China Manipulates Yield Curve to Engineer a Boom

Learning from the West, China’s political authorities has clearly been assimilating Keynesian policies of promoting permanent quasi booms, but this time through the manipulation of interest rates…

From Bloomberg,

China’s long-term bonds are offering investors the biggest yield advantage over shorter-maturity notes in six months as Premier Wen Jiabao relaxes lending curbs to combat a slowdown in Asia’s biggest economy.

The gap between the government’s one-year note yields and 10-year securities widened to 102 basis points on Nov. 11 from 62 at the start of the month, Chinabond data show. That’s the most since May 4. The difference in U.S. Treasuries with similar maturities rose four basis points since October to 204, while the so-called yield curve for Indian bonds shrank two to 19, according to data compiled by Bloomberg.

“The curve will continue to steepen because long-term yields priced in too much concern of a slump,” said Wang Mingfeng, a Beijing-based bond analyst at Citic Securities Co., the nation’s third-biggest brokerage by assets. “There won’t be a hard landing, and the loosening measures may lead to a rebound in growth in the second quarter.”

Wen said Oct. 25 that policies will be “fine tuned,” a turnaround after interest rates were increased five times and lenders’ reserve-requirement ratios raised on nine occasions since September 2010 to tame inflation. The central bank has since lowered the yield on one-year bills for the first time since 2008 and injected 163 billion yuan ($25.7 billion) into the financial system…

Here is how China’s yield curve looks like (as of November 11, from Asian Bonds Online)

A steep yield curve induces borrow short-lend long dynamic or maturity transformation which carries the risk of maturity mismatching that could lead to a systemic bust or insolvency.

Yet, to stave off a hard landing, China has recently been expanding loans to reflate the economy (from the same Bloomberg article)

Some 587 billion yuan of loans were granted in October, the most in four months, the People’s Bank of China reported Nov. 11. That exceeded all 18 economist estimates in a Bloomberg News survey.

“This is a meaningful pickup in new loans which suggests selective easing has already started,”Qu Hongbin, a Hong Kong- based economist with HSBC Holdings Plc (HSBA), wrote in a research note. “China has no risk of a hard landing.”…

Add to expansion of loans, China may also be hiking government expenditures… (from the same Bloomberg article)

As much as 1 trillion yuan of public funds will be injected into the economy in December, ensuring abundant liquidity for lenders and making a cut in reserve-ratio requirements unlikely this year, according to Chen Jianheng, a bond analyst at China International Capital Corp. The finance ministry typically does most of its spending at the end of the year, he said

At the end of the day, the same noxious practices of Western contemporaries haunt China’s political stewards. The implication of which would likely be the same consequence—boom bust cycles.

Over the years, politicians have been doing the same thing and expecting different results.

Politics indeed signifies insanity.

China Aims For Global Financial Center, Plans To List Foreign Shares

China proposes to internationalize her stock exchanges.

From the Bloomberg,

China is “basically ready” to allow foreign companies to sell equity in the world’s second- biggest stock market, according to the Shanghai Stock Exchange official in charge of the so-called international stocks board.

The exchange has finished working on listing and trading rules, while the technological, regulatory, and system requirements are “basically ready,” Xu Ming, executive vice president of the Shanghai Stock Exchange, said in a Nov. 11 interview at the bourse. While there is no timetable for introducing the board, it should start “as soon as possible when the time is ripe,” he said.

“The internationalization of the securities market will benefit the whole nation and overseas companies are highly motivated,” Xu said.

Shanghai, home to one of China’s two stock exchanges, is luring overseas companies to list as part of the local government’s drive to make the city a global financial center by 2020. HSBC Holdings Plc, Coca-Cola Co. (KO) and NYSE Euronext are among the multinational companies that have expressed interest in selling shares to investors in China. Shanghai, the nation’s financial hub, has been contacted by foreign companies in the finance, telecommunications, consumer goods and manufacturing industries, Fang Xinghai, head of the city’s financial services office, said in a May 2010 interview.

Listing in China would let foreign companies benefit from higher valuations and give them access to Chinese currency to fund their expansion in the world’s second-biggest economy, Arjuna Mahendran, Singapore-based head of investment strategy for Asia at HSBC Private Bank, overseeing $460 billion globally, said in a June interview…

Xu said the Shanghai bourse has set no priority on which foreign companies can list first, refuting media reports that so-called red-chips, or overseas-incorporated Chinese businesses listed in Hong Kong, would be first. Hong Kong-listed Cnooc Ltd., China’s largest offshore energy producer, would sell stock if it received regulatory clearance, Chairman Fu Chengyu said in March.

Companies seeking to list on the international board should have a market value of more than 30 billion yuan ($4.7 billion) and combined three-year net income of more than 3 billion yuan, the 21st Century Business Herald reported in April, citing a draft plan. Ten companies may be allowed to sell shares initially, according to the report.

“We have no plan for the first batch of companies to be listed or how many there will be in the first batch,” Xu said. “We don’t give priority to whether foreign companies or red- chip companies should be listed first. Whoever is ripe will get listed first.”…

There are about 104 million investors in China, including mutual funds, institutional investors and 85 million individuals, the Shanghai exchange said.

