Why the Chinese Government Cannot Afford a Bubble Bust

A recent disturbing sturdy reveals how deep the wealth of Chinese households have been tied to real estate sector. The massive concentration of wealth poses as a grand policy dilemma for the Chinese political leadership. 

Writes Bloomberg’s William Pesek (hat tip Mark Thornton) [bold mine]

Gan, a professor at Southwestern University of Finance and Economics in Chengdu, Sichuan and at Texas A&M University in College Station, Texas, recently crunched some disturbing numbers on the level and distribution of household income and wealth. After examining survey results from 28,000 households and 100,000 individuals, Gan believes that roughly 65 percent of China’s household wealth is sitting in real estate.

An astounding 90 percent of households in nation of more than 1.3 billion people already owns homes. In the first half 2012, he found, about 42 percent of demand for properties came from buyers who already owned at least one. Many of these homes and apartments, it goes without saying, were bought in the midst of one of history's biggest real estate booms and bubbles.

“The Chinese housing market is clearly oversupplied,” Gan told Tom Orlik, a Bloomberg economist based in Beijing. “Existing housing stock is sufficient for every household to own one home, and we are supplying about 15 million new units a year. The housing bubble has to burst. No one knows when.”

When is does, the damage to household wealth will reverberate across the second-biggest economy, devastate consumption and increase risks of social unrest. In other words, it's something the Communist Party can't allow to happen. While Xi's promises to tolerate less gross domestic product growth as he weans China off its addiction to exports, the pressure to sustain property prices will take precedence over reform.

While it may be true that the Communist Party can't allow bubbles to pop, this assertion would seem like the modern day equivalent of King Canute who in trying to “rebuke the flattery of his courtiers” to show them the limits of a king's power, “set his throne by the sea shore and commanded the tide to halt and not wet his feet and robes”. In other words, Chinese political leadership may kick the can down the road but they will be unable to stop economic reality from coming to fruition. This is a question of 'when' and not an 'if'. And that 'when' may be soon.

In reality, the current unsustainable real estate bubble signifies the “unintended consequences” or policy backlash from the policies adapted by the Chinese government, particularly financial repression (to corral the resources of her constituents via mandates) along with PBoC’s inflationism as earlier explained here.

China’s boom phase of the bubble cycle seems to have reached an advanced or maturing state.

When the political leadership tried to restrain the bubble in June 2013, Chinese markets went haywire as exhibited by soaring interest rates. Rising interest rates and price inflation are signs of the deepening insufficiencies of resources to supply or finance these bubbles.

The Chinese government then backtracked and began infusing money into the system. The outcome has been to escalate a runaway credit which underpinned a juggernaut in the run up of property prices.

Moreover, with new regulations aimed at curbing lending growth, credit dynamics has fundamentally shifted from banking sector into shadow banks. Local governments, whose career has been underpinned by meeting statistical economic growth quotas, resorted to new schemes of availing  credit in order to finance local projects for political goals by circumventing new regulations.

And with huge amount of debt targeted for a rollover this year in the face of rising interest rates, I pointed out that China’s bubbles could serve as a potential trigger to a global Black Swan event.

In addition, fears over looming systemic instability from a major default has compelled the Chinese government owned bank to bail out a troubled Trust product a week prior to the week long celebration of this year's Spring Festival. Yet such bailout is likely to serve as a magnet for more credit inflation.

The Chinese government seems faced with the proverbial devil and the deep blue sea. Accommodate credit, unstable debt conditions compounds, bubble inflates even more. Stop credit, economic depression emerges.

So the Chinese government appears to be approaching her bubble problems with a whack a mole (game) or deal with the problem as they surface. The dilemma will be magnified when the “mole” transmutates into “gremlins”.

The depth of exposure by the Chinese households on her gigantic property bubble means that a bust will bring about a major setback to the Chinese economy (and will most likely ripple across the world). 

This may also extrapolate to a pushback on the much vaunted “Chinese century”. [The Chinese may recover swiftly if real reforms towards a market economy will be pursued]

The predicament of the Chinese government as predicted by the great Austrian economist Ludwig von Mises: 

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system

Behind Russia’s Central Bank’s “Unlimited Intervention”

With the ruble under fire, the Russian central bank mimics ECB Mario Draghi’s “Do whatever it takes” with their own “unlimited intervention” in the hope to stem the faltering currency. 

