China’s Coup Rumors: Signs of the Twilight of Centralized Government?

China’s political system has shown increasing signs of fracturing.

Writes the Wall Street Journal Editorial,

Rumors of a coup in Beijing ricocheted around the Chinese Internet on Tuesday and even caused the cost of credit default swaps on Chinese debt to rise slightly. That's remarkable considering there wasn't one iota of evidence that shots were fired at the Diaoyutai State Guest House or tanks were taking to the streets, as viral microblog posts had it.

But then consider that a month ago, Wang Lijun, an official of vice ministerial rank, sought asylum in the U.S. Consulate in Chengdu. Last week, his boss Bo Xilai, the popular party secretary of Chongqing, was dismissed from his post six months before a national leadership transition. In these strange days, it's easy to see why Chinese citizens may believe reports of a coup.

China is supposed to have "institutionalized" its leadership transitions so that such an upheaval could never happen. The outgoing Politburo Standing Committee hands over power to the anointed party general secretary and premier and picks the rest of the new Politburo. The Standing Committee also selects the two slightly younger men who will take over the top jobs 10 years down the road.

I have previously noted that like Europe, China’s top down politics has had a fragile and unsustainable relationship with snowballing forces of decentralization inspired by the growing political power of entrepreneurs, which eventually will lead to a head-on collision that would translate to a political upheaval.

We are seeing more signs of these developments.

Again from the same article, (bold emphasis mine)

The party has been able to keep internal strife under control by avoiding ideological struggle over the last 20 years. The factions have competed for important posts and the spoils of power, but they ruled by consensus. The public was simply told to believe in the myth of a monolithic party and ignore the men squabbling behind the curtain.

This technocratic pragmatism may now be breaking down. For instance, Bo Xilai appealed to leftists' disgust with bourgeois individualism and public unhappiness with income inequality, a tactic that alarmed some leaders. Since his dismissal, leftist websites and commentators have also been silenced.

But there are plenty of other voices on the "right" advocating liberal political reform. Ten years ago, the prospect of achieving middle-class incomes made most intellectuals unwilling to rock the boat. Now they feel secure enough to demand more rights. The party sees this as evidence of Western infiltration, and it is tightening control over the media and launching new campaigns to promote the spirit of self-sacrifice.

Entrepreneurs are indeed becoming a political force.

Either China's politics harmonize with the dynamics of the economy through decentralization, or China’s politics would regress to the Mao Zedong model which would close their doors to the world. My bet is in the former.

Yet any crisis or recession will likely accelerate this turbulent transitional process.

And as I earlier posted

Entrepreneurship will be the hallmark of the information age.

Interesting times indeed

The Virtue of Failure

Here is a helpful career tip from my favorite marketing guru Seth Godin

Too many MBAs are sent into the world with bravado and enthusiasm and confidence.

The problem is that they also lack guts.

Guts is the willingness to lose. To be proven wrong, or to fail.

No one taught them guts in school. So much money at stake, so much focus on the numbers and on moving up the ladder, it never occurs to anyone to talk about the value of failure, of smart risk, of taking a leap when there are no guarantees.

Well tolerance of failure is a trait dovetailed for market economies.

In socialist countries anyone’s willingness to lose would have been substituted for dependence on the state.

That’s why productivity and innovation is hampered. People have not been motivated to take risks. Losses are perceived as stigma. Regimented conformity displaces competitive thinking.

Also as emphasized by Mr. Godin, gut is a character that is hardly learned from school.

High Taxes Equals Lower Revenues: UK Edition

The Wall Street Journal Wealth Blog writes,

To dig itself out of recession, Britain hiked its income-tax rate to 50% for those making £150,000 or more. Proponents said the tax was needed to bring fairness to an economy, in which the rich were getting richer and not contributing enough to the cause. Critics said the tax would chase out the job creators.

As it turned out, the real impact was in tax avoidance. According to the Chancellor of the Exchequer’s budget announced today, the income-tax hike caused “massive distortions” that cost the government.

A study found that £16 billion of income was deliberately shifted into the previous tax year. As a result, the tax raised only £1 billion – a third of the amount forecast.

This is another concrete example of a blowback of simplistic knee jerk policies embraced by the left.

In desperate attempts to raise revenues, the stereotyped recommendation by left leaning experts, which has often been adapted by politicians, has been to raise taxes.

They assume that people are like robots who will blindly comply with the regulations. They fail to understand that policies create incentives for people to act, particularly to circumvent on regulations whom they view as either undeserving or excessive.

And higher taxes, observes Cato’s Dan Mitchell, lower incentives to earn and report income, and lower tax rates increase incentives to earn and report income.

That’s exactly what transpired in UK. The response of the rich from higher taxes had been to use tax avoidance measures to withhold from paying more taxes. Common sense.

Unfortunately common sense is uncommon to people blinded by political self-righteousness

17 Reasons to be a Rational Optimist

My favorite science and environmental columnist and author of the must read Rational Optimist, the eminent Matthew Ridley propounds 17 reasons why we should be cheerful:

1. We're better off now

2. Urban living is a good thing

3. Poverty is nose-diving

4. The important stuff costs less

5. The environment is better than you think

6. Shopping fuels innovation

7. Global trade enriches our lives

8. More farm production = more wilderness

9. The good old days weren't

10. Population growth is not a threat

11. Oil is not running out

12. We are the luckiest generation

13. Storms are not getting worse

14. Great ideas keep coming

15. We can solve all our problems

16. This depression is not depressing

17. Optimists are right

Read Mr. Ridley’s explanations here.

All the above redounds to a single most important theme: the human being.

