Should Your Housemaid Invest In The Stock Market?

``Demanding immediate success invariable leads to playing the fads or fashions currently performing well rather than investing on a solid basis. A course of investment, once charted, should be given time to work. Patience is a crucial but rare investment commodity. The problem is not as simple as it may appear; studies have shown that businessmen and other investors abhor uncertainty. To most people in the market place, quick input-output matching is an expected condition of successful investing.” David Dreman, Contrarian Investment Strategies: The Next Generation

Should your housemaid invest in the stock market?

All Actions Are A Function Of Tradeoffs

Recently, I chance upon a message advocating housemaids to invest their money in the stock market. The supposed goal is to help the underprivileged financially by capitalizing on the rising markets.

While I would agree with the underlying motive, the basic problem with this idea is that purported intentions hardly square with reality.

In the real world, all actions have consequences. And actions are driven by the preferences (value scale) and incentives of individuals to seek relief from discomfort.

In short, people’s actions represent purposeful behaviour.

As the great Ludwig von Mises explains[1], (all bold highlights mine)

``Acting man is eager to substitute a more satisfactory state of affairs for a less satisfactory. His mind imagines conditions which suit him better, and his action aims at bringing about this desired state. The incentive that impels a man to act is always some uneasiness. A man perfectly content with the state of his affairs would have no incentive to change things. He would have neither wishes nor desires; he would be perfectly happy. He would not act; he would simply live free from care.”

``But to make a man act, uneasiness and the image of a more satisfactory state alone are not sufficient. A third condition is required: the expectation that purposeful behavior has the power to remove or at least to alleviate the felt uneasiness. In the absence of this condition no action is feasible. Man must yield to the inevitable. He must submit to destiny.”

This means that the consequences of everyone’s action for betterment can have short term or long term effects. Hence, in a world of scarcity, everyone’s action is a consequence of a tradeoff in personal values and preferences.

And one cannot isolate actions taken by individuals from these underlying influences, even from the perspective of impulses.

Again from von Mises[2],

``He who acts under an emotional impulse also acts. What distinguishes an emotional action from other actions is the valuation of input and output. Emotions disarrange valuations. Inflamed with passion, man sees the goal as more desirable and the price he has to pay for it as less burdensome than he would in cool deliberation. Men have never doubted that even in the state of emotion means and ends are pondered and that it is possible to influence the outcome of this deliberation by rendering more costly the yielding to the passionate impulse.”

Take for instance in the recent infamous hostage taking[3] (at the Luneta Grandstand in the Philippines), which has now become a political controversy.

Some have suggested that the actions of the criminal signified that of a fit of rage. True, but again it was choice made from a tradeoff of what the culprit sees as a better way to resolve a personal unease or predicament.

In other words, a choice had been made based on short term time horizon (immediate gratification) which alternatively meant the failure of the felon’s emotional intelligence which paved way for a severe miscalculation that proved to be fatal for him, the victims and politically strained the relations diplomatic between the nationalities involved in the unfortunate incident.

Also there is a suggestion that the perceived depravity of the due process which prompted for the criminal’s misdeeds should be detached. False. Again people are driven by purposeful behaviour where actions and motives are inseparable, interrelated or intertwined, again from the Professor Mises[4], “It is impossible for the human mind to conceive a mode of action whose categories would differ from the categories which determine our own actions”

The point of the above is to show you that people’s choices are ALWAYS based on tradeoffs, all of which comes with intertemporal (occurring across time) consequences, positive or negative, where good intentions can lead to the opposite of the desired goals.

Housemaids And The Bubble Cycle

And how does this apply to the wisdom of housemaids investing in the markets?

The fundamental reason for such advocacy is predicated on the broadening expectation of the linearity of the ongoing trend (see figure 1).

Figure 1: Bloomberg: The ASEAN Bull Market

As earlier explained[5], the ASEAN bullmarket appears to be segueing into what billionaire George Soros calls as the “growing conviction” phase of the boom cycle.

This simply means that as the uptrend becomes more entrenched, people will intuitively flock to where the returns are. In behavioural finance this is called the herding effect or the Herd Behavior.

Indonesia (JCI, green) is the first among the contemporaries to surpass the 2007 highs. All the rest, particularly Philippines, (PCOMP yellow), Malaysia (KLSI, orange) and Thailand (SET, red) appear to be at the threshold of testing their 2007 highs.

The point of my showing the synchronous action of ASEAN markets is to demonstrate that this hasn’t been mainly because of national political-economic issues, but because of other variables UNSEEN by the public or by even most of the experts. Yet among the popular experts, who at the start of the year, predicted that the Phisix will likely break 3,800?

Here is what I wrote in May 2009[6],

``Nonetheless, if the Phisix does end the year above 2,500, we may expect a full recovery (Phisix 3,800) by the end of 2010 or even an attempt at the 5,000.”

5,000 may seem too optimistic but one can’t discount the acceleration of the speed and depth of the shaping bullmarket. Sri Lanka and Bangladesh for instance on a year to date basis is up astoundingly by 73% and 49% respectively, compared to the Phisix at 22%[7] which makes ASEAN bourses look dismal. At any rate, my predictions are mostly becoming a reality.

And where money is seen as being picked up on the streets, even housemaids will, by their volition, perhaps prodded or influenced by their peers or their household employers, will gravitate to “easy money”.

