Sunday, November 11, 2007

The Politics Behind The Peso

``The moment we want to believe something, we suddenly see all the arguments for it, and become blind to the arguments against it."-George Bernard Shaw

Again we can’t help but emphasize on what the history says; in all 60 years where the Peso devalued from Php 2 to a US dollar until its peak of Php 56.4 (or about 96% loss) in 2005, our export industry has NOT gained a hefty market share enough to navigate or steer our economy into Nirvana, which has remained sluggish all throughout the past 6 decades, as we discussed in our August 20 to 24 edition [see In Defense of the Philippine Stock Exchange From Political Correctness].

The point being that the function of price as represented by currency changes alone has not been a beneficial factor to our export industry simply because OTHER variables has led to our lack of competitiveness, ergo the seeming price inelasticity of our exports.

Whereas even if the Peso falls to Php 100 to a US dollar, it is not guaranteed that our export industry will recover without adequate reforms in the areas which has impeded on our capacity to compete. Those arguing on the elasticity of our export industry are simply suggesting of short term solutions again, notably through government interventions-a cure worse than the disease-without asking how such wretched conditions emanated from in the first place.

This fallacious linear way of thinking, “falling peso is good for exports” can easily be debunked using with Zimbabwe as an example. Because of Zimbabwe’s hyperinflationary depression has resulted to an inflation rate of 6,598% in August 2007 (BBC), the value of its currency has dropped like a stone from a cliff, where its official rate is at Z$30,000 to a US dollar, but in the unofficial “black markets” are trading at (VOA) Z$1 Million to a US dollar! In effect, Zimbabwe, given such grotesquely skewed premise, should be the WORLD’S LEADING EXPORTER! Duh!

When reforms are made to reflect on the capacities to compete in the market, then prices come into play depending on the level of products produced and to which markets they are sold to, here the cost efficiency and productivity factors would play the leading roles. Hence, addressing these factors requires no short term solution where eventually currency markets should reflect on its true price levels.

As you have seen in Figure 4, the entire region has appreciated against the US dollar in relative terms. So if one argues about pricing in terms of currency adjustments, ALL Asian countries have generally seen their export pricing costs climb. This holds true for most of the rest of the world. So the argument of losing export market share is entirely out of context.

It is not the issue of the Philippines versus the US alone; in the global trade dynamics, it is the issue about the US dollar falling against most global currencies.

To likewise expose such misleading grounds, exporters can always hedge their exports via currency forwards, which if I am not mistaken are also offered by domestic banks. That is why financial markets need to generate more sophistication and deepening, so as to allow our investors alternative sources of financing or acquire additional capabilities to hedge their risks. A natural outcome of a well functioning market is for our industries to achieve increased efficiencies and heightened competitiveness.

Looking at the context of statistics, our external trade has been a less significant factor if based on our 2nd quarter GDP’s computation, by expenditure at current prices (NSCB). Private consumption accounts for about 70% of the GDP, followed by capital formation 15% and government consumption 11%. Net exports (Exports- Imports) account for only .1% of the GDP. This means that both exports and imports are almost at parity with the exports having a slight edge (both 42% of GDP), hence the net exports.

Of course, what the market critics wants to say is that the government needs to protect these groups by intervening in the markets. And the unseen part is that intervening eventually translates to balance sheet losses by our (BSP) Bangko Sentral ng Pilipinas which would imply to future actions of selling assets to cover deficits. Exhausting all available assets for sale extrapolates to either incurring more debts or printing more money or increasing taxes, whose side effects would mean losing purchasing power over the longer horizon aside from again the loss of competitiveness.

The desire to help a select group over a popularly themed perceived inequality over the short term means sacrificing the future for the benefit of a few.

The following excerpt reflects on the sentiment of domestic businessmen on the perceived factors which inhibits the country from attaining competitiveness (Businessworld), ``But from a list of 14 "factors for doing business," senior business executives in the poll selected corruption, inadequate supply of infrastructure, policy instability, an inefficient government bureaucracy, and "government instability/coups" as their five top concerns.

``Others include stiff taxes and complicated tax regulations, lack of access to financing, restrictive labor regulations, crime and theft, poor worker ethics, and inflation.” (highlight ours)

Our guess is that inflation which rank last seems so because it is the least understood among the lay people. However, generally stated, the frustrations emanate from again misdirected and distortive (inflationary) policies, which have been the main cause of our present plight. Yet ironically, these experts have been urging our officials to apply the same measures with which had caused them in the first place. It’s like giving an alcoholic his next bottle of gin.

