Phisix: The Convergence Trade in the Eyes of a Prospective Foreign Investor

The Phsix lost 3.5% this week, the largest among the regional contemporaries.

Except for Indonesia, Asia, the BRIC and Indonesia have largely been in the red.

In the meantime, US and European stocks remain turbocharged and on a Wile E. Coyote momentum.

Last week[1] I pointed how Japan’s Nikkei 225’s 10 year boom-bust chart closely resembles the Philippine Phisix and Thailand’s SET’s year-to-date chart.

This week’s marked decline by the Phisix and the SET seems to reinforce the fourth downside arc of the Nikkei.

I am not in a position to guess whether the coming week will herald continued decline or a rebound, although if we should approximate on the Nikkei’s post bust consolidation pattern, any further decline would equally be met with a limited rebound. And the rangebound phase can be expected to continue perhaps until the first or second quarter of 2014 before a major move.

But this would be conditional to a pattern repetition.

As a side comment, as I have previously pointed out[2], the Philippines shares the same “supply-side” imbalances as with Japan’s bubble dynamics prior to the bust. There even have been similarities in foreign currency reserves and current account surpluses. Yet despite the huge savings and the NIIP complimenting on the substantial forex reserves and current account surpluses, these much touted advantages eventually had been overwhelmed by the basic laws of economics. Credit fuelled boom turned into a massive banking and property bust. Yet the bubble bust hangover continues to linger twenty three years (Japan’s lost two decades) and counting. And the desperation from the deepening frustration of the inability by the Japanese economy to break-away from the seemingly perpetual malaise has forced incumbent policymakers to undertake the grandest central bank experiment—Abenomics or doubling of the money base in two years—which is virtually doing the same thing over and over again but at a bigger scale but expecting different results.

And absent big economic or financial news, the current weakness by domestic stocks has been impelled by net foreign selling. For the past 3 weeks, the Philippine Stock Exchange registered consecutive net selling of Php 4.6, Php .7 and Php 3 billion. 

Why?

Let move to hypotheticals. Let me put on the hat of a US or European investor and see how Philippine assets should fare with my prospective portfolio

The Unsustainable Convergence Trade

Philippine 10 year bond yields relative to German bond equivalent have been in a historic convergence. 

As of Friday, with 10 year yields at 3.53% for the Philippines and 1.76% for Germany, the yield spread has narrowed to a landmark 177 basis points from about 400 to 500 basis points in 2010. Incredible.

The same historic convergence can be seen between 10 year US Treasury notes and the Philippine counterpart. As of Friday’s close, the spread between UST which closed at 2.751% and the Philippines has been at an astounding 78 basis points that’s from about 400-450 basis points in 2012.

Based on Tradingeconomics.com[3] categorization of yield where the “yield required by investors to loan funds to governments reflects inflation expectations and the likelihood that the debt will be repaid”, the narrowing spreads has been premised from the belief that the Philippines will be immune from the global bond vigilantes and or from the belief that the Philippines will proximate (soon) the economic status of developed economies such as the US, Germany, Singapore or Hong Kong in terms of creditworthiness or capacity to pay debt

Unless one shares such ridiculous beliefs, there hardly seems any upside room for Philippine 10 year bonds.

Has anyone ever given a thought how the Philippines, with a per capita income of $4,410 (2012 World Bank), would be able to approximate the US $49,965 or Germany US $40, 901 in terms of “the likelihood that the debt will be repaid” as previously discussed[4]?

True the US has unwieldy debts but they have a currency, the US dollar, which has functioned as the de facto currency reserve of the world[5], which for now gives them the upper hand or the space to finance such intractable debts.

Per capita GDP[6] of the US represents 11.32x the Philippines, yet bond markets are presupposing that the Philippines will narrow the gap substantially soon (!!).

And if one were to use New Zealand’s bond equivalent as benchmark, which closed Friday with a 4.67% yield (meaning New Zealand has been priced as less creditworthy than the Philippines) and whose per capita income has been $32,219 (2012 World Bank), then the implication is that Philippine bond market have priced Philippine per capita GDP to explode by over 7.3x and surpass New Zealand.

Yet how will we attain this? Pump up bigger bubbles?

This is like saying 80+ PE ratio of the US Russell 2000 small cap index[7] is considered ‘cheap’ and thus a buy! It’s the kind of euphoria that espouses on a “this time is different” outlook.

Philippine bond markets have been grotesquely mispriced.

The Eurozone’s Convergence Bubble Trade as Paradigm

We have seen this kind of interest rate convergence before. 

The introduction of the euro led to a near synchronous convergence of interest rates acrossf Euro members[8]. Such convergence inflated domestic bubbles fuelled by domestic credit which was aggravated by capital flows from the core (Germany, France) to the periphery (Portugal, Ireland, Italy and Greece).

Associate Professor at the Universidad Rey Carlos and associate scholar of the Mises Institute Philipp Bagus explains[9]

The lower interest rates coupled with an expansionary monetary policy by the ECB led to distortions in peripheral economies. The Greek government used the lower interest rate to build a public adventure park. Italy delayed necessary privatizations. Spain expanded the public sector and built a housing bubble. Ireland added to their housing bubble a financial bubble. These distortions were partially caused by the EMU interest-rate convergence and the expansionary policies of the ECB. Naturally, people related to the bubble activities in these countries — such as public employees and construction workers — benefited. However, the population in general took a loss through the extension of the public sector and reduction of the private sector, as well as through malinvestments in the construction industry.

Well, I hardly see any difference then and now…

This is the update of the credit boom that has fuelled a Philippine version of public sector “infrastructure” spending boom and a property bubble induced by the interest rate convergence. 