Rational optimism is a bet on human capital, or in the context of the Austrian economic school, praxeology or the science of human action—purposeful behavior towards the fulfillment of an end which aims to substitute present unsatisfactory conditions.

Human actions in pursuit of constant improvements is likely to bring about positive changes, despite attendant challenges (especially from politicians, the regulators and cronies).

People are the ultimate resource, as the great author and Professor Julian Simon once wrote,

Only one important resource has shown a trend of increasing scarcity rather than increasing abundance. It is the most important and valuable resource of all—human beings

Quote of the Day: Economic Fascism

It is again worth noting that this is merely the most extreme manifestation of the economic effects of interventionism in the mixed economy. Since fascism is, in essence, a system of hyperinterventionism, the economic effects of the fascist system are merely the logical extremes of smaller "pragmatic" interventionist programs. Each intervention in a mixed economy distorts prices, misallocates resources to unproductive endeavors, and results in a net loss of production. At the same time intervention increases the value of political influence and thereby shifts effort from production to political lobbying.

With enough political intervention in the economy, this culminates in economic stagnation, then net capital consumption, and, finally, economic collapse, occurring when capital supplies become insufficient to sustain basic services. As this process occurs, parasitic groups in the system suck as much as possible from the dying economy, with their parasitic activities becoming increasingly frantic as the economy collapses and the resources available for capture become scarcer.

The problems with the fascist economic system become more and more clear, but there is no incentive for those in control of the state apparatus to avoid the approaching disaster. Since the only antidote to the problem is liberalization of the economy from state control, the cure for the economic decline threatens the personal livelihoods of the state bureaucrats and the ideological program of the higher-level members of the ruling regime.

Of course, it is true that sustained economic decline will eventually threaten the position of the ruling elite, particularly since they must make some appeals to the "public good" in their efforts to maintain their own power. However, their situation is threatened far more directly and far more immediately by the cure for economic decline than from the decline itself.

That’s from a brilliant article by Ben O’Neill at the Mises Institute on the Vampire Economy/authoritarian capitalism/state capitalism/ economic fascism. These conditions resonate or evinces signs of relevance to current developments here and abroad. Also, these represents the main cause why black markets or informal or shadow economies exists.

In Defense of Insider Trading

From Harvard Professor Jeffrey Miron (Hat tip: Bob Wenzel)

Most policymakers, along with the general public, believe that insider trading should be banned. Yet straightforward economic reasoning suggests the opposite.

The most obvious effect of a ban is delaying the release of relevant information about the fortunes of publicly traded companies. This means slower adjustment of stock prices to relevant information, which inhibits rather than promotes market efficiency.

Imagine, for example, that the CEO of a pharmaceutical company learns that a blockbuster drug causes previously unknown side effects. Absent a ban, the CEO might rush to sell or short his company’s stock. This would have a direct effect on the share price, and it would signal investors that something is amiss. Insider trading thus encourages the market to bid down the shares of this company, which is the efficient outcome if the company’s fortunes have declined.

Under a ban on insider trading, however, the CEO refrains from dumping the stock. Market participants hold the stock at its existing price, believing this is a good investment. That prevents these funds from being invested in more promising activities. Thus the ban on insider trading leads to a less efficient allocation of the economy’s capital.

Whether these efficiency costs are large is an empirical question. Short delays of relevant information are not a big deal, and the information often leaks despite out the rules. Thus, the damage caused by bans is probably modest. But efficiency nevertheless argues against a ban on insider trading, not in favor.

And bans have other negatives. Under a ban, some insiders break the law and trade on inside information anyway, whether by tipping off family and friends, trading related stocks, or using hidden assets and offshore accounts. Thus, bans reward dishonest insiders who break the law and put law-abiding insiders at a competitive disadvantage.

Bans implicitly support the view that individuals should buy and sell individual stocks. In fact, virtually everyone should just buy index funds, since picking winners and losers mainly eats commissions, adds volatility, and rarely improves the average, risk-adjusted return.

Thus, if policy is worried about small investors, it should want them to believe they are at a disadvantage relative to insiders, since this might convince them to buy and hold the market. Bans instead encourage people to engage in stupid behavior by creating the appearance – but not the reality – that everyone has access to the same information.

The ban on insider trading also makes it harder for the market to learn about incompetence or malfeasance by management. Without a ban, honest insiders, and dishonest insiders who want to make a profit, can sell or short a company’s stock as soon bad acts occur. Under a ban, however, these insiders cannot do so legally, so information stays hidden longer.

Thus, bans on insider trading have little justification. They attempt to create a level playing field in the stock market, but they do so badly while inhibiting economic efficiency

Information will always be asymmetric.

People do not read news or even mandated ‘public disclosures’ at the same time or at similar degrees. And people’s interpretation and absorption of information will be always be distinct.

I don’t read the newspaper by choice, so I am at a disadvantage on information or facts disclosed. Also, readers of broadsheets have different preferences, e.g some value the business section, some read sports, some prefer entertainment and so forth…

Yet this deficiency in information does not deprive me of the necessary knowledge required for investing overall. In short, the desire for information is about tradeoffs and preferences. Legal mandates will not equalize information dissemination.

And this applies to insiders as well.

The price channel is always the best medium for information (economic or fundamentals).

Importantly, a ban on insider trading or attempts to equalize information through restrictions of insider knowledge does not attain the political objectives intended, as pointed by Professor Miron. In reality, such regulations tilt the balance to favor transgressors.

Insider trading bans is another example of feel good arbitrary laws which in reality are ambiguous, uneconomical, and repressive, i.e. can be or has been used to intimidate or harass individuals or entities for political goals rather than to attain market efficiency.

