How the Welfare State Promotes Violence: The Swedish Edition

One of the least expected places for social upheavals to occur is Sweden.

Image from the Guardian

Why is this happening? 

The prolific Simon Black of the Sovereign Man eloquently explains (bold mine)

Anytime a free market guy rails against central planning and socialism, there is always someone who stands up and says “what about Sweden?” 

Ah, Sweden… a socialist’s paradise… a place where taxes are among the highest in the world, few people are wealthy, and the government is involved in people’s lives from cradle to grave.

And in all of these government surveys on ‘happiness’, places like Sweden, Norway, and Denmark consistently rank among the happiest countries in the world.

Well… the veneer is cracking.

Though the coverage has been limited, there’s been rioting in Sweden over the past week, specifically in the immigrant-dense suburbs around Stockholm where 80% of the population are first or second-generation immigrants.

Dan West, my right hand man at Sovereign Man, is actually Swedish and on the ground right now in the country. He recently sent me a note describing the situation:

“Hundreds of cars are burning. Schools were set on fire. Police stations were set on fire. Businesses were vandalized. Rioters clashed with police. Hundreds of masked rioters ran wild in the streets.

Seeing photos and video of this you’d think it was a war zone in some unstable part of the world, not Stockholm.

Allegedly it started last week because the police fatally shot a 69-year-old man who wielded a machete in public. Now people are angry and destroying things.

Swedish politicians say the root causes of these riots are inequality of the immigrant minorities.

Bear in mind, this is a place so obsessed with equality that the words “him” and “her” have been blended into “hem”… and taxpayers fork over 70% of their income to ensure that everyone can live to an equal level.

But to those of us living outside of this statist bubble, the real problem is obvious: however well-intentioned they may be, welfare states almost always attract people who want to be taken care of at the expense of others.

And ultimately this engenders serious conflict… between those who are on the receiving end, and those on the paying end.

Occasionally this conflict becomes violent. And that’s exactly what’s been playing out.

The government has all sorts of propaganda to influence the way Swedes view the welfare state and convince us that we should pay huge taxes to support others.

In other words, we should not be economically free so that others can live for free. This is the definition of a welfare state.

And in addition to such ‘thought controls’, the Swedish government also rules with capital controls, people controls, and media controls.

The government here tries to churn citizens out as if we’re widgets coming off a factory line, influencing everything from what we think to how we spend our time.

Yet despite such a finely-tuned system, the capital suburbs practically turned into a war zones over the past week.

The politicians here claim it can all be fixed with more redistribution of wealth. It’s not enough that the average working Swede pays ~70% in taxes; if only they could extract 80% or 90% in taxes, they could solve everything!

If all you have is a hammer, everything looks like a nail.

People have the wrong idea of this place. It is not a well-functioning welfare state. Any system based on giving people something for nothing, and sticking hard-working, productive citizens with the bill, is doomed to fail. Sweden is no exception.

People in North America who are rapidly being dragged into a welfare state should pay very close attention… because this is the future that awaits.”

The Zero Hedge adds more to the Swedish Welfare dilemma:

The recent riots in Stockholm may highlight widening divisions within Swedish society generated by rising inequality, cuts in welfare spending and a failure to integrate immigrants. Inequality has increased the most in Sweden of any OECD member country over the past 25 years.

Inequality

Inequality has increased by one-third since 1985, according to the OECD. Sweden has dropped to 10th place from first in 1995 in the OECD’s ranking of income distribution after the nation’s Gini coefficient rose to 0.27 from 0.21.The average income of the top 10 percent of income earners was more than six times that of the bottom 10 percent in 2008. That compares with a ratio of about four to one during the 1990s.

Immigration

The incidence of child poverty is more than five times as common to people whose parents were born outside Sweden, a report from Save the Children Sweden shows. Those born outside the country account for 14.3 percent of the population of 9.1 million. Sweden ranked fourth in terms of the total number of asylum seekers and second in terms of the number of asylum seekers relative to the population, according to UN data comparing 44 countries.

Employment Gap

Sweden has one of the largest employment gaps between natives and foreign-born residents of any OECD country. Employment rates between local and immigrant workers differ by more than 30 percentage points in some areas, according to Statistics Sweden. The unemployment rate among immigrants from countries outside the EU was 16.5 percent in 2011, compared with 5.7 percent for native Swedes, Statistics Sweden says.

Redistribution

Sweden’s welfare state has been squeezed by about 140 billion kronor of tax cuts since 2006, Eurostat data show. That has contributed to tax revenue as a share of GDP falling to 44.3 percent, below Denmark’s figure of 47.7 percent in 2011. Income taxes and cash benefits play a greater role in redistributing income in Sweden, reducing inequality by about 30 percent, compared with an OECD average of 25 percent.

