The Ugly Head of Protectionism Resurfaces in Brazil

In my view, Brazil’s recent boom has been getting into the heads of their policymakers.

From the Economist, (bold emphasis mine)

ON SEPTEMBER 15th Guido Mantega, Brazil’s finance minister, announced a 30-point increase in the country’s industrial-product tax on cars. The amount was startling, but the purpose familiar. Cars that are mostly made in Brazil, Mexico or the Mercosur trade block will be exempt; only importers will pay. “Brazilian consumption has been appropriated by imports,” he said in announcing the tax.

According to the National Carmakers’ Association, poor infrastructure and pricey credit and labour mean that making cars is 60% more expensive in Brazil than in China. Local manufacturers have long relied on high tariffs. Imports are gaining market share, from 16% of sales in 2009 to 23% this year. The new measure will probably reverse that trend, since it will increase the price of imports by a quarter.

The government has taken small steps to help local firms.

Contrary to the publicly stated goals, Brazil’s politicians will not be helping local firms but politically favored ones or political cronies.

Yet more ugly head of protectionism in Brazil

Again from the same Economist article,

Farmland is being treated as a strategic asset on a par with oil. Last year, spooked by the idea of foreign sovereign-wealth funds and state-owned firms buying up vast tracts, the government resurrected a 1971 law limiting the amount of rural land foreigners can buy. It was revived even though in the 1990s it was deemed incompatible with the new democratic constitution and open economy. The details are under review: foreigners may be allowed to buy a bit more without restriction, and still more if the government thinks it is in the national interest. But there is no timetable for passing a new law. The Brazilian Rural Society estimates that $15 billion of planned foreign agriculture investments are being dropped.

The strength of the new protectionist mood can be gauged by the government’s willingness to tolerate legal uncertainty and collateral damage. It reintroduced the antique land-ownership law despite knowing that its flawed design would almost halt much-needed foreign investment. Since it limits the total share of each district that can be owned by foreigners, many land registries are playing it safe and rejecting all foreign purchasers. Kory Melby, an agricultural consultant, advises foreigners on land purchases in Brazil. He says he has heard from furious sellers whose deals are now “as good as garbage”.

As the great Murray N. Rothbard once wrote,

The system of mercantilism needed no high-flown "theory" to get launched. It came naturally to the ruling castes of the burgeoning nation-states. The king, seconded by the nobility, favored high government expenditures, military conquests, and high taxes to build up their common and individual power and wealth. The king naturally favored alliances with nobles and with cartelizing and monopoly guilds and companies, for these built up his political power through alliances and his revenue through sales and fees from the beneficiaries.

Neither did the cartelizing companies need much of a theory to come out in favor of themselves acquiring monopoly privilege. Subsidy to export, keeping out of imports, needed no theory either: nor did increasing the supply of money and credit to the kings, nobles, or favored business groups. Neither did the famous urge of mercantilists to build up the supply of bullion in the country: that supply in effect meant increased bullion flowing into the coffers of kings, nobles, and monopoly export companies. And who does not want the supply of money in their pockets to rise?

Theory came later; theory came either to sell to the deluded masses the necessity and benevolence of the new system, or to sell to the king the particular scheme being promoted by the pamphleteer or his confreres. Mercantilist "theory" was a set of rationales designed to uphold or expand particular vested economic interests.

Perhaps, the current market crash may bring about some humbling effects on them.

War on Precious Metals: Amidst Market Slump, Credit Margins Raised Anew!

From Barrons,

The CME Group (CME) on Friday raised margin requirements for some gold, silver and copper futures contracts. The hikes will be effective after the close of business on Monday, according to the exchange operator.

Initial requirements to trade and hold gold’s benchmark contract rose 21% to $11,475 per contract. Meanwhile, maintenance margins climbed to $8,500 from $7,000 per contract.

At the same time, initial requirements for silver rose 16% to $24,975 a contract and maintenance margins increased to $18,500 from $16,000 a contract.

Initial requirements for copper jumped 18% to $6,750 per contract, from $5,738. Also, maintenance margins were increased to $5,000 from $4,250 per contract.

Margin hikes have been blamed by traders for curtailing rallies earlier in the year. This time around, however, CME’s attempt to again dampen speculation comes at a time when market forces are already seemingly at work doing much the same.

Here is how the gold and the precious metal markets responded.

From Barrons,

Silver futures kept heading down on Friday, finishing with an 18% fall marking the metal’s biggest drop in decades. Meanwhile, the most active gold contract in New York sank 5.9% to register its largest percentage loss since June 2006.

More from Bloomberg,

Commodities fell to a nine-month low, led by routs in metals, on deepening concern that governments are running out of tools to avert a global recession, eroding prospects for raw-material demand.

