Graphics: Cigarette ‘Sin’ Taxes Equals Smuggling US Edition Updated

Nice graphics exhibiting how populist 'sin' taxes fuel smuggling. This is an update from my January 2013 post

From Joseph Henchman and Scott Drenkard of the Tax Foundation:

-Large differentials in cigarette taxes across states create incentives for black market sales.

-Smuggled cigarettes make up substantial portions of cigarette consumption in many states, and greater than 25 percent of consumption in twelve states.

-The highest inbound cigarette smuggling rates are in New York (56.9 percent), Arizona (51.5 percent), New Mexico (48.1 percent), Washington (48 percent), and Wisconsin (34.6 percent).

-The highest outbound smuggling rates are in New Hampshire (24.2 percent), Wyoming (22.3 percent), Idaho (21.3 percent), Virginia (21.1 percent), and Delaware (20.9 percent).

-Cigarette tax rates increased in 30 states and the District of Columbia between 2006 and 2012.

Public policies often have unintended consequences that outweigh their benefits. One consequence of high state cigarette tax rates has been increased smuggling as criminals procure discounted packs from low-tax states to sell in high-tax states. Growing cigarette tax differentials have made cigarette smuggling both a national problem and a lucrative criminal enterprise.

Read the rest here

If it can happen to the US, then this can happen elsewhere. Yet in contrast to the popular wisdom where proliferation of smuggling has been a consequence of delinquent administration or lax enforcement, the crux of the problem is in the taxation.

Dealing with symptoms will hardly serve as a sufficient cure to the disease.

Lured by More Debt, Chinese Stocks Zoom

All it takes is to give the substance which addicts pine for.

Friday’s closing from Bloomberg

From Bloomberg: (bold mine)

China’s stocks rallied, sending the benchmark index to its biggest gain in four months, amid speculation the government is loosening funding restrictions for property developers and banks to support economic growth.

Shanghai Pudong Development Bank Co. (600000) and Industrial Bank Co. both surged at least 6.6 percent. The China Securities Regulatory Commission said after exchanges closed that lenders can issue preferred shares. China Vanke Co. and Poly Real Estate Group Co. jumped more than 6 percent after the Shanghai Securities News reported regulators are reviewing financing applications from “many” listed developers.

The Shanghai Composite Index (SHCOMP) climbed 2.7 percent to 2,047.62 at the close, the biggest gain since Nov. 18, after reaching record-low valuations yesterday. Policy makers are trying to bolster real estate and financial companies as the economy slows and bad debts increase. Allowing lenders to sell preferred shares would give them a new way to meet long-term fundraising requirements…

The Shanghai index has dropped 3.2 percent this year as analysts cut their estimates for 2014 economic growth, the nation suffered its first onshore corporate bond default and an unlisted developer collapsed. Today’s announcement on preferred shares follows a government statement this week that China will speed up construction projects to bolster the economy.

Preferred stocks are a hybrid instruments or as defined by Wikipedia.org "may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument". So the Chinese government essentially incentivize the overindebted entities to have access to more credit via alternative ways.

This announcement comes a day after reports that China’s largest private steel maker the Highsee Group has failed to repay a 3 billion yuan ($3.75 billion) that threatens another account of bankruptcy or default.

Another report also says that Chinese economy has been materially slowing

From another Bloomberg report

China’s economy slowed this quarter, with industries including retail and mining showing weaker revenue growth while loans through non-traditional channels became more expensive, according to a private survey.

Even with the moderation, the labor market and wage growth were little changed from the previous quarter, according to the China Beige Book survey, published by New York-based CBB International.

The report adds to signs that Premier Li Keqiang may face difficulties reaching an expansion target of 7.5 percent this year without stimulus. The State Council, or cabinet, said this week it will speed up construction projects and other measures to support the economy after data showed moderating growth in industrial production and investment.

So the Chinese government seems to be applying a whack-a-mole approach or to deal with the problem as they appear. Treating symptoms rather than the disease is a kick the can down the road strategy. Yet the debt problems comes in the face of a slowing economy which magnifies the default risks.

But don’t worry be happy. Stocks should continue to rise even when problems mount.

China's debt problem is further compounded by her currency woes. 

China’s currency continues to crash as shown by the US Dollar-renminbi (yuan). The USD-Rmb collapsed by 1.2% this week!

The yuan has now crossed the Rmb 6.2 threshold considered by some analyst as “danger zone” because the previously one way trade has attracted many export companies to use “complex hedging products” with the said level as the watershed for losses. There has been “roughly $150bn of such positions remained open when the renminbi began its rapid decline in mid-February, and that current mark-to-market losses on such products stand at more than $2bn,” according to the Financial Times.

As I noted during this week’s second default

Have a debt problem? Easy, for modern day government the solution has just been to borrow and spend. Problem solved.

How many more stimulus in the face of waves of debt defaults just to boost the markets? Interesting stuff.

