But in inflation, saying it is “transitory” is just a weasel word. The inflation of the 1970s was transitory. It was just a long transit—Michael Ashton “ALL Inflation is Transitory”
In this issue
Stagflation Rules! BSP Pulls Back QE and Liquidity! The Peso’s Purchasing Power Declined by 22% in the last 9-Years
I. The Peso’s Purchasing Power Declined by 22% in the last 9-Years
II. Stagflation Rules Despite the BSP’s Cost-Push/Supply Side Rhetoric
III. The BSP Pulls Back Some QE/Liquidity! Has the CPI Peaked?
IV. The Push for Lower Rates via the Decrease in CPI
V. Treasury Yields and Spreads Buck Reduced Monetary Liquidity
VI. Conclusion: BSP Holds the Key to the CPI
Stagflation Rules! BSP Pulls Back QE and Liquidity! The Peso’s Purchasing Power Declined by 22% in the last 9-Years
I. The Peso’s Purchasing Power Declined by 22% in the last 9-Years
From the Businessworld (June 4 2021): Consumer price increases steadied for the third straight month at 4.5% in May, matching market expectations. The figure was within the 4-4.8% estimate by the Philippine central bank for that month and matched the median estimate in a BusinessWorld poll last week. Year to date inflation was 4.4%, higher than the 2-4% target of the Bangko Sentral ng Pilipinas (BSP) and its revised inflation forecast of 3.9% for the year. May was the fifth month in a row that inflation went beyond target.
From the BSP (June 4, 2021) Food inflation eased slightly in May as rice prices declined coinciding with the summer harvest season in most parts of the country. At the same time, ample domestic supply given favorable weather conditions also brought down year-on-year inflation for fruits and vegetables in May compared to the previous month. These developments, in turn, were enough to offset still elevated meat inflation. On the other hand, non-food inflation picked up as most major commodity groups registered either higher or unchanged inflation rates in May relative to the previous month’s reading. The increase in non-food inflation also reflects the impact of higher international oil prices on domestic petroleum products as shown in the uptick for the month-on-month inflation for electricity, gas, and other fuels as well as transport in May.
Figure 1
As usual, the consensus portrays inflation as nothing more than ‘price increases’ rather than a loss of purchasing power of the currency.
Based on the BSP’s data, the peso lost a cumulative purchasing power of at least 22% from an annual inflation rate of 2.9% per year since 2012 or in 9-years. Or, at the current inflation rate, the peso will lose half of its 2012 value in 15 years. (Figure 1, upmost pane)
Unless one’s income grows ahead of the CPI rate, the loss of peso’s purchasing power translates to reduced discretionary income.
This semantic dissimulation of the definition of inflation as narrated by the great Austrian economist Ludwig von Mises:
To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call "inflation" the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase.
Ludwig von Mises, 19. Inflation Chapter II. Interventionism Economic Freedom and Interventionism, Mises.org
Because prices are a function of voluntary exchange, the convenient scapegoat for policy excesses will always be the market economy.
They put the responsibility for the rising cost of living on business, This is a classical case of the thief crying "catch the thief." The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices. While the Office of Stabilization and Price Control is busy annoying sellers as well as consumers by a flood of decrees and regulations, the only effect of which is scarcity, the Treasury goes on with inflation.
Greed. ASF. Supply-side disruptions. According to the consensus, exogenous factors are supposedly the principal causes of the elevated CPI. Incumbent policies have little to do with it. And when others point to rigorous health protocols, such as mobility or travel and business operations as hurdles to the supply network, the pandemic is ultimately culpable. This is the self-attribution bias at work.
Policies, for them, can barely go wrong.
On the other hand, the benchmark M3 grew by 206% over the same period or at an annual inflation rate of 13.21%. That is, every 4.6% increase in M3 generates a 1% increase in the CPI.
But money creation isn’t equal in distribution. The primary beneficiaries are those who borrow from formal financial institutions. Another set of main recipients are the private sector suppliers/providers/financiers of public expenditures.
