Taking The Hyperinflation Risk With A Grain Of Salt?

``But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a ‘crack-up boom’ and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis." Ludwig von Mises in Interventionism: An Economic Analysis (p. 40)

Recently a link from last year’s TV interview of an eminent Cassandra, Mr. Gerald Celente, was posted at a social community network. Mr. Celente prophesized, not only of the “greatest” depression for the US, but of an environment marked by “revolution, food riots and tax rebellions”. Such development would bring about America’s “ceasing to be a developed nation” or essentially would translate to the country’s defacement as the world’s premier economic and financial power by 2012.

The accompanying the link had a note from the link author who questioned about how such an interview was “allowed” to be aired and what was this “doomsday” scenario all about.

We have long known about such extreme views (which should include James Kunstler-another Cassandra who believes of the real risks of a world at war arising from the unsustainable energy infrastructure from which the world currently operates and survives on), but has refrained from discussing it because of our “optimistic” predilections. Nonetheless, on the account of the “ripeness” of the occasion, this article will attempt to elaborate on the risks of such concerns.

Cognitive Biases and Censorship

As Julius Caesar remarked, ``People readily believe what they want to believe."

Obviously the late great Caesar alluded to people’s proclivity to act in social norms. And as social norms, popular views are often dressed up as lies which are repeated so often and digested as the reality or the truth, especially when buttressed or promulgated by figures considered as “authorities” in their fields or from the bureaucracy. Yet, most people only look at the superficial and intuitive side of any issues without belaboring on the tacit intents proposed by the advocates or of its unseen consequences.

Bluntly put, people are basically faddish and tend to look for grounds to confirm or substantiate their beliefs or are predisposed to absorb only the quality of information which they believe suits their palate. In behavioral finance, this is known as the CONFIRMATION bias or “the tendency to search for or interpret information in a way that confirms one's preconceptions” (wikipedia.org).

Applied to social trends, the acceptance of mainstream views (or seeking “comfort of the crowds”) or conformity represents as the more psychologically rewarding route than in defiance of them (regardless of the validity of the observations or theories).

For instance, the mainstream has repeatedly mocked, jeered or scorned at those who warned of the illusions of the wealth derived from unsustainable debt driven boom. Contrarians were deemed or labeled as “killjoys” or “partypoopers”. Eventually as the boom turned into a bust, losses turned into reality, and the “IN” thing or “THE” social trend is now to be a pessimist.

The contrarians, who were previously the “outcasts”, have been exonerated and have now commanded sufficient clout of an audience enough to be embraced by mainstream media. In short, since media’s role is to sell what is mostly in popular demand, the Celente interview represents as pessimism becoming an entrenched social trend.

And that’s why gloomy videos have found their way into social networks. And that’s why too, we should expect more of these until perhaps we have reached the stage of “revulsion” or “capitulation” for one to reckon the US as in a “bottoming” phase.

Remember, throngs of “finance and banking” professionals or organizations (such as banking institutions, insurance and hedge funds) have not been eluded from such basic human frailties of “crowd” following or falling prey to “confirmation bias”. As the present bust or crisis clearly shows, technical expertise or even quant algorithmic models can’t substitute for the process ability driven emotional intelligence which is more a required attribute in the analysis of the market’s risk-reward tradeoff. As we have discussed in many occasions, most of them have even fallen prey to Ponzi schemes as the Bernard Madoff or the Robert Allan Stanford case.

I won’t suggest anyone to disregard extreme views especially if the Cassandra sports a good track record in projecting major trends and this includes Mr. Gerald Celente.

Yet, a remarkable past may not necessarily extrapolate to another successful forecast. Since any mortal can only wield so much of limited information in a highly complex world, like anyone else, his views aren’t infallible. The point is to understand the merits of his argument than simply to dismiss it out of the Pollyannaism or blind optimism or from the outrageous belief of a messianic salvation from the present leadership or fanatical subscription to the economic school of orthodoxy.

Worst of all, is the implication for the socialistic bent of “censorship” by those intolerant of diametric or contradictory perspectives. One should ask: would it be better for us to adhere to fantasies masquerading as truth and eventually suffer? Or would reading an expository “falsifiable” mind be a better alternative as to recognize potential risks and prepare for them?

The Fundamental Problem: UNSUSTAINABLE DEBT

So what seems to ail the US economy so much as to risk turning its political economy into an emerging market?

This from Bloomberg, ``Bill Gross, co-chief investment officer of Pacific Investment Management Co., said the Federal Reserve’s purchases of Treasuries and mortgage securities won’t be enough to awaken the economy.

``We need more than that,” Gross said today in a Bloomberg Television interview from Pimco’s headquarters in Newport Beach, California. The Fed’s balance sheet “will probably have to grow to about $5 trillion or $6 trillion,” he said.”

The Fed’s balance sheet is roughly around $2 trillion with an additional $1 trillion more for the QE as it gets implemented. This brings the Fed’s balance sheet around $3 trillion. Mr. Gross has asked to double the size.

Now this from Jeremy Grantham an erstwhile ferocious stock market bear whom has turned into a raging bull recently said, ``To be successful we need to halve the level of debt. Somewhere between $10 trillion and $15 trillion will have to disappear."

So how do we do that? ``Grantham sees three ways, according to the Wall Street Journal, “to restore the balance between private debt levels and asset values.” That is by “1) Drastically write down debt, 2) let the passage of time wear down debt levels, 3) “inflate the heck out of our debt” and reduce its real value.” (bold highlight mine)

In short, the fundamental problem comes with the government policy induced overdose of debt intake as shown in Figure 1.