The same question applies.

Social Cycles: The Rise and Fall of Civilizations

Cycle as defined by dictionary.com is “any complete round or series of occurrences that repeats or is repeated.”

And cycles are not only evident in natural sciences (e.g. planetary, organic, physics), but most importantly in the dynamics of human social relations.

Aside from business economic cycles which occupies much of the discussion of this blog, the rise and fall of civilizations is another example of such social cycles.

There are important lessons to learn from social cycles.

As example, Sovereign Man’s Simon Black has an eloquent narrative of the rise and fall of the French empire. (bold mine)

Throughout the 18th century, for example, France was the greatest superpower in Europe, if not the world.

But they became complacent, believing that they had some sort of ‘divine right’ to reign supreme, and that they could be as fiscally irresponsible as they liked.

The French government spent money like drunken sailors; they had substantial welfare programs, free hospitals, and grand monuments.

They held vast territories overseas, engaged in constant warfare, and even had their own intrusive intelligence service that spied on King and subject alike.

Of course, they couldn’t pay for any of this.

French budget deficits were out of control, and they resorted to going heavily into debt and rapidly debasing their currency.

Stop me when this sounds familiar.

The French economy ultimately failed, bringing with it a 26-year period of hyperinflation, civil war, military conquest, and genocide.

History is full of examples, from ancient Mesopotamia to the Soviet Union, which show that whenever societies reach unsustainable levels of resource consumption and allocation, they collapse.

Mr. Black goes on to cite a recent NASA funded study which identified 32 advanced civilizations that rose and collapsed. Again Mr. Black.

A recent research paper funded by NASA highlights this same premise. According to the authors:

“Collapses of even advanced civilizations have occurred many times in the past five thousand years, and they were frequently followed by centuries of population and cultural decline and economic regression.”

The results of their experiments show that some of the very clear trends which exist today– unsustainable resource consumption, and economic stratification that favors the elite– can very easily result in collapse.

In fact, they write that “collapse is very difficult to avoid and requires major policy changes.”

This isn’t exactly good news.

But here’s the thing– between massive debts, deficits, money printing, war, resource depletion, etc., our modern society seems riddled with these risks.

And history certainly shows that dominant powers are always changing.

Empires rise and fall. The global monetary system is always changing. The prevailing social contract is always changing.

Social cycles are a product of the same series of human interactions that leads to parallel consequences. In short, people hardly ever learn from mistakes to keep repeating them. And such cyclical transitions are hardly ever smooth sailing.

But not everything is bad news. 

Again Mr. Black.

But there is one FAR greater trend across history that supercedes all of the rest… and that trend is the RISE of humanity.

Human beings are fundamentally tool creators. We take problems and turn them into opportunities. We find solutions. We adapt and overcome.

The world is not coming to an end. It’s going to reset. There’s a huge difference between the two.

Think about the system that we’re living under.

A tiny elite has total control of the money supply. They wield intrusive spy networks and weapons of mass destruction. The can confiscate the wealth of others in their sole discretion. They can indebt unborn generations.

Curiously, these are the same people who are so incompetent they can’t put a website together.

It’s not working. And just about everyone knows it.

We’re taught growing up that ‘We the People’ have the power to affect radical change in the voting booth. But this is another fairy tale.

Voting only changes the players. It doesn’t change the game.

Technology is one major game changer. The technology exists today to completely revolutionize the way we live and govern ourselves.

Today’s system is just a 19th century model applied to a 21st century society. I mean– a room full of men making decisions about how much money to print? It’s so antiquated it’s almost comical.

But given that the majority of Western governments borrow money just to pay interest on money they’ve already borrowed, it’s obvious the current game is almost finished.

When it ends, there will be a reset… potentially a tumultuous one.

The 19th century industrial age top-down centralized model has been running on a head on collision with the deepening of the information age characterized by decentralization. And such underlying seismic shifts causes massive societal strains as previously discussed. This is what futurist Alvin Toffler once predicted as the Third Wave. 

And when the socio-political-economic system has been routinely abused to the point that the accrued imbalances reaches a climax and a critical mass, the system eventually implodes. Nonetheless people will adjust to such changes.Thus a reset.

This quote MISattributed to British lawyer and Alexander Fraser Tytler on democracy captures some of the essence of the political-behavioral cycle (wiikiquote):

The average age of the world's greatest civilizations from the beginning of history has been about 200 years. During those 200 years, these nations always progressed through the following sequence:

-From bondage to spiritual faith; 

-From spiritual faith to great courage; 

-From courage to liberty; 

-From liberty to abundance; 

-From abundance to complacency; 

-From complacency to apathy;

-From apathy to dependence;

-From dependence back into bondage.

The reset nears.

Do you know that Shanghai was once an Almost Free City-State?

