Warren Buffett’s Greenback Effect Weighs On Global Financial Markets

``If it seems too good to be true, it probably is. Always look at how much the other guy is making when he is trying to sell you something. Stay away from leverage.” Warren Buffett, Three Rules for Average Investors

Hardly has the ink dried from the issues we dealt with last week when events unfolded almost exactly as anticipated, albeit in a fusion [see Will China’s Stock Market Correction Spread Globally?]

US Dollar Leads The Markets

Here is a summary of what we wrote:

1) We expected that China’s overextended markets to have some ripple or leash effect on global stock markets and the commodities markets.

2) The correction in the China’s markets would possibly trigger a correlation trade-where the US dollar would rise in conjunction with falling markets.

3) We also noted of a contingent provision-our suspicion that the US dollar’s rise wouldn’t find firm legs to stand on, ``if the US dollar fails to rally while global stocks weaken, then any correction, thus, will likely be mild and short.”

True enough during the early part of the week, global markets crumbled resonating China’s rapid fall. This initially prompted for a short rise in the US dollar index.

However, the US dollar index failed to maintain its bullish composure (can’t get to cross the 50-day moving averages) and eventually faltered steeply going into the close of the week.

Figure 1: Stockcharts.com: USD Dollar Index Leads The Markets

The result-global markets, especially in the US and Europe, came back with a vengeance. (see figure 1)

On the other hand, China’s market (SSEC down 2.83% week on week) appears to have hit our defined bottom range and has fiercely bounced back, while the commodities market caught fire- Oil (WTIC) sped back and drifts at its resistance levels!

And again we see some technical pictures failing to keep up with evolving market events.

All of these hyper volatile actions in just a span of one week! Amazing.

And when the US dollar leads the financial asset markets, it is no less than a symptom of inflation driving markets today.

Warren Buffett Warns On The Greenback Effect

Even the sage of Omaha Mr. Warren Buffett acknowledges the growing risk of inflation as the “greenback effect or greenback emissions”. Last week in the New York Times he wrote

(all bold highlights mine)

``Because of this gigantic deficit, our country’s “net debt” (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent. Admittedly, other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to G.D.P. at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out.

``An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually — and in combination.

``The current account deficit — dollars that we force-feed to the rest of the world and that must then be invested — will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients — China leads the list — to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.

``Then take the second element of the scenario — borrowing from our own citizens. Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

``Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington’s printing presses will need to work overtime.

``Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”

Here Mr Buffett makes an elementary calculation. I have to admit my admiration for Mr. Buffett’s ability to explain or relate circumstances in very simple “layman connecting” terms.

Essentially, US savers “borrowing from our own citizens” ($500 billion) + Foreign surpluses “borrowing from foreigners” ($400 billion)= $900 billion. US debt initially estimated at $1.8 trillion, which has been scaled down to $1.58 trillion equals a deficit of still at least $680 billion-that would have to be financed out of “a roundabout process, printing money” or central bank money from thin air!

The US treasury is slated to sell $197 billion next week (CNBC). This means that the US sovereign bond markets will likely be tested anew and the US dollar index will likely remain under siege or under pressure.

Analyzing Inflation From A Political Dimension

While many have been saying that because of the deflationary pressures in bubble stricken economies inflation won’t take hold soon, for sundry mainstream reasons of money velocity, oversupply, output gap, excess capacity, liquidity trap, capital short banking systems, Federal Reserve paying interest rates on commercial bank reserves or a combination thereof, we aren’t sure of the interim impact.

We can’t be “timing” inflation because its impact has always been relative.

However we understand inflation to be an epochal problem of human society, which specifically constitutes a series of processes that makes up a cycle.

We can’t simply read through recent events and interpret them as the future.

Since inflation is a political process, it requires the understanding of the underlying motivations of the current crop of political leaders and their prospective actions. After all, politics revolve around economics.

And this has been a phenomenon that has haunted civilizations, kingdoms, governments or empires alike, which has always been expressed through the purchasing power of the underlying currencies.

Mises Institute President Douglas French in recommending cigarettes as an inflation hedge enumerates on such cycle, ``one of Ludwig von Mises's outline of the typical inflation process: prices aren't rising nearly as much as the money supply… phase two of Mises's inflation outline: instead of a rising demand for money moderating price increases, a falling demand for money will instead intensify price inflation. Finally, we come to phase three, where prices go up faster than money supply, the demand for money drops to zero, and government fiat currencies collapse.” (bold highlights mine)

Currently we seem to be drifting in between the phases of “prices aren't rising nearly as much as the money supply” and “falling demand for money”.

Eventually, we should see a transition deeper into “intensifying price inflation” and most probably segueing into “prices go up faster than money supply” depending on the incentives driving policymaking.

And if consumer prices don’t immediately reflect on the impact of the intermediate inflation process, then most of the present political actions will likely be felt or manifested in the financial asset markets.

And so a boom in asset markets is in the first order, as what we’ve been seeing today, and may likely continue as the US dollar index falls.

In short, asset markets are likely to continue functioning as the immediate absorbers of the inflation process.