Yet the ultimate violators of insider trading are central banks who have been manipulating the financial markets, through various means (QEs, swaps, zero bound rates, subsidies, etc...), all to the benefit of the banking system and other Fed cronies, as well as, regulators who erect walls of protectionism to protect favored political entrepreneurs (cronies) which enhances their company's stocks values.

Web Wars: Pirate Bay to Use Hovering Server Drones

The web is a frontier for the cat-and-mouse analogy signifying the constant struggle between politics and markets.

I pointed out how social media activists have resorted to various means of technology innovations to elude censorship.

Yet more of these battles have been developing at an awesome pace.

From KurzweilAI,

The Pirate Bay (TPB), which allows users to share media files via BitTorrent, plans to avoid shutdown by Hollywood by putting some of its servers in GPS controlled drones hovering over international waters, the TPB team told TorrentFreak.

“With the development of GPS controlled drones, far-reaching cheap radio equipment and tiny new computers like the Raspberry Pi, we’re going to experiment with sending out some small drones that will float some kilometers up in the air,” TPB revealed in a blog post.

“This way our machines will have to be shot down with aeroplanes in order to shut down the system. A real act of war. With modern radio transmitters we can get over 100Mbps per node up to 50km away.”

Looking ahead, The Pirate Bay team thinks the site may no longer be hosted on this planet. “When the time comes we will host in all parts of the galaxy, being true to our slogan of being the galaxy’s most resilient system. And all of the parts we’ll use to build that system on will be downloadable.”

So the social media battlefield will be transformed into “star wars”. Drone technology will be used as commercial instruments, particularly as medium of transport and perhaps as shield, to defend against political censorship. And via drone platform based social media warfare, governments will be tasting their own medicine.

Social Drinkers Earn More than Non-Drinkers

Hear ye, Hear ye! Below should be good news for social drinkers.

In a 2006 research paper, Professors Bethany L. Peters and Edward Peter Stringham discusses the economic benefits of social drinking and how alcohol prohibition statutes negates these. [There are so many of aspects in life that goes against popular wisdom, which makes economics so interesting]

Here is the Abstract:

A number of theorists assume that drinking has harmful economic effects, but data show that drinking and earnings are positively correlated. We hypothesize that drinking leads to higher earnings by increasing social capital. If drinkers have larger social networks, their earnings should increase. Examining the General Social Survey, we find that self-reported drinkers earn 10-14 percent more than abstainers, which replicates results from other data sets. We then attempt to differentiate between social and nonsocial drinking by comparing the earnings of those who frequent bars at least once per month and those who do not. We find that males who frequent bars at least once per month earn an additional 7 percent on top of the 10 percent drinkers’ premium. These results suggest that social drinking leads to increased social capital.

Download the Paper here

I love beer, unfortunately I haven’t been to bars in years (only restaurants) and I don’t socialize much too.

Maybe I should…

From HS Dent

…before time catches up.

Global Weapons Exports and the Spratlys Dispute

I previously asked if the Spratlys dispute has partly been about promoting weapons exports for the benefit of the military industrial complex and domestic politicians.

The Economist gives us some clues (bold emphasis mine)

GLOBAL transfers of large conventional weapons such as tanks and planes were 24% higher in 2007-2011 than in 2002-2006, according to new data from the Stockholm International Peace Research Institute. Deliveries to South-East Asia rose particularly steeply, jumping by 185% as tensions mounted over territorial claims in the South China Sea. Three-quarters of all exports in the past five years were made by five countries, as can be seen in the chart below. A notable recent development is China's ability to manufacture its own weapons. Consequently it now ranks as the sixth-biggest exporter, and having been the second-largest importer in 2002-06, it was only the fourth-largest in 2007-11. India remains the biggest importer of arms, buying 10% of the world's total. Perhaps surprisingly there was little change in the volume of arms sent to Arab Spring countries in the past year, though exports to Syria in 2007-2011 (supplied overwhelmingly by Russia) increased by nearly 600% on figures for 2002-06.

We never really know if governments, through their respective foreign policies, have been working in complicity to promote undeclared political agenda.

Cartoon of the Day: Have You Thanked Your Central Banker Today?

Well, have ya? (hat tip Bob Wenzel)

Thank them for this…

Central banking balance sheets at levels never seen in history!

Economic Integration is a Function of Economic Freedom, not Planned Chaos

Cato’s Marian Tupy rightly points out that the much touted benefits from European Union’s integration has been overrated.

The European politicians love to talk about the “huge” benefits of membership in the European Union. It is certainly true that the “single” market between the EU member states has brought tangible benefits, but those have been declining in importance as technological change made access to services and capital cheaper and easier, and trade liberalization progressed world-wide.

Moreover, as the Brussels-based EU bureaucracy expanded, economic liberalization gave way to regulation that helped to strangle European growth (see the graph below). Consider the latest absurdity to emerge from Brussels—a poultry regulation, which aimed to increase the comfort of the egg-laying chickens, but resulted in a drastic cut in egg production and a 100% increase in the price of eggs.

The EU bureaucracy may not appreciate the problem of unintended consequences, but ordinary Europeans are beginning to realize that the EU no longer is what it used to be—a byword for prosperity and stability. In the Czech Republic, for example, a record number of citizens do not trust the EU (63 percent) and the EU Parliament (70 percent). If the EU elite persist in killing jobs and growth, it may bring about the ultimate unintended consequence—the break up of the EU.

The EU represents a political economic entity premised on incorrigible self-contradiction.

On the one hand, the purported mission has been to economically integrate EU’s diverse national economies. On the other hand, the direction of politics has been to centralize the system. Yet political centralization and economic decentralization are fundamentally incompatible.

