Investing in the PSE: Will Negative Real Rates Generate Positive Real Returns?

Easy money also helps the fiscal position of the government. Lower borrowing costs mean lower deficits. In effect, negative real interest rates are indirect debt monetization. Allowing borrowers including the government to get addicted to unsustainably low rates creates enormous solvency risks when rates eventually rise. I believe that the Japanese government has already reached the point where a normalization of rates would create a fiscal crisis. David Einhorn

We are living in interesting times.

Negative Real Interest Rate as Stock Market Driver

In the Philippines, interest rates have considerably been below inflation rates.

Banks like the BPI[1], offers yields anywhere 2-2.75% for 364 days on their regular time deposit account, depending on the size of the account (as of November 15 to 21), whereas statistical Consumer Price Inflation rate has reached 5.2% last October[2].

Most people don’t realize that real money returns for the Peso has been negative or that savers have been losing money in terms of reduced purchasing power.

Curiously, inflation rates are even higher than the yields of domestic government bonds, from 1 to 10 years in maturity. This implies that bondholders of 10 years maturity and below are also getting squeezed from the current negative real interest rate regime (chart from Asian Bonds Online[3]).

Aside, the steep yield curve likewise induces borrow-short lend-long activities or maturity transformation which implies of higher future CPI rates as banks are incentivized to expand lending.

And since the yield curve has been steep even from last year, we are seeing credit activities ramping up.

From the BSP[4], (bold emphasis mine)

Growth in outstanding loans of commercial banks, net of banks’ reverse repurchase (RRP) placements with the BSP, accelerated in September to 21.7 percent from the previous month’s expansion of 19.8 percent. Meanwhile, the growth of bank lending inclusive of RRPs slowed down to 18.9 percent from 24.8 percent in August. Commercial banks’ loans have been growing steadily at double-digit growth rates since January 2011. On a month-on-month seasonally-adjusted basis, commercial banks’ lending in September grew by 1.0 percent for loans net of RRPs, while loans inclusive of RRPs fell by 2.0 percent.

Loans for production activities—which comprised 84.2 percent of commercial banks’ total loan portfolio—grew steadily by 22.9 percent in September from 21.5 percent a month earlier. Growth in consumer loans likewise accelerated to 17.9 percent from 13.4 percent in August, reflecting the rapid growth in lending across all types of household loans.

The expansion in production loans continued to be driven largely by higher lending to electricity, gas and water (which grew by 56.3 percent); manufacturing (24.2 percent); real estate, renting and business services (26.1 percent); wholesale and retail trade (29.8 percent); financial intermediation (32.8 percent); transportation, storage and communication (19.3 percent); and construction (17.6 percent). Moreover, with strong global demand driving growth in the mining and quarrying industry, loans to mining and quarrying more than tripled in September from a year ago, sustaining the three-digit growth rate since May 2011. Meanwhile, contractions were posted in lending to three production sectors, namely, health and social work (-4.9 percent), education (-10.0 percent), and agriculture, hunting and forestry (-3.5 percent).

From a mainstream economic viewpoint this will be seen as a good sign.

Theoretically low interest rate should reflect on the time preferences of individuals, where the preference to consume goods later rather than now (lower time preference) means that there should be an abundance of savings available for investments.

According to Mises.wiki[5]

The act of saving is a means through which man can achieve his ultimate goal, which is bettering his situation. Saving implies giving up some benefits at present - this is the price paid for the attainment of the end sought. The value of the price paid is called cost, and costs are equal to the value of the satisfaction which one must forego to attain the end aimed at.

The return on savings must be in excess of the cost of savings. If the costs are too high - if savings can’t better an individual’s life and well being - then saving will not be undertaken.

Consequently, the return on savings must be above the premium for man to agree to save. A positive time preference (i.e., the existence of a premium) precludes the natural emergence of a zero interest rate. Should a zero interest rate be imposed, this will abort all savings and lead to the destruction of the production structure. The premium of having goods now versus having them in the future is getting smaller with the increase in their stock. This, in turn, means that the required return on savings will be lower. An increase in the pool of funding sets the platform for lower interest rates.

Apart from time preferences, the purchasing power of money and business risk are important elements in the formation of interest. However, their importance is assessed in reference to the fundamental factor, which is time preference.

However as pointed out above a policy induced boom from manipulated interest rates distorts the production structure which will be misdirected towards investments in capital goods (higher stages of production) that leads to a bubble cycle (Austrian Business Cycle Theory—ABCT).

As I wrote last week[6],

Although I am not sure which sector should give the best returns over the short term, I am predisposed towards what Austrian economics calls as the higher order stages of production or the capital goods industries, which are likely the beneficiaries of the business cycle, specifically, mining, property-construction and energy, as well as financials whom are likely to serve as funding intermediaries for these projects.

Interestingly, even the relative performances by different sectors in the PSE seem to coincide or reflect on the distribution of credit growth as noted by the BSP.

For this week, except for Financial-Banking sector, the best gainers have been the mining index, followed by the industrial (mostly weighted on energy and utility companies) and the property sector. Here I am comparing apples to oranges because of the variances of time considerations between the PSE sectoral activities and loan portfolio growth in the real economy.

Yet the outperformance of the mining sector in the PSE can likewise be accounted for in the tripling of loans to the mining and quarrying industry.

Overall, the point is that the accelerating credit growth in capital good industries such as in mining, real estate and construction, power and financial intermediation appears to corroborate the boom bust process.

Another fascinating observation is that negative real interest rates may have altered the composition of trading activities seen during the current cycle in the Philippine Stock Exchange (PSE).

