Example of Unintended Consequences From Tax Hikes

As we earlier noted in Competitive Global Tax Structures As Major Investment Determinant, tax policies play a significant role in shaping an economic environment.

Here is an example how policymakers underestimates the public response to tax increases.

This from the Wall Street Journal, (all bold highlights mine)

``Illinois Governor Pat Quinn is the latest Democrat to demand a tax increase, this week proposing to raise the state's top marginal individual income tax rate to 4% from 3%. He'd better hope this works out better than it has for Maryland.

``We reported in May that after passing a millionaire surtax nearly one-third of Maryland's millionaires had gone missing, thus contributing to a decline in state revenues. The politicians in Annapolis had said they'd collect $106 million by raising its income tax rate on millionaire households to 6.25% from 4.75%. In cities like Baltimore and Bethesda, which apply add-on income taxes, the top tax rate with the surcharge now reaches as high as 9.3%—fifth highest in the nation. Liberals said this was based on incomplete data and that rich Marylanders hadn't fled the state.

``Well, the state comptroller's office now has the final tax return data for 2008, the first year that the higher tax rates applied. The number of millionaire tax returns fell sharply to 5,529 from 7,898 in 2007, a 30% tumble. The taxes paid by rich filers fell by 22%, and instead of their payments increasing by $106 million, they fell by some $257 million.

``Yes, a big part of that decline results from the recession that eroded incomes, especially from capital gains. But there is also little doubt that some rich people moved out or filed their taxes in other states with lower burdens. One-in-eight millionaires who filed a Maryland tax return in 2007 filed no return in 2008. Some died, but the others presumably changed their state of residence. (Hint to the class warfare crowd: A lot of rich people have two homes.)"

At the end of the day, when the society's productive agents get fed up by the sanctions imposed by the government to pay for profligacy, misdeeds or for the maintenance of the interests of bootlickers, the law of unintended consequences applies.

Others calls this "Atlas Shrugged"

Decoupling In Global Employment?

Here is the Economist with a graph from a survey of global employment.


According to the Economist, (bold highlights mine)

``IN 27 out of 36 countries surveyed by Manpower, an employment-services firm, more companies said they expected to add jobs in the three months to the end of June than said they reckoned on reducing their workforce. The difference between the proportion of hirers and firers was highest in Brazil and India. Throughout Asia companies have become more optimistic about hiring than they were a year ago, most dramatically in Singapore but only slightly in Japan. Things look less rosy in Europe. In several countries, including Spain and Ireland, more companies expect to see cuts to their workforce than expect it to grow. Of the four countries where the outlook has darkened, three are in Europe."

My comment:

Again Asia and Emerging markets are likely to see more meaningful improvements on their domestic job markets compared to OECD economies. Such variance is especially amplified when compared to Europe.

As what we've been previously saying; fundamentally, the driving force of the macro picture appears to have shifted from the core (US and OECD) to the periphery (Emerging Markets).

The Imploding 'Man Made' Global Warming Bubble In The US

In the US, the global warming paranoia or bubble seems to be imploding. And like any social fads, bubbles eventually unravel and fade.

This from Gallup,


``The last two years have marked a general reversal in the trend of Americans' attitudes about global warming. Most Gallup measures up to 2008 had shown increasing concern over global warming on the part of the average American, in line with what one might have expected given the high level of publicity on the topic. Former Vice President Al Gore had been particularly prominent in this regard, with the publication of his bestselling book, "An Inconvenient Truth," an Academy Award-winning documentary movie focusing on his global warming awareness campaign, and Gore's receipt of a Nobel Peace Prize in 2007.

``But the public opinion tide turned in 2009, when several Gallup measures showed a slight retreat in public concern about global warming. This year, the downturn is even more pronounced."

The accompanying charts...

shows how American sentiment towards global warming appear as...

collapsing!!!

For us, climate change is a real phenomenon. It's plainly the work of mother nature than from the activities of people, the latter of which constitutes only a fraction of influence on nature.

Common sense tells us that if we can't predict earthquakes what more for us to presume the accuracy of gloom and doom predictions or the alleged adverse consequences from "carbon emissions", years ahead.

People's belief in the gospel of model derived scientific analysis had been unwarranted; if quant models failed to predict the latest financial catastrophe, and was believed to have exacerbated the crisis, how much more should we come to believe that people's presumed actions (based on models) are far potent than the influences of mother nature?

Obviously, anything unsustainable won't last.

And with climategate or the revelation where mainstream scientists had been unmasked or exposed to have 'manipulated, suppressed and or distorted' data just to be able come up with conclusion that weather changes was due to anthropogenic reasons, the mainstream scientific model has been under siege.

Gallup adds, ``Some of the shifts in Americans' views may reflect real-world events, including the publicity surrounding allegations of scientific fraud relating to global warming evidence, and -- perhaps in some parts of the country -- a reflection of the record-breaking snow and cold temperatures of this past winter. Additionally, evidence from last year showed that the issue of global warming was becoming heavily partisan in nature, and it may be that the continuing doubts about global warming put forth by conservatives and others are having an effect."

So partisan politics and empirical evidences have been mainly responsible for this change in sentiment.

Of course what's not been said is that partisan politics is the attempt to pin the blame on people actions for changes in weather so as to justify measures to control or regulate people's behavior (euphemistically called socialism).

In the Philippines, media remains reticent about the global warming bubble. That's because it seems fun to live in a fantasyworld in the belief that a political superman would come and save the day from the villains (markets) or mother nature.

Why Americans Are Jobless

Here is my reply to a joke circulating in the cyberspace blaming globalization for US job losses.

