The curse of modernity is that we are increasingly populated by a class of people who are better at explaining than understanding, or better at explaining than doing—Nassim Taleb, Skin in the Game
In this issue
1Q 2021 GDP: A Statistic of Government Spending, Debt, Bailouts, and the BSP’s Financial Repression
I. Statistical Trends and Anomalies: Auto Sales and the GDP; Forecasting Growth from Low-Base Effects
II. 1Q 2021 GDP: Record Government Spending Funded by Record Debt; The Debt-to-GDP Myth
III. The GDP’s Growing Dependency on the BSP’s Liquidity Operations, Bailouts of Banks Equals GDP Growth!
IV. Financial Repression and the Crowding Out: The Accelerating Decline of the Household Spending Share of the GDP!
V. Stagflation Ahoy! Why Looking Forward to the Return of Pre-Pandemic Conditions is not about to Happen
1Q 2021 GDP: A Statistic of Government Spending, Debt, Bailouts, and the BSP’s Financial Repression
I. Statistical Trends and Anomalies: Auto Sales and the GDP; Forecasting Growth from Low-Base Effects
From the CNN Philippines (May 11): The Philippine economy declined anew in the first quarter of 2021 as quarantine restrictions and the lingering COVID-19 pandemic continue to hamper business and consumer activity. National Statistician Dennis Mapa reported Tuesday an economic contraction of 4.2% for the period, milder than the 8.3% plunge recorded in the last three months of 2020 and steeper than the 0.7% drop from January to March last year. The country’s recent economic performance is worse than the average -2.82% growth forecast resulting from a CNN Philippines poll among analysts, in line with expectations the economy will remain in recession albeit with a softer drop. The latest figure marks the fifth straight quarter of annual economic decline for the Philippines. According to the Philippine Statistics Authority, the longest period of negative gross domestic output for the country covered nine consecutive quarters: from the fourth quarter of 1983 to the last quarter of 1985 under the administration of former President Ferdinand Marcos.
When the division of labor endures a massive disruption from social policies, it requires no statistics to infer that the outcome would be a regression.
Even if statistical figures exhibit a less bad from the worst scenario, this barely shows the reality.
Figure 1
Let us apply this concept first to car sales.
The following headline and excerpt from the Businessworld “April car sales recover from slump a year ago” (May 12): VEHICLE SALES surged in April from the extremely low base a year ago when Luzon was placed under the strictest form of lockdown, according to industry data. A joint report from the Chamber of Automotive Manufacturers of the Philippines, Inc. (CAMPI) and Truck Manufacturers Association (TMA) showed 17,843 vehicles were sold in April, 13,315% higher than the 133 sold during the same month in 2020.
Because of the baseline effect, auto sales % recovered strongly. That is, the dislocation from the ECQ in April 2020 produced a statistical anomaly compared with this April’s performance, which the media puts a spin on.
However, in terms of unit sales, April’s sharp decline month-on-month (-13.8%) only reinforced the downtrend in auto sales. (Figure 1, upper pane)
Vehicle sales climaxed in December 2017, a month before the implementation of the TRAIN Law, as buyers rushed in to avoid higher taxes. The prospects of the car industry soured from then. That’s because taxes on vehicles are subject to the law of demand: if you tax something, you get less of it.
Why have the major Japanese car producers Honda and Nissan decided to close their assembly plants in 2020 and 2021 if prospects for the industry have been rosy?
Instead, the trend of auto sales performance has validated the actions of Honda and Nissan, which are manifestations of the unintended consequences of policies against the industry and the economy.
Auto sales performance will likely remain sluggish until authorities take measures to liberalize the economy or if the current trajectory towards centralization reverses.
Sure, authorities can throw out money to the public to boost sales. But there are hidden costs from such redistribution that would matter over time. Thus, artificial boosters are not only unsustainable but like taxes, are subject to the law of unintended consequences.
The lessons of the auto industry apply to the GDP.
Since the trough in the 2Q 2020, the rate of GDP contraction has eased in the last three quarters.
But from the standpoint of real GDP in pesos, 1Q 2021 GDP of Php 4.245 trillion signified a paltry 2.5% improvement from 2Q 2020’s Php 4.139 trillion! 1Q NGDP (current) was also up by a measly 5.1%!
And due to the low-base effect from the same period last year, the consensus predicts a "surge" in the 2Q GDP 2021. The low base, like the auto sales, emerged from the panicked response by authorities during the initial outbreak of the pandemic by imposing a rigorous lockdown.
Unless something significant happens between now to the end of June, using the peso-based 1Q 2021 GDP as a proxy, the establishment is bound for an immense disappointment from their lofty 2Q GDP 2021 expectations.
Of course, it’s not only about the changes in percentage or the peso, 1Q data exposes a critical shift in the path of the real GDP.