[I’ll argue below that this seems more than about the currency where the latter is only a symptom]

From Bloomberg:

Bank Rossii, which aims to let the ruble trade freely by 2015, bought the most rubles since September 2011 this week to slow the currency’s drop as central banks from Turkey to South Africa raised interest rates to prop up their currencies. The Moscow-based regulator will intervene “without quantitative limitations” until the ruble returns to the target band or the corridor is lifted to its level, it said in a statement on its website, reiterating the present framework for the currency…

The central bank has spent $29 billion since May 29 to smooth exchange-rate fluctuations, cutting its gold and forex reserves to $496.7 billion, the lowest level since 2011.

The effect of Bank Rossii’s “unlimited intervention” has been to spike ruble against the USD yesterday. The ruble has been under pressure along with most emerging markets currencies. 

The question is will this serve as a temporary patch or will this enough to calm Russia’s financial tantrums? I believe that like her peer, the Turkish central bank's who surprised with a “shock and awe” of dramatically pushing up interest rates, this will have a short term impact.

And like everywhere else, Russia’s currency woes have been manifestations of homegrown credit bubbles rather than fickle foreign money flows as consequence to zero bound rates.

Following the global crisis in 2008 Bank Rossii stepped on the interest rate pedal.

The result? Again like anywhere else, from 2008 loans to the private sector has more than doubled. 

This has been accompanied by a near doubling of M2 during the same period.

Part of that credit bubble has been due to Bank Rossii’s foreign currency reserve accumulation. [As a side note, the ruble’s weakness comes amidst a mountain of forex reserves which many mistake as a free lunch to bubbles.]

The build up in foreign exchange reserves has been reflected on the Bank Rossii’s asset growth.

So zero bound rates and Bank Rossii’s forex accumulation has prompted for a credit fueled property boom which supposedly had been one of the “hot” market for real estate in the world in 2013.

While Russia’s housing prices has not reached the pre global crisis of 2007 level (left), housing loans acquired from mostly local institutions have ballooned (middle) to record highs.

And as one would further observe, the gravitation to the real estate boom via housing loans came with declining housing loan rates (right) as charts from Global Property Guide reveal

Zero bound rates has not just been an enticement for the private sector to splurge, the real aim of zero bound rates has been to redistribute of resources from the real economy to the government and to their favored interest groups. This is known as financial repression. Zero bound rates (negative real rates) is just part of the many ways government applies financial repression.

And as proof, while Bank Rossii held rates artificially down, Russia’s local government went into a spending binge.

The Stratfor writes: (bold mine)

Most of Russia's regional governments have always had some level of debt, but resource-based export revenues have kept it mostly manageable since the 1998 crisis. However, since the 2008-2009 financial crisis, most of the regions' debt has risen by more than 100 percent -- from $35 billion in 2010 to an estimated $78 billion in 2014, and Standard & Poor's has estimated that this will rise to $103 billion in 2015. Russia's overall government debt -- the federal and regional governments combined -- is around $300 billion, or 14 percent of gross domestic product. This is small for a country as large as Russia, but the problem is that so much of the debt is concentrated in the regions, which do not have as many debt reduction tools as the federal government does.

Of the 83 regional subjects in Russia, only 20 will be able to keep a budget surplus or a moderate level of debt by 2015, according to Standard & Poor's calculations. This leaves the other 63 regions at risk of needing a federal bailout or defaulting on their debt.

Currently, the Russian regions are financing their debt via bank loans, bonds and budget credits (federal loans, for example). Each region has to get federal approval to issue bonds, because regional bonds create more market competition for the federal and business bonds. Most of the banking loans to the regions carry high interest rates and are short term (mostly between two and five years). The federal loans come with much lower rates and longer repayment schedules (mostly between five and 20 years), so naturally federal credits and loans are more attractive for the local governments, though unprofitable for the federal government. The issuance of federal credits or loans to the regions in 2013 was limited; initially, Moscow said it would issue $4.8 billion in new credits to the regions in 2013, but only issued $2.4 billion due to its own budgetary restrictions. This is one contributing factor to the dramatic local-government debt increases.

In terms of federal external currency debt one may note that Russian foreign liabilities jumped by 34% in just two years. So the devaluing ruble will magnify on the Russia’s external credit risks.

Russia’s major exports has been predominantly commodities, particularly oil, the latter accounts for 71% of total exports in 2012. This has allowed Russian government to post a surplus in both the trade balance and her current account. [note the latter graphs I will not show anymore as this post might exceed the 512k size limits, so pls just click on the links]

Despite the huge foreign reserve, current account surpluses and balance of trade account, Russia has been experiencing private capital outflows since 2008 both from the formal and likewise in the informal sector.

