Phisix: Will Domestic Fundamentals Outweigh External Factors?

The Philippine central bank, the Bangko ng Pilipinas (BSP) released its 2^nd quarter inflation report last week. 

And as expected, the BSP, which interprets the same statistical data as I do, sees them with rose colored glasses. On the other hand, I have consistently been pointing out that beneath the statistical boom based on credit inflation, has been a stealth dramatic buildup of systemic imbalances

BSP Predicament: Strong Macro or Fed Policies?

In a special segment of the report, the BSP recognizes of the tight correlation between US Federal Reserve policies and the price action of the local stock market (as noted above)

The BSP implicitly infers of the influence or the transmission mechanism of the actions of the US Federal Reserve (FED) on foreign portfolio flows to emerging markets, such as the Philippines, by stating that Fed policies “followed generally by upward trends in portfolio investment inflows”. 

The BSP also sees portfolio flows as having contributed to the recent stock market boom, “A similar trend was observed with the Philippine stock exchange index; that is, QE announcements were followed generally by an increasing trend in prices, with varying lags.”[1]

And when the jitters from the FED “taper” surfaced on the global markets late May, the BSP admits that foreign funds made a dash for the exit door, “In May 2013, portfolio investment flows registered a net outflow of US$640.8 million, a reversal from the previous month’s inflow of US$1.1 billion. Net capital flows for the period 3-14 June 2013 have recovered somewhat to US$65.13 million”

The BSP also noted that the sudden reversal of sentiment affected other Philippine markets, particularly

a) Philippine credit outlook represented by credit default swap (CDS), “The credit default swap (CDS) index exhibited a widening trend to 157 bps on 24 June after trading below 100 bps in the past month, as the market increased its premium in holding emerging market bonds. The country’s CDS narrowed to 145 bps as of 25 June 2013, improving further to 139 bps by 27 June 2013” and

b) The currency market, “the peso weakened significantly by 6.36 percent year-to-date against the US dollar, closing at a low of P43.84/US$ on 24 June 2013. Subsequently, the peso began to recover, closing the quarter at P43.20/US$ on 28 June 2013.”

The BSP dismissed the domestic market’s convulsion as having “overreacted to some extent”, and put a spin on a recovery “are now beginning to bounce back”.

But curiously the BSP justifies the selloff as having a beneficial effect of “reducing the build-up of stretched asset valuations and in making the growth process more durable in long run”, this predicated on the “inherent strength of Philippine macroeconomic fundamentals”.

See the contradictions?

If the BSP thinks that the domestic market’s reactions to external forces reduced the “build-up of stretched asset valuations”, which essentially represents an admission of overpriced domestic markets, then what justifies significantly higher markets from current levels?

And in my reading of the BSP’s tea leaves, domestic markets should rise but at a gradual pace to reflect on the “growth process” over the “long run”.

But this hasn’t been anywhere true in the recent past where mania has dominated sentiment.

The BSP doesn’t explain why markets reached levels that “stretched asset valuations” except to point at foreign portfolio flows (which they say has been influenced by the external or US policies).

And similarly in the opposite spectrum, the BSP doesn’t enlighten us why markets “overreacted to some extent” except to sidestep the issue by defending the ‘stretched’ markets with “strong macroeconomic fundamentals”.

Basically the BSP connects FED policies to rising markets, but ironically, sees a relational disconnect from a threat of a reversal of such external factors, banking on so-called strong “macroeconomic fundamentals”.

The BSP, thus, substitutes the causality flow from the FED to domestic macroeconomic fundamentals whenever such factors seemed convenient for them.

Notice that the May selloff hasn’t been limited to the stock market, but across a broad range of Philippine asset markets, which the BSP acknowledges, specifically, domestic treasuries, local currency (Peso) and CDS. Yet if ‘macroeconomic fundamentals” were indeed strong as claimed, then there won’t be ‘overreactions’ on all these markets.

And it would be presumptuous to deem actions of foreign money as irrational, impulsive, finical and ignorant of “macroeconomic fundamentals”, while on the contrary, latently extolling the optimists or the bulls as having the ‘righteous’ or ‘correct’ view.

The BSP also misses that the point that the impact by FED policies, and more importantly, their DOMESTIC policies, has not only influenced the stock market, but other asset prices and the real economy, as well, via credit fueled asset bubbles.

Central banks have become the proverbial 800 lb. gorilla in the room for the interconnected or entwined global financial markets. 

Take the Peso-Euro relationship. The balance sheet of the European Central Bank (ECB) began to contract in mid-2012 (right window[2]), which has extended until last week[3].

On the other hand the balance sheet of the BSP continues to expand over the same period[4]. The result a declining trend of the Peso vis-à-vis the euro (left window[5]).

The Peso-Euro trend essentially validates the wisdom of the great Austrian economist Ludwig von Mises who wrote of how exchange rates are valued[6],

the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money

The BSP seem to ignore all these.

And because today’s artificial boom has been depicted as a product of their policies, the BSP thinks that the market’s politically correct direction can only be up up up and away!

Cheering on Unsustainable Growth Models

The BSP cheers on data whose sustainability has been highly questionable.

On the aggregate demand side, the BSP admits that household spending growth has been at a ‘slower pace’.

With slowing household, the biggest weight of the much ballyhooed statistical growth of domestic demand has been in capital formation. This has been attributed to the massive expansion in construction (33.7%) and durable (9.4%) equipment, and in public (45.6%) and private (30.7%) construction[7]

As pointed out in the past, construction and construction related spending has all been financed by a bank deposit financed or credit fueled asset bubbles.

The other factor driving demand has been government demand or public spending.

As I have been pointing out, this supposed growth in demand via government deficit spending means more debt and higher taxes over the future. Frontloading of growth via debt based spending signify as constraints to future growth.