Figure 1: American Institute for Economic Research: Total Debt by the US

AS you can see, the debt ratios for the US economy mostly held by the private sector have exploded beyond the nation’s paying capacity, according to the AIER, ``The debt-to-dollar ratio currently tops $3.50, more than double the ratio of 50 years ago.”

Given the unsustainable debt structure from which the US and the world economy has been built, the recent collapse in the financial markets (estimated at $50 trillion-ADB) and the subsequent meltdown in global trade, and investments (or deglobalization) has managed to reduce parts of such massive scale of imbalances.

But the adjustment process has a long way to go.

The US Federal Reserve’s Agency Problem

However instead of allowing for an orderly rebalancing of the US economy by permitting institutions that took upon the unnecessary burden of the speculative excess to fail or undergo bankruptcy proceedings, the US government has been pushing to revive the past Ponzi financing model by substituting the losses from these institutions with taxpayer money…to no avail so far.

And the Federal government’s heavy handed interventions in many significant parts of the economy and the prevention of price discovery has contributed to the prolonged nature of recovery and has added uncertainties in the marketplace, by distorting market price signals and altering the incentives for market participants which has been skewed towards prospective actions of the government.

The recent fracas of over the bonuses is a case in point.

Take this article from the New York Times,

``As public outrage swells over the rapidly growing cost of bailing out financial institutions, the Obama administration and lawmakers are attaching more and more strings to rescue funds.

``The conditions are necessary to prevent Wall Street executives from paying lavish bonuses and buying corporate jets, some experts say, but others say the conditions go beyond protecting taxpayers and border on social engineering.

``Some bankers say the conditions have become so onerous that they want to return the bailout money.”

In other words, some banks have resisted availing of government bailouts because of the burdensome conditions imposed on them, which is not helping the situation at all. As we said earlier the incentives in trying to normalize bank operations are being contorted by minute by minute changes in government intervention. Investors look for stability in policy.

And how much of these government intervention has been affecting the banking industry? The same New York Time article admits…

``At the height of the savings and loan crisis in the 1980s and 1990s, Congress and regulators adopted new rules known as “prompt corrective action” that required the government to quickly close weak financial institutions if they could not raise money to absorb mounting losses.

``The rules were a response to a consensus that keeping weak institutions open longer, under an earlier practice known as forbearance, damaged healthy banks competing with the government-subsidized ones and ultimately destabilized the banking system. By shutting weakened institutions before their losses grew, prompt corrective action was also seen as less costly to taxpayers and the deposit insurance fund.

``Administration officials say that some of the banks at issue today are simply too large to be seized by the government, making comparisons to the savings and loan crisis less meaningful.”

But this is exactly what has been happening today, damaged banks have been competing with government subsidized ones at the expense of the industry and the economy. And much worst, those subsidized are banks have been TOO LARGE to be seized by government, which is why the accrued losses have led to a creeping nationalization. See figure 2…

Figure 2: BCA Research: Top 20 Banks

According to the BCA Research, ``The Chairman of the FDIC, Sheila Bair, contends that U.S. banks are well capitalized. However, she must be referring to the multitude of small banks, rather than large banks (i.e. there are many small banks that are well capitalized). The top 20 financial institutions have a thin capital cushion of only 3.4% (defined as tangible capital/total assets). In other words, it would require a writedown of total assets of only 3%-4% to wipe out all tangible capital for the largest banks. The FDIC data on the broader banking universe confirms that the capital cushion of large banks is much less than their smaller counterparts. Moreover, toxic assets are concentrated in large financial institutions.”

As you can see the risk profile of the top 20 banks have largely been because of the Level 3 assets which simply means ``Assets whose fair value cannot be determined by using observable measures, such as market prices or models.” (investopedia.com)

And what are the possible Level 3 assets? Perhaps figure 3 may provide the explanation…

Figure 3: OCC: 3^rd quarter Report: The Average Credit Exposure to Risk Based Capital

The average credit exposure to risk based capital in percentage is 317.4% for the 5 largest banks as of the third quarter of 2008! The pecking order of the riskiest banks: HSBC (664.2%), JP Morgan (400.2%), Citibank (259.5%), Bank of America (177.6%) and Wachovia (85.2%).

Moreover, consider that 96.9% of the total derivatives of the US commercial banking system is held by the just these 5 institutions according to the Comptroller of the Currency Administrator of National Banks!

In other words, of the 8,451 banks and savings institutions insured by the FDIC, or of the 7,203 commercial banks operating in US (Plunkett Research), 5 banks have essentially held hostage the entire industry, if not the economy!!!

Free market anyone?

Why is this?

Could it be because the US Federal Reserve is a privately held corporation, bestowed with a monopolistic power to create and manage the country’s legal tender, whose complex web of owners could be some of the same institutions that are presently being rescued?

According to James Quinn, ``Most Americans believe that the Federal Reserve is part of the government. They are wrong. It is a privately held corporation owned by stockholders. The Federal Reserve System is owned by the largest banks in the United States. There are Class A,B, and C shareholders. The owner banks and their shares in the Federal Reserve are a secret.”

As Henry Ford once wrote, ``It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

So could Mr. Celente’s dire projections have been partly premised from such agency problem or conflict of interest issues that would perhaps gain national consciousness over the coming years?

Regulatory Arbitrage + Regulatory Capture=Market Distortion

In addition, considering the US banking industry have been a heavily regulated industry, why have the core institutions, which originally attempted to disperse risk by introducing financial innovations, ended up with the “risk concentrations”?

This from Gillian Tett of the Financial Times, ``After all, during the past decade, the theory behind modern financial innovation was that it was spreading credit risk round the system instead of just leaving it concentrated on the balance sheets of banks.