The informal sector has been estimated at 50-65% share of the economy where earlier I pointed out that the Russian government attempted to wage war against this sector by putting limits on cash transactions. Russia, according to Global Financial Integrity (GFI), has been the fifth largest victim of illicit capital outflow notes the RT

In my view, such outflows have partly been consequence to the economic and financial repression which has been reflected by the huge informal sector. Some in the formal and informal sector may have sought monetary refuge or safehaven from the grips of Russia’s autocratic government (e.g Cyprus, Cayman Islands). Some perhaps may have sought alternative investments abroad, and some may have been sensing trouble ahead in the Russian economy.

And symptoms of the latter can be seen via last week’s suspension of cash  withdrawals for a week by ‘My Bank’ supposedly one of Russia’s top 200 lenders by assets, according to the Zero Hedge. 

Some questions: Has this signified the continuing war against the informal economy? But if so, why limit to My Bank? Or has this been signs of a Russian bank in serious trouble? If the latter, has the problems of My Bank been large enough for the Bank Rossii to stay at the sidelines and compel My Bank to take her own measures? Will this not send signals to depositors and investors that Russia’s banking system may be in dire predicament? Could the Bank Rossi’s “unlimited intervention” have been really directed to calm the banking sector or forestall a depositor stampede/bank run?

Interesting twist of events.

In other words, instead of the mainstream’s impression that today’s emerging market rout has been led by foreign money, in Russia’s conditions, the weak ruble and the spike in bond yields 10 year Russian treasuries may have been mostly an exodus of resident money.

And this Wall Street Journal article seems to back my suspicion “High capital outflows have become a sore point in Russia in recent years, with critics saying official corruption is hampering the investment climate and driving money out of the country. The central bank considers debt redemption, dividends paid to foreign shareholders, Russian residents buying foreign currencies, and mergers and acquisitions as capital outflow.”

Bottom line:

One huge foreign reserves, and surpluses in current account and balance of trade account serve as no free pass to bubbles. Russia’s case is just one example

Two contra popular wisdom, it doesn’t take foreign money to pull the trigger for a bust to occur as in the case of Japan in the 1990. While there has hardly been a full credit bust in Russia yet, developing events seem to indicate that Russia’s credit bubble may have already reached its maximum elasticity point (in the face of rising bond yields). And the bubble bust will likely be sparked by a capital flight from resident depositors and investors.

Russia’s plight seems far from over.

Welcome the Year of the Wooden Horse: Happy New Year!

From Fastmaza.com

2014 is the year of the wooden horse. What should we expect from the wooden horse?

Well, here is a clue from the New Strait Times

In the year of the Wood Horse, the most dominant element is Fire. Fire element industries, therefore, will generally do well. These industries include oil and gas, airlines, restaurants, IT, electronics, metaphysics, and spiritual studies. With Fire being extremely prosperous, it does indicate a general impatience, volatility, and unrest in the minds of people. In the year’s birth chart, the element of Water is missing, indicating a lack of ideas and deeper thoughts. Put these two situations together, we will see a tendency for more fighting and quarrels across the world. Fire-related natural disasters are also to be expected, such as volcano eruptions, earthquakes, and also forest fires.

The second most prominent element of the year is Wood. Therefore, Wood industries, such as education, printing, fashion, herbs and botany, are expected to continue flourishing. The Earth element, in the presence of extreme Fire, starts to harden. This indicates obstructions and lethargy in Earth industries, such as property and real estate. The Metal element, which is weak in the year’s birth chart, also indicates challenges in sectors such as finance, the auto industry, and machinery. Changes in the legal system and financial trends are to be expected when strong Fire melts Metal. However, with the Water element missing, a lot of big decisions will be made based on emotions and fear, rather than wisdom and intelligent reasoning. The year will also see Water-related industries, such as tourism, travel, and fishery, slowing down.

Regardless of the above; Happy new year!

Quote of the Day: Protection against the tyranny of the prevailing opinion and feeling

Like other tyrannies, the tyranny of the majority was at first, and is still vulgarly, held in dread, chiefly as operating through the acts of the public authorities. But reflecting persons perceived that when society is itself the tyrant—society collectively, over the separate individuals who compose it—its means of tyrannizing are not restricted to the acts which it may do by the hands of its political functionaries. Society can and does execute its own mandates: and if it issues wrong mandates instead of right, or any mandates at all in things with which it ought not to meddle, it practises a social tyranny more formidable than many kinds of political oppression, since, though not usually upheld by such extreme penalties, it leaves fewer means of escape, penetrating much more deeply into the details of life, and enslaving the soul itself. Protection, therefore, against the tyranny of the magistrate is not enough: there needs protection also against the tyranny of the prevailing opinion and feeling; against the tendency of society to impose, by other means than civil penalties, its own ideas and practices as rules of conduct on those who dissent from them; to fetter the development, and, if possible, prevent the formation, of any individuality not in harmony with its ways, and compel all characters to fashion themselves upon the model of its own. There is a limit to the legitimate interference of collective opinion with individual independence: and to find that limit, and maintain it against encroachment, is as indispensable to a good condition of human affairs, as protection against political despotism.

