Phisix: Global Financial Volatility Intensifies

Fourth Touchdown into the Bear Market Zone

The Philippine equity benchmark, the Phisix touched the bear market zone for the FOURTH time since June 2013 this week. This comes amidst two successive weeks of heavy foreign selling where net foreign sales accounted for about 11.18% (Php 6.475 billion) of the two week volume of Php 57.9 billion. 

However, in contrast to previous week, the Phisix resonated on the steep volatility of the US stock markets.

Monday’s over 2% slump by US stock markets rippled through Asian stock markets the following day. Japan’s Nikkei 225 suffered a quasi-collapse of 4.18% (-11.23% year-to-date), Hong Kong’s Hang Seng tumbled 2.98% (-7.16% ytd) while the Phisix tanked by 2.15%[1] (+2.06% ytd).

By the end of the week as US markets pole-vaulted to recover all of Monday’s losses to even close the week higher, e.g. S&P 500 +.81% (-2.78% ytd), where risk OFF abruptly morphed into risk ON.

Asian markets rallied sharply to shave off Monday’s losses. For instance the Nikkei posted a weekly 3.03% loss, the Hang Seng -1.81% and the Phisix -.5%. Indonesia and Thailand’s equity benchmarks the JKSE and the SETI even registered sharp gains 1.08% and 1.74% respectively.

Amazingly, even Singapore’s stock market broke below the September 2013 lows early this week, but like the Phisix, the STI rallied furiously by the week’s close.

The purpose of my reference to Singapore has been to demonstrate that financial stress hasn’t been limited to emerging markets but has begun to impact even developed economies.

This seems part of the periphery-to core transmission mechanism in motion.

And this also validates my repeated observations on the predominating character of stock market activities[2].

We should expect sharp volatility in the global financial markets (stocks, bonds, commodities and currencies) in the coming sessions. The volatility may likely be in both directions but with a downside bias.

Such volatility has hardly been manifestations of a bullish backdrop. Instead they seem like a varied strain of the 1994-1997 episode, which are reflections of a “toppish” or increasingly high risks financial markets.

Yet today’s degree of volatility has been muted relative to pre-Asian crisis landscape where then the Phisix endured a series of vertiginous rollercoaster swings marked by four sharp sell offs (3 of which had been bear market strikes) that had been accompanied by very ferocious denial rallies for two years (1994-1995). 

The rollercoaster eventually transitioned into a bull trap. In 1996 to early 1997 the Phisix went on to recover the highs of 1994 (56% gain). But like all bull traps, the Phisix eventually succumbed to a full bear market cycle where the local benchmark hemorrhaged nearly 70% from the 1997 highs[3]. 

The fourth attempt by the Phisix last week to reach the bear market territory is a reminder of how treacherous today’s markets operate on.

Phisix and US Treasuries: the Devil and the Deep Blue Sea

Yet for many of those afflicted by the Aldous Huxley “facts do not cease to exist because they are ignored” syndrome they cling on to spurious logic in support of the bullish backdrop whose foundations are presently being eroded by signs of sustained rise in interest rates.

For instance many fail to see of the relationship between yields of 10 US treasury notes with the actions of the Phisix. The overlapped charts of the Phisix (PSEC) and 10 year UST yields (TNX) have shown of emerging correlations since May 2013.

Notice that each of the Phisix ‘lower’ peaks (blue ellipses) comes in the face of either low or bottom in UST yields. And that for each time the UST yield reach an interim apex (red ellipses) the Phisix bottoms. Put differently when UST yields begin to rise, this puts selling pressure on the Phisix and vice versa.

Yet if the current correlations persist then this implies that for the Phisix to have a sustainable upside move, US bonds should continue to rally or that yields should be in a falling streak. This should be conditional to US stocks trading either sideways or to the upside and NOT on the downside.

The fantastic two day rally in the US stock markets (of more than 2%) last Thursday and Friday provides us some clues.

Excess volatility has pervaded into the US bond markets too. Monday’s US stock market selloff incited a fierce rally in US bonds (where yields collapsed). US bonds fell (yields rose) from Tuesday until Thursday, in response to Monday’s sharp rally (falling yields). The yield spike in Wednesday was followed thru in Thursday. By Friday, much of Thursday’s yield gains had been reduced. 10 year USTs ended the week very little change despite the wild pendulum swings over the week.

What activities influenced both the actions of the stock and bond markets? The gains of US stocks and rising UST yields came amidst anticipation of a strong jobs report for Friday.

At the same time, ECB’s Mario Draghi floated a “teaser” for the Wall Streets spanning the Atlantic and Pacific Oceans. The ECB reportedly would act by March “to counter low inflation”, this partly by suspending sterilization or “ending the absorption of crisis-era bond purchases” in order to flood Europe’s system with more liquidity[4].

Also the US government reported that trade deficit widened as exports fell[5].

[As a side note, I have been saying[6] the reason why the Fed has resorted reluctantly to the “taper” has been because of the looming shortages of debt papers issued by the US government due to improving twin deficits in both budget and trade. Wider trade deficit means more leeway for the Fed to cease with “tapering”]

So while the anticipation of good news in the job markets resulted to higher yields, the gains appear to have been capped by the signalling of monetary easing from the proposed unsterilized injections by the ECB and from a wider US trade deficit.

Thus the scent of monetary heroin sent stocks into a Risk ON “high” mood.

Friday confirmed Wall Street’s addiction to monetary heroin. Aside from increases in earnings of several companies, the disappointing job report heightened the speculations for monetary easing, as this news report implies, the Fed has been “scrutinizing employment data to determine the timing and pace of cuts to stimulus”[7] So the “bad news is good news” has sent stocks into another overdrive session as bond yields fell.

But there is a big hole with the concept of a sustained decline of yields of USTs considering the record borrowing in the bond market which has now spilled over to banking system.

For instance fund withdrawal from emerging markets, has reportedly further fuelled a “doubling down” of Wall Street’s buying in junk bonds[8]

As the Bond King PIMCO’s William Gross rightly explains[9] (bold original)

Asset prices are dependent on credit expansion or in some cases credit contraction, and as credit goes, so go the markets, one might legitimately say, and I do most emphatically say that!

A sustained inflationary boom in the US would mean higher bond yields due to greater demand for credit and/or due to rising pressures on price inflation mostly on the input prices in support of the bubble sectors.

In other words, for as long as the US stock market bubble inflates, there will pressure on yields of USTs to rise. On the other hand, if US stock markets convulses, this will likely be accompanied by a slowdown in credit thus rallying bonds.

The proof of the latter has been a record outflow from stocks to bonds in the US (US $24 billion) and the world (US $28 billion) in the week through February 5[10].

This bring to fore a devil and the deep blue sea paradox for Emerging Markets including the Phisix. The era of rising stocks amidst low interest rates have increasingly become outmoded. Rising stocks in the US or developed economies will most likely be backed by higher UST yields. This means pressure on emerging markets financial markets.

On the other hand, falling stocks in US and developed economies accompanied by rallying bonds would signal ‘asset deflation’ which will likewise put a lid on any rally for emerging markets.

So the escalating volatility in US treasuries have hardly provides for a bullish backdrop on Emerging Markets and the Phisix.

Direction of US Treasuries as Prognosticator of Emerging Market Money Policies

It’s not just in the correlations in the financial context, rising yields of USTs will soon be revealed in monetary policies of the world. The Emerging Market turmoil represents a symptom of such unfolding progression.

Relative yield spreads in EM will have to adjust in accordance to the directional path of the yields of USTs.

