Inflation is a policy. And a policy can be changed. Therefore, there is no reason to give in to inflation. If one regards inflation as an evil, then one has to stop inflating. One has to balance the budget of the government. Of course, public opinion must support this; the intellectuals must help the people to understand. Given the support of public opinion, it is certainly possible for the people's elected representatives to abandon the policy of inflation—Ludwig von Mises
In this issue
Another Bailout of Banks: The BSP Silently Re-Launches the 2nd Leg of QE with a Bang! December’s CPI Doubled!
-The Yield Curve Takes Control: Statisticians Succumb to Traders: CPI Doubled in December!
-BSP Re-Launches the Nuclear Option: Unleashed Record Debt Monetization!
-The BSP’s QE 2.0: Liquefying the Financial System More than Deficit Financing!
-“Shock and Awe” QE Plus Massive RRRs Aimed at Flooding Liquidity onto Banking System!
-Treasury Market Defies the BSP, T-Bill Yields Rise!
-BSP’s QE 2.0: An Inflationary Bailout of the Banking System! USD Peso To Strengthen
-Summary
Another Bailout of Banks: The BSP Silently Re-Launches the 2nd Leg of QE with a Bang! December’s CPI Doubled!
The Yield Curve Takes Control: Statisticians Succumb to Traders: CPI Doubled in December!
The official statistical inflation, the CPI jumped to 2.5% in December, lifting the year’s average to also 2.5%. The December data was almost TWICE November’s 1.3% number! November’s unrounded figure was 1.25%, and thus, December’s CPI was DOUBLE from a month ago.
Why the spike?
The BSP’s justification: “Food inflation picked up in December as tight domestic supply conditions, triggered by weather-related supply constraints, led to higher prices of fish and vegetables. Meanwhile, non-food inflation also increased as a result of the upward adjustment in electricity rates due to higher generation charges. At the same time, prices of domestic petroleum products rose, reflecting higher oil prices in the international market.”
Despite increases in fish (+7.4%), meat (+3.2%), vegetables (+8.2%), and fruit (+7.5%), the Food CPI rose by only 1.7%, below the official numbers. And in spite of the upward adjustment in electricity rates, the Electricity, gas, and other fuels posted a NEGATIVE .6% CPI!
Figure 1
And though higher oil prices in the international market contributed to the increase in prices of domestic petroleum products, the Transport CPI rose 2.2%, below the official numbers! Put differently, the factors attributed to the doubling of the statistical inflation played a minor role in December’s data.
In contrast, alcoholic beverage and tobacco (+18.4%), house rentals (+3%), water supply, and other household services (+2.9%), health (+2.9%), education (+4.6%), and restaurant CPI (+2.7%) were the components that had growth rates higher than the headline, and therefore were the main factors in raising the CPI.
Recall that the 42-month low CPI last October widened the gap between the headline and the CORE CPI. While the core CPI also registered a stark increase to 3.1% in December from 2.55% in November, the doubling of the headline CPI have narrowed the aberrant gap. (figure 1, middle window)
Importantly, the bulging components of demand deposits M1 and money market borrowing of M3 appear to have presaged the rise in the headline and core CPI. (figure 1, upmost pane)
I then offered different angles from those posited by the mainstream on the CPI.
Not only have the fundamental premise and logic behind the statistics been flawed, but these numbers have been detached from the real world as proven by micro-evidence.
Hence, sorry guys, that CPI thing has been misstated.
With T-bills holding steady in the face of a crashing Headline CPI, not even the treasury markets (BVAL rates) believe these numbers!
3Q CPI Fall to 42-Month Low as Divergences in Component CPIs Widen; Flawed CPI—the Shakey’s Pizza Evidence November 10, 2019
The yield curve, instead, projects the incumbent policies of the BSP, which drives the CPI cycle. And once the curve reaches a certain point from which the CPI follows with a time lag, treasury investors foresee and prices a turnaround on the BSP policies in response to such dynamic. The yield curve’s inflection points, thereby, represent the treasury market’s anticipation of the denouements of the peak and troughs of the CPI cycle…
And because of the tenacious widening of the curve, which has clashed with the artificially depressed statistical inflation, confronted with a credibility dilemma, the National Government relented to publish a higher CPI last November.
