US CPI Inflation’s Smoke and Mirror Statistics, Part 2

In defense of their interventionist bias, the conventional question framed by mainstream statists goes around this context, “given the FED’s printing of money, where is inflation?”

So I will be updating my earlier post questioning the reliability of US CPI Inflation as an accurate or dependable measure of inflation.

The magnificent charts below are from dshort.com, here, here and here

First, the breakdown of the CPI basket…

Next, the changes of inflation rate for each of the components from 2000 as shown by the line chart below…

The histogram perspective of the same rate of change over the same period….

What has weighed on the CPI inflation index has been the housing component which represents 42% of the basket. Apparel, recreation and communication which constitutes a 16.5% share has also had a downside influence on both indices (CPI and CORE CPI). Meanwhile inflation rates of energy, tuition fee and medical care have skyrocketed.

Yet energy’s impact on the basket appears to have been suppressed or muted.

Writes Doug Short

The BLS does not lump energy costs into an expenditure category, but it does include energy subcategories in Housing in addition to the fuel subcategory in Transportation. Also, energy costs are indirectly reflected in expenditure changes for goods and services across the CPI.

The BLS does track Energy as a separate aggregate index, which in recent years has been assigned a relative importance of 8.553 out of 100. In other words, Uncle Sam calculates inflation on the assumption that energy in one form or another constitutes about 8.55% of total expenditures, about half of which (4.53%) goes to transportation fuels — mostly gasoline.

Finally, below is the long term inflation chart which includes

“the alternative look at inflation *without* the calculation modifications the 1980s and 1990s”

In short, the current methodological construct of the US CPI inflation vastly understates the genuine rate of inflation, which appears to be accelerating (green arrow)—even when measured without current CPI modifications.

And contrary to the mainstream arguments, deflation seems nowhere in sight. This only implies that those dismissing the presence of inflation seem to be engaged in sophism anchored on political bias rather from reality.

Statistics can be manipulated to suit one’s dogmatic perspective.

While much of the money created and parked at the FED will pose as an inflationary problem ahead, the dilemma would be in the timing or that when these will enter the market.

Besides the US Federal Reserve appears to be in an undeclared QE 3.0 mode, as the Fed’s balance sheet has began to swell anew, with notable increases in lending to financial institutions, growth in liquidity to key credit markets and purchases of the Fed agency debt mortgage-backed securities (chart from the Cleveland Federal Reserve).

Applying Austrian economics means to explain how future events will transpire rather than to make exact predictions.

In other words, we don’t know when the tipping point would occur, which would result to rapid escalation of inflation rates that will be increasingly visible to the public. Instead we do know that if the present trend of policymaking continues, the subsequent outcome would be a ramped up rate of inflation.

As the great Ludwig von Mises wrote,

Economics can only tell us that a boom engendered by credit expansion will not last. It cannot tell us after what amount of credit expansion the slump will start or when this event will occur. All that economists and other people say about these quantitative and calendar problems partakes of neither economics nor any other science. What they say in the attempt to anticipate future events makes use of specific "understanding," the same method which is practiced by everybody in all dealings with his fellow man.

In the fullness of time, surging inflation will explode on the nonsensical or absurd arguments peddled by statist-inflationists.

Hurricanes are Not Linked to Global Warming

A popular myth exposed.

From John Ransom

One of the of the most popularized predicted effects of global warming from the models given us by the climate change clowns, increased hurricane and tropical storm activity, has recently been shown to be without merit according to the science and operations officer of the National Hurricane Center, Dr. Chris Landsea.

In a work published in late November and carefully labeled an “opinion” piece on the site for the National Oceanic and Atmospheric Administration - which is quick to distance itself from the conclusions reached by Landsea, who makes very clear that he subscribes to the theory man of man-made global warming- concludes that “the overall impact of global warming on hurricanes is currently negligible and likely to remain quite tiny even a century from now.”

In the rarefied atmosphere of climate politics this is enough to get you labled as a "climate skeptic," perhaps enough to get you excommunicated as a "climate denier." Landsea resigned from the UN's Intergovernmental Panel on Climate Change in 2005 because he felt it had become politicized and was ignoring the science.

Yet somehow he remains the leading hurricane expert in the US, despite his "shoddy" science.

Landsea attacked three specific datasets that are often used by global warming alarmists to show that the warming of the earth will have terrible consequences for human-kind: 1) the frequency of storms; 2) the intensity of storms and; 3) the economic damage of storms.

Read the rest here.

Heard at a discussion last night, “We cannot predict the impact of hurricanes but we can predict global warming because of melting ice caps”

Woa. So aside from the post hoc fallacy, such a comment implies that storms are not part of, or are isolated from, the atmosphere or weather. This just goes to show how environmentalism, thanks to complicit mainstream media, has mangled people’s logic and transformed the public’s mentality into a political religion.

Philippine Phisix: From Death Cross to the Golden Cross

I have been validated!

Video: Anthology of 2011 Movies

At the VIMEO, Matt Shapiro compiles numerous films of 2011 into this splendid video montage. (original link here).

2011: The Cinescape from Matt Shapiro on Vimeo.

It dawned on me that I have missed much of last year's best movies.

Video: Predictive Value of Austrian Economics versus Keynesian Economics

To kick off my vacation blogging, the following video shows of the predictive value of Austrian Economics versus mainstream mostly Keynesian economics (hat tip Bob Wenzel).

Notice the intense pressures Austrians face when confronted by usually hostile mainstream crowd. I know how this feels.

And this is where Mahatma Ganhi's rule applies

First they ignore you, then they laugh at you, then they fight you, then you win

Vacation Blogging

Well, holiday season is upon us.