``But the AIG list shows what the fatal flaw in that rhetoric was. On paper, banks ranging from Deutsche Bank to Société Générale to Merrill Lynch have been shedding credit risks on mortgage loans, and much else.

``Unfortunately, most of those banks have been shedding risks in almost the same way – namely by dumping large chunks on to AIG. Or, to put it another way, what AIG has essentially been doing in the past decade is writing the same type of insurance contract, over and over again, for almost every other player on the street.

``Far from promoting “dispersion” or “diversification”, innovation has ended up producing concentrations of risk, plagued with deadly correlations, too. Hence AIG’s inability to honour its insurance deals to the rest of the financial system, until it was bailed out by US taxpayers.”

Institutions as the AIG Financial Product (AIGFP) circumvented or went around regulatory loop holes to ante up on leverage and increase risk exposure in order to generate additional returns. Arnold Kling of Econolib.org quotes Houman Shadab, ``AIGFP was treated as a bank for its counterparties' risk-weighting purposes, but AIGFP was not regulated as a bank (or an insurance company) for its own CDS credit exposures (had it been, it would've had to set aside capital/reserves).”

In short, this hasn’t been a free market problem as some anti-market pundits paint them to be, but one of regulators conspiring with Wall Street participants to “game the system”.

For Wall Street it had been one of regulatory arbitrage (profiting from legal loopholes) but for the regulators it has been one of regulatory capture (situations where government acts in favor of the interest groups of which it is regulating).

As we have previously quoted Robert Arvanitis Risk Finance Advisers, in Seeking Beta: Interview with Robert Arvanitis, ``Being mortal, the bureaucrats desire to avoid pain is as dear to them as the desire by their counterparts in private industry to seek gain. And it is far more profitable to game the rules, for example, than to enforce them. And any system can be gamed.”

To quote Mr. Celente, ``It was Fed finagling, Washington deregulation and Wall Street’s compulsive gambling that created the crisis.”

Yet people have been distracted by the most recent BONUS issue, which simply implies that Americans have been looking for an issue to vent their wrath on (a misguided one though).

To consider, the enormous backlash over the $168 Million is a pittance over the money spent by US taxpayers ($178 BILLION) to sustain AIG counterparties as Goldman Sachs ($12.9 billion), Merrill Lynch ($6.8 billion), Bank of America ($5.2 billion), Citigroup ($2.3 billion) and Wachovia ($1.5 billion). Big foreign banks also received large sums from the rescue, including Société Générale of France and Deutsche Bank of Germany, which each received nearly $12 billion; Barclays of Britain ($8.5 billion); and UBS of Switzerland ($5 billion) and some 20 largest states (New York Times).

Yet as the Federal government expands its presence into industries these governance conflicts, e.g. as in the proposed bonuses of Freddie Mac and Fannie Mae, will certainly serve or operate as a major disincentive that would impact diverse institutions from meeting desired goals, which eventually results to an increased overall inefficiency in the system.

Again, with big government comes the inevitable ramifications: resource allocation inefficiencies or wasteful spending, incompetence, corruption, dispensation of favors to political constituents, conflicts of interests, governance conflicts which may lead to organizational demoralization and reduced productivity, bureaucratic rigidities (tendency to be too technical or legal), crowding out of private sector investments, massive distortion of incentives, a vague pricing system which increased uncertainties and other impediments –all of which obstructs on the US’s economy wellbeing.

Obviously, governance policies based on populism will do harm than good.

Signs of Resurgent Inflation?

Now that the US policymakers appear to be losing out of ammunition, they have begun to openly resort to the crudest of all central banking policy approach-money printing.

As mentioned above our money experts have recommended “inflating away debts levels” which means reducing the currency’s purchasing power (or raise price levels) in order to diminish real debt levels, from which our policymakers have obliged.

According to the Economist, ``Mr Bernanke showed his own will on Wednesday March 18th, when the Fed’s policy panel said it would purchase $300 billion in Treasury debt, mostly maturing in two to ten years, starting next week. It will also boost its purchases of mortgage-backed securities to a total of $1.25 trillion from a previously announced $500 billion, and its purchases of debt issued by Fannie Mae and Freddie Mac, the mortgage agencies, to a total of $200 billion from $100 billion.”

But since the US is privileged to have her debts denominated on her own currency, when she can’t payback her obligations, instead of defaulting, she may resort to flooding the economy with money enough so as to reduce the value of liabilities at the expense of her existing creditors-i.e. local savers and foreign creditors.

Of course, these will temporarily benefit those who own financial assets, because “money out of thin air” will likely be absorbed by the institutions who will sell their portfolio of treasuries or mortgages to the US government. Eventually, the proceeds can be expected to be recycled into the financial markets. Although the policymakers are hoping that a revival in the capital markets will fire up the credit process by reigniting the speculative “animal” spirits.

Unfortunately the “moneyness” of Wall Street instruments (e.g. structured products, MBS, ABS etc…) has been lost and is unlikely to be revived anytime soon.

But on the other hand, any flow of credit to parts of the world where credit conditions have remained unimpaired is likely to fuel a surge in asset prices first, then consumer prices, next. Apparently such dynamics appear to have emerged, see Figure 4.

Figure 4: A Return of Inflation?

Oil has sprinted beyond the $50 mark and this has been accompanied by Dr. Copper (upper window) and even some industrial metals. Oil’s rapid rise may suggest of a rising wedge or a forthcoming decline. Anyway, the surge in key commodity prices comes alongside with a rally in Dow Jones Asia (ex-Japan) seen at the pane below the main window and Emerging Markets index (lowest pane), as the US dollar index suffered its 3^rd largest one day decline.

The unfortunate part for the US is that a resurgent inflation will likely induce more sufferings to the middle and lower class and possibly worsen the political scenario by provoking a “class” conflict.

