregate demand which is reality serves as an academic cover for the true purpose—finance extravagant governments.

Unfortunately the world isn’t that simple. People refuse to take on more credit for several reasons: They have been drowning in debt, they have been tarnished by bad or blemished credit scores, they could be suffering from lower income or unemployment is high due to the recession, business environment has been hampered by politics banking institutions have been clogged and for many other reasons which reduces their incentives to do so.

What negative deposit rates will likely do is to destabilize allocation of resources and spawn more malinvestments and fuel frenetic speculation that leads to boom-bust cycles and worsen the situation

At the press conference following the announcement of the cutting of rates, the Financial Times’ Person of the year ECB’s Chief Mario Draghi has remarkable comments on the negative deposit rate and on the direction of ECB policies which deserves some comments. (bold mine)

On negative deposit rates:

We said in the past we are technically ready. There are several unintended consequences that may stem from this measure. We will address and cope with these consequences if we decide to act. And we will again look at this with an open mind and stand ready to act if needed.

Unintended consequences, which are likely to be systemic, will be suffered, not only by the taxpayers, but by the regional economy that may affect the world. This is because centralization of risk taking, which assumes simplicity and homogeneity, goes against the reality of a complex world.

Central bankers have been revealed as having no qualms using the economy as guinea pigs for their grand designs.

And for whose benefit?

Mr. Draghi on the direction of ECB policies:

I would use the word frustrated, yes. We view improvements in financial markets. We think financial markets are the only and the necessary channel for the transmission of monetary policy. You don’t go around with helicopter money, throwing money. In Europe, you go through banks. You don’t have capital markets as you have in the U.S. We have to go via the banking system. That is why in my press conference I try to give you a very detailed reading of different indicators because it shows how closely we are trying to examine and analyze reality to see whether these impulses that we’ve been transmitting to the economy get translated into better welfare, lower unemployment, better economic activity.

So there you have it folks, no helicopter money, ECB’s policies will mainly be directed at the rescues of the crony banking system.

Thus the consideration of negative deposit rates or of the charging financial institutions for the money they deposited with the central bank which once again will penalize savers.

Today’s derring-do rock star central bankers hardly understands why centralization will mostly fail to accomplish its goals.

As the great Nobel laureate Austrian economist Friedrich von Hayek warned of Fatal Conceit by political authorities 

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. To the naive mind that can conceive of order only as the product of deliberate arrangement, it may seem absurd that in complex conditions order, and adaptation to the unknown, can be achieved more effectively by decentralizing decisions and that a division of authority will actually extend the possibility of overall order. Yet that decentralization actually leads to more information being taken into account

Video: Ron Paul and Jim Rogers on bankrupt governments: They will use intimidation, force and guns

At the recent Sovereign Man Workshop, former US congressman Ron Paul together with the legendary investor Jim Rogers talks about what to expect from desperate bankrupt governments 

Some noteworthy quotes: (video courtesy of the Sovereign Man)

Ron Paul: I would expect that there would a lot more chaos to come and it will not be limited to Europe. I think it will be a worldwide phenomenon 

Jim Rogers: They won’t take our bank accounts…they will take our retirement accounts.

Ron Paul: They will do what I think is necessary, they will use force and they will use intimidation, they will use guns because you can’t challenge the state’s right to control the money

Bank of Israel Buys Equities and Foreign Currencies

As I have been pointing out, inflationism has now become a central banking standard.

The Bank of Israel has reportedly bought $200 million of foreign currencies

From Ynet News.com

The Bank of Israel bought an estimated $200 million of foreign currency on Tuesday in a bid to weaken the shekel after it hit a 19-month high, although the move had little effect.

With exports comprising 40% of Israeli economic activity, the central bank has made it clear it will not allow a steep rise in the shekel.

So nearly every country have been attempting to “devalue” against another, which should provoke a competition or a race to the bottom. Some call this the currency wars.

This also shows how global central bankers will put to test the current paper money standard to the limits. Current developments have made them believe that they have attained a policymaking nirvana or where money printing bears no consequences to the real economy.

Also Bank of Israel is one example of countries supposedly diversifying into equities.

From Bloomberg:

The Bank of Israel plans to almost double equity holdings by the end of the year after falling bond yields prompted the central bank to invest in European shares for the first time.

The bank will increase its stock holdings to as much as 6 percent of foreign-exchange reserves, or about $4.5 billion, from 3 percent at the end of 2012, according to Yossi Saadon, a Bank of Israel spokesman. Investments in shares rose to about 4.5 percent of assets in the first four months of 2013 as the institution made a “small allocation” to European equities in addition to its U.S. funds, he said.