As Morgan Stanley’s Manoj Pradhan observed of the difference between today’s cyclical patterns with the previous,

``During this cycle, however, interest rates that matter for borrowers have fallen only very slowly while the flow of credit to the private sector is likely to be weaker than usual due to financial sector deleveraging. Only risky asset prices have been roaring forward since the rally began in March. This imbalance between the various channels creates complications for the prospects of returning monetary policy to neutral. If central banks decide to tolerate higher asset prices in order to compensate for the weaker impact of both the interest rate and the credit channel, they risk inflating another asset bubble. If they respond to rapidly rising asset prices while the other transmission mechanisms have only played a weak role, they risk tightening policy into a weak economic recovery.” (bold highlights mine)

Politically, further inflation is required to sustain the elevation of asset prices, however economically, the risks is that these surges will result to a bubble. So maneuvers for an exit from policymakers seem to be getting trickier by the moment.

Will they take the booze away from the party and allow “normalization” or will they further supply more booze to enliven the atmosphere?

Here, we will bet on another major policy miscalculation.

Yet this boom in financial asset prices won’t translate to sustainable “green shoots” of economic recovery. Instead today’s inflation process will heighten misallocation of resources that would eventually culminate into another enormous bubble cycle.

As Murray N. Rothbard in Money Inflation and Price Inflation wrote, (bold highlights mine)

``Even if prices do not increase, this does not alleviate the coercive shift in income and wealth that takes place. As a matter of fact, some economists have interpreted price inflation as a desperate method by which the public, suffering from monetary inflation, tries to recoup its command of economic resources by raising prices at least as fast, if not faster, than the government prints new money…there is a relative underinvestment in consumer goods industries. And since stock prices and real estate prices are titles to capital goods, there tends as well to be an excessive boom. It is not necessary for consumer prices to go up, and therefore to register as price inflation. And this is precisely what happened in the 1920s, fooling economists and financiers unfamiliar with Austrian analysis, and lulling them into the belief that no great crash or recession would be possible. The rest is history. So, the fact that prices have remained stable recently does not mean that we will not reap the whirlwind of recession and crash.”

So while consumer price inflation may still be currently subdued, this doesn’t exempt us from a prospective bust from the fast evolving malinvestments.

More Inflation Equals Greater Risks

Despite the recent crisis, the fractional banking sponsored debt driven economy conjoint with government policies to rev up the credit cycle has reflected on Mr. Buffett’s admonition of debts reaching record unsustainable levels.

Figure 2: AIER: US DEBT AT RECORD LEVELS

According to Mr. Kerry A. Lynch senior fellow of the American Institute of Economic Research, `` The total debt owed by Americans increased to $51 trillion in the first quarter of 2009. One way to put such a mind-boggling number in perspective is to compare it to the value of what Americans produce. Gross domestic product is roughly $14 trillion per year. Thus, Americans now owe $3.62 for every dollar of GDP. As can be seen in the chart below, this is a record.

``By comparison, in 1980 Americans owed just $1.55 per dollar of GDP. The ratio began to rise sharply in the 1980s, leveled off in the early 1990s, and surged again in the late ‘90s, continuing to do so through the past decade.”

While the recent crisis should have pruned down debt levels to the capacity where the economy may be able to handle it, however, the inherent fear by US and global governments of “deflation”, aside from the implied goal to sustain previous boom days, and the addiction towards inflation has prompted such continued accumulation of systemic imbalances.

As we said in the The Fallacies of Inflating Away Debt, the misleading notion of inflating away such debt levels would make the stagflation era of the 70s a virtual “walk in the park”.

Yet, Mr. Buffett seems quite optimistic on the resolve of the present administration to work this out, which we think could be attributable to the special political influenced privileges acquired from the administration, during the latest crisis, for his personal benefit [see Warren Buffett: From Value Investor To Political Entrepreneur?].

However, Mr. Buffett seems to seriously underestimate the political nature of the inflation process.

The expanded cash for clunkers, the administration’s foisting of its socialized version of health reform (which means another $1.3 trillion through 2019), cap and trade policies and the potential bailouts from the next wave of mortgage resets, the prospective support on FDIC’s eroding funding base as more banks suffer from closure, and the Obama administration’s consideration of future stimulus programs are simply symptoms of MORE (NOT LESS) government addiction towards consolidating power by debt and inflation based solutions.

As Ludwig von Mises on The Truth About Inflation presciently wrote, ``But the administration does not want to stop inflation. It does not want to endanger its popularity with the voters by collecting, through taxation, all it wants to spend. It prefers to mislead the people by resorting to the seemingly non-onerous method of increasing the supply of money and credit. Yet, whatever system of financing may be adopted, whether taxation, borrowing, or inflation, the full incidence of the government's expenditures must fall upon the public.” (emphasis added)

Hence, the current political leadership adheres to the typical path of leaders opting for the profligate inflation route. Inflation is what they want, then inflation is what we get.

So in contrast to the mainstream who thinks inflation isn’t in the near horizon, we join the outliers who have been warning of the risks of a potential disorderly unwind.

The Newsmax quotes Nobel Prize economist Joseph Stiglitz, ``The "dollar now is yielding almost zero return," Stiglitz said in a speech at the United Nations regional headquarters in Bangkok. "The current global reserve system is fraying. It's falling apart. The issue isn't whether we go to a new system. The question is do we do so in an orderly or disorderly way.” (emphasis added)

Meanwhile, PIMCO’s CEO Mohamed El-Erian says the policy divergence or “disjointed approach” between the US and other global central bankers could risk leading “to volatile financial markets, a damaging drop of the dollar and slower global growth.”