Credit growth has once again reaccelerated, particularly to what I call as bubble areas.

BSP data as of September[10] reveals that general banking loans advanced to 14.84% (year on year) surpassing the March levels and is at a breath away from the January 2013 high of 15.64%. The major push comes from a sharp upside recovery from Real Estate, Rent & Business Services which was up 26.46% (y-o-y) and accounts for the second best month after January’s 28.53 (y-o-y). Real estate loans accounted for 21.15% of loans issued by the banking industry.

Financial intermediation more than doubled to 9.03% (y-o-y) compared to last month’s 4.09%. Part of this doubling of financial intermediation growth must have spilled over to the post August low rebound of the Phisix which returned 1.9% for September.

Loans to the Hotel and Restaurant and Trade (wholesale and retail) remain robust at 35.46% and 15.51% respectively. Meanwhile loans to the construction sector fell to a still amazing 43.72% as against 58.03% last month.

These bubble sectors constitute about half or 50.1% of total loans by the banking industry in September.

Also the impact from World Bank IFC’s Doing Business reforms[11] in the easing of construction permits (based on June 2012-May 2013 survey) appears to have taken effect. Reforms appear to be based on lobbying by the property-financial sector. Such reforms, including guaranteeing borrowers’ right to access their data reveal of the skewed economic priorities of the current administration in accommodating bubbles.

Loans to the manufacturing, a non-bubble area so far, likewise ballooned by 13.1%. Manufacturing loans accounted for an 18.58% share of total banking production side loans last September.

Consumer loans, where only a few households have access to, grew by only 10.91% over the month.

The surge in banking loans was equally reflected on domestic liquidity or M3 which grew by 31% year on year[12].

So the BSP will achieve a $32k per capita income by continually inflating of bubbles via a massive build-up of debt or by borrowing tomorrow’s spending today.

This also means that statistical economic growth for the third quarter will likely remain at 7% or above.

Yet if I am a foreign investor, in the realization that domestic bonds have been flagrantly mispriced, economic growth have been reflected on statistics rather than the real economy and a persistently growing imbalance between the supply side and the demand side financed by a sustained asymmetric build-up on debt all dependent on the Fed’s easy money policy, the potential returns on Philippine investments hardly justifies the risk spectrum from converging yield spreads in terms of credit risk, currency risk, inflation risk, interest rate risk and the market risk.

China’s Hissing Bubble as Potential Spoiler to the Convergence Trade

And I don’t need to look at the West to realize of potential risks from the outlandish convergence trade.

Last week’s considerable improvement in China’s export data[13], proposed reforms on the Third Plenum[14] and liberalization of the bond markets via the stock market[15] failed to inspire Chinese stock markets to rally. The Shanghai index sank 2.02% this week.

One can understand why. While Shibor (short term interbank lending) rates have partially been soothed, rampaging bond vigilantes can be seen in the yields of China’s 10 year bonds which has spiked to 4.27% as of Friday the highest level since November 2007[16].

While ascendant yields of Chinese 10 year bonds will affect lending rates of domestic debt, a seeming return of the bond vigilantes in the US, the UK, Germany and France will impact soaring China’s foreign debt exposure

The Institute of International Finance (IIF), the world's only global association or trade group of financial institutions with over 450 members which includes banks and financial houses[17], notes of a new study by the Bank of International Settlements where FX loans to China's corporations have more than tripled from $270 billion in 2009 to $880 billion in March 2013.

The surge of FX loans can also be seen in Hong Kong $375 billion and Korea $160 billion[18]

Bond vigilantes will not only put a dent on a debt dependent statistical economic growth, the bond vigilantes will put into question credit quality of outsized debts from the private sector to the government.

Importantly, emerging markets have outpaced corporate debt growing everywhere. “Corporate indebtedness has increased across the world” according to the cartel of global financial institutions, the IIF.

The IIF seems worried about bubbles too, “after six years of abundant liquidity and near-zero policy rates, additional easing of monetary conditions, justifiable as it is in the case of the Euro Area and Japan, could increasingly lead to financial distortions and pockets of bubbles in asset markets”

Distortions fueling “pocket of bubbles” have been a laughable understatement, but of course, what can one expect from the key beneficiaries of bubbles.

Momentum Trades; The Stock Market Returns and Economic Growth

Third, if I am a foreign momentum or yield chaser, I wouldn’t pile on Philippine stocks but rather on US and European markets.

Since the reinvigorated bond vigilantes rationalized by the Taper Talk last May, the Phisix has vastly underperformed US and European markets (via the blue chip Stoxx 50). Given the shared characteristics of Thailand’s SET with the Phisix, the SET will also reflect on the PSEC’s underperformance

And since I expect the bond vigilantes to continue with their growing incidences of raids on the international financial markets, the trend seems to favor a sustained underperformance by the Phisix-SET.

Finally as foreign investor, despite media’s hullabaloo over Philippine growth story, the reality is that statistical growth has hardly been related with stock market performance.

The investing giant, the John Bogle founded Vanguard group identifies weak correlation between real stock market performance and real GDP across the 46 countries.

From 1970-2012 real returns by the Phisix has been NEGATIVE despite the recent boom. I would add that considering suppression of inflation rates and constant changes in the Phisix components favouring the high flyers, real returns based on original construct must be even lower.

But it is not just the Phisix, real GDP growth has been relatively uncorrelated with stock market returns.

As the Vanguard notes[19]

Growth expectations, globalization, financial deepening, and valuation levels all play significant roles in disconnecting long-term growth outcomes from equity market returns

I may add that central bank policies have sharply reduced such correlation. By punishing savers and rewarding speculation via Zero bound rates and QEs, redistribution of resources tilted towards stock markets has increased the disconnection between the real economy and financial performance. Overall such price distortions are signs of bubbles.

