deficit
spending itself inhibits economic growth by causing the Federal Reserve to
monetize the federal debt. The Fed lowering interest rates and increasing the
money supply distorts the signal interest rates send to market actors. This
distortion causes the boom-bust cycle that plagues the American economy—Ron Paul
In this issue:
Stagflation Part 19: Twin Deficits, a Third Inflation
Wave, and the Bill for Free-Lunch Politics
I. One Imbalance, Two Record Deficits
II. The Debt That Slowed
III. The Export Boom That Imports Itself
IV. The Financial Repression Behind the Free-Lunch
Politics
V. Three Markets, One Signal
VI. October: The Third Wave of the Inflation Cycle
Affirmed
VII. Interventions Beget Interventions: From Minimum
Wages to Struggling Labor Conditions
VIII. The Peso Rally is a Loan, Not a Fix
IX. Conclusion: The Bill Arrives
Stagflation Part 19: Twin Deficits, a Third Inflation
Wave, and the Bill for Free-Lunch Politics
Record deficits, a peso under siege, a banking system
steering credit to the favored, and 7.8% inflation. Free-lunch politics wrote
the check. The economy is paying it.
I. One Imbalance, Two Record Deficits
A country can consume beyond what it produces, but only
by drawing on savings, borrowing from abroad, or running down existing
resources. Free-lunch (social
democratic) politics makes this imbalance politically attractive:
subsidies, welfare spending, price controls, transfers, public works,
regulatory mandates such as minimum wages, and deficit spending deliver
immediate benefits while postponing the costs. The political rewards are
immediate; the economic bill arrives later.
Figure 1
The nine-month fiscal
deficit reached a record Php 1.303 trillion, with Q3 alone registering an
unprecedented Php 516.4 billion. (Figure 1, topmost and middle windows)
The nine-month merchandise trade
deficit also reached a record $47.158 billion, exceeding the previous 2022
record of $46.207 billion.
Both deficits are
now at record levels. The coincidence is not the argument; the underlying
savings-investment imbalance is.
But the deeper imbalance lies between national saving and
domestic investment.
Government deficits reduce public saving. Unless
private saving rises sufficiently to compensate, national saving falls relative
to domestic investment. The resulting savings-investment
gap must be financed from abroad. This
is the underlying connection between the fiscal imbalance and the external
imbalance: the economy is absorbing more resources than its national saving can
finance.
The merchandise trade gap is only one side of the
external imbalance. Remittances and services offset part of the deficit, but
not enough to eliminate the external financing pressure. The current-account
balance captures the broader relationship between national saving and
investment, while the balance-of-payments (BoP) position, examined in Section
VII, reveals the resulting external financing pressures.
Part 17 documented eight months of twin deficits. One
month later, both had widened. The imbalance was no longer merely persistent.
It was growing.
II. The Debt That Slowed
September's
national debt hit a record
Php 19.66 trillion, but increased by only Php 53.46 billion during the
month. That looks oddly restrained alongside a record Q3 fiscal deficit of Php 516.4
billion. The apparent disconnect deserves closer examination. (Figure 1, lower image)
The slower
monthly increase should not obscure the cumulative borrowing. National debt had
increased by Php 1.952 trillion over the first nine months, the second-largest
increase since 2021's Php 2.122 trillion. The nine-month fiscal deficit of Php 1.303
trillion was also 14.4% higher than the comparable Php 1.139 trillion figure.
Even so, September's debt stock remained slightly below the Development
Budget Coordination Committee's (DBCC) Php 19.77 trillion full-year 2026 target.
A deficit is a
flow; debt is a stock. How much
of the deficit translates into additional reported debt, and when, depends on
the financing mix, cash balances, debt repayments, and valuation adjustments. A
smaller monthly increase in debt after a record quarterly deficit is not
evidence of fiscal consolidation. It raises a more important question: where
did the financing go, and through which channels was the government's borrowing
absorbed?
One place to
look is the banking system. Net claims on central government (NCoCG) have been
rising for years, reaching a historic Php 6.499 trillion in September,
according to BSP data. This growing exposure matters because government
financing does not take place in isolation from the rest of the financial
system. Banks' expanding claims on government reflect the increasing absorption
of financial resources by the sovereign.
