Japan’s Ticking Black Swan

And speaking of carry trade. There seems no other fantastic example than the Nikkei 225-Japanese Yen.

The Nikkei Yen trade is a Bet on the Direction of Stimulus

Since Abenomics, the Nikkei’s (Nikk) movements have practically been a mirror image of the Japanese Yen (XJY) where each time the yen troughs, the Nikkei peaks (green ellipses). It is a stunning picture which shows that Japan’s stocks have become a proxy for a punt on the yen and vice versa, and where stock market investors have been trading shoes with currency traders.

And you think stocks are about fundamentals? The Nikkei Yen correlation has basically been a bet on the direction of stimulus from Abenomics.

Early during the year, the Bank of Japan (BoJ) reportedly bought beyond its quota thus the central bank expected to slow their monthly purchases[1]. The result has been devastating, the Nikkei plunged while the yen rallied.

This week has been “bad news is good news” for the Nikkei.

Two bad news: one the GDP numbers had been reported below mainstream expectations, and two, Japanese consumers showed reluctance to spend. The frontloading effect in the face of the coming increase in sales taxes from 5-8% this April has failed to inspire a surge in consumer spending. Hence the mainstream urged for more stimulus, the good news, the BoJ relented.

The BoJ without adding to the QE programs, announced an expansion in two key lending programmes. Upon the announcement last Tuesday the Yen fell, the Nikkei skyrocketed 3.3%[2]!

The Nikkei ended the week 3.86% up which means the Tuesday’s gains has been more than preserved, as rumors of more stimulus[3] seem to have whetted on the appetite for stock market bulls.

In the face of very strong evidence I don’t why the mainstream stubbornly insist that the Nikkei actions has been about fundamentals when it has been a bet on the direction of stimulus.

What’s Really Wrong with Japan?

This graph serves as a startling evidence of the kernel of the problems facing the Japanese economy. The graph represents prices of corporate goods by stage of demand and use[4]. In other words, this should reflect on the price levels of various stages of production. I don’t know to what degree of representativeness this applies to Japanese corporations.

But the message above is that price of raw materials and intermediate goods have been rising faster than final goods.

In short, corporations appear to be very hesitant to raise prices perhaps in fear of demand slowdown. Thereby this means a squeeze in corporate profits. Abenomics has only worsened such existing conditions.

What’s has been the repercussions?

One, Japanese corporations have been hesitant to expand. Growth in machinery orders remain sluggish as December data reported a sharp drop following an increase in November[5].

Two, Japanese firms seem unwilling to raise wages, as base pay slip to “levels around those during the global recession of 2009”[6]. While unemployment rates have reportedly improved[7], statistics hardly identifies which industry has been hiring. My suspicion is that most of the hiring will come from sectors benefiting the boom, financials and real estate[8].

Like the Philippines Japan’s Prime Minister Shinzo Abe wants to stoke another property bubble from QE and zero bound rates helped by the easing of construction, building and land zoning regulations[9]

And a lower yen has hardly been beneficial to Japan’s stagnating exports which has also been hampered by high energy costs.

Third Japanese companies continue to invest abroad[10].

And the lower than expected performance by Japanese enterprises has been reflected on the consumption patterns by households in the face of Abenomics.

This report gives us a clue how Japanese consumers have seen a reduction in disposable income[11] from Abenomics

Price increases are prompting Japanese shoppers to buy less mayonnaise, showing the fragility of any economic rebound unless wages keep up with living costs

The article like most mainstream articles sees a simple solution: higher wages.

But higher wages can only happen if there are more investors. To have more investors mean that profit opportunities should abound. And that is what has been missing.

Governments can temporarily provide jobs, but such jobs have to come from taxpayer money. This means again shifting capital from productive ventures to unproductive bureaucratic tenures. At the end of the day everything boils down to productive risk taking from private investors.

Since every politician and economic expert seem to have a magical elixir in influencing Japan’s policies, they end up creating more problems than less.