A society that depends heavily on welfare state produces both political and income inequality as revealed by the brewing frictions between natives and foreign born residents in Sweden.

Yet the welfare state has been enabled and facilitated by debt and inflation which are the pillars of the paper money system.

As the great Ludwig von Mises wrote in Liberty and Property:

The welfare state with its methods of easy money, credit expansion and undisguised inflation continually takes bites out of all claims payable in units of the nation’s legal tender. The self-styled champions of the common man are still guided by the obsolete idea that a policy that favors the debtors at the expense of the creditors is very beneficial to the majority of the people. Their inability to comprehend the essential characteristics of the market economy manifests itself also in their failure to see the obvious fact that those whom they feign to aid are creditors in their capacity as savers, policy holders, and owners of bonds.

Today’s global polices have clearly been designed to favor the debtors over creditors. Such been primarily meant to boost the insolvent welfare states, their clients, patrons (political agents, banking system) and other related interests (cronies).

Nonetheless when parasites dominate the hosts, as revealed by the immense and unsustainable accretion of government debts and by the intensifying use of financial repression (negative interest rates, QE) that ”bites out of all claims payable in units of the nation’s legal tender”, such are signs of desperation that exposes the growing fragility and vulnerability of the welfare state which has painted itself to a corner. 

The Santa Claus principle is in a self-liquidates mode

Events in Sweden is a harbinger of things to come.

JGB Watch: Nikkei Dives by 5.15%, Yields Ease, Phisix Commiserates

Back to my JGB-Japan debt crisis watch. 

I pointed out yesterday that JGB yields reentered crash territory. At that time, Nikkei futures seem to have discounted this: The Japanese bellwether barely moved. But this was not to last.

By evening, Nikkei futures tumbled along with European markets.

The Intraday chart shows the Nikkei in a gap down during the opening bell. Losses mounted until the close. The Nikkei closed at 13,589.03 down 5.15%

The dominant explanation by media of falling stocks has been due to the  Federal Reserve’s supposed “tapering”. If true, should the FED scale down, yields should rise further.

But this has hardly been the issue last night. US 10 (TNX) and 30 (TYX) year treasuries eased as US stocks tumbled. UST 5 year (FVX) was marginally higher.

Such “tapering” has been unlikely the driver of the second bout of crashing Japanese stocks. The real force has been climbing JGB yields or Japan's crashing bond markets

As of this writing JGB 10 year yields has been pushed back to .88%, that’s below the .92-.94 range yesterday. Yields of 5 year and 30 year bonds have also retraced.

If I am not mistaken the BoJ has set the .9% as the line in the sand for interventions.

The BoJ did intervene today. But I think that the scale of interventions has been more than what has been declared.

Importantly responding to the request of Japan’s Wall Street “to increase the frequency of its debt purchases”, the BoJ released its QE schedule for June.

1. Amount to be Purchased

Approximately 7+ trillion yen per month in principle. The Bank takes account of market conditions and conducts purchases in a flexible manner in order to ensure that the effects of monetary policy permeate the economy.

2. Bonds to be Purchased

Japanese government bonds with coupons (2-year bonds, 5-year bonds, 10-year  bonds, 20-year bonds, 30-year bonds, 40-year bonds, floating-rate bonds, and inflation-indexed bonds).

It is unclear if the BoJ will be able to cap their interventions, given the repeated attempt by the 10 year JGBs to break the 1% threshold.

I believe that the BoJ will be using up much of their programmed asset purchases just to stabilize the bond markets, which won’t be enough to cover her deficits.

Nonetheless, Asian  markets seem to have empathized with the second series of Japan’s stock market crash. But their losses had been modest. 

One surprising consoler of today's Japan’s crash has been the Philippine Phisix. (technistock.com)

Many have been surprised at such selling violence despite the announcement that the Philippines posted the "best" economic growth in almost 3 years.

The mainstream overlooked that today's Phisix sympathy crash coincides with today’s spike in the yields of the Philippine 10 year bonds. 

This serves as an example of how interest sensitive stock markets are whether the Nikkei or the Phisix. 

And this also serves as warning to "best" economic growth underpinned by massive credit growth.

More Signs of the End of Easy Money? Brazil Raises Rates amidst Stagflation

Could Brazil’s actions of raising interest rates signify as another precursor (aside from Japan) to the culmination of the era of easy money?  

From the Wall Street Journal Blog:

Brazil’s central bank on Wednesday confronted an increasingly acute policy dilemma with firm hand and clear voice, seeming to throw its customary caution to the wind.