The Bloomberg quotes Mr. El-Erian ``The question is not whether the dollar will weaken over time, but how it will weaken,” said El-Erian, a former deputy director of the International Monetary Fund whose firm runs the world’s largest bond fund. “The real risk is that you will get a disorderly decline.” (emphasis added)

Thus, we won’t underestimate or discount the odds of the growing risks of an inflationary pass through by a lower (or a possible meltdown of the) US dollar on asset, commodity or consumer prices.

Remember inflation isn’t only generated through the credit system but also through fiscal expenditures.

In Zimbabwe, where consumer credit is virtually inexistent, an output gap of -99% (Marc Faber) and unemployment of 94% didn’t stop hyperinflation (89,700,000,000,000,000,000,000% year on year basis in 2008 or a doubling of prices daily)!!!

So the obsession with all sorts of perverse math models by mainstream economics vividly manifest that they don’t have a clue on reality.

That’s the reason why they haven’t rightly predicted last year’s crisis and why they are unlikely to be dependable forecasters.

Gold As Our Seasonal Barometer

``If our present inflation, as seems likely, continues and accelerates, and if the future purchasing power of the paper dollar becomes less and less predictable, it also seems probable that gold will be more and more widely used as a medium of exchange. If this happens, there will then arise a dual system of prices — prices expressed in paper dollars and prices expressed in a weight of gold. And the latter may finally supplant the former. This will be all the more likely if private individuals or banks are legally allowed to mint gold coins and to issue gold certificates.” Henry Hazlitt (1894–1993) Gold versus Fractional Reserves

I wouldn’t be in denial that seasonal factors could weigh on asset pricing as we mentioned last week.

This Ain’t 2008

But many analysts seem to have taken a rear view mirror (anchoring) of the seasonal factors on the possible performances of the global stock markets.

Given the fresh traumatic experience from the 2008 meltdown, it is understandable that many have written words of caution about navigating the turbulent periods of September and October.

But unless we are going to see another seizure in the banking system, the 2008 episode seems unlikely to be the appropriate model.

True, we could see some heightened volatility, as a result of the variable fluxes in inflation (as in the recent case of China).

But for us, the focus should be on how the US dollar index would be responding to the stickiness of inflation on the financial markets in the current environment, instead of one dimensionally looking at the stock markets vis-à-vis the seasonal forces.

In my view, gold’s strong performance during this period could be a fitting a precursor see figure 3.

Figure 3: Uncommon Wisdom/Sean Brodrick: Entering Gold’s Seasonal Strengths

If gold functions its traditional role as the archrival or nemesis to paper money, then simplistically a weaker dollar should translate to higher gold prices.

In Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy we pointed out that one of the major reasons why the mainstream has been wrong in attributing “fear” in gold prices was because of the massive distortions by governments in almost every market.

Hence, gold or the oil markets, which represents as the major benchmarks to commodity indices, hasn’t been on free markets to reflect on pricing efficiency enough to attribute fear.

Instead, over the short term, government interventions working through different channels such as the signaling, an example would be the previous announcements of IMF gold sales [which eventually got discounted], or other forms of direct or indirect manipulation, has been used as a stick to control gold prices.

This, plus the seasonal weakness has indeed brought gold prices to a tight trading range, instead of collapse as predicted by the mainstream, thereby validating our thesis and utterly disproving the “fear” thesis.

Nevertheless, governments appear to have retreated from selling their reserves under the Central Bank Gold agreement which expires on September. Central Bank’s selling during the first 6 months of the year are down 73% at 39 tonnes (commodityonline). Although as the calendar year closes, central bank selling could step up, but this would likely be met by the seasonal strength and won’

Investment Taking Over Traditional Demand

Also, as we also pointed out in February’s Do Governments View Rising Gold Prices As An Ally Against Deflation?, the dynamics of gold pricing has rightly been changing.

Then we said, ``The implication of which is a shift in the public’s outlook of gold as merely a “commodity” (jewelry, and industrial usage) towards gold’s restitution as “store of value” function or as “money”. The greater the investment demand, the stronger the bullmarket for gold.” (see Figure 4)

Figure 4: World Gold Council: Investment Leads Gold Demand

It would seem like another vindication for us, this from the Financial Times, (bold emphasis ours)

``Total identifiable gold demand, at 719.5 tonnes in the second quarter, was down 8.6 per cent compared with same period in 2008, with jewellery consumption down 22 per cent to 404.1 tonnes.

``Investment demand, which includes buying of bars and coins as well as inflows into exchange-traded funds, reached 222.4 tonnes in the second quarter, a rise of 46.4 per cent from the same period a year ago.

``However, the second quarter was the weakest three-month period for investment demand since before the implosion of Lehman Brothers in September 2008…

``Mr Shishmanian [Aram Shishmanian, chief executive of the World Gold Council-my comment] said that although total demand had failed to match the exceptional levels seen when the economic and financial crisis was at its peak, investment demand had enjoyed a strong quarter, underlining a growing recognition of gold as an important and independent asset class.”

In short, yes, investment demand has materially been taking over the dominant role in gold demand over jewelry and industry and will continue to do so as global central banks inflate the system.

China’s Role And The Reservation Price Model

Moreover, China’s government recently loosened up on its investment rules for gold and silver and even encourages the public to participate [see China Opens Silver Bullion For Investment To Public].

On a gold [in ounces] per capita basis, China has only .028 ounces of gold for every citizen, against the US which has .9436 ounces of gold in its reserves for every Americans (Gold World). That’s alot of gold for the Chinese with its huge savings and humongous foreign currency reserves to buy. And that’s equally alot of room for gold prices to move up.