Remember the US dollar remains as the world’s primary reserve currency as shown in the above chart[11]. 86% of the world’s transaction has been facilitated by the US dollar. 64% of the international currency reserves are in US dollar. 46% of debt securities have been priced and issued in US dollar. 65% of the banknotes held overseas are denominated in US dollars and so with cross boarder deposits and banking loans, 59% and 52% respectively.

In short, global trade and finance have been deeply anchored on the US dollar which have been partly reflective of the conditions provided by the monetary policies of the US Federal Reserve. Thus actions of US dollar assets will have material influence in shaping EM policies.

So if yields of UST climb, the rest of the world will follow suit. But this will follow a time consuming process and won’t happen overnight.

Since EM economies took excessive debt in order to generate statistical growth when USTs were low, the coming adjustments would naturally expose on these unsustainable growth models

And symptoms of such adjustments, which so far have been disorderly and violent, have been substantially weaker currencies, higher inflation, foreign outflows and subsequently rising rates (e.g. Turkey, India, Indonesia).

Such adjustments will be seen in the Philippine arena. This has not only been via a falling peso, the pressures are now being felt by the tightly controlled (by government and their allied private sector banks) and less liquid domestic bond markets.

As a side note, for the first time in 2014 or in 5 successive weeks, the Philippine peso rallied to 44.985 vis-à-vis the US dollar this week. This is likely a dead cat’s bounce.

From the short end (1 month) to the mid curve 5 year to the benchmark rate (10 year), the latter usually has been used as basis for the lending rates, to even the long curve the 20 year (not in the above chart), yields across the curve have all reached June 2013 levels. 5 and 20 year yields have even surpassed the June highs. Remember, the crash in domestic bonds which saw a spike of yields in June has been in consonance with the first bear market encroachment by the Phisix over the same period.

Some questions for the bulls: how will rising rates influence the financial positions of over indebted or overleveraged companies? How will rising rates impact credit quality? What will be the ramifications of rising rates to the real and statistical growth aspects of the demand side and the supply side? How will rising rates impact demand and supply of credit? How will higher interest rates amidst high debt levels be bullish for the stock markets? How will high interest rates in the face of relatively higher debt levels today be bullish for foreigners? 

An even more important question is why has the Phisix been sensitive to the movements in the 10 year UST notes, if indeed “fundamentals” have been indeed sound as alleged?

Pardon my appeal to authority, but one of the former major defenders of the status quo, Emerging Market guru Franklin Templeton’s Mark Mobius, who earlier predicted that foreign flows will revive in 2014 due to “fast economic growth, low debt relative to gross domestic product and high foreign-exchange reserves” apparently made a volte face in declaring just the other day, that EM outflows will “deepen” or intensify[12].

Whatever happened to the standard mantra of “fast economic growth, low debt relative to gross domestic product and high foreign-exchange reserves”?

We don’t even look far ahead to see how confused policymakers have been in wavering from one stance to another.

Take for instance the Wall Street Journal notes of a dithering BSP governor Amando Tetangco, who allegedly said a few days back that policy interest rates is “not necessarily the most appropriate response at this time”. But in the face of rising statistical inflation the same article quotes the BSP governor, “We still have room to keep rates steady, but given how these factors play out, that room may be narrowing,” Mr. Tetangco said in a text message to reporters after the data release. “We will see if any adjustments to the stance of policy are warranted based on the balance of these risks to the inflation outlook over our policy horizon”[13]

First BSP officials have been hesitant to use the interest rate channel but updated inflation data[14] seem to have painted the BSP into the corner. Has the BSP been revealing increasing signs of desperation?

For the BSP, who have been blindsided by the adverse effects of soaring M3 (add to this soaring deposit levels), has the inflation chickens come home to roost?

It’s important to add that the BSP data for December[15] shows a still stunning 32.7% jump in M3 growth year on year where claims on the private sector and on other financial corporations constitute 67.83% of December M3. (no credit bubble?)

Not only has soaring M3 been a major symptom of the unsustainable credit boom underpinning the artificial statistical growth, the falling peso has been another transmission channel for higher consumer prices since the Philippines buys more than she produces as evident by her sustained balance of trade deficits.

If rising bond yields have been signs of upcoming consumer price inflation which means a reduction of purchasing power by consumers or a reduction in disposable income, how will this be bullish for the economy and the stock market?

Essentially the BSP’s concerns could be a validation of the results of the recent surveys depicting a serious deterioration of the outlook of the general populace over the quality of life as noted last week[16]. 

And whatever happened to the much hyped foreign currency reserves? The BSP data reveals that forex reserves[17] stumbled by 5.17% last month and 7.42% from a year ago due purportedly to “foreign exchange operations of the BSP and payments by the National Government (NG) for its maturing foreign exchange obligations”.

Has the BSP been massively selling US dollars to shore up the Peso in January? Yet despite the about $4 billion in interventions the peso lost 2.07% over the month.

Will forex currency reserves fail to work as “elixir” as so-claimed by worshippers of the bubble? Will this prove my thesis that forex reserves are symptoms of bubbles rather than signs of strength[18]?

And why the state of confusion by BSP officials?

Because of the resistance to realize that domestic yield spreads would need to be adjusted to reflect on the changes in interest rates of the US. Since the BSP mimicked on the FED’s zero bound rate policies, naturally any aftereffects of the latter will most likely be reflected on the former’s operating environment as presently expressed through the unfolding developments in the financial markets and in the real economy. See the M3 example and the January losses in forex reserves.

The major flaw of the mainstream economic experts, who really are statisticians masquerading as economists, has been to project the past as operating in a linear motion into the future. Yet there have been little incentives for them to understand of the causal realist link or the entwined cause and effect relationships between markets and policies. Besides, incumbent bureaucrats are naturally expected to be salespeople of any administration everywhere, so everything will look rosy until it isn’t.

Remember late last year I noted how the interest rate spread between the US and Philippine 10 bonds have narrowed to a record 78 basis points which I called the convergence trade[19]?

Presently this spread has widened to 168 bps (as of Friday) which has unfortunately been accompanied by market distress. Yet I expect a reversion to the mean in yields of UST and Philippine treasuries to occur sometime and I doubt if this will be in an orderly manner.

And if interest rate levels, for the mainstream, serve as a reflection of creditworthiness of a nation, then what justifies such record interest rate convergence? Statistical economic growth predicated on the actions of mostly the less than 20% of the households whom have access to the formal banking and capital markets? And statistical growth founded on a credit boom which distributes the risks and the benefits to a concentrated few?

And how can a nation with a nominal per capita GDP of US $2,611 (IMF 2012) with a relative underdeveloped banking and financial system, implying the paucity of intermediation channels of savings into investments and equally indicative of high costs of, and limited access, to capital, as well as, high transaction costs and inefficient facilities for capital accumulation, establish a position as being more creditworthy, than say, compared to New Zealand with a nominal per capita GDP of US $38,225? (IMF 2012)

Yield of New Zealand 10 year treasuries have been priced at 4.59% as of Friday which still remains higher than the Philippines.

As reminder yield spreads are based on domestic currencies which even accentuate the grotesqueness of domestic bond market mispricing. Lower rates for the peso postulates to less currency risk for the peso relative to the New Zealand dollar, for instance. All these premised on the less than 20% of households!

Yet it would seem that in a milieu where investors have been conditioned like Pavlov’s dogs through central bank policies to chase yields, running a façade of anti-corruption theatrics combined with a puffery in statistical growth data has been enough to pull the proverbial wool over the eyes of the indiscriminate money allocators.

Well economic reality seems as knocking on the door.

