The Flaws of BSP’s Real Estate Monitoring and Banking Stress Tests

Rushing in defence over growing concerns of the risks of asset bubbles, the Philippine central bank, the Bangko Sentral ng Pilipinas conducted a real estate exposure test monitoring which included a partial banking stress test[1].

In the report the BSP has not explicitly issued a confirmation or a denial of the risks of a domestic bubble. But they placed into the context the following

-The Philippines’s total banking exposure on real estate was at Php 821.7 billion as of December 2012.

-The BSP continues to monitor the 20 percent cap on RELs since 1997 where current report includes “loans by developers of socialized and low-cost housing, loans to individuals, loans supported by non-risk collaterals or Home Guarantee Corporation guarantee as well as exposures by bank trust departments and thrift banks.”

-The thrust to examine the banking sector’s exposure in real estate “is in line with the BSP’s pursuit of financial stability”

-The BSP hasn’t shown any signs of worries, due to stable non-performing RELs ratio which was “reported at 3.7 percent as of end-December 2012”

-And the BSP seems confident there is enough capital to withstand any potential shocks “with capital adequacy ratio of tested U/KBs and TBs will stand at 15.77 percent despite a 50 percent simulated default on residential real estate loans.”

First of all, the BSP does not mention that Real Estate Loans (REL) at 821.7 billion pesos and with a total loan portfolio TLP (net of interbank lending) of 3,938.9 billion pesos, real estate loans as a share of TLP would now account for 20.86%.

And so if my interpretation of their data is accurate then the banking sector has essentially hit its speed limits on issuing loans to the property sector. Will the BSP put on the brake and reverse the boom? How?

Next, it isn’t clear what the BSP means by “financial stability”? If they are referring to controlling price inflation my question is—are there no opportunity costs in in implementing “financial stability” measures? Or why should moderating price inflation come at the costs of blowing asset bubbles?

Let me cite the former chief of Monetary and Economic Department at the Bank of International Settlement’s William R. White in his 2006 paper who argued against price stability policies (bold mine)[2]

…price stability is indeed desirable for a whole host of reasons. At the same time, it will also be contended that achieving near-term price stability might sometimes not be sufficient to avoid serious macroeconomic downturns in the medium term. Moreover, recognising that all deflations are not alike, the active use of monetary policy to avoid the threat of deflation could even have longer term costs that might be higher than the presumed benefits. The core of the problem is that persistently easy monetary conditions can lead to the cumulative build-up over time of significant deviations from historical norms – whether in terms of debt levels, saving ratios, asset prices or other indicators of “imbalances”.

Also Non Performing Loans (NPLs) are coincident if not lagging indicators. NPLs are low because the current boom continues. NPLs become reliable indicators, when asset quality deteriorates or when the credit boom is in the process of reversing itself into a bust. Again they are coincident if not lagging indicators.

In addition, the BSP appears to have isolated its bank stress test by limiting “simulated default on residential real estate loans”. Why? Doesn’t the BSP know that economies are complex and vastly interdependent such that economies do not operate on isolation as the BSP model presumes?

A bursting bubble will ripple through not only through the residential real estate segment but would also impact commercial property sectors (office, shopping malls, casinos etc...) or firms that are highly leveraged.

More importantly, once the real estate sector gets slammed by the entwined factors of financial losses and deleveraging, such will likewise impact all sectors that have exposure on them, and so with the banks.

And affected secondary sectors will also hit firms from different industries connected to them, and so forth.

Thus the complex latticework of commercial networks means that the feedback mechanisms from the bubble busts will have a domino effect and thus spawn a crisis.

So models will not be able to capture the contagion effects from a real-estate-stock market bust for the simple reason that models tend to mathematically oversimplify what truly is a complex reality.

The fundamental flaw with BSP’s implied defence of the risks of asset bubbles has been to interpret statistics as economics.

The above diagram represents the compounded average of 15%. A compounded average of 15% means a doubling of anything in 5 years. This applies to leveraging or economic imbalances.

Let us assume that a doubling of leveraging or imbalances will put an economy to a state of vulnerability to financial risks. It would not be helpful to say that, if we are at the T-3 stage, where statistics show only 152.09, to claim that there is no risk because of the current state. While such statement may be true, it essentially denies the imminence based on the trajectory.

In other words, the shifting of the burden of risk analysis from the rate of growth to reading today’s numbers would represent as misleading analysis and a denial.

The same logic applies to a pre-debt crisis build up as shown by history.

.

In the chronicle of about 250 crisis in 8 centuries, Harvard’s Carmen Reinhart and Kenneth Rogoff notes of the same pattern[3] (bold mine)

domestic debt is not static around default episodes. In fact, domestic debt often shows the same frenzied increases in the run-up to external default as foreign borrowing does. The pattern is illustrated in Figure 5, which depicts debt accumulation during the five years up to and including external default across all the episodes in our sample. Presumably, the comovement of domestic and foreign debt is produced by the same procyclical behavior of fiscal policy documented by previous researchers. As shown repeatedly over time, emerging market governments are prone to treating favorable shocks as permanent, fueling a spree in government spending and borrowing that ends in tears.

Again it is the trajectory that matters.

In short, it is the presence or absence of the factors that drives the incentives for these frenzied desire to accumulate debt that needs to be identified and curtailed.

Unfortunately since the genesis of such incentives have been political which have been effected through social policies, and from which the untoward impact from such polices are invisible and incomprehensible to the public, such policies will hardly be stopped until a blowback from the marketplace occurs.

And as for the state of euphoria, where governments think that they have reached a state of presumed perfection, the passing of the bank stress test in Cyprus in 2011 should serve as a fantastic example:

From the Cyprus Mail[4],

In Nicosia the Finance Ministry issued a statement saying: “The measures which the banks are taking or planning to take will further increase solvency.”