European officials may accelerate the setup of a permanent rescue fund as the sovereign-debt crisis mounts. On Sept. 21, the Federal Reserve said the U.S. economy faces “significant downside risks.” In the next two days, gold plunged the most since 1983, and copper had the biggest slide in almost three years. Today, silver posted the largest drop in 32 years…

“We are seeing commodity prices correcting, so they are more compatible with the global economy,” said Christin Tuxen, a senior analyst at Danske Bank A/S in Copenhagen. “When we have fears over the economic cycle as we have now and a higher probability of contraction, it hits industrial metals and commodities.”

“We are not predicting a recession in the Western world, but low growth for the long term,” Tuxen said. “We are looking for a rebound in China and Asia in the fourth quarter and in 2012, which will help copper and aluminum.”

Some things to note here

The current financial market carnage has been indicating of an ongoing liquidity contraction, given that Mr. Bernanke’s has thwarted expectations of further aggressive rescue policies. Yes, Bernanke’s non inflation stance is something to cheer at, but this has not been about political-economic apostasy but rather about political obstacles.

Second, the timing of CME’s intervention appears suspicious. Such needless interventions have been weighing on an already bleak sentiment.

Yet the public is being impressed upon by media and experts that this has been about economic performance. If current environment is “not predicting a recession” then the dramatic selloff in commodities would seem unwarranted, except for liquidity and or manipulation issues.

I deem this continuing series of credit margin hikes as part of the signaling channel tool employed by team Bernanke to project on the intensifying risk environment of a deflationary bust, which will be used to rationalize QEs and to quell QE policy dissenters. As stated above, I am don’t think that Mr. Bernanke has backtracked from his activist central banking dogma.

And as pointed out earlier, Mr. Bernanke appears to be implicitly challenging his political detractors by laying the recent market carnage on their doors.

My guess is that eventually the divided FOMC will accede to Bernanke’s policy preferences, but that would entail more market pressures. In other words, the global financial markets would remain hostage to, or will be used as negotiation leverage by the political class in furtherance of their interests.

But until there will be clarity in the directions of policy actions, it would be best to stay clear from the current environment whom signifies as victims of the imbroglio or the bickering of political stewards.

Nonetheless, despite the slump in precious metals, these are likely to be temporary events.

Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms

Despite my current circumstances, I felt the compulsion to offer a reaction on today’s market meltdown.

Here is what I recently wrote,

I would certainly watch the US Federal Reserve’s announcement and the ensuing market response.

If team Bernake will commence on a third series of QE (dependent on the size) or a cut in the interest rate on excess reserves (IOER), I would be aggressively bullish with the equity markets, not because of conventional fundamentals, but because massive doses of money injections will have to flow somewhere. Equity markets—particulary in Asia and the commodity markets will likely be major beneficiaries.

As a caveat, with markets being sustained by policy steroids, expect sharp volatilities in both directions.

Obviously the market’s response on team Bernanke’s failure to deliver on what had been expected has apparently been violent.

The Philippine Phisix (chart from technistock.net), as well as ASEAN equity markets, has basically suffered the same degree of bloodbath relative to her developed economy equity market peers

This reaction from a market participant captures the underlying sentiment. From a Bloomberg article

“This is not likely to provide any significant stimulus,” said Jason Schenker, president of Prestige Economics LLC in Austin, Texas. “The market really needed a boost of confidence. There is no confidence from this.”

So what did the Mr. Bernanke deliver?

Again from the same article at Bloomberg

The Federal Reserve will replace $400 billion of short-term debt in its portfolio with longer- term Treasuries in an effort to reduce borrowing costs further and counter rising risks of a recession.

The central bank will buy securities with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less, the Federal Open Market Committee said today in Washington after a two-day meeting. The action “should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the FOMC said.

Chairman Ben S. Bernanke expanded use of unconventional monetary tools for a second straight meeting after job gains stalled and the government lowered its estimate of second- quarter growth. Yields on 30-year Treasuries fell below 3 percent for the first time since 2009 and U.S. stocks had their biggest drop in a month on the Fed’s plan, dubbed “Operation Twist” after a similar Fed action in 1961.

The twist, as earlier stated, has been telegraphed. What was not expected has been the non-appearance of Bernanke’s QE which resulted to today’s convulsions.

The ‘twist’ which essentially attempts to flatten the yield curve basically reduces the banking system’s profitability from the borrow short and lend long (maturity transformation) platform that has partly catalyzed these selloffs.

From the Wall Street Journal

But for bankers, who are already struggling with low interest rates on loans and tepid loan demand, the twist option could further dent already-weakened profits. That is because lower long-term interest rates would result in contracting net interest margins for banks—essentially, the profit margin in the lending business—at a time when their revenue is growing slowly, if at all. Banks would earn less on loans and investments, and might end up making fewer loans as well.

"Ouch" is how one executive at a big retail bank described the prospect of Operation Twist. (Bankers typically don't publicly comment on Fed policy given the central bank's role as a bank regulator.)