Waking up to the fact that the Philippine Economy has been in a Bubble

Speaking of credit driven statistical economic boom, the BSP finally released their yearend data for 2013[20]. This gives me the opportunity to combine both BSP and NSCB data and see whether the highly acclaimed Philippine economy have been founded on sound principle or from a bubble.

As I noted last week, I find it unusual for timing of the Philippine government’s early release of the NSCB’s statistical growth data when the BSP publishes loans data a month ahead of the latter. 

BSP data reveals that based on nominal peso, loans to the construction sector (right) as well as the real estate sector (left window, green line) has gone parabolic since 2010.

Meanwhile banking loans issued to the trade (wholesale and retail, blue line left window) and financial (red line; left window) industries has likewise accelerated over the same period.

A better perspective can be seen in year on year % change window, where the country’s credit boom can be seen accelerating from 2010, particularly for the real estate, financial, trade and construction sectors, as well as the banking system’s overall loans. For the trade and financials sectors, the boom peaked in 2012, where the loan growth astoundingly ballooned by 43% and 31.75% respectively. Yet despite the slowdown, trade and financial loans remain at 13.82% and 11% in 2013 respectively. The average growth for the past 6 years has been at 20.21% for trade and 13.3% for financials.

Loans to the real estate sector marginally slowed in 2013 but remains at 23.24% after a high of 25.64% in 2012. The average growth over the past 6 years has been at 20.34%.

Meanwhile the construction sector continues to sizzle where loan growth for 2013 skyrocketed by 51.36%. The average loan growth in the past 6 years has been at 19%

Such fabulous growth rates, which have been vastly above general statistical growth, divulge of the extent of leverage being amassed by the underdeveloped banking and financial system to (as I suspect) a few but big players of the abovementioned industries.

The mainstream defense says “low debt levels”. True, if we apply this to the general formal economy. False if this is seen in the prism of credit growth rates of specific industries. Yet the more the concentrated the credit exposure has been, the bigger the risks of a Black Swan.

As a side note, not every firm from the industries registering significant credit growth rates share the same degree of loan exposures or credit risks. Either a majority of the firms in the industry has significant credit exposure or that the issuance of large credit volumes has been tilted towards a few big firms. I suspect the latter than the former.

Now for the juicier aspect.

In the above table, NSCB’s growth data[21] has been shown side by side with BSP banking loan data in terms of % share and growth rates.

On the left section of the table is the % share of the industries, which I suspect, as having been plagued by a massive credit bubble.

Total contribution of these bubble sectors—specifically in trade (wholesale and retail or the shopping mall bubble), financial (bond and stock market bubble), real estate and construction, and hotel (casino bubble) industries to the Philippine gdp in 2013—accounts for 44.84% of the statistical economy. This compares with the 49.61% share of banking loans issued to these sectors.

If we add to the non-bubble manufacturing, share of gdp growth of the above mentioned sectors have been at 65.2% for gdp and 68% for banking loans.

The point of the above exercise is to show the size and scale of banking exposure on a significant critical segment of the statistical economy. In short, a bubble bust will tend to have a major direct impact on the statistical economy, aside from the potential contagion.

As reminder, bubbles are hardly about generalized credit exposure but on the malinvestments or misdirected investments towards the heavy capital goods industries such as construction, and titles to these capital goods, such as the stock market and real estate[22]. This is also the reason why I included the manufacturing sector which so far has shown little signs of credit boom.

The right side of the table has a very illuminating picture of how banking loans extrapolated to statistical growth.

I should be jumping in joy to say that growth in the loans to the financial sector at 11% produced 15.7% of statistical economic growth. This means that 70 cents credit produced 1 peso growth for the financial sector in 2013. The 30 cents should translate to productivity growth. But I would suspect that the numbers may not reveal its true dynamics considering that the financial intermediaries consist mostly of banks and non bank financials and to the lesser extent insurance.

The loan growth by the manufacturing sector at 7.6% relative to the supposed output at 8.6% explains why I don’t consider the domestic manufacturing a bubble. The manufacturing sector has been producing more than they have been borrowing.

Yet what appear as quite disturbing have been in the growth figures of the construction, real estate and hotel industries. For every 1.9 pesos of loans acquired by the real estate sector generated only 1 peso of additional growth. More staggering has been the proportionality of each peso growth for the construction and the hotel industry that has been financed by borrowings of 3.25 pesos and 2.7 pesos respectively.

Why such large discrepancies? Has costs of these projects ballooned faster than expected for developers to seek more financing? Or are the large gaps symptoms of deep inefficiencies of these industries? Or has politics played a role in the additional costs incurred by these sectors? Also have the money borrowed by these sectors been diverted into other ventures?

The figures indicate that growth in these industries have hardly been enough to finance current projects thus the recourse to more loans. This also means some companies may have resorted to ‘debt-in debt-out’ as a way to go around their routine activities. This also points to the increasing sensitivity by these sectors to the fluctuations in interest rates or particularly the deepening dependence on the perpetuation of zero bound rates.

Such developments reveal why the BSP officials have been hesitant to tighten monetary policies or why inflation data has caught them off guard.

In a latest interview with the CNBC[23], the good BSP governor declares a ‘this time is different’ dynamic which allegedly will bring about renewed interest in the Philippine economy. He says that investors will “wake up to the fact that the Philippines is different” and that “investors will focus on the fundamentals again and come back to countries like the Philippines”

I believe he is correct in a sharply contrasting sense. When investors focus on the real fundamentals, and not just ‘shouting’ statistics, they will “wake up to the fact” that the Philippine economy, like most of the economies in the world today, has been in operating in an unsustainable bubble backed by a severely maladjusted economy (weighted heavily to those with access to the banking sector), vastly mispriced assets and the obstinate refusal by policymakers to calibrate their policies to reflect on the current developments in the hope to perpetuate a quasi-permanent boom.

Conclusion and recommendations

-Expect wild gyrations in the global and local financial markets (be it in stocks, bonds and or currencies). The outsized volatility will come in both direction but eventually the downside bias will reassert dominance.

-The extent of volatility is a manifestation of a toppish process and underscores amplified risks which hardly is a bullish environment

-Technically and factually, the Phisix is in a bear market. Therefore until proven wrong, the path of least resistance should be on the downside.

-Emerging markets and the Phisix are all tied to the actions of US monetary policies or bond markets. The nasty side effects of both US and domestic policies are being felt in the local arena.

-Domestic officials will continue to resist adjustments in policies in the hope that boom days will return. The substantial fall in January's forex reserves is an example of such resistance to change. However the more officials resist, the more volatility will occur.

-Price inflation seems now a real concern. Deteriorating sentiment on the quality of life, sinking peso, rising bond yields across the curve and the BSP has been caught in a bind appear to be reinforcing this.

-Price inflation means redistribution of spending patterns. Considering that the Philippine consumer are highly sensitive to food, transportation and energy inflation a rise in inflation translates to diminished disposable income. This means consumer spending will be hobbled. This also means a slowdown on real economic growth.

-Use any rebound to decrease exposure on popular themed stocks, particularly those exposed to shopping malls, real estate, so-called consumer spending stocks and financials (banks and non-banks). Today’s high risk environment will hardly be an issue of return ON investment this will be an issue of return OF investment

-On the urge for stock market exposure. Again avoid popular issues. Choose issues with little or no debt. Choose issues eschewed by the public or by mainstream analysts. Or choose non-popular stocks that have been sold down heavily (more than 50% off the highs) or has flat lined through the boom. Should a black swan occur these stocks are likely to have limited downside. Avoid aggressive positioning.