“China and its capital markets don’t lack money,” Xu said. “Once the companies are listed, it will have a huge advertisement effect.”

Basically this means that China wants to local investors to diversify.

On the other hand, this also allows foreign companies to tap on Chinese savings.

While this should be seen as substantially a positive development, this may not be enough as China ought to open more her stock markets to foreigners and not just to allow trading of foreign shares.

Cross listing with her neighbors may even seem better.

And another thing, Chinese equity investors represent about 8% of the population which is substantially more than the Philippines with about less than 1%.

Nevertheless, to wean dependence away from the banking system, capital markets in Asia will need, not only to grow, but to modernize, deepen and outperform the world.

Phisix-ASEAN Equities: Awaiting for the Confirmation of the Bullmarket

The interests behind the Bush Administration, such as the CFR, The Trilateral Commission -- founded by Brzezinski for David Rockefeller -- and the Bilderberger Group, have prepared for and are now moving to implement open world dictatorship within the next five years. They are not fighting against terrorists. They are fighting against citizens."-- Dr. Johannes B. Koeppl, PhD, former German defense ministry official and advisor to former NATO Secretary General Manfred Werne

I have gradually[1] been making made my case[2] for a Santa Claus-Chinese New Year rally for global equity markets and the resumption of the region and domestic inflation driven bullmarket.

Parameters for the Resumption of the Bullmarket

Essentially what I think will drive this rally will mainly be the cumulative credit easing and bailout policies, which will be seconded and or buttressed by seasonal forces going to the first quarter of 2012.

One must not forget that in developed economies, stock markets are partly seen as targets of monetary policies which underpins the ‘confidence’ factor that drives the orthodoxy’s perceived economic transmission from the fallacious theory of spending, based on the wealth effect multiplier.

Additionally, with the politically advantaged banking and financial sector’s substantial exposures to the stock markets, this implies that part of bailout mechanism will be channeled through policies supportive of global stock markets. In short, a bailout of stock markets signify as partly a bailout of the banking and financial sector.

In the US, in 2010, life insurance, pension funds, mutual funds and exchange traded funds accounted for 38% of net equity purchases by investor type[3]. Whereas household investors which comprises 36% of equity ownership, are the largest group of investors in funds and registered investment companies accounting for 23% of the household’s financial assets at the year-end 2010[4]

Yet, unknown to most, such bailout policies constitute as a redistributive mechanism from the real economy to financial markets. In short, looting society to save the banking and political elites.

Moreover, while I have ruled out the risks of recession in the US, I continue to maintain vigilance over the highly fragile developments of the Eurozone and on China.

So far China appears to be exhibiting tentative signs of economic recovery.

Signs of improvements in new orders and industrial production aside from moderating inflation rate, which in October fell to 5.5 percent from 6.1% the previous month—the biggest drop in the annual rate from one month to the next since February 2009 -- and a further pullback from July's three-year peak of 6.5 percent[5].

Some have been speculating that monetary tightening policies may come to a halt and even bring about greater chance of “a small easing in the reserve requirement ratio”[6]

Nevertheless, the recent slowdown which has affected some sector has forced China’s government to banks sell bonds to raise money for loans to small enterprises and tolerate higher rates of non-performing loans among other measures to encourage bank lending[7]. Further, the collapse of some manufacturers in Wenzhou, which I earlier mentioned[8], has forced the government to set up an emergency 1 billion yuan fund and launched an anti-loan shark campaign which led to the Oct. 27 arrest of a couple suspected of illegally raising 1.3 billion yuan

Overall like in the West, the intuitive response has been to provide liquidity to parties affected by the slowdown.

I have also outlined my parameters in ascertaining the impact of the aforementioned global policies on the financial markets and the respective economies which should either confirm or falsify on my expectations of a bubble cycle at work.

Here I pointed out that for a meaningful recovery to occur, ASEAN region’s stock markets in conjunction with the commodity markets should pick up the tempo and begin to outperform other financial assets. And such dynamic should also be supported by recovering US and global equity markets.

Internal dynamics should also support the resumption of the Phisix bullmarket. These should be seen in improvements in the volume of trading, Philippine Peso, foreign trade, sectoral performance and the general market breadth.

Global Ruling Elites Tightens Grip

Again the sharp vicissitude in the marketplace only proves how global political developments have become the dominant factor in driving investor sentiments, and equally, how financial markets have been transformed into a short-term oriented financial rollercoaster underwritten by casino like demeanor through the growing dependence on policy steroids.

Last Wednesday, as Italian sovereign yields soared beyond 7% major global equity markets tanked[9].

Nevertheless, the losses has swiftly been neutralized as Greece has named former central banker Lucas Papademous as the new Prime Minister[10] the next day.

And as of this writing, Italy’s politics has Mario Monti[11], another Goldman Sachs adviser and who is also chairman of the David Rockefeller’s think tank, the Trilateral Commission[12] and a member of the highly enigmatic and exclusively for people with immense political clout, the Bilderberg group[13], has replaced Prime Minister Silvio Berlusconi[14].

Along with ECB President Mario Draghi[15], who has also been a Goldman Sachs alumnus, the Draghi-Papademous-Monti appointments appear to be growing evidence where global ruling elites appear to be flexing their political muscles to maintain their stranglehold over the crumbling welfare states.