Given the uncertainty brought about by bond vigilantes, popularly expressed via the Taper Talk (which is only half true) a serious foreign investor would question the sustainability of the convergence trade and doubt the relationship between real stock market returns relative to GDP growth, while a momentum player will prefer US and European stocks.

Foreigners Determine Returns of the Phisix

This brings us to the role played by foreigners.

Three facts to consider

-Publicly listed firms in the Philippines remain largely family businesses where the elites control 83% of the total market cap as of 2011 (left table)

-Retail investors remain insignificant players in terms of numbers. Amount is uncertain.

96.4% of the 525,850 accounts[20] in the Philippine Stock Exchange have been identified as retail, 3.6% institutional, 98.5% local investors. Online accounts represent 14.9% of total. Retail investors include members of the economic elite.

Despite the 432% jump by the Phisix from October 2008, to May 2013, new accounts grew by only 22% or a CAGR of 4.07%

-The gap between family owned % share of the market cap and retail investors have been filled by foreigners. Foreign investors as of 2009 accounts about 16% share of market cap (right window)[21]

Unless there will be a major change in the present dynamics, this leaves foreigners as the critical participants instrumental in determining the path of the Phisix.

Since the historic convergence trade or the significant narrowing of yield spreads between the US Treasuries/German Bunds and Philippine bonds, the flow of foreign money has been sharply volatile according to BSP data[22]. 

And despite a seemingly steady low bond yields, the Philippine Peso seem to reflect on the volatility of the Phisix and of the foreign portfolio flows.

Scroll back up to see how narrowing yields has coincided with the Phisix-Peso tempest

In short, Philippine bonds look like the odd man out.

As foreigner, Philippine assets will hardly be appealing mainly due to the lack of margin of safety.

---

[1] See Phisix: The Myth and Realities of a Yearend Rally November 3, 2013

[2] See Phisix: Will Domestic Fundamentals Outweigh External Factors? August 12, 2013

[3] Tradingeconomics.com PHILIPPINES GOVERNMENT BOND 10Y

[4] See Phisix: Rising Systemic Debt Erodes the Margin of Safety October 14, 2013

[5] See Why a US debt default extrapolates to the END of the US dollar hegemony October 12, 2013

[6] Wikipedia.org List of countries by GDP (PPP) per capita

[7] See Phisix: The Implication of the US Boom Bust Cycle October 28, 2013

[8] FXTimes.com A History of Europe’s Debt Crisis and Current Issues

[9] Philipp Bagus The Eurozone: A Moral-Hazard Morass

[10] Bangko Sentral ng Pilipinas Bank Lending Sustains Growth in September October 31, 2013

[11] See Philippine Economy: The Unseen Factors behind the “Doing Business” improvements October 30 2013

[12] Bangko Sentral ng Pilipinas Domestic Liquidity Growth Holds Steady in September October 31, 2013

[13] Businessweek/Bloomberg China's Exports: Back on Track November 8, 2013

[14] Wall Street Journal Real Time Economics Blog China’s Third Plenum: A Scorecard November 8, 2013

[15] Reuters.com UPDATE 1-China to let banks sell bonds on stock exchange to boost capital November 8, 2013

[16] Wall Street Journal Real Time Economics Blog Early Look: China Set for a Slowdown November 7, 2013

[17] Wikipedia.org Institute of International Finance

[18] Institute of International Finance November 2013 Capital Markets Monitor and Teleconference

[19] The Vanguard Group The outlook for emerging market stocks in a lower-growth world September 2013

[20] See Phisix: Will the Fed’s Spiking of the Punchbowl Party Be Sustainable?

[21] Asian Development Bank Asia Capital Markets Monitor AUGUST 2011

[22] Bangko Sentral ng Pilipinas Foreign Portfolio Investments Yield Net Inflows in September Table October 17, 2013

Video: Mark Thornton on the Unintended Economic Consequences of NSA Spying

Austrian economist Mark Thornton explains of the unintended consequences from National Security Agency's (NSA) rampant spying 

(Source: The Circle Bastiat/Mises Media)

Central Bankers are the Real Centers of Political Power

Central bankers have already been portrayed or regarded by media as superheroes.

In the modern economy, which operates on fiat money based fractional reserve banking system, central bankers have served as the proverbial power behind the throne. 

Such dynamic has especially been reinforced in the post 2007 crisis landscape, where monetary policies via asset purchasing program has encroached on the fiscal space (Hussman 2010)

Sovereign Man’s prolific Simon Black explains why central bankers, led by the US Federal Reserve, have been in command of the US political economy since 1971: (bold mine)

Check out this chart below. It’s a graph of total US tax revenue as a percentage of the money supply, since 1900.

For example, in 1928, at the peak of the Roaring 20s, US money supply (M2) was $46.4 billion. That same year, the US government took in $3.9 billion in tax revenue.

So in 1928, tax revenue was 8.4% of the money supply.

In contrast, at the height of World War II in 1944, US tax revenue had increased to $42.4 billion. But money supply had also grown substantially, to $106.8 billion.

So in 1944, tax revenue was 39.74% of money supply.

You can see from this chart that over the last 113 years, tax revenue as a percentage of the nation’s money supply has swung wildly, from as little as 3.65% to over 40%.

But something interesting happened in the 1970s.

1971 was a bifurcation point, and this model went from chaotic to stable. Since 1971, in fact, US tax revenue as a percentage of money supply has been almost a constant, steady 20%.

You can see this graphically below as we zoom in on the period from 1971 through 2013– the trend line is very flat.

