Quote of the Day: Colonial Nationalism and Anti Colonial Nationalism

If nationalism inspired two incompatible movements, how should we evaluate it?  You might just call it a wash: Nationalism giveth, and nationalism taketh away.  But this shoulder shrug overlooks two mountains of bodies.  The first mountain: All the people killed to establish colonial rule.  The second mountain: All the people killed to overthrow colonial rule.  It is perfectly fair to blame nationalism for both"transition costs." 

Surprising implication: Regardless of the relative merits of colonial versus indigenous rule, the history of colonialism makes nationalism look very bad indeed.  Why?  Because colonial rule didn't last!  So if you're pro-colonial, nationalism led to a high transition cost, followed by ephemeral wonders, followed by another high transition cost.  And if you're anti-colonial, nationalism led to a high transition cost, followed by ephemeral horrors, followed by another high transition cost.  Two dreadful deals, however you slice it.

But don't you either have to be pro-colonial or anti-colonial?  No.  You can take the cynical view that foreign and native rule are about equally bad.  You can take the pacifist view that the difference between foreign and native rule isn't worth a war.  Or, like me, you can merge these positions into cynical pacifism.  On this view, fighting wars to start colonial rule was one monstrous crime - and fighting wars to end colonial rule was another.  Nationalism is intellectually guilty on both counts, because it is nationalism that convinced people around the world that squares of multi-colored cloth are worth killing for.

(italics original)

This is from economics professor,  prolific blogger and author Bryan Caplan at the Library of Economics and Liberty

PBoC Injects 255 Yuan to Calm Debt Jitters, Asian Stock Market Celebrate

China’s financial markets “hooked” on liquidity injections, got another shot in the arm with 255 billion yuan of reverse-repurchase agreements by the People’s Bank of China to to large commercial banks

From Bloomberg:

China’s benchmark money-market rate fell while stocks rebounded as the central bank added more than 255 billion yuan ($42 billion) to the financial system and expanded a loan facility to meet Lunar New Year demand for cash.

The seven-day repurchase rate, a gauge of interbank funding availability, dropped 88 basis points to 5.44 percent in Shanghai, according to a daily fixing compiled by the National Interbank Funding Center.

China’s 7 day repo rate (china money.com) has declined on PBoC’s injection (green ellipse). 

Media says that this measure will “reduce risk in the interbank market and help restore confidence as concern mounts about potential defaults” and that “Money-market rates typically spike before the new year break, a period in which cash gifts are made and families get together for celebratory feasts”

The above picture tells of a vastly different story. Those blue arrows on top reveal of the episodes of “major” short term liquidity squeezes over the past year. The (blue) trend line also reveals of a seeming increase in repo rates since the last quarter of 2013. 

Rising frequency of incidences of liquidity turmoil and the seeming gradual build up in the magnitude (expressed via rising trend of repo rates) seem like mounting pressures looking for an outlet valve to ventilate. They seem hardly about celebratory feasts, instead they seem as writing on the wall for a Black Swan.

Curiously despite the action by the PBoC, yields of China’s 10 year bonds remain in a consolidation mode at recent highs.

China’s stock market investors nevertheless cheer the same theme of more "bad news is good news" [I see this as an oversold bounce].  And so with the ASEAN counterparts.

Yet the PBoC’s liquidity injection and declining yields of US treasury notes appear to have hardly calmed ASEAN bond markets which continues to show weakness via higher yields (yes Philippine treasury yields seem as rising today from 1 year through 20 year curve. 10 year at 4.3%). Such has also been expressed via their respective currencies (the USD-Philippine peso is 45.2+ from Friday's 45). Rising stocks amidst rising treasury yields and falling currency represents a widening of unsustainable divergences. 

Well, stock market investors see none of these as risks: again symptoms of what I call as the Aldous Huxley “Facts do not cease to exist because they are ignored” syndrome.

Cayman Islands: Success Story and the Coming Risk from Revenue Starved Governments

At the Lew Rockwell.com, historian Eric Margolis describes the success story of Cayman Islands.

Two things happened to change Cayman from insect hell to the world’s second most important tax haven after Switzerland, and the fifth largest banking center.

First, an intense mosquito control campaign and swamp drainage killed most of the island’s insects. Second, the British Crown colony adopted a no tax policy and removed any restraints on the flow of funds.

The New York and London principals of the West Indies port, land and shipping group for which I was working at the time sent me to Cayman to open up banks. I chartered three, including my favorite brainchild, the German-Atlantic Bank.

