Emerging Markets: Why Adjustments For Relative Yield Spreads has been Disorderly

Rising yields of USTs will have an impact on the policies of central banks whom has dovetailed their policies with that of the US Federal Reserve configured on zero bound rates

At the basic level, rising yields of USTs will compel for an adjustment in the respective contemporaneous ‘yield spread’ of domestic bond markets relative to the USTs that will get reflected on monetary policies.

What has made the adjustment disorderly, particularly for Emerging Markets has been the overdependence of specific economies on the zero bound regime, principally due to economic growth structured on credit expansion rather than economic reforms.

The relative yield spread adjustments has only exposed on the distinct vulnerabilities of these economies thereby leading to massive outflows.

The idea that the emerging market selloffs has passed days of turbulence neglects the importance of the fundamental relationship between respective pre-Taper/Abenomics ‘yield spreads’ of distinct EM nations with that of the USTs.

I pointed out last week how the direction of the Phisix seems to have found an anchor on the actions of USTs, where each time yields of 10 year USTs close in at 3% this seem to have spurred weakness or a spontaneous selloff in Philippine stocks.

It would seem that the same relationship holds true for ASEAN currencies. Since September 2013, where the yields of 10 year USTs (TNX, below chart) approached 3%, ASEAN currencies TWICE—particularly the USD-Philippine peso (red orange), US-Indonesian rupiah (orange), USD-Thai baht (green) and the USD-ringgit (red)—suffered convulsions from what should be normal yield spread adjustments.

Moreover, the second episode has led to greater (and not lesser) volatility where all four currencies broke beyond the September 2013 highs. So it would seem misguided to impulsively conclude that the emerging Asia’s woes have been short lived or has passed. Such assumption will have to be premised on a sustained decline of the TNX. However as pointed above, declining TNX has, of late, been accompanied by falling US stocks. And a steep drop in US stocks has likewise had a negative impact on local and regional stock market performance.

It is true that all of the region’s currencies have been rallying during the past two weeks. This has also been accompanied by buoyancy in the region’s equity markets. And again that has been largely because the TNX has dropped steeply. Nonetheless, the lull in ASEAN’s markets may be temporary as TNX has been climbing again (red ellipse). 

Notice that when the TNX peaked in September, the two month of tranquil space permitted the region’s financial markets to somewhat recover. However it is a question if the TNX has found a bottom. If it has, then it means a narrowing of the time span covering the previous peaks of September and December. This may imply that the ascent of the TNX may be accelerate or intensify. A fresh record breakout by US stocks can easily power the TNX to new highs.

Yet the current rally of domestic bonds of emerging Asia has hardly been impressive. Additionally, while regional currencies have bounced back, they are far from the lows of the post September levels. ASEAN currencies are rallying in lesser degree than during the post September lows.

The question now is if the TNX should continue to climb or spike, will the impact be devastatingly larger this time?

Presently even the mainstream has come to notice the recent bout of volatilities has exposed on the price inflation predicament of ASEAN[1]. But the emerging stagflation ogre has been seen as a supply side driven predicament rather than a credit inspired demand side imbalance. Debt exists nowhere in mainstream analysis.

Yet debt has been the anchor of any potential transmission mechanisms for a contagion

For instance, US and European banks have been found to have chased yield by having bigger exposure on EM’s the Fragile Five.

Philip Coggan of the Buttonwood Blog fame at the Economist quotes Erik Nielsen[2]

According to the BIS, US banks’ exposure to the “Fragile Five” increased by 37% to $212bn, while their exposure to the Eurozone periphery declined by 17% to $164bn. UK banks’ exposure to the Fragile Five increased by 29% to $291bn – while their exposure to the periphery declined by 30% to $277bn. German banks expanded their exposure to the Fragile Five by 34% to a relatively modest $69bn – while shrinking their exposure to the periphery by an eye-watering 50% to $354bn. French banks increased their Fragile Five exposure by a modest 15% (to $69bn) – while chopping their Eurozone peripheral exposure by 43% to $514bn. Italian banks doubled their exposure to the Fragile Five – but to a total of just $11bn, while cutting their exposure to the periphery (excluding Italy itself) by 46% to $33bn.  And Spanish banks increased their exposure to the Fragile Five by 26% to $185bn, while chopping their peripheral exposure (ex Spain) by 29% to $105bn.

So mainstream western banks flocked into the Fragile Five when the PIGS crisis surfaced.

And the powerful argument presented by Mr. Coggan has been to debunk the use of accounting identities in denying the above risk. Mr. Coggan writes, “the fragile five got that tag because they have current account deficits, but such deficits require, as an accounting identity, capital inflows. Someone had to lend these countries money so they could buy imports.”

In short behind all the smoke screens thrown by the consensus to defend the status quo via statistical figures and accounting identities, everything else will all boil down to sustainability or unsustainability of DEBT operating under the presence of the bond vigilantes.

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[1] Wall Street Journal Real Time Economics Blog, In Asia, Concerns About Inflation Re-Emerge, February 11, 2014

[2] Buttonwood, The money has to go somewhere February 10, 2014

Lessons from Kazakhstan’s currency Meltdown

I was surprised to see Kazakhstan’s stock market (KASE) zoom by 13.4% this week. And I found out that the rise has been due to a massive 19% devaluation imposed this week which mainstream attributes to “currency war”[1]. Yes stocks can serve as haven against hyperinflating governments.