-There is one reason to be in stocks. Should a global black swan occur in 2014 or 2015, I expect some if not many governments to use Cyprus bail-in or deposit haircut policy paradigm as a way out of the mess. It is not clear though which government/s will resort to them. The stock market can serve as safehaven from such bank deposit confiscation. But timing will be necessary here.

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[1] See Asian Risk OFF Day: Japan's Nikkei Dives 4.2%, Singapore’s STI Breaks Support, Yields of Indonesian Bonds Soar, February 4, 2014

[2] See Phisix: A Bull Trap and the Switch to a Global Risk OFF Mode? January 25, 2014

[3] See Phisix: Don’t Ignore the Bear Market Warnings June 30, 2013

[4] Bloomberg.com Draghi Signals ECB Ready to Wait Until March for Action February 7, 2014

[5] Reuters.com U.S. trade deficit widens in December as exports fall February 6, 2014

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

[7] Bloomberg.com U.S. Stocks Cap Best 2-Day Rally Since October on Economy February 8, 2014

[8] Bloomberg.com Contagion Rejected as Biggest Bond Buyers Double Down on Junk February 6, 2014

[9] William Gross Most Medieval

[10] Bloomberg.com Investors Shift Record Amounts From U.S. Stocks to Bonds February 7, 2014

[11] Zero Hedge Triffin's Dilemma: The 2014 Edition February 5, 2014

[12] See EM Guru Mark Mobius changes outlook, says EM outflows will continue February 8, 2014

[13] Wall Street Journal Real Times Economic Blog As Prices Rise, Philippine Banker Fires Warning Shot on Rates February 5, 2014

[14] Bangko Sentral ng Pilipinas January Inflation Slightly Higher at 4.2 Percent January 30, 2014

[15] Bangko Sentral ng Pilipinas, Domestic Liquidity Growth Slows Down in December January 30, 2014

[16] See Phisix: Will the Global Risk OFF Environment Intensify? February 3, 2014

[17] Bangko Sentral ng Pilipinas End-January 2014 GIR Stands at US$78.9 Billion February 7, 2014

[18] See Emerging Market Turmoil: The Fallacy of Foreign Currency Reserves as Talisman February 3, 2014

[19] See Phisix: The Convergence Trade in the Eyes of a Prospective Foreign Investor November 11, 2013

[20] Bangko Sentral ng Pilipinas Bank Lending Continues to Expand in December January 30, 2014

[21] National Statistical Coordination Board. Philippine Economy Grew by 7.2 percent in 2013; 6.5 percent in Q4 2013 January 30, 2014

[22] Murray N. Rothbard, 15. Business Fluctuations Chapter 11—Money and Its Purchasing Power (continued) Man, Economy and State

[23] CNBC.com Investors will wake up to Philippines 'pretty soon': Central bank February 6, 2014

Hard Lessons from the US Shopping Mall Bust

One of the popular meme has been to project domestic shopping malls as an impregnable investing theme for the Philippines, based on the presumed unlimited spending prowess of the Filipino consumer[1].

As previously discussed and which I won’t elaborate further[2] there that the two common objections against my controversial case on the shopping mall bubble. They can be summed up in terms of sentiment and habit.

The first has been based on the tenuous notion that “crowd traffic” or the “public park” paradigm alone equals store revenues and thus extrapolates to shopping mall revenues. The crowd traffic equals revenue echoes on the dotcom bubble where “eyeballs” or “page views” had been used as justifications to boost stock market prices. Of course in hindsight we know how these misimpressions ended.

The second has been based on the feeble idea that habits are unchangeable or cultural ethos has made shopping malls immune from the laws of economics. Again there is no such thing as people operating in a stasis, as everyone will change in accordance to the changes in the environment or technology or influences in politics or the markets. In the early 90s mobile phones had been a rarity, today mobile phones have become ubiquitous. Such is an example of change.

The ongoing experience of the US shopping mall bust demolishes these objections.

In the US, department stores which peaked in the 2000 have long been in a steep decline. Again the decline of department stores coincided with the dotcom bubble bust.

A recent flurry of job layoffs has been announced in the US shopping mall-big retailing industry

Retail bigwigs such as Sears, JC Penny, Macy’s, Target and Best Buy among many others have announced a wave of store closures and job eliminations. A CNBC article noted of a “tsunami” of forthcoming retail store closures[3].

Moreover, an estimated 15% of shopping malls or retail spaces are expected to be demolished or converted into non retail space within the next 10 years. In addition, one expert believes that half of America’s shopping malls are doomed to fail within 15 to 20 years[4].

Five reasons for the continuing slump in US shopping mall-big retailing arena.

One. As heritage from the 2008 crisis. Notes the Wall Street Journal[5],

Traffic to U.S. retailers was hurt during the financial crisis and recession, when job losses soared and shoppers kept a tight grip on their dollars. But nearly five years into the recovery, it appears many of those shoppers may never be coming back.

Consumers borrowed to spend more than they can afford to pay. Eventually they had pull back as the bills came due. 

Two. Uneven economic recovery. Again from the same article

A Target spokesman said shoppers are making fewer trips as "traffic has been impacted by the uneven economic environment," but are spending more when they do show up.

The FED’s implicit support on Wall Street via the Greenspan-Bernanke-Yellen Put (Zirp and QE) has driven a wedge between main street and Wall Street.

This resonates with the stagflation story for the Philippine consumers.

Three. US $ 1 trillion of legacy debt from the recent crash are coming due over the next three years which some specialty hedge funds have been trying to offer bridge finance[6].

This is the supply side angle of the first factor: Commercial Real Estate or shopping mall or big retail developers built malls or retail outlets MORE than the consumers can afford to spend on, or simply stated, an overexpansion spree financed by debt.

Again bills have been coming due. This is more relevant to the Philippine shopping mall case.

Fourth, change in consumer preference where online sales have become a major alternative channel (again from the WSJ)

Online sales accounted for just 5.9% of overall retail sales in the third quarter, according to the Commerce Department, but they have an outsize impact on how shoppers use stores and what they will pay.

While online sales have been rapidly growing they haven’t entirely been able to replace lost physical retail sales. Nonetheless online sales will cannibalize on costly physical malls or retail space. Online sales I believe will become a dominant force.

Lastly, change in consumer preference in terms of physical stores from CNBC

One big shift in store closings has come from retailers shying away from indoor malls, instead favoring outlet centers, outdoor malls or stand-alone stores. Although new retail construction completions are at an all-time low, according to CB Richard Ellis, the supply of new outlet centers has picked up in recent quarters.

Yes Filipino consumers may not be technically the same as Americans. But the point is economic conditions, technology and shifts in social preferences will impact local habits, activities and buying patterns.

Think of it, if the US, which has a nominal per capita income of $51,704 (IMF 2012) combined with her power to tap the credit from the banks and capital markets that extends her purchasing power, have not able to sustain a debt financed shopping mall boom, how could a lowly economy like the Philippines with a measly $2,611 (IMF 2012) or a mere 5% of US per capita, seemingly parading herself as a pseudo developed economy and whom has frenetically been building malls at a rate that even Americans can’t sustain, be capable of doing so? 

Here is one prediction. Something will have to give.

Finally pls don’t entertain thoughts that today’s giants will remain so or that these so-called blue chips are impervious to any crisis of internal or external in origin. All one has to do is to think about the fate of former titans Lehman Brothers, Bear Stearns, Washington Mutual or General Motors or Enron all of whom ended up as the largest bankruptcy cases in the US[7].