And the irony, the yield curve, as a product of the treasury market populated by establishment traders, has fundamentally defied their research and statistics departments! So while the public sees the opinion of the spokespeople of establishment institutions, unrecognized has been the contradictory actions of their trading desks that shape Treasury prices and yields! In short, traders beat statisticians and economists for implicit control over data, and subsequently, policies.
That is, the National Government (NG) had been induced to align its statistics with the actions of the treasury market to maintain its reputation and integrity.
BSP Re-Launches the Nuclear Option: Unleashed Record Debt Monetization!
Of course, the CPI does not operate in a vacuum. As I have been saying, government policies play a critical role in shaping not only the statistical CPI, but more importantly, prices in the real economy.
For instance, though the oscillations of the CPI appears to be consonant with that of oil prices, its magnitude has been variable. That is, from 2013 to 2015, the CPI treaded below the international prices of oil. That all changed at the outset of 2016, where the CPI has surpassed the rate of change in the level of the US oil benchmark, the West Texas Intermediate (WTI). Said differently, since 2015, international oil prices have contributed LESS to the National Government’s CPI. (figure 1, lowest window)
But you won't hear that anywhere. That's because international oil prices serve as a convenient but plausible excuse to cover domestic shortcomings. And that’s because nothing can or could go wrong locally. The Fundamental Attribution bias.
And guess what has contributed to the declining oil-CPI correlations?
The answer: the combination of the BSP’s version of Quantitative Easing, which started in the 2H of 2015, and which rocketed to new highs last November (!), the record low policy rates in June 2016, and finally, the grand fiscal stimulus bannered under the ‘build, build and build’ spend oneself to prosperity shibboleth.
The BSP added a new tool; it chopped an aggregate 600 bps of the banking system’s reserve requirements ratio (RRR) to arrest the dramatically falling liquidity in 2018 to 2019!
Not only has the Philippine economy been unable to wean away from emergency measures instituted since the Great Recession, but the escalation of policy interventions reveal that it has become deeply addicted to it!
Since the economy can’t operate under normal conditions, WITHOUT the massive injections of policy steroids, the illusions of a boom would unravel!
And here’s the thing, it seems that the establishment barely understands the fundamental precept of diminishing returns.
And if you haven't noticed, the shortfalls from previous interventions have only paved the way for MORE interference. Interventions beget more interventions.
Figure 2
For instance, with its inflation targeting policy, the BSP started with drastic rate cuts to shield the economy from the Great Recession. However, in response to the astounding 30% money supply growth in the 10 months of 2013 to 2014 that spiked street inflation, the BSP raised its policy rates, which spurred disinflationary pressures in 2015. To reverse this, the BSP opened the Quantitative Easing spigot late 2015, which helped fuel the 2018 spike in inflation. And with the intensifying decrease in financial liquidity, as a consequence of the boom in bank credit expansion since 2009, RRR adjustments have been tucked into its toolbox!
The chronology of events illustrated by the chart. (figure 2, upmost chart)
Interventions beget interventions.
The great Austrian economist Ludwig von Mises*, presciently pointed this out,
All varieties of interference with the market phenomena not only fail to achieve the ends aimed at by their authors and supporters, but bring about a state of affairs which-from the point of view of their authors' and advocates' valuations--is less desirable than the previous state of affairs which they were designed to alter. If one wants to correct their manifest unsuitableness and preposterousness by supplementing the first acts of intervention with more and more of such acts, one must go farther and farther until the market economy has been entirely destroyed and socialism has been substituted for it.
And not only has diminishing returns been accruing from such interventions, the other ramification has been a buildup of risks.
For instance, to fend off untoward effects of the Great Recession, the BSP pruned its policy rates from 7.5% to 4% in two years, should any shocks appear, does this mean that the rates will come down to ZERO or even NEGATIVE? Can the Philippine economy afford this?
Because monetary, and even fiscal policies, have been pushed to the limits, policymakers have little buffer left as contingent against future shocks!
Yet, for the establishment, price volatility merely represents statistical outputs, with little relevance to the ebbs and flows in the allocation of economic resources. More importantly, mounting debts accompanying these, serve only as a footnote in the economy’s balance sheet!