Professor Ludwig von Mises called this Planned Chaos.

The market economy safeguards peaceful economic co-operation because it does not use force upon the economic plans of the citizens. If one master plan is to be substituted for the plans of each citizen, endless fighting must emerge.

And this is why the ongoing EU debt and welfare crisis has been symptomatic of the friction from the clashing forces of centralization and decentralization. The result of which has been underperformance. [The declining growth in EU, in spite of the 12 year old union, is mostly a result of capital consumption from the EU's welfare state and from various distortive regulations exemplified by the above.]

In reality, EU’s economic integration serves merely a cover for covert plans to establish political fantasyland. Eventually the path towards centralization will lead to unnecessary violence and the self-implosion of an unsustainable and unviable political system

If people in Brussels hold economic integration as their primary goal, then all they should do is voluntarily drop their political ambitions and allow the individual market economies in Europe to flourish with little or no political baggage attached.

But of course, this would mean that EU bureaucrats would be out of jobs and vested interest groups would lose their politically endowed privileges.

So this is not going to happen until the cumulative effects of “planned chaos” becomes totally unwieldy. Yet they seem headed in that direction.

Quote of the Day: Fatal Conceit

Once again my favorite heretic, Black Swan author Nassim Taleb does a Hayek like zinger—against the intellectuals—at his Facebook page but at a much unpretentious, bland or even brutal fashion.

Many of the so-called intellects bear the chutzpah to call or recommend the use of force to impose on their overestimated or bloated sense of understanding of the world, which in reality constitutes no more than fatal wishful thinking or deadly utopian fantasies.

Markets in Everything: Prison Cells, Car Pool Lane and More…

It is inherent in us to trade.

From the Atlantic

THERE ARE SOME THINGS money can’t buy—but these days, not many. Almost everything is up for sale. For example:

• A prison-cell upgrade: $90 a night. In Santa Ana, California, and some other cities, nonviolent offenders can pay for a clean, quiet jail cell, without any non-paying prisoners to disturb them.

• Access to the carpool lane while driving solo: $8. Minneapolis, San Diego, Houston, Seattle, and other cities have sought to ease traffic congestion by letting solo drivers pay to drive in carpool lanes, at rates that vary according to traffic.

• The services of an Indian surrogate mother: $8,000. Western couples seeking surrogates increasingly outsource the job to India, and the price is less than one-third the going rate in the United States.

• The right to shoot an endangered black rhino: $250,000. South Africa has begun letting some ranchers sell hunters the right to kill a limited number of rhinos, to give the ranchers an incentive to raise and protect the endangered species.

• Your doctor’s cellphone number: $1,500 and up per year. A growing number of “concierge” doctors offer cellphone access and same-day appointments for patients willing to pay annual fees ranging from $1,500 to $25,000.

• The right to emit a metric ton of carbon dioxide into the atmosphere: $10.50. The European Union runs a carbon-dioxide-emissions market that enables companies to buy and sell the right to pollute.

• The right to immigrate to the United States: $500,000. Foreigners who invest $500,000 and create at least 10 full-time jobs in an area of high unemployment are eligible for a green card that entitles them to permanent residency.

Read more here

Quote of the Day: Entrepreneurs as Political Force

Entrepreneurship is clearly becoming a global movement, one that is in its infancy, but whose ultimate power is sure only to grow over time. It will take that power to remove many of the obstacles that governments in many countries put in the way of their entrepreneurs.

That’s from Robert Litan of the Kaufmann Foundation describing the success of the Global Entrepreneurship Congress.

Entrepreneurship will be the hallmark of the information age.

Graphic: Has Facebook been Reconnecting Past Colonial Ties?

Interesting observation from the Economist

The Economist writes

EIGHT years ago Facebook launched as an online social network connecting a small college community from a dorm room at Harvard University. Today the company has 845m active users across the globe and a wealth of data. One aspect of these data, which Facebook has shared with The Economist, shows a rough correlation between current global Facebook friendships and the old boundaries of once-mighty European empires.

The maps below rank 214 countries according to the strength of their ties to Britain, France, Spain and Portugal respectively. The darker the blue the higher the fraction of foreign Facebook connections with the imperial power in question. (Facebook has not shared the underlying percentage data, just the ranking.) These closely correspond to countries or territories which were, whether wholly or in part, at one point under British, French, Spanish or Portuguese rule, as seen in the bottom set of maps.

Australia, New Zealand and swathes of east Africa hold the strongest ties to Britain. West African Facebookers have most connections with France. Spanish-speaking Latin America is most strongly tied to Spain. Brazilians remain firmly linked to Portugal, as do people in Mozambique, Angola and Guinea-Bissau.

For the complete view of the graph, proceed to the Economist original site here

iPhone Shows How Trade Statistics are Flawed

I earlier pointed out that statistics hardly captures the realities of the swiftly shifting trade dynamics brought about by globalization as exemplified by the iPhone.

Here’s an update. From the Wall Street Journal Blog

The iPhone provides a good example of the problems with the way trade is currently calculated. The Apple device features hardware from all over the world, but because it’s manufactured in China that country gets credit for the entire wholesale export cost. According to research from Kenneth L. Kraemer of the University of California, Irvine, Greg Linden of University of California, Berkeley, and Jason Dedrick of Syracuse University, each iPhone sold in the U.S. adds $229 to the U.S.-China deficit. Based on 2011 cellphone activations from AT&T, Verizon and Sprint, Apple sold around 30 million iPhones in the U.S. last year — accounting for about $6.83 billion of the U.S.’s $282 billion 2011 trade deficit with China.

