The Canary in the Coal Mine for the Casino Bubble: Macau’s Casino Woes Deepens

2014 has not been a good year for Macau’s casinos.

From Bloomberg:

Macau’s casinos recorded their worst year, ending a decade of expansion that turned the former Portuguese enclave into the world’s biggest gambling hub. More tough times are ahead.

Casino revenue in the city fell 2.6 percent to 351.5 billion patacas ($44 billion) in 2014, after a record 30.4 percent monthly drop in December, according to figures from Macau’s Gaming Inspection and Coordination Bureau today.

That sharp 40.3% February 2014 monthly gross revenue growth served as the peak, from which rapidly deteriorated through the year. Chart from Macau’s Gaming Inspection and Coordination Bureau

Media blames this on anti-corruption crackdown. Again from the same article.

Chinese President Xi Jinping’s bid to catch “tigers and flies” in an anti-corruption drive and weaker economic growth means Macau may face shrinking revenue until at least mid-2015, when new resorts open. The crackdown has deterred high rollers who account for two-thirds of Macau’s casino receipts, and wiped out about $73 billion in market value of companies including Wynn Macau Ltd. (1128) and SJM Holdings Ltd. last year…

Also on money flows to stealth money flows…

Macau’s government has been curbing money flows to the territory over concern that illegal funds are being taken out of the mainland. It is restricting the use of China UnionPay Co.’s debit cards and its hand-held card swipers at casinos. Further clampdowns are expected with the help of banks.

Let us put this in perspective. If indeed Macau’s casinos have only served as conduits for stealth transfers or 'capital flight' then only part of that money would have been funneled to the casinos, the rest would have moved elsewhere. This means Macau’s casinos should hardly have boomed. 

But Macau’s previous boom most likely highlights easy money debt financed spending activities with capital flight as a subordinate cause.

Some have even suggested that such money flows has funded record high inflows to US real estate and perhaps rechanneled gambling activities to the US. 

But actions of stocks of the US gaming industry suggests otherwise.

The 47 component Dow Jones Gambling index has swiftly capsized into a bear market since its peak in March. This would mark a real time example of how mania morphs into a collapse.

Since part of the US gambling index incorporates Macau exposure by US firms, then part of the decline may be attributed to Macau’s morose fate.

Apparently domestic (US) operations have failed to offset external conditions which explains the accentuated contagion effect.

But gambling industry woes hasn’t been just about Macau. 

Singapore’s Genting’s G13.SI stocks has halved, since its October 2011 peak. This year’s decline has only punctuated the ongoing hemorrhage.

And when considering Genting’s competition, the Marina Bay Sands operated by Las Vegas Sands whose stocks has been shaved by a third, there seems hardly any difference.

Singapore’s casinos compete with Macau’s rivals for Chinese visitors.

So has the Chinese government’s crackdown on the political opposition bannered as ‘anti-corruption’ also spread to Singapore?

Interestingly, Macau’s casino operators seem to be focusing diverting expansion towards the leisure industry. Back to the Bloomberg report: 

Casino companies including Sands China and Galaxy are shifting resources from high rollers to lure more vacationing Chinese and other mass-market gamblers by building malls, theaters, restaurants and hotels.

New project openings starting in mid-2015 with Galaxy’s second-phase expansion of its resort on the Cotai Strip may help underscore a market revival, by targeting tourists who’re seeking a broader holiday experience in addition to gambling, according to CLSA’s Fischer.

In Asia, there seems to be an intensive race to build capacity to chase after the Chinese consumers/gamblers as seen by grand projects casino-leisure integrated resorts, not only in Macau but also in Vietnam, South Korea and the Philippines.

These operators hardly realize of the rapidly faltering conditions of the Chinese economy as shown by the 21 charts from zero hedge.

But the real reason for the casino industry’s weakness as I previously wrote:

The reality is that China’s sputtering economy has been reducing demand for the region's casinos. Political persecution of the opposition (via crackdown on graft) represents only the icing on the cake. Add to this the slowing regional economic growth which should exacerbate demand sluggishness.

On the supply side, zero bound has led to casino operators to overestimate on demand, thus the region's overcapacity which has most likely having been funded by cheap debt.

Now the chicken comes home to roost.

And as I also pointed out earlier, the Philippine counterparts has racked up a colossal Php 45-50 billion of debts to finance grand projects. 

If those Chinese gamblers don’t come this year, if the domestic economy continues with its downshifting momentum and if political financial elites don’t patronize these entities enough to provide them financial viability, those humongous debts will come into the spotlight. This should make 2015 very interesting!