Would that I had stayed in the banking business. My principals had remarkable foresight. Forty-four years later, Cayman hosts almost 300 banks, insurance firms of every type, and over 10,000 hedge funds managing some $36 billion in funds, as well as registries for ships and aircraft.

The population has grown to 56,000, nearly a third of whom are expatriate financial executives. The inflow of bank business has allowed life without personal taxes and a per capita income of $47,000, giving Cayman the highest living standard in the West Indies. Over 50% of government revenue comes from the finance industry.

With its azure waters, beautiful beaches, fine hotels, well-regarded restaurants, highly developed communications and public infrastructure, Cayman is a paradise for tourists and finance.

Now the coming risk:

By contrast, tax collectors everywhere hate Cayman.

The island’s ultra discreet banks are awash with hot money, particularly from Russia. In fact, almost every major business deal in Russia is run through either Cayman, Switzerland, or Cyprus (though it’s gone bust). This island is a world center for legitimate business but also financial hanky-panky and shielding money from taxes, angry ex-wives and lawsuits.

What makes Cayman so attractive is that it remains a British colony, meaning no revolutions or coups by wild-eyed fanatics. The island offers still largely impenetrable secrecy and a safe place for money. And, to quote Somerset Maugham’s wonderful description of Monaco, “a sunny place for shady people.”…

But Cayman, like other tax havens, is now under heavy fire from abroad. Last year, President Barack Obama singled out Cayman as a major financial malefactor. Revenue hungry governments across the globe are closing in on Cayman.

See the complete article here

If "revenue hungry government across the globe" have been intensifying their leeching of their captive taxpayers, think of what may likely happen when a Black Swan event occurs.

Quote of the Day: Trade is Not a Scoreboard

We need to do better a job explaining how trade does not lend itself to sports metaphors. Exports are not our “points.” Imports are not “their” points. The trade account is not a scoreboard. It is not Team America against the world. Trade is about mutually beneficial exchange between individuals in different political jurisdictions, and to the extent that those kinds of transactions are subject to the whims of politicians, more and more resources will be diverted from economic to political ends.

This is from Cato Institute director Daniel Ikenson debunking mercantilist myths

Will China Trigger the Black Swan Event in 2014?

The ongoing financial tremors in China appears to be absent in the eyes of the mainstream

Instability in China’s Credit Markets

Yields of China’s 10 year local currency bond remains at 2008 levels.

As of Friday, China’s money market rates leapt to the highest level in a month as banks have reportedly been hoarding funds in order to meet withdrawals before the Spring Festival (New Year) holidays and concerns over “first trust-product default”.

The seven-day repurchase rate, reports the Bloomberg[1], surged 81 basis points, the most since Dec. 20, to 5.17 percent in Shanghai, according to a weighted average from the National Interbank Funding Center. That was the highest level since Dec. 31. It climbed 114 basis points this week.

The Chinese government attempted to ferret out her shadow banking system by withdrawing liquidity last June only to discover that the vehemence of market reactions[2].

For the Chinese government market instability would run the risk of upsetting political goals of generating statistical economic target which may have political repercussions. This forced the People’s Bank of China to inject funds and abort the mission. 

But artificial treatments have led China’s debt disease to rear her ugly head. Not only has interest rates soared, but the credit pressures have become apparent anew as China’s annual probability of default based on 5 year credit default swaps have risen.

Ballooning Debt Levels

Runaway credit growth underpinning China’s property bubble plus growing complexity from deepening politicization of the banking sector via credit allocation has prompted for a dramatic evolution of credit activities in China over the past few years.

Local government debt has reportedly reached 17.89 trillion yuan or about US $ 3 trillion. Lending restrictions by the central government on the local government has forced the latter to migrate and tap shadow banks consisting of trust securities, insurance and leasing companies, and other non-bank financial institutions, which accounted for 27.8% of new debt. Aside from shadow banks the local government has resorted to other financial engineering instruments too, they have used IOUs and shifted the use of local government financing vehicles (LGFV) into using State Owned Enterprises (SOE) who acquired loans in their behalf (backed by illicit guarantees by the borrowing local government).[3]

Mainstream media wants to put the blame financial liberalization on the explosive growth of lending, but as one would note from the above, credit growth has largely been from the local governments camouflaged through the private sector, via LGFVs, or through the Shadow banks. All these avalanche of debt financed spending on mostly property projects has spurred a massive property bubble. Although  these has mostly been contrived to produce statistical growth which has been meant to get the blessings of the higher ups in order to ensure the political tenure and to fulfil the political ambitions of the officials of local governments.