And be reminded, even billions can go to zero in just a year or two as in the case of Brazil’s Eike Batista, who in 2012 was worth $30 billion and today or in less than two years has reportedly a “negative net worth”[8]

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[1] See Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux) January 13, 2013

[2] See Phisix: Escalating Risks from the Region and from Internal Bubbles December 9, 2013

[3] CNBC.com A 'tsunami' of store closings expected to hit retail January 22, 2014

[4] Business Insider America's Shopping Malls Are Dying A Slow, Ugly Death January 31,2014

[5] Wall Street Journal Stores Confront New World of Reduced Shopper Traffic January 16,2014

[6] Bloomberg.com Hedge Funds Preparing for $1 Trillion Property Bill: Mortgages February 6, 2014

[7] Wikipedia.org Largest cases Chapter 11, Title 11, United States Code

[8] Wikipedia.org Eike Batista

Quote of the Day: The desire to impress others is one of the most painful forms of mental imprisonment

The desire to impress others is one of the most painful forms of mental imprisonment.  It not only requires a great deal of time and energy, it eats away at a person’s self-esteem as well.  There is nothing more degrading than knowing, whether or not it is consciously acknowledged, that you are saying something, doing something, or buying something with the primary purpose of impressing others.

Unfortunately, at one time or another, everyone says and does things that are motivated by the desire to elevate his status in the eyes of his peers.  Even the most forthright among us are “on stage” more than we would like to admit, whether or not we are consciously aware of it.  As with everything in life, however, when the desire to impress others gets too extreme, it can be debilitating — even fatal — to the professional purveyor of puffery.

This is from self development author and writer Robert Ringer on the travails of the status seeker

EM Guru Mark Mobius changes outlook, says EM outflows will continue

Emerging market fund manager Franklin Templeton’s Mark Mobius predicts that the outflows on emerging markets will continue.

From Bloomberg:

The worst isn’t over for emerging markets after the benchmark stock index sank to a five-month low and the nations’ currencies tumbled, said Templeton Emerging Markets Group’s Mark Mobius.

“The negative sentiment is pretty much in place so you can expect a lot more selling,” Mobius, 77, who oversees more than $50 billion in developing-nation assets as an executive chairman at Templeton, said in an interview from Rio de Janeiro today. “We are looking but actually not buying at this stage. Prices can come down or take time to stabilize.”

The same article notes that in an interview last January 29 Mr. Mobius predicted that “inflows into developing nations would resume later this year because they have fast economic growth, low debt relative to gross domestic product and high foreign-exchange reserves.”

This seems consistent with his 2014 forecast at the start of the year where he wrote at his Franklin Templeton blog:

As long-term fundamental investors, we do not make short-term predictions for share prices, but we believe longer-term developments that look likely to gain traction in 2014 could drive solid growth potential in many emerging economies.

Pardon me, but based on the above accounts, I interpret Mr. Mobius’ most recent stance as a drastic U-turn.

Has he come to the realization that the standard sloganeering of “fast economic growth, low debt relative to gross domestic product and high foreign-exchange reserves” barely serve as effective antidotes to the current selloff? Or has he come to realize that the supposed advantage of EM are really defective metrics which is why there has been sustained outflows?

Yet it’s odd for people who love to chatter about “long term” seem to fail to understand that “Long term is a product of accumulated short term activities”. This is best epitomized by a popular aphorism from Chinese philosopher Laozi’s “Journey of a thousand miles begins with a single step”. 

Long term outcomes are hardly ever linear. They are dependent on the course of people’s present actions.

Take for instance if Mr. Mobius’ epiphany is correct and outflows continue, what happens if these outflows would lead many EMs to suffer a crisis?  

What will be the respective reactions by each of the affected government of EM nations?

Will they apply more political actions as therapy? Will they resort to capital controls? Will they ballout affected sectors? How will they finance these? By indulging in massive monetary inflation or by raising taxes steeply or (updated to add) by deposit bail-in haircuts? Will protectionism rear its ugly head?

Or will they apply less political actions? What if some governments resort to the following unpopular measures such as allow banks to fail, allow debt defaults, reduce taxes, and or undertake market economy reforms? 

The conflicting actions above will have different impacts to the economic environment for each EM nation. Which of the two environment would be bullish post-crisis?

The point is, to repeat, the long horizon strictly depends on accrued short term actions of society such that an overhaul of the present template of activities will lead to vastly different long term outcomes. 

This also means that "outflows" have not been anomalies or reflective of investor irrationality (as popularly alleged) but instead a manifestation of the evolving dramatic changes in 'fundamentals' in response to earlier easy money conditions. 

"Outflows" are essentially symptoms of the boom-bust cycle.

The Myth of Low Currency Equals Strong Exports: Brazil Edition

Low currency equals cheap exports. That’s the mainstream’s resonant “incantation” as if such a claim represents an a priori irrefutable truth.

In reality, such a claim has really been a myth though. They signify nothing more than propaganda to promote anti competition regulations via Mercantilism that works to favor of vested interest groups (politicians and their allies).

This has been debunked even as far back in the 18th century by Scottish philosopher Adam Smith in his classic Wealth of Nations

As a recent example I pointed out that since Japan’s adaption of Abenomics, such so-called boost to exports through destroying the yen has failed to come about meeting their objectives. Instead this has generated record trade deficits via exploding import growth. The update of charts of the Japan’s exports, imports and trade balance here. 

What Japan’s yen debasement program has only achieved has been to inflate a stock market bubble which has benefited the financial system at the expense of the consumers.

We see the same falsehood being exposed in Brazil where the weak real has brought about faltering exports backed by a decline in industrial production.

From Bloomberg’s chart of the day:

The biggest monthly plunge in Brazil’s industrial output since December 2008 shows policy makers’ confidence that a weaker real will stimulate manufacturing is proving misguided.

The CHART OF THE DAY tracks Brazil’s industrial production index, the real on a percentage-change basis and exports on a rolling six-month average. Output fell in December by the most in five years even as the exchange rate weakened 34 percent since the manufacturing index reached a record-high in May 2011. The currency is the biggest decliner against the U.S. dollar in the last three years among 16 major currencies tracked by Bloomberg after the South African rand.

President Dilma Rousseff said on Feb. 3 that a weaker real would help drive exports this year, an affirmation of Finance Minister Guido Mantega’s comments in September that a currency drop would make Brazilian products more competitive and boost manufacturing. Goldman Sachs Group Inc.’s Alberto Ramos said the government’s optimism isn’t warranted, as companies are hampered by rising labor costs and lack of incentives to modernize.

Low currency equals cheap exports represents a heuristic “oversimplified” way in looking at trade data. Such have been assumed to generalize that all trade are about “cheapness”. 

The reality is that trade, which is a largely function of the private sector conducting voluntary exchanges goods or services across geographical boundaries, are driven by manifold complex intertwined factors: such as subjective preferences of buyers (which are hardly about “cheapness” as cheapness usually indicates low quality or commoditized goods), availability and access to markets, availability and access to financing to facilitate trade, relative ease or convenience of conducting trade, security of transactions and or the institutional protection of market activities (sanctity of contracts) and more. 

Unfortunately “a lie that has been told to often to become a truth” doesn’t apply to mercantilist propaganda, that’s because economic forces will expose on them.

Peter Schiff on Dark Gold

Why has the US Federal Reserve been slow to deliver physical gold owned by Germany’s central bank? Why has China’s government been quietly accumulating physical gold? 

Author and businessman Peter Schiff explains Dark Gold at his company’s website:

Gold is the simplest of financial assets - you either own it or you don't. Yet, at the same time, gold is also among the most private of assets. Once an individual locks his or her safe, that gold effectively disappears from the market at large. Unlike bank deposits or stocks, there is no way to tally the total amount of gold held by individual investors.