The faulty insinuation is that the world has been “stealing” jobs from the US.

This is a mercantilistic perspective that tries to shift the blame on Filipinos, Chinese, Brazilians, Russians or the world for her economic woes.

For further explanation on these see my posts here: Trade Fallacies: Big Business Sucks Out Lifeblood From The Consumers and Mercantilism: Misunderstanding Trade And The Distrust Of Foreigners

Here is why Americans have lost jobs

1. Americans lost jobs primarily due to the misdirection of resources and employment (as revealed) in the aftermath of bubble policies:

a. monetary policy-low interest rates that fueled a credit boom,

b. housing policies- encouraged speculative purchases and subsidizes mortgage indebtedness via the GSEs (fannie Freddie fha etc..), community reinvestment act,

c. tax- encouraged banks and other firms to assume and maximize debt relative to equity and

d. bank capital regulations- which prompted for regulatory arbitrage which resulted to financial innovation such as securitization (and its offspring-the shadow banking system).

Simply said, when a big segment of the population got employed as mortgage or real estate brokers, bankers, contractors or investors indulged in real estate flipping, construction or constructed related investments, traded mortgage backed securities and ancillary industries because that’s where prosperity seems to be, a burst in the bubble exposed popular delusion and rendered a massive dislocation in the economy. In short, this resulted to lost jobs and lost investments. (the retail, financial and construction sectors are the largest employers see chart below)

2. Existing circumstances such as burgeoning fiscal deficits aside from political reforms towards cap and trade and health seem to be causing regime uncertainty or anxiety in the investment environment which is assumed to entail greater risks of higher taxes, more rigidity in employment requirements and etc.

Furthermore, with over $10 trillion of expenditures and guarantees on the assets of the US banking system, this may have “crowded out” potential investments elsewhere (albeit current interest rates have not yet been validating these, on the other hand interest rate markets are being skewed by government “quantitative easing” or money printing).

And the resulting fiscal policies have a major influence in the investing decisions when considering alternatives [see my post Competitive Global Tax Structures As Major Investment Determinant]

Simply said diminishing competitiveness and [indirect] consequences from political actions may have had a substantial impact on the investing and employment dynamics.

Nevertheless in spite of the crisis, the US still is the primary recipient of Foreign Direct Investments [see my post Global Foreign Direct Investments Down; US Still Dominates]

3 . The composition of the US economy could be transitioning to a post industrial or the information age. When 20-30% of the public’s time in OECD economies (including the US) are estimated spent on social media (facebook or twitter or myspace) then such magnitude of lifestyle changes are likely to impact economic output (investment and employment decisions)

Current statistics have been designed to measure industrial era output and not metrics geared towards the information age, so employment data may not be “accurate”. But again there are evidence that implies of such transition [see my post US Leads In Global Service Exports].

Although many argue that the contribution of the technology is small, my impression is that this is being underestimated (see chart below from McKinsey Quarterly)

So while there are still many other factors that may contribute to the state of “unemployment” in the US, blaming the world for the losses is another popular delusion founded on false premises.

Philippine Election Update: Jitters From Election Failure Risks?

The problem with getting too engrossed with politics is that sensationalism frequently substitutes for sound reasoning.

Here is an example from the Philippine Inquirer, ``The possibility amid recent power outages of the first national computerized elections failing to produce a president, whether real or imagined, is sending chills to the financial community."

The article suggests of an exodus of foreign investors and mayhem in the economy in the event of an election failure.

How real is the perceived risks?

From our perspective we will let the market do the talking...
The above chart is the USD-Peso (green) and the Phisix (blue).

And here is foreign money flows in the Phisix as of March 11, based on a year to date basis.

The Phisix appears to be rising amidst "failure of election jitters" concerns supported by foreign inflows.

Moreover the Peso has been similarly appreciating, which means demand for the peso is stronger relative to its conventional pair-the US dollar.

So hardly any trace of the so-called "jitters" seem to be reflected on the financial markets, as alleged by the account.

To the contrary, the markets appear to be firming up (climbing a wall of worry??)!

So what's going on here?

We see two possible interpretations here:

one, people say one thing and act the opposite, and

second, news accounts don't exhibit real sentiment (or could be tainted with political slant).

So essentially what's reported and what's in action don't match.

In addition, the odds for the alleged risks seem remote.

Why?

Let's put it this way: if the current administration is hell bent to remain in power, then actions to perpetuate her tenure should have been implemented as early as late last year (e.g. crisis from typhoons would have been a good excuse to implement martial law).

In addition, given PGMA's nearly depleted political capital, trying to extend power by any other means would translate to a political suicide. This means that the risks of being ousted would seem larger to the point that it would losing proposition for everyone, most especially her.

So maybe markets have been thinking more like I am, and discounting less of what's being bruited about.

This reminds me of George Orwell who once said, “Early in life I had noticed that no event is ever correctly reported in a newspaper.” Definitely.

Philippine Election Myth: New President Will Determine Direction of Economy And Markets

The notion that an elected political leader will "determine the fate of the economy or the markets" is a popular myth.

It is a myth which is repeatedly peddled by government to present accomplishments. And it is an illusion because the essence of government is to redistribute and consume resources forcibly extracted from productive sectors of the economy.