When price levels of consumer goods are raised at a time when unemployment is high or possibly even growing, where real income levels are also diminishing, and where corporations faced with a struggling environment will be faced with higher costs of operations, these combined could redound as the ingredients for a large scale hunger triggered political malcontent.

Moreover, inflation, as seen through higher cost of money and shrinking purchasing power, is likely to wreak havoc on the cash flows of those attempting repair their overleveraged balance sheet by increasing savings and paying off debts.

And the orthodoxy is putting so much hope that the authorities will know the right time when to close the barn doors before the horses run astray, a hope that seems unfounded to begin with as the authorities have failed to recognize the crisis in advance or limit the scale of its impact.

Again from Mr. Celente, ``What "steps?" The Bernanke Two-Step? Adjust interest rates or print more money? Neither stopped the credit crisis from worsening, the real estate market from tanking or the stock markets from crashing.”

Figure 5: yardeni.com: Net Foreign Selling Are These Signs On The Wall?

The United States’ Treasury International Capital flow have registered a significant net foreign selling (excluding US T-bills) last January see figure 5, although as an important reminder-one month does not a trend make.

While others have argued that such fall in capital flows may have been a function of reduced growth of foreign exchange surpluses, the growing restiveness by global policymakers over the US dollar, could be another incipient dynamic at work.

Over the past weeks we heard resonating voices suggesting a move away from the US dollar as the world’s reserve currency- from Joseph Stiglitz, a UN Panel and Russia at the G20, which was reportedly backed by China, India, South Africa and South Korea.

While there has been no unanimity on the possible replacement, most have recommended the IMF’s Special Drawing Rights or the old European Currency Unit Ecu, albeit both of which have been “combinations of currencies, weighted to a constituent's economic clout, which can be valued against other currencies and against those inside the basket” (Reuters).

Importantly, a new currency can’t takeoff without OECD participation which includes the US. Thus, such cacophony appears to be more symbolic- an implied protestation over the risks of imprudent government spending.

Take The Risks of Hyperinflation With A Grain of Salt At Your Peril

Finally, we can’t discount the risks from the ravages from hyperinflation.

As we brought up in 2009: The Year of Surprises?, a tip over from deflation expectations towards a ramping up of inflation will be a tough act to manage. If government starts to tighten as inflation rises, the ensuing effect will be a sharp fall in prices from which government will need to restoke the inflation engine again.

Again to quote Murray Rothbard in Mystery of Banking,

``But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to “catch up” to prices, then the country is off to the races. Money and prices will follow each other upward in an ever-accelerating spiral, until finally prices “run away,” doing something like tripling every hour. Chaos ensues, for now the psychology of the public is not merely inflationary, but hyperinflationary, and Phase III’s runaway psychology is as follows: “The value of money is disappearing even as I sit here and contemplate it. I must get rid of money right away, and buy anything, it matters not what, so long as it isn’t money.”

In essence Mr. Celente’s Tax Revolt, Food Riots, Revolution and the return to a banana republic or the state of an emerging market is nothing more than a function of hyperinflation. (Of course, we’re not suggesting that this will surely happen, but what we are saying is that the present actions of the US policymakers have been increasing the odds for such risks to occur. America’s hope depends on the world to absorb those surplus dollars enough to pull the US out of its debt trap.)

So for those hoping against hope that the present administration will deliver the economy’s much needed elixir in defiance of the fundamental function of the natural laws of economics, good luck to you. No economy has survived by merely the government running on the printing press, ask Dr. Gideon Gono.

One must be reminded of US 33^rd President Harry S. Truman’s noteworthy comment, ``It's a recession when your neighbor loses his job; it's a depression when you lose your own.”

Take this risk with a grain of salt until such scenario becomes a personal depression.

Has Meralco’s Takeover Been A Good Sign?

``The main political problem is how to prevent the rulers from becoming despots and enslaving the citizenry.”-Ludwig von Mises, The Theory of Credit and Money

The Phisix defied the world’s seemingly buoyant environment with a 1.2% decline over the week. This comes amidst an early week tumble of 4.66% which saw an extension of the PLDT-Meralco led carnage of the Phisix from last week.

As earlier noted, the combined PLDT-Meralco market cap weighting was about 40% before Monday but fell to 34% at the end of this week. We described the politically driven selling as a foreign investor strike in King Kong Versus Godzilla at the PSE; Where Politics Trumps Markets.

News accounts say that the Lopezes giving up on Meralco had been a winning proposition for the former, we argue that it isn’t.

If the Lopez sellout had been out of voluntary efforts then I would probably agree. Unfortunately, the repeated harassment by the administration on the Lopezes could have been a big factor on their decision to give up their reign of Meralco.

In short, Meralco served as a prized trophy for the political football, where allies of the present administration appeared to have successfully outmaneuvered the besieged Lopezes.

This is a bad precedent.

If the management of Meralco has to be under the blessing of those seated in Malacañang then we should expect structural prices of electricity to go up in the future at the expense of the domestic economy.

Instead of looking for profitability, efficiency and productivity, the management direction of Meralco will be highly political in nature, aimed at gratifying to the whims of those in power.

In other words, the management of Meralco will function as the unofficial de facto extension of the Office of the President.

This implies many costs:

Social Political costs-if the Philippine Presidency decides to lower rates for the purpose of scoring political points on the public, Meralco as a private institution will suffer revenue losses from such subsidies.

Cost of bureaucracy- instead of aiming for professionalizing the institution, Meralco’s organization will likely be stuffed with political appointees which in effect would raise the cost of operations.

As an aside, it risks productivity loses and equally raises the risks of corporate corruption.