Kazakhstan is basically a commodity (mostly energy) producing country[2],being the 9^th largest country in the world, whose geopolitical origins have been linked with Russia[3]. Nursultan Nazarbayev[4] has been Kazakhstan’s first and only president since the country gained independence from the Soviet Union. President Nazarbayev has been alleged as a dictator[5].

What interests me is that despite the supposed low consumer price inflation, low debt to gdp levels, current account and trade balance surpluses, it is ironic to see a country devalue quite so massively.

It turns out that some of the statistics stated may not be accurate or deliberately fudged.

Since the 2008 global crisis, Kazakhstan’s government has engaged in a spending binge that has resulted in sustained budget deficits where such has been financed with an explosive growth of external debt. This is in spite of the low debt to gdp ratio where the gdp numbers looks cosmetically embellished. 

Since attaining financing from external sources have been deficient, the government has tapped into the foreign currency reserves which has shrunk by nearly a third from the high of April 2011, as well as monetized her deficits as seen via a runaway M3. Kazakhstan has apparently adapted Argentina’s stylized policies of addressing internal imbalances[6].

Kazakhstan’s currency the tenga has endured almost a similar degree of sizeable devaluation in 2008. But recent financial pressures mostly on domestic financing may have forced the government to act. As one would realize, Kazakhstan’s dilemma has not been revealed by the current and trade balances but on her currency tenga, forex reserves, external debt and importantly M3. And another thing, given the 19% devaluation, this shows that the alleged low inflation figures have also been patently inaccurate.

The other lesson is that shouting “forex reserves!”, “forex reserves!”, “forex reserves!” or citing surpluses of trade and current accounts serves as no elixir against government rapacity (or from reckless bubble policies) as expressed via Kazakhstan’s financial markets.

While I am not certain that Kazakhstan’s policies would lead towards hyperinflation, exploding M3, unless curtailed, points towards this direction.

When stocks rise due to hyperinflationary policies, this isn’t about delivering real returns, but rather as signs of “flight to safety” (crack-up boom) where stocks as title to capital goods or real assets become a shock absorber from a collapsing currency.

However, the idea of thousands of % of gains in nominal domestic currency terms, under hyperinflation, may be equal to a buying power of just three eggs, as noted by fund manager Kyle Bass, on the Zimbabwe hyperinflationary experience[7].

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[1] Bloomberg.com Kazakh Devaluation Shows Currency War Stirring as Ruble Dips February 12,2014

[2] Wikipedia.org Economy of Kazakhstan

[3] Wikipedia.org Kazakhstan

[4] Wikipedia.org Nursultan Nazarbayev

[5] CBSNews.com The world's enduring dictators: Nursultan A. Nazarbayev, Kazakhstan, June 19, 2011

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

[7] CNBC.com Why Inflation Could Eat Into Stock Gains: Kyle Bass February 1, 2013

Phisix: Stagflation is here, Expect a Weaker Peso

I have been saying that stagflation will be a force to reckon with given the easy money policies adapted by central banks of the Asia

Stagflation now a Reality

In September 2012 I pointed out that risks of stagflation or a bubble bust will become apparent in 2014 or 2015[1]

And one of the above risks (a bubble or stagflation) will become a force to reckon with in Asia, possibly in 2014 or 2015. All these will essentially depend on the feedback mechanism between the dynamics at the marketplace and policy responses on them.

The point is that inflationary policies results to different impact on the economy and the markets depending on the stage of the process. The boom phase appears to have ended. Now the backlash for promoting reckless policies has surfaced.

What’s stagflation? Wikipedia defines this[2] as “a situation where the inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high.”

Based on official announcement where the Philippine economy continues to reveal strength, stagflation would not be an adequate characterization of the current conditions. 

But the recent shocking 27% quarter on quarter surge in unemployment survey figures defies whatsoever government claims about the robustness of the Philippine economy[3].

The survey essentially squares with two earlier surveys underscoring the equally stunning sharp deterioration in the general public’s opinion of their quality of life through 2013[4]

In addition, with the official admission that the current rate of inflation has been in the high end of estimates at 4.2% backed by a huge decline of the peso and stubbornly higher bond yields of 10 year Philippine treasuries considering that the domestic bond markets have been tightly controlled by both the government and the private sector banking system, the proverbial inflation genie has been unleashed from his lamp.

Moreover despite the 7.2% growth rate for 2013[5], based on the quarter year on year statistical growth rates, the Philippine economy from a high of 7.7% from the first quarter of 2013 dropped in the following quarters 7.6% (2^nd Q), 6.9% (3^rd Q) and 6.5% (4^th Q).

So if we go by the checklist

1) inflation rate is high—√

2) economic growth rate slows down—√

3) unemployment remains high—√

Stagflation has entrenched herself on the Philippine setting. Now the question is will stagflation prick the Philippine credit bubble?

Financial Repression as Key Culprit

The recent unemployment survey essentially validates my analysis that the representativeness of the Philippine statistical growth data has been inaccurate or suffers from large statistical errors.