(bold and italics mine)

This is from English philosopher and political economist John Stuart Mill from his essay On Liberty as published at the Bartleby.com.

Video: Humor: Here Comes "The Kronies"

(hat tip Bob Murphy) 

Walter Block on Why the Minimum Wage Law is a Stab on the Back of the Poor

Austrian economist Walter Block’s take on the baneful invisible effects of the minimum wage law (sourced from lewrockwell.com, with permission of Professor Block) [bold mine, italics Professor Block]

The minimum wage on its face is an unemployment law, not an employment law. It does not compel anyone to hire anyone else. It only stipulates who CANNOT legally be employed: no one may be hired for less than the amount stipulated by law. If the minimum wage law is set at $10 per hour, the law does not require any employer to hire any employee at that wage level. It only FORBIDS employment contracts set at $9.99 or below. This is not a matter of empirical evidence, not that there can be any such thing in proper, e.g., Austrian economics; this conclusion is a matter of pure logic. We repeat: the minimum wage on its face is an unemployment law, not an employment law.

What about empirical studies (economic history, for praxeological economists)? Here, economists disagree. Some say there will be no unemployment effects whatsoever. That is, a person with a productivity level of $6 per hour will still be hired and paid $10 per hour, even though any such firm that does so will lose $4 per hour. Such “economists” are in a distinct minority. Other dismal scientists opine there will be very slight unemployment effect; some few unskilled workers will lose their jobs or not attain them in the first place; but a large number will retain their jobs and be paid more. Then there is a third or majority view: most economists conclude that this law will boost unemployment for those with low productivity, and will only raise wages for them temporarily, until employers can substitute away from the factor of production (unskilled labor) now priced out of the market.

What is the Austrian take on all of this? The praxeological view is that the minimum wage law will raise unemployment higher than it would otherwise be, in the absence of this law, other things equal, provided only that it is set above the level of productivity of at least one worker. This is an apodictic claim, not subject to refutation, falsification or testing. This claim is necessarily true, and yields knowledge about real world effects. Austrian economics is causal – realist, unlike the economics of the mainstream logical positivists, who recognize no economic law, only hypotheses to be tested, and if not falsified, then provisionally accepted.

Some economists who have recently signed this open letter in support of the minimum wage law have published introductory and intermediate economics textbooks. In those publications, they take the usual position that minimum wage legislation unemploys laborers with low skills. Thus, their textbooks blatantly contradict the open letter they signed.  I take great joy in listening to and reading their responses to this charge that they are contradicting themselves. Talk about talking without saying anything.

What of the ethics of the matter? Here, again, there can be no controversy. The minimum wage law violates people’s rights to engage in consenting adult behavior. An employer and an employee agree to a wage contract of, say, $5 per hour. Both are considered criminals under this pernicious legislation. But it is a victimless “crime” to pay someone $5 per hour for his labor services, and/or to receive such an amount of money for working. Both parties agreed to this contract! Our society is now in the process of legalizing other victimless crimes, such as those concerning prostitution, drugs, gambling, etc. Many people favor “choice” when it comes to adult behavior without victims. The minimum wage law is a step backwards from these moves in a moral direction.  And, yet, paradoxically, it is to a great degree precisely those people who advocate the legalization of these victimless crimes who are the staunchest supporters of the minimum wage law.

Posit that the “moderate” economists were right. A few people will lose their jobs, but the overwhelming majority would either find or keep their employment slots, at higher compensation rates. Suppose I were to go to the inner city (which contains a disproportionate number of the unskilled), and did the following. I went to one in every 20 people I met, and, at the point of a gun, I relieved them of, oh, $10,000 (40 hours per week time 50 weeks multiplied by $5 per hour). Whereupon I turned to the other 19 out of 20 people and dispersed these stolen funds amongst them. If I did so, I would be promoting the precise effects that the moderate members of the economics profession who are supporters of minimum wage claim will occur. Namely, this law, they contend, they concede, will hurt very few but benefit the many. But how would my excursion into the inner city, and my wealth transfer, be considered by law? Of course, I would be considered a criminal, and very properly so.