Political Costs-the cost of political programs that Malacañang may not want to directly carry may be passed on to Meralco, again raising Meralco’s cost of operations.

Nonetheless accrued losses of Meralco will translate to higher electricity prices as they will be eventually passed on to its consumers. Remember the fate of Napocor?

And high prices will in effect extrapolate to the loss of competitiveness for enterprises covered by the Meralco franchise which means less investments equals less job opportunities equals more poverty.

Were the management of Meralco incur the ire of the Malacañang for one reason or another in the future, we could expect another round of takeover from parties favorable to the palace.

This again sacrifices the stability of the organization which incidentally is a monopoly for Metro Manila’s electricity distribution. And sacrificing stability may raise the cost of obtaining credit or financing cost.

Of course financing cost isn’t just about the organizational stability but likewise the ability to pay which also means bottom line pressures likewise apply to higher credit risks for the company which in turn may raise the cost of Meralco’s operations.

It never seems to occur to most people, not even to our so-called analysts that government intrusion into the private sector has far reaching unintended consequences at a severe cost to Meralco as a company and importantly to the economy.

We should thank our lucky stars that the political costs from today’s political football may be overwhelmed by the surging costs structures from collective government intervention abroad.

Global Property Prices: Still Depressed

The Economist.com recently published market indicators of global property prices. Their conclusion: global property prices remain depressed.

Based on global housing prices, according to the Economist (bold highlight mine),

``WHEN we last looked at global house prices, only six of the countries we surveyed had recorded year-on-year declines. Three months later that figure has risen to 16. In America some saw signs of a bottom in a report on March 17th showing sharp rises in housebuilding starts and permits in February, after months of decline. Others, however, just saw a bigger stack of apartments for sale which no one will be very keen to buy. Fear has now replaced frenzy, and house prices may overshoot on the way down. A recent report by Numis Securities estimated that British house prices could fall by a further 40-55%, saddling millions with properties worth less than their mortgage debt. Long was the uphill march, long will be the downhill descent."

Based on office rents, again from the Economist, ``Office rents in London, measured in dollars, fell by 41% in the year to the fourth quarter of 2008, according to CB Richard Ellis, a property firm. Around half of that drop reflects lower local charges for office space. The rest was down to a fall in sterling against the dollar. Almost all of Sydney’s 25% decline in rents was because of a weaker Australian dollar. Rents in other rich cities, such as Frankfurt, New York and Paris, dropped by less. These places are already cheaper than Moscow. The rise in Tokyo rents makes it the most expensive city in the survey. All and more of the rise in charges was because of the yen’s appreciation. Rents in Beijing were barely changed in yuan, but cost 8% more than a year earlier in dollars."(bold emphasis mine)

Amazing Pictures: Undersea Volcano Eruptions

Magnificent photographs, which captures the explosion of undersea volcano off the coast of Tonga in the South Pacific Ocean, from "The Big Picture" at the Boston.com.

A sample of below...

Check out the rest here.

Cartoon of the Day: Pass The Hat- "For The Next Bailout"

Kal of the Economist makes another germane depiction of the current political trend in the US...

To further validate on Kal's theme, this from last night's the social liberal New York Times,

`` President Obama’s budget proposals, if carried out, would produce a staggering $9.3 trillion in total deficits over the next decade, much more than the White House has predicted, the Congressional Budget Office said on Friday.

``The office’s estimates of deficits in the fiscal years 2010 through 2019 “exceed those anticipated by the administration by $2.3 trillion,” the budget office said in a report.

``The deficits under the Obama plan would be $4.9 trillion more than the deficits that would be projected if there were no changes in current laws and policies — what the nonpartisan budget office calls its baseline assumption."

The Moral: More Bailouts=more wasteful spending (e.g. AIG), more corruption, more mistakes, more dissatisfaction and growing risks of political upheaval.

Quantitative Easing Basics

The Financial Times has an audio explanation of the basics of Quantitative Easing (press on image or link to redirect to the FT.com)

$9.9 Trillion and Counting, Accelerating the Mises Moment

US government's bailout tab has now risen to $9.9 trillion as tabulated by the New York Times.

And as we have said, more of these would be coming until everything becomes unsustainable.

From the New York Times, ``The Fed said it would purchase an additional $750 billion worth of government-guaranteed mortgage-backed securities, on top of the $500 billion that it is currently in the process of buying. In addition, the Fed said it would buy up to $300 billion worth of longer-term Treasury securities over the next six months. That would tend to push down longer-term interest rates on loans of all types."

Gonoism lives!

A reminder from the prescient words from Ludwig von Mises in Human Action, ``There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

The Mises Moment seems to be gathering steam.

Jay Leno's Pseudo Altruism?

Media is inherently predisposed to preach about "collectivism" (particularly in the Philippines).

For us, the implicit motivation or the reason for this is about saleability.

People buy mostly on emotions. And to generate more audience means to connect with people's emotions. And collectivist themes of 'equality', 'fairness', 'justice', 'charity' etc... greatly appeals to emotions. And more audiences translate to more ad revenues. Audience plus ad revenues equals the life of the show.

Thus, media content-whether it is news, soap opera, talk shows, movie or reality shows-are almost always scripted or produced to appeal to the emotions.

Occasionally some of these pseudo acts of altruism are unmasked, especially when they "diss" the markets.

An example is from a recent amusing incident where the popular US comedian Jay Leno brings his show to Michigan aimed at helping autoworkers and those displaced by today's recession by giving away free tickets.

Unexpected to Mr. Leno, one of the recipient attempts to sell the "donated" ticket at ebay. The donor discovers the attempt and vehemently objects!