The early recipients are privileged to acquire at yesterday’s prices, while those late recipients bear the brunt of the tail-end of high prices. That is, fiat money creation fosters wealth and income inequality.
Thus, losses of purchasing power are shouldered most by the less political-economically privileged, not just represented by the bottom 30% of households.
Of course, the CPI, the official statistical measure of inflation, is based on estimates, which are likely to be vastly understated. Reason? The inflation tax represents another source of seigniorage profits for political authorities.
At present, negative real rates, or the spread between the CPI and 1-year Treasury bill, is at the deepest level in at least 9-years or since 2013. This invisible tax represents a transfer from savers to borrowers. (Figure 1 middle pane)
And as the biggest borrower, the primary beneficiary of the BSP's Financial Repression policies is the National Government. The banking system and the companies owned by the elites are also major beneficiaries.
II. Stagflation Rules Despite the BSP’s Cost-Push/Supply Side Rhetoric
Authorities employ abstruse technical gobbledygook to conceal monetary expansion as a source of inflation.
Here is a great example. From the Inquirer (March 29): On Monday (March 29), BSP Governor Benjamin Diokno said the country is far from experiencing this phenomenon called “reflation”, since higher inflation seen in recent months were the result of a “transitory” mess in supply of a narrow range of agricultural products and an increase in oil prices worldwide. “Reflation is the act of bringing inflation from very low levels back up to its long-term trend after a period of disinflation and economic downturn,” he said at an online briefing. “This is not the case.”
Translation: Reflation signifies a healthy form of BSP-induced inflation from the improvement of aggregate demand fueled by bank credit expansion channeled through money supply growth.
For them, printing money equals growth based on their trickle-down theory.
Hence, from the BSP latest’s Statement on the State of Financial Stability (June 4), “Bank credit and GDP growth are naturally connected. As prospects for the economy improve, entrepreneurs wish to tap into business opportunities by expanding or creating new businesses through bank credit. Good economic outcomes, in turn, allow the loans to be repaid and sustained economic activity nurtures further demand for loans.”
Or: “With no threat of an overheating economy and the markets already liquid, the current policy rate is appropriate given the path of growth and inflation” and “Upward inflationary pressures stem from cost-driven factors that may be outside the traditional purview of monetary policy”.
See? The BSP is beyond reproach because of factors "outside the traditional purview of monetary policy".
Then we get conflicting signals from different sources of statistics.
From the Philstar (June 2): Factory gate prices declined at a slower pace in April, with majority of industry groups still reporting price contractions, the Philippine Statistics Authority (PSA) said. Latest data from PSA showed that the Producer Price Index (PPI) for April declined three percent, trailing the 3.4 percent contraction level in March and much slower than the five percent decline in April 2020. (Figure 1 lowest left pane)
While admitting to a pick-up in non-food inflation in the economy, how consistent is the idea that factory input prices remain in deflation?
IHS Markit provides an antipodal narrative.
From Shreeya Patel, Economist at IHS Markit: “Softer declines in output and new orders signalled a step in the right direction, whilst a renewed increase in overseas demand also supported the sector. "There are also signs manufacturers are dealing well with supply issues as safety stocks continued to be built, helping keep backlogs at bay for now. "That said, whilst firms continue to reduce outstanding business, they are facing strong inflationary pressures. Transportation bottlenecks and limited material availability weighed somewhat on profit margins. An increase in selling charges and cuts to workforces suggests firms are seeking to control soaring expenses.” (bold added) (Figure 1 lowest right pane)
Isn’t this environment characterized as stagflation (lower output, high unemployment, and rising inflation)?
So for all denials by the mainstream, stagflation remains a significant barrier confronting the economy.
I guess that those who control and manage public information, fabricate statistics, and massage market prices haven't been doing their jobs.
III. The BSP Pulls Back Some QE/Liquidity! Has the CPI Peaked?
If cost-push from supply shock has signified the cause of the statistical inflation that represents "outside the traditional purview of monetary policy", WHY have the BSP undertaken drastic measures to REDUCE systemic liquidity?
Figure 2
Last April, the BSP reduced substantial support to the National Government (NG) and the Financial System.