Aside from the political motive, central bank operations seem to have transitioned into hedge fund operations but underpinned by the “guns and badges” institutions.

Bank of Israel’s equity exposure on the European and US equities could be interpreted as providing support on the equity markets of the US and Eurozone.

Ironically, this comes as the shekel is deliberately being devalued by them.

Bank of Israel’s actions thus appears to be tweaking profits via foreing currency-foreign equity arbitrages through policies. 

Are these not insider trading or manipulations? At whose expense? Market players and the economy?

I am not sure whether Bank of Israel’s equity purchases has been entirely foreign.

Nonetheless Israel’s TA-25 appears to be on mends following a downdraft in 2011. (chart from tradingeconomics.com)

Bank of Israel’s recent actions are examples of implicit guarantees on asset prices that only balloons the global pandemic of asset bubbles.

More Poker Bluffs: FED will Cut QE by Yearend

Since 2010, each time the US economy showed some signs of strength, Fed officials talk about “exit” strategies or the communications strategy proposing policy changes by the reduction on the amount of stimulus applied to the economy. Such farcical routine I have repeatedly called as “poker bluffing”. 

Recent record stock market highs, a conspicuous rebound in the housing markets and some indications of economic “recovery” has again prompted Fed officials to blather anew about paring down stimulus.

From Bloomberg

Chairman Ben S. Bernanke will probably reduce the Federal Reserve’s monthly bond buying in the fourth quarter to $50 billion from $85 billion as he begins to unwind record stimulus, economists said in a Bloomberg survey.

Policy makers must find a way to slow the pace of purchases enough to signal confidence the economy is strengthening without prompting a sudden rise in interest rates, said former Fed economists Michael Feroli and Joseph LaVorgna. They said that probably means the Fed, which concludes a policy meeting today, will follow a three-step strategy to wind down bond buying.

How it seems so simple.

Yet since 2010, each exit blarney has led to the opposite outcome. The US Federal Reserve’s stock holding of US treasuries for instance continues to balloon. The recent jump includes QEternity.

At the end of 2012, 90% of US treasuries issued were bought by the US Federal Reserve.

As explained before, the exit talk is likely a sham because there are hardly enough savings (domestic or foreign) that the US government can tap to finance her spendthrift ways. 

Whatever recovery seen in the US economy are symptoms of inflationary boom rather than a genuine economic growth. Yet another economic bust would mean more debt from more bailouts and more inflationism.

Besides, US financial markets have become almost entirely dependent on government support which signifies as a byproduct of the wealth effect theory that undergirds such easing policies.

The removal or even a reduction of such stimulus essentially would “pull the rug from under” the inflationary boom and undermine the current government debt financing mechanics that would stir such massive market and economic disorder and volatility. This would raise the spectre of the “deflation”, a market phenomenon which incumbent authorities have a rabid phobia on, as well as, raise the risks of a default.

Also such policy reversals would undermine the interests of the political class and those dependent on them, which is why incumbent political officials aren’t likely to resort to them, except as trial balloon or as part of the manipulation scheme for the continued suppression of gold prices

Nevertheless, Simon Black of the Sovereign Man eloquently enunciates why US Federal Reserve has been TRAPPED by their own actions on financing the US government or the monetization of US treasuries.

Now, bear in mind that US debt already exceeds 100% of GDP.

Even using the US government’s own ridiculous budget projections (which assume 3.5% REAL GDP growth) Uncle Sam will still accumulate over $5 trillion in debt over the next decade.

But here’s the thing– the current $16.75 trillion of US debt has an average maturity of just 65 months. This means that the US government will be on the hook to repay a huge chunk of its debt within the next 5 1/2 years.

So in addition to issuing $5 trillion (optimistically) in new debt, they’ll also have to re-issue trillions more in existing debt.

Someone is going to have to mop up all that debt. The question is… who?

The Chinese are actually REDUCING their Treasury exposure as a percentage of total US debt (see chart). This is consistent with their objective to strengthen the renminbi.

The story is the same with Japan at the moment, whose nominal US debt holdings have actually been decreasing.

The US Social Security trust fund is also a major holder of US debt. Yet, according to the Washington Post, roughly 10,000 people EACH DAY become eligible to receive Social Security pension benefits.

Given the increased outflows and high level of US unemployment (fewer people paying into the system), it’s doubtful that the Social Security trust fund will have sufficient cash to bail out the Federal government.