In the 2003-2007 boom cycle, foreign investors had largely been the dominant force in the daily trading activities at the PSE. Today, local participants appear to have wrested that role.

And the ascendancy of local investors seems to have provided resiliency to the Phisix during the recent shakeout.

The implication is that negative real interest rates may have driven many savers to speculate on the stock market to eke out positive real returns.

Yet if holding cash and near term bonds generates negative real returns then where to put one’s resources?

Every investment competes for your money. There will always be a tradeoff for any choices we make. Investments would mean a trade-off in terms of risk-reward and on relative assets.

Market Risk: Debating The Role of the ECB

There is no such thing as a risk free investment as inculcated to us by media, the academe or by mainstream institutions.

The concept of “risk-free” has been impressed upon us to justify the institutional rechanneling of private savings via the banking system into funding pet programs of politicians. And part of the process has been enabled by banking regulations such as the Basel Accord.

Yet such masquerade is presently being exposed by the markets. The bond spread of Italy and France (relative to the German Bund) has soared to record highs[7] as shown in the above chart (chartoftheday.com).

To add, the cost to insure liabilities of AAA credit rating France is now higher than the Philippines or compared to ASEAN-4[8]. This means that the credit standings applied by the government licensed or accredited credit rating agency cartel does not accurately reflect on the credit risks by developed economies plagued by the unsustainable welfare state.

And because financial markets have been defying whatever the EU governments has been imposing such as credit margin hikes[9] on Italian bonds and ban on short selling of Italian stocks[10], credit rating agencies appear as being pressured to downgrade the AAA credit rating of France[11].

The economics of the marketplace has been reasserting her ascendancy against welfare based politics.

Yet political impasse over the role of the European Central Bank as the “lender of last resort” has proven to be a seething issue that continues to unsettled financial markets.

While some key officials such as German Chancellor Angela Merkel[12], ECB’s Mario Draghi[13] and IMF’s John Lipsky[14] were allegedly against the carte blanche backstop role for the ECB, there has been a growing clarion clamor for the ECB to aggressively support the bond markets from France and from political personalities such as former German Chancellor Gerhard Schroeder[15], Portuguese President Anibal Cavaco Silva[16] and many more.

One popular analyst have even called the ECB’s role as either to “Print or Perish” for the Euro, which resonates with the popular call to inflate. Little do these inflation advocates realize that historical accounts of currency destruction have hardly been about the “deflationary spiral” but more about serial episodes of hyperinflations and or wars[17].

For the ECB to rapidly and intensify inflationism would be to “Print and Perish”.

Nonetheless, print and perish has been the name of the game for global central bankers.

But the supposed political stalemate over the ECB’s role appears as “smoke and mirrors” for me.

That’s because in reality, the ECB along with rest of major Central Banks except the US Federal Reserve has been scaling up their asset purchases as shown by the above chart[18].

Since 2008, major central banks have been ramping up asset purchases which makes today’s developments as unprecedented or entirely unique in modern history. So there hardly can be merit to claims that we are bound for “deflationary spiral” for as long as central banks continue to inundate the world with the liquidity approach to contain what truly are insolvency issues.

The ECB has reportedly an undeclared €20 billion weekly limit of bond purchases[19]. I would conjecture that rules, laws, regulations, policies or self-imposed limits change according to the convenience and the interests of politicians.

And recent reports suggest that European banks have been unloading heaps of sovereign debt issues.

So EU banks have been taking the opportunity to transfer their supposed “risk free” securities to the ECB in order to rehabilitate their balance sheets.

And the desire for the ECB to take on a more aggressive role can be seen through the implied missives from this New York Times article[20],

The dynamic of falling bond prices also undermines the capital position of the banks, since they are among the biggest holders of government bonds in many countries. As those assets plunge in value, banks cut back on lending and hoard capital, increasing the likelihood of a recession.

All these money printing won’t be sucked into a financial black hole, as they will have to flow somewhere.

Yet despite the current turbulence, I think that the current volatility may be ignoring such dynamic.

As a final note, if events in the Eurozone should turn out for the worst, the local and ASEAN economies may not be immune from such disruption, which may affect the region’s stock markets.

As Gerald Hwang of the Matthews Asian Fund writes[21],

Asian fixed income markets can have heavy foreign participation in both bonds and bank loans. The amount of participation from European banks is noteworthy in light of their exposure to European debt and the probability of shrinking balance sheets in the near future. European bank lending into Asia is greater than U.S. bank lending in the region; therefore, weakness in European bank balance sheets may tighten the financing environment for Asia’s borrowers more so than similar weakness in U.S. banks.

While European banks do have material exposure on Asia, I wouldn’t call less than 25% as substantial enough to possibly rock the boat. But again this depends on general market sentiment. Also, any tightening of credit conditions by Euro banks may be used as an opportunity by non-European banks to expand their market share.

Market Risk: US ‘Sequester’ Spending Cuts Will Be a Nonevent

The Philippine Stock Exchange’s Phisix has been up 2.41% on a year-to-date basis and has outperformed the majors and other Emerging Market contemporaries. But it is important to point out that such outperformance has still been dependent on the ebbs and flows of global markets, particularly the US (SPX).

Over the past weeks, we seem to be seeing renewed weakness in Europe (STOX50), China (SSEC) and US S&P 500 (SPX).

So far the stock markets of the Eurozone has, I think, already priced in an economic recession given the current bear market status. The Stoxx50 is still 19% down from the February 2011 high. Yet should the ECB intensify the asset purchases or inflationism we should see European stocks pick up.