For reasons we need not discuss right now, the productivity of whites is higher than that of blacks. It is for this reason that the unemployment of the latter is higher than that of the former, actually, as an empirical finding, about twice as high. For reasons we need not discuss right now, the productivity of middle aged workers is higher than that of young employees, who are just starting out. . It is for this reason that the unemployment of the latter is higher than that of the former, actually, as an empirical finding, about twice as high. It is for this reason that the unemployment rate of black teens is roughly quadruple that of whites of mature years. All this stems from the minimum wage law serving as a barrier to entry, a hurdle, and not a floor raising wages. Supporters of the minimum wage, who just LOVE statistics, tend to shy away from this revealing data.

Who are the beneficiaries of the minimum wage law?  Quo bono?  This will come as a shock to some people, but the people who gain the most from this legislation are skilled workers, typically organized into labor unions. When they demand a boost in their own wages, the immediate response of the employer is to want to substitute away from this suddenly more expensive factor of production, skilled labor, and into a substitute for it; that is unskilled labor. There is more than one way to skin the cat. The same number of widgets might be able to be produced with 100 skilled and 100 unskilled workers, as with, for example, 50 of the former and 200 of the latter.  If there is any such thing as fixed proportions in manufacturing and production, it must be a great rarity. How best to fight such an eventuality from the point of the labor union? One way to do so is to castigate as scabs” (why this is not an example of “hate speech” similar to the use of the “N” or “K” word is beyond me; well, not really) the unskilled laborers hired in response to the union’s demand for higher wages. But there are problems here. For one thing, these newly hired employees would be disproportionately minority group members. It really looks bad for liberals, “progressives,” to be fighting this particular demographic. For another, these people can fight back. If you slash their tires, and hit them over the head with a baseball bat, they can reciprocate. No; this will not do. Organized labor has come up with an ingenious counterattack. Are you ready for this? Please take a seat, for you are now in danger of keeling right over. Yes: the minimum wage law; that is the solution to this quandary for organized labor. There is perhaps no better way to eliminate competition than to price it out of the market. (Hint, to burger providers; if you want to adopt crony capitalism, try to get a law passed compelling the prices of competitive products such as pizza, hot dogs, to be raised ten-fold. You can claim it is for health reasons.)

Who else benefits from the minimum wage law? This is like asking, who gains from high unemployment rates of young people, and unskilled workers? When looked at in this manner, several candidates immediately come to mind, given that unemployment breeds boredom and criminality: social workers, psychologists, psychologists, prison guards, policemen, etc. I don’t say that all of these people favor the minimum wage law because it will feather their nests. I only say their financial situation improves from its passage, and therefore empirical research into this possibility might be fruitful.

Why do we have this law on the books if it is so evil, so pernicious? One reason, already discussed, is that there are beneficiaries: organized labor, and our friends on the left who support them. Another is of course monumental economic illiteracy. Obdurate economic illiteracy. I teach freshman economics at Loyola University, and I usually take a survey of my students on opening day. Typically, a large majority favors the minimum wage law, and they do so not out of malevolence. Rather, they really think that this law will raise wages and help the poor. My students think this law is like a floor rising, and thus raising everyone with it. They do not realize that a better metaphor is a hurdle, or high jump bar: the higher the level stipulated by the minimum wage law, the harder is it to “jump” into employment. This law eliminates the lowest rungs of the employment ladder, where especially young people can gain valuable on-the-job training, which will help raise their productivity. If this legislation were of such great help to the poor, I ask my students, why are we so niggardly about it? Why limit the raise to $10, or $12 or even $15, as some radicals favor? Why not really help the poor, and raise the minimum wage level to $100 per hour, or $1000 per hour, or maybe $10,000 per hour. At this point they can see that virtually the entire population would be unemployed, because it is a rare person who has such high productivity. But, then, hopefully, then can begin to see that a minimum wage of a mere $7 per hour is an insuperable barrier to employment for someone whose productivity is $4 per hour.

When the minimum wage was raised from $.40 to $.70 cents per hour (the largest percentage increase so far) we went from manually operated elevators to automatic ones, helping high skilled engineers at the expense of the unskilled manual operators. This transition took a few years, but that was the cause. Initially, before anyone could be fired, wages did indeed rise. If the present minimum wage goes from $7.25 to, horrors!, $15.00, people who ask if you want “fries with” that will be supplanted by self serves and automatic machinery which will then be competitive with labor, but cannot now compete with low skilled people. Those jobs will go the same place, namely, booted out of existence, as the ones that used to exist at gas filling stations.