I will be preparing to spend this year’s holidays with my mom who resides overseas. My family and I will be leaving by the coming week. So in the interim, I will be doing some light blogging. This also that means that my weekend analysis of the stock market will resume in 2012.

Thank you for your patronage. Happy holidays.

As psychologist Elias Porter said

Love generously, praise loudly, live fully

Chart of the Day: Regime Uncertainty

Concludes the editor of the Wall Street Journal

The evidence is overwhelming that the Obama regulatory surge is one reason the current economic recovery has been so lackluster by historical standards. Rather than nurture an economy trying to rebuild confidence after a financial heart attack, the Administration pushed through its now-famous blitz of liberal policies on health care, financial services, energy, housing, education and student loans, telecom, labor relations, transportation and probably some other industries we've forgotten. Anyone who thinks this has only minimal impact on business has never been in business.

Regime Uncertainty as defined by economist Robert Higgs

To narrow the concept of business confidence, I adopt the interpretation that businesspeople may be more or less “uncertain about the regime,” by which I mean, distressed that investors’ private property rights in their capital and the income it yields will be attenuated further by government action.

Such attenuations can arise from many sources, ranging from simple tax-rate increases to the imposition of new kinds of taxes to outright confiscation of private property. Many intermediate threats can arise from various sorts of regulation, for instance, of securities markets, labor markets, and product markets. In any event, the security of private property rights rests not so much on the letter of the law as on the character of the government that enforces,or threatens, presumptive rights.

(hat tip John Cochran Mises Blog)

Quote of the Day: Insider-Outsider Government Theory

Bill Bonner’s theory of government.

Every theory of government we’ve come across is a scam. So we offer a better theory: government is just a way for the insiders to take advantage of the outsiders…

Insiders always use government to transfer power and money from the outsiders to themselves…

There never is one fixed group of people who are always insiders. Instead, the insider group has a porous membrane separating it from the rest of the population. Some people enter. Some are expelled. The group swells. And shrinks. Sometimes, a military defeat brings a whole new group of insiders sweeping into power. Elections change the make-up of the core group.

But the genius of modern representative government is that it cons the masses into believing that they are insiders too. They are encouraged to vote…and to believe that their vote really matters. Of course, it matters not at all. Generally, the voters have no idea what or whom they are voting for. Often, they get the opposite of what they thought they had voted for anyway.

Is this the End of the Gold Bull Market?

Over the past few days gold prices has been whacked.

Gold prices have breached the 200 day moving averages.

Immediately gold bears scream “This heralds the end of the gold bull market!”.

Not so fast.

As I earlier said, gold has been reflecting signs of global liquidity conditions which may have been affected by perceptions of inadequate actions by the global central bankers, a China slowdown (or perhaps a bubble bust?) and the MF Global fallout.

Heavily politicized and inflation addicted markets tend to selloff when policymakers declare “discipline”. For instance, last night Ben Bernanke said that the FED won’t be bailing out Euro banks.

From the Bloomberg,

Federal Reserve Chairman Ben S. Bernanke told Republican senators the Fed plans no additional aid to European banks amid the region’s sovereign debt crisis, according to two lawmakers who attended the meeting.

Senator Bob Corker, a Republican from Tennessee, said Bernanke made it “very clear” in closed-door comments today the central bank doesn’t intend to rescue European financial institutions. Lindsey Graham, a South Carolina Republican, said Bernanke told lawmakers that “he doesn’t have the intention or the authority” to bail out countries or banks. Both senators spoke to reporters after leaving the one-hour session at the Capitol in Washington.

In setting boundaries to Fed aid, Bernanke referred to steps beyond the currency-swap lines that were revived in May 2010 to help Europe alleviate its crisis, Corker said. Last month, the Fed led six central banks in announcing a half percentage-point cut in the cost of emergency dollar funding for financial companies overseas through the Fed’s swap lines.

Ben Bernanke has been under fire for having to bailout Euro banks, aside banks of other nations, in 2008. So the act to project an image of nonpartisanship is understandable.

Of course there are many ways to go about conducting a bailout…

The same Bloomberg article observed,

While the Fed may not be able to lend directly to banks outside the U.S., it can provide loans to their U.S. branches through the discount window. The Fed’s currency-swap lines also provide indirect dollar funding to overseas banks through the ECB and other central banks who assume the credit risk.

Lending through the swap lines peaked at $586 billion in December 2008. The swaps are separate from Fed emergency loans to banks and other businesses that peaked at $1.2 trillion the same month, including about $538 billion that European financial companies borrowed directly, according to a Bloomberg News examination of available data.

And once conditions worsens, you may expect the FED to reverse tune.

And paradoxically, Ben Bernanke’s has been signaling that the FED may ease further (QE 3.0) if contagion risks from the Europe escalates [Businessweek/Bloomberg]—a sign of ambiguity.

Besides, the EU has been preparing to mount another grand rescue scheme.

From the Economic Times.

Germany is reactivating its financial sector rescue fund as the eurozone debt crisis raises increasing questions about how banks can cover their capital needs.

Chancellor Angela Merkel's spokesman, Steffen Seibert, said the Cabinet decided Wednesday to reopen the (euro) 360 billion ($474 billion) fund, first established at the height of the 2008 financial crisis.

The fund closed to new applications at the end of 2010. But much of the money _ which totaled (euro) 60 billion for potential capital injections and (euro) 300 billion for loan guarantees _ remains untapped.

European authorities have determined that German banks require a total of (euro) 13.1 billion in new capital to comply with tougher new requirements. The country's second-biggest bank, Commerzbank AG, has been told it needs (euro) 5.3 billion.