Japan’s problems can’t be solved by opening or closing the monetary gap or by government providing jobs or by more government spending, the issue is to create profit opportunities for investors to invest. And that’s something the Japanese government has been doing in the opposite direction. Given the aging population, liberalizing immigration could be a good start.

Also Japan’s stock market bubble has hardly been providing consumers resources to spend, the subsidy from Abenomics only supports a small number of Japanese stock punters. Japanese households only own 8.5% of assets in stocks. Rising stocks has only been supportive of financial institutions and non financial private institutions whose shares have been listed in the markets[12].

And it has been ironic that even with deep capital markets, Japanese households own about a record “ more than $6,000” in cash per person compared to the US at $2,029 where much of such cash has been “ socked away at home in dressing cabinets and shoe boxes” Cash accounts for 38% of retail transactions[13]. This is a sign of distrust on the banking system.

Japan’s Ticking Black Swan: the JGB

All these remain sideshow to Japan’s real problem: the Japanese government bonds (JGB).

10 year JGB yields have been declining since the early spike in May 2013, rose at the end of 2013 as the Nikkei boom climaxed, but collapsed again this year, when the public expectations for more stimulus waned. Like stocks and the yen all seem to have focused on whether the BoJ will increase or decrease her easing programs.

The BoJ has essentially become the only major buyer of Japanese debt as banks, foreigners and households have shown a decline in JGBs ownership from June 2013 to September 2013. Aside from the BoJ only life and nonlife insurance posted a minor .1% gain.

The odd thing is that the Japanese government in their latest budget projection has been expecting a jump in revenues. They expect tax revenues to grow by 16% in 2014 and also expect a reduction of bond issuance by 3.6% to fund government budget. Japan’s government budget has been expected to grow by 3.5%[14].

Meanwhile expected tax revenues accounts for 52% of the Japan’s government budget while JGB issuance constitutes 43%. The budget for debt service which has been expected to grow by 4.6% represents 46.5% of tax revenues. So about half of tax revenues will end up just servicing debt and that is if the optimistic target will be met.

Yet the Japanese government maintains a cognitive dissonance—holding two ideas—as part of their finance management. First they are optimistic that they can raise the targeted budget so they even expect a reduction in bond issuance.

Yet in December, they raised a bogeyman to secure more stimulus. They argued that the slated national sales-tax hike in April may jeopardize growth, thus appealed and got approval for a fiscal stimulus worth 18.6 trillion yen ($182 billion). Most of the loans have been said will emanate from existing spending by local governments and loans from government backed lenders[15].

Two months after, the government seems deeper in straits as the economy has hardly performed as expected and thereby markets expect an increase in BoJ support

Japan’s dilemma is that if Abenomics successfully ignites “inflation” then this should bolster JGB yields and put burden on her trillion yen debt load. The Japanese government has a debt to gdp ratio of 244%[16]. And higher yields will likely force the BoJ to bring down yields by increasingly frantic money printing that may not only lead to a debt crisis but to a currency crisis.

On the other hand if Japan’s thrust to inflate a bubble fails, then a bust would mean greater dependence on debt to finance her budget. With debt servicing accounting for 46% of tax revenues a severe shrinkage in tax revenues may force the government into a debt crisis.

Japan’s current tenuous “kick the can” measures operates midway between these two extreme conditions.

As noted at the start of the year[17], Japan is a closet Black Swan in the making.

---

[1] Japan Times BOJ near limit for bond buys but boost may be needed, January 20, 2014

[2] See Japan’s NIkkei Rockets 3.3% as Bank of Japan Promises More Kool Aid February 18, 2014

[3] Reuters.com Bank of Japan likely to expand asset buying by summer February 21, 2014

[4] Bank of Japan Monthly Report on the Corporate Goods Price Index, February 13, 2014

[5] Wall Street Journal Japan Machinery Data Show Companies Still Cautious on Outlook February 11, 2014

[6] Wall Street Journal Real Times Economic Blog Real Japanese Wages Slip, Posing Challenge to ‘Abenomics’ February 5, 2014