In its fourth monetary policy meeting of 2013, the central bank voted unanimously to raise its Selic base interest rate by a half point to 8%. In a brief statement, the central bank said the change was “continuing with” an adjustment in interest rates that would help put inflation on a downward path.

Most analysts had expected a more modest quarter-point increase in the face of soft economic growth.

“They finally woke up,” said Paulo Faria-Tavares, managing partner of Sao Paulo’s PTX Lending consultants. “But they need to stay awake or it won’t work.”

The central bank’s policy dilemma became unexpectedly acute earlier Wednesday, when the government’s IBGE statistics bureau released first quarter economic growth figures. The data showed disappointing first quarter growth of only 0.6%. Most analysts had predicted 0.9% growth.

But slower growth is coming at the same time as rising inflation. Brazil’s 12-month inflation rate is currently running at 6.46%, up from 5.84% at the end of 2012. The current rate is skating dangerously close to the 6.5% ceiling of Brazil’s inflation targeting range, which is 2.5%-to-6.5%.

Under Brazil’s 1999 inflation-targeting law, the central bank is obliged to take action whenever inflation bursts through the top of the range. That could happen at any time

Mainstream media seems to be confused about the causal relationship between growth, zero bound rates, and price inflation.

Let’s see what has been driving Brazil’s “inflation”

Loans to the private sector has essentially more than tripled since 2004!!!

Seen from a different perspective or as ratio to the GDP, domestic credit has been on a sharp upside trend since 2007.

But such upswing has been less than the sharp growth surges of the late 80s and early 90s which culminated with recessions.

The same holds true for domestic credit provided for the banking sector.

And where has all such immense growth in credit been flowing to?

The lackluster general growth of the Brazilian economy seems hardly a manifestation of an evenly distributed credit boom

Instead, booming credit as consequence from easy money policies have channeled to titles representing capital goods, particularly stock market and the real estate.

Brazil’s stock market as seen from the Bovespa appears to have been an early recipient as shown by the booms of 2002-2007 and 2008-2010, but not today.

The chart above reveals of the broadening mismatch between credit and income growth. Such mismatch represents a symptom of the property bubble in progress.

The rate of Brazil’s sizzling property boom makes it one of hottest in the world.

According to an article from Forbes: 

When it comes to rising housing prices, no country in the world beats Brazil.

According to Knight Frank’s Global Real Estate Index, released this month, Brazil ranks No. 3 in the world and No. 1 in the Americas for rising home prices. Only ridiculously expensive Hong Kong and Dubai, which are not countries, have seen prices rise more. So in fact, no single country has seen its housing prices rise as much as Brazil.

Brazil housing prices rose 13.7% from the fourth quarter of 2011 to Dec. 31, 2012. By comparison, U.S. housing prices rose 7.3% in the same period, putting it at No. 12 in a list of 55 countries ranked by Knight Frank.

The only other country in the hemisphere to make it into the top 20 was Colombia, with real estate prices rising 8.3% in 2012.

Brazil stands out. And one reason is the low cost of financing. Or at least low by Brazilian standards. Mortgage rates are at least 1.3% a month, and loan payments are generally for just 15 years. It used to be that Brazilians bought homes in cash, but not anymore. They are financing purchases with down payments. Since 2009, when Brazilians starting buying homes on debt, mortgage lending has risen five fold, by 550% between then and 2012.

According to Brazil’s Institute for Economic Research, or FIPE, housing prices rolled into the end of 2012 in seven capital cities on a high note. Prices in all seven cities — from São Paulo to Rio de Janeiro — rose well above the inflation rate of 5%. At the start of the fourth quarter last year, at the end of September, Brazilian housing prices had already risen by 15% while inflation was not even half that.

Looking back at September, FIPE said São Paulo real estate rose 1.5%, three times higher than the national inflation average for the month.

So Brazil’s property bubbles may end soon.

But this has not been solely a private sector affair

Even as Brazil’s government have been posting surpluses, government spending has zoomed by almost 5 times in 11 years from 2002.  Part of such spending growth has been financed by the explosion of Brazil’s external debt.

In other words, tight competition for scarce resources from the sector’s underpinning the property bubble which has been compounded by the burgeoning growth of government spending—all of which has been financed by credit expansion—has led to higher price inflation amidst stagnant growth.

In essence, Brazil endures from both stagflation and asset bubbles.

Yet the actions of Brazil’s authorities if sustained will put enormous strains on these wealth consuming activities over the near term. This will come with nasty repercussions

Every boom eventually turns into a bust, as the great Ludwig von Mises warned:

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances

Such applies to Brazil’s boom bust cycle.