And Japan and possibly ex-European nations will be part of the rescue operations. Reports the AFP

Japan has purchased 13 percent of the eurozone rescue fund's latest bond sale, a government official said Wednesday, as the region continues fundraising to help contain its sovereign debt crisis.

The Japanese government bought 260 million euros ($338 million) of the three-month bills, or 13 percent of the 1.972 billion euros raised by the bailout fund, the official said.

Data published by Germany's Bundesbank showed there was strong demand for the debt issued by the European Financial Stability Facility (EFSF).

The sale was oversubscribed by more than three times with investors bidding a total 6.286 billion euros, the German central bank said.

So as I have been saying, you can’t depend on reading current trends and use these to make forecasts. Policymakers will be responding to market developments which will have repercussions.

And I will like to further emphasize that the recent drop in gold is being accompanied by a slump in developed economy equity markets

Chart from Bespoke

Correlation between gold and stocks has intensively tightened.

This exhibits more evidence that in an environment faced by liquidations, margin calls and increased demand for money for safekeeping reasons, gold won’t likely function as refuge. This isn’t the Great Depression era of the 1930s where the gold was money.

In short, gold isn’t a refuge against deflation under a fiat paper money system

Here is a graph of the ECB’s deposits in relation to margin calls (from the Financial Times Blog) [hat tip Bob Wenzel]

We can expect that political authorities will continue to refuse adjustments from the markets, because these would imperil the interests or the beneficiaries of the incumbent political economic system—the political and banking class.

Thus, we will see them resort to accelerating inflationism or policies that will “extend and pretend” or “kick the can down the road” which only exacerbates the current problems. We can construe that most of the signals of “discipline” represent political posturing.

What will happen is that funds will be provided by political institutions (central banks or rescue funds) to allow banks to buy sovereign debt (to keep down yields) which will be used by banks as collateral for acquiring loans from the ECB. This will be like two drunks attempting to prop up one another. (to borrow the analogy from Professor Arnold Kling)

And banks will profit from arbitrages on the manipulated yield spreads.

So inflationism will be a policy that should be expected to continue.

For all of history commodities/gold has served as money or as refuge against inflationism. Thus we should expect gold to eventually find a bottom and begin to reverse the current downtrend once such policies are announced and triggered.

As a final note, the US dollar is the world’s premier currency reserve, which means global banks, finance companies and governments hold as reserves [The US dollar and the Euro make up 90% of Allocated Reserves globally. Unallocated Reserves are not included in this graph, although they make up over 45% of total world foreign exchange holdings-Wikipedia.org] and comprises about 70% of the world trade/transactions [China Daily].

Thus, we shouldn’t be surprised, as this would be intuitive if not commonsense, that the US dollar will serve as temporary lightning rod against the current turbulence, in an environment where demand to hold money increases (again from liquidation, margin calls or safety reasons).

It will take the US Federal Reserve to hyperinflate to drastically reduce the role of US dollar, an event which has not been happening yet.

So I would rather use this opportunity to accumulate gold or gold related investments.

Rising Demand for British Butlers by Emerging Market Super Rich

Super Chinese and Russian millionaires seem to have a penchant for English household workers.

Earlier I posted news which exhibited a surge in demand for British nannies, this time we are told that demand for English butlers have been the chic.

From the Bloomberg

English butlers, synonymous with Reginald Jeeves in the novels of P.G. Wodehouse, are answering more calls from super-rich Chinese and Russian clients as wealth shifts between east and west.

The Guild of Professional English Butlers has trained 20 percent more butlers this year than last, placing them with clients as soon as they are ready, according to Robert Watson, head of the firm in southern England, last week. The number of domestic staff registered with Greycoat Placements has trebled over the past three years, Managing Director Debbie Salter said.

“Demand is outstripping supply,” Watson said by telephone. “We deal with people who often are cash rich and time poor. The credit crunch did affect things for a time, but before you get rid of the butler, get rid of the Ferrari.”

As Europe struggles with a debt crisis and the U.S. tries to revive its economy, burgeoning growth in emerging markets is boosting spending on luxuries like never before, and creating opportunities for more people to look after them.

The ranks of millionaires in 10 major Asian economies will more than double to 2.8 million by 2015, according to a Julius Baer Group and CLSA Asia Pacific Markets report on Aug. 31. China’s economy grew 9.1 percent in the third quarter from a year earlier, compared with U.S. growth of 1.5 percent.

We need to qualify who the nouveau super rich Chinese and Russians are, because many of them have attained their status via political privilege.

Yet, shifting preference for Western household workers by EM super millionaires could also signify symptoms of the ongoing wealth convergence from globalization.

And such dynamic could be magnified by the continuing trend to adapt inflationist policies by the West, as Emerging Markets open their economies to the world and or to domestic entrepreneurship. Interesting signs of evolving times.

Prediction Failure: Hurricane Forecasters Give Up

Another instance where math models, here applied to weather forecasting, has failed to live up to its much touted reputation (hat tip: Professor Russ Roberts)

From OttawaCitizen.com

Two top U.S. hurricane forecasters, famous across Deep South hurricane country, are quitting the practice of making a seasonal forecast in December because it doesn’t work.

William Gray and Phil Klotzbach say a look back shows their past 20 years of forecasts had no predictive value.

The two scientists from Colorado State University will still discuss different probabilities of hurricane seasons in December. But the shift signals how far humans are, even with supercomputers, from truly knowing what our weather will do in the long run.

Cheers to William Gray and Phil Klotzbach for admitting the truth.

Reason TV video: Anatomy of Government Stimulus Failure

Jim Epstein of Reason.tv documents in the following video, what went wrong with Obama's stimulus spending program which features the case study of Silver Spring, Maryland. (hat tip Professor Russ Roberts).