What should be done? We should not raise the present national minimum wage from its present $7.25. Nor should we maintain it at that level. Nor should we decrease it (some politicians advocate a lower minimum wage, for example, $4 per hour, just for the summer and only for high school kids to help them get jobs; but to counsel such a course of action is to admit that the law is a hurdle which must be jumped over, not a floor supporting rises). We should instead eliminate it entirely, and sow salt where once it stood. More than that. We should criminalize passage of this law. That is, we should throw in jail, or deal with these miscreants as we would other criminals, all those responsible for the passage of this law and for its implementation, such as the legislators who passed such a law, the police who enforced it and the judges who gave it their seal of approval. After all, is this not the way we would treat a person who unemployed other people at the point of a gun? Suppose there were a law that explicitly did consign people to involuntary unemployment, not implicitly and indirectly as does the minimum wage law, but direcetly. That is, an enactment such as this: It shall be illegal to employ black people. It shall be illegal to employ white people. It shall be illegal to employ young people. It shall be illegal to employ old people. It shall be illegal to employ Jews. It shall be illegal to employ Christians. It shall be illegal to employ gays.  It shall be illegal to employ heterosexuals. It shall be illegal to employ men. It shall be illegal to employ women. How would we treat all those responsible for the passage of such laws and for their implementation such as the legislators who passed such a law, the police who enforced it, the judges who gave it their seal of approval? Precisely, we would throw the book at them. We would penalize them to the fullest extent of the law.  Why should we do any less for those responsible for the minimum wage law?

I may add that the recent trends in globalization particularly outsourcing [as this 2010 yahoo article points out “The United States has one of the highest rates for minimum wage. In fact, there are some countries that do not set minimum wage rates. As of 2008, minimum wage in China was $ .60 (US Dollars), while in India it was $2.15 (US Dollars), and it was $2.46 (US Dollars) in Mexico.* Besides higher minimum wage in the United States, companies must contribute to Social Security, Medicare, FICA and unemployment insurance. These payments do not have to be made for foreign employees, and therefore the American companies save on payroll and costs for payroll.”]…as well as China’s export boom via “cheap labor” may partly have been one of the unseen consequences of the US minimum wage law.

Behind the 2013 Philippine Statistical Economic Growth of 7.2%

The Philippine statistical economy reportedly grew by 7.2% in 2013. 

As a side note, in my opinion, this news release has been timed to temper down on the renewed selling pressure from the "taper"

Question is what’s been driving the so-called growth?

The following graphs are from the National Statistical Coordination Board

Aside from the non-bubble manufacturing, the gist of the growth on a per industry basis comes from the usual base: construction, financial intermediation and real estate.

These are areas where most of the credit growth from the banking sector can be seen (data from the BSP updated November 2013).

One would note that financial intermediation soared by 40% in January of 2013 but turned lower and grew by less than 10% at the latter semester. The growth during the early half basically offset the slower growth at the second semester. This led to the annualized considerable growth figure.

Meanwhile credit expansion in construction, and real estate growth remains significantly above statistical economy.

On the per expenditure basis, growth mainly came from Intellectual Property Products (IPP) 15.4%, Durable equipment 14.4%, construction 10.9%, government expenditure 8.6% and household consumption 5.6%

Note the demand side (HFCE) has been growing 5.6% slower than the growth in the supply side.

Also IPP represents only 2.6% share of the fixed capital. The bulk of the distribution of fixed capital comes from construction with a 40% share and durable equipment at 50% share. 

And where is the growth in the durable equipment?

Largely in air transports. Whoever has been buying those planes. Could it be the government? Transports account for 44% share of the durable equipment. Road vehicles which has the largest share (in terms domestic currency at constant 2000 prices) have shown little growth at 5.5%. As a side note I used the constant 2000 as measure to be consistent in all of the above.

The other growth areas are ‘other general industrial machineries’ which accounts for about a third of the General Industrial Machinery, the latter category holds a 14.5% share of durable equipment.

Another ‘other misc durable equipment’ which accounts for 88% of miscellaneous ‘equipment’. The last category has an 18% share of the durable equipment data.

I wonder what constitutes the “other” categories in the durable equipment data which are derived from surveys: Annual Survey of Establishments (ASE) and the Census of Establishments (CE). The NSCB admits that “the estimates are affected by the limitations of these surveys.”

The bottom line: Whatever statistical growth the Philippine economy in 2013 has registered has largely been based on credit inflation. This means that for such rate of statistical growth to be sustained, credit inflation in these sectors would have be maintained; this via zero bound rates and a stable currency, something which unfortunately, the current market environment has been pushing back. The USD- Philippine Peso seems back at 45.30s level as of this writing and yields of 10 year Philippine treasuries have hardly gone down.