Figure 2
Nor is this exposure confined to banks. In Q2 2026, net
claims on central government held by other
financial corporations (OFC) reached a record Php 3.18 trillion. BSP
holdings stood at Php 491 billion, while banks
held Php 6.339 trillion. (Figure 2, topmost pane)
Combined, these positions totaled Php 10.012 trillion. This represented roughly 78% of the Php 12.84
trillion domestic debt stock. The broader point is that sovereign
financing increasingly draws on financial resources held across the
domestic financial system.
This brings us
to crowding out. As government
borrowing competes with private borrowers—mostly elite owned corporations and
banks—for domestic savings, it can push up borrowing costs, restrict
private-sector access to credit, and divert financial resources from
private investment toward government financing. The consequence extends
beyond the immediate cost of borrowing: resources absorbed by the sovereign
are resources that may otherwise have financed business expansion, productive
investment, and capital formation. The government finances present spending
demands while potentially constraining the productive capacity needed to
support future growth.
Financial
repression can intensify this
displacement. When political arrangements channeled through regulatory and
monetary policies are redirected to favor sovereign financing or privileged
borrowers, credit allocation becomes distorted. The issue is no longer simply
how much the government borrows, but how institutional arrangements
influence who gets access to credit, at what cost, and at whose expense.
This concentration of financial-sector claims on
the sovereign also creates the conditions for a sovereign-bank feedback loop.
As financial
institutions accumulate government exposure, their balance sheets become deeply
intertwined with the government's fiscal position.
As such, any
deterioration in sovereign creditworthiness can transmit stress to financial
institutions, potentially restricting private credit and increasing pressure
for public support. Such support can further weaken public finances,
reinforcing the original fiscal problem. The danger is not that this loop has
necessarily reached its terminal stage, but that institutional arrangements are
making the financial system have become chronically
dependent on sovereign stability.
Fiscal absorption,
crowding out, and financial repression can therefore reinforce one another. The
sovereign absorbs financial resources, institutional arrangements privilege its
financing, and private capital formation becomes the residual claimant.
The
establishment blames
peso depreciation for the record debt. That confuses an accounting
consequence with the underlying economic problem.
True, a weaker
peso increases the domestic-currency value of foreign-currency-denominated
debt, adding to the reported debt stock. But depreciation is a product of deeper
external pressures, including the foreign-exchange demand generated by
persistent financing requirements, capital-flow dynamics, and deteriorating
confidence. Currency weakness is
therefore not merely an accounting explanation of the debt problem. It is
a symptom of the broader macroeconomic imbalance.
III. The Export Boom That Imports Itself
Philippine exports hit a record $9.87
billion in September, up
35.6% year on year. Electronics accounted for $6.92 billion, or 70.1% of total
exports. Semiconductor exports likewise registered record year-on-year growth
and a record share of total exports. (Figure 2, middle diagram)
Much of this expansion rides the global AI boom, which
has fueled demand for semiconductors, memory chips, and computing
infrastructure. The Philippines is benefiting from this external investment
cycle, but the concentration of export growth in electronics also exposes the
economy to its reversals.
But electronics were also the country's largest import
category, at $5.80 billion, or 38.6% of total imports. The PSA's September
tables show electronic exports increasing by $2.894 billion, against a $2.704
billion increase in electronic imports. (Figure 2, lowest tables)
The export boom brings a substantial import bill with
it. The relatively narrow difference between these incremental gross trade
flows also underscores the importance of imported inputs in sustaining export
expansion, although it should not be mistaken for a measure of domestic
value added.
The crux is: the
concentration also creates and fosters vulnerability. If the AI investment cycle
reverses, semiconductor orders and export momentum could drastically weaken.
The current
global technology selloff makes that risk harder to dismiss.
Figure 3
Meanwhile,
consumer goods imports fell 4.25%, suggesting weaker household demand.
Manufacturing's S&P
PMI fell to 49.1 in October, its second consecutive month of contraction,
with output, new orders, and employment all declining. (Figure 3, topmost visual)
Exports are
booming while domestic manufacturing contracts. The economy is riding an
externally driven technology boom while its broader domestic production base
shows signs of weakness.
IV. The Financial Repression Behind the Free-Lunch
Politics
The
government's financing requirements do not operate independently of the private
economy. Financial repression extends
crowding out beyond competition for savings. Through captive savings,
directed credit, regulatory accommodation, and suppressed financing costs,
financial arrangements can steer resources toward government and politically
favored borrowers.
Bank
lending grew 11.4% in September, while M3
expanded 9.3% to Php 20.7 trillion. Slower money growth does not mean
monetary contraction. M3 is still expanding on an already enlarged base, adding
to the outstanding stock of money.