This means that if the inflation process will continue to be reflected on the financial asset prices, then the likelihood is that gold will pick up much steam going to the yearend on deepening investment demand from global investors, perhaps more from Asia and augmented by the seasonal strength.

Moreover, gold will likely serve as a better barometer for the liquidity driven stock markets, in spite intermittent volatility, than from traditional seasonal forces.

Finally, Mises Institute’s Robert Blumen gives a good account of why evaluating the price dynamics of gold shouldn’t be from the conventional consumption model but from reservation prices model.

Since gold prices are not consumed by destruction and where above ground supply remains after being processed or used, the ``owners of the existing stocks own much more of the commodity than the producers bring to market.”

Hence to quote Mr. Blumen, ``The offered price of each ounce is distinct from that of each other ounce, because each gold owner has a minimum selling price, or "reservation price," for each one of their ounces. The demand for gold comes from holders of fiat money who demand gold by offering some quantity of money for it. In the same way that every ounce of gold is for sale at some price, every dollar would be sold if a sufficient volume of goods were offered in exchange.”

Read the rest here.

Asia: Policy Induced Decoupling, Currency Values Aren’t Everything

``The biggest lesson of the current crisis for Asian countries is that they can no longer depend on the West as a market for their exports, nor for reliable returns on their investment capital. To address the first issue, Asia has to cultivate its domestic consumer markets to sustain its growth. For the second, it faces a potentially more daunting challenge: to grow and strengthen its domestic capital markets, and stimulate Asian investment in Asia. Should Asia achieve these goals, it would mark a fundamental shift in the economic relationship between Asia and the West—and in particular between China and the U.S.” Matthews International Capital Management Asia Now, The Growth Issue

As we have been saying, inflationary policies are essentially vented on currencies which are instantaneously transmitted to the financial asset markets.

Besides, the impact of inflation has always been relative, since money enters the economy at specific points of the economy, and considering the distinct capital structure of national economies, the effects from these policies are likely to be divergent.

Take for instance, high savings, low systemic leverage, and an unimpaired banking system from the recent crisis [as we recently discussed in Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble] are likely to be more responsive to low interest rate policies regime implemented by domestic central banks. The massive outperformance of emerging markets relative to developed economies is a symptom of such response [see Global Stock Market Performance Update: Despite China's Decline, Emerging Markets Dominate]

It doesn’t stop here. This phenomenon has somewhat distilled also into national economies, see figure 5.

Figure 5: Divergent Impact On Industrial Production (Economist) and Car Sales (PIMCO)

Industrial production in the Emerging Asia has sharply been reinvigorated in contrast to the sluggish performance in the US.

The same divergent dynamics can also be seen in the comparative car sales between China and the US.

In short, what you are seeing is a clear manifestation of decoupling at work.

This from the Economist,

(bold highlights mine)

``Across the region, aggressive fiscal and monetary stimulus has helped revive domestic demand. Asia has had the biggest fiscal stimulus of any region of the world. China’s package grabbed the headlines, but South Korea, Singapore, Malaysia, Taiwan and Thailand have all had a government boost this year of at least 4% of GDP. Most Asian countries, with the notable exception of India, entered this downturn with sounder budget finances than their Western counterparts, so they had more room to spend. Bank of America Merrill Lynch forecasts that the region’s public debt will rise to a modest 45% of GDP at the end of 2009, only half of the average in OECD countries.

``Moreover, pump-priming has been more effective in Asia than in America or Europe, because Asian households are not burdened with huge debts, so tax cuts or cash handouts are more likely to be spent than saved. It is also easier in a poorer country to find worthwhile infrastructure projects—from railways to power grids—to spend money on.”

Mainstream analysts, whom mostly have been deflation advocates, jeered and hectored on the decoupling theme following the climax of the US banking seizure last September and October. Unfortunately, it appears that the deflationary episode signified as a fleeting moment of glory and as developments deepen things has once again been turning out to refute their highly flawed assumptions.

Importantly, we described in our February article Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?, that creative destruction, the role of real savings, supply side responses, and the role of Asia’s middleclass could act as possible channels for decoupling.

Currency Values Aren’t Everything

The Economist highlights another point we’ve been making,

``The basic problem is that although the Asian economies have decoupled from America, their monetary policies have not. In a world of mobile capital, an economy cannot both manage its exchange rate and control domestic liquidity. By trying to hold their currencies down against the dollar Asian economies are, in effect, being forced to shadow the Fed’s monetary policy even though their economies are much stronger. Foreign-exchange intervention to hold down their currencies causes domestic liquidity to swell. Consumer-price inflation is not an imminent threat, because prices are falling in most Asian countries. Chinese consumer prices fell by 1.8% in the year to July. But asset prices look dangerously frothy. The obvious solution is to let exchange rates rise, but with exports still well below last year’s level, governments are reluctant to set their currencies free.” (bold emphasis mine)

What we are in agreement is here is that of the US Fed policy transmission to the Asian markets and economy.

Although it would be ideal that Asian currencies be allowed to rise to reflect some of these adjustments, the idea that currencies are the only major factor for adjustments represent as logical fallacies of hasty generalizations based on unfounded assumptions or Ipse Dixitism.

To consider, the Philippines saw its currency the Peso depreciate from Php 2 to a US dollar in 1960s to Php 55 pesos to a US dollar in 2005 (or 96% devaluation!).

