Keeping the Public in the Dark: The DoF and the BSP’s Conflicting Views of Inflation

“Inflation is in fact always and everywhere the creation of governmental policy. It is caused by the increase in the supply of money and credit”—Henry Hazlitt

In this issue

Keeping the Public in the Dark: The DoF and the BSP’s Conflicting Views of Inflation

-The DoF and the BSP’s Conflicting Views of Inflation

-The Epicenter of Inflation: Build, Build and Build; Unsustainable Price Divergences in Wholesale and Retail Construction Material Prices

-Growing Gap in Wholesale and Retail Prices Highlights Inflation Risk From the Supply Chain Perspective

-The Disconnect Between Poverty Surveys and Inflation; Statistical Inflation Spurs The Raising of Minimum Wages?

-Charts of June Vehicle Sales

Keeping the Public in the Dark: The DoF and the BSP’s Conflicting Views of Inflation

The DoF and the BSP’s Conflicting Views of Inflation

The Department of Finance reportedly sees inflation in July to rise to 5.3%, “the highest in more than 5 years, mainly on the back of higher cigarette prices”. (Inquirer)

On the other hand, the feeble peso has been identified by the Bangko Sentral ng Pilipinas as the principal culprit of mounting price pressures.

From the Inquirer: “The central bank yesterday vowed to take more aggressive action to rein in the country’s record high inflation rate, saying evidence was now emerging that more forceful policies were needed to keep the peso’s volatility from fueling further price increases. In a briefing, Bangko Sentral ng Pilipinas Governor Nestor Espenilla Jr. said the policy makingMonetary Board “is considering strong follow-through monetary adjustment” when it convenes to decide on the interest rate policy on Aug. 9. “We are taking into account the potential price pressures of excessive volatility in the foreign exchange market,” the central bank chief said. “While we believe that our fundamentals remain solid and healthy, sustained pressures on the peso could adversely affect inflation expectations.”

Media has even noticed the BSP’s moving of the goalpost. From the same article: “In justifying its decision to hold off on raising its key policy rates—despite clamor from financial markets that had been steadily rising since late 2017— the central bank stood pat on its statements that the current price hikes were being fueled by “supply side” factors that were beyond the ability of monetary policy to control. This time, however, Espenilla conceded that “some demand side pressure may also be already feeding into inflation.”

Strange but two major financial and monetary government agencies have different perspectives on the origins of price pressures. 

Supply and demand appear to operate independently from each other in the purview of mainstream experts which sees statistics as economics. 

From their published perspective, inflation has been about externally generated shocks (supply or demand) that ripple across the economy. That is, fiscal and monetary policies can be at best, beneficial, or at worst, neutral.

The Epicenter of Inflation: Build, Build and Build; Unsustainable Price Divergences in Wholesale and Retail Construction Material Prices

Figure 1

The Philippine Statistics Authority released their monthly data on construction material wholesale and retail prices for June.  Wholesale prices have been furiously rising with June rate at a staggering 8.8%!

On the other hand, retail prices have remained in blissful ignorance of its wholesale counterpart; it rose at the same rate of 2.6% from a month ago. 

That is, wholesale prices have rocketed by a stunning 238% more than retail prices!

Since the arithmetic average of monthly price quotations from sixteen retail markets in NCR determines the retail prices, these have more or less been representative of private sector demand.  

In contrast, the wholesale price index represents changes in the average construction material prices used in various government projects.  Id est, "build, build and build" account for changes in the wholesale price index.

I previously explained this divergence as epitomizing crowding out syndrome and the Cantillon effect.

Demand from aggressive deficit spending by the government channeled mainly through build, build and build, have been displacing demand from the private sector. Since political objectives rather than profitability determine its projects, the government outcompetes the private sector by bidding away resources and labor at higher prices.

And through debt monetization, the BSP’s financing of the National Government has facilitated such increases in demand. The rapidly expanding deficits translate to greater access of resources and financing by the National Government that comes at the expense of the private sector. 

And because such deficit spending has been financed by the BSP, as the initial recipient of money from thin air, government’s bidding away of resources has spread to many other aspects of the economy. 

As one of the principal source of demand, the government has functioned as a critical factor in contributing to the prices pressures in the general economy. 