Nonetheless, applying the law of holes to the incumbent political-economic conditions, “if you find yourself in a hole, stop digging”, but the politicians, bureaucrats and the bankers keep digging us a deeper hole!
The BSP’s QE 2.0: Liquefying the Financial System More than Deficit Financing!
The predicament affecting the banking system, as I predicted back in October 2019, will prompt for a massive response from the Bangko Sentral ng Pilipinas.
With the stumble of M3’s savings deposits into deflation territory, the BSP will likely supercharge its QE, if the RRR cuts would prove to be ineffectual. Liquidity represents the primary risk, as admonished the BSP Governor Ben Diokno in their latest (2018) FSR, “If there are risk issues to raise, it will have to be the prospects of managing liquidity”.*
From the BSP: “net claims on the central government grew by 13.9 percent in November from 6.6 percent (revised) in October, due in part to the sustained increase in borrowings by the National Government.”
Since the BSP defines Net Claims on Central Government as consisting of “domestic securities issued by and loans and advances extended to the national government (NG), net of NG deposits”, it is effectively debt monetization! Printing money as you will!
Thar she blows! (figure 2, middle window)
The BSP monetized Php 150.58 billion month-on-month of NG debt, the largest since January 2014, pushing the 11-month aggregate to an unprecedented Php 2.119 trillion or about 1.13% of the estimated Nominal GDP!
The 11-month increase of Php 207.9 billion has slightly been off 2018’s annual Php 275.6 billion, which would account for the third-largest in history if this number remains unchanged in December! (figure 2, lowest pane)
The BSP monetized a total of Php 424.9 billion during the last six months or an average of Php 70.81 billion, which suggests that if this average is met, 2018’s QE of Php 275.6 billion may be topped!
Such behind-the-scene numbers stunningly reveal how the BSP has resorted to increasingly unorthodox measures to liquefy the financial system!
The BSP’s actions can hardly be about deficit financing.
The NG incurred only a budget deficit of Php 60.8 billion in November, totaling Php 409.133 billion in 11-months of 2019, 35.2% short of the Php 631.5 billion, or 3.2% deficit to GDP target. (figure 3, upmost table)
Figure 3
Even when the NG’s deficit target has performed below target, the NG has raised a total of Php 850.471 billion from the capital markets in the 11-months of 2019, accounting for the highest in history, and which has been more than twice the deficit of the same period! (figure 3, upmost and middle windows)
The previous record cash reserves have all but faded as the NG spent these to pay for amortization, which spiked to Php 197.37 billion last November! The NG has been left with only Php 2.6 billion last November. (figure 3, lowest pane)
In eleven months, the increases in the BSP’s nominal in net claims on the central government of Php 207.9 billion and the total public debt of Php 977.4 or an aggregate of Php 1.185 trillion as of November account for 189% or nearly twice of the Php 409.133 billion deficit! Where’d the money go?
And with the substantial disproportion between public finance and deficit spending, has the published deficit of Php 409.133 billion been accurately stated? Or, where has the surplus funding been diverted to? Or what parts of the political economy has been imbuing such excess funding?
Differently put, while debt was the primary vehicle to finance the deficit, the BSP’s aggressive monetization was most likely designed to shore up liquidity in the system!
“Shock and Awe” QE Plus Massive RRRs Aimed at Flooding Liquidity onto Banking System!
If there are risk issues to raise, it will have to be the prospects of managing liquidity. Aside from simply having more loans versus deposits, using liquid assets as a source for funding more earning assets needs our attention. However, the bigger issue will be that continuing on the path of being a bank-based financial market means that the provision of credit will require taking on mismatches in tenor and in liquidity. As more credit is dispensed, such mismatches will only increase.
The downside adjustments in rates of BSP’s overnight lending facilities (75 bps), and the Reserve Ratio Requirements (300 bps as of November), as well as the QE’s of previous months have done little to improve the banking system’s liquidity generation.