Just take the account of remittances; bleeding hearts say that since remittances accounts for about 10% of the economy, it makes up a big portion of private consumption. And since it is a big part of our consumption it should be subsidized by a weak peso.

We wrote NSCB to ask for an estimated figure from which remittances contributes to this share. Apparently since I made the initial query two weeks ago and they have not responded, our guess is that they have no precise figure for such claims. Previously our requests were promptly responded for, not this one though.

The implication is while remittances do vastly help the GDP, rising currencies ex-Peso or a falling peso should help in the purchasing power of those who benefit or the supposed “majority”.

Again, the deceptive linear logic, “falling peso=greater purchasing power for OFWs=the better economy”, yet nobody says anything about higher future consumer prices, an offshoot to such policies.

First of all, if remittances account for 10% of GDP then apparently 90% of the other sectors are also there to deal with. When has the “popular” 10% been greater than the “unheralded” 90%?

Second, even assuming that the OFW’s beneficiaries constitute a big portion say a majority of our consumer spending power today, it is not spending that helps our economy but generating savings and channeling them into investments. The assumption that consumer spending has a multiplier effect is a dubious one. Even if we send half of our population abroad, if the country does not generate enough investments we are unlikely to improve and remain as we are today.

From Dr. Frank Shostak of the Ludwig von Mises Institute (emphasis ours),

``What gives rise to the expansion of real wealth is the expansion in the pool of real savings. It is real savings that funds the making of various capital goods i.e. tools and machinery. In short, it is real savings that sustain various individuals that are engaged in various stages of production. All that money does in all of this is to provide the facility of the medium of the exchange. It makes it possible for individuals to exchange goods and services. The services of money are not enhanced on account of its greater supply. If anything the increase in the supply undermines the services of money. After all when people’s demand for money rises they don’t want more money as such but rather more purchasing power, it is the increase in the purchasing power of money that makes goods and services more marketable. The increase in the supply of money only prevents an increase in the purchasing power of money from taking place.”

Third, all you have to do is look at the Peso for empirical evidence; has 60 years of devaluation and greater OFW exports resulted to a better economy??? I think the answer is quite evident for those who are wise enough to see the truth. Besides, OFW flows are likewise levered to global growth. In general, if global growth slows substantially so will the flow of OFWs and the remittances. Mexico’s remittance flows, which has been levered to the US economy, has started to slow (MSNBC).

Fourth, there is also the unseen implication of money flows, where under a falling peso, OFWs tended to delay remittances in the hope of garnering more “purchasing power”.

Investors are seen in the same light, under a falling peso, capital flight is the common option. People invest in the US dollar instead of the Peso investments. How can withholding money or investing in ex-Peso assets by resident investors benefit the economy?

If there is one domestic reason why we specialize in exporting labor, aside from globalization/demographic trends, is the belated effect of policy outcomes or the law of unintended consequences. It seems that we never learn.

Finally some pertinent quips from US presidential aspirant Ron Paul on currency manipulation (from Mish Shedlock),

``[The answer] is inflate the currency. They don't say inflate the currency, they don't say debase the currency, they don't say devalue the currency, they don't say cheat the people. They say lower the interest rates.'"

``And you never tell them 'the only way you can lower the interest rate is to create more money'. I see this as the problem we don't want to talk about

``We ignore the fundamental flaw and that is not only have we had a subprime market in housing, the whole economic system is subprime in that we have artificially low interest rates. This has been going on for 10 years or longer and now we are bearing the fruits of that policy… The real deception is when we distort the value of money, when we create money out of thin air…. So my question boils down to this: 'How in the world can we expect to solve the problems of inflation, that is the increase in the supply of money, with more inflation.” (highlight ours)

In essence most of the policy makers, political demagogues and anti-market experts have the all same solution to the very problem from which was created; inflate the system, distort the markets, benefit from it (by being a part of the bureaucracy or the special interest/parallel groups), feed the public with the scraps of money and cry inequality! That is what personality based rent seeking politics is all about.

As they say in France, “plus ca change, plus c'est la meme chose” or in English, the more things change the more they remain the same.

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