Considering the macro assumptions that such magnitude of adjustments ought to reflect on its products, this implies that the Philippines should have been an export giant by now.

Unfortunately this hasn’t been the case. Instead, we became a giant of labor exports, as an aftereffect of a vastly lowered standard of living out of the inflationary policies accrued from present and the previous administrations.

Unfortunately, such simpleminded fallacy of composition by experts deals with the assumption of an economy producing a single good from a single type of labor funded by a single type of capital.

I’ll further the example; San Miguel Beer which cost Php 19 per bottle in a local sari sari store (informal retail outlet), costs Php 50 in local B rated bars, and Php 200 in 5-star hotels. This is known as Price Discrimination, which basically means the selling of identical products to different markets through market segmentation.

In other words, depending on the markets, some products are more price sensitive (price elastic) than the others. In practice, a product that caters to the lower income class of the society is more price sensitive compared to a product marketed to the high end income segment.

So markets, not only prices (through currencies), are the more important qualifying variables for any required economic adjustments.(yet, high profile local experts continue to call for inane Peso depreciation!)

The fundamental reason why the Philippines haven’t benefited from a depreciated currency is because the local political economy has a limited and underdeveloped market due to an unfree economic rent seeking crony capitalist structure which has remained in place until today.

Besides, if currency value is the sole determinant of economic growth then Zimbabwe should be the biggest exporter or the wealthiest nation today!!!

The Japan Experience

More example; if rising currency translates to “greater domestic demand” then why has the Japan’s economy remained an export dependent economy despite the huge (threefold) appreciation of the yen? (see figure 6)

Figure 6:Gold News: Soaring Japanese Yen

Nathan Lewis for the Daily Reckoning says that aside from the deflation in the banking system what mattered most had been the series of tax hikes that has kept Japan’s economy in the doldrums, 20 years from the bubble bust.

This from Mr. Lewis (bold highlights mine) , ``They began with a series of tax measures on January 1, 1990 - the first day of the bear market - which eliminated certain preferential capital gains tax treatments for property. To take a few of a great many such steps which followed: In 1992, the tax rate on short-term capital gains (under 2 years) on property was raised to 90%. Long-term gains were taxed at 60%. A 0.3% National property tax was introduced (this was several multiples greater than existing property taxes). A City Planning Tax of 0.3%. A Registration and License Tax of 5% of the sale value of a property. A Real Estate Acquisition Tax of 4%. An Office Tax of 0.25%. A Land Ownership Tax of 1.4%. Even the regular property tax, the Fixed Assets Tax, was effectively raised by several multiples. From 1990 to 1996, Japanese property values imploded by as much as 70%. However, the revenues from this tax rose by 46%. You can do the math…

``Already there is an annual rise in payroll taxes, scheduled for every year between 2004 and 2017, which will eventually take the payroll tax rate from 13.6% to 18.3%. (Employers match this, and there is no maximum income to which it applies.) And what about the increase in taxes on dividends from 10% to 20%? Or the introduction of a brand-new capital gains tax on equities of 20%, which had effectively been tax-free before? Or the effective 25% increase in personal income taxes, the result of the elimination of a 20% tax cut introduced in 1998? On top of all that, politicians are talking about increasing the consumption tax (similar to a sales tax) from 5% presently to 10% or higher. Until a 3% consumption tax was introduced in 1989, there was no consumption tax at all in Japan, not even at the prefectural or municipal level.”

In addition, John Hempton of Bronte Capital says the legacy of zombie corporations has consumed capital resources which was otherwise meant for other productive investments, ``the problem in Japan was their ability to keep zombie corporations (not zombie banks) alive for decades. Japan has a “Rip-Van-Winkle” industrial legacy to go along with its absolutely brilliant modern technology industries. This old industry sucks resources which would better be used by the modern industry.” (emphasis added)

In short, like the Philippines, domestic policies have been responsible for restricting the required adjustments to expand the marketplace in spite of the currency adjustments. So calling for adjustments of imbalances via the currency route is no less than a fantasy.

Therefore, I’d avoid listening to “expert” economists who would reason along logical fallacies and prescribe snake oil medicines.

Stephen Roach On China's Consumers

McKinsey Quarterly's Clay Chandler interviews Morgan Stanley's Stephen Roach on Unlocking the Power of China's consumers.






Here is Mr. Roach's end quote,

``I think China has the potential to become a major engine of global growth. But I think it’s unrealistic to expect China to step into that role immediately in this post-crisis era. I think it’ll take three years, more likely five to ten years, for China to really have the type of balance and scale of its economy that can fill the void that’s about to be left—or that is now being left—by the demise of what heretofore has been the biggest and most dynamic and powerful consumer in the world: the American consumer." (emphasis added)

Read the transcript here

Big Mac Index: Work Time Needed To Earn A Big Mac

This is an interesting change of perspective in looking at the Purchasing Power Parity based on the Economist's Big Mac index.

See previous post Big Mac Index Update: Asia Cheapest, Europe Priciest

It shows the work time required to earn a Big Mac.

According to the Economist,

``THE size of your pay packet may be important, but so is its purchasing power. Helpfully, a UBS report published this week offers a handy guide to how long it takes a worker on the average net wage to earn the price of a Big Mac in 73 cities. Fast-food junkies are best off in Chicago, Toronto and Tokyo, where it takes a mere 12 minutes at work to afford a Big Mac. By contrast, employees must toil for over two hours to earn enough for a burger fix in Mexico City, Jakarta and Nairobi"

Interesting.