A lot of the supposed private sector entities appear to be either wards or crony arms of local and state governments. And all these collective attempts to generate statistical “growth” have led to China’s dire pollution problems where smog has reached dangerous levels[4].

Meanwhile Chinese credit expansion has also been in a product of the PBoC’s printing of yuan in exchange for foreign currency. Although much of the proceeds of foreign exchange transactions end up with the banking system and subsequently converted into loans. China’s money supply growth has soared past the US[5]

China’s foreign exchange reserves have now reached new records at $3.82 trillion at the end of December. Importantly, China’s vendor financing scheme with the US has led to record holdings of US treasuries. China now has $ 1.317 trillion worth of USTs[6]. This record holding of US contradicts the PBoC’s earlier claim where they will not increase acquiring of USTs last November[7]. This also shows how China continues to implicitly finance the US military via UST purchases, which for me, represents a Dr. Jekyll and Mr. Hyde or an inconsistency in terms of the brinkmanship geopolitics of territorial disputes.

Emergent Signs of Credit Stress

Yet despite the huge reserves, the Chinese government appears to be a bind. They would like to put a curb on the shadow banks, but they fret that doing so might impair the credit channels via the banks, which may harm credit conditions, undermine the economy and imperil the already fragile political conditions.

An example can be seen in a reported infighting between banking regulators: the People’s Bank of China (PBoC), whom has been finding ways to “move loans off their books” and China’s banking regulator, the China Banking Regulatory Commission (CBRC), whom has supposedly “watered down” regulations to accommodate the requests of the banking system[8].

A proposed new rule by the CBRC known as Regulation 9 has been designed to restrict off banking sheet lending activities that would limit backdoor activities, but lobbying from the banking industry allegedly pushed the CBRC to dilute the essence of the regulation.

Nonetheless a record 2.6 trillion yuan ($427 billion) of interest and principal on securities issued by non-financial companies have reportedly been due this year[9]. This has brought about growing concerns over credit risks.

There have already been signs of emerging credit stress. 74 of about 800 Peer-to-peer online lending companies which came online in 2013[10] with outstanding loans of 26.8 billion yuan ($4.4 billion) have either shut down or have been unable to facilitate cash withdrawals to its users.

Importantly at the start of the article I noted that rising money market rates have reportedly been due to banks hoarding funds in anticipation of the “first trust-product default”.

The world’s largest bank (in terms of assets[11]), the Industrial & Commercial Bank of China Ltd., which is state owned bank, has reportedly rejected calls to bailout a 3 billion-yuan ($495 million) shadow banking trust product which it had distributed[12]. The company reportedly invested in a coal mine venture, Shanxi Zhenfu Energy Group, which recently collapsed. 

A default on the investment product, according to a report from Bloomberg, which comes due Jan. 31, may shake investors’ faith in the implicit guarantees offered by trust companies to lure funds from wealthy people. Assets managed by China’s 67 trusts soared 60 percent to $1.67 trillion in the 12 months ended September even as policy makers sought to curb money flow outside the formal banking system.

A China Triggered Global Black Swan Event?

This is interesting because the Chinese government embarked on a massive stimulus program in 2008 to the tune of 4 Trillion RMB US$ 586 billion[13] to shield her from the global crisis. Apparently the Chinese government got hooked on such political measures from which stimulus spending have now become a standard and stealthily implemented via state and local governments.

And yet the government may have already drained the people’s savings and has thus used debt to attain statistical growth. And as noted above, most of today’s economic growth model comes with heavy reliance on leveraging which results to the loss of productivity making them vulnerable to bursting bubbles.

Applied to China, billionaire, market guru and crony capitalist George Soros appears to share the same insight. In a recent article, Mr Soros writes[14] that China’s “model depended on financial repression of the household sector, in order to drive the growth of exports and investments. As a result, the household sector has now shrunk to 35% of GDP, and its forced savings are no longer sufficient to finance the current growth model. This has led to an exponential rise in the use of various forms of debt financing.”

Mr. Soros continues “There are some eerie resemblances with the financial conditions that prevailed in the US in the years preceding the crash of 2008. But there is a significant difference, too. In the US, financial markets tend to dominate politics; in China, the state owns the banks and the bulk of the economy, and the Communist Party controls the state-owned enterprises.”

And while many including Mr. Soros points to China’s Third Plenum as being an optimistic factor, as I recently noted[15],

implementation will mark the difference from rhetoric

Yet the Chinese political economy and her financial markets will have to face vast immediate or short term challenges first. And the ultimate  challenge is how to deal with her overleveraged economy.