Remember the stock market is a social phenomenon driven by expectations, whether these expectations are valid or not[8].

And the rising tide compels people to make various attributions to market actions, such as economic growth or earnings or mergers and acquisitions, no matter how loosely correlated they are or how little relevance they are with the genuine market drivers. Most of this account for as popular dogmatic fables or widely held superstitions as evidences does not support the causality nexus from such premises.

What has been driving today’s stock markets has been the tsunami of liquidity, or what I have long called as the Machlup-Livermore[9] paradigm, from the coordinated monetary policies by global central banks in an attempt to forestall the “deflation” bogeyman.

And these policies have had relative effects on the marketplace, where areas largely unblemished from the recent bubble implosion appear to have been “positively” influenced. This seems quite evident in the markets of the periphery more than that of the developed economies, from which most of these policies have been directed.

I say positive, in the context, where rising markets are being misconstrued as signs of rising prosperity, which is illusory, when in fact what such dynamic account for is the tacit depreciation of the currency, but presently seen in the dynamic of “asset price inflation”. As we have long said, these are symptoms of the seductive sweet-spot phase of inflation. Heck, why has gold been rising against ALL currencies[10], if this hasn’t been so?

Eventually this illusion morphs into nasty bubbles (see figure2), or at worst, inflation spiralling out of control.

Figure 2: World Bank: Paper Money and Banking Crisis

And it is NO coincidence that since the world went off the quasi gold standard of the Bretton Woods system in 1971 the account of banking crisis globally have exploded.

Why?

Because inflation, as a short term fix is like narcotics, is addicting.

Again Professor Mises[11],

``The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

In short, the paper money-fractional reserve central banking system induces boom bust cycles only shifts around the world. And ASEAN economies, as well as other peripheral emerging economies, seem like candidates to a formative bubble.

And this is why we also have long been saying of a Phisix 10,000[12] or the potential of the Philippine Phisix to reach bubble proportions sometime in the future.

If experts hardly grasp the dynamic of bubble cycles, how the heck do you expect housemaids to understand?

The Housemaid Indicator

Housemaids investing in the stock markets have NOT been unusual. During the acme of the bubble cycle in China in 2008, the onrush of retail punters into stocks, which included housemaids, signified the peak of frenzied activities.

As Shujie Yao Dan Luo of The University of Nottingham wrote in their recent study[13], (emphasis added)

``Most of these investors, which included farmers, cleaners, taxi drivers and house maids, knew little about stock markets and how share prices were determined. Many of these people started investing in the stock markets when prices had already risen rapidly to peak levels, just before the market bubble burst. The participation of these ‘envious’ investors artificially prolonged the bullish market and created a much larger market bubble than would have occurred had they not become involved.”

In short, retail investors GOT SINGED and were left HOLDING THE EMPTY BAG. They accounted for as the FOOL in the Greater Fool Theory.

Former Morgan Stanley analyst Andy Xie describes the “Maid Indicator” as great way of looking at market tops, he says[14],

``Now housemaids are in the market. Who else? Never underestimate 1.3 billion people. In China, they say you should take the shoeshine boy’s advice. Many would listen to him. Welcome to China, the land of getting rich quick.”

In other words, retail money represents unintelligent money. Retail money is mostly drawn into the prospects of free lunches and who turn stock markets into casino-like gambling orgies. They signify as the culmination of irrational behaviour.

A most recent example has been in the US markets, where there has been a pronounced shift of retail investors OUT of stocks and INTO bonds.

And guess what? It would appear that the counterpart of the Maid Indicator or the RETAIL money indicator is accurate (figure 3).

Figure 3: Retail Investors Hardly Gets Investing Right

As the New York Times highlighted on this monumental shift, markets immediately sprung to the opposite direction against the bets of retail money.

As I recently wrote[15], ``I’d suggest that, like always, they are wrong and betting against them (in stocks) would likely be a profitable exercise.”

By the way things are developing, I could be validated anew.

And like my son’s finance professor who initially required that he and his classmates to invest in the stock markets for the semester (four months), to which I argued against, and instead told my son that his professor speak to me, it must be understood that profiting from stock markets is NOT a function of three or four months exposure unless one is positioned as a PUNTER than an investor.

Stock Market investing, like all other successful endeavours requires diligence, perseverance, perceptiveness and patience. And importantly, unlike other professions, it also requires the ability to think independently and to resist social or peer pressures, which alternatively means going against the crowd or popular wisdom even to the risk of ostracism.

For instance the world’s most successful stock market investor Mr. Warren Buffett, at the height of the dot.com boom was labelled a “dinosaur” for avoiding investments in technology companies. In hindsight, he was vindicated. His advice[16], “If you’re applauded, worry. Great moves are usually greeted by yawns.”

The same holds true with the fallacious notion of learning from simulated stock market games. When one deals with “monopoly” play money, the tendency is to GET aggressive because there is no real cost. To lose is simply a game. Yet repeated exposure to simulated games could amplify risk tolerance and aggressiveness at the expense of profit opportunities.

In other words, simulated trading games impart the wrong traits or attitudes in dealing with the financial markets. Since the market is a function of social actions, the understanding of people’s behaviour and the direction of such actions is a MUST.

Yet one must be reminded that since everyone has different value scales and preferences, these can’t be quantified or seen in aggregates, which has been the major flaw of mainstream economics.