Anyway Macau’s stocks as the canary in the coal mine

MGM China Holdings (HK:2282)

Galaxy Entertainment Group (HK:27)

Melco Crown Entertainment (HK: 6883)

Sands China Ltd. (HK: 1928)

Wynn Macau Ltd. (HK: 1128)

SJM Holdings Ltd. (HK:880) owner of Grand Lisboa

The obverse side of every mania is a crash.

Or has it been that gambling has turned into household activity where Chinese punters bid up frenetically stocks prices!

The week prior to the 2014's end, the Zero Hedge reports (bold and italics original) “a stunning 900,000 new stock trading accounts opened - the most since October 2007 (right before the Shanghai Composite collapsed 70% in the following 9 months)

As revealed above, market crashes have become real time events.

Caveat emptor.

The Real Economy versus Statistical GDP: How Reducing GDP Increases Economic Growth

At the Ludwig von Mises Institute, Austrian economist Joseph Salerno differentiates statistical GDP with the real economy and explains why a reduction of statistical GDP INCREASES real economic growth (italics original, bold mine)

Recently, the Financial Times published an article containing charts displaying the correlation between government spending and real GDP growth.1 Based on these correlations, the author of the article, Matthew Klein, comments: “It’s no secret that spending cuts (and tax hikes) have retarded America’s growth for the past four years.” He goes on to argue that from mid-2010 to mid-2011, the reduction in government spending in the US shaved 0.76 percent off of the economic growth rate. Klein conjectures that this slowdown in the growth rate caused a level of real GDP today that is 1.2 percent less than it would have been in the absence of this exercise in “austerity.” He also points out that since 2012 almost all of the depressive effect on real GDP growth of government austerity was the result of the reduction in military spending. While some of the reduction was beneficial, Klein opines, “some of it represents a self-inflicted wound.” Indeed it may represent a self-inflicted wound on the Federal government, but in that case it benefits the private economy. 

Now it is certainly true that a reduction in real government spending causes a reduction in real GDP, as it is officially calculated. But contrary to Mr. Klein, the reduction in government spending does not retard the growth of production of goods that satisfy consumer demands and, in fact, most likely accelerates it. In addition, real incomes and living standards of producers/consumers in the private sector rise as a direct result of the decline in government spending. The reason for this seeming paradox lies in the conventional method used to calculate real output in the economy. Let me explain with a simple example.

The Problem with Calculating GDP

Let us suppose a simple island economy in which the private sector produces 1,000 apples per year. Suppose further that the government of the island taxes the private producers 200 apples per year to sustain its military as it invades a neighboring island in order to neutralize a “potential terrorist threat.” According to standard national income accounting, which is deeply rooted in Keynesian economics, real GDP is calculated as 1,200 apples: the 1,000 (pre-tax) apples either currently consumed by the producers, invested by them in planting new apple trees to provide for future consumption, or paid out in taxes plus the 200 apples expended on the island’s military which is busily producing the “public good” of national defense. In other words, the island’s real GDP2 includes the 1,000 apples voluntarily produced by the private sector plus the “apple value” of national defense which is valued at its cost of production, that is, the 200 apples of compulsory tax revenues spent on conquering the adjacent island. 

Now let us assume that by the next year the conquest has been completed and the island allegedly harboring the terrorists has been pacified. Our island’s government decides to cut its military and reduces taxes by 100 apples. All other things equal, real GDP falls from 1,200 to 1,100 apples, since national defense now contributes only 100 apples worth of government services to the 1,000 apples produced by the private sector. But there is the rub. The apples were voluntarily produced and therefore were demonstrably more highly valued than the resources (effort and time) used to produce them. In sharp contrast, there is no evidence whatever that the private producers/consumers valued the military services supplied by government more highly than the cost of producing them or even that they valued them at all. The reason is because government military spending was financed by the coercive extraction of resources from the private sector, whose members had no choice and therefore expressed no valuations in the matter.

No Way to Calculate Real Value of Tax-Financed Amenities

The same conclusion holds for any coercively-financed venture, such as government construction of an island infirmary. In the absence of voluntary production and exchange, there is no meaningful way of ascertaining the value of goods and services. The government investments and services may have some value to private consumers, but there is no objective scientific method of gauging what that value is. Indeed, assuming government wastes at least 50 percent of the resources expended, the net benefit to consumers of government production would be zero.

