Inflation Has Hardly Been About the TRAIN Law; The Credit and Liquidity Cure Can Be Worse Than The Tax Disease!

The real danger does not consist in what has happened already, but in the spurious doctrines from which these events have sprung. The superstition that it is possible for the government to eschew the inexorable consequences of inflation by price control is the main peril. For this doctrine diverts the public's attention from the core of the problem. While the authorities are engaged in a useless fight against the attendant phenomena, only few people are attacking the source of the evil, the Treasury's methods of providing for the enormous expenditures. While the bureaus make headlines with their activities, the statistical figures concerning the increase in the nation's currency are relegated to an inconspicuous place in the newspapers' financial pages—Ludwig von Mises

In this issue

Inflation Has Hardly Been About the TRAIN Law; The Credit and Liquidity Cure Can Be Worse Than The Tax Disease!

-Has the Public Been Lusting for Blood? Or Is Pres. Duterte in Search for a Scapegoat?

-The Vehement Backlash Against Inflation! TRAIN as the Object of Scorn!

-Inflation Has Hardly Been About TRAIN But About The BSP’s Free Money Policy!

-The Credit and Liquidity Cure Can Be Worse Than The Tax Disease!

Inflation Has Hardly Been About the TRAIN Law; The Credit and Liquidity Cure Can Be Worse Than The Tax Disease!

What an eventful week!

Has the Public Been Lusting for Blood? Or Is Pres. Duterte in Search for a Scapegoat?

I’d start off with two awesome news quotes.

From the Inquirer (May 29, 2018): “Despite his frequent defeatist talk, President Rodrigo Duterte is ready to declare war on China or any other country if they attempt to exploit the natural resources in the West Philippine Sea, Foreign Secretary Alan Peter Cayetano said on Monday.”

From the Inquirer (May 28, 2018): ““When the stomach protests, prepare for revolution.” Sen. Panfilo Lacson issued this warning on Sunday, urging the government to do something to arrest price increases being blamed on the Tax Reform for Acceleration and Inclusion (TRAIN) Act.”

Wow, war and revolution! What bloody rhetoric! Has the public not had enough of blood on the streets? The war on drugs has recorded 41 fatalities in the past three weeks. 

“Our present situation calls for a revolution” said a daughter of a national artist in her graduation speech at an elite school.

Has the public been pining for violence as a solution to socio-economic ills?

Back to the two quotes.

Did the present leadership tergiversate on his position on China?

It was just in February when he jokingly said that the Philippines should be a province of China. And it was only a week back when he uttered: I won't go to war I can't win.

Even if current developments have signified a political vaudeville, what has prompted such precipitate façade?

Could this have been due to the probe by lawmakers on the administration’s inaction on China? But that would be a parochial reason for such publicity skit

Could it have been because the Senator raised the issue of a revolution in response to the present policies that have prompted Mr. Duterte to look for a convenient foreign scapegoat?

As I have said here, the epoch of easy money is over. Aside from a troubled banking sector, inflation has reared its ugly head.

And for the Senator to warn of a “revolution” epitomizes an inflation problem that has gone beyond official statistics. And because other senators have joined the call to have the TRAIN Law suspended, this has been more than political sensationalism.

The backlash against inflation has been amazingly vehement. It has surpassed the scale of 2014 which spurred the BSP to tighten. The difference between now and 2014 is the object of scorn. The spiraling inflation problem has been blamed solely on the Duterte-Dominguez signature tax reform policy, the RA 10963 or the TRAIN LAW.

One has to wonder, why have SWS surveys been saying that hunger incidence dropped to a 14-year low and that 1-in-3 families escaped povertyin the 1Q of 2018 when the public’s reaction has gone in the opposite direction? Have such surveys been a part of leadership’s propaganda machinery?

The Vehement Backlash Against Inflation! TRAIN as the Object of Scorn!

Just look at the stunning intensity of the pushback.

The Chair of the House Ways and Means Committee has initially expressed openness for the suspension of TRAIN.

Meanwhile, in response to inflationary pressures, various labor groups have backed bills that have been filed in Congress asking for a staggeringPhp 750 and Php 320 (across-the-board) increases in the minimum wage. The present minimum wage is Php 512/day. A Php 320 increase would amount to an astounding 62.5% hike!

