Newly Inaugurated BSP Chief Warns On The End of Global Easy Money

There is a time lag between changes in liquidity i.e. a monetary surplus, and changes in asset prices such as the prices of stocks. (The reason for the lag is because when money is injected it doesn’t affect all individuals and hence all markets instantly. There are earlier and later recipients of money). For instance, there could be a long time lag between the peak in liquidity and the peak in the stock market. The effect of previously rising liquidity can continue to overshadow the effect of currently falling liquidity for some period of time. Hence the peak in the stock market emerges once declining liquidity starts to dominate the scene—Frank Shostak

In this issue

Newly Inaugurated BSP Chief Warns On The End of Global Easy Money

-Who’s Afraid of Tight Money??

-Easy Money Policies Equals Credit Bubble

-Easy Money Beneficiaries: The Stock Market and the Real Estate Industry

-Philippine Banking System’s Radical Reshuffling of Investments

Newly Inaugurated BSP Chief Warns On The End of Global Easy Money

The recently inaugurated BSP chief opened his regime with a warning: the days of free and easy money is about to end.

And when it comes to inauspicious developments, cautionary words even from the BSP governor have been taken with a grain of salt by those market participants acutely addicted to free money.

From Reuters: (July 3, 2017)

"We have to be prepared for the seemingly imminent wind-down of ultra-easy monetary policies in advanced economies," said Espenilla, who took over from the well-respected Amando Tetangco after a 12-year tenure.

The U.S. Federal Reserve has been raising rates and is looking to start reducing its massive balance sheet. At the same time the European Central Bank and even the Bank of Japan are cautiously looking to the end of monetary easing…

"We need to be mindful of such events and their potentially far-reaching consequences since these could undermine our economic performance and disrupt our carefully-laid plans," Espenilla said in a speech.

Who’s Afraid of Tight Money??

The world financial system operates in a de facto US dollar standard.

The implication of which is that the reduction of policy accommodation by officials of the advanced economies, primarily by the US, will eventually be assimilated by the rest of the world. The FED has embarked on a series of rate increases. It now proposes to take incremental steps to drawdown its artificially inflated balance sheets.

The response to these will not be a matter of plain vanilla politics. That’s because financial market prices will tend to reflect on the transitional asymmetries of global financial policies. For instance, the variability in spreads or returns will cause trading arbitrages from which prices may influence policymakers. Fund flows, both internal and external, will thus entail a feedback mechanism: prices will reflect on these changes, as well as, impel for responses to such price dynamics.

Since the Lehman episode culminated with the Great Recession 10 years ago, the world has essentially embraced easy money policies.

The Philippine government, particularly the BSP has done so in 2008-9. [See Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy April 14, 2014]

 

While the worship of mainstream G-R-O-W-T-H has morphed into a form of zealotry, there hardly have beenrealizations that the current economic and financial climate has operated under EMERGENCY conditions since 2008-9! (see above)

Even worse, the BSP DOUBLED DOWN on extant emergency policies in 2015-16!

Policy rates have been chopped to HISTORIC lows in June 2016, while the BSP continues to engage in the massive RECORD monetization of the National Government’s debt!!! [See Confirmed: May 2017 Fiscal Deficit was Monetized by the BSP; Softening Tax Revenues and The Phisix Casino July 5, 2017]

Has not the current environment been about G-R-O-W-T-H??? So what exactly has been so dire in 2015 for the BSP to use these contingent or emergency tools???? Think of this as “martial law” central bank version. A morbid dread of deflation risks, in reaction to the BSP’s tepid tightening??? [see Phisix 7,800: Record Phisix as the BSP Continues with Deflation Spiel! March 9, 2015]. And consternation has metastasized into addiction???

When price inflation surged in response to the 10 months of 30%+++ money supply growth in the 2H of 2013 until the 1H of 2014, the BSP implemented a mild withdrawal of policy accommodation. They raised reserve requirements and policy rates twice and the SDA rates thrice.

