Capitalism And World Peace

Here is a wonderful Christmas gift for humanity: World peace!

Citing a study from the Human Security Center at the University of British Columbia, the Democratic Leadership Council (DLC) notes that the world has become more peaceful

Their observations (from DLC): (italics original)

Wars are less frequent: The Center's 2009/2010 report group finds 34 conflicts, including 5 international wars in Afghanistan, Iraq, and the Congo Basin. This is a lower total than at any time since the 1970s, reflecting the fact that warfare in Europe has almost vanished, with exceptions in the Caucasus; and that the numbers of wars in East Asia, Southeast Asia, and Latin America have also plummeted. And despite the Iraq, Afghan, Somalia and Yemen conflicts, the Center argues that wars in the Muslim world are rarer too, reporting a decline of 70 percent in the scale of conflict in these regions.

Great-power wars are rare: No war has pitted great powers -- meaning any of the world's 10 biggest economies -- against one another since the Sino-Soviet clashes of 1969. No war among Asian states has broken out since the Sino-Vietnamese war of 1979; the last war among European big powers is now 65 years in the past. All three intervals -- the great-power, the European, and the Asian -- are the longest periods of peace in the historical record.

Wars are less bloody: The report, reviewing the grimmest statistics, finds that the average war in the 1950s killed 20,000 soldiers and/or guerrillas each year, with war deaths averaging 155,000 in each year of the decade. Figures for the 1960s, 1970s and 1980s were similar. In the new millennium's first decade, the casualty rate was about 3,000 per war; the average for all wars combined, having fallen to 95,000 by the 1990s, has been 27,000 (and 17,000 annually since 2002, with an all-time low of 11,000 in 2005.)

The identified socio-political reasons: (all bold emphasis mine)

Some are political and military: (a) decolonization and the end of the Cold War mean there are fewer nationalistic or ideological reasons to fight, (b) the spread of democracy may produce less belligerent governments, (c) today's great powers are both less bellicose and less vulnerable than they used to be, with armies, air forces and navies strong enough to deter potential aggressors, (d) lots of international activism, from peacekeeping missions to sanctions on potentially aggressive states; and (e) with notable exceptions in East and South Asia, fewer border and land disputes.

And importantly, the economic driver...(all bold emphasis mine)

Economic issues too may play a part: lower trade barriers, more open economic policies, more efficient logistics industries and better communications technology speed up and deepen integration across borders through trade and investment, strengthening mutual interests and reducing reasons for conflict. The report suggests that a 10 percent increase in FDI reduces a nation's chance of international or civil war by about 3 percent, and that globalization reduces the reasons a country might want to fight:

"[T]he most effective path to prosperity in modern economies is through increasing productivity and international trade, not through seizing land and raw materials. In addition, the existence of an open global trading regime means it is nearly always cheaper to buy resources from overseas than to use force to acquire them."

Since politics is ultimately about economics (allocation of scarce resources), where the great Bastiat once said if goods don’t cross borders then armies will, then the improvements in the economic sphere has preceded the marked progress in the socio-economic dimensions. This has been manifested by the apparent lesser degree of political interest towards nationalism, and conversely, a greater tolerance for democracy.

[As an aside, it would be greatly misplaced to suggest that markets operates under the auspices or the graces of governments as markets have existed even prior to the advent of governments. The fact that markets also exists in spite of manifold government regulations, or what is known as as regulatory arbitrage, or circumventing (going around) regulations, is a testament to the innate dominance of markets over politics.]

Of course, technology has also played an important role by vastly enhancing social connectivity. Yet the innovation in technology front has likewise been a product of free market forces.

In short, the deepening trends of free markets (globalization) buttressed by technology has influenced the evolving geopolitical institutional framework, in spite of the recent crisis.

Importantly, the market economy (or capitalism) and war represents as two antipodal forces from which mankind can only choose one.

As the great Ludwig von Mises wrote in Omnipotent Government, (bold highlights mine)

Social coöperation and war are in the long run incompatible. Self-sufficient individuals may fight each other without destroying the foundations of their existence. But within the social system of coöperation and division of labor war means disintegration. The progressive evolution of society requires the progressive elimina­tion of war. Under present conditions of international division of labor there is no room left for wars. The great society of world-embracing mutual exchange of commodities and services demands a peaceful coexistence of states and nations. Several hundred years ago it was necessary to eliminate the wars between the noblemen ruling various countries and districts, in order to pave the way for a peaceful development of domestic production. Today it is in­dispensable to achieve the same for the world community. To abolish international war is not more unnatural than it was five hundred years ago to prevent the barons from fighting each other, or two thousand years ago to prevent a man from robbing and kill­ing his neighbor. If men do not now succeed in abolishing war, civilization and mankind are doomed.

Bottom line: The world appears to be on the path to a deepening degree of acceptance of the politics of free trade (capitalism) than from militant (nationalistic) politics, as Professor von Mises predicted. The only major counterbalance to this is inflationism.

Merry Christmas!

Should Economics Be Left To The Economists? Is Economics Value Neutral?

At a recent assembly, I counselled a promising and youthful colleague, who had been rebuffed in trying to introduce classical liberalism to the economics departments of one of the elite schools in the Philippines, that since we eat, drink and sleep economics—where everyone engage in making and acting upon choices around the world of scarcity—that economics must not be left to the economists.

My point is since these elite schools have benefited from the current arrangement, there would be no incentive to assimilate changes that would only risk undermining their stature.

And I further added that politics is essentially economics, where politics signify no less than economics in morality’s clothing. Morality here, I am speaking of depends on whose sense of morality gets to be argued and or implemented; is it the minority, the majority, the despot, the King?

Thus, since economics is ubiquitous, it must be learned by everyone.