The pressure has been mounting.

President Duterte also ordered the Department of Labor to convene the regional wage boards. An increase in minimum wages can be expected to happen within a month, says the Labor Secretary. 

If the government grants the request for such gargantuan minimum wage hike, there will be considerable adverse consequences.  The first is that firms will likely pass through the cost to consumers, thereby aggravating price pressures on the economy. If a full pass through can't be accomplished, firms may resort to diminishing the quality of their products or services for sale. They could also downscale operations through the downsizing of the labor force and or shrink their workflow process that leads to a reduction in output. It could be a combination of the above. The other ramification would be for firms to reduce investments. And if this leads to losses, closures will be next option.

As a testament to this, an association of employers warned the possibility of a mass layoff in their workforces should the published minimum wage bill be upheld (Inquirer June 2, 2018): “Jose Roland Moya, director general of the Employers Confederation of the Philippines (Ecop), said companies were also reeling from the effects of the Tax Reform for Acceleration and Inclusion (TRAIN) Act due to the increase in the cost of their raw materials. Should the government order a significant wage increase, Moya said businesses might suffer huge losses which could either lead to layoffs or closures” (italics added)

Though President Duterte admitted to having been spooked by rising prices, which he blamed on oil prices, he said that he would not suspend the TRAIN Law. He also admitted that TRAIN has contributed to the current inflation problem (GMA, May 31): ““Inflation is always there. There are many reasons, but actually, one of them is TRAIN. But I need money also to run the country. If you do not give it, fine,” Duterte said in his speech during the change of command ceremony of the Presidential Security Group in Malacañang.” (italics added)

The administration would provide instead additional financial assistance to the most adversely affected sectors and acquire oil from alternative sources as Russia and undisclosed suppliers.

Seen from a different light, the proposed policy response against inflation is to throw money into a system suffering from an overdose (OD) of money or throw gasoline on the fire! 

And you know that the things have been getting desperate for the Duterte regime.

The next tool to be used to combat inflation appears to be price controls.

To protect the consumers from “profiteering”, the government plans to impose implicit price controls by requiring stores to comply with a Standard Retail Price (SRP) on basic farms goods. In the meantime, with the opening of classes, the Department of Trade and Industry (DTI) have commenced on making rounds on retail outlets to check on prices of school supplies.

Let us get this straight. Mr. Duterte has admitted that the government has been responsible for this mess. However, rather than addressing their mistakes, it is public who have been bearing the brunt not only of economic pressures but, more importantly, of political repression. If TRAIN has caused “profiteering”, why penalize the “profiteers” than those who pushed for the law? Because “spend, spend and spend” has been too addictive to withdraw from? Or, will Mr. Dominguez be shown the door soon? [If Dominguez exits, expect a sharp turn to the left!]

When the going gets tough, palpably, implicit price controls will morph into explicit policies.  

Considering that price controls have repeatedly been used for more than forty centuries, wherein Professor Meiselman wrote*, “The historical record is a grimly uniform sequence of repeated failure. Indeed, there is not a single episode where price controls have worked to stop inflation or cure shortages. Instead of curbing inflation, price controls add other complications to the inflation disease, such as black markets and shortages that reflect the waste and misallocation of resources caused by the price controls themselves”, once the Duterte regime engages in direct price controls, it would be the proverbial last nail on the coffin.

*David I. Meiselman, Robert L Schuettinger and  Eamonn F. Butler FORTY CENTURIES OF WAGE AND PRICE CONTROLS: How Not To Fight Inflation Mises.org

Inflation Has Hardly Been About TRAIN But About The BSP’s Free Money Policy!

 

It’s easy to pinpoint rising prices to TRAIN because of its coincidental effects. The populist political logic falls for the narrative fallacy.

But TRAIN hasn’t been the main culprit!

Even without TRAIN, price inflation surged in 2013 to 2014 (because of the 10 consecutive months of 30%+++ m3 growth!). That was until the BSP implemented partial tightening through a series of policy actions including raising reserve requirements and increasing policy and SDA rates in 2014.

And CPI has been rising anew since 2015. TRAIN has only accelerated the extant momentum.

Moreover, theoretically, the dislocations from excise taxes and the reduction of exemptions from VAT should be a one-off event. Demand and supply still govern the pricing system despite the displacements brought about by the Train Law.

