The Era of Easy Money is OVER! President Duterte Confirmed This With “The Economy Is In Doldrums”

The worst of all false remedies for inflation is price fixing and wage fixing. For if more money is put into circulation, while prices are held down, most people will be left with unused cash balances seeking goods. The final result, barring a like increase in production, must be higher prices—Henry Hazlitt

In this issue

The Era of Easy Money is OVER! President Duterte Confirmed This With “The Economy Is In Doldrums”

-President Duterte: The Economy Is In Doldrums (Stagflation is here)

-With the Inflation Genie On The Loose, The ERA of Easy Money Is OVER!

-The Crowding Out Effect  Plague The Real Economy

-President Duterte is Right; Higher Interest Rates Will Choke An Economy Dependent on Credit

-Remember Boracay? The Island’s Demand and Supply Chains will Haunt the Economy

-So Far, Price Controls Have Been About PR Effect

-President Duterte Mulls Jueteng as Funding for Spend, Spend and Spend! Why Mining will be Liberalized

The Era of Easy Money is OVER! President Duterte Confirmed This With “The Economy Is In Doldrums”

President Duterte: The Economy Is In Doldrums (Stagflation is here)

Time and again I have been saying this: The era of easy money is over!

Well, no less than the President Duterte has attested to this.

From the Inquirer.net (June 24, 2018) [bold mine]

Economic activity is stagnating in the provinces and no less than President Duterte himself is worried that the rising prices of goods could prolong the period of gloom.

“Now, the economy is in the doldrums, actually [it is] now,” Mr. Duterte said on Friday night, less than a week after the Bangko Sentral ng Pilipinas (BSP) raised interest rates for the second time since September last year to counter inflation.

The President admitted that the situation in the provinces had become a problem for his administration because projects were barely progressing.

Interest rates are picking up, are getting high so it destroys the existing [economic gains] … You raise your [interest rate], our [peso value] goes down, theoretically,” Duterte said in a speech at the National Information and Communications 2018 Summit at SMX Convention Center here.

“I said in Manila, they’re starting the megaprojects well. I supposed that they would be doing it on time. But in the provinces, it’s a doldrums thing,” he added.

For a leader who “dislikes” or “loathes” economics, you’d have to forgive him for such presumptuous claims. Perhaps that spiel was made by his ghost speechwriter.

With stocks plunging to bear market levels, such may have added to the souring sentiment.

Nevertheless, the President has merely been echoing what we have been saying here: economics is NOT statistics.

1Q GDP of 6.8%? For bank borrowers perhaps. But certainly not for the average non-bank borrowers or the Juans, Marios, and Pedros in the provinces.

Rising prices in the face of a stagnating economy? That’s stagflation!

And the President’s statements basically debunk surveys stating that poverty incidences and hunger have gone down. How can an “economy in the doldrums” or “stagflation” alleviate poverty incidences and hunger?

Perhaps the administration’s PR people have forgotten to inform the President of this. And perhaps a clarification on this speech by administration officials will be made soon. Otherwise, an oversold peso, bonds, and stock market may lose its footings further.

Of course, two aspects have been raised from the speech: inflation and government projects.

With the Inflation Genie On The Loose, The ERA of Easy Money Is OVER!

The ghost speechwriter bungled clumsily on the economic aspects raised by President. 

Well, higher rates, which should translate to diminished money supply, actually should boost a currency. Theoretically.

And higher rates don’t necessarily entail lower economic growth (or “destroy economic gains”).  An economy becomes sensitive to interest rates only when credit, instead of savings, drive it. That is the Keynesian framework. “Borrow and spend” to prosperity.

Such borrow and spend template hasn’t been the case for the Philippine economy before 2008.

Only when the BSP aggressively eased policy by cutting of policy rates and employing debt monetization in the post-Great Recession era has the “borrow and spend” template been embraced as the nation’s formula and tool for economic development.

Free lunch from the BSP’s easy money policy became entrenched and embedded in the public’s mindset as a permanent landscape.

The above chart is a depiction of the relationship of Philippine 10-year yields compared to total nominal bank loans (production plus consumer) in peso.

Yields of 10-year ROPs have been in a structural decline since 1988. (green arrow)

It was in the era leading to the Asian Crisis when yields have spiked most. From then, yields headed downhill. A mini-spike occurred in 2008-9 which coincided with the domestic financial assets meltdown (violet oval).

The crux of the matter is a selloff in bonds and the peso have embodied economic strains that eventually spillovers to stocks.

Let me rewind a bit.

To repeat, there was hardly any borrow and spend phenomenon during the 2002-2008 era. (left orange oval) The lack of leverage or the relatively clean balance sheets allowed the Philippine economy to recover swiftly from the Great Recession.