In the monumental words of Frank Chodorov, ``The intrusion of politics into the field of economics is simply an evidence of human ignorance or arrogance, and is as fatuous as an attempt to control the rise and fall of tides. Since the beginning of political institutions, there have been attempts to fix wages, control prices, and create capital, all resulting in failure. Such undertakings must fail because the only competence of politics is in compelling men to do what they do not want to do or to refrain from doing what they are inclined to do, and the laws of economics do not come within that scope. They are impervious to coercion. Wages and prices and capital accumulations have laws of their own, laws which are beyond the purview of the policeman."

If government can defeat the law of scarcity then poverty and inequality would have long been vanquished from this world and everyone can just have fun! But this simply isn't so.

And applied to elections, as author and professor Steve Landsburg in his blog aptly writes, ``The primary problem with representative democracy is that our representatives are captured by special interests." (bold highlight mine)

Election is, thus, a question of, redistribution for whose benefit? Or asked differently, which among the special interest groups will the new leader be working for?

What we are trying to say is the political winds will tend to blow into three basic directions:

1. increased socialism (which is deemed high risk because the distribution of resources is heavily politicized by the leadership; this means that such actions are likely to be influenced by favoritism, affiliations, patronage, cognitive biases, subjective interpretation of events, or etc... than public weal. In short, special interest groups have big influence in shaping the economy)

2. status quo

3. increased liberalization (lesser impact on the actions of leadership, because markets play a greater role in the distribution of resources than special groups)

And it is the same set of questions that needs to be asked relative to the forthcoming Philippine elections, for whose special interest group will the new leader/s be working for?

If we exclude the "election spending" factor and instead base our extrapolation on historical trends of Philippine politics and merge this with the qualifications (or previous records) of the frontrunners and present political realities, our guess is that the policy imperatives by the new President will be to maintain the status quo and work for the changes at the margins for 'special groups'.

In addition, considering the reported "tightness" in the race for the top spot in the current presidential derby, the new President is likely to get exhaustively engaged in "horse trading" just to be able to generate a coalition from various parties to support such "changes". This means alot of political concessions.

Think of it, in the US even if the Democratic party holds the majority in both Congressional houses, political dominance hasn't equated to successfully ramming down the political reforms on the throats of public, as in the health and climate bills. What more if there is no significant political support?

Alternatively, political straddling implies heightened odds of a status quo, which chimes with our historical political trends.

As Joe Studwell rightly argues, ``The lesson of the past decade has been that the relationship between political and economic elites in Southeast Asia is more enduring than almost anyone imagined."

And how has this worked in the past?

Adds Mr. Studwell, (bold emphasis mine)

``To this day, there are precious few Southeast Asian tycoons whose wealth is not rooted in some form of state-sanctioned monopoly. (The exceptions are a couple of lesser Hong Kong billionaires, Patrick Wang of micromotor maker Johnson Electric and Michael Ying of clothing business Esprit, whose money was made in recent years in manufacturing in mainland China.) Soft-commodity monopolies for consumer items like sugar and flour produced early cash flows for Indonesia's Liem and Malaysia's Robert Kuok. Gaming licenses primed Stanley Ho in Macau and Lim Goh Tong, Ananda Krishnan and Vincent Tan in Malaysia, and lumber concessions made Mohamad (Bob) Hasan, Prajogo Pangestu and Eka Tjipta Widjaya in Indonesia.

``In Hong Kong and Singapore, real estate became an effective cartel because of the way British colonial regimes structured the land market—selling off "crown land" in large lots that created a barrier to entry for all but a few big players. In the 1990s land packages in Hong Kong were commanding prices of about US$1 billion. The city-states also restricted access to their banking markets, creating other huge rents for local players; the biggest of all went to the institution that is now known as HSBC.

``After access to concessions, access to capital was the second prerequisite of Southeast Asian tycoons. Elsewhere in the region, tycoons used their political influence to secure credit lines from state banks or opened their own institutions, which served as private piggy banks. The Philippines has lurched from one banking crisis to the next for almost a century, some based around state banks and others around private banks set up by tycoons. The country has never recovered from the financial-sector meltdown in the mid-1980s, when Marcos went into exile."

Looking at the roster of publicly listed companies in the Philippines one can observe such traits (state monopolies, cartels, and etc.).

And as a political force, the economic elite is likely to be among the top contributors to financing the present elections. So in our view, the odds for a radical transformation is not imminent and is unlikely to pose as a threat.

Finally, the direction of political winds in the Philippines is likely to get influenced more by our deepening interactions with external forces-particularly, the new free trade zone (with ASEAN and China), China's growing role as a major political force as regionalism deepens, a deeper impact from globalization buttressed by technology and OFWs (or migration flows) and deepening financial globalization which includes transmission effects of inflationism, steep yield curves, bubble policies and etc. as we previously discussed in [Why The Presidential Elections Will Have Little Impact On Philippine Markets]

Since political forces are inherently reactive, the new President will respond to and not determine economic and market actions.

McKinsey's Outlook On Global Banks: Asian And Emerging Markets To Outperform

Here is an interesting outlook on global banks from the McKinsey Quarterly team.

From McKinsey (all bold highlights mine)

One key finding is that the capital shortage triggered by the crisis and recently addressed through several rounds of massive capital raising will endure and get worse. Our scenarios model both the demand for capital (the amount needed to finance projected asset growth and meet regulatory requirements) and the supply (earnings, less the amount likely to be paid out as dividends). In every case, demand exceeds supply. Capital needs will range from small (investment banks, which have already raised significant amounts and are holding substantial buffers, anticipating regulatory change) to vast (emerging-market giants, which will need to finance their growth). In between are the universal banks, which will have modestly challenging capital needs in the midpoint scenario and a very challenging problem in the extreme one.

A second factor weighing on returns will be the high and rising cost of long-term funding.