But the researchers note that such estimates overstate China’s contribution. Though the iPhone is assembled in China, most of its component parts come from elsewhere. Separate research by Yuqing Xing and Neal Detert for the Asian Development Bank Institute noted that for the iPhone 3G just about 3.6% of the wholesale price came from China, the rest could be attributed to inputs from companies in Japan, Germany, Korea and even the U.S. (Read more about that study here.)

The iPhone is just one example. This same phenomenon is happening all over the world in products ranging from cars to children’s toys. In an attempt to better gauge which countries are benefiting or losing the most through trade, the Organization for Economic Co-operation and Development and the World Trade Organization announced that they will be working on a project that identifies where value-added flows are coming from.

More confirmatory evidence where human action cannot be quantified.

This only validates Professor Ludwig von Mises who wrote

The impracticability of measurement is not due to the lack of technical methods for the establishment of measure. It is due to the absence of constant relations. If it were only caused by technical insufficiency, at least an approximate estimation would be possible in some cases. But the main fact is that there are no constant relations. Economics is not, as ignorant positivists repeat again and again, backward because it is not "quantitative." It is not quantitative and does not measure because there are no constants. Statistical figures referring to economic events are historical data. They tell us what happened in a nonrepeatable historical case. Physical events can be interpreted on the ground of our knowledge concerning constant relations established by experiments. Historical events are not open to such an interpretation.

To add, the deepening of the information age will further complicate trade dynamics as commerce will become increasingly more about niches and specialization or decentralization.

Lastly, the other implication is that using flawed trade statistics to argue for political actions (such as protectionism) is like shooting oneself in the foot.

Quote of the Day: Central Banking Crony Capitalism

The second point made in the classic video is that open market operations are a handout to the dealer banks. Suppose the government is going to spend an extra $100 that it does not have, and it will finance this by printing $100. In practice, it borrows $100 from "the Goldman Sachs" by issuing a bond, prints the $100, then pays "the Goldman Sachs" to get its bond back. This second method of funding the deficit is costlier to the government, but yields profits to "the Goldman Sachs." It also yields profits to the Fed, because the Fed is the agency printing the money, while the Treasury is the agency issuing the bonds. However, from a taxpayer's point of view, the Fed's profits are a wash (all of the Fed's gains come at the expense of the Treasury), and the only net impact is the income transfer to "the Goldman Sachs."

The Fed's response to the financial crisis was to massively increase the size of its balance sheet, thereby massively increasing the income transfer to private financial institutions. In addition, in order to keep this additional money from leaking to businesses or consumers in the form of loans*, the Fed introduced a policy of paying interest to banks on reserves. This increased the value of the transfer from taxpayers to financial institutions.

That’s from Professor Arnold Kling.

Will Japan’s Investments Drive the Phisix to the 10,000 levels?

The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.-Ludwig von Mises

Last week I noted that a broad based strengthening Philippine Peso against major currencies could likely fuel carry trades and arbitrage opportunities ahead that may push the Phisix towards the 10,000 levels.

I wrote[1],

What this means is that the Philippines (and our ASEAN contemporaries) is likely to lure spread arbitrages or carry trades from US, Japanese, Swiss and European investors or punters that is likely to kick start a foreign stimulated boom in the local assets including those listed on the Philippine Stock Exchange.

It has barely been a week since I penned this observation. However today’s news headlines seem to provide clues in the direction which may confirm my long held thesis.

The headline says that Japanese investors are bullish the Philippines and would likely commit more investments[2].

In a survey, JETRO, the Japanese government’s trade and investment outfit, said that the Philippines has the ‘the least problematic’ factors for investments among ASEAN neighbors. And this would serve as the impetus for Japanese investments.

Rationalization Process of the Reflexivity Theory

First of all, I would say that this represents the rationalization phase of the current bullmarket.

By rationalization, I mean that price signaling channel exerts influence to the real world (or economic) developments, which at present, are being extrapolated with rose colored glasses. And developments in the real world eventually reinforces the thrust to further bid up of stock market prices paving way to a reflexive feedback loop or the reflexivity theory at work.

Writes the Billionaire (and crony) George Soros[3],

The underlying trend influences the participants' perceptions through the cognitive function; the resulting change in perceptions affects the situation through the participating function. In the case of the stock market, the primary impact is on stock prices. The change in stock prices may, in turn, affect both the participants' bias and the underlying trend.

The essence of the reflexivity theory is the dynamics of the bubble psychology as reflected on people’s expectations and their consequent actions expressed through the price mechanism and through real world actions.

Going back to the politically colored Pollyannaish article, it has been rightly pointed out that the wide scale dislocation or disruption from Japan’s total shutdown of the entire nuclear power industry (except for the two remaining plants)[4], which has been prompted for by last year’s catastrophic earthquake-tsunami disaster, has served as one of the primary reasons for their proposed investments here.

Japan’s nuclear industry previously contributed to about 30% of the nation’s energy requirements. Now the Japanese has to import 84% of their energy requirements[5]; this has partly led to the recent record trade deficits.

Also note the phrase ‘least problematic’ instead of ‘best potential returns’ as basis for attracting Japanese investments from which several criterion has been enumerated supposedly to the advantage of the Philippines, particularly “increasing financial costs”, “rising prices or shortage of land or office”, “skyrocketing payroll costs”, aside from labor conditons of “recruiting general staff”, “recruiting executives”, “low rate of employment retention”, “problems in workers competency”, “difficulty in quality control” and the “the least problems in salary base rate”.

So in a shade of schadenfreude, the Philippines may benefit from the adverse developments in Japan. With seemingly limited options, least problematic becomes a significant variable and has been equated with competitiveness in attracting Japanese investments.