Second, yet growth in these sectors have largely emanated from those entities with access to the banking sector which means statistical growth has been concentrated to few. 

This also leads us to the third issue, the current statistical growth has largely been representative of the formal economy and hardly the overall economy where the informal economy has a big presence. The fact that the banking system has low penetration levels exhibits on the structural inefficiencies of the Philippine economy which means that savings have hardly found its way into productive undertakings. Thus the bellyaching by the mainstream of the lack of investments.

So the domestic central bank (BSP) instead resorts to implementing bubble blowing policies while the executive branch wants to spend its way just to generate statistical growth (thus benefiting cronies).

And signs of unproductive credit based spending can be seen from the sustained deficits in the Philippine trade balance. 

Real growth comes only from real savings and not from credit expansion

This also means that the Philippine GDP have been prone to significant statistical errors.

Fourth, supply side growth continues to substantially surpass demand side growth. And this means no imbalances (as alleged by the mainstream and those obsessed with impeccability of statistics)? Whatever happened to the law of supply and demand? 

Lastly all these cheerleading of the statistical growth (really a legacy of the mania phase from last year) reminds me of the warnings of the the great Austrian economist Ludwig von Mises (bold mine)

Public opinion is utterly wrong in its appraisal of the phases of the trade cycle. The artificial boom is not prosperity, but the deceptive appearance of good business. Its illusions lead people astray and cause malinvestment and the consumption of unreal apparent gains which amount to virtual consumption of capital. The depression is the necessary process of readjusting the structure of business activities to the real state of the market data, i.e., the supply of capital goods and the valuations of the public. The depression is thus the first step on the return to normal conditions, the beginning of recovery and the foundation of real prosperity based on the solid production of goods and not on the sands of credit expansion.

Pension Confiscation: US Edition

Resource starved governments from different parts of the world have either nationalized (at various degrees) or raided the pension industry in order to finance budget deficits or to attain various political goals. Some examples: Poland, Hungary, Ireland, Bulgaria and Ireland, Argentina (fully nationalized), in Spain retirement funds had been used to buy Spanish government debts, and in the Philippines where government pension have been used to prop up the stock market

Well, the US government seems likewise headed in that direction. This via President Obama’s “new retirement-savings vehicle aimed at workers who don't have access to traditional retirement accounts” through his new "myRAs" which he announced during his latest State of the Union address

Sovereign Man’s prolific Simon Black explains further

This is his new “MyRA” program. And the aim is simple– dupe unwitting Americans to plow their retirement savings into the US government’s shrinking coffers.

We’ve been talking about this for years. I have personally written since 2009 that the US government would one day push US citizens into the ‘safety and security’ of US Treasuries.

Back in 2009, almost everyone else thought I was nuts for even suggesting something so sacrilegious about the US government and financial system.

But the day has arrived. And POTUS stated almost VERBATIM what I have been writing for years.

The government is flat broke. Even by their own assessment, the US government’s “net worth” is NEGATIVE 16 trillion. That’s as of the end of 2012 (the 2013 numbers aren’t out yet). But the trend is actually worsening.

In 2009, the government’s net worth was negative $11.45 trillion. By 2010, it had dropped to minus $13.47 trillion. By 2011, minus $14.78 trillion. And by 2012, minus $16.1 trillion.

Here’s the thing: according to the IRS, there is well over $5 trillion in US individual retirement accounts. For a government as bankrupt as Uncle Sam is, $5 trillion is irresistible.

They need that money. They need YOUR money. And this MyRA program is the critical first step to corralling your hard earned retirement funds.

Pensions first? Bank deposits and rigid capital controls next? Will gold be banned too?

Bernanke Tapers Anew, Emerging Market Rout Resumes

The US Federal Reserve announced a second round of “tapering” or the reduction in their asset purchasing (money printing).

From Reuters:

The Federal Reserve on Wednesday decided to trim its bond purchases by another $10 billion as it stuck to a plan to wind down its extraordinary economic stimulus despite recent turmoil in emerging markets.

The action was widely expected, although some investors had speculated that the U.S. central bank might put its plans on hold given the jitters overseas.

Fed Chairman Ben Bernanke, who hands the Fed's reins to Vice Chair Janet Yellen on Friday, managed to adjourn his last policy-setting meeting without any dissents from his colleagues. It was the first meeting without a dissent since June 2011 - a sign of how tumultuous Bernanke's tenure has been.