And these are the same “behind the scene” working group, who mostly represents the heads of big banking houses, who played a major role in the establishment of the US Federal Reserve and whom has long been promoting a centralized foundation of fiat paper money standard system (a global central bank) and crony capitalism through statist laws.

As Hans-Hermann Hoppe in an interview with the Daily Bell recently said[16],

And they realized that their ultimate dream of unlimited counterfeiting power would come true only if they succeeded in creating a US-dominated world central bank issuing a world paper currency such as the bancor or the phoenix; and so they helped set up and finance a multitude of organizations, such as the Council on Foreign Relations, the Trilateral Commission, the Bilderberg Group, etc., that promote this goal. As well, leading industrialists recognized the tremendous profits to be made from state-granted monopolies, from state-subsidies, and from exclusive cost-plus contracts in freeing or shielding them from competition, and so they, too, have allied themselves to and "infiltrated" the state.

So it would signify as obtuseness for some to argue that adapting inflationary policies (e.g. devaluation) has been meant to attain “employment equilibrium” through adjustments on “real wages” using the money illusion, when evidence reinforces the political incentives behind all these.

The attempt to takeover control of EU’s political institutions looks increasingly like signs of desperation by global financial elites to preserve their politically enshrined privileges.

Going back to the equity markets, while expectations of the passage of the proposed austerity based reforms combined with hopes on the efficacies from technocratic based governance may have helped market sentiment to expunge earlier losses, in reality the driving force of the weekend gains has primarily been due to the European Central Bank’s intercessions whom has been acquiring Italian bonds to calm twitchy markets[17].

The point is that anytime the markets suffer from a convulsion whether in the US, Europe, Japan, China or elsewhere, the mechanical or impulsive response by central bankers has been to inject massive dosages of liquidity into the system or by manipulating or the easing of interest rates, which also means liquidity injections.

And as earlier pointed out, the easing process seems like a worldwide phenomenon.

To quote Morgan Stanley’s Spyros Andreopoulos & Manoj Pradhan[18]

Global re-easing is underway as the global central bank reacts to the risk of recession in the major economies. The central banks of Australia and Romania became the latest to cut policy rates this week, joining the central banks of Switzerland, Turkey, Brazil, Russia, Israel and Indonesia. G4 central banks have been active too, on the unconventional side. Mostly because of the lack of conventional room to ease, the Fed, the ECB, the BoJ and the BoE have all delivered unconventional packages. The result? An increase in the G5 excess liquidity metric we track, though liquidity in the BRICs has not yet turned thanks to China's monetary policy maintaining its position and a recent tightening from the RBI.

These cumulative easing measures being undertaken by global central banks are likely to buttress risk assets as equities.

Gold & Oil Signals Inflation Ahead

I have pointed out lasted week that gold prices seem to be indicating to us the liquidity conditions of the world.

My guess is that once gold prices breaks above the $1,800 psychological barrier, we will likely see a test of the recent record high which if successfully encroached would probably imply another test of the psychological $ 2,000 level. We may see $ 2,000 sometime early 2012.

Gold hasn’t been the only commodity that has been exhibiting signs of an inflationary driven boom, interim oil price trends seem to validate gold’s price action.

There appears to be a developing ‘tight correlation of oil and of the US S&P 500’ as shown in the upper window of the chart above.

According to US Global Investors’ Frank Holmes[19]

The EIA says “the recent strong relationship between oil and equity prices resembles that seen during the economic downturn and recovery in 2008-2010.” According to EIA data, crude oil and the S&P 500 Index have had a positive correlation in 12 of the past 13 quarters. A positive correlation had not occurred once in the previous 35 quarters. In fact, crude oil and equities experienced a negative correlation during five quarters over that time period.

This implies if this oil-stocks correlation should hold, then rising US equity markets will be supported by higher oil prices.

In addition, the Brent-WTI oil spread which recently hit a record has been precipitously falling.

The widening spread of the Brent oil[20], which represents the international benchmark sourced from the North Sea and traded in London, compared to the WTI, the US benchmark, has been attributed to the glut of supplies from infrastructure restrained refinery system at Cushing Oklahoma which have been receiving inputs from expanding supplies of unconventional shale oil and bitumen[21] and partly due to growing demand from Asia, who imports[22] more of the region’s oil requirements from London.

While Bespoke Invest says that the narrowing spread could be because of the “lack of a meaningful rally in Brent North Sea crude”[23], I would add that the relatively faster increase in money supply in the US, which may partly translate to relative to stronger inflation driven “economic growth” could also serve as the cause.

Besides, the embattled Eurozone has just commenced to use their printing presses more aggressively. This means that the effects from such policies has yet to filter into their markets and economy. (chart from Danske Bank[24])

In other words, the inflationary momentum seems stronger in the US than in the Euro-Asia sphere.

Thus I expect such momentum to likewise be expressed in the relative performance of the global equity benchmarks.

Mixed Showing of ASEAN Bourses and the Phisix

This week’s volatility has not left ASEAN markets unscathed.

Instead this week’s market actions appear to have generated mixed results for the ASEAN-4.

The Philippine Phisix (PCOMP) and the Thailand (SET) posted modest gains, while Indonesia (JCI) and Malaysia (FBMKLCI) registered marginal losses, one should expect that if global central banks continue with this easing environment, then these markets should regain its lost footing and resume with their outperformance.