[7] IBC Times UK Japan's Unemployment Rate Drops to Six-Year Low Amid Rising Inflation January 31, 2014

[8] FoxNews.com Japan economy grows slower-than-expected 1 percent in Oct-Dec despite housing boom February 16, 2014

[9] Bloomberg.com Abe Eyes Land-Price Reflation to Spur Construction Boom January 20, 2014

[10] Bloomberg.com Japan Companies to Keep Up Foreign M&A Even After Yen Drop January 17, 2014

[11] Japan Times Arrival of ‘bad inflation’ trend bodes ill for Japan’s rebound January 16, 2014

[12] Bank of Japan Basic Figures of the Flow of Funds -- Third Quarter of 2013 December 25, 2013

[13] Wall Street Journal Japanese Keep Holding Cash January 9, 2014

[14] Ministry of Finance Japan's Fiscal Condition December 2013

[15] Reuters.com Japan approves $182 billion economic package, doubts remain December 5, 2013

[16] Bloomberg.com Abe Doomsday Risk Prompts Moody’s Warning on JGBs: Japan Credit January 31, 2014

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

Behind Ukraine’s Bank Run

The emerging market Bank run has now spread to political crisis stricken Ukraine. 

From Bloomberg:

Ukraine’s deadly clashes prompted OAO Sberbank to stop offering loans to individuals in the country less than one year after it opened 50 branches there, Chief Executive Officer Herman Gref said.

Russia’s biggest bank, which closed three branches in downtown Kiev this week as violent clashes killed at least 77, has also witnessed a “run on” its automatic teller machines in the country, Gref told reporters in Moscow today. The hryvnia, which is managed by Ukraine’s central bank, plunged almost 8 percent against the dollar this year and non-deliverable forward rates show it will slump another 11 percent in three months….

Growing pressure on the currency could lead individuals to rush to pull money from Ukrainian bank accounts, Dmitri Barinov, a money manager overseeing $2.5 billion of debt at Frankfurt-based Union Investment Privatfonds, said Feb. 18.

Political instability has been blamed on the “bank run” while ignoring the fact that Ukraine has been in a recession even prior to the current political crisis. 

The World Bank during the 2nd quarter of 2013 outlook even notes of the Ukraine’s government’s spendthrift ways even during the recession. (bold mine)

Weak economic performance resulted in a significant budget shortfall in the second half of 2012. Actual revenue of the central budget was UAH 33 billion (2.5 percent GDP) lower than initial budget plan because both real GDP growth and inflation were lower than the forecast on which the budget was based. Meanwhile, expenditures remained inflated due to a hike in social spending (by over 2 percentage points of GDP) introduced in Spring 2012. Fiscal deficit (general government definition) reached 4.5 percent GDP in 2012. In addition, structural deficit of the state-owned company “Naftogaz” was not addressed.

I also pointed out that this has not just been the government, but the private sector sector has been engaged in a debt financed-borrowing spree.

Ukraine’s credit as % to gdp as of 2012 (based on World Bank Data)

Ukraine’s banking sector credit as % of gdp as of 2012.

As you can see Ukraine’s debt levels in both dimensions has more than doubled since 2005.

What the credit inflation has done? Well it has inflated two incredible stock market bubbles in a span of about 5-6 years (2007-12).

Like the first stock market bubble collapse, the second coincided with a recession. The imploding stock market bubbles has now segued into a currency meltdown.

The question unaddressed is how much of money has been lent by the banks to the private sector that had been funneled to inflate such stock market bubbles? How much had been borrowed in foreign currencies?

To what degree have Ukraine’s banks have been affected by deterioration in loan quality? 

So given Ukraine’s Wile E. Coyote moment, 'bank runs' would seem as natural consequence as bank assets deteriorate in the face of fractional reserve banking, a recession, escalating shortage of liquidity and debt deflation.

And banks can hardly rely on the public sector support because Ukraine government has been cash strapped, she desperately sealed a financing deal with Russia in December 2013

In short Ukraine’s economic crisis, primarily due to inflationism or bubble blowing policies, set stage for this political crisis. The likely ramification from the Ukraine's economic crisis is that more bank runs will occur.