Several factors are at work here, beginning with a shift in demand. As part of balance sheet restructuring, many banks are cutting back on short-term, unsecured funding (such as commercial paper) and seeking instead to issue longer-dated debt. Demand will also rise as the longer-dated funding currently on banks’ books expires and is renewed. On the supply side, government asset-purchase programs—quantitative easing—are already being retired. Finally, the market will see greater competition for funds, not least from governments that must finance their deficits. All this implies that prices for long-term funding will inexorably rise, shaving as much as several percentage points off ROE, depending on the scenario.

Given these drags on performance, returns will be weak by the standards of the past decade. Worse, they will be highly uncertain—our third finding. In the midpoint case, industry revenues would grow by 5 percent annually through 2014; in the extreme case, the industry would eke out much less attractive annual growth of 1 percent. Under either scenario, the emerging-markets giants come out on top. The story for the other groups of banks is mixed. In the midpoint case, the European and US universals and the investment banks would generate middling ROEs well below their pre-crisis levels. The Japaneseuniversals’ returns would suffer from a poor macroeconomic environment. In the extreme scenario, all but the emerging-market giants will find it extraordinarily difficult to return even their cost of equity. In other words, these banks will face a challenging period reminiscent of the early 1980s.

Our estimates may be cautious. We did not include, for example, the effects of a liability levy such as the one the Obama administration recently proposed. Instead we modeled this proposal separately and found that if such a tax were adopted globally and imposed on the banks in our model, the effect would be to reduce their ROEs by 0.7 to 1.2 percentage points.

A fourth finding confirms the economic evidence of the past several months: the crisis affected emerging markets, especially Asia, less severely than Western ones. Parts of Asia were the last areas to enter into recession and the first to emerge from it—indeed, China’s economy never stopped growing. Asian banks had less trouble with toxic assets and excess leverage than their counterparts elsewhere did. The crisis served to demonstrate that the balance of power shifts abruptly and powerfully rather than gradually; many Asian banks have vaulted to the top of league tables in one go.

Our research confirms that for the next several years, Asia’s economic might will continue to grow, as will the influence and power of its banks. Indeed, in these markets, banking is likely to grow much faster even than the broader economy, because so much of the population is “unbanked.” In both scenarios, all the emerging markets will grow substantially faster than the more mature markets of Europe and North America.

Our last finding stands apart from the rest—and offers a ray of light to many banks. The archetypes constitute a form of destiny: emerging-market giants, riding the back of faster GDP growth, will outperform developed-market universals. In many ways, banking is a leveraged bet on the underlying economy. Yet despite that destiny, banks can do a lot about their performance. The model suggests that within archetypes, differences in performance will be even greater in the future than they are today. The crisis has considerably ratcheted up economic volatility, putting an end to the period some have dubbed “The Great Moderation.” This volatility will amplify the existing differences in performance. Even banks that have been dealt a challenging hand can do much to outperform their peers and reward stakeholders.

Bottom line: global banking is likely to be faced with higher interest rates and an outperformance of Asia and Emerging Markets relative to their OECD peers.

WTO: Little Signs Of Protectionism

In spite of mainstream's implied agitation for "protectionist" measures aimed at alleviating concerns over "trade imbalances", evidence shows that this has hardly been the case when seen from the actions of OECD economies.

Protectionism has been a typical knee jerk reaction to previous crisis, but apparently not this time.

According to a report by WTO, (Reuters)

``The report calls on G20 leaders to reinforce recovery from the crisis by reaffirming their commitment to open markets and putting their many calls for an early conclusion of the Doha trade round into effect.``"The figures we have released today show that G20 governments have, on the whole, managed to contain protectionism. It is clear that if we are to have a sustainable economic recovery we must keep markets open," WTO Director-General Pascal Lamy told Reuters.

``The report, prepared with the Organization for Economic Cooperation and Development (OECD) and the United Nations Conference on Trade and Development (UNCTAD) at the request of the G20, notes that over 200 million people were unemployed in 2009, taking the jobless rate to record levels.``But most G20 countries are managing the political process of keeping domestic protectionist pressures under control, said the report.'

Here is a table exhibiting the tariffs erected during Sept 2009-February 2010 from the WTO

Nevertheless, earlier trade distorting policies imposed by some countries as the US, as in the case of cotton subsidies, are being challenged today.

This from Wall Street Journal, (bold highlights mine)

``Brazil won the right to trade retaliation late last year as a result of a case filed with the WTO in 2002 against an alleged $12 billion in illegal subsidies offered by the U.S. to its cotton industry between 1999 and 2002. The WTO said Brazil could retaliate up to a ceiling of $830 million.

``Brazil argued that the U.S. subsidies distorted cotton market prices and put local producers at a disadvantage, hurting potential Brazilian exports...

``On Monday, Brazil published a list of more than 100 imports from the U.S. that will be subject to higher tariffs under the WTO ruling. It's made up of mostly nonessential consumer products such as cosmetics and electronic devices, but also includes some pharmaceuticals, hospital products, food items, and some bigger ticket imports such as automobiles.

``Brazilian officials estimated the retaliation measures were worth up to $591 million annually. The country is also considering another $238 million in other forms of retaliation such as limits on royalties and intellectual-property rights.

``Jorge said Tuesday that Brazil still hopes to avoid a drawn-out conflict over the matter.

"Nobody is interested in entering a trade war," he said. "We'll be ready to negotiate when called upon."

``Brazil has given the U.S. 30 days to come up with an alternative proposal for dealing with the cotton subsidy dispute before putting the retaliatory measures into effect.