Austrian Economist Bob Wenzel says that Operation Twist represents a failed experiment…

So how did the original Operation Twist turn out? Three Federal Reserve economists in 2004 completed a study which, in part, examined the 1960's Operation Twist. Their conclusion (My bold):

“A second well-known historical episode involving the attempted manipulation of the term structure was so-called Operation Twist. Launched in early 1961 by the incoming Kennedy Administration, Operation Twist was intended to raise short-term rates (thereby promoting capital inflows and supporting the dollar) while lowering, or at least not raising, long-term rates. (Modigliani and Sutch 1966).... The two main actions of Operation Twist were the use of Federal Reserve open market operations and Treasury debt management operations.. Operation Twist is widely viewed today as having been a failure, largely due to classic work by Modigliani and Sutch.”

The economists go on to state that the size of Operation Twist was relatively small, possibly too small to determine if such an operation could be successful if carried out at on a larger scale. That experiment is now being conducted on the economy of the United States with the $400 billion Operation Twist announced today. How big was the original Operation Twist? $8.8 billion.

The three Fed economists, who seem to concur that the first Operation Twist was a failure, are sure going to get an experiment on the United States economy on a much grander scale to see if this time it will work different than it did the first time. So who are these three lucky Fed economists who are now going to be able to witness Operation Twist on a grander scale? Vincent R. Reinhart, Brian P. Sack and BEN S. BERNANKE.

So part of the market’s virulent reaction signifies a revolt on Bernanke’s experimental policy. This is an example of how interventionist measures prompts for heightened uncertainties.

The Fed also promised to support mortgage markets by keeping the interest low. Again from the same Bloomberg article,

The central bank said today it will also reinvest maturing housing debt into mortgage-backed securities instead of Treasuries “to help support conditions in mortgage markets.”

Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates tumbled the most in more than two years relative to Treasuries. The average rate on a typical 30-year fixed loan fell to a record low 4.09 percent last week.

So why has Bernanke failed to live up with the expectations for more QE?

Like in the Eurozone, there has been mounting opposition to Bernanke’s inflationist bailout policies as seen by a divided FOMC… (same Bloomberg article)

The FOMC vote was 7-3. Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Charles Plosser of the Philadelphia Fed voted against the FOMC decision for a second consecutive meeting. They “did not support additional policy accommodation at this time,” the Fed statement said today.

…and from some Republicans who mostly recently who made public representations against further QEs.

Republican lawmakers including Boehner and Senate Minority Leader Mitch McConnell urged Bernanke in a letter this week to refrain from additional monetary easing to avoid “further harm” to the economy.

This is aside from political pressures applied by his predecessor, Paul Volker

In my view, Chairman Ben Bernanke could be:

-trying to lay the blame of policy restraints at the foot of his opponents in the recognition that markets would behave viciously from a stimulus dependent ‘withdrawal syndrome’, or

-that his penchant for grand experiments made him deliberately withhold QE to see how the markets would respond to his innovative ‘delusion of grandeur’ measures.

By withdrawal, I don’t mean a reduction of the Fed’s balance sheet, which the Fed aims to maintain (which probably would incrementally expand on a less evident scale) but from further specifically targeted asset purchases. The ‘twist’ essentially sterilizes the operation which means no money supply growth.

Today’s brutal reaction in global financial markets essentially validates my view that the contemporaneous market has been built on boom bust policies such that NOT even gold prices has been spared.

The tight correlations in the collapsing prices of equities and commodities as well as the rising dollar (falling global currencies) are manifestations of a bust process at work.

The primary issue here is that in absence of government’s backing via assorted stimulus, mostly via monetary injections, artificially established price structures from government stimulus or from credit expansion unravels.

Only when the tide goes out, to paraphrase Warren Buffett, do we know who has been swimming naked.

Or as Austrian economist George Reisman writes,

A fundamental fact is that our present monetary system is characterized both by irredeemable paper money, i.e., fiat money, and by credit expansion. There is no limit to the quantity of fiat money that can be created. This is the foundation for potentially limitless inflation and the ultimate destruction of the paper money, when the point is reached that it loses value so fast that no one will accept it any longer. The fact that our monetary system is also characterized by credit expansion is what creates the potential for massive deflation — for deflation to the point of wiping out the far greater part of the money supply, which in the conditions of the last centuries has been brought into existence through the mechanism of credit expansion

Blogging Hiatus

Because of a personal emergency, I am not certain if I can go on posting through the weekend. But if I find the any opportunity to do so, I will give a try.

Thanks for your understanding.

Quote of the Day: Fallacy of Animal Spirits

From Bob Wenzel

Markets clear. If consumer products are out there, they will be purchased, and a production-consumption structure will emerge based on those prices. Steve Jobs isn't successful selling iPads and iPhones because consumers are confident. He is able to sell them because first he produced the products, second consumers desire the products he has produced, and third the products are sold at a price where the market clears, which also happens to be at a price where Apple can make a profit.