Using “Gross Private Product” Instead

So for these and other reasons, national income accounting on Austrian principles would exclude government expenditures in calculating the total production of the economy. Thus in our island economy real output or what Austrians, following Murray Rothbard, call “Gross Private Product” or “GPP”3 is equal to only the 1,000 apples produced by the private sector and excludes government expenditures of 200 apples on the provision of military services (or an infirmary).4 But the 1,000 apples of GPP actually overstates the resources left at the disposal of the private sector, because 200 apples were forcibly siphoned off from potentially valuable private consumption and investment activities to fund government activities that can only be judged as wasteful from the point of view of the original producers of those resources. In this sense the 200 apples paid in taxes can be seen as a “depredation” on the private economy as measured by GPP.5 

Netting out this depredation we then arrive at what Rothbard calls “private product remaining in private hands” or PPR. PPR equals GPP minus total depredation (i.e., government spending).6 In our hypothetical island economy PPR is therefore 800 apples (= 1,000 apples – 200 apples). Thus government spending should not be added to private production but rather subtracted from it to get a sense of the living standards of private persons engaged in productive economic activity.7

Reducing Taxes and Spending Increases Welfare

Based on the above analysis, when the island government cuts military spending by 100 apples, assuming no other changes, it does indeed reduce real GDP from 1,200 to 1,100 apples. However, from the Austrian perspective, real output of valuable goods remains constant at GPP = 1,000 apples, while the economic welfare of producers is significantly enhanced because depredation on their output falls by 100 apples causing PPR to rise from 800 to 900 apples! But this is not all. A portion of the tax cut of 100 apples will be devoted to investing in the seeding of new trees, thus increasing the capital sock and accelerating economic growth over time.

Even in the short run, there is likely to be positive growth of GPP due to “supply-side effects.” For instance the cut in marginal tax rates increases the opportunity cost of leisure and spurs producers to work more hours. The private labor force further expands with the influx of former soldiers. Thus it may turn out that GPP increases from 1,000 to 1,075 apples (and, consequently, PPR from 800 to 975 apples). In this scenario the 100-apple cut in government expenditure would be partially offset by the 75-apple rise in private product so that the GDP statistic would register a smaller decline then previously calculated, from 1,200 to 1,175 apples. Despite the decline of the meaningless GDP statistic, however, the result would be a boon for the private economy, as apple production, the real incomes and living standards of apple producers, and the capacity to produce apples in the future all improve.

From the Austrian standpoint, then, the path back to immediate economic health and sustainable long-term growth is massive tax and spending cuts anywhere and everywhere. Yes, this is austerity — but only for the government. Slashing political depredation on the private economy will release a cornucopia of current and future benefits on private consumers. And these benefits are virtually cost free because the resources consumed by the government budget are almost all a pure waste from the point of view of the private producers of those resources.

Deeply slashing the bloated budget of the US government by, say, 25 percent would not only cure the sham deficit problem, but more importantly it would rapidly reverse the trend of the declining middle class and powerfully and permanently stimulate the anemic long-run US economic growth rate. For the real problem is not the size of the budget deficit per se, but rather the depredation on gross private production contributed by the overall federal budget.8 Thus a US government budget of $4 trillion and a deficit of $500 billion represents far greater depredation on and is far more harmful to the private economy then a budget of $3 trillion partly financed by a deficit of $1 trillion.

• 1.A report on the article that includes some of the charts may also be found on an ungated website here.
• 2.For simplicity, we ignore capital depreciation in this in this simple island economy, assuming that the apple trees once planted live forever never needing to be maintained or replaced. Thus GDP = NDP.
• 3.Once again, absent depreciation, GPP = NPP.
• 4.The Austrian approach to national income accounting was pioneered by Murray Rothbard, pp. 339–48 and Rothbard, pp. 1292–95.
• 5.I am using the term “depredation” to mean the forcible taking of the property of another, whether legal or not, and for whatever purpose. There is precedent for this usage in older law codes. In French law, “depredation” denoted “the pillage that is made of the goods of a decedent.” Old Scottish law defined “depredation” as “the (capital) offence of stealing cattle by armed force” (Lesley Brown, ed., The New Shorter Oxford English Dictionary on Historical Principles, 4th ed. [New York: Oxford University Press, 1993], p. 639).
• 6.Actually, depredation is calculated as government spending or tax revenues, whichever is greater (Rothbard, p. 340). But since the US government has rarely run a surplus since World War 2 we can ignore this complication.
• 7.Robert Batemarco uses Rothbard’s approach to calculate GPP, PPR and PPR/Employment (nongovernment) for the years 1947–83 to track the movement of private living standards during these years.
• 8.To calculate total depredation on the private economy, of course, state and municipal spending must be accounted for.