What does this mean? Remember– 1971 was the year that Richard Nixon severed the dollar’s convertibility to gold once and for all.

And in doing so, he handed unchecked, unrestrained, total control of the money supply to the Federal Reserve.

That’s what makes this data so interesting.

Prior to 1971, there was ZERO correlation between US tax revenue and money supply. Yet almost immediately after they handed the last bit of monetary control to the Federal Reserve, suddenly a very tight correlation emerged.

Furthermore, since 1971, marginal tax rates and tax brackets have been all over the board.

In the 70s, for example, the highest marginal tax was a whopping 70%. In the 80s it dropped to 28%.

And yet, the entire time, total US tax revenue has remained very tightly correlated to the money supply.

The conclusion is simple: People think they’re living in some kind of democratic republic. But the politicians they elect have zero control.

It doesn’t matter who you elect, what the politicians do, or how high/low they set tax rates. They could tax the rich. They could destroy the middle class. It doesn’t matter.

The fiscal revenues in the Land of the Free rest exclusively in the hands of a tiny banking elite. Everything else is just an illusion to conceal the truth… and make people think that they’re in control.

Money, which represents half of almost every transactions made every day, has been in the control of a few unelected technocrats who have the capacity to run society aground.

Said differently centralization of money equates to a top-down dynamic of risk distribution in terms of money thereby making risks systemic, e.g. boom bust cycles, stagflation and hyperinflation

Unknown to many, central planning and control of money represents one of the 10 planks of the communist manifesto:

5. Centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly.

It's an oxymoron for the public, who supposedly oppose communism, to adhere to one of communism's major creed. 

Yet the rapidly expanding role by central banks applied today will lead to a train wreck. As Austrian economist Thorsten Polleit warns:

Central banks will become the real centers of political power. You could even say they are on the way to assuming the role of a “Politburo.” Central banks will effectively decide who is going to get credit at what conditions. They will decide which governments, which banks, and which kind of business sectors and companies will flourish or go under. The truth is that if the fiat money regime is not brought to an end — either by political will or by economic collapse — the economies will end up in a kind of socialist-totalitarian dead-end. But I tend to be optimistic: namely, that the fiat money scheme will break down before such a situation is reached.

European Economic Recovery? ECB Cuts Interest Rates

The mainstream has been adamantly insisting about a supposed economic recovery in Europe. 

But if true, then why the need for the European Central Bank (ECB) to cut rates?

ECB President Mario Draghi was quoted by the CNBC at last night’s press conference saying that “risks to the outlook remain weighted to the downside”

In addition, Mr. Draghi raised the issue of the risks of deflation to justify such actions.

From Bloomberg

The European Central Bank unexpectedly cut its benchmark interest rate to a record low in a bid to prevent slowing inflation from taking hold in a still-fragile euro-area economy.

With inflation at the weakest level in four years and less than half the ECB’s target, the Frankfurt-based bank halved its key refinancing rate to 0.25 percent in a shift anticipated by just three of 70 economists in a Bloomberg News survey.

“Our monetary-policy stance will remain accommodative for as long as necessary,” ECB President Mario Draghi told reporters in Frankfurt. “We may experience a prolonged period of low inflation…

Euro-area inflation surprisingly deteriorated in October to 0.7 percent, below the ECB’s goal of “close to but below” 2 percent, sparking fears of a deflationary cycle. Unemployment of 12.2 percent is the highest level since the currency bloc was formed in 1999, while the euro’s almost 4 percent rise against its major peers this year is challenging exporters. The ECB will better detail its economic outlook when it releases forecasts next month.

While it is true that the Euro zone’s CPI has been falling which reflects on the declining monetary aggregate M3, that’s only half of the picture.

The other half of what the mainstream doesn’t tell you when discussing central bank policies: Financial markets in the Eurozone has been booming. 

Europe’s crisis stricken economies (Portugal-PSI 20, Spain’s IBEX and the Irish ISEQ) has produced returns of significantly more than 20% over a one year window. Greece’s Athens Index has generated more than 40%!

Even Europe’s blue chip index the Stoxx 50 has strongly risen year-to-date.

And it’s not just stocks…

European sovereign bonds has had a robust performance. The spread of PIGS relative to the German bond has significantly narrowed* after peaking in early 2012.

In other words, the ECB and the mainstream sees TWO different self-contradicting worlds: risks of “deflation” in the economy—based on CPI inflation measures, while alleged “recovery” in the economy based on rising markets.

Or differently put, the mainstream sees financial markets as seemingly irrelevant or unrelated to the real economy unless it serves as convenient alibi to justify rising asset prices.

Yet zero bound rates function as a one size fits all policy that would have different impact on distinct European economies. 

As one would note, bank credit to core Europe has been in the positive (although stagnant) while crisis stricken periphery remains in negative territory*.

Of course, looking at the aggregates can be deceiving. While it may be true that general bank lending has been falling, in breaking down the details we find the Eurozone’s banking system credit to the government has exploded even as credit to the private sector has weakened.

In short, government borrowing has taken the slack from the private sector.

The complex maneuvering by the troika, the ECB, the banking system and the government to keep rates low has resulted to a massive expansion of debt.

The Eurozone’s debt as % to the GDP has been skyrocketing

Yet banks have not been the only source of lending.

 

Europe’s High Yield corporate bond issuance is at record highs*!

Europe’s corporate debt has also been ballooning*.

Corporate debt in core Europe has modestly increased from 2007…

While corporate debt at the periphery has been robust over the same period

Bottom line: Contra policymakers and the mainstream, the risks of deflation remains a popular bogeyman used to justify the “euthanasia of the rentier” via zero bound rates and QE.