So far, it looks as if the recent highs made by the ASEAN bourses could be tested by the end of the year, if not during the first quarter of 2012.

Again we would like to see material improvements in the actions within the Philippine Phisix.

This week’s gains have yet to diffuse into the average daily Peso volume traded, market breadth and the Peso.

And the largely mixed showing can partly be seen in the sectoral performances where in 4 of the 6 industries, the top two gainers led by property and services has provided much of the weight of gains of the Phisix composite.

Another bright development is that while the Phisix wasn’t able to dodge the selloff in the Wednesday’s US-European equity markets, the magnitude of the decline was a lot less than the developed economy counterparts.

Investing in the Higher Order Stages of Production

So far, from the depth of September 26^th shakeout, the mining index appears to have recovered most. This has been followed by the property index which apparently has been this week’s best gainer.

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.

As the great Murray N. Rothbard wrote[25]

Now what happens when banks print new money (whether as bank notes or bank deposits) and lend it to business? The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in "longer processes of production," i.e., the capital structure is lengthened, especially in the "higher orders" most remote from the consumer. Businessmen take their newly acquired funds and bid up the prices of capital and other producers' goods, and this stimulates a shift of investment from the "lower" (near the consumer) to the "higher" orders of production (furthest from the consumer) — from consumer goods to capital goods industries

Finally one can’t discount that volatile pendulum swings will remain a common trait of the financial markets as investors attempt to decipher on the political directions of crisis affected nations.

But so far political developments continues to point towards central bank policies taking the centerstage, which implies that for ASEAN equities which includes the Philippine Phisix, an inflation fueled boom phase of the current bubble cycle, is likely ahead.

---

[1] See Global Risk Environment: The Transition from Red Light to Yellow Light, October 30, 2011

[2] See Gold Prices Climbs the Wall of Worry, Portends Higher Stock Markets, November 6, 2011

[3] US Census Bureau Equities, Corporate Bonds, and Treasury Securities--Holdings and Net Purchases, by Type of Investor (December 31^st 2010), 2012 Statistical Abstract

[4] ICI.org 2011 Investment Company Fact Book A Review of Trends and Activity in the Investment Company Industry

[5] Reuters.com China inflation, output create room for pro-growth steps, November 9, 2011

[6] von Mehren Allan Forecast update: Euro area in recession, US and China recover, Danske Research Global, November 9, 2011

[7] Bloomberg.com, China Credit Squeeze Prompts Suicides, Violence, November 7, 2011

[8] See More Evidence of China’s Unraveling Bubble?, October 16, 2011

[9] See Politically Driven Global Stock Markets Slammed Anew, November 10, 2011

[10] See Former Central Banker Papademos Is Greece New Prime Minister, November 11, 2011

[11] Wikipedia.org Mario Monti

[12] Wikipedia.org Trilateral Commission

[13] Wikipedia.org Bilderberg Group

[14] Bloomberg.com Berlusconi Resigns as Monti Prepares New Italian Government, November 13, 2011

[15] See Revolving Door Syndrome: European Central Bank’s New Head was Goldman Sach’s Honcho, June 25, 2011

[16] Hoppe Hans-Hermann The Mind of Hans-Hermann Hoppe, Mises.org, April 13, 2011

[17] CNN money Italian bonds on ECB life support, November 10, 2011

[18] Andreopoulos Spyros and Pradhan Manoj Global Re-Easing, November 7, 2011 Morgan Stanley Global Economic Forums

[19] Holmes, Frank The Many Factors Fueling a Return to $100 Oil, November 11, 2011 US Global Investors

[20] Wikipedia.org Brent Crude

[21] Vuk Verdan Understanding Oil Price Differences, August 19, 2011 Casey Research

[22] Fontevecchia, Agustino, Oil Prices: Brent-WTI Spread Above $22 And Here To Stay, July 8, 2011 Forbes.com

[23] Bespoke Invest Brent - WTI Spread Drops to Lowest Level Since June, November 10, 2011

[24] von Mehrn Allan Spotlight turns to Italy November 11, 2011 Weekly Focus, Danske Bank

[25] Rothbard, Murray N. How the Business Cycle Happens, September 6, 2005 Mises.org

ASEAN Integration: ASEAN Economic Community

Despite the ongoing grim conditions in many key developed nations, there is a major development to cheer about: The goal to integrate the economies and markets of ASEAN via the ASEAN Economic Community (AEC) by 2015

From Matthew Asia’s Tarik Jaleel, (bold emphasis added)

The establishment and prioritization of a move toward a common market by 2015 with free movement of resources comes in response to increased competition posed by China and India. A grouping of 10 countries, with a combined population of 600 million and GDP of more than US$1.7 trillion, would give its members greater influence on the world stage than they might individually attract.