I recall that in late November, as companies borrowing costs spiked, China’s state newspapers warned about a “limited debt crisis”[16]. 

China’s Shanghai Index seems to share the same worries and has been down 5.25% year to date as of Friday’s close

2014 will probably answer the following questions:

Will the year of the horse usher in a series of defaults for the China’s overleveraged system? Will such defaults be contained (perhaps by her record reserves)? Will the Chinese government resort to bailouts? Or will it cause a domino effect that may spread through the financial system? Will there be a global contagion?

Has the proverbial chicken come home to roost for China’s credit and property bubbles?

Will economic and financial troubles prompt China into a military showdown with her neighbors over territorial disputes?

Will China trigger the Black Swan Event in 2014?

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[1] Bloomberg.com China Money Rate Surges on Cash Demand Amid Trust-Product Risks January 17, 2014

[2] See China’s PBOC: From Tapering to Easing? June 21, 2013

[3] Wall Street Journal Real Times Economics Blog A Micro Reading of China’s Local Government Audit January 9, 2013

[4] Australia New Network Dangerous pollution hits the Chinese capital as index hits top of the scale January 17, 2014

[5] New York Times With China Awash in Money, Leaders Start to Weigh Raising the Floodgates, January 15, 2014

[6] Bloomberg.com China’s Treasury Holdings Climb to Record in Government Data January 16, 2014

[7] Bloomberg.com PBOC Says No Longer in China’s Interest to Increase Reserves November 21, 2013

[8] Wall Street Journal Regulators at Odds on Reining In China's Shadow Lending January 14, 2014

[9] Bloomberg.com First China Default Seen as Record $427 Billion Debt Due December 9, 2014

[10] Bloomberg.com China Peer-to-Peer Loan Sites Fail as Fraud Climbs, Xinhua Says January 13, 2014

[11] Global Finance Magazine World’s Biggest Banks 2013 October 2013

[12] Bloomberg.com ICBC Won’t Repay Troubled China Trust Product, Official Says January 17, 2014

[13] Wikipedia.org Chinese economic stimulus program

[14] George Soros The World Economy’s Shifting Challenges Project Syndicate January 2, 2014

[15] See China’s Stock Market Soars on ‘Leaked’ Reform Documents as Bond Markets Seize Up November 16, 2013

[16] Bloomberg.com Record Spread Blowout Sparks Mini-Crisis Warning: China Credit November 27, 2014

Rallying US Bonds Lifts Phisix and ASEAN Markets

Mark Hanna:   The name of the game, move the money from your client’s pocket into your pocket.

Jordan Belfort:   But if you can make your clients money at the same time it’s advantageous to everyone, corrent?

Mark Hanna:   No

…

Mark Hanna:   Nobody knows if a stock is going to go up, down, sideways or in circles. You know what a fugasi is?

Jordan Belfort:   Fugazy, it’s a fake.

Mark Hanna:   Fugazy, fugasi, it’s a wazi it’s a woozy, it’s [makes a flittering sound] fairy dust.

The above quotes have been lifted from the 2013 movie “The Wolf of Wall Street”[1]. That’s the advice given by Wall Street veteran Mike Hanna (Matthew McConaughey), playing as mentor to neophyte Jordan “Wolf of Wall Street” Belfort (Leonardo DiCaprio).

The above quote is a wonderful example and or a great depiction of the conflict of interests involving market participants. This is known as the principal agent problem[2].

When people talk up their industry while at the same time ignoring or downplaying risks in their framing of their discussions, such could be symptoms of the agency problem at work.

Be careful of fugazies. They may come in the form of Hopium dealers or could be experts afflicted by the Aldous Huxley syndrome.

The Schadenfreude Rally

I noted last week that rallying US bonds (falling yields) could spark a rally on risk assets[3]

the dramatic fall on yields of US Treasuries last Friday due to lower than expected jobs, may buy some time and space or give breathing space for embattled markets. But I am in doubt if this US bond market rally will last.

So ASEAN markets rallied strongly on the prospects of a weak US economic performance. Indonesian stocks soared by 3.7% over the week, while Thailand and the Philippines surged by 3.18% and 2.47% respectively.

Here is an example of how mainstream media described of Monday’s risk ON in Asian markets “Asian stocks outside Japan rose the most in eight weeks after slower growth in U.S. payrolls eased concern the Federal Reserve will accelerate cuts to stimulus.”[4]

Shades of schadenfreude eh? ASEAN financial market speculators would need to wish or pray for sustained stagnation of the US economy in order to keep the bond vigilantes at bay or to prevent UST bond yields from rising in order to see another round of booming financial markets.