The statement also referred to a “removed possibility” of having to support the banks, stating the government was ready to “immediately take any necessary measures to maintain financial stability.”

BoC “successfully passed the test” because of its strong capital base, fluidity and satisfactory profitability, Bank of Cyprus’ Chief Executive Officer, Andreas Eliades.

Strong capital base, fluidity, increase solvency and satisfactory profitability, all turned on its head, March this year. The rest is history.

I know, the Philippines is not Cyprus. But the important lesson from the Cyprus episode is one of overconfidence that leads to complacency that further enhances systemic buildup of risks.

Remember bubbles are manifestations of the reflexive feedback loop between expectations as influenced by prices, and actions as influenced by expectations, which are enabled and facilitated by debt and incentivized by policies.

Overconfidence and complacency fosters systemic instability which is hardly “the pursuit of financial stability”

The BSP’s Wealth Transfer

These two charts embody the structural deficiencies of the Philippine political economy.

The BSP estimates that only 21.5% of households have access to the formal banking sector[5].

Yet domestic credit provided by the banking sector accounts for 51.54% of the GDP in 2011[6]. I would guess that the latter figure would be substantially higher today, given the credit boom mostly channelled through the banking sector.

Yet what these two diagrams say is that statistical economic growth has been immensely tilted towards those less than 21.5 households who have access and or have used credit from the banking system.

Not all depositors like me have used credit from the banking sector for whatever purpose. Yes I have credit cards but I which I use infrequently.

The BSP confirms this; they estimate that only 4% households have credit cards.

The lopsided exposure to the banking industry has been likewise reflected on the stock market.

As of 2011, according to Bloomberg/Matthews Asia[7] the wealthy elites control 83% of the market capitalization of the Philippine Stock Exchange

And considering the low penetration levels to the banking system and to the stock market, it would be even more conceivable that the general public hardly has any access to the more complex bond markets.

Again capital markets and the banking system have been greatly biased to the formal economy and to the oligarchs and plutocrats who control them.

Though we know that this has been an inherited problem, there has been little attempt by the powers-that-be to distribute them through liberalization ever since.

The procrastination by the PSE to hook up with the ASEAN trading link or the integration of ASEAN bourses[8] is an example. Philippine political and economic elites seem apprehensive over the prospects of losing their privileges with an ASEAN interconnection. The same applies with the lack of commodity markets where such markets would undermine the privileges of these plutocrats.

The much ballyhooed policy reforms has been more of the same. For example, government spending based on public-private partnerships, would only mean that the politically connected will be rewarded with such economic opportunities or concessions.

Yet foisting a zero bound rates in order to supposedly boost domestic demand doesn’t really help the real economy, for the simple reason that the informal economy has little direct access to the formal sector. And this will not change unless the government deregulates or liberalizes.

On the contrary credit easing policies has only boosted the wealth of the politically privileged elite.

As to quote anew the Atlantic[9]:

In 2012, Forbes Asia announced that the collective wealth of the 40 richest Filipino families grew $13 billion during the 2010-2011 year, to $47.4 billion--an increase of 37.9 percent. Filipino economist Cielito Habito calculated that the increased wealth of those families was equivalent in value to a staggering 76.5 percent of the country's overall increase in GDP at the time.

In short, BSP policies represent transfers of resources from the real economy to the political class (via bigger government spending and bigger bureaucracy) and politically connected economic elites.

Thus the manipulated boom, which has been peddled by media and bought for by the gullible public, has been used as license via populist mandate to extend on such privileges.

BSP’s Underbelly: The Philippines’ Shadow Banks

Now going back to the direction of BSP policies.

Promoting “domestic demand” through expanded access of credit has been the purported reason for zero bound rates and the lowering of interest rates of the SDAs[10].

Combine these with the recent credit rating upgrades from major international credit agencies, all these means subsidizing or rewarding debt. Thus the natural outgrowth of accelerating debt.

So the BSP’s direction has been to promote debt. But on the other hand they claim that they would regulate or control it. So the BSP essentially operates in a cognitive dissonance, holding two conflicting ideas as policies. This is a wonderful example of the idiom “the left hand doesn’t know what the right hand is doing”: a self-contradiction

Now that the real estate sector has reached its limits as noted above, the question is will the BSP act?

Even if the BSP does, I am quite sure that many market participants would resort to regulatory arbitrage to circumvent them.

They may shift the use of loans even if they are classified as non-real estate into real estate or into the stock market, such as the fateful Bangladesh stock market crash in 2011[11]. Banks may use off balance sheets. Others may resort to bribery.

Of course, given the huge domestic informal economy, the most likely avenue for regulatory arbitrage is to use the nexus between the formal and the informal economy: the shadow banking system.

The BSP believes that they have the banking sector within their palms, but the World Bank says otherwise 

Shadow banking system in Philippines and Thailand accounts for more than one-third of total financial system assets[12]. One would note in the right chart that the Philippine shadow banking system has seen an intensifying rate of growth which has polevaulted since 2009 and has nearly surpassed Thailand’s level.

Aside from common informal microfinancing[13] as 5-6 lending, “paluwagan” or pooled money, “hulugan” instalment credit, much of the growth in the shadow banking system has reportedly been in the real estate sector, particularly the in-house financing from developers[14].

The BSP claims that it would investigate[15] these even if they hardly control the formal system.

The shadow banking system has become a worldwide phenomenon and has grown to as high as $67 trillion in 2011 according to the CNBC[16] or nearly 83% of the $80 trillion world economy. The risks of the shadow banking sector doesn’t intuitively or automatically emerge out of “lack of regulation”, rather, the shadow banking industry has been largely a product of overregulation via regulatory arbitrage. Where an economic or financial system has been hobbled by politics, risks becomes centralized and thus systemic.

Bottom line: Loans to the real estate sector have significantly been more than the caps set by the BSP. Easy money policies have apparently filtered into the informal sector. This means systemic leverage has been far more than what the BSP oversees and supervises. Lastly the BSP hardly has solid control over the formal sector. The same is amplified with the informal or shadow banking system.