Déjà vu, Asian Crisis 2.0? Phisix 10,000

Yet the article’s projections have been based on Jetro’s survey. Surveys or polls are predicated only from opinions which may or may not reflect on the real motivations or values of surveyed actors. And because there are no stakeholdings involved in surveys, they are fluid, ambiguous, and volatile, ergo, unreliable.

Whereas demonstrated preferences or the actual choice taken by the economic agents represents the more important of the two, since this signifies actual voting or expression of preferences or values.

As the great Professor Murray N. Rothbard wrote[6],

The concept of demonstrated preference is simply this: that actual choice reveals, or demonstrates, a man's preferences; that is, that his preferences are deducible from what he has chosen in action

Since Japan’s calamity struck last year, it should be of note that Indonesia has been the largest recipient, in terms of percentage, of Japan’s outward Foreign Direct Investment (FDI) flow[7].

Meanwhile, Thailand and Vietnam has substantially bested the Philippines. The Philippines only ranked 6^th in Asia.

A better perspective of Japan’s OUTWARD FDI long term trend in ASEAN can be seen above. The trumpeted competitiveness framed by media hardly reveals on the reality.

Of course, these charts represent ex post actions and that ex ante could translate to vital changes as proposed. But I doubt so.

Yet there are several very important things of note from here.

One, as pointed above, the Philippines has not been grabbing the biggest pie of Japanese FDI. There have been little signs of any radical changes into the direction as broached by the headlines.

So far, Thailand has been the biggest magnet in attracting Japanese FDIs. Thailand has the largest nominal dollar based flows at $7.1 billion, signifying 54% share of Japan’s outward FDI flows into ASEAN in 2011.

The Philippines, despite recent material gains, has the smallest inflows.

Two, the growth trend of nominal US dollar based investment flows exhibits that even Vietnam ($1.8 billion) has far outclassed the Philippines ($1.0 billion).

Three, ALL of the ASEAN majors have registered substantial Japan based FDI gains. ASEAN has basically surpassed their regional Newly Industrial Country (NIC) contemporaries in attracting Japanese money.

In short, Japan’s investments in ASEAN do not seem to be country specific, but more of a regional dynamic. Or that the Japanese probably hedge their ASEAN exposure by spreading their investments throughout the region.

Well the past, according to Mark Twain, does not repeat itself, but it rhymes.

Today’s FDI flows eerily resonates or resembles on the time window[8] of the 1985 Plaza Accord to the post Japan bubble in 1990s until the climax, the 1997 Asian Crisis.

The Business Insider quotes author and former Deputy Chief of the Hong Kong Monetary Authority Andrew Sheng[9] in the latter’s book From Asian to Global Financial Crisis

… shift production to countries that not only welcomes Japanese FDI but also had cheap land and labour… By the late 1980s, Japan had become the single largest source of FDI for the fast-growing emerging Asian economies. This trend was particularly clear when another surge of Japanese FDI into Asia took place between 1993 and 1997, with Japanese FDI rising nearly twofold from US$6.5 billion to US$ 11.1 billion during this period…

… banks followed their manufacturing customers into non-Japan Asia in earnest… From 1985 to 1997 Japanese banks supplied over 40 percent of the total outstanding international bank lending to Asia in general… The massive expansion in Japanese bank lending, in both yen and foreign currency, created huge capital flows globally.”

So could we be experiencing a déjà vu, Asian Crisis 2.0?

Let me be clear: bubbles or business cycles account for as policy induced processes, fuelled by monetary injections, marked by transitional stages.

FDI’s are by itself not the source of the disease but are symptoms or the ramifications of manifold political actions.

This is NOT to say that ASEAN faces the risks of an imminent bust soon. Instead this is to say that if these flows continue at a pace similar to 1985 to the mid-1990s then they could evolve into a full pledge bubble.

Yet there are many other indicators which will converge to give evidence to the maturing phase or the climax of a domestic business cycle. These may include the current account balances, state of banking credit, the yield curve, financial innovation, currency values and the state of the stock market.

And speaking of the stock market in the 1986-1997, Japan’s investment flows pumped up the region’s stock markets including the Phisix.

The 11 year bull market phase (green circle) of the local benchmark had two interruptions marked by two botched coup d'état attempts in 1987 and 1989, but nonetheless went to climax at 3,300+ levels. Remember, in 1986 the Phisix was at about only 150.

Put differently, if a similar Japan based investment flow dynamic should swamp into the region, then the Phisix is likely to put to realization my 10,000 level target first, before the structural implosion would occur. Again, trends don’t go in a straight line, and there can be substantial medium term obstacles or counter cycles or bear markets, like 2007-2008, before my targets could be fulfilled.

I would like to repeat, money flows won’t likely be limited to a Japan dynamic but from major western economies as well. This is the wealth convergence in motion.

Capital Flight Camouflaged as FDIs and Portfolio Flows

The recent surge in Japan’s FDI could just be the beginning.

The far more important or the major driver of Japan’s coming FDI and portfolio flows into ASEAN has already been manifested in the region’s currency markets.

Since the advent of 2012, the long term price appreciation of the Japanese Yen relative to ASEAN markets (Peso, Rupiah, Baht and Ringgit, the order from the top left to bottom right) seems to have been reversed.

Under pressure from politicians[10], the Bank of Japan (BoJ) has aggressively been ramping up its balance sheet[11] to allegedly support the economy by making ‘exports’ competitive.

Thus ASEAN-4 currencies along with the US dollar relative to the Yen have recently spiked!

If Japan’s basic problems today have primarily been due to a dysfunctional nuclear energy sector, then it would represent a logical error to see money printing as replacing the idled nuclear energy sector. Money is just a medium of exchange. Money doesn’t produce energy.