Bank lending is
also a channel of money creation. When commercial banks extend loans, they
generally create matching deposit liabilities, expanding deposit money in the
economy. Loan repayments, conversely, extinguish deposit money. The
resulting purchasing power does not enter every sector equally; it flows
through the credit allocation decisions of banks and the institutional
arrangements shaping those decisions. The issue is therefore not simply how
much money and credit are created, but where
the newly created purchasing power goes.
Electricity,
water supply, and transportation and storage continued to register strong
credit growth, while household borrowing continues to weaken.(Figure 3, middle
chart) Credit expansion was therefore
far from uniform.
This sectoral concentration becomes more interesting when
viewed against the institutional landscape. Electricity and transport are not
simply market sectors operating independently of political decisions. Their economics are heavily shaped by
regulatory decisions, concessions, pricing arrangements, public policy, and
government intervention.
From power-sector tax relief and corporate deals (e.g.,
SMC-AEV-MER, Prime Infra-FGEN) to renewable-energy payment arrangements
(discussed last year) and transport fare adjustments, political decisions
influence the distribution of costs, revenues, and financial risks. The
resulting credit expansion deserves examination not just as lending growth, but
in terms of the activities and institutional arrangements it finances.
Consumer
lending continues to reveal sustained softening. Growth peaked at 25.63% in May
2024, reached another peak of 23.91% in August 2025, and then decelerated for
13 consecutive months to 16.17% in September 2026. Consumer credit is still
expanding, but its growth impulse is weakening. (Figure 3, lowest image)
The contrast
exposes the uneven transmission of liquidity: aggregate credit continues to
grow, but household credit is losing momentum while selected politically favored
sectors maintain stronger expansion.
Credit creation is
not capital formation. A growing financial system does not automatically mean a
growing productive economy.
V. Three Markets, One Signal
Emergency
policies did not abolish adjustment. They displaced it. EO 110's price
suppression, BSP relief measures, and the managed foreign-exchange regime
shifted costs among government, corporate, bank, and household balance sheets.
Those costs are
now surfacing in three markets.
Figure 4
The peso
repeatedly set new lows, breaking Php 64 to the dollar at the end of October.
BVAL Treasury
yields across the 1-to-25-year curve climbed to multi-year highs.
Meanwhile, the
PSEi remained within a managed range even as market breadth narrowed. (Figure
4, topmost and middle diagrams)
The signals
differ, but point toward the same underlying pressure: the growing cost of
sustaining an economy whose imbalances remain unresolved.
The BSP raised
its policy rate by 50 basis points to 5.5%, an increase described by the media
as ‘jumbo’ or ‘aggressive’. Yet with headline inflation at 7.8%, the policy
rate remained deeply negative in real terms, at approximately -2.3%.
The 2022–2023
experience offers a revealing precedent. Despite 350 basis points of rate
increases between July 2022 and February 2023, lending growth slowed to 6.65%
by September 2023, while M3 growth remained around 6–8%. Lending subsequently
resumed its upward trajectory. Higher rates slowed credit expansion but did not
reverse the underlying monetary and credit dynamics. (Figure 4, lowest graph)
Higher interest
rates cannot manufacture electricity, fuel, food, or productive capacity. They
raise financing costs precisely when manufacturing demand and household credit
momentum are weakening.
The BSP was
already behind the inflation curve in 2023. The same question confronts it now:
does monetary tightening lead price adjustment, or merely follow it? A central
bank reacting to already-established price movements can raise the price of
credit, but it cannot retroactively create the goods whose scarcity helped
drive inflation.
The price of
credit moved. The supply constraints did not.
VI. October: The Third Wave of the Inflation Cycle
Affirmed
The monetary expansion examined earlier provides the
financial backdrop to this inflation wave. Deficit spending sustains nominal
demand, while the twin deficits and peso depreciation raise the domestic cost
of imported goods and production inputs. The 2026 oil shock compounds these
existing pressures.
Figure 5
October
headline inflation reached 7.8%, the highest since February 2023, against
just 1.7% a year earlier. Core inflation climbed to 5.4%, its fastest since
September 2023, while inflation for the bottom 30% of households reached 9.5%. (Figure
5, topmost chart)
Transport
inflation surged to 20.1%, and rice inflation reached 20.7%, despite the price
cap. (Figure 5, middle and lowest graphs)
The oil shock
lit the fuse; accumulated monetary expansion and continued credit creation
provided the conditions for broader price pressures to persist. This is no
longer simply an energy-price disturbance. The rise in core inflation points to
a wider deterioration in purchasing power, extending beyond the immediate
effects of higher fuel and food prices.