I don’t deny that politics have become a factor. But this is a consequence rather than the cause. 

Ukraine’s economic crisis has only deepened the polarization of Ukraine’s fragmented society via partisan politics. Geopolitics may even have been involved here. Some have even alleged that the US has been operating behind the scenes in fomenting another Orange revolution

Because of Russia’s intensive exposure in Ukraine in terms of culture (Russian population in Ukraine) and embedded interests in the energy sector, aside from perceived threats from a supposed US ‘encirclement strategy’ of Russia, where a new US friendly government in Ukraine will be enticed to join NATO.…Russia has reportedly declared that she is “prepared to fight a war over the Ukrainian territory” using the Russian population as cover.

So Ukraine’s crisis can easily metastasize into a international geopolitical crisis. 

And while Ukraine has just signed a peace deal, this serves as no certainty that the political crisis has passed. Russia, a major influence to Ukraine's politics, didn’t join the accord.

What is likely to aggravate the political conditions will be sustained economic uncertainty brought about by Ukraine’s earlier bubble blowing policies amidst heated tensions from culture based politics inflamed by geopolitical interventions.

Anyway the above charts from the World Bank demonstrates why relative debt position seem irrelevant in the measuring of credit risks.

Ukraine’s debt in terms of nominal USD stock has been lower than many developing nations or emerging markets equivalent. This can also be seen in terms terms of % of gdp but at a much lesser scale. Yet Ukraine’s government recognized her near bankruptcy last year.

Debt tolerance has been always based on independent valuations from creditor’s perception of the capacity and willingness of debtors to settle indentures which differs from country to country. When a critical mass of creditors begin to call on the loans, the crisis becomes apparent--one symptom "bank runs".

Going back to the bank run, again if Ukraine’s economic crisis intensifies then more bank runs should be expected.

Yet increasing accounts of emerging market bank runs such as in Thailand, Kazakhstan and now Ukraine, aside from China’s continuing bailouts of delinquent financial institutions demonstrates why the EM crisis have not been over. And as reminder, all these has transpired in a span of two weeks.

And contra the bulls, this may just be the tip of the iceberg.

This isn’t your granddaddy’s bond markets

Sovereign Man’s Simon Black puts my “grotesque mispricing of bonds via the convergence trade” into perspective: (bold mine)

This is really amazing when you think about it. Central bankers have destroyed money and interest rates to the point that near-bankrupt companies in shaky jurisdictions can borrow money for practically nothing.

It’s an utter farce. The rate of inflation is -at least- 3% in many developed countries. Central bankers will even say they are targeting 3% inflation.

This means that if investors simply want to generate enough income so that their after-tax yield keeps pace with inflation, they have to assume a ridiculous amount of risk.

This is a really important point to understand given that the global bond market is so massive– roughly $100 trillion, with nearly $1 trillion traded each day in the US alone.

This is almost twice the size of the global stock market. And even if people never invest in a bond themselves, they’re directly connected to the bond market.

Your pension fund owns bonds. The bank that is holding on to your money owns bonds. The companies listed on the stock market that you invest in own bonds.

Yet bonds are some of the worst investments out there right now. And that’s saying a lot given how overvalued stock markets are.

Here’s the bottom line: adjusting for both taxes and inflation, bondholders are losing money, even on risky issuances.

Think about it– if you make a 4% return and pay 25% in taxes, your net yield is 3%. If inflation is 3%, your entire gain is wiped out… so you have taken that risk for nothing.

If inflation rises just a bit then you are in negative territory.

There are those who suggest that deflation is a much greater risk right now than inflation… and that bonds are great investments to own in the event of deflation.

But here’s the thing– even if deflation takes hold and prices fall, anyone who is deeply in debt is going to feel LOTS of pain. Instead of their debt burden inflating away, now they’ll be scrambling to make interest payments.