Intra-ASEAN trade already represents nearly 25% of total exports by ASEAN countries and about 24% of total imports. Intra-ASEAN trade over the last 10 years has grown at a faster rate of 10.7% compound annual growth rate, compared to the total trade growth of 7.6%. The AEC, therefore, will build on an already robust trade platform and extend ASEAN to the next level to that of a single market and production base. The AEC will be comprised of five core elements which espouse the free flow of: goods, services, investment, capital and skilled labor. Industrial sectors to be included in the single market and production-base comprise 12 priority integration sectors, including food, fisheries, air transportation, automotives, health care, apparel, tourism and logistics. In an open economic region this would create a multitude of opportunities—a company in Singapore or Malaysia could easily invest in infrastructure projects in lesser developed countries such as the Philippines or Vietnam. More importantly, in increasingly service-driven economies, mobility of skilled labor would be improved, facilitated through employment passes and mutual recognition arrangements for professional services.

What is therefore surprising is the indifference, or lack of awareness, amongst the investment community and the private sector to the many opportunities and threats. In a recent investment bank survey of 60 publicly listed ASEAN companies, approximately one-third of respondents classified themselves as either “familiar” or “very familiar” with the AEC. In light of the plans, some companies are undergoing measures to strengthen their position within the community. Malaysian banks backed by the government, for example, have expanded aggressively in the region in hopes of capturing a bigger share of regional business that may result from increased trade among AEC countries.

For investors, the move toward a single market may present a period of change from the previous state of business as companies consolidate, aim to increase transparency and to adopt standardized regulations. The blueprint for the formation of the community also calls for business dynamics to be conducted under free market competition. The hope is that an open market environment would provide a broader and more attractive investment universe in Southeast Asia.

This looks like one step in the right direction. I hope that free trade won’t stop with ASEAN but spread throughout the entire world that should not only increase wealth and prosperity but likewise foster peace, cooperation and social harmony.

As the great Ludwig von Mises wrote,

What makes friendly relations between human beings possible is the higher productivity of the division of labor. It removes the natural conflict of interests. For where there is division of labor, there is no longer a question of the distribution of a supply not capable of enlargement. Thanks to the higher productivity of labor performed under the division of tasks, the supply of goods multiplies. A preeminent common interest, the preservation and further intensification of social cooperation, becomes paramount and obliterates all essential collisions.

More Devaluation Fallacies

Celebrity guru Nouriel Roubini writes about the Euro crisis and delivers his grand prescription,

So if you cannot devalue, or grow, or deflate to a real depreciation, the only option left will end up being to give up on the euro and to go back to the lira and other national currencies. Of course that will trigger a forced conversion of euro debts into new national currency debts.

Utter nonsense.

First of all, devaluation represents a default, not against the duplicity of the central bank-bankers-welfare state but against the average Greeks or the Italians. So politicians will be saving their skins at the expense of their respective citizenry.

Thus, the currency devaluation nostrum aims to preserve the welfare state which serves as the root of the Eurozone’s problem. This does nothing to solve the problem.

Second, if devaluation causes economic growth, then why has Zimbabwe’s massive devaluation (hyperinflation) not spurred her economy into the stratosphere?

Chart from Wikipedia.org

The answer; since inflationism forcibly redistributes resources from creditors to debtors, such policies impairs an economy’s division of labor via price signal distortions (aside from regulatory obstructions, particularly the twin of inflation: price controls) which restrains competitiveness and consequently poses a significant impediment to trading activities, capital accumulation, and most importantly, a substantial reduction in the purchasing power.

Chart from Indexmundi.com

Zimbabwe’s inflationism has led to 7 years of hyperinflationary depression (where economic recession has ranged from minus 3% to minus 18% in 2001-2008).

Zimbabwe’s economy has only begun to recover after the Mugabe government abdicated on such cataclysmic hyperinflationist policies which resulted to the demise of the Zimbabwe dollar and the adaption of the US dollar and South African Rand as mediums of exchanges.

This so applies with Brazil's experience too.

Three, devaluation will be a messy and chaotic process as pointed out by Professor Steve Hanke because this will translate to massive and widespread bankruptcies of the private sector (such as in Zimbabwe).

It is true that lowered standards of living from devaluation will force those affected to work more to cover for the loss of purchasing power, but this can hardly be construed as an improvement. Effects must not be read as a cause.

What is needed is to allow markets to clear by reducing the amount of government interferences, and importantly, by allowing malinvestments to be liquidated

As Professor Philipp Bagus writes,

First, relative prices must adjust. For instances, housing prices had to fall, which made other projects look relatively more profitable. If relative housing prices do not fall, ever more houses will be built, adding to existing distortions.

Second, savings must be available to finance investments in the hitherto neglected sectors, such as the commodity sector. Additional savings hasten the process as the new processes need savings.

Lastly, factor markets must be flexible to allow the factors of production to shift from the bubble sectors to the more urgently demanded projects. Workers must stop building additional houses and instead engage in more-urgent projects, such as the production of oil.

Fourth, currency devaluation nostrum signifies as an appeal to emotion rather than a logical construction of economic reality.

Such pretentious policy prescription has been predicated upon the oversimplistic assumptions of the world as operating in the prism of aggregates (where there is a single dynamic for wages, labor, product, price sensitivity and demand).

Again the Zimbabwe example shows how much quackery currency devaluation prescriptions are.

Fifth Mr. Roubini has an inferior batting average in terms of predicting markets (such as his debate with Jim Rogers on Gold), which implies that his analytical methodology must be severely flawed. And instead his views seem to be influenced by his political connections.