President Obama's Popularity Falling Back To Reality

In our January post US Politics: Extrapolating Hope and Change to Presidential Term Realities here is what we said,

``Yet high approval ratings tend to be followed by a collapse over the years."

This from Gallup

This from Pew ResearchFrom RassmussenReports.com

"Change we believe in" appears turning out to be-"the more things change the more they remain the same".

As H.L Mencken presciently wrote of politicians, ``These men, in point of fact, are seldom if ever moved by anything rationally describable as public spirit; there is actually no more public spirit among them than among so many burglars or street-walkers. Their purpose, first, last and all the time, is to promote their private advantage, and to that end, and that end alone, they exercise all the vast powers that are in their hands … Whatever it is they seek, whether security, greater ease, more money or more power, it has to come out of the common stock, and so it diminishes the shares of all other men. Putting a new job-holder to work decreases the wages of every wage-earner in the land … Giving a job-holder more power takes something away from the liberty of all of us .…" (emphasis added)

Americans seem to be waking up to the harsh realities of life.

Yet the higher the expectations, the greater fall.

Although with the rate the above has been going, it doesn't seem to take years-after all it's been only about 7 months!

China Opens Silver Bullion For Investment To Public

China has introduced its first-ever investment opportunity for silver bullion. (HT: HiredGunz98)

Marc Faber: China Next Shoe To Drop, Bullish Japan, Possible War Ahead

Here is an audio of Dr. Marc Faber's latest interview (source Marc Faber)

some excerpts...

China’s Imminent Implosion

My guess is that the economy despite all the stimulus is growing at between 0% to 3 ½%...

Bank lending went mostly into further misallocation of resource, it created another bubble in the share market and probably led to over construction in properties around major cities...

When will the Chinese economy also implode? And I think that is still a shoe to drop on the global economy. Maybe it is going to happen in 2010 and maybe they can postpone it for another year or 2 and so forth…

We have a credit bubble in the US, in China we have an investment bubble with overcapacity arising in the export industries..in the property market. When you try to kindda of support these bubbles markets with intervention through fiscal and monetary measures, you don’t solve the problem but you postpone it...

My view is that the economy globally will remain weak, maybe we have a period of recovery that last 6-9 months, because of all the stimulus packages, and then the economies weaken again, but that asset markets in some cases despite the weak economy will go up for the simple reason central banks will keep on printing money...

Bullish on Japan

In the case of Japan I would add that when the market bottomed out in March 2009, we were at the 30 year low basis, we were at the same level then we were in 1981, so if you took the S&P down to that level we would be at 120...

So we have in Japan a secular bear market, in other words we peak out in 1989 and from 89 we went down and we had several rallies of over 40% and finally bottomed out in 2009 and in my view this is a major secular low, the way we had a secular lows in the US in the 1940s in real terms and in 1982, we were we had significant increases in share prices. So on any setback, I would consider increasing my position in Japan...

Possible War Ahead

Nothing at all has been solved or improved..

Policymakers took decisions that will actually make the system less transparent and more vulnerable than before..

What kind of policy that try to create prosperity out of bubbles?...that’s the mentality of the Federal Reserve..

The entire capitalist system will totally collapse…I don’t whether it will collapse in one year’s time or in 5 years time or 10 years time…

Total collapse is ahead of us…

Before everything collapse what governments usually do is to go to war so they can distract attention for awhile, and stay in power, and then eventually everything goes sour….

Buy gold but keep it out of the US

Emerging Markets Joins The Space Industry Race

In contrast to popular perception, the space race don't seem to be dominated by any country.


Notes the Economist, (bold emphasis mine)

``ON WEDNESDAY August 19th South Korea's attempt to launch its first rocket ended in failure, for the seventh time since 2002. Pressure on the country has been mounting since neighbouring North Korea claimed it had put a satellite into space in April this year. Most launches are made from countries with the well-established space programmes. As of last year, Russia had sent 245 rockets with payloads into orbit successfully since 1999, compared with America's 218, according to data from Futron, a technology consultancy. China now surpasses Europe as a base for spacecraft launches, while India and Japan send up a few every year. Israel has also put two rockets into space."

Even in the space industry, emerging markets are becoming major contenders.

Global Stock Market Performance Update: Despite China's Decline, Emerging Markets Dominate

No trend goes in a straight line. That's the fundamental truism of the marketplace.

Yet some analysts have taken China's monstrous 2 week decline as something to gloat on.

True, China has entered the bear market cycle based on the 20% decline technical rule.

But it is unclear that she could suffer from the same fate of the 2008 meltdown. Yet, we won't bet on such idea, especially not when global policymakers have been targeting the asset markets.

Nonetheless here is the updated year to date global performance chart from Bespoke Investments.

From Bespoke Invest, (bold highlight theirs)

``After a 20% decline in a matter of days, China is now just the third best performing BRIC (Brazil, Russia, India, China) country year to date. Russia is up 57.24% year to date, India is up 53.51%, and China is up 52.99%. But it could be worse for China. At least they're not down 50% year to date like Ghana.

``You can tell how much China has sold off versus the rest of the world by looking at its percentage from its 50-day moving average. China is one of just 5 countries that are up year to date and currently trading below their 50-day moving averages, and it is the second furthest below its 50-day (-10.34%) out of all countries behind only Nigeria (-11.97%)."