Consumers can be totally unconfident about the economy to the point where iPads and iPhones have only consumer demand at $1.00. If all other products are also bid at such an overall low price level, the factors of production will adjust to the new low price level and products will continue to be produced. Keynesian concerns about "confidence", "animal spirits" etc. have no place in an economy where markets are allowed to clear through pricing.

Again beware of the fallacy of mistaking effects (confidence-fear, greed) as causes.

Declining World Economic Freedom (includes the Philippines)

The Cato Institute and the Fraser Institute has just published the 2011 Economic Freedom of the World with bleak results.

From Cato’s Ian Vasquez (bold emphasis mine)

After having risen for decades, global economic freedom has fallen for a second year in a row. That’s according to Economic Freedom of the World: 2011 Annual Report co-published today with the Fraser Institute. The average global economic freedom score rose from 5.53 (out of 10) in 1980 to 6.74 in 2007 and has fallen to 6.64 in 2009, the last year for which data is available.

As the graph below shows, the United States has had one of the largest declines in the past decade. It now ranks in 10th place compared to 3rd in 2000, largely due to higher government spending and lower ratings on “rule of law” measures.

The report documents the strong, positive relationship between economic freedom and a range of indicators of standard of living including wealth, economic growth, longer life spans, better health care, lower poverty, civil and political liberties, and so on.

Economic freedom is central to human progress. As the response of activist governments to financial and ongoing debt crises fails to address underlying issues responsible for low growth and high unemployment, this report is an important empirical reminder about the wide-ranging consequences of politics or markets in determining the use of resources.

More from the study

Economic freedom has suffered another setback

• The chain-linked summary index permits comparisons over time. The average economic freedom score rose from 5.53 (out of 10) in 1980 to 6.74 in 2007, but fell back to 6.67 in 2008, and to 6.64 in 2009, the most recent year for which data are available.

• In this year’s index, Hong Kong retains the highest rating for economic freedom, 9.01 out of 10. The other nations among the top 10 are: Singapore (8.68); New Zealand (8.20); Switzerland (8.03); Australia (7.98); Canada (7.81); Chile (7.77); United Kingdom (7.71); Mauritius (7.67); and the United States (7.60).

• The rankings (and scores) of other large economies are Germany, 21 (7.45); Japan, 22 (7.44); France, 42 (7.16); Italy, 70 (6.81); Mexico, 75 (6.74); Russia, 81 (6.55); China, 92 (6.43); India, 94 (6.40); and Brazil, 102 (6.19).

• The bottom 10 nations are: Zimbabwe (4.08); Myanmar (4.16); Venezuela (4.28); Angola (4.76); Democratic Republic of Congo (4.84); Central African Republic (4.88); Guinea-Bissau (5.03); Republic of Congo (5.04); Burundi (5.12); and Chad (5.32).

The world’s largest economy, the United States, has suffered one of the largest declines in economic freedom over the last 10 years, pushing it into tenth place. Much of this decline is a result of higher government spending and borrowing and lower scores for the legal structure and property rights components. Over the longer term, the summary chainlinked ratings of Venezuela, Zimbabwe, United States, and Malaysia fell by eight-tenths of a point or more between 1990 and 2009, causing their rankings to slip.

The chain-linked summary ratings of Uganda, Zambia, Nicaragua, Albania, and Peru have increased by three or more points since 1990. The summary ratings of eight other countries—Bulgaria, Poland, El Salvador, Romania, Ghana, Nigeria, Hungary, and Guinea-Bissau—increased by between two and three points during this same period.

The spate of government interventions which can be seen via “higher government spending and borrowing” and various forms of legislative and monetary policy interventions, especially in the developed world (meant to save the highly privileged banking sector) has definitely been weakening the underlying trends of global economic freedom.

Distortion of price signals in the marketplace has been one big symptom.

All these will continue for as long as politics is the preferred avenue to solve current social predicaments.

Nevertheless, it’s hardly been good news for the Philippines…

…whose Economic Freedom continues to decline since 2005

Quote of the Day: The Religion called Government

From Ron Paul

It has been said that when all you have is a hammer, everything is a nail. Our government is full of people who sincerely believe big government and more spending is the answer to every problem. They automatically look to government for every solution. Government is their hammer, and all they know to do is to keep hammering. When government "solutions" still don't solve the problems, they are unfazed. They keep calling for more government, more laws, and more programs. Americans are tired of being treated like nails.

This government-centric mindset is the root of the problem. People who think this way are naturally drawn to politics and government. To them, the Constitution is an annoying road block, something to get around, or ignore.

Such dogmatism looks like a universal phenomenon, not limited to Americans. Also this seem to deeply ingrained to the Filipino mindset.

OPEC’s Welfare State: Buying Off the Populace to Maintain Political Power

From Bloomberg, (bold highlights mine)

Saudi Arabia will spend $43 billion on its poorer citizens and religious institutions. Kuwaitis are getting free food for a year. Civil servants in Algeria received a 34 percent pay rise. Desert cities in the United Arab Emirates may soon enjoy uninterrupted electricity.