Austrian economist Dr. Richard Ebeling narrates of Shanghai's laissez faire capitalism experience at the Northwood University blog: 

China’s impressive modernization since the death of Mao Zedong in 1976 and the end to the destructive madness of the Cultural Revolution has been epitomized by the dramatic growth of the industrial and port city of Shanghai, with its majestic skyline of impressive futuristic skyscrapers. It is forgotten that Shanghai already was a commercial and industrial center before the Second World War, built on the principles of laissez-faire capitalism.

Following the Chinese-British War of 1842, several ports along the China coast were opened to Western merchants. In these “treaty ports,” portions of the cities were recognized to be under European jurisdiction. Known as “concession” areas, the European powers administered these areas according to Western principles of the “rule of law,” with recognition and protection of property rights, personal freedom and civil liberties.

By the end of the 19th century, Shanghai had become the most important of the treaty ports. Indeed, it was the industrial, commercial and cultural center of modem China until the Japanese occupation of the city in December 1941, following the attack on Pearl Harbor.

Shanghai an Almost Free City-State

The Western-administered portions of Shanghai were divided into two districts: the French Concession and the International Settlement. A Consul-General appointed by Paris administered the French Concession.

But the much larger International Settlement was administered by a Municipal Council composed of fourteen members elected by the permanent foreign residents of the city, with the franchise based on being a “ratepayer,” i.e., a tax-paying property owner within the boundaries of the International Settlement. By the 1930s, around 90,000 Europeans and Americans lived in Shanghai.

Hence, Shanghai’s International Settlement was almost an independent “city-state” based on the nearly unhampered principles of free trade and free enterprise under the protection of the Western Powers (which ended up meaning mostly a British and American military presence).

In general, the economic policies of Shanghai’s International Settlement followed the ideas of Adam Smith’s system of natural liberty and laissez faire. The Municipal Council limited itself primarily to three functions: administration of justice; police protection of individual liberty and property; and the undertaking of a limited number of “public works,” such as construction of roads, traffic control (administered by Sikh policemen brought by the British from India), harbor patrol, and the dredging of the Whangpoo River that connects Shanghai with the mouth of the Yangtze.

Read the rest here

ASEAN Financial Markets Convulses on Janet’s Yellen’s FOMC Debut

At her inaugural news conference as the head of the US central bank, the US Federal Reserve, Ms. Janet Yellen uttered something that has largely been considered a “taboo” in the financial world.

What did she say? From Reuters:

The U.S. Federal Reserve will probably end its massive bond-buying program this fall, and could start raising interest rates around six months later, Fed Chair Janet Yellen said on Wednesday, in a comment which sent stocks and bonds tumbling…

Ms. Yellen's market shaking statement:

"I -- I, you know, this is the kind of term it's hard to define, but, you know, it probably means something on the order of around six months or that type of thing. But, you know, it depends -- what the statement is saying is it depends what conditions are like."

Why should the higher interest rates suffer the markets? Well the simple answer is DEBT.

So how did ASEAN financial markets react?

Let us first check on Asia’s currency markets.

The Bloomberg data shows that the US dollar soared by over .5% against 5 Asian currencies, the Indonesian rupiah (1.16%), Indian rupee (+.62%), the Philippine Peso (+.58%), the Chinese yuan (+.55%) and the Korean won (+.52%). The US dollar even firmed against the New Zealand and Aussie dollars. 

It was an all US dollar show for today for the rest of Asia.

For the Peso, the USD-Peso has now breached the 45 level (45.1) and is within striking distance at the 52-week high of 45.48. Today’s sharp losses by the Peso essentially piggybacks on the declines of the early week.

Now let us move to the bonds.

ASEAN bonds crumbled today. This has been led by…guess who?…the Philippines whose yields has spiked by 31.3 bps!

Yields of 10 year Philippine bonds have now surpassed the July 2013 “taper tremor” highs.

Didn’t Moody’s just recently blessed the Philippines saying the she won’t be hurt by a sudden stop?  Then why today’s violent  reaction?

Most Asian stocks as shown by the Bloomberg had been hit pretty hard. The Nikkei plunged 1.65%, the Shanghai Index 1.4%, Australia’s S&P/ASX 200 1.15% and Taiwan 1.06%.

Except of Indonesia’s JKSE, ASEAN stocks were the least relatively damaged. 

Indonesia’s JKSE was hammered down by 2.54%. Today's loss which adds to this week’s earlier declines has nearly erased Friday’s dramatic 3.23% advance. 

ASEAN’s stock market still remains very complacent. So far stock markets of Malaysia, Philippines and Thailand appear to be implying that falling currencies and higher yields won’t impact earnings. 

They seem to also forget that once monetary policies of US and other developed economies tightens, emerging markets including emerging Asia will need to align with them. And such policy adjustments will expose on her unsustainable debt levels accrued during zero bound days. Thus the likelihood of more market earthquakes as I previously discussed.

Well good luck to the staunch worshipers of bubbles who believe that they are immune to the growing variety of risks.