And for those in the know, it would be our civic duty to teach economics even in the non-traditional sense in our non-conventional way. In warfare, this is known guerrilla tactics.

As Ludwig von Mises once said,

Economics must not be relegated to classrooms and statistical offices and must not be left to esoteric circles. It is the philosophy of human life and action and concerns everybody and everything. It is the pith of civilization and of man's human existence.

Nevertheless the main aspect that differentiates the mainstream and classical liberalism would be the former’s emphasis on mathematical or empirical formalism vis-à-vis the latter whose analysis are based on logical deductions via praxelogical axioms or methodological individualism.

For instance, the mainstream would argue that their brand of math and statistical models based economics can be value neutral or value free when applied scientifically.

But this is would only be partly true because:

1. We are dealing with human action where every action involves subjective value preferences and ethical judgments.

As Murray N. Rothbard wrote, (bold emphasis mine)

I am not taking the position, now fashionable in many quarters, that there is no such thing as a value-free economics, that all economic analysis is inextricably shot through with value assumptions. On the contrary, I believe that the main body of economic analysis is scientific and value-free; what I am saying is that any time that economists impinge on political or policy conclusions, value-judgments have entered into their discussion. My conclusion, then, is that economists must either make their value judgments explicit and defend them with a coherent ethical system, or strictly refrain from entering, directly, or indirectly into the public policy realm.

In short, it would be inescapable for economists to fall for the value trap once they incorporate analysis based on the socio-political spectrum.

For instance, opportunity costs may not all be quantified in monetary terms as there would psychic and disutility costs. Thus, value free or value neutral can hardly be realizable except under classroom environment.

2. Economics is not the same as natural science.

Economics, as Jörg Guido Hülsmann wrote in MISES: The Last Knight of Liberalism, is a science with clear political implications, not a mere intellectual exercise.

Bottom line: Economics is human action.

Doug Kass On Gold As ‘The Emperor's New Clothes’

Investment manager Doug Kass predicts that gold will plummet in 2011 by $250 or about 17-20% from current levels.

He writes,

Surprise No. 9: The price of gold plummets by more than $250 an ounce in a four-week period in 2011 and is among the worst asset classes of the new year…

My surprise is that next year the price of gold has the potential to become the modern-day equivalent of Hans Christian Andersen's "The Emperor's New Clothes," a short tale about two weavers who promise an emperor a new suit of clothes that are invisible to those unfit for their positions, stupid or incompetent. When the emperor parades before his subjects in his new clothes, a child cries out, "But he isn't wearing anything at all!"

With a finite supply, gold has historically been viewed as a tangible asset that increases in value during uncertain (and inflationary) times. No wonder it has become such a desirable asset class following the Great Decession and credit crisis of 2008-09. Gold bugs remind the nonbelievers that for thousands of years, gold has been a store of value and, given the current state of the world's financial system, gold is the best house in a bad neighborhood of asset classes.

But gold, which may be the most crowded trade around, is viewed now as a commodity for all seasons -- during inflation, deflation, low or high economic growth.

There is a body of thought that maintains gold holds little intrinsic value, that it is only a shiny metal with limited industrial value that throws off no income or cash flow (and, as such, its value cannot be determined or analyzed with any precision based on interest rates or any other measure).

Mr. Kass argues that gold has been rising out of misplaced faith or equivalent to a “religion” (with reference to gold bugs), which apparently has been spreading like wildfire.

When we say people adapt a faith or religion based outlook, this extrapolates to fundamental evidences being discarded in favor of a desired outlook or outcome. In short, a form of rational ignorance or deliberately sidelining information that opposes on one’s belief.

Here Mr. Kass parrots the mainstream view that gold has little intrinsic value (commercial value) even while citing the role of gold as money for thousands of years which of course is a self-contradiction.

Mr. Kass does not mention how and why gold, among many other commodities and the paper money system as competition, emerged as money for thousands of years. And this would be similar to abandoning evidence or yet represents as another form of rational ignorance.

It is important to remember that one of the most essential functions of the emergence of commodity money is its marketability. And what is seen as marketable is likewise seen as having high commercial value. Of course the other important qualities of commodity money would be its being divisible, durable, recognizable, homogenous, high value per unit and scarcity.

Well I don’t deny that gold may correct given its recent steep rise as no price trends goes in straight line even as gold prices seem to be consolidating at the moment.

But I wouldn’t depend on the dismal track record of Mr. Kass’ predictions, since he also predicted gold prices to fall back to $900 levels for this year, which palpably went to the opposite direction.

And given that most of what he predicted didn’t emerge in 2010: strong US dollar, falling treasury yields, war in the Middle East, retirement of Warren Buffett, Central bank tightening and etc…, most which I rightly argued against, this only goes to show how fatal wrong predictions from a “faith” based analysis can be.

To give credit to Mr. Kass, he had been right that the stockmarket would correct by 10% during the first half of the year. But his overall predictions went the opposite way.

If gold bugs have been blindly bullish, as Mr. Kass alleges, so has Mr. Kass been perfervidly bearish and apparently in staunch denial, which after all, just shows that gold “atheism” can also signify a form of rational ignorance that is likewise cut from the same cloth as with gold bug zealots-dogmatism.

Graph: Warren Buffett's Berkshire Hathaway Portfolio Holdings

Here is a bubble chart of the portfolio holdings of Warren Buffett's flagship, Berkshire Hathaway from gurufocus.com

Berkshire's portfolio has been mostly into 'blue chips'.

This would be understandable considering the heft and expanse of the estimated $197 billion portfolio.

Reductio Ad Absurdum on Wage Disparities, Supply of Labor and Exports

In trying to demonstrate the importance of the distinction between causation and correlation, my favorite marketing guru Seth Godin asks “Does a ski trip to Aspen make you a successful bond trader, or do successful bond traders go skiing in Aspen?”