From the BSP’s report card on the banking system’s loans last November: “Loans for production activities—which comprised 87.2 percent of banks’ aggregate loan portfolio, net of RRPs—expanded at a rate of 8.1 percent in November, higher than the reported growth in October at 7.5 percent…. Meanwhile, loans from universal and commercial banks for household consumption grew by 26.6 percent in November from 26.7 percent in October due to faster growth in motor vehicle loans during the month.”
From the BSP’s report card on November’s money supply growth: Preliminary data show that domestic liquidity (M3) expanded by 9.8 percent year-on-year to about ₱12.4 trillion in November 2019, faster than the 8.5-percent growth in October. On a month-on-month seasonally-adjusted basis, M3 increased by 1.7 percent. Demand for credit remained the principal driver of money supply growth.
Figure 4
Except for consumer loans, production loans have barely improved in spite of the mammoth injections or stimulus by the BSP in the context of cuts in RRR, rate cuts and QE! (figure 4, upper window)
And in spite of the record financing, while M1’s demand deposit growth continues to recover, posting a 13.6% growth in November from 11.4% a month ago, the bank’s total loans improved slightly to 9.65% from 9.03% over the same period, which shows a diverging dynamic between the two, which is likely a product of the BSP's QE. (figure 4, middle window)
Meanwhile, the rate of growth of public debt continues to ease. Domestic debt growth slowed to 8.66% last November from 14.82% a month ago, while Foreign debt growth doubled to 4.3% from 2.14% in October. Total Debt growth slid to 7.15% from 10.31% over the same period. (figure 4, upper window)
And in the face of the massive liquidity injections, M2’s savings deposits jumped tenfold from .3% in October to 3.2% in November to bounce away from deflation. However, November’s growth rate has hardly recovered its average. In the meantime, the growth of currency in circulation or cash expanded slightly from 10.9% in October to 11.3% in November, which reveals another divergence between savings and the former. (figure 4, lowest pane)
To broaden the perspective, in eleven months, the system's leverage grew by a total of Php 977.4 billion, comprising bank credit expansion, and public borrowing. This data excludes other forms of lending as bonds, intra-company loans and other forms of shadow banking, informal lending, and more. To include the BSP's QE, such will add up to Php 1.185 trillion! In aggregate, public debt (Php 7.71 trillion), bank credit expansion (Php 8.62 trillion), and the BSP’s net claims on central government (Php 2.119 trillion) amounts to 96% of the annualized 9-month nominal GDP of Php 19.2 trillion!
Yet, in its face, deflationary impulses remain a force plaguing the financial system. And that’s a taboo for central banks!
These numbers neatly explain why the BSP did what they did in November! Since the massive injections had done little to improve liquidity, they had to keep digging the hole deeper by interjecting a "Shock and Awe" QE!
Treasury Market Defies the BSP, T-Bill Yields Rise!
Aside from the sharply contrasting numbers exhibited by different segments of the money supply and bank balance sheet conditions, the Philippine Treasury markets have like been emitting mixed signals.
Figure 5
Even when the NG celebrated the CPI’s plunge to a 42-month low, the trading desks of financial institutions construed a different perspective; they smelled inflation, hence, sold the longer-end of the Philippine treasuries starting at the late 1Q 2019 that caused a sharp steepening. (figure 5, upper pane)
So while media and their favorite experts declared triumph with the low CPI, traders steepened the curve signaling inflation ahead!
However, despite the BSP’s three rate cuts, the last of which was in September, the widening curve appears to have peaked in the same month, as yields of T-bills climbed faster than the longer-end. (figure 5, middle window)
In contrast to the previous episode where the curve flattened and inverted in response to yields falling faster at the backend than the front, the current flattening has been about the push from the T-Bills. And curiously too, after easing in December, yields of the longer-end spiked last week, coinciding with the BSP’s publication of November’s money supply conditions. (figure 5, lowest pane)
“Don’t fight the Fed” has been a popular Wall Street maxim.
But in the domestic sphere, the Treasury markets have been defiant of the BSP. Instead of lower rates at the front to conform to the BSP’s policy rate cuts, T-bills have been sold, hence the higher rates. "Inflation surprise and the Middle East war jitters" had been blamed for traders staying on the sidelines.