I like to call this concept "dark gold." This is the real, broader gold market that exists below the surface-level transactions on the major exchanges. It's impossible to know precisely how much dark gold exists around the world, but we do know that it is enough to render "official" gold holdings insignificant. That's why I don't buy and sell gold based on the decisions of John Paulson, or even J.P. Morgan Chase. It is a long-term investment that requires a deep understanding of the nature of money - and how little Wall Street's media circus really matters.

Observing Dark Gold

Think of dark gold like dark matter. Dark matter is a mysterious substance that scientists hypothesize is an essential building block of our universe. All we know is that the universe is a certain size and that a huge amount of its mass is unobservable - this is what we've come to call dark matter.

We haven't yet looked directly at dark matter. We can only observe phenomena that suggest there is a substance we aren't seeing and can't quite measure.

Likewise, dark gold is an essential building block of global financial stability. But the extremely private nature that makes it so valuable also makes it nearly impossible to directly observe.

But every now and then, we get a glimpse into the hidden undercurrents of dark gold. In the past year, the Federal Reserve slipped up in a big way and momentarily poked a hole that we can peek through to see what's happening with some of the largest stores of dark gold in the world.

Gib Mir Mein Gold!

A year ago, the big news was that the Bundesbank, Germany's central bank, would begin the process of repatriating a portion of its foreign gold reserves, including 300 metric tons stored at the New York Federal Reserve Bank.

The controversy really started in late 2012, when Germany simply wanted to audit its gold reserves at the Fed. They were denied this access, so the Germans switched their approach. If they weren't allowed visitation with their holdings, they would instead demand full custody. In response, the Fed said it would oblige - within seven years!

As of the end of 2013, a Bundesbank spokesman reported that only 5 tons had been transported from New York to Germany so far, leaving the repatriation far behind schedule.

"But wait," some might argue, "the repatriation process might be delayed, but we know the gold is there. Central bank holdings constitute the most visible gold in the world. These institutions report their holdings to the world regularly. The gold at the Fed isn't dark gold at all!"

If this is a true and certain fact, then why was the Bundesbank denied a third-party audit of its gold in the Fed's vaults? The closest we've seen was an internal audit by the US Treasury last year. Of course, the US government holds the sovereign privilege of answering to no one but itself, but that hardly makes for reassuring statistics on which to base one's investments.

Read the rest here

Has the US government been dipping their hand in Ukraine’s political cookie jar?

Just awhile back I had been censured by so called ‘nationalist’ netizens as a ‘conspiracy theorist’ for linking Philippine military spending with that of the US-Israel military industrial complex.

Political logic flows only in singular dimension: the world operates in either black or white (false choice dilemma)

Yet we learn that US foreign policy of low intensity conflict (LIC) has been alive and kicking.

For instance, has the US government been dipping their hand into Ukraine’s political cookie jar? A case of quasi LICs?

Daniel McAdams at the Lew Rockwell Blog explains why the answer is yes…

US Assistant Secretary of State Victoria Nuland and US Ambassador to Ukraine Geoffrey Pyatt were caught in a phone conversation leaked yesterday actively plotting over which of the Ukrainian opposition figures should take which position in a post-coup Ukraine government. In the call, they were furious that the EU was not as quick to move from words to action as the US, and decided to bring in the UN to “glue” the “deal” together instead.

This is a major international scandal, and the implications of this clear evidence of direct US involvement in civil unrest in Ukraine are much more serious than most in the US and EU realize. As is to be expected, however, the US mainstream press is focused not on this evidence of extreme US recklessness and deception, but rather on whether the Russians leaked the call or not. They are ignoring the real core of the scandal to focus on salacious aspects, real or imagined.

Caught red-handed actively planning and manipulating internal politics and acting as if Ukrainian opposition politicians were literally US agents to be ordered into this position or that in a new government, the US State Department behaved as a child with his hand discovered in the cookie jar.

Witness the truly breathtaking performance by US State Department Spokesperson Jan Psaki today at a daily press briefing (and kudos to some of the journalists there who seem to be tuned in to the seriousness of this affair):

Q. Does not the fact that U.S. diplomats purportedly are discussing who should and should not be in the Ukrainian government hint at some possibility of U.S. interference here?

MS. PSAKI: Absolutely not… It’s up to the people of Ukraine, including officials from both sides, to determine the path forward. But it shouldn’t be a surprise that there are discussions about events on the ground.

Q. This is more than discussions, though. This was two top U.S. officials that are on the ground discussing a plan that they have to broker a future government and bringing officials from the U.N. to kind of seal the deal. This is more than the U.S. trying to make suggestions. This is the U.S. midwifing the process.

PSAKI: Well, Elise, you’re talking about a private diplomatic conversation…. Of course these things are being discussed. It doesn’t change the fact that it’s up to the people on the ground. It is up to the people of Ukraine to determine what the path forward it.
…

Q: But I’m sorry, if you’re saying privately behind the scenes that you’re cooking up a deal, and then you’re saying publicly that this is up for Ukrainians to decide, those are two totally different things. I understand that diplomatic discussions are sensitive and you don’t want everything to come out, but those are two totally different — totally different positions.

The entire exchange must be watched to be believed. Even then the brazenness of the lies is unbelievable.

The US government has repeatedly denied and even ridiculed Russian suggestions that the US is playing an active role in the unrest in Ukraine. The tape erases any excuse they might have been able to field.

Read the rest here

Another conspiracy theory or denial of reality?

Walter Block on Economic Warfare

Political arguments in mainstream media have been predominantly framed with reference to some sort of "economic warfare" meant to demean certain agents.

In the following article, Austrian economist and professor Walter Block exposes on such misrepresentations (via Building Blocks for Liberty p 354-356/Mises.org)

Pundits are accustomed to utilizing the language of war and strife to depict economic relationships. This is confusing, irrational and misleading. For the dismal science addresses mutual benefit, or positive-sum games. All participants gain whenever a trade, a purchase, sale, rental agreement, job, etc., gets consummated; necessarily so in the ex ante sense, and in the overwhelming majority of cases ex post.

For example, if I purchase a newspaper for $1, it is an apodictic undeniable truth that at that moment, I ranked the periodical more highly than the money I had to pay for it. Why else, for goodness sakes, would I have been willing to engage in this commercial transaction was this not so? I anticipated that I would benefit from this trade. Even in the ex post sense, from the vantage points of afterward, in virtually all such cases I and everyone else in this position gains. Rare is the case where I, or anyone else for that matter, regrets the purchase of a paper on the ground that there was no good news in it after all, and that was what the buyer was seeking and expecting.

Consider in this regard, then, concepts such as "price war," or "hostile takeover." Here, it would appear, there is not mutual benefit occurring in the market, but rather an antagonistic relationship. Nothing could be further from the truth.

Take the latter first. This charge is fueled by the spectre of corporate raiders who swoop down on a helpless firm, engage in a "hostile takeover," sell off its assets, and fire all the employees. There are numerous fallacies here. First of all, unemployment is created by artificially boosting wages above workers' productivity. If the minimum wage law, or a union, insists that an employee be paid $10 per hour, but he is only worth $7 in terms of productivity, he will be unemployed, period. This has nothing to do with so-called hostile takeovers. Yes, people are fired, but unemployment is no higher in industries that witness such activities than in any other.

But do not corporate raiders sometimes dismember firms for their assets? Indeed, they do. However, they only earn a profit when these selfsame assets are actually worth more in other areas of endeavor than where they were first deployed. This means that if jobs are lost in one corporation, they will be created in others, to the places where the assets are now more productively employed, thus raising wages.