Further, I think that US stock markets will likely steer the global markets rather than that of the EU. This means that an ascendant US markets should likely bolster the bullish case of the Phisix and of the ASEAN-4 and vice versa.

Yet another worry being promoted by some of the bears is the brewing gridlock by Congressional super committee over spending cuts that would result to sequester rules or automatic spending cut.

The Wall Street Journal editorial says that such concerns are exaggerated[22],

Under the sequester rules, roughly half of the spending cuts would come from defense and homeland security, and the other half from domestic programs such as roads, education, energy and housing. An automatic cut from every federal agency is far from an ideal way to write a budget, because it sets no priorities and largely exempts the major entitlements like Medicare and Medicaid.

But the sequester does have the virtue of imposing reductions in spending that Congress rarely agrees to on its own. The Congressional Budget Office estimates domestic programs would take a 7.8% cut, while defense programs would get sliced by 10%. Medicare spending, mostly payments to providers, would fall by 2%. This would yield $68 billion in savings in 2013, and more savings in future years by ratcheting down the baseline level of spending.

Given the spending increases of recent years, those cuts are hardly excessive. Domestic programs received a nearly $300 billion windfall under the 2009 stimulus, so a sequester would take back a little more than one-fifth in 2013. Total domestic discretionary spending doubled to $614 billion in 2010 from $298 billion in 2000. Even if there were a 10-year $1.2 trillion "cut," total discretionary spending would still rise by $83 billion by 2021 because those cuts are calculated from inflated "current services" projections.

Essentially, the $1.2 trillion sequester spending cuts will be spread over 10 years, and as mentioned above will be apportioned mostly towards defense, homeland security and domestic programs which hardly tackles on welfare entitlement programs.

The sequester or automatic spending cuts extrapolates to a cut on the rate of growth spending rather than real or actual cuts as shown above[23].

This only means that risks from the supposed political gridlock won’t be anywhere as disastrous as portrayed by political fanatics.

For the US markets, the reaccelerating growth of money supply should filter into and continue to provide support to her stock markets and the economy.

This week, the US economy posted strong growth which apparently surprised the mainstream[24]. Of course we understand this to be inflation boosted growth.

Barring any unforeseen events, I think this momentum should continue.

A Short Note On Commodities

Commodity markets experienced intensified downside volatility last week which many blamed on the Euro crisis.

While the Euro crisis may have aggravated sentiment, my guess is that these have been largely related to the liquidation process being undertaken by the trustee committee handling bankruptcy of MF Global Holdings who incidentally filed papers to set up the required accelerated filing of claims a day before the selloff[25].

Gold oil and copper simultaneously fell the following day.

I earlier noted that this should be expected[26] last week but apparently has been deferred until this week.

And I think that once the proceedings culminate, the upside trend for the commodity markets should resume.

Bottom line: Negative real interest rates and expanding balance sheets of major global central banks will impact asset prices differently. Nevertheless such dynamic will continue to provide support to the Phisix-ASEAN equity markets and the commodity markets.

On the other hand, unless a massive collapse occurs, political developments particularly in the Eurozone should spice up market actions.

So my guess is that the current domestic environment of negative real interest rates should bode well for investors of the PSE.

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[1] BPI Expressonline Regular Time Deposit (Peso) November 15 to November 21, 2011

[2] Tradingeconomics.com Philippine Inflation rate

[3] AsianBondsOnline Philippine Government Bond Yields

[4] bsp.gov.ph Bank Lending Growth Expands Further in September, November 11, 2011

[5] Wiki.mises.org Saving and the Interest rate

[6] See Phisix-ASEAN Equities: Awaiting for the Confirmation of the Bullmarket, November 13, 2011

[7] Telegraph.co.uk Spread between French and German bonds hits record, November 9, 2011

[8] See Chart of the Day: France ‘Riskier’ than the Philippines, ASEAN, November 17, 2011

[9] Reuters.com MONEY MARKETS-Italian banks risk becoming dependent on ECB, November 10, 2011

[10] Reuters.com Italy to ban naked short-selling on stocks, November 11, 2011

[11] Guardian.co.uk Debts in France threaten top credit rating, November 15, 2011

[12] Bloomberg.com Merkel Rejects ECB as Crisis Backstop in Clash With France, November 17, 2011

[13] Washington Post, ECB leader Mario Draghi rebuffs calls for greater central bank role, November 19, 2011

[14] CNBC.com IMF’s Lipsky Backs Merkel Over ECB Powers November 18, 2011

[15] Reuters.com German ex-chancellor sees ECB steps in "last resort", November 18, 2011

[16] Bloomberg.com ECB as Lender of Last Resort Will Resolve Debt Crisis for Portugal’s Silva, November 12, 2011

[17] Hewitt Mike The Fate of Paper Money, January 5, 2009 DollarDaze.org

[18] Danske Bank, Bank of Japan on hold, still sees substantial downside risks November 16, 2011

[19] Reuters.com ECB has secret 20 billion euro bond-buying limit: report November 18, 2011

[20] New York Times Europe Fears a Credit Squeeze as Investors Sell Bond Holdings, November 18, 2011

[21] Hwang Gerald Capital Flows: Asia's Quiet Revolution Asia Insight November 2011 Matthews International Capital Management, LLC

[22] Wall Street Journal Editorial The Sequester Option, November 18, 2011

[23] Mitchell Daniel What Matters More to Republicans, Defending Taxpayers or Expanding Government?, November 18, 2011

[24] See Strong Performance of the US Economy Surprises the Mainstream November 19, 2011

[25] See MF Global Holding’s Liquidations and the November 17th Commodity Prices Rout, November 19, 2011

[26] See Client Accounts Transfer from MF Global Holdings may trigger Market Volatility Next Week, November 5, 2011

Will Gold Backed Bonds Play a Role in the Euro Debt Crisis?