I am reminded of the great Ludwig von Mises who demolished the populist fallacies of inflationism…(bold emphasis mine)

The popularity of inflationism is in great part due to deep-rooted hatred of creditors. Inflation is considered just because it favors debtors at the expense of creditors. However, the inflationist view of history which we have to deal with in this section is only loosely related to this anticreditor argument. Its assertion that "expansionism" is the driving force of economic progress and that "restrictionism" is the worst of all evils is mainly based on other arguments…

…The question is whether the fall in purchasing power was or was not an indispensable factor in the evolution which led from the poverty of ages gone by to the more satisfactory conditions of modern Western capitalism. This question must be answered without reference to the historical experience, which can be and always is interpreted in different ways, and to which supporters and adversaries of every theory and of every explanation of history refer as a proof of their mutually contradictory and incompatible statements. What is needed is a clarification of the effects of changes in purchasing power on the division of labor, the accumulation of capital, and technological improvement…

In the conduct of business, reflections concerning the secular trend of prices do not bother any role whatever. Entrepreneurs and investors do not bother about secular trends. What guides their actions is their opinion about the movement of prices in the coming weeks, months. or at most years. They do not heed the general movement of all prices. What matters for them is the existence of discrepancies between the prices of the complementary factors of production and the anticipated prices of the products. No businessman embarks upon a definite production project because he believes that the prices, i.e., the prices of all goods and services, will rise. He engages himself if he believes that he can profit from a difference between the prices of goods of various orders. In a world with a secular tendency toward falling prices, such opportunities for earning profit will appear in the same way in which they appear in a world with a secular trend toward rising prices. The expectation of a general progressive upward movement of all prices does not bring about intensified production and improvement in well-being. It results in the "flight to real values," in the crack-up boom and the complete breakdown of the monetary system.

See the difference? The analytical backing of inflationism fundamentally relies on heuristics (mental shortcuts/cognitive biases) and or aggregates (math models) against the real world, whose risk-taking operations by capitalists and entrepreneurs are principally driven by the desire to earn profits.

Video: Steve Hanke on the Eurozone Crisis

Here is Cato's Steve Hanke's take on the Eurozone crisis (interviewed by Reuters)

Some pointers from the interview:

-Glaring 'lack of sense of history' by "Euro-crats" in dealing with the crisis leaves them unable to accurately diagnose the problems which subsequently means applying wrong prescriptions (2:18)
-the ECB may be forced to provide unlimited support for EU's bond markets (3:08)
-two fundamental scenarios: One, the EU will evolve into a fiscal transfer union which will be very messy and take lots of time (3:50) 'My guess is that the cartel may fall' because of political problems. (4:20) Second, the Eurozone may split (4:40). Prof. Hanke says that the mainstream's popular panacea for an exit option, just to be able to resort to devaluation, would be 'a chaotic situation' as all companies and the households in Greece would effectively go bankrupt (4:56).

Quote of the Day: Financial Markets will Never Be an Exact Science

The factors that determine activity on the Exchange are innumerable, with events, current or expected, often bearing no apparent relation to price variation. Beside the somewhat natural causes for variation come artificial causes: The Exchange reacts to itself, and the current trading is a function, not only of prior trading, but also of its relationship to the rest of the market. The determination of this activity depends on an infinite number of factors: It is thus impossible to hope for mathematical forecasting. Contradictory opinion about these variations are so evenly divided that at the same instant buyers expect a rise and sellers expect a fall.

The calculus of probability can doubtless never be applied to market activity, and the dynamics of the Exchange will never be an exact science. But it is possible to study mathematically the state of the market at a given instant—that is to say, to establish the laws of probability for price variation that the market at that instant dictates. If the market, in effect, does not predict in fluctuations, it does assess them as being more or less likely, and this likelihood can be evaluated mathematically.

That’s from the opening lines of “Theorie de la Spéculation” by 20th century French Mathematician Louis Bachalier (1870-1946). Mr Bachalier has been credited with being the first person to model the stochastic process now called Brownian motion, which was part of his PhD thesis The Theory of Speculation, (published 1900). [Wikipedia.org]

Source: Benoit B. Mandelbrot and Richard L. Hudson, The (Mis) Behaviour of Markets p.51

Cartoon of the Day: Moral Relativism

Source GreatPlay.net; hat tip Stephan Kinsella

Should Markets Count on the ECB to Ride to the Rescue?

A Wall Street Journal blog says that markets should NOT “count on ECB riding to rescue”.

The article attempts to highlight on the differences in the expectations of institutional economists and what some of the European Central Bank officials have recently been saying.

“Clearly, it is not the task of the central bank to intervene… when there are fundamental doubts about the sustainability of some countries,” fellow board member Peter Praet said Thursday in comments posted on the blog Debating Europe.

Bank of Portugal head Carlos Costa, echoed that sentiment late Wednesday, saying the ECB “took its capacity to intervene to the limit.” Dutch Central Bank president Klaas Knot also said the ECB has about reached its limit.

But politicians usually say something but do another.