Thus, construction material wholesale prices have signified the epicenter of government-induced inflation.

But a prolonged and growing disparity in prices can hardly be sustainable. As the law of one price suggests, “differences between prices are eliminated by market participants taking advantage of arbitrage opportunities”

For instance, if government demand for steel has been provided for by manufacturers at vastly higher prices than in the markets, why wouldn’t wholesalers, dealers and importers arbitrage away such expansive price differentials to close the chasm?

That’s how competition weaves its magic.

Given the current free money for the government, wouldn’t these result to the closing of such gap where retail prices are likely to catch up with wholesale prices?

Have these statistics been referring to the same markets?

Such egregious price discrimination translates to the possibility of significant price padding in government projects measured by the PSA.

And the depicted swelling of divergences of prices bespeaks of dysfunctional markets or a patent miscalculation of statistics.   

Growing Gap in Wholesale and Retail Prices Highlights Inflation Risk From the Supply Chain Perspective

Here’s another unsettling indicator of inflation.

But again this depends on the accuracy of the government given statistics.

 

Figure 2

The Philippine Statistics Authority reported a significant price spike from 6.3% in April to 8.4% in the General Wholesale index in May. That’s 210 basis points! (see economic data below for details)

The general wholesale index, as defined by the PSA, “refers to the price of commodity transacted in bulk for further resale or processing. It is the actual “spot” transaction price received usually by the wholesalers, distributors or marketing agents for large lots but net of discounts, allowances and rebates”.

On the other hand, the General Retail index rose by 4.1% in May, little changed from the 4.0% in April.

The General Retail index as defined by the PSA refers to “changes in the prices at which retailers dispose of their goods to consumers or end-users relative to a base year.”

The gap between general wholesale and retail prices have only been widening. (see chart above)

Price inflation in the General Wholesale Price index has even been doubled that of the General Retail prices 4.1% in May. CPI was4.6% (base 2012) and 5.21% (base 2006) in May.

If the market for wholesalers are retailers, what does this growing gap between wholesale prices and CPI-General Retail prices imply?

Does it entail faster consumer retail price inflation ahead? Or does this presage a coming margin squeeze in the retail, the distribution, and the manufacturing industries? Or could it be a combination of the above?

If it is the former, up to what extent of price inflation before the consumer’s discretionary income will have been drained?

The asymmetric rate of changes in prices in the different stages of the supply chain highlights the risks from inflation.

Prices have been rising faster than supply because the BSP and the banking system have been printing tremendous amounts of pesos to finance demand which the supply chain can hardly cope with.

Add distortions from many other political interventions, such as excise taxes, endo, minimum wages, price controls and etc..., disruptions in the supply chain gets magnified.

The Disconnect Between Poverty Surveys and Inflation; Statistical Inflation Spurs The Raising of Minimum Wages?

Figure 3

And it marks a contradiction, if not disinformation for surveys to suggest that rising inflation has little relevance on poverty conditions. A reduction in the purchasing power of the peso makes one wealthier?

Truly?

Statistics isn’t economics.

Does the ruckus over TRAIN and street inflation hail from a mere 4-5% in statistical inflation?

Why did the National Government grant minimum wages hikes in 9 regions? Because of 4-5% inflation? Or because of pressures on the street which could translate to lost popularity and thereby the erosion of political capital?

These wage hikes will likely either cause a price pass-through or will most likely amplify dislocations in the supply chain. The result of which would be HIGHER prices and MORE unemployment.

Various labor groups have been hopeful that President Duterte may announce in his third SONA substantial increases in minimum wages and the end of labor contractualization on a national scale.

Will he?

Going back to the DOF and the BSP.

 

Figure 4

These agencies are unlikely to provide the real score of inflation picture. Admitting so would take away the privileges bestowed upon them by the people. Industrialist Henry Ford said it best. Quote attributed to Henry Ford originally from Charles Binderup(1937)

Charts of June Vehicle Sales

Oh as a final note, here is the updated car sales data as of June.

 

Figure 5

Vehicle sales dropped by 21.7% in June year on year and 12.5% in the 1H.

Nope, it’s not all about TRAIN