From the Guardian.co.uk

A solution to the eurozone crisis is staring European leaders in the face. Remarkably, they have failed to consider gold as the asset of last resort. Eurozone member nations and the European financial stability facility (EFSF), the bailout fund, could use gold to back new bond issues.

The security of gold-backed bonds would encourage investors. Indeed, central banks purchased 4.8m ounces of gold worth $8bn (£5bn) in the third quarter. The application of gold backing would allow stricken nations such as Greece, Portugal, Spain and Ireland to depart from the restrictive eurozone and the accompanying depressive austerity policies, if they wished. The bonds would give them time to devalue, adjust and grow again, and also isolate the crisis from other European nations.

As at the end of October, eurozone nation central banks owned 347m ounces of gold worth $604bn. This compares with 400.5m ounces, then worth only $110.5bn, in the first quarter of 2000. The gold reserves fell because European central banks subsequently sold gold at knockdown prices of $250 to $350 an ounce after the 11 September terror attacks. Since then the lemming instinct of European finance ministers and central banks has once again prevailed and their gold sales have dried up, despite recent record prices of $1,800-1,900 an ounce.

Fortunately for eurozone leaders and their advisers, there is still a lot of gold left in the kitty. The current market value of the eurozone's 347m ounces has surged to $604bn, or €447bn – more than the current capital of the EFSF…

Eurozone leaders have devised several complicated partial loss guarantee schemes to persuade China and other potential investors to invest in EFSF bonds. Hardly surprising that the response has been: "Thanks, but no thanks." On the other hand, if EFSF bond issues had the backing of gold plus interest, it would be surprising if European and international investors didn't snap them up. Depending on demand, gold backing could be 25% to 50% of the total value of an Italian bond, for example.

Gold backed bonds have worked before. Take some precedents. In 1981 and 1982, South Africa, which was then the world's largest gold producer, swapped nearly 5m ounces of gold collateral in return for foreign exchange. In the late 1970s and early 1980s, indebted nations such as Brazil, Uruguay and Portugal either swapped or sold their gold to raise funds. In 1973, France issued 'Giscard' bonds, indexed to the price of gold.

While I think bonds collateralized by gold could indeed be tapped, I don’t think this would work like a magical wand that could wish away the debt crisis, where crisis afflicted EU governments can just “depart from the restrictive Eurozone”, elude “depressive austerity policies”, or “to devalue”. That would be oversimplistic and naïve.

Growth of Social Transfers (From Faz community) [hat tip Prof. Antony Mueller]

The Eurozone has been blighted by insolvency issues, mostly emanating from an overextended welfare and heavily regulated state which has been compounded by a debt overdosed dysfunctional banking system.

EU’s gold holdings would signify only a fraction of EU’s debts.

The US and Japan has not been immune to the same crisis, except that the EU has been the first to feel the crunch from an unsustainable political economic system.

Growth of government debt (From Faz community)

Gold backed bonds does nothing to change this dynamic, except to possibly gain access to funding in the marketplace which may help the EU to mitigate current conditions as reform programs are undertaken.

Nevertheless, the good news is that the urgency to address the current dire situation from the fiat money based debt mess has been prompting mainstream media to reconsider gold as part of the possible solution. Such is the gradual transformation of gold from an ignored “barbaric metal” to eventually “money”.

Ron Paul in 1981: 5 Myths About the Gold Standard

In February 1981, Congressman Ron Paul introduced the Gold coin standard bill H.R. 7874 along with Congressman Larry McDonald at the House of Representatives.

Ron Paul then and today has been very much consistent with his views.

(source Charleston Voice 1st, 2nd and 3rd pages)

Key Man Risk: With Steve Jobs Gone, Apple In A Funk

From Bloomberg,

Anyone who expects Apple Inc.’s growth to rebound after sales and earnings shortfalls last quarter is “living in denial,” according to David Nelson, chief strategist at Belpointe Asset Management LLC.

As the CHART OF THE DAY shows, shares of the maker of iPhones and iPad tablet computers have trailed the Standard & Poor’s 500 Index and a gauge of S&P 500 technology companies since the company reported fourth-quarter results a month ago.

“This is no longer a hyper-growth company,” Nelson said yesterday in a telephone interview. Apple’s products are now reaching customers who are less likely to upgrade as newer models are released, he added…

Let me first disclose that I have no interest in Apple [AAPL] since I don’t use Apple’s products nor am I a stockholder.

The reason I posted this is to show what in insurance is known as Key Man Risk—the effect of losing one important member of the team.

I have no judgment of Apple except to say that the market currently prices the company as undergoing an uncertain transition process without the presence of the Key Man—Steve Jobs. In short, Apple appears to be suffering from a Key Man Risk.

I think the same Key Man dynamics will apply to Warren Buffett’s Berkshire Hathaway [BRK/A and BRK/B] or to Bill Gates’ Microsoft [MSFT] or to any successful company whose image has been built as an alter ego of the owner-manager.

Nonetheless, I don’t think that the markets has entirely written off Apple, as all will depend on the performance of the current team (owners and managers) in serving the consumers, which should theoretically reflect on the company’s stock prices.

MF Global Holding’s Liquidations and the November 17th Commodity Prices Rout

Aside from China’s proposed increase on credit margins for Silver, I think that the unwinding of mostly commodity assets of bankrupt MF Global Holdings has had much to do with the rout in the commodity markets last Thursday (November 17).