As we discussed in Global Stock Market Performance Update: Proof of Rotational Effects and Tight Correlations, it has been quite evident that the pricing of global stocks appears to be in rotation, which clearly is a symptom of global inflation dynamics.

Moreover, despite the precipitate 20% decline in China, they remain at the tenth spot among the world's best performers.

China's decline simply brings the BRIC (Russia-7th, India- 9th and Brazil 11th) in a tight pack of the race.

Recall earlier too that Russia fell 30% before rebounding (top window) but has presently been creeping higher. The same actions had been realized in India (BSE) and Brazil (BVSP) but both have recovered strongly.

In contrast, China's rise has been vertiginious or without any major correction since February. So the sharp decline seems much desired, as to normalize its long term trend. The same dynamics seen in its peers are likely to take hold on China's Shanghai index once it establishes a bottom.

Yet regardless of China's recent fate, the BRIC and emerging markets has simply outclassed, by a mile, developed economies, where 9 of the top 20 have been Asian bourses (by pecking order: Indonesia, Sri Lanka, Vietnam, India, China, Taiwan, Philippines, Singapore, Thailand and Hong Kong).

So it would seem like a pointless exercise to gloat over China's recent losses. In horse racing lingo, China's recent decline could be interpreted as part of the "handicapping" relative to developed economies.

Anyway here is the chart (courtesy of Bloomberg) of the world's topnotch equity bellwether-Peru.

If there is anything to be discerned from the above, no trend goes in a straight line.

Zimbabwe's Hyperinflation: Prices Doubled Everyday, But Only 2nd Worst In History, Lessons

Last February in Zimbabwe's Hyperinflation we featured the world's recent case of hyperinflation as featured by Cato.org's Steve Hanke.

Lately, Steve H. Hanke and Alex K. F. Kwok came up with an updated paper on this. (Hat Tip: Mark Perry)

From Steve Hanke, ``The 20th century witnessed 28 hyperinflations. Most were associated with the monetary chaos that followed the two World Wars and the collapse of communism. Zimbabwe’s hyperinflation of 2007–08 represents the first episode in the 21st century and the world’s 30th hyperinflation."

The table above shows that it took just about one day (24.7 hrs) for prices of goods to double.

Nevertheless it still lagged the Hungarian account which took only 15 hours to achieve the same astounding feat. This also means that Zimbabwe’s hyperinflation ranks as the second worst in human history.

This table shows of the exponential acceleration rate of inflation which peaked in November last year- a month on month rate of 79,000,000,000%!!!

This very important point from Steve Hanke, ``Hyperinflations have never occurred when a commodity served as money or when paper money was convertible into a commodity. The curse of hyperinflation has only reared its ugly head when the supply of money had no natural constraints and was governed by a discretionary paper money standard."

This means that yes, the paper money system is predisposed to the risks of hyperinflation.

To give you an idea how a society endures from hyperinflation Alexander Jung, from Spiegel Online takes account of the Weimar German experience (incidentally ranked as the fourth worst after Yugoslavia)

An excerpt, (bold highlights mine)

``History may hail "the miracle of the rentenmark," but in reality it constituted an admission that the German Reich was bankrupt. And as always, it was the populace that picked up the tab.

``The stupid ones were those who had nest eggs: the thrifty, holders of government bonds, but primarily the country's pensioners. In other words, those who received money without having to work for it, who lived on their pensions or the interest on their savings. Large sections of the middle classes saw themselves stripped of their assets, losing almost everything they had set aside for years. Banks, savings banks, and insurance companies suffered huge losses and were left with nothing but their paper money. As a result, they had to start the majority of their businesses from scratch in 1924.

``By perverse contrast, the winners of the hyperinflation first and foremost the state, but also were those with massive debts;private individuals who had borrowed money to buy houses, construction land or farmland, and whose loans were slashed by the switch to the rentenmark.

``Some industrialists made huge gains from the period of hyperinflation. Hugo Stinnes, whom Time magazine crowned "Germany's new Kaiser," built up an immense corporate empire comprising heavy industry, newspapers, ships and hotels -- all based on a mountain of debt. As late as the summer of 1922, Stinnes was recommending that people continue capitalizing on "the weapon of inflation." Indeed manufacturers and craftsmen in general profited from the crisis since they possessed plants and buildings -- that is, tangible assets that outlived the currency switch.

``Most farmers also did extremely well. "They had money to burn, and spent it willy-nilly," writer Lion Feuchtwanger recalled. Some bought themselves entire stables of racehorses, others expensive cars. "Farmer Greindlberger drove from the grimy village street of Englschalking to Munich in an elegant limousine complete with a liveried chauffeur, while he himself was dressed in a brown velvet jacket and a green chamois-tufted hat," Feuchtwanger wrote of the rural rich.

``Never before had Germany witnessed such a fundamental redistribution of wealth, and many of the winners were those who had previously been wealthy....

``Disillusioned, many Germans chose to withdraw from the bitter reality of their lives, and simply left the country. In 1923, the authorities counted three times as many emigrées as the year before. Some sought refuge in sects, others committed suicide. Millions more became radicalized."

Read the rest here

So experts and officials recommending inflation as the fix for today's debt woes, could actually be leading us to the precipice.

Be very careful of what you wish for.

A Bet On Free Education

This fantastic article from Marketing Guru Seth Godin is simply too irresistible not to share.

From Seth Godin, (blue bold emphasis mine)

``Should this be scarce or abundant?