In reality, with NG’s cash position depleted to pay for the ballooning debt servicing as a consequence of the bulging debt, the competition with banks to raise funding from the public's purse should exert further pressure on T-Bill rates exemplifying the crowding out of financing.
BSP’s QE 2.0: An Inflationary Bailout of the Banking System! USD Peso To Strengthen
Furthermore, the BSP’s “shock and awe” QE should fire up street inflation, as well as the CPI. Even the mainstream understands this. (bold added)
From Wikipedia: “When government deficits are financed through debt monetization the outcome is an increase in the monetary base, shifting the aggregate-demand curve to the right leading to a rise in the price level (unless the money supply is infinitely elastic). When governments intentionally do this, they devalue existing stockpiles of fixed income cash flows of anyone who is holding assets based in that currency. This does not reduce the value of floating or hard assets, and has an uncertain (and potentially beneficial) impact on some equities. It benefits debtors at the expense of creditors and will result in an increase in the nominal price of real estate.”
From a paper submitted by Dr. Roberto B. Raymundo**, an Associate Professor of the Economics Department and Graduate Studies Coordinator for the School of Economics at the DLSU, to the Research Congress last June 2019: “Chronic deficit spending financed by monetizing public debt is responsible for creating inflation that reduces the value of money, increases the cost of all goods and services and reduces the value of real income leading to a decline in living standards. Inflation over several years reduces the value of real wages and salaries, savings, pensions and other retirement benefits. Inflation is a hidden tax and is shouldered by every income earning individual. Deficit spending funded by the Central Bank’s creation of new money allows government to continually spend beyond its means and transfer this cost to the general public in the form of inflation and a guaranty of more taxation in the future.”
**DLSU Research Congress, Dr. Roberto B. Raymundo, Inflation is Primarily a Monetary Phenomenon June 19 to 21, 2019
The concluding remark of the research work, which sounded like a dissertation from an Austrian economist, had a footnote referring to Murray Rothbard. Yes, Austrian economics has gone mainstream!
Under the current conditions, while the aggressive debt monetization may partly be about deficit financing, such looks more likely directed at arresting the intensifying decay in the liquidity conditions afflicting the financial system.
Therefore, aside from direct and indirect beneficiaries from expanded expenditures giving rise to the near-record deficit spending, the current aggressive debt monetization represents a subsidy or an implicit bailout of the banking system!
Figure 6
The initial bout of debt monetization in 2015 widened the yield differentials between the 10-year and 1-year treasury. This occurred mostly because the yield of the 10-year benchmark rose faster than the T-bill. As shown in the chart, yields of the 10-year rocketed as the BSP pushed its debt monetization forward from 2015 to 2018. (figure 6, upmost windows)
When the BSP slowed or stalled its QE, the yield of the 10-year treasury began its descent, which accelerated along with the crashing CPI, as the BSP hiked rates in 2018.
And with the doubling of the CPI, in the face of the aggressive re-launching of the QE, positive real yields have recently tumbled. (figure 6, middle pane)
And if the current dynamic is sustained, then this premium, which has helped boost the peso, is about to reverse.
The crowding out from the BSP’s QE on the existing stock of the domestic currency translates to the lowering of its purchasing power.
Ergo, the peso, which is being pushed currently higher by the regional tide, should see a reversal. (figure 6, lowest window)
Or the peso should see a significant weakening this year similar to late 2005, where QE strengthened the USD-Php considerably, despite the record GIR, which has been a product of the BSP’s increased exposure on short-term credit transactions with US banking system.
Summary
The doubling of the CPI in November, not only reinforces the validity of the yield curve as an accurate predictor of the real economy price trends, but it also accounts for the consequence of the silent relaunching of the BSP’s nuclear option: debt monetization.
The massive injections to the financial system through the varied policy toolbox of the previous QE, cuts in RRR, and policy rates have barely improved financial conditions in November. Ergo, the BSP’s nuclear option was more than about deficit financing; it was principally undertaken to shore up the liquidity of the financial system.
If the BSP continues to fire up the use of debt monetization, we can expect street inflation, and the CPI to rise further, which should reverse the USD-Php trend.
Good luck to those who think that stagflation, resulting from overextended monetary inflationism should push the stock market higher.
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