Another socially beneficial effect of the corporate raider concerns salaries of chief executive officers. Many commentators complain that CEO salaries have hit the stratosphere, and constitute an unconscionable exploitation of the workingman. Suppose that the capital value of a firm would have been $100 million if the CEO salary was "moderate," but, because of a stupendous compensation package, it is now worth only $10 million. Such a firm would be ripe for the pickings of a corporate raider. He would purchase this business for, say, $11 million, fire the parasitical CEO, watch the firm's value rise to its "proper" $100 million, and pocket a hefty $89 million in profit. The corporate raider is to outrageous CEO salaries what the canary is to coal mine safety; only he does the bird one better: not only does he warn of a problem, he solves it in one fell swoop. Yet, government, in jailing people like Michael Milken, has obliterated this beneficial market mechanism. And now they have the audacity to complain of out-of-control CEO pay.

As for "hostility" there is no such thing between the buyer and seller of stock. The only "hostile" person is the CEO who was ripping off the firm. But when we say that in the market there is only peaceful cooperation, we mean on the part of those who engage in any specific transaction; e.g., the newspaper buyer and seller. Third parties, of course, can always be hostile. A Marxist, for example, might have his nose put out of joint by all commerce. He is "hostile" to all of them. So what?

What of price war? This, too, is a linguistic contortion. When grocers, or filling stations, for example, lower their prices in an attempt to attract customers, they are very far from having a "war" with those who buy from them. Very much the opposite is the case. As far as the relation of these vendors with each other, the supposed participants in this "war," they are in the same position as the too-high-salaried CEO and the corporate "raider." They are third parties to all these transactions, and, as such, have no standing in any of them. They cannot reveal or demonstrate (Rothbard 1997) their hostility. That is, when customer A purchases groceries or gasoline from seller a, seller b might not like it, but he is not part of this transaction.

In the world of politics “us against them” (false choices) has been a very attractive way to win votes, if not to attain social desirability bias

Quote of the Day: I believe bear markets are made by God

I’ve been thinking about bull and bear markets.  Bull markets are man-made, they are a product of man’s desire for more and more, a product of man’s insatiable greed.  During a bull market investors disregard their need for God.  After all, they are loaded with money, money made on their own, without the help of God.  During bull markets, God is put aside and forgotten.

I believe bear markets are made by God.  Bear markets remind men that their greed and crime must be atoned for.  In bear markets investors become frightened and once again they seek the help and comfort of God.  In bear markets the crime and greed of the previous bull market comes to light.  Bear markets are God’s way of cleansing humanity.  In bear markets the dirty water streams out from under the closet.  In bear markets men turn to God again for peace and help and comfort.

I’d be lying if I said that I wasn’t worried about the way things are going.  Frankly, I’m truly scared for myself, my family and the nation.  I have the sinking feeling that the stock market is on the edge of a crash.  If that happens, investor sentiment will turn quickly bearish.  And the bear market will start feeding on itself.  Ironically, the recent action occurred in the face of almost insane bullishness on the part of the crowd and on the part of investors.

This is thought from the heart quote is from the founder of Dow Theory Letters Richard Russell as excerpted by the King World News (hat tip lewrockwell.com)

Inflation is a process: 1960-80 Edition

One observation I recently received concerned about how US Federal Reserve policies allegedly produced an “immediate inflation” in the 1970s (via stagflation) while today’s massive over $4 trillion of balance sheet expansion as of December 2013 hasn’t produced the same effect.

graphics via the CNN

Well inflation don’t just appear, like a genie, from nowhere. Inflation is a process.

This applies as well to during the 1960s to 1980s

From Wikipedia: (bold mine)

In 1944, the Bretton Woods system fixed exchange rates based on the U.S. dollar, which was redeemable for gold by the U.S. government at the price of $35 per ounce. Thus, the United States was committed to backing every dollar overseas with gold. Other currencies were fixed to the dollar, and the dollar was pegged to gold.

For the first years after World War II, the Bretton Woods system worked well. With the Marshall Plan Japan and Europe were rebuilding from the war, and foreigners wanted dollars to spend on American goods – cars, steel, machinery, etc. Because the U.S. owned over half the world's official gold reserves – 574 million ounces at the end of World War II – the system appeared secure.

However, from 1950 to 1969, as Germany and Japan recovered, the US share of the world's economic output dropped significantly, from 35 percent to 27 percent. Furthermore, a negative balance of payments, growing public debt incurred by the Vietnam War and Great Society programs, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s. The drain on US gold reserves culminated with the London Gold Pool collapse in March 1968.

By 1971, America's gold stock had fallen to $10 billion, half its 1960 level. Foreign banks held many more dollars than the U.S. held gold, leaving the U.S. vulnerable to a run on its gold.

By 1971, the money supply had increased by 10%. In May 1971, West Germany was the first to leave the Bretton Woods system, unwilling to devalue the Deutsche Mark in order to prop up the dollar. In the following three months, this move strengthened its economy. Simultaneously, the dollar dropped 7.5% against the Deutsche Mark. Other nations began to demand redemption of their dollars for gold. Switzerland redeemed $50 million in July. France acquired $191 million in gold. On August 5, 1971, the United States Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against "foreign price-gougers". On August 9, 1971, as the dollar dropped in value against European currencies, Switzerland left the Bretton Woods system. The pressure began to intensify on the United States to leave Bretton Woods.

The above chart from economagic reveals that price inflation didn’t just “appear”. 

The US government had already indulged in monetary inflation as far back in the advent of the 1960s (as seen via M2 blue line). Meanwhile price inflation (CPI red line) began its upward trek only 5 years after. (both are measured via % change from a year ago).

When the Bretton Woods era came to a close, US M2 soared in two occasions. This  led to accompanying spikes in CPI which resulted to ‘stagflationary’ recessions.

Former Fed Chair Paul Volcker was widely credited for wringing out inflation by massively raising interest rates. Although Dr. Marc Faber already noted that the supply side glut from the early inflation has began to impact prices and that Mr. Volcker’s action may have complimented on this adjustment phase. The US economy had 3 agonizing recessions in the late 1970s to the early 1980s following the monetary experiment from the Nixon Shock before the imbalances brought about by previous monetary inflation had been reversed.

The point is inflation is a process which undergoes different stages

As the late Austrian economist Percy Greaves Jr. explained in simple layman terms

The first stage of inflation is when housewives say: "Prices are going up. I think I had better put off buying whatever I can. I need a new vacuum cleaner, but with prices going up, I'll wait until they come down." During this stage, prices do not rise as fast as the quantity of money is being increased. This period in the great German inflation lasted nine years, from the outbreak of war in 1914 until the summer of 1923.

During the second period of inflation, housewives say: "I shall need a vacuum cleaner next year. Prices are going up. I had better get it now before prices go any higher." During this stage, prices rise at a faster rate than the quantity of money is being increased. In Germany this period lasted a couple of months.

If the inflation is not stopped, the third stage follows. In this third stage, housewives say: "I don't like flowers. They bother me. They are a nuisance. But I would rather have even this pot of flowers than hold on to this money a moment longer." People then exchange their money for anything they can get. This period may last from 24 hours to 48 hours.

From the US ‘stagflationary’ experience, market developments combined with policy actions prevented the third stage (crack-up) boom from transpiring. But the policy tradeoff had been to induce harrowing periods of recessions.

Some notes:

-The foundation of the stagflation era of 1970s went as far back to the inflationary policies by the Fed during the early 1960s. The sustained inflationist policies eventually led to consumer price inflation.

-US inflationist policies largely due to the Vietnam war and US welfare (New Society) programs put an end to the Bretton Woods Standards.