In the assumption that 2Q 2020 represents the trough or the bottom, then GDP’s new path will emerge from a lower base, and consequently, its rate of growth will likely decrease relative to the previous years. (Figure 1, lower window)
Again, the supposition is that 2Q 2020 represents a pivotal nadir. But what if it isn’t? What if the current trajectory of declines has yet to culminate? What if the longer-term costs from imposing the health policy of economic stasis transmogrify into a financial crisis? If so, the GDP trajectory will emerge from a much lower base than the present.
The thing is, the real economy is not about statistics. Narratives can be contrived to confirm the public’s biases using selective segments of statistics.
After all, there is little understanding that conflict of interests or the principal-agent problem, asymmetric information and the lack of skin of the game are involved in the relationships within the political and financial community, as well as, the public and the establishment institutions.
Reeling from deficits, not only are financial institutions seeking to tap the public’s savings, they compete with each other for it.
If providing an objective assessment of the socio-economic environment would risk this privilege and be baneful to their interests, why would they do this?
II. 1Q 2021 GDP: Record Government Spending Funded by Record Debt; The Debt-to-GDP Myth
Because of its unsustainable framework, why would the GDP not fall further?
Figure 2
Why "unsustainable"? Because 1Q GDP was almost entirely about the National Government
The magnificent massive spending by the National Government and the spectacular bailouts by the BSP saved the 1Q 2021 GDP from a meltdown. (Figure 2, upmost pane)
Real GDP of government expenditure jumped 16.1% (current 19.8%) to expand its share of the headline GDP to 15.3%, which marked the second-highest in history after the 2Q 2020’s share of 20.5%. (Figure 2, middle pane)
That is, the 1Q GDP would have posted declines of OVER 5% had the National Government (NG) adopted a tightwad policy on public spending!
Also, don't blame the pandemic. Public spending has signified a rising trend. The pandemic only accelerated it.
But there is no free lunch.
The NG raised a whopping record Php 1.187 trillion debt to finance this historic deficit spending program. Outstanding public debt jumped Php 978 billion (+4.32%) to a record Php 10.774 trillion in the 1Q, led by domestic debt (+5.72%).
This colossal debt absorption pushed the debt-to-GDP to over 60% (60.4% Bureau of Treasury, 61.98% annualized 1Q GDP)
Of course, debt-to-GDP barely represents meaningful statistics.
For one, this represents an arithmetical relationship between facts and estimated growth figures from surveys, where the latter’s construction may be subject to political agenda.
Second, public spending constitutes political activities designed to redistribute and consume.
And since the steady increases in public spending assume substantial gains in its share of the GDP, it required proportional increases in tax intake, wherein the private sector carries this brunt. Given such premises, the GDP is not only overstated by public spending but also provides a murky picture of the underlying economic and financial health of the taxpayers.
Third, it assumes that nominal public debt levels have an independent relationship with the banking system. Yet, both have entwined relationships in the dimensions of financing, collateral, and the latter’s capital structure.
Before, the banking system, through credit expansion, was not only the principal contributor to the money supply growth but was also the primary source of funding for public spending through taxes from its credit activities.
Today, the primary source of financing for public spending comes from the BSP (through operations with the banking system) and direct borrowing. In short, to fill the void from bank credit expansion to finance to public spending, the BSP and the capital markets took over. That said, public debt and bank credit expansion have a co-dependent relationship. Debts don’t melt away. (Figure 2, lowest pane)
Fourth, there are distributional effects involved, which are likewise assumed away.
Lastly, the structure of debt composition is not static, but dynamic, viz., subject to the political exigencies of the moment.
To this end, with the 1Q GDP almost entirely a government affair, to cushion the decline of the statistical economy required the rocketing of the debt burden, which carrying costs should weigh substantially on the real economy over time.
III. The GDP’s Growing Dependency on the BSP’s Liquidity Operations, Bailouts of Banks Equals GDP Growth!
And there’s more.
Figure 3
As noted above, public spending carried the day for the GDP in the 1Q, which diminished the decline/recession. But financing this involved not only the capital markets but also the BSP.
Yes, the BSP’s unparalleled interventions through unmatched liquidity injections and unprecedented relief operations likewise cushioned the GDP’s fall. Because of this, money supply growth spiraled to historic levels as of the 1Q.
From the BSP (May 10): Domestic claims rose by 5.6 percent year-on-year in March from 5.7 percent (revised) in the previous month due mainly to the modest expansion in net claims on the central government, even as bank lending to the private sector remained weak. Net claims on the central government grew by 47.4 percent in March from 46.5 percent (revised) in February, owing partly to the sustained borrowings by the National Government.
At the end of 1Q, M1 to GDP (cash and demand deposits) reached a record 30.5%. M3 to GDP rose to 78.9%, second to the all-time of 79.1% in 2Q 2020! (Figure 3, upmost pane)
No, the outgrowth of monetary liquidity was not only because of the response to the pandemic. The acceleration of money supply to the GDP commenced from 2013 or in response to the US Fed’s Taper Tantrum and surged through 2019. However, the BSP spiked this acceleration in 2020.