This applies to political economic analysis as well.

Mainstream analysis, particularly those of the rigid Keynesian persuasion, would take the former - ski trip to Aspen make you a successful bond trader-over the latter as the answer or correlation mistaken as causation.

Applied to the political economic sphere they would argue that in order to preserve employment at home, the policy prescription should be a mercantilistic one: inflate (currency devaluation) or impose protectionism (limiting trade via tariffs). Never mind if this flawed argument has been a discredited idea even by 18^th century economists. For Keynesian mercantilists, subtraction and not addition equals prosperity (gains).

Their assumption, which mostly signifies from a reductionist perspective, oversimplifies trade as operating in fixed pie wherein one gains at the expense of the other (zero sum).

And this is supported by their rationalization which sees every economic variable as homogenous.

And through selective statistical aggregates, they derive the conclusion that only government, equipped by the knowledge on how to adjust the knobs, can rightly balance out the interest of the nation. [Applied to Seth Godin’s riddle, government should send everyone to Aspen to make them all successful bond traders!]

And also from such perspective they see employment as the only driver of businesses and of economies-forget profits, capital, productivity, property rights, market accessibility and everything else-in the rigid Keynesian world, what only counts are labor costs.

In other words, labor cost, not profits, determines investments which subsequently translate to employment. Thus for them government policies must be directed towards accomplishing this end.

It has further been alleged that the supply of labor accounts for as a vital part in determining wage levels.

The reductionism: large supply of labor equates to low wages and consequently export power.

Let’s see how true this is applied to the real world.

Since labor basically is manpower then population levels would account for as the critical denominator.

One might argue that demographic distribution per nation would be different, which is true, but the difference does not neglect the fact that population levels fundamentally determine the supply of available labor.

Here is the world’s largest population, according to Wikipedia.org,

Given the reductionism which postulates that large labor force equates to low wages, then we should expect these countries, including the US and Japan to have the lowest wage rates in the world!

Yet even without looking at wage statistics we know this to be patently false (as seen from the bigger picture)!

Since wage levels are different per nation or per locality, perhaps the best way to gauge wages would be to use minimum wages as a yardstick.

Minimum wage account for as the national mandated minimum pay levels that are directed towards the lowest skilled workers.

Going back to the mercantilist postulate, since the largest population (largest pool of available labor) per continent belongs to Asia,...

...then the mercantilist logic implies that the lowest wages should be in Asia. Chart courtesy of Geo Hive (xist.org).

Yet according to the International Labor Organization (ILO), based on median minimum wages per country (US $PPP) the lowest wages would be in South East Europe and the CIS!

Asian wages are even higher than Africa and Southeast Europe and the CIS. Another disconnect!!

In addition, if broken down on a per country basis, based on the level of minimum wages in 2007 (PPP US$).... (again from ILO)

We would find that NONE of the largest or most populous countries (all in red arrows) are at the lowest echelon, except for Bangladesh and the Russian Federation seen at the lowest decile. (Yet the latter two are NOT export giants)

In pecking order, China, Brazil, Indonesia, Nigeria Pakistan and India are mostly situated at the upper segment of the lower half of the graph.

Meanwhile the Philippines can be seen on the higher second quartile, and the US having the highest minimum wages (among the highest populated nations), along with European countries.

So what this proves?

There is hardly any correlation between population levels (supply of labor) and wage levels! The assertion that supply of labor equals low wages is outrageously naive and inaccurate!

And let us further examine how these minimum wage levels impact exports. The following chart of the world’s largest exporters is from Wikipedia.org

And I would also include global competitiveness as measured by the World Economic Forum (Global Competitiveness report)

So what do we see?

We see a strong correlation between the world’s biggest exporters and the most competitive nations. And one might add to that HIGH minimum wages!

While it would be tempting to argue that high minimum wages equals strong competitiveness/exports, we would be falling for the same post hoc argument trap of misreading correlation as causation like those employed by rigid Keynesians.

The real answer to such wage disparity is the high standards of living in developed economies which arises from the greater capital stock (or productive assets in the economy) and a higher productivity of the citizenry.

As Professor Donald J. Boudreaux explains, (bold highlights mine, emphasize his)

Low-wage labor is generally not low-cost labor. The reason is that the productivity of low-wage workers in China and other developing countries is much lower than is the productivity of workers in America. While low-wage foreigners outcompete high-wage Americans at many low-skill, routine, and repetitive tasks, high-wage Americans can (and do) outcompete low-wage foreigners in those tasks that can be performed efficiently only in advanced economies that are full of the machinery and intricate infrastructure – physical, legal, and cultural – that raise wages by raising worker productivity

In short, high American wages aren’t a disadvantage; they are a happy reflection of the fact the typical American worker is a powerhouse of production.

In short to argue from a wrong premise would mean wrong conclusions.

Why?

Because for politically blinded people, their intuitive tendency is to selectively pick on events or data points (data mining, e.g. low value low skill industries, China) and deliberately misinterpret them (to create a strawman-China's low wages stealing American and Filipino jobs) in order to fit all these into their desired conclusions (cart before the horse reasoning-erect trade barriers).

They similarly deploy false generalizations based on the perceived defects interpreted as a general condition (fallacy of composition-low wages equals export strength).

These represent not only as sloppy ‘blind spot’ thinking but likewise, a reductio ad absurdum or a conclusion based on the reduction to absurdity.

Caveat emptor.

What To Expect In 2011

We humans, facing limits of knowledge, and things we do not observe, the unseen and the unknown, resolve the tension by squeezing life and the world into crisp commoditized ideas, reductive categories, specific vocabularies, and prepackaged narratives, which, on the occasion, has explosive consequences- Nassim Nicolas Taleb, The Bed Of Procrustes

It’s crystal ball peeking time.

