Tale of The Tape: The Philippine Peso Versus The US Dollar

``It requires very unusual mind to make an analysis of the obvious."-Alfred North Whitehead

It has also been our exposition that the recent rally of the US dollar relative to the Philippine Peso, which has been popularly imputed to rampant “inflation”, had been based on a false premise, see Figure 2.

Figure 2: ADB Bond Monitor: Fiscal balance as % of GDP (left), Net food and petroleum exports in 2007 in $ billions (right)

In my view, the markets simply looked for an excuse (available bias) to sell down the Peso and Philippine asset classes, when it had been mostly a combination of the phenomenon of a natural countertrend cycle, the lowering of world economic growth expectations and forced liquidations from capital raising financial institutions abroad.

Although the so called food and energy driven “Inflation” (defined by mainstream as rising prices-which is not the true definition) had been somewhat a contributor, as a market driver, it signified a minor role relative to the above, but had immense political coverage or impact. Thus, in terms of easy to sell explanations for a consuming public that buys on the appeal of oversimplified information, the mainstream news accounted for what is popular backed by experts who fed on such fallacious biases (confirmation bias).

Since currency valuation comes in “pairs” or is a zero sum pricing dynamic (one advances, the other declines), the proper approach should be to cover similar variables of the nations being compared with, in assessing currency or asset pricing. You cannot deal with one factor without assessing the other because pricing comes in “pairs”.

Recently the easy and popular explanation had been- fiscal prudence relative to national balance sheets are likely to be sacrificed in order to mitigate social and political pressures arising from high food and energy costs. Thus, the fiscal costs amounts to balance sheet expansions which means rising interest rates at the expense of economic growth and the corresponding deterioration of asset valuations.

The ADB July Bond Monitor shows of the Asia’s net food and petroleum trade (right) and importantly the fiscal balance in % of GDP on the account of today’s “inflation” (see left).

The chart shows of the deterioration of fiscal balance even with the recent government actions of targeted subsidies for the Philippines as only 1% of the GDP even in the environment where the country would have to import more petroleum and food at the expense of its trade account.

But the US budget deficit projections calculated on February alone had been $410 billion for 2008 or 2.7% of GDP due to increased federal spending (yahoo).

Notwithstanding, the recent deterioration in tax revenues or collections has been putting a strain on financing the present government expenditures which has also been exacerbating the pressures of additional budget deficits especially under today’s recessionary environment. As discussed in our previous article Has The Underperformance of Philippine Markets Been Due To Policy Credibility?, the Nelson Rockefeller Institute has identified 36 states undergoing recession, which has been contributing to state budget deficits.

In addition, the present structure of US government debts have been mostly in short term instruments. Rising yields are likely to increase the costs of financing of its domestic spending requirements. Thus, the cost of financing is likewise a potential added burden for US taxpayers.

Moreover, the fiscal and monetary costs of nationalization of financial institutions, e.g. IndyMac- where the estimated costs of the Federal Deposit Insurance Corp (FDIC) takeover is $4-$8 billion (latimes) while 2 more banks were recently added to that casualty list (more of bank takeovers risks depleting the $53 billion insurance fund of the FDIC), the recent $168 billion national stimulus (with prospects of possibly more stimulus-William Gross of PIMCO is asking for $500 billion more!) and the provision of bridge financing to key financial institutions (recently including Fannie Mae and Freddie Mac) suffering from both an illiquid environment and potential insolvency.

Figure 3: Heritage Foundry: A Nation of Entitlements

It doesn’t end here. The US also bears the costs of its exploding unfunded entitlement programs which seem to likewise jeopardize the balance sheets of the Federal Government, see Figure 3.

According to the Heritage Foundry (highlight mine), ``The U.S. spends a total $1.2 trillion on the Big Three entitlement programs ($581.4 billion on Social Security, $370.8 billion on Medicare, $291.2 billion on Medicaid).”

So it isn’t as simple as inflation here should weigh on the Peso and financial assets-blah blah, because all the abovementioned costs have been a huge onus to the US economy relative to the problems in the Philippine setting.

Even in the spectrum of purchasing power, the Economist’s Big Mac Index (discussed on my recent post) shows that Asian currencies are terribly undervalued relative to the US dollar, which means that the prospects for the Peso to advance alongside its neighbors is quite compelling.