This also reveals how the statistics of the Philippine government overestimates on the importance of the formal economy while understates the relevance of the informal economy.

Yes, as stated earlier, the swelling numbers of unemployment means that the informal economy has been in sick bed for quite sometime now.

The unemployment data essentially signifies a major pushback from the official downplaying of informal economy.

This also reveals how concentrated the statistical Philippine economy has been, which largely has been dependent on the households, whom has not only access to the banking sector but importantly access to credit.

The risks and benefits from present policies that has painted a robust statistical economy has been largely channelled through a few individuals whom has access to credit.

The unemployment data also exposes on the politicized nature of redistribution of resources channelled via central bank policies as part of the financial repression used by the government to lay claim on the resources of their non-political constituents.

It has been absurd for officials to raise strawmen by attributing Typhoon Yolanda and Moro rebels which are largely regional problems to a national problem.

I had been right about my reservations[6] of Typhoon Yolanda being unable to surpass Typhoon Pablo in terms of most destructive Typhoon. While Typhoon Yolanda may be one of the strongest ever to land on Philippine soil, the devastation covered one of the country’s most economically depressed region. The same premise can be used to dismiss official strawman arguments.

And it seems that experts sporting economic labels and political groups have grasping at the straws to explain why the surge in unemployment.

One says that investments have been in capital intensive and not in labor intensive projects. Such is a false choice fallacy. There is a third concept. Government via easy money policies has misallocated money flows towards credit intensive projects, regardless whether they are capital intensive or labor intensive. The fact is that in 2013, the real estate sector, construction and hotel industry borrowed Php 1.9, Php 3.25 and Php 2.7 for every Php 1 growth generated by these sectors[7]. The inefficiency of use of resources meant that this has displaced other market based investments in favor of yield chasing by those with access to the banking sector’s credit. Such deadweight loss are signs of declining productivity while at the same time increasing credit risks.

A nuisance political observer even was even quoted as pointing to liberalization as the culprit. These guys should move to North Korea, whose closed economy should give their fantasies a hard dose of reality.

North Korea is an example where in communism the joke parlance has been “the authorities pretend they are paying wages, workers pretend they are working”. Such also lies in the heart of the economic dogma where economic growth can supposedly occur when people just dig holes and fill them back in.

The problem is that even pretending to work and pretending to get paid doesn’t work. Reason? In the case of North Korea, the country has run out of hard currency or real resources to pay for her pretentious employer-employee relations, so unemployment has been increasing[8]. Yes NK officials want the scarce resources for themselves than distribute to the others

The ADB comes up with their techno gibberish citing “low investment are reflections of the sluggish industrialization”[9]. Of course the ADB doesn’t say why there has been low investment except to utter the banalities about the symptoms.

None has been there to say that the banking system and capital markets have been soooo inadequately utilized for people to transpose savings into investments. So with low access to savings equally there will be low investments from residents. Add to this the stringent regulatory hurdles in doing business.

Besides given the low access to the formal system, this means high transaction costs, high cost of capital and equally inefficient means to accumulate real savings and capital.

Also for foreign money to deploy savings into the country means liberalization of capital flows something which monetary officials have been reluctant to do. Why? It’s called financial repression or the various political measures adapted to capture resources of the constituents of a country for the benefit of politicians and their cronies.

Based on Investopedia’s more benign terminology, financial repression are “measures by which governments channel funds to themselves as a form of debt reduction. This concept was introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon. Financial repression can include such measures as directed lending to the government, caps on interest rates, regulation of capital movement between countries and a tighter association between government and banks.”[10]

So naturally no country will have a great deal of investments when the government vacuums the resources of the people and restricts savings from efficient allocations in the marketplace.

How about zero bound rates (negative real rates) as part of the repression?

Let us hear from Harvard’s Carmen Reinhart[11].

One of the main goals of financial repression is to keep nominal interest rates lower than would otherwise prevail. This effect, other things being equal, reduces governments’ interest expenses for a given stock of debt and contributes to deficit reduction. However, when financial repression produces negative real interest rates and reduces or liquidates existing debts, it is a transfer from creditors (savers) to borrowers and, in some cases, governments.

While the supposed aim of financial repression has been to reduce debt, the free lunch access by politicians to savings ironically whets their appetite to add more debt.

Moreover based on the above the Philippine president will hardly make such statements: “I am sorry I kept interest rates lower than should be, so I can fund my pet projects. Anyway these are meant to benefit you like infrastructure, cash transfers, military budget, other welfare programs and before I forget my political constituent’s pork barrel. You see I have to get these politicians to agree with my spending plans. So the need for pork barrel. Anyway you will be financing this via low interest rate that should subsidize our spending. The good news is that you will not feel directly the pain from such transfers. This will be done by the loss of peso’s purchasing power which we will blame on producers and entrepreneurs for their greed. Also I am sorry that I didn’t realize that savers will be penalized in favor of borrowers who incidentally are mostly in the list of my network.”

So you expect real economic growth from a government who punishes savers by reducing their purchasing power and diverting these to political boondoggles and asset bubbles at the same time unwilling to dismantle legal barriers to economic activities?