And because central banks stance around the world changed from a passivism to activism, the BSP followed suit. 

Bank loans have been skyrocketing since the BSP employed the nuclear option of record debt monetization and pegged policy rates at record low. Even with nascent signs of inflation, 10-year yields remained rangebound from 2013 to 4Q 2016. The bear markets of 2013, 2015 and 2016 recovered from “doubling down” of easy money policy by the BSP

These all changed by the end of 2016. Yields of the 10-year benchmark broke from its resistance level and then accelerated higher. The inflation genie has been set loose. The TRAIN Law exacerbated inflation. Until excess money has been squeezed out from the system, treasury yields will continue to climb.

10-year yields have exhibited a bottoming formation (green arc) pointing to more increases. 

 

But for an economy that has been structured to see everlasting low-interest rates that would be devastating. Industries dependent on leveraging have now commanded a significant share of GDP. And that’s excluding financial intermediaries.

Now the BSP will have to choose between the devil and the deep blue sea to confront it.

Needless to say, the bear market in stocks has been consistent with previous historical accounts of the severe strains in bonds and the peso. Now the President has confirmed this view.

Mr. Duterte is right; stagflation is here. Economic doldrums haven’t been about economic growth.

The Crowding Out Effect  Plague The Real Economy

Unfortunately, the speechwriter didn’t tell the President that an economy thriving on transfers is unsustainable.

The world of scarcity has been bringing upon harsh economic lessons to the leadership.

If public “megaprojects” have been activated in Metro Manila, then the crowding out theory tells us that construction activities will not only move out of the private sector and into public works, resources, logistics, and manpower will likewise be drawn to the metropolis. [See Philippine Competitiveness Ranking Plunges! How the Crowding Out Strains Economic Competitiveness: The Construction Industry June 3, 2018]

In this way, the economic boost in Metro Manila has emerged at the expense of the provinces.

 

Instead of allowing the markets to dictate on the needs of the consumers, the price paid for political redistribution of the economy is being ventilated on resource and financial allocation as expressed in prices.

If the government’s numbers on construction material prices have been accurate then it shows how redistribution works.

Construction material wholesale prices continue to rocket in May, which showcases the bidding away of construction material resources by agents engaged in public works. On the other hand, construction material retail prices, which measures private sector activities, have been lagging. Or the growing gap between wholesale (public) and retail (private) prices demonstrate the crowding out effect from government activities relative to the private sector. So even when private construction has been developing a slack, prices rise because the government has been absorbing them.  That said, the National Government outcompetes the private sector.

Haven’t this been sufficient proof of a takeover by the government of the economy?

And because the government and the construction industry has been awash with cash and liquidity, rising general economy prices have only signified demand from these sectors which has diffused into the system

And that is just one side of it.

President Duterte is Right; Higher Interest Rates Will Choke An Economy Dependent on Credit

And since crowding out involves money, the government’s demand for financing should mean higher rates too. And since treasury issuances drain liquidity, the BSP has been forced to offset government financing with debt monetization.

 

The BSP raised its policy interest rate for the second time last week. But that’s after it reduced Reserve Requirements for the second time last May. So it has raised prices of credit while giving the banking system MORE money for its use. As I would suspect, the RR cuts were designed to shore up the banking system’s cash flow strains.

The banking system’s most liquid assets “cash and due banks” registered its fifth monthly contraction last April. The “cash and due banks” account lost Php 29.61 billion (month on month) and Php 228.2 billion from the start of the year. The first RRR cut, which took effect in May, should have made its presence felt. It hasn’t.

Mr. Duterte’s worries about interest rates can be seen in the spike of short-term yields which set 5-year highs.

Because yields of T-Bills rose faster than the longer end, the yield curve has substantially flattened. A flattened curve points to a decline in interest rate margins, which should squeeze the banking system’s earnings. And higher rates are about to reduce demand for credit. A double whammy.

Rising yields of fixed income instruments will also compete with risk assets for access to public’s savings. In the meantime, cost of working capital for businesses, which depend on credit, will rise, thereby adding pressure on demand for short-term liquidity. 

Because banking loans (production and economic) has reached Php 7.2 trillion as of May, every 100 basis points increase would translate to an additional Php 72 billion in interest rate cost.

And if the longer-end rates will be surpassed by the short-term, such inversion would most likely prognosticate a recession.

Crowding out, demand for credit and inflation all converge to suggest substantially higher rates in the future.

For an economy that has feted in credit, the backlash from its overdependence has appeared.

And the buck doesn’t stop here.

Remember Boracay? The Island’s Demand and Supply Chains will Haunt the Economy

Remember Boracay?