So while bonds are a sensible deflationary investment in theory, in practice deflation will only increase the likelihood of default. This puts many bond investments at serious risk.

Last, if interest rates rise from these all-time lows, a bond’s value in the marketplace will plummet. So not only will you have made zero income, you would be looking at a steep loss if you try to sell.

Longer term, fixed rate bonds in weak currencies are almost guaranteed losers and should be avoided at all costs. You would be much better off setting your cash ablaze in a bonfire. It’s at least a better story to tell and will save you years of anguish watching your position erode.

Oh stagflation, which pervades in ASEAN markets, equates to weak currencies. As noted above, if there will be more inflation, bond markets will lose. And if stagflation pricks the asset bubble, bonds lose too as debtors default or see rising real costs of debt amidst weak economic growth. Also an asset bust would mean tighter credit conditions that affects growth 

The convergence trade is destined for a reversion to the mean as easy money transitions into tight money. And since pension funds, publicly listed companies and banks hold bonds, such reversion to the mean will extrapolate into financial losses. 

Central banks have altered the complexion of the bond markets to the point that this isn't your granddaddy's bond markets.

Consequences of Inflationism: Caracas (Venezuela) and Kiev (Ukraine) Burns

Sad to see of what seems as escalating political instability around the world (mostly in emerging markets).

The backlash from hyperinflation by the Venezuelan government has become apparent as rioting has been intensifying. 

First the crashing bolivar and spiraling price inflation.  

Now writes Zero Hedge (bold original)

the situation in Venezuela has once again escalated as protest leader Leopoldo Lopez' arrest (and possible 10 year jail sentence) prompted more violence overnight. However, as we warned, the government crackdown is starting to raise concerns about the stability of the government.

• *VENEZUELA PROTESTS ESCALATING INTO NATIONWIDE UNREST: IHS
• *ESCALATION OF PROTESTS PUTS STABILITY OF GOVT AT RISK: IHS
• *RISING VIOLENCE COULD LEAD TO MADURO OUSTER BY MILITARY: IHS

As opposition leader Capriles asks Venezuela's military to uphold the constitution, he exclaims that "the poor' must participate for government to change.

• *VENEZUELA HATILLO MAYOR DAVID SMOLANSKY SPEAKS IN CARACAS
• *VENEZUELA PEOPLE WON'T STAY QUIET: SMOLANSKY
• *SMOLANSKY SAYS VENEZUELA SUFFERED TERROR LAST NIGHT
• *SMOLANSKY CALLS FOR MASSIVE VENEZUELA PROTESTS SATURDAY

The opposition leader speaks:

• *VENEZUELA OFFICIALS SHOT AT PROTESTERS YDAY: CAPRILES
• *VENEZUELA ARMED FORCES SHOULD ALLOW PEACEFUL MARCHES: SMOLANSKY
• *VENEZUELA STRENGTHENING TIES WITH CUBA, RAMIREZ SAYS
• *VENEZUELA GOVT USING VIOLENCE TO HIDE ECO PROBLEMS: CAPRILES
• *CAPRILES SAYS SOME IN VENEZUELA GOVT WANT MADURO OUT
• *CAPRILES ASKS VENEZUELA ARMED FORCES TO UPHOLD CONSTITUTION
• *VENEZUELA POOR MUST PARTICIPATE FOR GOVT TO CHANGE: CAPRILES
• *CAPRILES SAYS HE WON'T BE FORCED TO TALK TO VENEZUELA GOVT

And IHS warns:

• *VENEZUELA PROTESTS ESCALATING INTO NATIONWIDE UNREST: IHS
• *ESCALATION OF PROTESTS PUTS STABILITY OF GOVT AT RISK: IHS
• *RISING VIOLENCE COULD LEAD TO MADURO OUSTER BY MILITARY: IHS

Images from last night suggest this is getting considerably worse...despite Maduro's claims of "absolute calm"

The populist government recently even put a Happiness Ministry and promoted the public’s looting of “greedy”companies to enforce price controls.