 

Perhaps Ben Bernanke could be asking Asian-ASEAN markets: "Miss me yet?" (hat tip zero hedge)

Russia’s Interventions in Crimea: The Geopolitics of Oil Prices

Global politics are a complex dynamic.

I previously noted that Russia’s response to the Ukraine’s political crisis may have been a pushback on what the former’s political leaders see as “encirclement strategy” (Russia’s government doesn’t want to see US-NATO troops on her door steps). This via indirect interventions by the US on the latter’s affair.

But there seems to be another angle: the actions of the Russian government could have been meant to keep oil prices up. As the prolific fund manager Louis-Vincent Gave of Gavekal.com sums up “when the oil price is high, Russia is strong; when the oil price is weak, Russia is weak”

Mr. Gave writes [www.gavekal.com, hat tip John Mauldin, with Mr. Gave’s permission, Thanks Louis] (bold mine, italics original):

Nineteenth century statesman Lord Palmerston famously said that “nations have no permanent friends or allies, they only have permanent interests.” As anyone who has ever opened a history book knows, Russia’s permanent interest has always been access to warm-water seaports. So perhaps we can just reduce the current showdown over Crimea to this very simple truth: there is no way Russia will ever let go of Sevastopol again. And aside from the historical importance of Crimea (Russia did fight France, England and Turkey 160 years ago to claim its stake on the Crimean peninsula), there are two potential reasons for Russia to risk everything in order to hold on to a warm seaport. Let us call the first explanation “reasoned paranoia,” the other “devilish Machiavellianism.”

Reasoned paranoia

Put yourself in Russian shoes for a brief instant: over the past two centuries, Russia has had to fight back invasions from France (led by Napoleon in 1812), an alliance including France, England and Turkey (Crimean War in the 1850s), and Germany in both world wars. Why does this matter? Because when one looks at a map of the world today, there really is only one empire that continues to gobble up territory all along its borders, insists on a common set of values with little discussion (removal of death penalty, acceptance of alternative lifestyles and multi- culturalism...), centralizes economic and political decisions away from local populations, etc. And that empire may be based in Brussels, but it is fundamentally run by Germans and Frenchmen (Belgians have a hard enough time running their own country). More importantly, that empire is coming ever closer to Russia’s borders.

Of course, the European Union’s enlargement on its own could be presented as primarily an economic enterprise, designed mainly to raise living standards in central and eastern Europe, and even to increase the potential of Russia’s neighbors as trading partners. However, this is not how most of the EU leaders themselves view the exercise; instead the EU project is defined as being first political, then economic. Worse yet in Russian eyes, the combination of the EU and NATO expansion, which is what we have broadly seen (with US recently sending fighter jets to Poland and a Baltic state) is a very different proposition, for there is nothing economic about NATO enlargement!

For Russia, how can the EU-NATO continuous eastward expansion not be seen as an unstoppable politico-military juggernaut, advancing relentlessly towards Russia’s borders and swallowing up all intervening countries, with the unique and critical exception of Russia itself? From Moscow, this eastward expansion can become hard to distinguish from previous encroachments by French and German leaders whose intentions may have been less benign than those of the present Western leaders, but whose supposedly “civilizing” missions were just as strong. Throw on top of that the debate/bashing of Russia over gay rights, the less than favorable coverage of its very expensive Olympic party, the glorification in the Western media of Pussy Riot, the confiscation of Russian assets in Cyprus ... and one can see why Russia may feel a little paranoid today when it comes to the EU. The Russians can probably relate to Joseph Heller’s line from Catch-22:“Ju st because you're paranoid doesn't mean they aren't after you.” 

Devilish Machiavellianism

Moving away from Russia’s paranoia and returning to Russia’s permanent interests, we should probably remind ourselves of the following when looking at recent developments: 1) Vladimir Putin is an ex-KGB officer and deeply nationalistic, 2) Putin is very aware of Russia’s long-term interests, 3) when the oil price is high, Russia is strong; when the oil price is weak, Russia is weak. 

It is perhaps this latter point that matters the most for, away from newspapers headlines and the daily grind of most of our readers, World War IV has already started in earnest (if we assume that the Cold War was World War III). And the reason few of us have noticed that World War IV has started is that this war pits the Sunnis against the Shias, and most of our readers are neither. Of course, the reason we should care (beyond the harrowing tales of human suffering coming in the conflicted areas), and the reason that Russia has a particular bone in this fight, is obvious enough: oil. 

Indeed, in the Sunni-Shia fight that we see today in Syria, Lebanon, Iraq and elsewhere, the Sunnis control the purse strings (thanks mostly to the Saudi and Kuwaiti oil fields) while the Shias control the population. And this is where things get potentially interesting for Russia. Indeed, a quick look at a map of the Middle East shows that a) the Saudi oil fields are sitting primarily in areas populated by the minority Shias, who have seen very little, if any, of the benefits of the exploitation of oil and b) the same can be said of Bahrain, where the population is majority Shia.