In reality, Japan’s banking system has been stuffed with loans to electric utility companies, many of them nuclear based. The industry’s risk profile has previously been viewed as almost at par with government debt, thus has been part of the banking system’s portfolio. Syndicated loans to the electric power companies had reportedly tripled to 1.16 trillion yen in 2011 from 448.8 billion in 2010[12]. Thus, with a crippled energy sector, Japan’s banking system, which has still been nursing from the scars of the last bubble bust, is once again confronted with heightened risks of defaults. Thus the BoJ rides to the rescue!

The foremost reason why many Japanese may invest in the Philippines under the cover of “the least problematic” technically represents euphemism for capital fleeing Japan because of devaluation policies—capital flight!

As the great Ludwig von Mises wrote[13],

The holders of ready cash try as far as possible to avoid the dangers of devaluation which today threaten in every country. They keep large bank balances in those countries in which there is the least probability of devaluation in the immediate future. If conditions change and they fear for these funds, they transfer such balances to other countries which for the moment seem to offer greater security. These balances which are always ready to flee-so-called “hot money”—have fundamentally influenced the data and the workings of the international money market. They present a serious problem in the operation of the modern banking system.

The bottom line is that YES we should expect Japanese FDI and portfolio investments into the Philippines and the region to swell.

But since (inward) capital flows into ASEAN will reflect on global central bank activities, this dynamic would not be limited to Japan but would likely include western economies as well.

And under the political climate that induces yield chasing dynamics, YES we should expect these flows to translate to a vastly higher Phisix and ASEAN bourses overtime, largely depending on the degree of inflows. This will be further augmented by the response of local investors to such dynamic as well as to local policies.

Although NO the Philippines will not decouple from events abroad and the pace of FDIs and investment flows will largely be grounded on the general liquidity environment.

And finally NO, the incumbent political leadership has a smidgen of responsibility for today’s dynamic. The current global negative real rate environment has mainly been driven by collective central bank actions. Profit from folly.

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[1] See Phisix: The Journey Of A Thousand Miles Begins With A Single Step, March 12, 2012

[2] Inquirer.net Japan to pour more investments in PH, March 18, 2012

[3] Soros George The Alchemy of Finance p.53 John Wiley & Sons

[4] New York Times, Japan’s Nuclear Energy Industry Nears Shutdown, at Least for Now, March 8, 2012

[5] World Nuclear Energy Nuclear Power in Japan, Updated March 2012

[6] Rothbard Murray N. Toward a Reconstruction of Utility and Welfare Economics, July 6, 2008

[7] Jetro.go.jp FDI flow (Based on Balance of Payments, net), Japan's Outward and Inward Foreign Direct Investment Japanese Trade and Investment Statistics

[8] Thomsen Stephen SOUTHEAST ASIA: THE ROLE OF FOREIGN DIRECT INVESTMENT POLICIES IN DEVELOPMEN 1999 OECD.org

[9] Sheng Andrew From Asian to Global Financial Crisis Japan's Role In Asian Financial Crisis 1997, March 17, 2011 Business Insider

[10] See Bank of Japan Yields to Political Pressure, Adds $128 billion to QE, February 14, 2012

[11] Danske Bank No real easing from Bank of Japan this time Flash Comment March 13, 2012

[12] Reuters.com Japan utilities may return to bonds as $19 bln debt matures, January 25, 2012

[13] Mises, Ludwig von 4. The Flight of Capital and the Problem of “Hot Money” III. INFLATION

Global Stock Markets: Will the Recent Rise in Interest Rates Pop the Bubble?

The natural tendency of government, once in charge of money, is to inflate and to destroy the value of the currency. To understand this truth, we must examine the nature of government and of the creation of money. Throughout history, governments have been chronically short of revenue. The reason should be clear: unlike you and me, governments do not produce useful goods and services that they can sell on the market; governments, rather than producing and selling services, live parasitically off the market and off society. Unlike every other person and institution in society, government obtains its revenue from coercion, from taxation. In older and saner times, indeed, the king was able to obtain sufficient revenue from the products of his own private lands and forests, as well as through highway tolls. For the State to achieve regularized, peacetime taxation was a struggle of centuries. And even after taxation was established, the kings realized that they could not easily impose new taxes or higher rates on old levies; if they did so, revolution was very apt to break out.-Murray N. Rothbard

The rampaging bullmarket here and abroad has raised concerns that recent increases in nominal interest rates could put a kibosh to the current run.

As I pointed out before, the actions in the interest rates markets will be shaped by different circumstances[1] which means it is not helpful to apply one size fits all analysis to potentially variable scenarios that may arise.

Interest rates may reflect on changes in consumer price inflation, they may also reflect on the perception of credit quality and they may reflect also on the state of demand for credit relative to the scarcity or availability of savings or capital[2].

Since the current interest rate environment has been mostly manipulated by political actions, where the political goal has supposedly been to whet aggregate demand by bringing interest rates towards zero, then we are dealing with a policy based negative real rates economic environment.

So the crucial issue is, has the recent selloff in treasury bonds neutralized the negative real rates regime? The answer is no.

First of all, current environment has not been reflecting concerns over deterioration of credit quality as measured through credit spreads[3], which seem to have eased.

Also, milestone highs reached by global stock markets, led by the US, have encouraged complacency through a reduction of volatility[4].

Second, the yield curve of US treasuries despite having flattened (perhaps due to policy manipulations) still manifests opportunities for maturity transformation trade or lending activities.

Thus, we are seeing signs of recovery in business and commercial lending in the US.