Pardon my appeal to authority, but surprisingly even a local mainstream economist, the former Secretary of Budget and Management under the Estrada administration and current professor at University of the Philippines[8], Benjamin Diokno, acknowledges this.

In a 2010 speech Mr Diokno noted that[9]

Deficit financing leads to lower investment and, in the long run, to lower output and consumption. By borrowing, the government places the burden of lower consumption on future generations. It does this in two ways: future output is lowered as a result of lower investment, and higher deficits now means higher debt servicing thus higher taxes or lower levels of government services in the future.

The above debunks the populist myth which views the Philippine economy as having been driven by a household consumption boom[10].

The aggregate supply side dynamics mirrors almost the same as the above—bank deposit financed credit fueled asset bubbles.

While agriculture has pulled down or weighed on the growth statistics, production side expansion has been largely led by construction (32.5%) and manufacturing (9.7%).

On the service sector side, financial intermediation (13.9%) led the growth, followed by real estate and renting (6.3%) and other services (7.6%)[11].

In short, except for manufacturing, most of the supply side growth has centered on the asset markets (real estate and financial assets).

These booming sectors, which has benefited a concentrated few who has access to the banking system and or on the capital markets, have mostly been financed by a massive growth in credit. Yet this credit boom has fundamentally been anchored on zero bound interest rates policies.

The reemergence of the global bond vigilantes have been threatening to undermine the easy money conditions that undergirds the present growth dynamic, a factor which ironically, the BSP seems to have overlooked, and intuitively or mechanically, apply the cognitive substitution over objections or over concerns on the risks of bubbles with the constant reiteration of: “strong macroeconomic fundamentals”—like an incantation. If I am not mistaken the report noted of this theme 4 times.

And yet the recent market spasms appear to have been a drag on credit growth of these sectors (although they remain elevated).

And as noted last week, the rate of credit growth on financial intermediation, so far the biggest contributor of the services sector, has shriveled to a near standstill (1.45% June 2013)[12]. Financial intermediation represents 9.73% share of the total supply side banking loans last June.

This should translate to a meaningful slowdown for the growth rate of this sector over the next quarter or two.

It remains unclear if the growth in the other sectors will be enough to offset this. But given the declining pace of credit expansion in the general banking sector lending activities, particularly in sectors supporting the asset boom, growth will likely be pared down over the coming quarters.

So far the exception to the current credit inflation slowdown as per June data, has been in mining and quarrying (85.66%), electricity gas and water (13.84%), wholesale and retail trade (15.74%) and government services—administration and defense (17.11%) and social work (47.21%)—however these sectors only comprise 31% of the production side banking loan activities. Half of the 31% share is due to wholesale and retail trade; will growth in trade counterbalance the decline in the rate of growth of financial intermediation?

Interestingly, the BSP does not provide comprehensive data on bank lending except to deal with generalities. And puzzlingly, the BSP report has been absent of charts on the bank loans and money supply aggregates such as M3, which like the banking loans, the latter has been treated superficially. Why?

So far market actions in the Phisix and the Peso appear to be disproving the BSP’s Pollyannaish views.

Asia’s Credit Trap

The financial markets of Asia including the Philippines appear to be ‘decoupling’ from the Western counterparts, particularly the US S&P (SPX) and Germany (DAX) where the latter two has been drifting at near record highs.

Has the nasty side effects of “ultralow rates” where Southeast Asian economies, as Bloomberg’s Asia analyst William Pesek noted[13], “didn’t use the rapid growth of recent years to retool economies” been making them vulnerable to the recent bond market rout?

The appearance of current account surplus, relatively low external debt, and large foreign reserves, doesn’t make the Philippines invulnerable or impervious to bubbles as mainstream experts including local authorities have been peddling.

Japan had all three plus big savings and net foreign investment position[14] or positive Net international investment position (NIIP) or the difference between a country's external financial assets and liabilities[15], yet the Japanese economy suffered from the implosion of the stock market and property bubble in 1990 (red ellipse). 

As legacy of bailouts, pump priming and money printing to contain the bust, Japan’s political economy presently suffers from a Japanese Government Bond (JGB) bubble.

And given the reluctance to reform, the negative demographic trends, and the popular preference of relying on the same failed policies, the incumbent Japan’s government increasingly depends on surviving her political economic system via a Ponzi financing dynamic of borrowing to finance previously borrowed money (interest and principal) where debt continues to mount on previous debt. Japan’s public debt levels has now reached a milestone the quadrillion yen mark[16], which has been enabled and facilitated again by zero bound rates.

And this strong external façade has not just been a Japan dynamic.

China has currently all of the supposed external strength too, including over $3 trillion of foreign currency reserves, NIIP of US $1.79 trillion (March 2012[17]).

But a recession, if not a full blown crisis from a bursting bubble, presently threatens to engulf the Chinese economy.

As growth of “new” credit sank to a 21 month low where new loans grew by ‘only’ 9% in July and ‘only’ 29.44% y-o-y[18], the Chinese government via her central bank the People’s Bank of China (PBOC) continues to infuse or pump ‘money from thin air’ into the banking system[19]. 

Such actions can be seen as bailouts by the new administration on a heavily leverage system.

Incidentally, debt of China’s listed corporate sector stands at over 3x (EBITDA) earnings before interest, taxes, depreciation and amortization[20]. Notice too that listed companies from major Southeast economies (TH-Thailand, ID-Indonesia, and MY-Malaysia) have likewise built up huge corporate debt/ebitda.

State Owned Enterprises (SoE), their local government contemporaries and their private vehicle offsprings plays a big role in China’s complex political economy. Hence, latent bailouts targeted at these companies have allowed for the ‘kicked the can down the road’ dynamic. China recently announced a railroad stimulus[21], again benefiting politically connected enterprises.