Now of course, Iran has for decades tried to infiltrate/destabilize Shia Bahrain and the Shia parts of Saudi Arabia, though so far, the Saudis (thanks in part to US military technology) have done a very decent job of holding their own backyard. But could this change over the coming years? Could the civil war currently tearing apart large sections of the Middle East get worse?

At the very least, Putin has to plan for such a possibility which, let’s face it, would very much play to Russia’s long-term interests. Indeed, a greater clash between Iran and Saudi Arabia would probably see oil rise to US$200/barrel. Europe, as well as China and Japan, would become even more dependent on Russian energy exports. In both financial terms and geo-political terms, this would be a terrific outcome for Russia.

It would be such a good outcome that the temptation to keep things going (through weapon sales) would be overwhelming. This is all the more so since the Sunnis in the Middle East have really been no friends to the Russians, financing the rebellions in Chechnya, Dagestan, etc. So having the opportunity to say “payback’s a bitch” must be tempting for Putin who, from Assad to the Iranians, is clearly throwing Russia’s lot in with the Shias. Of course, for Russia to be relevant, and hope to influence the Sunni-Shia conflict, Russia needs to have the ability to sell, and deliver weapons. And for that, one needs ships and a port. Ergo, the importance of Sevastopol, and the importance of Russia’s Syrian port (Tartus, sitting pretty much across from Cyprus).

The questions raised

The above brings us to the current Western perception of the Ukrainian crisis. Most of the people we speak to see the crisis as troublesome because it may lead to restlessness amongst the Russian minorities scattered across Eastern Europe and Central Asia, and tempt further border encroachments across a region that remains highly unstable. This is of course a perfectly valid fear, though it must be noted that, throughout history, there have been few constants to the inhabitants of the Kremlin (or of the Winter Palace before then). But nonetheless, one could count on Russia’s elite to:

a) Care deeply about maintaining access to warm-water seaports and

b) Care little for the welfare of the average Russian

So, it therefore seems likely that the fact that Russia is eager to redraw the borders around Crimea has more to do with the former than the latter. And that the Crimean incident does not mean that Putin will try and absorb Russian minorities into a “Greater Russia” wherever those minorities may be. The bigger question is that having secured Russia’s access to Sevastopol, and Tartus, will Russia use these ports to influence the Shia-Sunni conflict directly, and the oil price indirectly?

After all, with oil production in the US re-accelerating, with Iran potentially foregoing its membership in the “Axis of Evil,” with GDP growth slowing dramatically in emerging markets, with either Libya or Iraq potentially coming back on stream at some point in the future, with Japan set to restart its nukes ... the logical destination for oil prices would be to follow most other commodities and head lower. But that would not be in the Russian interest for the one lesson Putin most certainly drew from the late 1990s was that a high oil price equates to a strong Russia, and vice-versa.

And so, with President Obama attempting to redefine the US role in the region away from being the Sunnis’ protector, and mend fences with Shias, Russia may be seeing an opportunity to influence events in the Middle East more than she has done in the past. In that regard, the Crimean annexation may announce the next wave of Sunni-Shia conflict in the Middle East, and the next wave of orders for French-manufactured weapons (as the US has broadly started to disengage itself, France has been the only G8 country basically stepping up to fight in the Saudi corner ... a stance that should soon be rewarded with a €2.7bn contract for Crotale missiles produced by Thales and a €2.4bn contract for Airbus to undertake Saudi’s border surveillance). And, finally, the Crimean annexation may announce the next gap higher in oil prices.

In short, buying a straddle option position on oil makes a lot of sense. On the one hand, if the Saudis and the US want to punish Russia for its destabilizing actions, then the way to do it will be to join forces (even if Saudi-US relations are at a nadir right now) and crush the oil price. Alternatively, if the US leadership remains haphazard and continues to broadly disengage from the greater Middle East, then Russia will advance, provide weapons and intelligence to the Shias, and the unfolding Sunni- Shia war will accelerate, potentially leading to a gap higher in oil prices. One scenario is very bullish for risk assets, the other is very bearish! Investors who believe that the US State Department has the situation under control should plan for the former. Investors who fear that Putin’s Machiavellianism will carry the day should plan for the latter (e.g., buy out-of-the-money calls on oil, French defense stocks, Russian oil stocks).

My thoughts 

The above chart from Daily Reckoning which I earlier pointed out represents oil prices required to maintain welfare states of many top oil producing countries (based on 2012). This should much higher today. So if the US-Saudi consortium will punish Russia by way of forcing down oil prices then many of these oil welfare states will incur financing problems that may lead not only to bigger fiscal issues but also to another wave of internal political upheavals or “Arab Spring” 2.0. This may lead to oil supply disruptions and higher prices.

And since Saudi Arabia’s breakeven may be at $80 per bbl, then a dramatic drop in oil prices seem not to be in the interest of Saudi.