The result has been obvious: the cumulative demand (printing money) and supply side (price controls) interventions has prompted businesses to refrain from operations. Thus all money printed by the government has emptied shelves and sent prices skyrocketing. The ensuing hunger now drives people into the streets. The riots even claimed the life of a Venezuelan beauty queen. 

Nonetheless Venezuela’s stock market continues to remain buoyant amidst all the unrest as people use stocks as shield against a collapsing currency.

In Ukraine, anti-government protests seem to have turned into a civil war as the riots have now claimed 26 lives as of this counting.

One region the Lviv has even declared independence from the Ukraine’s government

It is easy to look at the riveting rivalry between areas supportive of Europe on the one hand and areas supportive of Russia as causing the current troubles.

But there may be more than meets the eye.

Ukraine’s currency the hryvnia has seen a massive devaluation in 2008 and remained at this level prior to the political upheaval. Currently the hryvnia has been sold off as rioting spread.

But there has been a sharp deterioration in external and domestic financing even prior to the unrest. 

Ukraine’s government budget deficit has been widening since 2008. Ukraine has also swelling deficits in both trade and current accounts. 

Over the same period, loans to the private sector has been exploding to the upside, which likely means both the private sector and the government contributing to broadening deficits in the merchandise trade. 

Meanwhile Ukraine’s external debt has risen by almost 3.5x from 2006…

…as forex reserves plunge by almost half.

And soaring private and public sector loans has led to a spike in M3 from 2009 onwards.

And of course, driving all the soaring debt and money supply levels has been the same zero bound rates.

So Ukraine has been financing the splurge with debt which has resulted to the current financial and economic strains

And despite the so-called low inflation rate figures, what the above data suggests is that inflationism has driven a deep chasm to Ukraine’s fragmented society that has enflamed today’s violent riots.

Amazingly Ukraine’s easy money policies inflated a stock market bubble twice which also blew up in a span of 5 years. The above is a shining example of bubble driven volatility in both directions but with a downside bias.

Ukraine is largely a commodity commodity and energy based economy. The shadow economy has been estimated to contribute to about 40%. 

And energy geopolitics may have played a secondary role in the growing schism. The zero hedge quotes one analyst… (bold original)

BOTH the USA and EU will now fund the rebels as Russia will fund Yanukovych. At the political level, Ukraine is the pawn on the chessboard. The propaganda war is East v West. However, those power plays are masking the core issue that began with the Orange Revolution – corruption. Yanukovych is a dictator who will NEVER leave office. It is simple as that. There will be no REAL elections again in Ukraine. This is starting to spiral down into a confrontation that the entire world cannot ignore

Political instability seem to percolate into emerging markets, as we see the same violence in Thailand, Saravejo Bosnia and Conakry Guinea, which represents troubling signs of contagion (from economic sphere to the political sphere).

Yet political problems in Thailand, Ukraine and Venezuela has a common largely "invisible"denominator: inflationism

The advocate of inflationism John Maynard Keynes saw of  the destructive capacity of inflationism on society (yet ironically he still promoted this): 

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

Political instability in the above countries reveals how “Lenin was certainly right” on how inflationism destroys society.

Kazakhstan’s Devaluation Triggers Bank Runs

A few days back I wrote about Kazakhstan’s surprisingly huge devaluation despite what mainstream would see as strong statistical data. 

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.

Well my suspicion seems right, the devaluation exposed on Kazakhstan’s debt problems via a run on three banks

From EuroAsianet.org

Kazakhstan’s central bank is appealing for calm as rumors that some financial institutions are in trouble following last week’s currency devaluation have provoked a run on three banks.

On February 19 the National Bank sent text messages to the public urging people to disregard the “false information” and not succumb to panic.

“All Kazakhstani banks have sufficient funds in national and foreign currency,” the messages read; people should not submit to “provocations” and “keep calm.”

Large queues formed at some banks in the financial capital, Almaty, for a second day on February 19 as customers rush to withdraw funds, fearing a bank collapse.

Media and officials blame it on rumors.

