Why Oil Prices Haven’t Been the Principal Cause of Inflation; NEDA’s Failed Model, Inflation’s Crybabies and the Perfect Inflation Storm!

It is important to realize that there is never any possibility of measuring increases or decreases in happiness or satisfaction. Not only is it impossible to measure or compare changes in the satisfaction of different people; it is not possible to measure changes in the happiness of any given person. In order for any measurement to be possible, there must be an eternally fixed and objectively given unit with which other units may be compared. There is no such objective unit in the field of human valuation—Murray N. Rothbard

 

In this issue

Why Oil Prices Haven’t Been the Principal Cause of Inflation; NEDA’s Failed Model, Inflation’s Crybabies and the Perfect Inflation Storm!

-High Oil Prices Equals Inflation? Not so Fast…

-With NO money (demand), NO high prices of oil!

-No Oil Supply Displacements, Regulation Caused Inflation and the Perfect Inflation Storm!

-Price Instability Hounds the Domestic Manufacturing Sector

-Political Diversions Away From Inflation Woes, NEDA’s Failed Model and Inflation’s Crybabies!

Why Oil Prices Haven’t Been the Principal Cause of Inflation; NEDA’s Failed Model, Inflation’s Crybabies and the Perfect Inflation Storm!

High Oil Prices Equals Inflation? Not so Fast…

As I pointed out last week, the Duterte administration has attributed strains of rising prices in the economy to the recent surge in international oil prices. Mainstream experts and communique have echoed and reinforced the public's impression about oil prices as the inflation bogeyman.

A sample from Bloomberg (June 6): “Signs of price pressure spreading are becoming more evident with labor groups demanding higher wages and bus and other transport operators asking for fare increases. Airlines are also seeking to raise ticket prices. The culprit can be traced to oil prices, which breached $80 a barrel in May, and a peso that has dropped about 4.7 percent against the dollar this year. The Philippines imports almost all its oil requirements, and a law that was implemented this year had raised the taxes on the commodity.” (italics added)

Because populist politics require the visible hands of the leadership on the wheel, the administration said that it would acquire oil from alternative sources as Russia and undisclosed suppliers.

But how valid or significant has oil prices been in influencing consumer price inflation?

To answer we focus on the basics; demand and supply.

With NO money (demand), NO high prices of oil!

First, we take on demand.

Let us assume that the local scientists have discovered the conversion of water into energy to substitute for oil and other natural sources of energy. Because facilities for the use of this energy has been mass produced, it became the ONLY source of the nation’s power. However, like in Marvel hero Black Panther’s dominion Wakanda, this energy has been classified and exclusively used in the Philippines.

So what would be the price of oil and its byproducts here?

Because demand for oil is zero (value is zero), therefore, the price of oil is zero. So the fluctuations of oil prices in the international markets will neither have an impact nor influence on the prices in the economy.

The point of this exercise is to demonstrate that the influence of international oil prices on the local economy depends on the extent of the value of oil and its byproducts to domestic demand.  

Prices do not emerge out of a vacuum.

Bluntly put, it is the consumers and their purchasing power exercised through money prices (peso) that determine the demand for oil (and their byproducts).

There is more.

If domestic consumers don’t have the wherewithal or the means to support prices asked by the producers at a given price level, then oil prices will have to adjust downwards to levels where demand is. On the other hand, if quantity demanded increases substantially at a given price level, then prices rise.

Self-evidently, NO money (demand), NO high prices of oil.

Let us use gasoline as an example.

The average USD price of a liter of gasoline for the world was at 1.17 as of June 4. At USD 1.12 (average of Php 54.14 as of June 4 Global Petrol Prices), gasoline prices in the Philippines have been LOWER than the average!

How are gasoline prices determined?

According to GlobalPetrolPrices.com: “As a general rule, richer countries have higher prices while poorer countries and the countries that produce and export oil have significantly lower prices. One notable exception is the U.S. which is an economically advanced country but has low gas prices. The differences in prices across countries are due to the various taxes and subsidies for gasoline. All countries have access to the same petroleum prices of international markets but then decide to impose different taxes. As a result, the retail price of gasoline is different.”