Investing Is NO Free Lunch

Let me be clear with my position, I am not opposed to ANYONE, including maids, from engaging the markets. What I am vehemently opposed with is the idea of free lunches as path to prosperity.

Anyone who engages in the markets must be capable to deal with the intertemporal tradeoffs between risks and rewards.

Because every action has a consequence, the inability to reckon with such tradeoffs could translate into future losses far greater than any interim gains.

Another thing which I am rabidly opposed with is the pretentious morality of uplifting the underprivileged by advocating unnecessary exposure on the stock markets when the participants are under qualified to comprehend or imbue on the attendant risks involved.

To expose people to future losses which could be far greater than the current gains defeats the goal of social advancement.

Just ask the horde of speculators of the US housing bubble who had been apparent “victims” of Federal Reserve and US government policies. They who profited at first have now been suffering from the losses out of excessive speculations. These gullible participants were lured and abetted by the immoral policies of turning stones into bread.

Yet failed policies do NOT exonerate the individual’s recklessness because many have seen the potential impact of bubble policies prior to the bust per se. Warnings were unheeded because of the enticements of social pressure and the seeming perpetuation of rising prices.

And such consequentialist notion where “the ends justify the means” or the consequences of actions serving as moral propriety also fails to account for the tradeoff between present and future ramifications from such actions. Teaching housemaids to engage in risky ventures without the necessary understanding of risks is tantamount to gambling.

Another way to say it is that the reorientation of people’s behaviour towards reckless undertakings which is likely to result to adverse consequences is not morally justifiable nor is gambling, in anyway, going to create financial upliftment.

If the retail under qualified entities (housemaids, drivers or low skilled workers) insists on investing in the financial markets, then the right approach would be to let experts handle their money via mutual funds or UITF (Unit Investment Trust Funds) or through pooled discretionary accounts with able and qualified fund managers.

Yet, even if the experts do manage their accounts, the communication of the tradeoffs between risks and rewards should be a prerequisite or a sine qua non for the simple reason of harmonizing the expectations of the client and managers.

Unmatched expectations are often the root of most conflicts. In the financial markets, expectations in time preferences could be a principal source friction for a principal-agent relationship.

Thus, we go back to the simple operating precept: investing is NO Free lunch, period. That has to be understood by both retail investors (housemaids) and fund managers. Anybody who says otherwise is either being untruthful or deceiving oneself or the other party.

Beware of false prophets.

---

[1] Mises, Ludwig von The Prerequisites of Human Action, Human Action Chapter 1 Section 2

[2] Ibid

[3] See The Bloodbath At Rizal Park Hostage Drama Demonstrates The Pathology of Government, August 24, 2010

[4] Mises, Ludwig von The Alter Ego Human Action Chapter 1 Section 6

[5] See How To Go About The Different Phases of The Bullmarket Cycle, August 23, 2010

[6] See Kentucky Derby And The Global Stock Market, May 10 2009

[7] See Global Stock Markets Update: Peripheral Markets Take Center Stage, September 4, 2009

[8] See A Primer On Stock Markets-Why It Isn’t Generally A Gambling Casino, January 9, 2009

[9] See Are Stock Market Prices Driven By Earnings or Inflation?, January 25, 2009

[10] Gold.org, Daily gold price in a range of currencies since January 2000

[11] Mises Ludwig von, The Market Economy as Affected by the Recurrence of the Trade Cycle, Chapter 20 Section 9

[12] See Phisix 10,000:Clues From Philippine Bond Offering, July 15, 2009.

This has been a long held prediction of mine even prior to the last bubble cycle. The 2007-2008 bearmarket I had interpreted as a countercyclical trend in a secular uptrend. The current underlying secular trend reverses once the bubble dynamic, cultivated domestically, implodes. This has NOT been the case in the 2007-2008, which was largely a function of global contagion. This also why fundamentals (economic performances, earnings, etc..) and market actions went on the opposite ways serves as proof of the disconnect between popular wisdom and reality.

[13] Yao, Shujie and Lou, Dan Chinese Stock Market Bubble: Inevitable Or Incidental? University of Nottingham

[14] Investmentmoats.com, Andy Xie: Housemaid indicator says Chinese Bubble near to burst, April 28, 2010

[15] See US Markets: What Small Investors Fleeing Stocks Means, August 23, 2010

[16] KPMG.com "If you're applauded, worry"

Global Stock Markets Update: Peripheral Markets Take Center Stage

Going into the last quarter of the year, Bespoke Invest has a great snapshot of what has been happening in global stock markets.

From Bespoke Invest, (bold highlights mine)

The average year to date change for all 82 countries is 5.39%, while the median change is 2.23%. The S&P 500's year to date change of -1.24% is obviously below both of these. The US currently ranks 53rd out of 82 in terms of 2010 performance. At the top of the list is Sri Lanka with a 2010 gain of 73.69%. Bangladesh ranks second at 49.37%, followed by Estonia (41.94%), Ukraine (40.86%), and Latvia (40.26%).

India has been the best performing BRIC country so far this year with a gain of 4.33%. Russia ranks second at 1.42%, Brazil ranks third at -2.43%, and China is down the most at -18.97%. Canada is currently the top G7 country with a gain of 3.26%. Germany and Britain are the other two G7 countries that are up year to date, while Japan is the G7 country that is down the most year to date (-13.58%). Overall, Bermuda has seen the biggest losses this year with a decline of 38.25%. Greece is the second worst at -24.56%.