But logic tells us that if the banking system stands on a firm ground then they wouldn’t be vulnerable to rumors. 

The reason banks are prone to runs aside from Kazakhstan’s existing debt problems has been the roots of the monetary system: central bank fractional reserve banking standard.

"The answer lies in the nature of our banking system", writes the great dean of Austrian economics Murray N. Rothbard, that’s because “they have far less cash on hand than there are demand claims to cash outstanding.”

Professor Rothbard further explains:

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor think that they can withdraw their money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out. The confidence is essential, and also misguided. That is why once the public catches on, and bank runs begin, they are irresistible and cannot be stopped.

Given the recent bank run Thailand, it has been interesting to see what seems as increasing frequency of bank runs in emerging markets or failing financial institutions such as in China.

More signs that emerging markets could be the modern day version of "subprime". 

We live in very interesting times

Cracks in Malaysia’s Credit Bubble?

Malaysia’s inflation data rose faster than consensus expectations.

From the Wall Street Journal Real Time Economics Blog

Fast-rising prices in Malaysia, as the government dials back subsidies and the economy grows at a strong clip, could prompt the central bank to raise interest rates that have been on hold since mid-2011.

Data out Wednesday showed consumer prices rose 3.4% in January from a year earlier, the fifth straight month of gains and fastest pace in two and a half years. That was up from 3.2% in December and a tad above the 3.3% median forecast in a Wall Street Journal poll.

Malaysia’s price inflation seems a tad away from the 2011 highs.

In previous accounts where price inflation spiked beyond 5% levels, such has been associated with major economic turbulence, as the Asian Crisis and the the global crisis triggered by 2007-2008 US housing bust which culminated with the Lehman bankruptcy.

While 3.4% seems far from the 5% threshold, current dynamics seems to point at inflation rates headed towards such direction, unless otherwise reversed. 

Media blames inflation on supply side quirks. From the same article.

Economists say inflation will remain elevated for the rest of the year after electricity tariffs were raised in January. That follows other moves last autumn to raise prices of two widely-used fuel variants and to scrap subsidies on sugar.

Lifting of subsidies have hardly been the real forces driving Malaysia’s price inflation.

Instead the major forces driving Malaysia’s inflation has been a credit boom that has fueled a property bubble as previously discussed.

Since 2001, loans to the private sector has zoomed with the kernel of the accelerated credit boom happening from 2008 onwards. Loans to the private sector has ballooned by about 2.6x from December 2013 compared with the 2001 levels

Seen from another view, loans provided by the banks as % gdp, which dropped to a recent low of 109.4% in 2007 has regained a second wind to swell to a record 134% in 2012, based on World Bank data. 

Banking loans includes “all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net”

Also domestic credit provided to the private sector in the category of “loans, purchases of nonequity securities, and trade credits and other accounts receivable, that establish a claim for repayment” has increased from a recent low of 96.7% in 2008 to a record 117.8% in 2012 again from the World Bank data

Three facets of credit data depict on the same picture.

 

Yet all these fractional reserve based money creation has led to soaring money supply.

Malaysia’s M3 has accelerated along with the ramping up of credit over the same period.

Seen in terms of % growth, Malaysia’s M2 spiked to 14.6% in 2011 before retracing back to the 7-8% levels in 2013.

Malaysia’s average annualized growth has been at 4.65% from 2000-2013 according to tradingeconomics. This means that M2 has been running about more than double the growth of the economy

And interestingly, Malaysia’s banking credit profile looks almost exactly like the Philippines in terms of supply side distribution. The gist of credit growth has been in finance, real estate and trade! This is according to a report from RHB.

The difference is that Malaysia’s household has also been massively acquiring credit. And that’s the reason why private sector credit or banking sector loans have been above the 100% level in terms of gdp. 

This also means Malaysians have more financial depth than the Philippines for them to partly offset the adverse effects from credit inflation via productivity growth.

Unfortunately, artificial booms will eventually come to an end.

