I have been saying that stagflation will be a force to reckon with given the easy money policies adapted by central banks of the Asia
Stagflation now a Reality
In September 2012 I pointed out that risks of stagflation or a bubble bust will become apparent in 2014 or 2015[1]
And one of the above risks (a bubble or stagflation) will become a force to reckon with in Asia, possibly in 2014 or 2015. All these will essentially depend on the feedback mechanism between the dynamics at the marketplace and policy responses on them.
The point is that inflationary policies results to different impact on the economy and the markets depending on the stage of the process. The boom phase appears to have ended. Now the backlash for promoting reckless policies has surfaced.
What’s stagflation? Wikipedia defines this[2] as “a situation where the inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high.”
Based on official announcement where the Philippine economy continues to reveal strength, stagflation would not be an adequate characterization of the current conditions.
But the recent shocking 27% quarter on quarter surge in unemployment survey figures defies whatsoever government claims about the robustness of the Philippine economy[3].
The survey essentially squares with two earlier surveys underscoring the equally stunning sharp deterioration in the general public’s opinion of their quality of life through 2013[4]
In addition, with the official admission that the current rate of inflation has been in the high end of estimates at 4.2% backed by a huge decline of the peso and stubbornly higher bond yields of 10 year Philippine treasuries considering that the domestic bond markets have been tightly controlled by both the government and the private sector banking system, the proverbial inflation genie has been unleashed from his lamp.
Moreover despite the 7.2% growth rate for 2013[5], based on the quarter year on year statistical growth rates, the Philippine economy from a high of 7.7% from the first quarter of 2013 dropped in the following quarters 7.6% (2nd Q), 6.9% (3rd Q) and 6.5% (4th Q).
So if we go by the checklist
1) inflation rate is high—√
2) economic growth rate slows down—√
3) unemployment remains high—√
Stagflation has entrenched herself on the Philippine setting. Now the question is will stagflation prick the Philippine credit bubble?
Financial Repression as Key Culprit
The recent unemployment survey essentially validates my analysis that the representativeness of the Philippine statistical growth data has been inaccurate or suffers from large statistical errors.
This also reveals how the statistics of the Philippine government overestimates on the importance of the formal economy while understates the relevance of the informal economy.
Yes, as stated earlier, the swelling numbers of unemployment means that the informal economy has been in sick bed for quite sometime now.
The unemployment data essentially signifies a major pushback from the official downplaying of informal economy.
This also reveals how concentrated the statistical Philippine economy has been, which largely has been dependent on the households, whom has not only access to the banking sector but importantly access to credit.
The risks and benefits from present policies that has painted a robust statistical economy has been largely channelled through a few individuals whom has access to credit.
The unemployment data also exposes on the politicized nature of redistribution of resources channelled via central bank policies as part of the financial repression used by the government to lay claim on the resources of their non-political constituents.
It has been absurd for officials to raise strawmen by attributing Typhoon Yolanda and Moro rebels which are largely regional problems to a national problem.
I had been right about my reservations[6] of Typhoon Yolanda being unable to surpass Typhoon Pablo in terms of most destructive Typhoon. While Typhoon Yolanda may be one of the strongest ever to land on Philippine soil, the devastation covered one of the country’s most economically depressed region. The same premise can be used to dismiss official strawman arguments.
And it seems that experts sporting economic labels and political groups have grasping at the straws to explain why the surge in unemployment.
One says that investments have been in capital intensive and not in labor intensive projects. Such is a false choice fallacy. There is a third concept. Government via easy money policies has misallocated money flows towards credit intensive projects, regardless whether they are capital intensive or labor intensive. The fact is that in 2013, the real estate sector, construction and hotel industry borrowed Php 1.9, Php 3.25 and Php 2.7 for every Php 1 growth generated by these sectors[7]. The inefficiency of use of resources meant that this has displaced other market based investments in favor of yield chasing by those with access to the banking sector’s credit. Such deadweight loss are signs of declining productivity while at the same time increasing credit risks.