Like almost every central bankers today, BSP policies supposedly meant to promote “domestic demand” will be pushed to the limits, despite the rhetoric. And this will further fuel the mania phase in both the stock market and the property sector.

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[1] Bangko Sentral ng Pilipinas BSP Releases Results of Expanded Real Estate Exposure Monitoring, May 10, 2013

[2] William R. White Is price stability enough? Bank of International Settlement April 2006

[3] Carmen M. Reinhart and Kenneth S. Rogoff The Forgotten History of Domestic Debt September 21, 2010 Harvard University

[4] Cyprus Mail Cyprus banks pass EU stress test, July 16, 2011

[5] Bangko Sentral ng Pilipinas 2012 Annual Report Volume 1

[6] Tradingeconomics.com DOMESTIC CREDIT PROVIDED BY BANKING SECTOR (% OF GDP) IN PHILIPPINES

[7] Kenneth Lowe Kicking the Tires Asian Insight Matthews Asia 2013

[8] See Phisix 7,200: Up, up and away! The Illusions of Comfort May 6, 2013

[9] See The Atlantic on Philippine Economic Boom: Looks Great on Paper May 8, 2013

[10] See Phisix and the BSP: This Time is Different? March 17, 2013

[11] See Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets January 11, 2011

[12] Swati Ghosh, Ines Gonzalez del Mazo, and İnci Ötker-Robe Chasing the Shadows: How Significant Is Shadow Banking in Emerging Markets? World Bank September 2012

[13] See Phisix: In The Eyes of Asia’s Bond Market, Deflation Phantom, Hedge Against Inflation June 29, 2008

[14] Businessworld Research The pros and cons of shadow banking February 8, 2013

[15] Inquirer.net BSP to probe ‘shadow banking’ allegations October 1, 2012

[16] CNBC.com 'Shadow Banking' Still Thrives, System Hits $67 Trillion November 18, 2012

Phisix in the Shadow of Greed and Fear

Strange times are these in which we live when old and young are taught in falsehood's school. And the one man who dares to tell the truth is called at once a lunatic and fool. -- Plato

Up, up and away!

The Philippine Phisix only posted a marginal .24% gain this week. But on a weekly basis the local benchmark soared to an all-time high.

Such marginal gain reflects on this week’s sharp volatility, specifically the difference between the spike during the two post-election trading sessions and the subsequent profit taking at the close of the week which ended up with a residual net gain.

Year-to-date the Phisix has returned a fantastic 25.24% as of Friday’s close. We are fast closing in on the 32.95% annual return of 2012. Yet there are 7 months until the end of the year.

At the current rate of return of about 5% gain per month, if sustained, would translate to a 10,000 Phisix by the end of the year or at the first quarter of 2014.

The steepening of the ascending slope suggests of the deepening convictions of the bulls of the trend’s sustainability. Such convictions have now been strengthened by even more price increases.

But this seems to have morphed into more than just a reflexive feedback loop between expectations (shaped by prices) and outcomes (influenced by expectations); some people in social media have already been exuding an aura of invincibility by hectoring on very rare bearish international reports.

As I have said before[1], markets have hardly been pricing about “cheap” or “expensive” but about electrically charged emotions: Greed and Fear.

Sectoral returns have been demonstrating such dynamic.

Bulls have been swamping into popular investment themes, while the bears have frantically been smashing down what seems as ‘politically incorrect’ issues.

Bull markets tend to lift all, if not most issues, but apparently not this time.

Also, the annual rotational pattern has been broken. Instead of an alternating leadership as during the past 6-7 years, the mining sector has gone completely in the opposite direction of the general markets.

The decline in the mining issues has not been proportional. Some issues fell of the cliff where losses account for an astounding 50-70% from their recent zenith. 

Such dramatic selloffs and declines already exhibit a state of depression with hardly any “corporate fundamentals” to account for. Others have been down by 20-30%. I may add that the biggest losers have been those with operations within the Benguet area, so I am wondering whether domestic politics may have been aggravated the dour sentiment which has been partly imported.

So, on the one hand we see intensive yield chasing phenomenon. On the other, we see panic. Greed and Fear.

But what should concern serious participants is not the “fear”, but the dominant “greed” as manifested by a ballooning mania.

And I wouldn’t exactly characterize “greed” in the conventional sense, but rather greed in the context of expansive risk appetite as consequences from various social policies.

The public has been motivated to speculate from easy money policies and from implied guarantees on the financial market, thus the market has responded in such rampant and destabilizing manner.

When we tax something we get less of it, but when we subsidies something we get more of it. So this applies to stock markets too: Current policies subsidize or reward “greed”, and at the same time, punish “prudence”.

Even the Jaime Caruana, the chief of the Bank of International Settlements, or the central bank of all central banks, have come to recognize and warn about this[2].

Global Equity Markets Melt-UP

Year-to-date, major global benchmarks have seen a return of a RISK ON environment as the levitation of equity markets has been accelerating. 

The above table doesn’t give justice to the overall representation of the other bourses. This is due to the distortions from the magnified gains by Japan’s Nikkei which diminishes what should have revealed as outsized gains for developed economies and ASEAN equities

In the behavioral science field, this is called the perceptual contrast effect[3], where people’s judgement are shaped by perceptions framed from relative immediate or visible comparisons

Nonetheless, gains of major developed economies and ASEAN nations have been mounting while the BRICs seem to be recovering except for Brazil.

In observing price trends, the melt up in equity markets have become global.

The US major benchmark, the Dow Jones Industrials, as well as, Germany’s DAX index has shown upside acceleration. 

As of Friday’s close, the Dow Industrials has been up 17.2% year-to-date while the German DAX has been up 10.32%. In 2012, the Dow yielded gains of 6% while the DAX 29%.