This leaves the US Federal Reserve as the lone player to mop up all this debt. There simply are no other options; the US government will default in all likelihood, unless the Fed continues debauching the currency to buy Treasuries.

Yet the recent flash crash in gold has been used to justify calls from some quarters to indulge more rather than less inflationism.  

Fed officials and their apologists will continue with their blandishments of steroid withdrawals but real political economic conditions suggests that all these represent as mere bluffs.

How Tax Distortions Contribute to the Boom Bust Cycles

I recently posted about the glaring disconnect between stock market pricing and earnings expectations in the US. 

Aside from the US Federal Reserve’s easing policies and from the implicit guarantees also from the same agency, there is another very significant factor that adds to the serial blowing of asset bubbles: massive distortions from a tax regime which promotes share buybacks financed by leverage.

Philip Coggan under the pen name Buttonwood at the Economist articulates Apple as an example

WHAT a crazy world. Apple, a company with $145 billion of cash, is issuing some $17 billion of debt to buy back its own shares. Why doesn't it just use its cash to do the same thing? First, because a lot of that cash is overseas, and bringing it back to America would incur a tax charge. Second, because interest rates are low and debt interest is tax-deductible, making this look a great arbitrage.

But think of it from the point of view of the hard-working American taxpayer. Apple's money will still sit overseas and not be invested at home to create jobs. Apple's tax bill will fall, as it offsets the interest payments against its profits. The buy-back will probably push up the share price in the short term*, boosting the value of executive options; profits from those options will probably be taxed at the long-term capital gains tax rate of 15%, lower than the rate many workers pay. Organising a bond issue, rather than using a company's own cash, incurs costs in the form of fees to bankers on Wall Street; the same bankers taxpayers helped support five years ago

In short, the incumbent complex tax structure basically rewards debt accumulation and the principal-agent problem.

The latter or conflict of interest dilemma means that the same tax policies induces a fissure between the economic interests of the shareholders and of the option holders, held mostly by corporate officers.  Such has mostly been channeled through the tilting of the balance of incentives that encourages short term outlook and actions at the expense of the long term.

Buybacks and dividend issuance has accounted for a substantial share of the gains in the S&P.

Dr. Ed Yardeni notes that both has totaled “$2.1 trillion for the S&P 500 since stock prices bottomed during Q1-2009 through Q4-2012--has been driving the bull market since it began”.

Yet the distortions from tax incentives that promotes debt funded buybacks has not only been a bane via a conflict interest in corporate relationships particularly between between shareholders and corporate managers, but has also been materially affecting the real economy through the diversion of resources to speculation rather than to investments.

Notes analyst Martin Spring in his latest outlook (no link)

One reason why prices continue to rise despite sluggish growth in corporate profits is the contractionary impact on supply from share buybacks, which are rising towards to levels last seen in 2007.

“The motivation,” reports CLSA Asia-Pacific’s Christopher Wood, “appears to be primarily to boost earnings per share – a formula on which so many corporate executives’ remuneration is based.”

He adds: “The pick-up in commercial and industrial lending in America over the past two years has been primarily driven by the desire to finance financial engineering exercises such as share buybacks, rather than to fund new investment.”

Essentially, the money bubble is being used primarily for speculation rather than stimulating economic activity, its supposed intention.

Government policies whether via taxes or central bank policies or administrative policies (e.g. homeownership) have all been synched or engineered to promote leveraging and debt accumulation.  

Debt is the essence of the paper money system.

Since the world’s monetary system shifted away from the gold standard, debt has increasingly been a tool to promote statistical “growth”.

Thus the increasing recourse to debt also means the increasing frequency of financial-banking crises.

Going back on how tax distortions promote systemic fragility, again Mr. Coggan

In short, the whole deal is linked to tax distortions; the treatment of repatriated cash, debt versus equity and capital gains versus income. The ideal tax system, as we have argued many times, is neutral between sources of income. The tax deductibility of interest played its part in creating this mess, both in the corporate and mortgage markets. Why should the taxpayer want to encourage higher leverage, when high leverage is the root of financial crises?

Well, the answer to that is that debt or leverage mainly works to the interest of the banking-welfare warfare state-central banking cartel, who use debt to finance their intertwined interests. The incumbent political architecture in turn gives voters and taxpayers access to debt, via the above policies. Thus, the boom bust cycles.

That which is unsustainable, won’t last.

CME Chairman on Gold: People don’t want Paper gold. They want the real product.