Among the many reasons: red tape, prioritization of political objectives, cronyism, wrong targets, insufficient knowledge and more..., which has led to unintended consequences and most importantly to taxpayer losses.



This isn't a problem confined to the US, rather this needs to be seen as universally applicable, even to the Philippines. Politicians find it so easy to spend on other people's money which eventually not only fails to achieve its objectives but increases the overall burden of the people (through higher taxes and wastage of scarce resources). Yet government's failure has usually not been remedied by discipline, i.e. withdrawal of funding, but instead gets rewarded by more spending.

Cartoon of the Day: Damned Lies, Statistics and Correlation-Causation Explanations

Manipulation of statistics to generate causation-correlation explanations is shown below in a spoof.

From Businessweek/Bloomberg

Our pattern seeking instincts has been shaped by our quest for certainty. This has rendered us highly vulnerable to misinterpretation of events and the subsequent distortion of our expectations. Pattern seeking plays well into our cognitive biases. Yet many seek comfort in the confines of statistics, which unknowing to many could be manipulated or skewed to fit into the bias of the presenter for whatsoever purpose/s (often politics).

And this is why we should cautiously be screening or filtering data and opinions for their validity than just to accept them as irrefragable reality or truth.

As Mark Twain once said,

There are three kinds of lies: lies, damned lies and statistics

Global Equity Markets: Signs of Contracting Liquidity?

It’s the same politics-driving-markets story.

From the Bloomberg,

U.S. stocks retreated, reversing an earlier advance for the Standard & Poor’s 500 Index, after Federal Reserve policy makers refrained from taking new actions to bolster growth at the world’s largest economy.

While global central banks have been engaged in unprecedented acts of asset purchasing or quantitative easing (QE), the variances of the scale of applied QE will translate to differences in the impact on financial markets.

However, the continuing EU debt crisis, China’s ‘slowdown’ and liquidations from the MF Global fallout seem to be neutralizing whatever global central banks have been doing.

The Euro has broken down. Since the Euro has the largest share in the US dollar index basket then this means an upside breakout for the US dollar

Now if the US dollar’s rise has been signaling contracting liquidity in parts of the world, then this should be reflected on the price of gold.

And contracting liquidity could be also signal slower growth which should also reflect on prices of copper.

Copper indeed has been sluggish, but appears to have deviated from gold in terms of price trend. Copper still is consolidating while gold has broken down.

Nonetheless, part of such weakness could be percolating into equity markets.

The US S&P has languished but also remains on a consolidation mode. Since the degree of relative liquidity appears to be generating variable effects, then correlations will likewise manifest signs of divergence.

Chart from Bespoke

As with the US S&P 500, the lagging German DAX (relative to the S&P) seem to demonstrate such difference.

Finally to reemphasize, the breakdown of the Shanghai index continues to deepen.

Applied to the Phisix, which I think remains on the bullish phase of the current bubble cycle, the above signs or developments should keep us on our toes or should make us remain partly on the defensive.

However as caveat, we cannot simply read and project all these as the prospective trend.

Since the de rigueur trend in policymaking, which marks the difference from 2008 or anytime in history, has been a more activist approach where authorities have been quick to respond to the developments in the markets, any prospective actions will likely impact the markets anew (relatively depending on scale and in meeting with market's expectations).

The FOMC’s reluctance to undertake a direct QE is understandable. The FED may have observed that there has been an accelerating upside trend in US monetary aggregates. And more QE will only risk adding to inflationary pressures, so they may be reserving this option until (political and financial) conditions warrant.

Nevertheless the above quote from the Bloomberg only reveals how addicted financial markets have been to inflationism.

Rest assured that this political dynamic as major driver of the markets won’t fade away anytime soon and should continue to dominate the actions in the global marketplace.

Challenging times indeed.

More Signs of China’s Bubble: Deserted Fake Disneyland

From Reuters Blog (hat tip Bob Wenzel)

Along the road to one of China’s most famous tourist landmarks – the Great Wall of China – sits what could potentially have been another such tourist destination, but now stands as an example of modern-day China and the problems facing it.

Situated on an area of around 100 acres, and 45 minutes drive from the center of Beijing, are the ruins of ‘Wonderland’. Construction stopped more than a decade ago, with developers promoting it as ‘the largest amusement park in Asia’. Funds were withdrawn due to disagreements over property prices with the local government and farmers. So what is left are the skeletal remains of a palace, a castle, and the steel beams of what could have been an indoor playground in the middle of a corn field.

It’s sad to see vast amounts of capital wasted on grand projects.

Yet the above is just one of the many other symptoms (ghost cities, empty malls, vacant apartments) of failed government policies in promoting permanent quasi booms. Phony boom always ends up in a bust.

I am not sure if current market conditions in China have been exhibiting a systemic bust.

But China’s stock market and capital flows suggest that this could be happening. (commodity markets may also partly reflect this) The Shanghai index has forged a new 2 year+ low.

Hot money may also have began their exodus (chart from Danske Bank), although this has yet to be reflected on China's currency, the yuan.

Nevertheless, given today’s policy activism practiced by central banks (and backed by governments), we have to watch the PBoC's (as well as China's government) next moves and how markets will react on them.

As I have been saying a China crash is likely to surprise the global financial markets more than the events in the Eurozone, as everyone seems to have been fixated on the latter.

So we should keep constant vigil over the developments in China.