That is to say, aside from debt-financed deficit spending, the GDP is becoming entirely dependent on the BSP’s liquidity operations!
With bank credit falling into the deflationary zone (-3.93%), the BSP was primarily responsible for money supply or liquidity growth (+7.79%). (Figure 3, middle pane)
Meanwhile, the banking and financial system, the other principal beneficiary from the bailout operations of the BSP aside from the National Government, registered 5.2% real growth and 9.2% nominal GDP growth. This outgrowth spiked their share of their GDP pie to 11% real and 11.5% nominal, respectively, the second-highest on record. (Figure 3, lowest pane)
And instrumental in providing the cushion to the output and liquidity to the sector was the stunning interest expense collapse of 41.13% in 1Q, mainly due to the BSP’s historic 2% ON RRP rates!
Bailout equals GDP growth. Incredible. The magic of statistics.
IV. Financial Repression and the Crowding Out: The Accelerating Decline of the Household Spending Share of the GDP!
Figure 4
Here’s the thing.
As part of the financial repression policy package, the BSP’s subsidies to the banks came at the expense of the public’s savings.
Differently put, the implicit transfer from household and corporate savings to the banks through the interest channel meant that savers were penalized heavily for the mischiefs of balance sheet mismatching employed by the banking industry.
And as part of the cost of the financial repression package, households not only lost income, jobs, and wages but suffered steeply from diminished a share of the GDP.
Guess what sector took over?
Answer: 1Q GDP bolstered the crowding-out phenomenon where the growth of public spending came at the expense of the households that strengthened the trend or the transformation to a neo-socialist state or a centrally planned political economy.
And the falling trend of household-to-public spending has accelerated since 2017.
Sorry folks, this is a trend, an entrenched process that can only be reversed when the money runs dry. (see the war on mining)
Figure 5
Finally, to rub salt into the wound, bank consumer credit (auto, credit card, salary loans, and others, excluding real estate) plummeted by an incredible 9.94% to a multi-year low in the 1Q 2021! Credit card loans plunged by a record 10.4% in March! (Figure 5, upmost and middle window)
Aside from economic woes and soaring credit delinquencies, the BSP’s interest rate caps on credit cards must have contributed to the rapidly tightening credit conditions on consumers, as we previously explained. Such price controls had been extended this April.
Tightening credit conditions of consumers exacerbate, again, the shortfalls in jobs, income, and wages from supply (production and services) disruptions that have impelled sustained contractions in real household spending (-4.8%) in the 1Q 2021.
Bank credit, which used to drive the GDP, has given way to BSP QE and debt-financed deficit spending and bailouts.
And households, expected by the consensus to lead the recovery, will only endure the intertemporal ramifications of the intensified politicization of the economy.
V. Stagflation Ahoy! Why Looking Forward to the Return of Pre-Pandemic Conditions is not about to Happen
Because of the drastic transformation from the political response to the pandemic in combination with the previous setting, the reversion to a pre-pandemic economic state is an exercise of wishful thinking.
Well, at the rate of the buildup of the current public debt, it is easy to foresee that taxes would rise after the elections. Think of its deadweight loss on the economy, see the auto industry above.
Even the BSP knows this.
From the BSP’s April 2020 Financial Stability Report:
The key element now is that NGs are taking on the burden for funding the needed relief program. There is no other entity in place that can absorb the ultimate risks and the corresponding financing. This will certainly mean higher debts, much less fiscal space. Intertemporally, this debt can be bridge-financed with more debt just to sustain liquidity. Ultimately though, taxes will have to adjust intergenerationally to make up for the gap. This is a policy issue that, for the moment, is pushed down the road but is unlikely to be avoided.
Moreover, this grand experiment of record public spending and unmatched financial repression will also have intertemporal consequences that would manifest in many aspects of the economy, such as in street prices and prices of financial assets.
Cumulative interventions will not only involve intertemporal distortions on finances but also include systemic discoordination, resource and capital misallocations, and mispricing.
The consensus denies the risk of stagflation: stagnant growth, high unemployment, and rising inflation. But are these not the conditions prevailing today? (Figure 5, lowest window)
Further, the normalization of the banking system appears to be a distant prospect. It requires the agonizing process of cleansing their balance sheets to restore the pristine conditions. Unfortunately, this is something that the industry can be expected to resist doggedly.
And because of the interdependent relationship of banks, the process of convalescence must involve the political economy.
A decentralized system, from significantly reduced political interventions and the embrace of a broader market economy, should facilitate this renaissance.
Sadly, because of the popular appeal of the dogma of a centrally planned economy, little or none of these is about to happen soon.
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