If prices rise enough to cause a reduction in quantity demanded, prices will fall.  For instance, if soda prices have become unaffordable to prompt demand to fall (say close to zero), prices will adjust downward accordingly (approach zero). 

From this scenario, the producers would suffer from a profit margin squeeze. That's until (or if) these producers will be able to adjust production costs downwards to reflect on the new environment. Otherwise, they’d shut. Or, the supply side of the affected industries will likely see a reduction in output.

The difference has been that price pressures have occurred in areas that are considered inelastic or less responsive to price changes: food, household utilities and transport (based on the BSP’s April data).

And that’s the reason for political soundbites.

The BSP will post May CPI next week.

 

That said, the suspension or even a partial rollback of the TRAIN WITHOUT the necessary reductions in public expenditures will only balloon fiscal deficits.

April expenditures and revenues hit a record high.

Policies have time asymmetric impact. The best outcome occurs usually during the short-term, while the longer term produces unintended effects. So the recent revenue boom can hardly be expected to be sustained.

Thus, attacking TRAIN is like treating the symptom by ignoring the cause. The cure can be worse than the disease.

The Credit and Liquidity Cure Can Be Worse Than The Tax Disease!

If TRAIN will be repealed or reduced, the next question is how will such blowout in deficits be funded?

Remember, public expenditures are already programmed. However, revenues depend on economic conditions and collections management by the National Government (NG). Or NG revenues aren’t fixed. A shortfall in collections can disrupt the NG’s forecasted budgets.

  

Funding deficits through debt will only squeeze liquidity out of the system which would strain interest rates. The Bureau of Treasury’s total debtgrowth moderated to 7.92% in April due to the month’s Php 46.35 billion fiscal surplus.

Because of liquidity concerns, financing through debt will only constitute a part of the National Government’s overall funding program.

If the debt option is limited, how will the gap be filled?

Like today, the BSP and the BSP controlled banking system will be the other main contributors to the NG’s aggressive deficit financing programs.

 

From the BSP’s perspective, the banking system will have to continue to provide credit generously to the economy, which it hopes would transform into tax revenues. Total Bank Loans (production plus consumer) grew by a sizzling 19.6% in April. (see economic data below) Tax revenues spiked by 27.81% over the same period. It wants to believe that the system’s capacity to absorb credit is infinite.

So far, tax revenue performance has mirrored bank credit conditions.

On the other hand, the BSP will likely offset debt financing by liquefying the system through the funding of the central government.

From the BSP: “net claims on the central government rose by 13.0 percent in April from 7.0 percent (revised) as a result of continued borrowings by the National Government”.

The BSP has been monetizing the NG’s debt since 2015!

The mainstream has kept mum on this.

Again the BSP’s interest rate policy and QE are emergency measures that became a conventional tool.

 

The injection of liquidity through credit operations of the banking system and the BSP translates into an increase in money supply in circulation which affects economy prices. M3 grew by a torrid 14.21% in April.

As the Nobel Prize economist, the late Milton Friedman explained: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

To focus on TRAIN is to miss the forest for the trees.

Finally, it is important to recognize that the BSP and the NG have been trapped from their policies. Spend, spend and spend is about to end as free lunch dissipates. As I wrote in May

[See Why Interest Rates Will Rise: 1Q Fiscal Deficit Blowout Financed by BSP’s Debt Monetization (QE) and Spiking Public Debt! May 6, 2018]

1) If the NG uses the capital markets, rates will have to reflect the avalanche of supply. Moreover, NG spending will increase pressures on real economy prices.

2) If the NG will use the BSP option, the peso will fall steeply and inflation will rise, which again will ricochet or boomerang on bond yields.

3) If the government stops from its current undertaking, it will severely slow the GDP, prompt for a fall in tax revenues which should spike deficit as well. Credit risk will surface and subsequently impact the banking system. Markets will demand more collateral or increases in credit risk premium (higher yields!). 

4) If the government should use or depend on external sources for its financing, they should see the same dilemma: rates have been rising too!

5) The last option would be for the NG and BSP to manipulate markets and statistics in the hope that the markets will conform and comply with their political targets.

Yes, the piper will be paid soon.