Quote of the Day: Division of Labor Cheeseburger Edition

Writes Waldo Jaquith, (hat tip Professor Arnold Kling)

I realized that my prior plan hadn’t been ambitious enough—that wasn’t really from scratch. In fact, to make the buns, I’d need to grind my own wheat, collect my own eggs, and make my own butter. And I’d really need to raise the cow myself (or sheep, and make lamb burgers), mine or extract from seawater my own salt, grow my own mustard plant, etc. This past summer, revisiting the idea, I realized yet again that I was insufficiently ambitious. I’d really need to plant and harvest the wheat, raise a cow to produce the milk for the butter, raise another cow to slaughter for its rennet to make the cheese, and personally slaughter and process the cow or sheep. At this point I was thinking that this might all add up to an interesting book, and started to consider seriously the undertaking.

Further reflection revealed that it’s quite impractical—nearly impossible—to make a cheeseburger from scratch. Tomatoes are in season in the late summer. Lettuce is in season in spring and fall. Large mammals are slaughtered in early winter. The process of making such a burger would take nearly a year, and would inherently involve omitting some core cheeseburger ingredients. It would be wildly expensive—requiring a trio of cows—and demand many acres of land. There’s just no sense in it.

A cheeseburger cannot exist outside of a highly developed, post-agrarian society. It requires a complex interaction between a handful of vendors—in all likelihood, a couple of dozen—and the ability to ship ingredients vast distances while keeping them fresh. The cheeseburger couldn’t have existed until nearly a century ago as, indeed, it did not.

MF Global Fallout Haunts the Metal Markets

The MF Global mess continues to haunt the commodity markets. Reports suggest that MF Global could have engaged in rehypothecation or illicitly pledged collateral by their clients as collateral for its own borrowing (Wikipedia.org). And ownership issue over collateral has given way to numerous lawsuits and liquidations.

Writes Zero Hedge (bold emphasis mine)

That paper gold, in the form of electronic ones and zeros, typically used by various gold ETFs, or anything really that is a stock certificate owned by the ubiquitous Cede & Co (read about the DTCC here), is in a worst case scenario immediately null and void as it is, as noted, nothing but ones and zeros on some hard disk that can be formatted with a keystroke, has long been known, and has been the reason why the so called gold bugs have always advocated keeping ultimate wealth safeguards away from any form of counterparty risk. Which in our day and age of infinite monetary interconnections, means virtually every financial entity. After all, just ask Gerald Celente what happened to his so-called gold held at MF Global, or as it is better known now: "General Unsecured Claim", which may or may not receive a pennies on the dollar equitable treatment post liquidation. What, however, was less known is that physical gold in the hands of the very same insolvent financial syndicate of daisy-chained underfunded organizations, where the premature (or overdue) end of one now means the end of all, is also just as unsafe, if not more. Which is why we read with great distress a just broken story by Bloomberg according to which HSBC, that other great gold "depository" after JP Morgan (and the custodian of none other than GLD) is suing MG Global "to establish whether he or another person is the rightful owner of gold worth about $850,000 and silver bars underlying contracts between the brokerage and a client." The notional amount is irrelevant: it could have been $0.01 or $1 trillion: what is very much relevant however, is whether or not MF Global was rehypothecating (there is that word again), or lending, or repoing, or whatever you want to call it, that one physical asset that it should not have been transferring ownership rights to under any circumstances. Essentially, this is at the heart of the whole commingling situation: was MF Global using rehypothecated client gold to satisfy liabilities? The thought alone should send shivers up the spine of all those gold "bugs" who have been warning about precisely this for years. Because the implications could be staggering.

Probably the core primary consequence of this discovery, which obviously has a factual basis, or else it would not lead to an actual lawsuit between two "reputable" firms (aka ponzi participants), is whether gold in the GLD warehouse, supervised by HSBC, is truly theirs, or has it all been hypothecated from some other broker who never really had the asset or the liquidity, and so on in what effectively can be an infinite chain of repledging one asset to countless counterparties. Because if there is on cockroach...

Suffice to say, expect either a prompt settlement in this lawsuit, or a fervent denial by all parties involved that any gold was misplaced. Because here is the punchline: each physical gold or silver bar has a unique deisgnator that should never be replicated, yet this is precisely what happened to lead to the lawsuit! In a non-banana world, there should never be any debate over who owns a given physical asset, as replicated ownership (note - not liens) effectively means someone stole the gold (or there was counterfeiting involved) and was never caught... until MF Global finally expired of course.

Read the rest here

Chart of the Day: Crony Capitalism

This fantastic Venn diagram from Professor Mario Rizzo shows of the conflict of interests, particularly the US government's revolving door relationship with the too big too fail, Goldman Sachs.

This also serves as a good example of regulatory capture or when a “regulatory agency created to act in the public interest instead advances the commercial or special interests that dominate the industry or sector it is charged with regulating” (Wikipedia.org).

Libertarian Cities May Rise at Honduras

This is refreshing news, in a world of governments, here is a chance to prove the viability of Libertarian ideas. Honduras plans to open “free cities”.

From the Economist, (bold emphasis mine) [hat tip Bob Wenzel]

Now, for the first time, libertarians have a real chance to implement their ideas. In addition to a big special development region, the Honduran government intends to approve two smaller zones. And two libertarian-leaning start-ups have already signed a preliminary memorandum of understanding with the Honduran government to develop them.

One firm goes by the name of Future Cities Development Corporation. It was co-founded by Patri Friedman, a grandson of Milton Friedman, a Nobel laureate in economics, and until recently executive director of the Seasteading Institute, a group producing research on how to build ocean-based communes. The other is called Grupo Ciudades Libres (Free Cities Group) and is the brainchild of Michael Strong and Kevin Lyons, two entrepreneurs and libertarian activists.

Both share a purpose: to build “free cities”. Last April all three spoke at a conference organised by Universidad Francisco Marroquín, a libertarian outfit in Guatemala. In September they and Giancarlo Ibárgüen, the university’s president, launched the Free Cities Institute, a think-tank, to foster the cause.