As I have recently pointed out[4], the surge in the DAX comes in contrast with Germany’s struggling economy. Germany managed to eke out a .1% growth during the first quarter of the year. Whereas the overall direction of growth since 2011 has been on a downtrend, yet the German DAX seems on a melt up mode.

This Isn’t Your Daddy and Grand Daddy’s Market

The most striking parallel universe phenomenon would be in France.

French financial markets will tell you of a booming economy: 

The equity bellwether the CAC 40 has racked up gains of 9.89% year-to-date and was up 15.23% in 2012. Interest rates as measured by the French government 10 year yields[5] have been drifting at multi-year lows (see lower window).

So OECD France has a booming bond and the stock markets almost similar to the emerging market Philippines.

Ah, but France is not the Philippines. Ironically the French economy slipped into a recession in the first quarter of this year. For most of 2012, France has also been in periodical recessions. Yet the market booms. France was even downgraded by Moody’s last November[6]. But the stock and bond markets have ignored them. And this is why the French equity market seems in melt up mode even as the stagnating economy seems to intensify.

And given that the French economy has been hocked to the eyeballs with debt, as debt-to-gdp has been ballooning[7] since 2009, one would expect that the extended recessions would have amplified credit and market risks that should have roiled the financial markets.

But no, this time is different.

Bad news is good news. More signs of economic troubles translate to more prospects of accommodation from central banks. The more the bad news, the better for the financial markets.

In addition, central banks policies appear to have jaded the market’s perception of risks. French interest rates have gone down partly because of Japan government’s aggressive pursuit[8] of doubling her monetary base via “Abenomics”, where Japanese insurance and banking firms sought higher yields[9] (if not safehaven) from French bonds as shown above.

The Swiss National Bank (SNB) may have also been a party[10] to subsidizing the French government through accumulation of French bonds. 

Or it could be that French institutions with international exposure could have been downsizing partly by selling their holdings abroad from which they repatriate to buy French bonds for reserve requirements purposes.

Charles Gave of the Gavekal Research opines[11]

France has a large financial sector, with huge international positions. Some entities may be selling international holdings which demand large reserve requirements. The proceeds are then brought back in France to buy French government bonds—against which there are no reserve requirements.

As I earlier said, current developments reveal that there hardly has been anything fundamental in the traditional or conventional understanding from which current markets operate on.

This isn’t your granddaddy or your daddy’s financial markets.

Or take a look at three national benchmarks above.

All of them are apparently in a melt-up mode. Year-to-date the chart at the left has yielded 45.63%, the center 29.45% and the right 61.92% as of Friday’s close.

The melt-up for these three bellwethers has a common denominator: they have been spiked by strong monetary forces.

Argentina’s Merval[12] (center) and Venezuela’s Caracas[13] (right) have both been enduring hyperinflation but in different phases[14], their stock markets are proving to be partial safehavens. On the left is Japan’s Nikkei[15]. Japan’s Nikkei 225 has skyrocketed from the government’s plan to double her monetary base which is really is in the direction of Argentina and Venezuela except that Japan policies are in an embryonic phase.

Thus the conventional and popular wisdom where today’s market has been one about growth, or fundamentals or political salvation will be proven wrong in the fullness of time.

Again this isn’t your granddaddy or your daddy’s financial markets.

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

[2] See BIS Official: Loose Central Bank Policies Looking Increasingly Dangerous May 17, 2013

[3] ChangingMinds.org Perceptual Contrast Effect

[4] See Parallel Universe: Booming German and French Stocks as Economies Stagnate May 15, 2013

[5] Bloomberg.com France Govt Oats Btan 10 Yr Oat

[6] Guardian.co.uk Moody's downgrades France's credit rating to AA1 November 20, 2012

[7] Tradingeconomics.com FRANCE GOVERNMENT DEBT TO GDP

[8] Zero Hedge We Found The 'Other' Greater Fool May 13, 2013

[9] Businessinsider.com European Government Borrowing Costs Are Plunging — And It's All Thanks To Japan April 8, 2013

[10] Wall Street Journal Button-Down Central Bank Bets It All January 8, 2013

[11] Zero Hedge Charles Gave: "Get Out Of Banks, Get Out Of France - Get Out Of The Euro" May 16, 2013

[12] Bloomberg.com Buenos Aires Stock Exchange Merval Index

[13] Bloomberg.com Caracas Stock Exchange Stock Market Index

[14] See Inflation and Price Controls: Latin America Edition April 19, 2013

[15] Bloomberg.com Nikkei 225

Infographic: The Silver Squeeze

The following infographic courtesy of the Austrian Insider (hat tip Zero Hedge)
 
The Silver Squeeze – An infographic by the team at The Silver Squeeze Free Infographic

Quote of the Day: The Intelligencia pay no price for being wrong

Well, if you come up with a lot of wrong ideas and pay a price for it, you’re forced to think about it and to change your ways or else get eliminated. But there is no such test. The only test for most intellectuals is whether other intellectuals go along with them. And if they all have a wrong idea, then it becomes invincible.

This is from economic professor, author and political philosopher Thomas Sowell expounding a passage “The Intelligencia pay no price for being wrong” from his latest book Intellectuals and Race in a video interview with Wall Street Journal’s Peter Robinson. (hat tip Mises Blog)

Paying no price for being wrong can be seen in the same light as Nassim Taleb's “skin in the game”, the stakeholder’s dilemma or the principal agent problem—conflict of interests shaped by diverse incentives

This is very relevant not only to the participants of the financial markets but especially pronounced in public opinion arena where social policies are shaped. The crux: Bad ideas have consequences. And people with little “skin in the game” or “pay no price for being wrong” are the most notorious promoters of ‘noble sounding’ deceptive ideas.

War on Cash: Nigeria and Ghana Experiment with Cashless System

Governments and banksters have been trying their darn best to put the savings of their constituencies on their palms.