Some of the banking system’s excess reserves held at the US Federal Reserve seem to be finding its way into the economy.

Lastly, many are still in denial that inflation poses a risk, despite rising Treasury Inflation Protected Securities (TIPS).

TIPs are government issued treasury securities indexed to the consumer price index (CPI) with maturity ranging from 5 to 30 years which are usually considered as inflation hedges. (That’s if you believe on the accuracy of the CPI index. I don’t)

TIPs seem to have converged with the S&P 500.

Financial markets could be pricing in a risk ON environment and real economic activities, calibrated by the current negative real rates regime, combined with signs of escalating consumer price inflation.

The reality is that mainstream and the political establishment will continue to deny that inflation exists, when the US Federal Reserve has already been rampantly inflating.

Monetary inflation is inflation. However the public is being misled by semantics of inflation by pointing to consumer price inflation.

As Professor Ludwig von Mises wrote[5],

To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call "inflation" the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase

They put the responsibility for the rising cost of living on business, This is a classical case of the thief crying "catch the thief." The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices. While the Office of Stabilization and Price Control is busy annoying sellers as well as consumers by a flood of decrees and regulations, the only effect of which is scarcity, the Treasury goes on with inflation.

That’s because any acknowledgement of inflation would put to a stop or would prompt for a reversal of the Fed’s accommodative policies. And considering that the banking system has been laden with bad loans, and that welfare based governments have unsustainable Ponzi financing liabilities, then tightening money conditions, expressed through higher interest rates, means the collapse of the system.

Underneath the seeming placid signs of today’s marketplace have been central banking steroids at work as the balance sheets of major economies have soared to uncharted territories[6].

The US Fed and the ECB, as well as other central banks, including the local BSP, will work to sustain negative interest rates environment, no matter any publicized rhetoric to the contrary. There may be some internal objections by a few policy makers, but all these have signified as noises more than actual actions. The politics of the establishment has drowned out any resistance as shown by central banks balance sheets.

One must remember that the US Federal Reserve was created out of politics[7], exists or survives through political money and will die through politics. And so with the rest of central banks.

Thus there is NO way that central bankers will not be influenced[8] by political leaders, their networks and by the regulated. Political power always has corrupting influences.

A good example can be gleaned from Independent Institute research fellow Vern McKinley’s comments[9] on U.S. Treasury secretary Mr. Timothy Geithner’s recent Op Ed[10]

He recounts how the CEO of Bear, with his firm on the brink of bankruptcy, came to him looking for a shoulder to cry on. From his then leadership perch as president of the New York Fed, the bank ultimately extended nearly $30 billion for a bailout, the first in a series of such interventions.

Central bankers are human beings. Only people deprived of reason fail to see the realities of government’s role.

And since the FED has unleashed what used to be a nuclear option, other central banks have learned to assimilate the FED’s policy. This essentially transforms what used to be a contingency measure into conventional policymaking.

As been said before, inflationism has produced an unprecedented state of dependency

And that such state of dependency can be seen through the dramatically expanding role of non-market forces or the government.

As Harvard’s Carmen Reinhart observed in her Bloomberg column[11],

In the U.S. Treasury market, the increasing role of official players (or conversely the shrinking role of “outside market players”) is made plain in Figure 3, which shows the evolution from 1945 through 2010 of the share of “outside” marketable U.S. Treasury securities plus those of so-called government-sponsored enterprises, such as the mortgage companies Fannie Mae and Freddie Mac.

The combination of the Federal Reserve’s two rounds of quantitative easing and, more importantly, record purchases of U.S. Treasuries (and quasi-Treasuries, the government-sponsored enterprises, or GSEs) by foreign central banks (notably China) has left the share of outside marketable Treasury securities at almost 50 percent, and when GSEs are included, below 65 percent.

These are the lowest shares since the expansive monetary policy stance of the U.S. regularly associated with the breakdown of Bretton Woods in the early 1970s. That, too, was a period of rising oil, gold and commodity prices, negative real interest rates, currency turmoil and, eventually, higher inflation.

This is not an issue involving economics alone. This is an issue involving the survival of the current state of the political institutions.

Bottom line: Rising interest rates will pop the bubble one day. But we have not reached this point yet.

Again, the raft of credit easing measures announced last month will likely push equity market higher perhaps until the first semester or somewhere at near the end of these programs. Of course there will be sporadic shallow short term corrections amidst the current surge.

However, the next downside volatility will only serve as pretext for more injections until the market will upend such policies most likely through intensified price inflation.

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[1] See Global Equity Market’s Inflationary Boom: Divergent Returns On Convergent Actions, February 13, 2011

[2] See I Told You Moment: Philippine Phisix At Historic Highs! January 15, 2012

[3] Danske Bank, The US bond market finally surrendered, Weekly Focus March 16, 2012

[4] See Graphics: The Risk On Environment March 14, 2012

[5] Mises, Ludwig von 19 Inflation Economic Freedom and Interventionism Mises.org

[6] Zero Hedge, Is This The Chart Of A Broken Inflation Transmission Mechanism? March 13, 2012

[7] See The US Federal Reserve: The Creature From Jekyll Island, July 3, 2009

[8] See Paul Volcker Warns Ben Bernanke: A Little Extra Inflation Would Backfire, March 16, 2012

[9] McKinley Vern Timothy Geithner's Bailout Legacy Not One To Be Proud Of, Investor’s Business Daily March 15, 2012

[10] Geithner Timothy Op-Ed: ‘Financial Crisis Amnesia’ Treasury.gov March 1, 2012

[11] Reinhart Carmen Financial Repression Has Come Back to Stay, Bloomberg.com March 12, 2012