You see? The primacy of the purchasing power of the consumer in influencing prices of gasoline is demonstrated by “richer countries have higher prices while poorer countries… have significantly lower prices.”

Taxes and subsidies also contribute to prices of gasoline but are subject to the limits of demand and supply.

To expand the horizon on oil’s influence on real economy prices; if prices of oil go up, and if the consumed amount of oil remains the same, the increase in the money allocated to oil translates to lesser money available for other goods. That’s if the consumer’s purchasing power remains constant. More money for oil translates to less money elsewhere.

That is, there can’t be a widespread increase in the prices of goods and services in the economy. Or, the hollering and screeching over raging prices won’t be bannered on the headlines!

However, if the consumer’s purchasing power has been artificially augmented by an increase in money supply, which allows consumers to bid up other goods irrespective of higher prices of oil, that’s where the inflation sensationalism comes in.

More evidence that higher gas (oil) prices don’t necessarily lead to inflation 

 

Figure 1

The countries with the priciest gasoline in the world have been Iceland (USD 2.15/liter as of June 4), Hong Kong (USD 2.12), Norway (USD 2.07), the Netherlands (USD 2.0) and Greece (USD 1.95). In Asia, after Hong Kong, New Zealand (USD 1.65) and Singapore (USD 1.63) have the most expensive gasoline prices.

Yet, rising oil prices have not translated into price pressures for the non-major oil exporting nations of Hong Kong and Singapore. (figure 1)

In contrast to popular wisdom, importation of oil to finance domestic energy requirements doesn’t mechanically translate to inflationary pressures. Hong Kong and Singapore’s imports 99% and 98% of its energy requirements respectively, yet the inflation rates of both nations have been in a steady decline!

Figure 2

It’s a different story in the Philippines.

Though the US crude oil, the West Texas Intermediate (WTI), have risen almost in conjunction with domestic CPI, the latter has surpassed the previous high whereas the former (WTIC) represents only about 62% of 2014’s high.  (upper window, figure 2)

Used in the above is the US West Texas Intermediate (WTI) as a benchmark for oil price movements.  The Philippines imports most (90%) of its crude oil requirements from the Middle East (DOE).

Based on Tradingeconomics.com (as of May), although Philippine (USD) gasoline prices have been rising since 2016 it has been LOWER than 2014 levels! Echoing WTI, while domestic gasoline prices remain distant to its 2014 levels, the government’s CPI has exceeded the 2014 level! (lower window figure 2) 

 

Figure 3

The same story can be derived even from the government's statistics. 

Core inflation, which supposedly excludes energy and food prices accelerated in May to 3.61% from 3.52% in April.

The Philippine Statistics Authority defines core inflation as “the year-on-year rate of change of the monthly headline CPI after excluding food and energy items. Headline inflation is the rate of change in the overall consumer price index (CPI) currently published by the National Statistics Office (NSO).”

Of course, embedded in core inflation are prices of energy applied or used in the production, transport, storage, distribution and sales processes of non-energy and non-food products. Energy’s contribution to the goods or services for sale is impossible to isolate because of its ubiquity in all aspects of human action. 

Nevertheless, the core inflation numbers point to the widespread price pressures even OUTSIDE direct oil or energy consumption which goes against conventional wisdom.

No Oil Supply Displacements, Regulation Caused Inflation and the Perfect Inflation Storm!

And after demand is supply…

 

Figure 4

Present domestic demand for energy is being provisioned significantly by imports. The Philippines imports about 44.7% of energy requirements in 2016, according to the Department of Energy. Oil imports constituted 75% of total energy imports in 2016. (figure 4)

A disruption in the external source of energy, perhaps through a war or from an embargo or other geopolitical factors, may cause a ‘supply shock’ that sends prices of imported energy rocketing.

Again, a supply shock will be subject to the constraints of the laws of demand.

A supply shock, thus, is likely to be temporary as higher prices will induce conservation and the rationing of the availability of scarce energy supplies. Another factor would likely be that the market will look for replacement suppliers of oil and or would migrate to other variety of fuels. 