I have pointed to the fundamental difference between Wall Street “Paper” gold and physical “individual real” gold, where the former  serves the interests of Wall Street as against the latter which accounts for the real economics (demand and supply) of gold.

This quote from Terrence Duffy, President and Executive Chairman of CME Group Inc,. on Bloomberg TV (April 29, 2013) strongly reinforces my observations

What’s interesting about gold, when we had that big break two weeks ago we saw all the gold stocks trade down significantly, we saw all the gold products trade down significantly, but one thing that did not trade down, was gold coins, tangible real  gold.  That’s going to show you, people don’t want certificates, they don’t want anything else.  They want the real product.

Zero Hedge on the CME Chairman’s comment (bold mine)

I’m actually still in a state of shock that the head of the CME Group would make such an observation and in such blunt terms.  I mean the guy admits that volume on his exchanges suck, yet basically claims paper gold (one of their marquee products) is becoming irrelevant.  In my mind there are two likely explanations for this.  1) This is how he has started to feel personally and he is loading up on physical gold rather than his company’s paper products and would like some cover if that is ever unearthed. 2) This is what people close to the gold market are telling him and he’d rather make it clear he understands that paper is paper and gold is gold and that there is a big difference.  So “caveat emptor” if you are hanging around the COMEX.

This simply means that if the CME chairman understands the real drivers of the gold markets, then those (mainly the gold bears) who opt to ignore, downplay and or even discredit developments in the the real physical gold markets are making a colossal mistake.

CNBC: The Growing Risks from ASEAN’s Asset Bubbles

EVEN mainstream media appears to have caught up with my warnings. This lone nut's insights have began to spread. 

Here is the CNBC:

The risk of asset bubbles in Southeast Asia's fastest-growing emerging economies is rising, warn economists, pointing to red flags including surging domestic credit growth and rapidly rising property prices.

"We have long argued that monetary policy has been kept too loose for too long in Indonesia, but the policy authorities in the Philippines, Thailand and Malaysia are in significant danger of making the same mistake. In our view, evidence of overheating is set to become more obvious," said Robert Prior-Wandesforde, head of India & Southeast Asia economics at Credit Suisse.

Prior-Wandesforde, who expects central banks in the region will start tightening monetary policy in late 2013 or 2014, says policymakers are getting a false sense of security from benign inflation levels, and ignoring the excesses being built elsewhere in their economies.

"We expect interest rates to move higher and it is at that point that history suggests we should worry about possible bubbles turning to bust," he said.

The mix of U.S. monetary policy and relatively low levels of inflation have led many ASEAN nations to adopt "inappropriately" low interest rates, according to economists.

The World Bank and the IMF has recently recommended that easy money policies be reversed.

As I noted yesterday on the IMF’s prescription:

This means that putting a brake or policy tightening would also expose on the mirage brought about by statistical growth pillared from "strong credit growth". Doing so would effectively takes away the foundations of the “defied” status from which the political class and central bankers have been piggybacking on.

In short, reversing the “easy financing conditions” would go against the political and personal interests of those involved, particularly the political class and their cronies, and therefore will most likely be rejected or dismissed or ignored.

Easy money conditions will likely be pushed to the limits until the markets expose on them.

Developing events seem to be upholding my theory. 

Thailand’s government will likely address the rising baht mostly perhaps by paring down interest rates.

This is fresh from the Bangkok Post

The MPC is under pressure from the Finance Ministry and exporters who want it to implement measures to weaken the baht. The Federation of Thai Industries (FTI) chairman Payungsak Chartsutthipol has called on the MPC to cut its policy interest rate from 2.75% by 1% to weaken the baht.

He said the central bank will use foreign exchange and capital inflow management as the main instruments to keep the baht from rising too high.

Translation: Risk of bubbles? Who cares. Blow more of them.

Video: Nigel Farage on the Europe and the EU: Wholesale, Violent Possibly even Revolution

British politician and the “Ron Paul” of Europe, libertarian Nigel Farage in  the following speech at the Sovereign Man workshop gives two very important advice:

My fear is that in the end what will breakup the euro isn’t the economics of it, it will be wholesale, violent possibly even revolution that we see in the Mediterranean. But what I hate about this is that it is all so unnecessary.

He also says that Slovenia will bailed out in 2-3 months and that the EU governments will increasingly resort to confiscations of savings. The next advice

If you have investments, if you have money based on the Eurozone banks then my advice to you is get your money out of those banks and of those jurisdictions as quickly as you can, because next, when the next phase of the disaster come they will come for you 

Ever wonder why Berlin has transformed into a haven for bitcoins and why the furious assault on gold?