African nations of Nigeria and Ghana will be experimenting with cashless transactions.

The Nigerian program from theNextweb.com

Last week at the World Economic Forum on Africa held in Cape Town, South Africa the Nigerian National Identity Management Commission (NIMC) and MasterCard announced their collaboration with plans to roll-out an initial 13 million MasterCard-branded National Identity Smart Cards with electronic payment capability.

The 13 million cards will form part of a pilot program which will see the West African country’s citizens who are 16 years and older and those who have been residents in Nigeria for more than two years being issued with the new National Identity Smart Cards.

This announcement by Nigeria sees it following in South Africa’s footsteps as the country’s Department of Home Affairs has announced that it intends starting to issue smart ID cards to citizens starting in July, 2013 at a rate of  3 million smart ID cards a year.

It is hoped in both cases that the smart ID cards will help curb the prevalent fabrication of false identity documents in both Nigeria and South Africa as they will be embedded with microchips and with the South African smart ID cards being reported to incorporate biometric features that will also prevent identity theft as a result of the fraudulent use of a stolen or lost smart ID card.

There is also a notable difference between the South African and Nigerian smart ID cards with the West African country’s smart ID cards coming with immediate payment capability’s courtesy of MasterCard’s prepaid payment technology. The cards are also reported to come loaded with 12 other applications.

The cashless project in Ghana from the spyghana.com

Ghana, as a developing country in West Africa has taken the initiative to introduce a system where businesses can be done without using physical cash. Bank of Ghana, the regulator of the banking industry through Ghana Interbank, Payment and Settlement Systems (GhiPPS) introduced e-zwich card, where Ghanaians will feel comfortable in using the card to transact businesses rather than physical cash.

Even though there has been several effort to educate the masses about the product, the education on this e-zwich have not go well with many Ghanaians. A lot of the citizens as of today do not even know there is something called e-zwich card. With a population more than half of it been illiterate, there must be a thorough education where all Ghanaians will understand and use the platform.

In Ghana, some of the common cards we can identify are such as Sika Card by SSB, Visa Horizon by Standard Chartered Bank (Stored Value cards), deployment of Automated Teller Machines (ATM) and ATM cards by banks eCard (CAL Bank, Ecobank) and among others.

Harmless they all seem. But centralization means that people's lives will increasingly be subject to government control. Identity cards can be easily altered, changed or subjected to manipulations upon government's whim. These will be like sci-fi movies where people's identities can be wiped out or expunged through programming: You are alive, but you don't exist says the system

 

This also shows why governments will attack gold, bitcoins and cash, and in their stead promote centralized systems based on national IDs complimented by facilities of digital cash payments systems and other 'flavoring' or "add on" called applications.  Such systems will make confiscations and totalitarianism a cinch.

Why the Indian Government’s War on Gold will Fail

Prime Minister’s Economic Advisory Council (PMEAC) Chief C Rangarajan has declared that India’s love affair with must be contained. Gold imports must be substantially reduced from 1,000 tonnes a year to 700 tonnes.

The imperative to contain gold import has become urgent. The recent surge in gold demand is however creating some distortions and need to be rolled back to boost growth by reversing the trend of declining financial savings and keeping CAD* within prudent limit by contain gold demand.

*CAD-Current Account Deficit

India’s government has essentially placed the burden of the Indian economy on gold. And in doing so, they justify the reinforced holistic campaign against the precious metal.

Coincidentally, India’s stepped up war on gold comes amidst the ongoing Wall Street incited crash.

The Mineweb’s Shivom Seth wonderfully explains how the campaign against gold by India’s government is being orchestrated through various fronts. 

First India’s government proposes to provide an inflation hedge alternative: government inflation indexed bonds (bold mine)

It could have posed as a model scheme to curtail gold imports. In order to stifle India’s appetite for gold, the government has introduced inflation index bonds. The first tranche amounting to around $364 million (R20 billion) is to be introduced on June 4.

Inflation Indexed Bonds (IIBs) are a new category of debt instruments to be introduced in India, where the coupon and principal amount would be linked to the rate of wholesale price inflation with a lag of four months. The authorities have said the objective of introducing such bonds is to channelise savings into productive sources of instruments from unproductive ones like gold.

Slowly but surely, there seems to be an anti-gold campaign that is at play in India. The concerted effort by the Indian government to discredit gold by imposing several curbs, and channelise consumers away from the precious metal, indicates a desperation that has not gone unnoticed by savvy investors.

“The government is making it too expensive for retailers to sell gold, especially when prices have hit new all-time lows. Retailers are forced to apply hefty mark-up given the new curbs,” said Manohar Kedia, of Kedia Jewellery House.

Government inflation indexed bonds are being forced upon the average Indians, as the Indian government’s onslaught to curb the gold trade has intensified. 

India’s war on gold now covers higher taxes or tariffs and import bans and limits.

Knowing fully well that Indians cannot keep away from gold for long, the Reserve Bank of India first hauled up banks for selling gold coins, then came down hard on gold retailers and bullion houses. Now, they have turned their attention on investors, urging them to invest in debt instruments.

Further, in order to moderate the demand for gold for domestic use, the government has also restricted the import of gold on a consignment basis. A major bullion retailer in Mumbai said this would prove to be a major hurdle for exporters.

For, only those exporting gold jewellery will first have to impose on banks for each consignment, given that banks will henceforth be allowed to import gold only to meet the genuine needs of exporters of gold jewellery.

The Indian government's genuine but unstated objective have been to capture or corral people’s savings, by diverting them into the government regulated or controlled banking system, and use such savings to finance a chronically insatiable and profligate government.

India's "declining financial savings" has hardly been because of gold but because of rapacious government spending.

India’s government has more than doubled the rate of spending over the past 9 years. Such spending binge has exploded the the government’s budget deficits since 2009. (charts from tradingeconomics.com)

The intensive growth in food subsidies has been part of the such spending spree, as shown by the chart above from the Reuters. Food subsidies are expected to swell by about 40% in 2014.