China Bubble: Diminishing Returns of Credit

Here is an example why asset bubbles are being blown in China.

From the Bloomberg:

China’s economy is proving less responsive to credit, escalating pressure on Premier Li Keqiang to strengthen the role of private enterprise.

The government’s broadest measure of credit rose 58 percent to a record 6.16 trillion yuan ($1 trillion) in January-to-March, when gross domestic product gained 7.7 percent, compared with 8.1 percent a year earlier. Each $1 in credit firepower added the equivalent of 17 cents in GDP, down from 29 cents last year and 83 cents in 2007, when global money markets began to freeze, according to data compiled by Bloomberg.

The diminishing returns to lending heighten focus on the need for what the International Monetary Fund said yesterday are “decisive” policy changes in the world’s second-largest economy. Without a refocus away from state-approved projects, Li and President Xi Jinping risk overseeing both a further slowdown in growth and an increase in non-performing loans.

The article reveals of the Chinese government’s entrenched adaption of Keynesian policies which views credit as an indispensable macro tool used to attain economic growth. 

The Zero Hedge has great on charts representing the above dynamics:

China’s credit boom…

…amidst languishing economic growth

Policymakers hardly distinguish on the character of credit. For them, credit growth of any kind presupposes increased consumption or “aggregate demand”.

And the above report only validates my suspicion that the Chinese government’s covert stimulus has been channeled via state owned enterprises (SOE) since late last year.

In order to avoid controversies from the peering eyes of world, the Chinese government uses the SOEs, which remains a substantial force in her economy, as principal conduits for the transmission of social policies

Yet as explained yesterday much of the credit expansion has only been channeled into yield chasing speculations which has been evident by the ballooning property bubbles and massive expansion of the shadow banking system. 

The existence of ghost communities (towns or shopping malls) are manifestations of wanton misallocation of resources or capital wastage, thus the clueless media and policymakers scratch on their heads on the so-called ‘diminishing returns’ from credit in producing “economic growth”. 

In contrast to the mainstream impression and as shown above, inflationist and interventionist policies reduce aggregate demand over the long run. Thus, macro tools will hardly solve on real micro problems.

To add, the 58% jump in credit growth in the first quarter only means that much of the 7.7% “growth” represents a statistical artifice or a mirage.

The call to focus on private enterprises via economic freedom should signify a policy imperative. This means that the Chinese political economy should further decentralize and that the Chinese government must relinquish political power to the marketplace. This also suggest that people should be allowed to keep their savings from the stealth predations enabled by financial repression policies (e.g. negative interest rates)

But it is doubtful if officials will sacrifice political privileges.

Nonetheless real "private enterprise" based reforms will constitute real growth over the longer term.

Unfortunately there will be short to medium term consequences from all the intensive accumulation of malinvestments. 

Where every action has an attendant consequence, markets must be allowed to clear these imbalances. Otherwise these will continue to mount, until it snaps with greater intensity.

Bottom line: In a recast of Newton's 3rd law: for every bubble boom, there will be a corresponding bubble bust.

Ex-Fed Chair Paul Volcker on Bernanke Policies: Good luck in that

The Bloomberg has a noteworthy quote on Former Federal Reserve Chairman Paul Volcker's recent speech dealing with the policies of the incumbent Fed chief Ben Bernanke which the former thinks that the FED may “fall short” in achieving their goals (bold mine)

The Federal Reserve, any central bank, should not be asked to do too much to undertake responsibilities that it cannot responsibly meet with its appropriately limited powers,” Volcker said. He said a central bank’s basic responsibility is for a “stable currency.”

“Credibility is an enormous asset,” Volcker said. “Once earned, it must not be frittered away by yielding to the notion that a little inflation right now is a good a thing, a good thing to release animal spirits and to pep up investment.”

“The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives,” according to Volcker. “Up today, maybe a little more tomorrow and then pulled back on command. Good luck in that. All experience demonstrates that inflation, when fairly and deliberately started, is hard to control and reverse.”

When price inflation rears its ugly head, it will be sudden, swift and dramatic.

Richard Ebeling: The Case For Freedom and Free markets in the writings of Ludwig von Mises, F.A. Hayek and Ayn Rand

Dr. Richard Ebeling, American libertarian author, former president of the Foundation for Economic Education (FEE) and professor of economics, in a recent speech dealt with the works of Ludwig von Mises, Friedrich von Hayek and Ayn Rand as providing for the intellectual and ethical foundations for the case of Freedom and Free markets.  