But ASEAN markets responded differently to declining UST yields.

Indonesia’s $4 billion global bond sale also played a big part in this week’s magical reversal where the USD-rupiah fell by .6% to 12,091. Indonesian bonds rallied vigorously too, yields of the 10 year local government bonds fell by about 39 bp. So Indonesia’s financial markets went into full risk ON mode.

Thailand’s currency via the USD-baht dropped also by .6% to close the week below 33, particularly 32.81. On the other hand USD-Malaysian ringgit rose sizeably by .8% to 3.2959 as Malaysian stocks as measured by the KLSE fell by .74%

Thailand’s bonds rallied modestly with yields of 10 year local currency government bonds lower by 10 bps, while the yield of 10 year LC Malaysian bonds has been little changed.

Again curiously the mystical effect from the success of Indonesia’s global bond float hardly inspired the Philippine counterpart which also raised $1.5 billion a week back[5].

True yields of one month Peso sovereign bond, which spiked by nearly 200 basis points, last week retraced 75% of the earlier gains. Nonetheless, yields of the short term (1 month) Philippine treasury at 1% have been up 4 times from the lows during October 2013 at .2%. Interestingly, while short term yields fell, yields of 5 year and 10 year (4.3% this week as against 4.24% last week) were modestly up over the week, while 20 and 25 year bonds were little changed.

The USD-Peso even climbed up .6% to 45 to the highest level since September 2010

The “breathing space for embattled markets”, has thus, benefited Indonesian and Thai financial markets most, but had a mixed picture for the Philippine and Malaysian financial assets.

Again I would note, “curiously” because the Philippine government which raised $ 1.5 billion from the global bond markets a few days ahead of Indonesia have shown divergent results from the latter.

It would serve as a convenient pretext to say that perhaps Indonesia might have ran far ahead or has been heavily oversold. Could be. Or the Philippines may have a belated response. Could be too.

But could the present actions in the peso and domestic bond markets been signalling either inflation or incipient signs of credit stress? We will see.

Signs of increasing fissures in the tightly controlled Philippine bond markets and the falling peso are hardly indicators in favor of a bullish case for the Phisix.

Rising rates here or abroad and the falling peso will have negative impact on highly levered companies that should likewise put a strain on loan and asset portfolios of the banking industry. The bulls will need to see a sharp decline of the USD vis-à-vis the Peso as well as lower bond yields for local bonds and the USTs

Whose Fund Flow Data is Correct the BSP or the PSE?

I would like to also raise another of what seems as discrepancy in government-private sector statistics. 

The BSP announced this week that foreign portfolio investments reached US$4.2 billion in 2013 which is 8% higher a year ago where 74.7% of inflows where had been funnelled into the PSE-listed securities[6].

I keep tab with the PSE daily quotes and I find that the net foreign inflow data by the PSE and the BSP for 2013 a galaxy apart. Whether I apply 75% on the net inflows or via applying 75% in both gross inflow-gross out outflow, BSP’s inflows would register to USD $3+ billion for 2013. This seems to contradict PSE’s data which shows inflows at a measly USD $ 585.5 million, based on the average end month quote of the Peso for 2013 at 42.65. 

This means that foreign inflows constitute only 18% based on PSE data compared to that of the BSP’s data. So what gives?

I hope the PSE will come up with its official figures. But if the PSE’s data remains far from the BSP then this should point to a credibility issue on which party has been reporting patently inaccurate data.

Yet the variances in the above data exhibits two contrasting pictures; if the BSP data is correct, where during the latter half foreign money posted net inflows despite 2 months of Net outflows (August and December), then local selling not foreign selling brought the Phisix into the bear market territory. Could this be a case of Mike Hanna’s ‘Fugazis’ via pump and dump?

But if the PSE data is correct, where consistently every month from August until December showed net foreign selling, then this would be in sync with global trends where foreign funds yanked money out of emerging markets[7].

The Reasons Behind Rising Philippine Bond Yields and Falling Peso

BSP’s data on banking sector loans in November 2013 continues to exhibit the latter’s loan growth expanding faster than the statistical economy[8].

Much of the increase has emanated from the frothy construction and real estate industry which has served as the pillar to the Philippine statistical economic growth. This has been followed by manufacturing, which I don’t see as in a bubble.

An interesting picture is the negative credit growth posted by financial intermediation sector (pink ellipse), which has been the first since 2008. This negative credit growth came amidst the weakening of the Phisix and the Peso last November. It could mean some entities may have closed their credit positions possibly by selling stocks and possibly bought the US dollar out of the proceeds. They could be foreign entities.