From Mr. Leno, ``Here is something that annoys me. I look on eBay today and I see four tickets to my show for sale. ... You're out of your mind to pay $800 to see me. ... I would like to ask the people on eBay to take the tickets down. There is nothing for sale here.”

Picture from insidesocal.com

Harvard's Greg Mankiw on his blog wrote a caustic but deserving remark (bold highlights mine)...

``So I wonder: If a person down on his luck prefers the cash to the opportunity to watch Leno live, why would Leno object? Is it altruism that is really motivating Leno here? Is he really sure that the unemployed person in Detroit would be better off with an evening of laughs than $800 in his pocket? Or does Leno want to play to a live audience of unemployed workers so he will seem altruistic to his television audience?"

Ouch!

Again Mr. Mankiw, ``Absent externalities, markets improve the allocation of resources. Both the buyer and the seller of the ticket must be better off: otherwise they would not engage in the transaction. The only significant negative externality that I can see here falls on Mr Leno himself. In other words, Leno's objection to the eBay sale is an understandable and fundamentally self-interested act in that the sale impedes his abilty to appear selfless."

This reminds us of a quote from D.W. McKenzie who, in an article at the Misis.org, wrote,``Altruism alone does not harmonize social interaction. On the contrary, a world of altruistic people could easily be more rancorous than the world we know. It is not enough for people to want to promote the interests of others. We must also comprehend the interests of others, and this is impossible."

Showmanship-yes, comprehend the interests of others-no.

So much for altruism.

Global Unemployment or Bread Lines

Global unemployment rates courtesy of Casey Reseach

According to the Casey Research Team,``One estimate warns that job losses during this recession could top 50 million worldwide by the end of 2009."

The Philippines registered a 7.7% jobless rate in January, up from 6.8% last October or about 2.9 million unemployed (IHT).

Heck, that includes me in the stat! I wonder where's my bailout?!

Creative Destruction: Reinventing Models and Forced Entrepeneurship

Every crisis leads to a transformation.

Industries affected by malinvestments or bubbles are destroyed while new enterprises emerges or innovative business paradigms takeover. That's why crisis can always be seen as windows of opportunities as previously discussed in Entrepreneurship During Recessions: Booming Industries, Recession Babies, Reasons to Start and 999 Business Ideas.

People will always toil to look for opportunities in order to survive. And one of the options would be to put up a business. Take for example this article from the New York Times which focuses on "forced" entrepreneurship today (bold highlight mine),

``Economists say that when the economy takes a dive, it is common for people to turn to their inner entrepreneur to try to make their own work. But they say that it takes months for that mentality to sink in, and that this is about the time in the economic cycle when it really starts to happen — when the formerly employed realize that traditional job searches are not working, and that they are running out of time and money.

``Mark V. Cannice, executive director of the entrepreneurship program at the University of San Francisco, calls the phenomenon “forced entrepreneurship.”

``“If there is a silver lining, the large-scale downsizing from major companies will release a lot of new entrepreneurial talent and ideas — scientists, engineers, business folks now looking to do other things,” Mr. Cannice said. “It’s a Darwinian unleashing of talent into the entrepreneurial ecosystem.”

``Even in prosperous times, entrepreneurs have a daunting failure rate. But those who succeed could play a big role in turning the economy around because tiny companies are actually big employers. In 2008, 3.8 million companies had fewer than 10 workers, and they employed 12.4 million people, or roughly 11 percent of the private sector work force, according to the Bureau of Labor Statistics.

``Economists say there are some peculiarities to this wave of downturn start-ups. Chiefly, the Internet has given people an extraordinary tool not just to market their ideas but also to find business partners and suppliers, and to do all kinds of functions on the cheap: keeping the books, interacting with customers, even turning a small idea into a big idea.

``The goal for many entrepreneurs nowadays is not to create a company that will someday make billions but to come up with an idea that will produce revenue quickly, said Jerome S. Engel, director for the center for entrepreneurship at the Berkeley Haas School of Business. Mr. Engel said many people will focus on serving immediate needs for individuals and businesses."

As a saying go, Necessity is the mother of innovation (invention).

And as we earlier mentioned, crisis also induces change in business models.

For instance, we see accelerating signs of transitioning from the old print "newspaper" media model to one of the "online" paradigm.

Again from the New York Times (bold highlight mine),

``The Seattle Post-Intelligencer will produce its last printed edition on Tuesday and become an Internet-only news source, the Hearst Corporation said on Monday, making it by far the largest American newspaper to take that leap.

``But The P-I, as it is called, will resemble a local Huffington Post more than a traditional newspaper, with a news staff of about 20 people rather than the 165 it had, and a site with mostly commentary, advice and links to other news sites, along with some original reporting.

``Other newspapers have closed and many more are threatened. But the transition to an all-digital product for The P-I will be especially closely watched in an industry that is fast losing revenue and is casting around for a new economic model.

``For one thing, the closing may end up putting greater pressure on the surviving and financially struggling Seattle Times, because of the end of a joint operating agreement between the two papers. It may even bring closer the day when Seattle has no local paper at all.

``And the way The P-I is changing might hint at a path for future newspaper closings. To some extent, in shifting its business model, it will enter a new realm of competition. It will compete not just with the print-and-ink Times, but also with an established local news Web site, Crosscut.com, a much smaller nonprofit organization that focuses on the Northwest. The move shows how some newspapers, in the future, may not vanish but move the battle from print to the digital arena."

And this appears to be a firming trend...

chart courtesy of Pew's State of the Media

Cable and online have drawn most of audience traffic at the 'expense' of traditional media.

According to Pew Research, ``Only two platforms clearly grew: the Internet, where the gains seemed more structural, and cable, where they were more event-specific."

In short, real time or "on demand" news or opinion is on the rise, or in the fitting words of the research company, ``People increasingly want the news they want when they want it".