On the other hand, Mid-East wars and the risks of its escalation that will cause a spike in oil prices or an “oil shock” will likely spur more economic and political uncertainties. This should also bring forth stagflation which means soaring interest rates that may prick global debt bubbles.

And as previously noted “oil shocks” have been linked with recessions.

University of California economic professor James Hamilton argues that an “oil shock” played a substantial role in the recession of 2008. Mr. Hamilton further noted that high oil prices had been linked with 11 of the 12 post World War II recessions.

So current developments in Crimea may extrapolate to a deeper conundrum for global financial markets and world economies.

Video: 1,000 Years of Constant European Border Shifts

The Marketwatch.com writes: (ht: Gary North)

The borders of Europe have been static since the breakups of the Soviet Union, Czechoslovakia and Yugoslavia, and the reunification of Germany, but look set to shift shortly, if the Duma in Moscow ratifies the stated desire of a Crimean majority to quit Ukraine for Russia. But a broader perspective, taking into account the past 1,000 years of European history, shows that change on the continent has been a near-constant.

Watch on Loiter.co as Centennia Historical Atlas software condenses Europe’s history into a 3 ½-minute video representing the shifting borders from A.D. 1,000 through 2003: 

Video: Marc Faber: A lot of funny deals in China’s colossal bubble

Gloom Bloom & Doom publisher Dr. Marc Faber shares some very interesting insights on China and on Russia’s Putin in the following video interview with Bloomberg.

With regards to China’s deflating colossal bubble and statistical inconsistencies (transcript from Zero hedge) [bold mine]

...we had a colossal credit bubble in China and that this credit bubble is now being gradually deflated and will bring about problems in the real estate market and among some major players in the commodity markets as well. So overall, if I look at export figures from China, and they are very closely correlated to overall economic growth, then there is a huge discrepancy between what China reports and what China’s trading partners are reporting.

So if you look at the figures of China, exports are still growing. If you look at the trade figures China exports to Taiwan, so China records exports of so and so much. The Taiwan report imports from China at a much lower level. So which figures are more reliable? I think the figures of the trading partners of China are more reliable. And they would suggest that growth has slown down considerably.

Well deflating bubble and a slowing economy has not been surprising to us. 

More on the reliability of statistical data....

Governments will always publish the statistics that they wish to show irrespective whether that is in China or in other countries. Governments control basically the statistical offices, so they can show whatever they want. As Stalin said, it’s not important who votes but who counts the votes. And the government counts the statistics.

Now the kicker: A lot of funny deals in China’s trade financing…

...the fact is simply that Chinese stocks have been just about the worst performing stocks since 2006. Now analysts will dismiss that and say everything is perfect in China, but the stock market does not seem to believe everything that the government is saying about the economy. And clearly there are strength signs in the Chinese economy. In particular, as I said, we have this huge explosion of debt. Debt as a percent of GDP has increased in the last five years by more than 50 percent. Total debt is now over 215 percent of GDP, and a lot of it is trade finance that is being rolled over.

In addition to that, there are lots of funny deals. A friend of mine who analyzes China very carefully, Simon Hunt (ph), he pointed out that trade finance between one state-owned enterprise and a private company has amounted to over $5 trillion by continuing to roll over the same collateral several times. There’s lots of funny things that are happening in China. And when the whole thing unwinds it will be a disaster.

This looks like "Rehypothecation" which Investopedia.com defines as “The practice by banks and brokers of using, for their own purposes, assets that have been posted as collateral by their clients.” In other words, perhaps a lot of the trading finance debt has very little or even no collateral supporting them. 

On Putin’s action at Crimea

Mr. Putin did the right thing from his perspective. We have to look – put ourselves into his shoes. He did absolutely the right thing at the right time.

...By that I mean that there was interference by foreign powers in Ukrainian politics that were unfavorably from the perspective of Russia.

...The Crimea is strategically most important for Russia. It has practically no meaning strategically to the United States or to Europe. But for Russia it’s very important. I don’t think that Russia will move further into Ukraine unless there is serious provocation. But I doubt it will happen. But I think the wider implication is that we have now border lines. In other words, the US would intervene if a foreign power would establish bases in Haiti and in Cuba and so forth and so on, and the Chinese will react if foreign powers threaten Chinese access to resources.

Possible implications…

This is very important because the occupation or say the referendum (ph) in Crimea and Crimea moving to Russia gives essentially a signal to China that one day they can also move and seize some territory that they perceive that belongs to them.

This could also extrapolate to greater risks of real military conflicts surrounding territorial disputes. 

Have a nice day.

The Importance of Cash: The case of the €500 Note

Contra many governments whom has been at war with cash, e.g. Italy, Mexico, Russia, Nigeria and Ghana and US (add to this my personal experience at the domestic airport) here’s why cash plays a vital role in society.