I cast a doubt on the recent reported 5.1% surge in in export growth[22] considering her recent propensity to hide, delete or censor data[23]. These claims would have to be matched by declared activities of their trading partners. Nonetheless, eventually markets will sort out the truth from propaganda.

The point is that Asian economies have become increasingly entrenched in debt dynamics in the same way the debt has plagued their western contemporaries.

And the deepening dependence on debt as economic growth paradigm puts the Asian region on a more fragile position.

Asia is in a ‘credit trap’ according to HSBC’s economist Frederic Neumann[24]. Asian economies have traded off productivity growth for the credit driven growth paradigm, where Asian economies have “become increasingly desensitized to credit”. Yet lower productivity growth will mean increasing real debt burdens.

And if the bond vigilantes will continue to assert their presence on the global bond markets, then ‘strong macroeconomic fundamentals” will be put to a severe reality based stress test.

And the validity of strong macroeconomic fundamentals will also be revealed on charts.

Risk remains high.

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[1] Bangko Sentral ng Pilipinas Inflation Report, Second Quarter 2013, BSP.gov.ph p. 37-41

[2] JP Morgan Asset Management Weekly strategy report – 28 January 2013

[3] Reuters.com ECB balance sheet shrinks to 2.391 trillion euros, August 6, 2013

[4] see Phisix: BSP’s Tetangco Catches Taper Talk Fever July 29, 2013

[5] Yahoo Finance PHP/EUR (PHPEUR=X)

[6] Ludwig von Mises Trend of Depreciation STABILIZATION OF THE MONETARY UNIT—FROM THE VIEWPOINT OF THEORY On the Manipulation of Money and Credit p 25 Mises.org

[7] BSP op. cit., p.9-10

[8] Wikipedia.org Benjamin Diokno

[9] Benjamin Diokno Deficits, financing, and public debt UP School of Economics.

[10] see Phisix: The Myth of the Consumer ‘Dream’ Economy July 22, 2013

[11] BSP op. cit., p.19

[12] see Phisix: The Impact of Slowing Banking Loans August 5, 2013

[13] William Pesek Specter of Another Bond Crash Spooks Asia, June 7, 2013

[14] Bank of Japan Japan's International Investment Position at Year-End 2012, May 31, 2013

[15] Wikipedia.org Net international investment position

[16] see Japan’s Ponzi Finance: Public Debt Tops Quadrillion Yen Mark! August 10, 2013

[17] China Daily China's intl investment position reaches $1.8t July 14, 2012

[18] Bloomberg.com China’s Credit Expansion Slows as Li Curbs Shadow Banking August 10, 2013

[19] China Daily China central bank continues liquidity injection August 6, 2013

[20] Businessinsider.com 17 Reasons Why Experts Are Convinced China's Economy Is Doomed, July 15, 2013

[21] see China’s Railroad Stimulus is now Official: It’s an $85 billion boondoggle July 25, 2013

[22] Bloomberg.com China Trade Rebounds in Further Sign Economy Stabilizing August 8, 2013

[23] see China’s Government Hides, Deletes and Censors Economic Data, July 5, 2013

[24] AsianInvestor.net Asia in a credit trap, warns HSBC's Neumann August 8, 2013

Will the Triffin Dilemma Haunt the Global Financial Markets?

As measured by the Dow Jones Industrials US equity benchmark suffered their first loss in 7 weeks. Are these signs of fatigue or are these signs of an overheating or climaxing bubble? 

My impression is should US markets begin to wilt in earnest, then current downdraft in Asian markets are likely to intensify.

The US reportedly posted a substantial 22% reduction in the deficits of her trade balance owing to record exports and to a shrinking oil import bill according to the Wall Street Journal[1]. 

Shrinking US trade deficits can signify a symptom of unsustainable imbalances from the current monetary order, the US dollar standard.

The US dollar remains the largest international foreign exchange reserve with over 60% share (right window[2]).

International currency reserves are over $10 trillion with the US Dollar also having the biggest share (left window). Perhaps a big segment of the undisclosed reserve currency may also be in US dollars.

Over 50% (right window) of the $12 trillion (left window[3]) of international debt securities has been denominated in US dollars.

The point of this exercise is to demonstrate of the world’s continuing dependence on the US dollar as medium of exchange and as reserve currency.

Yet the US dollar standard seems to operate on the principle of the Triffin Dilemma, formulated by the late Belgian American economist Robert Triffin.

The eponymous theory by Mr Triffin elucidates of the economic conflict emanating from a world reserve currency particularly on meeting short term-domestic interests as against long term international objectives[4]

Under the Triffin dilemma, the issuing reserve currency makes it easy for a nation to consume more goods and services via an overvalued currency.

The same overvalued currency easily allows for financing of either budget deficits and or trade deficits, aside from having more latitude in “determining multilateral approaches to either diplomacy or military action”[5].

In short, a reserve currency provides the issuer the privilege of an interim “free lunch” or to quote the French economist Jacques Rueff “deficit without tears”[6]

One of the other side effects of the Triffin dilemma has been the intense deepening of the financialization of the US economy[7]. 

Instead of producing goods, the US economy evolved towards shuffling of financial papers partly required by foreigners to recycle their dollar holdings. As one would note, the gist of expansion of financialization came as the US dollar became unhinged from the Bretton Wood System in August 1971.

Of course the other side effect of the Triffin dilemma has been the growing frequency of global bubble cycles as evidenced by the greater incidences of global banking crises since the Nixon Shock of 1971

Aside from the massive accumulation of reserve currency by foreigners that would eventually undermine the reserve currency status, a dynamic which the world seems headed for, an equally detrimental factor to a reserve currency status is the proportional devaluation that would shrink these deficits.

Mr. Triffin actually articulated the problems of the Bretton Woods System where the failed system seemed to have validated his thesis. 