Behind the scenes, Malaysia’s credit boom has been driven by zero bound official rates. Or if measured from 10 year Malaysia’s local currency denominated treasuries, yields have been in a decline since 2009 as credit soared.

However, this picture seems to have been reversed as yields have been on an upside streak in late 2013 to reach 2009 levels. This means that the easy money environment that has stoked the boom has come under pressure from the bond vigilantes 

Even the Malaysian currency, the ringgit, has been showing signs of pressure. Since Abenomics-Bernanke taper in May-June2013, the ringgit has been in a major downtrend interspersed with short term rallies.

And such bond market-currency weakness should come as a surprise to the mainstream because Malaysia’s external façade looks solid; current and trade accounts remain in surpluses, government external debt has been in decline and Malaysia has $140.4 billion of forex currency reserves as of December. 

Malaysia’s forex reserves peaked in August 2011 at $155 billion, but perhaps, due to the latest EM turmoil, the Malaysian central bank may have used her surpluses to counter foreign outflows. 

The bond-currency weakness hasn’t been shared yet by the other markets...yet

Malaysia’s default risk as measured by the 5 year CDS spiked in August 2013, fell back to October lows and surged again in January (but only halfway) from the August highs. Recently the 5 year CDS has returned to October lows

Interestingly Malaysian stocks, as measured by the KLSE, which has also been hammered in June 2013, bounced backed strongly to even carve new highs at the close of 2013. 

This seems as signs of the growing desperation by those addicted to easy money climate to resist the ongoing shift in the economy by forcibly bidding up stocks in the hope of a return of the boom days. 

Yet the divergence in signals means that eventually something will have to give. Will bond yields reverse that should power stocks higher and bring about the next wave of credit boom? Or will stocks adjust to reflect on rising rates?

All these will depend on how rates will ultimately affect debt.

Let me post again ASEAN’s debt chart from the World Bank.

Malaysia’s overall debt runs at about 200% of gdp, mostly due to household debt. Malaysia’s economy in 2012 has been at a nominal US $307.2 billion. This makes her credit exposure which has been largely dependent on low rates at about $600 billion. Again forex reserves are only 23% of Malaysia's total debt stock.

This brings us back to the earlier article who rightly points to the danger of rising inflation amidst growing debts.

Caught in the middle are Malaysia’s consumers, who are facing growing debts just as rising prices erode their disposable income. Consumer borrowing in Malaysia has risen some 12% a year for the past five years, with household debt climbing to 80.5% of GDP by the end of 2012 from 50.4% in 2008, one of the highest levels in Southeast Asia.

The debt and inflation dynamic surely contributed to December’s weak consumer confidence reading, the lowest since June 2009.

Missing in the article is how inflation would mean higher rates and how higher rates would impact the cost of debt servicing in the face of slowing demand that subsequently should raise credit quality issues.  Or differently put, how will highly indebted Malaysians be able to pay back the debt which servicing costs has been rising, if growth slows aggravated by higher inflation? Will these not increase Malaysia's credit risks?

At the end of the day, like the Philippines Malaysia appears now confronted with a stagflationary setting (even unemployment rates have increased in November 2013 which broke out of 3.3% resistance levels), whose rising rates threaten to serve as a pin that could prick on Malaysia’s credit bubbles.

Quote of the Day: Robots should say a prayer to central bankers

Slaves – human or robotic – are a form of capital. After the cost of maintenance, the profits from their work go to their owners.

Wolf does not mention it, but the robots should say a prayer to central bankers. By reducing interest rates, they also reduce the cost of capital.

At zero rate of interest, for example, the real cost of a robot is zero. And if that robot can replace an average, marginally competent employee with a bad attitude, the employer makes a profit of $42,000 (or whatever he would have paid the human)… not counting health insurance and the parking place.

The lower the cost of capital, the more robots take their place in the labor force… and the more labor costs drop.

This is an excerpt from Agora Publishing’s Bill Bonner (published at Bonner & Partners) who takes a swipe at the neo-luddites. This shows just how blind the mainstream have been to the theory of capital to embrace age old discredited fallacies