The above chart from stockcharts.com, is the weekly charts for gold, silver and CRB indices which exhibits the steep decline last Thursday.

From Businessweek-Bloomberg dated November 16th, (bold emphasis mine)

The trustee liquidating commodities broker MF Global Inc. filed papers yesterday setting up an emergency hearing tomorrow for approval to require the accelerated filing of claims.

Six customers filed a motion asking the bankruptcy judge to overrule the trustee and allow customers to take out 90 percent or more of their collateral.

In papers filed yesterday referring to his “vigorous efforts,” the trustee said the “precise size of and the reasons for the shortfall in segregated accounts are not yet known by the trustee, law enforcement, and other officials and regulators conducting investigations.”

If the trustee has his way, there will be a two-track process where commodities and securities customers must file claims by Jan. 27 to receive the maximum distribution of so- called customer property. General creditors must submit claims by May 28.

James W. Giddens, the trustee for the MF Global broker, said he has already distributed about 3 million commodities contracts in 17,000 customer accounts, together with $1.55 billion in collateral, to 12 or more other brokers. Accounts that weren't transferred by Nov. 11 are undergoing an “orderly liquidation,” Giddens said.

Giddens also said he's looking for other brokers to accept bulk transfers of 450 customer accounts for securities. He also asked a judge to let him transfer about $520 million in collateral to commodity customers whose accounts consisted solely of cash on Oct. 31.

The trustee said he will review customer claims on a “rolling basis” as they are filed. Given what he called the “relatively poor state” of the books, the trustee said he hopes to make additional requests to the court for further distributions of so-called customer property.

Giddens was unable to transfer accounts immediately because about $600 million of customers' collateral is missing. Consequently, open contracts transferred to other brokers weren't accompanied by all the collateral customers had on account with MF Global.

Six customers in their motion filed yesterday contend the trustee should be giving them at least 90 percent of the collateral. They arrive at the figure saying that the $600 million in missing cash is about 10 percent of the $5.5 billion supposedly held for customers.

Missing cash, accelerated filing (November 15th) of claims and orderly liquidations for accounts that have not been transferred seem to coincide with November 17’s rout in commodity prices.

I expected this liquidation induced volatility from MF Global Holdings to happen a week ago. Apparently legal obstacles may have delayed the process from taking place until late this week.

While it is unclear if the procedural liquidations has culminated, the likely effect from this should be temporary which means current weakness in commodity prices may prove to be a great buying opportunity.

War on Commodities: China will Raise Credit Margins on Silver

From Reuters

The Shanghai Gold Exchange said it will raise margins on silver forwards to 18 percent from 15 percent from Monday if the silver contract hits its daily trade limit on settlement on Friday.

The exchange said it would lift daily trade limits on silver forward contracts to 15 percent from 12 percent if the contract hits limit up or down on settlement on Friday.

Last week’s steep drop in commodity prices may have been influenced by the above. As I have been tirelessly pointing out, global governments has repeatedly been attempting to rein and control prices for political motivations (e.g. manage inflation expectations).

Strong Performance of the US Economy Surprises the Mainstream

Yet another confirmation of my hunches.

From Reuters, (bold highlights mine)

The U.S. economy is gaining steam as factories churn out more cars and slowing inflation boosts spending power, putting the country on stronger footing to resist an economic storm gathering over Europe.

Recent readings of the U.S. economic pulse have steadily topped analysts' expectations. Many now think the fourth quarter will prove stronger than the third, when the economy expanded at a 2.5 percent annual rate. Forecasting firm Macroeconomic Advisers, for example, sees a growth rate of 3.2 percent over the final three months of the year.

While a widely expected European recession will likely drag on the U.S. economy next year, the United States will be able to lean into that headwind more than was possible just a few months ago.

"There is enough momentum in the near term to withstand some pain from overseas," said Michelle Meyer, an economist with Bank of America Merrill Lynch in New York.

U.S. industrial output rose last month by the most since July, helped by higher production of motor vehicles and parts.

The current upswing points to a continuation as evidenced by leading economic indicators (LOI)

From Bloomberg, (bold highlights mine)

The index of U.S. leading indicators climbed more than forecast in October, signaling the world’s largest economy will keep growing in early 2012.

The Conference Board’s gauge of the outlook for the next three to six months rose 0.9 percent, the biggest jump since February, after a 0.1 percent September increase, the New York- based research group said today. The median forecast of 56 economists surveyed by Bloomberg News projected the gauge would advance 0.6 percent.

Gains in consumer spending, manufacturing and homebuilding, combined with fewer job losses, point to an economy that is weathering the turbulence in financial markets caused by the debt crisis in Europe. Nonetheless, a 9 percent jobless rate and political gridlock over deficit-cutting have hurt confidence, which may be a hurdle to a further pickup in the pace of growth.

Many popular mainstream analysts mainly of the Keynesian persuasion have been predicting an economic downswing that would lead to a recession. The news above only contravenes their forecasts.

And like momentum traders, many of the mainstream analysts (experts), given their wrong assessment and forecasts, appear to be chasing the upside momentum by adjusting their forecasts. One doesn’t need to be an expert to seek “comfort of the crowds”.

Here is what I wrote at the end of October,

Importantly, as I have been repeatedly saying, I don’t see the imminence of a recession risk for the US economy for the simple reason that money supply growth has been exploding.

And a possible evidence of the diffusion of money supply growth has been the very impressive record breaking growth of US capital spending. Capital spending growth should be seen as a leading indicator which should mean more improvement in the employment data ahead. Besides, record capital spending growth demolishes the popular mythical idea of a liquidity trap.