Organization of Petroleum Exporting Countries members are poised to earn an unprecedented $1 trillion this year, according to the U.S. Energy Department, as the group’s benchmark oil measure exceeded $100 a barrel for the longest period ever. They are promising to plow record amounts into public and social programs after pro-democracy movements overthrew rulers in Tunisia, Egypt and Libya and spread to Yemen and Syria.

Unlike past booms, when Abu Dhabi bought English soccer club Manchester City and Qatar acquired a stake in luxury carmaker Porsche SE, Gulf nations pledged $150 billion in additional spending this year on their citizens. They will need to keep U.S. benchmark West Texas Intermediate crude oil at more than $80 a barrel to afford their promises, according to Bank of America Corp…

OPEC will need WTI at above $80 a barrel to maintain the increased social spending because the costs of Persian Gulf budget obligations have more than doubled since 2006 to $77, with Saudi Arabia needing an average $82, according to Deutsche Bank AG. OPEC’s basket price at more than $100 puts it on course to earn $1.01 trillion this year, the U.S. government said…

This time, rulers are shoring up domestic support. Demonstrations in Saudi Arabia, the Arab world’s biggest economy, failed to take off in March as citizens were offered extra money for housing. Government employees had their salaries increased 15 percent and got two months extra pay. Kuwaitis received 1,000 dinars ($3,664) and free food for 13 months, state news agency KUNA said in January. Earlier this month, Qatar’s crown prince Sheikh Tamim bin Hamad al-Thani ordered 30 billion riyals ($8.2 billion) in civil servant salary increases and pension-fund allowances.

“As soon as the government announced handouts, people went out and bought cars,” said John Stadwick, managing director of General Motors Co. (GM)’s Middle East operations. Sales in Saudi Arabia climbed as much as 48 percent a month since April, compared with a decline in February and March, he said.

Gulf nations are also aiding neighboring Sunni monarchies to prop up dynasties that have ruled parts of the Middle East for centuries. They pledged $20 billion for Oman and Bahrain to fend off protests and invited Morocco and Jordan to join the six-member Gulf Cooperation Council which will include economic assistance. In addition, newly democratic Egypt received $20 billion from Qatar and $4 billion from Saudi Arabia as the Gulf seeks to retain influence in the most populous Arab nation.

Of OPEC’s 12 members, nine increased 2011 budgets and of the remaining three, only Nigeria amended its budget lower, while the U.A.E. doesn’t disclose its public spending. Nigeria, Africa’s biggest oil producer, set up a $1 billion wealth fund in May split into an infrastructure fund, a future generations fund and a stabilization fund. Algeria’s cabinet approved a 25 percent budget increase to pay for the salary raise and food subsidies amid protests that have ended 19 years of emergency rule and led to a review of the election law.

For many of the incumbent political leaders of OPEC nations, buying off the population with expanded welfare spending extracted from oil revenues will only buy them sometime to preserve their grip on power.

With the growth of welfare spending increasing the cost of oil, OPEC’s welfare state has increasingly been dependent or sensitive to ascendant levels of the prices of oil.

Anytime oil prices don’t keep up with the cost of maintaining the system heightens the risks of political upheaval (Arab Springs).

So we can expect welfare states even among resource rich (resource curse) nations to continue to yearn for inflationism. As this should keep commodity prices elevated, as well as, depreciate the purchasing power of money used to finance the current welfare spending.

Again inflation is a policy that won’t last.

Paul Volker Swings at Ben Bernanke on Inflationism

Writing at the New York Times former Federal Reserve Chairman Paul A. Volcker takes a swing at Ben Bernanke over the latter’s inflationist policies (bold emphasis mine)

IN all the commentary about Ben S. Bernanke’s recent speech in Jackson Hole, Wyo., little attention has been paid to six crucial words: “in a context of price stability.” Those words concluded a discussion by Mr. Bernanke, the Federal Reserve chairman, of what tools the central bank could consider appropriate to promote a stronger economic recovery.

Ordinarily, a central banker’s affirming the importance of price stability is not headline news. But consider the setting. There is great and understandable disappointment about high unemployment and the absence of a robust economy, and even concern about the possibility of a renewed downturn. There is also a sense of desperation that both monetary and fiscal policy have almost exhausted their potential, given the size of the fiscal deficits and the already extremely low level of interest rates.

So now we are beginning to hear murmurings about the possible invigorating effects of “just a little inflation.” Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the “animal spirits” of business, or so the argument goes.

It’s not yet a full-throated chorus. But remarkably, at least one member of the Fed’s policy making committee recently departed from the price-stability script.

The siren song is both alluring and predictable. Economic circumstances and the limitations on orthodox policies are indeed frustrating. After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? Let’s try to get business to jump the gun and invest now in the expectation of higher prices later, and raise housing prices (presumably commodities and gold, too) and maybe wages will follow. If the dollar is weakened, that’s a good thing; it might even help close the trade deficit. And of course, as soon as the economy expands sufficiently, we will promptly return to price stability.