My comment: So with the blessing of WTO, Brazil will now be exerting pressure on US domestic politics. This is likely to result to a compromise at the expense of vested interest groups.

Forces of globalization appears to be gaining an upperhand.

Example Of Propaganda Masquerading As Analysis

This is another example of how economic theories are mangled in order to justify partisan political actions (I call it propaganda masquerading as analysis).

Here is Nobel winner Paul Krugman on Unemployment Benefits (hat tip: Mark Perry)

"From Paul Krugman's recent NY Times column:

``Today, Democrats and Republicans live in different universes, both intellectually and morally. Take the question of helping the unemployed in the middle of a deep slump. What Democrats believe is what textbook economics says: that when the economy is deeply depressed, extending unemployment benefits not only helps those in need, it also reduces unemployment.

``But that’s not how Republicans see it. Here’s what Senator Jon Kyl of Arizona, the second-ranking Republican in the Senate, had to say when defending Mr. Bunning’s position: unemployment relief “doesn’t create new jobs. In fact, if anything, continuing to pay people unemployment compensation is a disincentive for them to seek new work.”

``In Mr. Kyl’s view, then, what we really need to worry about right now — with more than five unemployed workers for every job opening, and long-term unemployment at its highest level since the Great Depression — is whether we’re reducing the incentive of the unemployed to find jobs. To me, that’s a bizarre point of view — but then, I don’t live in Mr. Kyl’s universe. And the difference between the two universes isn’t just intellectual, it’s also moral.

From Paul Krugman's textbook (page 210):

``Public policy designed to help workers who lose their jobs can lead to structural unemployment as an unintended side effect. In other countries, particularly in Europe, benefits are more generous and last longer. The drawback to this generosity is that it reduces a worker's incentive to quickly find a new job. Generous unemployment benefits in some European countries are widely believed to be one of the main causes of "Eurosclerosis," the persistent high unemployment that affects a number of European countries."

My comment: Like lawyers, many economists can "play" two opposing sides of the argument, depending on the "interests" of the "client", irregardless of the validity of the concept.

Why The Presidential Elections Will Have Little Impact On Philippine Markets

In this issue:

Why The Presidential Elections Will Have Little Impact On Philippine Markets

-Patronage Based Political Economy And The Fantasy of Change

-Minor Changes Won’t Cause Mass Uncertainties

-China And Regional Integration As Growing Influences To Domestic Political Trends

-Seasonal Patterns Of The Philippine Presidential Cycle Reflects On Fed Bubble -Policies

-Summary and Conclusion

Last week a friend asked if the upcoming national or the Philippine Presidential elections would have a perverse effect on the domestic market.

My reply is, why so?

Isn’t this what the people want, a “perceived” change in the leadership? So how can such percipient “change” translate to a net negative for the asset markets (stocks, bonds, real estate peso)? This may be true if a radical left leaning (or even a communist) candidate looms likely as the new leader, but this isn’t likely to be the case.

Patronage Based Political Economy And The Fantasy of Change

In the survey of leading candidates that are within the ambit of winning the electoral pageantry, all of them hail from the political elite strata. This suggests that none of them are likely to “rock the boat”, since they have all benefited from today’s environment.

What you and I are most likely to see is only a change of the guards and NOT a change in the welfare based patronage rent seeking system.

It’s equally the typical voter’s delusion to see a “clean” government when an awesome and fantastic eye-popping amount is being spent for the “marketing” these candidates![1]

Common sense or dispassionate reasoning will never add up to the voter’s faith.

Gargantuan money spent for elections are NOT for altruism purposes but as investments that will be recompensed, or translated into returns on investments (ROI), by virtue of covert political privileges: concessions, subsidies, monopolies, rebates, commissions, tacit partnerships etc...

And it isn’t a question about who among the candidate spends most, but about HOW THESE EXPENDITURES WILL BE REDEEMED!!

Does one ever think that the vested interest groups in support of their candidates (or even the candidate him/herself) will be satisfied in merely getting back of their investments once they are successful in capturing the highest office of the land-which incidentally is endowed with a huge discretionary public fund and with the ultimate say on how the swelling public coffers should be dispensed with?

The primary reason for people to invest or risk personal money is to profit from risk opportunities. Since elections are risk opportunities in the political spectrum, so the realistic and commonsensical answer is a NO!

The fact that using directly or indirectly public funds to offset private campaign expenses is most likely to signify largesse from a booty! But who cares? It is usually the political outcast or its “fall guy” equivalent who carries the brunt of “social justice” to somewhat satisfy the expectations of the masses for virtue.

Moreover, in the aftermath of elections, we are likely to see alliances forged from among the opposing camps with the winner. This will be a fodder for publicity that would project magnanimous efforts by the winners to “unify” the nation. In actuality, these will be designed to suppress or contain the opposition, by indirectly buying them by allowing them to recoup campaign expenditures!

Besides since democracy is a popularity contest, isn’t it quite obvious that all candidates will not only ride along with the most popular issues but likewise take upon a centrist or non radical stance just to lure votes?

Public choice economics calls this the “median voter” theorem. William F. Shughart II writes, (bold highlights mine)

``If voters are fully informed, if their preferred outcomes can be arrayed along one dimension (e.g., left to right), if each voter has a single most-preferred outcome, and if decisions are made by simple majority rule, then the median voter will be decisive. Any proposal to the left or right of that point will be defeated by one that is closer to the median voter’s preferred outcome.”

In short, what you see and hear in campaign platforms, isn’t what we are going to get.