In a testimony before the US congress in November 1960, Mr Triffin argued that “If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.[8]”

Given the deep reliance by global markets and global economy on the US dollar system, improving US trade deficits are likely to extrapolate to reduced liquidity in the ex-US global system. Such dynamic will only provide more muscle or ammunition for bond vigilantes, and equally, would mean a tightening of a system deeply dependent on the largesse of US dollar steroids from US authorities.

In the recent past, a reduction in the deficits of US trade balance coincided with strains in the global ex-US equity markets as measured by the MSCI[9] (lower pane)

Diminishing trade deficits here functioned as symptoms to dot.com bubble bust and to the 2008 Lehman bankruptcy. When financial markets collapsed as consequence to a bubble, international trade grinded to a near halt. This led to a substantial reduction of US trade deficits. Thus the narrowing trade balance coincided with recessions.

The causal flow may or could be reversed today; perhaps reduced liquidity from US exports of her currency the dollar may incite instability in the global financial markets.

The effect of shrinking liquidity on the global system will likewise affect US corporations. With 34% of the revenues of US S&P 500 companies coming from non-US sales[10], the adverse effect is that shrinking global liquidity will eventually land on US shores.

And it’s not just trade deficits that has contracted, US budget deficits have also dwindled to 4.2% of the GDP from 7.7% a year ago[11]. So this could be a one-two punch against the global markets and economy. And should the FED taper, such will exacerbate on the effects of the Triffin Paradox.

Will the European Central Bank, the Bank of Japan, the Bank of England and the People’s Bank of China fill in the vacuum from improving US twin deficits?

Or will Triffin’s ghost haunt the global financial markets?

Interesting times indeed.

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[1] Wall Street Journal Oil Boom Helps to Shrink U.S. Trade Deficit by 22% August 6, 2013

[2] The European Central Bank THE INTERNATIONAL ROLE OF THE EURO July 2013 p.19

[3] The European Central Bank, op cit., p23

[4] Wikipedia.org Triffin dilemma

[5] See The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency April 20, 2009

[6] Jacques Rueff, The Monetary Sin of the West, Mises.org

[7] Wikipedia.org Financialization

[8] IMF.org The Dollar Glut Money Matters: An IMF Exhibit—The Importance of Global Cooperation System in Crisis (1959-1991)

[9] MSCI.com World Ex-US MSCI Index Performance

[10] Businessinsider.com CHART: The S&P 500 Is Not The US Economy, May 10, 2013

[11] National Forex Calculated Risk; US Deficit is Shrinking August 10, 2013

Japan’s Ponzi Finance: Public Debt Tops Quadrillion Yen Mark!

To paraphrase a quote misattributed to the late US senator Everett Dirksen: A trillion here, a trillion there pretty soon we are talking about quadrillions! 

For Japan’s debt, quadrillion is now a reality

From Wall Street Journal Economics Blog: (bold mine)

Japan’s central-government debt topped the quadrillion-yen mark for the first time ever in the second quarter, passing the unwelcome milestone just as a national debate heats up on whether the government should follow through with a controversial a plan to raise the sales tax.

The central government’s outstanding liabilities totaled ¥1.009 quadrillion ($10.44 trillion) at the end of June, up from Y991.601 trillion three months earlier. A Finance Ministry official said it’s the first time total debt has risen above ¥1 quadrillion since the yen became Japan’s official currency in 1871.

The figure is more than 200% of what Japan’s economy, the world’s third-largest, produces per year. That’s by far the highest debt load among industrialized economies.

Add some ¥200 trillion of outstanding long-term municipal debt and the ratio jumps to 250%.

The quadrillion-yen level may be memorable but it isn’t a game changer. It was expected because Japan’s government continues to borrow heavily, financing nearly half of its spending with borrowed money as it pushes off tough reforms.

Any entity that engages in borrowing money to finance previously borrowed money is known as a Ponzi borrower.

According to the data from the Japanese government’s Ministry of Finance, 51% of the government’s revenues will come from tax, stamp and other revenues. The other 49% of the financing of the government’s expenditures will come from government bond issuance (red ellipse). 

So previous debts will be financed by issuance of new debt...thus today's accrued quadrillion yen milestone of debts.

Ponzi finance, according to Hyman P. Minsky in The Financial Instability Hypothesis, is when (bold mine)

the cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts

Of course all the seeming placid conditions will entirely depend on interest rates remaining at current levels and of the sustained confidence by creditors on Japan’s ability and willingness to pay. 

The above pie chart of JGB holdings, also from the MOF, is from the pre-Abenomics period. 

It shows that banks, life and non –life insurance, private and public pension as major creditors of Japan’s government. 

Recent developments reveal that banks, several insurance companies and foreigners have significantly pared their JGB holdings.

Meanwhile the ratio of JGBs held by retail investors has peaked in March of 2009 at 4.6% to about 2.5% in March 2013.

This leaves the Bank of Japan (BoJ) as the buyer and financier of last resort for the Japanese government. As the BoJ grabs a larger share of the JGB pie, the issue of confidence from the marketplace will decline, but...

Again Mr. Minsky on the inflationary dynamic of Ponzi financing:

if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.

In other words, the BoJ would need to keep piling up on such “inflationary state” in order to maintain the current balance, otherwise, the entire house of card collapses. 

The BoJ is trapped with the consequences of her previous actions: stop monetary inflation and the ponzi scheme unravels-- or-- proceed with more monetary inflation, interest rates soar as the currency dives, the same ponzi dynamic collapses. 

Funny how government outlaws Ponzi schemers like Bernard Madoff, when they operate on virtually the same 'something for nothing' 'screw the public' dynamics as social policies.