Of course, aside from the shift in viewership traffic preference, the other very important trigger has been no less than the flow of revenues. Ad spending has essentially shifted to cable and online. Put differently, it is basically a "follow the money" dictum.

The dramatic surge in online viewership hasn't not translated to strong flows of ad spending, though. The Pew Research suggests an explanation- strong competition. ``Even while online ad spending grew about 14% through the first three quarters of the year, most of it benefited Google and other search providers. Revenue from the sale of banners and other display ads that news websites depend on increased just 4%, and estimates are that it declined by the fourth quarter. One reason: the infinitely expanding universe of blogs and websites has forced them to cut their rates to compete for advertisers. The cost to reach 1,000 viewers fell by half in 2008 alone, to an estimated average of 26 cents."

But not all countries are incurring a decline in print media as we pointed out in Global Posttraumatic Stress Disorder (PTSD): The After Lehman Syndrome. But that is a topic for another day.

Nonetheless the last word from Internet analyst Clay Shirky who is quoted by the Research Recap, ``That is what real revolutions are like. The old stuff gets broken faster than the new stuff is put in its place. The importance of any given experiment isn’t apparent at the moment it appears; big changes stall, small changes spread. Even the revolutionaries can’t predict what will happen. Agreements on all sides that core institutions must be protected are rendered meaningless by the very people doing the agreeing.”

Peter Schiff: Why the Meltdown Should Have Surprised No One

In a recent talk at the Austrian Scholar's Conference, Peter Schiff delivers a great exegesis of the present crisis and the possible ramifications from current government policies.

source: Mises Blog

King Kong Versus Godzilla at the PSE; Where Politics Trumps Markets

The seeming resilience of the Philippine equity assets melted away today, despite signs of recuperating global markets. This has been premised mostly on 2 issues; namely PLDT and Meralco which got crushed today, -11.66% and -14.59% respectively.

And because the two issues comprised about 34% (tel) and 4% (meralco) based the adjusted free floated market cap, the magnitude of decline sunk the Phisix (green line) by 4.66%, putting in jeopardy the 5 months of consolidation.

PLDT (yellow orange line) accounted for about 33% of today's trade while MER (black candle) represented a measly 2.8%.

On the other hand, today's net foreign selling registered 241 million pesos where TEL accounted for 90% of the entire foreign exodus.

In addition, what used to be a broad market rout, when faced with such index based collapse, wasn't evident today, despite the whopping 4.65% decline the PSE's market breadth had 24 advancers against 55 decliners.

Plainly stated, this clearly isn't a sign of the previous forcible selling dynamics seen last year, since only one issue accounted for the significant majority of the stampede selling.

It is clearly a sign of an investor strike- against recent management priorities.

So why the investor strike?

Because like San Miguel which overhauled its business model overnight, which turned out to be "partly" politically motivated [see Has San Miguel's Shifting Business Model Been Linked To The Philippine Presidential Elections? Lessons], the precipitate shift by PLDT's leadership to include Meralco in its business model appeared to have been executed out of political exigencies than by strategic business design.

Bluntly put, with PLDT serving as the white knight for the besieged Lopez managed Meralco, politics became the underlying priority of the top telco company at the expense of minority shareholders. Resource allocation by PLDT's management isn't being based on the best probable returns but on political whims for the benefit of the company's top brass.

courtesy of cinemastrikesback.com

As we wrote in Beware Of The Brewing Meralco Bubble!,

``If this floated story is anywhere near correct, then MER, which is a regulation instituted monopoly, whose prized possession is being bitterly contested by politically privileged groups signify an engagement between “crony capitalists” representative of the opposite side of the political fence.

``It’s like a King Kong versus Godzilla movie, where one monster eventually wins but the rest of the city is devastated."

With the Philippine presidential elections around the corner, we seem to witnessing some abrupt changes in the corporate directions of major publicly listed companies. This implies of strong politically motivated actuations instead of profit oriented shareholder friendly actions. Hence such investor strike-especially from foreigners.

Besides, all these reeks of the Keynesian rent seeking crony capitalist model which the Philippine political economic structure has long operated on.

That's why King Kong and Godzilla continues to hold sway over the domestic economic structures (politicians and the elites pick the winners and losers of the society).

And that's also why their "battle for turf" translates to "externality costs"-devastation of the environment, the market or the economic wellbeing of the Philippine society.

Profit From Short Term Dividend Plays

"The margin of safety is the central concept of investment. A true margin of safety is one that can be demonstrated by figures, by persuasive reasoning and by reference to a body of actual experience". Ben Graham

The Phisix’s 3.34% decline this week contravened the surge in global equity markets. This was fundamentally a function of the collapse in the prices of Meralco (-26.59%) and from Philippine Long Distance Telephone (-6.33%). Combined, the free floated adjusted market cap comprised about 40% of the entire index last week, and from this Friday’s close, this has now declined to about 37%.

Meralco’s unraveled its formative bubble the way we hoped it would [see Beware Of The Brewing Meralco Bubble!], and has spared the Phisix of the menace of a full blown bubble.

Meanwhile, PLDT’s decline was basically a function of the company’s dividend ex-date, where share prices adjusted to its dividend yields.

The Case For Dividend Plays

And dividend yields in today’s environment presents us with short term opportunities to dabble with in an increasingly “cash hostile, risk friendly” environment.

So instead of technical or chart reasons to go into the market, I will provide you with fundamental reasons.

Since it is the annual stockholder season, this likewise implies of the “dividend” season.

And corporate financial statements, especially by the heavyweight market cap issues or the “blue chips”, usually reflect on the conditions of the domestic economy.