For the statistics is economics crowd, Boracay’s closure means nothing. Php 20 billion lost Period. But Boracay represents a network of human enterprises connected by a latticework of demand and supply chains. 

Thus Boracay’s closure would have a spillover effect to the economy. Remember this? (bold added)

The tourism industry directly accounted for 8.2% and indirectly 19.7% of the 2016 GDP (World Travel and Tourism Council 2017 report) and is about to get some nasty drubbing, in almost all aspects, output, earnings, investments and jobs.  And the coming slowdown will certainly spread to the economy.

See The March to a Neo-Socialist State: Duterte Administration Opens a War Front against Jollibee and PSE, Escalates War on Boracay and UBER-GRAB! April 10, 2018

See? It is happening!

The unintended costs of interventions have come to haunt Mr. Duterte.

Of course, that’s going get worse. With minimum wage initially imposed on the Visayan region, production output should fall as unemployment should rise. (Minimum wages will be hiked nationwide soon, perhaps during SONA)

Well, with income significantly reduced, the race to build supply in shopping malls and real estate industry would find diminishing support. With an enormous outstanding credit, how would such industries pay for them?

Environmental restrictions on tourism, fishing, fish culture and others will combine with the higher inflation tax that should further weaken the productive sectors of the economy as the government continues to sequester resources and finances for its boondoggles.

What goes around comes around.

So Far, Price Controls Have Been About PR Effect

And another thing, I noted that the once the government becomes desperate over inflation, they may institute price controls.

once the Duterte regime engages in direct price controls, it would be the proverbial last nail on the coffin.

See Inflation Has Hardly Been About the TRAIN Law; The Credit and Liquidity Cure Can Be Worse Than The Tax Disease! June 4, 2018

From the Inquirer (June 23, 2018): “Starting next week, the Department of Agriculture (DA) will impose a suggested retail price (SRP) on basic agricultural goods “to avoid an abnormal movement of prices in the market,” Agriculture Secretary Emmanuel Piñol said. A department order setting the SRP on eight basic food items was expected to be signed on Monday to coincide with the agency’s 118th foundation day, the DA official said. The order will cover Metro Manila initially, but will be rolled out in other regions in the coming days.”

Considering that even government experts know how price controls will lead to an economic hara-kiri, these threats could be deemed for publicity purposes (we have to be seen doing something) or seen as “desperate times call for desperate measures”.

The good thing, for now, has been that it seems the former than the latter.

From the Inquirer (June 24, 2018): “The Department of Trade and Industry (DTI) found 85 products costing above the suggested retail price (SRP) range nationwide but the excess was only “by a few centavos.” The DTI made results of its price monitoring public as it increased the number of establishments that were being watched to 1,100 stores nationwide. “These were considered minor violations,” the DTI said in a statement on Friday.

President Duterte Mulls Jueteng as Funding for Spend, Spend and Spend! Why Mining will be Liberalized

Because of such “economic doldrums”, Mr. Duterte appears to be having second thoughts over a crackdown on vices, in particular, jueteng gambling (bold added)

From the same article

The President said the government was seeking more funds to finance big-ticket projects in the provinces to induce economic growth.

“I’m just … brainstorming with everybody in the Cabinet how to come up with a system that would guarantee income to the government,” he said.

The President said the campaign to stop “jueteng” nationwide was well under way but he was considering a strong replacement for the numbers game to stimulate economic activity in the provinces.

“Now if I don’t have a replacement for jueteng, what can I do? It’s easy. If there’s another form of gambling that takes over, I’ll say, ‘You get out of there’ and arrest them all. Then what is the activity—economic activity? None. Now if there’s jueteng … at least money goes around. Some people will get hungry, others will be able to eat, [but] there’s commercial activity,” he said.

When starved of funds, the government may liberalize activities that were previously prohibited.

Such attitude reminds me of the US alcohol prohibition or the Volstead Act. The alcohol prohibition was repealed by US President Franklin Delano Roosevelt in 1933, hardly because of its social side effects but because the government wanted to generate financing in the face of the great depression.

As Professor Donald J. Boudreaux wrote,

And a House leader of Congress' successful attempt to propose the Prohibition-ending 21st Amendment said in 1934 that "if (anti-prohibitionists) had not had the opportunity of using that argument, that repeal meant needed revenue for our government, we would not have had repeal for at least 10 years."

There's no doubt that widespread understanding of Prohibition's futility and of its ugly, unintended side-effects made it easier for Congress to repeal the 18th Amendment. But these public sentiments were insufficient, by themselves, to end the war on alcohol.

Ending it required a gargantuan revenue shock -- to the U.S. Treasury.

From this premise, I shall make a prediction.

When the real economy falters, the government will liberalize the mining sector!