Widening Political Cracks in China’s Political Economy

More signs of the simmering tension between China’s political top-bottom leadership and bottom up forces (average Chinese)

In what appears to signal China’s prospective political actions, China has recently awarded the new Confucius Peace Prize to Russia’s autocratic leader Vladmir Putin.

Why Putin? The Wall Street Journal Editorial explains

A 16-member committee of Chinese scholars announced on Sunday that this year's winner is Vladimir Putin. To most of the world, the Russian prime minister may inspire many adjectives, but man of peace isn't one of them. The image he likes to project is that of the tough-guy Russian nationalist.

Which is precisely why the Chinese say they chose him. The Confucius committee cited in particular "his iron hand and toughness" and "large-scale military action" during the 1999 war in Chechnya. The committee cited as well "his teenage dream," subsequently realized, to join the Soviet secret police and his opposition this year to NATO's bombing campaign in Libya. Apparently Moammar Gadhafi, since deposed and now dead, wasn't eligible.

China created the Confucius Prize last year, in its fury that the Nobel Peace Prize was awarded to dissident Liu Xiaobo. It's a kind of anti-Nobel, and in that sense it is meant to flatter both Mr. Putin and China's government. China's Communist Party sees a kindred soul in a man who has stayed in power in Moscow for 12 years and has designs on at least 12 more.

China's other great fear is that ethnic nationalists in Tibet or Xinjiang, like democrats in Taiwan, might succeed in governing themselves. Thus does Mr. Putin, who razed the small province of Chechnya and who invaded Georgia in 2008 to teach an imperial lesson, became a hero to Chinese rulers.

To revere “iron hand and toughness” in a time where many Chinese reportedly have been deeply dissatisfied with their government seems to serve as admonition to political malcontents.

On the other hand, symbolisms like the above may also signify symptoms of veiled apprehensions by China’s political leaders.

Here’s why. From another Wall Street Journal Editorial,

Chinese lost faith in local-level officials a long time ago, but until recently they continued to believe in their national leaders. They also largely accepted the post-1989 social contract in which the Party provided rising living standards in return for not questioning its monopoly on power.

This is changing as a result of two trends. The first is a growing awareness among the bottom strata of society that it is policy made at higher levels, not merely the incompetence or corruption of local officials, that is responsible for their woes. The second is the interest of the wealthy and the intellectuals in reform after two decades of being bought off by the Communist Party.

The first trend is typified by the willingness of about 100 people across the country to risk their freedom and put themselves forward as independent candidates in elections for local People's Congresses. Some are professionals, but most seem to be ordinary workers. These government bodies have traditionally rubber-stamped Party decisions, but their members theoretically have the power to supervise officials.

Most Chinese won't to be so bold unless they are mobilized from above, which is why new activism among the educated minority is so significant. Beijing intellectuals are making pilgrimages to the remote Shandong town of Linyi where blind legal activist Chen Guangcheng is under house arrest. Since the tax authorities last week presented the dissident artist Ai Weiwei with a $2.4 million bill for fines and back taxes, a movement has sprung up to donate money, both electronically and in paper airplanes delivered to his house, to keep him out of prison. Anger over the government's concealment of air pollution levels, even as the leaders in Beijing install air purifiers to protect their own health, has spawned another ad hoc campaign.

What seems to be turning the tide toward political activism is a realization that unless one is a member of the Party elite, upward mobility is limited and hard-won advancement can be taken away without due process. Since universities expanded enrollments in the early 2000s, many families have borrowed heavily to pay tuition for their children. But graduates without political connections have trouble getting on the career ladder, ending up joining the "ant tribe," slang for educated young people living in slums. Meanwhile, the children of elites can street-race their Ferraris without fear of arrest.

Faith in the competence of the central government is also declining because of a lack of accountability. After the July crash of two trains in Wenzhou, the media exposed problems in the trophy high-speed rail program. Yet the Railways Ministry continues to receive massive amounts of new capital to finance rail lines that probably can't recoup the investment. New parents are obsessed with obtaining imported baby formula because they don't trust domestic brands.

State-owned industries increasingly prosper at the expense of private companies and households. In order to tackle high inflation the central bank tightened credit, but state companies continue to get bank loans while entrepreneurs are going bankrupt. Property developers are forced to sell inventory to stay afloat, so the price of real estate, one of the main stores of savings for the rich, is falling nationally, destroying wealth.

As I recently wrote,

China’s top-down political system and her attempt to bottom-up the economic system looks rife for a head-on collision course.

And it’s just a matter of time.

And that’s why the Chinese government will keep on inflating their economy to delay an inevitable economic bust that could spark a widespread revolt that risks toppling her government, which Chinese authorities seem to fear.

Nonetheless China’s political system would either have to reform to dovetail with the current economic conditions or revert back to an “iron-fisted” led closed economy which implies economic atavism.

No wonder many wealthy Chinese seem to be emigrating.

Sunshine Industry: Telemedicine or Digital Healthcare

The emergent digital healthcare or telemedicine industry will likely be a sunshine industry.

The Reuters reports,

Mobile technologies will be increasingly deployed to enable people in Asia to monitor and manage their health, with the market expected to hit $7 billion by 2017, an industry official said.

In parts of Europe and the United States, diabetics can now have doctors monitor their blood sugar levels by punching daily readings into their mobile phones and doctors can provide answers to expectant mothers via short message services (SMS).

Jeanine Vos, who heads the mobile health unit at Global System for Mobile Communications Association (GSMA), said such technologies are finding their way into Asia.