As so often with enthusiasts, divisions within the cause run deep. The two firms hail from different parts of the libertarian spectrum. Mr Friedman is an outspoken critic of democracy. It is “ill-suited for a libertarian state”, he wrote in an essay in 2009—because it is “rigged against libertarians” (they would always lose) and inefficient. Rather than giving its citizens a voice, he argues, they should be free to exit; cities should compete for them by offering the best services.

The second firm’s backers appear to be less radical. A founder of several charter schools, Mr Strong is now the force behind FLOW, a movement that claims to combine libertarian thinking “with love, compassion, social and environmental consciousness”, says its website. He too prefers exit over voice (meaning that he thinks that leaving and joining are better constraints on executive power than the ballot box). But he also believes that democratic consent is needed in certain areas, such as criminal justice. His goal in Honduras is less to implement libertarian ideals than to reduce poverty and to speed up economic development.

Some in the Honduran government have libertarian leanings, which is one reason why the authorities have moved so quickly. But when the master developers for the new zones are selected next year, strong political credentials will not be enough—and may even prove to be a drawback. Mr Friedman is stressing a difference between his political beliefs and his firm. “Ideology makes bad business,” he says, adding that Future Cities Development wants to focus on the needs of the people who live in the city.

Yet the biggest hurdle for the libertarian start-ups may be that the transparency commission, which will oversee the development regions, is unlikely to give them free rein. The “constitutional statute” for the development zones, which the Honduran national congress passed in August, does not leave much wiggle room in key areas, not least when it comes to democracy: ultimately their citizens will vote.

While I applaud the idea, I have some reservations.

“Free cities” will remain subject to the politics of Honduras. At the moment, free cities may thrive where “Some in the Honduran government have libertarian leanings”. But since the nature of politics is one of oscillation, then a change in regime could risk undermining the project.

[As an aside, to learn about “libertarian leaning” officials in Honduras is good news enough. Slowly but surely the classical liberal-libertarian creed seem to be percolating into the world and empowering some to get enough political influence to attempt to shape policies in the direction of the free market. Certainly signs of times]

Besides, success from such experiment will ripple into the world, and perhaps incite revolts and topple governments already encumbered with welfare crisis. This is something that socialists, politicians and their cronies won’t allow to happen, so one can’t discount massive efforts to conduct sabotage operations through various covert means such as infiltration.

In my view, the best “free city” model will emerge spontaneously out of the remnants of the collapsed welfare based nation states sometime soon.

In the meantime, the libertarian battle will remain with spreading freedom through education.

Yet one of the best reforms present day governments can do would be to allow people the freedom to vote with our feet or the freedom to exit.

Doing so will allow for tighter competition among nations. People will gravitate to nations where they would be treated best or where they think the type of governance fits them.

Of course, doing so translates to less tax revenues and less political control. So this brings us back to square one—the natural resistance to change by the beneficiaries of the incumbent political system.

Nevertheless, I wish the “free cities” project all the best. Perhaps I could pay them a visit soon.

Phisix: Primed for an Upside Surprise

In our age there is no such thing as 'keeping out of politics.' All issues are political issues, and politics itself is a mass of lies, evasions, folly, hatred and schizophrenia. -George Orwell

It’s the advent of the holiday season. Since the public’s attention will likely be diverted towards the coming festivities, the common intuition is to expect less of an active market which usually has been marked by lean trading volumes.

Central Bank Actions Should Amplify Seasonal Factors

Yet still, the seasonality factor favors December.

While seasonal forces may yield some influence on the marketplace (such as triple witching hour[1] and window dressing[2]), one cannot depend on its statistical accuracy, given the manifold factors involved, particularly the politicization of the marketplace.

However, the current financial and economic environment, which has been distinguished by near record low interest rates and global central banks heavy on the pump[3], are most likely to provide continued support to, and bolster the seasonal effects, on financial assets.

Most of the world’s major economies have been operating on negative interest rates as shown by the chart above[4].

Except for Brazil, even nations with positive real rates have not significantly been above zero. And that is if the statistics used to measure inflation has been accurate. Usually measurements of inflation have been understated.

And considering the politicized nature of the present state of the global financial markets, persistent volatilities should not be discounted.

And accentuated volatility has the tendency to attract short term traders despite the holiday season.

The EU Fiscal Union Masquerade

The EU crisis will continue to partly hold sway on the developments in the global markets.

Over the week, global equity markets gyrated on vacillating expectations brought about by conflicting statements by politicians and bureaucrats.

Growing expectations for more aggressive participation by the European Central Bank (ECB) in acquiring bonds through Quantitative Easing (QE) has helped buoyed global markets. However ECB’s chief Mario Draghi dispelled the popular clamor for a carte blanche approach which doused cold water on the markets that sent commodities and equity markets tumbling[5]. This resonates with US Fed chair Ben Bernanke’s recent jilting of market’s expectations over the telegraphed QE 3.0 at the end of September which incited a mini-crash[6].

Political factors have restrained the actions of both central banks. Prior to the FOMC meeting last September, Fed chair Ben Bernanke came under fire from various political fronts, which most likely prompted for him to backtrack on his pet QE 3.0 program.

Meanwhile Mr. Draghi’s ambivalence could be seen as extracting political leverage at this week’s EU summit for EU member states to accede to a “fiscal compact”.

Despite the recent volatility, the scale of the losses has not been similar to that of the Bernanke episode last September.

Perhaps markets may have digested on the other credit easing measures adapted by the ECB, particularly, a cut in interest rate, unlimited access to two long-term refinancing operations (LTRO), a reduction in reserve requirements and the lowering of credit rating threshold which expands the eligible collateral base.