Well, good luck.

Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with “stability,” but invokes inflation as a policy, it becomes very difficult to eliminate.

It is precisely the common experience with this inflation dynamic that has led central banks around the world to place prime importance on price stability. They do so not at the expense of a strong productive economy. They do it because experience confirms that price stability — and the expectation of that stability — is a key element in keeping interest rates low and sustaining a strong, expanding, fully employed economy.

At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.

Mr. Paul Volker appears to live up by his “inflation fighting” reputation

And with special emphasis, Mr. Volker criticism highlights Mr. Bernanke’s excessive reliance on models.

Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way.

Mr. Volker’s stinging rebuke reminds me that inflation is not a policy that will last.

From the great Ludwig von Mises,

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German Mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.

Definitely Not a Reprise of 2008, Phisix-ASEAN Equities Still in Consolidation

Note: I am in a hurry so this week's outlook will be abbreviated.

This year’s top-notch performers among global stock markets[1] (based on year-to-date) accounted for biggest losers in the region this week: I am referring to ASEAN equities.

Correction and NOT a Reversal

ASEAN markets had recently been defying ‘gravity’ but as I noted last week[2] there seems to be signs of tightening correlations.

Over the short term or during past two months, the correlation of Phisix and ASEAN indices with that of distressed global equity markets have evinced formative signs of tightening or reconvergence.

As I have been saying, divergences in market performance may persist for as long as a global recession is not in the horizon.

One must remember that decoupling signifies as an unproven thesis that can only be validated during a full-blown crisis. It’s a theory that I have been sceptical of, considering the concurrent interconnectedness and interdependence of global economies.

So the previous downside volatility of the global financial markets appears to have been carried over during this week, which had adversely affected ASEAN markets.

Yet reports of China-led BRIC (Brazil, Russia and India) proposed rescue[3] of the Eurozone by buying of Euro bonds, and most importantly, the joint or coordinated liquidity infusions by major central banks[4] as the U.S. Federal Reserve, the Bank of England, Bank of Japan, and the Swiss National Bank through foreign currency swap lines or exchanging of an agreed amount of currencies (see the basics here[5]), underpinned a fierce rally in major global equity markets.

We seem to be witnessing another variety of quantitative easing (QE) or money printing measures at work.

Perhaps one unstated objective for the synchronized liquidity injections has been to finance $800 billion derivatives[6], where 40% of which has been accounted for by “equity” options, whose expiration on during last week would have reportedly triggered tremendous pressure on the marketplace. Also such interventions could have been meant to forcibly cover equity ‘shorts’ via the derivatives market which signifies another war against the markets and alternatively represents as policies aimed to bolster equity markets.

As I have repeatedly been pointing out, what I call as the Bernanke’s doctrine[7] has been about inducing a stock market boom that would serve as a wealth effect transmission to the economy.

Furthermore, the violent pendulum gyrations seen in the market breadth[8] of US markets resonates how today’s financial markets have behaving—boom bust cycles.

Essentially, emanating from the embers of the 2008 meltdown, global equity markets have increasingly been steroid dependent which means MORE boom bust cycles ahead.

Again as I projected last week

Friday saw big declines in Asian currencies as the US dollar fiercely rebounded over a broad number of major currencies. This US dollar rally may see an extension this Monday (unless there will be declarations for major actions by US and European policymakers over the weekend).

The unfolding crisis in the Eurozone has been prompting for short term funding predicaments that has led to liquidations across financial markets worldwide, including Asia.

This has been reflected on Asian currencies as well as the Peso.

This terse quote from a Bloomberg article summarizes the week’s action in Asia’s currency markets[9]

Losses for the won, rupee, ringgit and Taiwan dollar were the worst since mid-2010.

As with most of Asia, the Philippine Peso lost a hefty 1.91% over the week.

This Is NOT 2008, Redux

I would disagree to imputations that current environment is about rising risk aversion. Such description would likely apply to financial markets of crisis afflicted economies but not to Asia markets.

Proof?

The Euro debt crisis and fears of another recession has indeed been increasing overall market anxieties around, but for Asia such concern has been muted, relative to 2008.

The above graph of Credit Default Swap prices representing debt default risks of Asian sovereigns from ADB[10] shows that credit concerns in the region subdued.

In addition, net foreign trade in the Philippine Stock Exchange has been inconsequential despite emergent signs of selling pressures so far.

It could be that local investors may seem to have been more ‘traumatized’ (Post Stress Traumatic Disorder) by the last crisis to stampede into US dollars, relative to foreigners.

Moreover, while emerging markets in general have endured equity outflows from the recent volatility, this has partly been offset by inflows to the bond markets[11].

And there is even more evidence that risk environment has been conspicuously nuanced compared to 2008—the continuing lofty levels of prices of gold and other precious metals and even of oil.