An incisive anecdote from the Wall Street Real Times Economic Blog:

After the collapse of Lehman Brothers in 2008, public’s faith in banks wavered in many countries, sending people to exchange their savings for cash. Demand for the euro banknotes surged in and outside the euro area. “We could have not handled it without the €500 note,” Mr. Heinonen said.

Cash may function as one of the potential safehavens against bank failures.

Video: Communications Sabotage: Why the Missing Malaysian airline has likely been a Hijack

(hat tip Gary North)

From the Wall Street Journal Digital Network:

Updated to add: There may have been a fourth way fliers of the missing plane used to avoid detection. The MAS 370 was reported by the New Strait Times to have used "Terrain Marking" or flew at an altitude of 5,000 or lower.(ht: lewrockwell.com)

Bank Deposit Confiscation and the Lessons from the 2013 Cyprus Crisis

Sovereign Man Simon Black has a wonderful recollection of the events that led to the 2012-2013 Cyprus crisis and the ensuing bail-in or deposit confiscation, technically named as “bank deposit levy”

Mr. Black writes: (bold original)

It was almost exactly one year ago to the day that an entire nation was frozen out of its savings… overnight.

Cypriots went to bed on Friday thinking everything was fine. By the next morning, they had no way to pay bills or buy food.

It’s certainly a chilling reminder of how quickly things can change. And why.

The entire crisis sprang from a mountain of debt. The government had accumulated too much debt. The banking system had accumulated too much debt.

And banks had lost a lot of their customers’ money making risky, stupid bets on things like Greek government bonds.

By March 2013, Cypriot banks were almost entirely devoid of cash.

Sure, customers could log on to a website and check their bank balances.

But there’s a huge difference between a number displayed on a screen, and a well-capitalized bank that actually holds abundant cash.

The government was too insolvent to bail anyone out. And as a member of the eurozone, Cyprus didn’t have the ability to print its own money.

So they did the only thing they could think of– confiscate customer deposits.

And they imposed capital controls on top of that to make sure that people couldn’t withdraw their remaining funds out of the banks as soon as the freeze was lifted.

It was a truly despicable act. But again, even though it all unfolded overnight, the warning signs were building for at least a year. Especially the debt.

Having escaped the Euro-crisis, Cypriot officials developed a sense of severe overconfidence. They bragged about having passed the Eurozone banking stress test, and even received numerous accolades for the so-called excellence in banking management. Yet officials hardly recognized the excessive risks that their financial system was absorbing until the system broke. This looked very much like a classic sign of a pre-crisis mania.

So hindsight is 20-20. The point is that bad things (crisis) don’t just happen. Financial crises are outcomes of a process. These occur or surface when the accretion of imbalances hit a ‘tipping point’ or a ‘critical mass’. 

During boom days, rising asset prices hardly assumes away the risks involved. To the contrary, rising prices when funded by “a mountain of debt” are symptoms of acute overconfidence that have been masking the buildup of risks.

And the worst part is that governments have been “innovating” by the employment of a larger form of dragnet to capture the private sector’s resources…in the case of Cyprus—deposit bail in or confiscation.

And one year after the bail-in, Cyprus has still been mired in an economic depression

Despite the stock market boom, Mr. Black goes to warn about the mounting risks in the US…

When countries, central banks, and commercial banks accumulate too much debt, and specifically too much debt relative to assets, you can be certain there is trouble ahead in the system.

Think about it like your own personal finances. If you have a million dollars in debt, that seems like a lot. But if you own a home worth $5 million, you are still in good shape financially.

If, on the other hand, you have a million dollar mortgage for a home that’s worth $250,000, you’re in deep trouble.

The US government’s official, ‘on the books’ debt now exceeds $17.5 trillion. This is an enormous figure.

If the Uncle Sam just happened to have $20 trillion or so laying around, however, this debt load wouldn’t be a big deal. But that’s not the case.

By the US government’s own admission, their own financial statements show net equity (assets minus liabilities) of MINUS $16.9 trillion.

That’s including ALL the assets: Every tank. Every bullet. Every body scanner. Every highway.

Then you have to look at the Central Bank, which is itself teetering on insolvency.

The Federal Reserve’s balance sheet has exploded since 2008, and right now the Fed’s net equity (assets minus liabilities) is about $56 billion.

That’s a razor-thin 1.34% of its $4 trillion in assets (it was 4.5% before the crisis).

Here’s the thing: in its own annual report, the Fed just admitted that it had accumulated ‘unrealized losses’ totaling $53 billion. This is almost the Fed’s ENTIRE EQUITY.

So in the Land of the Free, you now have an insolvent government and insolvent central bank underpinning a commercial banking system that is incentivized to make risky, stupid bets with their customers’ money.

To be fair, I’m not suggesting that bank accounts in the US are going to be frozen tomorrow morning.

But a rational person should recognize that the warning signs are very similar to what they were in Cyprus last year.