This weekend hallmarks a “fiscal compact” that would most likely reconfigure the European Union. The main points of summit agreement can be found here[7].

However, contrary to popular wisdom, the ‘fiscal union’ elixir will likely prove to be an illusion to the current EU Debt crisis.

Any political system that becomes highly dependent on the redistributive process that overwhelms on society’s productive sectors will fail.

To analogize the current developments, in the words of the illustrious Ayn Rand,

When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing - when you see that money is flowing to those who deal, not in goods, but in favors - when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you - when you see corruption being rewarded and honesty becoming a self-sacrifice - you may know that your society is doomed.

Great examples of failed union states would be the Soviet Union or Yugoslavia or the Roman Empire.

And considering that the major directives undertaken towards resolving the debt crisis has been to mostly raise taxes[8] and to engage in more monetary inflation, we can expect that these policies would translate to growth retardant economies that would be marked by lesser investments and sustained high unemployment rates.

Using Italy as an example, author Joe Studwell writes[9],

Meanwhile Frau Merkel and Sarko are coming up with a scheme to sanction countries like Italy that don’t stick to budget targets. This plays to German political opinion, but completely misses the point.

It treats Italy as a debt problem. But it isn’t. Italy is a growth problem that can only be resolved with legal system, bureaucratic and labour market reforms that make growth possible. Italy needs to be made to work institutionally.

Aside from misdiagnosis by EU’s politicos, the one-size-fits-all therapy would signify the proverbial cure that could be worse than the disease.

And perhaps in acknowledging these flaws, the United Kingdom has vetoed plans for her inclusion in the treaty because of the EU-wide tax on financial transactions[10] which essentially would mean a loss of control over financial regulation.

Moreover, the fiscal union shaped by current political crisis exigencies postulates that the disciplinary mechanism to uphold on the treaty will likewise be insufficient and subject to various legal loopholes.

Similar to the current failings of the EU, errant member states of the EU such as Greece, who fudged her statistics to gain entry to the EU via complex currency and credit derivatives, and of other reports of creative accounting and manipulated statistics[11] by other EU nations, will possibly continue to plague an even more centralized European Union. We don’t expect Germany to send her army to delinquent members to enforce such penalties.

And any sign of temporary stabilization will result to political leaders of the EU states to relax on attaining fiscal balance which represents the moral hazard of the bailouts.

Further, treaty provisions and regulations will likely be arbitrary and predisposed towards the interests of politicians and bureaucrats.

And instead of dealing with the lack of competitiveness and impediments to economic growth as a result of bureaucratic red tape, welfare state, high tax regime and obstructive regulations, the political direction has essentially been to apply the same set of policies that has brought them to the current state of the crisis.

At the end of the day, the proposed remedies for a fiscal union, along with the additional money loaned by the EU to the IMF[12] to be lent to EU’s crisis affected nations (sort of an escrow arrangement), will only represent cosmetic changes that serves as veneer for the ECB to engage in more monetary inflation, and to transfer and expand the political power to EU technocrats at Brussels at the expense of the freedom and civil liberties of citizens of the EU member states.

The ECB’s balance sheets has rapidly been ballooning as shown by the chart from Danske Bank[13]. A new EU will likely prod the ECB to increase purchases.

This band aid approach may provide an ephemeral calm to the financial markets from which the effects of inflatonism will likely become more visible.

Bearish Chart Patterns Nearing Reversal

The Philippine benchmark, the Phisix has been in a consolidation phase and seems on the path to reverse the bearish technical indicator known as the ‘death cross’.

Following the September-Bernanke shakeout, the Phisix has been rangebound since the rally which climaxed last November.

The 50 day moving average (blue) has worked to narrow on the 200 day moving averages (red). Once the 50 day regains the upperhand or successfully crossover the 200 day moving averages then the bearish death cross transitions into a bullish golden cross.

Many use technicals, as the above, to analyse and predict the phases of markets. Yet it seems likely that “death cross” may not be living up to its putative billing. The current death cross has not led to a bear market.

And a reversal would mean a whipsaw or a chart pattern failure. This only would prove my point that sole reliance on chart patterns would translate to inaccurate reading of the markets.

Mechanical chart reading fundamentally ignores the vast differentials between past conditions with the present and future conditions. Also, mechanical charting has dubious statistical accuracies in terms of prediction success rates, as well as, feeding upon our mental impulse to seek patterns, or cognitive bias known as clustering illusion—seeing a pattern in what is actually a random sequence of numbers or events[14]

Most importantly, mechanical charting fails to account for the indispensable role of people’s action which ultimately determines price trends.

In the current case, negative interest rates and intensive money pumping by global central banks and the politicization of markets aimed at propping up asset prices, to keep banks and governments afloat, will continue to influence people’s reading, evaluation, interpretation and analysis of prices and their attendant actions to allocate scarce resources via the money medium.

As I previously wrote[15], (emphasis original)

The prospective actions of US Federal Reserve’s Ben Bernanke and European Central Bank’s Jean-Claude Trichet represents as the major forces that determines the success or failure of the death cross (and not statistics nor the pattern in itself). If they force enough inflation, then markets will reverse regardless of what today’s chart patterns indicate. Otherwise, the death cross could confirm the pattern. Yet given the ideological leanings and path dependency of regulators or policymakers, the desire to seek the preservation of the status quo and the protection of the banking class, I think the former is likely the outcome than the latter.

And any further material uptick by the Phisix will likely accelerate such reversal process.

To add, people who say that the Phisix will remain rangebound could be taken in for a big surprise.

