The difficulty of having people understand monetary theory is very simple—the central banks are good at press relations. The central banks hire people and the central banks employ a large fraction of all economists so there is a bias to tell the case—the story—in a way that is favorable to the central banks. — Milton Friedman
In this issue:
The BSP in a Panic: Drastically Hikes Policy Rates and Slashes Deficit Financing To Curb Demand as M3 Growth Plunges!
-Rising Interest Rates Represent a Global Phenomenon
-The Inflation Club in Motion, The BSP Gambles by Curbing Demand
-What Happened to BSP’s Inflation Targeting Policy? The National Government’s Low Margin of Safety
-BSP in Panic: Drastically Hikes Policy Rates in the Face of Plunging M3 Growth!
-BSP in Panic: Slashes Deficit Monetization in August! Build, Build, Build Prices Fall!
-National Government Used External Debt to Finance Record Deficit, Peso Will Rally Temporarily on the BSP’s Dramatic Tightening
The BSP in a Panic: Drastically Hikes Policy Rates and Slashes Deficit Financing To Curb Demand as M3 Growth Plunges!
Remember this?
From the BusinessWorld (September 14, 2018): “We are not in a major crisis. It may be a serious problem for some people, but for the nation in general it’s not a major crisis,” Finance Secretary Carlos G. Dominguez III told reporters yesterday at the Senate…“It was decided that there will be no off-cycle (meeting). You really think we are panicking? You are panicking, not us. That’s why you have to have perspective,” he said.” (bold added)
Recent actions, not comments or denials, should reveal on who DID panic.
Rising Interest Rates Represent a Global Phenomenon
First, the big picture.
The Reuters reported: “China, Taiwan and New Zealand sat tight after the Federal Reserve’s latest rate hike, but Indonesia and the Philippines pulled the trigger on Thursday to prop up their battered currencies and temper risks to inflation and financial stability.”
Led by the US Federal Reserve, the Philippines and Indonesia were among the 12 nations which central banks have increased interest rates this week
Rising interest rates represents a global phenomenon. Or, global liquidity is in the process of receding substantially.
Figure 1
So access to external funding will become increasingly scarce which will be reflected by rising rates.
Yields of 10-year bonds of the Philippine sovereign and its equivalent in UST Treasuries have moved in a lockstep fashion since 2016. (figure 1, upper window)
However, coupon differentials have risen faster in the Philippines (figure 1 lower window)
The reduced access to external funding which is reflected by its increased costs should lead to diminished cross-border arbitrages (carry trades) and investment flows.
And reduced cross-border transactions will be magnified by the escalation of protectionist policies.
Importantly, real servicing costs of domestic exposure on external liabilities should also balloon.
Now if access to external funding has become more prohibitive, how about domestic financing?
As noted above, this week’s 50 basis points rate hike added to the cumulative 100 bps increases during the BSP’s last three meetings (May, June and August). Or policy rates soared by 150 bps in the last 5+ months!
Compared to Indonesia’s central bank, Bank Indonesia, which increased rates by the same proportion in 5 months, the 4-four month action by the BSP reflects the degree of apprehension by monetary authorities.
Despite the Indonesian rupiah falling to 1997-98 levels, the BSP jacked up rates faster than its neighbor!
So who panicked?
The Inflation Club in Motion, The BSP Gambles by Curbing Demand
Last week’s BSP’s policy action had been characterized by mainstream media (Inquirer September 28) as follows: (emphasis mine)
Saying the country’s near decade-high inflation rate may get worse in the coming months, the central bank yesterday raised its key interest rate by 50 basis points, marking the most aggressive monetary policy tightening streak since the crisis-ridden Joseph Estrada presidency.
Bangko Sentral ng Pilipinas Deputy Governor Chuchi Fonacier said the rate hike—the second half percentage point increase in two months, and the fourth consecutive over four Monetary Board meetings since May—was necessary to “further anchor inflation expectations and to safeguard the inflation target over the policy horizon.”