The Indian government has been subsidizing many industries. Subsidies according to Wikipedia accounts for 14% of the the Indian economy in 2015 (note: not government budget). 

Yet subsidies has led to huge losses: as much as 39% of subsidized kerosene has been  stolen, and as I pointed out last year, politicians looted food subsidies to the tune of $14.5 billion!

Aside from food subsidies, the Indian government has joined the global bandwagon of stimulating the economy nearly a year ago or in June 2012, with various forms of fiscal spending mostly in infrastructure. Thus the spending ratios should be more today

Such lavish spending has resulted to expanding the debt.

Even as debt to GDP has been shrinking, the Indian government’s external debt has massively ballooned over the same period. 

This only means that the accrued government spending has been funded by debt acquired from external sources.

Again the debt to gdp metric is hardly a reliable statistical indicator because the denominator (GDP) can be driven by a credit boom and not by real growth. This is currently the case with India. India’s domestic credit to private sector has reached the highest level ever at 50.6% in 2011. India has an ongoing bubble.

While India’s foreign reserves remain near record highs, exploding fiscal deficits and ballooning external debt has led to sustained weakness in her currency, the Indian rupee.

In short, the frantic Indian government has been passing the blame on gold on what truly has been a problem of political greed via fiscal intemperance.

Importantly, the Indian government’s attack on gold represents a duplicitous move. 

While the government wants access on the private sector’s savings via the banking system (which aside from funding governments will incur various taxes and fees), the desire to reduce the public’s gold holdings by holding paper money, the rupee, means governments would also impose “the inflation tax”. 

So bank depositors will be hit by low interest rate, inflation tax, various fees and will be forced to hold and finance government debt, in favor of the government (who may default).  

One can’t rely on statistical inflation figures to accurately represent real conditions. Statistics are likely to be manipulated for the purposes of financial repression or government plunder of private sector resources. Thus, much of the average Indians will unlikely fall for such 'inflation indexed bonds' subterfuge.

So like anywhere else, governments have been resorting to direct and indirect confiscations with increasing frequency and intensity. 

Signs of boom days eh?

More entwined reasons why India’s war on gold will fail.

Gold has both cultural and monetary essence to the average Indians.

As the Deccan Gold Mines enunciates: (bold mine)

Over centuries and millennia, gold has become an inseparable part of the Indian society and fused into the psyche of the Indian. Having passed through fire in its process of evolution it is seen as a symbol of purity, the seed of Agni, the God of fire. Perhaps this is why it is a must at every religious function in India. Gold has acted as the common medium of exchange or the store of value across different dynasties in India spanning thousands of years and countless wars. Thus wealth could be preserved inspite of wars and political turbulence. For centuries, gold has been a prime means of saving in rural India.

Next as related to the cultural-religious context, India’s history has been littered with economic crises and even currency problems

To account for a recent history here is Wikipedia

Since 1950, India ran into trade deficits that increased in magnitude in the 1960s. The Government of India had a budget deficit problem and therefore could not borrow money from abroad or from the private sector, which itself had a negative savings rate. As a result, the government issued bonds to the RBI, which increased the money supply, leading to inflation. In 1966, foreign aid, which was hitherto a key factor in preventing devaluation of the rupee was finally cut off and India was told it had to liberalise its restrictions on trade before foreign aid would again materialise. The response was the politically unpopular step of devaluation accompanied by liberalisation. The Indo-Pakistani War of 1965 led the US and other countries friendly towards Pakistan to withdraw foreign aid to India, which further necessitated devaluation. Defence spending in 1965/1966 was 24.06% of total expenditure, the highest in the period from 1965 to 1989. This, accompanied by the drought of 1965/1966, led to a severe devaluation of the rupee. Current GDP per capita grew 33% in the Sixties reaching a peak growth of 142% in the Seventies, decelerating sharply back to 41% in the Eighties and 20% in the Nineties.

Aside from the rupee chart above, the following table shows how the rupee slumped relative to the US dollar from a conversion rate of 4.79 rupee/US in 1950 to 45.83 rupee/US in 2010.

One would also notice that from a base point of zero in 1975, inflation surged to 126 in 2010. And despite the plummeting rupee, through 1975 per capita income as % of the US has gyrated from 1.5% to 2.18%. This means that whatever growth India has posted over the years has failed to keep at the rate of the growth in the US. 

In short, devaluation has not solved what has been a problem of politicized economy.

This brings to fore the lessons from the great Austrian economist Ludwig von Mises

The economic backwardness of such countries as India consists precisely in the fact that their policies hinder both the accumulation of domestic capital and the investment of foreign capital. As the capital required is lacking, the Indian enterprises are prevented from employing sufficient quantities of modem equipment, are therefore producing much less per man-hour, and can only afford to pay wage rates which, compared with American wage rates, appear as shockingly low.

There is only one way that leads to an improvement of the standard of living for the wage-earning masses — the increase in the amount of capital invested. All other methods, however popular they may be, are not only futile, but are actually detrimental to the well-being of those they allegedly want to benefit.

What India requires is not to regulate or prohibit gold but to further liberalize or depoliticize the economy. 

Unfortunately politics is about smoke and mirrors rather than the upliftment of the general welfare

Another huge reason such campaign will fail is due to the informal economy. 

The informal economy means low banking penetration levels.

From DNB.com.in

With regard to financial access and penetration, India ranks low when compared with the OECD countries. India offered 6.33 branches per 100,000 persons whereas OECD countries provided for 23-45 branches per 100,000 people in 2009. For India, the number of branches and ATMs per 100,000 persons has increased to 7.13 and 5.07 in 2010.

In India, the penetration of banking services is very low. Merely, 57% of population has access to a bank account (savings) and 13% of population has debit cards and 2% has credit cards. This represents the unmet demand and the scope for expansion for the banks in India.