Additional comments:

1. Global stock markets are MOSTLY higher from a year-to-date basis, be it in terms of average or median changes or in nominal distribution (53 up against 29 down). This hardly evinces of the ballyhooed “double dip”.

2. The best performance has been at the periphery (as previously discussed), particularly in emerging South Asia, the Baltic States (Estonia have been a favourite since she has adapted a laissez faire leaning approach in dealing with the most recent bubble bust) and ASEAN.

This appears to be manifestations of the “leash effect” from policy divergences.

3. The BRICS has underperformed, but that’s because of last year’s outperformance. This excludes China, whose markets have repeatedly been under pressure from government intervention. I expect the BRICs to likewise pick-up, perhaps at the end of the year or in 2011 (perhaps including China).

4. Major East Asian economies have likewise underperformed. But this appears to reflect on the actions of major OECD economies.

Overall, what we seem to be seeing has been a spillover dynamic from the prodigious liquidity generated from coordinated global monetary policies into the peripheral markets. It’s the impact of inflation on asset prices on a relative scale. In addition, this also reflect signs of the allure of inflation’s “sweet spot” phase, especially for the peripheral markets.

As a caveat, while stock markets do resemble some signs of “decoupling”, such divergences can be deceiving.

Decoupling can only be established once the US goes into a recession while peripheral markets and their respective economies ignore this.

Yet, I doubt this will occur.

The Inflating Bubble In The Global Currency Markets

The mainstream says there has been NO inflation or inflation hardly poses as a risk.

Unfortunately this view ignores the relative and uneven effects of inflation on the markets and the economies.

Usually, the initial manifestations are seen in the asset markets.

And at present, the currency markets looks like a key absorber of inflationism (aside from US treasuries).

According to the Wall Street Journal,

``The $4 trillion mark represents a 20% gain from $3.3 trillion in 2007, the last time the global foreign-exchange markets were surveyed, according to the Bank for International Settlements. While the survey found continued growth in currency trading, it did reflect a slowdown in the market's growth from the prior survey, when trading volumes had soared 69% from $1.9 trillion in 2004.”

So money printing worldwide seems to be getting a new outlet as more and more people trade a wider dimension of currencies.

Again from the WSJ (bold emphasis mine)

The survey showed how investors are seeking out faster-growing economies and big commodity producers. Trading volume between the U.S. dollar and the Australian dollar rose 35% from 2007, and volume with the Canadian dollar was up 44%. Trading also jumped in the Indian rupee, Chinese yuan and Brazilian real. In contrast, trading in the U.S. dollar against the British pound, a mainstay of the currency markets, fell 6%. Trading in the euro against the dollar rose 23%.

It’s not just globalization of trade, but globalization of asset inflation.

Of course, the US dollar remains as the de facto currency pair of most currency trades.

Again the WSJ (bold highlights mine)

Overall, the U.S. dollar remained the dominant global currency. It accounted for 84.9% of transactions, down from 85.6% in 2007. The euro's share rose to 39.1% from 37%. The share count data add up to 200%, to reflect the fact that there are two currencies in each transaction.

One should note that the trading the currency market means exposing oneself to highly leveraged positions.

The WSJ,

Currently, investors can borrow $100 for every dollar they invest. The Commodity Futures Trading Commission, which regulates foreign-exchange trading in the U.S., tried to cut that amount to $10.

And that again they are mostly used by financial institutions, the WSJ... (bold emphasis added)

The foreign-exchange market is actually a network of bank dealers and electronic-trading systems. At its core are investors or corporations needing to convert one currency into another, either as they buy or sell a stock or bond from another country or bring home profits earned abroad. For example, any time a U.S. investor buys a Japanese stock or a German company buys parts from a Korean supplier, a foreign-exchange trade occurs.

Banks are also heavy users of the currency markets to convert cash they borrow from foreign investors. Mutual-fund managers overseeing portfolios of foreign stocks may use currency derivatives to offset the impact of exchange-rate swings on those investments. And finally, there are speculators, such as hedge funds and mutual funds, who place bets on whether individual currencies will rise or fall.

Derivatives, carry trade and all those sophisticated and complex arbitrages which played a major role in the last bubble bust seems to be a significant contributor to the explosion of the volume trades in the currency markets.

For a broader perspective, the WSJ provides us with a comparison of the currency markets with other financial markets...

The currency market is by far the world's largest financial market. It dwarfs U.S. stock trading, which in April averaged about $134 billion a day, down from a daily average of $148 billion in 2007, according to data compiled by the Securities Industry and Financial Markets Association. Even trading in U.S. Treasurys, among the biggest markets in the world, averaged $456 billion a day in April, down from an average of $570 billion for all of 2007.

Now small investors are increasing their foreign-currency exposure. They are piling into mutual funds which make bets on currencies as a core part of their strategy. More broadly, U.S. stock mutual funds that invest overseas have taken in $42 billion over the past year, according to Morningstar Inc.

So the ingredients of a bubble seem all in place: high leverage, massive interventions, complex instruments and irrational behavior.

Is Sound Money Incompatible With Democracy?

One of the recent feedbacks I received is the attribution that sound money can’t be compatible with democracy. The implication is that inflationism is an indispensable instrument for democratic survival.

Of course, this assertion accounts no less than an arrant bunk (nonsense) for the following reasons:

One, this serves as an example of argumentum ad populum (appeal to popularity), where the belief of the many holds that the argument is true.