Implied Government Guarantees on BRIC Banking system

Even in the BRICS, there has been an implied guarantee by their respective governments on their banking system, as indicated on their credit ratings.

From Reuters:

The ability of Brazil, Russia, India and China to support their leading banks is tightly correlated to the credit rating on the banks, according to ratings agency Moody’s. The agency compares the ratings of four of the biggest BRIC banks which it says are likely to enjoy sovereign support if they run into trouble…

In a self-perpetuating cycle, ratings will be higher because governments are prepared to provide high levels of support to the banks, reflecting the lenders’ systemic importance and in some cases government ownership.

Bailouts on the politically privileged banking system have become a global standard. And this encourages the moral hazard behavior where banks take unnecessary risks because they know they will be supported once "they run into trouble". This adds to the yield chasing phenomenon that increases systemic fragility.

Moreover this implies that the public's savings, even in emerging markets, will continue to be under duress from indirect and direct confiscations in favor of the banking system.

IMF to Asia: Put a Brake on Credit Bubbles!

Interesting developments. 

Asia has to put a brake from her asset bubble blowing policies, this has been the latest prescription by the IMF who joins the World Bank in the call to curtail asset bubbles

First the implicit advice as reported by the Bloomberg:

Asian policy makers must be ready to respond “early and decisively” to overheating risks in their economies stemming from rapid credit growth and rising asset prices, the International Monetary Fund said.

Growth is set to pick up gradually during the year and inflation is expected to stay within central banks’ comfort zones, the Washington-based lender said in a report today. Greater exchange-rate flexibility in the region would play a “useful role” in curbing overheating pressures and coping with speculative capital inflows.

Asian economic growth that the IMF estimates will be almost five times faster than advanced nations this year, and increasing investor appetite for risk have spurred capital inflows into the region. The Bank of Japan this month joined counterparts in the U.S. and Europe in unleashing monetary stimulus, which may fuel further currency gains in developing markets such as the Philippines, where policy makers have stepped up efforts to cool appreciation.

As a reminder all bubbles are homegrown or have domestic origins. The mainstream’s popular strawman or scapegoat, capital flows, which usually gets blamed for bubbles, may or may not add to the bubbles in progress. While many crises indeed involved capital flow dynamics, correlation is not causation.

Now the kicker:

Financial imbalances and rising asset prices, fueled by strong credit growth and easy financing conditions, are building in several Asian economies,” the IMF said. “Policy makers in the region face a delicate balancing act in the near term: guarding against the potential buildup of financial imbalances while delivering appropriate support for growth.

Translating the economic gibberish to the layman: Bubbles have become widespread "in several Asian economies", and could morph into a clear and present danger "face a delicate balancing act"!

Well readers here would be familiar with my constant admonitions on these. Now many, including multilateral institutions, appear to be recognizing on such developing risks. So I am no longer a “lone nut”.

But the IMF or the World Bank seem clueless on what appears as a good counsel of curbing bubbles. They ignore the economic and political implications of their “delicate balancing act” recommendations.

Since all the cumulative  “strong credit growth” have been a consequence of “easy financing conditions”, then “early and decisively” policy restraints would represent as financial losses on the manifold entities or borrowers (private, public, or hybrids e.g. PPPs) that contracted them with their corresponding creditor/s.  Remember all these  “strong credit growth” had been consummated based on expectations of a sustained or prolonged “easy financing conditions”. Now the IMF (and the World Bank) wants to reverse them.

This also means that if “strong credit growth” has metastasized into a systemic debt issue then policy tightening would translate into a sharp slowdown in economic growth (best case scenario), if not a recession or a crisis (worst case scenario).

Thus the “delicate balancing act” reveals that the IMF doesn’t seem to have a good grasp on such ramifications, or most possibly, refuses to candidly divulge of the true nature of their risks expressed via evasive opaque statements.

Moreover credit rating upgrades will whet the appetite for more debt which has been the case for the Philippines, aside from adding to the veneration of political ascendancy from current policies that undergirds today's manic phase

This means that putting a brake or policy tightening would also expose on the mirage brought about by statistical growth pillared from "strong credit growth". Doing so would effectively takes away the foundations of the “defied” status from which the political class and central bankers have been piggybacking on. 

In short, reversing the “easy financing conditions” would go against the political and personal interests of those involved, particularly the political class and their cronies, and therefore will most likely be rejected or dismissed or ignored. 

Easy money conditions will likely be pushed to the limits until the markets expose on them.