A nuisance political observer even was even quoted as pointing to liberalization as the culprit. These guys should move to North Korea, whose closed economy should give their fantasies a hard dose of reality.
North Korea is an example where in communism the joke parlance has been “the authorities pretend they are paying wages, workers pretend they are working”. Such also lies in the heart of the economic dogma where economic growth can supposedly occur when people just dig holes and fill them back in.
The problem is that even pretending to work and pretending to get paid doesn’t work. Reason? In the case of North Korea, the country has run out of hard currency or real resources to pay for her pretentious employer-employee relations, so unemployment has been increasing[8]. Yes NK officials want the scarce resources for themselves than distribute to the others
The ADB comes up with their techno gibberish citing “low investment are reflections of the sluggish industrialization”[9]. Of course the ADB doesn’t say why there has been low investment except to utter the banalities about the symptoms.
None has been there to say that the banking system and capital markets have been soooo inadequately utilized for people to transpose savings into investments. So with low access to savings equally there will be low investments from residents. Add to this the stringent regulatory hurdles in doing business.
Besides given the low access to the formal system, this means high transaction costs, high cost of capital and equally inefficient means to accumulate real savings and capital.
Also for foreign money to deploy savings into the country means liberalization of capital flows something which monetary officials have been reluctant to do. Why? It’s called financial repression or the various political measures adapted to capture resources of the constituents of a country for the benefit of politicians and their cronies.
Based on Investopedia’s more benign terminology, financial repression are “measures by which governments channel funds to themselves as a form of debt reduction. This concept was introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon. Financial repression can include such measures as directed lending to the government, caps on interest rates, regulation of capital movement between countries and a tighter association between government and banks.”[10]
So naturally no country will have a great deal of investments when the government vacuums the resources of the people and restricts savings from efficient allocations in the marketplace.
How about zero bound rates (negative real rates) as part of the repression?
Let us hear from Harvard’s Carmen Reinhart[11].
One of the main goals of financial repression is to keep nominal interest rates lower than would otherwise prevail. This effect, other things being equal, reduces governments’ interest expenses for a given stock of debt and contributes to deficit reduction. However, when financial repression produces negative real interest rates and reduces or liquidates existing debts, it is a transfer from creditors (savers) to borrowers and, in some cases, governments.
While the supposed aim of financial repression has been to reduce debt, the free lunch access by politicians to savings ironically whets their appetite to add more debt.
Moreover based on the above the Philippine president will hardly make such statements: “I am sorry I kept interest rates lower than should be, so I can fund my pet projects. Anyway these are meant to benefit you like infrastructure, cash transfers, military budget, other welfare programs and before I forget my political constituent’s pork barrel. You see I have to get these politicians to agree with my spending plans. So the need for pork barrel. Anyway you will be financing this via low interest rate that should subsidize our spending. The good news is that you will not feel directly the pain from such transfers. This will be done by the loss of peso’s purchasing power which we will blame on producers and entrepreneurs for their greed. Also I am sorry that I didn’t realize that savers will be penalized in favor of borrowers who incidentally are mostly in the list of my network.”
So you expect real economic growth from a government who punishes savers by reducing their purchasing power and diverting these to political boondoggles and asset bubbles at the same time unwilling to dismantle legal barriers to economic activities?
Peso as main Victim of Stagflation
I would predict that a stagflationary environment will be baneful for Philippine assets, particularly for the peso.
I expect the Peso to further weaken for one basic reason: The BSP seem to adapt policies that has been meant to erode dramatically the peso’s purchasing power at the rate faster than the US, Japan or even China.
Even with the Fed’s aggressive QE and Bank of Japan’s even bolder Abenomics year on year change of M2 has been at 5% for the Fed and 4.5% for the BoJ. China’s M2 comes at 13.2% in 2013 according to the People’s Bank of China
The above M2 and quasi money growth data for Turkey (upper pane) and for Argentina, Philippines, Indonesia and Thailand (lower pane) reveals how and why emerging markets have been enduring inflation pressures. Note I updated the World Bank chart[12] to include updates for Argentina[13] and the Philippines (based on latest BSP figures[14])
The green threshold line is the 10% about twice the level of my estimates of the average growth for these economies. Of course there is no line in the sand for M2 to generate X inflation number as different countries have different tolerance for inflation or debt accumulation.