Financial intermediation represents only about 9% of overall loans. This means that the credit contraction could easily be offset by gains in the real estate industry. The negative credit growth should also extrapolate to a marginal impact on domestic liquidity growth which has been running amuck. The BSP notes that last November M3 “increased by 36.5 percent year-on-year (y-o-y)…to reach P6.7 trillion”[9]. Gosh 36.5% against a statistical economy growing at 6-7%!

Domestic claims on private sector and other financial corporations constitute about 67.73% of M3.

This fantastic runaway growth in domestic liquidity fuelled by banking credit and the likely return of price inflation, which subsequently may lead to stagflation, is why emerging markets like the Philippines has been vulnerable to capital flow exodus from the so-called US Federal Reserve “tapering”.

And rising domestic bond yields mostly at the middle to the long end of the curve appear to be signalling the return of the risks of price inflation.

So rising rates, which has been signaling shortages of real resources, has been putting strains on an inflating bubble in the real economy. Such has likewise been signaling the possible return of the risks of price inflation. These factors are hardly conducive for bullmarkets

Yet we should expect sharp denial rallies to occur. Inflection points of any markets are typically characterized with high degree of volatility. Big denial rallies or relief rallies represent a common trait of bear markets. Yet a real recovery will only occur unless these factors will be addressed.

Moreover following a breach into the bear market, history doesn’t support a comeback for the Phisix. Since 1980, the best performance by the Phisix having endured a bear market strike following record highs has been denial rallies that recovered the previous highs but eventually faltered into a full bear market as in the case of 1994-97 and 2007[10].

As a Wall Street saw goes, “Bear market descends on the latter of hope”. And that hope is predicated on “this time is different”.

Of course I would not rule out a “this time is different” scenario, if the BSP decides to undertake the same measures as with her developed economy peers.

However the risk is that, unlike developed economies that has muted price inflation, any direct easing moves may spark a upside spiral in price inflation that may bring about political instability.

The Periphery to Core Dynamic

Let me repeat again, bubble cycles are market process induced by government interventions. Since they are a process they undergo distinct stages whether seen from the resource allocation/ production process or from the behavioral perspective. A usual symptom can be seen via the periphery to core dynamic.

Let us take the US crisis of 2008 as an example.

In response to the Greenspan Put[11] (Former Fed chair Alan Greenspan injected liquidity and lowered interest rates from 6.5% to 1%[12]), in 2003-6 real estate and stocks marched higher along with rising yields of US Treasury notes.

Underpinning this inflationary boom has been a massive ramping up of credit by US households, the real estate industry, the mortgage industry, US banks and the shadow banks (via various forms of financial engineering, particularly securitization[13] such as Mortgage Backed Securities, Asset Backed Securitization and various forms of derivatives).

The previously advancing US housing as measured by S&P Shiller 20 Index (upper window red line), peaked in early 2006 and began to decline. Yet US stocks as measured by the S&P 500 continued to climb ignoring the decline in the real estate even as the losses in the real estate and mortgage industry mounted and diffused into the financial system.

Almost a year and a half after the inflection point of the US housing industry, the ascendant stock market reached its inflection point and began its decline. Losses in the real economy from the hissing housing bubble became more apparent. Inflationary boom turned into a deflationary bust. The Wile E. Coyote moment arrived. Divergence became convergence as all assets swooned, except the US dollar and US treasuries. The US housing meltdown morphed into a banking and financial crisis which spread throughout the world.

The Wile E. Coyote moment culminated with the Lehman bankruptcy and the disappearance of the five largest investments banks of the US[14]

The ‘periphery’ then was the housing and mortgage markets and the stock markets. The ‘core’ was the banking and the shadow banking system and the real economy.

Hindsight is 20/20. Today’s dynamic may be different. It may be global. Current strains may be about emerging economies, functioning as the “periphery” with developed economies as the “core”.

The point is massive accumulation of debt in a system that has pillared rising asset prices amidst a vastly complacent “cheerleading” public would likely bring about a ‘periphery to core’ process that would redound to a Wile E Coyote moment elicited by rising rates.

The World Bank recently warned that should the Fed continue to taper or if advanced economies abruptly unwind central bank support then in their “disorderly adjustment scenario”, they see spiralling risks of sudden stops where capital flows to emerging markets may contract by “as much as 80%” which is likely to affect “nearly a quarter of developing countries”[15]

Again the question I will throw is that why should there be “sudden stops” or precipitate capital outflows if emerging market’s economic structures have been “sound”? 