Despite the unmatched deterioration in the economy as manifested in many of the corporate fundamentals by major public listed companies, even in the face of a steep decline in share prices, many companies will probably retain their previous scale of dividend payouts, which implies select companies with very impressive yields of more than 10%.

In short, depressed share prices with unchanged dividends will likely bring about outsized dividend yields! And this may prompt for a short bout of “yield chasing” by market participants after they are declared by the respective company.

Of course, the optimistic frame here is “unchanged”, because for the mainstream, a global recession prompted downshifting of the domestic economy should also account for a downside adjustment in most of the financial statements of the publicly listed firms.

While we agree that the economy could further weaken as a belated effect from the collapse of global trade last year and or in response to big increases in unemployment levels overseas, we are doubtful if the crash in share prices last year will equally be reflected on the performance of the corporate world.

Besides, our short term dividend play doesn’t consider the future but is a bet on last year’s performance.

On the other hand, what if instead of reduced dividends, a company, because of its strong showing last year in spite of the morose outlook, decides to hike its payout? We’ll make a guess; we get a catalyst for a short term run.

Nevertheless, if we are right about the Phisix drifting in a seeming “bottom formation” phase of the market cycle, then dividends can thereby represent as a “margin of safety” against risks of future price declines-because dividends represent as a value added factor for stock investments-can partially offset cyclical paper losses.

So from a short term perspective dividends can operate as a catalyst for a “short-term” run, and from a medium-long term horizon, dividends can be a cushion against further price decline pressures-our margin of safety-operating under today’s presumptive bottom phase.

Yet unlike the conventional market agents who react only after a dividend has been declared, the key to the game is in the anticipation of dividends. Of course, having a network of insiders could help a big deal.

So if we go by the premise of the short term “play” basis, we should start by looking at the company’s previous payout record and by vetting on its most recent financial statements, as we attempt to establish the speculative premise of whether the company will retain or even raise dividends. From here, we buy the target company before it announces its dividends.

And when the company announces and if they fall in line with our expectations, then we can expect the share prices to possibly surge in order to reflect mostly the rate of dividends which should adjust accordingly on the ex-date.

The dividend play means that we can “advance” the dividend by taking profit prior to the ex-date or as the price target reflective of the dividend level is met or wait for the dividend payout and hope for additional capital gains from the general market’s momentum swings.

The Risks And Recent Examples

Of course, one problem here would be the “timing” of the announcement of the payout. An early entry may reduce or if, fortunate enough, expand the scope of gains (see below examples of PLTL and PSE).

Another problem could be based upon wrong assumptions where the scale of the payout won’t occur.

Faced with such risk factors, however, if our assessment of today’s overall risk environment is anywhere accurate, then even wrong residual risk specific assumptions are less likely to equate to a disastrous portfolio.

For the many reasons cited above, the present environment, at worst may accommodate for a gracious exit with very minimal losses or even a breakeven. At best, if fortuitous enough, our exit might be accompanied by moderate capital gains.

In other words, the dividend play offers a far greater magnitude of gains than the degree of possible expected losses, basically from the premise of the margin of safety based on huge yields.

Over the past weeks, we have seen some of these dynamics at play. Here are some examples…

Figure 4: PLDT: Dividend dynamics

PLDT made its declaration of P 60/ share (special) and P 70/ share (regular) dividend last March 3^rd for a combined P 130/share. At the close of March 2^nd the company’s share price was at Php 2,175 or equivalent to a dividend yield of 6%.

The day from the announcement (blue arrow), the PSE’s largest company’s share prices rose to Php 2,310 basically manifesting the yield of the dividend. And on the ex-date (red arrow), share prices retreated beyond the price level. This sharp decline, however, appears to account for as an overreaction, as in the case of the PSE (below).

Figure 5: PLTL: Same Dividend Dynamics

Pilipino Telephone basically had the same dynamics with its parent PLDT.

The company declared a .52 cents dividend last March 2^nd where its share prices closed at Php 6.8 (blue arrow) or a yield of 7.6%. But share prices even rose beyond the rate of dividend yield but eventually fell back (even below the level from which the announcement was made) on the ex-date (red arrow).

But unlike PLDT, the company surged on 8.8% on Friday for reasons beyond the dividend play. PLTL’s experience shows that dividends can even compliment capital gains under today’s environment.

Figure 6: Philippine Stock Exchange: Dividend Play

As a last example, we see also the same dynamics with the Philippine Stock Exchange .

The non-banking monopoly finance company announced its dividend on February 25^th, which consisted of Php 3.65/share (special) and Php 4.35 (regular) or a total of Php 8/share. The share price on the day of the announcement (blue arrow) was at Php 129 for an equivalent 6.2% dividend yield.

Based on the said yield, the PSE should have climbed up to around to Php 137 per share. But it zoomed all the way to Php 147 a day prior to the ex-date.

While the share prices collapsed on the ex-date (similar to PLDT, red arrow), it quickly bounced back and was last traded at Php 138/share. This implies dividend plus capital gains from the original Php 129 level.

Finally, it is important point out that despite the sharp losses in share prices and a gloomy environment, two of the three issues mentioned above gave out special dividends, namely PSE and PLDT. In addition, while the overall dividends from the PSE (Php 10 per share adjusted on the 100% stock dividend) and TEL (Php 194- but may offer more at the second half of 2009) have been lower from last year, PLTL raised its dividend from .48 to .52 cents per share. Moreover, these issues dealt with less than 10% dividend yields.

Since it is the start of the dividend season, some issues seem as great opportunities from which we may be able to profit from based on this unorthodox tactical approach. If you are interested you can check with your broker if not you can write me by email (benson_te@gmail.com). But, except for clients, this won’t come for free.