Much of what we’ve been saying here isn’t likely to change for 2011, except to say that perhaps most of what we have been predicting may accelerate or escalate.

Here are the factors, which I perceive, constitute as the major drivers of the global asset markets (this includes the Philippines):

1. Monetary authorities of developed economies will fight to sustain low interest rates.

This comes even amidst pressures on the bond markets (see figure 1)

Figure 1: Economagic: US Treasury Yields leads Fed Fund Rate

Rising treasury yields (see green line) almost always leads Fed interest rates (red line). Said differently, markets influence policies than the other way around.

In addition, the Fed’s rates only reveal the path dependency or the penchant to artificially keep down interest rates until forced by hand by the markets.

Yet, rising interest rates do not automatically equate to financial markets turmoil, as suggested by some perma bears, who desperately keeps looking for all sorts of excuses to pray for the markets to go lower. The US S&P 500 index (blue) shows how US equities had surfed the rising interest tide over the years, until they have reached some pivotal point.

Nevertheless, it is important to determine the genuine dynamics of the interest rate movements[1] rather than to impute personal bias-based conclusions that are largely unfounded.

And as we earlier pointed out[2],

Rising interest rates presuppose one of the following drivers: increased demand for credit, concerns over credit quality, emerging scarcity of capital or the deepening inflation expectations.

Figure 2: Rising Yields A Global Phenomenon (charts courtesy of Cumberland Advisors[3] and Danske Bank[4])

Let me further point out scarcity of capital can be a consequence of perceived insecurities from political environment or protectionism.

Yet, the fact that rising interest rate appears to be a global phenomenon (see figure 2-upper window) suggest that the current interest dynamics has been less about credit quality concerns (despite the ongoing PIIGs crisis) but more about emerging inflation expectations, and secondarily, rising demand for credit.

Even China, whom sporadically applied some brakes over her system’s rapidly growing credit due to bubble concerns this year, has also been vacillating to implement a tight monetary environment despite posting inflation rates at 28-month high[5]. China reportedly plans to allow some 7 trillion yuan ($1.1 trillion) in new loans for 2011[6].

So like any conventional approach, when caught between the bind of choosing between the proverbial devil (the temporal benefits from inflationism) and the deep blue sea (prospects of having to suffer from economic rebalancing). Authorities as will most likely choose the former.

2. More Inflationism: Bailouts and QEs To Continue

In spite of the rhetoric on austerity, authorities of major developed economies will likely engage in more inflationism, stealthily coursed through central banks or in central banking vernacular “quantitative easing” or “credit easing”.

At the start of the year, policymakers blabbered about ‘exit strategies’ which we accurately debunked and exposed as poker bluff[7].

Even if the US had been declared out of recession by the National Bureau of Economic Research (NBER) in June of 2009[8], a non profit group in charge of ascertaining recession and business cycles, the Federal Reserve have stubbornly persisted on using the printing press option.

Incidentally and ironically, popular economic experts have again failed miserably with their misguided forecasts, such as Keynesian high priest Paul Krugman[9] and populist Nouriel Roubini[10] both whom had predicted of a large probability a double-dip recession, which apparently did NOT materialize this year.

Just how could these so called experts be so frequently awfully wrong, yet get so much the public’s attention?! As Nassim Taleb rightfully dissects, economics cannot digest the idea that the collective (and the aggregate) are disproportionately less predictable than individuals[11]. Of course Mr. Taleb refers to mainstream economics which fixates on mathematical-empirical formalism rather than the study of people’s actions or conduct (praxeology).

This also demonstrates that the public has hardly been concerned about accuracy or about dealing with reality. Instead the public have been indulging or assimilating dogmatic ideas that confirms to their beliefs or which runs along with their line of thinking, regardless if they work in the real world.

Nonetheless, we further argued that such inflationist policies had been actually directed at the banking system, which actually operates as some form of cartel under the aegis of central banks. Officials have only used the economy, particularly the employment figures, as cover[12] in order to continue with the redistributive process of ‘privatizing profits and socializing losses’ in order to buttress the banking sector.

To add, if higher treasury yields will translate to higher mortgage rates and thereby put renewed pressure on the housing markets, then we can expect more versions of QE to be activated. QE 2.0 has barely waded into the water and now Fed officials as Bernanke appear to be telegraphing or conditioning the public for a QE 3.0[13].

And this isn’t going to change anytime soon. Not unless consumer inflation runs berserk and consequently weigh on the political dimensions that would affect policymaking.

Yet while I am very pleased that Congressman Ron Paul will take over as the chairman of the Domestic Monetary Policy Subcommittee of the House Financial Services Committee[14], it remains uncertain whether Congressman Paul can successfully overhaul, or diminish the role of, or dismember the deeply entrenched interest groups that constitute the banking cartel, or at the least make a dent on the making the Federal Reserve transparent. Subjecting monetary policies to free market forces should salvage the system from self-disintegration (read: sell gold).

And the same dynamics appears to take hold whether in the Eurozone or Japan or the United Kingdom. Every perceived crisis would be met by the same approach.

My point is: bailouts and flooding the world with liquidity would remain instrumental in determining the direction of asset prices in 2011.

3. Effects of Divergent Monetary Policies

Divergent monetary policies will impact emerging markets and developed markets distinctly, with the former benefiting from the transmission effects from the latter’s policies.

While most economic experts will talk about interrelationships of the output gap, economic growth and trilemma of international finance or the impossible trinity[15] of fixed exchange rate, free capital movement and independent monetary policies-where only two of the three conditions can be attained, we see current coordinated policies as no more than designed to artificially promote growth by inflating bubbles.