While the Eurozone’s banking system remains clogged or the transmission mechanism broken due to impaired balance sheets, substantial credit growth has been taking place at the bond markets.

And credit growth in the bond markets fired up by ECB and government policies has been redistributing resources or has been benefiting the asset markets (via asset inflation) at the expense of the real economy (revealed by CPI disinflation). 

The real intent of the ECB’s rate cut has been to keep interest payments low for the rapidly swelling the Eurozone’s government debts since the Eurozone government’s refusal to reform, France should serve as an example. 

A second unstated goal has been to boost asset markets in order to keep their 'broken' banking system afloat. 

European politicians, bureaucrats and their mainstream lackeys have been pulling a wool over everyone’s eyes.

And it seems that for the first time this year, the unexpected credit easing by a major central bank has hardly been welcomed warmly by the global equity markets. Europe’s markets appear jaded as US stocks fell considerably. Asian markets are down as of this writing.

Has the global financial markets seen ECB’s actions as insufficient? Or has the positive impact on financial markets from credit easing policies reached a tipping point in terms of diminishing returns?

We surely live in interesting times

* charts from the Institute of International Finance November 2013 Capital Markets Monitor and Teleconference

Quotes from Peter Drucker’s The Sickness of Government

The late management guru Peter Drucker bewailed the public’s dependence on government from a practical standpoint in a chapter called the Sickness of Government in his 1969 book The Age of Discontinuity

Tip of the hat to Cato’s Chris Edwards. Mr. Edward’s blog post is the source of the following quotes which I cross checked with Mr. Drucker’s essay (bold mine)

Government surely has never been more prominent than today. The most despotic government of 1900 would not have dared probe into the private affairs of its citizens as income tax collectors now do routinely in the freest society. Even the tsar’s secret police did not go in for the security investigations we now take for granted.” p.3

…

For seventy years or so – from the 1890’s to the 1960’s – mankind, especially in the developed countries, was hypnotized by government. We were in love with it and saw no limits to its abilities, or to its good intentions. p.4

…

This belief has been, in effect, only one facet of a much more general illusion from which the educated and the intellectuals in particular have suffered: that by turning tasks over to government, conflict and decision would be made to go away. Once the “wicked private interests” had been eliminated, a decision as to the right course of action would be rational and automatic. There would be neither selfishness nor political passion. Belief in government was thus largely a romantic escape from politics and from responsibility.” p.5

…

The greatest factor in the disenchantment with government is that government has not performed. The record over these last thirty or forty years has been dismal. Government has proven itself capable of doing only two things with great effectiveness. It can wage war. And it can inflate the currency.” p.7 (I would add spending and borrowing too—benson)

…

The best we get from government in the welfare state is competent mediocrity. More often we do not even get that; we get incompetence such as we would not tolerate in an insurance company. In every country, there are big areas of government administration where there is no performance whatever – only costs. p.7

…

Modern government has become ungovernable. There is no government today that can still claim control of its bureaucracy and of its various agencies. Government agencies are all becoming autonomous, ends in themselves, and directed by their own desire for power, their own narrow vision rather than by national policy. p.8

…

We are very good at creating administrative agencies. But no sooner are they called into being than they become ends in themselves, acquire their own constituency as well as a “vested right” to grants from the treasury, continuing support by the taxpayer, and immunity to political direction. No sooner, in other words, are they born than they defy public will and public policy. p.9

…

Nothing in history, for instance, can compare in futility with those prize activities of the American government, its welfare policies and its farm policies. Both policies are largely responsible for the disease that they are supposed to cure. p.13

US IPO Mania: I’m just buying because everybody’s talking about Twitter

I have noted of the intensifying IPO rage in US stocks.

Well it appears that Twitter’s IPO embodies such mania.

Twitter has been priced at $26 per share and will be listed today. With a 70 million shares offered to the public, the firm will raise $1.82bn and place the company’s market capitalization at $14.2 billion.

Twitter’s $26 per has been significantly higher than the original estimated price range at $17-20 according to the Guardian. That’s a 30-50% premium!

Skeptics point to supply side problems of Twitter. Even with 87% shares under a “lock up period”, according to the Quartz, “about 10 million shares held by non-executive employees will be available for sale in February; the bulk of the rest will hit the market in May.”

Then there are stock options via restricted stock units (RSUs) where again the popular social media firm, according to Quartz  “has awarded large amounts of restricted stock to its employees, which vest after certain length of service and performance hurdles are met”

And there are also new issues after the IPO which has been estimated to add to the outstanding shares to 723 million

The Quartz raises a very important concern of supply relative to profitability: “The question is whether Twitter’s growth potential can outweigh the dilutive effect of more shares hitting the market. That’s anyone’s guess in a frothy market like this one; Twitter is an unprofitable company being valued at north of $15 billion, and Pinterest, which has yet to make any money, is valued at $4 billion.”

Hedge fund Andy Kessler writing at the Wall Street Journal pitches a buy for Twitter. Why?

This marks a new era for advertisers. The days are over of Mad Men figuring out how to cajole or trick us into buying products through mushy psychological profiling of demographic groups. The new model is going to mean including buyers and sellers in more transparent conversations about a product's pros and cons.

In short, This time is different.

While I share the idea that social media will bring about radical changes of business models, it is one thing to bank on hope (perhaps delusional hope) and it is another thing to see the new models transformed into financial feasibility.