“The Monetary Board recognized that a further tightening of monetary policy was warranted by persistent signs of sustained and broadening price pressures,” she said, briefing the media in lieu of BSP Governor Nestor Espenilla Jr. who is on medical leave.
The last time the BSP raised interest rates this aggressively was in May 2000 when the peso was dropping sharply during the administration of President Estrada. That month, the central bank raised interest rates by 50 basis points twice in a single week to defend the currency from speculative attacks.
Explaining the Monetary Board’s latest decision, Fonacier said that the latest baseline forecasts for inflation “have shifted higher for both 2018 and 2019, with risks to the outlook still leaning toward the upside. With supply-side forces expected to continue to drive inflation in the coining months, inflation expectations have remained elevated amidindications of second-round effects.”…
Fonacier explained that a tighter monetary policy stance would help steer inflation toward a target-consistent path over the medium term by reducing further risks to the inflation outlook, including those emanating from exchange rate volatility given the continued uncertainty in the external environment amid geopolitical tensions and the normalization of monetary policy in advanced economies.
In order not misquote, the first five paragraphs and the eighth paragraph has been excerpted in full.
Heck, just where in the six paragraphs does it show how rising rates will “further anchor inflation expectations”, curb “supply-side forces” and “help steer inflation toward a target-consistent path”???
How are interest rates transmitted to the economy to affect statistical inflation???
That inflation is all about policy levers, constructed out of abstruse econometrics, has represented the essence of BSP's programming of the public's beliefs.
The gullible laypeople have been told to accept, without question, the technical wizardry of authorities.
See what I mean by this?
The first rule of the Inflation Club is: You do not talk about the BSP’s contribution. The second rule of the Inflation Club is: Remember the First rule.
The Two Rules of the Inflation Club, BSP’s QE Hits Fresh Record in July, Government’s FSCC “Shocked” by “Dislocations of Crisis Proportions” September 2, 2018
To better understand the communique’s opaqueness, the BSP-led FSCC FSR’s report lays out the source of the country’s risk.
The low interest rate environment greatly encouraged the search for yield as greater risks were taken in exchange for higher returns. However, the change in market prices (i.e., rising interest rates and depreciating peso against the US dollar) could trigger negative outcomes which, if not properly addressed, would amplify into systemic consequences (p.24)
Cutting through the fog of technical jargon, since interest rates represent the price of time expressed in money in the loanable fund markets, higher rates should mean reduced demand for credit. And such would likewise entail a reduction in the demand for goods and services dependent on credit finance. Consequently, diminished demand should lower prices.
Yes folks, in desperation, the BSP have decided to implement policies that would WITHDRAW demand!
As I wrote back in May…
3) If the government stops from its current undertaking, it will severely slow the GDP, prompt for a fall in tax revenues which should spike deficit as well. Credit risk will surface and subsequently impact the banking system. Markets will demand more collateral or increases in credit risk premium (higher yields!).
See Why Interest Rates Will Rise: 1Q Fiscal Deficit Blowout Financed by BSP’s Debt Monetization (QE) and Spiking Public Debt!May 6, 2018
What Happened to BSP’s Inflation Targeting Policy? The National Government’s Low Margin of Safety
But who shaped the “low-interest rate environment greatly encouraged the search for yield”?
Or, who has been responsible for the massive buildup of excess demand or consumption which had incited by the “low-interest rate environment” that has destabilized the supply chain to force up street prices?
In contrast to popular thinking, demand doesn’t exist in a vacuum.
Hasn’t the surge in street prices been a symptom of immense malinvestments?
In particular, have there not been massive overinvestments in the bubble segments (real estate, shopping mallsand hotels) of the economy, which concomitantly emerged with substantial underinvestments in the consumer goods industry, specifically, the agriculture industry?
Or has the bubble economy not crowded out the agricultural economy?
Haven’t resources and labor from the agriculture industry been drawn away to build, build and build and other political boondoggles which led to reduced output of the former?
Or has the centrally planned economy not crowded out the agricultural economy?