Peso as main Victim of Stagflation

I would predict that a stagflationary environment will be baneful for Philippine assets, particularly for the peso.

I expect the Peso to further weaken for one basic reason: The BSP seem to adapt policies that has been meant to erode dramatically the peso’s purchasing power at the rate faster than the US, Japan or even China.

Even with the Fed’s aggressive QE and Bank of Japan’s even bolder Abenomics year on year change of M2 has been at 5% for the Fed and 4.5% for the BoJ. China’s M2 comes at 13.2% in 2013 according to the People’s Bank of China

The above M2 and quasi money growth data for Turkey (upper pane) and for Argentina, Philippines, Indonesia and Thailand (lower pane) reveals how and why emerging markets have been enduring inflation pressures. Note I updated the World Bank chart[12] to include updates for Argentina[13] and the Philippines (based on latest BSP figures[14])

The green threshold line is the 10% about twice the level of my estimates of the average growth for these economies. Of course there is no line in the sand for M2 to generate X inflation number as different countries have different tolerance for inflation or debt accumulation.

Yet these economies have been pumping money at far more than the rate of statistical economic growth. For the Philippines the 30+% levels have practically reached Argentina’s fantastic rate levels. This is four times statistical economic growth.

The difference is that: Argentina, hobbled by the lack of access to credit markets, has long been using monetization of deficits as seen via the soaring of M2 whereas the recent 2013 spike in Philippines M2 has largely been from the domestic credit bubble.

The Philippine dilemma has been that current statistical economic growth rates have been dependent on a credit boom. This means that a reduction in M2 would extrapolate to a significant slowdown or a contraction of the high growth areas as credit growth slows or screech to a halt.

The recent decline of forex reserves serve as evidence that in the impossible trinity[15], where government can only use two of the three factors: free movement of capital, exchange rate and domestic policy targets, the BSP intends to keep the credit boom alive in the hope that EM storm will breeze over. I hope they are right because the alternative would be worse.

This also means that M2 will remain elevated and sometime in the future. This means that unless these are restrained, the Philippines will likely suffer from a serious inflation problem ahead (10% or more??).

Be reminded again that every economy has distinct sensitivity to inflation risks. 

In the Philippines, in the assumption that there has been little change in the above spending distribution or that the data above has some relevance to current conditions, the Filipino consumer has been highly sensitive to food, housing and transport[16].

For a country with $ 2,600 nominal gdp (IMF 2012) or $2,587 (world bank 2012) and who are price sensitive to basic goods, an explosion of price inflation would translate to severe social dislocations via increased poverty levels and increased likelihood for social and political instability.

A surge in inflation would also mean a dramatic decrease in disposable incomes of the residents, soaring interest rates, declining peso, and importantly, puts to the forefront the excessive credit conditions, as well as, over expansions of projects that had been financed by debt.

When the great Austrian Ludwig von Mises warned that the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money[17], this also puts into the spotlight imbalances brought about by massive issuance of quantity of money by domestic authorities that erodes the valuation of a currency unit, the peso.

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[1] See The Impact of Open Ended QEs on Asia: Bubbles or Stagflation September 15, 2012

[2] Wikipedia.org Stagflation

[3] See Behind the 27.5% (Q-on-Q) Surge in Philippine Unemployment Rate February 11, 2013

[4] See Phisix: Will the Global Risk OFF Environment Intensify? February 3, 2013

[5] See Behind the 2013 Philippine Statistical Economic Growth of 7.2% January 30, 2013

[6] See Typhoon Yolanda: From Natural to Man-Made Calamity; Spontaneous Order Thrives! November 18, 2013

[7] See Phisix: Global Financial Volatility Intensifies February 10, 2014

[8] Daily NK In the So-called Socialist Country, North Korea, the Number of Unemployment Is Increasing October 16, 2007

[9] Inquirer.net Aquino on rise in joblessness: What went wrong? February 12, 2014

[10] Investopedia.com Financial Repression

[11] Carmen Reinhart Financial Repression Back to Stay: Carmen M. Reinhart, March 12, 2012

[12] World Bank Money and quasi money growth (annual %)

[13] Wall Street Journal Argentine Central Banker Says He Aims to Slow Money Growth December 24, 2013

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

[15] Wikipedia.org Impossible trinity

[16] Hyun H. Sun Has Inflation Hurt the Poor? Regional Analysis in the Philippines in the Philippines Asian Development Bank

[17] Ludwig von Mises II: The Emancipation of Monetary Value from the Influence of Government - On the Manipulation of Money and Credit: Three Treatises on Trade-Cycle Theory [1978] onlinelibertyfund.org

Quote of the Day: Traits of Sociopaths and Psychopaths

When you look at Obamacare and the destruction it has caused in so many people’s lives, it’s just more of the same.  Whether it’s spying on us, or wars around the world, when you put it all together, the people in charge fall into two categories:  sociopaths and psychopaths.

Did you hear our secretary of state saying that ‘The US will defend Japan against China.’  Who is he speaking for?  Is he speaking for me?  Is he speaking for you?  We’re going to defend Japan against China?  This guy is a madman.  These are the characteristics and the traits of sociopaths and psychopaths.