And prohibition of gold and offering inflation indexed bonds as alternative will hardly improve on banking penetration levels hobbled by overregulation.

And because of intensive politicization of the Indian economy, a significant segment of India’s growth has been in the informal economy

From Businessworld/Bloomberg: (bold mine)

The size of India’s “informal” economy, meanwhile, handicaps efforts to track the number of Indians who are gainfully employed. Four out of five urban workers—who collectively produce an estimated three-quarters of the country’s output—are informally employed. That means their work does not show up in official figures on productivity, innovation, social mobility and other standard metrics of progress. It’s possible to debunk some of the myths about India’s work force—three-quarters of self-employed workers in urban areas, for example, are in single-person businesses or family enterprises without hired labor, rather than upwardly mobile entrepreneurs—but a clear picture of exactly how many Indians are working, and where, remains elusive.

The informal economy, hence, represents political or government failure from which India's government has taken gold as the 'fall guy'.

Finally, gold fits to a tee the informal economy

From the Economist (bold mine) 

Pune’s wide boys aside, the traditional gold consumers are southern peasants buying jewellery. They have no access to formal finance; gold requires no paperwork, incurs no tax and is liquid. But over the past decade the mania has spread. By weight consumption has doubled, for several reasons: a surge in money earned on the black market; investors chasing the gold price; and the dismal returns savers get from deposit accounts. Real interest rates are low, reflecting high inflation and a repressed financial system that is geared to helping the state finance itself.

Another significant factor why the war on gold will fail is political insanity: doing things over and over again and expecting different results. 

Attacking gold as part of financial repression measures has previously failed, it shouldn't be different this time

From the same Economist article:

India has tried coercion. Between 1947 and 1966 it banned gold imports. After that it used a licensing system. Neither worked. Smuggling soared and policymakers were reduced to tinkering with airport-baggage allowances. By 1997 trade was liberalised.

All these political pretenses which are really intended as confiscations of private savings whether through gold, cash transactions, bank deposits or bitcoins (cryptocurrencies) will eventually be exposed for the fraud they are.

India's war on gold will only intensify the growth of smuggling and the informal economy.  

India's war on gold signifies also an expression of growing desperation by the Indian political class over their hold on power whose economy has partly been buoyed by credit bubbles.

India's war on gold could likewise be a part of the grand design of the cabal of political institutions or the banking system, central banks and welfare warfare states led by Wall Street in working to preserve the current unsustainable system by spreading disinformation and by the manipulation of the markets in order to dissuade the public on currency alternative options as gold or bitcoins.

US Federal Reserve’s James Bullard: Why Unemployment Targets Won’t Work

For the mainstream, macro-policies such as inflationism has been immensely expected to solve “micro” problems. The popular wisdom specifically fixates on the “money illusion” or “price illusion” effects of inflationism, where experts see people as having the tendency to think of currency in nominal, rather than real, terms (wikipedia). 

In short, so-called experts think that people hardly think at all. Everyone of us, except them, are boneheads.

The premise where people can hardly feel, notice and respond to the changes in the purchasing power of their nominal currency serves as justification for governments to manipulate money supply intended to DECEIVE people into attaining so-called economic objectives, like lowering real value of wages. (So much for so-called "virtuous" and "transparent" governments) 

Well it does seem that even some officials of the US Federal Reserve recognize the folly of such premise.

Austrian economist Joseph Salerno at the Mises Blog refers to the dissent by US Fed President of St. Louis James Bullard on unemployment targets: (bold mine)

The Fed has committed itself to maintaining its zero interest rate policy as well as quantitative easing for as long as the unemployment rate remains above 6.5 percent (and inflation rate below 2.5 percent). James Bullard, the President of the Federal Reserve Bank of St. Louis, heroically dissents from this policy of unemployment targeting, which is basically a reversion to the crude and discredited Old Keynesian doctrine. In a speech last month entitled “Some Unpleasant Implications for Unemployment Targeters”, Bullard, himself a New Keynesian inflation targeter, stated:

Attempts to address the various labor market inefficiencies solely with monetary policy do not work very well because improvements on one dimension are simultaneously detriments on other dimensions. . . . monetary policy alone cannot effectively address multiple labor market inefficiencies, and so one must turn to more direct labor market policies to address those problems.

Unfortunately, President Bullard did not articulate those “more direct labor market policies,” but they would include: the repeal of minimum-wage legislation, which destroys jobs for the unskilled; the repeal of the National Labor Relations Act, which coerces employers into collective bargaining and privileges union “insiders” against non-union “outsiders” causing unemployment or lower wage rates among the latter; and the phasing out of unemployment “insurance,” which encourages unemployed workers to spend an excessive amount of time in “searching” for jobs.

In short, mainstream’s oversimplification of micro conditions as merely driven by a SINGLE variable (price levels) signifies as arrant myopia. 

There are many more or equally important factors, such as the state of property rights and other political hurdles (regulatory environment, taxes, mandates, unionism and etc..) that influence people’s incentives to conduct commercial activities.

Moreover, price level manipulation theories hardly ever consider the invisible (opportunity costs) and the secondary effects of such policies: particularly price instability (boom bust cycles, stagflation, hyperinflation) and economic discoordination.

The reality is that so-called economic objectives have been used as front or as excuse for the real design: transfer of wealth from society to the political class and the politically connected groups.

Ironically, the gist of the wisdom of economic talking heads which mainly belittles on people’s capacity to think, is founded on self-deception (from highly flawed model based assumption) and on the pandering to the political class.

Yet many fall prey to the political contrivance, "lies told often enough becomes the truth"

Heroes of Capitalism: The Humble Shipping Container

Many people hardly appreciate on the role played by the advances in technology in shaping social progress. Think the discovery of fire which initially allowed humans to cook, obtain warmth and protection. Fire eventually became important part of production. 