So haven’t price dislocations been a symptom of supply chain disruptions brought about by expanded demand from the low-interest rate regime fostered by the BSP?
The principal channel from which the BSP executes its inflation targeting policy is interest rates.
The BSP joined the crowd of global central bankers to artificially lower rates to ward off the untoward effects of the Great Recession. But instead of using these for emergency purposes, the BSP became addicted to its balming (boom) phase and doubled down on it.
And not only has the BSP engaged in tampering with the interest rate but likewise have deployed another emergency tool: money printing.
The consensus worshipped as a sound model, the artificial incipient beneficial effects of monetary emergency tools.
The BSP had been mesmerized by the benefits, but ignored the cost. Now the chickens have come home to roost.
The gravity of misperception has spilled over to the political sphere.
The leadership, who saw a centrally planned political economy as an ideal governance template, was ushered in. In wanting to take advantage of the free money sponsored boom to execute his dream society, the regime transformed another emergency tool into a developmental model.
Deficit spending mainly on infrastructure, used in 2009 as a shield against the Great Recession (Economic Resilience Plan in 2009), essentially became a primary vehicle to divert resources in pursuit of the shift to a neo-socialist state.
Now the unforeseen consequence from the toxic combination of stretching and converting emergency tools policy into economic growth engines has emerged.
The $64 trillion question: with monetary and fiscal emergency tools still in place, what will be left for the government and the BSP to use once “dislocations of crisis proportions have come as a surprise” becomes “evidence of a looming crisis”????
Since the government and the BSP have stretched themselves thin, they are in effect operating with a very low margin of safety making the economy susceptible to a 'black swan'.
BSP in Panic: Drastically Hikes Policy Rates in the Face of Plunging M3 Growth!
Reactive rather than preemptive signifies the BSP’s “aggressive” and drastic interest response.
And it seems a reaction out of fear.
Figure 2
The BSP has been compelled to react to the massive selloff in domestic Treasury securities as seen in the spikes in yields.
Yields of domestic Treasuries have been rocketing across the curve! (figure 2, upper window)
With the surge in the cost of credit, demand for it should slow.
Consumer loans have already been tumbling fast! August consumer loan growth clocked in at 15.8%, significantly lower from July’s 16.85% and June’s 17.75%. Salary loans contracted for the second month. Production loans growth retreated to 19.11% in August slightly down from 19.74% in July and 19.18% in June. Total bank loans growth in August dropped to 18.83% from July’s 19.49% and June’s 19.06% (figure 2, lower window)
And combined with narrowing interest margins, cash-starved banks will see more liquidity drought from a considerable decrease in loan volumes.
And surging rates would be detrimental to the highly fragile banking system.
Figure 3
Through the issuance of various loans, cash-starved banks, in heightened competition with the National Government, have been draining liquidity away from the financial system.
And it is striking to see money supply dropped to 2015 levels!
The BSP reported M3 growth at 10.4% in August down from 10.98% in July. The downdraft in the growth rate of the banking system’s peso deposits and cash and due banks has resonated with M3.
And yes, the BSP just raised rates against such a backdrop!
And the buck doesn’t stop at interest rates.
BSP in Panic: Slashes Deficit Monetization in August! Build, Build, Build Prices Fall!
Having been so spooked morbidly by inflation, the BSP resorted to an eye-popping cutback of direct financing to the National Government!
From the BSP, “Net claims on the central government also rose at a slower pace of 8.7 percent in August from 12.3 percent in July on account of higher deposits of the National Government with the BSP”.
On a month to month basis, the BSP slashed its holdings of National Government arrears by Php 74.05, the largest since April 2017! (figure 3, middle window)
So the two critical sources of financing demand, bank credit and debt monetization will be drastically chopped so as to meet the government’s agenda on the CPI!
And curiously, despite the slump in domestic liquidity, the BSP sees September CPI in the range of 6.3% to 7.1% which may settle at 6.8%. On the other hand, the Department of Finance expects September CPI at 6.4%
Since the BSP’s net claims on the national government and or money supply growth lead the CPI with a time lag, current declines should extrapolate to a pullback in street and statistical inflation soon.