As pointed out above, Twitter’s new model hasn’t been profitable (yet). A table of Twitter’s financials as per the Zero Hedge

Well the zeitgeist of the US IPO mania as clearly revealed by this article from the Wall Street Journal Money Beat Blog: (hat tip Zero hedge) [bold mine]

Ms. Watkins said she plans to buy about 50 shares, which would add up to $1,250 plus any commissions if the stock prices at the top of its current price range, but could cost her more or less depending on what price she happens to get.

She said she’s not worried about price increases; she just wants to stick to her purchasing plan and buy the shares immediately, though she hasn’t ruled out selling them quickly if there’s a sharp bump.

Ms. Watkins said she’s interested in the hyped stock because of her economics-major nephew and because she knows what happened with Apple Inc. and Facebook Inc. prices and doesn’t want to miss out, even though the 140-character message service, often used on smartphones, is largely foreign to her.

“I don’t even use it,” she said. “You know what kind of phone I’ve got? A pre-paid!”

Ms. Watkins opened a TD Ameritrade account about four years ago, she said. She bought a few shares of stock in petroleum-related companies and was burned when the price fell through. She doesn’t trade now, relying on the mutual funds available through her employer to manage her nest egg.

The avid Mother Jones reader doesn’t really trust the market and says it’s like gambling, but with the addition of lies and subterfuge.

“I’m just buying because everybody’s talking about Twitter,” she said. “I’m just gonna take a chance.”

Price insensitive, momentum chasing, “doesn’t want to miss out” and “everybody’s talking about twitter” highlights on the FED’s easy money regime that has incited the bandwagon (herding) effect which has reflected on the syndromes of speculative orgies and the greater fool dynamics, all of which are manifestations of the euphoric phase of the stock market cycle.

As the legendary Jesse Livermore warned: (bold mine)

But the average man doesn't wish to be told that it is a bull or a bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn't even wish to have to think. It is too much bother to have to count the money that he picks up from the ground.

Bitcoin’s Creative Myth and Appeal

Bitcoin surged to its highest level ever

Nick Colas of ConvergEx via the Zero Hedge explains Bitcoin’s creative myth and appeal. (bold original)

Creation myths are great anchors for a belief system, but there have to be other parts to the narrative; bitcoin is safely into its own “Exodus” – the second book of the Old Testament.  That fall from the highs was just the beginning of its problems.

The U.S. government made it clear that they expect all currencies and their users to adhere to anti-money-laundering laws, including know-your-customer statutes which eliminate the notional secrecy of bitcoin.

The Feds also went after the druggies, shutting down Silk Road – a widely known website for the purchase of illicit substances.

In an odd twist of fate, the U.S. government now owns about 174,000 bitcoins, with a current value of $42 million thanks to the Silk Road bust and other actions.

If bitcoin were a company, the class action lawyers would be circling, fighting for air with the bankruptcy experts.  There is simply no way so much legal action, let alone several ongoing problems with security in the system, would have left Satoshi Nakamoto’s creation as anything but roadkill on the world’s economic superhighway.

But here’s the beauty part: bitcoin is making a new high this week, breaking through the spiky bubble levels of April in a pretty controlled and orderly manner. What gives? A few points:

The biggest bitcoin exchange is now in China, displacing Japanese, American and European sources of demand.  That enterprise is called BTC China, and its CEO Bobby Lee hails from Yahoo! and Walmart China. Oh, and he graduated from Stanford with a degree in Computer Science.  In short, an apparently pretty clever fellow.

Our sources in the bitcoin community also agree that Second Market, the New York based business best known for trading pre-IPO company stock, has become a major player in demand for bitcoin. Earlier this year they started the Bitcoin Investment Trust, an open ended product to buy and hold bitcoins.  There’s no way to know how much Second Market has purchased on behalf of its clients, but it must be a popular offering – the banner ad on their site for the trust occupied the top third of their front page.

It’s not all been roses for bitcoin, even in this recent run-up. Back in September computer science researchers from UC – San Diego showed that it was actually fairly easy to track individual transactions in the bitcoin transaction ledger.  Just this week, academics at Cornell proposed that bitcoin could eventually be coopted by a handful of “Miners” who could hijack the system.

So why is bitcoin seemingly minted on Teflon? Limited supply, for one reason.  There will never be more than 21 million bitcoins, and there are only 12.0 million currently.  In the 4-ish minutes it has taken you to read this far, the most new bitcoins that might have been issued is 25, or $6,250.  In the same timeframe, the Federal Reserve has pushed another $7.8 million into the financial system with Quantitative Easing.  And then there is the undeniable creation-story appeal – a technology based sort-of-secret store of value.  If James Bond, Sergey Brin and Paul Volcker all got together and designed their ideal currency, it might look a lot like bitcoin.

At the same time, the story isn’t over yet.  If the “Exodus” analogy is to fit at all, then bitcoin is still in the wilderness.  It has clearly withstood many challenges, and there are probably more to come.  The end of the journey actually has little to do with how much bitcoin is worth, but what it might be good for.

That’s the piece some investors – many made quite wealthy by the incredible increase in bitcoin’s value – are working on now.  A few final thoughts here:

Bitcoin is a more efficient method of transferring money than the current global banking system. The transaction ledger is essentially kept for free by the mining community.  Want to send $100 to someone in England and have them redeem British pounds? It will likely cost you $5 or more.  A bitcoin transfer is essentially free.

Merchants can accept bitcoin payments without paying the typical credit card fees of 1-5%. That’s one reason for the growing acceptance of bitcoin in China – online merchants are starting to accept this online currency.

Bitcoin could become a country’s ‘Second currency’. One of the more interesting conversations with one of our industry sources is the thought that one or more sovereign nations would entertain making bitcoin a parallel currency to their existing monetary system.  Keep in mind that our source owns a lot of bitcoin personally….  But it is an intriguing thought nonetheless

In my view, bitcoin and other forms of cryptocurrencies represent one of the major manifestations of the deepening evolution to the information age which 20th century political systems have been vehemently resisting.