Remember, the last time the BSP used such highly inflationary policy tool [See Chart of the Day: Debt Monetization represents a Policy of Devaluation! July 7, 2017] was in 2008-09 which came in the wake of the Great Recession (see top chart).

Easy Money Policies Equals Credit Bubble

So what have been the main effects of the BSP’s free lunches?

Let us hear it from the BSP’s “report card” to the Bank for the International Settlements*.

We also know from BIS reporting countries that cross-border debt incurred by non-bank corporates in the Philippines increased from USD 7,781 million as of end 2008 to USD 13,046 million as of March 2016…

Between September 2008 and the latest figure of September 2016, consumer loans increased from PHP 400.1 billion to PHP 1,202.6 billion.6 The latter represents 11.6% of nominal GDP – as opposed to 5.7% in September 2008 – which appears modest when compared to often-cited Asian regional data.

* Johnny Noe E Ravalo, Head of the newly created Office of Systemic Risk Management at BSP, Credit build-up and financial stability issues: do we know enough to calibrate appropriate intervention? March 2017 p.177, Bank for International Settlements. I quoted this earlier: See The BSP’s Confession to the BIS: We Have Little Knowledge About Risks! The BSP’s Harrison Plaza Blind Spot! May 7, 2017

For a financial system that has a paltry participation or penetration level, the above credit growth numbers are striking.

Here are some financial inclusion data from the (One) the World Bank (2014): 31% of the population have bank accounts, of which 15% have a formal savings account while 12% have borrowed from the formal financial system. (Two) the BSP (2013): 26.6% of adults have a deposits account, 2 out of 10 of households have a deposit account, 10.5% have taken a loan from the banking system, 55% use money transfers and loan and bill providers, 1.1% represents the share of insurance premiums to GDP, 43% of the total number of deposit numbers and 68% of the total amount of deposits have been concentrated on the National Capital Region (NCR)

Corporate debt has almost doubled while consumer debt has tripled based on the BSP’s BIS numbers.

 

For a better perspective let us drill down on the BSP’s numbers, which are limited to bank-financed credit.

In response to the great recession, the BSP has intensively eased on credit conditions. Since the BSP’s actions, the banking industry’s production and loan portfolio has exploded by about 15% each year.  Since 2010, the CAGR of banking system’s cumulative loan portfolios have accrued to a whopping 18.51%! Since end 2007, the CAGR amounted to 16.54%!

This can be seen further in the context of banking credit’s contribution to the GDP.

In terms of credit intensity, or the amount of credit used to generate GDP, since 2011, credit growth contributed to more than TWICE the GDP! Put differently, the financial system borrowed to at least Php 2 for every Php 1 GDP.

And because of the high credit intensity, the share of the banking system’s nominal or gross credit to Nominal GDP (NGDP) has ballooned from 24.7% in 2008 to a staggering 40% in 2016! In detail, at Php 5.9 trillion, the banking system’s loan portfolio in 2016 accounted for 40.48% share of the Php 14.5 trillion NGDP in 2016.

In short, the banking loans in proportion to GDP spiked by a noteworthy 61% in 9 years to spur a bank credit to GDP of 40%! And that represents leverage from the banking system alone. Such accretion of liabilities doesn’t include capital market debt, informal or shadow banking debt, overseas borrowing or cross-border debt and government’s debt.

And this analysis assumes that those NGDP numbers are correct.

However, if the NGDP numbers have been overstated, which I suspect has been, then credit growth should play a far larger role in the economy.  Or stated from a different angle, the extent of credit risks would have been understated by inflated GDP numbers.

And don’t forget that GDP is in fact INFLATED by credit growth - again even assuming that the former is a precise measure of economic activity. That’s because statistically measured spending has substantially been financed by credit. And this is what credit intensity is all about!

Anyone can figure this out by themselves. The BSP credit data (PSIC 2009 and 1994) can be extracted here.  The Philippine Statistics Authority’s time series National Income data can be accessed here.