ECB Mario Draghi’s Keynesian Fallacies

At the Mises Canada blog, Austrian economist Patrick Barron censures ECB’s Mario Draghi’s justification for launching QE (italics mine)

From today’s Open Europe news summary:

Draghi: ECB ready to initiate QE to counter low inflation

In an interview with Handelsblatt, ECB President Mario Draghi warned that persistently low inflation in the Eurozone meant that “the risk that we do not fulfill our mandate of price stability is higher than six months ago”. Draghi reiterated that the ECB was ready to step in with a programme of Quantitative Easing, noting that “We are in technical preparations to adjust the scope, speed and composition of our measures for early 2015.”

Handelsblatt Reuters Telegraph

ECB President Mario Draghi’s latest statement is full of Keynesian fallacies, to wit:

1. That price stability is a worthy goal. No, monetary stability is essential, so that prices may reflect the true preferences and productive limitations of the market in order to allocate scarce resources to their most important purposes as dictated by the market.

2. That low inflation or even deflation is harmful. No, in a economy with increasing productivity prices will fall, benefiting all of society. Preventing prices from falling or, as ECB President Draghi desires, encouraging price inflation, causes the Cantillon Effect, whereby early receivers of the new money benefit at the expense of later receivers. Continuing monetary expansion will cause the Austrian Business Cycle.

3. That GDP is a good measure of an economy’s success. if this were the case, then Zimbabwe would be a huge success story. GDP simply adds up the monetary prices of goods sold, so higher prices on the same or even slightly lower volume of sales necessarily will be interpreted by Keynesian economists as success.

4. That monetary expansion can spur an economy to greater prosperity. If this were the case, then counterfeiters would be doing all of us a big favor. Monetary expansion distorts the structure of production, sending more resources to the expansion of enterprises further removed from final consumption. This malinvestment eventually will be revealed by losses in these industries. The current collapse of commodity prices and anticipated bankruptcies in commodity production industries are a good illustration of this process and are attributable to massive monetary expansion by central banks since the 2008 great recession.

Let me add J M Keynes quote on inflation: (bold mine)

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

There can be no general prosperity on policies of “legal plunder” channeled through money manipulation. Since there is no such thing as free lunch, central banking’s invisible confiscatory policies eventually unravel. Real time market crashes have been symptoms of these.

Happy 2015!

Wishing you a happy, healthy, fruitful and peaceful New Year!

Welcome 2015!

(image source)

yours in liberty,

Benson

How Mania Looked Like When Japan’s Nikkei 225 Reached Record Highs in 1989

In documenting financial and or economic crises over 200 years Harvard’s Carmen Reinhart and Ken Rogoff noted of a common psychological denominator: This time is different

The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crisis is something that happens to other people in other countries at other times; crises do not happen here and now to us. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many previous booms that preceded catastrophic collapses (even in our country), is built on sound fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes …

“This time is different” circa 1989 as the Nikkei reached record highs.

From the Wall Street Journal Japan Real Time Blog (hat tip/chart from Zero Hedge) [bold mine]

After the Japanese stock market hit its all-time high on Dec. 29, 1989, analysts were still looking forward to another strong year for shares in 1990, despite some signs of danger.

The following is a Wall Street Journal article by Marcus W. Brauchli looking at the likely direction of the Japanese stock market following its record finish in 1989. The article was published Jan. 2, 1990.

Tokyo Stocks: Japan’s Believers Expect Surge in Stocks to Continue

TOKYO–Japan’s stock market spawns two kinds of investors: believers and skeptics. The believers are getting rich. The skeptics are getting sore.

For much of the past decade, the world’s biggest stock market has stumped the skeptics. Price-earnings ratios are astronomical. The differential between interest rates and corporate earnings is wide. Yet just when the market seems most top-heavy, it heads even higher.

The skeptics’ experience has been a litany of missed opportunities, and last year was no exception. The year-end rout many analysts feared in the bumpy days after the Oct. 13 slump turned into a record-stomping rally.

For believers, Japan’s stock market has been a money-spinner. Daiwa Securities Co. estimates that $100 invested in Japan’s market in 1981 would have generated capital gains worth nearly $650 today at prevailing exchange rates. The same amount invested on Wall Street would have earned $185 above the initial $100 invested.

As Tokyo’s market gallops into the Year of the Horse, the skeptics once again are wondering how long the market’s advance can continue. The believers are betting that it won’t slow anytime soon-and the consensus emerging from 1990 forecasts supports them. Even cautious predictions call for the Nikkei Index to end 1990 above the 45000-point level, climbing from its 1989 close of 38916. Other markets may perform better — and many did in 1989 — but few trend so chronically higher.