Just because many seek to live off at the expense of the others this doesn’t mean that their demands are necessarily justifiable or valid and should be provided for.

This is similar to the unwisdom of the crowds which we have recently critiqued. Moreover, these proponents seem oblivious to the fact that populist policies tend to self-destruct overtime. What is unsustainable won’t last.

Second, the alleged incompatibility is also misleading because this operates on the premises of the 'tyranny of the majority' or the rule of the mob.

Say for example, 10 persons get stuck in a remote island where only one of them is a woman. Yet 6 of the male elected to force themselves on her. Is the majority’s action justified? The answer is obviously NO. The means to an end isn’t justified by mere numbers.

What is needed is the rule of law, of which inflationism chafes at.

As Friedrich A. von Hayek wrote in the Decline of the Rule of Law, Part 1

The main point is that, in the use of its coercive powers, the discretion of the authorities should be so strictly bound by laws laid down beforehand that the individual can foresee with fair certainty how these powers will be used in particular instances; and that the laws themselves are truly general and create no privileges for class or person because they are made in view of their long-run effects and therefore in necessary ignorance of who will be the particular individuals who will be benefited or harmed by them. That the law should be an instrument to be used by the individuals for their ends and not an instrument used upon the people by the legislators is the ultimate meaning of the Rule of Law.

Three, the collectivist charade is to sell popular wisdom to the economic ignoramus. The collectivists forget to tell everyone that inflationism is a redistribution scheme which benefits the minority at the expense of society.

As Jörg Guido Hülsmann wrote in Deflation and Liberty (emphasis added)

``Inflation is an unjustifiable redistribution of income in favor of those who receive the new money and money titles first, and to the detriment of those who receive them last. In practice the redistribution always works out in favor of the fiat-money producers themselves (whom we misleadingly call central banks) and of their partners in the banking sector and at the stock exchange. And of course inflation works out to the advantage of governments and their closest allies in the business world. Inflation is the vehicle through which these individuals and groups enrich themselves, unjustifiably, at the expense of the citizenry at large. If there is any truth to the socialist caricature of capitalism—an economic system that exploits the poor to the benefit of the rich—then this caricature holds true for a capitalist system strangulated by inflation. The relentless influx of paper money makes the wealthy and powerful richer and more powerful than they would be if they depended exclusively on the voluntary support of their fellow citizens. And because it shields the political and economic establishment of the country from the competition emanating from the rest of society, inflation puts a brake on social mobility. The rich stay rich (longer) and the poor stay poor (longer) than they would in a free society.”

Fourth, what collectivists see as essential is actually the opposite. History reveals that democracy and sound money has had and can have a symbiotic relationship.

In The Gold Standard, Indirect Exchange section of the epic Human Action, Ludwig von Mises wrote, (bold emphasis mine)

``The gold standard was the world standard of the age of capitalism, increasing welfare, liberty, and democracy, both political and economic. In the eyes of the free traders its main eminence was precisely the fact that it was an international standard as required by international trade and the transactions of the international money and capital market. It was the medium of exchange by means of which Western industrialism and Western capital had borne Western civilization into the remotest parts of the earth's surface, everywhere destroying the fetters of age-old prejudices and superstitions, sowing the seeds of new life and new well-being, freeing minds and souls, and creating riches unheard of before. It accompanied the triumphal unprecedented progress of Western liberalism ready to unite all nations into a community of free nations peacefully cooperating with one another.”

Finally, the hucksters of false promises of inflationism are no less than blinded by economic dogma whose foundations seem to operate outside the realm of the law of scarcity—yes fantasyland.

As Ron Paul wrote on Why Governments Hate Gold, (bold emphasis mine)

``Time and again it has been proven that the Keynesian system of big government and fiat paper money are abject failures in the long run. However, the nature of government is to ignore reality when there is an avenue that allows growth in power and control. Thus, most politicians and economists will ignore the long-term damage of Keynesianism in the early stage of a bubble when there is the illusion of prosperity, suggesting that the basic laws of economics had been repealed.”

Hardly does any of these fanatics have ever explained why throughout the centuries, experiments with paper money has ALWAYS failed.

Of course if one believes redistribution is a way or a path to prosperity, then apparently they are merely deluding themselves.

As Henry Hazlitt once wrote,

Any attempt to equalize wealth or income by forced redistribution must only tend to destroy wealth and income. Historically the best the would-be equalizers have ever succeeded in doing is to equalize downward. This has even been caustically described as their intention.

The collectivists amuse us with their logical fallacies, incoherent theories, misleading definitions, short term nostrums, and misinterpretation and deliberate twisting of facts.

For them it’s not about being right, but about blind faith.

Beware of false prophets.

More Taxes Equals More Revenues?

More Taxes Equals More Revenues?

Not so fast.

The fundamental law of economics are always at work to defy conventional wisdom.

Here is a great example.

From Reuters, (bold highlights mine)

Cash-strapped Bulgaria and Romania hoped taxing cigarettes would be an easy way to raise money but the hikes are driving smokers to a growing black market instead.

Criminal gangs and impoverished Roma communities near borders with countries where prices are lower -- Serbia, Macedonia, Moldova and Ukraine -- have taken to smuggling which has wiped out gains from higher excise duties.