The BCA Research writes, (bold emphasis mine)

Political events in Italy are not progressing as fast as markets would like. The announcement that Prime Minister Silvio Berlusconi would resign provided only short-lived relief. It is unclear, however, whether any political evolution will be sufficient to satisfy the markets at this point. Thus, the ECB is once again being forced to intervene and is reportedly buying Italian bonds in the secondary market. Unfortunately, the impact on yields is muted since there are now few other buyers for the debt. Two major clearinghouses have announced increased margin requirements for Italian debt as the spread over bunds crossed the 450 basis point “line in the sand” that previously had prompted similar moves on Irish and Portuguese debt. This is important since the decision to raise margin requirements decreases the bonds’ liquidity, leading to a further spike in yields. The further danger is that Italian banks begin to come under pressure as markets discount the effect of sovereign debt markdowns on their balance sheets. Given that there is not enough firepower in the EFSF to support Italian banks, the ECB may soon find itself dealing with a bigger and bigger problem. A further deterioration in Italian sovereign debt prices might prompt the ECB to follow the Federal Reserve and Bank of England and expand its balance sheet through more aggressive purchases, possibly unsterilized, of government debt.

In short, continued political wrangling will likely force the hand of the ECB to resort to the printing press.

And in contrast to what the political bureaucrats cited above recently said, the ECB reportedly did intervene in the bond markets yesterday.

Of course political bickering has not been exclusive to political entities, such as in Italy and in Greece, but likewise apparent in the ECB—as evidenced by the infighting over policies, as well as, political appointments to its organizational hierarchy.

Earlier two ECB officials, Jürgen Stark and Axel Weber resigned over policy differences—in protest of ECB’s bond purchases.

Yesterday another ECB official, Bini Smaghi, resigned

The Bloomberg reports

Lorenzo Bini Smaghi resigned from the European Central Bank’s Executive Board, clearing the way for France to regain a seat after the retirement last month of President Jean-Claude Trichet.

Bini Smaghi, whose term officially ends in May 2013, will join Harvard University’s Center for International Affairs on Jan. 1, 2012, the Frankfurt-based ECB said in an e-mailed statement yesterday. ECB President Mario Draghi thanked Bini Smaghi for his “contributions in the field of European and international monetary and economic affairs over many years.”

Italy’s Prime Minister Silvio Berlusconi had stepped up pressure on Bini Smaghi to quit in recent weeks in a bid to defuse a row with French President Nicolas Sarkozy over the Italian’s seat on the central bank’s six-member Executive Board. Sarkozy had backed Mario Draghi’s candidacy to head the central bank on the condition that Berlusconi get Bini Smaghi to step aside to make way for a French candidate and avoid leaving the board with two Italians when Trichet, a Frenchman, finished his term at the end of October.

Berlusconi angered France last month when he failed to name Bini Smaghi to replace Draghi as head of the Bank of Italy, which would have resolved the impasse over the ECB board. After saying that Bini Smaghi was a candidate on Oct. 18, Berlusconi appointed Ignazio Visco, the bank’s deputy director general, to run the Italian central bank. Bini Smaghi had initially refused to resign before his term ended in 2013.

And that based on demonstrated preference, which as defined by Murray N. Rothbard signifies as the

actual choice reveals, or demonstrates, a man's preferences; that is, that his preferences are deducible from what he has chosen in action

…the cumulative actions by policymakers suggest that the interests of political authorities remain supreme.

This means that the ECB will continue to do what central banks have originally been designed to do—finance deficits and conduct bailouts of the banking cartel (with or without political tussles—as everything else will be used as an excuse)

And importantly, the popular notion that central bank acts independently from political influence has been exposed as a mirage.

Former Central Banker Papademos Is Greece New Prime Minister

Over at Europe, Central Bank—Wall Street—Welfare state interests are becoming entrenched politically.

First we have Mario Draghi, an alumnus of Goldman Sachs as the president of the European Central Bank (ECB).

Now we have an ex-ECB vice president as Greece’s PM.

From the Bloomberg

Lucas Papademos, named today to be interim prime minister of Greece, steered the country into the euro region as central bank governor more than a decade ago. Now the former European Central Bank vice president will have to secure the country’s euro membership for a second time.

Papademos, who has never held elected office, helped foster economic growth rates that surpassed Germany’s and France’s in his eight years at Greece’s central bank before moving to the ECB in 2002. Most recently a visiting professor at Harvard University in Cambridge, Massachusetts, and an adviser to departing Prime Minister George Papandreou, Papademos takes over a country weeks from being unable to meet its debt obligations…

Appointed Greek central bank chief in 1994, Papademos presided over an economy lagging behind its European counterparts. Growth had averaged 1.3 percent in the previous decade, almost half the average of the other 11 countries preparing to join the euro.

Papademos, who described his monetary strategy as “eclectic” in a 2001 interview with Institutional Investor magazine, stabilized the drachma and inflation in his early years at the Greek central bank.

In March 1998, Greece devalued the drachma by 14 percent against a basket of European currencies to join the EU’s exchange-rate mechanism. Papademos then kept the bank’s main rate above 10 percent for the next two years to curb consumer prices following the devaluation. By 2000, inflation, which had been 14.2 percent in 1993, slowed to 3.2 percent.

Papademos’s legacy as central bank governor was blown apart by the debt crisis that’s ricocheting through world markets. As Papandreou’s government, elected two years ago, revealed that the country’s budget deficit was more than double the previous administration’s effort, investors dumped the country’s bonds, forcing the country to seek a European Union-led bailout.