From Dr. Ebeling at the Northwood University Blog (bold mine)

Three names are widely associated with the cause of human freedom and economic liberty in the 20^thcentury: Friedrich A. Hayek, Ludwig von Mises, and Ayn Rand. Indeed, it can be argued that Hayek’s The Road to Serfdom (1944) and The Constitution of Liberty (1960), Mises, Socialism ((1936) Human Action(1949), and Rand’s The Fountainhead (1943) and Atlas Shrugged (1957) did more to turn the intellectual tide of opinion away from collectivism in the second half of the twentieth century than any other works that reached out to the informed layman and general public.

Now, in the second decade of the 21st century their enduring influence is seen by the continuing high sales of their books, and the frequency with which all three are referred to in the media and the popular press in the face of the current economic crisis and the concerns about the revival of dangerous statist trends in the United States and other parts of the world.

The Influence of Mises, Hayek, and Rand

In Hayek’s case, his influence has reached inside academia, that bastion of the social engineering mentality in which too many professors, especially in the social sciences, still dream wistfully about society being remade in their own images of “social justice” and political correctness – regardless of the expense in terms of people’s personal and economic liberty.

Hayek’s message of intellectual humility – that there is more to the complexities of the world than any government planning or intervening mind can ever master – has forced some in that academic arena to take seriously the possibility that there may be “limits” to what political paternalism can achieve without undermining the essential institutional foundations of a free and prosperous society.

Mises continues to be recognized as the most original and influential member of the Austrian School of Economics during the greater part of the 20th century. Mises stands out as that unique and original thinker who proved why socialist planning cannot work, that government intervention breeds inescapable distortions and imbalances throughout the market, and how central bank manipulation of money and interest rates sets in motion the booms and busts of the business cycle. The current recession has brought new attention to the Austrian theory of money and economic fluctuations, which was first formulated by Mises in the early decades of the 20th century.

While the academe of philosophers is still not willing to give Ayn Rand the respect and serious attention that others believe she rightly deserves, it is nonetheless true that her novels and non-fiction writings, especially The Virtue of Selfishness (1964) and Capitalism: the Unknown Ideal (1966), continue to capture the interest and imagination of a growing number of students in the halls of higher education in the United States. In other words, her ideas continue to reach out to that potential generation of “new intellectuals” that Rand hoped would emerge to offer a principled and morally grounded defense of individualism and capitalism.

The Common Historical Contexts of Their Time

Hayek, Mises and Rand each made their case for freedom and the political order that accompanies it in their own way. While Mises was born in 1881 and, therefore, was 18 years older than Hayek (who was born in 1899) and nearly a quarter of a century older that Rand (who was born in 1905), there were a number of historical experiences they shared in common, and which clearly helped shape their ideas.

First, they came from a Europe that was deeply shaken by the catastrophic destruction and consequences of the First World War. Both Mises and Hayek saw the horrors of combat and the trauma of military defeat while serving in the Austro-Hungarian Army, as well as experiencing the economic hardships and the threat of socialist revolution in postwar Vienna. Rand lived through the Russian Revolution and Civil War, which ended with the triumph of Lenin’s Bolsheviks and the imposition of a brutal and murderous communist regime; she also experienced “socialism-in-practice” as a student at the University of Petrograd (later Leningrad, now St Petersburg) as the new Marxist order was being imposed on Russian society.

Second, they also experienced the harsh realities of hyperinflation. Rand witnessed the Bolshevik’s intentional destruction of the Russian currency during the Russian Civil War and Lenin’s system of War Communism, which was designed as a conscious attempt to bring about the abolition of the market economy and capitalist “wage-slavery.” In postwar Germany and Austria, Mises and Hayek watched the new socialist-leaning governments in Berlin and Vienna turn the handle of the monetary printing press to fund the welfare statist and interventionist expenditures for instituting their collectivist dreams. In the process, the middle classes of Germany and Austria were decimated and the social fabric of German and Austrian society were radically undermined.

Third, Rand was fortunate enough to escape the living hell of socialism-in-practice in Soviet Russia by being able to come to America in the mid-1920s. But from her new vantage point, she was able to observe the rise and impact of “American-style” collectivism, during the Great Depression and the coming of Franklin Roosevelt’s New Deal in the 1930s. In Europe, Mises and Hayek watched the rise of fascism in Italy in the 1920s and then the triumph of Hitler and National Socialism in Germany in 1933, the same year that FDR’s New Deal was implemented in the United States. For both Mises and Hayek, the Nazi variation on the collectivist theme not only showed it to be one of the most deadly forms that socialism could take on. It represented, as well, a dark and dangerous “revolt against reason” with the Nazi’s call to the superiority of blood and force over the human mind and rational argumentation.