Other milestone innovative technologies such as the Gutenberg printing press, the steam engine and today’s internet has dramatically transformed people’s lifestyle.

For the majority, technology advances “just happens”, they hardly have an inkling of how these things take place.

There is one significantly underappreciated hero of global trade: the shipping container

The Economist explains: (hat tip Prof Mark Perry)

THE humble shipping container is a powerful antidote to economic pessimism and fears of slowing innovation. Although only a simple metal box, it has transformed global trade. In fact, new research suggests that the container has been more of a driver of globalisation than all trade agreements in the past 50 years taken together.

Containerisation is a testament to the power of process innovation. In the 1950s the world’s ports still did business much as they had for centuries. When ships moored, hordes of longshoremen unloaded “break bulk” cargo crammed into the hold. They then squeezed outbound cargo in as efficiently as possible in a game of maritime Tetris. The process was expensive and slow; most ships spent much more time tied up than plying the seas. And theft was rampant: a dock worker was said to earn “$20 a day and all the Scotch you could carry home.”

Containerisation changed everything. It was the brainchild of Malcom McLean, an American trucking magnate. He reckoned that big savings could be had by packing goods in uniform containers that could easily be moved between lorry and ship. When he tallied the costs from the inaugural journey of his first prototype container ship in 1956, he found that they came in at just $0.16 per tonne to load—compared with $5.83 per tonne for loose cargo on a standard ship. Containerisation quickly conquered the world: between 1966 and 1983 the share of countries with container ports rose from about 1% to nearly 90%, coinciding with a take-off in global trade (see chart).

The container’s transformative power seems obvious, but it is “impossible to quantify”, in the words of Marc Levinson, author of a history of “the box” (and a former journalist at The Economist). Indeed, containerisation could merely have been a response to tumbling tariffs. It coincided with radical reductions in global trade barriers, the result of European integration and the work of the General Agreement on Tariffs and Trade (GATT), the predecessor of the World Trade Organisation (WTO).

Read the rest here.

It is unfortunate that media and politics has successfully implanted on the public of the false importance of the short term or temporary visible gains of specific personalities or groups, such that "heroes" are characterized by victors of zero-sum activities, particularly in sports, the celebrity gossip culture and in politics.

Yet the real heroes are those inventions or ideas that ingloriously radicalized improvements on the way we live over the long run.

BIS Official: Loose Central Bank Policies Looking Increasingly Dangerous

The chief of the central bank of global central banks, the Bank of International Settlements, has warned of unintended consequences of prolonged easy money policies

From the Wall Street Journal Real Times Economics Blog: (bold mine)

The latest to take up the refrain is Jaime Caruana, general manager of the Bank for International Settlements, who warned in an unusually frank speech in London that, while the ultra-low interest rates and ultra-easy monetary policy adopted by advanced economy central banks might have been the right response to the crisis when it broke, they are looking increasingly dangerous the longer they last.

“A vicious circle can develop, with a widening gap between what central banks are expected to deliver and what they actually can deliver,” Mr. Caruana said. “This may ultimately undermine their credibility and, with it, their legitimacy and effectiveness.”

Low rates may have helped keep banks alive and keep a roof over the heads of overextended borrowers—but they are threatening the ability of insurance and pension funds to meet their commitments, and tempting them into all kinds of wrong investment decisions in the meantime. Although he didn’t spell it out, he painted a picture of a massive and stealthy transfer of wealth from savers to borrowers.

Perhaps Mr. Caruana may have noticed of the growing disparity between asset markets and the real economy and how such policies have been failing to generate the much anticipated results.

Importantly, Mr. Caruana notes of the ethical inequities from  the “massive and stealthy transfer of wealth” which in reality is taken from society (those not politically connected) and transferred to the political class and politically privileged banksters and other cronies.

The article suggest the BIS’s view should be heeded because “the BIS is one of the few international financial institutions (some say the only one) to see the financial crisis coming and to issue clear warnings ahead of time.”

This represents that cognitive bias called anchoring. In reality, past performance does not assure of future outcomes. Correct prediction by the BIS in the recent past doesn’t necessarily hold that they will be as accurate in the future.

What makes the BIS council worthwhile is the economic and the epistemological reasoning behind the analysis of current du jour easy money policies.

For instance, Mr. Caruana implicitly points to the moral hazard as consequence from such policies, noting that instead of real reforms, politicians have used central bankers as instruments to maintain the status quo.

From the same article:

Like many central bankers, Mr. Caruana put a good deal of the blame for the current mess on governments for failing to address the root causes of unemployment and low growth. “After five years of buying time, one has to ask whether that time has been – or will be – used wisely,” he said.

Likewise he warns of the anchoring bias applied to looking at inflation risks…

But he reserved a decent measure of criticism for central banks too, warning that they can’t just shut their eyes to the risks they are creating just because a certain measure of domestic consumer inflation is within its official target range.

…and of bubble cycles:

“If you don’t get financial stability, you will not be able to get price stability,” he said in follow-up comments to his speech, making clear that he understood financial stability as something to be defined globally, not just in a single country or region. That’s a problem because no central bank in the world is mandated to give a hoot about what effects its policy causes outside its jurisdiction. With an eye on the huge cross-border capital flows triggered by radical central bank action, he warned his audience how easy it is, in a globalized world, for distortions created in one country to spill over into other countries before returning “like a boomerang” to haunt the originating country.

So very apropos. 

Seems like Mr. Carauana, a telcom engineer by education, has revealed tinges of influence from Austrian economics. 

The BIS has been no stranger to the Austrian school. Canadian economist, William R. White, former manager in the monetary and economic department has been reputed as one of the Austrian school influenced economist in the BIS. In fact, it was Mr. White's paper in 2006, during his tenure, that accurately predicted the crisis of 2007-2008, from which the reputation of the above article rests on.