The interests of politically endowed banking cartel are evidently being protected through revolving door politics.

Obviously the same story, but only different personalities involved.

Are Emigrating Wealthy Chinese Afraid of a Coming Political Tempest?

Recently I blogged about an increasing number of Chinese elites who are emigrating or considering to emigrate, which contrary to conventional thinking, does not augur well or reflect sanguine signs of a “China Century”

I even alluded to snowballing risks of a political crisis

Perhaps many of these Chinese millionaires may be sensing trouble ahead (see bold highlights above), not only from a bubble bust, but also from the growing fragile state of China’s unsustainable capitalist-communist political economy.

Well, I guess my hunches seem to be getting some confirmation.

This from Financial Times/CNBC

In private conversations, many of the people who supposedly make up the ruling elite of China express serious misgivings about the direction and future stability of the country, while admitting that they feel largely powerless to affect meaningful change.

“There is a sense that we are approaching an inevitable breaking point, when the pressures in society will boil over and consume the rulers,” says one Chinese banker with close ties to a number of powerful political families.

“Almost all of the elements are in place for an uprising like we saw in 1989 – corruption is worse today than it was then, people feel they can’t get ahead without political connections, the wealth gap is much bigger and growing and there has been virtually no political reform at all. The only missing ingredient now is a domestic economic crisis.”

And many wealthy Chinese seem to be flocking to the US, by investing in “US citizenship”

From the Wall Street Journal Blog

In 2011, 2,969 Chinese citizens applied for the program and 934 were approved, according to the Immigration Service. (Approval doesn’t mean they get citizenship, it just means they can start the program). Their numbers represented more than three quarters of the total number of applicants and approvals.

It’s also a huge increase from previous years. In 2007, only 270 Chinese citizens applied and only 161 were approved, accounting for only about a third of the totals.

Why the huge increase?

The obvious reason is that China has a lot more millionaires and billionaires.

But the other reason is that these newly rich want out – or at least an escape hatch and presence in another country in case they have to flee.

So speaking of voting with their feet, many wealthy Chinese seem to view the US as having a relatively better potential compared to their homeland. They could be right.

But they could also be wrong. Maybe these Chinese elites don’t realize that they risk jumping from the proverbial frying pan to the fire.

Quote of the Day: A Very Expensive Education in Basic Economics

From First Trust’s Brian Wesbury (italics original)

There is a simple rule in monetary economics, which many seem to have forgotten. A weak currency cannot replace a strong currency. In other words, the existence of the euro will force the countries of Europe to confront budgetary problems fiscally, not monetarily. No wonder governments are collapsing across the continent.

The Greek government, and some misguided economists, think the failure of the welfare state could be averted if Greece would only devalue its currency. This is a sad statement. A de-valuation is just a default by another name. It puts most of the burden on creditors, savers, and income earners, who face the pain and loss of reduced purchasing power.

Without the ability to devalue, the pain of restructuring falls on those who benefit from the largesse of government spending. Government jobs, pension payments, subsidies, and services will all need to be cut. The pain will fall inordinately on those who count on government for some form of support.

No wonder governments often choose devaluation instead of austerity. Devaluations can be blamed on the markets and Wall Street. But spending cuts hit constituents – those who voted for politicians who promised that government would never run out of money. This is why governments are collapsing, and will continue to collapse. Voters are completely disillusioned and they are facing a great deal of pain as they get a very expensive education in basic economics.

Read the rest here

Unsustainable political economic systems, particularly the Welfare state, will eventually get undone by the laws of scarcity.

Politically Driven Global Stock Markets Slammed Anew

Global stock markets got clobbered anew as Italian bonds breached the 7% threshold level in the face of Italy’s lingering political crisis in trying to resolve the debt issue. This also demonstrates signs of the diffusion of debt crisis in the Eurozone

From the Bloomberg report, (bold highlights added)

Europe’s biggest clearinghouse said that customers must put down bigger deposits to trade Italian bonds as concern rises that the government will struggle to reduce the world’s third- largest debt burden. Italian yields surged as Prime Minister Silvio Berlusconi said he won’t resign until austerity measures are passed, even after he failed to muster an absolute majority on a routine ballot in parliament yesterday.

A senior lawmaker said German Chancellor Angela Merkel’s Christian Democratic Union may adopt a motion at an annual party congress next week to allow euro members to exit the currency area. In Greece, Prime Minister George Papandreou’s drive to put together a unity government fell into disarray as rival parties squabbled over the next premier.

The important twist here is that the formerly rigid stance of the Eurozone on their membership standings seem to have shifted, EU bureaucrats appear to be exploring the option for member exit.

None the less, if the market’s downside volatility has been due to the Eurozone, then it is a curiosity to see US equities falling more than the Euro stocks

(from Bloomberg)

Are the markets suggesting that US stocks, which has outperformed the Euro contemporaries, will be doing a catching up?

Well gold prices despite yesterdays’ steep losses remain on bullish trend which may indicate that the current volatility may be an interim development

As I have been saying expect sharp market volatilities based on the effects of the politicization of the financial markets and from boom bust policies.

The market climate remains very fragile and highly sensitive to the fluid developments in the realm of global politics.