“We’re looking for another good year,” says Lawrence S. Praeger, chief strategist for Nikko Securities Co. Adds Christopher Russell, manager of research at Jardine Fleming Securities Co.: “The market looks well set.”

Behind such uniform optimism are many of the same fundamental struts that supported the 1989 market. The economy is expected to grow nearly 5% in the year ending March 30, and many economists already are predicting growth of more than 4% for the following year. Also, recurring corporate profits will grow about 11% in both years, according to forecasts by Nomura Research Institute 4307.TO -2.60%.

“The outlook is extremely good,” says Pelham Smithers, a research analyst at Shearson Lehman Hutton Inc.’s Tokyo office. Even the risk of a long-term decline, he notes, appears more limited than it was in 1989.

That’s mainly because some of the key negatives that sapped the market’s strength at times won’t recur. Last year, for instance, the market was hurt by a prolonged slowdown in market speculation and economic activity caused by the January death and February funeral of Emperor Hirohito. The market was then dragged lower at midyear by a series of political scandals. And external events took a toll, with the crackdown in Beijing weakening investor confidence in companies with ties to China.

Most of those market pitfalls were temporary. True, there is the chance of political trouble in February, when Prime Minister Toshiki Kaifu is expected to call a general election. But polls suggest his Liberal Democratic Party has been getting stronger, not weaker. Any gain by the party surely would aid market sentiment.

Yet there are a handful of danger signs that investors must guard against, analysts say. “The biggest negative for the market would be if the dollar picks up,” says Shearson’s Mr. Smithers. A weaker yen would increase the price of imports, fueling consumer-price inflation — which is expected to rise more than the government’s estimate of 2% this year in Japan. That might force the Bank of Japan to raise interest rates, which would tend to discourage stock market investment.

Moreover, some analysts worry that a weaker yen would exacerbate Japan’s trade surplus with the U.S. and might trigger protectionist measures by Washington. That kind of fight could hurt a lot of companies and send the market into a slide.

Any signs of these factors could be enough to send Japan’s institutional investors scurrying into cash. And because big investors, who tend to act in unison in Japan, are such major forces, that could set off a broad decline.

It’s that vulnerability that has caused some skeptics to miss out on some of the Tokyo market’s broad gains.

The skeptics fret that the price of Japanese stocks averages more than 60 times the issuing company’s per-share earnings. That price-earnings ratio is more than four times the U.S. average. And the differential between the yield available on short-term interest-bearing instruments, such as certificates of deposit, and the average earnings yield of Japanese stocks, is nearly 4% — high by historical standards.

These days, though, instead of analyzing why those numbers point to a collapse in share prices, more analysts are trying to explain how, with no wires apparently attached, stocks are still flying.

For instance, Paul H. Aron, vice chairman emeritus of Daiwa Securities America Inc., is the beacon of a movement that aims to show that differences in corporate accounting and business practices account for most of Japan’s high P-E ratios. If the ratios were adjusted for the differences, he says, Japan’s average P-E ratio would have been about 17.5 at the end of August, against a U.S. average of 13.5.

Another factor that boosts stocks is rotational buying. Instead of buying across all sectors, Japanese investors tend to look for special circumstances that will help one sector or another. Stocks that might benefit from a reduction in tensions with the East bloc or from economic cooperation with the Soviet Union rallied strongly in the last quarter of 1989 and are expected to continue advancing.

“In between the sector rallies, there could be some cooling down,” says Robert Jameson, an executive at Dresdner Bank’s Tokyo brokerage unit. “But a year is a long time in the Tokyo market, and it won’t stay cool for long.”

Overconfidence, bandwagon effect/appeal to majority, rationalization, vehement denial of risks, linear thinking (anchoring), and  voracious risk appetite—hallmarks of the “this time is different” mania.

Yet the battle between the skeptics and the believers highlight Dr. John Hussman’s Exit Rule for Bubbles: you have to decide whether to look like an idiot before the crash or an idiot after it. 

The bottom line: the obverse side of every mania is a crash.

Philippine Bonds Close the Year with a Rally; Flattening Yield Curve as Business Cycle Indicator

Philippine bonds ended the year with a rally that partly offset some last week’s selloffs.

Given the tightly controlled bond markets, this would be natural; the establishment would like to give the bond markets a facelift from current pressures. Besides, the Philippine government will be raising from the international market dollar bonds early January 2015, so domestic bond yields would have to reveal of "confidence". 

Also since no trend goes in a straight line and given the sharp moves of the past weeks, a rally should be expected.

Today’s yearend rally has normalized the 4 and 5 year inversion from last week.

However, today’s rally hasn’t changed the dramatic flattening of the domestic yield curve seen over the past month.