This quote is from quoted business consultant and Trend forecaster Gerald Celente in an interview with Eric King at KingWorldnews.com (hat tip Lew Rockwell.com)

Quote of the Day: Defense of Liberty Must Emphasize on Principle versus Expediency

What must be developed is a case for freedom that starts with a better demonstration and defense of the nature of man in the world and what is necessary for his survival and improvement. In an age in which religion has lost it hold and appeal for many, such a defense of freedom must have its basis in reason, logic and objective reality.

Central to such a new defense of liberty must be its emphasis on principle versus expediency; that freedom is a tightly woven tapestry of principles that when compromised “at the margin” between individual liberty and political paternalism has the risk of incremental loses of freedom that cumulatively run the danger of an unplanned but no less serious “road to serfdom.”

As Friedrich Hayek argued, minor or marginal “exceptions” to advance seemingly “good causes” through government regulation, redistribution, or planning, always threaten to become a slippery slope:

“The preservation of a free system is so difficult precisely because it requires a constant rejection of measures which appear to be required to secure particular results, on no stronger grounds than that they conflict with a general rule [of non-government intervention], and frequently without our knowing what will be the costs of not observing the rule in the particular instance. A successful defense of freedom must therefore be dogmatic and make no concessions to expediency, even where it is not possible to show that, besides the known beneficial effects, some particular harmful result would also follow from its infringement. Freedom will prevail only if it is accepted as a general principle whose application to particular instances requires no justification. It is thus a misunderstanding to blame classical liberalism for having been too doctrinaire. Its defect was not that it adhered too stubbornly to principles, but rather that it lacked principles sufficiently definite to provide clear guidance . . .

“People will not refrain from those restrictions on individual liberty that appear to them the simplest and most direct remedy of a recognized evil, if there does not prevail a strong belief in definite principles. The loss of such belief and the preference for expediency is no part the result of the fact that we no longer have any principles that can be rationally defended.”

As Hayek argued on another occasion, if the cause of liberty is to prevail once again, it is necessary for friends of freedom to not be afraid of being radical in their case for classical liberalism – even “utopian” in a right meaning of the term. To once more make it a shining and attractive ideal to imagine a world of free men who are no longer slaves to others, whether they be monarchs or majorities.

It would be a world of sovereign individuals who respect each other, who treat each other with dignity and who view each other as an end in himself, rather than one of those pawns to be moved and sacrificed on that chessboard of society to serve the ends of another who presumes to impose coercive control over his fellow human beings.

This is an excerpt from a speech by American libertarian author and Northwood University economics professor Dr. Richard Ebeling published at the Northwood Blog (hat tip Bob Wenzel)

1929 Stock Market Chart Parallels and Real Private Businesses Investing

Sovereign Man’s Simon Black makes a reasonable case for investing in real private business than to gamble in financial markets by showing this chart. 

Mr. Black eloquently writes:

But as we have pointed out before, world stock and bond markets are heavily manipulated, if not rigged, by central bankers who control the money supply.

Fundamentals no longer matter. If one single person (now Fed Chair Janet Yellen) says she will print, stocks go up. If she says she will taper, stocks go down.

This isn’t investing. It’s gambling. Financial analysis has been replaced by soothsaying and tasseography (reading the tea leaves), hoping to detect some hint in the direction that central bankers are leaning.

This is the chief reason why I seldom participate in public markets anymore; it seems ludicrous to pile on a giant tidal wave of paper currency and entrust central bankers with my investment returns.

Not to mention, it’s uncertain how long they can keep this party going as the following (rather scary) chart shows. There’s an eerie parallel between the market’s performance today and the runup to the crash of 1929.

Financial markets dependent on Central Bank steroids is a real concern.

However, before I deal with investing in real private business, there has been an objection to the above chart.

Stock market bulls at the Businessinsider downplayed the above calling the former “flawed logic” by presenting another chart.

The bulls didn’t address how and why the nominal based chart pattern parallel of the 1929 chart had been “flawed”, but rather shifted their objection by framing another chart in terms of “percentage”. 

This devious way of challenging the original premise is called the alternative substitution—i.e. in behavioral finance, when people are faced with a difficult question, the response would be to  “answer a related but different question, without realizing that a substitution has taken place.”

History is no guarantee of future outcomes. From this premise we understand that patterns may just be patterns, whose outcomes may or may not repeat. I pointed years back how the father of fractal geometry, Benoit Mandelbroit advised people not to trust charts: (bold mine)

And in the fun-house mirror of logic of markets, the chartists can at times be correct...But this is a confidence trick: Everybody knows that everyone else knows about the support points, so they place their bets accordingly. It beggars belief that vast sums can change hands on the basis of financial astrology. It may work at times, but it is not a foundation on which to build a global risk-management system.

And if history does repeat, it will not be in exactitude of the past but rather as American author and humorist Mark Twain says History rhymes. 

And any repetition of history hasn’t just because patterns repeat, but rather such reveals of people’s underlying responses to certain conditions.

The reason “cycles” exists can be imputed or traced to on the admonitions of Spanish born philosopher and essayist George Santayana who wrote “Those who cannot remember the past are condemned to repeat it.”

Essentially what underscores a potential repetition of the 1929 scenario are the ‘real’ fundamentals behind them. 