Quote of the Day: Why Capitalism is Awesome

But the true genius of the market economy isn’t that it produces prominent, highly publicized goods to inspire retail queues, or the medical breakthroughs that make the nightly news. No, the genius of capitalism is found in the tiny things — the things that nobody notices.

A market economy is characterized by an infinite succession of imperceptible, iterative changes and adjustments. Free market economists have long talked about the unplanned and uncoordinated nature of capitalist innovation. They’ve neglected to emphasize just how invisible it is. One exception is the great Adam Smith…

The brilliance of the market economy is found in small innovations made to polish and enhance existing products and services. Invention is a wonderful thing. But we should not pretend that it is invention that has made us rich.

We have higher living standards than our ancestors because of the little things. We ought to be more aware of the continuous, slow, and imperceptible creative destruction of the market economy, the refiners who are always imperceptibly bettering our frozen pizzas, our bookshelves, our pencils, and our crayons.

This is from a wonderful essay by Chris Berg at the Cato Institute. (hat tip: AEI’s Professor Mark Perry)

Video: Marc Faber on the Parallels of 1987 Stock Market Crash

Dr Marc Faber in a short 90 seconds CNBC interview draws some eerie similarities between events preceding the the Black Monday US stock market crash in 1987 and today. (hat tip zero Hedge)

In my view, incompatible forces between record stocks and a slew of negatives--elevated interest rates, $100 oil prices, a prospective shift in the Fed leadership, exploding debt levels, seemingly confused central banks whom are seemingly caught between the desire for more easing but continues to float the 'taper', parallel universes, increasing signs of struggling economies, government manipulation of statistics (China) and pervading symptoms of 'this time is different' manic outlook by the mainstream--all combines to increase the risks of a substantial downshift in global equity markets. 

Although I am not inclined to see a 1987 scenario, considering that financial markets have been founded on the equivalent of sand castles predicated on central banking steroids and guarantees, such a black swan scenario shouldn't be ruled out.

Americans Are Ditching Citizenship in Record Numbers, Part 2

As I noted last May, the rate of wealthy Americans renouncing on their citizenship due to deepening political repression and the prospect of higher taxes, has been accelerating. Facebook co-founder Eduardo Saverin and celebrity Tina Turner embodies this hastening trend. 

Amazingly, despite the stiff or the punitive exit tax or expatriation tax, the rate exodus has nearly doubled from 670 from the first quarter to last quarter's 1,131.

Sovereign Man’s Simon Black explains:

A massive 1,131 individuals renounced their US citizenship last quarter, according to data that has yet to be officially released (though I was able to procure an advanced copy).

This is a HUGE jump.

Compared to the same quarter last year in which 188 people renounced their US citizenship, this year’s number is over SIX TIMES higher.

Not to mention, it’s 66.5% higher than last quarter’s 679 renunciations.

This brings the total number of renunciations so far this year to 1,810.

While still embryonic, it’s difficult to ignore this trend– more and more people are starting to renounce their US citizenship.

After all, the number of people who renounced citizenship this past quarter is roughly the same as the number of people who renounced for the previous four quarters COMBINED.

"Nationalism" losing its luster… Again from Mr. Black

This movement shouldn’t be that surprising for a species that began as nomadic hunter gatherers, or for a society that was founded by foreigner settlers in search of a better life.

Yet, in a rather anomalous twist, the emotional ties we have for our passports are incredibly strong.

It doesn’t matter where you’re from– the United States, Sweden, New Zealand, or Venezuela… many people all over the world are inculcated from birth with a sense that their country is ‘better’ than all the others.

We grow up with the songs, the flag waving, and the parades until the concept of motherland becomes deeply rooted in our emotional cores.

Not to mention, when so many of our friends and neighbors unquestionably fall in line, it’s a powerful social reinforcement that only strengthens the bond.

We come to view our nationalities rather ironically as a big piece of our core individuality. I am an American. I am a Canadian. I am an Austrian. Instead of– I am a human being.

It has taken decades… centuries even… to reach this point. So the fact that more and more people are making the gut-wrenching decision to ditch their US passports is truly a powerful trend.

Indeed, we are all human beings regardless of the supposed social divisions caused by race or geographic boundaries.

And if we are to talk about “race”, as I earlier pointed out, we are all “Africans” by genetic origins (mtDNA and paternal Y-chromosome). 

To quote National Geographic’s lead scientist Spencer Wells on the National Geographic-IBM’s Genographic Project

You and I, in fact everyone all over the world, we’re literally African under the skin; brothers and sisters separated by a mere two thousand generations. Old-fashioned concepts of race are not only socially divisive, but scientifically wrong.

(italics mine)

The mental concept of nationalism signifies a legacy of the tribal hunter-gatherer age. Then, the dearth of division of labor and trade made man’s survival entirely dependent on the limited scope of land which sustained them, thus, social bonds among tribes and neighbors were forged to resist against intrusions by marauders. Tribalism set stage for the 'nationalist' order.

Yet as trade or voluntary exchange or markets expanded, the importance of territorial boundaries has vastly been diminished. In essence, trade knows of no boundaries. It is the politicians who create such borders and barriers to trade.

And in the understanding of the potential loss of usufruct and privileges from wangling resources from the citizenry, the political class resists such dynamic by selling "nationalism" as a way to maintain the status quo by curbing people’s ability to freely transact with each other.

Modern day nationalism represents no more than the populist justifications that bequeaths to the political class the power to tax and the power to extend political control over their respective constituents in the name of “feel good” pseudo- social belongingness.

And why are Americans are exiting? Back to Mr. Black:

So what’s driving it? Taxes… and the search for liberty.

For many, their tax bills constitute a financial breaking point. Particularly for people who spend most of their time outside of the United States and are constantly hamstrung by worldwide taxation and information disclosures, the burden for many of them has just become too much to bear.