Let me deal with an objection that I have recently received.

Obviously annoyed by my post, an internet troll recently wrote: “Yields spiked simply because of the long holiday. A lot of traders wanted to sell, and few wanted to buy, because of fears that something might happen between Dec 3 and Jan 5 (many of them would probably take Dec 29 off). Basic supply and demand. If/When nothing happens, expect rates to fall back in the new year.”

The troll ended with snide ad hominems.

The above suggests that the current spikes in the yield curve have been about the “long holiday”.

As a side note I already dealt with this, but let me expound.

In celebration of Christmas, there are at least 5 public holidays in the last two weeks of December. I say “at least” because the government tends to declare unilaterally some in-between working days as holidays. This means long holidays has been a tradition in the Philippines. So fundamentally, to imply of ‘seasonality’ from long holidays means that turmoil in Philippine treasuries should consistently occur as an annual event!

A glimpse at the chart of yields of various Philippine treasury maturities will expose of the general invalidity of this claim (as shown below).

Paradoxically, the current turbulence in Philippine bond markets has been attributed to “fear” out of the long holidays. 

What has not been specified has been the motivation of the “fear” which produced such actions, except to declare in conclusion that this should signify an anomaly. Why “fear” the long holidays if everything has been hunky dory? Because traders woke up with a hangover from their holiday bacchanalia and decided to become fearful to go into a selling spree???

So in the absence of the identification of cause/s, yet a generalization was made: Yields must go down because the claimant says so! See the wonderful self-proclaimed economic logic?!

Bluntly stated, nothing can ever go wrong with this boom! Warts, wrinkles and all blemishes have to be passionately denied out of existence!

Normally I would ignore such trolls, but the comment showcases what's wrong with the current conditions. They represent rabid denials which has part of the bubble psychology as indicated the anatomy of the bubble cycle above.

As a side note, in mainstream media, there seems to be a code of silence in recent developments at the domestic bond markets.

For instance this Bloomberg December 12 article reports on the big bond market gains in response to Moody’s upgrade: “The yield on peso bonds due November 2024 fell 16 basis points this week, the most since the five-day period ended Oct. 25 last year, to 4.17 percent in Manila, according to noon fixing prices from Philippine Dealing & Exchange Corp. The yield dropped 18 basis points, or 0.18 percentage point, today. That move was also the biggest since October 2013"

The following day, the “biggest” move “since October 2013” had been more than completely obliterated, yet media’s deafening silence on the event. 

Good news reported, bad news censored? Why? Have bad developments not been real?

Going back to the objection, Dictionary.com defines “fear” as a distressing emotion aroused by impending danger, evil, pain, etc., whether the threat is real or imagined; the feeling or condition of being afraid.

In short, fear arises from a sense of heightened risk and or uncertainty. So how the heck can seasonality, which implies regularity, routine and predictability, generate “fear”?

If people are driven by incentives from subjective values, preferences and expectations, then the predictable end-of-the-year increased demand for liquidity should make financial institutions prepare for mundane events. Financial institutions may avail of interbank borrowing or BSP facilities (e.g. repos/ rediscounting) among the many modern tools in the financial toolkit. There won’t be need for abrupt liquidations of bonds.

And if bond markets have been reckoned as an option, the actions would be limited to some maturities, which has been the case for some yearend episodes. It is for this reason that Philippine bond markets have hardly demonstrated annualized turbulence as today.

In a nutshell, to rationalize current mayhem in the Philippine bond markets via proof of assertion, post hoc and begging the question— a bundle of flagrant logical fallacies—represents a rickety and inferior, if not a ridiculous way, to explain current events.

And because such comments have been predicated on faulty assumptions and premises they account for as blind faith to the perils of “This time is different” mentality which fits to a tee on the psychological aspect of what Harvard’s Kenneth Rogoff and Carmen Reinhart observed as common denominator of every financial crises from 1800-2010 which they documented in their book

The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crisis is something that happens to other people in other countries at other times; crises do not happen here and now to us. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many previous booms that preceded catastrophic collapses (even in our country), is built on sound fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes …

What has been the relationship among these key factors—exploding credit growth in both the banking system and the bond markets, declining statistical economic G-R-O-W-T-H, tumbling money supply growth rates and rising credit risks, as revealed by the resurgence in Philippine (and ASEAN) CDS spreads—to current bond market turbulence?

How about prospective US Federal Reserve policies? How will US interest rates impact domestic rates? Has all these been unrelated to the actions in Philippine bond markets? How about the soaring US dollar? 

Again what incentives or expectations or events has triggered the “fear” via a scramble for liquidity in the bond markets?