Notice that the recent downside actions of the S&P 500 (SPX) has been accompanied by downswings of gold, precious metals (DJGSP) and oil (WTIC), yet the former two has basically risen above the levels from where the declines were triggered.

Furthermore, oil at $87 hardly accounts for a ‘recessionary’ environment.

And there have been some insinuations that bullion banks have been significantly hurt by the recent upsurge in gold prices, such that manipulation of the gold-precious metal markets downwards has been undertaken to ease on the losses of these banks under the camouflage of central bank actions.

As Goldmoney.com Alasdair Macleod writes[12],

In common with dealers and market makers in all markets, bullion traders run short positions in bull markets. The turnover on the bullion markets is massive, and a dealer active on behalf of its customers and its own trading book can make substantial dealing profits. So long as those profits exceed the losses on their short positions, all is well. This is why the greatest threat to the bullion market is not the bull market itself, but prices rising too rapidly.

In the last two months, the market for gold has been particularly strong, erasing trading profits for many bullion dealers. Central bankers see this as the result of financial flows building due to the difficulties in the euro area. The targets for these flows out of the euro are the Swiss franc and gold, so the SNB’s move is designed to take the heat out of both of them.

The whopping $2 billion trading losses racked up by Swiss bank UBS[13] from supposedly unauthorized trade by a ‘rogue’ trader, Kweku Adoboli, has allegedly been due to voluminous exposure in “shorting” silver[14].

All machinations to manipulate the metals market will prove to be a temporary event. We should see metals rally significantly in the light of intensifying interventions (via assorted money printing measures) in the marketplace.

With the team Ben Bernanke meeting this week (September 21^st) for an extended 2 days[15], we should expect Operation Twist, a pioneering measure telegraphed by Mr. Bernanke in his last speech[16], which aims to lower interest rates on the longer duration securities, to be formally in operation.

This could be backed by another formal QE 3.0 or by a significant interest rate cut on excess reserves (IOER) meant to disincentivize banks from parking their excess reserves at the Fed.

And considering that much of the developed world has been already been immersed into various forms of QE, we should expect improvements in global equity markets that should filter over to ASEAN markets.

Again, to repeat, this has NOT been 2008. There are hardly signs of deflationary risks that warrant an increase of cash holdings. In the US, money supply has been rampaging along with improving signs of credit conditions[17]. Elsewhere, we should expect policy directions towards an accommodative stance by keeping current levels of interest rates or perhaps even by lowering policy rates.

Central bank activism essentially differentiates today’s environment from that of 2008.

PSE Still in Consolidation Mode

The local market has indeed been under pressure, but again there have hardly been signs of major deterioration.

True, every sector has been marked by declines this week with the ALL sector suffering the largest loss due to Manulife (-6.02%).

Mining, being overextended, suffered most from last week’s profit taking. Again I view this as a fleeting event.

The Phisix has been rangebound. However, trading indicators seem to suggest of partially oversold conditions (MACD). This implies that a rebound could be in the offing.

And peso volume has been dropping as the Phsix consolidates. This serves as indication of the diminishing strength of sellers.

Market internals, despite last week’s significant profit taking, has not materially deteriorated.

If US markets will continue to rebound, then we should see the current consolidation trend in the Phisix to segue into an ascending trend.

I would certainly watch the US Federal Reserve’s announcement and the ensuing market response.

If team Bernake will commence on a third series of QE (dependent on the size) or a cut in the interest rate on excess reserves (IOER), I would be aggressively bullish with the equity markets, not because of conventional fundamentals, but because massive doses of money injections will have to flow somewhere. Equity markets—particulary in Asia and the commodity markets will likely be major beneficiaries.

As a caveat, with markets being sustained by policy steroids, expect sharp volatilities in both directions.

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[1] See Global Equity Market Performance Update: ASEAN Equity Markets as co-Leaders, September 13, 2011

[2] See Phisix-ASEAN Equities: Staying Afloat Amidst Global Financial Market Hurricane, September 11, 2011

[3] See BRICs Mulls Bailout of the Eurozone September 14, 2011

[4] See Hot: Major Central Banks to Jointly Offer US Dollar Liquidity, September 15, 2011

[5] See How Does Swap Lines Work? Possible Implications to Asia and Emerging Markets, October 30, 2008

[6] Naked trader.com Almost 40% of S&P 500 Options Expire Sept. 16, JPMorgan Says

[7] See US Stock Markets and Animal Spirits Targeted Policies, July 21 2010

[8] See US Equity Markets: Signs of Intensifying Boom Bust Cycles, September 17, 2011

[9] Bloomberg.com Asian Currencies Fell in Week on Concern Europe’s Debt Crisis Will Worsen, September 17, 2011

[10] Asianbondsonline.org Emerging East Asia CDS - Senior 5-year

[11] Wall Street Journal Emerging Market Local Currency Bonds Funds Continue To Draw Money, September 16, 2011