The recent surge in the international prices of oil has barely been about sudden dislocations about supplies.

And compared to Hong Kong and Singapore, it hasn’t been true that just because oil prices have been rising, inflation should.

That said, the inflationary pressures presently being experienced in the domestic landscape has hardly been about an international oil supply shock or oil supply related displacements.

Current inflation has been driven principally by the demand side, which continues to be powered by increases in money supply, from the banking system and from the BSP. And distortions from the RA 10963 or TRAIN law have only amplified it.

Oil’s contribution to rising prices can be considered epiphenomenon – a secondary or minor or less significant cause.

Of course, aside from oil or energy, other supply issues should also contribute to price pressures such as food.

For instance, last week, the administration imposed a moratorium on Pangasinan’s fish farming due to the recent fish kills.

The Bureau of Fisheries and Aquatic Resources also enforced a 3-month ban on mackerel, scad, and trevally fishing in Southern Mindanao for marine biology conservation reasons.

Such regulations are bound to reduce the supply of fish inventories for consumption. Unless replaced with imports, prices of fish seem headed higher.

Of course, should the government strictly enforce ENDO and should a substantial hike in minimum wages be approved such would likely result in a reduction in output. 

Demand spurred inflation to be abetted by supply constraints from regulations! A perfect inflation storm!

Price Instability Hounds the Domestic Manufacturing Sector

Figure 5

Price instability may have also resulted to the present “boom” in manufacturing output.

April’s Industrial Production (IP) reported by the PSA rocketed by 31.7% in April even as exports plummeted by an eye-popping 8.45% to register a FOURTH consecutive month of output shrinkage! (IP middle left window, exports upper left, figure 5)

Because of the diametrically opposite direction of merchandise trade, April’s trade deficit has swelled to $3.62 billion, the third highest monthlydeficit since 2013! (upper right)

Where has the vigorous increase in the demand for manufacturing output been coming from? Has domestic demand been so strong for manufacturers to produce in a panic? Or have manufacturers been frontloading output in response to their buyer’s anticipation of higher prices ahead?

The Markit’s PMI report provides clues on this.

Importantly, hasn’t demand been derived mostly from the government as shown by the GDP during the last 4-5 quarters?

Markit’s Nikkei’s PMI hasn't validated the PSA's data.

Though the private sector manufacturing survey registered an increase in May, it hasn’t been a boom.  The Nikkei Index has risen for three successive months or since March. May’s high has yet to reach 4Q 2017 levels. (figure 5, middle right window)

The ongoing price instability in the account of Markit Economics: (bold added): “However, stronger demand conditions failed to stretch operating capacity. On the contrary, May data indicated a further drop in the level of unfinished work, stretching the trend of falling backlogs to well over two years. The persistent lack of capacity pressure imposed no urgency on firms to boost hiring even as sales increase. Employment growth remained marginal in May. Furthermore, there were some reports of layoffs due to cost saving measures.

More from Markit: “Input cost inflation intensified midway through the second quarter as a combination of factors, including supply shortages, a weaker peso, higher global commodity prices, and tax reforms, led to inflation. As a result, firms raised selling prices again, with the rate of increase remaining solid, reflecting efforts to pass on higher costs to their customers.

Firms won’t react by laying off workers when they are able “to pass on higher costs to their customers”. That some firms resorted to layoffs translates to ongoing margin squeezes. 

The Markit’s economist attempts at putting the proverbial lipstick on a pig: “Another area of concern is the increasing pressure on Filipino manufacturers’ profit margins. PMI data showed firms raising selling prices at a slower rate in May amid rising costs, suggesting that companies may have a threshold of the extent to which their customers can bear higher prices without affecting demand. The good news is that improving demand conditions permitted firms to share some of the higher costs with their customers. Survey indicators point to increasing economic activity in the coming months.

In English: When companies “have a threshold” in which “their customers can bear higher prices without affecting demand” such exhibits the natural impediments of a pass-through of higher costs to customers.

And such limitations expose the artificiality or tenuousness of present conditions.