We have also witnessed an inversion of 4 and 5 year yields last week, when was the last time the Philippine bond markets experienced this?

Does the following yield spreads from 2011 to 2014 (based on December monthly close from Investing.com) indicate that the Philippine bond markets have been about “long holidays”?

Except for the 10 year minus 2 year, even if we exclude this year’s actions, the short term-long term spread has exhibited a general flattening dynamic from 2011-2013. 

This year's actions seems to only amplify an ongoing trend. 

Yet the periodical December flattening dynamic resonates with the current activities over the past  month.

Instead of an anomaly, the flattening of the yield curve is an indication of the business cycle in progress. 

It has been a sign of monetary produced imbalances that has prompted credit markets to arbitrage on the asset liability mismatches via the spread differentials—whose windows have now been closing. It has been a sign of how credit expansion has engendered massive pricing distortions in the economy that has been demonstrated by inflationary pressures* which have now been reflected on the bond markets. And it has also been a sign that such credit expansion fueled boom has been backed by a lack of savings.

*As for relative inflation pressures, retail beer prices has risen 8%, my favorite fish ball vendor has not only had a decrease in size of the product, (value deflation or shrinkflation) recently the price has gone by 33%! (Previously Php 2 for every 4 pieces or 50 cents each now Php 2 for every 3 pieces or 66 cents each)

As Austrian economists Philip Bagus and David Howden explained: (bold mine)

Lacking adequate savings for the terms of the projects, these malinvestments must be liquidated. But when exactly will the recession set in? Two cases may be distinguished. In the first, the disturbance directly affects productive ventures. In the second case, financial intermediates first enter distress and only later affect productive enterprises.

In the first case, companies finance additional long-term investments with short-term loans. This is the case of Crusoe getting a short-term loan from Friday. Once savers fail to roll over the short-term loans and commence consuming, the company is illiquid (assuming other savers also curtail their lending activities). It cannot continue its operations to complete the project. More projects were undertaken than could be completed with the finally available savings. Projects are liquidated and the term structure of investments readapts itself to the term structure of savings.

In the second case, companies finance their long-term projects with long-term loans via a financial intermediary. This financial intermediary borrows short and grants long-term loans. The upper-turning point of the cycle comes as a credit crunch when it is revealed that the amount of savings at that point in time is insufficient to cover all of the in-progress investments. There will be no immediate financial problems for the production companies when the rollover stops, as they are financed by long-term loans. The financial intermediaries will absorb the brunt of the pain as they will no longer be able to repay their short-term debts, as their savings are locked-up in long-term loans. The bust in this case will reverberate backward from the financial sector to the productive sector. As financial intermediaries go bankrupt, interest rates will increase, especially at the long end of the yield curve, lacking the previous high-degree of maturity mismatching driving them lower. Short-term rates will also increase due to a scramble for funds by entrepreneurs who try to complete their projects. This will place a strain on those production companies that did not secure longer-term funding, or rule out new investment projects that were previously viable under the lower interest rates. Committed investments will not be renewed at the higher rates

Current developments in the Philippine bond markets suggest that yields have been rising across the curve but the pressure of increases has been in the short (bills) maturities than the longer bonds…thus the flattening. The flattening of the yield curve thereby signals the ongoing tightening of monetary conditions. Rising short term yields are symptoms of emergent strains in the Philippine financial system.

Let me further add that if the current ruckus in the bond markets will be sustained, the BSP will be forced to intervene. They may inject funds into pressured financial institutions, they may cut interest rates (contra mainstream expectations of higher rates), or at worst, if the problem spirals out of control, they may resort to bailouts. 

The BSP will likely impose the same policies as her international peers: I recognize the problem of addiction but a withdrawal syndrome would even be more cataclysmic.

Yet interventions from the BSP won’t bring back “normality”, rather they’d be pushing the progressing credit problems down the road. So BSP actions may prompt for the current stress in Philippine bonds to temporarily backoff, but the deepening addiction and dependence by credit hooked institutions would mean more accumulation of systemic debt based problems overtime. 

Via the law of scarcity, this means that eventually the developing entropy in the domestic credit markets, presently being ventilated in the bond markets, will reach a point to expose on the Potemkin Village pillared on a credit bubble; an inflection point from which the BSP won’t be able to control.

The great Austrian economist Ludwig von Mises warned: 

All governments, however, are firmly resolved not to relinquish inflation and credit expansion. They have all sold their souls to the devil of easy money. It is a great comfort to every administra­tion to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors. It is the typical policy of après nous le déluge. Lord Keynes, the champion of this policy, says: "In the long run we are all dead." But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years.