Their Common Premises on Collectivism and the Free Society

What were among the common premises that Mises, Hayek and Rand shared in the context of the statist reality in which they had lived? Firstly, I would suggest that it clarified conceptual errors and political threats resulting from philosophical and political collectivism. The “nations,” “races,” “peoples” to which the totalitarian collectivists appealed resulted in Mises, Hayek and Rand reminding their readers that these do not exist separate or independent from the individual human beings who make up the membership of these short-hand terms for claimed human associations.  Anything to be understood about such “collectives” of peoples can only realistically and logically begin with an analysis of and an understanding into the nature of the individual human being, and the ideas he may hold about his relationships to others in society.

Furthermore, political collectivism was a dangerous tool in the hands of the ideological demagogues who used the notions of the “people’s will,” or the “nation’s purposes,” or the “society’s needs,” or the “race’s interests,” to assert their claim to a higher insight that justified the right for those with this “special intuitive gift” to guide and rule over others.

Secondly, all three rejected positivism’s denial of the human mind as something real, and as source for knowledge about man and his actions. Mises and Rand, especially, emphasized the importance of man’s use of his reasoning ability to understand and master the world in which he lived, and the importance of reasoned reflection for conceiving rational rules and institutions for a peaceful and prosperous society of free men.  Mises and Rand considered the entire political trend of the 20thcentury to be in the direction of a “revolt against reason.”

Even Hayek, who is sometimes classified as an “anti-rationalist” due to his emphasis on the limits of human reason for designing or intentionally constructing the institutions of society, should also be classified as an advocate of man’s proper use of his reasoning powers when reflecting on man and society. While the phrasing of his arguments sometimes created this confusion, in various places Hayek went out of his way to insist that he was never challenging the centrality of man’s reasoning and rational faculty. Rather, he was reminding central planners and social engineers that one of the important uses of man’s reasoning ability is to understand the limits of what man can and cannot know or hope to do in terms of trying to remake society according to some preconceived design.

Thirdly, all three firmly believed that there was no societal arrangement conceivable for free men and human betterment other than free market capitalism. Only a private property order that respects and protects the right of the individual to his life, liberty, and honestly acquired possessions give people control over their own lives. Only the voluntary associative arrangements of the marketplace minimize the use of force in human relationships. Only the market economy allows each individual the institutional means of being free from the power of the government and its historical patterns of plunder and abuse. And only the market economy gives each individual the latitude to live for himself and use his knowledge and abilities to further his own ends as he best sees fit.

And, finally, Mises, Hayek, and Rand all emphasized the importance of the intellectuals in society in influencing the tone and direction of political, economic, and social ideas and trends. These “second-hand” thinkers of ideas were the driving force behind the emerging and then triumphing collectivist ideas of the 19th and 20th centuries. They were the molders of public opinion who have served as the propagandizers and rationalizers for the concentration of political power and the enslavement and deaths of hundreds of millions of people – people who were indoctrinated about the need for their selfless obedience and sacrifice to those in political power for a “greater good” in the name of some faraway utopia.

The Consequentialist Rationale for Freedom

But where they differed was on the philosophical justification for the free society and the rights of individuals within the social order. Both Mises and Hayek were what today might go under the term “rule utilitarians.” Any action, policy or institution must be evaluated and judged on the basis of its “positive” or “negative” consequences for the achievement of human ends.

However, the benchmark for such evaluation and judgment is not the immediate “positive” or “negative” effects from any action or policy. It must, instead, be placed into a longer-run context of theoretical insight and historical experience to determine whether or not the policy or action and its effects are consistent with the sustainability of the overall institutional order that is judged to be most effective in furthering the long-run possible goals and purposes of the members of society, as a whole.

Thus, the rule utilitarian is concerned with the “moral hazard” arising from an action or policy implemented. That is, will it create “perverse incentives” that results in members of society acting in ways inconsistent with the long-run betterment of their circumstances?

Welfare payments may not only involve a transfer of wealth from the productive “Peters” in society to the unproductive “Pauls.” It may also reduce the motives of the productive members of society to work, save and invest as much as they had or might, due to the disincentive created by the higher taxes to pay for the redistribution. At the same time, such wealth transfers may generate an “entitlement” mentality of having a right to income and wealth without working honestly to earn it. Thus, the “work ethic” is weakened, and a growing number in society may become welfare dependents living off the honest labor of others through the paternalistic transfer hands of the State.

The net effect possibly is to make the society poorer than it otherwise might have been, and therefore making everyone potentially worse off in terms of the longer-run consequences of such policies.

Read the rest here.

I would add the great Murray Rothbard, but contra rule utilitarians Mr. Rothbard was a champion of natural rights based libertarianism

JGB Watch: 10 Year Yields Reenters Crash Zone

I am in a Japan debt crisis alert mode so my JGB updates.