If such price threshold has been met, what happens to the stocks/inventories of producers and wholesalers? Will these not lead to a glut or oversupply? If it does, will this not lead to a drop in output?

The reported layoffs signify as incipient symptoms of firms struggling to maintain profit margins amidst rising costs. The Producer Price Index or manufacturing input costs has turned positive in April. (lowest window figure 5) Will an overcapacity not aggravate the current conditions?

So how would “increasing pressure on profit margins” reflect “improving demand condition” that leads “to increasing economic activity in the coming months”?

As I have said repeatedly here, the establishment's Statistics is Economics is about salesmanship more than about economic analysis.

As one can see from the above, political interventions channeled through mainly the BSP’s policies, secondarily from the NG’s “spend, spend, spend” and the broadening of regulations and prohibitions have been escalating demand and supply (or economic) instability.

Political Diversions Away From Inflation Woes, NEDA’s Failed Model and Inflation’s Crybabies!

Current developments have signified a fascinating twist of events.

Yes, the populist backlash against escalating price pressures in the real economy has indeed been mounting!

Inflation has been getting more political!

Haven’t we been told that crime rates have been going down???

So what has prompted President Duterte to declare in public to “Expect “radical changes” in government in the coming days”  as he vowed to use his “meager emergency power to the hilt” to check rising criminality? (Philstar June 6).

People have then speculated that President Duterte would impose martial law. But then Mr. Duterte suddenly threw martial law under the bus by stating that it is “not feasible” and will only divide the nation (Inquirer June 9)

Why has Mr. Duterte been blurting out controversial statements then backpedaling from it? What has been stirring him?

Recall that his Foreign Secretary claimed that Mr. Duterte was ready for war last week. This week Mr. Duterte made a fabulous U-turn by pronouncing that to send soldiers to war is a suicide mission that would lead to his ouster.

Is Mr. Duterte employing smokescreen to divert the public’s attention? From what?

I would propound PRICE INFLATION.

This week, some senators and other groups lambasted National Economic Development Authority (NEDA) over the agency’s exposition indicating that a family of five can live with P10,000 a month.  They have accused the government agency of being insensitive to the plight of the poor.

A report says that NEDA officials didn’t say this. The top NEDA official, Ernesto Pernia, publicly denied that the agency made such a claim. Instead, officials asserted that the agency’s media presentation hypothesized how a family with an income of Php 10,000 would have been affected by an inflation rate of 4.6% 

But this hasn’t been the first time.

A week ago, Mr. Duterte’s Budget Secretary implied that the Filipinos had been overreacting to inflation. From Philstar (May 31), “Budget Secretary Benjamin Diokno said Filipinos should not complain too much amid rising prices of fuel and widely used goods, saying the country was able to withstand higher pump prices in the past…In a press conference on Wednesday, Diokno pointed out that the country has had worse in the past when global oil prices hit $135 per barrel during the Arroyo administration. “So I think we should be less of a crybaby. I think we should not take on a rather controversial statement,” Diokno said

There has hardly been any hullabaloo over the Budget Secretary’s snide comments. Nonetheless, Mr. Duterte promptly countered his subordinate by publicly stating that "he does not view Filipinos as crybabies" (Inquirer May 31).

The Budget Secretary was referring to oil prices as I pointed out above. (see Figure 2)

You see the problem with the statistics equals economics crowd?

True, nominal oil prices have gone down and have yet to reach its old highs. But that would be comparing apples with oranges.

That’s because CPI represents % change. While the CPI’s rate of increase has gone down, the nominal index has hardly ever gone down. Unless we see deflation (negative price changes), CPI always go UP! That’s the fundamental character of a fiat money system operating on a fractional reserve banking system.

Besides, since CPI has always been rising, the baseline matters. A 5% CPI increase from a Php 10 base would translate to Php 10.5 or a Php .5 increment. A 5% increase from a Php 20 base would translate to Php 21 or a Php 1 increment.  Same percentage change, different increments. It stands to reason that the higher base number, the greater would be the impact of price changes.