The government’s other numbers have already been showing this!
Figure 4
The grand “build, build and build” projects are, what I discern, as the epicenter of street inflation. Money from this politicized sector spreads or ripples across the economy to affect general price levels.
And that pullback by the BSP on the direct financing of the NG has also appeared in construction material wholesale prices in August (+7.86%) to possibly reinforce its rollover since its zenith in June (+8.79%). (Figure 4, upper window)
Construction retail prices have dropped by even more. Following a peak in May (+2.61%), August prices registered a 2.05% sharply down from 2.54% in July. That’s a 19% plunge! (Figure 4, upper window)
Demand from the government, which sizably spiked wholesale construction material prices, have percolated or spilled over to retail or private sector construction prices. The wide gap between wholesale and retail prices underscores the "crowding out effect" of government projects. Hence, with “build, build and build” slowing down, the downturn in retail prices have only been magnified.
General wholesale prices have also shown a possible inflection point. In July, wholesale price inflation was marginally down at 8.97% from 9.8% in June. With M3 even lower in August, growth in wholesale prices may have also turned down more. (Figure 4, lower window)
The effects of the BSP’s drastic hikes in interest rates (in August and September for a total of 100 bps) and NG financing (in August) have yet to appear!
That’s how desperate the BSP is! They have lost control!
And it wouldn’t be a surprise if the outcome would be a 2015 template or worse (most likely outcome).
In 2015, in response to the elevation of the CPI brought about by 10 consecutive months of 30% money supply growth, the BSP raised policy rates twice then.
Real and nominal GDP fell, earnings declined, shopping mall vacancies appeared and disinflation became a chief concern of the ex-BSP governor. The banking system was at the risk of 'disinflation' which the BSP responded with the nuclear option!
Will the BSP’s dramatic tightening strangulate the economy that would result in a shock?
National Government Used External Debt to Finance Record Deficit, Peso Will Rally Temporarily on the BSP’s Dramatic Tightening
And there’s more.
Because the BSP withdrew from financing the government’s record fiscal deficit in August (Php 74.05 billion month on month), and because the Bureau of Treasury also saw a decline in domestic debt (Php 27.6 billion month on month), the National Government utilized external sources to finance the month’s narrow deficit.
Figure 5
FX liabilities grew Php 87.9 billion (month on month) and 11.01% or Php 251 billion (year on year.) The NG was reported to have raised about Php 74.4 billion worth in yen-denominated Samurai bonds. (Figure 5, upper window)
The substitution from domestic to external financing was designed to limit the siphoning liquidity in a rapidly tightening environment.
See? More signs of having lost control of the situation!
And such represents more signs of the entrenchment of US dollar shorts.
Meanwhile, total Public Debt reached a record Php 7.104 trillion last August, 10.45% up from a year ago!
And with higher debt levels and rising rates, the NG’s eight-month debt servicing, which reached Php 582 billion in August (30.48% of revenues), has now surpassed the annual debt service levels of the last 5 years. (Figure 5, lower window)
At the current pace, debt service may hit a fresh record at the year’s close (estimated Php 873 billion).
I have shown here how domestic financial conditions have tightened and will get tighter, as the banking system and national government are in a frantic race to secure resources. That would be aside from the coming stagflation (elevated inflation and economic stagnation).
And with interest rates also rising abroad, access to free money is drying up.
Surging rates have only been amplifying the FSCC’s 3Rs repricing, refinancing and repayment risks (3Rs) which could bring about the Minsky Moment soon.
With bank led M3 down significantly and with the BSP retreating from deficit monetization, I expect the peso to mount a modest rally.
But it is a rally which wouldn’t last, because of capital flight and because of the BSP’s path dependency for credit expansion or money printing which will be resorted to again.
And for the same demand withdrawal factors, CPI should also fall significantly.
For a system heavily dependent on credit for demand, not only will its retrenchment choke the economy; it may also incite considerable social tensions.