Artificial low interest rates, which punish savers and rewards borrowers, have been the conventional or the orthodox policy treatment to modern financial and economic maladies. Thus, suppressed interest rates are likely to impact both domestic and international reallocation of resources applied to nations under the rubric of emerging markets and of nations classified as developed.

For nations whose banking and financial system have not been directly affected or impaired by the recent financial crisis, and for economies that had been relatively unscathed and whose financial system have been less leveraged and has been marked by high rate of savings, the impact from such interest rate policies have been dramatically magnified.

And this appears to be case for ASEAN bourses (see figure 3).

Figure 3: Policy Divergences And ASEAN Bourses

With the exception of Malaysia (green), the bellwethers of major ASEAN bourses, namely Philippines (yellow), Indonesia (Orange), and Thailand (red) has broken above the pre-crisis highs largely driven by the above stated dynamics.

Local investors will likely continue to ramp up speculations on asset prices (stocks, real estate[16] and private sector bonds) which should give some semblance of or will likely be interpreted as an ongoing economic boom, where in truth, many will account for misdirected investments.

And this will be amplified by portfolio flows from foreign funds, whose incentives to arbitrage on global markets have been driven by home policies of similar depressed interest rates and the deliberate debasement of their currency.

Add to that would be pressures from resurgent domestic inflation that would force up rates or the appreciation of the domestic currency or both, whose yield spreads would equally attract foreign arbitrage. Thus, in cognizance of the volatility of policy induced portfolio flows, some emerging markets have either been contemplating on capital controls[17] or have begun implementing them, albeit largely in a benign scale.

Yet one can’t discount the role of momentum or the herd mentality in the bidding up of asset prices, where psychology fuelled by circulating credit would lead to irrationality or extreme valuations which would be justified as “new paradigm”.

4. The Globalization Factor

Aside from globalization of monetary and administrative-fiscal policies, globalization of trade, migration and finance similarly plays a significant role in shaping asset prices.

While inflationism does play a role in the allocation of resources, so does globalization. So in one way globalization somewhat offsets the malinvestments from inflationism. However it remains to be seen how much of malinvestments can be muted by globalization.

Nevertheless, mainstream economics not only to tend misread the effects of globalization for political ‘mercantilist’ purposes, but likewise underestimate on the role it plays on the economy, as well as the rapidly changing dynamics behind these[18].

For instance many perma bears have mainly used “lack of aggregate demand” from developed economies as the principal reason to argue for “depression economics”.

But this is false for the simple reason that it oversimplifies and underestimates the impact of trade and of people’s action and likewise sees past performance as a static trend going forward!

And this is why high profile experts have entirely missed out predicting the recent rally or the recent improvements in the global economy

A good example of sicj underestimation is the dynamics of Asia’s domestic consumption (see figure 4).

Figure 4: DBS Research: Asia 2011 How Scissors Cut

According to the DBS Group Research[19],

Remember all that talk about global imbalances and the worry that if the US did not consume then Asia, which purportedly lived off the US, could not grow? Oops. Since 3Q08, US consumption has grown by 1%, or by paltry $27 bn. Asia’s consumption has grown by 22%, or by $225 bn. That’s an expansion 8x bigger than in the US. With new consumption running 8:1 in Asia’s favor, it’s simply no longer credible to claim that Asia’s growth depends on the US or that failure to fix some ‘imbalance’ puts global growth in peril. It doesn’t. US growth maybe in peril...but that’s another kettle of fish: one that everything to do with explosive leverage and abysmal risk management and nothing to do with current account surpluses or deficits.

So aside the mainstream missing out the improvement of Asia’s domestic consumption, the DBS Research group goes on to argue that the region’s growth has been spurred mostly by the private sector in spite of the safety nets applied (bottom window).

And as we have long argued, trade openness and economic freedom lubricates demand, which serves as the ultimate end of production. And demand isn’t constructed based on circular flows but on people’s changing subjective value preferences.

And for as long people are allowed to openly engage in free markets, depression-deflation economics, which stems largely from government bubble and protectionist policies that induces such systemic distortions, is no more than a figment of a mercantilists imagination. Under free markets, greater output translates to growth deflation that increases the public purchasing power.

Besides, the aggregate demand deflation camp also tends to underestimate the fundamental function of why central banks ever exist at all: they exist not only as a lender of last resort, but as financer of government liabilities or the financier of political goals of the political leaders.

To repeat, what generates market instability or what are called as “market failures” are fundamentally bubble policies and interventionism and not some random flux arisng from from the lack of confidence or “animal spirits”.

My Working Targets for 2011

So here is how I see 2011:

Unless inflation explodes to the upside and becomes totally unwieldy, overall, for ASEAN and for the Philippine Phisix we should see significant positive gains anywhere around 20-40% at the yearend of 2011 based on the close of 2010. Needless to say, the 5,000 level would seem like a highly achievable target. What the mainstream sees as an economic boom will signify a blossoming bubble cycle.

Of course my foremost barometer for the state of the global equity markets would be the price direction of gold, which I expect to continue to generate sustained gains and possibly clear out in a cinch the Roubini hurdle of $1,500[20].

To repeat, Gold hasn’t proven to be a deflation hedge as shown by its performance during the 2008 Lehman collapse. The performance of Gold during the Great Depression and today is different because gold served as a monetary anchor then. Today, gold prices act as a temperature that measures the conditions of the faith based paper money system.

In addition if inflation will become more widespread, then we should likewise see the oil jump above $100 per barrel and this will be accompanied by general increases in other commodity prices, particularly in food prices.

And in my opinion, while everyone likes to focus on what seems sensational, I’d focus on what I think is more important. I don’t expect the Euro to evaporate soon as some others suggest. I’d probably pay a closer look to China, whose yield curve appears to be flattening (see figure 5).