The third wave
has already surpassed the first wave's 6.7% peak in 2018 and stands just 0.9
percentage points below the second wave's 8.7% peak in January 2023.
And 7.8% is not
the entirety of the household experience. CPI tracks the prices of a defined
basket, but cannot fully capture every deterioration in product quantity,
quality, or value and even stealth charges.
Shrinkflation,
skimpflation, and sneakflation can erode purchasing power beyond
what headline inflation communicates.
Nor does the official index necessarily capture unrecorded transactions in
informal and black markets. As an aside, authorities
deny shrinkflation on some of commodities.
Here is the
thing: the problem extends beyond measurement.
Official statistics influence monetary policy, government
financing costs, indexed liabilities, wage adjustments, and collateral
valuations. Governments therefore have powerful incentives to influence not
only inflation itself, but also how inflation is measured, represented, and
communicated.
Benchmarkism is
not merely about the numbers published nor the market’s headline output, it
concerns the institutional incentives surrounding numerical representation and
the economic decisions anchored to those benchmarks. Lower reported inflation can ease pressure on interest rates,
government financing costs, and collateral valuations.
Governments
therefore have incentives to influence or even ‘manage’ not only economic and
market outcomes, but also how those outcomes are measured and communicated. Argentina's
statistical manipulation under the Kirchners illustrates that these
incentives are not merely theoretical.
We have been
warning about this trajectory for years.
In 2023, we
argued that the slowdown in the second inflation wave would be a transition
toward a more potent third wave, anchored in deficit spending and the BSP's
priority of maintaining ample liquidity.
"And yes, we may be seeing peak inflation for this second wave. The
first wave was in 2015-2018. The cracks in bank lending have emerged
while Treasury markets exhibit a sharp tightening.
Furthermore, both banks and
the BSP have scaled down their liquidity interventions. The BSP has
reversed most of the December injections.
But the coming CPI slowdown
may be a transition to a more potent third wave—all of which will be
anchored on the path dependency politics of deficit
spending by the executive branch and the priority of maintaining
and expanding liquidity by the BSP. (Prudent Investor, 2023)"
In 2025, before
the infrastructure scandal and the 2026 oil shock, we warned of a fiscal shock
and its stagflationary consequences.
"As fiscal risks mount, so too does the potential for
cross-sectoral contagion and cascading effects. The banking system—already struggling with liquidity depletion—faces
heightened exposure due to its expanding claims on sovereign securities
(implicit quantitative easing).
Again, though partially obscured, stagflationary pressures,
deteriorating credit quality, and rising funding costs may converge, amplifying
broader macro-financial instability.
In short, the fiscal storm is
no longer a distant threat—it is approaching fast, and its first casualties may
already be visible in the cracks forming across the financial system. "
The third wave
is no longer a forecast. It is showing
up in the price data.
VII. Interventions Beget Interventions: From Minimum
Wages to Struggling Labor Conditions
Price
suppression postpones price adjustment. Subsidies shift the burden. Cheap
credit props up claims, while currency defense consumes reserves. Each
intervention creates pressures that invite another intervention. The adjustment
is displaced, not eliminated.
Western Visayas
is the latest example. A Php
40–45 daily minimum-wage increase takes effect on November 19, following
increases in Central
Visayas and NCR.
It cannot explain October's inflation, which has already been recorded. But it
adds another cost to firms already facing dearer inputs, weaker orders, and
tighter financing. Wages can be raised
by decree; productivity cannot. Businesses absorb the difference through
thinner margins, higher prices, reduced investment, or fewer jobs. Consumers
ultimately pay part of the bill.
Figure 6
September's
labor data reveal the deterioration beneath the employment headlines. (Figure
6, upper image)
The labor force
expanded by 629,000 month on month (MoM) to 53.19 million, but employment
increased by only 543,000, while unemployment rose by 96,000 to 2.86 million.
The employment rate slipped from 94.7% to 94.6%, while unemployment increased
from 5.3% to 5.4%. Year on year, unemployment surged from 1.96 million to 2.86
million, and the employment rate fell from 96.2% to 94.6%.