People hardly ever learn from history.

Popular Presidents as the current incumbent US President Barack Obama has seen a steep decline in approval ratings in just one year in office.[2]

Former Philippine President Joseph Estrada, who walloped former rivals by a landslide in pluralistic victory in 1998, was ousted in the 2^nd chapter of People Power’s revolution in 2001, about halfway during his tenure.

The former president, who had been pardoned by outgoing incumbent Philippine President GMArroyo in 2007, is now one of the many challenger-aspirants to the crown this May, perhaps in a quest for personal exoneration.

Minor Changes Won’t Cause Mass Uncertainties

It is unfortunate that people can’t seem to differentiate between what truly matters and what has been a longstanding fable.

Wall Street Street Journal Op-ed columnist Daniel Henninger, who argues for a return of the Robber Barrons, aptly identifies on such nuances,

``Market entrepreneurs like Rockefeller, Vanderbilt and Hill built businesses on product and price. Hill was the railroad magnate who finished his transcontinental line without a public land grant. Rockefeller took on and beat the world's dominant oil power at the time, Russia. Rockefeller innovated his way to energy primacy for the U.S.

``Political entrepreneurs, by contrast, made money back then by gaming the political system.”

In other words, Filipinos ought to realize that an environment of political entrepreneurship, the transference or the sucking out of taxpayer’s money from productive market activities to non-productive ventures due to the dispensation of political privileges or patronage economics, will unlikely provide for any material improvements in the system.

It is market entrepreneurship that is required for our economic upliftment.

And once the ball of “political entrepreneurship and paybacks” gets rolling, who or what should serve as “check” to sufficiently restrain abuses? Media?

Unless we are so gullible to “swallow hook line and sinker” the bunkum of media’s puritanical traits, the truth is media is just another self-interested agent that could be laced or infected with partisan politics or embroiled with conflicts of interests with that of public welfare. A recent example is ABC’s reporter Brian Ross caught lying in video in attempt to stage manage his Toyota death ride.

Hence, electing new leaders with fundamentally the same set of guiding incentives to prospective political actions do not actually trigger an abrupt systematic shift in the underlying nature of our political economy.

In short, the old aphorism “the more things change the more they remain the same” will most likely be a realistic application for today’s evolving political trends.

Thus, the outcome from the upcoming elections is unlikely to generate massive uncertainties in the market given the implied policies of continuity.

Yet public expectations from the “lotto” mentality of delusional “change” based on personality based politics will translate to effectively having “the rubber meeting the road” epiphany, post-elections. And this is the principal reason why ratings of populist leaders tend to collapse thereafter. Reality will expose that the emperor is naked.

And that’s why I’d prefer to see a tightly fought election so as to reduce the odds of the winning party to ‘confidently’ impose polarizing radical interventionist measures in the mistaken belief that a popular mandate backs their actions.

China And Regional Integration As Growing Influences To Domestic Political Trends

Figure 1: DBS Research: Changing Composition of Asian Exports

A one major positive (hopefully) structural factor OUTSIDE the range of political elections is that the Philippines, despite being a reluctant participant, has been enlisted in ASEAN’s pursuit of a free trade zone with China[3] (see figure 1)

As you will note from the above chart, the changes in the trade composition of the Asian-8 nations; namely Hong Kong, Taiwan, Singapore, Korea, Malaysia, Indonesia and Thailand aside from the Philippines, has materially shifted- where the chunk of its business is now with China than from the US.

And given this increasing prospects of deepening regionalism, this is likely to also manifest in the direction of regulatory and political trends- hopefully against the prospects of a surprise emergence of a clandestine zealot socialist leader.

This means that China will likely have an increasing influence in shaping our political order at the expense of the US.

This also means that we should expect the course of our domestic political affairs to tilt its balance towards the incremental accommodation to greater integration of trade, finance and investment and migration, with the region, as the opportunities from the ramifications of free trade presents itself.

And this does not entail the need to mimic the Eurozone’s route towards integration, as fund manager Andrew Foster of Matthews Asia writes,

``Developing a unified monetary framework within Asia Pacific is unlikely in light of the region’s history; the region holds too many memories of conflict and mutual distrust. Forging a unified currency out of such a construct is even less likely. However, what may occur is a gradual and de facto harmonization of interest rate cycles, dictated by the business cycles of the largest economies in the region. This may ultimately prove to be a more sustainable union. While a political project would likely fail to get off the ground, Asia’s currencies and interest rate cycles may align based on underlying trade flows, capital markets and other linkages in the real economy.” (bold highlights mine)

So yes, political and monetary integration may not be feasible at the moment, but what matters most is for the economic environment to operate freely.

Although I’d be more optimistic for Asia to adopt China’s yuan (the renminbi) as a regional currency reserve especially once the impact of monetary inflation from OECD policies becomes increasingly evident on the markets. And this will also depend if China has taken the necessary steps to avoid the same path.

China needs to only hasten the convertibility of her currency which implies more liberalization of capital flows to compliment the region’s free trade covenants.

Of course, for us, one possibility to defuse a ballooning endogenous bubble is to allow for liberalized capital flows as money trapped by capital controls has been forced to bid up domestic asset prices. Nevertheless, there is hardly any anti-bubble measure that is likely to succeed for as long as her government continues with its ‘accommodative’ money printing policies.

Meanwhile, I don’t think a political integration is a realizable option for Asia. Perhaps not until there will be cultural immersion and integration from substantially increased migration flows and or intermarriages. Such prospects are likely beyond our lifetime.