Since US stocks have been rising driven mainly by massive debt accumulation (record net debt margin and various record bond market issuance), the question is at what or how much degree of additional debt load can the US economy and financial markets absorb in the face of rising yields of USTs just to push up stock market values? What if the capacity to absorb more debt hits the brick wall? What if the rate of return of stock markets will be eclipsed by the rate of increases in the cost of servicing debt, how will all these affect the stock market? 

You see, the mainstream thinks that debt is a free lunch thing that has no repercussions. This kind of thinking is a recipe to a rude awakening. 

Moreover, people hardly realize how the severe distortions from the easy money landscape has influenced earnings and economic coordination. With Fed Chairwoman Janet Yellen’s debut who appear to echo on policy path of  the previous chair Ben Bernanke on “tapering”, how will reduced monetary accommodation impact asset prices whose foundations have been built on easy money? The violent response in emerging markets have been manifestations of the drastically changing environment. What if a periphery to core will occur whose transmission mechanism will simply be higher rates in the face of massive debt?

As you can see these are questions that will determine whether the Dow Jones parallels of the 1929 today will be repeated.

Going back to real business. I don’t deny that investing in business should be a viable alternative. But my concern is that if earnings and the general economy has been massively skewed in favor of bubble blowing activities, putting up a business based on assessment of current conditions may lead to serious miscalculations therefore potential losses.  Besides, the current inflationary boom has already been inflating the cost of doing business. Unstable prices adds to the uncertainty. Compounding such uncertainty has been the equally fickle political environment.

So unless potential businesses would deal with some sort of niche, whose markets are going to be least affected from any downside economic volatility, investing in real business should be thoroughly scrutinized.

Importantly, if 1929 should ever rhyme, then this means shades of the great depression.

Wikipedia describes the post-1929 stock market crash

The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in 1930 and lasted until the late 1930s or middle 1940s. It was the longest, deepest, and most widespread depression of the 20th century.

In the 21st century, the Great Depression is commonly used as an example of how far the world's economy can decline. The depression originated in the U.S., after the fall in stock prices that began around September 4, 1929, and became worldwide news with the stock market crash of October 29, 1929 (known as Black Tuesday).

The Great Depression had devastating effects in countries rich and poor. Personal income, tax revenue, profits and prices dropped, while international trade plunged by more than 50%. Unemployment in the U.S. rose to 25%, and in some countries rose as high as 33%.

Cities all around the world were hit hard, especially those dependent on heavy industry. Construction was virtually halted in many countries. Farming and rural areas suffered as crop prices fell by approximately 60%. Facing plummeting demand with few alternate sources of jobs, areas dependent on primary sector industries such as cash cropping, mining and logging suffered the most.

A rhyming of 1929 stock market crash also means that even real businesses will take a hit.

Southeast Asia as Retirement Haven

Outside all the easy money inspired yield chasing actions that has led to various bubbles around the world, here is one potential bullish theme for Southeast Asia: Retirement Haven 

Analyst Martin Spring writes (link not available)

Southeast Asian countries have become magnets for retirees from other parts of the world who want to spend their final years in the comfort of year-round sunny climates, friendly people who treat the elderly well, and inexpensive “colonial” lifestyles.

Two of them – Malaysia and Thailand – are listed in the top ten in the latest survey of best countries in the world for North Americans to retire to...

Thailand is now home to 45,000 foreigners who live there permanently on retirement visas. They cost little, but have to be renewed annually. To qualify you must be at least 55 years old, agree to do no work, and meet a financial requirement.

You must either prove that you have a monthly income of 65,000 baht (that’s just over $2,000), or have at least 800,000 ($25,000) in a local bank.

Although Thais’ fluency in the English language is less than desirable, that has never been a problem for us in the seven years we’ve lived here. The Thais make up for it with their ever-willing desire to be helpful – greng jai (concern for the contentment of others) being such a dominating force in their social behaviour.

Almost everything required by retirees is inexpensive, sometimes really cheap, compared to Europe, North America, even my own South Africa. Domestic help is abundant, willing and friendly – no more housework now it’s become increasingly difficult to do yourself. Medical and dental services are world-class and a remarkable bargain, with consultants fluent in English and often with advanced US/European/Australian qualifications.

Malaysia has become home to 23,000 foreign retirees under its programme designed to attract them. Its visa offer is far better than Thailand’s – once granted, it’s valid for ten years.

However, financial qualifications are much higher – you have to prove a retirement income of 10,000 ringgit (more than $3,000), and have at least 350,000 ($110,000) in a local bank.

For retirees, life in Malaysia has the same kind of advantages as in Thailand – warm climate, low costs, friendly people, world-class medical services – with the added advantages that English is widely spoken and the local language much easier to learn.

It’s topped the list as the most popular “long-stay” destination for Japanese retirees for the past six years.

Philippines was the first Asian country to welcome foreign “Silver” migrants, and now has about 23,000 who have qualified under the nation’s Special Resident Retiree visa. Many thousands more qualify for residence under other visas, or have married locals.

Financial requirements for the retiree visa are a pension of at least $1,000 a month, and a cash deposit of $50,000 in a government-designated bank.