The answer is that they have hardly been “sound”. Since 2008, global governments have used interventions via monetary policies and by fiscal means to generate “growth”. And this applies as well to Emerging Asia.

Reports the Wall Street Journal[16]

An environment of falling productivity has arisen in which local authorities have had to plough ever-greater amounts of stimulus into their economies to support growth, amid a lack of concrete structural reforms.

Post crisis governments almost everywhere have used massive build-up of leverage to drive statistical growth, which in return has reduced productivity, and consequently increased the risks of imploding bubbles. The current environment has lead emerging markets to become heavily dependent on low interest rates, rising asset prices and foreign capital flows. Yet such intensive accumulation of debt and the possible adverse consequences from malinvestments has been ignored by the mainstream and in fact glorified as “new paradigms”.

Aside from a global dynamic I think that emerging markets will have their own unique versions of “periphery to core dynamic” where financial asset markets could represent one of the peripheral indicators.

Rising rates have gradually been exposing on such fragilities and frailities.

---

[1] ‘The Wolf of Wall Street’ Movie Quotes Quotereels.com

[2] Wikipedia.org Principal-Agent Problem

[3] See Phisix: Will a Black Swan Event Occur in 2014? January 13, 2014

[4] Bloomberg.com Asian Stocks Rise as U.S. Payrolls Ease Stimulus Concerns January 13, 2014

[5] See Will an ASEAN Black Swan Event Occur in 2014? January 13, 2014

[6] Bangko Sentral ng Pilipinas Record High Foreign Portfolio Investments Noted in 2013 January 16, 2013

[7] Barrons Blog Are Fund Flow Data From EPFR Global Reliable Readings Of Investor Sentiments? January 17, 2014

[8] Bangko Sentral ng Pilipinas Bank Lending Grows Further in November December 27, 2013

[9] Bangko Sentral ng Pilipinas Domestic Liquidity Rises Further in November December 27, 2013

[10] See Phisix: Don’t Ignore the Bear Market Warnings June 13, 2013

[11] Wikipedia.org Greenspan put

[12] Wikipedia.org Historically low interest rates Causes of the United States housing bubble

[13] Mark Fagan Tamar Frankel MBS, ABS, SPV, CDS, ARM, BBB+: Understanding the Alphabet Soup of Securitization Harvard Kennedy School October 2008

[14] Agora.com Poof! 5 Biggest Wall Street Investment Banks Gone In 6 Months September 29, 2008

[15] Financial Times World Bank warns of capital flow risk to emerging markets January 15, 2014

[16] Wall Street Journal Real Economics Blog Rapid Asian Growth Comes at a Cost January 17, 2014

How Western Environmentalism Shaped China’s One Child Policy

Ideas have consequences. 

China’s one child policy hasn’t been a communist idea, writes author Matthew Ridley. Instead this has emanated from western environmentalist ‘Malthusian’ concept, which had been embraced by a Chinese missile scientist who repackaged and pushed these to Chinese policymakers. The result from the adaption, as usual, has been unintended consequences

A slice from Mr. Ridley:

As China’s one-child policy comes officially to an end, it is time to write the epitaph on this horrible experiment — part of the blame for which lies, surprisingly, in the West and with green, rather than red, philosophy. The policy has left China with a demographic headache: in the mid-2020s its workforce will plummet by 10 million a year, while the number of the elderly rises at a similar rate.

The difficulty and cruelty of enforcing a one-child policy was borne out by two stories last week. The Chinese film director Zhang Yimou, who directed the Beijing Olympics’ opening ceremony in 2008, has been fined more than £700,000 for having three children, while another young woman has come forward with her story (from only two years ago) of being held down and forced to have an abortion at seven months when her second pregnancy was detected by the authorities.

It has been a crime in China to remove an intra-uterine device inserted at the behest of the authorities, and a village can be punished for not reporting an illegally pregnant inhabitant.

I used to assume unthinkingly that the one-child policy was a communist idea, just another instance of Mao’s brutality. But the facts clearly show that it was a green idea, taken almost directly from Malthusiasts in the West. Despite all his cruelty to adults, Mao generally left reproduction alone, confining himself to the family planning slogan “Later, longer, fewer”. After he died, this changed and we now know how.

Susan Greenhalgh, a professor of anthropology at Harvard, has uncovered the tale. In 1978, on his first visit to the West, Song Jian, a mathematician employed in calculating the trajectories of missiles, sat down for a beer with a Dutch professor, Geert Jan Olsder, at the Seventh Triennnial World Congress of the International Federation of Automatic Control in Helsinki to discuss “control theory”. Olsder told Song about the book The Limits to Growth, published by a fashionable think-tank called the Club of Rome, which had forecast the imminent collapse of civilisation under the pressure of expanding population and shrinking resources.