Figure 5 Asianbondsonline: China’s Flattening yield curve

And I will get to scream fire once the yield curve turns negative.

Finally, surging inflation may not be good for the stock market in the entirety but that would be conditional. It should be good for certain assets as commodities or real properties (see figure 6).

Figure 6: Stagflation’s Winners (courtesy of Dr. Marc Faber[21])

Based on a seemingly similar economic environment or during the stagflation days of 1970-1980, hard assets turned out to be the winner.

Of course, it would be a different picture once hyperinflation gets into play; equities became store of value in Weimar Germany (1921-1923) and in Zimbabwe (2000s-2009).

But this could be one of the two options that could likely happen once the next bubbles go bust. The other one is debt default.

For now, identifying the whereabouts of the bubble cycle is my primary concern. And it should be yours too.

---

[1] see Rising US Treasury Yields: Credit Quality Concern or Symptoms of Bubble Cycles, December 14, 2010

[2] see Global Markets And The Phisix: New Year Rally Begins, December 6, 2010

[3] Kotok, David R. The Bond Herd, 6% and Gold, Financialsense.com December 16, 2010

[4] Danske Bank, Basel III impact study published, Fxstreet.com December 16, 2010

[5] BBC.co.uk China sees inflation jump to 5.1%, a 28-month high, December 11, 2010

[6] Bloomberg.com China Said to Aim for at Least 7 Trillion Yuan Loans, December 13, 2010

[7] See Poker Bluff: The Exit Strategy Theme For 2010, January 11, 2010

[8] Marketwatch.com U.S. recession ended June 2009, NBER finds September 10, 2010

[9] Bloomberg.com, Krugman Sees 30-40% Chance of U.S. Recession in 2010, January 4, 2010

[10] Reuters.com Roubini says U.S. economy may dip again next year, May 29, 2009, Roubini, Nouriel Beware Of A Double-Dip Recession, March 11, 2010 Forbes.com

[11] Taleb, Nassim Nicholas The Bed of Procrustes, Philosophical and Practical Aphorisms Random House

[12] See QE 2.0: It’s All About The US Banking System, November 18, 2010

[13] See QE 3.0: How Does Ben Bernanke Define Change, December 6, 2010

[14] Norris, Floyd, Ron Paul Appears Poised to Irk the Fed Chief, December 16, 2010

[15] Wikipedia.org Impossible trinity

[16] See The Upcoming Boom In The Philippine Property Sector, September 12, 2010

[17] See The Possible Implications Of The Next Phase Of US Monetary Easing, October 17, 2010

[18] See iPhone Shows Why Global Imbalances Will Remain, December 16, 2010

[19] DBS Research, Asia 2011: How Scissors Cut, Economics Markets Strategy, December 9, 2010

[20] In 2009 Jim Rogers and Nouriel Roubini went into a heated public debate, where celebrity guru Roubini predicted that gold won’t surpass $1,500. See Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble, November 5, 2009

[21] Faber, Marc Tomorrow's Gold: Asia's Age of Discovery

Different Trading Partners And The Currency Option

Another reason why proposed mercantilist policies particularly based on the currency valve option are not likely to work: different trade partners by different states or regions.

This from the Wall Street Journal Blog, (bold emphasis mine)

But the dollar’s impact will not be equal on each state or region. That’s because, for instance, Texas ships more exports to Mexico while New York sends more exports to Canada. Understandably, then, the health of Texan exporters depends more on changes in the dollar-peso rate while New York exporters care more about the U.S.-Canadian exchange.

To gauge the regional impact of exchange rates, the Federal Reserve Bank of Dallas has developed a real trade-weighted value of the dollar index for each state.

Foreign-exchange markets tend to focus on the dollar’s value versus the euro or yen. But for state exporters, the exchange rates in emerging nations and our NAFTA partners Canada and Mexico are probably more important.

“National exchange rate indexes do not always reflect individual state experiences,” the report says. “States at times face sharply different effective exchange-rate shifts, often provoked by economic or financial crises.”

This should not even be limited to the state or region level.

Competitiveness can be analytically regressed to independent enterprises where each firms operates on distinct cost structures, have different fields or areas of specialization and of the idiosyncratic competitive advantages, [even if they come from the same industry and operate in the same territory].

Where exchange rates could have diverse effects from the micro level from the different location of trading partners, the transmission mechanism of proposed exchange rate policies are likely to be ambiguous.

The other way to say this is that one size fits all exchange rate option is a political gamble undertaken by technocrats with society’s equity at stake.

Philippine Classical Liberalism and Libertarianism: Unpopular But Remarkable

I find the message of my favourite marketing guru, Seth Godin, especially relevant to my political economic perspective.

With reference to Lady Gaga, Mr. Godin writes, (bold emphasis mine)

Do you think it bothers her that I don't listen to her music and wouldn't recognize her if she stopped by and said hi?

It shouldn't.

Even if you're a pop star, you don't need everyone to be a fan or a customer. And especially if you're not a pop star, worrying about whether everyone laughs at your jokes, buys your product or even likes you is counterproductive.

Unless you're running for something that requires a unanimous vote, it's a mistake to focus on the frowning guy in the back of the room or the dolt who doesn't get your subtle references or the miser who isn't going to buy from you regardless...

You're on the hunt for sneezers, for fans, for people willing to cross the street to work with you. Everyone else can pound sand, that's okay. Being remarkable also means being ignored or actively disliked.

BTW, I'm virtually certain that Lady (do her friends call her that?) doesn't read my stuff, so we're even.

I feel that this applies also to contrarians or fringe thinkers, who have been frequently ostracized, reviled, despised and dismissed for their unorthodox and unconventional ideas, despite being trenchantly correct for most occasions. (yes even in the financial market's standards)

That’s because conformity represents as the social norm or the need to get accepted, regardless if this means embracing popular delusions. In short, the implicit herd mentality.