Bulgaria increased taxes by nearly half this year and stepped up customs controls and police checks at shops and markets. Customs office data, however, shows tax revenues from cigarette sales so far in 2010 have fallen by nearly a third.

"The government created something unique. We actually now have a whole industry that provides for a big group of people," said Tihomir Bezlov of anti-corruption think-tank Center for the Study of Democracy.

Cato’s Dan Mitchell calls this the wonkish Laffer Curve at work.

But I like Professor Mark Perry’s simple quote, “If you tax something, you get less of it”

The higher the taxes, the likelihood of a larger informal economy, smuggling, corruption and inefficient allocation of resources as shown above.

Even the IMF has pointed this out as we have shown in an earlier post

Signs of Bond Bubble: Clashing Price Dynamics of US State CDS And The Treasury Market

Here is an example of the market’s current cognitive dissonance.

In the US, as many as 5 states appear to be having serious credit problems and are presently being reflected on the Credit Default Swaps (CDS) or the cost to insure a bond.

One might say that they are the US equivalent to Europe’s version of the PIIGS. We made an earlier similar observation here.

According to Bespoke Invest (chart also from them),

The number next to each state represents the cost per year to insure $10,000 worth of state bonds for 5 years. The higher the price, the higher the default risk. As shown, Illinois has the highest default risk of all states at 303.2 bps -- even higher than California. California ranks 2nd, followed by Michigan, New York, and New Jersey. Not to anyone's surprise, these are basically the five states in the country with the biggest fiscal problems at the moment. States that appear to be in pretty good shape include Texas, Virginia, Maryland, and Delaware.

As you can see the credit problems are NOT being reflected on US treasury yields (10 year TNX), which seem to ignore the developments in the CDS markets.

In contrast, the Eurozone recently had a fit of convulsion over the Greece-led PIIGs episode.

And instead, the US sovereign papers are seen “safety” assets where an ongoing onrush appears to be taking place as the mainstream hollers about “deflation (!)”.

In short, you have two markets seemingly headed for a collision course. This means one of them is decisively wrong.

For me, this represents part of the massive distortions engendered by interventionism. And vastly skewed prices have been misleading investors (led by the retail-dumb money). The treasury markets increasingly look like a time bomb, in the perspective of a ‘bond bubble’, set to implode.

The other way to say it is that if those credit woes exacerbate, then eventually, they will be vented on the treasury markets.

Caveat emptor.

The Road To Inflation

``The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptising it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.”-Ludwig von Mises

As expected, like the dogs in Pavlov’s experiment, US markets passionately cheered on the assurances provided by the US Federal Reserve to provide support to her economy even by possibly resorting to unconventional means or by taking the nuclear option to the table.

In a speech last Friday, Chairman Ben Bernanke[1] said that the Federal Reserve ``is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly”. (emphasis added)

US markets, of late, has been reeling from successive weekly losses giving rise to intensifying anxieties over a re-emergence of another recession or what many calls as “double dip recession”.

And for the mainstream, the prospect of another bout of ‘deflation’ has provided them with the ammunition to demand for more intervention from her government.

Unfortunately, as we have been repeatedly saying, inflationism is simply unsustainable. Like narcotics, it will always have soothing effects that are ephemeral in nature, but whose repercussions would always be nasty, adverse and baneful that would result to capital consumption or a lowered standard of living emanating from the unravelling of malinvestments or the misdirection of resources and on relative overconsumption. And at worst, persistent efforts to inflate could lead to a breakdown of the monetary system (hyperinflation). The 2007 US mortgage crisis had been a lucid example of the boom bust cycles from inflationism yet the public refuses to learn.

And since the time preferences of the masses are mostly directed towards the short term, the elixir of inflationism always sells. The illusion of free lunch policies is just too beguiling to reject.

As Ludwig von Mises once wrote[2], ``The favour of the masses and of the writers and politicians eager for applause goes to inflation.”

And such dynamics is exactly how the present environment operates.

Economic Hypochondria

Figure 1: Danske Bank[3]: Worries Are Intensifying

And as we previously noted[4],

For the mainstream, anything that goes down is DEFLATION. There never seems to be within the context of their vocabulary the terms as moderation, slowdown and reprieve. Everything has got to go like Superman, up up up and away!

The weakening of some economic indicators such as the manufacturing index has led many to envision the same scenario as in 2008 (see figure 1). But this seems more like an economic hypochondria, where the apparent infirmities today seems more like a manifestation of the countercyclical or reactive forces following a V-shape spike in 2009 (right window). The point is NO trend goes in a straight line.

And also this seems to be an extension of the Posttraumatic Stress Distorder (PTSD) which we accurately exposed on the mainstream’s false attribution on the crisis as being prompted by the lack of aggregate demand in 2009[5].

The follies from the same cognitive biases have reared their ugly heads, or perhaps have merely been used to justify government’s actions.

The main mistake of the mainstream is to ignore the interplay of relationships, in terms of stimulus-response action-reaction, between markets or the economy on the one hand and the policy actions from the government on the other.

The mainstream believes that ALL human actions are uniform and consequently discern linearly from such premises. They disregard the diversity of human actions which encapsulates the markets/economy and the political leadership, as well as the bureaucracy which incidentally government is basically run by human beings too. The difference lies in the incentives which drive their respective actions.

