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     Feb 14, '14


Define irony ...
By Chan Akya

"Define irony ... A bunch of idiots dancing on a plane to a song made famous by a band that died in a plane crash." [Sweet Home Alabama plays in the background] - Quote from the movie Con-Air [1] - Touchstone Pictures, 1997

On a recent trip, I ended up watching the film Con-Air for reasons that are inexplicable really, but I very much enjoyed the quote from one of the characters, as it happened one of the less Hollywood cardboard types that plaster the action film genre.

The reason the quote resonated with me is of course the state of the global equity market today, wherein equity investors are


cheering every dumb move by global central banks, not quite realizing that the seeds of their own decline germinate with every such antic.

Think about it. Whatever the names of various entities that plough around the stock market, ultimately what is being invested is individuals' capital. These individuals are typically middle-aged and older, with savings buckets that depend on two major assumptions for their retirement: (a) capital preservation and (b) regular income to be accrued over retirement. Think about that for a minute longer and you figure out that what is sought to be preserved is purchasing power, not nominal dollars.

So then, let's think about the purchasing power rather than nominal currency figures for a bit. What are the factors that drive down the value of a currency? The traditional view is the following are the primary causes:
a. Inflation - the obvious culprit
b. Devaluation (leading to inflation as above)
c. Loss of confidence (leading to devaluation etc.)

But that traditional view has a deep flaw, as anyone living in Hong Kong or Singapore would attest to. In this part of the world, governments have low tax rates - typically under 20% effective tax rates. Additionally, capital gains are also usually exempt from taxes, unless there are special taxes to counter property price increases and so on.

All of which brings you to the corner shop. Take any consumer staple that you would buy at a supermarket, and easily one would find that the prices in Hong Kong and Singapore are at least double what a similar good would cost in London or New York. The difference in price is referred to by locals as the "Li Ka-shing Tax", named after one of the world's richest men who is also a property developer in both Hong Kong and Singapore.

The reason for the higher product prices - ironically also on products manufactured in China (meaning ultra-low shipping costs) - is the high commercial rents that have to pay in these cities. That rent leads to extraordinary mark-ups on the products populating the aisles, leading to much higher living costs (or lower living standards).

Time for cages, men
The dirty little secret of Hong Kong and Singapore is that despite the glitzy facade and awe-inspiring skylines, a large portion of locals in these countries live in extremely poor conditions. In the case of Hong Kong, the prevalence of people living in cages stacked upon each other (no, really) is both depressing and a testament to the drive of immigrants to get ahead. [2]

In the case of Singapore, there was the recent riot in a place called "Little India" that provided a glimpse - and only a glimpse thanks to the stringent controls on media in that country - of the plight of immigrant laborers who toil under the hot sun to put up the city-state's tall buildings. Images in the press show policemen on one side and what looks like a mob ganged up on the other side of the burning car. [3]

Whatever the specific merits of the two city-states, it is easy to see that asset price inflation is not a victimless crime.

Back to the Fed ... and other central banks
When the incoming head of the Federal Reserve, Janet Yellen, quietly comforts global equity markets (leading to this week's recovery after the decline for the previous two weeks), the underlying message is that central banks want to keep asset prices high (or push them higher) in order to stop the apparent economic death spiral from deflation.

That might be all well and good under traditional economics, but global trends have moved far away from the secular trend before the 2007 crisis. Since then, it has been painfully obvious that central bank policies and government stimulus efforts have ended up benefiting only the rich and left the poor much worse off. In turn, this has spawned many a protest movement including the excitable folks at "Occupy" on the one end and the "Arab Spring" folks on the other, with the Singapore riots being somewhere in between.

Ah, you say - there hasn't been any such riot in the US or Europe (ignoring the London riots of a couple of years ago). [4] That would be true on the surface if only because the poor have been too busy making a living to bother with rioting.

There is also a more subtle trend that has taken hold. Many ideologists for fiscally conservative political parties in developed countries, ranging from US Republicans to UK Conservatives, are convinced that a "permanent" shift to the left has taken place across the general population. This has prompted them to adjust both their politics and rhetoric to the new reality. This Realpolitik is blamed for the capitulation by the Republicans this week on the debt limit, which has now been suspended until March 2015, or well after this year's elections. These trends offer cold comfort for people like me who predicted just such a shift many moons ago. [5]

It doesn't quite take a genius to figure out that asset prices are not only too high, but also unaffordable for anyone under the age of 30 in most developed countries. In places where some assets are affordable - for example, homes in Spain - other factors such as youth unemployment have conspired to keep younger people well out of the market.

Therein lies the deepest fault line in the global economy today.

My readers know well enough that I am no communist or even socialist, so this is not a Paul Krugman-type appeal for more handouts. Instead, as a market capitalist, it is my firm belief that policymakers need to withdraw their stimulus quicker than currently envisaged to allow a semblance of normal valuations to return to global asset markets.

Without doing so, the vicious cycle of central bank intervention that keeps asset prices artificially high but fails to provide any tangible benefits in terms of employment generation or real wage increases appears all set to continue.

About those characters in the film, subjects of the "define irony" comment - spoiler alert but yes, most of them perish and the plane also crashes. When markets cheer for the Federal Reserve and other central banks continuing their idiotic Keynesian policies, they are in effect dancing to the sweet music of Sweet Home Alabama.

Enjoy the music while it lasts, but do take care to dance nearer the door.

Notes:
1. Sweet Home Alabama was recorded by Lynyrd Skynyrd in 1974. Three members of the band died in a plane crash in 1977.
2. Where home is a metal cage: How tens of thousands of Hong Kong's poorest are forced to live in 6ft by 2ft rabbit hutches, Daily Mail, February 8, 2013
3.Singapore bus death triggers riot, BBC News, December 9, 2013
4.See "London Riots reduce lies of Left to ashes" Asia Times Online, August 16, 2011.
5.See "Principal over principle", Asia Times Online, June 6, 2009.


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