The US government figured this out some years ago and began charging an exit tax to certain high income / high net worth expatriates seeking to renounce.

This applies to anyone whose average US tax liability over the last five years was about $150,000 (the equivalent of roughly $500,000 in taxable income in 2012 dollars), and/or has a net worth of at least $2 million on the date of expatriation. Curiously this net worth figure does not adjust with inflation.

The ironic thing is that in the “Act of July 27, 1868″, the United States Congress declared that “the right of expatriation is a natural and inherent right of all people, indispensable to the enjoyment of the rights of life, liberty, and the pursuit of happiness.”

Yet I would expect that as the number of expatriates continue to grow, this exit tax will become more and more onerous as the government tries to trap people, and their wealth, in the country.

I would like to add that aside from taxation and political repression, financial intrusion has been compounding to the incentives of Americans to exit.

The US is the only country who taxes her citizens on a worldwide basis. This means offshore Americans are taxed twice—one in the country where they operate, and second by the US government.

Yet the US government will expand the dragnet of taxation and of the intrusion of financial privacy via the Foreign Account Tax Compliance Act (FACTA).

FACTA will force Americans to disclose to the US government all foreign held financial accounts and will force domestic banks operating under the FACTA framework to share information with the US Internal Revenue Services (IRS)

So FACTA essentially will undermine the supposed 'sovereignty' of other governments as US policies now dictate (by virtue of what seems as a foreign policy erected on the premise of 'might is right') on domestic politics.

The jurisdictions covered by FACTA has now expanded to include about 83 countries, which includes, Germany, Israel, Singapore, Malaysia, Taiwan, Thailand and the Philippines.

So far only the Swiss government appear to be resisting the US overlord's FACTA framework and where Swiss banks have reportedly been shunning accounts of American citizens.

So deepening political interventions, the prospects of bigger taxes and loss of financial privacy, as well as, economic uncertainty via monetary policies, appear to motivate wealthy Americans to opt out. 

And as the taxpayer base of the US erode, the fragile fiscal balance of the US will increasingly operate under duress from the growing mismatch between revenues and expenditures. A looming debt based welfare crisis will further this trend.

Despite heavy exit taxes, the growing 'opt out' option is increasingly a disturbing sign, not only for the US political economy which should have a leash effect on the world, but importantly for the US dollar standard.

Bring on the Whale Markets

Prohibition frequently or almost always works in the opposite direction as what populist politics intends them to be. 

The policy failure from the longstanding ban on whale hunting has prompted proposals to commercialize ‘whaling’ as a means of conservation.

From Economist Tim Taylor:

The International Whaling Commission imposed a moratorium on commercial whaling in 1986, which is still in effect. However, the moratorium has effectively allowed "scientific" whaling (mainly Japan),  "subsistence" whaling (various aboriginal groups), and limited commercial whaling (mainly by Norway and Iceland).  The total number of whales caught has doubled since the 1990s to about 2,000 per year, which is a pace that many biologists consider to be unsustainably high. After watching the moratorium approach struggle and fail over the last quarter-century, it's time to think about alternatives. In the Spring 2013 edition of Issues in Science and Technology, Ben A. Minteer and Leah R. Gerber discuss the possibility of "Buying Whales to Save Them."

What Minteer and Gerber have in mind is that the International Whaling Commission or some similar body would set a quota for the number of whales that could be taken, based on estimates of sustainable catch from biologists. These quotas would be marketable; in particular, environmentalist groups could purchase the right to take a whale--but then not do so. As they describe it:

"Under this plan, quotas for hunting of whales would be traded in global markets. But again, and unlike most “catch share” programs in fisheries, the whale conservation market would not restrict participation in the market; both pro- and antiwhaling interests could own and trade quotas. The maximum potential harvest for any hunted species in any given year would be established in a conservative manner that ensures sustainability of the marketed species (that is, harvest levels would be established that would not permit taking more individuals than can be replaced) and maintains their functional roles in the ecosystem. The actual harvest, however, would depend on who owns the quotas. Conservation groups, for example, could choose to buy whale shares in order to protect populations that are currently threatened; they could also buy shares to protect populations that are not presently at risk but that conservationists fear might become threatened in the future."

As you might expect, this kind of proposals is controversial. Many environmentalists feel that putting a value on whales is unethical, a betrayal of the underlying values involved. Other environmentalists, especially those with an economic turn of mind, note that if those who would be catching whales sell their quota to those who do not wish to catch whales, both parties can be benefit from the exchange--and the result may be that fewer whales are killed.

Commercialization as means of environmental conservation has great examples. Markets has saved American alligators from extinction (Carpe Diem’s Mark Perry) and so with China’s private and public tiger farms as well as China's creation of “legal domestic market for some wild-life products” (Barun Mitra at PERC). 

So bring on the whale markets.

Video: James Buchanan on the Myth of Public Interest

Nobel prize winner in economics and public choice theorist James M. Buchanan offers his terse explanation on why--what populist politics perceives as "public interest" is a myth (hat tip Cafe Hayek)

There is certainly no measurable concept that’s meaningful that should be called the public interest. Because how do you weigh different interests of different groups and what they can get out of it? 

The public interest as a politician thinks, it does not mean it exist but what he thinks is good for the country… And to come out and say that, that’s one thing…but behind the hypocrisy of calling something THE public interest that doesn’t exist—that was what I was trying to tell them

Quote of the Day: Liberalism’s trifecta

The industry was liberalism’s trifecta: newspapers, television networks, and the school system. Two are bleeding red ink. The third soon will be, as online education enables students to live at home, take courses online, graduate with accredited degrees, and pay $15,000 in tuition, total. A widely accepted estimate is that half of all American universities will go under over the next five decades. It won’t take anywhere near that long. The no-name private colleges will go under first, Cutbacks in tax funding will complete the procedure. Legislators will figure out that they can fire two-thirds of the faculty and replace them with online lectures and low-paid, untenured professors and graduate students to grade written exams.