As for rational people they seem to headed towards extinction, as more and more people are being sucked into the financial market "Truman Show"

Yet the lessons of the Cyprus Crisis of 2013 should not be seen only in the context of the US but is as relevant to other nations, whether China, Japan, ASEAN or the Philippines.

Since the baptism of the bail-in experiment, a growing number of governments have indicated their willingness to use the Cyprus model. This means that once the boom morphs into a bust via the “Black Swan” or Wile E. Coyote moment, the Cyprus model may just become a standard form of government response.

These are writings on the wall.

China’s 2nd Bond Default, EU and US imposes Sanctions on Russian Officials

China’s first bond default occurred just about 2 weeks back.

Today the Bloomberg reports a second company to declare a bond default. (hat tip zero hedge)

A closely held Chinese real estate developer with 3.5 billion yuan ($566.6 million) of debt has collapsed and its largest shareholder was detained, said government officials familiar with the matter.

Zhejiang Xingrun Real Estate Co. doesn’t have enough cash to repay creditors that include more than 15 banks, with China Construction Bank Corp. (939) holding more than 1 billion yuan of its debt, according to the officials, who asked not to be named because they weren’t authorized to discuss the matter. The company’s majority shareholder and his son, its legal representative, have been detained and face charges of illegal fundraising, the officials said.

The collapse of the company, based in the eastern town of Fenghua, adds to concern of strains in the nation’s real estate sector and comes less than two weeks after the first bond default by a Chinese company. Shanghai Chaori Solar Energy Science & Technology Co.’s inability to repay its debt may become China's own “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. securities firm was rescued in 2008, Bank of America Corp. said March 5. 

The second incident in just two weeks with much more to come.

But China’s stock markets looked the other way and instead zoomed ahead. Why? Because of reports of a government stimulus (again)

From another Bloomberg report  (bold mine) 

China’s stocks rose to the highest level in a week, led by property, auto and cement companies, after the government outlined urbanization plans.

China Vanke Co. and Poly Real Estate Group Co., the nation’s biggest developers, advanced more than 1 percent, while Anhui Conch Cement Co. gained the most in a month. SAIC Motor Corp. led a rally for automakers. China will invest more than 1 trillion yuan ($163 billion) redeveloping shantytowns this year, state broadcaster China Central Television reported yesterday.

Have a debt problem? Easy, for modern day government the solution has just been to borrow and spend. Problem solved.

How many more stimulus in the face of waves of debt defaults just to boost the markets? Interesting stuff.

Now to the Ukraine political crisis.

In a referendum recently held, people from Crimea voted overwhelmingly (96%) to secede from Ukraine and join Russia. But the Western government refused to acknowledge the outcome and instead imposed sanction on Russian officials.

From Reuters:

The European Union is to impose sanctions including asset freezes and travel bans on 21 officials from Russia and Ukraine after Crimea applied to join Russia on Monday following a weekend referendum, Lithuania's foreign minister said.

Crimea's leaders declared a Soviet-style 97-percent result in favor of seceding from Ukraine in a vote condemned as illegal by Kiev and the West.

After a meeting lasting around three hours, the EU's 28 foreign ministers agreed on a list of those to be sanctioned for their part in Russia's seizure of Crimea and Sunday's referendum on joining Russia.

The US have joined the EU. From the CNBC

U.S. President Barack Obama imposed sanctions on 11 Russians and Ukrainians on Monday blamed for Russia's military incursion into Crimea, including two top aides to Russian President Vladimir Putin.

Obama's order freezes any assets in the United States and bans travel into the country of 11 people named as responsible for the Russian move into Ukraine's Crimea region.

Among those sanctioned were ousted Ukraine President Viktor Yanukovich and Putin aides Vladislav Surkov and Sergei Glazyev.

And I thought the West has been about promoting 'democracy'?

As the former US congressman Ron Paul wrote,

The Obama Administration’s policy toward Ukraine is hypocritical. The overthrow of the government in Kiev by violent street protests was called a triumph of democracy, but when the elected parliament in autonomous Crimea voted last week to hold a referendum to decide its future, President Obama condemned it as a violation of international law. What about the principle of self-determination, which is also enshrined in international law

So democracy seem as really about whose nests are being feathered.

So far, sanctions has been directed only to officials. But one thing can lead to another. The question now is how will the Russian leadership react? What if Putin and co. retaliates?  Will this not lead to an escalation? Will this not bring about greater risks of a collapse in global trade, and worse, war? 

Again Dr. Ron Paul (from the same article) echoing the great French classical liberal Frederic Bastiat

Though many mistakenly believe that sanctions are a relatively harmless way of forcing foreign countries to do what we say, we should be clear: sanctions are an act of war.

Don’t worry be happy. 

US and European stock markets seem to have discounted the above risks and appear to be relishing the moment by markedly bidding up equity assets. 

In today's central bank supported equity markets which looks like a Truman Show, Bad news is good news.