GSMA represents nearly 800 mobile operators around the world and 200 other mobile-related companies such as handset makers, software, media and Internet companies.

"We foresee that market opportunities can reach $7 billion by 2017 (from under $500 million now)...We are really at the start of a take-off," Vos told Reuters in an interview.

The figures were derived from a study conducted by GSMA and PricewaterhouseCoopers and will be released in full in December. Fifty-five percent of that amount would involve health monitoring services and 24 percent, diagnostic services.

Companies that stand to gain from the expansion of mobile technologies for healthcare purposes include mobile operators, device manufacturers, software developers and healthcare providers, Vos said.

Digital healthcare are evidences of how rapidly evolving technological progress has been permeating into vast areas of industries.

Although Asia has the demographic scale that should work to her advantage, telemedicine will be a global phenomenon. And I do hope that competition will lead to lower healthcare costs.

Besides telemedicine should substantially help improve the world’s life expectancy given that access to health information will become widespread. And as previously pointed out, telemedicine may reshape the global health industry.

And investors may handsomely profit from this promising field if they meticulously do their homework.

A Classroom Experiment on Socialism

Below is a great anecdote of the efficacy of socialism applied to a classroom (Thanks to Cato’s prolific Dan Mitchell) [Bold highlights mine]

An economics professor at a local college made a statement that he had never failed a single student before, but had recently failed an entire class. That class had insisted that Obama’s socialism worked and that no one would be poor and no one would be rich, a great equalizer.

The professor then said, “OK, we will have an experiment in this class on Obama’s plan”. All grades will be averaged and everyone will receive the same grade so no one will fail and no one will receive an A…. (substituting grades for dollars – something closer to home and more readily understood by all).

After the first test, the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little.

The second test average was a D! No one was happy.

When the 3rd test rolled around, the average was an F.

As the tests proceeded, the scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.

To their great surprise, ALL FAILED and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great, but when government takes all the reward away, no one will try or want to succeed.
It could not be any simpler than that.

There are five morals to this story:

1. You cannot legislate the poor into prosperity by legislating the wealthy out of prosperity.

2. What one person receives without working for, another person must work for without receiving.

3. The government cannot give to anybody anything that the government does not first take from somebody else.

4. You cannot multiply wealth by dividing it!

5. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that is the beginning of the end of any nation.

Chart of the Day: France ‘Riskier’ than the Philippines, ASEAN

Insuring 5-year debt against default or credit risk as measured by CDS prices has been more expensive for France than ASEAN countries such as Indonesia, the Philippines and Thailand, according to the Daily Reckoning

Insider Trading: What is Legal isn’t Necessarily Moral

Cato’s Walter Olson has a splendid article on the recent controversy over alleged insider trading by some politicians

Mr. Olson writes, (italics original)

Washington has been buzzing for the past 48 hours over revelations that some of Capitol Hill’s best-known lawmakers have been making fortunes speculating in the stocks of companies affected by official actions, typically while in possession of market-moving inside information. Rep. John Boehner (R-OH), Senatorial wife Teresa Kerry and others made bundles trading in health companies’ stocks shortly before Congressional or executive-branch action affecting the companies’ fortunes. After closed-door 2008 meetings in which Fed chairman Ben Bernanke briefed Congress on the gravity of the financial collapse, some lawmakers dumped their own stockholdings or even placed bets that the market would fall. Rep. Nancy Pelosi (D-CA) got access to highly desirable IPO (initial public offering) stock placements, some in companies with business before Congress. And so on. Studies have found that lawmakers as a group reap far above-average returns on their investments—suggesting either that these politicians are among the world’s cleverest investors, or else that they are profiting from inside information. All this has been turned into a front-page issue thanks to Throw Them All Out, a book by Hoover fellow Peter Schweizer, whose findings were showcased the other night on 60 Minutes.

So the question is: is all this legal? While there’s some difference of opinion on the issue among law professors, the proper answer to that question is most likely going to be, “Yes, it’s legal.” As UCLA’s Stephen Bainbridge points out, existing insider trading law, developed by way of a long series of contested cases under the Securities and Exchange Commission’s Rule 10b-5, assigns liability to persons who are not corporate insiders if they are violating a recognized duty of loyalty to those for whom they work. As applied to the investment whizzes of the Hill, this implies that trading on inside information might be a violation if done by Congressional staffers (since they owe a duty of loyalty to higher-ups) but not when done by members of Congress themselves.

First of all, I am not certain about the validity of the alleged statistics. Unless the analysts, who uncovered the controversial wealth derived from supposed insider trading, have been privy to the personal accounts of the aforementioned politicians or entirely trust disclosures as being forthright, these figures should be seen with cynicism.

How do we ascertain if under the table deals (concessions, bribery and etc.) are being passed off or camouflaged as investment gains? In short, what distinguishes money laundering from insider trading?

Second, what is legal isn’t necessarily moral.

Are insider trading laws moral?

As Professor Philosopher Tibor Machan writes, (bold emphasis mine, italics original)

It is conventional wisdom to treat this version of insider trading as morally wrong because it supposed to adversely affect others by being unfair. As one critic has put it, “What causes injury or loss to outsiders is not what the insider knew or did, rather it is what they themselves [the outsiders] did not know. It is their own lack of knowledge which exposes them to risk of loss or denies them an opportunity to make a profit.” By the fact that these others do not know what the insider does know, they are harmed since they are not able to make use of opportunities that are in fact available, knowable to us.