Inflationism To Protect The Banking Cartel and Gold’s Status

True, the US housing sector reveals renewed feebleness (left window). But this again is a manifestation of the failure of inflationism or the waning temporal positive effects, where the US government has tried to keep prices from reflecting the natural ‘market’ levels by using manifold interventions such as the manipulation or artificial suppression of the interest rates, quantitative easing (or printing of money), the tweaking of the accounting standards (Financial Standards Accounting Board reversed itself on FAS 157[6]), and the substantial exposure of GSE (Government Sponsored Enterprises) as Fannie Mae and Freddie Mac which currently accounts for $5.7 trillion of the $11 trillion market and provides 75% of the funds in the mortgage market[7].

In my view, whereas the official declaration (propaganda) has always been about the economy (social good), this conceals the true intent, which is to provide support and redistribute taxpayers resources to the banking cartel, whose balance sheets have been stuffed with toxic assets and thus the seeming stagnation in credit conditions.

True, the Federal Reserve has absorbed considerable part of questionable assets via the massive expansion of her balance sheets, but without the sustained redistribution from the US taxpayers to the cartel via more inflationism, this would extrapolate to the collapse of the fractional reserve banking system. Hence, the underlying economic moderation in the economy is sold to the public as requiring more inflationism.

As Murray N. Rothbard wrote[8],

It should be clear that modern fractional reserve banking is a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts

And the market seems to be validating such an outlook (see Figure 2)

Figure 2: Deflation? Recession? Not Quite (from stockcharts.com)

First of all, as said above we don’t believe that the US is anywhere near a recession. The gold market seems to be saying so.

We don’t believe gold is a deflation hedge. The recession of 2008 clearly indicates this phenomenon as gold’s prices materially fell along with the bear market in the S&P 500 and the strength in the US dollar or the obverse weakness of the Euro (green circles).

So gold does not elude the forces of recession, much more the forces of deflation as signified by the collapse of prices of gold along with all the other markets as the effect of the Lehman bankruptcy rippled in October of 2008.

And those making a comparison of gold’s performance during the depression days of the 1930s have only been looking at patterns without noting of the differences in the underlying conditions.

Gold during those days had been part of the monetary system. It was a gold standard then until its temporary suspension following the enactment of the Gold Reserve Act of 1933[9]. Today gold is only part of the assets of central bank reserves. It is only now where gold has seen increasing recognition as ‘store of value’ among global central bankers as gold prices continue with its winning streak[10]. So in accordance to the reflexivity theory, prices changes have been influencing the fundamental factors surrounding gold.

And also today, we have a fiat money standard backed by nothing but empty promises of government to settle.

The Function of Market Prices

Second, those “tunnelling” or obsessively fixated at the treasury markets who scream “deflation” have been misinterpreting markets.

The treasury markets have been the one of key targets of interventionism. The other way to say it is that the prices of US treasury do NOT reflect activities of free markets in relative terms as compared with gold (main window), the Euro (XEU) and the S&P 500. This means prices represent distorted or highly skewed or artificial information.

This seems apparent with indications that small or retail investors have been fleeing the US stock markets and have been gravitating into the bond markets[11]. Yet these are likely symptoms equivalent to the Pied Piper of Hamelin[12] leading the rats to their perdition as they interpret erroneously current price signals to represent reality.

We are reminded of the unwisdom of the crowds[13] which we recently wrote about, and would quote anew Gustave Le Bon who wrote[14] ``The Masses have never thirsted after truth. They turn aside from evidence that is not to their taste, preferring to deify error, if error seduce them. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusion is always their victim.”

The crowd has been seduced by the siren song of government propaganda called “deflation”.

Remember prices serve not only as information to account for the relative balance of demand and supply, prices are the most essential tool for economic calculation.

According to Gerard Jackson[15],

``Without market prices it is impossible to engage in economic calculation and thus have a rational allocation of resources. Now the market is a coordinating process that assembles fragments of continuously changing information from millions of people; information that can only be known to them personally and expressed as preferences. The market transforms these preferences into prices which then act as signals to producers and consumers. It is this process that enables consumers to achieve the best possible outcome. If a socialist had invented the market it would have been hailed as one of man's greatest achievements. At any time there is always a configuration of prices determined by market data each price is closely interrelated with the others. No price is independent or exists in isolation. It therefore follows that to interfere with one price means interfering with others. Another fact the significance of which ardent price controllers and their supporters cannot seem to grasp. (bold emphasis mine)

Importantly, prices represent property rights which allows for voluntary exchanges between parties to happen that leads to social cooperation.

Bettina Bien Greaves says it best[16],

``Without private property, there would be no private owners bidding for goods and services, and no exchanges among real owners. Without private owners, each guided by the desire for profits and the fear of losses, there would be no market prices to indicate what people wanted and how much they were willing to pay for it. Without market prices, there would be no competition and no profit-and-loss system. And without a profit-and-loss system, there would be no network of interrelated, consumer-directed, independent producers. Without private property, competition, market prices, and a profit-and-loss system, the planners would not know what to produce, how much to produce, or how to produce it.” (emphasis added)

Thus, marginal utility (the cardinal order of want satisfaction or the scale of values), time preferences, rationing, coordination, the dynamic process of spontaneous order in the marketplace and property rights are all jeopardized when government undertakes interventionism or inflationism.

At worst, interventionism represents an assault on private property, which consequently means an attack against civil liberty.