Read the rest here

Quote of the Day: The fear of missing out

There’s a nasty little parasite that exists in nature known as the nematomorph hairworm (Spinochordodes tellinii) which typically infects grasshoppers and crickets.

Once fully grown, the worm is able to profoundly affect the behavior of its host; most notably, the worm can actually compel a grasshopper to throw itself into water.

This is great for the worm as it needs the moisture to reproduce. But for the grasshopper, it’s deadly.

There’s another vile protozoan known as Toxoplasma gondii. According to a 2007 study, rats and mice who are infected with it demonstrate a marked reduction in natural defenses, making them far more susceptible to being eaten by cats.

Nature is full of these unpleasant parasites which cause their hosts to engage in irrational, destructive, or even suicidal behavior.

Of course, they exist for humans too… especially for investors. In fact probably the number one parasite which affects investors is a very peculiar emotion: fear.

Specifically, it’s the fear of missing out that drives so much irrational investment behavior. Nobody wants to miss a big boom, no matter how baseless the fundamentals.

It’s this fear of missing out that compels people to continue investing in stocks, even though they are near all-time highs and trading at Price/Earnings ratios that are historically dangerous.

Ironically, this fear of missing out is stronger than the fear of loss. But if everyone else is jumping in, it’s easier to ignore the obvious risks of losing our life’s savings investing in ridiculously overvalued stocks.

Following the crowd is a great way to lose a lot of money.

Some of the most successful investors in history have been those who had the courage to go against the investment herd mentality. They conquered the fear of missing out, and they bought what everyone else hated… or looked where nobody else was looking.

(italics original, bold mine)

 

This priceless wisdom is from Sovereign Man’s Simon Black.

Quote of the Day: The Biggest Insider Trading Perpetrator

We put in a good citizen call to the SEC yesterday.

“There’s a massive scheme to manipulate stock prices,” we told the friendly agent.

“I have to tell you that your call is being monitored so that we can better serve the public,” he replied.

“Oh, don’t worry about that. The NSA is tapping our call anyway.”

“Are you talking about a specific stock?”

“Oh no… I’m talking about all of them.”

“You mean a Madoff-style scandal?”

“No… no… This is much, much bigger than the Madoff scandal. We’re talking major manipulation. Intentional. Knowledge aforethought. Pumping up all stock prices. Trillions of dollars.”

“Who is doing this?” the agent asked… a certain tone creeping into his voice. He was starting to suspect he had a lunatic on the line.

“The Fed, of course.”

“Uh… thank you…”

“You gotta go after those bastards…”

“Uh… yes… we’ll look into it…”

“Okay… thanks… I just thought you should know.”

...

Without Fed support, the economy would probably be in recession. US GDP went up about $350 billion last year. The Fed offset it with $1.2 trillion worth of QE. Even so, the economy only limps along. Without it, the economy slumps. The Fed can’t tolerate a slump. So, it has to continue with QE.

Meanwhile, the federal government is absorbing $400 billion less capital this year than last as a result of lower budget deficits. This leaves a lot of excess stray kittens in need of adoption. Who will take them in?

Stocks! Real estate! Yes, dear reader, we will most likely see more gains in 2014.

This is blatant manipulation of the markets. The Fed is open about it. Even proud of it.

This is from Bill Bonner writing at the Bonner & Partners

Quote of the Day: From Socialism to Economic Fascism

The philosophy of socialism — in essence, the naked claim that one should have what another has produced — is as old as mankind. The societal implementation of this philosophy in the form of full-fledged state ownership and control of the major means of production and central planning of resource and output allocations, however, occupied only a brief historical span. Owing to its intrinsic inability to solve problems of calculation, knowledge, and motivation, socialism in practice consumed previously accumulated capital and impoverished billions of people caught up in the experiment, killing hundreds of millions in the process, and by now it has been abandoned almost everywhere it was tried. The underlying philosophy, however, has weakened not a whit. Now, in practically every country of any consequence, a system of economic fascism — a system with severely compromised private property rights, but some room for entrepreneurial maneuver — serves as a more viable replacement and as the context in which the age-old sin of envy drives politico-economic action as strongly as it ever did in the USSR and Maoist China.

This is from economist, author and Senior Fellow at the Independent Institute Robert Higgs (source Lew Rockwell Blog)