For the second straight month, direct loans to the NG had been slashed by the BSP by a sizeable Php 178.2 billion month-on-month. The BSP’s QE through the banking system (secondary purchases) similarly fell Php 79.867 billion.
Year-to-date, BSP’s net claims on the NG shrank by Php 270.7 billion while Depository’s net claims on NG decreased to only Php 14.142 billion. (Figure 2 upmost pane)
These operations sopped significant amounts of liquidity from the financial system.
The growth of BSP’s currency issued plunged to a flat .43% in April from 4.06% in March. Meanwhile, the growth of BSP’s liabilities to the other depository corporations dived to 1.6% from 11.3%, as the growth of currency outside depository corporations or cash in circulation slumped to 5.4% from 15.9%. (figure 2 middle pane)
The BSP borrowed another Php 100 billion from the capital markets last week.
Such liquidity siphoning measures, if sustained, could reduce public spending materially, including infrastructure spending, adversely affecting the GDP. That is unless the public's savings, through magnified borrowings, will be used to fund such expenditures. But savings are finite.
Also, the diminished liquidity may be about to realize the BSP’s projection of a "transitory" CPI through a squeeze in the demand channel.
It would be inaccurate to ascribe the downshift in liquidity growth to the BSP’s actions alone. Cash in circulation and M3 growth peaked in August 2020 and May 2020, respectively, gradually declined from then, before April 2021’s plunge.
Surging bank credit delinquencies and sustained street price pressures, which corrodes the monetary surplus, are the main causes of this depletion.
From our standpoint, this QE pullback should be a welcome development. This reduces the diversion of funds and resources to politically-directed unproductive and unnecessary consumption activities. Genuine healing can occur should markets be allowed to operate.
However, since all actions have consequences, the economic sins of the past will eventually find a reckoning.
IV. The Push for Lower Rates via the Decrease in CPI
Figure 3
So, again, why the abrupt liquidity drain? The answer, in short, is to keep interest rates down. In the last 8-years, PDS 10-year yields moved in tandem with the CPI. (Figure 3, upmost pane)
For a heavily leveraged system, lower rates buy the economy time from a financial crisis. At Php 19.74 trillion, bank credit and public debt account for about 110% of the 2020 NGDP (Figure 3 middle pane)
The grand hope is that the economy will weather the storm and grow its way out of debt.
But this concept, anchored on free lunch, is wishful thinking. Mounting economic and financial maladjustments will continue to weigh on the balance sheets of corporations/single proprietorships, reduce profitability, diminish capital formation, curtail investments, and erode economic growth. Or, such will dampen people's standards of living.
And instead of liberalization or economic freedom, in the avoidance of a crisis, authorities will likely continue to resort to deepening interventions that beholden the economy and the financial system towards politicization and centralization.
Ballooning regulations, for instance, will continue to pose a critical obstacle to the formation of small and medium scale enterprises. It will also debilitate marginal enterprises increasing the risks of their closures. Further, the deepening regulatory maze will likely divert finances and resources to the politically connected rent-seeking entities, increasing malinvestments, reducing productivity, and promoting state-sanctioned quasi-monopolies.
Example. From the Businessworld (June 4): Businesses are seeking a three-year extension of the grace period to comply with the Water Quality Guidelines and General Effluent Standards of 2016, the Philippine Chamber of Commerce and Industry (PCCI) said. In a statement on Friday, the PCCI said that compliance with standards in the Administrative Order 2016-08 of the Department of Environment and Natural Resources (DENR) “would entail substantial capital investment, operational and maintenance expenses, which may hamper the recovery of businesses from the devastating impact of the pandemic.”
With reduced competition or fewer producers and service providers, will prices not be inclined higher? Won’t consumers bear the burden of increased operating costs of the supply-side from more regulations?
Circling back to the liquidity, with the banking system enduring deflation in their core operations as the BSP steps back from its operations, who should fill the liquidity vacuum? Credit deflation of universal and commercial banks accelerated in April to 4.51% from 3.93% in March. (Figure 3 lowest pane)
In short, banks haven’t been generating liquidity for the system. Instead, they have been feeding on the BSP’s generosity, until the last two months.