``MIT and Stanford are starting to make classes available for free online. The marginal cost of this is pretty close to zero, so it's easy for them to share. Abundant education is easy to access and offers motivated individuals a chance to learn.

``Scarcity comes from things like accreditation, admissions policies or small classrooms.

Should this be free or expensive?

``Wikipedia offers the world's fact base to everyone, for free. So it spreads.

``On the other hand, some bar review courses are so expensive the websites don't even have the guts to list the price.

``The newly easy access to the education marketplace (you used to need a big campus and a spot in the guidance office) means that both the free and expensive options are going to be experimented with, because the number of people in the education business is going to explode (then implode).

``If you think the fallout in the newspaper business was dramatic, wait until you see what happens to education.

``Should this be about school or about learning?

``School was the big thing for a long time. School is tests and credits and notetaking and meeting standards. Learning, on the other hand, is 'getting it'. It's the conceptual breakthrough that permits the student to understand it then move on to something else. Learning doesn't care about workbooks or long checklists.

Read the rest here.

So here's how things might shape in the future:

The laws of economics should apply: lower costs equates to higher demand.

Taxpayer funded public education may go down as free online education flourishes.

What should matter now is securing online access for the public and investments (in content and infrastructure) are likely to get focused here.

Consequently too, certificate courses will have to be reconfigured.

It's simply just amazing how free markets, underpinned by innovative technological infrastructure (likewise a product of the markets), have evolved to make society much progressive.

INO's Adam Hewison on Nasdaq: Two Way Market, But Upside Has Been Broken

INO.com's Adam Hewison on the Nasdaq; it's a two market but the upside has been broken.

Pls click on the image for the updated technical developments

Disclosure: this blog is a member of INO's affiliate partner program

Politicians Don't Grow The Economy

An article from the Wall Street Journal provides evidence which separates facts from fiction.

The popular myth, being that espoused by the mainstream, particularly advocated by politicians, the media, leftwing academics, or self-righteous welfare interest groups or even the Pope, is that governments “manages” the economy.

From Wall Street Journal, (all bold highlights mine)

``We witnessed that rarest of things last week—a politician's public humility. When France, along with Germany, reported an unexpected uptick in economic growth for the second quarter, French Finance Minister Christine Lagarde called the return to growth "very surprising." Imagine that—a major global economy stops shrinking, without the benefit of trillion-dollar stimulus packages or major reforms, and a politician doesn't rush to claim credit for the achievement.

``Politicians don't "grow" an economy like a vegetable garden, and the reasons behind economic growth in the global economy are at least as mysterious to our political class, if not more so, than they are to the rest of us. Ms. Lagarde, who spent decades in the private sector, is perhaps better placed than many politicians to appreciate this fact. A single quarter of 0.3% growth hardly means it's off to the races for France or Germany, and the euro zone's economy as a whole still shrank in the quarter, by 0.1% of GDP.

``But at a time when politicians around the world are desperate for any sign of a turnaround, it's refreshing to hear the minister responsible for France's economy speak the truth about growth. It is the product of literally millions of decisions made by millions of people about what to produce, buy and sell. Politicians can influence all that decision making, especially by increasing or decreasing the incentives to produce, work and innovate. But they can't control today's multi-trillion-dollar economies, no matter how much they'd like to take credit for doing so when things start looking better.

``France did pass a modest stimulus package earlier in the year, and it has joined the cash-for-clunkers craze that has swept the Western world. But France and Germany were among the countries in Europe that resisted Treasury Secretary Tim Geithner's imprecations to join the U.S. on the megastimulus bus, and on present evidence this fiscal restraint does not appear to be hurting their chances for recovery.”

Here's my take...

The fundamental reason why governments CANNOT manage an economy is because economies are vastly too diverse and too complex- from which are driven by the continuous changes in the human mind adapting to the rapidly evolving conditions or circumstances- to be accurately predicted or modeled which are the requisites of control or management.

Mario Rizzo on predictions, (emphasis added) ``This is because there are many radically unpredictable (in the lay sense) elements in human decisionmaking.

``One important argument in this regard was made by Sir Karl Popper in The Poverty of Historicism (also endorsed by economists George Shackle and Ludwig Lachmann). Adapting the argument for our current purposes:

``1. The course of economic events is strongly influenced by changes in the contents of the human mind that is, the future course of knowledge. This includes what we would call knowledge of the external world and of ourselves.

``2. We cannot predict, by rational or scientific methods, the future course of knowledge (in the sense of reasonable conjectures that we will have in the future or even in the sense of our moods – animal spirits).

``3. This is because if we could predict future knowledge it would not be future, but present. No one believes that we know now everything we will know in the future.

``4. Therefore, we cannot predict the future course of economic events.”

Hence, economic progress will always emanate from the entrepreneurs, because entrepreneurs operate on local [specialized and detailed] knowledge and values that allows for the coordination of the fulfillment of the needs and wants of a society through the marketplace.

As Ludwig von Mises wrote ``The vehicle of economic progress is the accumulation of additional capital goods by means of saving and improvement in technological methods of production the execution of which is almost always conditioned by the availability of new capital. The agents of progress are the promoting entrepreneurs, intent upon profiting by means of adjusting the conduct of affairs to the best possible satisfaction of the consumers. In the performance of their projects for the realization of progress they are bound to share the benefits derived from progress with the workers and also with a part of the capitalists and landowners and to increase the portion allotted to these people step by step until their own share melts away entirely."