I’d also reckon that the new Free Trade Agreements (FTA) as more of open markets/market liberalization measures, as they are not “free trade” in the theoretical sense.[4]

Lastly, based on the above premises, it seems foreseeable that domestic political actions will likely be in response to the pressures extended by external forces, through the evolving changes in the macro picture than from internally impelled initiatives, unless the next batch of political stewards will resist or fight rather than accept these trends.

As economist Peter Boettke writes about Transitional Economies[5], ``The scourge of successful reform efforts is the desire to protect people from the rigors of market discipline. This is as true for the labor force as it is for the entrepreneurial class. Persistence of inefficient organizations and patterns of resource (both capital and labor) use simply ensure that short-term pain is sacrificed for long-term misery and economic deprivation.” (emphasis added)

Figure 2: DBS Research/Philippine Dealing System: Peso And Remittances Hardly A Correlation To Justify Causality

This should be congruent to the political transition of the Overseas Filipino Workers (OFW), whom once had been reckoned as ‘victims’, and now having accumulated a vote rich constituency via their increased contributions to the economy, is now hailed as “heroes”.

The greatly embellished political role of the OFWs have prompted mainstream media and analysts to even exaggerate on the strength of Peso as having been ‘caused’ by remittances; a causation that isn’t even justified by [tight] correlation, as we have time and again debunked[6] (see figure 2)

Seasonal Patterns Of The Philippine Presidential Cycle Reflects On Fed Bubble Policies

As human beings, we have been hardwired to a pattern seeking behaviour. This apparently has been inherited from our ancestors, whom depended on such instincts so as to deal with the harshness of nature, given the primal era, for survivorship goals.

Despite the notable manifold advances in the realm of science and technology, people resort to the same intuitive approaches today. And this can be observed in many accounts, studies or reports from media or from institutional or academic experts which are fundamentally nothing more than schematics based on pattern searching framework masquerading as analyses. There is this propensity to construct paradigms or models similar to natural sciences, even when conditions are different in the context of social sciences, in order to argue or justify for a possible similarity in the assumed outcome.

I have to say that I am occasionally guilty of this too. For instance, I have made much out of the bullish outcome based on the seasonal performances of the Phisix relative to presidential election cycles which seemed quite compelling as argued here before[7] (see figure 3).

Figure 3: PSE: Presidential Election Cycles

The Philippine stock market has boomed after every election, so far.

On an annualized basis, only 2004 produced the most impressive returns with 26.37% gains. The 1992 and 1998 elections produced an uneventful 9% and 5.3% respectively.

One would notice through the red ellipses in the chart that post election returns were quite significant. This means that the gist of the gains all came in the years following the election, except for 1998 which had a truncated honeymoon.

The easy part is to “rationalize” on the newfound confidence awarded to the new leadership.

But I found such explanation as too facile to be true.

This doesn’t explain the outsized movements of the Phisix during the heydays and this also doesn’t adequately clarify on the fleeting glory of 1998. And importantly, in contrast to the mainstream ideology, asset prices don’t get massively overvalued out of overconfidence or “animal spirits”.

In the basic understanding that shifting bubble cycles are products of government policies then this only means that the essence of bubbles are founded on excessive credit or leverage.

Only waves of speculative money from easy money policies could engender such dramatic movements.

With this in mind, the so-called honeymoon or confidence bestowed to a new leadership is likely to be superficial, coincidental and representative of a secondary effect rather from an ultimate cause.

This type of rationalization, which is often used by media or by surface looking analyst is typically known in the behavioural science as the “available” bias.

Well my suspicion appears to have been given some credible evidence.

We found that in every occasion that the Phisix materially rose in conjunction with the aftermath of Philippine Presidential elections, we discovered that US interest rates have been at the bottom of cycle (see figure 4).

Figure 4: Economagic.com: Fed Fund Rates At Bottom As The Phisix Boomed!

All the blue arrows above have corresponded with the red ellipses in the previous PSE chart.

The explanation is that the low US interest rates, mostly in response to a previous crisis, were meant to provide a cushion on asset prices (except in 1980-1986). This has been popularly known as the Greenspan Put or in the definition of wikipedia.org, ``During this period, when a crisis arose, the Fed came to the rescue by significantly lowering the Fed Funds rate, often resulting in a negative real yield. In essence, the Fed pumped liquidity back into the market to avert further deterioration.” (emphasis added)

The cascading Fed Fund rates of 1980-86 were in reaction to the subsiding inflationary pressures (first arrow). This had been followed by the Black Monday crash in the 19^th of October 1987. Incidentally, Black Monday of 1987 proved to be a baptism of fire for the then newly appointed Federal Reserve Chairman Alan Greenspan (August 1987)

Japan’s property and stock market bubble imploded in 1991 which was nearly concurrent with the US Recession of 1990-1991 triggered by the Savings and Loans crisis (second arrow).

The Asian crisis of 1997 rippled into a Russian financial crisis in 1998. Russia defaulted on her debt and subsequently triggered the Long Term Capital Management (LTCM) crisis. The LTCM crisis was resolved by a rescue from Mr. Greenspan’s US Federal Reserve.

The LTCM episode was further compounded by the concerns over what was deemed as a risk of massive dislocations from the computer and automated adjustments to the new millennium (third arrow).

Finally since bubble after bubble popped around the world (this comprised as the periphery), hot money finally thronged back towards the center or the source of munificent money flows (a.k.a inflation).

And this culminated with the bust of dot.com bubble in 2000 (exacerbated by the 9/11 of 2001), which prompted the Federal Reserve to intensely pare down rates which it held until 2004 (fourth arrow).