Yet it would take so much mettle and grit to stand up to challenge such falsehood. A challenge only a few will likely partake of.

Nonetheless, not all contrarians share similar insights. [Think communists.]

And in this occasion I would like to credit my domestic classical liberals and libertarians colleagues, who despite the odds, have taken this challenge to expose mainstream delusions and have made some critical inroads in expanding awareness, organizing a niche/tribe for people with similar persuasions and the spreading of knowledge in the local community. I once thought that I operated alone. Not anymore.

The great Ludwig von Mises assimilated a passage of Latin poet Publius Vergillius Maros, or popularly known as Virgil, as his motto: Tu ne cede malis sed contra audentior ito ("Do not yield to the bad, but always oppose it with courage."); a motto, which I think, is worth carrying over.

So despite our unpopular stance, your passionate efforts have made fighting for such a cause, remarkable and inspirational.

Merry Christmas.

iPhone Shows Why Global Imbalances Will Remain

Mercantilists are simply wrong.

The are mistaken in arguing for the "currency valve" policy option to address global ‘imbalances’. That’s because these mercantilists read or interpret trade as operating simplistically in an “aggregate” manner.

Yet as this study based on the iPhone’s business process shows, trade hasn’t been that simple.

Trade has been swiftly evolving in such a way that has deepened the role of specialization (division of labor) and national comparative advantages which has affected how “imbalances” are being shaped.

To add, current statistical aggregates tend to overlook many important data points which have been used for policy analysis. This makes many of these politically sensitive data unreliable.

Illustration from Wall Street Journal Blog

The following conclusion from Yuqing Xing And Neal Detert on their paper “How iPhone Widens the US Trade Deficits with PRC” (all bold emphasis mine)

In this paper, we use the iPhone as a case to show that even high-tech products invented by American companies will not increase US exports, but to the contrary exacerbate US trade deficits.

Unprecedented globalization, well organized global production networks, and low transportation costs all contribute to rational firms such as Apple making business decisions that contributed directly to the US trade deficit reduction.

Global production networks and highly specialized production processes apparently reverse trade patterns: developing countries such as PRC export high-tech goods—like the iPhone—while industrialized countries such as the US import the hightech goods they themselves invented. High-tech products such as iPhones in this context do not help increase the US exports, but instead contribute to trade deficits.

In addition, conventional trade statistics greatly inflate bilateral trade deficits between a country used as export-platform by multinational firms and its destination countries. In the case of iPhone trade, China actually contributed only 3.8% of the United States’ US$1.9 billion trade deficit, the rest was simply a transfer from Japan, Korea, and Taipei,China.

If the US high-tech companies, such as the Apple, are willing to share their profits with low skilled American workers by keeping assembling jobs in the US, it would be more effective in reducing the US trade deficits than targeting the exchange rate policy of PRC.

University of Michigan Professor Mark J. Perry has a nice illustration of the composition or breakdown of revenues of the iPhone per location/geography as shown above.

He also notes that

“only about $6.54 (a little more than than 1%) of the full $600 retail price of an iPhone goes to China and more than 60% goes directly to Apple and other American companies (see chart above), according to a "teardown report" by iSuppli that was featured in a July New York Times article. It also doesn't mean that your purchase of an iPhone contributed very much to the U.S. trade deficit, even though that's what the government trade statistics tell us.”

So despite being assembled or "made in China" most of the profits still accrue to the US.

Bottom line: Globalization equals “imbalances”. That’s because of the fast evolving supply chain platforms or networks which has been determining the trading patterns globally.

Yet interventionist policies based on easy fixes are likely to backfire since they do not address the business and micro realities of trade.

Philippine Justice System on the Vizconde Massacre Case: Letter of the Law Over Spirit of the Law

This from today’s Inquirer, (bold emphasis mine)

The decision of the Supreme Court clearing Hubert Webb and six others of criminal liability in the 1991 Vizconde massacre is not a vindication of them, the tribunal’s spokesperson said Wednesday.

Speaking at a news briefing, Midas Marquez said the acquittal of Webb et al. did not mean they were innocent of the charges. He said the high court voted 7-4 to acquit them because of the prosecution’s failure to prove their guilt beyond reasonable doubt and because of infirmities in the testimony of star witness Jessica Alfaro.

“The court said there was not enough basis to [affirm] the conviction of the accused. The court did not say they are not guilty,” Marquez stressed.

“The magistrates did not say that they were innocent and that they did not commit the crime,” he said.

In short, technical issues or legal loopholes prevailed.

Yet in looking at how laws should be complied with, we found this from wikipedia.org

The letter of the law versus the spirit of the law is an idiomatic antithesis. When one obeys the letter of the law but not the spirit, one is obeying the literal interpretation of the words (the "letter") of the law, but not the intent of those who wrote the law. Conversely, when one obeys the spirit of the law but not the letter, one is doing what the authors of the law intended, though not adhering to the literal wording.

"Law" originally referred to legislative statute, but in the idiom may refer to any kind of rule. Intentionally following the letter of the law but not the spirit may be accomplished through exploiting technicalities, loopholes, and ambiguous language. Following the letter of the law but not the spirit is also a tactic used by oppressive governments. (bold emphasis on this paragraph mine)

Bottom line: as we previously argued, arbitrary laws and regulations, as well as, arbitrary interpretation of laws signify as symptoms of a much deeper structural malaise known crony capitalism or legal protectionism of the political economic elite.

Migration Twist: Many Britons Desire Relocation While Filipinos Want To Stay Home

It would seem as no news for us to hear people from developing nations yearn to emigrate to developed nations mostly to seek greener pastures.