Imagine a small segment of the population can drive such scale of credit growth! As I have been saying here, once the credit growth is computed or calculated based on the population of enrolled bank accounts, those numbers will explode phenomenally higher! The population of unbanked people has essentially suppressed the current credit conditions.

Yet all these figures tell us that whatever GDP, earnings/profits, income, wages, jobs, taxes, or the popular perception of G-R-O-W-T-H have been principally driven by credit growth from the BSP’s emergency policies!

Easy Money Beneficiaries: The Stock Market and the Real Estate Industry

It has not just been the real the real economy, credit policies and credit activities have substantially pillared the serial inflation of asset prices.

And the stock market has signified a major beneficiary of such easy money policies.

Proof?  Philippine stocks have been priced to perfection!

The Warren Buffett indicator, the market cap to (2016) NGDP which was last at a remarkable 93.16% or at the pre Asian crisis level, the Price to Book value (2016) at 3.15 (average) and at 2.74 (weighted average) and the Price to Earnings (2016) at 20.3 (average) and at 24.86 (weighted average) – all based on Friday’sclose – have signified as evidence that credit financed excessive speculations have been the main driver of equity prices.

Add to such price imbalance, the rampant and massive tweaking of end session prices through pumps. Such are wanton testaments of easy money policies that have run amuck!

Aside from stocks, if there would be any other prices that mesmerize and captivates the establishment, such would be no other than real estate.

 

The general idea is that being big ticket items, rising real estate would redound to G-R-O-W-T-H. Bunk.

The mainstream seems oblivious to the fact that credit conditions function as the PRINCIPAL driver of the real estate industry. From sales to operations to inventory or supply, the real estate model has heavily depended on credit.

To understand why. The artificial lowering of interest rates induces capital investments flows into interest-sensitive assets of long duration - yes such as the real estate industry. Hence, money supply expansion propelled by credit growth would initially cause a boom in titles of capital goods as evidenced in the history of real estate and stocks prices.

Real estate price indices can hardly function as a reliable measure. The IMF Global House Price index showed a contraction or negative growth in 4Q of 2016. However, the Philippines stood as the second-largest provider of credit to the said sector in the world - over the same period.

Real estate firm Colliers, which provides data for the Bank for International Settlements, has radically altered the numbers constituting their property pricing index in the last quarter.

The earlier data exhibited the cascading of the growth rates of real estate prices from about 7.9% in 1Q 2015 to -3% in the 3Q of 2016. The deceleration of real estate (home) price growth has resonated with Global Property Guide’s (GPG) housing measure which showed a negative 7.65% in the 3Q and +.44 in 4Q 2016.

However, the latest Colliers data showed that instead of a declining price trend from 2015, home and commercial (Makati) growth rate remained steady at 9-10% through the 4Q of 2016. Commercial land prices, however, picked up speed to 10.72% from 9.95% in the 1Q 2017.

So property measures from different firms have contravened each other. Sometimes one would wonder if there has been a hidden agenda for such dramatic changes.

The Bangko Sentral ng Pilipinas reported that real estate prices have risen modestly by 1.1% in the 1Q 2017 (year on year). On the other hand, condominium prices rose 2.7% over the same period.

Commercial and residential real estate prices climaxed to their respective landmark highs at the time where money supply zoomed at 30%+++ in 2013 through 2014. So it would not be a coincidence that money supply growth via credit expansion backed by yield chasing has fueled price surges in the real estate industry.

Additionally, the slowdown in money supply growth in 2015 has likewise reverberated with the old property data of Colliers and the GPG.

And since the industry has been considerably outgrowing the other sectors, as I have pointed out elsewhere here, real estate and the related industries, specifically trade (shopping malls) and construction have amassed an incredible 38.62% share of the Philippine government’s NGDP!

Furthermore, the same industries accounted for a splendid 37.66% share of domestic banking system’s loansas of May.

The gravitation or funneling of financing, manpower, and resources into these interest rate sensitive sectors extrapolates to a deepening of concentration risks which represents symptoms of malinvestments.