And that’s why inflation should bite today more than the inflation rates in 2014. Today’s rates haven’t been only rising from a HIGHER base; it has been accelerating faster than the 2014 episode!

Even more, how accurate are the measures of inflation?

Wouldn’t the government have the incentive to suppress inflation numbers to justify lower rates to fund its deficit spending programs? 

CPI measures are a sham, as the great Austrian economist Ludwig von Mises wrote*,

The pretentious solemnity which statisticians and statistical bureaus display in computing indexes of purchasing power and cost of living is out of place. These index numbers are at best rather crude and inaccurate illustrations of changes which have occurred. In periods of slow alterations in the relation between the supply of and the demand for money they do not convey any information at all. In periods of inflation and consequently of sharp price changes they provide a rough image of events which every individual experiences in his daily life.A judicious housewife knows much more about price changes as far as they affect her own household than the statistical [p. 223] averages can tell. She has little use for computations disregarding changes both in quality and in the amount of goods which she is able or permitted to buy at the prices entering into the computation. If she "measures" the changes for her personal appreciation by taking the prices of only two or three commodities as a yardstick, she is no less "scientific" and no more arbitrary than the sophisticated mathematicians in choosing their methods for the manipulation of the data of the market.

*Ludwig von Mises, 4. Stabilization Part Three: Economic Calculation > Chapter XII. The Sphere of Economic Calculation Human Action Mises.org

Because officials can hardly distinguish between statistics and economics, they have been caught flat-footed with the sheer intensity of the public’s reactions! 

Here’s more.

The NEDA people have been whitewashing their statements on the ruckus they raised over the Php 10,000 estimated household income.

However, in a 2016 report, the PSA observed that “at least Php 9,140 on the average every month to meet both basic food and non-food needs” in 2015 for a family of 5.

The Consumer Price index (CPI) registered 1.3% in 2016 and more than doubled to 2.9% in 2017 (base 2012), according to the Philippine Statistics Authority.

If the CPIs of 2016 and 2017 have been incorporated into the 2015 estimated household income of Php 9,140 "required to meet both basic food and non-food needs", then the household income would rise to Php 9,527 at the end of 2017. So if they apply the 4.6% inflation rate for 2018, that base number rises to Php 9,965.24. Boom!

Is it a wonder why they used the Php 10,000 benchmark?

Needless to say, what NEDA officials wrote rather than what they said in public is what mattered.

Deny for all they want, but their numbers show it.

NEDA’s econometric models have failed!

Just look at the unfolding events.

Nikkei Asian Review (June 5) “Rising prices pressure Duterte to enact rice tariff bill”: Diokno said Congress must fast-track the enactment of a bill that would relax current strict restrictions on rice imports and instead slap high tariffs on them that would ease prices. The import restrictions were first put in place to protect local farmers. Government economists said the bill would reduce inflation by 0.4 percentage points if it is passed in the third quarter.”

GMA (June 9) “Duterte’s order to convene wage boards ‘cheap trick’ —labor group”: “Militant labor group Bukluran ng Manggagawang Pilipino (BMP) slammed the recent order by President Rodrigo Duterte to convene all the regional wage boards to address the rising prices of basic commodities as a "cheap trick" to offset the "negative publicity caused by the TRAIN Law-induced hike in inflation rates."”

Philstar (June 10) “Senate panel to probe hike in prices of goods”: “A Senate panel will investigate if the Tax Reform for Acceleration and Inclusion (TRAIN) law is the main cause of the continued rise in the prices of basic goods. Sen. Aquilino Pimentel III, chairman of the Senate committee on trade, commerce and entrepreneurship, said it is the “call of the times” that a public hearing be held to address concerns over rising inflation, or the rate of increase in the prices of goods. Consumers have been complaining about the continued increase in the prices of fuel and other basic goods, and many are blaming the TRAIN law for the increases”

Such striking backlash could NOT be just about oil.

And the NG’s inflation numbers 4.6% (Base 2012) and 5.21% (2006) has vastly UNDERSTATED street inflation.

The epoch of easy money is over!

Expect the USD peso to test Php 53 anytime soon!

We live in interesting times!

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