For instance, the Philippines has been a major exporter of labor or manpower (OFWs), thus the popular desire by locals to work or move permanently abroad has been embedded into my expectations.

Yet recent surveys appear to contradict this—only about 1 in 10 Filipinos, according to ABS-CBN, say that they would like to migrate to another country. This has been significantly down from about 3 in 10 in 2006. The apparent optimism has been reportedly associated with high expectations on the political economy from the new political administration.

But what surprised me most was this poll from Gallup which reported that in UK, 1 in 3 Britons wanted to migrate to another country. (see below chart from Gallup)

Gallup says that this hasn’t been related to the recent crisis, where “high level of desire to migrate permanently cannot be attributed to the recent global economic crisis or the country's own recession”

And it’s not just the UK, although she ranks the highest, but also among major European contemporaries, as Germany (21%), France (23%), Sweden (19%), Netherlands (18%) and others, all of which registered high levels of desire to migrate.

For Britons, the target places for relocation are Australia, Spain, US and Canada.

While the local survey may not square with Gallup’s survey, enough for me to make a strong conclusion, I suspect that such developments appear to be indicative of a twist: people from developed nations could likely help deepen the globalization of labor or population mobility worldwide.

Importantly, this shows how people’s reaction could be fickle and can’t be aggregated and that meaningful changes could be happening at the fringes.

Nonetheless, it’s a development worth monitoring.

Warren Buffett Is Human

What I mean is that investing guru Warren Buffett makes mistakes like anyone else.

Joe Mont writes, (bold emphasis mine)

In a recent annual letter to Berkshire Hathaway (BRK-A) shareholders, an eagerly awaited piece of investing insight, Buffett cops to several mistakes. Among them: authorizing the purchase of a large amount of ConocoPhillips stock when oil and gas prices were near their peak. A dramatic fall in energy prices soon followed.

"The terrible timing of my purchase has cost Berkshire several billion dollars," Buffett wrote, segueing into regret over a $244 million parlay in two Irish banks "that appeared cheap" but soon incurred an 89% loss on the initial investment.

"The tennis crowd would call my mistakes 'unforced errors,'" Buffett said.

When a Buffett, Bill Gross or Larry Fink publicly discusses bad decisions, it makes headlines. But there is hardly an investor, pro or amateur, who doesn't have some woeful tale of a sure thing that wasn't or can't-miss advice that did. The key is learning from mistakes and moving on.

The main difference between the pros and the tyros is the ability to accept the emotional and self-esteem angst of making wrong decisions and consequently adapting remedial measures. Yet for many, investing is like a one way street: cash in on profits (or brag about success) and long the losses (or deny the errors).

Another aspect here, aside from human frailty issue, could be one of “karma”.

I have pointed out that Warren Buffett seems to have been transformed from a value investor to a political entrepreneur or an agent who directly profits from government actions/concessions (such as bailouts). Apparently this time investing on such special political conditions engineered by the government (Irish banks) didn’t work.

Since bailouts signify redistribution of resources to political benefactors at the cost of taxpayers, then Mr. Buffett’s loss could be construed in the light of poetic justice.

Rising US Treasury Yields: Credit Quality Concern or Symptoms of Bubble Cycle?

The Wall Street Examiner writes,

For those who argue it does matter, one number being tossed around is the level at which debt service equals 30% of tax revenues. Once interest payments take 30% of tax revenues, a country has an out-of-control debt-trap issue. When you think clearly about it, this just makes sense as the ability to dodge, weave, and defer is pretty much removed, as is the logic that it will be repaid in a low-risk manner. The world is going to be a different place when the US is perceived to be in a debt trap.

I suspect the problem will rear its ugly head well before this 30% number is hit as markets start discounting the trajectory by hiking interest rates because of poor credit quality and/or inflation (or more accurately stranguflation). Naturally that question should be asked in terms of the recent and sudden uptick in Treasury note and bond rates that appeared strongly correlated to the latest round of tax “stimulus” and handouts, and the “unexpected” reaction to QE2. The latter is nothing more than a brazen, dangerous gamble to monetize the debt. Sure, one crowd is claiming economic growth is the causa proxima, but that feels like utter nonsense. Could it be that the markets at long last are anticipating a very bad result from QE2 and even more government largess? (emphasis added)

Although I sympathize with this observation, in my opinion, this looks more like a cart before the horse analysis when it comes to forecasting.

Two observations:

the analysis does not say how such mayhem would be triggered, except to presuppose intuitively that rising rates signifies implied doubts on on credit quality and

second it also does not say how authorities are likely to respond to such environment.

For instance, the claim that rising rates from economic growth feels like utter nonsense may not seem consistent with a seemingly tranquil credit environment in many parts of the world.

An environment manifesting concerns about of the credit quality would look like this…

In other words, the rising interest will be accompanied by turbulent credit markets (e.g. rising CDS) perhaps globally.

Yet we are not seeing this today YET (see below chart)

charts above courtesy of Danske Bank research

While the PIIGS episode today could likely foreshadow the milieu of tomorrow’s crisis, the difference is that the interest rate, credit and other financial markets have, for now, demonstrated benign reaction.

And this has allowed governments to continue with the current orthodox responses to the crisis—bailouts and the flooding of liquidity in the system.

A full blown crisis would likely occur when global government’s hands are tied.

And there are two likely series of events that would pose as trigger: accelerating inflation on a worldwide scale (symptoms-consumer, producer, commodity), and or another major bubble bust elsewhere around the globe (China?, Emerging markets?).

In my view: rising US treasury yields appear to be indicative of a brewing bubble cycle (in many parts of the globe) that is likely being transmitted from the disparities in monetary policies between developed economies and the emerging market economies.