The implication has been the Philippine GDP and or the real economy has been stupendouslyleveraged to interest-sensitive industries.  And in the case of extensive tightening of financial conditions, such would have an earthshaking impact not only on the economy but to the political spectrum as well.

It would be interesting to see how the current regime would respond to such pressure-packed scenario or eventuality.

Philippine Banking System’s Radical Reshuffling of Investments

Finally, people hardly realize that the Philippine banking system’s investment structure has been experiencing a radical makeover.

I am referring to the Available-for-Sale (AFS) financial assets and Held-to-Maturity (HTM) financial assets. As of May 2017, at Php 2.459 trillion, both accounted for 81.97% share of the Philippine banking system’s total investments (NET)

Prior to the Ben Bernanke’s taper tantrum in 2013, AFS accounted for the larger share of investments relative to HTM. At its peak in September 2013, for every Php 1 of HTM, there were Php 4.75 of AFS investments.

From then, HTM raced to eliminate the gap with AFP. By May 2015, HTM came to dominate banking investments. As of May 2017, there had been Php 1.49 invested in HUM for every Php 1 of AFS.

While there may be other reasons, such as possibly BSP purchases of NG debt or more, the likely main reason could be rising coupon yields. Moreover, increasing volatility of local currency unit (LCU) government bonds may have compounded on the predicament of banking investment assets (lower right pane from ADB’s Asian Bonds Online).

BSP subsidies have not only fostered a boom in stocks and in real estate but in Philippine bonds as well. The collapse in bond yields (LCU 10 year yields) in 2012 alternatively translated to a majestic windfall for bond investments.

Falling yields attracted demand for credit which helped bolster the banking system’s loan portfolio.

However, yield chasing may have also seduced banks to heavily load up on Philippine treasuries.

Unfortunately, the taper tantrum emerged. While the taper tantrum did play a role, it was more a convenient pretext for the selloffs.  That’s because the taper tantrum was backed up by a more crucial factor: the 10 fascinating months of 30%+++ M3 growth which sparked a surge in CPI, and the first leg of the USD-Php’srise. And the spike in inflation percolated eventually into bond yields/ prices.

Hold-to-Maturity (HTM) has been famous for the concealment of investment losses through accounting treatment used by banks.

The government owned DBP was charged with “market manipulation” for engaging in an alleged ‘wash sale’ with a local investment bank in 2014. The wash sale was intended to re-categorize DBP’s Php 720 bond losses as HTMs. This controversy came as no coincidence in a milieu of rising yields. As for the case’s settlement, officers from both firms were slapped with fines.

The point here is that should global central banks pursue its recent pronouncements to squeeze excess liquidity, then domestic bond yields will likely follow actions abroad.

And it would be more than global central banks, whose actions would only compound on the domestic factors. The bigger force would be the repercussions from the proposed gargantuan infrastructure spending programs through the “crowding-out” dynamic

And perhaps a sizeable chunk of the prevailing dominance of HTM’s in the banking system’s investment portfolio has been engineered to sanitize or sterilize losses from the recent streak of higher bond yields. And if my guess is right, what should happen if bond yields accelerate upwards?

The current swing from AFS to HTMs should give any sensible investors a reason to pause when it comes to investing in banks.

While the industry’s liberalization should be a welcome development, balance sheet conditions matter especially in the face of changing credit conditions.

If HTMs have served as an accounting vehicle to shield losses from higher yields, then headline earnings and financial conditions may not be anywhere accurate at all. And such misleading information may also extrapolate to systemic liquidity issues which greatly depend on an interminable credit expansion.

In other words, should higher yields percolate into rising rates, then the banking system’s skeletons in the closet, such as loan and asset quality, may surface to impact credit transactions and thereby liquidity conditions and the system’s credit profile.

The BSP chief’s warning on free lunches is partly correct. However, so much blind faith has been given to an ecosystem BUILT PRIMARILY ON the continuity of subsidized interest rates or of free lunches.

So the BSP chief will be faced with a lot of challenges which he and his former boss have instituted.

Good luck to him.