Why Small is Beautiful

At the Daily Reckoning, Dominic Frisby has a splendid article on why small societies have mostly been prosperous

First Mr. Frisby notes of the role played by decentralization and centralization in shaping Italy's present conditions

In the story of man, Italy has twice been the global center of innovation and invention — once under the Romans, and then again during the Renaissance, when it produced such great men as Leonardo da Vinci, Michelangelo and Galileo. No other part of the world can claim such an emphatic double — not China, not Britain, not the USA. You cannot doubt the potential of the Italian people. You cannot doubt their talent.

Yet throughout the 20th century, Italy has been (and still is) a cradle of corruption, political infighting, bureaucracy, crime (think Mafia and Camorra), corruption, rent-seeking, inflations, division, fascism, communism and goodness knows what else. Its state is bloated, its political system dysfunctional. The country might be nominally unified, but in reality it is anything but.

Where did Italy go wrong? The answer: It unified.

Admittedly, this unification was forced on it. As the city-states lost their independence, it came under foreign domination, first under Spain (1559-1713), then Austria (1713-1796), then France, then the Austrians again. Finally, in the mid-19th century, came the Italian Wars of Independence, unification, and birth of the Italy we know today.

Next he narrates a short history of "small is beautiful" in the global context.

Small is beautiful. In A.D. 1000, Europeans had a per capita income below the average of the rest of the world. China, India, and the Muslim world were richer and had superior technology: China had had the printing press for 400 years. Her navy “ruled the waves.” Even as late as 1400, the highest standards of living were found in China, in the robust economies of places like Nanjing. But the empires of the East became centralized and burdened with bureaucracy and taxes.

In Western Europe, however, made up of many tiny nation-states, power was spread. There was no single ruling body except for the Roman Catholic Church. If people, ideas, or innovation were suppressed in one state, they could quickly move to another, so there was competition. The cities, communes, and maritime republics that made up what we now call Italy — Genoa, Rome, and Florence, for example — became immensely prosperous. Venice in particular showed great innovation in turning apparently useless marsh and islands into a unique, thriving metropolis that would become the wealthiest place in the world.

In the 16th century, the repressive forces of Roman Catholicism, which was becoming corrupt, began to be overturned in Northern Europe. The Bible was translated into local vernacular. The Protestant movement saw deregulation and liberalization. Gutenberg’s printing press, invented a century earlier, was furthering the spread of knowledge and new ideas — and thus the decentralization of power.

Over the next two hundred years, Northern Europe caught up with Southern Europe, which remained Catholic, and then overtook it. First, it was the Dutch, also made up of many small states. Then, in the 18th century, it was England, which, in spite of its union with Scotland and its later empire building, had further dispersed centralized power by reducing the authorities of the monarch after the civil war of 1642-51 and by linking its money to gold.

Meanwhile, out East, the Ottoman Empire and China went into a relative dark age, centrally governed by autocratic or imperial elites, burdened with heavy taxes and slow to react and unable to cope with the plagues and wars that befell them. By 1950, the average Chinese, according to author Douglas Carswell, was as poor, if not poorer, than someone living there a thousand years before.

Third, Small is beautiful exists until today…

Nothing changes… The success of small nation-states continues even today. If you look at the World Bank’s list of the richest nations in the world (as measured by GPD per capita at purchasing power parity), you see Luxembourg, Qatar, Macau, Singapore, Norway, Kuwait, Brunei, Switzerland, and Hong Kong. Perhaps Macau and Hong Kong, as parts of China, should not be included, in which case you add the U.S. and the United Arab Emirates (similar nations appear on the International Monetary Fund’s list).

Why is being small beautiful?

In a small state, there is less of a gap between those at the top and bottom, there is more transparency and accountability, it is harder for the state to hide things, there is more monitoring, less waste and more dynamism. Small is flexible, small is competitive — small really is, as economist E.F. Schumacher said, beautiful.

Read the rest here

Small is beautiful because of decentralization. Decentralization promotes a culture of spontaneous diversity, heterogeneity, specialization, tolerance of failure, trial and error, and competition necessary for greater efficiency in the allocation of resources and innovation.

Decentralization thus extrapolates to individual advancement that accrues to, and reflects on the society level.

In short, small is beautiful because it is a bottom up dynamic where commerce or free markets drive real (not statistical) prosperity

Importantly decentralization disperses risks and promotes legal institutions which have mostly been attuned with local customs, traditions and grassroots social interactions.

Decentralization also is an optimum way for people to convert localized knowledge into productive activities.

As the great Austrian economist Friedrich von Hayek wrote: (bold mine)

If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. We cannot expect that this problem will be solved by first communicating all this knowledge to a central board which, after integrating all knowledge, issues its orders. We must solve it by some form of decentralization. But this answers only part of our problem. We need decentralization because only thus can we insure that the knowledge of the particular circumstances of time and place will be promptly used. 

In centralized political systems, “small is beautiful” can be seen in the informal economy.

And with the fast advancing information age, the world will eventually evolve towards decentralization. But the transition will not be smooth as the friction from the resistance to change by 20th century based centralized political systems vis-à-vis technology based decentralization have only intensified.

Infographics: Tracing the great Chinese gold rush

From the Real Asset Co

(hat tip Zero Hedge)

For a clearer view click here to redirect to source

Video: Humor: If I Don't Post about It Online, Did It Really Happen? (Why People Overshare on Social Media)

This video is a spoof on why people tend to overshare in social media.  