In addition, it is important to recognize that ALL bubbles (boom-bust) cycles have been engendered by the illusion of perpetually rising prices which mainly accounts for the massive systemic distortions built from a variation mix of interventionism channelled via interest rates or monetary policies, tax policies, administrative and legislative policies all of which may combine to encourage irrational behaviour fuelled by credit expansion.

Figure 3: St. Louis Fed: Loan Conditions of US Commercial Banks

Another, I’d be careful to listen to pay heed to experts who claim that the US credit system remains totally dysfunctional (see figure 3).

At this time when the mainstream has been audibly shouting “deflation!”, bank credit of all commercial banks (upper window) seems to be ramping up.

Moreover, while commercial and industrial loans remain depressed, on an annual rate of change basis, we seem to be seeing a bottoming phase (middle window). To add, consumer loans at all commercial banks remain buoyant (lower window).

So in my view, industrial loans still remains problematic or has been the laggard, but may have already bottomed out which could likely see some improvement over the coming months.

Now if all these credit activities advances as I had long expected them to, mainly as a function of the belated effects of the yield curve[17], all the monster excess reserves held by the commercial banks at the Federal Reserve could simply turn into massive inflation. And this would be the rude awakening for the mainstream.

Therefore, deflation, for me, is no more than political propaganda, made by the major beneficiaries—the government and their clique of institutional and academic “experts”, in order to justify inflationism or extend more government control over our lives.

It would be foolish for people to simply read through economics without comprehending the indirect implications of the actions by the incumbent political leaders.

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[1] Bernanke, Ben The Economic Outlook and Monetary Policy, Speech Given At the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 27, 2010

[2] Mises, Ludwig von The Import of the Money Relation, Human Action Chapter 17 Section 10

[3] Danske Bank, Weekly Focus, August 27, 2010

[4] See Why Deflationists Are Most Likely Wrong Again, August 15, 2010

[5] See What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis, February 1, 2009

[6] North, Gary Translation of Bernanke's Jackson Hole Speech, marketoracle.co.uk August 28, 2010

[7] Laing, Jonathan What's Ahead for Fannie and Fred? Barron’s online, August 28, 2010

[8] Rothbard, Murray N. Mystery of Banking p. 97

[9] Wikipedia.org History of the United States dollar

[10] See Is Gold In A Bubble? November 22, 2009

[11] See US Markets: What Small Investors Fleeing Stocks Means, August 23, 2010

[12] Wikipedia.org Pied Piper of Hamelin

[13] See The UNwisdom Of The Crowds, August 15, 2010

[14] Le Bon, Gustave Le Bon, The Crowd The Study of the Popular Mind, p.64 McMaster University

[15] Jackson, Gerard Are price controls on the way? Brookesnews.com December 29, 2008

[16] Greaves, Bettina Bien A Prophet Without Honor in His Own Land, Mises.org

[17] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010

Market’s Seasonality Accentuated By Macro and Political Developments

``All political theories assume, of course, that most individuals are very ignorant. Those who plead for liberty differ from the rest in that they include among the ignorant themselves as well as the wisest.” Friedrich A. von Hayek

In my opinion the effect of the prospective US government actions to shore up her banking system, aside from the other factors is likely to work against the expectations of the consensus.

Yet if seasonality performances would be our guidepost, assuming a certain material degree of accuracy, then September for the US markets could see some extension of the current weakness while October through December could likely be the strongest months (see figure 4).

Figure 4: Chart of the Day[1] /US Global Funds[2]: Seasonality of The Dow Jones and Mining/Metal issues

In other words, for the US markets, September could signify as a viable buying window for a 6 months trading opportunity.

Now of course, while any assessment of seasonality factors should be taken with some degree of caution, as patterns should NOT be interpreted from a single dimension, I’d say that based on the belated effects of the yield curve, the seasonality pattern could possibly play out because it would NOT only be backed only by statistical percentages (of patterns) but by four other factors as:

-the high likelihood of markets factoring in an improvement in general credit conditions,

-the bottoming of the current slowdown of the growth cycle or a pick up in the recovery phase from the current slack

-and importantly, the impact of global policies (steep yield curve) on inflation could intensify on the markets (oil $90-100?).

-outside the yield curve, one shouldn’t discount the realization of another set of quantitative easing as the political authorities resolve to shore up their banking system. As caveat, all current actions will have future negative ramifications.

And it would also seem that our observation about the rotational effects to the mining sector isn’t limited to only the Philippine markets[3] as US markets appear to highlight the same cycle (right window).

Outside of the recession of 2007-2008, the mining and the metal sector has had pronounced gains during the last 12 years, as gauged by sector’s annual performances over the last FOUR months of every year. As the commodity boom was enhanced during 2003-2006 boom cycle, this had similarly been reflected on the mining and metal issues.

We should see a redux of the same dynamics probably with accelerated momentum.

So the policy divergences between emerging markets and the major developed economies and the prospective money printing measures by the Ben Bernanke and US Federal Reserve which is likely to flood the world again with liquidity should lend support or drive up emerging market stocks and commodities.

And I’d recommend that any interim price weakness of mining issues as opportunities to accumulate for trade or to position against the emergence of the broadening impact of consumer price inflation.

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[1] Chartoftheday.com, Dow Jones Average Monthly Gain

[2] US Global Investors, Investor’s Alert- August 27, 2010

[3] See How To Go About The Different Phases of The Bullmarket Cycle, August 23, 2010