-Recessions are necessary to reverse previous monetary abuse. The Bust serve as necessary medicine and therapy for the inflationary boom ailment.

There are also other factors that influence price inflation. For one, productivity growth from globalization helped reduced the impact of US Federal Reserve policies in the post Volcker era. This has been wrongly construed as the Great Moderation.

The massive explosion in the growth of the asset markets supported by debt that have also been instrumental in shifting the nature of the impact of inflation since a lot of monetary inflation today have been absorbed by asset markets (trillion dollar derivatives, bond markets, currency markets, etc...).

Bottom line: Just because statistical consumer price inflation seem subdued today, doesn’t mean there won’t be price inflation tomorrow or sometime in the future.

As one would note from the experience of the 1970s when price inflation emerges, it comes rather quickly. 

And in my view, the highly volatile financial markets today are symptoms such transition, but in a different light: asset inflation boom morphing into asset bust.

The next question is how will central bankers and the government react? Will their response lead to a crack-up boom (ruination of a currency via hyperinflation) or deflationary depression? I call this the von Mises Moment

Asian Risk OFF Day: Japan's Nikkei Dives 4.2%, Singapore’s STI Breaks Support, Yields of Indonesian Bonds Soar

What an astounding risk OFF day. 

The 2+% plunge in US stocks last night hit some Asian markets right smack on the chin.

Japan’s Nikkei 225 plummeted a whopping 4.2% today!

The Nikkei 225’s ongoing meltdown (top  window) which ironically commenced during the New Year, has been tightly correlated with the sharply rallying Japanese Yen vis-à-vis the US dollar.

And it has not just been the Nikkei, Hong Kong’s Hang Seng Index likewise got drubbed by 2.89%. 

Given that China’s financial markets remain closed due to the week long New Year festivities, has the Hang Seng’s decline been an indicator to the sentiment of the Chinese financial markets once they open? 

The Philippine Phisix also tumbled by 2.15% on heavy foreign selling (technistock.net)

Singapore’s stock market benchmark’s decline, as measured by the Strait Times Index (STI), hasn’t been as deep as those above… 

...but today’s action highlights the confirmation of yesterday’s breakdown from key support levels (see above). 

Although the STI is still about 5.9% away from a technical bear market.

And in addition, the weakening STI goes along with a sluggish Singapore Dollar which seems also nearing a breakdown from support levels. 

Singapore’s bond markets seem also in distress. Yields of 10 year Singapore SGD denominated treasuries while down by about 12 bps from the recent highs has still been about 100 bps from the 2013 lows.

Could it be that the strains in Singapore’s financial markets have been  symptoms of her significant exposure on ASEAN economies, with emphasize on Indonesia, as previously discussed?

And speaking of Risk off and Indonesia, yields of the latter’s 10 year rupiah bonds soared today; currently priced at 9.13% (as of this writing) which backed off from a high of 9.27%. Nonetheless current yield stands at the 2011 levels.

Although the Indonesia’s equity bellwether the JCI which is still trading as of this writing has been down by less than 1%.

All this brings us back to the issue of foreign currency exchange reserves.

The mainstream assures us with confidence that forex reserves should shield markets or economies from such events.

Yet none of this panacea appears to be working. That’s because there seems hardly any correlation between stock market/economy and forex reserves.

Just look, Japan has $1.25 trillion in forex reserves. The Japanese government continued to amass forex reserves through her own bubble bust in 1990, the 1997 Asian crisis and the 2007-8 Global Crisis. 

As a side note: Japan’s reserve accumulation may have peaked given the recent record streak of balance of trade deficits as well as record budget deficits.

Meanwhile, despite the current financial tremors, Singapore’s government continues to pileup on Forex reserves which is now at almost $350 billion (about 3x the Philippines). 

Yet with all these accumulation, Singapore has not been immune from the Asian Crisis, US dot.com bust or from 2008 Global Crisis in terms of…

the stock market via the STI… where the STI fell dramatically into bear markets during the above stated episodes

...and or even as exhibited in the statistical economy which reveals of recessions during the above events.

Meanwhile Hong Kong has $311 billion of forex reserves.

And by the way, Indonesia’s government had record forex exchange reserves during the 2008 global crisis and continued to accumulate until the peak in 2011

In spite of all the evidences, the Panglossian consensus continue to holler in unison “forex reserves!”, “forex reserves!”, “forex reserves!”

Has this rabid denial been because "a pleasant illusion is better than a harsh reality?" (quote from Christian Nevell Bovee)

Bitcoin depends on human valuation and volition

At the Mises Blog Austrian economist Joseph Salerno brings about a very important insight on Bitcoin (bold mine)

Whether or not Bitcoin survives and whether gold returns to favor among investors and, eventually, to its traditional monetary role are, of course, purely empirical questions, which cannot be solved by theoretical arguments. At the moment both are valuable commodities and neither one can be considered as money.  Thus, tedious arguments on the blogosphere  which invoke Ludwig von Mises’s regression theorem, are completely irrelevant to the issue.  Both items are scarce commodities which are valued by consumers and command a price on the market.  As such, the regression theorem does not prevent bitcoin from being monetized or gold from being re-monetized in the event or anticipation of a fiat-money breakdown.  Rather, it is a matter of human valuations and volition which are not determined by economic law.  In this matter, our only guides are historical experience and what Mises called “thymological” insight into people’s likely choices  under varying circumstances.  Will the general public  trust and routinely accept a commodity embodied in lines of computer code or a tangible commodity that has served for millennia as the general medium of exchange?  Hmmm, I wonder.

Right. This is why I think debate on bitcoin is a waste of scarce time. What is needed is to simply observe Bitcoin’s progression via “matter of human valuations and volition”  in the face of the ‘resistance to change’ obstacles.

Many governments have thrown the kitchen sink on bitcoin, such as charging bitcoin operators with money laundering, many governments issuing warning on bitcoin usage, if we can’t beat them join them—by calling for more regulations and etc. But this should be an expected reaction since bitcoin poses a challenge to government’s monopoly control of money.

On the other hand, bitcoin’s function as a settlement medium appears to be rapidly growing. There are now more than 10,000 merchants spanning 164 countries accepting bitcoin for transactions. Some high profile examples: Online shopping Overstock.com now accepts bitcoin. Bitcoin have been accepted by some Las Vegas casinos. 

True while 10,000+ is a speck compared to millions of merchants in the global economy, again the question here is if “human valuation and volition” with regards to bitcoin usage will continue to spread. 

The ballooning merchant acceptance appears to be complimented by reports of flourishing bitcoin ATMs

Vancouver Canada opened the world’s first bitcoin ATM in October 2013. Toronto Canada has also opened an ATM this year. Helsinki Finland has the “first permanent Bitcoin ATM installation in Europe”

New York will open its first ATM soon. Bitcoin ATMs are slated to open in Hong Kong, Singapore and Australia also this year. 

And bitcoin ATM manufacturers have reportedly been rushing to take advantage of this growth momentum

In addition, there are 88 crytocurrencies in existence, 84 of which has market capitalizations. This means that bitcoin’s success has been drawing in many competitors. Such competition should extrapolate to more improvements on the quality of cryptocurrencies offered.

What the above dynamics suggest? For as long as the internet exists, and most importantly, for as long as people preferences will be expressed by actions in favor of cryptocurrenncies, then this means that cryptocurrencies, which represent as the evolving innovations from the deepening of the information age, are here to stay. 

[Disclosure: I don’t have any exposure onbitcoin or other cyrptocurrencies yet, but I am contemplating to experiment with this sometime ahead]