Hat Tip Austrian Economist Bob Murphy, who contributed to the story.

Why Social Security Is Not an Insurance

Social Security has been sold to the public as insurance.  The reality is that coercive redistributive welfare programs (Rothbard, Friedman) have been hijacked and repackaged as “insurance” by the progressive left to make these sound or appear politically palatable. 

Even legalistically, Social Security isn’t an insurance. American economist, author and professor Walter E. Williams explains at the Lew Rockwell.com (bold mine)

The Social Security pamphlet of 1936 read, “Beginning November 24, 1936, the United States Government will set up a Social Security account for you. … The checks will come to you as a right” (http://tinyurl.com/maskyul). Therefore, Americans have been led to believe that Social Security is like a retirement account and money placed in it is their property. The fact of the matter belies that belief.

A year after the Social Security Act’s passage, it was challenged in the U.S. Supreme Court, in Helvering v. Davis. The court held that Social Security is not an insurance program, saying, “The proceeds of both employee and employer taxes are to be paid into the Treasury like any other internal revenue generally, and are not earmarked in any way.” In a 1960 case, Flemming v. Nestor, the Supreme Court held, “To engraft upon the Social Security system a concept of ‘accrued property rights’ would deprive it of the flexibility and boldness in adjustment to ever-changing conditions which it demands.”

Decades after Americans had been duped into thinking that the money taken from them was theirs, the Social Security Administration belatedly — and very quietly — tried to clean up its history of deception. Its website explains, “Entitlement to Social Security benefits is not (a) contractual right.” It adds: “There has been a temptation throughout the program’s history for some people to suppose that their FICA payroll taxes entitle them to a benefit in a legal, contractual sense.

… Congress clearly had no such limitation in mind when crafting the law” (http://tinyurl.com/49p8fl2). The Social Security Administration failed to mention that it was the SSA itself, along with Congress, that created the lie that “the checks will come to you as a right.”

Here’s my question to those who protest that their Social Security checks are not an entitlement or handouts: Seeing as Congress has not “set up a Social Security account for you” containing your Social Security and Medicare “contributions,” where does the money you receive come from? I promise you it’s neither Santa Claus nor the tooth fairy. The only way Congress can send checks to Social Security and Medicare recipients is to take the earnings of a person currently in the workforce. The way Congress conceals its Ponzi scheme is to dupe Social Security and Medicare recipients into thinking that it’s their money that is put away and invested. Therefore, Social Security recipients want their monthly check and are oblivious about who has to pay and the pending economic calamity that awaits future generations because of the federal government’s $100 trillion-plus unfunded liability, of which Social Security and Medicare are the major parts.

I previously made the same argument against the local pseudo health insurance (Philhealth) here

Quote of the Day: JGB market is dead

The JGB market is dead with only the BOJ driving bond prices...These low yields are responsible for the lack of fiscal reform in the face of Japan’s worsening finances. Policy makers think they can keep borrowing without problems. 

This is from Tetsuya Miura, the chief bond strategist at Tokyo-based Mizuho, one of the 23 primary dealers obliged to bid at government auctions as quoted by a Bloomberg article. 

Japan's political class have come to the belief that central bank's 'free lunches' are elixirs that lasts forever.

US Stock Market Mania: The IPO Craze

In the US, IPOs have now become a craze.

This intro from a mainstream USA Today article captures the zeitgeist: (bold mine)

Investors are buying up just about anything with a ticker symbol, and that frenzy certainly includes stocks that are brand new to the market.

IPOs have metastasized into a centripetal force for wild and rampant punts… (bold mine)

The performance of IPOs is starting to hit the kind of feverish pitch not seen since the last market peak in 2007, and it even has hints of the IPO heyday of the 2000 dot-com boom. The signs:

First-day pops. Container Store's first-day return is certainly one to remember, rising 101% from its $18 a share IPO price to $36.20 a share. Container Store was the fifth IPO to double in its first day of trading this year, the biggest year for 100% one-day jumps since 78 did it in 2000. Seeing stocks double on their first day has become rare. During 2012, just one IPO, a company named Splunk, doubled on its first day, said Jay Ritter, professor of finance at the University of Florida. No IPOs doubled on their first day in 2009, 2008 or 2007, Ritter said. IPOs on average have gained 16% on their first day this year, Renaissance said, the highest in at least a decade…

Already this year, 182 companies have seen their shares start trading, up 50% from this point last year, said Renaissance. This coming week week of 11/4, 10 IPOs are expected to hit the market, including the much-anticipated online message service Twitter. At the current pace, there could be 220 IPOs in 2013, making it the busiest year for IPOs since 2000 by topping the 217 deals in 2004, Renaissance said.

Volume and number of IPOs in the US has now equaled or surpassed the 2005 highs according to the chart from PWC. The above represents 3rd quarter data which means given the current incredibly strong momentum, this would be so much higher.

I have previously pointed out “The scrapping for yields has impelled many to jump on the IPO bandwagon despite poor track record of newly listed companies”. The IPO mania only validates my view where market activities have increasingly been detached with ‘fundamentals’. Market participants see only one direction for stock prices; up up and away.

By flagrantly pushing up prices for the sake of momentum and for adrenaline boosting short term punts, they have virtually ignored or dismissed all forms of risks

With 100% one day returns, the appropriate metaphor for the IPO mania is that everyone is a scalper or a day trader now.

IPOs are useful sentiment indicators as these give us hints on the whereabouts of the stages of the stock market cycle.

And the late stock market guru Sir John Templeton was right when he warned that the "time is different" represents the four most dangerous words on investing as they account for popular delusions. 

Yet while the mania may continue and even accelerate or intensify, what is unsustainable won't last.