[12] Macleod Alasdair Central banks and the gold price goldmoney.com September 11, 2011

[13] Washington Post, UBS says rogue trader caused $2 billion loss, September 15, 2011

[14] Keiser Max BREAKING: UBS rogue trader was trying to exit a naked silver short…. [UPDATED], maxkeiser.com September 15, 2011

[15] IBTimesFX The Week Ahead September 16, 2011

[16] See US Mulls ‘official’ QE 3.0, Operation Twist AND Fiscal Stimulus, September 9, 2011

[17] See US in a Deflationary Environment, NOT! (In Charts) September 16, 2011

Quote of the Day: Law Differs from Legislation

Today’s quote of the day comes from Professor Don Boudreaux

law is not at all the same thing as legislation. Law deserves far more respect (although, still, not respect given mindlessly) than does legislation; indeed, legislation, by its very nature, is frequently used to break the law. For example, Jim Crow legislation in the late 19th-century American south broke the law that effectively enforced racial desegregation on streetcars.

One of the greatest dangers unleashed by modern language is the treatment of “legislation” and “law” as synonyms for each other – and, hence, the bestowal on legislation of the genuine respect that is due to law.

Gold as Money: China’s Gold ATMs and Donald Trump’s Gold Security Deposit

We are witnessing more signs of gold’s reassuming its place as money.

From Forbes, (bold emphasis mine)

China’s got the gold bug. Recently, the government allowed citizens to actually own gold bullion. And now, starting on Sept 23, Chinese people can buy gold bars directly from vending machines.

Gold has caught on like a wrong and oversold political narrative. Is this WMD, or is gold for real?

The China machines, made by German firm TG Gold Super Market, is the first of its kind there, but are already up and running in Las Vegas and Boca Rotan in the U.S., as well as Abu Dhabi, Germany, Spain and Italy. The ATMs dispense gold bars weighing up to 2.5 kilograms and work just like the normal ATMs. The machines can accept both cash and credit cards.

The cash-for-gold machines will be on trial at Beijing’s upscale night clubs and private banks during the initial period for security reasons.

I posted Germany’s first gold vending machine or ATMs in 2009 here.

With gold more accessible to the public, it won’t be long when the function of payment and settlement in the marketplace will include gold bars or coins. (That’s if governments won’t engage in gold confiscation)

In fact, Donald Trump may be setting a precedent on this.

Mr Trump recently accepted gold bars as payment for Security Deposit for property rentals.

From the Wall Street Journal,

On Thursday, the newest tenant in Donald Trump's 40 Wall Street, a 70-story skyscraper in Manhattan's Financial District, will hand Mr. Trump a security deposit worth about $176,000. No money will change hands—just three 32-ounce bars of gold, each about the size of a television remote control.

The occasion will mark the first time the Trump Organization has accepted 99.9% pure gold bullion, rather than cash, as a deposit on a commercial lease. The tenant, precious-metals dealer Apmex, will sign a 10-year lease for 40 Wall's 50th floor at a leasing rate of about $50 a square foot, according to Apmex Chief Executive Michael R. Haynes. The company is promoting the use of gold as a replacement for cash in some situations.

As the great Ludwig von Mises wrote, (bold emphasis mine)

Under the gold standard gold is money and money is gold. It is immaterial whether or not the laws assign legal tender quality only to gold coins minted by the government. What counts is that these coins really contain a fixed weight of gold and that every quantity of bullion can be transformed into coins. Under the gold standard the dollar and the pound sterling were merely names for a definite weight of gold, within very narrow margins precisely determined by the laws. We may call such a sort of money commodity money.

Sound money could be in the future as the current paper money based system self-destructs.

Video: Jon Stewart on President Obama’s Solyndra Green Jobs Scandal

President Obama’s green jobs showcase… (hat tip: Lew Rockwell blog)

The true engines of economic growth will always be companies like Solyndra...

It's here that companies like Solyndra are leading the way towards a brighter and most prosperous future

…appears to collapsing into a scandal.

Here is the Daily Show Jon Stewart’s comical take…

US Equity Markets: Signs of Intensifying Boom Bust Cycles

More evidence where US equity markets seem as increasingly being influenced by monetary policy propelled tidal flows.

Again another marvelous observation as exhibited by the chart above and the comment below by Bespoke Invest

we have made numerous references to how the increased volatility this Summer has caused a big uptick in the number of 'all or nothing' days for the equity market. We consider 'all or nothing' days in the market to be days where the net daily A/D reading in the S&P 500 exceeds plus or minus 400.

So far this year there have been 38 days where the net A/D reading for the S&P 500 was above +400 or below -400. On an annualized basis, this now puts 2011 on pace to see 54 'all or nothing' days, which would make it the most volatile year since at least 1990.

The amplifying accounts of market breadth volatility signifies as intensifying price distortions which have been symptomatic of the escalating government interventions in the US financial and monetary system, which I would add as being transmitted or diffused worldwide.