Yet these economies have been pumping money at far more than the rate of statistical economic growth. For the Philippines the 30+% levels have practically reached Argentina’s fantastic rate levels. This is four times statistical economic growth.
The difference is that: Argentina, hobbled by the lack of access to credit markets, has long been using monetization of deficits as seen via the soaring of M2 whereas the recent 2013 spike in Philippines M2 has largely been from the domestic credit bubble.
The Philippine dilemma has been that current statistical economic growth rates have been dependent on a credit boom. This means that a reduction in M2 would extrapolate to a significant slowdown or a contraction of the high growth areas as credit growth slows or screech to a halt.
The recent decline of forex reserves serve as evidence that in the impossible trinity[15], where government can only use two of the three factors: free movement of capital, exchange rate and domestic policy targets, the BSP intends to keep the credit boom alive in the hope that EM storm will breeze over. I hope they are right because the alternative would be worse.
This also means that M2 will remain elevated and sometime in the future. This means that unless these are restrained, the Philippines will likely suffer from a serious inflation problem ahead (10% or more??).
Be reminded again that every economy has distinct sensitivity to inflation risks.
In the Philippines, in the assumption that there has been little change in the above spending distribution or that the data above has some relevance to current conditions, the Filipino consumer has been highly sensitive to food, housing and transport[16].
For a country with $ 2,600 nominal gdp (IMF 2012) or $2,587 (world bank 2012) and who are price sensitive to basic goods, an explosion of price inflation would translate to severe social dislocations via increased poverty levels and increased likelihood for social and political instability.
A surge in inflation would also mean a dramatic decrease in disposable incomes of the residents, soaring interest rates, declining peso, and importantly, puts to the forefront the excessive credit conditions, as well as, over expansions of projects that had been financed by debt.
When the great Austrian Ludwig von Mises warned that the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money[17], this also puts into the spotlight imbalances brought about by massive issuance of quantity of money by domestic authorities that erodes the valuation of a currency unit, the peso.
[1] See The Impact of Open Ended QEs on Asia: Bubbles or Stagflation September 15, 2012
[2] Wikipedia.org Stagflation
[3] See Behind the 27.5% (Q-on-Q) Surge in Philippine Unemployment Rate February 11, 2013
[4] See Phisix: Will the Global Risk OFF Environment Intensify? February 3, 2013
[5] See Behind the 2013 Philippine Statistical Economic Growth of 7.2% January 30, 2013
[6] See Typhoon Yolanda: From Natural to Man-Made Calamity; Spontaneous Order Thrives! November 18, 2013
[7] See Phisix: Global Financial Volatility Intensifies February 10, 2014
[8] Daily NK In the So-called Socialist Country, North Korea, the Number of Unemployment Is Increasing October 16, 2007
[9] Inquirer.net Aquino on rise in joblessness: What went wrong? February 12, 2014
[10] Investopedia.com Financial Repression
[11] Carmen Reinhart Financial Repression Back to Stay: Carmen M. Reinhart, March 12, 2012
[12] World Bank Money and quasi money growth (annual %)
[13] Wall Street Journal Argentine Central Banker Says He Aims to Slow Money Growth December 24, 2013
[14] Bangko Sentral ng Pilipinas Domestic Liquidity Growth Slows Down in December January 30, 2014
[15] Wikipedia.org Impossible trinity
[16] Hyun H. Sun Has Inflation Hurt the Poor? Regional Analysis in the Philippines in the Philippines Asian Development Bank
[17] Ludwig von Mises II: The Emancipation of Monetary Value from the Influence of Government - On the Manipulation of Money and Credit: Three Treatises on Trade-Cycle Theory [1978] onlinelibertyfund.org
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