Part-time
employment, despite retreating in September, has also followed a rising trend
since January. (Figure 6, lowest graph)
Fishing
presents another revealing contradiction. Employment expanded by 303,000 in the
quarterly comparison, while fisheries
production value contracted 8.5% to Php 50.86 billion in Q3. Labor is
entering an activity whose economic output is declining. This raises a more
important question than the employment headcount: are labor and financial
resources being sustained in activities that cannot generate adequate returns?
These
developments expose the deeper problem of capital allocation. Government can
sustain economic activity through subsidies, transfers, and credit
accommodation, but sustaining activity is not the same as generating wealth.
Real savings finance productive
investment; productive investment expands the capital base and creates
sustainable employment via productivity.
Hiring depends on
expected profitability, precisely what stagflation undermines. Inflation erodes household purchasing
power and real savings, while higher financing and operating costs raise the
hurdle every new project must clear. Firms facing weaker demand and rising
costs postpone investment and hiring. Add minimum wages to this pressure.
The labor
market is not simply adding workers; it is revealing the economy's declining
capacity to absorb them productively.
Employment
headcounts cannot substitute for capital formation, and government-supported
activity cannot substitute for wealth creation.
VIII. The Peso Rally is a Loan, Not a Fix
In response to
the peso's record Php 64.17 close on October 27, President Marcos urged Filipinos
not to panic. The peso subsequently returned to the Php 63 range, closing
the week at Php 63.055. But the exchange-rate rally does not change the
underlying balance sheet.
Figure 7
The September
balance-of-payments deficit (BoP) reached
$3.144 billion, bringing the cumulative January–September deficit to a
record $9.087 billion, almost the BSP's entire
$9.2 billion full-year projection. (Figure 7, upper chart)
Meanwhile, Gross
international reserves (GIR) fell further from $99.494 billion in September to $97.350
billion in October, a decline of $2.143 billion and a three-year low.
(Figure 7, lowest visual)
The record
external deficit echoes the domestic financing imbalance examined earlier: net
claims on central government have reached historic highs, reflecting the
growing absorption of financial resources by the sovereign.
A currency rally does not erase a record
external financing deficit or replenish depleted reserves. The peso may
recover temporarily, but the demand for dollars generated by the underlying
imbalance remains.
Defending the
peso has costs. The BSP can supply dollars from reserves, but that depletes
its external buffer. It can rely on foreign borrowing, but that adds
liabilities. Foreign-exchange swaps and derivatives can provide
temporary liquidity, but creates future obligations. The latter two adds to
the “dollar shorts.”
Alternatively, genuine monetary tightening would attack
the debt financed savings-investment imbalance by withdrawing the liquidity
that sustains excessive domestic absorption and demand for foreign currency.
But this is
where the debt trap becomes apparent. In an economy dependent on deficit
spending, cheap credit, and continued liquidity to sustain politically
protected claims, genuine monetary tightening would expose the accumulated malinvestments and debt dependency. Higher
financing costs and shrinking liquidity would undermine debt servicing, force
spending and investment contractions, and trigger recession or financial
crisis.
This is precisely why free-lunch politics resists
genuine monetary restraint: it would expose the savings-investment gap that
continued intervention has concealed. Yet postponing adjustment through
further borrowing and monetary accommodation only deepens the dependency and
increases the eventual cost.
The country
cannot indefinitely defend its currency while ignoring the fiscal, monetary,
and external forces generating the demand for dollars.
A peso rally can
buy time. It cannot buy an external adjustment.
IX. Conclusion: The Bill Arrives
The third inflation wave is not an isolated
statistical event. It is the cumulative
outcome of fiscal expansion, monetary accommodation, financial repression, and
the suppression of economic price signals.
The oil shock
intensified the process. The corruption scandal exposed its political costs.
Neither created the underlying vulnerability.
We warned of the fiscal shock before either event.
The bill has
arrived. The question is no longer whether the economy must adjust, but how much more real savings, purchasing
power, and productive capacity will be sacrificed in the attempt to postpone
that adjustment.
References:
Stagflation
Part 17: Eight Months of Twin Deficits, Record Debt, and the Bill for Deferred
Adjustment, October 4, 2026
Predictions on
Fiscal shock…
Liquidity
Under Pressure: Philippine Banks Struggle in Q1 2025 Amid a Looming Fiscal
Storm, May 18, 2025
Third wave of
the inflation cycle…
Philippine
Core CPI Forged a New 22-year High! Signs of Peak 2nd Wave Inflation: Pullback
in Bank Lending and BSP Injections, March 12, 2023