If I am not mistaken, even the US markets could be on a path similar to the Phisix. The US version of the ‘death cross’ could be reversed once the S&P slams past the resistance portal of 1,262-1,285 and beyond.

And given the continuing growth in monetary aggregates and material signs of improvement in the US credit markets, we should expect these conditions to be reflected on equity prices.

Bank Loans and Credit as measured by activities in all US commercial banks[16] as well as commercial and industrial loans have been ramping up.

Outside any shocks from the EU or China, US equities seem poised to move higher.

Charts are useful when used as guide rather than as principal determinant in the evaluation of the risk-reward tradeoff and the accompanying actions to attain portfolio management goals.

And the further point is that a chart pattern reversal should add to the bullish sentiment as many technically based traders or investors will most likely reenter the markets. At least you have been ahead.

Regional Activities and Market Internals Exhibit Upside Potentials

Since every financial asset competes to attract one’s money, then a functional correlationship exists with all other asset markets around the world.

Then observing price actions of other asset markets especially those which are closely related should be a worthy exercise.

Given the price action of our neighbors, I think it would be a folly to write off a potential yearend run.

The chances for an emergent upside seem to increases once we examine the developments in the region’s markets and of the market internals in the Philippine Stock Exchange.

Only Malaysia (FBMKLCI; light orange) has been (3.9%) down on a year-to-date basis, while Indonesia (JCI; green), Phisix (PCOMP; red) and Thailand (SET; dark orange) have been marginally higher 1.52%, 2.17% and .12% respectively as of Friday’s close.

So far Thailand’s SET, among the three, has been the most aggressive having risen by nearly 7% over the past 2 weeks.

Given the seemingly tight correlations (based on trend undulations rather than numerical coefficients), one can’t discount the same belated actions on the Phisix, on Indonesia’s JCI and Malaysia’s KLSE. On the other hand one may argue that Thailand may fall along the line with rest.

However given that Southeast Asia’s relatively lesser debt exposed or leveraged economies, the region’s financial markets are likely to be more receptive towards negative real rates policies which should induces speculative activities.

So far, Indonesia and the Philippine banking sector has the least exposure to real estate loans in the region[17]. This implies that the region’s bubble cycle could be in the formative stages, and may have more room to climb.

Yet the price actions of the region’s bourses seem to be replicated or mirrored in the sectoral performance of the Phisix or the Philippine Stock Exchange.

All sectors appear to be in a consolidation phase. However there seems to be emergent signs of restiveness. The banking sector (black candle) has been the best performer over the past two weeks as revealed by the recent attempt to gain higher grounds.

This has been followed by mining (light orange) and the property sector (violet) while services (red), holding (teal) and the Commercial Industrial (blue) have moved almost in tandem with the Phisix.

Additionally, market internals appear to be also manifesting some signs of notable improvements which may compliment the sectoral activities.

Net foreign buying averaged on a weekly basis seems to be on a sustained upswing since June of this year.

If net foreign buying will accelerate or improve further, then much of these fund flows will likely be directed to elite Phisix member components.

A boost on the Phisix is likely to buttress general sentiment.

Average daily trade on a weekly basis also has been incrementally improving. This sentiment indicator seems to be exhibiting signs of confidence gaining momentum.

Any sustained rally in the Phisix which may come during the yearend or during the first quarter of 2012 will likely translate to a broad market rally.

Bottom line:

While the holiday season may lead to less active markets which could be manifested by leaner volume of trades, they could also serve as windows to accumulate or position. But this is no certainty as current market volatility may induce more trading activities.

Nonetheless given the concerted global credit easing efforts and the predominantly negative real rates worldwide, I think current conditions may suggest of a potential sizeable upside swing in the equity markets of the region and in the Phisix.

My guess is that such moves may also be reflected on commodity markets.

Again global market activities will hold sway or materially affect activities in the regional and local financial markets. And the conventional “kick the can down the road” policies by major developed economies and by China may generate heightened demand for risk assets over the interim.

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[1] Investopedia.com Triple Witching

An event that occurs when the contracts for stock index futures, stock index options and stock options all expire on the same day. Triple witching days happen four times a year on the third Friday of March, June, September and December.

[2] Investopedia.com, Window Dressing

A strategy used by mutual fund and portfolio managers near the year or quarter end to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders. To window dress, the fund manager will sell stocks with large losses and purchase high flying stocks near the end of the quarter. These securities are then reported as part of the fund's holdings.

[3] See Global Central Banks Ease the Most Since 2009, November 28, 2011

[4] US Global Investors Investor Alert - You Can’t Print More Gold, usfunds.com December 9, 2011

[5] See ECB’s Draghi Balks at More QE, Global Equity Markets Tumble, December 9, 2011

[6] See Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms, September 22, 2011

[7] Guardian.co.uk European Union summit agreement: the main points, December 9 2011

[8] See European Debt Crisis: Taxing the Economy to Prosperity December 10, 2011

[9] Studwell Joe Wrong Menu, Joestudwell.com, December 5, 2011

[10] DailyMail.com A day for Britain to salute Mr Cameron, December 9, 2011

[11] Wikipedia.org National statistics, European Sovereign Debt Crisis

[12] Bloomberg.com IMF Seeks Funds for European Debt Crisis, December 11, 2011

[13] Danske Bank Euro tensions to continue, Weekly Focus, December 9, 2011

[14] Rationalwiki.org Clustering illusion

[15] See How Reliable is the S&P’s ‘Death Cross’ Pattern?, August 14, 2011

[16] Federal Reserve Bank of St. Louis, US Financial Data Economic Research Bank Loans and Credit and Commercial and Industrial Loans

[17] Worldbank.org Navigating Turbulence, Sustaining Growth WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE 2011, VOLUME 2