Japan’s key stock market benchmark, the Nikkei closed marginally up (.1%) today after steep intraday swings

Part of the early upside in the Nikkei could be due to the early interventions by the BoJ on JGBs. 

Near the closing bell, the Nikkei’s more than 1% gains were almost wiped out, except for the residual gains.

As of this writing, JGB yields across the curve has gone materially higher except the 30 year.

10 year yields have already encroached on Last Thursday’s flash crash zone.

So far, the ongoing turmoil in Japan’s bond markets have not yet caused panic elsewhere. Although Europe’s markets have been modestly lower as of this writing.

The Nikkei futures has likewise been moderately down by less than 1%.

Fitch Defies S&P on China’s Credit Bubble

Defying the consensus, US Credit rating agency Fitch ratings says China’s bubble is unsustainable.

From the Bloomberg: (bold mine)

Chinese banks are adding assets at the rate of an entire U.S. banking system in five years. To Charlene Chu of Fitch Ratings, that signals a crisis is brewing.

Total lending from banks and other financial institutions in China was 198 percent of gross domestic product last year, compared with 125 percent four years earlier, according to calculations by Chu, the company’s Beijing-based head of China financial institutions. Fitch cut the nation’s long-term local-currency debt rating last month, in the first downgrade by one of the top three rating companies in 14 years.

“There is just no way to grow out of a debt problem when credit is already twice as large as GDP and growing nearly twice as fast,” Chu, 41, said in an interview.

Usually I would take the opposite side of the fence vis-à-vis credit rating agencies, but in the case above, the Fitch analyst Ms. Charlene Chu resonates on my analytical methodology: She focuses on the trajectory.

China has implemented a massive RMB 4 trillion or $586 billion stimulus meant to shield against the US epicenter crisis in 2008. This serves as an aggravating or secondary cause. From the same article:

Amid the global credit crunch of 2008, China ramped up lending by state-controlled banks to prevent an economic slowdown. The assets of Chinese banks expanded by 71 trillion yuan ($11.2 trillion) in the four years through 2012, according to government data. They may increase by as much as 20 trillion yuan this year, Chu said April 23. That will exceed the $13.4 trillion of assets held by U.S. commercial banks at the end of last year, according to the Federal Deposit Insurance Corp.

Chu says companies’ ability to pay back what they owe is wearing away, as China gets less economic growth for every yuan of lending.

In short, the stimulus only created massive malinvestments or transfers of resources to wealth consuming activities. Thus the diminishing returns of credit. The payback from which is likely to come sooner than later.

The Chinese government’s denial:

China’s expansion of credit hasn’t caused a surge in the proportion of bad loans, data from the banking regulator show.

While loans overdue for at least three months have grown for six straight quarters to reach 526.5 billion yuan at the end of March, the ratio of nonperforming loans declined to 0.96 percent as of March 31 from 2.42 percent at the end of 2008, according to the China Banking Regulatory Commission.

As previously noted, Non Performing Loans (NPL) are coincidental or lagging indicators. They usually become apparent when the bubbles are in the process of reversing. 

Yet for as long as the bubble inflates, or for as long as housing prices moves up, the Ponzi financing scheme may continue to thrive.

When entities (private or public) can hardly finance principal and interests of outstanding loans from cash flows but increasingly depends on rising assets to cover funding requirements, through asset sales or as collateral for more borrowing such is called a Ponzi finance as postulated by economist Hyman Minsky.

China’s housing bubble continues to balloon even as the real economy has materially been slowing down, as shown in the chart from Wall Street Journal. Such is a sign of growing Ponzi finance.

In short, current inflationist policies by the Chinese government motivates the public to speculate on housing and other financial packages rather than invest on productive enterprises.

Such housing bubble has likewise drawn in hot money as shown by the chart from Zero Hedge

The Chinese government has recently moved to curtail hot money flows using copper imports to facilitate “carry trades” based on “interest rate arbitrages”.

Going back Fitch. Ms. Chu says China’s statistical data has been unreliable. Importantly she says that much of what I call Ponzi finance may have found a channel in the burgeoning “Shadow Banking Sector”

Chu, who has covered Chinese financial institutions at Fitch for seven years, says these figures are distorted. The ratio of nonperforming loans to total lending has declined mainly because credit has surged, she said. Moreover, the regulator’s data doesn’t reflect the real amount of debt because of the ways banks move loans off their books, Chu said.

Some loans, often for real estate, are bundled together and sold to savers as so-called wealth-management products, while other assets are sold to non-bank financial institutions, including trusts, to lower the lenders’ bad debt levels, according to Chu. Wealth management products and trusts are sold to investors eager to get more than the government-mandated benchmark of 3 percent annual interest on bank savings accounts.