This blog has not been intended to join the selling of “their souls to the devil of easy money” by the consensus. Instead, in spite of social signaling costs, this blog has been intended to warn of its perils

With or without me, the Aldous Huxley rule will apply “facts do not cease to exist because they are ignored”.

History, economics and finance tell us that the obverse side of every credit fueled mania is a crash.

In spite of the above, have a wonderful new year!

China’s PBOC Offers More Easing, Fuels a Wild Stock Market Ramp

More evidences of the tightening embrace by the Chinese government of “I recognize the addiction problem but a withdrawal syndrome would even be more cataclysmic” where existing debt problems will be solved by more encouraging acquisition of more debt!

The PBOC has reportedly signaled easing restrictions on banking system’s deposit requirements to encourage more credit activities.

From Dow Jones Business Nasdaq:

China's central bank is allowing banks to lend more out of their deposits as the world's second-largest economy struggles to gain momentum, according to banking officials with knowledge of the matter.

At a closed-door meeting on Wednesday, officials at the People's Bank of China told representatives from two dozen banks and other financial firms that the central bank will soon relax a major restraint on banks' abilities to make loans, according to the banking officials. The move would essentially allow them to include more money in their deposit base, giving them more room to lend…

Analysts estimate the move is roughly equivalent to injecting 1.5 trillion yuan--or about $242 billion--into the banking system. PBOC officials didn't respond to requests for comment.

Unlike her counterparts who attempt to project transparency in policy communication, the PBOC has undertaken monetary stimulus via the stealth measures

From Bloomberg: (bold mine)

Contrary to the Federal Reserve’s forward guidance, the Bank of England’s increased transparency and a Group of 20 Nations vow to clearly communicate policies, China has added liquidity by stealth at least four times in the past four months. One proxy it has been using is China Development BankCorp., the nation’s biggest policy lender.

Balancing the need to buoy an economy set for its slowest full-year expansion since 1990 and efforts to contain a debt pile that’s almost doubled in six years, China’s leaders have sought a targeted monetary path that’s deviating from advanced economy peers. Problem is, by keeping in the shadows, speculators have jumped in, pushing the stock market up over 20 percent since the PBOC’s benchmark interest rate cut on Nov. 21 in anticipation of more monetary easing…

The PBOC will lower the benchmark one-year lending rate by 25 basis points to 5.35 percent in the first quarter and by another 15 basis points by the end of June, according to economists surveyed by Bloomberg from Dec. 18-23. The central bank may cut banks’ required reserve ratio by a total of 1 percentage point in the first half, the survey found.

The PBOC rolled over at least part of a 500 billion yuan ($80 billion) three-month lending facility to the largest Chinese lenders last week, days after it injected 400 billion yuan via CDB, according to people familiar with the steps. Neither move, nor an offer of short-term liquidity to banks, has been officially announced.

Targeted easing means choosing winners and losers for monetary largesse by the PBOC.

And as I have been saying here stock markets have been about liquidity and credit that fuels fragile (false) confidence. The prospects of more easing compounded by the government’s IPO management has incited an orgy of speculation. 

From the wall Street Journal:

Chinese stocks rose Thursday on the news of corporate-finance deregulation in otherwise quiet Asian trading as the end of the year nears.

Shanghai Composite Index rose 3.4% to 3072.54, driven by financial stocks, following the announcement by China’s State Council Wednesday that it would scrap geographic restrictions for Chinese companies and commercial banks issuing yuan bonds abroad. The council also said it would make it easier for companies to offer shares, conduct mergers and acquisitions, and open branches overseas.

It could be possible that the PBOC has been channeling those loans to stock market, indirectly (bank loans to brokerages?)

Yet all these latest "easing" measures has done the opposite, it has raised interest rates based on 7 days repo moving averages.

Media has blamed this on demand for IPOs and stock market activities, but as previously explained for every security transaction represents a buyer and a seller. Money passes only from the buyer to the seller, so there should be no liquidity pressures.

Yet record high of margin trades last December 22nd of 670.6 billion yuan hardly has been indicative of liquidity strains at the stock market. 

The credit crunch has been in the real economy where China’s flow of credit has been diminishing.

I believe that the stock market serves as a convenient camouflage for the monetary tightening occurring in the real economy emanating from deepening signs of debt deflation.

So like governments almost everywhere, where stock markets have been used as policy communications tools to conceal real economic problems, to buy time from a violent market clearing adjustments and to promote a spurious G-R-O-W-T-H model based on the trickle down from the “wealth effect”, the PBOC desperately pins her hope based policies that stock market boom will do the wonders of exorcising her debt woes.