The Philippines mainly attracts Asian retirees, from China, South Korea and Taiwan. The country is also a particular favourite of Japanese retirees as it’s only a four-hour flight to Japan when they wish to return to visit family or receive medical treatment (which for them is both free and high-quality in Japan).

Bali – a province of Indonesia – has attracted 10,000 foreigners over the past five years who have settled there permanently.

It offers retirement visas for those aged at least 55 who can prove a minimum income of $1,500 a month and rent an apartment costing at least $500 a month. They must also have medical insurance, employ at least one local such as a domestic, and cannot work or own a business.

The attractions are similar to those found in other favoured Southeast Asian long-stay destinations, except for inferior medical services.

Continued financial repression (combined with growing police state) in developed economies may force productive segments of society to emigrate. One example is the US where Americans renouncing their citizenship has reached new record highs. Southeast Asia could serve magnet for such capital flight aside from retirement flows.

But attracting overseas retirees or migrants will also depend on many factors. The Philippines government would need to ease capital controls for instance. They could also liberalize on foreign ownership restrictions to allow retirees and their families options to have wider investment options.

Nonetheless ASEAN as retirement haven hardly serves as a free pass for bubble blowing economics. Blowing bubbles will easily eclipse any positive feedback from retirement flows. Worst, possible adverse political reactions in the face of bubble blowups may even scare retirees.  Today's recent EM outflows are symptoms of hissing bubbles.

ASEAN governments will have to adapt real 'market economy' reforms and not depend on bubble blowing policies to prop up "growth" where the latter has been more about statistics. 

ASEAN would need to rely on substance rather than form. A greater degree of market economy will attract prospective investors, migrants and retirees. This will even allow the domestic informal economy to migrate into the formal economy therefore increasing efficiency of economic coordination thus leading to real growth.

EM Guru Mark Mobius Flip Flops Anew: EM Sell Off Nears End

One of the costs of wildly fluctuating markets has been to expose on the confusions of experts, who try to preserve their public image.

For example I noted that EM guru cheerleader Mark Mobius, who claimed at the start of the year that EM outflows will turn into inflows, suddenly made a volte face last week to predict that EM outflows will “deepen”. This call was made when markets had been going on the opposite direction of his early forecasts.

Now that EM financial markets have shifted from Risk OFF to Risk ON, Mr. Mobius changes his mind for the second time over the past two weeks.

From Bloomberg:

The selloff that triggered the worst start for emerging-market stocks in four years is approaching the end as valuations begin to look attractive, Templeton Emerging Markets Group’s Mark Mobius said.

“We are nearing the point where people are beginning to say ‘hey, it looks pretty good now in terms of valuations,’” Mobius, who oversees more than $50 billion in developing-nation assets as an executive chairman at Templeton, said in an interview on Bloomberg Radio today. “We are probably nearing the end of this big rush out of emerging markets.”

The comments mark a shift in sentiment for Mobius, 77, who said on Feb. 7 that developing nations could “expect a lot more selling.”

The issue of “pretty good now in terms of valuations” depends on how one sees the current environment. 

In my view, when EM economies are facing weak currencies, increasing CPIs and higher bond yields (indicative of higher interest rates) amidst elevated debt levels, then accordingly this means a shift in the valuations landscape as the same factors will not only alter the profit environment, they will also have an impact on consumer demand, credit conditions and credit quality and the supply side growth. If such a shift will be disorderly then this may even lead to a drastic change in the political environment that could also impact again valuations.

In short, a benign environment from zero bound rates and a convulsing environment, which are symptoms of resistance to change against rising rates amidst high debt levels, will extrapolate to apples and oranges comparison. Thus failure to understand such transition would lead to confusions.

And because fund managers earn from varied fees (e.g. Franklin Templeton) from their investor’s portfolio it is understandable for them to promote their interests. Talking down the fund's investment themes may lead to investor withdrawals thus reducing fund fees.

The point of this exercise is not to disparage any experts, particularly on Mr. Mobius whom I respect, but to show of how sharply gyrating markets entwined with industry interests seem to have led some experts to vacillate on their forecasts.

Quote of the Day: Perpetual price inflation as means to assure full employment

…And these were the policies that Keynes did his best to try to overthrow in the pages of his book, "The General Theory." He argued that a market economy was inherently unstable, open to swings of irrational investor optimism and pessimism, which resulted in unpredictable and wide fluctuations in output, employment, and prices. Only government, he believed, could take the long view and rationally keep the economy on an even keel by running deficits to stimulate the economy during depressions and surpluses to rein it in during inflationary booms. He therefore attacked the notion of annual balanced budgets; instead, government should balance its budget over the “business cycle.”

To do this job, Keynes said, governments should not be hamstrung by the “barbarous relic” of the gold standard. Wise politicians, guided by brilliant economists like himself, had to have the flexibility to increase the money supply, manipulate interest rates, and change the foreign-exchange rates at which currencies traded for each other. They required this power so they could generate any amount of spending needed to put people to work through public-works projects and government-stimulated private investments. Limiting increases in the money supply to the quantity of gold would only get in the way, Keynes insisted.