All that liberalism will have left is the public school system, K-12. This dinosaur has been caught trapped in the tar pit ever since 1963, when SAT scores peaked. Online education is invading today. The American Federation of Teachers is on the defensive. In 50 years, the suburban schools will be online. Competition will demonstrate that the public school bureaucracies cannot compete.

Liberalism made entrepreneurial decisions on where the future was headed. The World Wide Web is taking the world in a different direction. It is leaving liberalism behind.

Liberals call this process of ideological decentralization “Balkanization.” I call it the break-up of a cartel that can no longer compete on the free market.

This is from Austrian economist Gary North at the lewrockwell.com. Decentralization will likewise erode the 20th century top-down political institutions.

On University of Chicago’s Raghuram Rajan as India’s Central Bank Governor

Austrian economist Peter Klein cheers the appointment of University of Chicago’s finance and banking professor as the Governor of the central bank of India, noting of Mr. Rajan’s familiarity of the Austrian Business Cycle.

Writes Professor Klein at the Mises Blog

Raghu Rajan is a very good neoclassical economist who has made important contributions to banking, finance, the theory of the firm, corporate governance, economic development, and other fields. He is also taking over as head of India’s central bank. Rajan is no Austrian, but he has a quasi-Austrian take on the financial crisis, and far greater appreciation for free markets in general than any of the key US or European policymakers. As I tweeted this morning, Rajan is about 1,000,000 times better than either Summers or Yellen. I’d gladly trade him for any US central banker.

Consider, for example, Rajan’s take on the financial crisis:

The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet.

As I wrote before, I’d reverse the order of emphasis — credit expansion first, housing policy second — but Rajan is right that government intervention gets the blame all around.

Rajan also wrote an interesting theoretical paper with Peter Diamond that echoes the Austrian theory of the business cycle: “[W]hen household needs for funds are high, interest rates will rise sharply, debtors will have to shut down illiquid projects, and in extremis, will face more damaging [bank] runs. Authorities may want to push down interest rates to maintain economic activity in the face of such illiquidity, but intervention may not always be feasible, and when feasible, could encourage banks to increase leverage or fund even more illiquid projects up front. This could make all parties worse off.”

Read the rest here

Having a free market proponent in the belly of the beast can both be a blessing or a curse. Although like Mr. Klein, one side of me wishes Mr. Rajan all the luck, another side of me tells me not to expect anything substantial.

While it may be true that Mr. Rajan has a magnificent track record of understanding central banks and the entwined interests of the banking system coming from the free market perspective, in my view, it is one thing to operate as an ‘outsider’, and another thing to operate as a political ‘insider’ in command of power.

Mr. Rajan will be dealing, not only conflicting interests of deeply entrenched political groups, but any potential radical free market reforms are likely to run in deep contradiction with the existing statutes or legal framework from which promotes the interests of the former.

Moreover, other political agencies, whose interests has been to promote the status quo, may run roughshod with Mr. Rajan perspective of reforms.

It would be interesting to see how Mr. Rajan will deal with  the present repressive “war on gold” policies by the Prime Minister’s Economic Advisory Council (PMEAC) whose interventionists actions has expanded to cover not only gold imports, but on gold transactions at every distribution level of the Indian economy.

In short, assuming the central bank governorship won’t just be about monetary, or banking policies but about the politics of bureaucracy, the welfare state and crony capitalism. 

Mr. Rajan will also have to deal with the huge resistance-to-change attitude from these groups.

In addition, in assuming the role of the proverbial hammer, where everything would look like a nail, the allure of the possession of the extraordinary power of political control over society risks overwhelming Mr. Rajan’s principles.

A great precedent would be former Fed Chair Alan Greenspan. Dr, Greenspan used to be an ardent Ayn Rand fan and a Ms. Rand influenced objectivist who embraced free market principles. Mr. Greenspan even authored the splendid, Gold and Economic Freedom in 1966. 

However upon assuming the Fed Chairmanship, Mr. Greenspan eventually abandoned free market principles to become a rabid inflationist or a serial bubble blower. Yet today’s lingering problems have, in effect, been a legacy of Greenspan-Bernanke actions.

True Mr. Rajan may not be Dr. Greenspan. But with the manifold challenging tasks ahead coming from different fronts, Mr. Rajan may want to take heed of Yoda’s advice to Anakin Skywalker: The fear of loss is a path to the dark side.

Chart of the Day: Troubled Currencies

Cato Senior Fellow and John Hopkins University Professor Steve H. Hanke in the following table shows where the risks of currency crises are 

A Breakdown of the Yen-Nikkei Correlation?

Is the yen-Nikkei correlations breaking down?

Over the recent past, or from a year to date basis, yen and the Nikkei has had what seems as a ‘tight’ inverse correlations, where falling yen coincided with a rising Nikkei and vice versa.

Such relations appears to have even tightened during the post Kuroda’s doubling of monetary base announcement last April.

The green vertical lines illustrated above has shown almost precise inflection points between the yen-Nikkei.

Ironically since the 2nd week of July such phenomenon appears to be breaking down where the Nikkei seems on an upside trek along the yen. 

In short, over the interim, from negative correlations to positive correlations.

Has this been an anomaly?  Or has the Yen-Nikkei’s broken negative correlations signify a start of a new dynamic?

And what appears to be an influence behind the scene has been the Japanese Government Bonds (JGB). 

Ironically in contrast to the actions of her western counterparts, yields of 10 year JGBs have been falling. 

As of this writing, 10 year JGBs are at a 3-month low.

Chart from investing.com

And this comes even as Japan’s inflation rate has reportedly jumped by .2% (chart from tradingeconomics.com)

The reality is that the inflation data has been skewed. 