It is the epilogue of Bernanke reign at the Fed, so it would seem that he would like to be remembered as having the discipline to rein or reverse his lavish monetary policies. Like Pontius Pilate, he "washes his hand" via the taper

And as I warned yesterday “It's even more interesting for Emerging Markets and for Asia to pray that the US Federal Reserve, whom are meeting today, won't add to their woes by increasing the "taper"

EM and Asia's prayers were apparently not answered. And signs are that the EM nightmare will continue. 

The soothing effect by Turkish central bank’s ‘shock and awe’ seems to have been neutralized by the Fed’s “taper”.

Fun for a day. The Turkish lira’s sharp one day rally (green ellipse) has been fully erased (red arrow). Such one day tryst spread to Asia yesterday

The currency rout can also be seen in the other members of the so-called fragile five

The Brazilian real

The South African Rand

We will see how the taper will impact the Indian rupee and the Indonesian rupiah later.

Nonetheless, the Russian ruble has also been slammed.

It’s not just EM currencies. It appears that US stocks have likewise been hammered last night.

The flow of events will go from intensifying market distress to liquidity squeezes to real economic issues via crises. This is the periphery-to-the-core dynamics. The question is will EM and developed economy policymakers be able to prevent the cycle from materializing? And will policymakers be able to forestall a contagion? Will a Black Swan event occur in 2014? By the way, it’s just the end of January and progression of events appear to be headed in the direction of the Black Swan.

Don’t we live in interesting times?

Turkey’s Central Banks Surprises With Huge Interest Rate Increases

Turkey’s central bank just made a stunning “shock and awe” move in order to calm her mercurial financial, particularly the currency market. The central bank substantially raised interest rates by 400-500 basis points

From Bloomberg:

Turkey’s central bank raised all its main interest rates at an emergency meeting, resisting political pressure and reversing years of policy, after the lira slid to a record low.

The bank in Ankara raised the benchmark one-week repo rate to 10 percent from 4.5 percent, according to a statement posted on its website at midnight. It also raised the overnight lending rate to 12 percent from 7.75 percent, and the overnight borrowing rate to 8 percent from 3.5 percent. The lira extended gains after the announcement, adding 3 percent to 2.18 per dollar at 1 a.m. in Istanbul.

Turkey is one of the supposed member of the emerging market Morgan Stanley coined “fragile 5”—along with Brazil, South Africa, India and Indonesia.

Some have cheered that Turkey’s central bank’s surprising move may have contained the emerging market contagion, but such optimists may be overlooking the possible impact of these rate increases on the real economy.

The central bank’s action has been meant to stabilize the Turkish lira which has been in a collapse mode vis-à-vis the US dollar.

This is the historical performance of Turkey’s interest rates. Like everywhere else, Turkey rates has been zero bound since 2008. Yet the recent rate hike is still far from the highs of the 2008 crisis

What has been the outcome of the zero bound rates?

Again like everywhere else, the short answer is a Credit Bubble.

Loans to the private sector spiraled to the firmament. Turkey’s credit backed spending spree has led to massive deficits in her trade and current account balances. This means that her lavish debt financed spending depended also on foreign money to plug these holes. This is another symptom of the Credit Bubble.

Moreover Turkey government continues to spend more than she collects thus sustaining a budget deficit.

And this gap has been financed by external borrowing which has leapt since 2010. External debt has grown by about 40% from the 2010 lows.

So zero bound rates promoted debt financed spending of the private sector and of the government which had been funded by banks and by foreign money. 

This is very interesting because there are about $160+ billion short term external debt due this year according to Turkey’s Central Bank, mostly held by private banks and by the other sectors.

And the other concern is of the external financing requirements excluding short term debt.

Another point of concern is of the $350 billion worth of foreign banking exposure on Turkey. Should there be any default/s will these foreign banks not be affected?

Interesting no?

Some questions

Will the current shock and awe be enough to stabilize Turkey’s financial system? Or will this just have a short term effect, where the current hike could be the first of the series of many more rate hikes to come?

How will the current dramatic rate hike impact the real economy (private sector and the government)? Importantly how will the current interest policy affect Turkey’s government and the private sector’s capacity to service debt? 

The markets have already been pricing in higher probability of Turkey’s debt default via higher CDS spreads

Mind you, for all those singing hosannas that forex reserves serve as talisman from a crisis, so far Turkey’s massive record foreign exchange reserves has done little to contain the financial upheaval.

It’s very interesting because Turkey could function as a paradigm to a possible crisis contagion or ‘domino effect’ in emerging markets.

It's even more interesting for Emerging Markets and for Asia to pray that the US Federal Reserve, whom are meeting today, won't add to their woes by increasing the "taper"