Keynes believed not only that the market economy could not keep itself on an even keel he also believed that it would be undesirable to allow the market to work. He once said that to have the market determine prices and wages to balance supply and demand was to submit society to a cruel and unjust “economic juggernaut.” Instead, he wanted wages and prices to be politically fixed on the basis of “what is ‘fair’ and ‘reasonable’ as between the [social] classes.”

The level of wages imposed by trade unions, for example, was to be viewed as sacrosanct, even if many workers were priced out of the market because the level was higher than potential employers thought those workers were worth. The government, instead, was to print money, run deficits, and push up prices to any level needed to make it again profitable for employers to hire workers. In other words, perpetual price inflation was to be the means to assure “full employment” in the face of aggressive trade unions demanding excessive wages.

This is from libertarian author and economics professor Richard Ebeling on the myths of Keynesianism published at the Epic Times.  (hat tip Bob Wenzel) The Keynesian policy prescription essentially means two wrongs (interventions and inflationism) make a right.

Behind the 27.5% (Q-on-Q) Surge in Philippine Unemployment Rate

Today’s the mainstream headline reports a staggering 27.5% quarter on quarter surge in unemployment

From the Inquirer

The number of unemployed Filipinos in the last quarter of 2013 swelled to more than 12 million, making the 7.2-percent growth in the country’s gross domestic product (GDP) last year, considered the second-fastest after China, far from inclusive.

The unemployment rate rose to 27.5 percent, or an estimated 12.1 million individuals, as 2.5 million Filipinos joined the ranks of the jobless between September and December, a Social Weather Stations (SWS) survey found.

The level of joblessness across the country was almost 6 points higher than the 21.7 percent (some 9.6 million) in the previous quarter, results of the SWS survey conducted from Dec. 11 to 16 showed. The results were first published in BusinessWorld…

The article, as always, has used Typhoon Yolanda and the Moro problem as the convenient bogeymen. Ironically both factors represents a regional concern rather than a national issue. The unemployment issue is a national issue.

Two weeks back I wrote

Yet if there has been any truth to these surveys then this means that whatever the statistical growth hasn’t been shared by most of the population (in numbers, in geographic areas, in the distribution of socio economic groups).

Even when we account for ‘improvement’ criteria, for both March and December, the proportionality of growth 23% and 9% seem to reflect on the distribution of the formal sector. However, the 9% improvement in December means that even many in the formal sector feels polarized from the current boom.

Worse, the above are signs that the informal economy have been in sick bed for quite sometime.

So the unemployment survey appears to validate my earlier observations.

 

And it has been a curiosity that the economic industry still upholds a code of silence. There hardly has been anyone willing to point out how the BSP’s inflationism, as evidenced by a spike in M3…

…and which has been ventilated in the falling Peso, has been a major factor in driving high unemployment levels. 

The privileged few (less than 2 of 10 households) with access to the banking system and to banking credit has been corralling resources as evidenced by the massive explosion of bank lending growth to select sectors, further by soaring bank deposits, weak peso, spiraling of M3, soaring property and stock markets, debt financed overexpansion of the supply side and real (not statistical) price inflation. 

These had been used to generate a mirage called ‘strong’ economic growth when in reality such statistical economic growth benefited mostly cronies and private sector political allies which trickled down to some in the industry. 

The 'strong' economic growth story combined with anti-corruption histrionics has been used as a Public Relations prop to attain popularity ratings in order to secure access to cheap money in the global and local credit markets in order to finance political boondoggles. This has resulted to what I call as the convergence trade, a symptom of the grotesqueness in the mispricing of the domestic bond markets and interest rate levels that has underpinned the concentrated credit bubble hidden in the eyes of the general public.

All these reveals how inflationism represents a redistribution of resources from society to the government and to government private sector cronies.

And the emperor has no clothes is being gradually exposed by economic reality. 

Tick Tock Tick Tock

Americans are Ditching Citizenship in Record Numbers, Part 3

The more desperate a government is as to apply more punitive Financial Repression measures via higher taxes, more regulations and mandates, inflation and etc…, the more we should expect the productive segment of the society to flee. I previously noted how Americans have been ditching their citizenship in record numbers here and here

Here is an update from the Wall Street Journal (hat tip Zero hedge)

Last year saw a record for expatriations by U.S. taxpayers, exceeding by two-thirds the previous high set in 2011.

According to the Treasury Department, 630 individuals renounced their U.S. citizenship or ended their long-term U.S. residency by turning in their green cards during the fourth quarter.

The fourth-quarter figure brought to 2,999 the total number of expatriations for 2013. The previous record was 1,781 in 2011, said Andrew Mitchel, a tax lawyer in Centerbrook, Conn., who tracks the data.

The Treasury is required by law to publish a list of the names of expatriates quarterly. The list doesn't indicate when people expatriated or why. It also doesn't distinguish between people giving up passports and those turning in green cards.

Mr. Mitchel attributed the surge to increased awareness of the obligation to file U.S. tax returns, the increasing burden of compliance and the fear of large penalties for failure to file U.S. returns.

"Above all, fear seems to be driving this increase in expatriations," Mr. Mitchell said.

And if the productive segment of society leaves, who is going to do the investing? And if the number host declines, where will political parasites get their sustenance?