“The data may be somewhat accurate for the on-balance-sheet loan portfolios of the banks, but banks have substantial off-balance-sheet positions for which there is no asset-quality information,” she said.

The Moody’s estimates that China’s Shadow Banking System have reached 29 trillion yuan or  $4.7 trillion  compared to 17.3 trillion yuan in 2010

Shadow banks are manifestations of regulatory arbitrages or the circumvention of regulations. China's shadow banks has been mainly through Wealth Management Products (WMP) which have mainly been about short term financing

Quoting Ms. Chu from another article:

WMPs are vehicles that can borrow/lend, and banks engage in transactions with their own and each other’s WMPs. This makes the pools of assets and liabilities tied to WMPs in effect second balance sheets, but with nothing but on-balance-sheet liquidity, reserves, and capital to meet payouts and absorb losses. These hidden balance sheets are beginning to undermine the integrity of banks’ published balance sheets.

The leverage being accreted can be seen in the accelerating growth of China’s bank assets as shown from the chart by Northern Trust. Bank Assets in the official sector have now topped 250% of GDP and excludes the shadow banks. Bank assets has spiked since 2008. 

Every bubble culminates with a mania phase, characterized by a blow off in the build up of debt which ultimately implodes

A jump in the ratio of credit to GDP preceded banking crises in Japan, where the measure surged 45 percentage points from 1985 to 1990, and South Korea, where it gained 47 percentage points from 1994 to 1998, Fitch said in July 2011. In China, it has increased 73 percentage points in four years, according to Fitch’s estimates.

“You just don’t see that magnitude of increase” in the ratio of credit to GDP, Chu said. “It’s usually one of the most reliable predictors for a financial crisis.”

I have previously shown this chart from Harvard’s Reinhart-Rogoff where debt build up leading to every crisis intensifies until this hits a certain debt intolerance level which may triggered internally or externally.

Fitch versus S&P

The nation is in a better position now to tackle nonperforming loans, said Liao Qiang, a Beijing-based director at S&P. In the past decade, China’s economy has quadrupled, the number of urban residents surpassed those on farms and policy makers allowed freer flows of its currency in and out of the country. Its foreign-exchange reserves surged fivefold from 2004 to $3.3 trillion at the end of 2012.

“Given that China’s credit is mostly funded by its internally generated deposits, I don’t think a real financial crisis, which is normally manifested in a liquidity shortage, will happen anytime soon,” S&P’s Liao said by phone. Local-currency savings stood at 92 trillion yuan at the end of 2012, according to the National Bureau of Statistics.

Again we see the conflict between analysis based on statistics and with that of economic logic.

Bubbles are symptoms of savings being squandered for yield chasing speculative wealth consuming activities.

With underdeveloped capital markets and as the Chinese government uses financial repression via negative real rates to confiscate people’s savings, real savings by the average Chinese are being transferred (to the government) and consumed (through speculations—housing and Ponzi Shadow banks). The implication is that real savings are being depleted. 

China’s stock market continues to languish since the 2007 top. This provides scant returns for the public (tradingeconomics.com)

And that’s why many Chinese gravitate to gold. The state of the Chinese yuan, like other fiat currencies, reveals of the "inflation tax" and continues to depreciate against gold as shown by the chart from GoldMoney.com

Surging bank loans

Chinese banks extended 2.8 trillion yuan of loans in the first quarter, 12 percent more than a year earlier and the second-largest quarterly total on record, government data show. Economic growth in the period slowed to 7.7 percent from 7.9 percent in the fourth quarter.

Only 29 percent of last year’s aggregate financing translated into economic growth, the lowest rate on record, as borrowers use more resources to finance outstanding debt and less for investment, Sanford C. Bernstein & Co. analyst Michael Werner wrote in January.

The reality is that the Chinese government has already launched a stealth stimulus since last year. 

This can be seen in the continuing credit growth in the Chinese banking sector as seen from ‘the chart from Dr. Ed Yardeni.

Most of the pick up in credit growth I believe has been directed to State Owned Enterprises (SOE). One must realize that Chinese economy remains heavily politicized where many firms are wards of the government. So Chinese policies can be coursed through them without official admission. 

And as a final note, the covert stimulus being reflected as credit boom is likewise manifested on money supply as shown by the chart from Zero Hedge

Denials will not assume away the effects of unsound policies.

At the end of the day: bubbles (something out of nothing) and Ponzi schemes will reveal of their true nature. 

This means I will not bet on the China led “Asian century” until we see significant liberalization of her economy and monetary system.