With liquidity down from both banks and the BSP, what and how will the economic and financial system finance itself?
Once again, the BSP has taken a big gamble.
The BSP has yet to provide us an update of its balance sheet, which shows its yearend standings. Slated to be published next week is the balance sheet of the banking system.
V. Treasury Yields and Spreads Buck Reduced Monetary Liquidity
But here is the thing.
Figure 4
The BSP’s QE pullback occurred in April, but treasury yields moved slightly lower in May, and treasury yield spreads barely moved even from last week relative to the 1Q. Monthly 10-year PDS spreads have been accurate forecasters of the CPI. The BVAL yield curve was slightly lower compared to March 31 (Figure 4, upmost window).
Two things come into mind.
One, the treasury markets have yet to ingest the impact of liquidity retrenchment on the economic and financial system.
Two, the treasury markets remain unimpressed with the BSP’s operations. They may be thinking that because the BSP’s actions are temporary, a reversal is due in May or June or anytime soon. Or, in lieu of the central bank, banks will come into action.
The bottleneck in the supply network is deeper than popularly expected.
The treasury yields may be factoring in credit risk than just inflation.
They may also be thinking that external forces may have a substantial influence on domestic prices.
Figure 5
Here is an example.
From the Financial Times (June 3): “Global food prices have surged by the biggest margin in a decade, as one closely watched index jumped 40 per cent in May, heightening fears that the inflation initially stoked by pandemic disruption was accelerating. The year-on-year rise in the UN Food and Agriculture Organization’s monthly index was the largest jump since 2011, as commodity prices surged. The higher inflation will hit poorer countries reliant on imports for staple goods. For richer countries, the cost of raw ingredients accounts for only part of the overall price paid for products at supermarkets and restaurants. However, the rise in raw material prices has been so steep that big companies such as Nestlé and Coca-Cola have said they would pass on any increases. Economists and analysts also warned that the return of eating out as lockdowns lifted around the world would add to price pressures.”
It is interesting to note how valid the assertion that the return of eating out would supposedly add to the price pressures on food globally. (Figure 5, upmost) Here in the Philippines, the trend of the change in restaurant CPI has been outsprinting the price increases of its inputs since April 2021. The Food CPI’s growth trend appears to have inflected or is in a hiatus.
If true, this translates to higher profit margins for the restaurant industry. But this assumption rest on the premise that "eating-out" activities are supported by significant income growth (from jobs or government transfers or credit), which is unlikely given the current conditions (recessionary economy and the GCQ).
Nonetheless, the global price surge reduces the arbitrage opportunities to acquire affordable products, whether food, semi-conductor chips, and others.
The emerging complexity of economic responses to public policies will continue to catch the mainstream off-guard.
Put this way, other factors may have been influencing the Philippine treasury markets than liquidity alone.
VI. Conclusion: BSP Holds the Key to the CPI
As previously noted, supply shocks are indeed transitory when prices and markets are allowed to function normally. But this has not been the case today.
That said, despite the supply gridlocks, the actions of the BSP will most likely determine the performance of the CPI.
Should the BSP sustain its current thrust to sop liquidity off the system, the CPI may see a slight downtrend thru the close of 2021. But a lower CPI would drag down the GDP, increasing credit delinquencies in the banking system.
However, if the BSP reverses, the CPI may likely find sufficient footing for a higher bounce. It would raise rates, sending credit alarm bells to the banking system.
Self-evidently, the BSP is trapped. Damned if you do, damned if you don’t.
The mixed performance of the Treasury markets suggests that they believe that the BSP's liquidity drawdown will be temporary. Or, perhaps treasury traders will soon act on it.
Nevertheless, despite the vehement denials, the economic environment will continue to be dominated by forces of stagflation.
Lastly, how much of the cash reserves of financial institutions been used to camouflage a buildup in liquidity shortfall through the capital markets (in particular the PSEi 30)? (Figure 5 lowest pane)
We shall soon see.
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