But what kind of causation is it that fails to make a difference when it does not exist? If someone’s knowing a good deal has no impact on what another does, it cannot be said that any harm upon another had been caused by that someone. Certainly, had the other known what the insider knew, he or she could have acted differently. By not acting differently, he or she could easily have failed to reap advantages the insider did reap. But nothing here shows that the insider caused any harm, only that he or she had a better set of opportunities. Unless we assume that valuable information known by one person ought, morally—and perhaps legally—be distributed to all interested parties—something that would beg the most important question—there is no moral fault involved in insider trading nor any causation of harm.

In short, insider trading is fundamentally about asymmetric information or "a situation in which one party in a transaction has more or superior information compared to another" (investopedia.com) and its effect on the marketplace.

I might add that even if there have been symmetry of information, people’s interpretation of information have factually been nuanced or different such that diversity of thoughts leads to variable actions, and thus voluntary exchange. In reality, there will never be symmetry of information because of the variable factors people read or construe information.

So how does one establish “fairness” in information?

Again, Professor Machan, (bold added, italics original)

As this applies to insider trading, if I have a prior obligation to share my information with others, that is, a fiduciary duty to clients or associates, then it is not that the information is “from the inside” but that it is owed to others that makes my dealings morally and possibly legally objectionable. It is only in such cases that fairness is obligatory, as a matter of one’s professional relationship to others, one established by the promise made or contract one has entered into prior to the ensuing duty to be fair. It is only then that one cause injury by refusing to do what one has agreed to do, namely, divulge information prior to using it for oneself. Accordingly, Hetherington’s objection to insider trading is without moral force. What he should have objected to is the breaching of fiduciary duty, which may occur on occasion by means of failing to divulge information (possibly gained “from the inside”) that has been—perhaps even contractually— promised to a client.

Furthermore, if I have stolen the information—spied or bribed for or extorted it—again the moral deficiency comes not from its being inside information but from its having been ill gotten.

If there has been no established fiduciary duty then fairness or unfairness becomes another abstraction used by politicians as pretext to enforce control over the marketplace. Insider trading, thus, becomes subjective and arbitrarily determined by politicians and regulators

This leads us back to Mr. Olson’s conclusion (bold emphasis mine)

It is tempting to approach the new revelations the way an ambitious prosecutor might, trying to stitch together a test-case indictment from, say, the penumbra of the mail and wire fraud statutes bulked up with a bit of newly hypothesized fiduciary duty here and a little “honest services” there. But that’s not how criminal law is supposed to work: for the sake of all of our liberties, prohibited behavior needs to be clearly marked out as prohibited in advance, not afterward once we realize it doesn’t pass a smell test. But we are still free to deplore the hypocrisy of a Congress that has long been content to criminalize for the private sector—often with stiff jail sentences—behavior not much different from what lawmakers are happy to engage in themselves.

My conclusions

It is unclear whether politicians benefited from insider trading or from other shady deals which has been passed off as stock market investments, thus the alleged outpeformance.

Insider trading, as argued from a moral standpoint, without clear parameters of the how the inequitable distribution or the lack of knowledge affects other parties accounts for as an arbitrary law. Hence these can be used by politicians to harass some participants in the marketplace for political or personal goals, and thus can be construed as an immoral law.

Given that politicians have become above the law, this accentuates the unfairness or the unilateral nature of the ethically flawed insider trading law or regulations

Finally, politicization of the marketplace, bailouts, inflationism, green energy and other market manipulation which predominate today’s have been skewing gains in favor of political clients at the expense of society, so where has the prosecution on insider trading been?

Clearly, what is legal may not be moral as the insider trading law reveals.

P.S. The Philippines has seen its popular Insider trading Scandal via the BW Resources.

Don’t blame this on free markets but one of state corporatism or crony capitalism

As the PCIJ writes, (bold emphasis mine)

The machinations surrounding the operation of the BW Resources Corp. and its affiliated BW Gaming and Entertainment Co. were probably the height of presidential recklessness. To begin with, Estrada was Dante Tan's secret partner in BW, confirms Espiritu. That was why BW became the recipient of so many government favors: an online bingo license given in record time by the Philippine Amusement and Gaming Corporation (Pagcor), the state-owned gaming company; a P600-million loan from the Philippine National Bank that was approved even if the collateral was worthless land; and a contract from Pagcor that ensured the transfer of Pagcor operations to a building that BW was constructing in downtown Manila.

Moreover, as various officials attested during the impeachment hearing, Estrada intervened on behalf of Tan when he was being investigated by the Securities and Exchange Commission (SEC) for insider trading and stock price manipulation. The President also ordered Jimenez and ethnic Chinese businessmen Wilson Sy and Willy Ocier, whose speculative play in the market was believed to have caused BW prices to fall precipitously in late 1999, to return the money Tan had lost to shore up BW prices.

"That was the version of Dante Tan when I confronted him about it," says Espiritu. "That version was also confirmed by the brokers at the Philippine Stock Exchange." Face to face with an angry president, Sy and Ocier agreed to reimburse Tan's losses, according to prosecution lawyers in the Estrada impeachment trial. The payoff was supposedly made not in cash but in 650 million shares of Belle Corp. worth P1.5 billion. The shares were turned over not to Tan but to Estrada, who then supposedly sold them to SSS and GSIS at a profit of P800 million.

Such politically driven stock market manipulation has been fated to meet with divine justice.

President Estrada has been impeached (yes I know Mr. Estrada ran and placed second in the 2010 presidential elections), where the scandal had been part of the impeachment proceedings, and BW Resources crashed back to earth, where crony Dante Tan, reportedly lost lots of money and has fled country and reportedly is in Canada even if the courts eventually absolved him--which again reveals of the nebulousness of the law.

BW Resources (blue chart) [from my previous post]