Put differently, every time the Philippines held a Presidential election, Fed fund rates were coincidentally were at the maximum state of ‘negative real yields’ from which prompted US based hot money to look for asset markets from which it could push.

And the Phisix bullmarket of 1986-1997 simply accommodated the movements of global hot money flows, which apparently provided a boost to the Presidential honeymoon story which turned out to be more a descriptive narrative than a real causal event.

Yet the lowering of Fed Fund rates in 1998, failed to sustain the rally in the local market because the latter had been afflicted by massive malinvestments from the previous boom, and was yet undergoing a market clearing process which extended until 2003 (if measured from the performance of the Phisix).

As a caveat, I don’t have access to the actual data representing the fluxes of money in and out of the Phisix or in the Philippines, prior to 2003. Nevertheless the Asian crisis was blamed by policymakers on speculative capital or hot money and serves as circumstantial evidence on money flows.

Fortuitously, we find ourselves at the same cycle anew.

But this time, instead of simply the US we have major OECD economies in concert with zero bound policy rates. (see figure 5)

Figure 5: Bank of International Settlements: Low Interest Rates Equals Steep Yield Curve

To quote the BIS, [bold emphasis added]

``Expectations that exceptionally low policy rates would prevail for some time in major developed economies meant that banks and other investors could continue to exploit cheap funding and invest in higher-yielding assets. In fixed income markets, yield curves remained extraordinarily steep, highlighting the potential profit from investing long-term with short-term financing (left-hand panel). The taking of such positions may also have contributed to recent downward pressure on long-term yields. Implied volatilities on interest rate derivatives contracts declined further, suggesting that the perceived risk associated with such investments continued to drop (centre panel).

``The combination of higher returns and lower risk meant that such positions were gaining in attractiveness from a risk-adjusted perspective too. Notably, measures of “carry-to-risk”, which gauges return in relation to a risk measure, reached new highs for this type of position (right-hand panel). Given such incentives, one concern was that financial institutions could be taking on excessive duration risk. Once expectations change and interest rates begin to rise, the unwinding of such speculative positions could reinforce repricing in fixed income markets and result in yield volatility.”

As you would note, the record steep yield curves, by artificially lowering of the interest rates, provides a very compelling incentive to get cheap financing over the short term in order to profit from investing or speculating on the long term high yielding assets.

And forcing down rates has created an impression of a stable environment conducive to risk taking.

Essentially you have the seeds of a global bubble in place. Next is to see financial institutions (private or even government institutions) taking on more leverage and this means bidding up asset prices.

Carry trades that arbitrages OECD currencies to invest in high yielding emerging markets like the Philippine Stock Exchange (PSE) or commodities will likely intensify, and other forms of vehicles for leveraging could surface.

Nevertheless, the inflationary bias by global policymakers are very very clear. And this reflects on the revolting fear by central bankers on the prospects of deflation.

As Frederick Hayek once wrote[8], ``the chief source of the existing inflationary bias is the general belief that deflation, the opposite of inflation, is so much more to be feared that, in order to keep on the safe side, a persistent error in the direction of inflation is preferable. But, as we do not know how to keep prices completely stable and can achieve stability only by correcting any small movement in either direction, the determination to avoid deflation at any cost must result in cumulative inflation." [emphasis added]

Summary and Conclusion

In summary, we don’t expect to see any material changes in the Philippine political economy emanating from a change in leadership from the upcoming elections. It’s more about a change of guards than from an overhaul of a system that will still be dominated by the same patronage-rent seeking politics.

Hence, markets are not likely to also reflect on uncertainties by a new face at Malacañang, unless an underdog outside the sphere of candidates among political elites surprises the public.

What would matter more will be the political reactions by the new stewards to the growing influence of external forces. We expect political trends to increasingly be shaped by the free trade zone recently established with our neighbours and with China, aside from the growing foreign policy influence of China in Asia, at the expense of the US.

Finally, it is more likely that zero bound OECD monetary policies will provide traction to the domestic market action than from the results of election. The steep yield curve, from artificially reduced rates induces the public to undertake speculative and encourages international carry trade or currency arbitrages. Such dynamic should underpin the activities in the Philippine Stock Exchange.

One must be reminded that due to the morbid fear of policymakers of deflation, they have inexorably taken an inflationary bias that punishes savers. This is likely to fuel bubble cycles in several parts of the world.

To my mind, the Phisix seems likely a candidate.

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[1] see Philippine Election Myth: "I Am Not A Thief!"

[2] See Popularity Based Politics Equals Waking Up To Frustration

[3] See Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone

[4] "It is a mistake to assume that as long as such conceptions prevail any endeavors to lower the obstacles to international trade could be successful. If the theories in favor of protection and self-sufficiency are considered as right, then there is no reason to bring down trade barriers; only the conviction that these theories are wrong and that free trade is the best policy can shake them. It is inconsistent to support a policy of low trade barriers. Either trade barriers are useful, then they cannot be high enough; or they are harmful, then they have to disappear completely". see von Mises, Ludwig, The Disintegration of the International Division of Labor, Money, Method, and the Market Process, Chapter 9

[5] Boettke Peter, An Austrian Economist Perspective on Transitional Political Economy

[6] See How The Surging Philippine Peso Reflects On Global Inflationism

[7] see Focusing On The Future: the Phisix and the Philippine Presidential Cycle

[8] Boettke, Peter Reading Hayek -- Or Why I Think Monetary Policy Based on Monetary Equilibrium Theory Might Run Into Problems in a World of Central Banking