Even as Japan’s monetary base has reached a record high in July, up 41% year on year (Japan News), the gist of price inflation has concentrated on energy and transportation related industries, according to data from the Ministry of Internal Affairs. The rest of the industries has shown little evidence of mounting price inflation.

This means that Japan's financial markets may have been pricing in lesser expectations of a revival of price inflation in JGBs and thus firming yen.

Rising stocks has partly been bolstered via conveyance of political support through media.  For instance,  the incumbent administration continues to exert pressure on the largest public pension fund or Japan's Government Pension Investment Fund (GPIF) to shift her resources to the stock markets (Chicago Tribune). 

Governments raiding of savings via pensions-social security has become a global trend.

A bigger factor has been the boom bust cycles that has plagued Japan’s financial markets. The near daily rollercoaster swings of the Nikkei has been evident of such dynamic.

This only shows how JGBs are in a trap.

If price inflation fails to take off, then higher real rates would mean the amplification of the cost of servicing Japan’s colossal, and still growing, debt load.

And should her domestic boom bust cycle weigh on the real economy, diminished revenues will magnify on her deficits thus even putting more strains on unsustainable Japan’s debt levels.

When the investors begin to question on the ability of Japan’s government to service her debts, this will be reflected on JGBs.

Even considering the recent decline, Japan’s credit default swaps remains elevated (Tokyo Stock Exchange). This means Japan’s credit risks remains relative higher today than from the first quarter of the year.

On the other hand, if price inflation does take off, then expect JGBs to rise in correspondence.

For now, Abenomics has mixed up or has vastly distorted the relationships of her markets. 

JGBs appear as in a transition equivalent to the proverbial calm before the storm.

Meanwhile the changing relationship between the yen-Nikkei seems as a manifestation of the monumental struggle between inflationary and deflationary forces or the boom bust cycle in Japan’s financial and economic system.

Interesting developments.

Video: F.A. Hayek, on Milton Friedman, Monetarism and Monetary Policy

In the following video interview, the great F. A. Hayek talked about Milton Friedman, macroeconomics, monetarism, monetary policies, knowledge problem and currency competition. (hat tip Cafe Hayek)

Notable quotes:

Statistics offer you a no substitute for the detailed knowledge of every single price relations to each other which really guide economic activities. That's a mistaken attempt to overcome our limited knowledge. (2:08) 

No government is capable of politically or intellectually providing the exact of amount of money which is needed for economic development (2:55) 

Abolishing the government monopoly to issue money would deprive government of the possibility of pursuing monetary policy. That's what I want (4:40)

Charts of ASEAN Stock Markets: Troubling Signs

Although I started out as a chart technician, I haven’t been a big fan of charting ever since I learned of other more important real drivers of the markets.

I believe that the biggest flaw in charting has been in the assumption of the constancy of market psychology that which disregards the incentives that drives the intertemporal psychology operating across diverse environments and dissimilar conditions, giving undue weight to past performance in the knowledge and understanding that past performance does not guarantee future results, and that which assumes away the probabilistic success of the heuristic of pattern seeking backed by mathematical formalism as prediction tools.

Nonetheless I still observe charts because a large segment of market participants use them and because of such large following, charts patterns can be occasionally become a self-fulfilling mechanism.

Besides chart interpretation are subject to the interpreter’s bias. People tend to see what they like to see—a confirmation bias.

As trader and author Alexander Elder warns[1],

Groups suck us in and cloud our judgment. The problem for most analysts is that they get caught in the mentality of the groups they analyze.

The longer a rally continues, the more technicians get caught up in bullish sentiment, ignore danger signs and miss the reversal. The longer the decline goes on, the more technicians get caught up in bearish gloom and ignore bullish signs.

I earlier pointed out ASEAN markets appear to showing signs of increasing strains.

There have been two opposing head and shoulder patterns operating on the Phisix. 

The short term bullish reverse head and shoulder as shown by the green lines has been a common sight among bulls chartists.

However last week’s huge decline in the Phisix appears to have formed a conflicting but longer term bearish head and shoulders.

And what adds to the bearishness is that of the declining slope of the neckline, which according to stockcharts.com[2] “The slope of the neckline will affect the pattern's degree of bearishness—a downward slope is more bearish than an upward slope.”

And when there is a conflict between short term and long term patterns, according to chartist author Deron Wagner[3] “When chart patterns conflict with one another, the important thing to remember is that the longer time frame always holds more sway that the shorter one”

The Phisix pierced through the 50-day moving averages, but if selling pressures will be sustained then a death cross, where the 200 day moving average move above the 50 day average, may add to the bearish outlook.

In and of itself I wouldn’t give so much merit to these, since I understand that Mssrs. Bernanke, Kuroda, Draghi, Carney and Tetangco can reinforce or falsify patterns.

What interests me today, is that the Phisix and Thailand’s SETI has nearly identical patterns, albeit the SETI seems as in a far more advanced state of infirmity.

The death cross seeks almost imminent.

Indonesia’s JCI can be seen in the same light, a conflict between short term double bottom against the longer descending triangle.

Malaysia’s KLCI seems as the most resilient among the three. But last week the ringgit was beaten down and this has been reflected on the decline of the KLCI.

It will be interesting to see if Malaysia will be able to decouple from her contemporaries or if she can lead the region to breakaway from the bearish backdrops.

Bottom line: Even if stock markets of developed economies appear to have entered a euphoric mood, the failure of ASEAN stocks to join bandwagon looks like a warning signal.

Trade cautiously.

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[1] Alexander Elder Trading for a Living p 64

[2] Stockcharts.com Head and Shoulders Top (Reversal)

[3] Deron Wagner Trading ETFs: Gaining an Edge with Technical Analysis